10-Q 1 nhc-2q1810q.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 June 30, 2018
OR
[  ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________to __________.
COMMISSION FILE NUMBER: 001-37349
NOBILIS HEALTH CORP.
(Exact name of registrant as specified in its charter)
British Columbia
(State or other jurisdiction of
incorporation or organization)
98-1188172
(I.R.S. Employer
Identification No.)
11700 Katy Freeway, Suite 300, Houston, Texas
(Address of principal executive offices)
77079
(Zip Code)
(713)355-8614
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES  [ X ]  NO  [  ]
(Note: As a voluntary filer not subject to the filing requirements of Sections 13 or 15(d) of the Exchange Act, the registrant has filed all reports pursuant to Section 13 or 15(d) of the Exchange Act during the preceding 12 months as if it were subject to such filing requirements.)
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES  [ X ]  NO  [  ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  [  ]  
Accelerated filer  [ X ]
Non-accelerated filer  [  ]
Smaller reporting company  [  ]
 
Emerging growth company  [ X ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES  [  ]  NO  [ X ]
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   [ ]
Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.
78,250,469 common shares as of August 3, 2018.

1


TABLE OF CONTENTS
In this Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2018 (“Quarterly Report”), the terms "Nobilis", "we", "us", "our", "ours", or "the Company" refers to Nobilis Health Corp. and all of its subsidiaries.

2




Part I - Financial Information

Item 1. Financial Statements

Nobilis Health Corp. and Subsidiaries
Consolidated Balance Sheets
June 30, 2018 and December 31, 2017
(in thousands, except share amounts)
(unaudited)
 
June 30, 2018
 
December 31, 2017
Assets
 
 
 
Current Assets:
 
 
 
Cash
$
16,531

 
$
22,536

Trade accounts receivable, net of allowance of $0 and $2,598 at June 30, 2018 and December 31, 2017, respectively
143,699

 
144,522

Medical supplies
3,236

 
3,356

Prepaid expenses and other current assets
14,484

 
14,472

Total current assets
177,950

 
184,886

Property and equipment, net
46,173

 
51,559

Intangible assets, net
62,695

 
65,990

Goodwill
116,072

 
116,072

Deferred tax asset
10,710

 
9,951

Other long-term assets
2,571

 
2,580

Total Assets
$
416,171

 
$
431,038

Liabilities and Shareholders' Equity
 
 
 
Current Liabilities:
 
 
 
Trade accounts payable
$
23,790

 
$
24,312

Accrued liabilities
29,516

 
35,393

Current portion of capital leases
2,992

 
3,249

Current portion of long-term debt
3,764

 
3,766

Current portion of convertible promissory notes
5,750

 
4,250

Other current liabilities
14,665

 
16,324

Total current liabilities
80,477

 
87,294

Lines of credit
26,000

 
18,000

Long-term capital leases, net of current portion
11,303

 
12,667

Long-term debt, net of current portion
88,072

 
90,619

Convertible promissory notes, net of current portion
1,750

 
4,250

Warrant and stock option derivative liabilities
228

 
384

Other long-term liabilities
2,853

 
3,036

Total liabilities
210,683

 
216,250

Commitments and Contingencies


 


Contingently redeemable noncontrolling interest
15,765

 
17,161

Shareholders' Equity:
 
 
 
Common shares, no par value, unlimited shares authorized, 78,250,469 and 78,183,802 shares issued and outstanding at June 30, 2018 and December 31, 2017

 

Additional paid in capital
227,735

 
225,790

Accumulated deficit
(78,212
)
 
(75,245
)
Total shareholders’ equity attributable to Nobilis Health Corp.
149,523

 
150,545

Noncontrolling interests
40,200

 
47,082

Total shareholders' equity
189,723

 
197,627

Total Liabilities and Shareholders' Equity
$
416,171

 
$
431,038

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

3



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

Three Months Ended June 30,
 
Six Months Ended June 30,

2018

2017
 
2018
 
2017
Revenues:



 
 
 
 
  Net patient and professional fees
$
64,479


$
77,073

 
$
126,961

 
$
141,974

  Contracted marketing revenues
2,309


1,573

 
2,444

 
2,952

  Factoring revenues
1,561


1,316

 
2,370

 
3,338

  Other revenue
840

 

 
1,758

 

    Total revenues
69,189


79,962

 
133,533

 
148,264

Operating expenses:



 
 
 
 
  Salaries and benefits
16,187


15,417

 
32,414

 
30,738

  Drugs and supplies
10,501


12,579

 
20,416

 
25,323

  General and administrative
26,353


35,150

 
54,676

 
68,838

  Depreciation and amortization
5,114


2,728

 
9,745

 
5,066

    Total operating expenses
58,155


65,874

 
117,251

 
129,965

Corporate expenses:



 
 
 
 
  Salaries and benefits
2,975


3,623

 
5,586

 
6,062

  General and administrative
3,197


2,595

 
6,742

 
6,848

  Legal expenses
638


405

 
1,468

 
976

  Depreciation
94


80

 
188

 
163

    Total corporate expenses
6,904


6,703

 
13,984

 
14,049

Income from operations
4,130


7,385

 
2,298

 
4,250

Other (income) expense:
 

 
 
 
 
 
  Change in fair value of warrant and stock
option derivative liabilities
(217
)
 
188

 
(156
)
 
(187
)
  Interest expense
3,292

 
1,363

 
6,177

 
2,618

  Other (income) expense, net
(1,180
)
 
330

 
(2,113
)
 
72

    Total other expense
1,895


1,881

 
3,908

 
2,503

Income (Loss) before income taxes and noncontrolling interests
2,235


5,504

 
(1,610
)
 
1,747

Income tax expense (benefit), net
495


2,249

 
(209
)
 
698

Net income (loss)
1,740


3,255

 
(1,401
)
 
1,049

Net income attributable to noncontrolling interests
855

 
1,670

 
1,566

 
1,862

Net income (loss) attributable to Nobilis Health Corp. (Basic)
$
885

 
$
1,585

 
$
(2,967
)
 
$
(813
)
Net income (loss) per basic common share
$
0.01

 
$
0.02

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

 
$
0.02

 
$
(0.04
)
 
$
(0.01
)
Weighted average shares outstanding (basic)
78,186,000

 
77,805,014

 
78,184,907

 
77,805,014

Weighted average shares outstanding (fully diluted)
82,153,945

 
78,115,242

 
78,184,907

 
77,805,014

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

4



Nobilis Health Corp. and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
Six Months Ended June 30,
 
2018

2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 Net income (loss)
$
(1,401
)

$
1,049

 Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
 Depreciation and amortization
9,933


5,229

 Share-based compensation
1,681


1,630

 Change in fair value of warrant and stock option derivative liabilities
(156
)

(187
)
 Deferred income taxes
(759
)

120

 Loss on sale of property and equipment
61



 Loss from equity method investment


108

 Amortization of deferred financing fees
670


233

 Changes in operating assets and liabilities, net of assets acquired and liabilities assumed:
 

 
    Trade accounts receivable
823


15,279

    Medical supplies
120


1,300

    Prepaid expenses and other current assets
(12
)

(2,714
)
    Other long-term assets
9



    Trade accounts payable and accrued liabilities
(6,399
)

(5,130
)
    Other current liabilities
(1,659
)

2,280

    Other long-term liabilities
(183
)

(303
)
       Net cash provided by operating activities
2,728


18,894







CASH FLOWS FROM INVESTING ACTIVITIES:
 

 
  Purchase of property and equipment
(1,338
)

(3,802
)
    Proceeds on sale of property and equipment
22



    Acquisitions, net of cash acquired


(7,883
)
    Sale of additional ownership interest in subsidiaries
263

 

        Net cash used for investing activities
(1,053
)

(11,685
)






CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
  Distributions to noncontrolling interests
(9,840
)

(1,520
)
    Principal payments on capital lease obligations
(1,621
)

(2,214
)
    Proceeds from line of credit
8,000


3,000

  Payments on debt
(4,219
)

(1,356
)
  Deferred financing fees


(466
)
        Net cash used for financing activities
(7,680
)

(2,556
)






NET INCREASE (DECREASE) IN CASH
(6,005
)

4,653

CASH — Beginning of period
22,536


24,572

CASH — End of period
$
16,531


$
29,225


5



SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
 Cash paid for interest
$
5,579

 
$
1,778

 Cash paid for taxes
$
1,203

 
$
950

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

 
$
2,461

Convertible promissory note
$

 
$
5,000


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

6



Nobilis Health Corp. and Subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
NOTE 1 – COMPANY DESCRIPTION
Nobilis Health Corp. and Subsidiaries (“Nobilis” or the “Company”) was incorporated on March 16, 2007 under the name "Northstar Healthcare Inc." pursuant to the provisions of the British Columbia Business Corporations Act. On December 5, 2014, Northstar Healthcare Inc. changed its name to Nobilis Health Corp. The Company owns and manages health care facilities in the States of Texas and Arizona, consisting primarily of specialty surgical hospitals, ambulatory surgery centers (ASCs) and multi-specialty clinics. The Company's service offerings within the health care industry include providing contracted marketing services and trade accounts receivable factoring.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation
The Company consolidates entities in which it has a controlling financial interest. The Company consolidates subsidiaries in which it holds, directly or indirectly, more than 50% of the voting rights and variable interest entities, with respect to which the Company is determined to be the primary beneficiary. In the opinion of management, material adjustments, consisting of normal recurring adjustments, necessary for fair presentation have been included. All significant intercompany transactions and accounts have been eliminated upon consolidation.
The accompanying interim consolidated financial statements have not been audited by the Company’s independent registered public accounting firm, except the Consolidated Balance Sheet at December 31, 2017, which is derived from previously audited consolidated financial statements.
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, 2017 (“2017 Annual Report”) filed with the SEC on March 12, 2018. 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 2017 Annual Report.
Certain reclassifications have been made to prior period amounts to conform to current period financial statement classifications. The reclassifications included in these comparative interim consolidated financial statements represent a change in presentation within the consolidated statement of cash flows for the prior period presented and within Note 7 - Accrued Expenses and Other Current Liabilities to separately state deferred lease liabilities. The reclassifications were deemed to be immaterial to the consolidated financial statements both individually and in the aggregate.
Recently Issued Accounting Pronouncements
In June 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2018-07, Compensation - Stock Compensation (Topic 718) - Improvements to Nonemployee Share-Based Payment Accounting. This update expands the scope of Topic 718 Compensation - Stock Compensation to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. The update is effective for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year, with early adoption permitted upon issuance. The Company is currently evaluating the method of adoption and the impact of adopting ASU 2018-07.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) which supersedes FASB ASC Topic 840, Leases (Topic 840) and provides principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than twelve months regardless of classification. Leases with a term of twelve months or less will be accounted for similar to existing guidance for operating leases. The standard is effective for annual and interim periods beginning after December 15, 2018, with early adoption permitted upon issuance. The Company is currently evaluating the method of adoption and the impact of adopting ASU 2016-02 on its results of operations, cash flows and financial position. The Company also continues to monitor proposals issued by the FASB to clarify the ASU and certain industry implementation issues. 


7




Recently Adopted Accounting Standards
Revenue Recognition
Effective January 1, 2018, we adopted Accounting Standards Updates (ASU) 2014-09, Revenue from Contracts with Customers (ASC 606, "new revenue standard") and a series of related ASU's designed to create improved revenue recognition and disclosures to all contracts that were not completed, using the modified retrospective method.
Under the modified retrospective method, the cumulative effect of initially applying the new revenue standard is recorded as an adjustment to the opening balance of retained earnings on the date of initial application; prior periods are not restated. The Company did not identify any changes to the recognition of revenue under ASC 606 as compared to legacy U.S. GAAP. However adoption of the new standard also resulted in changes with regard to the presentation of revenues and the provision for uncollectible accounts. Upon adoption, any estimation of uncollectable amounts that were previously considered allowance for doubtful accounts are generally considered implicit price concessions that are a direct reduction to net operating revenues, with a corresponding reduction in the amounts presented separately as bad debt expense.
Under ASC 606, revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new revenue standard provides a principles-based, five-step model to be applied to all contracts with customers. The five steps are to identify the contract(s) with the customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract and recognize revenue when each performance obligation is satisfied.
The Company’s sources of revenues within the scope of ASC 606 include patient and net professional fees and related ancillary services, management fees, and contracted marketing revenues. These revenues are further discussed within Note 6 - Revenues and Related Trade Accounts Receivable, net.
The Company also recognizes revenues from factoring. Factoring revenues are generated from certain trade accounts receivables purchased from third parties (typically, practicing physicians) in the ordinary course of business, and are accounted for under ASC 860 Transfers and Servicing. Purchase price is determined either by a flat fee per medical procedure (reflecting a discount to the face amount of the receivable), as dictated per the agreement, or as a percentage of final collections. At the time of purchase, Nobilis acquires the right to collect the full amount of the receivable and assumes all associated financial risk. Costs related to billings and collections are borne by the Company, without any recourse to the third-party seller and reflected as a component of operating expenses. Factoring revenues represent the excess of collections of purchased receivables over their acquisition cost and are recognized over the period from purchase to collection.
Other Recently Adopted Accounting Standards
In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities. This update was issued to clarify certain narrow aspects of guidance concerning the recognition of financial assets and liabilities established in ASU No. 2016-01, “Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities”. This includes an amendment to clarify that an entity measuring an equity security using the measurement alternative may change its measurement approach to a fair valuation method in accordance with Topic 820, Fair Value Measurement, through an irrevocable election that would apply to that security and all identical or similar investments of the same issued. The update is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years beginning after June 15, 2018. The Company adopted this pronouncement in the first quarter of 2018 and had no material impact on our consolidated financial statements.
NOTE 3 – BUSINESS ACQUISITIONS
The Company accounts for all transactions that represent business combinations using the acquisition method of accounting, where the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquired entity are recognized and measured at their fair values on the date the Company obtains control in the acquiree. Such fair values that are not finalized for reporting periods following the acquisition date are estimated and recorded as provisional amounts. Adjustments to these provisional amounts during the measurement period (defined as the date through which all information required to identify and measure the consideration transferred, the assets acquired, the liabilities assumed and any noncontrolling interests has been obtained, limited to one year from the acquisition date) are recorded as of the date of acquisition. Any material impact to comparative information for periods after acquisition, but before the period in which adjustments are identified, is recognized during the measurement period in the reporting period in which the adjustment amounts are determined.



8



2017 Transactions:
Elite Management Companies ("Elite")
On November 15, 2017, pursuant to four separate Membership Interest Purchase Agreements (the “Purchase Agreements”), Northstar Healthcare Surgery Center - Houston, LLC ("NHSC") and Nobilis Health Corp. (the "Company"), (NHSC and the Company are each a "Buyer" and collectively "Buyers") and Elite Surgical Affiliates (ESA) and other membership interests, (Elite and other membership interests are each a "Seller" and collectively "Sellers") finalized the Purchase Agreements dated as of November 15, 2017 ("Elite Transaction"). The Company purchased ownership interests in Elite Sinus Spine and Ortho LLC, Elite Center for Minimally Invasive Surgery, LLC, Houston Metro Ortho and Spine Surgery Center LLC and Elite Hospital Management LLC (collectively the "Management Companies", “Elite” or "Elite Management Companies").
The Company purchased Elite for approximately $64.7 million, comprised of $53.6 million in cash, $4.4 million as contractual obligation to purchase additional equity interests, $3.5 million in the form of a convertible promissory note, $2.5 million in form of escrow and $0.7 million in shares of common stock and stock options in order to acquire 53.8% of the Sellers’ ownership interests in Management Companies responsible for three ambulatory surgery centers and one surgical hospital in the greater Houston area. Under U.S. GAAP our equity position effectively increased 3.7% from 50.1% to 53.8% due to an obligation to purchase ESA's 15.1 remaining equity units within the first year after the acquisition date for a fixed price of $4.4 million. As a result, noncontrolling interest is 46.2%. The noncontrolling interest was measured using Finnerty's (2012) Average-Strike Put Option Model (the "Finnerty Model") at its acquisition-date fair value and incorporates the discount for lack of marketability. The Finnerty Model assumes that the put option is struck at the average price of the stock over the period from valuation date to expiration date.
The $2.5 million in escrow was held back and is subject to certain indemnification provisions. On the twelve-month anniversary of closing, 100% of the amount held back, less any amounts paid as, or claimed as, indemnification, will be paid to the Sellers.
As a result of the acquisition, the Company has recognized $46.1 million of goodwill within our Medical Segment, of which, $27.4 million is expected to be deducted for tax purposes. The Company believes that the goodwill is primarily comprised of the business opportunities to be gained through the expanded case volume as well as the access to additional physicians.
For the three months ended June 30, 2018, Elite had $6.6 million in net revenues and net income attributable to the Company of $1.1 million which is included in the Company's consolidated statement of operations for the three months ended June 30, 2018. For the six months ended June 30, 2018, Elite had $13.0 million in net revenues and net income attributable to the Company of $2.5 million which is included in the Company’s consolidated statement of operations for the six months ended June 30, 2018.
The costs related to the transaction were $0.3 million and were expensed during the fourth quarter in 2017. These costs are included in the corporate general and administrative expenses in the Company’s consolidated statement of operations for the year ended December 31, 2017.
The fair values assigned to certain assets acquired and liabilities assumed in relation to the Company's acquisition have been prepared on a preliminary basis with information currently available and are subject to change. Specifically, the Company is still in the process of assessing the fair value of trade accounts receivable, property and equipment, intangibles, goodwill, leases and working capital adjustment. The Company expects to finalize the analysis during 2018. For the Elite intangible assets, the Company used the multi-period excess earnings method to estimate the fair value of the hospital department management agreements, the with-and-without method to estimate the fair value of a non-compete agreement, and the relief-from-royalty method to estimate the fair value of the trade name. These are included within the intangible assets balance in the table below. To evaluate the contract value of the acquired trade accounts receivable, the Company compared historical trended accrued revenue and collections to determine the appropriate amount to record at time of acquisition.
The following table summarizes the preliminary fair values of the identifiable assets acquired and liabilities assumed at the date of acquisition (in thousands):

9



Management Companies Combined
 
November 15, 2017
 
 
 
Assets acquired:
 
 
  Cash
 
$
150

  Trade accounts receivable
 
6,490

  Prepaid expenses and other current assets
 
145

  Property and equipment
 
11,225

  Other long-term assets
 
1,057

  Intangible assets
 
47,905

  Goodwill
 
46,069

Total assets acquired
 
$
113,041

 
 
 
Liabilities assumed:
 
 
  Trade accounts payable
 
$
499

  Accrued liabilities
 
674

Total liabilities assumed
 
$
1,173

 
 
 
Consideration:
 
 
  Cash
 
$
53,620

  Noncontrolling interests
 
47,124

  Future obligation - payment for additional equity interests
 
4,389

  Convertible promissory note
 
3,500

  Escrow
 
2,500

  Stock issued
 
500

  Stock options issued
 
235

Total consideration
 
$
111,868

DeRosa Medical, P.C. ("DeRosa")
On September 13, 2017, the Company purchased DeRosa in exchange for $0.9 million in cash. DeRosa adds three additional primary care clinics to Nobilis' health network. As a result of the acquisition, the Company has recognized $0.7 million of goodwill within our Medical Segment, of which, 100% is expected to be deductible for tax purposes. The Company believes that the goodwill is primarily comprised of the business opportunities to be gained through the expanded geographical coverage as well as the access to a new physician group.
Unaudited Supplemental Pro Forma Information
The following table presents the unaudited pro forma results of the Company as if all of the business combinations previously discussed had been made on January 1, 2016, the annual period prior to the date of the acquisitions. The pro forma information is based on the Company’s consolidated results of operations for the three and six months ended June 30, 2017. 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.
The unaudited supplemental pro forma financial information presented below has been prepared by adjusting the historical results of the Company to include historical results of the acquired businesses described above and was then adjusted: (i) to increase amortization expense resulting from intangible assets acquired; (ii) to reduce interest expense from debt which was retained by the seller upon acquisition of the respective businesses and concurrently increase the Company's interest expense based upon the purchase price; and (iii) to increase depreciation expense for the incremental increase in the value of property and equipment acquired; (iv) to decrease expenses for management services which were provided by the preceding parent entity and to concurrently

10



increase expenses for management services which are now provided by the Company; (v) to adjust earnings per share to reflect the common shares issued as part of the purchase consideration. The unaudited supplemental pro forma financial information does not include adjustments to reflect the impact of other cost savings or synergies that may result from these acquisition.
The following table shows our pro forma results for the three and six months ended June 30, 2017 (in thousands, except per share amounts):
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
 
2017
 
2017
 
 
 
 
 
 
Revenue
 
 
$
90,254

 
$
171,518

Income from operations
 
 
$
12,819

 
$
15,423

Net income (loss) attributable to Nobilis Health Corp.
 
 
$
2,840

 
$
1,682

Net income (loss) per basic common share
 
 
$
0.02

 
$
0.02

Pro-forma adjustments for 2018 are not applicable as all of the entities mentioned above were acquired prior to the three and six months ended June 30, 2018.
NOTE 4 – INVESTMENTS IN ASSOCIATES
In March 2016, the Company acquired a 58% interest in Athelite Holdings LLC ("Athelite"), a holding company with a 70% interest in Dallas Metro Surgery Center LLC ("Dallas Metro"), a company formed to provide management services to a Hospital Outpatient Department (HOPD). In April 2016, Athelite interest in Dallas Metro was reduced to 62%. The Athelite investment is accounted for as an equity method investment as the Company did not obtain the necessary level of control for the investment to be accounted for as a business combination. This is due to the fact that the Company does not have the ability to directly appoint a majority of the board members of Dallas Metro or independently make strategic operational decisions. The carrying value as of June 30, 2018 was $0.4 million. The investment is classified as other long-term assets in the Consolidated Balance Sheets.
NOTE 5 – FINANCIAL INSTRUMENTS AND CONCENTRATION
The Company is exposed to risks that arise from its use of financial instruments. This note describes the Company’s objectives, policies and processes for managing those risks and the methods used to measure them. Further quantitative information in respect to these risks is presented throughout these consolidated financial statements.
Principal financial instruments
The principal financial instruments used by the Company, from which financial instrument risk arises, are as follows:
Trade 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, trade 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
Market risk
Liquidity risk
Interest rate risk


11



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 trade accounts receivable from insurance companies, other third-party payors, and physicians. Trade 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.
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.
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 June 30,
 
Six Months Ended June 30,
Payors
 
2018
 
2017
 
2018
 
2017

 
 
 
 
 
 
 
 
Private insurance and other private pay
 
96.9
%
 
97.4
%
 
97.4
%
 
97.4
%
Workers compensation
 
1.4
%
 
1.3
%
 
1.2
%
 
1.8
%
Medicare
 
1.7
%
 
1.3
%
 
1.4
%
 
0.8
%
Total
 
100
%
 
100
%
 
100
%
 
100
%
MARKETING SEGMENT
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Payors
 
2018
 
2017
 
2018
 
2017

 
 
 
 
 
 
 
 
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 June 30,
 
Six Months Ended June 30,
Payors
 
2018
 
2017
 
2018
 
2017

 
 
 
 
 
 
 
 
Private insurance and other private pay
 
97.1
%
 
97.6
%
 
97.5
%
 
97.5
%
Workers compensation
 
1.3
%
 
1.2
%
 
1.1
%
 
1.7
%
Medicare
 
1.6
%
 
1.2
%
 
1.4
%
 
0.8
%
       Total
 
100
%
 
100
%
 
100
%
 
100
%
Three facilities represent approximately 80% and 88% of the Company's contracted marketing revenues for the three months ended June 30, 2018 and 2017, respectively, and 82% and 84% for the six months ended June 30, 2018 and 2017.

12




NOTE 6 - REVENUES AND RELATED TRADE ACCOUNTS RECEIVABLE
Net Patient and Professional Fees
Net patient and professional fees - Net patient and professional fees include facility fees, ancillary services fees, and management fees for services rendered at the healthcare facilities we operate or manage and consist primarily of fees for the use of those facilities. Facility fees and ancillary services fees are recognized at the date the related medical procedure is performed, which is the point in time the promised services are provided. Given the nature of our business, we have no material post-care performance obligations after the date of the medical procedure. Ancillary services are performed during an episode of care and include neuromonitoring, anesthesia, and professional staffing. Facility fees as well as related ancillary services fees are recognized at the amounts expected to be collected, net of any patient discounts, contractual and other adjustments of third-party payors and any implicit price concessions. Our revenues exclude any amounts billed for physicians’ services, which are billed separately by the physicians to the patient or third-party payor.
Management fees are earned from long-term management agreements entered into with third-party healthcare facilities. The Company’s performance obligation in these arrangements is to manage the day-to-day operations of these facilities for which the Company earns monthly management fees based on a percentage of collections of the facilities, less certain expenses incurred by the facilities during the period. The Company acts as an agent of the contracting healthcare provider in these scenarios and recognizes revenue over the management period as the management services are performed.
The Company estimates patient and net professional fees using the expected value of each patient visit, which is based on the facility in which the service was performed, the services provided and the third-party payor, if one is applicable, that is associated with the encounter.
If a service is provided at an in-network facility, these three parameters are utilized to determine the contract rate for such services.
If a service is provided at an out-of-network facility, these three parameters are utilized along with historical collection experience to determine the applicable expected value.
Payment terms for services vary depending on the benefits available from the patient's insurance provider. In some cases, services provided are not covered by a contract between the Company and the payor. In these instances, payment terms such as timing are not defined. In instances where a contract is in place for services, the timing of payment is required within a specified time frame or interest begins to accrue on the outstanding balance. Given these constraints and the variable nature of the information required by payors, the collection timing is protracted and can be lengthy.
The Company does not disclose the transaction price allocated to unsatisfied performance obligations because its performance obligations have an expected duration of one year or less (facility fees and ancillary services fees) or the promised consideration is variable and relates to a wholly unsatisfied promised service (management fees). As of June 30, 2018, our management fee contracts have a remaining duration of approximately five years.
The following table disaggregates the Company’s net patient and professional fees by facility type - i.e., by hospital, ASC, clinic service and ancillary services (in thousands except case data):
 
Three Months Ended June 30,
 
Six months ended June 30, 2018
 
Net Revenues
(in thousands)
 
Number of Cases
 
Net Revenues
(in thousands)
 
Number of Cases
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hospitals
$
46,275

 
$
50,866

 
3,247

 
2,441

 
$
91,944

 
$
92,717

 
5,962

 
5,034

ASCs
11,095

 
8,289

 
2,859

 
1,945

 
23,139

 
16,402

 
5,260

 
3,621

Clinic service
5,172

 
4,650

 

 

 
8,237

 
7,756

 

 

Ancillary services
1,937

 
13,268

 

 

 
3,641

 
25,099

 

 

Total
$
64,479

 
$
77,073

 
6,106

 
4,386

 
$
126,961

 
$
141,974

 
11,222

 
8,655


Contracted Marketing
Contracted Marketing Revenues - The Company earns contracted marketing revenue for marketing services provided through marketing services agreements with third-party specialty surgical hospitals, ASC’s and other ancillary service providers that are not a part of the Company’s network of licensed facilities. The Company’s performance obligation under these arrangements is to identify candidates for applicable medical procedures through marketing, patient intake, and upfront education efforts for which

13



we earn a fee based on a percentage of collections from the marketed procedures performed by the outside facilities. Revenue is recognized upon performance of the corresponding medical procedure, which is the point in time our marketing services transfer a benefit to the third-party facilities.
The Company does not disclose the transaction price allocated to unsatisfied performance obligations because the promised consideration is variable and relates to wholly unsatisfied promised services. The Company estimates contracted marketing revenue using the expected value of each successfully marketed medical procedure, which is based on the facility in which the service is performed, the services provided and the third-party payor, if one is applicable. These parameters are utilized along with historical collection experience to determine the contracted marketing fee. Most of our marketing contracts have initial one-year terms with automatic renewals.
Revenues for contract marketing were $2.3 million and $1.6 million for the three months ended June 30, 2018 and 2017, respectively. Revenues for contract marketing were $2.4 million and $3.0 million for the six months ended June 30, 2018, and 2017, respectively.
All contract marketing revenues, together with factoring revenues, are included in our Marketing segment.
Contract Assets and Liabilities
Payment for services performed is generally received at the date of the related medical procedure or thereafter, at which time the Company has an unconditional right to collection. For management fees, payment is received monthly for the services rendered in the preceding month. As such, the Company does not have any material contract asset or contract liability balances.
Trade Accounts Receivable
A detail of trade accounts receivable, net is as follows (in thousands):
 
June 30, 2018
 
December 31, 2017
Trade accounts receivable
$
136,839

 
$
140,580

Allowance for doubtful accounts

 
(2,598
)
Receivables purchased
6,860

 
6,540

   Trade accounts receivable, net
$
143,699

 
$
144,522

Trade accounts receivable related to accounts greater than 365 days was $38.8 million and $20.4 million as of June 30, 2018 and December 31, 2017, respectively.
For patient accounts receivable resulting from revenue recognized prior to January 1, 2018, an allowance for doubtful accounts was established to reduce the carrying value of such receivables to their estimated net realizable value. Under the new revenue standard, which we adopted effective January 1, 2018, the estimated uncollectable amounts are generally considered implicit price concessions that are a direct reduction to trade accounts receivable rather than allowance for doubtful accounts. However, subsequent changes in estimate of collectability due to a change in the financial status of a payor, for example a bankruptcy, will be recognized as bad debt expense in operating expenses. Bad debt expense was nil for the three and six months ended June 30, 2018 and nil for the three and six months ended June 30, 2017.
A detail of allowance for doubtful accounts as of June 30, 2018 and December 31, 2017 is as follows (in thousands):
 
 
Balance at Beginning of Period
 
Costs and Expenses
 
Reclassification for Implicit Price Concessions
 
Write-offs, net (1)
 
Balance at End of Period
Allowance for doubtful accounts:
 
 
 
 
 
 
 
 
 
 
Balance as of December 31, 2017
 
$
(750
)
 
(2,402
)
 

 
554

 
$
(2,598
)
Balance as of June 30, 2018
 
$
(2,598
)
 

 
2,598

 

 
$

 
 
 
 
 
 
 
 
 
 
 
(1) Adjudication of previously recorded allowance for doubtful accounts
From time to time, we transfer to third parties certain of our trade accounts receivable balances on a non-recourse basis in return for advancement on payment to achieve a faster cash collection. As of June 30, 2018 and December 31, 2017, there were no transferred receivables included in trade accounts receivable.
For the three months ended June 30, 2018 and 2017, the Company did not receive any advanced payments. For the six months ended June 30, 2018 and 2017, the Company received advanced payments of nil and $0.1 million, respectively. During the same time period, the Company transferred nil and $0.5 million of receivables, net of advancement of payment.
Athas Health, LLC ("Athas"), Nobilis Health Network Specialist Group, PLLC (NHNSG), NH Clinical Services, PLLC ("NH Clinical") and Premier Health Specialists, LLC ("Premier") purchase receivables from physicians, at a discount, on a non-recourse

14



basis. The discount and purchase price vary by specialty and are recorded at the date of purchase, which generally occurs 30 to 45 days after the accounts are billed. These purchased receivables are billed and collected by Athas, NHNSG, NH Clinical and Premier and they retain 100% of what is collected after paying the discounted purchase price. Following the transfer of the receivable, the transferor has no continued involvement and there are no restrictions on the receivables.
Gross revenue from purchased receivables was $3.5 million and $3.1 million for three months ended June 30, 2018 and 2017, respectively. Revenue, net of the discounted purchase price, was $1.6 million and $1.3 million for the three months ended June 30, 2018 and 2017.
Gross revenue from purchased receivables was $6.1 million and $7.5 million for six months ended June 30, 2018 and 2017, respectively. Revenue, net of the discounted purchase price, was $2.4 million and $3.3 million for six months ended June 30, 2018 and 2017, respectively.
Trade accounts receivable for purchased receivables was $6.9 million and $6.5 million as of June 30, 2018 and December 31, 2017, respectively. Revenue from receivables purchased is recorded in the factoring revenue line item within the Consolidated Statements of Operations.
NOTE 7 – ACCRUED LIABILITIES AND OTHER CURRENT LIABILITIES
The following table presents a summary of items comprising accrued liabilities and other current liabilities in the accompanying Consolidated Balance Sheets is as follows (in thousands):
 
June 30, 2018
 
December 31, 2017
Accrued liabilities:
 
 
 
Accrued salaries and related benefits
$
4,819

 
$
4,588

Contract services
4,340

 
3,836

Lab expense
3,233

 
6,366

Deferred lease liability
3,418

 
3,269

Other
13,706

 
17,334

Total accrued liabilities
$
29,516

 
$
35,393

Other current liabilities:
 
 
 
Estimated amounts due to third party payors
$
5,081

 
$
5,081

Additional equity interest purchase obligation in conjunction with Elite acquisition
4,389

 
4,389

Other
5,195

 
6,854

Total other current liabilities
$
14,665

 
$
16,324

NOTE 8 – OTHER LONG-TERM LIABILITIES
The Company assumed real property leases in conjunction with certain business acquisitions which required the Company to pay above market rentals through the remainder of the lease terms. Of the $2.9 million balance in other long-term liabilities at June 30, 2018, approximately $2.6 million relates to unfavorable leases. The unfavorable lease liability is amortized as a reduction to rent expense over the contractual periods the Company is required to make rental payments under the leases. Estimated amortization of unfavorable leases for the five years and thereafter subsequent to June 30, 2018, is $0.1 million for the remainder of 2018, $0.3 million for each of 2019, 2020, 2021, $0.2 million for 2022, and $1.7 million thereafter.
NOTE 9 – DEBT
BBVA Credit Agreement
On October 28, 2016, the Company ("Borrower") entered into a BBVA Credit Agreement by and among the Company, certain subsidiaries of the Company parties thereto, the lenders from time to time parties thereto (the “Lenders”) with BBVA Compass Bank as Administrative Agent for the lending group.
The principal amount of the term loan (the “Term Loan”) pursuant to the BBVA Credit Agreement is $52.5 million, which bears interest on the outstanding principal amount thereof at a rate of the then applicable LIBOR, plus an applicable margin of 4.75%. The effective rate for the Term Loan as of June 30, 2018 was 7.08%. All outstanding principal on the Term Loan under the Credit Agreement is due and payable on October 28, 2021.
The revolving credit facility is $30.0 million (the “Revolver”), which bears interest at the then applicable Interest Rate. The effective rate for the Revolver as of June 30, 2018 was 7.08%. The maturity date of the Revolver is October 28, 2021. Additionally, the

15



Borrower may request additional commitments from the Lenders in the maximum amount of $50 million, either by increasing the Revolver or creating new term loans. The Company executed Amendment No. 2 to the BBVA Credit agreement and exercised its option to extend our commitments. The Company created ("Term Loan B") and added $50 million in debt on November 15, 2017 (discussed further below). As of June 30, 2018, the outstanding balances on the Term Loan and Revolver were $97.3 million and $26.0 million, respectively.
The Loan Agreement also contains customary events of default, including, among others, the failure by the Borrower to make a payment of principal or interest due under the BBVA Credit Agreement, the making of a materially false or misleading representation or warranty by any loan party, the failure by the Borrower to perform or observe certain covenants in the BBVA Credit Agreement, a change of control, and the occurrence of certain cross-defaults, subject to customary notice and cure provisions. Upon the occurrence of an event of default, and so long as such event of default is continuing, the Administrative Agent could declare the amounts outstanding under the BBVA Credit Agreement due and payable.
The Company entered into Amendment No. 1 to BBVA Credit Agreement and Waiver, dated as of March 3, 2017, by and among NHA, certain subsidiaries of the Company party thereto, Compass Bank, and other financial institutions (the "Amendment"). The purpose of the Amendment was to (i) modify the definition of “Permitted Acquisition” to require Lender approval and consent for any acquisition which is closing during the 2017 fiscal year; (ii) modify certain financial definitions and covenants, including, but not limited to, an increase to the maximum Consolidated Leverage Ratio to 3.75 to 1.00 for the period beginning September 30, 2016 and ending September 30, 2017, and an increase to the Consolidated Fixed Charge Coverage Ratio to 1.15 to 1.00 for the period beginning September 30, 2016 and ending June 30, 2017; (iii) waive the Pro Forma Leverage Requirement in connection with the previously reported HVC; and (iv) provide each Lender’s consent to the HHVC acquisition. The Amendment also contained a limited waiver of a specified event of default.
The Company entered into Amendment No. 2 to BBVA Credit Agreement, dated November 15, 2017, by and among Northstar Healthcare Acquisitions, L.L.C., a Delaware limited liability company and wholly owned subsidiary of Nobilis Health Corp., and Northstar Healthcare Holdings, Inc., a Delaware corporation, entered into the Amendment and certain subsidiaries of the Company. The purpose of the Amendment was to finance the aforementioned Elite acquisition, thereby increasing the aggregate principal amount by $50.0 million through issuance of the Term B Loan. The Term B Loan bears interest on the outstanding principal amount at a rate of the then applicable LIBOR, plus an applicable margin of 6.75%. The effective rate for the Term B Loan as of June 30, 2018 was 9.08%. All outstanding principal on the Term Loan under the Credit Agreement matures on November 15, 2022.
The BBVA Compass Credit Agreement contains three financial covenants that are tested beginning on December 31, 2017. The consolidated leverage ratio may not exceed (i) 4.00 to 1.00 as of the last day of any fiscal quarter from December 31, 2017 through and including September 30, 2018 (ii) 3.75 to 1.00 from December 31, 2018 through and including September 30, 2019 (iii) 3.50 to 1.00 from December 31, 2019 and thereafter, subject to covenant holidays upon the occurrence of certain conditions. The consolidated modified fixed charge ratio must be at a minimum (i) 1.25 to 1.00 as of the last day of any fiscal quarter from September 30, 2017 through and including December 31, 2018 (ii) 1.30 to 1.00 from March 31, 2019 through and including December 31, 2019 (iii) 1.35 to 1.00 from March 31, 2020 and thereafter, subject to covenant holidays upon the occurrence of certain conditions.The consolidated fixed charge ratio must be at a minimum (i) 1.25 to 1.00 as of the last day of any fiscal quarter from September 30, 2017 through and including December 31, 2017 (ii) 1.10 to 1.00 from March 31, 2018 through and including December 31, 2019 (iii) 1.35 to 1.00 from March 31, 2020 and thereafter, subject to covenant holidays upon the occurrence of certain conditions.
As of June 30, 2018, the Company was in compliance with its covenants.
Substantially all of the Company’s assets are pledged as collateral to secure the Facility.
Loan origination fees are deferred and the net amount is amortized over the contractual life of the related loans.
Convertible Promissory Note - AZ Vein
In conjunction with our purchase of AZ Vein, we entered into a $2.25 million convertible promissory note. The convertible promissory note bears interest at 5% per annum and matures on the date that is 36 months from closing. The convertible promissory note (outstanding principal but excluding accrued and unpaid interest) can be converted into common shares of NHC (the "Conversion Shares"), at the sole discretion of NHC and NHA, on the maturity date. The number of Conversion Shares will be based on a price per share equal to the quotient obtained by dividing the conversion amount by the volume weighted average price of the common shares on the New York Stock Exchange (NYSE) in the trailing ten trading days prior to the maturity date. There are no pre-payment penalties.
In February 2018, the Company entered into a settlement agreement in connection with contract disputes that arose during the year with the sellers of the Company's acquisition of Arizona Vein and Vascular Center, LLC (AVVC) and its four affiliated surgery centers operating as Arizona Center for Minimally Invasive Surgery, LLC (ACMIS), (collectively “AZ Vein”). This settlement resulted in the derecognition of certain liabilities, including the convertible promissory note of $2.25 million discussed herein.

16



Convertible Promissory Note - HVC
In conjunction with our purchase of HVC, we entered into a $5.0 million convertible promissory note. The convertible promissory note matures on March 8, 2019, bears interest at 5% per annum and is payable in two equal installments over a two-year period. The convertible promissory note (outstanding principal but excluding accrued and unpaid interest) can be converted into common shares of NHC (the "Conversion Shares"), at the sole discretion of NHC and NHA, on the maturity date. The number of Conversion Shares will be based on a price per share equal to the quotient obtained by dividing the conversion amount by the volume weighted average price of the common shares on the NYSE in the trailing ten trading days prior to the maturity date. There are no pre-payment penalties.
Convertible Promissory Note - Elite
In conjunction with our purchase of Elite, we entered into a $3.5 million convertible promissory note. The convertible promissory note matures on November 15, 2019, bears interest at 6.75% per annum and is payable in three installments over a two year period. The interest payments are due quarterly. The promissory note (outstanding principal but excluding accrued and unpaid interest) may be converted into common shares of the Company (the "Conversion Shares"), only upon the occurrence of both (i) default by Maker, as defined in the promissory note, and (ii) the election of the Sellers as defined in the promissory note. The number of Conversion Shares will be based on a price per share equal to the quotient obtained by dividing the conversion amount by the lesser of (i) the closing bid price of the common shares on the trading day immediately prior to the conversion date, or (ii) the volume weighted average price of the common shares on NYSE in the trailing ten trading days prior to the maturity date. There are no pre-payment penalties.
Debt as of June 30, 2018 and December 31, 2017 consisted of the following (in thousands):
 
 
June 30, 2018
 
December 31, 2017
 
 
 
 
 
Lines of credit
 
$
26,000

 
$
18,000

Term loan
 
97,269

 
100,488

Convertible promissory notes
 
7,500

 
8,500

Gross debt
 
130,769

 
126,988

Less: unamortized debt issuance costs
 
(5,433
)
 
(6,103
)
Debt, net of unamortized debt issuance costs
 
125,336

 
120,885

Less: current debt, net of unamortized debt issuance costs
 
(9,514
)
 
(8,016
)
 Long-term debt, net
 
$
115,822

 
$
112,869


Future maturities of debt as of June 30, 2018 are as follows (in thousands):
 
June 30, 2018
 
 
2018
$
5,813

2019
9,375

2020
5,125

2021
70,456

2022
40,000

 Total
$
130,769


17



NOTE 10 – FAIR VALUE MEASUREMENTS
The Company measures certain financial assets and liabilities at fair value on a recurring basis, including warrant and stock option derivative liabilities. There have been no transfers between fair value measurement levels during the six months ended June 30, 2018.
The following table summarizes our assets and liabilities measured at fair value on a recurring basis as of June 30, 2018 and the Company's fiscal year ended December 31, 2017, 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, 2017:
 
 
 
 
 
 
 
Warrant and stock option derivative liabilities
$

 
$

 
$
384

 
$
384

Total
$

 
$

 
$
384

 
$
384

June 30, 2018:
 
 
 
 
 
 
 
Warrant and stock option derivative liabilities
$

 
$

 
$
228

 
$
228

Total
$

 
$

 
$
228

 
$
228

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 12 - Options liabilities). Due to the nature of valuation inputs, the valuation of the warrants is considered a Level 3 measurement.
The remaining outstanding warrants expired in May of 2017. The balance of the Company's warrants is zero as of June 30, 2018.

18



NOTE 11 – SHARE BASED COMPENSATION
Stock Options
The Company granted a total of 280,000 and 650,000 stock options during the three and six months ended June 30, 2018, respectively. Of the options granted during the three months ended June 30, 2018, 250,000 of those vested immediately and 30,000 vest ratably over one and three-year periods. Of the options granted during the six months ended June 30, 2018, 350,000 of those vested immediately and 300,000 vest ratably over one and three-year periods. During the six months ended June 30, 2018, 325,000 options were forfeited, with various vesting periods.
The following table summarizes stock option activity for the six months ended June 30, 2018 and 2017:
 
Shares Underlying
Options
 
Weighted-
Average Exercise
Price
 
Weighted-Average
Remaining Life
(years)
 
 
 
 
 
 
Outstanding at January 1, 2017
7,544,025

 
$
2.61

 
9.0

 Granted
615,000

 
$
1.61

 
9.8

 Exercised

 
$

 

 Forfeited
(605,000
)
 
$
3.14

 

Outstanding at June 30, 2017
7,554,025

 
$
2.49

 
8.6

Exercisable at
 
 
 
 
 
Exercisable at June 30, 2017
3,773,400

 
$
2.32

 
8.3

Exercisable at
 
 
 
 
 
Outstanding at January 1, 2018
8,864,025

 
$
2.17

 
8.5

 Granted
650,000

 
$
1.34

 
9.8

 Exercised
(66,667
)
 
$
0.97

 

 Forfeited
(325,000
)
 
$
2.61

 

Outstanding at June 30, 2018
9,122,358

 
$
2.11

 
8.2

Outstanding at
 
 
 
 
 
Exercisable at June 30, 2018
6,263,703

 
$
2.21

 
7.9

The above table includes 500,000 options issued to a non-employee, 500,000 of these are exercisable, and all are still outstanding at June 30, 2018. Refer to Note 12 - Options liabilities for discussion regarding the classification of these options within the Company's consolidated balance sheets.
The total intrinsic value of stock options exercised was nil during the six months ended June 30, 2018 and 2017. There were no options exercised during the six months ended June 30, 2017. Assuming all stock options outstanding were fully vested at June 30, 2018, the total intrinsic value of in-the-money outstanding stock options would have been nil at June 30, 2018.
The Company recorded total stock compensation expense relative to employee stock options of $0.8 million and $0.2 million for the three months ended June 30, 2018 and 2017, respectively, and $1.7 million and $1.6 million for six months ended June 30, 2018 and 2017.
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 six months ended June 30, 2018 and 2017.

19



 
Six Months Ended June 30,
 
2018
 
2017
 
 
 
 
Expected price volatility
80% - 91%
 
87% - 91%
Risk free interest rate
2.45% - 2.84%
 
1.78% - 2.14%
Expected annual dividend yield
0%
 
0%
Expected option term (years)
5 - 6
 
5-6
Expected forfeiture rate
7.4% - 12.9%
 
3.1% - 11.6%
Grant date fair value per share
$0.95 - $1.15
 
$0.99 - $1.81
Grant date exercise price per share
$1.22 - $1.57
 
$1.35 - $2.32
For stock options, the Company recognizes share based compensation net of estimated forfeitures and revises the estimates in the subsequent periods if actual forfeitures differ from the estimates. Forfeiture rates are estimated based on historical experience as well as expected future behavior.
NOTE 12 – OPTIONS LIABILITIES
Options Issued to Non-Employees
In 2014, the Company issued 650,000 options to professionals providing services to the organization. These professionals did not meet the definition of an employee under U.S. GAAP. During 2017, one of the two non-employee professionals became an employee of the Company. At this time, the Company revalued the associated 150,000 shares and reclassified $0.1 million out of the liability and into equity. At June 30, 2018, there were 500,000 options outstanding all of which are fully vested and exercisable to the remaining non-employee professional.
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.
Options issued to non-employees are reclassified from liabilities to equity 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 derivative 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 derivative liabilities”. At June 30, 2018, there were 500,000 unexercised non-employee options requiring liability classification.
The changes in fair value of the liability related to vested yet unexercised options issued to non-employees during the six months ended June 30, 2018 and 2017 were as follows (in thousands):
 
Six Months Ended June 30,
 
2018
 
2017
Balance at beginning of year
$
384

 
$
899

Vested during the period

 

Change in fair value recorded in earnings
(156
)
 
(184
)
Balance as of June 30, 2018 and 2017
$
228

 
$
715


20



NOTE 13 – EARNINGS PER SHARE
Basic net earnings attributable to Nobilis common shareholders, per common share, excludes dilution and is computed by dividing net earnings attributable to Nobilis common shareholders by the weighted-average number of common shares outstanding during the period. Diluted net earnings attributable to Nobilis common shareholders, per common share, is computed by dividing net earnings attributable to Nobilis common shareholders by the weighted-average number of common shares outstanding during the period plus any potential dilutive common share equivalents, including shares issuable upon the vesting stock option awards determined under the treasury stock method, or potentially convertible shares related to our convertible promissory notes determined under the if-converted method, whichever method is more dilutive.
A detail of the Company’s earnings per share is as follows (in thousands, except for share and per share amounts):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
Net income (loss) attributable to Nobilis Health Corp.
$
885

 
$
1,585

 
$
(2,967
)
 
$
(813
)
Weighted average common shares outstanding
78,186,000

 
77,805,014

 
78,184,907

 
77,805,014

Net income (loss) per common share
$
0.01

 
$
0.02

 
$
(0.04
)
 
$
(0.01
)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
Net income (loss) attributable to Nobilis Health Corp.
$
885

 
$
1,585

 
$
(2,967
)
 
$
(813
)
Dilutive effect of convertible debt interest
49

 

 

 

Net income (loss) attributable to Nobilis Health Corp. after assumed conversion
$
934

 
$
1,585

 
$
(2,967
)
 
$
(813
)
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
78,186,000

 
77,805,014

 
78,184,907

 
77,805,014

Dilutive effect of stock options and convertible debt
3,967,945

 
310,228

 

 

Diluted weighted average common shares for assumed conversion
82,153,945

 
78,115,242

 
78,184,907

 
77,805,014

Net income (loss) per common share
$
0.01

 
$
0.02

 
$
(0.04
)
 
$
(0.01
)
Since the Company reflected a net loss during the six months ended June 30, 2018 and 2017, the effect of considering any common stock equivalents would have been anti-dilutive. As a result, a separate computation of dilutive loss per share is not presented.
NOTE 14 – NONCONTROLLING INTERESTS
Interests held by unaffiliated parties in consolidated entities are reflected in noncontrolling interest, which represents the noncontrolling partners' share of the underlying net assets of our consolidated subsidiaries. Noncontrolling interest that is not redeemable is reported in the equity section of the consolidated balance sheets.
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 June 30, 2018 and December 31, 2017. 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 at June 30, 2018 and December 31, 2017 (in thousands):

21



 
NHC - ASC Dallas
 
First Nobilis
 
Total
 
 
 
 
 
 
Balance at January 1, 2017
$
397

 
$
13,907

 
$
14,304

Distributions

 

 

Net income attributable to noncontrolling interests
149

 
2,708

 
2,857

Total contingently redeemable noncontrolling interests at December 31, 2017
$
546

 
$
16,615

 
$
17,161

 
 
 
 
 
 
Balance at January 1, 2018
$
546

 
$
16,615

 
$
17,161

Distributions

 
(1,617
)
 
(1,617
)
Net income (loss) attributable to noncontrolling interests
(11
)
 
232

 
221

Total contingently redeemable noncontrolling interests at June 30, 2018
$
535

 
$
15,230

 
$
15,765

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 VIEs for which we are the primary beneficiary. In order to determine whether we own a variable interest in a VIE, we perform a 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 VIEs 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 VIEs 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 VIEs health care facilities, and (ii) as a result of our obligation to absorb losses and the right to receive residual returns that could potentially be significant to the VIE, which we have through our equity interests.
The following table summarizes the carrying amount of the assets and liabilities of our material VIEs included in the Company’s Consolidated Balance Sheets (in thousands):
 
June 30, 2018
 
December 31, 2017
 
 
 
 
Total cash and short term investments
$
973

 
$
1,709

Total trade accounts receivable
20,883

 
25,385

Intercompany (1)
9,181

 
9,021

Total other current assets
1,663

 
1,918

Total property and equipment
14,020

 
15,457

Total other assets
190

 
190

Total assets
$
46,910

 
$
53,680

 
 
 
 
Total accounts payable
$
5,400

 
$
3,617

Total other liabilities
1,458

 
1,662

Intercompany (1)
42,829

 
41,201

Total accrued liabilities
9,459

 
14,057

Long term - capital lease
10,714

 
11,407

Total liabilities
$
69,860

 
$
71,944

(1) These intercompany balances are due to/from other Nobilis entities and eliminate upon consolidation of Nobilis Health Corp. The intercompany liabilities net of receivables indicate the VIE's indebtedness to the Company and represents the amounts the Company has advance to these entities over the past years to fund operations.

22



NOTE 15 – INCOME TAXES
The Company is a corporation subject to federal income tax at a statutory rate of 21% of pretax earnings. The Company estimates an annual effective income tax rate of 19.7% for U.S. and none for Canada based on the projected results for the year and applies this rate to income before taxes to calculate income tax expense.
The net tax benefit for the six months ended June 30, 2018 was $0.2 million, resulting in an effective tax rate of approximately 13.0%, compared to an income tax expense of $0.7 million with an effective tax rate of approximately 39.9% for the prior corresponding period, which was subject to a federal income tax statutory rate of 35%. The net tax expense amount includes $0.6 million tax expense for states in which the Company operates for each of the six months ended June 30, 2018 and 2017. The Company did not recognize any foreign tax expense or benefit for the six months ended June 30, 2018 and 2017, as the Company had a full valuation allowance against deferred tax assets.
The following items caused the first quarter effective income tax rate to be different from the statutory rate:
Canada is excluded from the worldwide annual effective tax rate calculation because Canada has historical ordinary losses but does not expect to recognize them and has recorded a full valuation allowance, which increases the effective tax rate by approximately 0.1% for the six months ended June 30, 2018.
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 Company’s earnings allocated to its noncontrolling interests, which increases the effective tax rate by approximately 4.6% for the six months ended June 30, 2018.
Based on management’s analysis, the Company did not have any uncertain tax positions as of June 30, 2018.

23



NOTE 16 – BUSINESS SEGMENT INFORMATION
A summary of the business segment information for the three and six months ended June 30, 2018 and 2017 is as follows (in thousands):
 
Three Months Ended June 30, 2018
 
Medical
Marketing
Corporate
Total
 
 
 
 
 
Revenues
$
65,341

$
3,848

$

$
69,189

Operating expenses
54,825

3,330


58,155

Corporate costs


6,904

6,904

Income (loss) from operations
10,516

518

(6,904
)
4,130

Change in fair value of warrant and option liabilities



(217
)
(217
)
Interest expense
558


2,734

3,292

Other income
(252
)

(928
)
(1,180
)
Income (loss) before income taxes
$
10,210

$
518

$
(8,493
)
$
2,235

 
 
 
 
 
Other data:
 
 
 
 
     Depreciation and amortization expense
$
4,749

$
365

$
94

$
5,208

     Income tax expense
$
437

$
5

$
53

$
495

     Capital expenditures
$
586

$
42

$
69

$
697

 
Three Months Ended June 30, 2017
 
Medical
Marketing
Corporate
Total
 
 
 
 
 
Revenues
$
77,122

$
2,840

$

$
79,962

Operating expenses
61,899

3,975


65,874

Corporate costs


6,703

6,703

Income (loss) from operations
15,223

(1,135
)
(6,703
)
7,385

Change in fair value of warrant and option liabilities



188

188

Interest expense (income)
258

(8
)
1,113

1,363

Other expense
$
305

$

25

330

Income (loss) before income taxes
$
14,660

$
(1,127
)
$
(8,029
)
$
5,504

 
 
 
 
 
Other data:
 
 
 
 
     Depreciation and amortization expense
$
2,297

$
431

$
80

$
2,808

     Income tax expense
$
131

$
27

$
2,091

$
2,249

     Capital expenditures
$
1,637

$
1,090

$
100

$
2,827


24



 
Six Months Ended June 30, 2018
 
Medical
Marketing
Corporate
Total
 
 
 
 
 
Revenues
$
128,943

$
4,590

$

$
133,533

Operating expenses
111,296

5,955


117,251

Corporate costs


13,984

13,984

Income (loss) from operations
17,647

(1,365
)
(13,984
)
2,298

Change in fair value of warrant and option liabilities



(156
)
(156
)
Interest expense
820


5,357

6,177

Other income
(1,225
)

(888
)
(2,113
)
Income (loss) before income taxes
$
18,052

$
(1,365
)
$
(18,297
)
$
(1,610
)
 
 
 
 
 
Other data:
 
 
 
 
     Depreciation and amortization expense
$
9,022

$
723

$
188

$
9,933

     Income tax expense (benefit)
$
691

$
45

$
(945
)
$
(209
)
Intangible assets, net
$
52,286

$
10,409

$

$
62,695

Goodwill
$
97,059

$
19,013

$

$
116,072

     Capital expenditures
$
1,009

$
53

$
276

$
1,338

Total assets
$
337,509

$
47,354

$
31,308

$
416,171

Total liabilities
$
70,265

$
7,944

$
132,474

$
210,683

 
Six Months Ended June 30, 2017
 
Medical
Marketing
Corporate
Total
 
 
 
 
 
Revenues
$
141,928

$
6,336

$

$
148,264

Operating expenses
122,357

7,608


129,965

Corporate costs


14,049

14,049

Income (loss) from operations
19,571

(1,272
)
(14,049
)
4,250

Change in fair value of warrant and option liabilities


(187
)
(187
)
Interest expense (income)
518

(8
)
2,108

2,618

Other (income) expense
(25
)
(8
)
105

72

Income (loss) before income taxes
$
19,078

$
(1,256
)
$
(16,075
)
$
1,747

 
 
 
 
 
Other data:
 
 
 
 
   Depreciation and amortization expense
$
4,254

$
812

$
163

$
5,229

   Income tax expense
$
444

$
55

$
199

$
698

   Intangible assets, net
$
8,610

$
12,159

$

$
20,769

   Goodwill
$
50,386

$
19,011

$

$
69,397

   Capital expenditures
$
4,253

$
2,215

$
168

$
6,636

   Total assets
$
219,977

$
45,785

$
44,327

$
310,089

   Total liabilities
$
65,334

$
6,720

$
80,392

$
152,446



25



NOTE 17 – RELATED PARTY TRANSACTIONS
In March 2016, the Company acquired an interest in Athelite, a holding company which owns an interest in Dallas Metro, a company formed to provide management services to an HOPD. The Athelite investment is accounted for as an equity method investment (refer to Note 4 - Investments in associates). At June 30, 2018, the Company had $3.8 million in trade accounts receivable from the HOPD.
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 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 nil and $0.4 million to the entity during the six months ended June 30, 2018 and 2017, respectively.
In September 2014, the minority interest holder of a fully consolidated entity, who is also a partial owner of two other hospitals, entered into an ongoing business relationship with the Company. At June 30, 2018, the Company has a net amount due from these related parties of $5.4 million. In addition, the Company leases certain medical equipment and facility space from these related parties. Equipment lease costs of $1.0 million and $1.1 million were incurred during the six months ended June 30, 2018 and 2017, respectively. Facility lease costs of $0.9 million were incurred during both the six months ended June 30, 2018 and 2017, respectively.
In October 2014, the Company entered into a management agreement with an entity controlled by a physician equity owner. In June 2015, the Company expanded the relationship with this physician equity owner and an entity owned by the physician equity owner's wife to include consulting, marketing, medical supplies, medical directorship and on-call agreements (collectively "service agreements"). The Company incurred expenses of $0.3 million and $1.5 million in fees owed pursuant to the management agreement to the entity during the six months ended June 30, 2018 and 2017, respectively. The Company has incurred expenses of $0.7 million and $4.3 million in fees owed pursuant to the service agreements to the entity during the six months ended June 30, 2018 and 2017, respectively.
In April 2017, the minority interest holder of a fully consolidated entity, who is also a member of the Company's board of directors, entered into an ongoing business relationship with the Company. The Company incurred expenses of $0.5 million during the six months ended June 30, 2018. At June 30, 2018, the Company has a net amount due to this related party of $0.1 million.
NOTE 18 – COMMITMENTS AND CONTINGENCIES
Litigation
In the normal course of our business, we are subject to legal proceedings brought by or against us and our subsidiaries, including claims for damages for personal injuries, medical malpractice, breach of contracts, and employment related claims. In certain of these actions, plaintiffs request payment for damages, including punitive damages that may not be covered by insurance. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially impact the financial position, results of operations or liquidity of the Company.
A statement of claim (complaint), Vince Capelli v. Nobilis Health Corp. et. al, was filed on January 8, 2016 in the Ontario Superior Court of Justice under court file number CV-16-544173 naming Nobilis Health Corp., certain current and former officers and the Company’s former auditors as defendants. The statement of claim seeks to advance claims on behalf of the plaintiff and on behalf of a class comprised of certain of our shareholders related to, among other things, alleged certain violations of the Ontario Securities Act and seeks damages in the amount of $80 million Canadian dollars plus interest. The defendants intend to vigorously defend against these claims. At this time, the Company believes it is too early to provide a realistic estimate of the Company’s exposure.

26



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements
This Quarterly Report and the documents that are incorporated herein by reference contain certain forward-looking statements within the meaning of Canadian and United States securities laws, including the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended. Forward-looking statements include all statements that do not relate solely to historical or current facts and may be identified by the use of words including, but not limited to the following: “may,” “believe,” “will,” “expect,” “project,” “estimate,” “anticipate,” “plan,” “continue” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. These forward-looking statements are based on the Company's current plans and expectations and are subject to a number of risks, uncertainties and other factors which could significantly affect current plans and expectations and our future financial condition and results. These factors, which could cause actual results, performance and achievements to differ materially from those anticipated, include, but are not limited to the following:
our ability to successfully maintain effective internal controls over financial reporting;
our ability to implement our business strategy, manage the growth in our business, and integrate acquired businesses;
the risk of litigation and investigations, and liability claims for damages and other expenses not covered by insurance;
the risk that payments from third-party payers, including government healthcare programs, may decrease or not increase as costs increase;
adverse developments affecting the medical practices of our physician limited partners;
our ability to maintain favorable relations with our physician limited partners;
our ability to grow revenues by increasing case and procedure volume while maintaining profitability;
failure to timely or accurately bill for services;
our ability to compete for physician partners, patients and strategic relationships;
the risk of changes in patient volume and patient mix;
the risk that laws and regulations that regulate payments for medical services made by government healthcare programs could cause our revenues to decrease;
the risk that contracts are canceled 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 2017 Annual Report filed with the SEC on March 12, 2018.
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 2017 Annual Report.

27



Executive Overview
Our operations consist of two reportable business segments, the Medical Segment and the Marketing Segment, each of which is described in more detail in the following paragraphs. Our Medical Segment owns and manages specialty surgical hospitals, ambulatory surgery centers (ASCs) and multi-specialty clinics. It focuses on improving patient outcomes by providing minimally invasive procedures that can be performed in low-cost, outpatient settings. To promote further improvements in patient satisfaction and clinical outcomes, Nobilis has spent the last two years developing a full suite of ancillary services that we offer patients treated in our facilities. To date, Nobilis is able to provide a variety of in-house ancillary services, such as Anesthesia, Surgical Assist, Intraoperative Neuromonitoring ("IOM"), and clinical lab testing (collectively, "Nobilis Ancillary Service Lines").
Our business also utilizes innovative direct-to-consumer marketing and proprietary technologies to drive patient engagement and education. Our Marketing Segment provides these services to the facilities that comprise our Medical Segment; we also provide these services to third parties as a stand-alone service.
Our portfolio of specialty surgical hospitals, ASCs and multi-specialty clinics is complemented by our Marketing Segment, which allows us to operate those facilities in many instances with few, if any, physician partners. Our differentiated business strategy provides value to patients, physicians and payors, and enables us to capitalize on recent trends in the healthcare industry, particularly with regard to increased consumerism in the healthcare space. As a result, we believe we are positioned for continued growth.
In 2018 we will continue to expand the continuum of care that we offer our patients by furthering the integration of primary care physician practices into our business model. Through the alignment of primary care physicians, which includes an array of options from clinical integration to employment, this initiative will allow us to grow our referral based business, while providing direct exposure to the initial level of patient care and diversifying the services provided throughout our healthcare system. It also affords us the opportunity to broaden marketing services throughout the continuum of care and match the healthcare needs of patients, all while maintaining a focus on patient outcomes and satisfaction. Our engagement of primary care physicians at the clinical level will continue to drive contracted revenues and Management’s ongoing efforts to strengthen our revenue platform.
Our pipeline of acquisition targets is robust and varies by geography. We will be opportunistic in choosing the order of these acquisitions and will make our decisions based on geographic location, existing and potential physician relationship and marketing opportunities within the targeted market.
On October 28, 2016 and March 8, 2017, we purchased Arizona Vein and Vascular Center, LLC and its four affiliated surgery centers operating as Arizona Center for Minimally Invasive Surgery, LLC, (collectively, "AZ Vein") and Hamilton Vein Center (HVC) brand and associated assets, respectively. The acquisitions expanded our specialty mix to include the treatment of venous diseases with little modification to our existing infrastructure of specialty surgical hospitals and ASCs. Our facilities will be able to offer a range of treatments, both surgical and non-surgical, for those patients suffering from venous diseases, which today affect more than 30 million Americans.
In addition to our vein and vascular business acquisitions, on September 13, 2017, we purchased DeRosa Medical, P.C. ("DeRosa"). DeRosa is a primary care practice that specializes in health and wellness, medically supervised weight loss, and chronic health condition management. The practice has three locations in the Phoenix, Arizona metropolitan area: Scottsdale, Chandler, and Glendale. The acquisition of DeRosa allows the Company to enhance our ability to serve patients across the continuum of care, from primary care needs to surgical procedures, utilizing its concierge care delivery model. The addition of DeRosa also complements the existing facilities located in Arizona.
On November 15, 2017, the Company acquired a 50.1% ownership in Elite Surgical Affiliates' ("Elite"), an in-network portfolio that manages three ASCs and one surgical hospital in Houston. The purchase was financed through an expansion of $50.0 million to the Company's current credit facility, cash of $6.1 million, a seller's note of $3.5 million, and stock of $0.5 million. This transaction represents the Company's largest acquisition to date and provides a significant enhancement to the Company's goal to realize the majority of revenues from in-network managed care contracts. In addition, this acquisition represents an expansion of 76 physician partners to the Houston market network of physicians and provides additional benefits in the form of operational efficiencies, increased company footprint, and an increase to available resources.
During the fourth quarter of 2017, the Company began operations at Mountain West Surgical Center (ASC) located in El Paso, Texas and Uptown Surgical Center (ASC) in Dallas, Texas. These ASCs will provide similar multi-specialty services to the current brands the Company markets to customers and those currently performed at other company owned facilities. These ASCs generate revenue through in-network contracts and progress the Company's overall in-network contributions to revenue while also capturing additional patients in the Dallas, West Texas, and New Mexico markets.
Our growth strategy focuses on:
Driving organic growth in facilities that we own and operate; and
Executing a disciplined acquisition strategy that results in accretive acquisitions.


28



Medical Segment
Our Medical Segment broadly includes our ownership or operation of healthcare facilities (the “Nobilis Facilities”) (which include specialty surgical hospitals, ASCs and multi-specialty clinics) and Nobilis Ancillary Service Lines.
As of June 30, 2018, there are 33 Nobilis Facilities, consisting of 5 specialty surgical hospitals (4 in Texas and 1 in Arizona) (the "Nobilis Hospitals"), 13 ASCs (9 in Texas and 4 in Arizona) and 15 multi-specialty clinics (8 in Texas and 7 in Arizona), partnered with 34 facilities across the country and 9 marketed brands. We earn revenue in our Medical Segment from the “facility fees” or “technical fees” from third party payors or patients for the services rendered at the Nobilis Facilities. The Nobilis Facilities are each licensed in the state where they are located and provide surgical procedures in a limited number of clinical specialties, which enables them to develop routines, procedures, and protocols to maximize operating efficiency and productivity while offering an enhanced healthcare experience for both physicians and patients.
These clinical specialties include musculoskeletal surgery, orthopedic surgery, podiatric surgery, vein and vascular, ear nose and throat (ENT) surgery, pain management, gastro-intestinal surgery, gynecology and general surgery. The Nobilis ASCs do not offer the full range of services typically found in traditional hospitals.
Marketing Segment
Our Marketing Segment provides marketing services, patient education services and patient care coordination management services to the Nobilis Facilities, to third party facilities in states where we currently do not operate, and to physicians. We market several minimally-invasive medical procedures and brands, which include the following:
North American Spine: promotion of minimally invasive spine procedures (pain management, musculoskeletal and spine);
Migraine Treatment Centers of America: promotion of procedures related to chronic migraine pain (interventional headache procedure);
NueStep: promotion of surgical procedures designed to treat pain in the foot, ankle and leg (podiatry);
Evolve: The Experts in Weight Loss Surgery: promotion of surgical weight loss procedures (bariatrics);
Minimally Invasive Reproductive Surgery Institute (“MIRI”): promotion of women’s health related procedures;
Onward Orthopedics: promotion of general orthopedics, sports medicine related to orthopedics (orthopedics and pain management interventions);
Clarity Vein and Vascular: promotion of cosmetic and medical vein and vascular treatments; and
Arizona Vein and Vascular Center: promotion of cosmetic and medical vein and vascular treatments.
Hamilton Vein Center: promotion of cosmetic and medical vein and vascular treatments.
Our Marketing Segment does not directly provide medical services to patients; rather, we identify candidates for our branded procedures, educate these potential patients about the relevant procedure and direct those patients to affiliated physicians who diagnose and treat those patients at affiliated facilities. Through our Marketing Segment, we have contractual relationships with facilities and physicians in several states.
We earn service fees from our partner facilities that, depending on the laws of the state in which a partner facility is located, are either charged as a flat monthly fee or are calculated based on a portion of the “facility fee” revenue generated by the partner facility for a given procedure.
Our revenues from physician-related services are, depending on the laws of the state in which a partner-physician practices, either earned directly from professional fees or through the purchase of trade accounts receivable. In Texas, we engage physicians through entities exempt from Texas corporate practice of medicine laws that directly earn professional fees for partner-physician services and, in turn, pay partner-physicians a reasonable fee for rendering those professional services. In other states, we manage our partner-physicians’ practices and purchase the trade accounts receivable at a discount of those practices through trade accounts receivable purchase agreements, consistent with the laws in those states. The revenues generated from certain trade accounts receivables purchased from third parties in the ordinary course of business represents our factoring revenues.
Seasonality of the Business
The surgical segment of the healthcare industry tends to be impacted by seasonality because most benefit plans reset on a calendar year basis. As patients utilize and reduce their remaining deductible, Nobilis Facilities typically experience an increase in volume throughout the year, with the biggest impact coming in the fourth quarter. Historically, approximately 35% - 40% of our annual revenues have been recognized in the fourth quarter.

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Operating Environment
The Medical Segment depends primarily upon third-party reimbursement from private insurers to pay for substantially all of the services rendered to our patients. The majority of the revenues attributable to the Medical Segment are from reimbursement to the Nobilis Hospitals and Nobilis ASCs as “out-of-network” providers. This means the Nobilis Facilities are not contracted with a major medical insurer as an “in-network” participant. Participation in such networks offer the benefit of larger patient populations and defined, predictable payment rates. The reimbursement to in-network providers, however, is typically far less than that paid to out of network providers. To a far lesser degree, the Nobilis Facilities earn fees from governmental payor programs such as Medicare. For the three months ended June 30, 2018 and 2017, we derived approximately 1.7% and 1.3% for the respective periods of our Medical Segment’s net revenues from governmental healthcare programs, primarily Medicare and managed Medicare programs, and the remainder from a wide mix of commercial payers and patient co-pays, coinsurance, and deductibles.
We receive a relatively small amount of revenue from Medicare. We also receive a relatively small portion of revenue directly from uninsured patients, who pay out of pocket for the services they receive.
Insured patients are responsible for services not covered by their health insurance plans, deductibles, co-payments and co-insurance obligations under their plans. The amount of these deductibles, co-payments and co-insurance obligations has increased in recent years but does not represent a material component of the revenue generated by the Nobilis Facilities. The surgical center fees of the Nobilis Facilities are generated by the physician limited partners and the other physicians who utilize the Nobilis Facilities to provide services.
Revenue Model and Case Mix
Revenues earned by the Nobilis Facilities vary depending on the procedures performed. For every medical procedure performed there are usually three separately invoiced patient billings:
the surgical center fee for the use of infrastructure, surgical equipment, nursing staff, non-surgical professional services, supplies and other support services, which is earned by the Nobilis Facilities;
the professional fee, which is separately earned, billed and collected by the physician performing the procedure, separate and apart from the fees charged by the Nobilis Facilities; and
the anesthesiology fee, which is separately earned, billed and collected by the anesthesia provider, separate and apart from the fees charged by the Nobilis Facilities and the physicians.
Overall facility revenue depends on procedure volume, case mix and payment rates of the respective payors.

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Three Months Ended June 30, 2018 and 2017
(in thousands)
 
 
 
 
Three Months Ended June 30,
 
 
 
 
2018

2017
Revenues:
 
 
 
 
 
 
  Net patient and professional fees
 
 
 
$
64,479

 
$
77,073

  Contracted marketing revenues
 
 
 
2,309

 
1,573

  Factoring revenues
 
 
 
1,561

 
1,316

  Other revenue
 
 
 
840

 

    Total revenues
 
 
 
69,189

 
79,962

Operating expenses:
 
 
 
 
 
 
  Salaries and benefits
 
 
 
16,187

 
15,417

  Drugs and supplies
 
 
 
10,501

 
12,579

  General and administrative
 
 
 
26,353

 
35,150

  Depreciation and amortization
 
 
 
5,114

 
2,728

    Total operating expenses
 
 
 
58,155

 
65,874

Corporate expenses:
 
 
 
 
 
 
  Salaries and benefits
 
 
 
2,975

 
3,623

  General and administrative
 
 
 
3,197

 
2,595

  Legal expenses
 
 
 
638

 
405

  Depreciation
 
 
 
94

 
80

    Total corporate expenses
 
 
 
6,904

 
6,703

Income from operations
 
 
 
4,130

 
7,385

Other (income) expense:
 
 
 
 
 
 
  Change in fair value of warrant and stock
option derivative liabilities
 
 
 
(217
)
 
188

  Interest expense
 
 
 
3,292

 
1,363

  Other (income) expense, net
 
 
 
(1,180
)
 
330

    Total other expense
 
 
 
1,895

 
1,881

Income (Loss) before income taxes and noncontrolling interests
 
 
 
2,235

 
5,504

Income tax expense (benefit), net
 
 
 
495

 
2,249

Net income (loss)
 
 
 
$
1,740

 
$
3,255

Revenues
Total revenues for the three months ended June 30, 2018, totaled $69.2 million, a decrease of $10.8 million or 13.5%, compared to $80.0 million in the prior corresponding period. Total cases increased by 1,644 to 6,241 cases, or 35.8%, compared to 4,597 cases in the prior corresponding period. Medical Segment revenues decreased by $11.8 million to $65.3 million or 15.3%, compared to $77.1 million in the prior corresponding period, and the Marketing Segment increased by $1.0 million.
Salaries and Benefits
Operating salaries and benefits for the three months ended June 30, 2018, totaled $16.2 million, an increase of $0.8 million or 5.0%, compared to $15.4 million in the prior corresponding period. The Medical Segment increased by $0.4 million or 3.0%, while the Marketing Segment increased by $0.4 million or 16.1%, from the prior corresponding period.
Drugs and Supplies
Drugs and supplies expense for the three months ended June 30, 2018, totaled $10.5 million, a decrease of $2.1 million or 16.5%, compared to $12.6 million in the prior corresponding period.




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General and Administrative
Operating general and administrative expense for three months ended June 30, 2018, totaled $26.4 million, a decrease of $8.8 million or 25.0%, compared to $35.2 million in the prior corresponding period. The Medical Segment accounted for $8.0 million of the decrease and the Marketing Segment made up the remaining $0.8 million of the decrease.
Depreciation and Amortization
Operating depreciation for the three months ended June 30, 2018, totaled $5.1 million, an increase of $2.4 million or 87.5%, compared to $2.7 million in the prior corresponding period. This increase is primarily due to the additional depreciation expense incurred related to acquired equipment and intangible assets through acquisitions of Elite and DeRosa within our Medical Segment.
Total Corporate Costs
To illustrate our operational efficiency, corporate costs are presented separate of operating expenses of the revenue generating facilities. Corporate costs totaled $6.9 million, an increase of $0.2 million or 3.0%, compared to $6.7 million in the prior corresponding period.
Salaries and benefits for the three months ended June 30, 2018, totaled $3.0 million, a decrease of $0.6 million or 17.9%, compared to $3.6 million in the prior corresponding period. General and administrative expenses for the three months ended June 30, 2018, totaled $3.2 million, an increase of $0.6 million or 23.2%, compared to $2.6 million in the prior corresponding period. The increase in general and administrative expense was primarily attributable to an increase in share based compensation expenses and infrastructure enhancement of revenue cycle. Legal expenses for the three months ended June 30, 2018, totaled $0.6 million, an increase of $0.2 million or 57.5%, compared to $0.4 million from the prior corresponding period.
Other Expense (Income)
For the three months ended June 30, 2018, the Company recognized $1.9 million of other expense compared to $1.9 million in the prior corresponding period. Interest expense increased $1.9 million in the current period as a result of an increase in borrowings and amortization of debt issuance costs, partially offset by an increase of $1.5 million in other income and a change in warrant and stock option derivative liability of $0.4 million.
The 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. All of the warrants previously issued expired in first half of 2017.
Income Tax Expense (Benefit), Net
The net tax expense for the three months ended June 30, 2018 was $0.5 million, compared to an income tax expense of $2.2 million in the prior corresponding period. For the three months ended June 30, 2018, the effective tax rate differs from the annual tax rate primarily due to 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 June 30, 2018. Our effective tax rate during the three months ended June 30, 2018 was approximately 22.1%. The Company estimates an annual effective income tax rate of 19.4% 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 revenues and case volume for our facilities as of the three months ended June 30, 2018 and 2017 (in thousands, except case and per case data):
 
Three Months Ended June 30,
 
Net Revenues
(in thousands)
 
Number of Cases
 
 Net Revenues
per Case (2)
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
 
 
 
Hospitals
$
43,674

 
$
50,858