10-Q 1 nhc-093016x10q.htm 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, 2016
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 Web site, 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, or a smaller reporting 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  [  ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES  [  ]  NO  [ X ]
Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.
76,877,014 common shares as of October 28, 2016.



TABLE OF CONTENTS
In this Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2016 (“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
Part I – Financial Statements
Nobilis Health Corp.
Consolidated Balance Sheets
September 30, 2016 and December 31, 2015
(in thousands, except share amounts)
(unaudited)
 
September 30, 2016
 
December 31, 2015
Assets
 
 
 
Current Assets:
 
 
 
Cash
$
19,614

 
$
15,666

Trade accounts receivable, net of allowance of $2,144 at September 30, 2016 and $5,165 at December 31, 2015
86,170

 
92,569

Medical supplies
4,321

 
4,493

Prepaid expenses and other current assets
3,727

 
2,789

Total current assets
113,832

 
115,517

Property and equipment, net
34,638

 
35,303

Intangible assets, net
18,268

 
19,619

Goodwill
44,833

 
44,833

Deferred tax asset
27,470

 
25,035

Other long-term assets
1,942

 
1,720

Total Assets
$
240,983

 
$
242,027

Liabilities and Shareholders' Equity
 
 
 
Current Liabilities:
 
 
 
Trade accounts payable
$
19,702

 
$
23,381

Accrued expenses
20,661

 
16,648

Current portion of capital leases
3,484

 
5,193

Current portion of long-term debt
1,006

 
1,243

Current portion of warrant and stock option derivative liabilities
380

 
332

Other current liabilities
6,802

 
5,025

Total current liabilities
52,035

 
51,822

Lines of credit
8,135

 
3,000

Long-term capital leases, net of current portion
12,711

 
13,654

Long-term debt, net of current portion
22,826

 
21,469

Warrant and stock option derivative liabilities, net of current portion
1,537

 
2,619

Other long-term liabilities
3,523

 
3,386

Total liabilities
100,767

 
95,950

Commitments and Contingencies

 

Contingently redeemable noncontrolling interest
10,567

 
12,225

Shareholders' Equity:
 
 
 
Common shares, no par value, unlimited shares authorized, 76,855,014 and 73,675,979 shares issued and outstanding, respectively

 

Additional paid in capital
218,724

 
211,827

Accumulated deficit
(88,410
)
 
(85,491
)
Total shareholders’ equity attributable to Nobilis Health Corp.
130,314

 
126,336

Noncontrolling interests
(665
)
 
7,516

Total shareholders' equity
129,649

 
133,852

Total Liabilities and Shareholders' Equity
$
240,983

 
$
242,027

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,
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
   Patient and net professional fees
$
65,666

 
$
46,237

 
$
167,199

 
$
126,661

   Contracted marketing revenues
2,604

 
4,410

 
10,754

 
8,059

   Factoring revenues
2,413

 
1,836

 
5,874

 
4,481

         Total revenues
70,683

 
52,483

 
183,827

 
139,201

Operating expenses:
 
 
 
 
 
 
 
   Salaries and benefits
13,209

 
10,255

 
38,377

 
26,927

   Drugs and supplies
15,473

 
8,405

 
39,670

 
22,265

   General and administrative
33,195

 
21,025

 
85,678

 
54,625

   Bad debt expense

 
929

 

 
1,129

   Depreciation and amortization
1,952

 
1,522

 
6,462

 
3,114

         Facility operating expenses
63,829

 
42,136

 
170,187

 
108,060

Corporate expenses:
 
 
 
 
 
 
 
   Salaries and benefits
1,765

 
1,540

 
5,077

 
3,532

   General and administrative
4,576

 
5,192

 
14,984

 
17,707

   Legal expenses
1,535

 
521

 
4,110

 
1,733

   Depreciation
79

 
43

 
209

 
99

         Total corporate costs
7,955

 
7,296

 
24,380

 
23,071

         (Loss) income from operations
(1,101
)
 
3,051

 
(10,740
)
 
8,070

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

 
(6,381
)
 
(1,566
)
 
(4,677
)
   Interest expense
744

 
322

 
2,115

 
1,106

   Bargain purchase gain

 
(4,358
)
 

 
(4,358
)
   Other income, net
(198
)
 
(106
)
 
(3,011
)
 
(1,518
)
         Total other expense (income)
679

 
(10,523
)
 
(2,462
)
 
(9,447
)
(Loss) income before income taxes and noncontrolling interests
(1,780
)
 
13,574

 
(8,278
)
 
17,517

Income tax expense (benefit)
483

 
256

 
(1,766
)
 
862

         Net (loss) income
(2,263
)
 
13,318

 
(6,512
)
 
16,655

Net income (loss) attributable to noncontrolling interests
496

 
2,375

 
(3,594
)
 
10,617

Net (loss) income attributable to Nobilis Health Corp.
$
(2,759
)
 
$
10,943

 
$
(2,918
)
 
$
6,038

Net (loss) income per basic common share
$
(0.04
)
 
$
0.15

 
$
(0.04
)
 
$
0.09

Net (loss) income per fully diluted common share
$
(0.04
)
 
$
0.14

 
$
(0.04
)
 
$
0.08

Weighted average shares outstanding (basic)
76,774,967

 
70,935,587

 
76,114,538

 
65,310,610

Weighted average shares outstanding (fully diluted)
76,774,967

 
77,656,264

 
76,114,538

 
75,067,623

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)
 
Nine Months Ended September 30,
 
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 Net (loss) income
$
(6,512
)
 
$
16,655

 Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
 Depreciation and amortization
6,671

 
3,213

 Provision for bad debts

 
1,129

 Share-based compensation
5,226

 
12,469

 Change in fair value of warrant and stock option derivative liabilities
(1,566
)
 
(4,677
)
 Recoupment of indemnified expenses

 
(1,700
)
 Deferred income taxes
(2,435
)
 

 Gain on bargain purchase of a business

 
(4,358
)
 Gain on sale of property and equipment
(265
)
 

 Earnings from equity method investment
(1,000
)
 

 Amortization of deferred financing fees
112

 
66

 Changes in operating assets and liabilities, net of assets acquired and liabilities assumed:
 
 
 
       Trade accounts receivable
6,399

 
(11,962
)
       Medical supplies
172

 
(612
)
       Prepaid expenses and other current assets
(938
)
 
(2,095
)
       Other long-term assets
152

 
(37
)
       Trade accounts payable and accrued liabilities
334

 
(4,372
)
       Other current liabilities
1,777

 
(900
)
       Other long-term liabilities
137

 
19

       Distributions from equity method investments
1,079

 

       Net cash provided by operating activities
9,343

 
2,838

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 Purchase of property and equipment
(4,388
)
 
(2,533
)
 Investment in associate

 
(206
)
 Purchase of equity method investment
(609
)
 

 Note receivable, net
150

 
(197
)
 Acquisition of Victory

 
(1,436
)
 Acquisition of Peak

 
(849
)
 Acquisition of Peak, net of cash acquired

 
(1,299
)
 Deconsolidation of imaging centers and urgent care clinic

 
(166
)
       Net cash used for investing activities
(4,847
)
 
(6,686
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 Distributions to noncontrolling interests
(6,245
)
 
(9,015
)
 Proceeds from exercise of stock options
2,074

 
521

 Proceeds from exercise of stock warrants
130

 
4,343

 Proceeds from private placement

 
28,395

 Payments on capital lease obligations
(2,652
)
 
(719
)
 Proceeds (payments) from line of credit
5,135

 
(5,420
)
 Proceeds from debt
6,440

 
20,000

 Payments on debt
(5,026
)
 
(20,124
)
 Deferred financing fees
(404
)
 
(662
)
       Net cash (used for) provided by financing activities
(548
)
 
17,319

 
 
 
 
NET INCREASE IN CASH
3,948

 
13,525

CASH — Beginning of period
15,666

 
7,568

CASH — End of period
$
19,614

 
$
21,093

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

5


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 ambulatory surgery centers and acute-care surgical hospitals. In 2014, through its acquisition of Athas Health, LLC (“Athas”), the Company expanded its service offering within the health care industry to include providing contracted marketing services and accounts receivable factoring.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation
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, 2015, 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 significant 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 consolidated financial statements are (i) a change in presentation of other comprehensive income and (ii) a reclassification from cost of goods sold to operating expenses. 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, 2015 (“2015 Annual Report”) filed with the SEC on March 15, 2016. 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 2015 Annual Report.
Recent Accounting Pronouncements
In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments-Overall (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). This update changes how entities account for and measure the fair value of certain equity investments and updates the presentation and disclosure of certain financial assets and liabilities. This new ASU is effective for annual and interim periods beginning on or after December 15, 2017, and for interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact that ASU 2016-01 will have on the Company’s consolidated financial position and disclosures.
In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net) (“ASU 2016-08”). The amendments address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The ASU clarifies that an entity should evaluate whether it is the principal or the agent for each specified good or service promised in a contract with a customer. The amendments affect the guidance in ASU 2014-09 which is not yet effective. The effective date and transition requirements for the amendments in this ASU are the same as the effective date and transition of ASU 2014-09, which will be 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 its consolidated financial statements.

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

6


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 No. 2016-09 is effective on January 1, 2017, with early adoption permitted. The transition method varies for each of the areas in the ASU. The Company is currently evaluating the impact of adopting this new accounting standard on its results of operations and financial position.
In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing, which clarifies the guidance in ASU 2014-09 regarding assessing whether promises to transfer goods or services are distinct, and whether an entity's promise to grant a license provides a customer with a right to use or right to access the entity's intellectual property. The effective date and transition requirements for the amendments in this ASU are the same as the effective date and transition of ASU 2014-09, which will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its consolidated financial statements.
In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients (“ASU 2016-12”). This Update provides for amendments to ASU 2014-09, amending the guidance on transition, collectability, noncash consideration and the presentation of sales and other similar taxes. Specifically, ASU 2016-12 clarifies that, for a contract to be considered completed at transition, all (or substantially all) of the revenue must have been recognized under legacy GAAP. In addition, ASU 2016-12 clarifies how an entity should evaluate the collectability threshold and when an entity can recognize nonrefundable consideration received as revenue if an arrangement does not meet the standard’s contract criteria. The effective date and transition requirements for the amendments in this ASU are the same as the effective date and transition of ASU 2014-09, which will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its consolidated financial statements.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 provides guidance on how certain cash receipts and cash payments are to be presented and classified in the statement of cash flows. For public entities, ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the potential impact of adopting this guidance on our consolidated financial statements.


7


NOTE 3 – SUPPLEMENTAL CASH FLOWS
The supplemental cash flows information for the nine months ended September 30, 2016 and 2015 are comprised of the following (in thousands):
 
Nine Months Ended September 30,
 
2016
 
2015
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
 Cash paid for interest
$
2,052

 
$
1,129

 Cash paid for taxes
$
2,279

 
$
633

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
     Non-cash acquisition of property and equipment
$


$
15,345

     Non-cash acquisition of goodwill and intangibles
$


$
13,532

 Non-cash deconsolidation of property and equipment
$

 
$
2,828

 Non-cash deconsolidation of goodwill
$

 
$
701

     Athas settlement in lieu of contingent shares
$


$
5,685

NOTE 4 – ACQUISITIONS
Scottsdale Liberty Hospital (SLH)
In November 2015, the Company acquired a 60% interest in Freedom Pain Hospital (n/k/a SLH) located in Scottsdale, Arizona. The Company acquired management control of the entity which was formed to own and operate the successor hospital. The transaction was treated as a business combination.


8


The following table summarizes the fair values of the identifiable assets acquired and liabilities assumed at the date of acquisition (in thousands):
 
November 1, 2015
 
 
Net assets acquired:
 
 Trade accounts receivable
$
82

 Prepaid expenses and other current assets
36

 Inventory
69

 Property and equipment
13,266

 Other long-term assets
113

 Goodwill
6,932

 Tradename
160

 Hospital license
12

Net assets acquired
$
20,670

 
 
Net liabilities assumed:
 
 Trade accounts payable
$
2,668

 Accrued liabilities
419

 Current portion of capital leases
658

 Long-term portion of capital leases
12,213

Total liabilities assumed
$
15,958

 
 
Consideration:
 
 Cash, net of cash acquired
$
3,180

 Noncontrolling Interest
1,532

Total consideration
$
4,712

Unaudited Supplemental Pro Forma Information
The following unaudited supplemental pro forma financial information includes the results of operations for SLH, and is presented as if the acquired company had been consolidated as of the beginning of the year immediately preceding the year in which the company was acquired. 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.
There were no acquisitions during the period ended September 30, 2016, thus the consolidated financial statements for the period include full financial results of all consolidated subsidiaries. The following table shows our pro forma results for the nine months ended September 30, 2015 (in thousands, except per share amounts):
 
September 30, 2015
 
 
Revenue
$
139,774

Income from operations
$
8,225

Net income attributable to noncontrolling interests
$
10,360

Net income attributable to common stockholders
$
6,282

Net income per basic common share
$
0.10



9



NOTE 5 – TRADE ACCOUNTS RECEIVABLE, NET
A detail of trade accounts receivable, net as of September 30, 2016 and December 31, 2015 is as follows (in thousands):
 
September 30, 2016
 
December 31, 2015
Trade accounts receivable
$
84,573

 
$
95,114

Allowance for doubtful accounts
(2,144
)
 
(5,165
)
Receivables transferred
(357
)
 
(298
)
Receivables purchased
4,098

 
2,918

   Trade accounts receivable, net
$
86,170

 
$
92,569

Bad debt expense was zero for the three and nine months ended September 30, 2016 and was $0.9 million and $1.1 million for the three and nine months ended September 30, 2015 respectively.
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, 2016 and December 31, 2015, there remained a balance of $0.4 million and $0.3 million, respectively, in transferred receivables pursuant to the terms of the original agreement. For the three months ended September 30, 2016 and 2015, the Company received advanced payments of $0.1 million and $0.3 million, respectively. During the same time period, the Company transferred $0.8 million and $1.4 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, 2016 and 2015, the Company received advanced payments of $0.6 million and $1.4 million, respectively. During the same time period, the Company transferred $4.9 million and $5.2 million of receivables, respectively. Concurrently, upon collection of these transferred receivables, payment will be made to the transferee.
Athas, Peak Neuromonitoring (“Peak”), and Nobilis Surgical Assist (“First Assist”) 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, Peak, and First Assist 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 and $3.2 million for the three months ended September 30, 2016 and 2015, respectively. Gross revenue from purchased receivables was $11.2 million and $8.3 million for the nine months ended September 30, 2016 and 2015, respectively. Revenue, net of the discounted purchase price, was $2.4 million and $1.8 million for the three months ended September 30, 2016 and 2015, respectively. Revenue, net of the discounted purchase price, was $5.9 million and $4.5 million for the nine months ended September 30, 2016 and 2015, respectively. Accounts receivable for purchased receivables was $4.1 million and $2.9 million for the nine months ended September 30, 2016 and year-ended December 31, 2015, respectively. Revenue from receivables purchased is recorded in the factoring revenue line item within the Consolidated Statements of Operations.
NOTE 6 – INVESTMENTS IN ASSOCIATES
During the first quarter of 2015, The Company completed the deconsolidation of two imaging centers and one urgent care clinic in Houston, which consisted of the following entities: Spring Northwest Management, LLC, Spring Northwest Operating, LLC, Willowbrook Imaging, LLC, GRIP Medical Diagnostics, LLC and KIRPA Holdings, LLC. The Company resigned as the manager of these facilities resulting in loss of control and its rights to exercise significant influence. The Company retained investments in these facilities that are accounted for as cost method investments beginning January 1, 2015. The carrying value as of September 30, 2016 and December 31, 2015 was $0.7 million. The investments are classified as other long-term assets in the Consolidated Balance Sheets.
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, 2016 was $0.5 million. The investment is classified as other long-term assets in the Consolidated Balance Sheets.

10



NOTE 7 – FINANCIAL INSTRUMENTS AND CONCENTRATION
In common with all other businesses, 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.
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.



11


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
 
2016
 
2015
 
2016
 
2015

 
 
 
 
 
 
 
 
Private insurance and other private pay
 
96.3
%
 
94.4
%
 
96.2
%
 
94.7
%
Workers compensation
 
3.4
%
 
5.1
%
 
3.4
%
 
4.8
%
Medicare
 
0.3
%
 
0.5
%
 
0.4
%
 
0.5
%
Total
 
100
%
 
100
%
 
100
%
 
100
%
MARKETING SEGMENT
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Payors
 
2016
 
2015
 
2016
 
2015

 
 
 
 
 
 
 
 
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
%
CONSOLIDATED SEGMENTS
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Payors
 
2016
 
2015
 
2016
 
2015

 
 
 
 
 
 
 
 
Private insurance and other private pay
 
96.8
%
 
95.1
%
 
96.7
%
 
95.2
%
Workers compensation
 
3.0
%
 
4.5
%
 
3.0
%
 
4.3
%
Medicare
 
0.2
%
 
0.4
%
 
0.3
%
 
0.5
%
Total
 
100
%
 
100
%
 
100
%
 
100
%
Three facilities represent approximately 75.1% and 83.0% of the Company’s contracted marketing revenue for the three and nine months ended September 30, 2016, and three facilities represent approximately 83.6% of the Company’s contracted marketing accounts receivable as of September 30, 2016.
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.
Foreign exchange risk
Foreign exchange risk arises because the Company has certain expenses that are incurred in Canadian dollars.

12


The Company is also exposed to currency risk on purchases made from vendors based in Canada. The Company has Canadian denominated cash (“Cdn”) of $0.2 million and a nominal amount of trade payables at September 30, 2016. The Company had Cdn of $0.3 million and a nominal amount of trade payables at December 31, 2015.
NOTE 8 – ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
The following table presents a summary of items comprising accrued expenses and other current liabilities in the accompanying Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015 (in thousands):
 
September 30, 2016
 
December 31, 2015
Accrued expenses:
 
 
 
Accrued salaries and related benefits
$
3,941

 
$
5,309

Other
16,720

 
11,339

Total accrued expenses
$
20,661

 
$
16,648

Other current liabilities:
 
 
 
Estimated amounts due to third party payors
$
6,348

 
$
3,795

Other
454

 
1,230

Total other current liabilities
$
6,802

 
$
5,025

NOTE 9 – OTHER LONG-TERM LIABILITIES
The Company assumed real property leases as part of certain acquisitions which required the Company to pay above market rentals through the remainder of the lease terms. Of the $3.5 million balance in other long-term liabilities at September 30, 2016, approximately $3.2 million of that balance 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, 2015, is $0.1 million for the remainder of 2016, $0.5 million for 2017 and $0.3 million for 2018, 2019, 2020, and $2.2 million thereafter.
NOTE 10 – LINES OF CREDIT
On March 31, 2015, the Company secured a $5.0 million revolving line of credit from Healthcare Financial Services, LLC (f/k/a General Electric Capital Corporation), or “HFS” (the “HFS Revolver”) maturing in March 2020, which was subsequently amended and increased to $11.6 million on August 19, 2016. The HFS Revolver bears interest at a rate of 4% plus LIBOR per annum (effective rate of 5.24% at September 30, 2016) and requires quarterly interest payments. Principal amounts borrowed under the HFS Revolver may be repaid and re-borrowed periodically. The HFS Revolver is collateralized in the same manner as the HFS term loan discussed in Note 11 - Debt. As of September 30, 2016 and December 31, 2015, $8.1 million and $3.0 million, respectively, were outstanding under the HFS Revolver.
The revolving line of credit is subject to certain restrictive covenants in conjunction with the HFS Term Loan, as defined in Note 11 - Debt.
On July 30, 2015, the Company issued a $1.5 million letter of credit to the Landlord of the PSH (“PSH Landlord”) facility in connection with the execution of the hospital facility lease. The PSH Landlord shall have the right to draw upon the letter of credit in an event of default. The letter of credit is secured by the $5.0 million HFS Revolver, which was subsequently amended and increased to $11.6 million on August 19, 2016.
On May 18, 2016, the Company secured a $3.0 million revolving line of credit from Legacy Texas Bank (the “Legacy Revolver”). The Legacy Revolver bears interest at a rate of 4% plus LIBOR per annum on drawn funds and requires monthly payments of interest. Monthly payments of principal commenced in September 2016. As of September 30, 2016, the outstanding balance was zero and the Legacy Revolver was extinguished using the increased borrowing capacity acquired through the Seventh Amendment to Credit Agreement ( the "Seventh Amendment") discussed in Note 11 - Debt.

13


NOTE 11 – DEBT
On March 31, 2015, the Company secured a $20.0 million term loan from HFS (the “HFS Term Loan”), which was subsequently amended and increased to $25.0 million on August 19, 2016. The HFS Term Loan bears interest at a rate of 4% plus LIBOR per annum (effective rate of 5.24% at September 30, 2016) and requires quarterly payments of principal and interest until it matures in March 2020. The HFS Term Loan provides for a 0.70% LIBOR floor. The HFS Term Loan is collateralized by the accounts receivable and physical equipment of all of the Company’s 100% owned subsidiaries as well as the Company’s ownership interest in all less than wholly owned subsidiaries.
The HFS Term Loan primarily served to refinance all previously held debt and lines of credit. Debt issuance costs associated with the new credit facility approximated $1.0 million. The issuance costs are a direct deduction from the carrying value of the HFS Term Loan, amortized using the interest method and reported as interest expense on our statement of operations. As of September 30, 2016, the outstanding balance of the HFS Term Loan was $24.7 million.
The Company entered into the Sixth Amendment to Credit Agreement (the "Sixth Amendment"), dated as of August 1, 2016, among Northstar Healthcare Acquisitions, L.L.C. ("NHA"), HFS and the credit parties named therein. The Sixth Amendment among other things, added a cap on Investments in Nobilis Health Anesthesia Network, PLLC of $2.0 million; increased the permitted indebtedness of the Company pursuant to that certain Loan Agreement, dated as of July 30, 2015, between PSH and Legacy Texas Bank from 7.0 to 7.05; modified the maximum leverage ratio as of March 31, 2016, to 3.05 to 1.00; and modified the definition of "Subsidiary" to exclude the following entities: Athelite, Dallas Metro, Marsh Lane Surgical Hospital, LLC, Nobilis Health Network, Inc. ("NHN") and the subsidiaries of NHN.
The Company entered into the Seventh Amendment, dated as of August 19, 2016, among HFS, other credit parties named therein and other financial institutions. The Seventh Amendment, among other things, increased total borrowing capacity to $36.6 million from $30.6 million. The increased borrowing capacity provided under the Seventh Amendment consisted of aggregate term and revolving loan commitments from HFS of $25 million and $11.6 million, respectively.
The Seventh Amendment includes material financial covenants, ratios and tests. The Company must maintain a Consolidated Leverage Ratio of not more than 2.00 to 1.00 and a Consolidated Fixed Charge Coverage Ratio of at least 3.00 to 1.00. Capital Lease Obligations allowed under the covenants increased from $3.0 million to $6.1 million and the HFS Term Loan's quarterly amortization payment increased under the Seventh Amendment from $250,000 to $312,500 per quarter.
The Company entered into the Eighth Amendment to Credit Agreement and Limited Waiver (the "Eighth Amendment"), dated as of October 20, 2016, by and among NHA, other credit parties named therein, HFS and other financial institutions. The purpose of the Amendment was to (i) modify the covenant regarding the Company’s holding company status to permit certain business activities thereunder (ii) define a new permitted lien and an applicable basket with regard to a lien filed by a Company vendor and (iii) amend the management fees covenant to permit payment of certain management fees under the Loan Agreement. As a result, the Company was in compliance with its covenants under the HFS Term Loan as of September 30, 2016.
On July 30, 2015, the Company secured a $4.5 million term loan from Legacy Texas Bank (the “Legacy Bank Term Loan”). The term loan bears interest at a rate of 4% plus LIBOR per annum and requires monthly payments of interest. Monthly payments of principal commenced in August 2016. The Legacy Bank Term Loan matures in July 2020 and is subordinated to the Company’s term loan and revolver with HFS. As of September 30, 2016, the outstanding balance was zero and the Legacy Bank Term Loan was extinguished using the increased borrowing capacity acquired through the Seventh Amendment.
Loan origination fees are deferred and the net amount is amortized over the contractual life of the related loans.
Debt at September 30, 2016 and December 31, 2015 consisted of the following (in thousands):
 
September 30, 2016
 
December 31, 2015
 
 
 
 
Gross debt
$
24,687

 
$
23,275

Less: unamortized loan fees
855

 
563

Debt, net of unamortized loan fees
23,832

 
22,712

Less: current portion of term loan, net of unamortized loan fees
1,006

 
1,243

Long-term debt, net of unamortized loan fees
$
22,826

 
$
21,469


14


NOTE 12 – 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, 2016 and 2015.
The following table summarizes our assets and liabilities measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015, 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, 2015:
 
 
 
 
 
 
 
Warrant and stock option derivative liabilities
$

 
$

 
$
2,951

 
$
2,951

Total
$

 
$

 
$
2,951

 
$
2,951

September 30, 2016:
 
 
 
 
 
 
 
Warrant and stock option derivative liabilities
$

 
$

 
$
1,917

 
$
1,917

Total
$

 
$

 
$
1,917

 
$
1,917

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. The estimated fair values of the warrant and stock option derivative liabilities were measured using the Black-Scholes valuation model (refer to Note 14 - Warrants and options liabilities). Due to the nature of valuation inputs, the valuation of the warrants is considered a Level 3 measurement.
NOTE 13 – SHARE BASED COMPENSATION
Restricted Share Units (“RSUs”)
The Company had no stock compensation expense relative to RSUs for both the three months ended September 30, 2016 and 2015. The Company recorded stock compensation expense relative to RSUs of nil and $5.4 million for the nine months ended September 30, 2016 and 2015, respectively. There were no grants during the three and nine months ended September 30, 2016 and 2015.
During the nine months ended September 30, 2015, two key executives experienced triggering events, as defined in their employee agreements, which accelerated all unrecognized stock compensation expense on their outstanding RSUs. As a result of this acceleration, the Company recognized $4.5 million of stock compensation expense during the nine months ended September 30, 2015.
The Company had no outstanding RSUs at September 30, 2016 and 2015.
Stock Options
The Company granted a total of 350,000 and 2,457,075 stock options during the three and nine months ended September 30, 2016, respectively. Of the options granted during the nine months ended September 30, 2016, 297,075 of those vest immediately and 2,160,000 vest ratably over a three-year period.
The Company granted a total of 3,166,782 stock options during the year ended December 31, 2015. Of the options granted during the year ended December 31, 2015, 451,782 of those vest immediately, 450,000 vest ratably over a one-year period, 1,865,000 vest ratably over a three-year period, and 400,000 cliff vest at the end of a five-year period.

15


The following table summarizes stock option activity for the nine months ended September 30, 2016 and 2015:
 
Shares Underlying
Options
 
Weighted-
Average Exercise
Price
 
Weighted-Average
Remaining Life
(years)
 
 
 
 
 
 
Outstanding at January 1, 2015
3,118,218

 
$
1.45

 
9.80

 Granted
2,601,782

 
$
5.50

 
9.78

 Exercised
(447,787
)
 
$
1.26

 

 Forfeited
(372,213
)
 
$
1.11

 

Outstanding at September 30, 2015
4,900,000

 
$
3.65

 
9.47

Exercisable at
 
 
 
 
 
Exercisable at September 30, 2015
1,408,461

 
$
2.54

 
9.47

Exercisable at
 
 
 
 
 
Outstanding at January 1, 2016
5,465,000

 
$
2.97

 
9.20

 Granted
2,457,075

 
$
2.14

 
9.40

 Exercised
(1,083,750
)
 
$
1.91

 

 Forfeited
(966,800
)
 
$
3.01

 

Outstanding at September 30, 2016
5,871,525

 
$
2.77

 
8.90

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

 
$
2.32

 
8.50

The above table includes 650,000 options issued to non-employees, all of which are still outstanding at September 30, 2016. Refer to Note 14 - Warrants and options liabilities for discussion regarding the classification of these options within the Consolidated Balance Sheet.
The total intrinsic value of stock options exercised was $1.3 million and $2.9 million during the nine months ended September 30, 2016 and 2015, respectively. The total intrinsic value for all in-the-money vested outstanding stock options at September 30, 2016 was $1.8 million. Assuming all stock options outstanding at September 30, 2016 were vested, the total intrinsic value of in-the-money outstanding stock options would have been $4.2 million at September 30, 2016.
The Company recorded total stock compensation expense relative to employee stock options of $1.6 million and $1.3 million for the three months ended September 30, 2016 and 2015, respectively, and $5.0 million and $4.3 million for the nine months ended September 30, 2016 and 2015, 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, 2016 and 2015.
 
Nine Months Ended September 30,
 
2016
 
2015
 
 
 
 
Expected price volatility
114% - 117%

 
113% - 122%

Risk free interest rate
1.03% - 1.53%

 
1.34% - 1.87%

Expected annual dividend yield
0
%
 
0
%
Expected option term (years)
5 - 6

 
5 - 6

Expected forfeiture rate
0.5% - 11.6%

 
1.3% - 8.8%

Grant date fair value per share
$1.73 - $2.41

 
$2.97 - $6.31

Grant date exercise price per share
$1.99 - $2.82

 
$2.53 - $6.10

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.

16


NOTE 14 – 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,
 
2016
 
2015
 
 
 
 
Risk free interest rate
0.26% - 0.59%

 
0.11% - 0.64%

Expected life in years
0.25 - 1.15

 
0.25 - 2.0

Expected volatility
76% - 112%

 
71% - 89%

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, 2016 and 2015 were as follows (in thousands):
 
2016
 
2015
 
 
 
 
Balance at beginning of year
$
2,109

 
$
6,657

Issuance of warrants and options

 
12,797

Transferred to equity upon exercise

 
(8,882
)
Change in fair value recorded in earnings
(1,729
)
 
(4,742
)
Balance as of September 30, 2016 and 2015
$
380

 
$
5,830

The following warrants and options were outstanding at September 30, 2016:
 
Exercise price in Cdn$
 
Number of warrants and
options
 
Remaining contractual
life (years)
 
 
 
 
 
 
2015 Warrants
$
11.50

 
3,923,834

 
0.90
2015 Options
$
9.00

 
392,383

 
0.90
Outstanding and Exercisable as of September 30, 2016
 
 
4,316,217

 
 
As of September 30, 2016, there were no warrants or options outstanding from the 2014 issuances.
Options Issued to Non-Employees
As discussed in Note 13 - Share based compensation, in 2014 the Company issued 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, 2016, there were 650,000 options outstanding to these non-employees.
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.

17


The estimated values of the option awards are determined using the Black Scholes pricing model with the following inputs:
 
Nine Months Ended September 30,
 
2016
 
2015
 
 
 
 
Risk free interest rate
1.01% - 1.14%

 
1.37% - 1.56%

Expected life in years
4 - 5

 
5 - 6

Expected volatility
103% - 114%

 
113% - 115%

Expected dividend yield
0
%
 
0
%
For the three month periods ended September 30, 2016 and 2015, the Company recorded expense for non-employee stock options of $0.1 million and $0.2 million, respectively. For the nine months ended September 30, 2016 and 2015, the Company recorded expense for non-employee stock options of $0.2 million and $2.8 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, 2016 and 2015 were as follows (in thousands):
 
 
2016
 
2015
Balance at beginning of year
 
$
841

 
$

Vested during the period
 
533

 
1,531

Change in fair value recorded in earnings
 
163

 
65

Balance as of September 30, 2016 and 2015
 
$
1,537

 
$
1,596

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, 2016, there were 0.6 million unexercised non-employee options requiring liability classification.


18


NOTE 15 – 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,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
Net (loss) income attributable to Nobilis Health Corp.
$
(2,759
)
 
$
10,943

 
$
(2,918
)
 
$
6,038

Weighted average common shares outstanding
76,774,967

 
70,935,587

 
76,114,538

 
65,310,610

Net (loss) income per common share
$
(0.04
)
 
$
0.15

 
$
(0.04
)
 
$
0.09

 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
Net (loss) income attributable to Nobilis Health Corp.
$
(2,759
)
 
$
10,943

 
$
(2,918
)
 
$
6,038

Weighted average common shares outstanding
76,774,967

 
70,935,587

 
76,114,538

 
65,310,610

Dilutive effect of stock options, warrants, RSUs

 
6,720,676

 

 
6,720,676

Athas share consideration

 

 

 
3,036,337

Weighted average common shares outstanding assuming dilution
76,774,967

 
77,656,263

 
76,114,538

 
75,067,623

Net (loss) income per fully diluted share
$
(0.04
)
 
$
0.14

 
$
(0.04
)
 
$
0.08


19


NOTE 16 – NONCONTROLLING INTERESTS
Noncontrolling interests at September 30, 2016 and December 31, 2015 represent an 8.1% interest in The Palladium for Surgery - Houston, Ltd, 75% interest in the Medical Ambulatory Suites, L.P., 65% interest in Microsurgery Institute, LLC., 2.3% interest in Houston Microsurgery Institute, LLC., 50% in Northstar Healthcare Dallas Management, LLC., 65% in NHC ASC – Dallas, LLC., 49% in First Nobilis, LLC., 40% in First Nobilis Hospital Management, LLC., 45% in Hermann Drive Surgical Hospital, LP., and 40% in Perimeter Road Surgical Hospital, LLC.
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, 2016 and December 31, 2015. 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):
 
NHC - ASC Dallas
 
First Nobilis
 
Total
 
 
 
 
 
 
Balance at January 1, 2015
$
6,654

 
$
6,213

 
$
12,867

Distributions
(3,892
)
 
(7,617
)
 
(11,509
)
Net income attributable to noncontrolling interests
631

 
10,236

 
10,867

Total contingently redeemable noncontrolling interests at December 31, 2015
$
3,393

 
$
8,832

 
$
12,225

 
 
 
 
 
 
Balance at January 1, 2016
$
3,393

 
$
8,832

 
$
12,225

Distributions
(2,929
)
 
(600
)
 
(3,529
)
Net (loss) income attributable to noncontrolling interests
(210
)
 
2,081

 
1,871

Total contingently redeemable noncontrolling interests at September 30, 2016
$
254

 
$
10,313

 
$
10,567

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.








20


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, 2016
 
December 31, 2015
 
 
 
 
Total cash and short term investments
$
1,071

 
$
191

Total accounts receivable
8,638

 
8,660

Total other current assets
1,768

 
1,582

Total property and equipment
17,547

 
5,227

Total other assets
165

 
144

Total assets
$
29,189

 
$
15,804

 
 
 
 
Total accounts payable
$
3,847

 
$
2,286

Total other liabilities
5,924

 
7,059

Total accrued liabilities
4,242

 
2,664

Long term - capital lease
11,543

 
780

Noncontrolling interest
(8,547
)
 
(1,488
)
Total liabilities
$
17,009

 
$
11,301


21


NOTE 17 – 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 32.5% for U.S. and none for Canada based on projected results for the year and applies this rate to income before taxes to calculate income tax expense. The following items caused the third quarter effective income tax rate to be significantly different from the statutory rate:
Canada is excluded from the worldwide annual effective tax rate calculation because Canada has losses but does not expect to realize them, which reduces the third quarter effective tax rate by approximately 3.8% for the nine months ended September 30, 2016.
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 reduces the third quarter effective tax rate by approximately 4.5% for the nine months ended September 30, 2016.
The Company adjusted the prior year tax provision. The adjustment to the existing deferred tax assets and liabilities decreases the third quarter effective tax rate by approximately 1.6% for the nine months ended September 30, 2016.
The third quarter effective tax rate includes a discrete item for the stock compensation shortfall, which reduces the effective tax rate by approximately 3.8% for the nine months ended September 30, 2016.
The net tax for the three and nine months ended September 30, 2016 was $0.5 million expense and $1.7 million benefit, respectively, resulting in an effective tax rate of approximately -29.3% and 21.1% respectively. The net tax includes $0.3 million and $0.8 million of state tax expense, respectively. The Company did not recognize any federal or foreign tax expense or benefit for the three and nine months ended September 30, 2015 as the Company had a full valuation allowance against deferred tax assets at that time. The state tax expense for the three and nine months ended September 30, 2015 was $0.3 million and $0.9 million, respectively.
On April 22, 2016, the Company received notification from the Internal Revenue Service to examine our December 31, 2014 and 2013 Federal income tax return. Based on management tax analysis, the Company did not have any uncertain tax positions as of September 30, 2016.

22


NOTE 18 – BUSINESS SEGMENT INFORMATION
A summary of the business segment information for the three months ended September 30, 2016 and 2015 is as follows (in thousands):
 
Three months ended September 30, 2016
 
Medical
Services
 
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


 
Three months ended September 30, 2015
 
Medical
Services
 
Marketing
 
Corporate
 
Total
 
 
 
 
 
 
 
 
Revenues
$
46,150

 
$
6,333

 
$

 
$
52,483

Operating expenses
36,466

 
5,670

 

 
42,136

Corporate costs

 

 
7,296

 
7,296

Income (loss) from operations
9,684

 
663

 
(7,296
)
 
3,051

Change in fair value of warrant and option liabilities

 

 
(6,381
)
 
(6,381
)
Interest expense (income)
169

 
(15
)
 
168

 
322

Bargain purchase
(4,358
)
 

 

 
(4,358
)
Other expense (income)
1,583

 
(205
)
 
(1,484
)
 
(106
)
Income before income taxes
$
12,290

 
$
883

 
$
401

 
$
13,574

 
 
 
 
 
 
 
 
Other data:
 
 
 
 
 
 
 
Depreciation and amortization expense
$
1,178

 
$
344

 
$
43

 
$
1,565

Income tax expense
$
176

 
$
80

 
$

 
$
256

Capital expenditures
$
1,041

 
$

 
$

 
$
1,041

Non-cash acquisition of property
$
10,485

 
$

 
$

 
$
10,485

Non-cash acquisition of intangibles and goodwill
$
1,534

 
$

 
$

 
$
1,534


23


A summary of the business segment information for the nine months ended September 30, 2016 and 2015 is as follows (in thousands):
 
Nine months ended September 30, 2016
 
Medical
Services
 
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
)
     Capital expenditures
$
4,000

 
$

 
$
388

 
$
4,388

     Intangible assets
$
5,246

 
$
13,022

 
$

 
$
18,268

     Goodwill
$
25,822

 
$
19,011

 
$

 
$
44,833

     Total assets
$
175,279

 
$
44,413

 
$
21,291

 
$
240,983

     Total liabilities
$
55,602

 
$
6,928

 
$
38,237

 
$
100,767



24


 
Nine months ended September 30, 2015
 
Medical
Services
 
Marketing
 
Corporate
 
Total
 
 
 
 
 
 
 
 
Revenues
$
123,638

 
$
15,563

 
$

 
$
139,201

Operating expenses
94,589

 
13,471

 

 
108,060

Corporate costs

 

 
23,071

 
23,071

Income (loss) from operations
29,049

 
2,092

 
(23,071
)
 
8,070

Change in fair value of warrant and option liabilities

 

 
(4,677
)
 
(4,677
)
Interest expense
169

 
65

 
872

 
1,106

Bargain purchase
(4,358
)
 



 
(4,358
)
Other expense (income)
1,383

 
(446
)
 
(2,455
)
 
(1,518
)
Income (loss) before income taxes
$
31,855

 
$
2,473

 
$
(16,811
)
 
$
17,517

 
 
 
 
 
 
 
 
Other data:
 
 
 
 
 
 
 
     Depreciation and amortization expense
$
2,079

 
$
1,035

 
$
99

 
$
3,213

     Income tax expense
$
703

 
$
159

 
$

 
$
862

     Capital expenditures
$
2,406

 
$
127

 
$

 
$
2,533

     Intangible assets
$
5,734

 
$
14,172

 
$

 
$
19,906

     Goodwill
$
14,163

 
$
19,011

 
$

 
$
33,174

     Non-cash acquisition of property
$
15,345

 
$

 
$

 
$
15,345

     Non-cash acquisition of intangibles and goodwill
$
13,532

 
$

 
$

 
$
13,532

     Total assets
$
103,836

 
$
43,528

 
$
18,158

 
$
165,522

     Total liabilities
$
38,360

 
$
3,909

 
$
22,831

 
$
65,100


25


NOTE 19 – RELATED PARTY TRANSACTIONS
The minority interest holder of First Nobilis Hospital, a fully consolidated entity, is also a partial owner of First Street Hospital, L.P. and First Street Surgical Center, L.P., both of which have an ongoing business relationship with the Company. At September 30, 2016, the Company has a net amount due from these related parties of $1.4 million. In addition, the Company leases certain medical equipment and facility space from these related parties. Equipment lease costs of approximately $0.5 million and $0.6 million were incurred during the quarter ended September 30, 2016 and 2015, respectively. Facility lease costs of approximately $0.4 million were incurred during both the three months ended September 30, 2016 and 2015. Equipment lease costs of approximately $1.6 million and $1.7 million were incurred during the nine months ended September 30, 2016 and 2015, respectively. Facility lease costs of approximately $1.3 million were incurred during both the nine months ended September 30, 2016 and 2015, respectively.
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 6 - Investments in associates). At September 30, 2016, the Company had $3.6 million in accounts receivable from the HOPD and $0.9 million in accounts receivable from Dallas Metro. The Company also rents, on a monthly basis, certain medical equipment to Dallas Metro and subleases operation facility to Benton Transitional.
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 October 2014 the Company entered into a marketing services agreement with an entity controlled by a physician equity owner. In June 2015, the Company expanded the relationship with this physician equity owner to include consulting, medical supplies, medical directorship and on-call agreements. The Company incurred expenses of $2.5 million and $2.5 million as of September 30, 2016 and 2015, respectively. The Company has incurred expenses of $1.9 million and $0.2 million in fees owed pursuant to the service agreements as of September 30, 2016 and 2015, 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 $1.0 million and $0.3 million as of September 30, 2016 and 2015, respectively.
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 $3.9 million and $2.4 million as of September 30, 2016 and 2015, respectively.

26


NOTE 20 – 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. 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.
Shareholder Lawsuits
After the Company announced it would be restating its 2014 annual financial statements and 2015 first and second quarter interim financial statements, one complaint, Schott v. Nobilis Health Corp. et al, was filed in the United States District Court for the Southern District of Texas against the Company, our former chief executive officer and our current chief financial officer. The complaint sought class action status on behalf of our shareholders and alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 arising out of the restatement. The defendants vigorously defended against these claims and filed motions to dismiss the consolidated complaint for failure to plead particularized facts supporting a strong inference of scienter on the part of the individual defendants.On June 1, 2016 the court heard oral arguments on the Company’s pending motion to dismiss which the court later granted on September 29, 2016. The court ultimately dismissed the case with prejudice on October 24, 2016.
In addition, 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 C$80 million plus interest. The defendants intend to vigorously defend against these claims. At this time the Company believes the likelihood of loss, if any, is remote.

27


NOTE 21 – SUBSEQUENT EVENTS
The Company entered into the Eighth Amendment on October 20, 2016, by and among NHA, other credit parties named therein, HFS and other financial institutions. The purpose of the Amendment was to (i) modify the covenant regarding the Company’s holding company status to permit certain business activities thereunder (ii) define a new permitted lien and an applicable basket with regard to a lien filed by a Company vendor and (iii) amend the management fees covenant to permit payment of certain management fees under the Loan Agreement. As a result, the Company was in compliance with its covenants under the HFS Term Loan as of September 30, 2016.
On October 28, 2016, the Company entered into an $82.5 million credit agreement (the “Compass Bank Loans”) with Compass Bank.  The credit agreement includes a $52.5 million term loan and a $30.0 million revolving credit facility.  The proceeds will be used to refinance all previously held debt and lines of credit and for the acquisition of Arizona Vein and Vascular Centers.  As of September 30, 2016, the outstanding balance of the HFS Term Loan and Revolver was $24.7 million and $8.1 million, respectively.  The Compass Bank loans are collateralized by the accounts receivable and physical equipment of all of the Company’s 100% owned subsidiaries as well as the Company’s ownership interest in all less than wholly owned subsidiaries.  The Compass Bank Loans require the Company to maintain a consolidated leverage ratio of 2.75 to 1.00 through September 30, 2018, 2.50 to 1.00 for December 31, 2018 to September 30, 2019, 2.25 to 1.00 for December 31, 2019 to September 30, 2020 and 2.00 to 1.00 through December 31, 2020; and a consolidated fixed charge coverage ratio of 2.00 to 1.00.  

The Compass Bank Loans bear interest from the closing date to the first business day immediately following the date on which Compass Bank receives a compliance certificate from the Company for the fiscal quarter ending March 31, 2017; 2.75% per annum for base rate loans, 3.75% per annum for Eurodollar Rate Loans, 3.75% for line of credit fees, and 0.500% per annum for the commitment fee.  Thereafter, the Compass Bank Loans bear interest based on the Company’s consolidated leverage ratio as follows:  (i) Less than 1.00 to 1.00; base rate margin 2.00%, LIBOR margin 3.00%, commitment fee rate 0.375%, (ii) Less than 1.75 to 1.00 but greater than or equal to 1.00 to 1.00; base rate margin 2.25%, LIBOR margin 3.25%, commitment fee rate 0.375%, (iii) Less than 2.50 to 1.00 but greater than or equal to 1.75 to 1.00; base rate margin 2.50%, LIBOR margin 3.50%, commitment fee rate 0.450%, (iv) Greater than or equal to 2.50 to 1.00; base rate margin 2.75%, LIBOR margin 3.75%, commitment fee rate 0.500%

The Compass Bank term loan requires quarterly payments of Principal as follows: (i) March 31, 2017 to December 31, 2018 of $0.7 million, (ii) March 31, 2019 to December 31, 2020 of $1.3 million, (iii) March 31, 2021 to September 30, 2021 of $2.0 million, (iv) October 28, 2021, the remaining principal balance of the term.   The Compass Bank Loans mature on October 28, 2021.

In connection with the funding of the Compass Bank Loans, the Company also completed the acquisition of the operating assets of Arizona Center for Minimally Invasive Surgery, LLC, an Arizona limited liability company (“ACMIS”), L. Philipp Wall, M.D., P.C., an Arizona professional corporation (“PC”), Arizona Vein & Vascular Center, LLC, an Arizona limited liability company and wholly owned subsidiary of PC, (“AVVC” and with ACMIS and PC, each a “Seller” and collectively “Sellers”), and L. Philipp Wall (“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 Purchase Agreement”) dated as of October 28, 2016.

Buyer received substantially all of the operating assets of Sellers in exchange for an aggregate purchase price of approximately $22.0 million, consisting of $17.0 million in cash (subject to a holdback described below), $2.5 million of NHC’s common shares, and $2.50 million the form of a convertible promissory note (“Convertible Promissory Note”) between Buyer and ACMIS.

In addition, the Sellers may receive an additional earnout payment based on the growth in trailing twelve month EBITDA of the new vascular division on the twelve-month anniversary of closing (as compared to the trailing twelve month EBITDA for the twelve months prior to closing). The earnout payment shall be equal to fifty percent (50%) of such growth.

As part of the Amended and Restated Purchase Agreement, $1.05 million of the cash purchase price was held back and is subject to the Amended and Restated Purchase Agreement’s indemnification provisions. On the twelve-month anniversary of closing, fifty percent (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.




28


The common shares issued to Owner at closing were issued at a price per share based on the NYSE MKT closing price of NHC’s common shares on the day prior to closing. The common shares are restricted under Rule 144 of the Securities Act of 1933, as amended, and are subject to additional contractual lock-up provisions, which lift in one-quarter increments on the twelve-month, fifteen-month, eighteen-month and twenty-first month anniversaries of closing.

On October 31, 2016, the Company increased its ownership interest in SLH from 60% to 75%.  Pursuant to a subscription agreement, the Company was the only member to participate in the capital raise and acquired an additional 60 Class C Units.




29


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, including the impact of material weaknesses identified by management and our ability to remediate such control deficiencies;
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 2015 Annual Report filed with the SEC on March 15, 2016.
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 2015 Annual Report.

30


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/or manages outpatient surgery centers and surgical hospitals. It focuses on improving patient outcomes by providing minimally invasive procedures that can be performed in low-cost, outpatient settings. Our business also utilizes innovative direct-to-patient 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 business line, which is a separate reportable business segment.
Medical Segment
Our Medical Segment broadly includes our ownership and operation of healthcare facilities (the “Nobilis Facilities”) (which include outpatient surgery centers and hospitals) and ancillary service providers (“Nobilis Ancillary Service Lines”).
There are nine Nobilis Facilities, consisting of four hospitals (three in Texas and one in Arizona) and five ambulatory surgery centers (three in Houston, Texas, one in Dallas, Texas and one in Scottsdale, Arizona). 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. These clinical specialties include orthopedic surgery, podiatric surgery, 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, allowing the Nobilis ASCs to operate with lower operating expenses. The Nobilis Hospitals do offer the services typically found in traditional hospitals and, as a result, have ability to take on more complex cases and cases that may require an overnight stay.
There are three Nobilis Ancillary Service Lines: intraoperative monitoring, surgical assist and anesthesia. Peak Neuromonitoring, a wholly owned subsidiary, oversees our intraoperative monitoring service line, and Nobilis Surgical Assist oversees our surgical assist service line. There are several small subsidiaries through which we provide anesthesia services. In the third quarter of 2016, we added laboratory services.
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, 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; and
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.
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

31


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 of those practices through accounts receivable purchase agreements.
Recent Developments
Compass Bank Loans

On October 28, 2016, the Company entered into a $82.5 million credit agreement (the “Compass Bank Loans”) with Compass Bank.  The credit agreement includes a $52.5 million term loan and a $30.0 million revolving credit facility.  The proceeds will be used to refinance all previously held debt and lines of credit and for the acquisition of Arizona Vein and Vascular Centers.  As of September 30, 2016, the outstanding balance of the HFS Term Loan and Revolver was $24.7 million and $8.1 million, respectively.  The Compass Bank loans are collateralized by the accounts receivable and physical equipment of all of the Company’s 100% owned subsidiaries as well as the Company’s ownership interest in all less than wholly owned subsidiaries.  The Compass Bank Loans require the Company to maintain a consolidated leverage ratio of 2.75 to 1.00 through September 30, 2018, 2.50 to 1.00 for December 31, 2018 to September 30, 2019, 2.25 to 1.00 for December 31, 2019 to September 30, 2020 and 2.00 to 1.00 through December 31, 2020; and a consolidated fixed charge coverage ratio of 2.00 to 1.00.  

The Compass Bank Loans bear interest from the closing date to the first business day immediately following the date on which Compass Bank receives a compliance certificate from the Company for the fiscal quarter ending March 31, 2017; 2.75% per annum for base rate loans, 3.75% per annum for Eurodollar Rate Loans, 3.75% for line of credit fees, and 0.500% per annum for the commitment fee.  Thereafter, the Compass Bank Loans bear interest based on the Company’s consolidated leverage ratio as follows:  (i) Less than 1.00 to 1.00; base rate margin 2.00%, LIBOR margin 3.00%, commitment fee rate 0.375%, (ii) Less than 1.75 to 1.00 but greater than or equal to 1.00 to 1.00; base rate margin 2.25%, LIBOR margin 3.25%, commitment fee rate 0.375%, (iii) Less than 2.50 to 1.00 but greater than or equal to 1.75 to 1.00; base rate margin 2.50%, LIBOR margin 3.50%, commitment fee rate 0.450%, (iv) Greater than or equal to 2.50 to 1.00; base rate margin 2.75%, LIBOR margin 3.75%, commitment fee rate 0.500%. 

The Compass Bank term loan requires quarterly payments of Principal as follows: (i) March 31, 2017 to December 31, 2018 of $0.7 million, (ii) March 31, 2019 to December 31, 2020 of $1.3 million, (iii) March 31, 2021 to September 30, 2021 of $2.0 million, (iv) October 28, 2016, the remaining principal balance of the term.   The Compass Bank Loans mature on October 28, 2021.

Acquisition of Arizona Vein and Vascular

In connection with the funding of the Compass Bank Loans, the Company also completed the acquisition of the operating assets of Arizona Center for Minimally Invasive Surgery, LLC, an Arizona limited liability company (“ACMIS”), L. Philipp Wall, M.D., P.C., an Arizona professional corporation (“PC”), Arizona Vein & Vascular Center, LLC, an Arizona limited liability company and wholly owned subsidiary of PC, (“AVVC” and with ACMIS and PC, each a “Seller” and collectively “Sellers”), and L. Philipp Wall (“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 Purchase Agreement”) dated as of October 28, 2016.

Buyer received substantially all of the operating assets of Sellers in exchange for an aggregate purchase price of approximately $22 million, consisting of $17 million in cash (subject to a holdback described below), $2.5 million of the Company's common shares, and $2.5 million the form of a convertible promissory note (“Convertible Promissory Note”) between Buyer and ACMIS.

In addition, the Sellers may receive an additional earnout payment based on the growth in trailing twelve month EBITDA of the new vascular division on the twelve-month anniversary of closing (as compared to the trailing twelve month EBITDA for the twelve months prior to closing). The earnout payment shall be equal to fifty percent (50%) of such growth.

As part of the Amended and Restated Purchase Agreement, $1.05 million of the cash purchase price was held back and is subject to the Amended and Restated Purchase Agreement’s indemnification provisions. On the twelve-month anniversary of closing, fifty percent (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.


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The common shares issued to Owner at closing were issued at a price per share based on the NYSE MKT closing price of our common shares on the day prior to closing. The common shares are restricted under Rule 144 of the Securities Act of 1933, as amended, and are subject to additional contractual lock-up provisions, which lift in one-quarter increments on the twelve-month, fifteen-month, eighteen-month and twenty-first month anniversaries of closing.
See Part I, Item 1-“Financial Statements, Note 21 - Subsequent events” of this Quarterly Report for more information on the Compass Bank Loans and the Transaction.
We recently partnered with a group purchasing organization (GPO) who maintains over $28.5 billion purchasing power and provides us access to the highest quality of products and industry leading contract pricing from suppliers.  The GPO will partner with us to drive best operating and clinical practices, and accelerate cost savings across the Nobilis Facilities. The agreement contemplates immediate contract value from the GPO's committed portfolio as well as access to clinical and sourcing experts that will be closely integrated with the our service lines, operations and supply chain leadership.
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, surgical ASCs and hospitals 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 and nine months ended September 30, 2016 and 2015, we derived approximately 0.2% and 0.3% for the respective periods 2016, and 0.4% and 0.5% for 2015 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. 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 coinsurance 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.

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Three Months Ended September 30, 2016 and 2015
 
Three Months Ended September 30,
 
2016

2015
Revenues:
 
 
 
   Patient and net professional fees
$
65,666

 
$
46,237

   Contracted marketing revenues
2,604

 
4,410

   Factoring revenues
2,413

 
1,836

         Total revenues
70,683

 
52,483

Operating expenses:
 
 
 
   Salaries and benefits
13,209

 
10,255

   Drugs and supplies
15,473

 
8,405

   General and administrative
33,195

 
21,025

   Bad debt expense

 
929

   Depreciation and amortization
1,952

 
1,522

         Facility operating expenses
63,829

 
42,136

Corporate expenses:
 
 
 
   Salaries and benefits
1,765

 
1,540

   General and administrative
4,576

 
5,192

   Legal expenses
1,535

 
521

   Depreciation
79

 
43

         Total corporate costs
7,955

 
7,296

         (Loss) income from operations
(1,101
)
 
3,051

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

 
(6,381
)
   Interest expense
744

 
322

   Bargain purchase gain

 
(4,358
)
   Other income, net
(198
)
 
(106
)
         Total other expense (income)
679

 
(10,523
)
(Loss) income before income taxes and noncontrolling interests
(1,780
)
 
13,574

Income tax expense
483

 
256

         Net (loss) income
$
(2,263
)
 
$
13,318

Revenues
Total revenues for the three months ended September 30, 2016, totaled $70.7 million, an increase of $18.2 million or 34.7%, compared to $52.5 million in the prior corresponding period. Total cases increased 679 or 15.4% versus the prior corresponding period. Medical Segment revenues increased by $19.2 million to $65.4 million, or 41.7% compared to $46.2 million from the prior corresponding period, while the Marketing Segment offset this increase by $1.0 million.
Salaries and Benefits
Operating salaries and benefits for the three months ended September 30, 2016, totaled $13.2 million, an increase of $3.0 million, or 28.8%, compared to $10.3 million in the prior corresponding period. The Medical Segment increased by $2.4 million, or 29.4%, and the Marketing Segment increased $0.5 million period over period.
Drugs and Supplies
Drugs and supplies expense for the three months ended September 30, 2016, totaled $15.5 million, an increase of $7.1 million or 84.1% compared to $8.4 million in the prior corresponding period. The Medical Segment increased by $6.8 million or 83.7%, while the Marketing Segment increased $0.3 million period over period.
General and Administrative
Operating general and administrative expense for three months ended September 30, 2016, totaled $33.2 million, an increase of $12.2 million, or 57.9%, compared to $21.0 million in the prior corresponding period. The Medical Segment accounted for $16.2 million of the increase, offset by a decrease of $4.0 million in the Marketing Segment.

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Depreciation and Amortization
Depreciation for the three months ended September 30, 2016, totaled $2.0 million, an increase of $0.5 million or 34.8%, compared to $1.5 million the prior corresponding period. This increase is primarily due to an increase in property and equipment acquired through our purchase of three hospitals.
Total Corporate Costs
To illustrate our operational efficiency, corporate costs are presented separate of operating expenses of the revenue generating facilities. Corporate costs totaled $8.0 million, an increase of $0.7 million or 9.0%, compared to $7.3 million in the prior corresponding period. Salaries and benefits for the three months ended September 30, 2016, totaled $1.8 million, an increase of $0.2 million or 14.6%, compared to $1.5 million from the prior corresponding period. The $0.2 million increase is due to the hiring of additional corporate staff in 2016 related to accounting, finance and information technology. Legal expenses for the three months ended September 30, 2016, totaled $1.5 million, an increase of $1.0 million or 194.6%, compared to $0.5 in from the prior corresponding period. The increase in legal expenses was attributable to litigation expenses. General and administrative expenses for the three months ended September 30, 2016, totaled $4.6 million, a decrease of $0.6 million or 11.9%, compared to $5.2 million in the prior corresponding period. The decrease in general and administrative expense was primarily attributable to a decline in non-cash compensation expense for the three months ended September 30, 2016.
Other Expense (Income)
For the three months ended September 30, 2016, the Company recognized $0.7 million of other expense compared to $10.5 million of other income. The change primarily related to a change in warrant and stock option derivative liability of $6.5 million. 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 and therefore recorded as derivative liabilities. Change in fair value of warrant and stock option derivative liabilities are a result of adjusting the estimated fair value at the end of the period, using the Black-Scholes Model.
There was a change of $4.4 million bargain purchase gain in the prior period related the acquisition of one of our facilities.
Lastly, interest expense increased $0.4 million as a result of average increase in borrowings and amortization of debt issuance costs.
Income tax expense
The net tax expense for the three months ended September 30, 2016 was $0.5 million, compared to $0.3 million from the prior corresponding period. The temporary differences attributable to the projected taxable income include goodwill amortization, net operating loss carryforward-U.S. and other accrued liabilities. For the three months ended September 30, 2016, the effective tax rate differs from the annual tax rate primarily due to equity compensation, return to provision true-ups, Canada's loss that we do not expect to realize, and noncontrolling interests. The Company’s state tax expense was $0.3 million for the three months ended September 30, 2016. Our effective tax rate during the three months ended September 30, 2016 was approximately -29.3%. The Company estimates an annual effective income tax rate of 32.5% for U.S., and none for Canada, based on projected results for the year.
Noncontrolling Interests
Net income attributable to noncontrolling interests are based on ownership percentages in the Nobilis Facilities that are owned by third parties.



















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MEDICAL SEGMENT

REVENUES
The following table sets out our comparable changes in Medical Segment revenue and case volume for our facilities as of the three months ended September 30, 2016 and 2015 (in thousands, except case and per case data):