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 JuneSeptember 30, 2015

Commission File Number 001-31932     

_______________________

CATASYS, INC.

(Exact name of registrant as specified in its charter)

_______________________

11601 Wilshire Boulevard, Suite 1100, Los Angeles, California 90025

(Address of principal executive offices, including zip code)

(310) 444-4300

(Registrant's telephone number, including area code)

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

Yes☑          No☐

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

Yes☑          No☐

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

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

Yes☐            No☑

As of August 13,November 12, 2015, therewere 46,597,760shares55,007,761shares of the registrant's common stock, $0.0001 par value per share, outstanding.

TABLE OF CONTENTS

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

Item 1.     Financial Statements

CATASYS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes to the financial statements.

CATASYS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

See accompanying notes to the financial statements.

CATASYS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(unaudited)

See accompanying notes to the financial statements.

Catasys, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

The expected volatility assumptions have been based on the historical and expected volatility of our stock, measured over a period generally commensurate with the expected term. The weighted average expected option term for the three and sixnine months ended JuneSeptember 30, 2015 and 2014, 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.

As of JuneSeptember 30, 2015, there was $1.6$1.2 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of approximately 2.132.01 years.          

Stock Options and Warrants – Non-employees

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

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

There were no options issued to non-employees for the three and sixnine months ended JuneSeptember 30, 2015 and 2014, respectively.2014. Share-based compensation expense relating to stock options and warrants recognized for non-employees was $1,000$0 and $3,000 for the three and sixnine months ended JuneSeptember 30, 2015 and $2,000 and $3,000$5,000 for the three and sixnine months ended JuneSeptember 30, 2014, respectively.

Non-employee stock option activity for the three and sixnine months ended JuneSeptember 30, 2015, are as follows:

Common Stock

In September 2015, we entered into a Stock Purchase Agreement with Acuitas, relating to the sale and issuance of approximately 1.5 million shares of common stock for gross proceeds of $463,000 (the “September Offering”).

In May 2015, we entered into Warrant Exchange Agreements (the “Exchange Agreements”) whereby 21,277,220 warrants, at an exercise price of $0.58 per shares, issued by the Company between December 2011 and May 2014, were exchanged for 21,277,220 shares of common stock.stock to eliminate the liability associated with these warrants.

There were 0 and 76,000 shares of common stock issued for investor relations or consulting services during the three and sixnine months ended JuneSeptember 30, 2015 compared to 200,00055,000 and 255,000 shares issued for the same periods in 2014, respectively. Generally, the costs associated with shares issued for services are being amortized to the related expense on a straight-line basis over the related service periods.

Income Taxes

We have recorded a full valuation allowance against our otherwise recognizable deferred tax assets as of JuneSeptember 30, 2015.  As such, we have not recorded a provision for income tax for the period ended JuneSeptember 30, 2015.  We utilize the liability method of accounting for income taxes as set forth in ASC 740, Income Taxes. Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. In determining the need for valuation allowances, we consider projected future taxable income and the availability of tax planning strategies.  After evaluating all positive and negative historical and perspective evidences, management has determined it is more likely than not that our deferred tax assets will not be realized. 

We assess our income tax positions and record tax benefits for all years subject to examination based upon our evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where there is greater than 50% likelihood that a tax benefit will be sustained, we have recorded the largest amount of tax benefit that may potentially be realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where there is less than 50% likelihood that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements.  Based on management's assessment of the facts, circumstances and information available, management has determined that all of the tax benefits for the period ended JuneSeptember 30, 2015 should be realized.   

Fair Value Measurements

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

The following table summarizes fair value measurements by level at JuneSeptember 30, 2015 for assets and liabilities measured at fair value:

Financial instruments classified as Level III in the fair value hierarchy as of JuneSeptember 30, 2015, represent our liabilities measured at market value on a recurring basis which include warrant liabilities and derivative liabilities resulting from recent debt and equity financings. In accordance with current accounting rules, the warrant liabilities and derivative liabilities are being marked-to-market each quarter-end until they are completely settled. The warrants and derivative liabilities are valued using the Black-Scholes option-pricing model, using both observable and unobservable inputs and assumptions consistent with those used in our estimate of fair value of employee stock options. SeeWarrant Liabilities below.

The following table summarizes our fair value measurements using significant Level III inputs, and changes therein, for the three and sixnine months ended JuneSeptember 30, 2015:

Intangible Assets

As of JuneSeptember 30, 2015, the gross and net carrying amounts ofthere were no intangible assets that are subject to amortization are as follows:amortization.

During the three and sixnine months ended JuneSeptember 30, 2015, we did not acquire any new intangible assets and at JuneSeptember 30, 2015, all of ourwe determined that the intangible assets consisted of intellectual property, which is not subject to renewal or extension.

We review our intangible assets for impairment whenever events or circumstances indicate that the carrying amount of these assets may not be recoverable. In reviewing for impairment, we compare the carrying value of such assets to the estimated undiscounted future cash flows expected from the use of the assets and/or their eventual disposition. If the estimated undiscounted future cash flows are less than their carrying amount, we record an impairment loss to recognize a loss for the difference between the assets’ fairhad no value and their carrying value. Since we have not recognized significant revenue to date, our estimates of future revenue may not be realized and the net realizable value of our capitalized costs of intellectual property or other intangible assets may become impaired. We had no intangible impairment for the three and six months ended June 30, 2015 or 2014.were written off in full.

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

Property and Equipment

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

Warrant Liabilities

In July 2015, we entered into $3.55 million 12% Original Issue Discount Convertible Debenture due January 18, 2016 (the “July 2015 Convertible Debenture”) with Acuitas and five-year warrants to purchase 935,008 shares of our common stock, at an exercise price of $1.90 per share, subject to adjustment, including for issuances of common stock and common stock equivalents below the then current conversion or exercise price, as the case may be (the “July 2015 Warrants”).

The conversion price of the July 2015 Convertible Debenture is $1.90 per share, subject to adjustments, including for issuances of common stock and common stock equivalents below the then current conversion or exercise price, as the case may be.  The July 2015 Convertible Debentures are unsecured, bear interest at a rate of 12% per annum payable in cash or shares of common stock, subject to certain conditions, at our option, and are subject to mandatory prepayment upon the consummation of certain future financings. 

The conversion price of the July 2015 Convertible Debenture and the July 2015 Warrants were subsequently adjusted to $0.30 per share based upon the September Offering.

In May 2015, we entered into the Exchange Agreements whereby 21,277,220 warrants, at an exercise price of $0.58 per shares, issued by the Company between December 2011 and May 2014, were exchanged for 21,277,220 shares of common stock (the “Warrant Exchange”). We recognized a $0 and $4.4 million loss related to the Warrant Exchange for the three and sixnine months ended JuneSeptember 30, 2015.2015, respectively.

In conjunction with the Securities Purchase Agreement entered in April 2015, the Company issued five year warrants to purchase an aggregate of 530,303 shares of our common stock, at an exercise price of $2.00 per share, subject to adjustment, including for issuances of common stock and common stock equivalents below the then current conversion or exercise price, as the case may be (the “April 2015 Warrants”). The exercise price of the April 2015 Warrants was subsequently adjusted to $0.30 per share based upon the September Offering.

We have issued warrants to purchase common stock in July 2010, November 2010, December 2011, February 2012, April 2015, and AprilJuly 2015. The warrants are being accounted for as liabilities in accordance with FASB accounting rules, due to anti-dilution provisions in some warrants that protect the holders from declines in our stock price, and a requirement to deliver registered shares upon exercise of the warrants, which is considered outside our control.  The warrants are marked-to-market each reporting period, using the Black-Scholes pricing model, until they are completely settled or expire.

For the three and sixnine months ended JuneSeptember 30, 2015 and 2014, we recognized a gain of $7.4$1.0 million and $9.9$10.9 million, respectively, compared with a gain of $1.4 million and a loss of $25 million and $20$19.0 million for the same periods in 2014, respectively, related to the revaluation of our warrant liabilities.

Derivative Liabilities

In July 2015, we entered into the July 2015 Convertible Debenture. The derivative liability associated with the July 2015 Convertible Debenture was calculated using the Black-Scholes model based upon the following assumptions:

The expected volatility assumption for 2015 was based on the historical volatility of our stock, measured over a period generally commensurate with the expected term. The weighted average expected lives in years for 2015 reflect the application of the simplified method set out in Security and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) 107 (and 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. We use historical data to estimate the rate of forfeitures assumption for awards granted to employees.

For the three and nine months ended September 30, 2015 and 2014, we recognized a loss of $5.0 million, related to the revaluation of our derivative liability.

Recently Issued or Newly Adopted Accounting Standards

In February 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-02,Consolidation (Topic 810): Amendments to the Consolidation Analysis (“ASU 2015-02”). ASU 2015-02 modifies existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. ASU 2015-02 is effective for fiscal years and interim periods within those years beginning after December 15, 2015, and requires either a retrospective or a modified restrospectiveretrospective approach to adoptions. Early adoption is permitted. We are currently evaluating the potential impact of this standard on our consolidated financial statements, as well as the available transition methods.

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

There was no carrying amount of the assets and liabilities of discontinued operations as of JuneSeptember 30, 2015 and December 31, 2014, respectively.2014.

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

The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements including the related notes, and the other financial information includedelsewherein this report.

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the financial condition, results of operations, business strategies, operating efficiencies or synergies, competitive positions, growth opportunities for existing products, plans and objectives of management, markets for our stock and other matters. Statements in this report that are not historical facts are hereby identified as “forward-looking statements” for the purpose of the safe harbor provided by Section 21E of the Exchange Act of 1934 and Section 27A of the Securities Act of 1933. Such forward-looking statements, including, without limitation, those relating to the future business prospects, our revenue and income, wherever they occur, are necessarily estimates reflecting the best judgment of our senior management as of the date on which they were made, or if no date is stated, as of the date of this report. These forward-looking statements are subject to risks, uncertainties and assumptions, including those described in the “Risk Factors” in Item 1A of Part I of our most recent Annual Report on Form 10-K (“Form 10-K”) for the fiscal year ended December 31, 2014 and other reports we filed with the Securities and Exchange Commission (“SEC”), that may affect the operations, performance, development and results of our business. Because the factors discussed in this report could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any such forward-looking statements. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. We assume no obligation and do not intend to update these forward looking statements, except as required by law.

OVERVIEW

General

We provide specialized healthcare management services to health plans and other third party payors through our OnTrak program. Our OnTrak program is designed to improve member health and at the same time lower costs to the insurer for underserved populations where behavioral health conditions are causing or exacerbating co-existing medical conditions. The program utilizes proprietary analytics, member engagement and patient centric treatment that integrates evidence-based medical and psychosocial interventions along with care coaching in a 52-week outpatient program. Our initial focus was members with substance use disorders. In the second quarter of 2015, we expanded our program into anxiety disorders, and we have plans to expand into other behavioral health conditions including anxiety andfor depression. We currently operate our OnTrak for substance dependence programprograms in Florida, Illinois, Kansas, Kentucky, Louisiana, Massachusetts, Missouri, New Jersey, Oklahoma, West Virginia, and Wisconsin, and our OnTrak for anxiety program in Kansas.Wisconsin. We provide services to commercial (employer funded), managed Medicare Advantage and managed Medicaid populations. 

Recent Developments

In MayOn October 16, 2015, we entered into Warrant ExchangeStock Purchase Agreements (the “Exchange“Purchase Agreements”) whereby 21,277,220 warrants, at an exercise pricewith each of $0.58 per shares, issued by the Company between December 2011 and May 2014, were exchanged for 21,277,220 shares of common stock.

In July 2015, we entered into a promissory note with Crede CG III, Ltd.Acuitas Group Holdings, LLC (“Crede”Acuitas”), 100% owned by Terren SS. Peizer, our Chairman and Chief Executive Officer of the Company, Shamus, LLC (“Shamus”), a company owned by David E. Smith, a member of the Company’s board of directors, and Steve Gorlin, a member of the Company’s board of directors (the “Investors”), pursuant to which we received gross proceeds of $3.35$2.0 million for the sale of $3.35approximately 6.7 million in principal amountshares of our common stock, at a purchase price of $0.30 per share.

In addition, we and Acuitas entered into an amendment to the 12% Original Issue Discount Convertible Debenture (the “Promissory Note”“Convertible Debenture”). The Promissory Note is due on August 21, dated July 30, 2015 and carries an interest rate on any unpaid principal amount of 8% per annum untilwhich extended the maturity date after which the interest rate will increase to 12% per annum. We are currently negotiating a longer term financing. We used approximately $2.2 million of the net proceeds of this transactionConvertible Debenture from January 18, 2016 to redeem its Bridge Notes. FollowingJanuary 18, 2017 and extended the redemption, all of the Bridge Notes were extinguished.date by which we must consummate a qualified public offering from December 31, 2015 to June 30, 2016.

In July 2015, we entered into a Securities Purchase Agreement with Crede, pursuant to which we exchanged the $3.35 million Promissory Note, for a $3.56 million 12% Original Issue Discount Convertible Debenture due January 18, 2016 (the “July 2015 Bridge Note”) and five-year warrants to purchase an aggregate of 936,462 shares of our common stock, at an exercise price of $1.90 per share (the “July 2015 Warrants”).

The conversion price of the July 2015 Bridge Note is $1.90 per share, subject to adjustments, including for issuances of common stock and common stock equivalents below the then current conversion or exercise price, as the case may be.  The July 2015 Bridge Notes are unsecured, bear interest at a rate of 12% per annum payable in cash or shares of common stock, subject to certain conditions, at our option, and are subject to mandatory prepayment upon the consummation of certain future financings. 

As a result of the issuance of the July 2015 Bridge Note and July 2015 Warrants, the exercise price of the April 2015 Warrants to purchase an aggregate of 530,303 shares of common stock were adjusted to $1.21 per share.

Operations

In the secondthird quarter of 2015, we operated our OnTrak for substance dependence solutions for third-party payorsprograms in Florida, Illinois, Kansas, Kentucky, Louisiana, Massachusetts, Missouri, New Jersey, Oklahoma, West Virginia and Wisconsin. During the secondthird quarter of 2015, we launched our programs in Illinois and Missouri and signed new agreementsan agreement with existingone of our national health plan customers to expand our program to Illinois, Missouri, and Texas. During the first and second quarterPennsylvania. In addition, we received approval from one of 2015, we signed an agreement with a new customer to expand to Illinois, and signed an agreement with an existing customerour national health plan customers to expand our program starting in the fourth quarter of 2015 to Missouri. The programits Medicare members in Illinois commenced enrollmentseveral states under our national contract, which was signed earlier this year. In the third quarter 2015 we enrolled 230% more members in our programs than in the third quarter of 2015, and our program in Missouri is expected to commence enrollment in the third quarter of 2015. In addition, during the second quarter of 2015 we expanded our existing program in Kansas to cover high cost members with anxiety and commenced enrollment. In addition, we are in discussions to expand our existing customers into several additional markets.2014. We have generated fees from our launched programs and expect to increase enrollment and fees throughout 2015. However, there can be no assurance that we will generate such fees or that new programs will launch as we expect.

Discontinued Operations

We have discontinued our license and management fees segment. The operations of this segment were shut down effective April 1, 2014 and all of the assets were absorbed by the healthcare services segment.

RESULTS OF OPERATIONS

Table of Summary Consolidated Financial Information

The table below and the discussion that follows summarize our results of consolidated operations for the three and sixnine months ended JuneSeptember 30, 2015 compared to the three and sixnine months ended JuneSeptember 30, 2014:

Summary of Consolidated Operating Results

Loss from continuing operations before provision for income taxes for the three and sixnine months ended June 30.September 30, 2015 was $585,000$7.5 million and $843,000,$8.3 million, compared with a net loss of $27.5 million$207,000 and $25.1$25.3 million for the same periods in 2014, respectively. The difference primarily relates to the increase in the change in fair value of warrant liability, offset by a loss on exchange of warrants, the change in fair value of derivative liability and inan increase in general and administrative expenses for the three and sixnine months ended JuneSeptember 30, 2015, compared to the same periods in 2014.

Revenues

During the sixnine months ended JuneSeptember 30, 2015, we have expanded our customer base and health plan populations covered under our programs, which has resulted in a significant increase in the number of patients being treatedenrolled in our programs compared with the same period in 2014, respectively.2014. For the sixnine months ended JuneSeptember 30, 2015, enrollment increased by more than 90%230% over the same period in 2014. Recognized revenue increased by $160,000$168,000 and $394,000,$562,000, or 51%45% and 77%64%, for the three and sixnine months ended JuneSeptember 30, 2015, compared with the same periods in 2014, respectively. We reserve a portion, and in some cases all, of the revenue related to these contracts as the revenue is subject to performance guarantees, or in the caseinstance of case rates received upon enrollment and other fees in advance, recognized ratably over the period of enrollment. Deferred revenue increased by $1.2 million since December 31, 2014, and a $701,000 increase since June 30, 2015.

Cost of Healthcare Services

Cost of healthcare services consists primarily of salaries related to our care coaches, community care coordinators, healthcare provider claim payments to our network of physicians and psychologists, and fees charged by our third party administrators for processing these claims.  The increase of $262,000$374,000 and $403,000$777,000 for the three and sixnine months ended JuneSeptember 30, 2015, compared with the same periods in 2014, respectively, relates primarily to the increase in the number of members being treated, and the addition of care coaches and clinical care coordinators to our staff to manage the increasing number of enrolled members and the expansion of our program in Kansas to cover high cost members with anxiety disorders.

General and Administrative Expenses

Total general and administrative expense increased by $713,000$372,000 and $2.1$2.5 million for the three and sixnine months ended JuneSeptember 30, 2015, compared with the same periods in 2014, respectively. The increase was primarily due to an increase in share-based compensation expense related to stock options issued to our board of directors during the first quarter of 2015, investor relations services, and legal services.

Other Income

The decrease of $1.1$1.2 million in other income relates to the 2014 write off of all balances in accounts payable and accrued liabilities related to a contract that was amended and breached in 2010 for which the statute expired in accordance with Section 337 of the California Code of Civil procedures during the second quarter of 2014.

Interest Expense

Interest expense increased by $1.2 million and decreased by $352,000 and $1.7 million$455,000, respectively, for the three and sixnine months ended JuneSeptember 30, 2015 compared with the same periods in 2014, respectively. The decrease relatedincrease relates to the issuance of warrants as part of our January and May 2014 financings offset by the issuance of warrants issued in the April 2015 financingand July 2015 financings during the sixnine months ended JuneSeptember 30, 2015.

Loss on Exchange of Warrant

The loss of $4.4 million on the exchange of warrants related to the exchange of 21,277,220 warrants in for 21,277,220 shares of common stock in May 2015 for the nine months ended September 30, 2015.

Change in fair value of warrant liability

We have issued warrants to purchase common stock in July 2010, November 2010, December 2011, February 2012, April 2015, and AprilJuly 2015. The warrants are being accounted for as liabilities in accordance with Financial Accounting Standards Board (“FASB”) accounting rules, due to anti-dilution provisions in some warrants that protect the holders from declines in our stock price and a requirement to deliver registered shares upon exercise of the warrants, which is considered outside our control.  The warrants are marked-to-market each reporting period, using the Black-Scholes pricing model, until they are completely settled or expire.

The increasedecrease in the change in fair value for the warrants was $32.9 million$390,000 for the three months ended September 30, 2015 and $30.32014, and an increase of $29.9 million for the three and sixnine months ended JuneSeptember 30, 2015 compared with the same period in 2014, respectively.2014.

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

Change in fair value of derivative liability

The change in fair value of derivative liabilities was $5.0 million for the three and nine months ended September 30, 2015 compared with the same period in 2014. The derivative liability was the result of the issuance of the July 2015 Convertible Debenture.

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

Depreciation and Amortization

Depreciation and amortization was immaterial for the three and sixnine months ended JuneSeptember 30, 2015 and 2014, respectively.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity and Going Concern

As of August 13,November 12, 2015, we had a balance of approximately $451,000$1.3 million cash on hand. We had working capital deficit of approximately $5.0$11.3 million at JuneSeptember 30, 2015. We have incurred significant operating losses and negative operating cash flows since our inception. We could continue to incur negative cash flows and operating losses for the next twelve months. Our current cash burn rate is approximately $450,000 per month, excluding non-current accrued liability payments. We expect our current cash resources to cover expenses intothrough the fourth quarter;first quarter of 2016; however delays in cash collections, revenue, or unforeseen expenditures could impact this estimate.We are in need of additional capital, however, there is no assurance that additional capital can be timely raised in an amount which is sufficient for us or on terms favorable to us and our stockholders, if at all. If we do not obtain additional capital, there is a significant doubt as to whether we can continue to operate as a going concern and we will need to curtail or cease operations or seek bankruptcy relief. If we discontinue operations, we may not have sufficient funds to pay any amounts to our stockholders.

In JulyOn October 16, 2015, we entered into a promissory notethe Purchase Agreements with Crede,each of Acuitas, Shamus, and Steve Gorlin, pursuant to which the Companywe received gross proceeds of $3.35$2.0 million for the sale of $3.35approximately 6.7 million in principal amount (the “Promissory Note”). The Promissory Note is due on August 21, 2015, and carries an interest rate on any unpaid principal amount of 8% per annum until the maturity date, after which the interest rate will increase to 12% per annum. We are currently negotiating a longer term financing. We used approximately $2.2 million of the net proceeds of this transaction to redeem its Bridge Notes. Following the redemption, all of the Bridge Notes were extinguished.

In July 2015, we entered into a Securities Purchase Agreement with Crede, pursuant to which we exchanged the $3.35 million Promissory Note, for a $3.56 million 12% Original Issue Discount Convertible Debenture due January 18, 2016 (the “July 2015 Bridge Note”) and five-year warrants to purchase an aggregate of 936,462 shares of our common stock, at an exercisea purchase price of $1.90$0.30 per share (the “July 2015 Warrants”).share.

The conversion priceIn addition, we and Acuitas entered into an amendment to the Convertible Debenture which extended the maturity date of the JulyConvertible Debenture from January 18, 2016 to January 18, 2017 and extended the date the by which we must consummate a qualified public offering from December 31, 2015 Bridge Note is $1.90 per share, subject to adjustments, including for issuances of common stock and common stock equivalents below the then current conversion or exercise price, as the case may be.  The July 2015 Bridge Notes are unsecured, bear interest at a rate of 12% per annum payable in cash or shares of common stock, subject to certain conditions, at our option, and are subject to mandatory prepayment upon the consummation of certain future financings. June 30, 2016.

Our ability to fund our ongoing operations and continue as a going concern is dependent on signing and generating fees from existing and new contracts for our Catasys managed care programs and the success of management’s plans to increase revenue and continue to control expenses. We currently operate our OnTrak for substance dependence program in Florida, Illinois, Kansas, Kentucky, Louisiana, Massachusetts, Missouri, New Jersey, Oklahoma, West Virginia and Wisconsin. During the secondthird quarter of 2015, we launched our programs in Illinois and Missouri and signed new agreementsan agreement with existingone of our national health plan customers to expand our program to Illinois, Missouri, and Texas.Pennsylvania. In addition, we signed an agreement with a new customerreceived approval from one of our national health plan customers to expand our program starting in Illinois during the firstfourth quarter of 2015 to its Medicare members in several states under our national contract, which has commenced enrollment duringwas signed earlier this year. In the third quarter of 2015.2015 we enrolled 230% more members in our programs than in the third quarter of 2014. We have generated fees from our launched programs and expect to increase enrollment and fees throughout 2015. However, there can be no assurance that we will generate such fees or that new programs will launch as we expect.We are in need of additional capital, however, there is no assurance that additional capital can be timely raised in an amount which is sufficient for us or on terms favorable to us and our stockholders, if at all. If we do not obtain additional capital, there is a significant doubt as to whether we can continue to operate as a going concern and we will need to curtail or cease operations or seek bankruptcy relief. If we discontinue operations, we may not have sufficient funds to pay any amounts to our stockholders.

Cash Flows

We used $2.6$3.9 million of cash for continuing operating activities during the sixnine months ended JuneSeptember 30, 2015 compared with $2.6$3.4 million in the same period in 2014, respectively. Significant non-cash adjustments to operating activities for the sixnine months ended JuneSeptember 30, 2015 included share-based compensation expense of $1.0$1.2 million, amortization of debt discount of $1.1$2.2 million, loss on exchange of warrants of $4.4 million, fair value adjustment on derivative liability of $5.0 million, offset by a fair value adjustment on warrant liability of $9.9$10.9 million.

Capital expenditures for the sixnine months ended JuneSeptember 30, 2015 were not material. We anticipate that capital expenditures will increase in the future as we replace our computer systems that are reaching their useful lives, upgrade equipment to support our increased number of enrolled members, and enhance the reliability and security of our systems. These future capital expenditure requirements will depend upon many factors, including obsolescence or failure of our systems, progress with expanding the adoption of our programs, and our marketing efforts, the necessity of, and time and costs involved in obtaining, regulatory approvals, competing technological and market developments, and our ability to establish collaborative arrangements, effective commercialization, marketing activities and other arrangements.

Our net cash provided by financing activities was $2.1$3.5 million for the sixnine months ended JuneSeptember 30, 2015, compared with net cash provided by financing activities of $2.8$4.1 million for the sixnine months ended JuneSeptember 30, 2014, respectively. Cash provided by financing activities for the sixnine months ended JuneSeptember 30, 2015 primarily consisted of the net proceeds from the issuance of our 12% Original Issue Discount Convertible Debenture in April 2015, leaving a balance of $152,000 in cash and cash equivalents at June 30,July 2015.

As discussed above, we currently expend cash at a rate of approximately $450,000 per month, excluding non-current accrued liability payments. We also anticipate cash inflow to increase during 2015 as we continue to service our executed contracts and sign new contracts. We expect our current cash resources to cover our operations intothrough the fourthfirst quarter of 2015; however delays in cash collections, revenue, or unforeseen expenditures could impact this estimate.Weestimate. We are in need of additional capital, however, there is no assurance that additional capital can be timely raised in an amount which is sufficient for us or on terms favorable to us and our stockholders, if at all. If we do not obtain additional capital, there is a significant doubt as to whether we can continue to operate as a going concern and we will need to curtail or cease operations or seek bankruptcy relief. If we discontinue operations, we may not have sufficient funds to pay any amounts to our stockholders.

OFF BALANCE SHEET ARRANGEMENTS

As of JuneSeptember 30, 2015, we had no off-balance sheet arrangements.