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OTRK Ontrak

Filed: 9 Mar 21, 4:17pm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___to _____
Commission File Number 001-31932
__________________________
Ontrak, Inc.
(Exact name of registrant as specified in its charter)
__________________________

Delaware88-0464853
(State or other jurisdiction of incorporation)(I.R.S. Employer Identification Number)

2120 Colorado Ave., Suite 230
Santa Monica, CA 90404
(Address of principal executive offices, including zip code)

(310) 444-4300
(Registrant’s telephone number, including area code)

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

Title of Each ClassTrading SymbolName of Each Exchange on Which Registered
Common Stock, par value $0.0001 per shareOTRKThe NASDAQ Global Market
9.50% Series A Cumulative Perpetual Preferred Stock, $0.0001 par valueOTRKPThe NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act:
Not Applicable
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes
No
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes
No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes
No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company ☑
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.

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 June 30, 2020, the last business day of the registrant’s second fiscal quarter, the aggregate market value of the common stock held by non-affiliates of the registrant (without admitting that any person whose shares are not included in such calculation is an affiliate) was $194,131,885 based on the $24.74 closing sales price of the common stock on The NASDAQ Capital Market on that date.

As of March 3, 2021, there were 17,690,285 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the 2021 definitive Proxy Statement are incorporated by reference into Part III of this Form 10-K.

_______________________________________________________________________________________________________




TABLE OF CONTENTS


In this Annual Report on Form 10-K, all references to “Ontrak,” “Ontrak, Inc.,” “we,” “us,” “our” or the “Company” mean Ontrak, Inc., its wholly-owned subsidiaries and variable interest entities, except where it is made clear that the term means only the parent company. The Company’s common stock, par value $0.0001 per share, is referred to as “common stock" and the Company’s 9.50% Series A Cumulative Perpetual Preferred Stock, par value $0.0001 per share, is referred to as “Series A Preferred Stock.”



PART I
Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed due to factors such as, among others, limited operating history, difficulty in developing, exploiting and protecting proprietary technologies, intense competition and substantial regulation in the healthcare industry. Additional information concerning factors that could cause or contribute to such differences can be found in the following discussion, as well as in Item 1A - “Risk Factors” and Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We encourage you to read those descriptions carefully. We caution you not to place undue reliance on the forward-looking statements contained in this report. These statements, like all statements in this report, speak only as of the date of this report (unless an earlier date is indicated) and we undertake no obligation to update or revise the statements except as required by law. Such forward-looking statements are not guarantees of future performance and actual results will likely differ, perhaps materially, from those suggested by such forward-looking statements.

ITEM 1.    BUSINESS
Overview
Ontrak, Inc. (“Ontrak,” “Company,” “we,” “us” or “our”) was incorporated in the State of Delaware on September 29, 2003. Ontrak was founded with a passion for engaging with and helping improve the health and save lives of anyone impacted by behavioral health conditions. We are a leading Artificial Intelligence (“AI”)-powered and telehealth-enabled, virtualized healthcare company, whose mission is to help improve the health and save the lives of as many people as possible. Our technology enabled platform, PRE™ (Predict-Recommend-Engage), organizes and automates healthcare data integration and analytics through the application of machine intelligence to deliver analytic insights. Our PRE platform predicts people whose chronic disease will improve with behavior change, recommends effective care pathways that people are willing to follow, and engages people who are not receiving the care they need. By combining predictive analytics with human engagement, we deliver improved member health and validated outcomes and savings to healthcare payors.

Our technology-enabled Ontrak™ solutions, a critical component of the PRE platform, are designed to provide integrated healthcare solutions to members with behavioral conditions. We 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. We integrate evidence-based psychosocial and medical interventions delivered either in-person or via telehealth, along with care coaching and in-market Community Care Coordinators who address the social and environmental determinants of health, including loneliness. As behavioral health conditions cause or exacerbate chronic medical conditions such as diabetes, hypertension, coronary artery disease, chronic obstructive pulmonary disease, and congestive heart failure, our programs seek to improve member health and deliver validated cost savings of more than 50% for enrolled members to healthcare payors.
We operate as one segment in the United States and we have contracted with leading national and regional health plans to make the Ontrak program available to eligible members in 30 states and our nation's capital.
Recent Developments
Corporate Name and Ticker Symbol Change
On July 6, 2020, we changed our corporate name from Catasys, Inc. to Ontrak, Inc. and changed our NASDAQ ticker symbol from CATS to OTRK effective July 7, 2020. We believe the change in our name leverages our national brand recognition of the Company's Ontrak solutions among our health plan members, health plan customers and network of behavioral health providers.
Acquisition
On October 28, 2020, we completed the acquisition of LifeDojo Inc. (“LifeDojo”), a comprehensive, science-backed behavior change platform based in San Francisco, California. LifeDojo provides online behavior change and wellness programs, using a combination of coaching and mobile apps to help members form health habits and change health behaviors. This acquisition expands the total addressable market by enabling the creation of lower cost digital interventions across behavioral
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health and chronic disease populations. LifeDojo's member-facing apps also enhances our market leading behavioral engagement capabilities.
Customer Notification

On February 26, 2021, we were notified by our largest customer that the participation status with this customer will be terminated effective June 26, 2021. We have been advised to stop enrollment of new members for this customer and await guidance from the customer on transition plans for the 8,100 members who are currently benefiting from the Ontrak program. For the year ended December 31, 2020, this customer accounted for approximately 58% of our total revenue.
Our Market
The true impact of behavioral health is often under-identified by organizations that provide healthcare benefits. Individuals with unaddressed behavioral health conditions that worsen chronic medical comorbidities cost health plans and employers a disproportionate amount of the total healthcare costs.
A smaller, high-cost subset of these patients with behavioral health conditions drives the majority of the claims costs for the overall substance dependent population. According to Milliman's research report titled "How do individuals with behavioral health conditions contribute to physical and total healthcare spending?" dated August 13, 2020, the behavioral subgroup patients constituted 5.7% of the total commercial population of insured lives but accounted for 44% of total commercial healthcare costs. Furthermore, it was noted in McKinsey and Co.'s article titled "A holistic approach for the U.S. behavioral health crisis during the COVID-19 pandemic," dated August 6, 2020, that in the post-COVID-19 period, traumatic stress, unemployment, and social isolation will lead to exacerbation of existing behavioral health conditions and onset of new conditions that could drive $100 billion to $140 billion of additional spending on behavioral and physical health services in 2020 and 2021.
The National Institute of Mental Health reports that nearly one in five adults in the United States of America are impacted by one of the following behavioral health issues:
Substance abuse. Scientific research indicates that not only can drugs interfere with normal brain functioning, but they can also have long-lasting effects that persist even after the drug is no longer being used. Data indicates that at some point, changes may occur in the brain that can turn drug and alcohol abuse into substance dependence—a chronic, relapsing, and sometimes fatal disease. Those dependent on drugs may suffer from compulsive drug craving and usage and be unable to stop drug use or remain drug abstinent without effective treatment. Professional medical treatment may be necessary to end this physiologically-based compulsive behavior.
Anxiety Disorders. According to the National Institute of Mental Health, anxiety disorders are the most common mental illness in the U.S., affecting an estimated 19.1% of adults aged 18 years or older.
Depression. In 2017, an estimated 17.3 million U.S. adults aged 18 or older, or approximately 7.1% of all U.S. adults, had at least one major depressive episode in the past year, according to the National Institute of Mental Health. Patients with substance dependence and mood disorders were ranked four out of the top 10 reasons leading to readmission rates for Medicaid patients.
When considering behavioral health-related costs, many organizations have historically only looked at direct treatment costs–usually behavioral claims. For the members we seek to engage our solution, costs associated with behavioral health treatment represent a small portion of their overall healthcare claims, while the medical costs are significant, as most patients with behavioral health conditions do not receive the appropriate treatment they need for other existing medical conditions.
Our Solution
Our Ontrak technology enabled solution includes identification, engagement and treatment of health plan members with unaddressed behavioral health conditions. We specifically focus on members with anxiety, depression and/or substance use disorder(s) by applying claims-based analytics and predictive modeling to first identify health plan members with medical costs that may be impacted through behavioral health treatment with the Ontrak program. These members may or may not be diagnosed with a behavioral condition. We then conduct multichannel outreach to engage and enroll these members. Enrolled members receive care coaching and the opportunity to participate in telehealth or face-to-face evidence-based psychosocial and pharmacological treatment from our proprietary network of third-party providers. We believe the benefits of Ontrak include improved clinical outcomes and decreased costs for the payor, as well as improved quality of life for the member. We provide outcomes reporting to payors on a periodic basis to demonstrate the value of the program.
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Our business strategy is to deliver proven, repeatable clinical and financial outcomes to health plans for their members with unaddressed behavioral conditions that worsen medical comorbidities. We do this by identifying, engaging and treating these members through our Ontrak solution. Our Ontrak solution to date has focused on substance use disorder, anxiety and depression.
Our Ontrak solution combines care coaching, innovative psychosocial and medical treatment delivered through a proprietary provider network and in-market support from Community Care Coordinators. The solution is designed to help payors treat and manage populations struggling with substance use disorder, depression and anxiety to improve their health and thereby decrease their overall health care costs.
We are currently marketing our Ontrak solution to payors on a case rate, monthly fee, or fee for service basis, which involves educating them on the disproportionately high cost of their population with unaddressed behavioral health conditions that exacerbate medical comorbidities, and demonstrating the potential for Ontrak to reduce these costs.
Regulatory Matters
The healthcare industry is highly regulated and continues to undergo significant changes. Healthcare companies are subject to extensive and complex federal, state and local laws, regulations and judicial decisions. For more information about regulatory matters, see discussion under "Risks related to our healthcare industry" in Item 1A - Risk Factors of this Form 10-K.
Human Capital Resources
We believe our employees are among our most important resources and are critical to the continued success of our business. We are focused on attracting and retaining talented and experienced individuals across all areas of our business and committed to hiring, developing and supporting a diverse and inclusive workplace. All of our employees are required to adhere to a professional code of conduct and comply with annual training on, but not limited to, raising awareness, preventing and reporting any type of unlawful discrimination. We are not a party to any labor agreements and none of our employees are represented by a labor union.
As of December 31, 2020, we had a total of 726 employees, which included 723 full-time, one part-time and two temporary employees, and represents an 84% year-over-year increase in our total employee headcount. A majority of our employee base is comprised of care coaches, member engagement specialists and other staff directly involved in member care, as well as research and development, engineering and administrative team members. We expect our headcount growth to continue for the foreseeable future as we continue to make investments to support the growth of our business.
In addition, as of December 31, 2020, we had a total of approximately 40 independent contractors who provide us various consulting services, including recruiting, health network providers, marketing and other professional services, that are important to the operation of our business.
Available Information
We were incorporated in the State of Delaware on September 29, 2003. Our principal executive offices are located at 2120 Colorado Avenue, Suite 230, Santa Monica, California 90404, and our telephone number is (310) 444-4300.
Our corporate website address is www.ontrak-inc.com, the contents of which are not incorporated herein. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission ("SEC"). The SEC maintains an internet site that contains our public filings with the SEC and other information regarding our company, at www.sec.gov. The contents of these websites are not incorporated into this Annual Report. Further, our references to the URLs for these websites are intended to be inactive textual reference only.

ITEM 1A.    RISK FACTORS
In evaluating us and our securities, we urge you to carefully consider the risks and other information in this Annual Report on Form 10-K. Any of the risks discussed in this Annual Report on Form 10-K, as well as additional risks and uncertainties not currently known to us or that we currently deem immaterial, could materially and adversely affect our results of operations or financial condition. If any of these risks occur, our business, results of operations and financial condition could be harmed, the
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price of our common stock could decline, and future events and circumstances could differ significantly from those anticipated in the forward-looking statements contained in this Annual Report on Form 10-K.

Summary of Risk Factors

Below is a summary of the principal factors that make an investment in our securities speculative or risky. This summary does not address all of the risks that we face. Additional discussion of the risks summarized in this risk factor summary, and other risks that we face, can be found below under the heading “Risk Factors” and should be carefully considered, together with other information in this Form 10-K and our other filings with the SEC, before making an investment decision regarding our securities.

We have a limited operating history, have incurred significant losses since our inception and may be unable to obtain additional funds before we achieve positive cash flows.
We may fail to manage our growing business and may not be successful in identifying or completing any acquisitions necessary to continue such growth. Any such acquisition completed may not be successfully integrated with our operations or yield additional value for stockholders.
Our programs and solutions may not be as effective as we believe and may not achieve broad market acceptance and announcements of disappointing results may lead to declines in the market prices of our securities.
Our business currently depends upon four large customers; the loss of any one of such customers would have a material adverse effect on us.
We depend upon our senior management and key consultants and their loss or unavailability could put us at a competitive disadvantage.
We need to attract and retain highly skilled personnel; we may be unable to effectively manage growth with our limited resources.
Customers may not achieve the savings we expect are created by our programs and solutions, which could adversely impact our business.
Market acceptance of our programs and solutions depends in large part on the willingness of third party payors to cover them, which is beyond our control.
We may be unable to protect our intellectual property rights and we may be liable for infringing the intellectual property rights of others.
Ongoing healthcare legislative and regulatory reform measures may have a material adverse effect on our business and results of operations.
We must comply with significant government regulations, including with respect to licensure and privacy matters.
The agreement with our lenders regarding our outstanding senior secured indebtedness contains significant restrictions on our business and operations and requires ongoing compliance with detailed financial covenants. Any failure to comply with the terms of such indebtedness would have a material adverse effect on our business and our securities.
Our Series A Preferred Stock has no fixed maturity date, ranks junior to our currently outstanding indebtedness, is entitled to the payment of dividends only to the extent we may do so under Delaware corporate law, is subject to restrictions on transfer contained in our charter and has limited voting rights.
Our Chairman and CEO controls over 51% of the outstanding common stock and may determine all matters presented for stockholder approval, including the election of directors, significant corporate transactions and our dissolution.
The price of our common stock and preferred stock may be volatile.
The market prices for our common stock and preferred stock may be adversely impacted by future events.
Our certificate of incorporation, bylaws and Delaware law have anti-takeover provisions that could discourage, delay or prevent a change in control, which may cause our stock price to decline.

Risk Factors
Risks related to our business

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We have a limited operating history, expect to continue to incur substantial operating losses and may be unable to obtain additional financing.

We have been unprofitable since our inception in 2003 and expect to incur substantial additional operating losses and negative cash flow from operations for at least the next twelve months. At December 31, 2020, cash and restricted cash was $103.2 million and accumulated deficit was $354.0 million. We expect our current cash resources to cover expenses through at least the next 12 months from the filing date of this Form 10-K. However, delays in cash collections, revenue, or unforeseen expenditures could impact this estimate.

Historically, we have seen and continue to see net losses, net loss from operations, negative cash flow from operating activities, and historical working capital deficits as we continue through a period of rapid growth. The accompanying financial statements do not reflect any adjustments that might result if we were unable to continue as a going concern. We have alleviated substantial doubt by both entering into contracts for additional revenue-generating health plan customers and expanding our Ontrak program within existing health plan customers as well as completing equity and debt financings totaling approximately $87 million and $10 million, respectively, in 2020. To support this increased demand for services, we invested and will continue to invest in additional headcount needed to support the anticipated growth. Additional management plans include adding new customers, increasing the outreach pool as well as improving our current enrollment rate. We will continue to explore ways to increase margins on both existing and new members.

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

We may need additional funding, and we cannot guarantee that we will find adequate sources of capital in the future.

We have incurred negative cash flows from operations since inception and have expended, and expect to continue to expend, substantial funds to grow our business. We may require additional funds before we are able to generate enough cash flows to fund our operations.

If we raise additional funds by issuing equity securities, such financing will result in further dilution to our stockholders. Any equity securities issued also may provide for rights, preferences or privileges senior to those of holders of our common stock. If we raise funds by issuing debt securities, these debt securities would have rights, preferences and privileges senior to those of holders of our common stock, and the terms of the debt securities issued could impose significant restrictions on our operations in addition to those referenced above.

We do not know whether additional financing will be available on commercially acceptable terms, or at all. If adequate funds are not available or are not available on commercially acceptable terms, we may need to downsize, curtail program development efforts or halt our operations altogether.

We may fail to successfully manage and grow our business, which could adversely affect our results of operations, financial condition and business.

Continued expansion could put significant strain on our management, operational and financial resources. The need to comply with the rules and regulations of the SEC will continue to place significant demands on our financial and accounting staff, financial, accounting and information systems, and our internal controls and procedures, any of which may not be adequate to support our anticipated growth. The need to comply with the state and federal healthcare, security and privacy regulation will continue to place significant demands on our staff and our policies and procedures, any of which may not be adequate to support our anticipated growth. We may not be able to effectively hire, train, retain, motivate and manage required personnel. Our failure to manage growth effectively could limit our ability to satisfy our reporting obligations, or achieve our marketing, commercialization and financial goals.

We may be unable to successfully execute on our growth initiatives, business strategies or operating plans.

We are continually executing a number of growth initiatives, strategies and operating plans designed to enhance our business. The anticipated benefits from these efforts are based on several assumptions that may prove to be inaccurate. Moreover, we may not be able to successfully complete these growth initiatives, strategies and operating plans and realize all of the benefits, including growth targets and cost savings, that we expect to achieve or it may be more costly to do so than we anticipate. A variety of risks could cause us not to realize some or all of the expected benefits. These risks include, among others, delays in the
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anticipated timing of activities related to such growth initiatives, strategies and operating plans, increased difficulty and cost in implementing these efforts, including difficulties in complying with new regulatory requirements and the incurrence of other unexpected costs associated with operating the business. Moreover, our continued implementation of these programs may disrupt our operations and performance. As a result, we cannot assure you that we will realize these benefits. If, for any reason, the benefits we realize are less than our estimates or the implementation of these growth initiatives, strategies and operating plans adversely affect our operations or cost more or take longer to effectuate than we expect, or if our assumptions prove inaccurate, our business, financial condition and results of operations may be materially adversely affected.

We may periodically consummate opportunistic acquisitions of other companies, and we may not realize expected benefits or such acquisitions or we may have difficulties integrating acquired companies into our operations in a cost-effective manner, if at all.

We may periodically consummate opportunistic acquisitions of businesses, assets, personnel or technologies that allow us to complement our existing operations, expand our market coverage, enter new geographic markets, or add new business capabilities. We continually evaluate and explore strategic opportunities as they arise, including business combination transactions, strategic partnerships, and the purchase or sale of assets. In October 2020, we completed a strategic acquisition and are focused on integrating this acquisition into our operations. No assurance can be given that the benefits or synergies we may expect from an acquisition will be realized to the extent or in the time frame we anticipate. We may lose key employees, customers, vendors and other business partners of a company we acquire after announcement of acquisition plans. In addition, an acquisition may involve a number of risks and difficulties, including expansion into new geographic markets and business areas in which our management has limited prior experience, the diversion of management’s attention to the operations and personnel of the acquired company, the integration of the acquired company’s personnel, operations and technology systems and applications, changing relationships with customers, vendors or strategic partners, differing regulatory requirements including in new geographic markets and new business areas, and potential short-term adverse effects on our operating results. These challenges can be magnified as the size of the acquisition increases. Any delays or unexpected costs incurred in connection with the integration of an acquired company or otherwise related to an acquisition could have a material adverse effect on our business, financial condition and results of operations.

An acquisition may require significant expenses and can result in increased debt or other contingent liabilities, adverse tax consequences, deferred compensation charges, the recording and later amortization of amounts related to deferred compensation and certain purchased intangible assets, and the refinement or revision of fair value acquisition estimates following the completion of an acquisition, any of which items could negatively impact our business, financial condition and results of operations. In addition, we may record goodwill in connection with an acquisition and incur goodwill impairment charges in the future. Any of these charges could cause the price of our common stock to decline. An acquisition also could absorb substantial cash resources, require us to incur or assume debt obligations, or involve our issuance of additional equity securities. If we issue equity securities in connection with an acquisition, we may dilute our common stock with securities that have an equal or a senior interest in our company. An acquired entity also may be leveraged or dilutive to our earnings per share, or may have unknown liabilities. In addition, the combined entity may have lower than expected revenues or higher expenses and therefore may not achieve the anticipated results. Any of these factors relating to an acquisition could have a material adverse impact on our business, financial condition and results of operations.

Our programs may not be as effective as we believe them to be, which could limit our potential revenue growth.

Our belief in the efficacy of our Ontrak solution is based on a limited experience with a relatively small number of members. Such results may not be statistically significant, have not been subjected to close scientific scrutiny, and may not be indicative of the long-term future performance of treatment with our programs. If the initially indicated results cannot be successfully replicated or maintained over time, utilization of our programs could decline substantially. There are no standardized methods for measuring efficacy of programs such as ours. Even if we believe our solutions are effective, our customers could determine they are not effective by utilizing different outcome measures. In addition, even if our customers determine our solutions are effective they may discontinue them because they determine that the aggregate cost savings are not sufficient or that our programs do not have a high enough return on investment. Our success is dependent on our ability to enroll third-party payor members in our Ontrak solutions. Large scale outreach and enrollment efforts have not been conducted and only for limited time periods and we may not be able to achieve the anticipated enrollment rates.

Our Ontrak solution may not become widely accepted, which could limit our growth.

Our ability to achieve further marketplace acceptance for our Ontrak solution is dependent on our ability to demonstrate financial and clinical outcomes from our agreements. If we are unable to secure sufficient contracts to achieve recognition or acceptance of our Ontrak solution or if our program does not demonstrate the expected level of clinical improvement and cost savings, it is unlikely that we will be able to achieve widespread market acceptance.

Disappointing results for our solutions or failure to attain our publicly disclosed milestones could adversely affect market acceptance and have a material adverse effect on our stock price.
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Disappointing results, later-than-expected press release announcements or termination of evaluations, pilot programs or commercial Ontrak solutions could have a material adverse effect on the commercial acceptance of our solutions, our stock price and on our results of operations. In addition, announcements regarding results, or anticipation of results, may increase volatility in our stock price. In addition to numerous upcoming milestones, from time to time we provide financial guidance and other forecasts to the market. While we believe that the assumptions underlying projections and forecasts we make publicly available are reasonable, projections and forecasts are inherently subject to numerous risks and uncertainties. Any failure to achieve milestones, or to do so in a timely manner, or to achieve publicly announced guidance and forecasts, could have a material adverse effect on our results of operations and the price of our common stock.

We face business disruption and related risks resulting from the novel coronavirus 2019 (COVID-19) pandemic, which could have a material adverse effect on our business and results of operations.

Our business could be disrupted and materially adversely affected by the COVID-19 pandemic, including as a result of mutations of such virus and the global spread of viral variants that may be more contagious or resistant to currently known treatments. As a result of measures imposed by the governments in affected regions, businesses and schools have been from time to time suspended due to quarantines intended to contain this outbreak and many people have been forced to work from home in those areas. As a result of the global pandemic, trade and business activities around the world have been adversely affected, international stock and commodity markets have fluctuated widely and many regions are exhibiting signs of economic recession. Several programs were enacted in different countries in efforts to alleviate rising levels of unemployment and economic dislocation created by significantly reduced levels of social and business activity, although their longer term effectiveness is still uncertain particularly in view of a "second wave" effect of the spread of the contagion and related variants. We are continuously assessing our business operations and system supports and the impact COVID-19 may have on our results and financial condition, but there can be no assurance that this analysis will enable us to avoid part or all of any impact from the spread of COVID-19 or its consequences, including downturns in business sentiment generally or in our sector in particular, or its effects on our members or outreach pool.

Our industry is highly competitive, and we may not be able to compete successfully.

The healthcare business in general, and the behavioral health treatment business in particular, are highly competitive. While we believe our products and services are unique, we operate in highly competitive markets. We compete with other healthcare management service organizations, care management and disease management companies, including Managed Behavioral Healthcare Organizations (MBHOs), other specialty healthcare and managed care companies, and healthcare technology companies that are offering treatment and support of behavioral health on-line and on mobile devices. Most of our competitors are significantly larger and have greater financial, marketing and other resources than us. We believe that our ability to offer customers a comprehensive and integrated behavioral health solution, including the utilization of our analytical models and innovative member engagement methodologies, will enable us to compete effectively. However, there can be no assurance that we will not encounter more effective competition in the future, that we will have financial resources to continue to improve our offerings or that we will be successful improving them, which would limit our ability to maintain or increase our business.

Our competitors may develop and introduce new processes and products that are equal or superior to our programs in treating behavioral health conditions. Accordingly, we may be adversely affected by any new processes and products developed by our competitors.

A substantial percentage of our revenues are attributable to four large customers, any or all of which may terminate our services at any time.

Four customers accounted for an aggregate of 94% and 85% of our total revenue for the year ended December 31, 2020 and 2019, respectively. Also, two customers represented an aggregate of 99% of our total accounts receivable as of December 31, 2020 and three customers represented an aggregate of 85% of our total accounts receivable as of December 31, 2019. On February 26, 2021, we were notified by our largest customer that the participation status with this customer will be terminated effective June 26, 2021 and were advised to stop enrollment of new members await guidance from the customer on transition plans for the 8,100 members who are currently benefiting from the Ontrak program. For the year ended December 31, 2020, this customer accounted for approximately 58% of our total revenue. We expect that revenues from a limited number of customers will continue for the foreseeable future. Sales to these customers are made pursuant to agreements with flexible termination provisions, generally entitling the customer to terminate with or without cause on limited notice to us. We may not be able to keep our key customers, or these customers may decrease their enrollment levels. Any substantial decrease or delay in revenues relating to one or more of our key customers would harm our financial results. If revenues relating to current key customers cease or are reduced, we may not obtain sufficient enrollments from other customers necessary to offset any such losses or reductions.

We depend on key personnel, the loss of which could impact the ability to manage our business.
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We are highly dependent on our senior management and key operating and technical personnel. The loss of the services of any member of our senior management and key operating and technical personnel could have a material adverse effect on our business, operating results and financial condition. We also rely on consultants and advisors to assist us in formulating our strategy.

We will need to hire additional employees in order to achieve our objectives. There is currently intense competition for skilled executives and employees with relevant expertise, and this competition is likely to continue. The inability to attract and retain sufficient personnel could adversely affect our business, operating results and financial condition.

Our success depends largely upon the continued services of our key executive officers. These executive officers are at-will employees and therefore they may terminate employment with us at any time with no advance notice. We also rely on our leadership team in the areas of research and development, marketing, services and general and administrative functions. From time to time, there may be changes in our executive management team resulting from the hiring or departure of executives, which could disrupt our business. The replacement of one or more of our executive officers or other key employees would likely involve significant time and costs and may significantly delay or prevent the achievement of our business objectives.

To continue to execute our growth strategy, we also must attract and retain highly skilled personnel. Competition is intense for qualified professionals. We may not be successful in continuing to attract and retain qualified personnel. We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining highly skilled personnel with appropriate qualifications. The pool of qualified personnel with experience working in the healthcare market is limited overall. In addition, many of the companies with which we compete for experienced personnel have greater resources than we have.

In addition, in making employment decisions, particularly in high-technology industries, job candidates often consider the value of the stock options or other equity instruments they are to receive in connection with their employment. Volatility in the price of our stock may, therefore, adversely affect our ability to attract or retain highly skilled personnel. Further, the requirement to expense stock options and other equity instruments may discourage us from granting the size or type of stock option or equity awards that job candidates require to join our company. Failure to attract new personnel or failure to retain and motivate our current personnel, could have a material adverse effect on our business, financial condition and results of operations.

We are dependent on our ability to recruit, retain and develop a very large and diverse workforce. We must transform our culture in order to successfully grow our business.

Our products and services and our operations require a large number of employees. A significant number of employees have joined us in recent years as we continue to grow and expand our business. Our success is dependent on our ability to transform our culture, align our talent with our business needs, engage our employees and inspire our employees to be open to change, to innovate and to maintain member- and client-focus when delivering our services. Our business would be adversely affected if we fail to adequately plan for succession of our executives and senior management; or if we fail to effectively recruit, integrate, retain and develop key talent and/or align our talent with our business needs, in light of the current rapidly changing environment. While we have succession plans in place and we have employment arrangements with a limited number of key executives, these do not guarantee that the services of these or suitable successor executives will continue to be available to us.

We may be subject to future litigation, which could result in substantial liabilities that may exceed our insurance coverage.

All significant medical treatments and procedures, including treatment utilizing our programs, involve the risk of serious injury or death. While we have not been the subject of any such claims, our business entails an inherent risk of claims for personal injuries and substantial damage awards. We cannot control whether individual physicians and therapists will apply the appropriate standard of care in determining how to treat their patients. While our agreements typically require physicians to indemnify us for their negligence, there can be no assurance they will be willing and financially able to do so if claims are made. In addition, our license agreements require us to indemnify physicians, hospitals or their affiliates for losses resulting from our negligence.

We currently have insurance coverage for personal injury claims, directors’ and officers’ liability insurance coverage, and errors and omissions insurance. We may not be able to maintain adequate liability insurance at acceptable costs or on favorable terms. We expect that liability insurance will be more difficult to obtain and that premiums will increase over time and as the volume of patients treated with our programs increases. In the event of litigation, we may sustain significant damages or settlement expense (regardless of a claim's merit), litigation expense and significant harm to our reputation.

If third-party payors fail to provide coverage and adequate payment rates for our solutions, our revenue and prospects for profitability will be harmed.

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Our future revenue growth will depend in part upon our ability to contract with health plans and other insurance payors for our Ontrak solutions. In addition, insurance payors are increasingly attempting to contain healthcare costs, and may not cover or provide adequate payment for our programs. Adequate insurance reimbursement might not be available to enable us to realize an appropriate return on investment in research and product development, and the lack of such reimbursement could have a material adverse effect on our operations and could adversely affect our revenues and earnings.

We may not be able to achieve promised savings for our Ontrak contracts, which could result in pricing levels insufficient to cover our costs or ensure profitability.

Many of our Ontrak contracts are based upon anticipated or guaranteed levels of savings for our customers and achieving other operational metrics resulting in incentive fees based on savings. If we are unable to meet or exceed promised savings, achieve agreed upon operational metrics, or favorably resolve contract billing and interpretation issues with our customers, we may be required to refund from the amount of fees paid to us any difference between savings that were guaranteed and the savings, if any, which were actually achieved; or we may fail to earn incentive fees based on savings. Accordingly, during or at the end of the contract terms, we may be required to refund some or all of the fees paid for our services. This exposes us to significant risk that contracts negotiated and entered into may ultimately be unprofitable. In addition, managed care operations are at risk for costs incurred to provide agreed upon services under our solution. Therefore, failure to anticipate or control costs could have a materially adverse effect on our business.

Our ability to use our net operating losses to offset future taxable income has been limited in certain cases and may be subject to certain limitations in the future.

Our net operating loss carryforwards ("NOLs") will begin to expire in 2023. These NOLs may be used to offset future taxable income, to the extent we generate any taxable income, and thereby reduce or eliminate our future federal income taxes otherwise payable. Section 382 of the Internal Revenue Code imposes limitations on a corporation's ability to utilize NOLs if it experiences an ownership change as defined in Section 382. In general terms, an ownership change may result from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50% over a three-year period. In the event that an ownership change has occurred, or were to occur, utilization of our NOLs would be subject to an annual limitation under Section 382 determined by multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in the Internal Revenue Code. Any unused annual limitation may be carried over to later years. We have experienced ownership changes in the past and can continue to experience ownership changes under Section 382 as a result of events in the past or the issuance of shares of common or preferred stock, or a combination thereof. As a result of such ownership changes, the use of our NOLs, or a portion thereof, against our future taxable income may be subject to an annual limitation under Section 382, which may result in expiration of a portion of our NOLs before utilization.

In order to protect the Company’s significant NOLs, we filed an Amended and Restated Certificate of Incorporation of the Company containing an amendment (the “Protective Amendment”) with the Delaware Secretary of State on October 28, 2019. The Protective Amendment was approved by the Company’s stockholders by written consent dated September 24, 2019.

The Protective Amendment is designed to assist in protecting the long-term value of our accumulated NOLs by limiting certain transfers of our stock. The Protective Amendment’s transfer restrictions generally restrict any direct or indirect transfers of stock if the effect would be to increase the direct or indirect ownership of the stock by any person from less than 4.99% to 4.99% or more of the stock, or increase the percentage of the stock owned directly or indirectly by a person owning or deemed to own 4.99% or more of the stock. Any direct or indirect transfer attempted in violation of the Protective Amendment will be void as of the date of the prohibited transfer as to the purported transferee.

The Protective Amendment also requires any person attempting to become a holder of 4.99% or more of our common stock to seek the approval of our Board. This may have an unintended “anti-takeover” effect because our Board may be able to prevent any future takeover. Similarly, any limits on the amount of stock that a shareholder may own could have the effect of making it more difficult for shareholders to replace current management. Additionally, because the Protective Amendment may have the effect of restricting a shareholder’s ability to dispose of or acquire our common stock, the liquidity and market value of our common stock might suffer.

The Protective Amendment is not binding with respect to shares of stock issued prior to its adoption unless the holder of such shares has voted in favor of the Protective Amendment and the resulting transfer restriction is noted conspicuously on the certificate representing such shares, or, in the case of uncertificated shares, the registered owners are notified of the Protective Amendment, or such registered owner has actual knowledge of the Protective Amendment. Therefore, even after the effectiveness of the Protective Amendment, we cannot assure you that we will not experience an ownership change as defined in Section 382, including as a result of a waiver or modification by our Board as permitted by the Protective Amendment.

Risks related to our intellectual property
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Confidentiality agreements with employees, treating physicians and others may not adequately prevent disclosure of trade secrets and other proprietary information.

In order to protect our proprietary technology and processes, we rely in part on confidentiality provisions in our agreements with employees, treating physicians, and others. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, others may independently discover trade secrets and proprietary information. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

We may be subject to claims that we infringe the intellectual property rights of others, and unfavorable outcomes could harm our business.

Our future operations may be subject to claims, and potential litigation, arising from our alleged infringement of patents, trade secrets, trademarks or copyrights owned by other third parties. Within the healthcare, drug and bio-technology industry, many companies actively pursue infringement claims and litigation, which makes the entry of competitive products more difficult. We may experience claims or litigation initiated by existing, better-funded competitors and by other third parties. Court-ordered injunctions may prevent us from continuing to market existing products or from bringing new products to market and the outcome of litigation and any resulting loss of revenues and expenses of litigation may substantially affect our ability to meet our expenses and continue operations.

Risks related to our healthcare industry

Recent changes in insurance and health care laws have created uncertainty in the health care industry.

The Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act, each enacted in March 2010, generally known as the Health Care Reform Law, significantly expanded health insurance coverage to uninsured Americans and changed the way health care is financed by both governmental and private payors. Following the 2016 federal elections, which resulted in the election of the Republican presidential nominee and Republican majorities in both houses of Congress, there were renewed legislative efforts to significantly modify or repeal the Health Care Reform Law and certain executive policy changes designed to modify its impact, including the enactment of the Tax Cuts and Jobs Act in December 2017 which repealed the penalties under the Health Care Reform Law for uninsured persons. In light of the recent 2020 federal elections, which resulted in the election of the Democrat presidential nominee and Democratic majorities in both the Senate and House, we cannot predict what further reform proposals, if any, will be adopted, when they may be adopted, or what impact they may have on our business. There may also be other risks and uncertainties associated with the Health Care Reform Law. If we fail to comply or are unable to effectively manage such risks and uncertainties, our financial condition and results of operations could be adversely affected.

Our policies and procedures may not fully comply with complex and increasing regulation by state and federal authorities, which could negatively impact our business operations.

The healthcare industry is highly regulated and continues to undergo significant changes as third-party payors, such as Medicare and Medicaid, traditional indemnity insurers, managed care organizations and other private payors, increase efforts to control cost, utilization and delivery of healthcare services. Healthcare companies are subject to extensive and complex federal, state and local laws, regulations and judicial decisions. Our failure or the failure of our treating physicians, to comply with applicable healthcare laws and regulations may result in the imposition of civil or criminal sanctions that we cannot afford, or require redesign or withdrawal of our programs from the market.

We may become subject to medical liability claims, which could cause us to incur significant expenses and may require us to pay significant damages if not covered by insurance.

Our business entails the risk of medical liability claims against both our providers and us. Although we carry insurance covering medical malpractice claims in amounts that we believe are appropriate in light of the risks attendant to our business, successful medical liability claims could result in substantial damage awards that exceed the limits of our insurance coverage. We carry professional liability insurance for ourselves, and we separately carry a general insurance policy, which covers medical malpractice claims. In addition, professional liability insurance is expensive and insurance premiums may increase significantly in the future, particularly as we expand our services. As a result, adequate professional liability insurance may not be available to us in the future at acceptable costs or at all.

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Any claims made against us that are not fully covered by insurance could be costly to defend against, result in substantial damage awards against us and divert the attention of our management and our providers from our operations, which could have a material adverse effect on our business, financial condition and results of operations. In addition, any claims may adversely affect our business or reputation.


Our business practices may be found to constitute illegal fee-splitting or corporate practice of medicine, which may lead to penalties and adversely affect our business.

Many states, including California where our principal executive offices are located, have laws that prohibit business corporations, such as us, from practicing medicine, exercising control over medical judgments or decisions of physicians or other health care professionals (such as nurses or nurse practitioners), or engaging in certain business arrangements with physicians or other health care professionals, such as employment of physicians and other health care professionals or fee-splitting. The state laws and regulations and administrative and judicial decisions that enumerate the specific corporate practice and fee-splitting rules vary considerably from state to state and are enforced by both the courts and government agencies, each with broad discretion. Courts, government agencies or other parties, including physicians, may assert that we are engaged in the unlawful corporate practice of medicine, fee-splitting, or payment for referrals by providing administrative and other services in connection with our treatment programs. As a result of such allegations, we could be subject to civil and criminal penalties, our contracts could be found invalid and unenforceable, in whole or in part, or we could be required to restructure our contractual arrangements. If so, we may be unable to restructure our contractual arrangements on favorable terms, which would adversely affect our business and operations.

Our business practices may be found to violate anti-kickback, physician self-referral or false claims laws, which may lead to penalties and adversely affect our business.

The healthcare industry is subject to extensive federal and state regulation with respect to kickbacks, physician self-referral arrangements, false claims and other fraud and abuse issues.

The federal anti-kickback law (the “Anti-Kickback Law”) prohibits, among other things, knowingly and willfully offering, paying, soliciting, receiving, or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing, arranging for, or recommending of an item or service that is reimbursable, in whole or in part, by a federal health care program. “Remuneration” is broadly defined to include anything of value, such as, for example, cash payments, gifts or gift certificates, discounts, or the furnishing of services, supplies, or equipment. The Anti-Kickback Law is broad, and it prohibits many arrangements and practices that are lawful in businesses outside of the health care industry.

Recognizing the breadth of the Anti-Kickback Law and the fact that it may technically prohibit many innocuous or beneficial arrangements within the health care industry, the Office of Inspector General (“OIG”) has issued a series of regulations, known as the “safe harbors.” Compliance with all requirements of a safe harbor immunizes the parties to the business arrangement from prosecution under the Anti-Kickback Law. The failure of a business arrangement to fit within a safe harbor does not necessarily mean that the arrangement is illegal or that the OIG will pursue prosecution. Still, in the absence of an applicable safe harbor, a violation of the Anti-Kickback Law may occur even if only one purpose of an arrangement is to induce referrals. The penalties for violating the Anti-Kickback Law can be severe. These sanctions include criminal and civil penalties, imprisonment, and possible exclusion from the federal health care programs. Many states have adopted laws similar to the Anti-Kickback Law, and some apply to items and services reimbursable by any payor, including private insurers.

In addition, the federal ban on physician self-referrals, commonly known as the Stark Law, prohibits, subject to certain exceptions, physician referrals of Medicare patients to an entity providing certain “designated health services” if the physician or an immediate family member of the physician has any financial relationship with the entity. A “financial relationship” is created by an investment interest or a compensation arrangement. Penalties for violating the Stark Law include the return of funds received for all prohibited referrals, fines, civil monetary penalties, and possible exclusion from the federal health care programs. In addition to the Stark Law, many states have their own self-referral bans, which may extend to all self-referrals, regardless of the payor.

The federal False Claims Act imposes liability on any person or entity that, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment to the federal government. Under the False Claims Act, a person acts knowingly if he has actual knowledge of the information or acts in deliberate ignorance or in reckless disregard of the truth or falsity of the information. Specific intent to defraud is not required. Violations of other laws, such as the Anti-Kickback Law or the FDA prohibitions against promotion of off-label uses of drugs, can lead to liability under the federal False Claims Act. The qui tam provisions of the False Claims Act allow a private individual to bring an action on behalf of the federal government and to share in any amounts paid by the defendant to the government in connection with the action. The number of filings of qui tam actions has increased significantly in recent years. When an entity is determined to have violated the False Claims Act, it may be
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required to pay up to three times the actual damages sustained by the government, plus civil penalties of between $5,500 and $11,000 for each false claim. Conduct that violates the False Claims Act may also lead to exclusion from the federal health care programs. Given the number of claims likely to be at issue, potential damages under the False Claims Act for even a single inappropriate billing arrangement could be significant. In addition, various states have enacted similar laws modeled after the False Claims Act that apply to items and services reimbursed under Medicaid and other state health care programs, and, in several states, such laws apply to claims submitted to all payors.

On May 20, 2009, the Federal Enforcement and Recovery Act of 2009, or FERA, became law, and it significantly amended the federal False Claims Act. Among other things, FERA eliminated the requirement that a claim must be presented to the federal government. As a result, False Claims Act liability extends to any false or fraudulent claim for government money, regardless of whether the claim is submitted to the government directly, or whether the government has physical custody of the money. FERA also specifically imposed False Claims Act liability if an entity “knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the Government.” As a result, the knowing and improper failure to return an overpayment can serve as the basis for a False Claims Act action. In March 2010, Congress passed the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, collectively the ACA, which also made sweeping changes to the federal False Claims Act. The ACA also established that Medicare and Medicaid overpayments must be reported and returned within 60 days of identification or when any corresponding cost report is due.

Finally, the Health Insurance Portability and Accountability Act of 1996 and its implementing regulations created the crimes of health care fraud and false statements relating to health care matters. The health care fraud statute prohibits knowingly and willfully executing a scheme to defraud any health care benefit program, including a private insurer. The false statements statute prohibits knowingly and willfully falsifying, concealing, or covering up a material fact or making any materially false, fictitious, or fraudulent statement in connection with the delivery of or payment for health care benefits, items, or services. A violation of this statute is a felony and may result in fines, imprisonment, or exclusion from the federal health care programs.

Federal or state authorities may claim that our fee arrangements, our agreements and relationships with contractors, hospitals and physicians, or other activities violate fraud and abuse laws and regulations. If our business practices are found to violate any of these laws or regulations, we may be unable to continue with our relationships or implement our business plans, which would have an adverse effect on our business and results of operations. Further, defending our business practices could be time consuming and expensive, and an adverse finding could result in substantial penalties or require us to restructure our operations, which we may not be able to do successfully.

Our business practices may be subject to state regulatory and licensure requirements.

Our business practices may be regulated by state regulatory agencies that generally have discretion to issue regulations and interpret and enforce laws and rules. These regulations can vary significantly from jurisdiction to jurisdiction, and the interpretation of existing laws and rules also may change periodically. Some of our business and related activities may be subject to state health care-related regulations and requirements, including managed health care, utilization review (UR) or third-party administrator-related regulations and licensure requirements. These regulations differ from state to state, and may contain network, contracting, and financial and reporting requirements, as well as specific standards for delivery of services, payment of claims, and adequacy of health care professional networks. If a determination is made that we have failed to comply with any applicable state laws or regulations, our business, financial condition and results of operations could be adversely affected.

If our providers or experts are characterized as employees, we would be subject to employment and withholding liabilities.

We structure our relationships with our providers and experts in a manner that we believe results in an independent contractor relationship, not an employee relationship. An independent contractor is generally distinguished from an employee by his or her degree of autonomy and independence in providing services. A high degree of autonomy and independence is generally indicative of a contractor relationship, while a high degree of control is generally indicative of an employment relationship. Although we believe that our providers and experts are properly characterized as independent contractors, tax or other regulatory authorities may in the future challenge our characterization of these relationships. If such regulatory authorities or state, federal or foreign courts were to determine that our providers or experts are employees, and not independent contractors, we would be required to withhold income taxes, to withhold and pay social security, Medicare and similar taxes and to pay unemployment and other related payroll taxes. We would also be liable for unpaid past taxes and subject to penalties. As a result, any determination that our providers or experts are our employees could have a material adverse effect on our business, financial condition and results of operations.

We may be subject to healthcare anti-fraud initiatives, which may lead to penalties and adversely affect our business.

State and federal government agencies are devoting increased attention and resources to anti-fraud initiatives against healthcare providers and the entities and individuals with whom they do business, and such agencies may define fraud
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expansively to include our business practices, including the receipt of fees in connection with a healthcare business that is found to violate any of the complex regulations described above. While to our knowledge we have not been the subject of any anti-fraud investigations, if such a claim were made, defending our business practices could be time consuming and expensive and an adverse finding could result in substantial penalties or require us to restructure our operations, which we may not be able to do successfully.

Our use and disclosure of patient information is subject to privacy and security regulations, which may result in increased costs.

In providing administrative services to healthcare providers and operating our treatment programs, we may collect, use, disclose, maintain and transmit patient information in ways that will be subject to many of the numerous state, federal and international laws and regulations governing the collection, use, disclosure, storage, privacy and security of patient-identifiable health information, including the administrative simplification requirements of the Health Insurance Portability and Accountability Act of 1996 and its implementing regulations (HIPAA) and the Health Information Technology for Economic and Clinical Health Act of 2009 (HITECH). The HIPAA Privacy Rule restricts the use and disclosure of certain patient information (“Protected Health Information” or “PHI”), and requires safeguarding that information. The HIPAA Security Rule and HITECH establish elaborate requirements for safeguarding PHI transmitted or stored electronically. HIPAA applies to covered entities, which may include healthcare facilities and also includes health plans that will contract for the use of our programs and our services. HIPAA and HITECH require covered entities to bind contractors that use or disclose protected health information (or “Business Associates”) to compliance with certain aspects of the HIPAA Privacy Rule and all of the HIPAA Security Rule. In addition to contractual liability, Business Associates are also directly subject to regulation by the federal government. Direct liability means that we are subject to audit, investigation and enforcement by federal authorities. HITECH imposes breach notification obligations requiring us to report breaches of “Unsecured Protected Health Information” or PHI that has not been encrypted or destroyed in accordance with federal standards. Business Associates must report such breaches so that their covered entity customers may in turn notify all affected patients, the federal government, and in some cases, local or national media outlets. We may be required to indemnify our covered entity customers for costs associated with breach notification and the mitigation of harm resulting from breaches that we cause. If we are providing management services that include electronic billing on behalf of a physician practice or facility that is a covered entity, we may be required to conduct those electronic transactions in accordance with the HIPAA regulations governing the form and format of those transactions. Services provided under our Ontrak solution not only require us to comply with HIPAA and HITECH but also Title 42 Part 2 of the Code of Federal Regulations (“Part 2”). Part 2 is a federal, criminal law that severely restricts our ability to use and disclose drug and alcohol treatment information obtained from federally-supported treatment facilities. Our operations must be carefully structured to avoid liability under this law. Our Ontrak solution qualifies as a federally funded treatment facility which requires us to disclose information on members only in compliance with Title 42.

In addition to the federal privacy regulations, there are a number of state laws governing the privacy and security of health and personal information. The penalties for violation of these laws vary widely and the area is rapidly evolving.

In 2018, California passed the California Consumer Privacy Act (the “CCPA”), which gives consumers significant rights over the use of their personal information, including the right to object to the “sale” of their personal information. In 2020, Californians voted to enact the California Privacy Rights Act (CPRA), which amends the CCPA by expanding consumers' rights in their personal information and creating a new governmental agency to interpret and enforce the statute. Most provisions of the CPRA will become effective on January 1, 2023. While information covered by HIPAA is generally exempt from the applicability of the CCPA as amended by the CPRA, the rights of consumers under the CCPA may restrict our ability to use personal information in connection with our business operations. The CCPA also provides a private right of action for certain security breaches.

In 2019, New York passed a law known as the SHIELD Act, which expands data breach reporting obligations and requires companies to have robust data security programs in place. More recently, New York and other states, including Washington, have introduced significant privacy bills, and Congress is debating federal privacy legislation, which if passed, may restrict our business operations and require us to incur additional costs for compliance.

In addition, several foreign countries and governmental bodies, including the E.U., Brazil and Canada, have laws and regulations concerning the collection and use of personally identifiable information obtained from their residents, including identifiable health information, which are often more restrictive than those in the U.S. Laws and regulations in these jurisdictions apply broadly to the collection, use, storage, disclosure and security of personally identifiable information, including health information, identifying, or which may be used to identify, an individual, such as names, email addresses and, in some jurisdictions, Internet Protocol (IP) addresses, device identifiers and other data. Although we currently conduct business only in the United States of America, these laws and regulations could become applicable to us in the event we expand our operations into other countries. These and other obligations may be modified and interpreted in different ways by courts, and new laws and regulations may be enacted in the future.

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Within the EEA, the General Data Protection Regulation ("GDPR") took full effect on May 25, 2018, superseding the 1995 European Union Data Protection Directive and becoming directly applicable across E.U. member states. The GDPR includes more stringent operational requirements for processors and controllers of personal data (including health information) established in and outside of the EEA, imposes significant penalties for non-compliance and has broader extra-territorial effect. As the GDPR is a regulation rather than a directive, it applies throughout the EEA, but permits member states to enact supplemental requirements if they so choose. Noncompliance with the GDPR can trigger fines of up to the greater of €20 million or 4% of global annual revenues. Further, a Data Protection Act substantially implementing the GDPR was enacted in the U.K., effective in May 2018. It remains unclear, however, how U.K. data protection laws or regulations will develop in the medium to longer term and how data transfers to and from the U.K. will be regulated in light of the U.K.'s withdrawal from the E.U. In addition, some countries are considering or have enacted legislation requiring local storage and processing of data that could increase the cost and complexity of delivering our services.

We believe that we have taken the steps required of us to comply with laws governing the privacy and security of personal information, including health information privacy and security laws and regulations, in all applicable jurisdictions, both state and federal. However, we may not be able to maintain compliance in all jurisdictions where we do business. Failure to maintain compliance, or changes in state or federal privacy and security laws could result in civil and/or criminal penalties and could have a material adverse effect on our business, including significant reputational damage associated with a breach. Under HITECH, we are subject to prosecution or administrative enforcement and increased civil and criminal penalties for non-compliance, including a four-tiered system of monetary penalties. We are also subject to enforcement by state attorneys general who were given authority to enforce HIPAA under HITECH, and who have authority to enforce state-specific data privacy and security laws. If regulations change, if we expand the territorial scope of our operations, or if it is determined that we are not in compliance with privacy regulations, we may be required to modify aspects of our program, which may adversely affect program results and our business or profitability.

Security breaches, loss of data and other disruptions could compromise sensitive information related to our business, prevent us from accessing critical information or expose us to liability, which could adversely affect our business and our reputation.

In the ordinary course of our business, we collect and store sensitive data, including legally protected patient health information, personally identifiable information about our employees, intellectual property, and proprietary business information. We manage and maintain our applications and data utilizing an off-site co-location facility. These applications and data encompass a wide variety of business critical information including research and development information, commercial information and business and financial information.

The secure processing, storage, maintenance and transmission of this critical information is vital to our operations and business strategy, and we devote significant resources to protecting such information. Although we take measures to protect sensitive information from unauthorized access or disclosure, our information technology and infrastructure may be vulnerable to attacks by hackers, viruses, breaches or interruptions due to employee error or malfeasance, terrorist attacks, earthquakes, fire, flood, other natural disasters, power loss, computer systems failure, data network failure, Internet failure or lapses in compliance with privacy and security mandates. We may be subject to distributed denial of service (DDOS) attacks by hackers aimed at disrupting service to patients and customers. Our response to such DDOS attacks may be insufficient to protect our network and systems. In addition, there has been a continuing increase in the number of malicious software attacks in the technology industry, including malware, ransomware, and email phishing scams, particularly since the start of the COVID-19 pandemic. Any such virus, breach or interruption could compromise our networks and the information stored there could be accessed by unauthorized parties, publicly disclosed, lost or stolen. We have measures in place that are designed to detect and respond to such security incidents and breaches of privacy and security mandates. Nonetheless, we cannot guarantee our backup systems, regular data backups, security protocols, network protection mechanisms and other procedures currently in place, or that may be in place in the future, will be adequate to prevent or remedy network and service interruption, system failure, damage to one or more of our systems, data loss, security breaches or other data security incidents. We might be required to expend significant capital and resources to protect against or address such incidents. Any access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information (such as HIPAA and state data security laws), government enforcement actions and regulatory penalties. We may also be required to indemnify our customers for costs associated with having their data on our system breached. Unauthorized access, loss or dissemination could also interrupt our operations, including our ability to provide treatment, bill our customers, provide customer support services, conduct research and development activities, process and prepare company financial information, manage various general and administrative aspects of our business and damage our reputation, or we may lose one or more of our customers, especially if they felt their data may be breached, any of which could adversely affect our business.

Certain of our professional healthcare employees, such as nurses, must comply with individual licensing requirements.

All of our healthcare professionals who are subject to licensing requirements, such as our care coaches, are licensed in the state in which they provide professional services in person. While we believe our nurses provide coaching and not professional services, one or more states may require our healthcare professionals to obtain licensure if providing services telephonically
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across state lines to the state’s residents. Healthcare professionals who fail to comply with these licensure requirements could face fines or other penalties for practicing without a license, and we could be required to pay those fines on behalf of our healthcare professionals. If we are required to obtain licenses for our nurses in states where they provide telephonic coaching, it would significantly increase the cost of providing our product. In addition, new and evolving agency interpretations, federal or state legislation or regulations, or judicial decisions could lead to the implementation of out-of-state licensure requirements in additional states, and such changes would increase the cost of services and could have a material effect on our business.


Risks related to our Note Agreement

The terms of our Note Agreement place restrictions on our operating and financial flexibility, and failure to comply with covenants or to satisfy certain conditions of the agreement may result in acceleration of our repayment obligations, which could significantly harm our liquidity, financial condition, operating results, business and prospects and cause the price of our securities to decline.

On September 24, 2019 (the “Closing Date”), we entered into the Note Agreement (as amended to date, the "Note Agreement"), by and among us, certain of our subsidiaries as guarantors, Goldman Sachs Specialty Lending Holdings, Inc. (with any other purchasers party thereto from time to time, collectively the “Holder”) and Goldman Sachs Specialty Lending Group, L.P., as collateral agent, in connection with the sale of up to $45.0 million aggregate principal amount of senior secured notes (the “2024 Notes”). On the Closing Date, we issued an aggregate of $35.0 million in principal amount of 2024 Notes and, on August 25, 2020, we issued an additional $10.0 million in principal amount of 2024 Notes.

The Note Agreement contains customary covenants, including, among others, covenants that restrict the our ability to incur debt, grant liens, make certain investments and acquisitions, pay dividends, repurchase equity interests, repay certain debt, amend certain contracts, enter into affiliate transactions and asset sales or make certain equity issuances, and covenants that require the us to, among other things, provide annual, quarterly and monthly financial statements, together with related compliance certificates, maintain its property in good repair, maintain insurance and comply with applicable laws. The Note Agreement also includes covenants with respect to our maintenance of certain financial ratios, including a fixed charge coverage ratio, leverage ratio and consolidated liquidity as well as minimum levels of consolidated adjusted EBITDA and revenue.

The Note Agreement and the 2024 Notes could have important consequences for us and our stockholders. For example, the Notes require a balloon payment at maturity in September 2024, which may require us to dedicate a substantial portion of our uncommitted cash flow from operations to this future payment if we feel we cannot be successful in our ability to refinance in the future, thereby further reducing the availability of our cash flow to fund working capital, capital expenditures, and acquisitions, and for other general corporate purposes. In addition, our indebtedness could:

increase our vulnerability to adverse economic and competitive pressures in our industry;
place us at a competitive disadvantage compared to our competitors that have less debt;
limit our flexibility in planning for, or reacting to, changes in our business and our industry; and
limit our ability to borrow additional funds on terms that are acceptable to us or at all.

The Note Agreement contains restrictive covenants that will restrict our operational flexibility and require that we maintain specified financial ratios. If we cannot comply with these covenants, we may be in default under the Note Agreement.

The Note Agreement contains restrictions and limitations on our ability to engage in activities that may be in our long-term best interests. The Note Agreement contains affirmative and negative covenants that limit and restrict, among other things, our ability to:

incur additional debt;
sell assets;
issue equity securities;
pay dividends or repurchase equity securities;
incur liens or other encumbrances;
make certain restricted payments and investments;
acquire other businesses; and
merge or consolidate.

The Note Agreement contains a fixed charge coverage ratio covenant, a leverage ratio covenant and minimum revenue and liquidity covenants. Events beyond our control could affect our ability to meet these and other covenants under the Note Agreement. We have in the past required waivers to or modifications of such covenant requirements which the lender has granted.
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There can be no assurance that we will not require additional such waivers or modifications or on what terms the lender will be willing to provide them, if at all. The Note Agreement also contains customary events of default, including, among others, payment default, bankruptcy events, cross-default, breaches of covenants and representations and warranties, change of control, judgment defaults and an ownership change within the meaning of Section 382 of the Code. Our failure to comply with our covenants and other obligations under the Note Agreement may result in an event of default thereunder. A default, if not cured or waived, may permit acceleration of the Notes. If the indebtedness represented by the Notes is accelerated, we cannot be certain that we will have sufficient funds available to pay the accelerated indebtedness (together with accrued interest and fees), or that we will have the ability to refinance the accelerated indebtedness on terms favorable to us or at all. This could have serious consequences to our financial condition, operating results, and business, and could cause us to become insolvent or enter bankruptcy proceedings, and shareholders may lose all or a portion of their investment because of the priority of the claims of our creditors on our assets.

If we are unable to generate or borrow sufficient cash to make payments on our indebtedness, our financial condition would be materially harmed, our business could fail, and shareholders may lose all of their investment.

Our ability to make scheduled payments on or to refinance our obligations will depend on our financial and operating performance, which will be affected by economic, financial, competitive, business, and other factors, some of which are beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations to service our indebtedness or to fund our other liquidity needs. If we are unable to meet our debt obligations or fund our other liquidity needs, we may need to restructure or refinance all or a portion of our indebtedness on or before maturity or sell certain of our assets. We cannot assure you that we will be able to restructure or refinance any of our indebtedness on commercially reasonable terms, if at all, which could cause us to default on our debt obligations and impair our liquidity. Any refinancing of our indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations.

Increases in interest rates could adversely affect our results from operations and financial condition.

The Notes bear interest at either a floating rate plus an applicable margin in the case of Notes subject to cash interest payments or a floating rate plus a slightly higher applicable margin in the case of Notes as to which current interest has been capitalized during the first twelve months following the Closing Date, at the Company’s option. The applicable margins are subject to stepdowns, in each case, following the achievement of certain financial ratios. As a result, an increase in prevailing interest rates would have an effect on the interest rates charged on the Notes, which rise and fall upon changes in interest rates. If prevailing interest rates or other factors result in higher interest rates, the increased interest expense would adversely affect our cash flow and our ability to service our indebtedness.

Risks related to our preferred stock

Our Series A Preferred Stock ranks junior to all of our indebtedness and other liabilities.

In the event of our bankruptcy, liquidation, dissolution or winding-up of our affairs, our assets will be available to pay obligations on the Series A Preferred Stock only after all of our indebtedness and other liabilities have been paid. The rights of holders of the Series A Preferred Stock to participate in the distribution of our assets will rank junior to the prior claims of our current and future creditors and any future series or class of preferred stock we may issue that ranks senior to the Series A Preferred Stock. Also, the Series A Preferred Stock effectively ranks junior to all existing and future indebtedness and to the indebtedness and other liabilities of our existing subsidiaries and any future subsidiaries. Our existing subsidiaries are, and future subsidiaries would be, separate legal entities and have no legal obligation to pay any amounts to us in respect of dividends due on the Series A Preferred Stock.

At December 31, 2020, our total liabilities equaled approximately $84.0 million. If we are forced to liquidate our assets to pay our creditors, we may not have sufficient assets to pay amounts due on any or all of the Series A Preferred Stock then outstanding.

Certain of our existing or future debt instruments may restrict the authorization, payment or setting apart of dividends on the Series A Preferred Stock. The Note Agreement restricts the payment of dividends on the Series A Preferred Stock and contains events of default which could result in acceleration of such indebtedness upon the occurrence of certain events, including failure to meet certain financial covenants and the payment of dividends on, or redemption amounts in respect of, the Series A Preferred Stock in violation of the Note Agreement. While the conditional amendment to the Note Agreement entered into in connection with our issuance of the Series A Preferred Stock (the “Conditional Amendment”) permits the payment of dividends on the Series A Preferred Stock for the first eight periods following issuance, thereafter we may only pay such dividends so long as there is no default or event of default under the Note Agreement. Accordingly, there can be no assurance that we will remain in compliance with the terms of the Conditional Amendment, and if we default, we may be contractually prohibited from paying dividends on the Series A Preferred Stock or any amounts in redemption of or otherwise in respect of, the Series A Preferred Stock. Also,
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future offerings of debt or senior equity securities may adversely affect the market price of the Series A Preferred Stock. If we decide to issue debt or senior equity securities in the future, it is possible that these securities will be governed by an indenture or other instruments containing covenants restricting our operating flexibility. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of the Series A Preferred Stock and may result in dilution to owners of the Series A Preferred Stock. We and, indirectly, our stockholders, will bear the cost of issuing and servicing such securities. Because our decision to issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. The holders of the Series A Preferred Stock will bear the risk of our future offerings, which may reduce the market price of the Series A Preferred Stock and will dilute the value of their holdings in us.

We may not be able to pay dividends on the Series A Preferred Stock if we have insufficient cash or available ‘surplus’ as defined under Delaware law to make such dividend payments.

Our ability to pay cash dividends on the Series A Preferred Stock requires us to have either net profits or positive net assets (total assets less total liabilities) over our capital, and that we have sufficient working capital in order to be able to pay our debts as they become due in the usual course of business. Our ability to pay dividends may also be impaired if any of the risks described in this Form 10-K, including the documents incorporated by reference herein, were to occur. Also, payment of our dividends depends upon our financial condition and other factors as our board of directors may deem relevant from time to time. We cannot assure you that our businesses will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to make distributions on our common stock, if any, and preferred stock, including the Series A Preferred Stock to pay our indebtedness or to fund our other liquidity needs.

We have established a segregated account that will be funded with a portion of the proceeds from sales of Series A Preferred Stock to pre-fund quarterly dividend payments on the Series A Preferred Stock until August 2022, although the payment of such amounts on deposit to holders of the Series A Preferred Stock is subject to compliance with applicable laws and with the foregoing limitations. Additionally, once the funds in the segregated account are exhausted, there can be no assurance that we will have sufficient cash flow from operations to continue such dividend payments. The amounts on deposit are also assets of our consolidated entity and while we have agreed not to use such amount for any corporate purposes other than payments of dividends on the Series A Preferred Stock, such account will be subject to a lien in favor of the collateral agent for the 2024 Notes and otherwise be available to our creditors generally in the event holders of our indebtedness or other obligations arising in the ordinary course of business seek to pursue remedies under bankruptcy or insolvency laws or otherwise. In addition, our Board of Directors may determine that the use of such amount on deposit for other corporate purposes is required pursuant to the exercise of their fiduciary duties to our common stockholders. You should be aware that the pre-funded dividends may not be available to make such payments in the amounts and at the times required under the terms of the Series A Preferred Stock offering.

Our Certificate of Incorporation contains provisions limiting the transferability and conversion of the Series A Preferred stock.

As noted above, the Protective Amendment is designed to assist in protecting the long-term value of our accumulated NOLs by limiting certain transfers of our common stock and certain of our other securities coming within the rules of the Internal Revenue Service under Section 382, including the Series A Preferred Stock as such does not meet the exception provided by Section 1504(a) of the Code and related Treasury Regulation §1.382.-2(a)(3)(i) (collectively, “382 Stock”). While the Board of Directors has approved the issuance of our Series A Preferred Stock after determining that such issuance is not likely to result in a prohibited ownership shift, the Protective Amendment will continue to apply to the Series A Preferred Stock after issuance, including the restrictions on transfer and exchange.

The market for our Series A Preferred Stock may not provide investors with adequate liquidity.

Our Series A Preferred Stock is listed on the Nasdaq Global Market. However, the trading market for the Series A Preferred Stock may not be maintained and may not provide investors with adequate liquidity. The liquidity of the market for the Series A Preferred Stock depends on a number of factors, including prevailing interest rates, our financial condition and operating results, the number of holders of the Series A Preferred Stock, the market for similar securities and the interest of securities dealers in making a market in the Series A Preferred Stock. We cannot predict the extent to which investor interest in our Company will maintain the trading market in our Series A Preferred Stock, or how liquid that market will be. If an active market is not maintained, investors may have difficulty selling shares of our Series A Preferred Stock.

Future issuances of preferred stock may reduce the value of the Series A Preferred Stock.

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We may sell additional shares of preferred stock on terms that may differ from the Series A Preferred Stock. Such shares could rank on parity with or, subject to the voting rights referred to above (with respect to issuances of new series of preferred stock), senior to the Series A Preferred Stock as to distribution rights or rights upon liquidation, winding up or dissolution. The subsequent issuance of additional shares of Series A Preferred Stock, or the creation and subsequent issuance of additional classes of preferred stock on parity with the Series A Preferred Stock, could dilute the interests of the holders of Series A Preferred Stock offered hereby. Any issuance of preferred stock that is senior to the Series A Preferred Stock would not only dilute the interests of the holders of Series A Preferred Stock, but also could affect our ability to pay distributions on, redeem or pay the liquidation preference on the Series A Preferred Stock.

Market interest rates may materially and adversely affect the value of the Series A Preferred Stock.

One of the factors that influences the price of the Series A Preferred Stock is the dividend yield on the Series A Preferred Stock (as a percentage of the market price of the Series A Preferred Stock) relative to market interest rates. Continued increase in market interest rates, which are currently at low levels relative to historical rates, may lead prospective purchasers of the Series A Preferred Stock to expect a higher dividend yield (and higher interest rates would likely increase our borrowing costs and potentially decrease funds available for dividend payments). Thus, higher market interest rates could cause the market price of the Series A Preferred Stock to materially decrease.

The special exchange right that the Series A Preferred Stock is entitled to may make it more difficult for a party to acquire us or discourage a party from acquiring us.

The Series A Preferred Stock special exchange right may have the effect of discouraging a third party from making an acquisition proposal for us or of delaying, deferring or preventing certain of our change of control transactions under circumstances that otherwise could provide the holders of our Series A Preferred Stock with the opportunity to realize a premium over the then-current market price of such equity securities or that stockholders may otherwise believe is in their best interests.

Holders of the Series A Preferred Stock may be unable to use the dividends-received deduction and may not be eligible for the preferential tax rates applicable to “qualified dividend income.”

Distributions paid to corporate U.S. holders of the Series A Preferred Stock may be eligible for the dividends-received deduction, and distributions paid to non-corporate U.S. holders of the Series A Preferred Stock may be subject to tax at the preferential tax rates applicable to “qualified dividend income,” if we have current or accumulated earnings and profits, as determined for U.S. federal income tax purposes. We do not currently have any accumulated earnings and profits. Additionally, we may not have sufficient current earnings and profits during future fiscal years for the distributions on the Series A Preferred Stock to qualify as dividends for U.S. federal income tax purposes. If the distributions fail to qualify as dividends, U.S. holders would be unable to use the dividends-received deduction and may not be eligible for the preferential tax rates applicable to “qualified dividend income.”

Holders of the Series A Preferred Stock may be subject to tax if we make or fail to make certain adjustments to the Exchange Rate of the Series A Preferred Stock even though you do not receive a corresponding cash dividend.

The exchange rate for the Series A Preferred Stock special exchange right is subject to adjustment in certain circumstances. A failure to adjust (or to adjust adequately) such exchange rate after an event that increases your proportionate interest in us could be treated as a deemed taxable dividend to you. If you are a non-U.S. holder, any deemed dividend may be subject to U.S. federal withholding tax at a 30% rate, or such lower rate as may be specified by an applicable treaty, which may be set off against subsequent payments on the Series A Preferred Stock. In April 2016, the Internal Revenue Service issued new proposed income tax regulations in regard to the taxability of changes in exchange rights that will apply to the Series A Preferred Stock when published in final form and may be applied to us before final publication in certain instances.

Our revenues, operating results and cash flows may fluctuate in future periods, and we may fail to meet investor expectations, which may cause the price of our Series A Preferred Stock to decline.

Variations in our quarterly and year-end operating results are difficult to predict, and our income and cash flows may fluctuate significantly from period to period. If our operating results fall below the expectations of investors or securities analysts, the price of our Series A Preferred Stock could decline substantially. Specific factors that may cause fluctuations in our operating results include:

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The Series A Preferred Stock represents perpetual equity interests in us, and it has no maturity or mandatory redemption date and are not redeemable at the option of investors under any circumstances. As a result, the Series A Preferred Stock will not give rise to a claim for payment of a principal amount at a particular date. As a result, holders of the Series A Preferred Stock may be required to bear the financial risks of an investment in the Series A Preferred Stock for an indefinite period of time. In addition, the Series A Preferred Stock will rank junior to all our current and future indebtedness and other liabilities. The Series A Preferred Stock will also rank junior to any other senior securities we may issue in the future with respect to assets available to satisfy claims against us.

The Series A Preferred Stock has not been rated.

We have not sought to obtain a rating for the Series A Preferred Stock. No assurance can be given, however, that one or more rating agencies might not independently determine to issue such a rating or that such a rating, if issued, would not adversely affect the market price of the Series A Preferred Stock. Also, we may elect in the future to obtain a rating for the Series A Preferred Stock, which could adversely affect the market price of the Series A Preferred Stock. Ratings only reflect the views of the rating agency or agencies issuing the ratings and such ratings could be revised downward, placed on a watch list or withdrawn entirely at the discretion of the issuing rating agency if in its judgment circumstances so warrant. Any such downward revision, placing on a watch list or withdrawal of a rating could have an adverse effect on the market price of the Series A Preferred Stock.

The market price of the Series A Preferred Stock could be substantially affected by various factors.

The market price of the Series A Preferred Stock depends on many factors, which may change from time to time, including:

prevailing interest rates, increases in which may have an adverse effect on the market price of the Series A Preferred Stock;
trading prices of similar securities;
our history of timely dividend payments;
the annual yield from dividends on the Series A Preferred Stock as compared to yields on other financial instruments;
general economic and financial market conditions;
government action or regulation;
the financial condition, performance and prospects of us and our competitors;
changes in financial estimates or recommendations by securities analysts with respect to us or our competitors in our industry;
our issuance of additional preferred equity or debt securities;
actual or anticipated variations in quarterly operating results of us and our competitors; and
the ongoing impact of the global COVID-19 pandemic.

As a result of these and other factors, holders of the Series A Preferred Stock may experience a decrease, which could be substantial and rapid, in the market price of the Series A Preferred Stock, including decreases unrelated to our operating performance or prospects.

A holder of Series A Preferred Stock has extremely limited voting rights.

The voting rights for a holder of Series A Preferred Stock are limited. Our shares of common stock are the only class of our securities that carry full voting rights. Voting rights for holders of the Series A Preferred Stock exist primarily with respect to voting on amendments to our certificate of incorporation, including the certificate of designations relating to the Series A Preferred Stock, that materially and adversely affect the rights of the holders of Series A Preferred Stock or authorize, increase or create additional classes or series of our capital stock that are senior to the Series A Preferred Stock. Other than the limited circumstances described in the Certificate of Designations establishing the Series A Preferred Stock and except to the extent required by law, holders of Series A Preferred Stock do not have any voting rights.

Risks related to our common stock

Failure to maintain effective internal controls could adversely affect our operating results and the market for our common stock.

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Section 404 of the Sarbanes-Oxley Act of 2002 requires that we maintain internal control over financial reporting that meets applicable standards. As with many smaller companies with small staff, material weaknesses in our financial controls and procedures may be discovered. If we are unable, or are perceived as unable, to produce reliable financial reports due to internal control deficiencies, investors could lose confidence in our reported financial information and operating results, which could result in a negative market reaction and adversely affect our ability to raise capital.


More than 51% of our outstanding common stock is beneficially owned by our chairman and chief executive officer, who has the ability to substantially influence the election of directors and other matters submitted to stockholders.

10,363,344 shares are beneficially held of record by Acuitas Group Holdings, LLC (“Acuitas”), whose sole managing member is our Chairman and Chief Executive Officer, which represents beneficial ownership of approximately 55% of our outstanding shares of common stock. As a result, he has and is expected to continue to have the ability to significantly influence the election of our Board of Directors and the outcome of all other matters submitted to our stockholders. His interest may not always coincide with our interests or the interests of other stockholders, and he may act in a manner that advances his best interests and not necessarily those of other stockholders. One consequence to this substantial influence or control is that it may be difficult for investors to remove management of our Company. It could also deter unsolicited takeovers, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices.

Our stock price may be subject to substantial volatility, and the value of our stockholders' investment may decline.

The price at which our common stock trades fluctuates as a result of a number of factors, including the number of shares available for sale in the market, quarterly variations in our operating results and actual or anticipated announcements of our Ontrak solution, announcements regarding new or discontinued Ontrak solution contracts, new products or services by us or competitors, regulatory investigations or determinations, acquisitions or strategic alliances by us or our competitors, recruitment or departures of key personnel, the gain or loss of significant customers, changes in the estimates of our operating performance, actual or threatened litigation, market conditions in our industry and the economy as a whole.

Numerous factors, including many over which we have no control, may have a significant impact on the market price of our common stock, including:

● announcements of new products or services by us or our competitors;
● current events affecting the political, economic and social situation in the United States;
● trends in our industry and the markets in which we operate;
● changes in financial estimates and recommendations by securities analysts;
● acquisitions and financings by us or our competitors;
● the gain or loss of a significant customer;
● quarterly variations in operating results;
● the operating and stock price performance of other companies that investors may consider to be comparable;
● purchases or sales of blocks of our securities; and
● issuances of stock.

We have used the market price of our common stock to establish future payment obligations to stockholders of acquisition targets in the past and may continue to do so in the future; any decline in the market price regardless of whether due to our performance or external market dynamics would give rise to a payment obligation to such holders. Furthermore, stockholders may initiate securities class action lawsuits if the market price of our stock drops significantly, which may cause us to incur substantial costs and could divert the time and attention of our management.

Future sales of common stock by existing stockholders, or the perception that such sales may occur, could depress our stock price.

The market price of our common stock could decline as a result of sales by, or the perceived possibility of sales by, our existing stockholders. Most of our outstanding shares are eligible for public resale pursuant to Rule 144 under the Securities Act of 1933, as amended. As of December 31, 2020, approximately 9.2 million shares of our common stock are held by our affiliates and may be sold pursuant to an effective registration statement or in accordance with the volume and other limitations of Rule 144 or pursuant to other exempt transactions. Future sales of common stock by significant stockholders, including those who acquired their shares in private placements or who are affiliates, or the perception that such sales may occur, could depress the price of our common stock.

Future issuances of common stock and hedging activities may depress the trading price of our common stock.

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Any future issuance of equity securities, including the issuance of shares upon direct registration, upon satisfaction of our obligations, compensation of vendors, exercise of outstanding warrants, or effectuation of a reverse stock split, could dilute the interests of our existing stockholders, and could substantially decrease the trading price of our common stock. As of December 31, 2020, we had outstanding options to purchase 3,616,314 shares of our common stock at exercise prices ranging from $7.50 to $60.16 per share and warrants to purchase 1,465,927 shares of our common stock at exercise prices ranging from $1.80 to $18.71 per share. Also, as of December 31, 2020, we had a total of 30,000 unvested RSUs outstanding. We may issue equity securities in the future for a number of reasons, including to finance our operations and business strategy, in connection with acquisitions, to adjust our ratio of debt to equity, to satisfy our obligations upon the exercise of outstanding warrants or options or for other reasons.

There may be future sales or other dilution of our equity, which may adversely affect the market price of our common stock.

In the future, we may need to raise additional funds through public or private financing, which might include sales of equity securities. The issuance of any additional shares of common stock or securities convertible into, exchangeable for, or that represent the right to receive common stock or the exercise of such securities could be substantially dilutive to holders of shares of our common stock. Holders of shares of our common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series. The market price of our common stock could decline as a result of sales of shares of our common stock made after this offering or the perception that such sales could occur. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their interests in our Company.

Provisions in our certificate of incorporation and Delaware law could discourage a change in control, or an acquisition of us by a third party, even if the acquisition would be favorable to you.

Our amended and restated certificate of incorporation and the Delaware General Corporation Law contain provisions (including the Section 382 Ownership Limit) that may have the effect of making more difficult or delaying attempts by others to obtain control of our Company, even when these attempts may be in the best interests of stockholders. In addition, our amended and restated certificate of incorporation authorizes our Board of Directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock. Delaware law also imposes conditions on certain business combination transactions with “interested stockholders.” These provisions and others that could be adopted in the future could deter unsolicited takeovers or delay or prevent changes in our control or management, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices. These provisions may also limit the ability of stockholders to approve transactions that they may deem to be in their best interests.

We do not expect to pay dividends in the foreseeable future.

We have paid no cash dividends on our common stock to date, and we intend to retain our future earnings, if any, to fund the continued development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future on our common stock. Further, any payment of cash dividends will also depend on our financial condition, results of operations, capital requirements and other factors, including contractual restrictions to which we may be subject, and will be at the discretion of our Board of Directors.

The exercise of our outstanding warrants may result in a dilution of our current stockholders' voting power and an increase in the number of shares eligible for future resale in the public market, which may negatively impact the market price of our stock.

The exercise of some or all of our outstanding warrants could significantly dilute the ownership interests of our existing stockholders. As of December 31, 2020, we had outstanding warrants to purchase an aggregate of 1,465,927 shares of common stock at exercise prices ranging from $1.80 to $18.71 per share. To the extent warrants are exercised, additional shares of common stock will be issued, and such issuance may dilute existing stockholders and increase the number of shares eligible for resale in the public market. Sales of substantial numbers of such shares in the public market could adversely affect the market price of our shares.


ITEM 1B.    UNRESOLVED STAFF COMMENTS
Not Applicable.
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ITEM 2.    PROPERTIES
Our principal executive and administrative offices are located in leased office space in Santa Monica, California. We believe that the current office space is adequate to meet our needs.
ITEM 3.    LEGAL PROCEEDINGS
From time to time, we are subject to various legal proceedings that arise in the normal course of our business activities. As of the date of this Annual Report on Form 10-K, we are not a party to any litigation the outcome of which, if determined adversely to us, would individually or in the aggregate be reasonably expected to have a material adverse effect on our results of operations or financial position, except for the following:
Loss Contingency

On March 3, 2021, a purported securities class action was filed in the United States District Court for the Central District of California, entitled Farhar v. Ontrak, Inc., Case No. 2:21-cv-01987 (C.D. Cal. filed Mar. 3, 2021). In this action, plaintiff, purportedly on behalf of a putative class of purchasers of Ontrak securities from November 5, 2020 through February 26, 2021, alleges that the Company and certain of its officers violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, by intentionally or recklessly making false and/or misleading statements and/or failing to disclose that (i) Ontrak’s largest customer evaluated Ontrak on a provider basis, valuing Ontrak’s performance based on achieving the lowest cost per medical visit rather than clinical outcomes or medical cost savings; (ii) as a result, Ontrak’s largest customer did not find Ontrak’s program to be effective and was reasonably likely to terminate its contract with Ontrak; (iii) because this customer accounted for a significant portion of Ontrak’s revenue, loss of the customer would have an outsized impact on Ontrak’s financial results; and (iv) as a result of the foregoing, Ontrak’s positive statements about its business, operations and prospects were materially misleading and/or lacked a reasonable basis. The complaint has not yet been served. We believe that the allegations lack merit and intend to defend against this action vigorously.

ITEM 4.    MINE SAFETY DISCLOSURES
Not Applicable.


PART II

ITEM 5.    MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is traded on the NASDAQ Global Market under the symbol "OTRK."
Holders
As of March 3, 2021, there were approximately 41 stockholders of record of our common stock.
Securities Authorized for Issuance under Equity Compensation Plans
Information regarding compensation plans under which equity securities may be issued is included in Item 12 of Part III of this report through incorporation by reference to our definitive proxy statement to be filed in connection with our 2021 Annual Meeting of Stockholders.
Unregistered Sales of Securities
All sales of unregistered securities during the year ended December 31, 2020 were previously disclosed in a Quarterly Report on Form 10-Q or Current Report on Form 8-K, except as follows:
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In November and December 2020, we issued a total of 74,984 unregistered, restricted shares of our common stock as partial consideration for our acquisition of LifeDojo Inc. We issued these shares in reliance upon Section 4(a)(2) of the Securities Act as a transaction by an issuer not involving a public offering.
Issuer Purchase of Equity Securities
None.
ITEM 6.    SELECTED FINANCIAL DATA
Not applicable.
ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements that involve a variety of risks and uncertainties, many of which are beyond our control, which may cause our actual results to differ materially from those discussed. These factors include, among others, limited operating history, difficulty in developing, exploiting and protecting proprietary technologies, intense competition and substantial regulation in the healthcare industry. Additional information concerning factors that could cause or contribute to such differences can be found in the following discussion, as well as in Item 1A. -“Risk Factors.”
OVERVIEW
General
Ontrak is a leading AI-powered and telehealth-enabled, virtualized healthcare company. We harness proprietary big data predictive analytics, artificial intelligence and telehealth, combined with human interaction, to deliver improved member health and cost savings to health plans. We identify, engage and treat health plan members with unaddressed behavioral health conditions that worsen medical comorbidities. Our mission is to help improve the health and save the lives of as many people as possible.
We apply advanced data analytics and predictive modeling to identify members with untreated behavioral health conditions, whether diagnosed or not, and coexisting medical conditions that may be impacted through treatment in the Ontrak™ program. We then uniquely engage health plan members who do not typically seek behavioral healthcare by leveraging proprietary enrollment capabilities built on deep insights into the drivers of care avoidance. Our technology enabled Ontrak program is an integrated suite of services that includes evidence-based psychosocial and medical interventions delivered either in-person or via telehealth, along with care coaching and in-market community care coordinators who address the social and environmental determinants of health, including loneliness. We believe that the Company's programs seek to improve member health and deliver validated cost savings of more than 50% for enrolled members to healthcare payors.
We operate as one segment in the United States and we have contracted with leading national and regional health plans to make the Ontrak program available to eligible members in 30 states, as well as the nation's capital.

Recent Developments
Acquisition

On October 28, 2020, we completed the acquisition of LifeDojo Inc. (“LifeDojo”), a comprehensive, science-backed behavior change platform based in San Francisco, California, for total consideration of approximately $8.9 million, including $3.4 million in cash payment, 75,000 shares of our common stock (of which 74,984 shares were issued and 16 fractional shares were settled in cash) worth approximately $5.0 million at close, as well as certain contingent consideration based on a computation, as defined in the merger agreement, in the event the daily closing price per share of our common stock falls below a specified target price of $60 on two consecutive trading days during a six month period beginning on the sixth month anniversary to the twelfth month anniversary of the closing date of the acquisition (measurement period). As of October 28, 2020, we determined that the fair value of this contingent consideration was $0.5 million. The contingent consideration amount, if any, is generally payable within five
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business days following completion of the measurement period. LifeDojo provides online behavior change and wellness programs, using a combination of coaching and mobile apps to help members form health habits and change health behaviors.
Preferred Stock Offering

In 2020, we completed the offering of a total of 3,770,265 shares of 9.50% Series A Cumulative Perpetual Preferred Stock (the "Series A Preferred Stock"), resulting in aggregate gross proceeds of $93.8 million to the Company (or $86.6 million net of underwriting fees and other offering expenses). The Series A Preferred Stock is listed on the Nasdaq Global Market under the symbol "OTRKP." We generally may not redeem the Series A Preferred Stock until August 25, 2025, except upon the occurrence of a Delisting Event or Change of Control (as defined in the Certificate of Designations establishing the Series A Preferred Stock), and on and after August 25, 2025, we may, at our option, redeem the Series A Preferred Stock, in whole, at any time, or in part, from time to time, for cash at a redemption price of $25.00 per share, plus any accrued and unpaid dividends. The Series A Preferred Stock has no maturity date and will remain outstanding indefinitely unless redeemed by us or exchanged for shares of common stock in connection with a Delisting Event or Change of Control. Holders of Series A Preferred Stock generally have no voting rights, but will have limited voting rights if we fail to pay dividends for six or more quarters, whether or not declared or consecutive) and in certain other events.

We used a portion of the net proceeds of the initial offering to fund a segregated dividend account for the payments of the first eight quarterly dividend payments on the Series A Preferred Stock and intends to use the remaining net proceeds for general corporate purposes, which may include working capital, M&A and investments in technology.

Holders of Series A Preferred Stock of record at the close of business of each respective record date (February 15, May 15, August 15 and November 15) are entitled to receive, when, as and if declared by our Board of Directors, out of funds legally available for the payment of dividends, cumulative cash dividends at the rate of 9.50% per annum of the $25.00 per share liquidation preference (equivalent to $2.375 per annum per share). Dividends, if and when declared by our Board of Directors, are payable quarterly in arrears, every February 28, May 30, August 31, and November 30, as applicable, beginning on or about November 30, 2020. Dividends will accumulate and be cumulative from, and including, the date of original issuance, which was August 25, 2020.

On November 11, 2020, our Board of Directors declared the first quarterly dividend on the Company's Series A Preferred Stock for shareholders of record as of the close of business on November 15, 2020. The first quarterly cash dividend equaled $0.6333333 per share, representing more than a full quarter as it covered the period from, and including, the first date we issued the Series A Preferred Shares, at 9.50% per annum of liquidation preference of $25.00 per share. As such, we paid cash dividends of $1.2 million on November 30, 2020. At December 31, 2020, we had undeclared dividends of $0.7 million.
Company Name and Ticker Symbol Change
On July 6, 2020, we changed our corporate name from Catasys, Inc. to Ontrak, Inc. and changed our NASDAQ ticker symbol from CATS to OTRK effective July 7, 2020. We believe the change in our name leverages our national brand recognition of the Company's Ontrak solutions among our health plan members, health plan customers and network of behavioral health providers.
Customer Notification

On February 26, 2021, we were notified by our largest customer that the participation status with this customer will be terminated effective June 26, 2021. We have been advised to stop enrollment of new members for this customer and await guidance from the customer on transition plans for the 8,100 members who are currently benefiting from the Ontrak program. For the year ended December 31, 2020, this customer accounted for approximately 58% of our total revenue
Metrics
The following table sets forth our key metrics that we use to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make strategic decisions:
Revenue. Our revenues are mostly generated from fees charged to health plan customers related to health plan members enrolled in our Ontrak program. Our contracts are generally designed to provide cash fees to us on a monthly basis, an upfront case rate, or fee for service based on enrolled members. Our performance obligation is satisfied over the length of the Ontrak program as our services our delivered.
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Effective Outreach Pool. Our Effective Outreach Pool represents individuals insured by our health plan customers who have been identified through our advanced data analytics and predictive modeling with untreated behavioral health conditions that may be impacted through enrollment in the Ontrak program.
Cash flow from operations. Our current business activities result in an outflow of cash flow from operations as we invest strategically into our business to help continue the growth of our operations.

Year Ended December 31,
(in thousands, except outreach pool)20202019Change% Change
Revenue$82,837 $35,095 $47,742 136 %
Effective outreach pool152,000 108,000 44,000 41 %
Cash flow from operations$(6,282)$(16,901)$10,619 63 %
Key Components of Our Results of Operations
Revenue

Revenue from contracts with customers is recognized when, or as, we satisfy our performance obligations by transferring the promised goods or services to the customers. Revenue from a performance obligation satisfied over time is recognized by measuring our progress in satisfying the performance obligation in a manner that depicts the transfer of the goods or services to the customer. Revenue related to health plan customers whose health plan members are enrolled in our program is recognized over the enrollment period of the program.

Cost of Revenue

Cost of healthcare services consists primarily of salaries related to our care coaches, member engagement specialists and other staff directly involved in member care, healthcare provider claims payments and related processing fees, and other direct costs incurred to serve our health plan customers. All costs are recognized in the period in which an eligible member receives services.

Operating Expenses

Our operating expenses consist of our sales and marketing, research and development and general and administrative expenses. Sales and marketing expenses consist primarily of personnel and related expenses for our sales and marketing staff, including salaries, benefits, bonuses, stock-based compensation and commissions, and costs of marketing and promotional events, corporate communications, online marketing, product marketing and other brand-building activities. All advertising related costs are expense as incurred. Research and development expenses consist primarily of personnel and related expenses for our engineers and software development staff, including salaries, benefits, bonuses and stock-based compensation, and the cost of certain third-party service providers. Research and development costs are expensed as incurred. General and administrative expenses consist primarily of personnel and related expenses for administrative, legal, finance and human resource staff, including salaries, benefits, bonuses and stock-based compensation, professional fees, insurance premiums, and other corporate expenses.

Interest Expense, net

Interest expense consists primarily of interest expense from our note agreements, accretion of debt discount, amortization of debt issuance costs and finance leases.
Other Income (Expense), net

Other income (expense) consists of gains (losses) associated with changes in fair value of warrant and contingent liabilities, debt termination costs and write-off of deferred debt issuance costs associated with loan payoff, as well as other miscellaneous income (expense).
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Results of Operations
The table below and the discussion that follows summarize our results of operations for each of the periods indicated (in thousands):

Year Ended December 31,
20202019
Revenue$82,837 $35,095 
Cost of revenue43,603 20,408 
Gross profit39,234 14,687 
Operating expenses:
   Research and development12,923 5,439 
   Sales and marketing4,525 4,735 
   General and administrative36,709 24,527 
Total operating expenses54,157 34,701 
Operating loss(14,923)(20,014)
Other expense, net(1,213)(2,598)
Interest expense, net(7,219)(3,047)
Loss before income taxes(23,355)(25,659)
Income tax benefit645 — 
Net loss$(22,710)$(25,659)

Revenue
The mix of our revenues between commercial and government insured members remained consistent year over year. The following table sets forth our sources of revenue for each of the periods indicated:
Year Ended December 31,
(in thousands, except percentages)20202019ChangeChange %
Commercial revenue$47,741 $21,753 $25,988 119 %
Percentage of commercial revenue to total revenue58 %62 %(4)%
Government revenue$35,096 $13,342 $21,754 163 %
Percentage of government revenue to total revenue42 %38 %%
Total revenue$82,837 $35,095 $47,742 136 %
Revenue increased $47.7 million, or 136%, in 2020 as compared to 2019. Enrolled members increased by 8,706 as of December 31, 2020 compared to December 31, 2019, or 124%. These increases were attributable to the continued expansion of our Ontrak program with our existing health plan customers, including the Ontrak-A Program expansions in the first half of 2020 for a national health plan in nine states, including Washington D.C., and the Ontrak-CI Program expansion launched in October 2020 for a national health plan in 13 states, as well as the increase in our enrolled members from existing and new health plans. Revenues relating to our expansion health plan members are generally billed up front for the Ontrak program's annual fee based on enrolled members and contributed to an increase in our deferred revenue at December 31, 2020, which we expect to recognize as revenue over the related service performance period. Our deferred revenue increased by $15.2 million, or 261%, as of December 31, 2020 compared to the same period last year.


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Cost of Revenue, Gross Profit and Gross Profit Margin

Year Ended December 31,
(in thousands, except percentages)20202019Change% Change
Cost of revenue$43,603 $20,408 $23,195 114 %
Gross profit39,234 14,687 24,547 167 
Gross profit margin47 %42 %%
Cost of revenue increased $23.2 million, or 114%, in 2020 as compared to 2019. The increase in cost of revenue was primarily due to a $13.6 million increase in member facing headcount and a $9.5 million increase in provider related costs as well as third party administrators for processing claims. Our member facing headcount, which includes our care coaches and member engagement specialists, increased by 229, or 89%, to 486 as of December 31, 2020 compared to the same period last year.
Gross profit and gross profit margin increased by $24.5 million and 5%, respectively, in 2020 as compared to 2019. The increase in gross profit was primarily due to the increase in our revenue discussed above. The increase in gross profit margin was primarily related to an improvement in hourly compensation costs and member related material printing costs as a percent of revenue, partially offset by an increase in costs for member visit claims from healthcare providers.
We expect our cost of revenue to increase as our revenue increases, but expect our gross margin to increase over time as we optimize the efficiency of our operations and continue to scale our business.
Operating Expenses

Year Ended December 31,
(in thousands, except percentages)20202019Change% Change
Operating expenses:
   Research and development$12,923 $5,439 $7,484 138 %
   Sales and marketing4,525 4,735 (210)(4)
   General and administrative36,709 24,527 12,182 50 
Total operating expenses$54,157 $34,701 $19,456 56 
Operating loss$(14,923)$(20,014)$5,091 (25)%
Operating loss margin(18.0)%(57.0)%39.0 %
Total operating expense increased $19.5 million, or 56%, in 2020 as compared to 2019. The increase in operating expenses was primarily due to a $12.2 million increase in our general and administrative costs, which was primarily related to $9.1 million of higher employee-related costs related to higher headcount and $3.6 million of higher vendor related costs to support our growing operations. In addition, the increase in operating expenses included a $7.5 million increase in our research and development costs, which was primarily related to an increase of $5.5 million in employee-related costs and a $1.3 million increase in professional consulting costs, as we invest in continued enhancement of our technology and related tools to support the growth of our business.
We expect our operating expenses to increase for the foreseeable future as we continue to make investments in the growth of our business, but we expect our operating expenses to decrease as a percentage of revenue over time. Our operating expenses may fluctuate as a percentage of our total revenue from period to period due to the timing and extent of our operating and strategic initiatives.
Other Expense, net
Year Ended December 31,
(in thousands, except percentages)20202019Change% Change
Other expense, net$1,213 $2,598 $(1,385)(53)%
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Other expense, net decreased $1.4 million, or 53%, in 2020 as compared to 2019. The decrease in other expense, net was primarily due to $2.6 million of debt termination related costs as well as write-off of debt issuance costs related to the repayment and termination of our 2022 Loan in 2019, partially offset by the $1.2 million increase in loss related to the change in fair value of the warrant liability in 2020.
Interest Expense, net
Year Ended December 31,
(in thousands, except percentages)20202019Change% Change
Interest expense, net$7,219 $3,047 $4,172 137 %
Interest expense, net increased $4.2 million, or 137%, in 2020 as compared to 2019. The increase in interest expenses was primarily due to interest and debt discount amortization expense related to our 2024 Notes entered into in September 2019, as well as higher average outstanding loan balance in 2020 compared to 2019.
Income Tax Benefit
Income tax benefit for the year ended December 31, 2020 was $0.6 million, which was a result of the deferred tax liability recorded at the time of the LifeDojo acquisition that was subsequently reversed at December 31, 2020. There were no income tax benefit for the year ended December 31, 2019.
Liquidity and Capital Resources
Cash and restricted cash was $103.2 million as of December 31, 2020. We had working capital of approximately $87.2 million as of December 31, 2020. We have incurred significant net losses and negative operating cash flows since our inception. We expect our current cash resources to cover expenses through at least the next twelve months from the filing date of this Form 10-K. 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 enroll in the Ontrak program. We operate our Ontrak solutions in 30 states, as well as the nation's capital. We provide services to commercial (employer funded), managed Medicare Advantage, managed Medicaid and duel eligible (Medicare and Medicaid) populations.
Historically, we have seen and continue to see net losses, net loss from operations, negative cash flow from operating activities, and historical working capital deficits as we continue through a period of rapid growth. The accompanying consolidated financial statements do not reflect any adjustments that might result if we were unable to continue as a going concern. We have alleviated substantial doubt by both entering into contracts for additional revenue-generating health plan customers and expanding our Ontrak program within existing health plan customers as well as completing debt and equity financings totaling approximately $87 million and $10 million, respectively, in 2020. To support this increased demand for services, we invested and will continue to invest in additional headcount and enhancements to technology needed to support the anticipated growth. Additional management plans include increasing the effective outreach pool as well as improving our current enrollment rate. We will continue to explore ways to increase operational efficiencies resulting in increase in margins on both existing and new members.
We have a growing customer base and believe we are able to fully scale our operations to service the contracts and future enrollment providing leverage in these investments that will generate positive cash flow by in the near future. We believe we will have enough capital to cover expenses through the foreseeable future and we will continue to monitor liquidity. If we add more health plans than budgeted, increase the size of the outreach pool by more than we anticipate, decide to invest in new products or seek out additional growth opportunities, we would consider financing these options with either a debt or equity financing.
The following table sets forth a summary of our cash flows for the periods indicated (in thousands):

Year Ended December 31,
20202019
Net cash used in operating activities$(6,282)$(16,901)
Net cash used in investing activities(4,638)— 
Net cash provided by financing activities100,112 27,349 
      Net increase in cash and restricted cash$89,192 $10,448 
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We used $6.3 million of cash from operating activities during the year ended December 31, 2020 compared with $16.9 million during the same period in 2019. The $10.6 million decrease in net cash used in operating activities in 2020 primarily relates to decreased in net loss related to higher revenue in 2020 resulting from 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, and increased non-cash expenses in 2020 such as payment in-kind interest and stock-based compensation expense in 2020 compared to 2019, as well as an increase in deferred revenue, partially offset by an increase in accounts receivable, related to the Ontrak-CI expansion in the fourth quarter of 2020.
Net cash used in investing activities in 2020 was $4.6 million and none in the year ended December 31, 2019. The $4.6 million of net cash used in investing activities includes $2.9 million relating to the acquisition of LifeDojo in October 2020 and $1.7 million of capital expenditures, which were primarily related to capitalized software development costs and purchases of computer equipment. We anticipate that software development costs and capital expenditures will increase in the future as we continue our investment in our IT infrastructure as well as replace our computer systems that are reaching the end of their useful lives, increase equipment to support our increased number of enrolled members, and enhance the reliability and security of our systems. These future capital expenditure requirements will also depend upon many factors, including obsolescence or failure of our systems, progress with expanding the adoption of our solutions, number of member facing employees needed based on the growth of our enrolled members 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 $100.1 million for the year ended December 31, 2020, compared with net cash provided by financing activities of $27.3 million for the year ended December 31, 2019. Net cash provided by financing activities for the year ended December 31, 2020 was primarily related to $87.4 million of total proceeds from the issuance of our Series A Preferred Stock, $10.0 million of proceeds from the issuance of the remaining 2024 Notes and $6.2 million of proceeds received from stock option exercises, partially offset by a $1.2 million dividend payment on our Series A Preferred Stock and $1.2 million of payments on our financed insurance premiums. Net cash provided by financing activities for the year ended December 31, 2019 consisted of the gross proceeds from the issuance of debt in the amount of $44 million, proceeds from option exercises of $1.9 million and warrant exercises of $1.1 million, partially offset by loan repayment of $16.9 million, debt issuance costs of $2.8 million and debt termination costs of $2.0 million.
As a result of the above, our total cash and cash equivalents, including restricted cash of $16.3 million, was $103.2 million as of December 31, 2020.
We expect our current cash resources to cover our operations through at least the next twelve months, however, delays in cash collections, revenue, or unforeseen expenditures could impact this estimate.
Debt
See Note 8 of the Notes to the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K for a detailed discussion about our debt.
Preferred Stock Offering
See Note 7 of the Notes to the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K for a detailed discussion about our preferred stock offering and related preferred stock dividends.
Off-Balance Sheet Arrangements
As of December 31, 2020, we had no off-balance sheet arrangements.
Critical Accounting Policy and 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
29

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 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.
Revenue Recognition
The Company generates virtual healthcare service revenue from contracts with customers as it satisfies its performance obligations to customers and their members enrolled in our Ontrak program. The virtual healthcare service is transferred to a customer when, or as, the customer obtains control of that 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 progress in a manner that depicts the transfer of services to the customer. Revenue from a performance obligation satisfied at a point in time is recognized at the point in time that the Company determines the customer obtains control over the promised service. The amount of revenue recognized reflects the consideration the Company expects to be entitled to in exchange for those promised services (i.e., the “transaction price”). In determining the transaction price, the Company considers multiple factors, including identification of the performance obligation and 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, the Company considers the range of possible outcomes, the predictive value of past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside the Company's influence, such as the judgment and actions of third parties.
Cost of Revenue
Cost of revenue consists primarily of salaries related to our care coaches, outreach specialists and other staff directly involved in member care, healthcare provider claims payments and related processing fees and other direct costs incurred in delivering our performance obligation. Salaries and fees charged by our third party administrators for processing claims are expensed in the period in which an eligible member receives services.
Cash and Cash Equivalents
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. The deposited cash exceeds Federal Deposit Insurance Corporation insured limits. We cannot provide assurance that we will not experience losses on these deposits.
Commissions
We defer commissions paid to our sales force and engagement specialists as these amounts are incremental costs of obtaining a contract with a customer and are recoverable from future revenue that gave rise to the commissions. Commissions for initial contracts and member enrollments are deferred on the consolidated balance sheets and amortized on a straight-line basis over a period of benefit that has been determined to be six years and one year, respectively.
Share-Based Compensation
Stock Options and Restricted Stock Units – 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 RSU awards based on the closing stock price of our common shares on the date of grant. We estimate the fair value of shares for stock option 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. We recognize forfeitures when they occur.
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Stock Options and Warrants – Non-employees
We account for the issuance of stock options and warrants for services from non-employees by estimating the fair value of stock options and warrants issued using the Black-Scholes pricing model. This model’s calculations incorporate the exercise price, the market price of shares on grant date, the weighted average risk-free interest rate, expected life of the option or warrant, expected volatility of our stock and 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.
Income Taxes
We account for income taxes using the liability method in accordance with Accounting Standards Committee (“ASC”) 740 “Income Taxes.” To date, no current income tax liability has been recorded due to our accumulated net losses. Deferred tax assets and liabilities are recognized for temporary differences between the financial statement carrying amounts of assets and liabilities and the amounts that are reported in the tax returns. Deferred tax assets and liabilities are recorded on a net basis; however, our net deferred tax assets have been fully reserved by a valuation allowance due to the uncertainty of our ability to realize future taxable income and to recover our net deferred tax assets.
Recently Issued or Newly Adopted Accounting Pronouncements
For information regarding recent accounting pronouncements adopted and under evaluation, refer to Note 2 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.
ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements and related financial information required to be filed hereunder are indexed under Item 15 of this report and are incorporated herein by reference.
ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.    CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We have evaluated, with the participation of our principal executive officer and our principal financial officer, the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K. 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
There were no changes in our internal controls over financial reporting during the fourth quarter of our year ended December 31, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Management's Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) and for assessing the effectiveness of our internal control over financial reporting. Our internal control system is designed to provide reasonable assurance to our management and Board of Directors regarding the preparation and fair presentation of published financial statements in accordance with United States generally accepted accounting principles (GAAP).
Our internal control over financial reporting is supported by written policies and procedures that:
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP and that our receipts and expenditures are being made only in accordance with authorizations of our management and our Board of Directors; and
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2020, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013). Management's assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of our internal control over financial reporting. Based upon this assessment, our management believes that, as of December 31, 2020, our internal control over financial reporting was effective based on those criteria.
Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions and that the degree of compliance with the policies or procedures may deteriorate.

Auditor’s Report on Internal Control over Financial Reporting

This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report.
ITEM 9B.    OTHER INFORMATION
None.

PART III

ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item will be included in our Proxy Statement for the 2021 Annual Meeting of Stockholders to be filed with the SEC within 120 days of the fiscal year ended December 31, 2020, and is incorporated herein by reference.

ITEM 11.    EXECUTIVE COMPENSATION
The information required by this item will be included in our Proxy Statement for the 2021 Annual Meeting of Stockholders to be filed with the SEC within 120 days of the fiscal year ended December 31, 2020, and is incorporated herein by reference.

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ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item will be included in our Proxy Statement for the 2021 Annual Meeting of Stockholders to be filed with the SEC within 120 days of the fiscal year ended December 31, 2020, and is incorporated herein by reference.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item will be included in our Proxy Statement for the 2021 Annual Meeting of Stockholders to be filed with the SEC within 120 days of the fiscal year ended December 31, 2020, and is incorporated herein by reference.

ITEM 14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item will be included in our Proxy Statement for the 2021 Annual Meeting of Stockholders to be filed with the SEC within 120 days of the fiscal year ended December 31, 2020, and is incorporated herein by reference.



PART IV

ITEM 15.    EXHIBIT AND FINANCIAL STATEMENT SCHEDULES
(a)(1),(2) Financial Statements
The Financial Statements and Financial Statement Schedules listed on page F-1 of this document are filed as part of this filing.
(a)(3)     Exhibits
The following exhibits are filed as part of this report:
Exhibit
No.
Description
3.1
3.2
3.3
3.4
3.5
3.6
4.1
4.2
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4.3
4.4
4.5
4.6*
10.1#
10.2#
10.3#
10.4#
10.5#
10.6
10.7
10.8
10.9
10.10
10.11
10.12#
10.13#
10.14#
10.15#
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____________________________
*    Filed herewith.
**    Furnished herewith.
#    Management contract or compensatory plan or arrangement.

ITEM 16.    FORM 10-K SUMMARY
Not applicable
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ONTRAK, INC.
Date: March 9, 2021By:/s/ TERREN S. PEIZER
Terren S. Peizer
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

SignatureTitle(s)Date
/s/ TERREN S. PEIZERChairman of the Board of DirectorsMarch 9, 2021
Terren S. Peizerand Chief Executive Officer
(Principal Executive Officer)
/s/ CURTIS MEDEIROSPresident, Chief Operating Officer March 9, 2021
Curtis Medeiros 
/s/ BRANDON H. LAVERNEChief Financial OfficerMarch 9, 2021
Brandon H. LaVerne(Principal Financial and 
Accounting Officer)
/s/ RICHARD A. BERMANDirectorMarch 9, 2021
Richard Berman
/s/ EDWARD ZECCHINIDirectorMarch 9, 2021
Edward Zecchini
/s/ MICHAEL SHERMANDirectorMarch 9, 2021
Michael Sherman
/s/ ROBERT REBAKDirectorMarch 9, 2021
Robert Rebak
/s/ GUSTAVO GIRALDODirectorMarch 9, 2021
Gustavo Giraldo
/s/ DIANE SELOFFDirectorMarch 9, 2021
Diane Seloff
/s/ KATHERINE QUINNDirectorMarch 9, 2021
Katherine Quinn

36

ONTRAK, INC.
Index to Consolidated Financial Statements and Financial Statement Schedules
Financial Statements


Financial Statement Schedules
All financial statement schedules are omitted as they are either not applicable or the information required is presented in the consolidated financial statements and notes thereto included in this Form 10-K.

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders of Ontrak, Inc., f/k/a Catasys, Inc.


Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Ontrak, Inc., f/k/a Catasys, Inc. and Subsidiaries (the “Company”) as of December 31, 2020 and 2019, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the years then ended, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2020 and 2019, and the consolidated results of their operations and their cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Calculation of variable consideration related to price concessions

As described further in Note 2 to the financial statements, the variable contract revenue is recognized at the amount that reflects the consideration the Company expects to receive in exchange for providing services directly to customers. The transaction price of the Company’s revenue contract is variable as it is calculated net of estimated price concessions. Management estimates the value of variable consideration based upon historical experience and other factors, including evaluation of expected adjustments, past adjustments and collection experience in relation to amounts billed, current contract and reimbursement terms. As disclosed by Management, the evaluation of these historical and other factors involves complex, subjective judgements.

We identified the calculation of variable consideration related to price concessions as a critical audit matter due to the significant judgment and estimation required by management in their process. These estimates require the consideration of key assumptions such as insurance coverage levels which has estimation uncertainty. This in turn led to a high degree of auditor judgment, subjectivity and effort in applying the procedures related to those assumptions.

F-2

Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures also included, among others, (i) obtaining an understanding of management’s process and evaluating the design of controls over management’s calculation of variable consideration related to price concessions, as well as the relevance and use of historical experience data as an input into the estimate, (ii) testing the completeness and accuracy of the input data, (iii) evaluating the historical accuracy of management’s process for developing the estimate of the amount which will ultimately be collected and (iv) developing an independent expectation of the amount expected to be collected. We used a retrospective approach that includes historical sales and collection data in developing our independent expectations and in testing management’s process.




/s/ EisnerAmper LLP


We have served as the Company’s auditor since 2018.


EISNERAMPER LLP
Iselin, New Jersey
March 9, 2021







F-3

ONTRAK, INC.
Consolidated Balance Sheets
(in thousands, except share and per share data)
December 31,
20202019
Assets
Current assets:
   Cash and cash equivalents$86,907 $13,610 
   Restricted cash - current9,127 
   Receivables, net16,682 3,615 
   Unbilled receivables4,426 2,093 
   Deferred costs - current2,352 341 
   Prepaid expenses and other current assets4,144 733 
Total current assets123,638 20,392 
Long-term assets:
   Property and equipment, net2,273 528 
   Restricted cash - long-term7,176 408 
   Goodwill5,727 
   Intangible assets, net3,561 
   Other assets367 112 
   Operating lease right-of-use asset1,959 2,415 
Total assets$144,701 $23,855 
Liabilities and stockholders' equity (deficit)
Current liabilities:
   Accounts payable$1,287 $1,385 
   Accrued compensation and benefits4,723 3,640 
   Deferred revenue20,954 5,803 
   Current portion of operating lease liability434 374 
   Other accrued liabilities9,012 2,205 
Warrant liabilities691 
Total current liabilities36,410 14,098 
Long-term liabilities:
   Long-term debt, net45,719 31,597 
   Long-term operating lease liability1,403 1,836 
   Long-term finance lease liabilities418 233 
Total liabilities83,950 47,764 
Commitments and contingencies00
Stockholders' equity (deficit):
   Preferred stock, $0.0001 par value; 50,000,000 shares authorized; 3,770,265 and 0 shares issued and outstanding at December 31, 2020 and 2019, respectively
   Common stock, $0.0001 par value, 500,000,000 shares authorized; 17,543,218 and
  16,616,165 shares issued and outstanding at December 31, 2020 and 2019, respectively
  Additional paid-in capital414,773 307,403 
  Accumulated deficit(354,024)(331,314)
Total stockholders' equity (deficit)60,751 (23,909)
Total liabilities and stockholders' equity (deficit)$144,701 $23,855 
See accompanying notes to the consolidated financial statements.
F-4

ONTRAK, INC.
Consolidated Statements of Operations
(in thousands, except per share data)
Year Ended December 31,
20202019
Revenue$82,837 $35,095 
Cost of revenue43,603 20,408 
Gross profit39,234 14,687 
Operating expenses:
   Research and development12,923 5,439 
   Sales and marketing4,525 4,735 
   General and administrative36,709 24,527 
Total operating expenses54,157 34,701 
Operating loss(14,923)(20,014)
Other expense, net(1,213)(2,598)
Interest expense, net(7,219)(3,047)
Loss before income taxes$(23,355)$(25,659)
Income tax benefit645 
Net loss(22,710)(25,659)
Dividends on preferred stock - declared and undeclared(1,987)
Net loss attributable to common stockholders$(24,697)$(25,659)
Net loss per common share - basic and diluted$(1.44)$(1.56)
Weighted-average common shares outstanding - basic and diluted17,112 16,418 
See accompanying notes to the consolidated financial statements.
F-5

ONTRAK, INC.
Consolidated Statements of Stockholders' Equity (Deficit)
(in thousands, except share and per share data)
Preferred StockCommon StockAdditional
Paid-In
Capital
Accumulated
Deficit
Total Stockholders'
Equity (Deficit)
SharesAmountSharesAmount
Balance at December 31, 2018 $ 16,185,146 $2 $296,688 $(305,655)$(8,965)
Reclassification of warrant liability to equity upon adoption of ASU 2017-11— — — — 86 — 86 
Warrants exercised— — 232,461 — 1,128 — 1,128 
Warrants issued for services— — — — 2,397 — 2,397 
Stock options exercised— — 195,351 — 1,894 — 1,894 
Stock-based compensation expense— — 3,207 — 5,210 — 5,210 
Net loss— — — — — (25,659)(25,659)
Balance at December 31, 20190 $0 16,616,165 $2 $307,403 $(331,314)$(23,909)
Preferred stock issued, net3,770,265 — — 86,553 — 86,553 
Preferred dividends declared— — — — (1,241)— (1,241)
Stock issued in acquisition— — 74,984 — 5,035 — 5,035 
Warrants exercised— — 72,112 — 133 — 133 
Reclassification of warrant liability to equity— — — — 1,924 — 1,924 
Stock options exercised— — 737,281 — 6,171 — 6,171 
401(k) employer match— — 16,952 — 669 — 669 
Stock-based compensation expense— — 25,724 — 8,126 — 8,126 
Net loss— — — — — (22,710)(22,710)
Balance at December 31, 20203,770,265 $0 17,543,218 $2 $414,773 $(354,024)$60,751 

See accompanying notes to the consolidated financial statements.
F-6

ONTRAK, INC.
Consolidated Statements of Cash Flows
(in thousands)
Year Ended December 31,
20202019
Cash flows from operating activities
Net loss$(22,710)$(25,659)
Adjustments to reconcile net loss to net cash used in operating activities:
          Stock-based compensation expense8,126 5,210 
          Write-off of debt issuance costs1,505 
           Paid-in-kind interest expense3,500 
           Depreciation303 133 
          Amortization1,624 696 
          Deferred taxes(654)
          Warrants issued for services43 
          Change in fair value of warrants1,233 60 
          Change in fair value of contingent consideration(20)
          401(k) employer match in common shares691 
          Deferred rent(26)
          Changes in operating assets and liabilities:
                    Receivables(13,014)(2,233)
                    Unbilled receivables(2,333)(2,093)
                    Prepaid and other assets(5,677)(246)
                    Accounts payable(175)888 
                    Deferred revenue15,057 1,608 
                    Lease liabilities(373)684 
                    Other accrued liabilities8,140 2,529 
Net cash used in operating activities(6,282)(16,901)
Cash flows from investing activities
          Purchases of property and equipment(1,757)
          Acquisition of LifeDojo, net of cash acquired(2,881)
Net cash used in investing activities(4,638)
Cash flows from financing activities
          Proceeds from issuance of preferred stock87,359 
          Preferred stock issuance costs(806)
          Dividends paid(1,241)
          Proceeds from revolving loan7,500 
          Repayment of revolving loan(15,000)
          Proceeds from A/R facility36,527 
          Repayment of A/R facility(1,938)
          Proceeds from loan10,000 1,938 
          Debt issuance costs(128)(2,813)
          Debt termination related fees(1,956)
          Proceed from warrant exercise133 1,128 
          Proceed from options exercise6,171 1,894 
          Finance lease obligations(186)69 
          Financed insurance premium payments(1,190)
Net cash provided by financing activities100,112 27,349 
Net change in cash and restricted cash89,192 10,448 
Cash and restricted cash at beginning of period14,018 3,570 
Cash and restricted cash at end of period$103,210 $14,018 
Supplemental disclosure of cash flow information:
          Interest paid$2,961 $870 
          Right of use asset obtained in exchange for lease obligation2,574 
Non-cash financing and investing activities:
          Stock issued in acquisition of LifeDojo$5,035 $
          Financed insurance premiums3,344 
          Warrant issued in connection with 2024 Note2,354 
          Reclassification of warrant liability to equity1,924 86 
          Finance lease and accrued purchases of property and equipment500 250 
          Contingent consideration and cash holdback relating to acquisition of LifeDojo605 
See accompanying notes to the consolidated financial statements.
F-7

ONTRAK, INC.
Notes to Consolidated Financial Statements
Note 1. Organization
Company Overview
Ontrak, Inc. (“Ontrak” or the “Company”), formerly known as Catasys, Inc., is an AI-powered and telehealth-enabled, virtualized healthcare company, whose mission is to help improve the health and save the lives of as many people as possible. The Company’s PRE™ (Predict-Recommend-Engage) platform organizes and automates healthcare data integration and analytics through the application of machine intelligence to deliver analytic insights. The Company's PRE platform predicts people whose chronic disease will improve with behavior change, recommends effective care pathways that people are willing to follow, and engages people who are not getting the care they need. By combining predictive analytics with human engagement, the Company delivers improved member health and validated outcomes and savings to healthcare payors.

The Company’s integrated, technology-enabled OntrakTM programs, a critical component of the PRE platform, are designed to provide healthcare solutions to members with behavioral conditions that cause or exacerbate chronic medical conditions such as diabetes, hypertension, coronary artery disease, chronic obstructive pulmonary disease, and congestive heart failure, which result in high medical costs. Ontrak has a unique ability to engage these members, who do not otherwise seek behavioral healthcare, leveraging proprietary enrollment capabilities built on deep insights into the drivers of care avoidance. Ontrak integrates evidence-based psychosocial and medical interventions delivered either in-person or via telehealth, along with care coaching and in-market Community Care Coordinators who address the social and environmental determinants of health, including loneliness. The Company’s programs seek to improve member health and deliver validated cost savings to healthcare payors of more than 50% for enrolled members. Ontrak solutions are available to members of leading national and regional health plans in 30 states and in Washington, D.C.


Note 2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements include Ontrak, Inc., its wholly-owned subsidiaries and its variable interest entities (VIEs). The accompanying consolidated financial statements for Ontrak, Inc. have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and instructions to Form 10-K and Article 10 of Regulation S-X. All intercompany balances and transactions have been eliminated in consolidation.
At December 31, 2020, cash and restricted cash was $103.2 million and the Company had a working capital of approximately $87.2 million. The Company could continue to incur negative cash flows and operating losses for the next twelve months, with an average monthly cash burn rate of approximately $0.5 million for the year ended December 31, 2020. The Company expect its current cash resources to cover expenses through at least the next twelve months from the date of this report. However, delays in cash collections, revenue, or unforeseen expenditures could impact this estimate.
The Company’s ability to fund ongoing operations is dependent on several factors. The Company aims to increase the number of members that are eligible for its solutions by signing new contracts and identifying more eligible members in existing contracts. Additionally, the Company’s funding is dependent upon the success of management’s plan to increase revenue and control expenses. The Company operates its Ontrak solutions in 30 states and the District of Columbia. The Company provide services to commercial (employer funded), managed Medicare Advantage, and managed Medicaid and dual eligible (Medicare and Medicaid) populations. The Company generates fees from its launched programs and expect to increase enrollment and fees in the near future.
Certain prior year amounts have been reclassified for consistency with the current year presentation.
Management’s Plans
Historically, we have seen and continue to see net losses, net loss from operations, negative cash flow from operating activities, and historical working capital deficits as we continue through a period of rapid growth. The accompanying financial statements do not reflect any adjustments that might result if we were unable to continue as a going concern. We have alleviated
F-8

substantial doubt by both entering into contracts for additional revenue-generating health plan customers and expanding our Ontrak program within existing health plan customers as well as completing equity and debt financings totaling approximately $87 million and $10 million, respectively, in 2020. To support this increased demand for services, we invested and will continue to invest in additional headcount and enhancements to technology needed to support the anticipated growth. Additional management plans include increasing the outreach pool as well as improving our current enrollment rate. We will continue to explore ways to increase operational efficiencies resulting in increase in margins on both existing and new members.

We have a growing customer base and believe we are able to fully scale our operations to service the contracts and future enrollment providing leverage in these investments that will generate positive cash flow in the near future. We believe we will have enough capital to cover expenses through the foreseeable future and we will continue to monitor liquidity. If we add more health plans than budgeted, increase the size of the outreach pool by more than we anticipate, decide to invest in new products or seek out additional growth opportunities, we would consider financing these options with either a debt or equity financing.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates, judgements and assumptions that affect the reported amounts in the financial statements and disclosed in the accompanying notes. Significant areas requiring the use of management estimates include expense accruals, accounts receivable allowances, accrued claims payable, the useful life of assets subject to depreciation and amortization, revenue recognition, the valuation of warrant liabilities and contingent consideration, and shared-based compensation. Due to the inherent uncertainty involved in making estimates, actual results could differ from those estimates.
Revenue Recognition
The Company generates virtual healthcare service revenue from contracts with customers as it satisfies its performance obligations to customers and their members enrolled in our Ontrak program. The virtual healthcare service is transferred to a customer when, or as, the customer obtains control of that 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 progress in a manner that depicts the transfer of services to the customer. Revenue from a performance obligation satisfied at a point in time is recognized at the point in time that the Company determines the customer obtains control over the promised service. The amount of revenue recognized reflects the consideration the Company expects to be entitled to in exchange for those promised services (i.e., the “transaction price”). In determining the transaction price, the Company considers multiple factors, including identification of the performance obligation and 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, the Company considers the range of possible outcomes, the predictive value of past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside the Company's influence, such as the judgment and actions of third parties.
Cost of Revenue
Cost of revenue consists primarily of salaries related to care coaches, outreach specialists and other staff directly involved in member care, healthcare provider claims payments, and fees charged by third party administrators for processing these claims. Salaries and fees charged by 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.
Cash and Cash Equivalents
Cash and cash equivalents consist of highly liquid investments with original maturities of three months or less from the
date of purchase. The Company's cash balance does not contain any cash equivalents at December 31, 2020 and 2019.
Commissions
Commissions paid to our sales force and engagement specialists are deferred as these amounts are incremental costs of obtaining a contract with a customer and are recoverable from future revenue that gave rise to the commissions. Commissions for initial contracts and member enrollments are deferred on the consolidated balance sheets and amortized on a straight-line basis over a period of benefit that has been determined to be six years and one year, respectively.
F-9

For the year ended December 31, 2020 and 2019, amortization expense relating to deferred commission costs was $1.7 million and $0.03 million, respectively.
Property & Equipment
Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets, as noted below. We capitalize computer software that meet both the definition of internal-use software and defined criteria for capitalization. See discussion below under "Capitalized Internal Use Software Costs" for more information.

Estimated Useful Lives (years)
Software3
Computers and equipment3 - 7
Right of use assets - finance leases3
Leasehold improvements5

Capitalized Internal Use Software Costs

We account for the costs of computer software obtained or developed for internal use in accordance with ASC 350, Intangibles—Goodwill and Other (“ASC 350”). We capitalize certain costs in the development of our internal use software when the preliminary project stage is completed and it is probable that the project will be completed and performed as intended. These capitalized costs include personnel and related expenses for employees and costs of third-party consultants who are directly associated with and who devote time to internal-use software projects. Capitalization of these costs ceases once the project is substantially complete and the software is ready for its intended purpose. Costs incurred for significant upgrades and enhancements to the Company’s internal use software solutions are also capitalized. Costs incurred for training, maintenance and minor modifications or enhancements are expensed as incurred. Capitalized software development costs are amortized using the straight-line method over an estimated useful life of three years.

Leases

ROU assets represent our right to use an underlying asset during the reasonably certain lease term and lease liabilities represent our obligation to make lease payments arising from the lease. We recognize ROU lease assets and lease liabilities at lease commencement on our consolidated balance sheet based on the present value of lease payments over the lease term using a discount rate determined based on our incremental borrowing rate since the rate implicit in each lease is not readily determinable. We elected the package of practical expedients, which permits us to not reassess (1) whether any expired or existing contracts are or contain leases, (2) the lease classification of any expired or existing leases, and (3) any initial direct costs for any existing leases as of the effective date. We elected the practical expedient to account for each separate lease component of a contract and its associated non-lease components as a single lease component. We also elected the hindsight practical expedient, which allows us to use hindsight in determining the lease term. We do not record an ROU asset and corresponding lease liability for leases with an initial term of 12 months or less (“short-term leases”). The terms in our leases may include options to extend or terminate the lease when it is reasonably certain that we will exercise those options. Judgment is required in our assessment as to whether renewal or termination options are reasonably certain to be exercised and factors such as contractual terms compared to current market rates, the importance of the facility and location to the Company’s operations, among others, are considered. Lease payments are made in accordance with the lease terms and lease expense, including short-term lease expense, is recognized on a straight-line basis over the lease term.
Share-Based Compensation
Stock Options and Restricted Stock Units – Employees and Directors
Stock-based compensation for stock options and RSUs granted is measured based on the grant-date fair value of the awards and recognized on a straight-line basis over the period during which the employee is required to perform services in exchange for the award (generally the vesting period of the award). The Company estimates the fair value of RSU awards based on the closing stock price of our common shares on the date of grant. The Company estimates the fair value of employee stock options using the Black-Scholes option-pricing model. Forfeitures are recognized as they occur.

F-10

Stock Options and Warrants – Non-employees
Stock-based compensation for stock options and warrants granted to non-employees is measured based on the grant-date fair value of the awards and recognized on a straight-line basis over the period during which the employee is required to perform services in exchange for the award (generally the vesting period of the award). The Company estimates the fair value of employee stock options using the Black-Scholes option-pricing model.
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.
Income Taxes
The Company accounts for income taxes using the liability method, under which deferred tax assets and liabilities are determined based on the future tax consequences attributable to differences between the financial reporting carrying amounts of existing assets and liabilities and their respective tax bases and tax credit carry forwards and net operating loss carryforwards. Deferred tax assets and liabilities are measured using the enacted tax rates that are expected to be in effect when the differences are expected to reverse. To date, no current income tax liability has been recorded due to the Company's accumulated net losses.
The Company assesses the likelihood that deferred tax assets will be recovered from future taxable income, and a
valuation allowance is established when necessary to reduce deferred tax assets to the amounts more likely than not expected to
be realized. The Company's net deferred tax assets have been fully reserved by a valuation allowance.
Fair Value Measurements 
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Assets and liabilities recorded at fair value in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure fair value. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level I) and the lowest priority to unobservable inputs (Level III). The three levels of the fair value hierarchy are described below:

Level Input:Input Definition:
Level IInputs are unadjusted, quoted prices for identical assets or liabilities in active markets at the measurement date.
Level IIInputs, 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 IIIUnobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

The following tables summarize fair value measurements by level at December 31, 2020 and 2019, respectively, for assets and liabilities measured at fair value on a recurring basis (in thousands):







F-11

Balance at December 31, 2020
Level ILevel IILevel IIITotal
Letter of credit (1)
$408 $$$408 
Total assets$408 $$$408 
Contingent consideration (2)
$$$485 $485 
Total liabilities$$$485 $485 

Balance at December 31, 2019
Level ILevel IILevel IIITotal
Letter of credit (1)
$408 $$$408 
Total assets$408 $$$408 
Warrant liabilities (3)
$$$691 $691 
Total liabilities$$$691 $691 
_______________
(1) $0.4 million was included in "Restricted cash - long-term" on our consolidated balance sheets as of December 31, 2020 and 2019.
(2) Contingent consideration was included in "Other accrued liabilities" on our consolidated balance sheet as of December 31, 2020.
(3) See Note 9 below under "Stock Options and Warrants – Non-employees" for more information about warrants.

Financial instruments classified as Level III in the fair value hierarchy as of December 31, 2020, represent liabilities measured at market value on a recurring basis which include warrant liabilities and contingent consideration relating to a stock price guarantee in an acquisition. In accordance with current accounting rules, the warrant liabilities and contingent consideration liability are being marked-to-market each quarter-end until they are completely settled or expire. The warrants are valued using the Black-Scholes option-pricing model, using both observable and unobservable inputs and assumptions consistent with those used in the estimate of fair value of employee stock options. See "Warrant Liabilities" below. The fair value of contingent consideration liability is valued using the Monte Carlo simulation model, using both observable and unobservable inputs and assumptions.

The carrying value of the 2024 Notes is estimated to approximate their fair value as the variable interest rate of the 2024 Notes approximates the market rate for debt with similar terms and risk characteristics.
The fair value measurements using significant Level III inputs, and changes therein, for the years ended December 31, 2020 and 2019 were as follows (in thousands):
Level III
Warrant
Liabilities
Balance as of December 31, 2018$86 
Reclassification of warrant liability to equity upon adoption of ASU 2017-11(86)
Issuance of warrants631 
Change in fair value60 
Balance as of December 31, 2019$691 
Reclassification of warrant liability to equity upon exercise of warrant(1,337)
Reclassification of warrant liability to equity upon change in classification(587)
Change in fair value1,233 
Balance as of December 31, 2020$
F-12


Level III
Contingent
Consideration
Balance as of December 31, 2019$
Contingent consideration - acquisition of LifeDojo505 
Change in fair value(20)
Balance as of December 31, 2020$485 

The $0.5 million of contingent liability as of December 31, 2020 was included in "Other accrued liabilities" on our consolidated balance sheet. We recorded a gain of $0.02 million relating to a change in fair value of the contingent consideration relating to stock price guarantee in "Other expense, net" on our consolidated statement of operations for the year ended December 31, 2020.

Variable Interest Entities
Generally, an entity is defined as a Variable Interest Entity (“VIE”) under current accounting rules if it either lacks sufficient equity to finance its activities without additional subordinated financial support, or it is structured such that the holders of the voting rights do not substantively participate in the gains and losses of the entity. When determining whether an entity that meets the definition of a business, qualifies for a scope exception from applying VIE guidance, the Company considers whether: (i) it has participated significantly in the design of the entity, (ii) it has provided more than half of the total financial support to the entity, and (iii) substantially all of the activities of the VIE are conducted on its behalf. A VIE is consolidated by its primary beneficiary, the party that has the power to direct the activities that most significantly affect the economics of the VIE and has the right to receive benefits or the obligation to absorb losses of the entity that could be potentially significant to the VIE. The primary beneficiary assessment must be re-evaluated on an ongoing basis.
As discussed under the heading Management Services Agreement (“MSA”) below, the Company has an MSA with a Texas nonprofit health organization (“TIH”) and a California Professional Corporation (“CIH”). Under the MSAs, the equity owners of TIH and CIH have only a nominal equity investment at risk, and the Company absorbs or receives a majority of the entity’s expected losses or benefits. The Company participates significantly in the design of these MSAs. The Company also agrees to provide working capital loans to allow for TIH and CIH to fund their day to day obligations. Substantially all of the activities of TIH and CIH include its decision making, approval or are conducted for its benefit, as evidenced by the facts that (i) the operations of TIH and CIH are conducted primarily using the Company's licensed network of providers and (ii) under the MSA, the Company agrees to provide and perform all non-medical management and administrative services for the entities. Payment of the Company's management fee is subordinate to payments of the obligations of TIH and CIH, and repayment of the working capital loans is not guaranteed by the equity owner of the affiliated medical group or other third party. Creditors of TIH and CIH do not have recourse to the Company's general credit.
Based on the design of the entity and the lack of sufficient equity to finance its activities without additional working capital loans the Company has determined that TIH and CIH are VIEs. The Company is the primary beneficiary required to consolidate the entities as it has power and potentially significant interests in the entities. Accordingly, the Company is required to consolidate the assets, liabilities, revenues and expenses of the managed treatment centers.
Management Services Agreement
In April 2018, the Company executed an MSA with TIH and in July 2018, the Company executed an MSA with CIH. Under the MSAs, the Company licenses to TIH and CIH the right to use its proprietary treatment programs and related trademarks and provide all required day-to-day business management services, including, but not limited to:
general administrative support services;
information systems;
recordkeeping;
billing and collection;
obtaining and maintaining all federal, state and local licenses, certifications and regulatory permits.
F-13

All clinical matters relating to the operation of TIH and CIH and the performance of clinical services through the network of providers shall be the sole and exclusive responsibility of the TIH and CIH Board free of any control or direction from the Company.
TIH pays the Company a monthly fee equal to the aggregate amount of (a) its costs of providing management services (including reasonable overhead allocated to the delivery of its services and including salaries, rent, equipment, and tenant improvements incurred for the benefit of the medical group, provided that any capitalized costs will be amortized over a five-year period), (b) 10%-15% of the foregoing costs, and (c) any performance bonus amount, as determined by TIH at its sole discretion. The Company's management fee is subordinate to payment of the entities’ obligations.
CIH pays the Company a monthly fee equal to the aggregate amount of (a) its costs of providing management services (including reasonable overhead allocated to the delivery of its services and including salaries, rent, equipment, and tenant improvements incurred for the benefit of the entity, provided that any capitalized costs will be amortized over a five-year period), and (b) any performance bonus, as determined by CIH at its sole discretion.
The Company's consolidated balance sheets included the following assets and liabilities from its VIEs (in thousands):
December 31,
20202019
Cash and cash equivalents$1,206 $379 
Accounts receivable564 
Unbilled accounts receivable272 
Prepaid and other current assets46 26 
Total assets$1,524 $969 
Accounts payable$$
Accrued liabilities234 100 
Deferred revenue76 73 
Payables to Ontrak1,695 685 
Total liabilities$2,014 $867 
Warrant Liabilities
The assumptions used in the Black-Scholes option-pricing model were determined as follows:
December 31,
20202019
Volatility96.30 %97.96% - 98.04%
Risk-free interest rate0.65 %1.81 %
Weighted average expected life (in years)5.426.25
Dividend yield%%

For the years ended December 31, 2020 and 2019, losses related to the revaluation of warrant liabilities, which were recorded in "Other expense, net" in the consolidated statements of operations, were $1.2 million and $0.06 million, respectively.
Concentration of Credit Risk
Financial instruments, which potentially subject us to a concentration of risk, include cash, restricted cash and accounts receivable. All of our customers are based in the United States at this time and we are not subject to exchange risk for accounts receivable.
F-14

The Company maintains its cash in domestic financial institutions subject to insurance coverage issued by the Federal Deposit Insurance Corporation ("FDIC"). Under FDIC rules, the company is entitled to aggregate coverage as defined by the Federal regulation per account type per separate legal entity per financial institution. The Company has incurred no losses as a result of any credit risk exposures.
For the year ended December 31, 2020, 4 customers accounted for approximately 94% of revenues and 2 customers accounted for approximately 99% of accounts receivable.
For the year ended December 31, 2019, 4 customers accounted for approximately 85% of revenues and 3 customers accounted for approximately 85% of accounts receivable.
Recently Adopted Accounting Standards

In March 2020, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting ("ASU 2020-04"). The guidance provides optional expedients and exceptions to accounting for contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022, and may be applied prospectively to contract modifications entered through December 31, 2022. The adoption of ASU 2020-04 on March 12, 2020 did not have a material effect on our consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). The amendments in this update align the requirements for capitalizing implementation costs incurred in a cloud computing arrangement (i.e. hosting arrangement) that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software under Subtopic 350-40. The amendments require certain costs incurred during the application development stage to be capitalized and other costs incurred during the preliminary project and post-implementation stages to be expensed as they are incurred. Capitalized implementation costs related to a hosting arrangement that is a service contract will be amortized over the term of the hosting arrangement including reasonably certain renewals, beginning when the module or component of the hosting arrangement is ready for its intended use. The guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within that fiscal year. The adoption of ASU 2018-15 prospectively on January 1, 2020 did not have a material effect on our consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820) ("ASU 2018-13"), which modifies the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, including, among other changes, the consideration of costs and benefits when evaluating disclosure requirements. For public companies, the amendments are effective for annual reporting periods beginning after December 15, 2019, including interim periods within those annual periods. The adoption of ASU 2018-13 on January 1, 2020 did not have a material effect on our consolidated financial statements.
Recently Issued Accounting Pronouncements
In October 2020, the FASB issued ASU No. 2020-10, "Codification Improvements" ("ASU 2020-10"), which includes amendments to improve consistency of disclosures by ensuring that all guidance that require disclosures or provides an option for an entity to provide information in the notes to the financial statement is codified in the disclosure section of the codification. ASU 2020-10 is effective for public companies, other than smaller reporting companies, for fiscal years beginning after December 15, 2020. For all other entities, ASU 2020-10 is effective for fiscal years beginning after December 15, 2021, and interim periods beginning after December 15, 2022. The Company is currently evaluating the impact of adoption of ASU 2020-10 on its consolidated financial statements and related footnote disclosures.
In August 2020, the FASB issued ASU No. 2020-06, “Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40) ("ASU 2020-06").” ASU 2020-06 modifies and simplifies accounting for convertible instruments, and eliminates certain separation models that require separating embedded conversion features from convertible instruments. ASU 2020-06 also addresses how convertible instruments are accounted for in the diluted earnings per share calculation. ASU 2020-06 is effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Early adoption is permitted, but no earlier the fiscal year beginning after December 15, 2020. The Company is currently evaluating the impact of adoption of ASU 2020-06 on its consolidated financial statements and related footnote disclosures.
F-15

In December 2019, the FASB issued ASU No. 2019-12, "Simplifying the Accounting for Income Taxes" ("ASU 2019-12"), which enhances and simplifies various aspects of income tax accounting guidance. The guidance is effective for the Company in the first quarter of 2021, although early adoption is permitted. The Company is currently evaluating the impact of adoption of ASU 2019-12 on its consolidated financial statements and related footnote disclosures.
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”), which requires recognition of an estimate of lifetime expected credit losses as an allowance. For companies eligible to be smaller reporting company as defined by the Securities and Exchange Commission (“SEC”), ASU 2016-13 is effective for annual reporting periods beginning after December 15, 2022, including interim periods within those annual periods. The Company is currently evaluating the impact of adoption of ASU 2016-13 on its consolidated financial statements and related footnote disclosures.


Note 3. Restricted Cash
At December 31, 2020, we had $15.7 million of cash restricted solely for the purpose of 7 future quarterly dividend payments on our Series A Cumulative Perpetual Preferred Stock (see detailed discussion in Note 4 below under "Preferred Stock"), of which $9.0 million was included in "Restricted cash - current" and $6.7 million was included in "Restricted cash - long-term." Also, $0.4 million relating to a letter of credit required as part of our corporate headquarters office lease and $50,000 cash balance required under our 2024 Note were included in "Restricted cash - long-term" as of December 31, 2020. At December 31, 2019, we had $0.4 million relating to the letter of credit required as part of our corporate headquarters office lease included in "Restricted cash - long-term."
The following table provides a reconciliation of cash, cash equivalents and restricted cash total as presented in the consolidated statement of cash flows for the years ended December 31, 2020 and 2019 (in thousands):

December 31,
20202019
Cash and cash equivalents$86,907 $13,610 
Restricted cash - current9,127 
Restricted cash - long term7,176 408 
Cash, cash equivalents and restricted cash$103,210 $14,018 


Note 4. Property and Equipment

Property and equipment consisted of the following (in thousands):

December 31,
20202019
Software$2,441 $1,247 
Computers and equipment893 461 
ROU assets - finance lease934 378 
Leasehold improvements17 
Software development in progress
   Subtotal4,290 2,086 
Less: Accumulated depreciation and amortization2,017 1,558 
    Property and equipment, net$2,273 $528 

During the year ended December 31, 2020, we capitalized $1.1 million of costs relating to development of internal use software and recorded approximately $0.2 million of amortization expense relating to these capitalized internal use software costs. There were 0 capitalized costs relating to development of internal use software, and 0 related amortization expense, during the year ended December 31, 2019.

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Note 5. Acquisition

We account for acquisitions under ASC 805, Business Combinations, in which the acquisition method of accounting requires us to record assets acquired and liabilities assumed in an acquisition at their respective estimated fair values at the date of acquisition. The excess of the total purchase price over the estimated fair value of the assets acquired and liabilities assumed is recorded as goodwill. Such valuations require management to make significant estimates and assumptions which are believed to be reasonable but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the one year period following the completion of an acquisition referred to as the measurement period, we may record adjustments to the fair values of assets acquired and liabilities assumed with corresponding adjustments to goodwill as additional information becomes available. Any adjustment after the measurement period is reflected through earnings.

LifeDojo

On October 28, 2020, we completed the acquisition of LifeDojo Inc. (“LifeDojo”), a comprehensive, science-backed behavior change platform based in San Francisco, California, for total consideration of approximately $8.9 million, including $3.4 million in cash payment, 75,000 shares of our common stock (of which 74,984 shares were issued and 16 fractional shares were settled in cash) worth approximately $5.0 million at close, as well as certain contingent consideration based on a computation, as defined in the merger agreement, in the event the daily closing price per share of our common stock falls below a specified target price of $60 on 2 consecutive trading days during a six month period beginning on the sixth month anniversary to the twelfth month anniversary of the closing date of the acquisition (measurement period). As of October 28, 2020, we determined that the fair value of this contingent consideration was $0.5 million. The contingent consideration amount, if any, is generally payable within five business days following completion of the measurement period. LifeDojo provides online behavior change and wellness programs, using a combination of coaching and mobile apps to help members form health habits and change health behaviors. This acquisition was not significant to our consolidated financial statements.

Note 6. Goodwill and Intangible Assets

Goodwill

The carrying amount of indefinite-lived goodwill was as follows (in thousands):

Goodwill
Balance at December 31, 2019$
Acquisition of LifeDojo5,727
Balance at December 31, 2020$5,727 

The $5.7 million of goodwill related to the acquisition of LifeDojo is not deductible for tax purposes.

Intangible Assets

The following table sets forth amounts recorded for intangible assets subject to amortization (in thousands):

At December 31, 2020Weighted Average Estimated Useful Life (years)Gross ValueAccumulated AmortizationNet Carrying Value
Acquired software technology3$3,500 $(194)$3,306 
Customer relationships5270(15)255
     Total$3,770 $(209)$3,561 

Amortization expense for intangible assets was $0.2 million for the year ended December 31, 2020. There were 0 intangible assets and 0 amortization expense for the year ended December 31, 2019.

F-17

At December 31, 2020, estimated amortization expense for intangible assets for each of the five years thereafter was as follows (in thousands):
2021$1,215 
20221,221
20231,026
202454
202545
  Total$3,561 

Note 7. Common Stock and Preferred Stock
Net Loss Per Common Share

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


Basic and diluted net loss per common share were as follows (in thousands, except per share amounts):

Year Ended December 31,
20202019
Net loss$(22,710)$(25,659)
Dividends on preferred stock - declared and undeclared(1,987)
Net loss attributable to common stockholders$(24,697)$(25,659)
Weighted-average shares of common stock outstanding17,112 16,418 
Net loss per common share - basic and diluted$(1.44)$(1.56)


The following common equivalent shares issuable upon the exercise of stock options and warrants have been excluded from the calculation of diluted earnings per common share as their effect was anti-dilutive:

December 31,
20202019
Warrants to purchase common stock1,465,927 1,550,975 
Options to purchase3,616,314 4,006,351 
Total shares excluded from net loss per share5,082,241 5,557,326 

Preferred Stock

In August 2020, we completed the offering of 1,700,000 shares of 9.50% Series A Cumulative Perpetual Preferred Stock (the "Series A Preferred Stock") and in September 2020, we completed the closing of the underwriters' full exercise of the over-allotment option of 255,000 additional shares of Series A Preferred Stock, resulting in aggregate gross proceeds of $48.9 million to the Company (or $45.1 million net of underwriting fees and other offering expenses). In mid-September 2020, we began an at-the-market ("ATM") offering of the Series A Preferred Stock through a designated broker for up to 2,000,000 shares, of which we sold 5,027 shares in November 2020. In December 2020, we terminated the ATM offering and began an underwritten offering of the Series A Preferred Stock, under which we completed the offering of 1,730,000 shares of Series A Preferred Stock as well as


the issuance of 80,238 shares of Series A Preferred Stock under the over-allotment option, resulting in total gross proceeds, including the proceeds of the ATM offering, of $44.9 million (or $41.4 million net of underwriting fees and other offering expenses). The Series A Preferred Stock is listed on the Nasdaq Global Market under the symbol "OTRKP." The Company, generally, may not redeem the Series A Preferred Stock until August 25, 2025, except upon the occurrence of a Delisting Event or Change of Control (as defined in the Certificate of Designations establishing the Series A Preferred Stock), and on and after August 25, 2025, the Company may, at its option, redeem the Series A Preferred Stock, in whole, at any time, or in part, from time to time, for cash at a redemption price of $25.00 per share, plus any accrued and unpaid dividends. The Series A Preferred Stock has no maturity date and will remain outstanding indefinitely unless redeemed by the Company or exchanged for shares of common stock in connection with a Delisting Event or Change of Control. Holders of Series A Preferred Stock generally have no voting rights, but will have limited voting rights if the Company fails to pay dividends for six or more quarters, whether or not declared or consecutive) and in certain other events.

Holders of Series A Preferred Stock of record at the close of business of each respective record date (February 15, May 15, August 15 and November 15) are entitled to receive, when, as and if declared by our Board of Directors, out of funds legally available for the payment of dividends, cumulative cash dividends at the rate of 9.50% per annum of the $25.00 per share liquidation preference (equivalent to $2.375 per annum per share). Dividends, if and when declared by our Board of Directors, are payable quarterly in arrears, every February 28, May 30, August 31, and November 30, as applicable, beginning on or about November 30, 2020. Dividends will accumulate and be cumulative from, and including, the date of original issuance, which was August 25, 2020.

On November 11, 2020, our Board of Directors declared the first quarterly dividend on the Company's Series A Preferred Stock for shareholders of record as of the close of business on November 15, 2020. The first quarterly cash dividend equaled $0.6333333 per share, representing more than a full quarter as it covered the period from, and including, the first date the Company issued the Series A Preferred Shares, at 9.50% per annum of liquidation preference of $25.00 per share. As such, we paid cash dividends of $1.2 million on November 30, 2020. At December 31, 2020, we had undeclared dividends of $0.7 million.

Note 8. Debt
2024 Notes

The Company is party to a Note Purchase Agreement dated September 24, 2019 (the “Note Agreement”) with Goldman Sachs Specialty Lending Holdings, Inc. and any other purchasers party thereto from time to time (collectively, the “Holders”) (the "Amended Note Agreement"), as amended, pursuant to which the Company initially issued $35.0 million aggregate principal amount of senior secured notes (the "Initial 2024 Notes"). In August 2020, pursuant to a Second Amendment to the Note Purchase Agreement (the "Second Amendment"), the Company issued an additional $10.0 million principal amount of senior secured notes as provided under the additional note purchase commitment of the Note Agreement (together with the Initial 2024 Notes, the "2024 Notes"). The Second Amendment included changes in certain definitions in the Note Agreement intended to permit the Company to issue the Series A Preferred Stock in an amount not to exceed $50 million and to pay dividends thereon under specified conditions, including a waiver of the mandatory prepayment of the 2024 Notes with the proceeds of the Series A Preferred Stock offering. The Second Amendment also modified the Leverage Ratio covenant, Consolidated Adjusted EBITDA covenant, Minimum Consolidated Liquidity covenant and Minimum Revenue covenant providing increased financial flexibility to the Company. In September 2020, the Company and the Holders entered into a Third Amendment to the Note Purchase Agreement, which increased the maximum amount allowed for issuances of the Series A Preferred Stock to $100 million. In late September 2020, the Company and the Holders entered into a Fourth Amendment to the Note Purchase Agreement, which changed certain definitions and covenants in the Note Agreement primarily intended to reduce the Company’s information reporting obligations to the Holders under specified conditions. The Company was subsequently notified on March 3, 2021, that pursuant to Section C of the Fourth Amendment to the Note Purchase Agreement, the Collateral Agent is rescinding all amendments under the Fourth Amendment and the Fourth Amendment shall immediately cease to be effective and all provisions amended by the Fourth Amendment shall revert to their respective formulations prior to the execution of the Fourth Amendment. In December 2020, the Company and the Holders entered into a Fifth Amendment to the Note Purchase Agreement, which increased the maximum amount allowed for issuances of the Series A Preferred Stock to $125 million.

F-19

The 2024 Notes bear interest, based on the Company's election, at either a floating rate plus an applicable margin based on cash interest payments or a floating rate plus a slightly higher applicable margin based on interest payment in kind. The applicable margins are subject to stepdowns, in each case, following the achievement of certain financial ratios. The LIBOR index is expected to be discontinued by the end of calendar year 2021. The terms of the Note Agreement allow for a replacement rate if the LIBOR index is discontinued. At December 31, 2020, the effective weighted average annual interest rate applicable to the outstanding 2024 Notes was 15.03%. The entire principal amount of the 2024 Notes is due and payable on the fifth anniversary of the Note Agreement (September 24, 2024) unless earlier redeemed upon the occurrence of certain mandatory prepayment events, including 50% of excess cash flow, asset sales and the amount by which total debt exceeds an applicable leverage multiple. The principal amount of the 2024 Notes increased by $3.5 million in the form of payment in kind of the interest component during the year ended December 31, 2020.

The Amended Note Agreement contains customary covenants, including, among others, covenants that restrict the Company’s ability to incur debt, grant liens, make certain investments and acquisitions, pay certain dividends, repurchase equity interests, repay certain debt, amend certain contracts, enter into affiliate transactions and asset sales or make certain equity issuances, and covenants that require the Company to, among other things, provide annual, quarterly and monthly financial statements, together with related compliance certificates if and when requested by Holders, maintain its property in good repair, maintain insurance and comply with applicable laws. The Amended Note Agreement also includes covenants with respect to the Company’s maintenance of certain financial ratios, including a fixed charge coverage ratio, leverage ratio and consolidated liquidity as well as minimum levels of consolidated adjusted EBITDA and revenue. The Amended Note Agreement also contains customary events of default, including, among others, payment default, bankruptcy events, cross-default, breaches of covenants and representations and warranties, change of control, judgment defaults and an ownership change within the meaning of Section 382 of the Internal Revenue Code. In the case of an event of default, the Holder may, among other remedies, accelerate the payment of all obligations under the 2024 Notes and all assets of the Company serves as collateral. Any prepayment of the 2024 Notes must be accompanied by a yield maintenance premium and on or prior to the third anniversary of the date of the Note Agreement must be accompanied by a prepayment premium. The Company was in compliance with all of its debt covenants as of December 31, 2020.

In accounting for the issuance of the 2024 Notes, the Company separated the 2024 Notes into liability and equity components. The fair value of the liability component was estimated using an interest rate for debt with terms similar to the 2024 Notes. The carrying amount of the equity component was calculated by measuring the fair value based on the Black-Scholes model. The gross proceeds from the transaction was allocated between liability and equity based on the proportionate value. The debt discount is accreted to interest expense over the term of the 2024 Notes using the interest method. The equity component is not re-measured as long as it continues to meet the conditions for equity classification.
The assumptions used in the Black-Scholes option-pricing model remain unchanged and are determined as follows:
Volatility98.01 %
Risk-free interest rate1.58 %
Expected life (in years)7
Dividend yield0 %

The net carrying amounts of the liability components consisted of the following (in thousands):

December 31,
20202019
Principal$50,001 $36,502 
Less: debt discount(4,282)(4,905)
Net carrying amount$45,719 $31,597 

2022 Loan

In June 2018, the Company entered into a venture loan and security agreement (the “2022 Loan”) with Horizon Technology Finance Corporation (“Horizon”), which provides for up to $7.5 million in loans to the Company. In addition, in June 2018, the Company entered into a loan and security agreement (the “A/R Facility”) in connection with a $2.5 million receivables financing
F-20

facility with Corporate Finance, a division of Heritage Bank of Commerce (“Heritage”). The Company borrowed and subsequently repaid $1.9 million on the A/R Facility during the six months ended June 30, 2019.

In March 2019, the Company entered into an amended and restated 2022 Loan with Horizon, which provides for up to $15.0 million in loans to the Company, including initial term loans in the amount of $7.5 million previously funded under the original agreement and an additional up to $7.5 million loan in three revolving tranches of $2.5 million in availability, subject to the Company's achievement of trailing three month billings exceeding $5.0 million, $7.0 million and $8.0 million, respectively (collectively, the “Billing Requirements”). An initial advance of $2.5 million was funded upon the execution and delivery of the Amended Loan Agreement, subject to repayment if the foregoing $5.0 million threshold is not reached by July 1, 2019. The Company concurrently entered into an amendment to the previously disclosed $2.5 million A/R Facility with Heritage intended primarily to reflect the amendment and restatement of the Amended Loan Agreement. The Company had met all three of the Billing Requirements and as a result had incurred the full $7.5 million under the Amended Loan Agreement. In connection with our entry into the Amended Loan Agreement, the Company issued Horizon 40,279 seven-year warrants to purchase an aggregate of $600,000 (depending on the level of availability under the Amended Loan Agreement) at the trailing volume weighted average price (“VWAP”) of our common stock on the NASDAQ Capital Market for the five days preceding the relative dates of grants at a per share exercise price equal to the lower of (i) $9.93 or (ii) the price per share of any securities that may be issued by us in an equity financing during the 18 months following the agreement date.

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

Upon the issuance of the 2024 Notes, the balance of the 2022 Loan was repaid and terminated. As part of the termination, the Company incurred $1.1 million of early termination costs and wrote off deferred debt issuance costs of $1.5 million, which has been recorded in "Other expense, net" in the consolidated statement of operations for the year ended December 31, 2019.




The following table sets forth total interest expense recognized related to the 2024 Notes and 2022 Loan (in thousands):

December 31,
20202019
Contractual interest expense$6,429 $2,653 
Accretion of debt discount750 394 
Total$7,179 $3,047 
Other
In August 2020, the Company financed a portion of its insurance premiums totaling $0.3 million at an annual effective rate of 8.25%, payable in 10 equal monthly installments beginning on September 1, 2020 and a down payment of $86,000 at inception. In November 2020, the Company financed $3.0 million of insurance premiums at an annual effective rate of 4.95%, payable in 10 equal monthly installments beginning on December 8, 2020 and a down payment of $0.8 million at inception. At December 31, 2020, a total of $2.2 million relating to these financed insurance premiums was outstanding, which was included as part of "Other accrued liabilities" on our consolidated balance sheet.

Note 9. Stock Based Compensation
Our 2017 Stock Incentive Plan (the “2017 Plan”) and 2010 Stock Incentive Plan (the “2010 Plan”) provides for the issuance of 4,806,513 shares of our common stock. We have granted stock options to executive officers, employees, members of our board of directors, and certain outside consultants, and restricted stock units ("RSUs") to employees. The terms and conditions upon which options become exercisable vary among grants; however, option rights expire no later than ten years from the date of grant and employee and Board of Director awards generally vest over three to five years on a straight-line basis. The terms and
F-21

conditions upon which RSUs vest vary among grants; however, RSUs generally vest over four years on a straight-line basis. As of December 31, 2020, we had 3,616,314 vested and unvested stock options outstanding, and 30,000 unvested RSUs. We had 198,636 shares reserved and available for future awards as of December 31, 2020.
Stock-based compensation expense was approximately $8.1 million and $5.2 million for the years ended December 31, 2020 and 2019, respectively. The Company issued $0.4 million of common stock to one of the Company's executives during the quarter ended March 31, 2020 and it is included in stock-based compensation expense for the year ended December 31, 2020.
During the quarter ended September 30, 2019, the Company determined that it was not probable to achieve its internal performance targets for a tranche of warrants issued for the fiscal year 2019, resulting in the reversal of the compensation expense recognized previously for the shares that were not expected to vest. As a result, the Company recognized a reversal of compensation expense related to these performance based awards of $1.1 million for the year ended December 31, 2019.
The assumptions used in the Black-Scholes option-pricing model were determined as follows:
Year Ended December 31,
20202019
Volatility78.00 %100.34 %
Risk-free interest rate0.00%-1.55%1.63%-2.60%
Expected life (in years)2.63-6.082.85-6.08
Dividend yield%%
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 year ended December 31, 2020, reflects the application of the simplified method prescribed in SEC's Staff Accounting Bulletin (“SAB”) No. 107 (as amended by SAB 110), which defines the life as the average of the contractual term of the options and the weighted average vesting period for all option tranches.

Stock Options – Employees and Directors
A summary of stock option activity for employee and director grants was as follows:
Number of
Shares Outstanding
Weighted-
Average
Exercise Price
Outstanding at December 31, 20194,006,351 $10.93 
Granted945,788 26.80 
Exercised(737,281)8.37 
Forfeited(569,739)12.07 
Expired(28,805)104.25 
Outstanding at December 31, 20203,616,314 14.66 
Options vested and exercisable at December 31, 2020945,148 $11.68 
As of December 31, 2020, there was $22.8 million of unrecognized compensation costs related to non-vested share-based compensation arrangements granted to employees and directors under the Plan. These costs are expected to be recognized over a weighted-average period of 2.14 years.
Restricted Stock Units - Employees
We estimate the fair value of RSUs based on the closing price of our common stock on the date of grant. The following table summarizes our RSU award activity during the year ended December 31, 2020 issued under the 2017 Plan:
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Restricted Stock UnitsWeighted-
Average
Grant Date Fair Value
Non-vested at December 31, 2019$
Granted30,000 51.98 
Non-vested at December 31, 202030,000 51.98 


As of December 31, 2020, there was $1.5 million of unrecognized compensation cost related to unvested outstanding RSUs. We expect to recognize these costs over a weighted average period of 3.89 years.
Stock Options and Warrants – Non-employees
The Company did 0t issue any stock options to consultants during the year ended December 31, 2020 compared to 50,000 stock options at a weighted average exercise price of $9.93 for the year ended December 31, 2019. Stock compensation expense related to consultants was $0.1 million for the year ended December 31, 2020 and $0.1 million for the year ended December 31, 2019. As of December 31, 2020, there was $0.1 million of total unrecognized compensation cost related to non-vested stock compensation arrangements granted to non-employees under the 2017 Amended Plan, which is expected to be recognized over a weighted-average period of approximately 1.17 years.
In addition to stock options granted under the Plan, we have also granted warrants to purchase common stock to certain non-employees that have been approved by our Board of Directors. A summary of warrants activity for non-employees was as follows:
Number of WarrantsWeighted Average
Exercise Price
Outstanding as of December 31, 20191,550,975 $6.08 
Exercised (1)
(85,048)7.14 
Outstanding as of December 31, 20201,465,927 6.02 
Warrants exercisable as of December 31, 20201,465,927 6.02 
_______________________
(1) Included in total number of warrants exercised are 12,936 shares that were net settled at the election of the warrant holders during the year ended December 31, 2020.
There were 0 warrants issued during the year ended December 31, 2020, compared with 228,607 warrants during the year ended December 31, 2019. Of the total outstanding warrants as of December 31, 2020, 1,249,189 warrants were held by an entity controlled by the Company's chairman and chief executive officer.
Performance-Based and Market-Based Awards
The Company’s Compensation Committee designed a compensation structure to align the compensation levels of certain executives to the performance of the Company through the issuance of performance-based and market-based stock options. The performance-based options vest upon the Company meeting certain revenue targets and the total amount of compensation expense recognized is based on the number of shares that the Company determines are probable of vesting. The market-based options vest upon the Company’s stock price reaching a certain price at a specific performance period and the total amount of compensation
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expense recognized is based on a Monte Carlo simulation that factors in the probability of the award vesting. The following table summarizes the Company's outstanding awards under this structure:

Grant DatePerformance MeasuresVesting TermPerformance Period# of SharesExercise Price
December 2017Weighted Average Price of our common stock is $15.00 for at least twenty trading days within a period of thirty consecutive trading days ending on the trading day prior to January 1, 2023.Fully vest on January 1, 2023January 1, 2023642,307 $7.50 
August 2018Weighted Average Price of our common stock is $15.00 for at least twenty trading days within a period of thirty consecutive trading days ending on the trading day prior to January 1, 2023.Fully vest on January 1, 2023January 1, 2023397,693 $7.50 

During the quarter ended March 31, 2020, the Company amended the option agreement of one of the Company's former executives to vest additional options previously forfeited and extend the period to exercise, resulting in $0.6 million of additional stock-based compensation expense, which is included in stock-based compensation expense for the year ended December 31, 2020.
During the quarter ended December 31, 2019, the Company entered into a separation agreement with a former executive. As part of the agreement, 115,950 of previously forfeited awards were immediately vested. As a result, $1.1 million of stock compensation expense was recorded during the quarter and classified in operating expenses within the consolidated statement of operations. The remaining awards were forfeited.
During the quarter ended September 30, 2019, the Company determined that it was not probable to achieve its internal performance targets for the tranche issued for the fiscal year 2019, resulting the reversal of the compensation expense recognized previously for the shares that did not vest.

Note 10. Leases
The Company determines whether an arrangement is a lease, or contains a lease, at inception and recognizes right-of-use assets and lease liabilities, initially measured at present value of the lease payments, on our balance sheet and classifies the leases as either operating or financing leases. The Company leases office space for our corporate headquarters in Santa Monica, California, which is accounted for as an operating lease and various computer equipment used in the operation of our business, which are accounted for as finance leases. The operating lease agreement includes 7,869 square feet of office space for a lease term of 60 months, which commenced in July 2019, with base annual rent of approximately $0.6 million subject to annual adjustments. The finance leases are generally for 36 month terms.
The Company’s operating lease relating to its Santa Monica Headquarters does not require any contingent rental payments, impose any financial restrictions, or contain any residual value guarantees. The lease includes renewal options and escalation clauses. The renewal options have not been included in the calculation of the operating lease liability and right-of-use asset as the Company is not reasonably certain to exercise the options. Variable expenses generally represent the Company’s share of the landlord’s operating expenses.
Quantitative information for our leases was as follows (in thousands):

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December 31,
Consolidated Balance SheetsBalance Sheet Classification20202019
Assets
Operating lease asset"Operating lease right-of-use-asset"$1,959 $2,415 
Finance lease assets"Property and equipment, net"721378
Total lease assets$2,680 $2,793 
Liabilities
Current
     Operating lease liability"Current portion of operating lease liability"$434 $374 
     Finance lease liabilities"Other accrued liabilities"321145
Non-current
     Operating lease liability"Long-term operating lease liability"1,4031,836
     Finance lease liabilities"Long-term finance lease liabilities"418233
Total lease liabilities$2,576 $2,588 

Year Ended December 31,
Consolidated Statements of Operations20202019
Operating lease expense$663 $443 
Short-term lease rent expense104 58 
Variable lease expense37 73 
     Total rent expense$804 $574 
Finance lease expense:
  Amortization of leased assets$209 $38 
  Interest on lease liabilities31 
     Total$240 $43 

Year Ended December 31,
Consolidated Statements of Cash Flows20202019
Cash paid for amounts included in the measurement of lease liabilities:
   Operating cash flows from operating lease$580 $381 
   Financing cash flows from finance leases186 48 

December 31,
Other Information20202019
Weighted-average remaining lease term (years)
   Operating lease3.84.5
   Financing leases2.42.9
Weighted-average discount rate (%)
   Operating lease10.15 %10.15 %
   Finance leases10.88 %7.89 %
The following table sets forth maturities of our lease liabilities (in thousands):
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At December 31, 2020
Operating LeaseFinancing LeasesTotal
2021$601 $363 $964 
2022622302924
2023643139782
2024332332
Total lease payments2,1988043,002 
    Less: imputed interest(361)(65)(426)
Present value of lease liabilities1,8377392,576
    Less: current portion(434)(321)(755)
Lease liabilities, non-current$1,403 $418 $1,821 

Note 11. Income Taxes
The components of our income tax benefit consisted of the following (in thousands):
Year Ended December 31,
20202019
Current:
   State$$
Total current taxes
Deferred:
    Federal(540)
    State(114)
Total deferred taxes(654)
    Income tax benefit$(645)$

The income tax benefit for the year ended December 31, 2020 was a result of the deferred tax liability recorded at the time of the LifeDojo acquisition that was subsequently reversed at December 31, 2020.

As of December 31, 2020, the Company had net federal operating loss carry forwards and state operating loss carry forwards of approximately $295 million and $159 million, respectively. The net federal operating loss carry forwards begin to expire in 2023, and net state operating loss carry forwards begin to expire in 2020.

As of December 31, 2020, the Company completed an analysis of its ownership changes since formation in accordance with Section 382 of the Internal Revenue Code of 1986, as amended. As a result of the study, the Company expects federal and state NOLs of approximately $151 million and $90 million, respectively, to expire unutilized and the Company has reduced its gross deferred tax asset associated with the NOL carryforward, for the amount that is expected to expire unutilized, with an offsetting reduction to the valuation allowance.
Due to such uncertainties surrounding the realization of the deferred tax assets, the Company maintains a valuation allowance of $38.6 million and $70.1 million against all of its deferred tax assets as of December 31, 2020 and 2019, respectively. For the years ended December 31, 2020 and 2019, the total change in valuation allowance was $(31.6) million and $6.0 million, respectively. Realization of the deferred tax assets will be primarily dependent upon the Company's ability to generate sufficient taxable income.
Net deferred tax assets and liabilities were as follows (in thousands):

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Year Ended December 31,
20202019
Net operating losses$34,593 $66,405 
Stock-based compensation1,888 1,648 
Interest expense3,253 1,494 
Accrued liabilities and reserves322 744 
Fixed assets(864)51 
Lease liability655 658 
Other temporary differences200 23 
Deferred commission(612)
Prepaid expenses(192)(186)
Right-of-use assets(681)(710)
Valuation allowance(38,562)(70,127)
   Net deferred tax asset$$

The Company has provided a valuation allowance in full on its net deferred tax assets in accordance with ASC 740 - "Income Taxes" ("ASC 740"). Because of the Company's continued losses, management assessed the realizability of its net deferred tax assets as being less than the more-likely-than-not criteria set forth by ASC 740. Furthermore, certain portions of the Company's net operating loss carryforwards were acquired, and therefore subject to further limitation set forth under the federal tax code, which could further limit the Company's ability to realize its deferred tax assets.
A reconciliation between the statutory federal income tax rate and the effective income tax rate for the years presented was as follows:

Year Ended December 31,
20202019
Tax at federal statutory rate21.0 %21.0 %
Stock-based compensation1.9 (1.2)
Section 162(m)(4.2)
Change in federal valuation allowance121.0 (19.6)
Reduction in federal NOL carryforward DTA due to 382 study results(135.6)
Other(1.3)(0.2)
   Effective tax rate2.8 %%

The Company has adopted guidance issued by the FASB that clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements and prescribes a recognition threshold of more likely than not and a measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In making this assessment, a company must determine whether it is more likely than not that a tax position will be sustained upon examination, based solely on the technical merits of the position and must assume that the tax position will be examined by taxing authorities. Our policy is to include interest and penalties related to unrecognized tax benefits in income tax expense. There were 0 interest and penalties for the years ended December 31, 2020 and 2019, respectively. The Company files income tax returns with the Internal Revenue Service (“IRS”) and various states with sufficient nexus. For jurisdictions in which tax filings are prepared, the Company is no longer subject to income tax examinations by state tax authorities for tax years prior to 2016, and by the IRS for tax years through 2017. The Company’s net operating loss carryforwards are subject to IRS examination until they are fully utilized and such tax years are closed.
There are currently no income tax audits in any jurisdictions for open tax years and, as of December 31, 2020, there have been no material changes to our tax positions. 

Note 12. Commitments and Contingencies
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From time to time, we are subject to various legal proceedings that arise in the normal course of our business activities. As of the date of this Annual Report on Form 10-K, we were not party to any litigation the outcome of which, if determined adversely to us, would individually or in the aggregate be reasonably expected to have a material adverse effect on our results of operations or financial position except the following:
Loss Contingency

On March 3, 2021, a purported securities class action was filed in the United States District Court for the Central District of California, entitled Farhar v. Ontrak, Inc., Case No. 2:21-cv-01987 (C.D. Cal. filed Mar. 3, 2021). In this action, plaintiff, purportedly on behalf of a putative class of purchasers of Ontrak securities from November 5, 2020 through February 26, 2021, alleges that the Company and certain of its officers violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, by intentionally or recklessly making false and/or misleading statements and/or failing to disclose that (i) Ontrak’s largest customer evaluated Ontrak on a provider basis, valuing Ontrak’s performance based on achieving the lowest cost per medical visit rather than clinical outcomes or medical cost savings; (ii) as a result, Ontrak’s largest customer did not find Ontrak’s program to be effective and was reasonably likely to terminate its contract with Ontrak; (iii) because this customer accounted for a significant portion of Ontrak’s revenue, loss of the customer would have an outsized impact on Ontrak’s financial results; and (iv) as a result of the foregoing, Ontrak’s positive statements about its business, operations and prospects were materially misleading and/or lacked a reasonable basis. The complaint has not yet been served. We believe that the allegations lack merit and intend to defend against this action vigorously.

Note 13. Related Party Transactions

Accounts payable outstanding with Mr. Peizer, the Company's Chief Executive Officer, was approximately $0.2 million and $0.4 million as of December 31, 2020 and 2019, respectively.
Note 14. Subsequent Event

On February 26, 2021, the Company was notified by its largest customer that the participation status with this customer will be terminated effective June 26, 2021. The Company has been advised to stop enrollment of new members for this customer and await guidance from the customer on transition plans for the 8,100 members who are currently benefiting from the Ontrak program. For the year ended December 31, 2020, this customer accounted for approximately 58% of our total revenue.


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