Ontrak, Inc. [OTRK] Filings

10-Q 1 otrk-20230630.htm 10-Q otrk-20230630

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________________

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2023

Commission File Number 001-31932

____________________________

Ontrak, Inc.

(Exact name of registrant as specified in its charter)

____________________________


Delaware			88-0464853
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification No.)

2200 Paseo Verde Parkway, Suite 280, Henderson, NV 89052

(Address of principal executive offices, including zip code)

(310) 444-4300

(Registrant's telephone number, including area code)

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


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.0001 par value	OTRK	The NASDAQ Capital Market
9.50% Series A Cumulative Perpetual Preferred Stock, $0.0001 par value	OTRKP	The NASDAQ Capital Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o

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


Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	☒	Smaller reporting company	☒
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No x

As of August 4, 2023, there were 4,887,969 shares of the registrant's common stock, $0.0001 par value per share, outstanding.

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TABLE OF CONTENTS


PART I - FINANCIAL INFORMATION			3

	ITEM 1. Financial Statements		3

		Condensed Consolidated Balance Sheets as of June 30 , 2023 (unaudited) and December 31, 20 22	3

		Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2023 and 2022 (unaudited)	4

		Condensed Consolidated Statements of Stockholders’ Equity for the Three and Six Months Ended June 30, 2023 and 2022 (unaudited)	5

		Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2023 and 2022 (unaudited)	6

		Notes to Condensed Consolidated Financial Statements	8

	ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		31

	ITEM 3. Quantitative and Qualitative Disclosures About Market Risk		40

	ITEM 4. Controls and Procedures		40

PART II - OTHER INFORMATION			40

	ITEM 1. Legal Proceedings		40

	ITEM 1A. Risk Factors		40

	ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds		61

	ITEM 3. Defaults Upon Senior Securities		61

	ITEM 4. Mine Safety Disclosures		62

	ITEM 5. Other Information		62

	ITEM 6. Exhibits		62

	Signatures		63

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

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

ONTRAK, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)


	June 30, 2023		December 31, 2022
Assets	(unaudited)
Current assets:
Cash and cash equivalents	$	6,094	$	5,032
Restricted cash - current	4,000		4,477
Receivables, net	282		973
Unbilled receivables	364		453
Deferred costs - current	188		156
Prepaid expenses and other current assets	2,925		3,168
Total current assets	13,853		14,259
Long-term assets:
Property and equipment, net	2,003		2,498
Restricted cash - long-term	—		204
Goodwill	5,713		5,713
Intangible assets, net	515		1,125
Other assets	310		1,326
Operating lease right-of-use assets	216		632
Total assets	$	22,610	$	25,757
Liabilities and stockholders' equity
Current liabilities:
Accounts payable	$	1,590	$	1,927
Accrued compensation and benefits	681		1,987
Deferred revenue	308		326

Current portion of operating lease liabilities	50		653
Other accrued liabilities, includes $4,000 related party deposit (see Note 10)	7,116		4,576

Total current liabilities	9,745		9,469
Long-term liabilities:
Long-term debt, net	11,913		10,065
Long-term operating lease liabilities	196		546


Total liabilities	21,854		20,080
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.0001 par value; 50,000,000 shares authorized; 3,770,265 shares issued and outstanding at each of June 30, 2023 and December 31, 2022	—		—
Common stock, $0.0001 par value; 500,000,000 shares authorized; 4,887,874 and 4,527,914 shares issued and outstanding at June 30, 2023 and December 31, 2022, respectively	3		3
Additional paid-in capital	458,600		448,415
Accumulated deficit	(457,847)		(442,741)
Total stockholders' equity	756		5,677
Total liabilities and stockholders' equity	$	22,610	$	25,757

See notes to condensed consolidated financial statements.

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ONTRAK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share data)


	Three Months Ended June 30,				Six Months Ended June 30,
	2023		2022		2023		2022
Revenue	$	2,960	$	3,903	$	5,489	$	9,161
Cost of revenue	804		2,206		1,651		5,052
Gross profit	2,156		1,697		3,838		4,109

Operating expenses:
Research and development	1,537		2,852		3,181		6,280
Sales and marketing	837		1,306		1,827		2,742
General and administrative	4,410		9,449		10,228		20,142
Restructuring, severance and related charges	—		—		457		—
Total operating expenses	6,784		13,607		15,693		29,164
Operating loss	(4,628)		(11,910)		(11,855)		(25,055)

Other (expense) income, net	(5)		(1,972)		286		(1,972)
Interest expense, net	(2,223)		(1,156)		(3,617)		(2,556)
Loss before income taxes	(6,856)		(15,038)		(15,186)		(29,583)
Income tax benefit (expense)	100		(20)		80		(120)
Net loss	(6,756)		(15,058)		(15,106)		(29,703)
Dividends on preferred stock - declared and undeclared	(2,238)		(2,238)		(4,477)		(4,477)
Net loss attributable to common stockholders	$	(8,994)	$	(17,296)	$	(19,583)	$	(34,180)

Net loss per common share, basic and diluted	$	(1.84)	$	(4.97)	$	(4.09)	$	(9.86)

Weighted-average common shares outstanding, basic and diluted	4,887		3,481		4,787		3,467

See notes to condensed consolidated financial statements.

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ONTRAK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(unaudited, in thousands, except share and per share data)


	Preferred Stock			Common Stock			Additional Paid-In Capital		Accumulated Deficit		Total Stockholders' Equity
	Shares	Amount		Shares	Amount
Balance at March 31, 2023	3,770,265	$	—	4,886,708	$	3	$	457,708	$	(451,091)	$	6,620

Restricted stock units vested, net	—	—		1,166	—		—		—		—

Stock-based compensation expense	—	—		—	—		892		—		892
Net loss	—	—		—	—		—		(6,756)		(6,756)
Balance at June 30, 2023	3,770,265	$	—	4,887,874	$	3	$	458,600	$	(457,847)	$	756

Balance at March 31, 2022	3,770,265	$	—	3,471,887	$	2	$	437,894	$	(405,813)	$	32,083
Common stock issued relating to settlement of contingent consideration	—	—		1,514	—		80		—		80
Warrants issued in debt financing	—	—		—	—		283		—		283
Restricted stock units vested, net	—	—		355	—		(1)		—		(1)
401(k) employer match	—	—		17,553	—		193		—		193
Stock-based compensation expense	—	—		—	—		2,152		—		2,152
Net loss	—	—		—	—		—		(15,058)		(15,058)
Balance at June 30, 2022	3,770,265	$	—	3,491,309	$	2	$	440,601	$	(420,871)	$	19,732

Balance at December 31, 2022	3,770,265	$	—	4,527,914	$	3	$	448,415	$	(442,741)	$	5,677


Common stock issued for financing	—	—		339,689	—		—		—		—
Warrants issued in debt financing	—	—		—	—		10,797		—		10,797
Loss on extinguishment of debt with related party	—	—		—	—		(2,153)		—		(2,153)
Restricted stock units vested, net	—	—		1,374	—		(2)		—		(2)
401(k) employer match	—	—		18,897	—		—		—		—
Stock-based compensation expense	—	—		—	—		1,543		—		1,543

Net loss	—	—		—	—		—		(15,106)		(15,106)
Balance at June 30, 2023	3,770,265	$	—	4,887,874	$	3	$	458,600	$	(457,847)	$	756

Balance at December 31, 2021	3,770,265	$	—	3,446,698	$	2	$	436,721	$	(391,168)	$	45,555
Preferred dividends declared	—	—		—	—		(2,239)		—		(2,239)
Common stock issued relating to settlement of contingent consideration	—	—		5,569	—		293		—		293
Common stock issued for consulting services	—	—		9,260	—		102		—		102
Warrants issued in debt financing	—	—		—	—		283		—		283
Restricted stock units vested, net	—	—		565	—		(3)		—		(3)
401(k) employer match	—	—		29,217	—		381		—		381
Stock-based compensation expense	—	—		—	—		5,063		—		5,063
Net loss	—	—		—	—		—		(29,703)		(29,703)
Balance at June 30, 2022	3,770,265	$	—	3,491,309	$	2	$	440,601	$	(420,871)	$	19,732

See notes to condensed consolidated financial statements.

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ONTRAK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

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	For the Six Months Ended June 30,
	2023		2022
Cash flows from operating activities
Net loss	$	(15,106)	$	(29,703)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock-based compensation expense	1,543		5,063
Write-off of debt issuance costs	—		2,023
Paid-in-kind interest expense	1,936		—
Gain on termination of operating lease	(471)		—
Depreciation expense	590		1,424
Amortization expense	2,382		1,310


Change in fair value of warrant liability	12		(51)
401(k) employer match in common shares	—		363
Common stock issued for consulting services	—		102


Changes in operating assets and liabilities:
Receivables	691		2,340
Unbilled receivables	89		2,484
Prepaid expenses and other current assets	326		2,136
Accounts payable	(371)		442
Deferred revenue	(18)		(119)
Leases liabilities	(142)		(12)
Other accrued liabilities	(1,529)		(2,017)
Net cash used in operating activities	(10,068)		(14,215)
Cash flows from investing activities
Purchase of property and equipment	(123)		(754)
Net cash used in investing activities	(123)		(754)
Cash flows from financing activities
Proceeds from Keep Well Notes	8,000		—

Proceeds from Keep Well Agreement held in escrow	4,000		—
Dividends paid	—		(2,239)
Repayments of 2024 Notes	—		(31,694)
Debt issuance costs	(98)		(440)



Finance lease obligations	(100)		(162)
Financed insurance premium payments	(1,228)		(1,505)
Payment of taxes related to net-settled stock awards	(2)		(3)
Net cash provided by (used in) financing activities	10,572		(36,043)

Net change in cash and restricted cash	381		(51,012)

Cash and restricted cash at beginning of period	9,713		65,946
Cash and restricted cash at end of period	$	10,094	$	14,934

Supplemental disclosure of cash flow information:
Interest paid	$	45	$	1,978
Income taxes paid	3		130
Non-cash financing and investing activities:
Warrants issued in connection with Keep Well Notes (in 2023)/2024 Notes (in 2022)	$	10,797	$	458
Loss on extinguishment of debt with related party	2,153		—
Finance lease and accrued purchases of property and equipment	28		77
Common stock issued to settle contingent consideration	—		293
Accrued debt issuance costs	85		190

See notes to condensed consolidated financial statements.

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1. Organization

Company Overview

Ontrak, Inc. (“Ontrak,” “Company,” “we,” “us” or “our”) is an 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. The Company's technology-enabled platform provides claim-based analytics and predictive modeling to provide analytic insights throughout the delivery of our personalized treatment program. The Company's program predicts people whose chronic disease will improve with behavior change, recommends effective care pathways that people are willing to follow, and engages and guides them to and through the care they need. By combining predictive analytics with human engagement, we deliver improved member health and validated outcomes and savings to healthcare payors.

The Company's integrated, technology-enabled OntrakTM programs are designed to provide healthcare solutions to members with behavioral conditions that cause or exacerbate chronic medical conditions such as diabetes, hypertension, coronary artery disease, chronic obstructive pulmonary disease, and congestive heart failure, which result in high medical costs. Ontrak has a unique ability to engage these members, who may not otherwise seek behavioral healthcare, leveraging proprietary enrollment capabilities built on deep insights into the drivers of care avoidance. Ontrak integrates evidence-based psychosocial and medical interventions delivered either in-person or via telehealth, along with care coaching and in-market community care coordinators who address the social and environmental determinants of health, including loneliness. The Ontrak programs seek to improve member health and deliver validated cost savings to healthcare payors.

Basis of Presentation

The accompanying condensed consolidated financial statements include Ontrak, Inc. and its wholly-owned subsidiaries and variable interest entities. The accompanying condensed consolidated financial statements for Ontrak, Inc. have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and instructions to Form 10-Q and Article 8 of Regulation S-X. All intercompany balances and transactions have been eliminated in consolidation. Certain information and note disclosures normally included in the annual consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the accompanying condensed financial statements includes all adjustments (consisting of normal recurring adjustments) necessary for the fair presentation of the interim periods presented. Interim results are not necessarily indicative of the results that may be expected for any other interim period or for the entire fiscal year. The accompanying unaudited financial information should be read in conjunction with the audited financial statements and the notes thereto included in the Annual Report on Form 10-K for the year-ended December 31, 2022 (the "2022 10-K"), filed with the Securities and Exchange Commission ("SEC"), from which the consolidated balance sheet as of December 31, 2022 has been derived. The Company operates as one segment.

All common share and common stock per share amounts presented herein for all periods have been retroactively adjusted to reflect the impact of the 1-for-6 reverse stock split the Company effected on July 27, 2023 discussed in Note 14 below.

The Company provides services to commercial (employer funded), managed Medicare Advantage, managed Medicaid and dual eligible (Medicare and Medicaid) populations to generate revenues. The Company also provides mental health and wellbeing support to members of employer customers under the Company's LifeDojo wellbeing solution. The Company aims to increase the number of members that are eligible for its solutions by signing new contracts and identifying more eligible members under existing contracts.

We have incurred significant net losses and negative operating cash flows since our inception, and we expect to continue to incur net losses and negative operating cash flow, in part due to the negative impact on our operations by customer terminations. As of June 30, 2023, our cash and restricted cash was $10.1 million and we had working capital of approximately $4.1 million. For the six months ended June 30, 2023, our average monthly cash burn rate from operations was $1.7 million. Throughout the year ended December 31, 2022 and in March 2023, as part of the Company's continued cost saving measures to reduce its operating costs and to better align with its previously stated strategic initiatives, the Company implemented a number of reduction in workforce and vendor cost optimization plans. The Company has begun realizing the full effect of these plans and expects continued effects to be realized during the remainder of 2023 and beyond, including a decrease in the Company's operating costs and an improvement in the Company's average monthly cash flow from operations. The cost optimization plans were necessary to right size the Company's business commensurate with its current customer base.

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

In addition to revenue from operations, our primary source of working capital is borrowing under the Keep Well Agreement (as defined in Note 10 below). As of June 30, 2023, $6.0 million remained available for funding under the Keep Well Agreement. We may also be able to raise capital through equity financings, however, when we can affect such financing and the amount of capital raised depends on a variety of factors, including, among others, market conditions, the trading price of our common stock and our determination as to the appropriate sources of funding for our operations.

Regardless of our success in raising additional capital, we expect our cash on hand and the $6.0 million remaining available for funding under the Keep Well Agreement will be sufficient to meet our obligations for at least the next 12 months from the date these financial statements are released.

Management plans to continue to execute on its strategy by (i) exploring other sources of capital with either debt or equity financing for future liquidity needs; (ii) continuing to manage operating costs by strategically pursuing cost optimization initiatives; and (iii) continuing to pursue executing our growth strategy by improving our marketing techniques and implementing new features to increase customer engagement, adding new members and securing new customer contracts.

There can be no assurance that we will be able to satisfy the conditions precedent to future borrowings under the Keep Well Agreement or that other capital will be available when needed or that, if available, it will be obtained on terms favorable to us and our stockholders, that we will be successful in implementing cost optimization initiatives, or that we will be successful in executing our growth strategy. In addition, the Keep Well Agreement contains various financial and other covenants, and any non-compliance with those covenants could prevent us from borrowing additional amounts under the Keep Well Agreement and/or result in an acceleration of the repayment of the amounts outstanding thereunder. Furthermore, equity or debt financings may have a dilutive effect on the holdings of our existing stockholders, and debt financings may subject us to restrictive covenants, operational restrictions and security interests in our assets.

Recently Adopted Accounting Standards

In October 2021, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2021-08, "Business Combinations (Topic 805) - Accounting for Contract Assets and Contract Liabilities from Contracts with Customers" ("ASU 2021-08"), which improves the accounting for acquired revenue contracts with customers in a business combination by addressing diversity in practice and inconsistency related to recognition of an acquired contract liability, and payment terms and their effect on subsequent revenue recognized by the acquirer. The amendments in ASU 2021-08 require that an entity (acquirer) recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606 - Revenue from Contracts with Customers. The amendments in ASU 2021-08, however, do not affect the accounting for other assets or liabilities that may arise from revenue contracts with customers in accordance with Topic 606, such as refund liabilities, or in a business combination, such as customer-related intangible assets and contract-based intangible assets. ASU 2021-08 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The amendments in ASU 2021-08 should be applied prospectively to business combinations occurring on or after the effective date of the amendments. The adoption of ASU 2021-08 on January 1, 2023 did not have a material effect on our condensed consolidated financial statements.

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 adoption of ASU 2020-10 on January 1, 2023 did not have a material effect on our condensed consolidated financial statements.

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 SEC, ASU 2016-13 is effective for annual reporting periods beginning after December 15, 2022, including interim periods within those annual periods. The adoption of ASU 2016-13 on January 1, 2023 did not have a material effect on our condensed consolidated financial statements.

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Recently Issued Accounting Pronouncements

Since the date on which the Company filed the 2022 10-K, there were no new accounting standards issued, but not yet adopted by the Company, which are expected to materially affect the Company's condensed consolidated financial statements.

Note 2. Restricted Cash

The following table provides a reconciliation of cash, cash equivalents and restricted cash total as presented in the condensed consolidated statement of cash flows for the periods presented (in thousands):


	June 30, 2023		December 31, 2022
Cash and cash equivalents	$	6,094	$	5,032
Restricted cash - current:
Dividend payments on preferred stock (1)	—		4,477
Cash in escrow (2)	4,000		—

Subtotal - Restricted cash - current	4,000		4,477
Restricted cash - long term:

Letter of credit (3)	—		204
Subtotal - Restricted cash - long term	—		204
Cash, cash equivalents and restricted cash	$	10,094	$	9,713

____________

(1) As of December 31, 2022, the amount represented the cash balance that was remaining in an account funded with a portion of the proceeds from the sale of the Series A Preferred Stock for the payment of dividends thereon until August 2022. The use of such funds for the payment of such dividends was subject to compliance with applicable laws. In April 2023, the Company’s board of directors determined that the use of such funds for other corporate purposes was in the best interests of the Company and its common stockholders after considering its fiduciary duties to the Company’s common stockholders. Therefore, the amount was classified as unrestricted cash as of June 30, 2023.

(2) Represents cash received under the Keep Well Agreement in June 2023 and held in a separate account pursuant to the terms of the Keep Well Agreement. See Note 10 below for more information. The amount has been included in "Other accrued liabilities" on the condensed consolidated balance sheet as of June 30, 2023.

(3) The letter of credit ("LOC") was required under the terms of the lease for our Santa Monica, California office. In accordance with the lease termination agreement entered into on February 16, 2023 (as discussed in Note 9 below), the LOC was canceled on June 16, 2023.

Note 3. Receivables and Revenue Concentration

The following table is a summary of concentration of credit risk by customer revenues as a percentage of our total revenue:


	Three Months Ended June 30,				Six Months Ended June 30,
Percentage of Revenue	2023		2022		2023		2022
Customer A	55.4	%	30.1	%	53.8	%	26.6	%
Customer B	33.5		46.8		34.6		47.7
Customer C	3.2		16.5		2.5		17.7


Remaining customers	7.9		6.6		9.1		8.0
Total	100.0	%	100.0	%	100.0	%	100.0	%

The following table is a summary of concentration of credit risk by customer accounts receivables as a percentage of our total accounts receivable:

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)


Percentage of Accounts Receivable	June 30, 2023		December 31, 2022
Customer D	77.7	%	3.8	%
Customer E	12.0		—
Customer C	10.3		1.1
Customer A	—		39.1
Customer B	—		35.7
Customer F	—		20.3

Total	100.0	%	100.0	%

The Company applies the specific identification method for assessing provision for doubtful accounts. There was no bad debt expense in any of the three or six months ended June 30, 2023 and 2022.

Other receivable - Insurance Recoveries

The Company is involved in various securities class actions and purported stockholder derivative complaints, and the Company has incurred legal costs related to the SEC/Department of Justice (the "DOJ") investigation of the Company's former Chief Executive Officer and Chairman of the Board of Directors, as described in Note 13 below. The Company maintains a corporate liability insurance policy which provides coverage for legal defense costs (the "Insurance Policy") and the Company has submitted claims for approximately $1.3 million of such legal costs as of June 30, 2023. The terms of the Insurance policy provide that the insurer will pay the third party directly on behalf of the Company for such claims. Based on the Company's analysis, the Company's obligation as the primary obligor of the invoices has not been transferred to the insurer and as such, the Company has recorded the $1.3 million claim as an other receivable included in "Prepaid expenses and other current assets," $0.3 million as part of "Accounts payable" and $1.0 million as part of "Other accrued liabilities" on the condensed consolidated balance sheet as of June 30, 2023.

Note 4. Property and Equipment

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


	June 30,		December 31,
	2023		2022
Software	$	4,473	$	6,882
Computers and equipment	417		466
ROU assets - finance lease	375		375
Leasehold improvements	—		17
Software development in progress	22		—
Subtotal	5,287		7,740
Less: Accumulated depreciation and amortization	(3,284)		(5,242)
Property and equipment, net	$	2,003	$	2,498

Total depreciation and amortization expense relating to property and equipment presented above was $0.3 million and $0.8 million for the three months ended June 30, 2023 and 2022, respectively, and $0.6 million and $1.5 million for the six months ended June 30, 2023 and 2022, respectively.

Capitalized Internal Use Software Costs

During the three months ended June 30, 2023 and 2022, we capitalized $0.1 million and $0.4 million, respectively, of costs relating to development of internal use software, and recorded $0.3 million and $0.7 million, respectively, of amortization

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

expense relating to capitalized internal use software, which was included in total depreciation and amortization expense as described above.

During the six months ended June 30, 2023 and 2022, we capitalized $0.2 million and $0.8 million, respectively, of costs relating to development of internal use software, and recorded $0.5 million and $1.3 million, respectively, of amortization expense relating to capitalized internal use software, which was included in total depreciation and amortization expense as described above.

Note 5. Goodwill and Intangible Assets

Goodwill

The carrying amount of indefinite-lived goodwill was $5.7 million as of June 30, 2023 and December 31, 2022.

Intangible Assets

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


		At June 30, 2023						At December 31, 2022
	Weighted Average Estimated Useful Life (years)	Gross Value		Accumulated Amortization		Net Carrying Value		Gross Value		Accumulated Amortization		Net Carrying Value
Acquired software technology	3	$	3,500	$	(3,111)	$	389	$	3,500	$	(2,528)	$	972
Customer relationships	5	270		(144)		126		270		(117)		153
Total		$	3,770	$	(3,255)	$	515	$	3,770	$	(2,645)	$	1,125

Amortization expense for intangible assets presented above was $0.3 million for each of the three months ended June 30, 2023 and 2022, and $0.6 million for each of the six months ended June 30, 2023 and 2022.

At June 30, 2023, estimated amortization expense for intangible assets for each year thereafter was as follows (in thousands):


Remainder of 2023	$	416
2024	54
2025	45
Total	$	515

Note 6. Restructuring, Severance and Related Costs

In March 2023, as part of the Company's continued cost saving measures and to reduce its operating costs and to help align with its previously stated strategic initiatives, the Company implemented additional headcount reductions wherein approximately 19% of the Company's employee positions were eliminated. In March 2023, the Company incurred a total of approximately $0.5 million of termination related costs, including severance payments and benefits payable to the impacted employees, which have been recorded as part of "Restructuring, severance and related costs" on its condensed consolidated statement of operations for the six months ended June 30, 2023. As of June 30, 2023, the Company paid $0.5 million of such amount and no amount remained outstanding as of June 30, 2023.

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 7. Common Stock and Preferred Stock

Net Loss Per Common Share

Basic net loss per common share is computed by dividing net loss attributable to common stockholders 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 shares of common stock potentially issuable upon exchange or exercise of outstanding shares of preferred stock and outstanding stock options and warrants, in each case, to the extent dilutive. Basic and diluted net loss per common share were the same for each period presented below as the inclusion of any such shares of common stock potentially issuable would have been anti-dilutive.

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


	Three Months Ended June 30,				Six Months Ended June 30,
	2023		2022		2023		2022
Net loss	$	(6,756)	$	(15,058)	$	(15,106)	$	(29,703)
Dividends on preferred stock - declared and undeclared	(2,238)		(2,238)		(4,477)		(4,477)
Net loss attributable to common stockholders	$	(8,994)	$	(17,296)	$	(19,583)	$	(34,180)

Weighted-average shares of common stock outstanding	4,887		3,481		4,787		3,467
Net loss per common share - basic and diluted	$	(1.84)	$	(4.97)	$	(4.09)	$	(9.86)

The following common equivalent shares as of June 30, 2023 and 2022, issuable upon exercise of stock options and warrants, have been excluded from the diluted earnings per share calculation as their effect was anti-dilutive:


	June 30,
	2023	2022
Warrants to purchase common stock	7,082,788	44,409
Options to purchase common stock	1,202,676	641,639
Total	8,285,464	686,048

Equity Offerings

Common Stock

In February 2023, pursuant to the terms of the Keep Well Agreement, as a result of stockholder approvals obtained at the Special Meeting of Stockholders held in February 2023, the Company issued to Acuitas (as defined in Note 10 below) 2,038,133 additional shares of the Company's common stock (which, after giving effect to the reverse stock split discussed in Note 14 below, was adjusted to 339,689 shares of the Company's common stock).

Preferred Stock

In 2020, the Company completed the issuance of a total of 3,770,265 shares of 9.50% Series A Cumulative Perpetual Preferred Stock (the "Series A Preferred Stock"), which is listed on the Nasdaq Global Market under the symbol "OTRKP." The Company, generally, may not redeem the Series A Preferred Stock until August 25, 2025, except upon the occurrence of a Delisting Event or Change of Control (as defined in the Certificate of Designations establishing the Series A Preferred Stock), and on and after August 25, 2025, the Company may, at its option, redeem the Series A Preferred Stock, in whole, at any time, or in part, from time to time, for cash at a redemption price of $25.00 per share, plus any accrued and unpaid dividends. The Series A Preferred Stock has no maturity date and will remain outstanding indefinitely unless redeemed by the Company or exchanged for shares of common stock in connection with a Delisting Event or Change of Control. Holders of Series A Preferred Stock generally have no

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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, including the right to elect two individuals to our Board of Directors.

Holders of Series A Preferred Stock of record at the close of business of each respective record date for quarterly dividends (February 15, May 15, August 15 and November 15 of each year) are entitled to receive, when, as and if declared by our Board of Directors, out of funds legally available for the payment of dividends, cumulative cash dividends at the rate of 9.50% per annum of the $25.00 per share liquidation preference (equivalent to $2.375 per annum per share or $0.593750 per quarter per share). Dividends, if and when declared by our Board of Directors, are payable quarterly in arrears, every February 28, May 30, August 31, and November 30, as applicable. In 2022, our Board of Directors declared the first quarterly dividend on the Series A Preferred Stock for holders of record on February 15, 2022 and paid cash dividends on February 28, 2022. Thereafter, no dividends have been declared by our Board of Directors. As such, at June 30, 2023, we had total undeclared dividends of $11.9 million.

Note 8. Stock-Based Compensation

The Company's 2017 Stock Incentive Plan (the “2017 Plan”) and 2010 Stock Incentive Plan (the “2010 Plan”) (the 2017 Plan and the 2010 Plan together, the "Plan") provide for the issuance of 1,695,741 shares of the Company's common stock. The Company has granted stock options to executive officers, employees, members of its Board of Directors, and certain outside consultants, and has granted restricted stock units ("RSUs") to executive officers, employees and members of its Board of Directors. The terms and conditions upon which stock options vest vary among grants; however, stock options expire no later than ten years from the date of grant and awards granted to employees, including to executive officers, and to members of the Company's Board of Directors generally vest over one to four years on a straight-line basis. The terms and conditions upon which RSUs vest vary among grants; however, RSUs generally vest over three to five years on a straight-line basis. As of June 30, 2023, the Company had 1,441,268 stock options and RSUs outstanding and 18,524 shares reserved for future awards granted under the Plan.

Stock-based compensation expense was $0.9 million and $2.1 million for the three months ended June 30, 2023 and 2022, respectively, and $1.5 million and $5.1 million for the six months ended June 30, 2023 and 2022, respectively.

The assumptions used in the Black-Scholes option-pricing model were as follows:


	Six Months Ended June 30, 2023
Volatility	101.0% - 109.0%
Risk-free interest rate	3.36% - 4.18%
Expected life (in years)	3.76 - 4.66
Dividend yield	0	%

The expected volatility assumptions have been based on the historical and expected volatility of our stock and stock of comparable companies, measured over a period generally commensurate with the expected term or acceptable period to determine reasonable volatility. The weighted average expected option term for the six months ended June 30, 2023 reflects the application of the simplified method prescribed in SEC Staff Accounting Bulletin (“SAB”) No. 107 (as amended by SAB 110), which defines the life as the average of the contractual term of the options and the weighted average vesting period for all option tranches.

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Stock Options - Employees and Directors

A summary of stock option activity is as follows:


	Number of Shares	Weighted Average Exercise Price
Outstanding as of December 31, 2022	815,970	$	18.54
Granted	600,813	2.70

Forfeited	(214,107)	38.52

Outstanding as of June 30, 2023	1,202,676	7.07


Options vested and exercisable as of June 30, 2023	234,223	$	24.96

Performance-Based and Market-Based Awards

The Company’s Compensation Committee designed a compensation structure to align the compensation level of the Company's former Executive Chairman to the performance of the Company through the issuance of market-based stock options. The market-based options vested upon the Company’s stock price reaching a certain price at a specific performance period and the total amount of compensation expense recognized was based on a Monte Carlo simulation that factored in the probability of the award vesting. The market-based stock options to purchase a total of 1,040,000 shares (173,334 shares, adjusted for the reverse stock split, which is discussed in Note 14 below) of the Company's common stock expired unexercised on June 2, 2023.

As of June 30, 2023, there was $3.7 million of unrecognized compensation cost 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 approximately 2.87 years.

Restricted Stock Units - Employees

The Company estimates the fair value of RSUs based on the closing price of its common stock on the date of grant. The following table summarizes our RSU award activity issued under the 2017 Plan:


	Restricted Stock Units	Weighted- Average Grant Date Fair Value
Non-vested at December 31, 2022	241,599	$	12.92

Forfeited	(913)	190.25
Vested and settled	(2,094)	222.64
Non-vested at June 30, 2023	238,592	10.40

As of June 30, 2023, there was $1.9 million of unrecognized compensation costs related to unvested outstanding RSUs. These costs are expected to be recognized over a weighted-average period of approximately 2.17 years.

Warrants - Non-employees

The Company has issued warrants to purchase shares of the Company's common stock that have been approved by our Board of Directors. A summary of warrants activity was as follows:

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)


	Number of Warrants	Weighted Average Exercise Price
Outstanding as of December 31, 2022	262,713	$	4.52


Granted	6,820,075	2.44


Outstanding as of June 30, 2023	7,082,788	2.51
Warrants exercisable as of June 30, 2023	7,082,788	2.51

On each of January 5, 2023 and March 6, 2023, the Company borrowed $4.0 million under the Keep Well Agreement. In connection with the January 5, 2023 borrowing, the Company issued to Acuitas a warrant to purchase 473,373 shares of the Company's common stock (78,896 shares of the Company's common stock as adjusted for the reverse stock split discussed in Note 14 below) with an exercise price equal to $1.69 per share. In February 2023, as discussed in Note 10 below, warrants to purchase an aggregate 1,775,148 shares of the Company’s common stock (295,860 shares of the Company's common stock as adjusted for the reverse stock split discussed in Note 14 below) previously issued by the Company to Acuitas through February 20, 2023 were exchanged for warrants to purchase 33,333,333 shares of the Company’s common stock (5,555,557 shares of the Company's common stock as adjusted for the reverse stock split discussed in Note 14 below) with an exercise price equal to $0.45 per share ($2.44 per share as adjusted for the reverse stock split discussed in Note 14 below). In connection with the March 6, 2023 borrowing, the Company issued to Acuitas a warrant to purchase 8,888,889 shares of the Company's common stock (1,481,482 shares of the Company's common stock as adjusted for the reverse stock split discussed in Note 14 below) with an exercise price equal to $0.45 per share ($2.44 per share as adjusted for the reverse stock split discussed in Note 14 below). All warrants issued to Acuitas have a five year term.

The assumptions used in the Black-Scholes warrant-pricing model were determined as follows:


	Six Months Ended June 30, 2023
Volatility	100.0	%
Risk-free interest rate	3.90% - 4.61%
Expected life (in years)	5.00
Dividend yield	0	%

Note 9. 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 the Company's balance sheet and classifies the leases as either operating or financing leases. The Company leases office space in Henderson, Nevada, which serves as the Company's headquarters, and in Rosemont, Illinois, which are accounted for as operating leases. The Rosemont lease expired in June 2023. The Company leases various computer equipment used in the operation of its business, which are accounted for as finance leases. The operating lease agreement for the Henderson, Nevada headquarters is for a total of 2,721 square feet of office space for lease term of 58 months. The Company's finance leases are generally for 36 month terms.

On April 12, 2022, the Company entered into a sublease agreement with a subtenant for 100% of the office space the Company leased in Santa Monica, California. The sublease agreement commenced on June 3, 2022 and provided for an expiration date of July 17, 2024, unless sooner terminated. On February 16, 2023, the Company, the landlord and the subtenant entered into a lease and sublease termination agreement for the office space, with a termination date of February 28, 2023. The Company agreed to pay to the landlord a $0.1 million early termination fee and monthly fixed rent for March and April 2023, and the subtenant agreed to pay to the Company monthly fixed sublease payments for March and April 2023. As a result of the lease termination, the Company wrote-off $0.3 million of operating lease right-of-use assets, and $0.6 million and $0.2 million of current and long-term operating lease liabilities, respectively, resulting in a non-cash gain of $0.5 million included in "Other income, net" on the condensed consolidated statement of operations for the six months ended June 30, 2023.

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

The Company’s operating leases do not require any contingent rental payments, impose any financial restrictions, or contain any residual value guarantees. The leases include renewal options and escalation clauses. The renewal options have not been included in the calculation of the operating lease liabilities and right-of-use assets as the Company is not reasonably certain to exercise the options. Variable expenses generally represent the Company’s share of the landlord’s operating expenses.

Quantitative information for our leases is as follows (in thousands):


Condensed Consolidated Balance Sheets	Balance Sheet Classification	June 30, 2023		December 31, 2022
Assets
Operating lease assets	"Operating lease right-of-use-assets"	$	216	$	632
Finance lease assets	"Property and equipment, net"	16		66
Total lease assets		$	232	$	698
Liabilities
Current
Operating lease liabilities	"Current portion of operating lease liabilities"	$	50	$	653
Finance lease liabilities	"Other accrued liabilities"	36		136
Non-current
Operating lease liabilities	"Long-term operating lease liabilities"	196		546

Total lease liabilities		$	282	$	1,335


	Three Months Ended June 30,				Six Months Ended June 30,
Condensed Consolidated Statements of Operations	2023		2022		2023		2022
Operating lease expense	$	32	$	118	$	119	$	216
Short-term lease rent expense	—		2		1		6
Variable lease expense	8		(18)		23		(3)
Operating sublease income	—		(32)		(65)		(32)
Total rent expense	$	40	$	70	$	78	$	187
Finance lease expense
Amortization of leased assets	$	25	$	32	$	50	$	63
Interest on lease liabilities	1		5		3		12
Total	$	26	$	37	$	53	$	75


	Six Months Ended June 30,
Condensed Consolidated Statements of Cash Flows	2023		2022
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	179	$	361
Financing cash flows from finance leases	100		162
Other
Cash received for operating sublease	97		63

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)


Other Information	June 30, 2023		December 31, 2022
Weighted-average remaining lease term (years)
Operating leases	3.7		2.5
Financing leases	0.3		0.7
Weighted-average discount rate (%)
Operating leases	16.25	%	12.56	%
Finance leases	13.89	%	12.92	%

The following table sets forth maturities of our lease liabilities (in thousands):


	At June 30, 2023
	Operating Leases		Financing Leases		Total
Remainder of 2023	$	43	$	36	$	79
2024	88		—		88
2025	90		—		90
2026	93		—		93
2027	16		—		16


Total lease payments	330		36		366
Less: imputed interest	(84)		—		(84)
Present value of lease liabilities	246		36		282
Less: current portion	(50)		(36)		(86)
Lease liabilities, non-current	$	196	$	—	$	196

Note 10. Debt

Keep Well Agreement

On April 15, 2022, the Company entered into a Master Note Purchase Agreement (the “Original Keep Well Agreement”) with Acuitas Capital LLC (“Acuitas Capital”), an entity indirectly wholly owned and controlled by Terren S. Peizer, the Company’s former Chief Executive Officer and Chairman. On August 12, 2022, the Company and Acuitas Capital entered into an amendment to the Original Keep Well Agreement in connection with the appointment of a collateral agent under the Original Keep Well Agreement (the “First Amendment”). On November 19, 2022, the Company and Acuitas Capital entered into another amendment to the Original Keep Well Agreement, as amended by the First Amendment (the “Second Amendment”), on December 30, 2022, the Company and Acuitas Capital entered into another amendment to the Original Keep Well Agreement, as amended by the First Amendment and the Second Amendment (the “Third Amendment”) and on June 23, 2023, the Company and Acuitas Capital entered into another amendment to the Original Keep Well Agreement, as amended by the First Amendment, the Second Amendment and the Third Amendment (the “Fourth Amendment”). The Company refers to the Original Keep Well Agreement, as amended by the First Amendment, the Second Amendment, the Third Amendment and the Fourth Amendment, as the “Keep Well Agreement” and to Acuitas Capital, together with any of its transferees or affiliates under the Keep Well Agreement, as “Acuitas.”

The Original Keep Well Agreement

Under the terms of the Original Keep Well Agreement, subject to the satisfaction of certain conditions precedent (some of which are described below), the Company could borrow from Acuitas up to $25.0 million, and in connection with each such borrowing, the Company agreed to issue to Acuitas a senior secured note (each, an “Original Keep Well Note”) with a principal amount equal to the amount borrowed. Subject to obtaining approval of the Company’s stockholders as required by applicable Nasdaq listing rules, which approval was obtained at the Company’s annual meeting of stockholders held on August 29, 2022 (the “2022 Annual

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Meeting of Stockholders”), in connection with each Original Keep Well Note issued by the Company, the Company agreed to issue to Acuitas a warrant to purchase shares of the Company’s common stock (each, an “Original Keep Well Warrant”). The number of shares of the Company’s common stock underlying each Original Keep Well Warrant was to be equal to (y) the product of the principal amount of the applicable Keep Well Note and 20% divided by (z) the exercise price of the applicable Original Keep Well Warrant, which was $1.69 per share, the Nasdaq Official Closing Price (as reflected on Nasdaq.com) of the Company’s common stock immediately preceding the time the parties entered into the Original Keep Well Agreement. The maturity date of the Original Keep Well Notes was September 1, 2023.

The conditions precedent to the Company’s ability to borrow, and Acuitas’ obligation to lend, under the Original Keep Well Agreement included that (x) the Company have used best efforts to obtain sufficient financing from a third party for the Company to pay and discharge, when due and payable, its obligations, (y) the Company be unable despite its best efforts to obtain such financing from a third party on reasonably acceptable terms, and (z) (1) absent obtaining the funds requested by the Company to borrow under the Original Keep Well Agreement, the Company would not have sufficient unrestricted cash to pay and discharge all of its obligations then due or scheduled to become due within the 30 days following the date of the borrowing request, and (2) there be no conditions or events that, when considered in the aggregate, raise substantial doubt about the Company’s ability to continue as a going concern through August 15, 2023 (the “Funding Condition”).

In connection with entering into the Original Keep Well Agreement, subject to obtaining approval of the Company’s stockholders as required by applicable Nasdaq listing rules, which approval was obtained at the 2022 Annual Meeting of Stockholders, the Company agreed to issue 739,645 shares of its common stock to Acuitas (or an entity affiliated with Acuitas, as designated by Acuitas) (the “Original Commitment Shares”). The Original Commitment Shares were issued to Acuitas in September 2022, and after giving effect to the reverse stock split discussed in Note 14 below, was adjusted to 123,275 shares of the Company’s common stock.

The Second Amendment, the Third Amendment and Fourth Amendment

Under the Second Amendment and the Third Amendment, many of the conditions precedent to the Company’s ability to borrow, and Acuitas’ obligation to lend, were eliminated, including the Funding Condition, the Company’s obligation to pay accrued interest on a monthly basis was eliminated, and instead accrued interest will be added to the principal amount of the applicable Keep Well Note (as defined below) (and of any other secured note issued under the Keep Well Agreement), the financial covenant that the Company’s consolidated recurring revenue be at least $15.0 million was reduced to $11.0 million, however, the satisfaction of such covenant as a condition to funding was eliminated, and certain other affirmative and negative covenants of the Company, the satisfaction of which were conditions to funding, were also eliminated as conditions to funding, and (a) the minimum conversion price of the Keep Well Notes and (b) the minimum dollar amount to which the denominator will be reduced for purposes of calculating the warrant coverage on future borrowings under the Keep Well Agreement (as discussed below), was revised to be $0.15 (subject to adjustment for stock splits or other recapitalizations that affect all common stockholders proportionately). The $0.15 referenced in the preceding sentence was adjusted to $0.90 after giving effect to the reverse stock split discussed in Note 14 below.

Below is a summary of certain other amendments effected by the Second Amendment, the Third Amendment and the Fourth Amendment:

•the maturity date of the Original Keep Well Notes (and of any other secured notes issued under the Keep Well Agreement) was extended from September 1, 2023 to June 30, 2024 in the Second Amendment, and further extended from June 30, 2024 to September 30, 2024 in the Fourth Amendment, subject to acceleration for certain customary events of default, including for failure to make payments when due, breaches by the Company of certain covenants and representations in the Keep Well Agreement, defaults by the Company under other agreements related to indebtedness, the Company’s bankruptcy or dissolution, and a change of control of the Company;

•per the Second Amendment, the remaining amount available to be borrowed under the Keep Well Agreement was increased from $10.7 million to $14.0 million and the provision that previously reduced the amount available to be borrowed by the net proceeds the Company received from equity financings was eliminated;

•per the Second Amendment, the funding structure was changed from borrowings as needed from time to time at the election of the Company, to the Company agreeing to borrow, and Acuitas agreeing to lend, subject to the conditions in the Keep Well Agreement (which conditions were also amended as described above), the entire then-remaining amount of $14.0 million as follows: $4.0 million in each of January (which was borrowed on January 5, 2023), March (which was borrowed on March 6, 2023) and June 2023, and $2.0 million in September 2023; the funding structure was further

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

amended in the Fourth Amendment with respect to the $6.0 million remaining available amount to be funded, as described below;

•per the Fourth Amendment, in lieu of the $6.0 million remaining available amount to be funded as described above (and in full satisfaction of Acuitas’ obligation to purchase Keep Well Notes from the Company), Acuitas agreed to deliver to the Company for deposit and to be held by the Company in a segregated account established by the Company until such time of qualified withdrawal and issuance of a Keep Well Note, as described below (the proceeds so deposited, the “Escrowed Funds” and the account into which the proceeds are so deposited, the “Escrow Account”): (i) $4.0 million on June 23, 2023 (which was received by the Company on June 26, 2023 and included in "Other accrued liabilities" on the condensed consolidated balance sheet as of June 30, 2023); and (ii) $2.0 million on September 1, 2023; Acuitas’ obligation to deliver the $2.0 million to the Company for deposit into the Escrow Account on September 1, 2023 remains subject to the satisfaction (or waiver by Acuitas) of the conditions precedent in the Keep Well Agreement;

•per the Fourth Amendment, any time, and from time to time, that the Company has less than $1.0 million of Qualified Cash (as defined in Fourth Amendment), the Company may withdraw $1.0 million of Escrowed Funds (or any lesser remaining amount of Escrowed Funds) from the Escrow Account; each such withdrawal will be treated as a sale by the Company to Acuitas of a Keep Well Note with a principal amount equal to the amount withdrawn by the Company and in connection with each such withdrawal, the Company will also issue a Keep Well Warrant to Acuitas; and

•per the Fourth Amendment, if the Company does not complete a Qualified Financing (as defined below) on or prior to October 31, 2023, then, on October 31, 2023, the Company must withdraw all of the Escrowed Funds (other than any accrued interest thereon, all of which will belong to the Company) then on deposit in the Escrow Account, and such withdrawal will be treated as a sale by the Company to Acuitas of a Keep Well Note, and in connection with such withdrawal, the Company will also issue a Keep Well Warrant to Acuitas.

In the event the Company completes a Qualified Financing, all of the Escrowed Funds (other than any accrued interest thereon, all of which will belong to the Company) then on deposit in the Escrow Account will be invested in the Qualified Financing on behalf of Acuitas on the same terms as all other investors in the Qualified Financing, and the Company’s obligation to sell to Acuitas, and Acuitas’ obligation to purchase from the Company, any further Keep Well Notes will thereupon be deemed discharged with respect to the amount so invested. Similarly, if a Qualified Financing is completed on or before September 1, 2023, Acuitas agreed, in lieu of delivering $2.0 million to the Company for deposit into the Escrow Account on September 1, 2023, to invest $2.0 million in the Qualified Financing on the same terms as all other investors in the Qualified Financing. No Keep Well Warrant will be issued to Acuitas with respect to any funds (including any Escrowed Funds) invested in the Qualified Financing by Acuitas or on its behalf.

A “Qualified Financing” generally means any financing in which the Company issues or sells any of its equity securities for cash to one or more third party investors resulting in gross proceeds to the Company of at least $10.0 million exclusive of any amount invested by Acuitas in such financing.

Conversion of Keep Well Notes

Following approval of the Company’s stockholders obtained at a special meeting of stockholders held in February 2023 (the “2023 Special Meeting”), Acuitas, at its option, has the right to convert the entire principal amount of the secured notes issued under the Keep Well Agreement, plus all accrued and unpaid interest thereon, in whole or in part, into shares of the Company’s common stock at a conversion price equal to the lesser of (i) $0.40 per share and (ii) the greater of (a) the closing price of the Company’s common stock on the trading day immediately prior to the applicable conversion date and (b) $0.15 (the “Conversion Right”). The $0.40 and $0.15 referenced in the preceding sentence are subject to adjustment for stock splits and similar corporate actions, and were adjusted to $2.39 and $0.90, respectively, after giving effect to the reverse stock split discussed in Note 14 below.

Each Original Keep Well Note outstanding as of the date of stockholder approval was deemed to be amended to contain the Conversion Right. The Company refers to such Original Keep Well Notes, as so amended, and to all other secured notes issued under the Keep Well Agreement, as the “Keep Well Notes.”

In addition, in connection with the conversion of the principal amount of any Keep Well Note and/or accrued interest thereon into shares of the Company’s common stock (as described above), the Company will issue to Acuitas a five-year warrant to purchase shares of the Company’s common stock, and the number of shares of the Company’s common stock subject to each such warrant will be equal to (x) 100% of the amount converted divided by (y) the conversion price of the Keep Well Note then in effect, and

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

the exercise price of each such warrant will be equal to the conversion price of the Keep Well Note then in effect, subject to adjustment as described below.

Increase in Warrant Coverage and Other Adjustments

Following approval of the Company’s stockholders obtained at the 2023 Special Meeting, (a) the exercise price of the warrants issued under the Keep Well Agreement (both the Original Keep Well Warrants outstanding as of the date of the Second Amendment and those issued thereafter) was reduced to $0.45 per share, which was the Nasdaq Official Closing Price (as reflected on Nasdaq.com) of the Company’s common stock immediately preceding the time the parties entered into the Second Amendment, and which is subject to future adjustment as described below; (b) the number of shares of the Company’s common stock subject to the warrants outstanding at the time of the 2023 Special Meeting (i.e., 1,775,148 shares) was increased to the number of shares that would have been subject to such warrants if the warrant coverage was equal to 100% of the amount borrowed under the Keep Well Agreement in respect of which the applicable Keep Well Warrant was issued (instead of 20%) divided by $0.45 (i.e., 33,333,333 shares, or an additional 31,558,185 shares); and (c) the warrant coverage on borrowings under the Keep Well Agreement after the date of the Second Amendment was increased to a number of shares of the Company’s common stock equal to (x) 100% of the amount borrowed (instead of 20% of such amount) divided by (y) $0.45 (the “Warrant Coverage Denominator”), subject to future adjustment as described below, and each warrant issued after the date of the Second Amendment has an exercise price equal to $0.45 per share, subject to future adjustment as described below.

As a result of stockholder approvals obtained at the 2023 Special Meeting, the Company issued to the holder of each warrant issued under the Keep Well Agreement outstanding as of the date of such approval, in exchange for such warrant, a new warrant to purchase shares of the Company’s common stock that reflect the amendments to the warrants described above and below, including the increase in the warrant coverage and the decrease in the exercise price. The Company refers to the new warrants issued in exchange for outstanding warrants and to any warrants issued in connection with future borrowings under the Keep Well Agreement or in connection with the conversion of the principal amount of any Keep Well Note and/or accrued interest thereon into shares of the Company’s common stock as the “Keep Well Warrants.”

Under the terms of the Second Amendment, if the reverse stock split approved at the 2023 Special Meeting is effected, then:

(1) the exercise price of each warrant issued pursuant to the Keep Well Agreement that is outstanding as of the effective time of the reverse stock split would be reduced to the lesser of (i) the volume-weighted average price of the Company’s common stock over the five trading days beginning on the trading day that commences immediately after the effective time of the reverse stock split (the “Reverse Stock Split Price”) and (ii) the exercise price after giving effect to the adjustment thereto as a result of the reverse stock split (the lesser of (i) and (ii), the “Post-Stock Split Price”), subject to further reduction as described below; and

(2) the Warrant Coverage Denominator would be reduced to the greater of $0.15 (adjusted for the reverse stock split) and the Post-Stock Split Price, subject to further reduction as described below.

As discussed in Note 14 below, the reverse stock split approved at the 2023 Special Meeting was effected on July 27, 2023. After giving effect to such reverse stock split, and in accordance with the above, the Post-Stock Split Price was determined to be $2.44. In addition, after giving effect to such reverse stock split, the number of shares of the Company’s common stock underlying the Keep Well Warrants outstanding at the effective time of the reverse stock split were proportionally adjusted such that the aggregate exercise price payable upon exercise of the Keep Well Warrants remains unchanged.

Also under the terms of the Second Amendment: (i) the exercise price of each Keep Well Warrant outstanding as of September 1, 2023 will be reduced to the closing price of the Company’s common stock on August 31, 2023, if such closing price is less than the Post-Stock Split Price; and (ii) the Warrant Coverage Denominator will be reduced to the greater of (a) $0.15 (or $0.90 as adjusted after giving effect to the reverse stock split discussed in Note 14 below) and (b) the lesser of (x) the Post-Stock Split Price and (y) the closing price of the Company’s common stock on August 31, 2023.

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Additional Commitment Shares

As a result of stockholder approvals obtained at the 2023 Special Meeting, the Company issued to Acuitas 2,038,133 additional shares of the Company’s common stock (which, after giving effect to the reverse stock split discussed in Note 14 below, was adjusted to 339,689 shares of the Company's common stock).

Issuance Cap

The Company and Acuitas agreed that (i) under no circumstances will the Company issue any shares upon exercise of any warrant issued under the Keep Well Agreement or upon conversion of any Keep Well Note to the extent that, after giving effect to the issuance of any such shares, Acuitas (together with its affiliates) would beneficially own shares of the Company’s common stock representing more than 90% of the total number of shares of the Company’s common stock outstanding as of the time of such issuance (the “Issuance Cap”); and (ii) in the event of a Fundamental Transaction (as defined in the Second Amendment), regardless of the actual number of securities of the Company beneficially owned by Acuitas and its affiliates at the effective time thereof, Acuitas shall not be entitled to receive any consideration pursuant to such Fundamental Transaction in respect of any shares underlying any of the warrants issued under the Keep Well Agreement or any shares issuable upon conversion of any Keep Well Note that would represent shares in excess of the Issuance Cap if beneficially owned by Acuitas and/or its affiliates immediately prior to such effective time, and all warrants and Keep Well Notes owned or beneficially owned by Acuitas and/or its affiliates at the effective time of such Fundamental Transaction, solely to the extent that, if exercised or converted, such warrants and Keep Well Notes would result in the issuance of such excess shares, will be cancelled and forfeited without consideration therefor, effective as of such effective time; provided, however, that the foregoing shall not affect the Company’s obligation to pay all amounts owed under such Keep Well Notes in connection with such Fundamental Transaction.

Covenants

The Keep Well Agreement contains customary covenants that must be complied with by the Company, including, among other covenants, restrictions on the Company’s ability to incur debt, grant liens, make certain investments and acquisitions, pay dividends, repurchase equity interests, repay certain debt, amend certain contracts, enter into certain asset sale transactions, and covenants that require the Company to, among other things, provide annual, quarterly and monthly financial statements, together with related compliance certificates, maintain its property in good repair, maintain insurance and comply with applicable laws. Subject to certain customary exceptions, the Company also agreed not to incur any indebtedness or issue any shares of its capital stock or capital stock equivalents without Acuitas’ consent until 180 days following the Final Funding Date.

As mentioned above, the Keep Well Agreement also includes the following financial covenants: a requirement that annualized consolidated recurring revenue for the preceding twelve months be at least $11.0 million tested monthly, and a requirement that consolidated liquidity must be greater than $5.0 million at all times. The Company was in compliance with such financial covenants as of June 30, 2023, except for the annualized consolidated recurring revenue for the preceding twelve months. On August 7, 2023, Acuitas waived the Company's non-compliance with the annualized consolidated recurring revenue covenant as of June 30, 2023 and through September 30, 2023. See discussion in Note 14 below.

Borrowings Under the Keep Well Agreement

In February 2023, as a result of approvals obtained at the 2023 Special Meeting relating to the terms provided for in the Second Amendment, as described above, the Company determined that terms of the Keep Well Agreement as amended by the Second Amendment is substantially different from the terms in the Original Keep Well Agreement and that extinguishment of the senior secured notes issued under the Original Keep Well Agreement and recognition of a new debt instrument for the senior secured notes under the Original Keep Well Agreement as amended by the Second Amendment was appropriate. As such, in February 2023, the Company recorded the extinguishment of the senior secured notes under the Original Keep Well Agreement, resulting in a loss on extinguishment of debt of $2.2 million, which was recorded as part of additional paid in capital since the debt transaction is with Acuitas, a significant shareholder. The new debt instrument includes an embedded conversion feature, as described above, which was accounted for in accordance with ASU 2020-06, "Accounting for Convertible Instruments and Contracts in an Entity's Own Equity," which the Company adopted on January 1, 2022, and accordingly the Company did not separately present such embedded conversion feature in equity but rather accounted for the convertible debt wholly as debt. The Company also assessed and determined that the Keep Well Warrants qualified for equity classification and applied the relative fair value method to allocate proceeds from the debt issuance to the Keep Well Warrants. The Company incurred $0.3 million of

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

debt issuance costs related to the Second Amendment. The fair value of the Keep Well Warrants and new debt issuance costs relating to the Second Amendment were recorded as part of debt discount and accreted using the effective interest method over the contractual term of the debt.

In connection with the Fourth Amendment entered into in June 2023 discussed above, the Company incurred approximately $0.04 million of legal costs, which have been expensed as incurred as the Company determined that the Fourth Amendment was a modification of original debt terms.

As of June 30, 2023, the Company borrowed a total of $19.0 million under the Keep Well Agreement. Each borrowing was evidenced with the issuance of a Keep Well Note, which will accrue interest based on the adjusted term SOFR for each interest period. At June 30, 2023, the Company had a cumulative total of $2.5 million of accrued paid-in-kind interest on the Keep Well Notes, of which $1.1 million and $1.9 million were related to the three and six months ended June 30, 2023, respectively. At June 30, 2023, the effective weighted average interest rate for the Keep Well Notes was 20.56%.

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


	June 30, 2023		December 31, 2022
Principal	$	21,489	$	11,553
Less: debt discount	(9,576)		(1,488)
Net carrying amount	$	11,913	$	10,065

The following table presents the interest expense recognized related to the Company's borrowings under the Keep Well Agreement and the 2024 Notes (as defined below) (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2023		2022		2023		2022
Contractual interest expense	$	1,088	$	784	$	1,936	$	1,944
Accretion of debt discount	1,119		262		1,640		504
Total interest expense	$	2,207	$	1,046	$	3,576	$	2,448

Securities Issued Under the Keep Well Agreement During 2022

Following approval of the Company’s stockholders obtained at the annual stockholder meeting held on August 29, 2022, (a) on September 2, 2022, the Company issued 739,645 shares of its common stock (the “Commitment Shares”) to Acuitas and (b) in August and September 2022, the Company issued to Acuitas warrants to purchase a total of 1,301,775 shares of the Company’s common stock. The Commitment Shares and such warrants, which qualified for equity classification, were accounted for as debt discount based on their respective fair values determined at each issuance dates. The warrants have a term of five years and had an exercise price equal to $1.69, which was the closing price of the Company’s common stock as reported on Nasdaq immediately preceding the time the parties entered into the Keep Well Agreement. As discussed above, as result of approvals obtained at the 2023 Special Meeting, each warrant issued under the Keep Well Agreement outstanding as of the date of such approval was exchanged for a new warrant to purchase shares of the Company’s common stock that reflect the amendments to the warrants described above, including the increase in the warrant coverage and the decrease in the exercise price. Neither the number of Commitment Shares nor the number of shares of the Company’s common stock subject to warrants issued to Acuitas described above give effect to the reverse stock split discussed in Note 14 below.

Stockholders Agreement

Under the terms of the Keep Well Agreement, if Acuitas' beneficial ownership of the Company’s capital stock equals at least a majority of the voting power of the Company’s outstanding capital stock, Acuitas Capital and the Company agreed to enter into a stockholders agreement (the “Stockholders Agreement”) pursuant to which, during any period that Acuitas’ beneficial ownership

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

of the Company’s capital stock equals at least 50% of the Company’s outstanding capital stock, Acuitas agreed to vote the shares of the Company’s common stock it beneficially owns (a) in favor of an amendment to the certificate of incorporation or bylaws of the Company that would require the Company’s board of directors to include not fewer than three independent directors at all times, (b) in favor of the election or re-election of independent directors nominated for election by the Company’s board of directors or by the nominating committee thereof unless the failure of a nominee to be elected or re-elected to the Company’s board of directors would not result in the Company having fewer than three independent directors following such election, and (c) against any proposal or action that would result in the Company’s board of directors having fewer than three independent directors at all times. In addition, under the Stockholders Agreement, the parties agreed that, during any period that such beneficial ownership of Acuitas affiliates equals at least 50% of the Company’s outstanding capital stock, the Company will not enter into any transaction between the Company or any of its affiliates, on the one hand, and Acuitas or any of its affiliates (excluding the Company and its affiliates), on the other hand, unless it is approved by a majority of the independent directors then serving on the Company’s board of directors. The Stockholders Agreement was entered into on February 21, 2023.

2024 Notes

The Company was party to a Note Purchase Agreement dated September 24, 2019 (the “Note Agreement”) with Goldman Sachs Specialty Lending Group, L.P. and any other purchasers party thereto from time to time (collectively, the “Holders”), as amended, pursuant to which the Company initially issued $35.0 million aggregate principal amount of senior secured notes (the "Initial 2024 Notes"). In August 2020, the Company issued an additional $10.0 million principal amount of senior secured notes as provided under the additional note purchase commitment of the Note Agreement (together with the Initial 2024 Notes, the "2024 Notes"). On February 14, 2022, the Company repaid $9.0 million of the outstanding balance of the 2024 Notes. On March 8, 2022, the Company entered into an Eight Amendment to Note Purchase Agreement with the Holders (the "Eighth Amendment"), which among other things, amended certain financial covenants intended to increase the Company's financial flexibility, required a prepayment of $11.0 million of the outstanding loan balance without the incurrence of a yield maintenance premium or prepayment fee, which prepayment was made by the Company on March 8, 2022. On July 15, 2022, the Company entered into a payoff letter agreement with the holders of the 2024 Notes, pursuant to which the Company paid in full the outstanding loan balance under the 2024 Notes of approximately $7.6 million, which included $0.1 million of accrued interest as of July 15, 2022. All obligations owing by the Company and the other Note Parties (as defined in the Note Purchase Agreement) under the Note Purchase Agreement were released, discharged and satisfied in full, the Note Purchase Agreement and all other Note Documents (as defined in the Note Agreement) were terminated (other than those provisions therein that expressly survive termination), and all liens securing the Company’s obligations under the Note Agreement were released. In July 2022, the Company wrote off the remaining $1.3 million of debt issuance costs related to the 2024 Notes.

In connection with entering into the Eighth Amendment, the Company issued to Special Situations Investing Group II, LLC (“Special Situations”), a warrant (the “Amendment Warrant”) to purchase up to 111,680 shares of the Company's common stock (18,614 shares as adjusted for the reverse stock split discussed in Note 14 below). Also, the Company agreed to issue to Special Situations, beginning March 31, 2022 and until the earlier of (i) date the 2024 Notes have been paid in full and (ii) October 31, 2022, additional warrants (each a “Ticking Warrant”) to purchase a number of shares of the Company's common stock equal to $47,500, to be calculated based on the volume weighted average trading price of the Company’s common stock during the five (5) trading day period immediately preceding the date such Ticking Warrant is issued, not to exceed 7% of the outstanding shares of the Company's common stock on the date of the Eighth Amendment. The Amendment Warrant and each Ticking Warrant have an exercise price equal to $0.01 per share ($0.06 per share as adjusted for the reverse stock split discussed in Note 14 below) and expire on September 24, 2026. As of June 30, 2023, Ticking Warrants to purchase 118,931 shares of the Company's common stock (19,823 shares as adjusted for the reverse stock split discussed in Note 14 below) were outstanding. The Company assessed and separated the warrants into liability and equity components, wherein the Amendment Warrant qualified for equity classification and the Ticking Warrants qualified for liability classification. See Notes 8 and 11 for more information.

Other

During August through November 2022, the Company financed a total of $2.5 million of its insurance premiums at an annual weighted average effective rate of 5.9%, payable in 10 to 11 equal monthly installments and down payments totaling $0.2 million at inception of each financing agreement. At June 30, 2023 and December 31, 2022, there was $0.7 million and $2.0 million, respectively, relating to such financed insurance premium outstanding, which were included as part of "Other accrued liabilities" on our condensed consolidated balance sheet as of each respective period.

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 11. Fair Value Measurements

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


Level Input						Input Definition
Level I						Inputs are unadjusted, quoted prices for identical assets or liabilities in active markets at the measurement date.
Level II						Inputs, other than quoted prices included in Level I, that are observable for the asset or liability through corroboration with market data at the measurement date.
Level III						Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

The following tables summarize fair value measurements by level for assets and liabilities measured at fair value on a recurring basis as of the periods presented (in thousands):


	Balance as of June 30, 2023
	Level I		Level II		Level III		Total



Contingent consideration (1)	$	—	$	—	$	64	$	64
Warrant liabilities (2)	—		—		55		55
Total liabilities	$	—	$	—	$	119	$	119


	Balance as of December 31, 2022
	Level I		Level II		Level III		Total
Letter of credit (3)	$	204	$	—	$	—	$	204
Total assets	$	204	$	—	$	—	$	204

Contingent consideration (1)	$	—	$	—	$	64	$	64
Warrant liabilities (2)	—		—		43		43
Total liabilities	$	—	$	—	$	107	$	107

___________________

(1) Included in "Other accrued liabilities" on our condensed consolidated balance sheets as of June 30, 2023 and December 31, 2022.

(2) Relates to Ticking Warrant issued in connection with the Eight Amendment to the 2024 Notes executed on March 8, 2022, as discussed in Note 10 above, and included in "Other accrued liabilities" on our condensed consolidated balance sheet as of June 30, 2023 and December 31, 2022.

(3) Included in "Restricted cash - long term" on our condensed consolidated balance sheets as of December 31, 2022.

Financial instruments classified as Level III in the fair value hierarchy as of June 30, 2023 and December 31, 2022 represent liabilities measured at market value on a recurring basis and include warrant liabilities relating to Ticking Warrants issued in connection with an amendment to our debt agreement for the 2024 Notes, as discussed in Note 10, and contingent consideration relating to a stock price guarantee provided in an acquisition (see further discussion below regarding this contingent consideration). In accordance with current accounting rules, the warrant liabilities and contingent consideration liability are marked-to-market each quarter-end until they are completely settled or expire. The fair value of the warrant liabilities was valued using the Black-Scholes pricing model, using both observable and unobservable inputs and assumptions consistent with those used in the estimate of fair value of employee stock options. The fair value of the contingent consideration liability was valued using the Monte Carlo simulation model, using both observable and unobservable inputs and assumptions.

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

The carrying value of the Keep Well Notes is estimated to approximate their respective fair values as the variable interest rate of the notes approximates the market rate for debt with similar terms and risk characteristics.

The fair value measurements using significant Level III inputs, and changes therein, was as follows (in thousands):


	Level III Contingent Consideration
Balance as of June 30, 2023 and December 31, 2022	$	64

The $0.1 million of contingent consideration liability, relating to a stock price guarantee in our acquisition of LifeDojo Inc. completed in October 2020, was included in "Other accrued liabilities" on our condensed consolidated balance sheets as of June 30, 2023 and December 31, 2022.

Warrant Liabilities


	Level III Warrant Liabilities
Balance as of December 31, 2022	$	43
Loss on change in fair value of warrant liabilities	12

Balance as of June 30, 2023	$	55

The assumptions used in the Black-Scholes warrant-pricing model were determined as follows:


	June 30, 2023
Volatility	100.0	%
Risk-free interest rate	4.49	%
Weighted average expected life (in years)	3.28
Dividend yield	0	%

Note 12. Variable Interest Entities

Generally, an entity is defined as a Variable Interest Entity (“VIE”) under current accounting rules if it either lacks sufficient equity to finance its activities without additional subordinated financial support, or it is structured such that the holders of the voting rights do not substantively participate in the gains and losses of the entity. When determining whether an entity that meets the definition of a business, qualifies for a scope exception from applying VIE guidance, the Company considers whether: (i) it has participated significantly in the design of the entity, (ii) it has provided more than half of the total financial support to the entity, and (iii) substantially all of the activities of the VIE are conducted on its behalf. A VIE is consolidated by its primary beneficiary, the party that has the power to direct the activities that most significantly affect the economics of the VIE and has the right to receive benefits or the obligation to absorb losses of the entity that could be potentially significant to the VIE. The primary beneficiary assessment must be re-evaluated on an ongoing basis.

As discussed under the heading Management Services Agreements (“MSA”) below, the Company has an MSA with a Texas nonprofit health organization (“TIH”) and a California Professional Corporation (“CIH”). Under the MSAs, the equity owners of TIH and CIH have only a nominal equity investment at risk, and the Company absorbs or receives a majority of the entity’s expected losses or benefits. The Company participates significantly in the design of these MSAs. The Company also agrees to provide working capital loans to allow for TIH and CIH to fund their day to day obligations. Substantially all of the activities of TIH and CIH, including its decision making and approvals are conducted for its benefit, as evidenced by the fact that (i) the operations of TIH and CIH are conducted primarily using the Company's licensed network of providers and (ii) under the MSA,

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

the Company agrees to provide and perform all non-medical management and administrative services for the entities. Payment of the Company's management fee by TIH and CIH is subordinate to payments of the other obligations of TIH and CIH, and repayment of the working capital loans is not guaranteed by the equity owner of the affiliated medical group or other third party. Creditors of TIH and CIH do not have recourse to the Company's general credit.

Based on the design of the entity and the lack of sufficient equity to finance its activities without additional working capital loans, the Company has determined that TIH and CIH are VIEs. The Company, as the primary beneficiary, is required to consolidate the VIE entities as it has power and potentially significant interests in the entities. Accordingly, the Company is required to consolidate the assets, liabilities, revenues and expenses of the managed treatment centers.

Management Services Agreements

In April 2018, the Company executed an MSA with TIH and in July 2018, the Company executed an MSA with CIH. Under the MSAs, the Company licenses to TIH and CIH the right to use its proprietary treatment programs and related trademarks, and provides all required day-to-day business management services, including, but not limited to:

•general administrative support services;

•information systems;

•recordkeeping;

•billing and collection; and

•obtaining and maintaining all federal, state and local licenses, certifications and regulatory permits.

All clinical matters relating to the operation of TIH and CIH and the performance of clinical services through the network of providers shall be the sole and exclusive responsibility of the TIH and CIH Board free of any control or direction from the Company.

TIH pays the Company a monthly fee equal to the aggregate amount of (a) its costs of providing management services (including reasonable overhead allocated to the delivery of its services and including salaries, rent, equipment, and tenant improvements incurred for the benefit of the medical group, provided that any capitalized costs will be amortized over a five-year period), (b) 10%-15% of the foregoing costs, and (c) any performance bonus amount, as determined by TIH at its sole discretion.

CIH pays the Company a monthly fee equal to the aggregate amount of (a) its costs of providing management services (including reasonable overhead allocated to the delivery of its services and including salaries, rent, equipment, and tenant improvements incurred for the benefit of the entity, provided that any capitalized costs will be amortized over a five-year period), and (b) any performance bonus amount, as determined by CIH at its sole discretion.

The Company's condensed consolidated balance sheets include the following assets and liabilities from its TIH and CIH VIEs (in thousands):


	June 30, 2023		December 31, 2022
Cash and cash equivalents	$	1,637	$	686
Accounts receivable	—		381
Unbilled receivables	124		90
Prepaid and other current assets	16		116
Total assets	$	1,777	$	1,273


Accrued liabilities	$	14	$	119
Deferred revenue	55		52
Payables to Ontrak	2,429		1,602
Total liabilities	$	2,498	$	1,773

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 13. Commitments and Contingencies

From time to time, we are subject to various legal proceedings that arise in the normal course of our business activities. As of the date of this report, we are 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 Contingencies

On March 3, 2021, a purported securities class action was filed in the United States District Court for the Central District of California, entitled Farhar v. Ontrak, Inc., Case No. 2:21-cv-01987. On March 19, 2021, another similar lawsuit was filed in the same court, entitled Yildrim v. Ontrak, Inc., Case No. 2:21-cv-02460. On July 14, 2021, the Court consolidated the two actions under the Farhar case (“Consolidated Class Action”), appointed Ibinabo Dick as lead plaintiff, and the Rosen Law Firm as lead counsel. On August 13, 2021, lead plaintiff filed a consolidated amended complaint. In the Consolidated Amended Complaint, lead plaintiff, purportedly on behalf of a putative class of purchasers of Ontrak securities from August 5, 2020 through February 26, 2021, alleges that the Company and Terren S. Peizer, Brandon H. LaVerne and Curtis Medeiros, violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, by intentionally or recklessly making false and misleading statements and omissions in various press releases, SEC filings and conference calls with investors on August 5, 2020 and November 5, 2020. Specifically, the Consolidated Amended Complaint alleges that the Company was inappropriately billing its largest customer, Aetna, causing Aetna to, in May 2020, shut off its data feed to Ontrak, and, in July 2020, require Ontrak to complete a Corrective Action Plan (“CAP”). Lead plaintiff alleges that defendants: (1) misrepresented to investors that the data feed was shut off in July 2020, and that it was part of Aetna’s standard compliance review of all of its vendors; (2) failed to disclose to investors that Aetna had issued the CAP; and (3) failed to disclose to investors that Ontrak was engaging in inappropriate billing practices. Lead plaintiff seeks certification of a class and monetary damages in an indeterminate amount. On September 13, 2021, defendants filed a motion to dismiss the Consolidated Amended Complaint for failure to state a claim under Federal Rules of Civil Procedure 12(b)(6) and 9(b) and the Private Securities Litigation Reform Act of 1995, 15 U.S.C. §§ 78u-4, et seq. The motion was taken under submission, with no oral argument. Prior to any ruling being issued on the motion to dismiss, on March 29, 2023, lead plaintiff filed a Second Amended Complaint. The Second Amended Complaint (1) adds Jonathan Mayhew as a defendant; (2) expands the purported class period to August 5, 2020 through August 19, 2021; and (3) now includes allegations that the defendants additionally intentionally or recklessly made false and misleading statements and omissions regarding the Company’s relationship with its then-second largest customer, Cigna, in various press releases, SEC filings and conference calls with investors on May 6, 2021 and August 5, 2021. On May 15, 2023, the Company filed its motion to dismiss the Second Amended Complaint. That motion is now fully-briefed, and has been taken under submission by the Court. The Company believes that the allegations lack merit and intends to defend against the action vigorously.

On August 6, 2021, a purported stockholder derivative complaint was filed in the United States District Court for the Central District of California, entitled Aptor v. Peizer, Case No. 2:21-cv-06371, alleging breach of fiduciary duty on behalf of the Company against Terren S. Peizer, Brandon H. LaVerne, Richard A. Berman, Michael Sherman, Diane Seloff, Robert Rebak, Gustavo Giraldo and Katherine Quinn, and contribution against Terren S. Peizer and Brandon H. LaVerne. On October 6, 2021, a similar shareholder derivative action was filed in the same Court, entitled Anderson v. Peizer, Case No. 2:21-cv-07998, for breach of fiduciary duty, abuse of control, unjust enrichment, gross mismanagement and waste of corporate assets against Terren S. Peizer, Brandon H. LaVerne, Curtis Medeiros, Richard A. Berman, Michael Sherman, Edward Zecchini, Diane Seloff, Robert Rebak, Gustavo Giraldo, and Katherine Quinn, and contribution against Terren S. Peizer, Brandon H. LaVerne and Curtis Medeiros. On December 1, 2021, a similar shareholder derivative action was filed in the United States District Court for the District of Delaware, entitled Vega v. Peizer, Case No. 1:21-cv-01701, for violation of Section 20(a) of the Exchange Act, breach of fiduciary duty, unjust enrichment and waste of corporate assets against Terren S. Peizer, Brandon H. LaVerne, Curtis Medeiros, Richard A. Berman, Michael Sherman, Edward Zecchini, Diane Seloff, Robert Rebak, Gustavo Giraldo, and Katherine Quinn. In these actions, plaintiffs allege that the defendants breached their fiduciary duties by allowing or causing the Company to violate the federal securities laws as alleged in the Consolidated Class Action discussed above. The plaintiffs seek damages (and contribution from the officers) in an indeterminate amount. On December 7, 2021, the Court in the Central District of California consolidated the two Central District of California actions under the Aptor case caption and number (the "Consolidated Derivative Action"), stayed the action pending a ruling on the Motion to Dismiss in the Consolidated Class Action and ordered plaintiffs to file a consolidated amended complaint within fourteen (14) days of a ruling on the Motion to Dismiss in the Consolidated Class Action. On February 7, 2022, the Court in the District of Delaware extended the deadline for defendants to respond to the

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ONTRAK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

complaint in the Vega action to April 8, 2022. On March 21, 2022 the Court in the District of Delaware granted plaintiff’s unopposed motion to transfer the case to the United States District Court for Central District of California in the interest of judicial efficiency due to the Consolidated Class Action and Consolidated Derivative Action already pending in that district, and that same day the case was transferred into the United States District Court for Central District of California and given the new Case No. 2:22-cv-01873-CAS-AS. On April 11, 2022, the Court stayed the action pending a ruling on the Motion to Dismiss in the Consolidated Class Action and ordered plaintiffs to inform defendants regarding their intention to amend their initial complaint within thirty (30) days of said ruling. Although all of the claims asserted in these actions purport to seek recovery on behalf of the Company, the Company will incur certain expenses due to indemnification and advancement obligations with respect to the defendants. The Company understands that defendants believe these actions are without merit and intend to defend themselves vigorously.

On February 28, 2022, a purported securities class action was filed in the Superior Court of California for Los Angeles County, entitled Braun v. Ontrak, Inc., et al., Case No. 22STCV07174. The plaintiff filed this action purportedly on behalf of a putative class of all purchasers of the 9.50% Series A Cumulative Perpetual Preferred Stock (the “Preferred stock”) of Ontrak pursuant to Registration Statements and Prospectuses issued in connection with Ontrak’s August 21, 2020 initial public stock offering, its September 2020 through December 2020 “at market” offering, and its December 16, 2020 follow-on stock offering (collectively, the “Offerings”). The plaintiff brings this action against the Company; its officers: Terren S. Peizer, Brandon H. LaVerne, and Christopher Shirley; its board members: Richard A. Berman, Sharon Gabrielson, Gustavo Giraldo, Katherine B. Quinn, Robert Rebak, Diane Seloff, Michael Sherman, and Edward Zecchini; and the investment banking firms that acted as underwriters for the Offerings: B. Riley Securities, Inc., Ladenburg Thalmann & Co., Inc., William Blair & Company, LLC, Aegis Capital Corp., Insperex LLC (f/k/a Incapital LLC), The Benchmark Company, LLC, Boenning & Scatteredgood, Inc., Colliers Securities, LLC, Kingswood Capital Markets, and ThinkEquity (the "Underwriters"). The plaintiff asserts three causes of action alleging that Ontrak violated § 11, § 12(a)(2), and § 15 of the Securities Act of 1933, respectively, (1) by failing to disclose facts required to be disclosed under SEC Regulation S-K items 105 and 303 – that Aetna had turned off the data feed of customer records to Ontrak citing dissatisfaction with the Company’s value proposition and billing practices and thereafter submitted a CAP to which Ontrak’s senior executives were unable to effectively respond; and (2) by issuing allegedly false or misleading statements in its Registration Statements and Prospectuses: (a) regarding Ontrak’s growing customer base; (b) regarding its ability to scale its operations; (c) that revenue from a limited number of its customers would continue; (d) that its services are provided to customers continuously; (e) that revenue increases were attributable to continued expansion of the Ontrak program; and (f) regarding the healthcare experience of its executives. The plaintiff seeks damages in an indeterminate amount. On July 7, 2022, the defendants filed demurrers to the complaint. On October 4, 2022, the Court issued its ruling, allowing the case to proceed but with a narrowed scope. Specifically, of the six alleged misleading statements, only two remain (that Ontrak had a growing “grow

Ontrak, Inc. [OTRK] Filings
Ontrak, Inc. [OTRKP] Filings
10-Q	[2023-08-10]
S-1	[2023-06-29]
10-Q	[2023-05-12]
10-K	[2023-04-17]
10-Q	[2022-11-21]
10-Q	[2022-08-09]
10-Q	[2022-05-11]
10-K	[2022-04-15]
10-Q	[2021-11-05]
10-Q	[2021-08-05]
10-Q	[2021-05-06]
10-K	[2021-03-09]
10-Q	[2020-11-05]
10-Q	[2020-08-05]
10-Q	[2020-05-07]
10-K	[2020-03-16]
10-Q	[2019-11-14]
10-Q	[2019-08-14]
10-Q	[2019-05-09]
10-K	[2019-03-22]
10-Q	[2018-11-14]
10-Q	[2018-08-14]
10-Q	[2018-05-15]
10-K	[2018-03-07]
10-Q	[2017-11-14]
10-Q	[2017-08-15]
10-Q	[2017-05-15]
10-K	[2017-02-28]
S-1	[2017-02-10]
10-Q	[2016-11-14]
10-Q	[2016-08-15]
10-Q	[2016-05-13]
10-K	[2016-03-30]
10-Q	[2015-11-13]
10-Q	[2015-08-14]
S-1	[2015-05-29]
10-Q	[2015-05-15]
10-K	[2015-03-31]
10-Q	[2014-11-14]
10-Q	[2014-08-14]
10-Q	[2014-05-15]
10-K	[2014-03-31]
10-Q	[2013-11-13]
10-Q	[2013-08-14]
10-Q	[2013-05-15]
10-K	[2013-04-01]
10-Q	[2012-11-14]
10-Q	[2012-08-14]
10-Q	[2012-05-15]
10-K	[2012-03-30]

Ontrak, Inc. [OTRK] Filings

Ontrak, Inc. [OTRKP] Filings