10-Q 1 nhc-093017x10q.htm FORM 10-Q Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
OR
[  ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________to __________.
COMMISSION FILE NUMBER: 001-37349
NOBILIS HEALTH CORP.
(Exact name of registrant as specified in its charter)
British Columbia
(State or other jurisdiction of
incorporation or organization)
98-1188172
(I.R.S. Employer
Identification No.)
11700 Katy Freeway, Suite 300, Houston, Texas
(Address of principal executive offices)
77079
(Zip Code)
(713)355-8614
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
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  [  ]
(Note: As a voluntary filer not subject to the filing requirements of Sections 13 or 15(d) of the Exchange Act, the registrant has filed all reports pursuant to Section 13 or 15(d) of the Exchange Act during the preceding 12 months as if it were subject to such filing requirements.)
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  [ X ]  NO  [  ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  [  ]  
Accelerated filer  [ X ]
Non-accelerated filer  [  ]
Smaller reporting company  [  ]
 
Emerging growth company  [ X ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES  [  ]  NO  [ X ]
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 the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.
77,805,014 common shares as of October 21, 2017.

1


TABLE OF CONTENTS
In this Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2017 (“Quarterly Report”), the terms "Nobilis", "we", "us", "our", "ours", or "the Company" refers to Nobilis Health Corp. and all of its subsidiaries.

2



Part I - Financial Information

Item 1. Financial Statements

Nobilis Health Corp.
Consolidated Balance Sheets
September 30, 2017 and December 31, 2016
(in thousands, except share amounts)
(unaudited)
 
September 30, 2017
 
December 31, 2016
Assets
 
 
 
Current Assets:
 
 
 
Cash
$
34,139

 
$
24,572

Trade accounts receivable, net of allowance of $750 at September 30, 2017 and December 31, 2016
112,402

 
124,951

Medical supplies
3,488

 
4,468

Prepaid expenses and other current assets
13,521

 
10,083

Total current assets
163,550

 
164,074

Property and equipment, net
39,873

 
36,723

Intangible assets, net
20,393

 
19,618

Goodwill
70,003

 
62,018

Deferred tax asset
21,867

 
21,652

Other long-term assets
1,413

 
1,350

Total Assets
$
317,099

 
$
305,435

Liabilities and Shareholders' Equity
 
 
 
Current Liabilities:
 
 
 
Trade accounts payable
$
19,169

 
$
22,184

Accrued liabilities
37,518

 
30,145

Current portion of capital leases
2,746

 
3,985

Current portion of long-term debt
2,127

 
2,220

Current portion of convertible promissory note
2,500

 

Current portion of warrant and stock option derivative liabilities

 
3

Other current liabilities
9,592

 
7,561

Total current liabilities
73,652

 
66,098

Lines of credit
18,000

 
15,000

Long-term capital leases, net of current portion
12,317

 
12,387

Long-term debt, net of current portion
46,190

 
48,323

Convertible promissory notes, net of current portion
4,750

 
2,250

Warrant and stock option derivative liabilities, net of current portion
458

 
899

Other long-term liabilities
3,736

 
3,999

Total liabilities
159,103

 
148,956

Commitments and Contingencies


 


Contingently redeemable noncontrolling interest
14,663

 
14,304

Shareholder's Equity:
 
 
 
Common shares, no par value, unlimited shares authorized, 77,805,014 shares issued and outstanding at September 30, 2017 and December 31, 2016


 


Additional paid in capital
225,122

 
222,240

Accumulated deficit
(78,841
)
 
(79,042
)
Total shareholders’ equity attributable to Nobilis Health Corp.
146,281

 
143,198

Noncontrolling interests
(2,948
)
 
(1,023
)
Total shareholders' equity
143,333

 
142,175

Total Liabilities and Shareholders' Equity
$
317,099

 
$
305,435

The accompanying notes are an integral part of the interim unaudited consolidated financial statements.

3


Nobilis Health Corp.
Consolidated Statements of Operations
(in thousands, except share and per share amounts)
(unaudited)

Three Months Ended September 30,

Nine Months Ended September 30,

2017

2016

2017

2016
Revenues:







   Patient and net professional fees
$
59,514


$
65,666


$
201,488


$
167,199

   Contracted marketing revenues
2,211


2,604


5,163


10,754

   Factoring revenues
2,927


2,413


6,265


5,874

         Total revenues
64,652


70,683


212,916


183,827

Operating expenses:




 

 
   Salaries and benefits
15,735


13,209


46,473


38,377

   Drugs and supplies
10,386


15,473


35,709


39,670

   General and administrative
27,571


33,195


96,409


85,678

   Depreciation and amortization
2,716


1,952


7,782


6,462

         Total operating expenses
56,408


63,829


186,373


170,187

Corporate expenses:




 

 
   Salaries and benefits
2,949


1,765


9,011


5,077

   General and administrative
3,252


4,576


10,100


14,984

   Legal expenses
667


1,535


1,643


4,110

   Depreciation
93


79


256


209

         Total corporate expenses
6,961


7,955


21,010


24,380

         Income (loss) from operations
1,283


(1,101
)

5,533


(10,740
)
Other expense (income):




 

 
   Change in fair value of warrant and stock
option derivative liabilities
(171
)

133


(358
)

(1,566
)
   Interest expense
1,380


744


3,998


2,115

   Other expense (income), net
143


(198
)

215


(3,011
)
         Total other expense (income)
1,352


679


3,855


(2,462
)
(Loss) income before income taxes and noncontrolling interests
(69
)

(1,780
)

1,678


(8,278
)
Income tax (benefit) expense, net
(70
)

483


628


(1,766
)
         Net income (loss)
1


(2,263
)

1,050


(6,512
)
Net (loss) income attributable to noncontrolling interests
(1,013
)
 
496

 
849

 
(3,594
)
Net income (loss) attributable to Nobilis Health Corp.
$
1,014

 
$
(2,759
)
 
$
201

 
$
(2,918
)
Net income (loss) per basic common share
$
0.01

 
$
(0.04
)
 
$

 
$
(0.04
)
Net income (loss) per fully diluted common share
$
0.01

 
$
(0.04
)
 
$

 
$
(0.04
)
Weighted average shares outstanding (basic)
77,805,014

 
76,774,967

 
77,805,014

 
76,114,538

Weighted average shares outstanding (fully diluted)
78,132,127

 
76,774,967

 
78,168,019

 
76,114,538

The accompanying notes are an integral part of the interim unaudited consolidated financial statements.

4


Nobilis Health Corp.
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
Nine Months Ended September 30,
 
2017

2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 

 
 Net income (loss)
$
1,050


$
(6,512
)
 Adjustments to reconcile net loss to net cash provided by operating activities:



 Depreciation and amortization
8,038


6,671

 Share-based compensation
2,773


5,226

 Change in fair value of warrant and stock option derivative liabilities
(332
)

(1,566
)
 Deferred income taxes
(215
)

(2,435
)
 Gain on sale of property and equipment


(265
)
 Loss (earnings) from equity method investment
108


(1,000
)
 Amortization of deferred financing fees
358


112

 Capital lease interest payments
(787
)

(1,040
)
 Changes in operating assets and liabilities, net of assets acquired and liabilities assumed:




    Trade accounts receivable
13,296


6,399

    Medical supplies
1,275


172

    Prepaid expenses and other current assets
(3,236
)

(938
)
    Other long-term assets


152

    Trade accounts payable and accrued liabilities
3,878


334

    Other current liabilities
2,032


1,777

    Other long-term liabilities
(355
)

137

    Distributions from equity method investments


1,079

       Net cash provided by operating activities
27,883


8,303







CASH FLOWS FROM INVESTING ACTIVITIES:
 

 
  Purchase of property and equipment
(4,470
)

(2,898
)
  Purchase of equity method investment


(609
)
  Note receivable, net


150

    Acquisitions, net of cash acquired
(8,798
)


        Net cash used for investing activities
(13,268
)

(3,357
)






CASH FLOWS FROM FINANCING ACTIVITIES:





  Distributions to noncontrolling interests
(2,413
)

(6,245
)
  Proceeds from exercise of stock options


2,074

  Proceeds from exercise of stock warrants

 
130

    Payments on capital lease obligations
(3,051
)

(3,102
)
    Proceeds from line of credit
3,000


5,135

  Proceeds from debt

 
6,440

  Payments on debt
(2,013
)

(5,026
)
  Deferred financing fees
(571
)

(404
)
        Net cash used for financing activities
(5,048
)

(998
)






NET INCREASE IN CASH
9,567


3,948

CASH — Beginning of period
24,572


15,666

CASH — End of period
$
34,139


$
19,614



5


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
 Cash paid for interest
$
2,966

 
$
2,052

 Cash paid for taxes
$
1,619

 
$
2,279


NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
 Capital lease obligations
$
2,461

 
$
405

 Convertible promissory note
$
5,000

 
$
2,250


The accompanying notes are an integral part of the interim unaudited consolidated financial statements.


6


Nobilis Health Corp.
Notes to Consolidated Financial Statements
NOTE 1 – COMPANY DESCRIPTION
Nobilis Health Corp. (“Nobilis” or the “Company”) was incorporated on March 16, 2007 under the name "Northstar Healthcare Inc." pursuant to the provisions of the British Columbia Business Corporations Act. On December 5, 2014, Northstar Healthcare Inc. changed its name to Nobilis Health Corp. The Company owns and manages health care facilities in the States of Texas and Arizona, consisting primarily of specialty surgical hospitals, ambulatory surgery centers and multi-specialty clinics. The Company's service offerings within the health care industry include providing contracted marketing services and accounts receivable factoring.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation
The Company consolidates entities in which it has a controlling financial interest. The Company consolidates subsidiaries in which it holds, directly or indirectly, more than 50% of the voting rights and, in the case of variable interest entities, with respect to which the Company is determined to be the primary beneficiary.
The accompanying interim consolidated financial statements have not been audited by the Company’s independent registered public accounting firm, except that the Consolidated Balance Sheet at December 31, 2016, is derived from previously audited consolidated financial statements. In the opinion of management, all material adjustments, consisting of normal recurring adjustments, necessary for fair presentation have been included. These interim consolidated financial statements include all accounts of the Company. All intercompany transactions and accounts have been eliminated upon consolidation.
Certain reclassifications have been made to prior period amounts to conform to current period financial statement classifications. The reclassifications included in these comparative interim consolidated financial statements represent a change in presentation of cash flows related to capital leases. The reclassifications were deemed to be immaterial to the consolidated financial statements both individually and in the aggregate.
These consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission ("SEC") for interim financial information. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for complete financial statements. Therefore, these interim consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 (“2016 Annual Report”) filed with the SEC on March 14, 2017. The operating results for interim periods are not necessarily indicative of results that may be expected for any other interim period or for the full year. There have been no material changes to the Company’s critical accounting policies or estimates from those disclosed in the 2016 Annual Report.
Recently Issued Accounting Pronouncements
In January 2017, the Financial Accounting Standards Board (FASB) issued Account Standard Update (ASU) No. 2017-01, Business Combinations – Clarifying the Definition of a Business. This standard clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions, disposals of assets or businesses. The standard introduces a test to determine when assets acquired are not a business and clarifies that a business must include, at a minimum, an input and a substantive process that contributes to an output to be considered a business. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company does not expect the adoption of this ASU to have a material impact on our consolidated financial statements.
In May 2017, the FASB issued ASU 2017-10, Service Concession Arrangements: Determining the Customer of the Operation Services. This standard clarifies the accounting and definition of the grantor in a service concession arrangement. Per ASU 2017-10, the grantor is the customer of the operation services in all cases for those arrangements. This new ASU is effective for the Company for reporting periods beginning after December 15, 2017. The Company is currently evaluating the new guidance to determine the method of adoption that it will use and the impact it will have on our consolidated financial statements.
Recently Adopted Accounting Standards
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). ASU 2016-09 impacts several aspects of the accounting for share-based payment transactions, including classification of certain items on the consolidated statement of cash flows and accounting for income taxes. Specifically, the ASU requires that excess tax benefits and tax deficiencies (the difference between the deduction for tax purposes and the compensation cost recognized for financial reporting purposes) be recognized as income tax expense or benefit in the consolidated statement of operations, introducing a new element of volatility to the provision for income taxes. ASU

7


2016-09 is effective on January 1, 2017, with early adoption permitted. The Company adopted this ASU in the first quarter of 2017. This adoption did not have an impact on the Company's financial statements.
In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. This standard simplifies the accounting for goodwill impairment by eliminating step two from the goodwill impairment test. Instead of a two-step impairment model, if the carrying amount of a reporting unit exceeds its fair value as determined in step one of the impairment test, an impairment loss is measured at the amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. This ASU is effective for any interim or annual impairment tests for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company adopted this ASU in the second quarter of 2017. This adoption did not have an impact on the Company's financial statements.
In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting. This standard clarifies the accounting and application of modifications to terms and conditions of share-based payment awards. This new ASU, based on meeting certain fair market value, classification and vesting conditions, includes guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718. Early adoption is permitted, including adoption in any interim period. The Company adopted this ASU in the second quarter of 2017. This adoption did not have an impact on the Company's financial statements.
Revenue Recognition Accounting Standards
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” The standard provides enhancements to the quality and consistency of how revenue is reported by companies, while also improving comparability in the financial statements of companies reporting using International Financial Reporting Standards or U.S. GAAP. The new standard also will require enhanced revenue disclosures, provide guidance for transactions that were not previously addressed comprehensively and improved guidance for multiple-element arrangements. This accounting standard becomes effective for the Company for reporting periods beginning after December 15, 2017, and interim reporting periods thereafter. Early adoption is permitted for annual reporting periods (including interim periods) beginning after December 15, 2016. This new standard permits the use of either the retrospective or cumulative effect transition method.
In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations. The purpose of this standard is to clarify the implementation of guidance on principal versus agent considerations related to ASU 2014-09. The standard has the same effective date as ASU 2014-09 described above.
In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customer (Topic 606) Identifying Performance Obligations and Licensing, which provides clarity related to ASU 2014-09 regarding identifying performance obligations and licensing implementation. The standard has the same effective date as ASU 2014-09 described above.
In May 2016, the FASB issued ASU 2016-12: Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which provides narrow scope improvements and practical expedients related to ASU 2014-09. The purpose of this standard is to clarify certain narrow aspects of ASU 2014-09, such as assessing the collectability criterion, presentation of sales taxes, and other similar taxes collected from customers, non-cash consideration, contract modifications at transition, completed contracts at transition, and technical correction. The standard has the same effective date as ASU 2014-09 described above.
In December 2016, the FASB issued ASU 2016-20: Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. The amendments in this standard affect narrow aspects of guidance issued in ASU 2014-09. The standard has the same effective date as ASU 2014-09 described above.
The Company plans to adopt these new revenue standard updates in the first quarter of 2018 and does not anticipate the adoption of these pronouncements to have a material impact with regard to its current contracts on its consolidated financial statements. The Company is still evaluating the possible effects of the new standard and has selected the modified retrospective transition method. The revenue recognition steering committee is currently evaluating the appropriate level of revenue disaggregation, as well as possible changes of internal control as it relates to the overall implementation. Moreover, industry guidance is continuing to develop around this issue, and any conclusions in the final industry guidance that is inconsistent with the Company’s application could result in changes to the Company’s expectations regarding the impact that this new accounting standard could have on the Company’s financial statements.



8


NOTE 3 – ACQUISITIONS
The Company accounts for all transactions that represent business combinations using the acquisition method of accounting, where the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquired entity are recognized and measured at their fair values on the date the Company obtains control in the acquiree. Such fair values that are not finalized for reporting periods following the acquisition date are estimated and recorded as provisional amounts. Adjustments to these provisional amounts during the measurement period (defined as the date through which all information required to identify and measure the consideration transferred, the assets acquired, the liabilities assumed and any noncontrolling interests has been obtained, limited to one year from the acquisition date) are recorded as of the date of acquisition. Any material impact to comparative information for periods after acquisition, but before the period in which adjustments are identified, is recognized during the measurement period in the reporting period in which the adjustment amounts are determined.
2017 Transactions:
DeRosa Medical, P.C. ("DeRosa")
On September 13, 2017, the Company purchased DeRosa in exchange for $0.9 million in cash. As a result of the acquisition, the Company has recognized $0.7 million of goodwill within our Medical Segment. The Company believes that the goodwill is primarily comprised of the business opportunities to be gained through the expanded geographical coverage as well as the access to a new physician group.
Hamilton Vein Center (HVC)
The Company completed the acquisition of the operating assets of HVC, Hamilton Physician Services, LLC, a Texas limited liability company (“HPS”), Carlos R. Hamilton, III, M.D., P.A. a Texas Professional Association (“PA”) (HPS and PA are each a “Seller” and collectively “Sellers”), and Carlos R. Hamilton III, M.D, a resident of the State of Texas (“Owner”). The Company, Northstar Healthcare Acquisitions, L.L.C. ("Buyer"), Sellers and Owner entered into an amended and restated purchase agreement (the “Amended and Restated Asset Purchase Agreement”) dated as of March 8, 2017.
Buyer received substantially all of the operating assets of Sellers in exchange for an aggregate purchase price of approximately $13.3 million, comprised of $8.3 million in cash, $5.0 million in the form of a convertible note and an additional $0.3 million purchase price increase related to a working capital adjustment. The note is convertible to cash or stock at the Company's election, and is payable in two equal installments over a two-year period.
As part of the Amended and Restated Purchase Agreement, $0.5 million of the cash purchase price was held back and is subject to certain indemnification provisions. On the twelve-month anniversary of closing, 50% of the amount held back, less any amounts paid as, or claimed as, indemnification, will be paid to the Owner. The remaining amounts held back, less any amounts paid as, or claimed as, indemnification, will be paid to the Owner on the twenty-four-month anniversary of closing.
As a result of the acquisition, the Company has recognized $8.3 million of goodwill within our Medical Segment. The Company believes that the goodwill is primarily comprised of the business opportunities to be gained through the expanded geographical coverage as well as the access to a new physician group.
Revenues and net loss for the three months ended September 30, 2017, are $3.0 million and $0.8 million, respectively. Revenues and net loss for the nine months ended September 30, 2017, are $7.8 million and $1.1 million, respectively.
The costs related to the transaction were nominal and were expensed during the nine months ended September 30, 2017. These costs are included in the corporate general and administrative expenses in the Company’s Consolidated Statement of Operations for the nine months ended September 30, 2017.
We finalized our purchase price allocation during the third quarter of 2017. The final fair values of the identifiable assets acquired and liabilities assumed at the date of acquisition is summarized in the following table (in thousands):



9


 
Recognized as of Acquisition Date
 
Measurement Period Adjustments (1)
 
March 8, 2017
 
 
 
 
 
 
Assets acquired:
 
 
 
 
 
  Cash
$
438

 
$

 
$
438

  Trade accounts receivable
747

 
(150
)
 
597

  Prepaid expenses and other current assets
42

 

 
42

  Medical Supplies
295

 

 
295

  Property and equipment
2,359

 
611

 
2,970

  Intangible assets

 
1,900

 
1,900

  Goodwill
10,828

 
(2,499
)
 
8,329

Total assets acquired
$
14,709

 
$
(138
)
 
$
14,571

 
 
 
 
 
 
Liabilities assumed:
 
 
 
 
 
  Trade accounts payable
$
612

 
$
(203
)
 
$
409

  Refunds payable
347

 
(347
)
 

  Accrued liabilities
524

 
(83
)
 
441

  Current portion of capital lease
69

 

 
69

  Long-term portion of capital leases
39

 

 
39

Total liabilities assumed
$
1,591

 
$
(633
)
 
$
958

 
 
 
 
 
 
Consideration:
 
 
 
 
 
Cash
$
8,321

 
$

 
$
8,321

Convertible promissory note
5,000

 

 
5,000

Working capital adjustment
(203
)
 
495

 
292

Total consideration
$
13,118

 
$
495

 
$
13,613

(1) The measurement period adjustments reflect changes in the estimated fair values of certain assets and liabilities. The measurement period adjustments were recorded to reflect new information obtained about facts and circumstances existing as of the date the acquisition was consummated and did not result from intervening events subsequent to that date.
2016 Transactions:
On October 28, 2016, the Company acquired Arizona Vein and Vascular Center, LLC (AVVC) and its four affiliated surgery centers operating as Arizona Center for Minimally Invasive Surgery, LLC (ACMIS), (collectively, “AZ Vein”) from Dr. L. Philipp Wall, M.D., for a total purchase price of $22.3 million comprised of $17.5 million in cash, $2.25 million in Nobilis common shares, $2.25 million in the form of a convertible note, $0.1 million earn-out arrangement to be paid in cash based on a trailing 12 month earnings before interest, income taxes, depreciation and amortization (EBITDA) of AZ Vein and the purchased assets and an additional $0.2 million purchase price increase related to a working capital adjustment.

In addition, $1.1 million of the cash purchase price was held back and is subject to certain indemnification provisions. On the twelve-month anniversary of closing, 50% of the amount held back, less any amounts paid as, or claimed as, indemnification, will be paid to Dr. Wall. The remaining amount held back, less any amounts paid as, or claimed as, indemnification, will be paid to Dr. Wall on the twenty-four-month anniversary of closing.

Dr. Wall was the sole equity holder for both AVVC and ACMIS and started the companies in 2007 and 2012, respectively. AVVC and ACMIS are leading clinical and surgical providers for vascular, radiology, podiatry, and general surgery, with five locations in the Phoenix and Tucson metropolitan areas. The acquisition expands Nobilis' presence in two high-growth geographic markets, Phoenix and Tucson, and increases its multi-specialty offering with new vascular surgical specialties within a group of established physician partners.
As a result of the acquisition, the Company has recognized $16.1 million of goodwill within our Medical Segment. The Company believes that the goodwill is primarily comprised of the business opportunities to be gained through the expanded geographical coverage as well as the access to a new physician group.

10


Revenues and net loss for the three months ended September 30, 2017, are $1.2 million and $2.2 million, respectively. Revenues and net loss for the nine months ended September 30, 2017, are $4.3 million and $5.3 million, respectively.
The costs related to the transaction were $0.3 million and were expensed during the year ended December 31, 2016. These costs are included in the corporate general and administrative expenses in the Company’s Consolidated Statement of Operations for the year ended December 31, 2016.
We finalized our purchase price allocation during the second quarter of 2017. The final fair values of the identifiable assets acquired and liabilities assumed at the date of acquisition is summarized in the following table (in thousands):
 
Recognized as of Acquisition Date
 
Measurement Period Adjustments (1)
 
October 28, 2016
 
 
 
 
 
 
Assets acquired:
 
 
 
 
 
  Cash
$
261

 
$

 
$
261

  Trade accounts receivable
3,472

 

 
3,472

  Prepaid expenses and other current assets
188

 

 
188

  Medical Supplies
191

 

 
191

  Property and equipment
2,745

 

 
2,745

  Other long-term assets
6

 

 
6

  Intangible assets
1,700

 

 
1,700

  Goodwill
17,185

 
(1,041
)
 
16,144

Total assets acquired
$
25,748

 
$
(1,041
)
 
$
24,707

 
 
 
 
 
 
Liabilities assumed:
 
 
 
 
 
  Trade accounts payable
$
996

 
$

 
$
996

  Accrued liabilities
273

 

 
273

  Current portion of capital leases
472

 

 
472

  Long-term portion of capital leases
666

 

 
666

Total liabilities assumed
$
2,407

 
$

 
$
2,407

 
 
 
 
 
 
Consideration:
 
 
 
 
 
Cash
$
17,500

 
$

 
$
17,500

Stock issued
2,250

 

 
2,250

Convertible promissory note
2,250

 

 
2,250

Working capital adjustment
1,241

 
(1,041
)
 
200

Earnout consideration
100

 

 
100

Total consideration
$
23,341

 
$
(1,041
)
 
$
22,300

(1) The measurement period adjustments reflect changes in the estimated fair values of certain assets and liabilities. The measurement period adjustments were recorded to reflect new information obtained about facts and circumstances existing as of the date the acquisition was consummated and did not result from intervening events subsequent to that date.
Unaudited Supplemental Pro Forma Information
The following table presents the unaudited pro forma results of the Company as if all of the business combinations previously discussed had been made on January 1, 2016. The pro forma information is based on the Company’s consolidated results of operations for the three and nine months ended September 30, 2017 and 2016. The unaudited supplemental pro forma financial information has been provided for illustrative purposes only and does not purport to be indicative of the actual results that would have been achieved by combining the companies for the periods presented, or of the results that may be achieved by the combined companies in the future. Further, results may vary significantly from the results reflected in the following unaudited supplemental pro forma financial information because of future events and transactions, as well as other factors.

11


The unaudited supplemental pro forma financial information presented below has been prepared by adjusting the historical results of the Company to include historical results of the acquired businesses described above and was then adjusted: (i) to increase amortization expense resulting from intangible assets acquired; (ii) to reduce interest expense from debt which was retained by the seller upon acquisition of the respective businesses and concurrently increase the Company's interest expense based upon the purchase price; and (iii) to increase depreciation expense for the incremental increase in the value of property and equipment acquired; (iv) to decrease expenses for management services which were provided by the preceding parent entity and to concurrently increase expenses for management services which are now provided by the Company; (v) to adjust earnings per share to reflect the common shares issued as part of the purchase consideration. The unaudited supplemental pro forma financial information does not include adjustments to reflect the impact of other cost savings or synergies that may result from these acquisition.
The following table shows our pro forma results for the three and nine months ended September 30, 2017 and 2016 (in thousands, except per share amounts):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
Revenue
 
$64,652
 
$
78,960

 
$
215,518

 
$
205,971

Income (loss) from operations
 
$1,283
 
$
(29
)
 
$
4,558

 
$
(12,175
)
Net income (loss) attributable to Nobilis Health Corp.
 
$1,014
 
$
(2,091
)
 
$
(726
)
 
$
(4,716
)
Net income (loss) per basic common share
 
$0.01
 
$
(0.03
)
 
$
(0.01
)
 
$
(0.06
)
NOTE 4 – INVESTMENTS IN ASSOCIATES
In March 2016, the Company acquired a 58% interest in Athelite Holdings LLC ("Athelite"), a holding company with a 70% interest in Dallas Metro Surgery Center LLC ("Dallas Metro"), a company formed to provide management services to a Hospital Outpatient Department (HOPD). In April 2016, Athelite interest in Dallas Metro was reduced to 62%. The Athelite investment is accounted for as an equity method investment as the Company did not obtain the necessary level of control for the investment to be accounted for as a business combination. This is due to the fact that the Company does not have the ability to directly appoint a majority of the board members of Dallas Metro or independently make strategic operational decisions. The carrying value as of September 30, 2017 was $0.4 million. The investment is classified as other long-term assets in the Consolidated Balance Sheets.
NOTE 5 – FINANCIAL INSTRUMENTS AND CONCENTRATION
The Company is exposed to risks that arise from its use of financial instruments. This note describes the Company’s objectives, policies and processes for managing those risks and the methods used to measure them. Further quantitative information in respect to these risks is presented throughout these consolidated financial statements.
Principal financial instruments
The principal financial instruments used by the Company, from which financial instrument risk arises, are as follows:
Accounts receivable and other receivables
Investments in associates
Accounts payable, accrued liabilities and other current liabilities
Other liabilities and notes payable
Capital leases
Lines of credit
Debt
Warrants
Non-employee stock options

The carrying amounts of the Company’s cash, accounts receivable and other receivables, accounts payable, accrued liabilities, other current liabilities and other liabilities as reflected in the consolidated financial statements approximate fair value due to their short term maturity. The estimated fair value of the Company's other long-term debt instruments approximate their carrying amounts as the interest rates approximate the Company's current borrowing rate for similar debt instruments of comparable maturity, or have variable interest rates.


12


Financial instruments - risk management
The Company’s financial instrument risks include, but are not limited to the following:
Credit risk
Fair value risk
Foreign exchange risk
Other market price risk
Liquidity risk
Interest rate risk

Credit risk
Credit risk is the risk of financial loss to the Company if a patient, non-partner surgeon or insurance company fails to meet its contractual obligations. The Company, in the normal course of business, is exposed mainly to credit risk on its accounts receivable from insurance companies, other third-party payors, and physicians. Accounts receivables are net of applicable bad debt reserves, which are established based on specific credit risk associated with insurance companies, payors and other relevant information.
Liquidity risk
Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due and arises from the Company’s management of working capital. The Company’s objective to managing liquidity risk is to ensure that it will have sufficient cash to allow it to meet its liabilities when they become due. To achieve this objective, it seeks to maintain cash balances (or agreed credit facilities) to meet expected requirements. The liquidity risk of the Company and its subsidiaries is managed centrally by the Company’s finance function. The Company believes that there are currently no concerns of its ability to meet its liabilities as they become due for the foreseeable future.
The following tables set forth certain information with respect to the Company’s payor concentration. Patient and net professional fee revenues by payor are summarized below for the applicable periods:
MEDICAL SEGMENT
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Payors
 
2017

2016
 
2017

2016

 
 
 
 
 
 
 
 
Private insurance and other private pay
 
96.2
%
 
96.3
%
 
97.0
%
 
96.2
%
Workers compensation
 
1.7
%
 
3.4
%
 
1.8
%
 
3.4
%
Medicare
 
2.1
%
 
0.3
%
 
1.2
%
 
0.4
%
Total
 
100
%
 
100
%
 
100
%
 
100
%
MARKETING SEGMENT
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Payors
 
2017
 
2016
 
2017

2016

 
 
 
 
 
 
 
 
Private insurance and other private pay
 
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Workers compensation
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
Medicare
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
Total
 
100
%
 
100
%
 
100
%
 
100
%



13


CONSOLIDATED SEGMENTS
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Payors
 
2017
 
2016
 
2017

2016

 
 
 
 
 
 
 
 
Private insurance and other private pay
 
96.5
%
 
96.8
%
 
97.2
%
 
96.7
%
Workers compensation
 
1.6
%
 
3.0
%
 
1.7
%
 
3.0
%
Medicare
 
1.9
%
 
0.2
%
 
1.1
%
 
0.3
%
       Total
 
100
%
 
100
%
 
100
%
 
100
%
Market risk
Market risk is the risk that the fair value of future cash flows of financial instruments will fluctuate due to changes in interest rates and/or foreign currency exchange rates.
Interest rate risk
The Company entered into a revolving line of credit that, from time to time, may increase interest rates based on market index.
NOTE 6 – TRADE ACCOUNTS RECEIVABLE, NET
A detail of trade accounts receivable, net as of September 30, 2017 and December 31, 2016 is as follows (in thousands):
 
September 30, 2017
 
December 31, 2016
Trade accounts receivable
$
104,981

 
$
121,599

Allowance for doubtful accounts
(750
)
 
(750
)
Receivables transferred

 
(309
)
Receivables purchased
8,171

 
4,411

   Trade accounts receivable, net
$
112,402

 
$
124,951

Bad debt expense was nil for the three and nine months ended September 30, 2017 and 2016.
A detail of allowance for doubtful accounts as of September 30, 2017 and December 31, 2016 is as follows (in thousands):
 
 
Balance at Beginning of Period
 
Costs and Expenses
 
Recovery
 
Write-offs, net (1)
 
Balance at End of Period
Allowance for doubtful accounts:
 
 
 
 
 
 
 
 
 
 
Balance as of December 31, 2016
 
$
(5,165
)
 
$
(750
)
 
$
1,135

 
$
4,030

 
$
(750
)
Balance as of September 30, 2017
 
$
(750
)
 
$

 
$

 
$

 
$
(750
)
 
 
 
 
 
 
 
 
 
 
 
(1) Adjudication of previously recorded allowance for doubtful accounts
From time to time, we transfer to third parties certain of our accounts receivable balances on a non-recourse basis in return for advancement on payment to achieve a faster cash collection. As of September 30, 2017 and December 31, 2016, there remained a balance of nil and $0.3 million, respectively, in transferred receivables pursuant to the terms of the original agreement.
For the three months ended September 30, 2017 and 2016, the Company received advanced payments of nil and $0.1 million, respectively. During the same time period, the Company transferred nil and $0.8 million of receivables, net of advancement of payment. Concurrently, upon collection of these transferred receivables, payment will be made to the transferee. For the nine months ended September 30, 2017 and 2016, the Company received advanced payments of $0.1 million and $0.6 million, respectively. During the same time period, the Company transferred $0.5 million and $4.9 million of receivables, net of advancement of payment.

14


Athas Health, LLC ("Athas"), Nobilis Health Network Specialist Group, PLLC (NHNSG) and Premier Health Specialists, LLC ("Premier") purchase receivables from physicians, at a discount, on a non-recourse basis. The discount and purchase price vary by specialty and are recorded at the date of purchase, which generally occurs 30 to 45 days after the accounts are billed. These purchased receivables are billed and collected by Athas, NHNSG and Premier and they retain 100% of what is collected after paying the discounted purchase price. Following the transfer of the receivable, the transferor has no continued involvement and there are no restrictions on the receivables.
Gross revenue from purchased receivables was $4.6 million for both the three months ended September 30, 2017 and 2016. Revenue, net of the discounted purchase price, was $2.9 million and $2.4 million for the three months ended September 30, 2017 and 2016, respectively. Gross revenue from purchased receivables was $12.1 million and $11.2 million for the nine months ended September 30, 2017 and 2016, respectively. Revenue, net of the discounted purchase price, was $6.3 million and $5.9 million for the nine months ended September 30, 2017 and 2016, respectively.
Accounts receivable for purchased receivables was $8.2 million and $4.4 million for the nine months ended September 30, 2017 and year ended December 31, 2016, respectively. Revenue from receivables purchased is recorded in the factoring revenue line item within the Consolidated Statements of Operations.
NOTE 7 – ACCRUED LIABILITIES AND OTHER CURRENT LIABILITIES
The following table presents a summary of items comprising accrued liabilities and other current liabilities in the accompanying Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016 (in thousands):
 
September 30, 2017
 
December 31, 2016
Accrued liabilities:
 
 
 
Accrued salaries and related benefits
$
5,435

 
$
3,333

Contract services
3,982

 
3,766

Lab expense
9,073

 
5,402

Other
19,028

 
17,644

Total accrued liabilities
$
37,518

 
$
30,145

Other current liabilities:
 
 
 
Estimated amounts due to third party payors
$
4,974

 
$
6,286

Other
4,618

 
1,275

Total other current liabilities
$
9,592

 
$
7,561

NOTE 8 – OTHER LONG-TERM LIABILITIES
The Company assumed real property leases in conjunction with certain business acquisitions which required the Company to pay above market rentals through the remainder of the lease terms. Of the $3.7 million balance in other long-term liabilities at September 30, 2017, approximately $2.9 million relates to unfavorable leases. The unfavorable lease liability is amortized as a reduction to rent expense over the contractual periods the Company is required to make rental payments under the leases. Estimated amortization of unfavorable leases for the five years and thereafter subsequent to December 31, 2016, is $0.1 million for the remainder of 2017, $0.3 million for 2018, 2019, 2020, 2021, and $1.9 million thereafter.
NOTE 9 – DEBT
BBVA Credit Agreement
On October 28, 2016 the Company entered into a BBVA Credit Agreement by and among the Company, certain subsidiaries of the Company parties thereto, the lenders from time to time parties thereto (the “Lenders”) with BBVA Compass Bank as Administrative Agent for the lending group.
The principal amount of the term loan (the “Term Loan”) pursuant to the BBVA Credit Agreement is $52.5 million, which bears interest on the outstanding principal amount thereof at a rate of the then applicable LIBOR, plus an applicable margin ranging from 3.0% to 3.75% (depending on the Company’s consolidated leverage ratio), with an option for the interest rate to be set at the then applicable Base Rate (the “Interest Rate”). The effective rate for the Term Loan as of September 30, 2017 was 5.33%. All outstanding principal on the Term Loan under the Credit Agreement is due and payable on October 28, 2021.

15


The revolving credit facility is $30.0 million (the “Revolver”), which bears interest at the then applicable Interest Rate. The effective rate for the Revolver as of September 30, 2017 was 5.33%. The maturity date of the Revolver is October 28, 2021. Additionally, Borrower may request additional commitments from the Lenders in the maximum amount of $50 million, either by increasing the Revolver or creating new term loans. As of September 30, 2017, the outstanding balances on the Term Loan and Revolver were $50.5 million and $18.0 million, respectively.
The BBVA Compass Credit Agreement contains two financial covenants that are tested beginning on December 31, 2016. The consolidated leverage ratio may not exceed (i) 2.75 to 1.00 as of the last day of any fiscal quarter from December 31, 2016 through and including September 30, 2018 (ii) 2.50 to 1.00 from December 31, 2018 through and including September 30, 2019 (iii) 2.25 to 1.00 from December 31, 2019 through and including September 30, 2020 and (iv) 2.00 to 1.00 from December 31, 2020 and thereafter, subject to covenant holidays upon the occurrence of certain conditions. The second financial covenant requires the loan parties to maintain a minimum consolidated fixed charge coverage ratio of not less than 2.00 to 1.00.
The Loan Agreement also contains customary events of default, including, among others, the failure by the Borrower to make a payment of principal or interest due under the BBVA Credit Agreement, the making of a materially false or misleading representation or warranty by any loan party, the failure by the Borrower to perform or observe certain covenants in the BBVA Credit Agreement, a change of control, and the occurrence of certain cross-defaults, subject to customary notice and cure provisions. Upon the occurrence of an event of default, and so long as such event of default is continuing, the Administrative Agent could declare the amounts outstanding under the BBVA Credit Agreement due and payable.
The Company entered into Amendment No. 1 to BBVA Credit Agreement and Waiver, dated as of March 3, 2017, by and among NHA, certain subsidiaries of the Company party thereto, Compass Bank, and other financial institutions (the "Amendment"). The purpose of the Amendment was to (i) modify the definition of “Permitted Acquisition” to require Lender approval and consent for any acquisition which is closing during the 2017 fiscal year; (ii) modify certain financial definitions and covenants, including, but not limited to, an increase to the maximum Consolidated Leverage Ratio to 3.75 to 1.00 for the period beginning September 30, 2016 and ending September 30, 2017, and an increase to the Consolidated Fixed Charge Coverage Ratio to 1.15 to 1.00 for the period beginning September 30, 2016 and ending June 30, 2017; (iii) waive the Pro Forma Leverage Requirement in connection with the previously reported HVC; and (iv) provide each Lender’s consent to the HHVC acquisition. The Amendment also contained a limited waiver of a specified event of default. As of September 30, 2017, the Company was in compliance with its covenants.
Loan origination fees are deferred and the net amount is amortized over the contractual life of the related loans.
Convertible Promissory Note - AZ Vein
In conjunction with our purchase of AZ Vein, we entered into a $2.25 million convertible promissory note. The convertible promissory note bears interest at 5% per annum and matures on the date that is 36 months from closing. The convertible promissory note (outstanding principal but excluding accrued and unpaid interest) can be converted into common shares of NHC (the "Conversion Shares"), at the sole discretion of NHC and NHA, on the maturity date. The number of Conversion Shares will be based on a price per share equal to the quotient obtained by dividing the conversion amount by the volume weighted average price of the common shares on the New York Stock Exchange (NYSE) in the trailing ten trading days prior to the maturity date. There are no pre-payment penalties.
Convertible Promissory Note - HVC
In conjunction with our purchase of HVC, we entered into a $5.0 million convertible promissory note. The convertible promissory matures on March 8, 2019, bears interest at 5% per annum and is payable in two equal installments over a two-year period. The convertible promissory note (outstanding principal but excluding accrued and unpaid interest) can be converted into common shares of NHC (the "Conversion Shares"), at the sole discretion of NHC and NHA, on the maturity date. The number of Conversion Shares will be based on a price per share equal to the quotient obtained by dividing the conversion amount by the volume weighted average price of the common shares on the NYSE in the trailing ten trading days prior to the maturity date. There are no pre-payment penalties.

16


Debt consisted of the following (in thousands):
 
 
September 30, 2017
 
December 31, 2016
 
 
 
 
 
Lines of credit
 
$
18,000

 
$
15,000

Term loan
 
50,487

 
52,500

Convertible promissory note
 
7,250

 
2,250

Gross debt
 
75,737

 
69,750

Less: unamortized debt issuance costs
 
(2,170
)
 
(1,957
)
Debt, net of unamortized debt issuance costs
 
73,567

 
67,793

Less: current debt, net of unamortized debt issuance costs
 
(4,627
)
 
(2,220
)
 Long-term debt, net
 
$
68,940

 
$
65,573

Future maturities of debt as of September 30, 2017 are as follows (in thousands):
 
September 30, 2017
 
 
2017
$
5,125

2018
5,125

2019
7,500

2020
5,250

2021
52,737

 Total
$
75,737

NOTE 10 – FAIR VALUE MEASUREMENTS
The Company measures certain financial assets and liabilities at fair value on a recurring basis, including warrant and stock option derivative liabilities. There have been no transfers between fair value measurement levels during the nine months ended September 30, 2017.
The following table summarizes our assets and liabilities measured at fair value on a recurring basis as of September 30, 2017 and the Company's fiscal year ended December 31, 2016, aggregated by the level in the fair value hierarchy within which those measurements fall (in thousands):
 
Fair Value Measurements Using


 
Quoted Prices in
Active Markets for
Identical Assets and
Liabilities
(Level 1)

Significant Other
Observable Inputs
(Level 2)

Significant
Unobservable Inputs
(Level 3)

Total
December 31, 2016:
 
 
 
 
 
 
 
Warrant and stock option derivative liabilities
$

 
$

 
$
902

 
$
902

Total
$

 
$

 
$
902

 
$
902

September 30, 2017:
 
 
 
 
 
 
 
Warrant and stock option derivative liabilities
$

 
$

 
$
458

 
$
458

Total
$

 
$

 
$
458

 
$
458

In certain cases, where there is limited activity or less transparency around inputs to valuation, securities are classified as Level 3 within the valuation hierarchy. Level 3 liabilities that were measured at estimated fair value on a recurring basis consist of warrant and stock option derivative liabilities.

17


The estimated fair values of the warrant and stock option derivative liabilities were measured using the Black-Scholes valuation model (refer to Note 12 - Warrants and options liabilities). Due to the nature of valuation inputs, the valuation of the warrants is considered a Level 3 measurement.
The remaining outstanding warrants and stock options expired in May of 2017. The balance of the Company's warrant and stock option derivative liabilities is zero as of September 30, 2017.
NOTE 11 – SHARE BASED COMPENSATION
Stock Options
The Company granted a total of 280,000 and 895,000 stock options during the three and nine months ended September 30, 2017, respectively. Of the options granted during the three months ended September 30, 2017, 175,000 of those vested immediately and 105,000 vest ratably over two and three-year periods. Of the options granted during the nine months ended September 30, 2017, 425,000 of those vest immediately and 470,000 vest ratably over a three-year period. During the nine months ended September 30, 2017, 1,045,000 options were forfeited, with various vesting periods.
The following table summarizes stock option activity for the nine months ended September 30, 2017 and 2016:
 
Shares Underlying
Options
 
Weighted-
Average Exercise
Price
 
Weighted-Average
Remaining Life
(years)
 
 
 
 
 
 
Outstanding at January 1, 2016
5,465,000

 
$
2.97

 
9.2

 Granted
2,457,075

 
$
2.14

 
9.4

 Exercised
(1,083,750
)
 
$
1.91

 

 Forfeited
(966,800
)
 
$
3.01

 

Outstanding at September 30, 2016
5,871,525

 
$
2.77

 
8.9

Exercisable at
 
 
 
 
 
Exercisable at September 30, 2016
2,234,025

 
$
2.32

 
8.5

Exercisable at
 
 
 
 
 
Outstanding at January 1, 2017
7,544,025

 
$
2.61

 
9.0

 Granted
895,000

 
$
1.71

 
9.7

 Exercised

 
$

 

 Forfeited
(1,045,000
)
 
$
3.02

 

Outstanding at September 30, 2017
7,394,025

 
$
2.45

 
8.4

Outstanding at
 
 
 
 
 
Exercisable at September 30, 2017
4,146,108

 
$
2.34

 
8.2

The above table includes 500,000 options issued to non-employees, 500,000 of them are exercisable, and all are still outstanding at September 30, 2017. Refer to Note 12 - Warrants and options liabilities for discussion regarding the classification of these options within the Company's Consolidated Balance Sheets.
The total intrinsic value of stock options exercised was nil and $1.3 million during the nine months ended September 30, 2017 and 2016, respectively. There were no options exercised during 2017. Assuming all stock options outstanding at September 30, 2017 were vested, the total intrinsic value of in-the-money outstanding stock options would have been $0.1 million at September 30, 2017.
The Company recorded total stock compensation expense relative to employee stock options of $1.2 million and $1.6 million for the three months ended September 30, 2017 and 2016, respectively, and $2.8 million and $5.0 million for the nine months ended September 30, 2017 and 2016, respectively.
The fair values of the employee stock options used in recording compensation expense are computed using the Black-Scholes option pricing model. The table below shows the assumptions used in the model for options awarded during the nine months ended September 30, 2017 and 2016.

18


 
Nine Months Ended September 30,
 
2017
 
2016
 
 
 
 
Expected price volatility
87% - 91%
 
114% - 117%
Risk free interest rate
1.78% - 2.14%
 
1.03% - 1.53%
Expected annual dividend yield
0%
 
0%
Expected option term (years)
5 - 6
 
5 - 6
Expected forfeiture rate
3.1% - 11.6%
 
0.5% - 11.6%
Grant date fair value per share
$0.99 - $1.81
 
$1.73 - $2.41
Grant date exercise price per share
$1.35 - 2.32
 
$1.99 - 2.82
For stock options, the Company recognizes share based compensation net of estimated forfeitures and revises the estimates in the subsequent periods if actual forfeitures differ from the estimates. Forfeiture rates are estimated based on historical experience as well as expected future behavior.
NOTE 12 – WARRANTS AND OPTIONS LIABILITIES
Warrants and Options Issued in Private Placements
The Company issued warrants and compensatory options in connection with private placements completed in December 2013, September 2014 and May 2015. These warrants and options have exercise prices denominated in Canadian dollars and as such may not be considered indexed to our stock which is valued in U.S. dollars. Hence, these warrants and options are classified as liabilities under the caption “Warrants and Options Derivative Liability” and recorded at estimated fair value at each reporting date, computed using the Black-Scholes valuation method. Changes in the liability from period to period are recorded in the Consolidated Statements of Operations under the caption “Change in fair value of warrant and stock option derivative liabilities”.
The estimated fair values of warrants and options accounted for as liabilities were determined on the date of the private placements and at each balance sheet date following using the Black-Scholes pricing model with the following inputs:
 
Nine Months Ended September 30,
 
2017
 
2016
 
 
 
 
Risk free interest rate
0.62%

 
0.26% - 0.59%

Expected life in years
0.15

 
0.25 - 1.15

Expected volatility
63
%
 
76% - 112%

Expected dividend yield
0
%
 
0
%
The changes in fair value of the warrants and options (excluding non-employees) liability during the nine months ended September 30, 2017 and 2016 were as follows (in thousands):
 
Nine months Ended September 30,
 
2017
 
2016
 
 
 
 
Balance at beginning of year
$
3

 
$
2,109

Issuance of warrants and options

 

Transferred to equity upon exercise

 

Change in fair value recorded in earnings
(3
)
 
(1,729
)
Balance as of September 30, 2017 and 2016
$

 
$
380

As of September 30, 2017, there were no warrants or options outstanding. The remaining outstanding warrants and stock options expired in May of 2017. The balance of the Company's warrant and stock option derivative liabilities is zero as of September 30, 2017.

19


Options Issued to Non-Employees
As discussed in Note 11 - Share based compensation, in 2014 the Company issued 650,000 options to professionals providing services to the organization. These professionals do not meet the definition of an employee under U.S. GAAP. At September 30, 2017, there were 500,000 options outstanding all of which are exercisable to the remaining non-employee professional. During the third quarter, one of the two non-employee professionals became an employee of the Company. At this time, the Company revalued the associated 150,000 shares and reclassified $0.1 million out of the liability and into equity.
Under U.S. GAAP, the value of these option awards is determined at the performance completion date. The Company recognizes expense for the estimated total value of the awards during the period from their issuance until performance completion since the professional services are being rendered during this time. The total expense recognized is adjusted to the final value of the award as determined on the performance completion date.
The estimated values of the option awards are determined using the Black-Scholes pricing model with the following inputs:
 
Nine Months Ended September 30,
 
2017
 
2016
 
 
 
 
Risk free interest rate
1.55%
 
1.01% - 1.14%

Expected life in years
3
 
4 - 5

Expected volatility
84%
 
103% - 114%

Expected dividend yield
0%
 
0
%
For the three months ended September 30, 2017 and 2016, the Company recorded a recovery for non-employee stock options of a nominal amount and a nominal expense for non-employee stock options, respectively. For the nine month periods ended September 30, 2017 and 2016, the Company recorded a recovery for non-employee stock options of a nominal amount and an expense for non-employee stock options of $0.2 million, respectively. The changes in fair value of the liability related to vested yet un-exercised options issued to non-employees during the nine months ended September 30, 2017 and 2016 were as follows (in thousands):
 
Nine Months Ended September 30,
 
2017
 
2016
Balance at beginning of year
$
899

 
$
841

Reclassification to additional paid in capital
(109
)
 

Vested during the period

 
533

Change in fair value recorded in earnings
(332
)
 
163

Balance as of September 30, 2017 and 2016
$
458

 
$
1,537

Options issued to non-employees are reclassified from equity to liabilities on the performance completion date. Under U.S. GAAP, such options may not be considered indexed to our stock because they have exercise prices denominated in Canadian dollars. Hence, these will be classified as liabilities under the caption “Warrant and stock option liabilities” and recorded at estimated fair value at each reporting date, computed using the Black-Scholes valuation method. Changes in the liability from period to period will be recorded in the Consolidated Statements of Operations under the caption “Change in fair value of warrant and stock option liabilities”. At September 30, 2017, there were 500,000 unexercised non-employee options requiring liability classification.






20


NOTE 13 – EARNINGS PER SHARE
Basic net earnings attributable to Nobilis common shareholders, per common share, excludes dilution and is computed by dividing net earnings attributable to Nobilis common shareholders by the weighted-average number of common shares outstanding during the period. Diluted net earnings attributable to Nobilis common shareholders, per common share, is computed by dividing net earnings attributable to Nobilis common shareholders by the weighted-average number of common shares outstanding during the period plus any potential dilutive common share equivalents, including shares issuable upon the vesting stock option awards, warrants and RSUs as determined under the treasury stock method.
A detail of the Company’s earnings per share is as follows (in thousands, except for share and per share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017

2016
 
2017

2016
 
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
Net income (loss) attributable to Nobilis Health Corp.
$
1,014

 
$
(2,759
)
 
$
201

 
$
(2,918
)
Weighted average common shares outstanding
77,805,014

 
76,774,967

 
77,805,014

 
76,114,538

Net income (loss) per common share
$
0.01

 
$
(0.04
)
 
$

 
$
(0.04
)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
 Net income (loss) attributable to Nobilis Health Corp.
$
1,014

 
$
(2,759
)
 
$
201

 
$
(2,918
)
 Weighted average common shares outstanding
77,805,014

 
76,774,967

 
77,805,014

 
76,114,538

 Dilutive effect of stock options, warrants, RSUs
327,113

 

 
363,005

 

 Weighted average common shares outstanding diluted
78,132,127

 
76,774,967

 
78,168,019

 
76,114,538

 Net income (loss) per fully diluted share
$
0.01

 
$
(0.04
)
 
$

 
$
(0.04
)
NOTE 14 – NONCONTROLLING INTERESTS
Noncontrolling interests at September 30, 2017 represent an 8.1% interest in The Palladium for Surgery - Houston, 75% interest in the Kirby Surgical Center, 65% interest in Microsurgery Institute, 2.3% interest in Houston Microsurgery Institute, 50% in Northstar Healthcare Dallas Management, 65% in NHC ASC – Dallas, 49% in First Nobilis Hospital, 40% in First Nobilis Hospital Management, 45% in Hermann Drive Surgical Hospital, 25% in Scottsdale Liberty Hospital, 10% in Series 1 Best Choice Anesthesia & Pain and 15% in Peak Neuromonitoring Physicians II, PLLC.
Agreements with the third-party equity owners in NHC - ASC Dallas and First Nobilis give these owners limited rights to require the Company to repurchase their equity interests upon the occurrence of certain events, none of which were probable of occurring as of September 30, 2017 and December 31, 2016. The contingently redeemable noncontrolling interests associated with these entities are classified in the Company’s Consolidated Balance Sheets as “temporary” or mezzanine equity. Changes in contingently redeemable noncontrolling interests are as follows (in thousands):

21


 
NHC - ASC Dallas
 
First Nobilis
 
Total
 
 
 
 
 
 
Balance at January 1, 2016
$
3,393

 
$
8,832

 
$
12,225

Distributions
(2,928
)
 
(599
)
 
(3,527
)
Net (loss) income attributable to noncontrolling interests
(68
)
 
5,674

 
5,606

Total contingently redeemable noncontrolling interests at December 31, 2016
$
397

 
$
13,907

 
$
14,304

 
 
 
 
 
 
Balance at January 1, 2017
$
397

 
$
13,907

 
$
14,304

Distributions

 

 

Net income attributable to noncontrolling interests
152

 
207

 
359

Total contingently redeemable noncontrolling interests at September 30, 2017
$
549

 
$
14,114

 
$
14,663

Certain of our consolidated subsidiaries that are less than wholly owned meet the definition of a Variable Interest Entity (VIE), and we hold voting interests in all such entities. We consolidate the activities of VIE’s for which we are the primary beneficiary. In order to determine whether we own a variable interest in a VIE, we perform qualitative analysis of the entity’s design, organizational structure, primary decision makers and relevant agreements. Such variable interests include our voting interests, and may also include other interests and rights, including those gained through management contracts.
Since our core business is the management and operation of health care facilities, our subsidiaries that are determined to be VIE’s represent entities that own, manage and operate such facilities. Voting interests in such entities are typically owned by us, by physicians practicing at these facilities (or entities controlled by them) and other parties associated with the operation of the facilities. In forming such entities, we typically seek to retain operational control and, as a result, in some cases, voting rights we hold are not proportionate to the economic share of our ownership in these entities, which causes them to meet the VIE definition. We consolidate such VIE’s if we determine that we are the primary beneficiary because (i) we have the power to direct the activities that most significantly impact the economic performance of the VIE via our rights and obligations associated with the management and operation of the VIE’s health care facilities, and (ii) as a result of our obligation to absorb losses and the right to receive residual returns that could potentially be significant to the VIE, which we have through our equity interests.
The following table summarizes the carrying amount of the assets and liabilities of our material VIE’s included in the Company’s Consolidated Balance Sheets (after elimination of intercompany transactions and balances) (in thousands):
 
September 30, 2017
 
December 31, 2016
 
 
 
 
Total cash and short term investments
$
9,043

 
$
3,445

Total accounts receivable
24,813

 
18,845

Total other current assets
1,875

 
1,664

Total property and equipment
16,207

 
16,804

Total other assets
190

 
190

Total assets
$
52,128

 
$
40,948

 
 
 
 
Total accounts payable
$
3,995

 
$
4,119

Total other liabilities
4,466

 
5,263

Total accrued liabilities
16,337

 
11,538

Long term - capital lease
11,712

 
11,169

Noncontrolling interest
(9,939
)
 
(8,892
)
Total liabilities
$
26,571

 
$
23,197

NOTE 15 – INCOME TAXES
The Company is a corporation subject to federal income tax at a statutory rate of 35% of pretax earnings. The Company estimates an annual effective income tax rate of 39.6% for U.S. and none for Canada based on the projected results for the year and applies this rate to income before taxes to calculate income tax expense.


22


The net tax expense for the nine months ended September 30, 2017 was $0.6 million, resulting in an effective tax rate of approximately 37.5%, compared to an income tax benefit of $1.8 million with an effective tax rate of approximately 21.1% for the prior corresponding period. The net tax expense amount includes $0.8 million and $0.9 million tax expense for states in which the Company operates for the nine months ended September 30, 2017 and 2016, respectively.  The Company did not recognize any foreign tax expense or benefit for the nine months ended September 30, 2017 and 2016, as the Company had a full valuation allowance against deferred tax assets.

The following items caused the third quarter effective income tax rate to be different from the statutory rate:

Canada is excluded from the worldwide annual effective tax rate calculation because Canada has historical ordinary losses but does not expect to recognize them and has recorded a full valuation allowance, which decreases the third quarter effective tax rate by approximately 2.2% for the nine months ended September 30, 2017.

All of the Partnership’s earnings are included in the Company’s net income; however, the Company is not required to record income tax expense or benefit with respect to the portion of the Partnership’s earnings allocated to its noncontrolling public limited partners, which increases the first quarter effective tax rate by approximately 1.0% for the nine months ended September 30, 2017.

The Company received notification from the Internal Revenue Service to examine the 2014 federal income tax return for First Nobilis, LLC that the Company owns 51%.

Based on management’s analysis, the Company did not have any uncertain tax positions as of September 30, 2017.

NOTE 16 – BUSINESS SEGMENT INFORMATION
A summary of the business segment information for the three and nine months ended September 30, 2017 and 2016 is as follows (in thousands):
 
Three Months Ended September 30, 2017
 
Medical
Marketing
Corporate
Total
 
 
 
 
 
Revenues
$
59,276

$
5,376

$

$
64,652

Operating expenses
52,052

4,356


56,408

Corporate costs


6,961

6,961

Income (loss) from operations
7,224

1,020

(6,961
)
1,283

Change in fair value of warrant and option liabilities



(171
)
(171
)
Interest expense (income)
253

(2
)
1,129

1,380

Other expense
$
105

$

38

143

Income (loss) before income taxes
$
6,866

$
1,022

$
(7,957
)
$
(69
)
 
 
 
 
 
Other data:
 
 
 
 
     Depreciation and amortization expense
$
2,298

$
418

$
93

$
2,809

     Income tax expense (benefit)
$
413

$
33

$
(516
)
$
(70
)
     Capital expenditures
$
775

$
522

$
118

$
1,415



23


 
Three Months Ended September 30, 2016
 
Medical
Marketing
Corporate
Total
 
 
 
 
 
Revenues
$
65,419

$
5,264

$

$
70,683

Operating expenses
60,871

2,958


63,829

Corporate costs


7,955

7,955

Income (loss) from operations
4,548

2,306

(7,955
)
(1,101
)
Change in fair value of warrant and option liabilities



133

133

Interest expense
329

1

414

744

Other (income) expense
(199
)
(57
)
58

(198
)
Income (loss) before income taxes
$
4,418

$
2,362

(8,560
)
(1,780
)
 
 
 
 
 
Other data:
 
 
 
 
     Depreciation and amortization expense
$
1,564

$
388

$
79

$
2,031

     Income tax expense
$
205

$
78

$
200

$
483

     Capital expenditures
$
1,289

$

$
72

$
1,361


 
Nine Months Ended September 30, 2017
 
Medical
Marketing
Corporate
Total
 
 
 
 
 
Revenues
$
201,204

$
11,712

$

$
212,916

Operating expenses
174,409

11,964


186,373

Corporate costs


21,010

21,010

Income (loss) from operations
26,795

(252
)
(21,010
)
5,533

Change in fair value of warrant and option liabilities


(358
)
(358
)
Interest expense (income)
771

(10
)
3,237

3,998

Other expense (income)
80

(8
)
143

215

Income (loss) before income taxes
$
25,944

$
(234
)
$
(24,032
)
$
1,678

 
 
 
 
 
Other data:
 
 
 
 
   Depreciation and amortization expense
$
6,552

$
1,230

$
256

$
8,038

   Income tax expense (benefit)
$
857

$
88

$
(317
)
$
628

   Intangible assets, net
$
8,521

$
11,872

$

$
20,393

   Goodwill
$
50,992

$
19,011

$

$
70,003

   Capital expenditures
$
5,028

$
2,737

$
286

$
8,051

   Total assets
$
225,646

$
49,240

$
42,213

$
317,099

   Total liabilities
$
69,742

$
8,760

$
80,601

$
159,103


24


 
Nine Months Ended September 30, 2016
 
Medical
Marketing
Corporate
Total
 
 
 
 
 
Revenues
$
166,922

$
16,905

$

$
183,827

Operating expenses
158,471

11,716


170,187

Corporate costs


24,380

24,380

Income (loss) from operations
8,451

5,189

(24,380
)
(10,740
)
Change in fair value of warrant and option liabilities



(1,566
)
(1,566
)
Interest expense
1,074

4

1,037

2,115

Other income
(1,682
)
(305
)
(1,024
)
(3,011
)
Income (loss) before income taxes
$
9,059

$
5,490

$
(22,827
)
$
(8,278
)
 
 
 
 
 
Other data:
 
 
 
 
Depreciation and amortization expense
$
5,026

$
1,436

$
209

$
6,671

Income tax expense (benefit)
$
662

$
149

$
(2,577
)
$
(1,766
)
Intangible assets, net
$
5,246

$
13,022

$

$
18,268

Goodwill
$
25,822

$
19,011

$

$
44,833

Capital expenditures
$
4,000

$

$
388

$
4,388

Total assets
$
175,279

$
44,413

$
21,291

$
240,983

Total liabilities
$
55,602

$
6,928

$
38,237

$
100,767


NOTE 17 – RELATED PARTY TRANSACTIONS
In March 2016, the Company acquired an interest in Athelite, a holding company which owns an interest in Dallas Metro, a company formed to provide management services to an HOPD. The Athelite investment is accounted for as an equity method investment (refer to Note 4 - Investments in associates). At September 30, 2017, the Company had $3.8 million in accounts receivable from the HOPD.
As a result of the AZ Vein acquisition in October 2016, an executive of the Company is owed $2.3 million, $2.2 million and $1.1 million related to a convertible promissory note, pre-acquisition and working capital adjustment and a cash holdback, respectively, as of September 30, 2017. In addition, the Company entered into agreements to lease facility space with the same executive.  Facility lease cost were $0.8 million in for the nine months ended 2017.
Physician Related Party Transactions
Nobilis maintains certain medical directorship, consulting and marketing agreements with various physicians who are also equity owners in Nobilis entities. Material related party arrangements of this nature are described below:

In September 2013, the Company entered into a book deal with a physician equity owner. In March 2015, the Company entered into a marketing agreement with that physician equity owner and a marketing services company owned by the physician equity owner’s father. The Company incurred expenses of nil and $1.7 million as a result of the book deal during the nine months ended September 30, 2017 and 2016, respectively. The Company incurred expenses of nil and $0.3 million related to the marketing services entity during the nine months ended September 30, 2017 and 2016, respectively. The Company incurred expenses of nil and $0.9 million related to the Consulting services entity during the nine months ended September 30, 2017 and 2016, respectively.
In July 2014, the Company entered into a marketing services agreement with a physician equity owner and an entity owned by that physician equity owner’s brother. The Company incurred expenses of $0.4 million and $1.0 million to the entity during the nine months ended September 30, 2017 and 2016, respectively.
In September 2014, the minority interest holder of a fully consolidated entity, who is also a partial owner of two other hospitals, entered into an ongoing business relationship with the Company. At September 30, 2017, the Company has a net amount due from these related parties of $3.2 million. In addition, the Company leases certain medical equipment and facility space from these related parties. Equipment lease costs of $1.6 million and $1.6 million were incurred during the nine months ended September 30, 2017 and 2016, respectively. Facility lease costs of $1.3 million and $1.3 million were incurred during the nine months ended September 30, 2017 and 2016, respectively.

25


In September 2014, the Company entered into a services agreement with a physician equity owner's wife who has financial interests in a related entity. The Company incurred expenses pursuant to service agreements of nil and $0.4 million to the entity during the nine months ended September 30, 2017 and 2016, respectively.
In October 2014, the Company entered into a management agreement with an entity controlled by a physician equity owner. In June 2015, the Company expanded the relationship with this physician equity owner and an entity owned by the physician equity owner's wife to include consulting, marketing, medical supplies, medical directorship and on-call agreements (collectively "service agreements"). The Company incurred expenses of $2.1 million and $1.9 million in fees owed pursuant to the management agreement to the entity during the nine months ended September 30, 2017 and 2016, respectively. The Company has incurred expenses of $5.6 million and $5.2 million in fees owed pursuant to the service agreements to the entity during the nine months ended September 30, 2017 and 2016, respectively.
In April 2017, the minority interest holder of a fully consolidated entity, who is also a member of the Company's board of directors, entered into an ongoing business relationship with the Company. The Company incurred expenses of $0.3 million during the nine months ended September 30, 2017. At September 30, 2017, the Company has a net amount due to this related party of $0.1 million.

NOTE 18 – COMMITMENTS AND CONTINGENCIES
Litigation
In the normal course of our business, we are subject to legal proceedings brought by or against us and our subsidiaries, including claims for damages for personal injuries, medical malpractice, breach of contracts, and employment related claims. In certain of these actions, plaintiffs request payment for damages, including punitive damages that may not be covered by insurance. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially impact the financial position, results of operations or liquidity of the Company.
A statement of claim (complaint), Vince Capelli v. Nobilis Health Corp. et. al, was filed on January 8, 2016 in the Ontario Superior Court of Justice under court file number CV-16-544173 naming Nobilis Health Corp., certain current and former officers and the Company’s former auditors as defendants. The statement of claim seeks to advance claims on behalf of the plaintiff and on behalf of a class comprised of certain of our shareholders related to, among other things, alleged certain violations of the Ontario Securities Act and seeks damages in the amount of $100 million plus interest. The defendants intend to vigorously defend against these claims. At this time, the Company believes it is too early to provide a realistic estimate of the Company’s exposure.

26


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements
This Quarterly Report and the documents that are incorporated herein by reference contain certain forward-looking statements within the meaning of Canadian and United States securities laws, including the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended. Forward-looking statements include all statements that do not relate solely to historical or current facts and may be identified by the use of words including, but not limited to the following: “may,” “believe,” “will,” “expect,” “project,” “estimate,” “anticipate,” “plan,” “continue” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. These forward-looking statements are based on the Company's current plans and expectations and are subject to a number of risks, uncertainties and other factors which could significantly affect current plans and expectations and our future financial condition and results. These factors, which could cause actual results, performance and achievements to differ materially from those anticipated, include, but are not limited to the following:
our ability to successfully maintain effective internal controls over financial reporting;
our ability to implement our business strategy, manage the growth in our business, and integrate acquired businesses;
the risk of litigation and investigations, and liability claims for damages and other expenses not covered by insurance;
the risk that payments from third-party payers, including government healthcare programs, may decrease or not increase as costs increase;
adverse developments affecting the medical practices of our physician limited partners;
our ability to maintain favorable relations with our physician limited partners;
our ability to grow revenues by increasing case and procedure volume while maintaining profitability;
failure to timely or accurately bill for services;
our ability to compete for physician partners, patients and strategic relationships;
the risk of changes in patient volume and patient mix;
the risk that laws and regulations that regulate payments for medical services made by government healthcare programs could cause our revenues to decrease;
the risk that contracts are cancelled or not renewed or that we are not able to enter into additional contracts under terms that are acceptable to us; and
the risk of potential decreases in our reimbursement rates.
The foregoing are significant factors we think could cause our actual results to differ materially from expected results. There could be additional factors besides those listed herein that also could affect us in an adverse manner.
This Quarterly Report should be read completely and with the understanding that actual future results may be materially different from what we may expect. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof, when evaluating the information presented in this Quarterly Report or other disclosures because current plans, anticipated actions, and future financial conditions and results may differ from those expressed in any forward-looking statements made by or on behalf of the Company.
We have not undertaken any obligation to publicly update or revise any forward-looking statements. All of our forward-looking statements speak only as of the date of the document in which they are made or, if a date is specified, as of such date. Subject to mandatory requirements of applicable law, we disclaim any obligation or undertaking to provide any updates or revisions to any forward-looking statement to reflect any change in our expectations or any changes in events, conditions, circumstances or information on which the forward-looking statement is based. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing factors and the risk factors set forth elsewhere in this report and in our 2016 Annual Report filed with the SEC on March 14, 2017.
The following discussion relates to the Company and its consolidated subsidiaries and should be read in conjunction with our consolidated financial statements and accompanying notes included under Part I, Item 1—Financial Statements of this Quarterly Report, as well as our consolidated financial statements, accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) included in our 2016 Annual Report.

27


Executive Overview
Our operations consist of two reportable business segments, the Medical Segment and the Marketing Segment, each of which is described in more detail in the following paragraphs. Our Medical Segment owns and manages specialty surgical hospitals, ambulatory surgery centers (ASCs) and multi-specialty clinics. It focuses on improving patient outcomes by providing minimally invasive procedures that can be performed in low-cost, outpatient settings. To promote further improvements in patient satisfaction and clinical outcomes, Nobilis has spent the last two years developing a full suite of ancillary services that we offer patients treated in our facilities. To date, Nobilis is able to provide a variety of in-house ancillary services, such as Anesthesia, Surgical Assist, Intraoperative Neuromonitoring ("IOM"), and clinical lab testing (collectively, "Nobilis Ancillary Service Lines").
Our business also utilizes innovative direct-to-consumer marketing and proprietary technologies to drive patient engagement and education. Our Marketing Segment provides these services to the facilities that comprise our Medical Segment; we also provide these services to third parties as a stand-alone service.
Our portfolio of specialty surgical hospitals, ASCs and multi-specialty clinics is complemented by our Marketing Segment, which allows us to operate those facilities in many instances with few, if any, physician partners. Our differentiated business strategy provides value to patients, physicians and payors, and enables us to capitalize on recent trends in the healthcare industry, particularly with regard to increased consumerism in the healthcare space. As a result, we believe we are positioned for continued growth.
In 2017 we will continue to expand the continuum of care that we offer our patients by vertically integrating primary care physician practices into our business model. Through the alignment of primary care physicians, which includes an array of options from clinical integration to employment, this initiative will allow us to grow our referral based business, while providing direct exposure to the initial level of patient care and diversifying the services provided throughout our healthcare system. It also affords us the opportunity to broaden marketing services throughout the continuum of care and match the healthcare needs of patients, all while maintaining a focus on patient outcomes and satisfaction. Our engagement of primary care physicians at the clinical level will drive contracted revenues and create an entirely new stream of business and revenue, and more importantly, will continue Management’s ongoing efforts to strengthen our revenue platform.
Our pipeline of acquisition targets is robust and varies by geography. We will be opportunistic in choosing the order of these acquisitions and will make our decisions based on geographic location, existing and potential physician relationship and marketing opportunities within the targeted market.
On October 28, 2016 and March 8, 2017, we purchased Arizona Vein and Vascular Center, LLC and its four affiliated surgery centers operating as Arizona Center for Minimally Invasive Surgery, LLC, (collectively, "AZ Vein") and Hamilton Vein Center (HVC) brand and associated assets, respectively. The acquisitions expanded our specialty mix to include the treatment of venous diseases with little modification to our existing infrastructure of specialty surgical hospitals and ASCs. Our facilities will be able to offer a range of treatments, both surgical and non-surgical, for those patients suffering from venous diseases, which today affect more than 30 million Americans.
In addition to our vein and vascular business acquisitions, on September 13, 2017, we purchased DeRosa Medical, P.C. ("DeRosa") for $0.9 million in cash. DeRosa is a primary care practice that specializes in health and wellness, medically supervised weight loss, and chronic health condition management. The practice has three locations in the Phoenix, Arizona metropolitan area: Scottsdale, Chandler, and Glendale. The acquisition of DeRosa allows the Company to enhance our ability to serve patients across the continuum of care, from primary care needs to surgical procedures, utilizing its concierge care delivery model and DeRosa also complements the existing facilities located in Arizona.
Our growth strategy focuses on:
Driving organic growth in facilities that we own and operate; and
Executing a disciplined acquisition strategy that results in accretive acquisitions.
Medical Segment
Our Medical Segment broadly includes our ownership or operation of healthcare facilities (the “Nobilis Facilities”) (which include specialty surgical hospitals, ASCs and multi-specialty clinics) and Nobilis Ancillary Service Lines.
As of September 30, 2017, there are 27 Nobilis Facilities, consisting of 4 specialty surgical hospitals (3 in Texas and 1 in Arizona) (the "Nobilis Hospitals"), 10 ASCs (5 in Texas and 5 in Arizona) and 13 multi-specialty clinics (6 in Texas and 7 in Arizona), partnered with 35 facilities across the country and 9 marketed brands. We earn revenue in our Medical Segment from the “facility fees” or “technical fees” from third party payors or patients for the services rendered at the Nobilis Facilities. The Nobilis Facilities are each licensed in the state where they are located and provide surgical procedures in a limited number of clinical specialties, which enables them to develop routines, procedures and protocols to maximize operating efficiency and productivity while offering an enhanced healthcare experience for both physicians and patients.

28


These clinical specialties include musculoskeletal surgery, orthopedic surgery, podiatric surgery, vein and vascular, ear nose and throat (ENT) surgery, pain management, gastro-intestinal surgery, gynecology and general surgery. The Nobilis ASCs do not offer the full range of services typically found in traditional hospitals.
Marketing Segment
Our Marketing Segment provides marketing services, patient education services and patient care coordination management services to the Nobilis Facilities, to third party facilities in states where we currently do not operate, and to physicians. We market several minimally-invasive medical procedures and brands, which include the following:
North American Spine: promotion of minimally invasive spine procedures (pain management, musculoskeletal and spine);
Migraine Treatment Centers of America: promotion of procedures related to chronic migraine pain (interventional headache procedure);
NueStep: promotion of surgical procedures designed to treat pain in the foot, ankle and leg (podiatry);
Evolve: The Experts in Weight Loss Surgery: promotion of surgical weight loss procedures (bariatrics);
Minimally Invasive Reproductive Surgery Institute (“MIRI”): promotion of women’s health related procedures;
Onward Orthopedics: promotion of general orthopedics, sports medicine related to orthopedics (orthopedics and pain management interventions);
Clarity Vein and Vascular: promotion of cosmetic and medical vein and vascular treatments; and
Arizona Vein and Vascular Center: promotion of cosmetic and medical vein and vascular treatments.
Hamilton Vein Center: promotion of cosmetic and medical vein and vascular treatments.
Our Marketing Segment does not directly provide medical services to patients; rather, we identify candidates for our branded procedures, educate these potential patients about the relevant procedure and direct those patients to affiliated physicians who diagnose and treat those patients at affiliated facilities. Through our Marketing Segment, we have contractual relationships with facilities and physicians in several states.
We earn service fees from our partner facilities that, depending on the laws of the state in which a partner facility is located, are either charged as a flat monthly fee or are calculated based on a portion of the “facility fee” revenue generated by the partner facility for a given procedure.
Our revenues from physician-related services are, depending on the laws of the state in which a partner-physician practices, either earned directly from professional fees or through the purchase of accounts receivable. In Texas, we engage physicians through entities exempt from Texas corporate practice of medicine laws that directly earn professional fees for partner-physician services and, in turn, pay partner-physicians a reasonable fee for rendering those professional services. In other states, we manage our partner-physicians’ practices and purchase the accounts receivable at a discount of those practices through accounts receivable purchase agreements, consistent with the laws in those states. The revenues generated from certain accounts receivables purchased from third parties in the ordinary course of business represents our factoring revenues.
Seasonality of the Business
The surgical segment of the healthcare industry tends to be impacted by seasonality because most benefit plans reset on a calendar year basis. As patients utilize and reduce their remaining deductible, Nobilis Facilities typically experience an increase in volume throughout the year, with the biggest impact coming in the fourth quarter. Historically, approximately 35% - 40% of our annual revenues have been recognized in the fourth quarter.
Operating Environment
The Medical Segment depends primarily upon third-party reimbursement from private insurers to pay for substantially all of the services rendered to our patients. The majority of the revenues attributable to the Medical Segment are from reimbursement to the Nobilis Hospitals and Nobilis ASCs as “out-of-network” providers. This means the Nobilis Facilities are not contracted with a major medical insurer as an “in-network” participant. Participation in such networks offer the benefit of larger patient populations and defined, predictable payment rates. The reimbursement to in-network providers, however, is typically far less than that paid to out of network providers. To a far lesser degree, the Nobilis Facilities earn fees from governmental payor programs such as Medicare. For the three months ended September 30, 2017 and 2016, we derived approximately 2.1% and 0.2% for the respective periods of our Medical Segment’s net revenues from governmental healthcare programs, primarily Medicare and managed Medicare programs, and the remainder from a wide mix of commercial payers and patient co-pays, coinsurance, and deductibles.
We receive a relatively small amount of revenue from Medicare. We also receive a relatively small portion of revenue directly from uninsured patients, who pay out of pocket for the services they receive.

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Insured patients are responsible for services not covered by their health insurance plans, deductibles, co-payments and co-insurance obligations under their plans. The amount of these deductibles, co-payments and co-insurance obligations has increased in recent years but does not represent a material component of the revenue generated by the Nobilis Facilities. The surgical center fees of the Nobilis Facilities are generated by the physician limited partners and the other physicians who utilize the Nobilis Facilities to provide services.
Revenue Model and Case Mix
Revenues earned by the Nobilis Facilities vary depending on the procedures performed. For every medical procedure performed there are usually three separately invoiced patient billings:
the surgical center fee for the use of infrastructure, surgical equipment, nursing staff, non-surgical professional services, supplies and other support services, which is earned by the Nobilis Facilities;
the professional fee, which is separately earned, billed and collected by the physician performing the procedure, separate and apart from the fees charged by the Nobilis Facilities; and
the anesthesiology fee, which is separately earned, billed and collected by the anesthesia provider, separate and apart from the fees charged by the Nobilis Facilities and the physicians.
Overall facility revenue depends on procedure volume, case mix and payment rates of the respective payors.
Three Months Ended September 30, 2017 and 2016 (in thousands)
 
Three Months Ended September 30,
 
2017

2016
Revenues:
 
 
 
   Patient and net professional fees
$
59,514

 
$
65,666

   Contracted marketing revenues
2,211

 
2,604

   Factoring revenues
2,927

 
2,413

         Total revenues
64,652

 
70,683

Operating expenses:
 
 
 
   Salaries and benefits
15,735

 
13,209

   Drugs and supplies
10,386

 
15,473

   General and administrative
27,571

 
33,195

   Depreciation and amortization
2,716

 
1,952

         Total operating expenses
56,408

 
63,829

Corporate expenses:
 
 
 
   Salaries and benefits
2,949

 
1,765

   General and administrative
3,252

 
4,576

   Legal expenses
667

 
1,535

   Depreciation
93

 
79

         Total corporate expenses
6,961

 
7,955

         Income (loss) from operations
1,283

 
(1,101
)
Other expense (income):
 
 
 
   Change in fair value of warrant and stock
option derivative liabilities
(171
)
 
133

   Interest expense
1,380

 
744

   Other expense (income), net
143

 
(198