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EX-32.2 - EXHIBIT 32.2 - NantHealth, Inc.exhibit3229302016.htm
EX-32.1 - EXHIBIT 32.1 - NantHealth, Inc.exhibit3219302016.htm
EX-31.2 - EXHIBIT 31.2 - NantHealth, Inc.exhibit3129302016.htm
EX-31.1 - EXHIBIT 31.1 - NantHealth, Inc.exhibit3119302016.htm
EX-10.1 - EXHIBIT 10.1 - NantHealth, Inc.exhibit1019302016.htm
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 
FORM 10‑Q

 
(Mark One)
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016  
OR
o    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: 001-37792

 
NANTHEALTH, INC.
(Exact name of registrant as specified in its charter)

 
 
Delaware
 
27-3019889
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

9920 Jefferson Blvd
Culver City, California
 
90230
(Address of principal executive offices)
 
(Zip Code)
(310) 883-1300
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
Common Stock, $0.0001 par value
 
NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act: None

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
¨
Accelerated filer
o
 
 
 
 
Non-accelerated filer
x  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
As of November 9, 2016 the registrant had 121,239,975 shares of common stock, par value $0.0001 per share, outstanding.
 


NANTHEALTH, INC.
AS OF AND FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2016

TABLE OF CONTENTS
   

 
 
Page
PART I.
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
PART II.
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 

We own or have rights to trademarks and service marks that we use in connection with the operation of our business. NantHealth, Inc. and our logo as well as other brands such as CareFx, our clinical operating system, cOS or NantOS, DeviceConX, FusionFX, GPS Cancer, HBox, Vitality, VitalsConX, NaviNet, CLINICS, eviti, eviti | Connect, eviti | IQ, and other marks relating to our eviti product line are used in this Quarterly Report on Form 10-Q. Solely for convenience, the trademarks and service marks referred to in this Quarterly Report on Form 10-Q are listed without the (sm) and (TM) symbols, but we will assert, to the fullest extent under applicable law, our rights or the rights of the applicable licensors to these trademarks, service marks and trade names. Additionally, we do not intend for our use or display of other companies’ trade names, trademarks, or service marks to imply a relationship with, or endorsement or sponsorship of us by, these other companies.

- 2 -


SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including without limitation the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors,” contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In some cases you can identify these statements by forward-looking words such as “believe,” “may,” “will,” “might,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “should,” “would,” “project,” “plan,” “outlook,” “target,” “expect,” or similar expressions, or the negative or plural of these words or expressions. These forward-looking statements include, but are not limited to, statements concerning the following:
the structural change in the market for healthcare in the United States, including uncertainty in the healthcare regulatory framework and regulatory developments in the United States and foreign countries;
the evolving treatment paradigm for cancer, including physicians’ use of molecular information and targeted oncology therapeutics and the market size for molecular information products;
physicians’ need for precision medicine products and any perceived advantage of our solutions over those of our competitors, including the ability of our comprehensive platform to help physicians treat their patients’ cancers;
our ability to generate revenue from sales of products enabled by our molecular and biometric information platforms to physicians in clinical settings;
our ability to increase the commercial success of our sequencing and molecular analysis solution;
our plans or ability to obtain reimbursement for our sequencing and molecular analysis solution, including expectations as to our ability or the amount of time it will take to achieve successful reimbursement from third-party payors, such as commercial insurance companies and health maintenance organizations, and government insurance programs, such as Medicare and Medicaid;
our ability to effectively manage our growth, including the rate and degree of market acceptance of our solutions;
our ability to offer new and innovative products and services;
our ability to attract new partners and clients;
our ability to estimate the size of our target market;
our ability to maintain and enhance our reputation and brand recognition;
consolidation in the healthcare industry;
competition which could limit our ability to maintain or expand market share within our industry;
restrictions and penalties as a result of privacy and data protection laws;
our use of “open source” software;
our ability to use, disclose, de-identify or license data and to integrate third-party technologies;
data loss or corruption due to failures or errors in our systems and service disruptions at our data centers;
breaches or failures of our security measures;
our reliance on Internet infrastructure, bandwidth providers, data center providers, other third parties and our own systems for providing services to our users;
risks related to future acquisition opportunities;
the requirements of being a public company;
our ability to attract and retain key personnel;
our ability to obtain and maintain intellectual property protection for our solutions and not infringe upon the intellectual property of others; and
our financial performance expectations, including our expectations regarding our revenue, cost of revenue, gross profit or gross margin, operating expenses, including changes in research and development, sales and marketing and general and administrative expenses, and our ability to achieve and maintain future profitability.
We caution you that the foregoing list does not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q.
These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those reflected in the forward-looking statements. These statements appear throughout this Quarterly Report on Form 10-Q and are statements regarding our intent, belief, or current expectations, primarily based on our current assumptions, expectations and projections about future events and trends that we may affect our business, financial conditions, operations results, cash flows or prospects, as well as related industry developments. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us and described in Part II, Item 1A, entitled “Risk Factors,” and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2 of this Quarterly Report on Form 10-Q. We undertake no obligation to update any forward-looking statements for any reason, or to conform these statements to actual results or to changes in our expectations.

- 3 -


PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
NantHealth, Inc.
Condensed Consolidated and Combined Balance Sheets
(In thousands, except share and per share amounts)
 
September 30,
2016
 
December 31,
2015
 
(Unaudited)
 
 
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
75,801

 
$
5,989

Marketable securities

 
1,243

Accounts receivable, net
12,928

 
11,472

Inventories
1,802

 
2,146

Deferred implementation costs
4,539

 
2,224

Related party receivables, net
882

 
1,245

Prepaid expenses and other current assets
5,803

 
8,707

Total current assets
101,755

 
33,026

Property, plant, and equipment, net
29,412

 
13,899

Deferred implementation costs, net of current
7,109

 
1,930

Goodwill
132,729

 
56,718

Intangible assets, net
124,645

 
54,971

Investment in related party
240,297

 
248,191

Related party receivable, net of current
1,987

 
1,300

Other assets
2,277

 
1,918

Total assets
$
640,211

 
$
411,953

 
 
 
 
Liabilities and Stockholders' / Members' Equity
 
 
 
Current liabilities
 
 
 
Accounts payable
$
6,540

 
$
6,447

Accrued expenses
23,027

 
15,967

Deferred revenue
17,180

 
10,656

Related party payables, net
7,530

 
10,166

Total current liabilities
54,277

 
43,236

Deferred revenue, net of current
16,750

 
17,312

Related party interest payable
4,171

 

Related party promissory note
112,666

 

Deferred income taxes, net
780

 

Other liabilities
428

 
358

Total liabilities
189,072

 
60,906

 
 
 
 
Redeemable Series F units: 53,580,996 units issued and outstanding at December 31, 2015

 
166,042

 
 
 
 
Stockholders' / members' equity
 
 
 
Members' equity, 541,228,171 units issued and outstanding at December 31, 2015 (Note 16)

 
476,263

Common stock, $0.0001 par value per share, 750,000,000 shares authorized; 121,236,673 shares issued and outstanding at September 30, 2016
12

 

Additional paid-in capital
865,889

 

Accumulated deficit
(415,322
)
 
(291,171
)
Accumulated other comprehensive income (loss)
560

 
(87
)
Total stockholders' / members' equity
451,139

 
185,005

Total liabilities and stockholders' / members' equity
$
640,211

 
$
411,953

The accompanying notes are an integral part of these Condensed Consolidated and Combined Financial Statements.


- 4 -

NantHealth, Inc.
Condensed Consolidated and Combined Statements of Operations
(In thousands, except share and per share amounts)
(Unaudited)

 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
Software and hardware
$
2,391

 
$
4,493

 
$
7,214

 
$
12,196

Software–as-a-service
14,603

 
4,143

 
43,485

 
11,361

Total software-related revenue
16,994

 
8,636

 
50,699

 
23,557

Maintenance
3,204

 
2,897

 
10,854

 
7,937

Sequencing and molecular analysis
77

 
75

 
122

 
75

Other services
5,082

 
2,797

 
14,623

 
6,330

Total net revenue
25,357

 
14,405

 
76,298

 
37,899

 
 
 
 
 
 
 
 
Cost of Revenue:
 
 
 
 
 
 
 
Software and hardware
764

 
74

 
1,438

 
(297
)
Software-as-a-service
4,930

 
1,670

 
18,667

 
5,460

Total software-related cost of revenue
5,694

 
1,744

 
20,105

 
5,163

Maintenance
702

 
694

 
1,975

 
906

Sequencing and molecular analysis
570

 
39

 
929

 
39

Other services
6,564

 
6,725

 
17,621

 
10,402

Amortization of developed technologies
3,706

 
2,889

 
11,884

 
7,446

Total cost of revenue
17,236

 
12,091

 
52,514

 
23,956

 
 
 
 
 
 
 
 
Gross profit
8,121

 
2,314

 
23,784

 
13,943

 
 
 
 
 
 
 
 
Operating Expenses:
 
 
 
 
 
 
 
Selling, general and administrative
24,715

 
18,147

 
99,336

 
52,386

Research and development
13,855

 
7,027

 
48,871

 
16,677

Amortization of software license and acquisition-related assets
1,814

 
760

 
5,442

 
782

Total operating expenses
40,384

 
25,934

 
153,649

 
69,845

Loss from operations
(32,263
)
 
(23,620
)
 
(129,865
)
 
(55,902
)
Interest income (expense), net
(1,415
)
 
1

 
(4,671
)
 
(627
)
Other income (expense), net
(336
)
 
662

 
(75
)
 
2,517

Loss from related party equity method investment
(2,604
)
 

 
(7,893
)
 
(145
)
Loss before income taxes
(36,618
)
 
(22,957
)
 
(142,504
)
 
(54,157
)
Provision for (benefit from) income taxes
256

 
1

 
(18,353
)
 
2

Net loss
$
(36,874
)
 
$
(22,958
)
 
$
(124,151
)
 
$
(54,159
)
 
 
 
 
 
 
 
 
Net income (loss) per share (1):
 
 
 
 
 
 
 
Basic and diluted - common stock
$
(0.30
)
 
$
(0.24
)
 
$
(1.19
)
(2) 
$
(0.62
)
 Basic and diluted - redeemable common stock
N/A

 
N/A

 
$
0.74

 
N/A

 
 
 
 
 
 
 
 
Weighted average shares outstanding (1):
 
 
 
 
 
 
 
Basic and diluted - common stock
121,245,440

 
95,906,797

 
108,359,973

 
86,696,282

 Basic and diluted - redeemable common stock
N/A

 
N/A

 
6,686,653

 
N/A


The accompanying notes are an integral part of these Condensed Consolidated and Combined Financial Statements.

- 5 -

NantHealth, Inc.
Condensed Consolidated and Combined Statements of Operations
(In thousands, except share and per share amounts)
(Unaudited)

(1)
The net loss per share and weighted-average shares outstanding have been computed to give effect to the LLC Conversion (See Note 16) that occurred on June 1, 2016, prior to the Company’s initial public offering ("IPO").  In conjunction with the LLC Conversion, (a) all of the Company’s outstanding units automatically converted into shares of common stock, based on the relative rights of the Company's pre-IPO equityholders as set forth in the Company's limited liability company agreement and (b) the Company adopted and filed a certificate of incorporation with the Secretary of State of the state of Delaware and adopted bylaws. The Company adopted and filed an amendment to its certificate of incorporation with the Secretary of State of the state of Delaware to effect a 1-for-5.5 reverse stock split of its common stock on June 1, 2016. See Note 18 for the calculation of net loss per share for common stock and redeemable common stock for the nine months ended September 30, 2016.
(2)
The net loss per share for the common stock for the nine months ended September 30, 2016 reflects $4,958 in accretion value allocated to the redeemable common stock. The redeemable common stock contained a put right, which expired unexercised on June 20, 2016. As a result of and as of that date, the shares were no longer redeemable and were included in common stock.


The accompanying notes are an integral part of these Condensed Consolidated and Combined Financial Statements.

- 6 -

NantHealth, Inc.
Condensed Consolidated and Combined Statements of Comprehensive Loss
(In thousands)
(Unaudited)


 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Net loss
$
(36,874
)
 
$
(22,958
)
 
$
(124,151
)
 
$
(54,159
)
Other comprehensive income (loss), net of reclassification adjustments and taxes -
 
 
 
 
 
 
 
Foreign currency translation gains (losses)
254

 
(184
)
 
647

 
(186
)
Comprehensive loss
$
(36,620
)
 
$
(23,142
)
 
$
(123,504
)
 
$
(54,345
)
The accompanying notes are an integral part of these Condensed Consolidated and Combined Financial Statements.

- 7 -

NantHealth, Inc.
Condensed Consolidated and Combined Stockholders’ / Members’ Equity
(In thousands, except share amounts)
(Unaudited)

 
Members' Equity
 
Common Stock
 
Additional
Paid-In Capital
 
Accumulated Deficit
 
Accumulated
Other
Comprehensive Income (loss)
 
Total Equity
 
Units
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
541,228,171

 
$
476,263

 

 
$

 
$

 
$
(291,171
)
 
$
(87
)
 
$
185,005

Issuance of membership interests
15,513,726

 
52,500

 

 

 

 

 

 
52,500

Stock-based compensation expense (pre LLC conversion)

 
170

 

 

 

 

 

 
170

Deemed capital contribution from Chairman and CEO (pre LLC conversion

 
830

 

 

 

 

 

 
830

Series F put right accretion (pre LLC conversion)

 
(4,375
)
 

 

 

 

 

 
(4,375
)
Conversion of members' interests
(556,741,897
)
 
(525,388
)
 
99,651,444

 
10

 
525,378

 

 

 

Issuance of common stock upon conversion of related party promissory note

 

 
2,899,297

 

 
40,590

 

 

 
40,590

Issuance of common stock in initial public offering, net of $13,034 in offering costs

 

 
6,900,000

 
1

 
83,565

 

 

 
83,566

Series F put right accretion (post LLC conversion)

 

 

 

 
(583
)
 

 

 
(583
)
Redeemable common stock put right expiration

 

 
10,714,285

 
1

 
170,999

 

 

 
171,000

Stock-based compensation expense (post LLC conversion)

 

 

 

 
49,172

 

 

 
49,172

Shares issued in connection with employee stock plans, net of shares withheld for employee taxes

 

 
1,071,647

 

 
(5,822
)
 

 

 
(5,822
)
Deemed capital contribution from Chairman and CEO (post LLC conversion)

 

 

 

 
2,590

 

 

 
2,590

Other comprehensive income

 

 

 

 

 

 
647

 
647

Net loss

 

 

 

 

 
(124,151
)
 

 
(124,151
)
Balance at September 30, 2016

 
$

 
121,236,673

 
$
12

 
$
865,889

 
$
(415,322
)
 
$
560

 
$
451,139

The accompanying notes are an integral part of these Condensed Consolidated and Combined Financial Statements.

- 8 -

 NantHealth, Inc.
Condensed Consolidated and Combined Statements of Cash Flows
(In thousands)
(Unaudited)

 
Nine Months Ended 
 September 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net loss
$
(124,151
)
 
$
(54,159
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
22,990

 
10,867

Unrealized changes in fair value of marketable securities
(49
)
 
(3,126
)
Realized changes in fair value of marketable securities
49

 
3,359

Stock-based compensation
48,982

 
1,350

Deferred income taxes, net
(18,752
)
 

Provision for bad debt expense
522

 
88

Inventory provision
479

 

Loss from related party equity method investment
7,893

 
145

Other non-cash expense
144

 

Changes in operating assets and liabilities, net of business combinations:
 
 
 
Accounts receivable, net
8,950

 
2,709

Inventories
(135
)
 
839

Related party receivables, net
(324
)
 
302

Prepaid expenses and other current assets
4,883

 
(5,582
)
Deferred implementation costs
(6,695
)
 
(1,783
)
Accounts payable
(4,315
)
 
1,769

Accrued expenses
1,729

 
11,478

Deferred revenue
3,304

 
(12,421
)
Related party payables
2,278

 
(8,064
)
Other assets and liabilities
71

 
(27
)
Net cash used in operating activities
(52,147
)
 
(52,256
)
Cash flows from investing activities:
 
 
 
Purchase of property and equipment
(12,701
)
 
(6,405
)
Investments in unconsolidated related parties

 
(150,816
)
Purchases of intangible asset

 
(5,000
)
Purchases of marketable securities
(31
)
 

Proceeds from sales of marketable securities
1,275

 
97,660

Proceeds from sales of property and equipment
138

 

Purchase of cost method investment

 
(1,750
)
Acquisitions of businesses, net of cash acquired
(79,423
)
 
(50,548
)
Deferred consideration for acquisition
1,949

 
2,494

Net cash used in investing activities
(88,793
)
 
(114,365
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of membership interests

 
200,000

Deemed capital contribution from Chairman and CEO
3,420

 
4,790

Payment of short-term notes payable
(23,324
)
 

Proceeds from (payment of) related party promissory notes
152,666

 
(34,502
)
Proceeds from initial public offering, net of offering costs
83,566

 

Tax payments related to stock issued, net of stock withheld, for vested phantom units
(5,822
)
 

 
210,506

 
170,288

Effect of exchange rate changes on cash and cash equivalents
246

 
(186
)
Net increase in cash and cash equivalents
69,812

 
3,481

Cash and cash equivalents, beginning of period
5,989

 
3,699

Cash and cash equivalents, end of period
$
75,801

 
$
7,180


- 9 -

NantHealth, Inc.
Condensed Consolidated and Combined Statements of Cash Flows (Continued)
(In thousands)
(Unaudited)

 
Nine Months Ended 
 September 30,
 
2016
 
2015
Supplemental disclosure of cash flow information:
 
 
 
Interest paid
$
(358
)
 
$
(2,364
)
Interest received
555

 
447

Non-cash transactions:
 
 
 
Transfer of marketable securities as investment in unconsolidated related party

 
99,184

NaviNet escrow receivable
1,678

 

Accretion to redemption value of Series F / redeemable common stock
4,958

 

Conversion of related party promissory note and interest payable to common stock
40,590

 

Reclassification of redeemable common stock to common stock (former Series F units)
$
171,000

 
$

The accompanying notes are an integral part of these Condensed Consolidated and Combined Financial Statements.

- 10 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)


Note 1. Description of Business and Basis of Presentation
Nature of Business
Nant Health, LLC was formed on July 7, 2010, as a Delaware limited liability company. On June 1, 2016, Nant Health, LLC converted into a Delaware corporation (the “LLC Conversion”) and changed its name to NantHealth, Inc. (“NantHealth”). NantHealth, together with its subsidiaries (the “Company”), is a healthcare cloud-based IT company converging science and technology through a single integrated clinical platform, to provide actionable health information at the point of care. NantHealth is a majority-owned subsidiary of NantWorks, LLC (“NantWorks”), which is a subsidiary of California Capital Equity, LLC (“Cal Cap”). The three companies were founded and are led by Dr. Patrick Soon-Shiong.
As of September 30, 2016, the Company conducted the majority of its operations in the United States, Canada, the United Kingdom, Singapore and India.
Initial Public Offering and LLC Conversion
On June 1, 2016, immediately prior to the pricing of its initial public offering (“IPO”) and in conjunction with the LLC Conversion, all outstanding units of Nant Health, LLC were automatically converted into shares of the Company’s common stock. Immediately following the LLC Conversion, the Company effected a 1-for-5.5 reverse stock split of its common stock. All share and per share amounts in the Condensed Consolidated and Combined Financial Statements and notes thereto have been retroactively adjusted, where necessary, to give effect to this reverse stock split.

On June 7, 2016, the Company completed its IPO, whereby it sold 6,500,000 shares of common stock at a public offering price of $14.00 per share. Additionally, on June 9, 2016, the underwriters partially exercised their over allotment option to purchase an additional 400,000 shares of common stock at $14.00 per share.

The Company received a total of $83,566 in proceeds from its IPO, after deducting underwriting discounts and commissions and offering costs of $13,034. The offering was registered under the Securities Act of 1933, as amended, on a registration statement on Form S-1 (Registration No. 333-211196), as amended (the “Registration Statement”).
Basis of Presentation
The accompanying unaudited Condensed Consolidated and Combined Financial Statements include the accounts of NantHealth and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. These interim Condensed Consolidated and Combined Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). These Financial Statements have been prepared on the same basis as the audited Consolidated and Combined Financial Statements for the fiscal year ended December 31, 2015 and, in the opinion of management, include all adjustments, which are normal and recurring in nature, necessary for a fair presentation of the Company's financial position and results of operation. Certain reclassifications have been made to prior period amounts to conform to the current year presentation. Operating results for interim periods are not necessarily indicative of the results that may be expected for a full fiscal year. The accompanying Condensed Consolidated and Combined Balance Sheet as of December 31, 2015 has been derived from the audited Consolidated and Combined Financial Statements at that date but does not include all of the disclosures required by GAAP.
Principles of Consolidation
The accompanying Condensed Consolidated and Combined Financial Statements include the financial statements of all wholly owned subsidiaries and other entities in which the Company has a controlling financial interest. For consolidated subsidiaries that are less than wholly owned, the third-party holdings of equity interests are referred to as non-controlling interests. All intercompany balances and transactions with the Company’s subsidiaries have been eliminated.

Note 2. Summary of Significant Accounting Policies
With the exception of the incremental software developed for internal use, stock based compensation and net loss per share policies described below, there have been no significant changes to the accounting policies as disclosed in the Company's Registration Statement. The accounting policies described below are included to supplement the disclosure in the Company’s Registration Statement.

- 11 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Condensed Consolidated and Combined Financial Statements and accompanying notes. Actual results may differ from those estimates.
Variable Interest Entities
The Company evaluates its ownership interests, contractual rights and other interests in entities to determine if the entities are variable interest entities (“VIEs”), if it has a variable interest in those entities and the nature and extent of those interests. These evaluations are highly complex and involve judgment, the use of estimates and assumptions based on available historical information. In order for the Company to be the primary beneficiary of a VIE, it must have both (1) the power to direct the activities of a VIE that most significantly affect the VIE’s economic performance and (2) the obligation to absorb losses or the right to receive benefits that, in either case, could potentially be significant to the VIE. The Company consolidates entities of which it is the primary beneficiary.

The Company determines whether it is the primary beneficiary of a VIE upon its initial involvement with the VIE and reassesses whether it is the primary beneficiary on an ongoing basis. This determination is based upon an analysis of the design of the VIE, including the VIE’s structure and activities, the power to make significant economic decisions held by the Company and by other parties, and the variable interests owned by the Company and other parties.
Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are classified and disclosed in one of the following three categories:
Level 1—Quoted prices for identical assets or liabilities in active markets;
Level 2—Quoted prices for similar assets or liabilities in active markets or quoted prices for identical or similar assets or liabilities in markets that are not active or are directly or indirectly observable; and
Level 3—Unobservable inputs that reflect estimates and assumptions.
The carrying amounts reported in the balance sheet for cash and cash equivalents, accounts receivable, accounts payable, notes payable, deferred revenue and other current monetary assets and liabilities approximate fair value because of the immediate or short-term maturity of these financial instruments.
 
In accordance with this guidance, the Company measures its cash equivalents and marketable securities at fair value. The Company’s cash equivalents and marketable securities are classified within Level 1. Cash equivalents and marketable securities are valued primarily using quoted market prices utilizing market observable inputs.
Revenue Recognition
Revenue represents the consideration received or receivable from clients for solutions and services provided by the Company. The Company’s revenue is generated from the following sources:

Software and hardware— Software and hardware revenue is generated from the sale of the Company’s software, on either a perpetual or term license basis, and the sale of hardware. The software is installed on the client’s site or the client’s designated vendor’s site and is not hosted by the Company or by a vendor contracted by the Company. The Company also sells third-party software and hardware to its clients. Solutions sold are grouped together under the NantOS Interoperability platform (formerly known as cOS) and FusionFX, NantOS, DeviceConX and HBox.
Software-as-a-service (“SaaS”)— SaaS revenue is generated from clients’ access to and usage of the Company’s hosted software solutions on a subscription basis for a specified contract term, which is usually monthly. In SaaS arrangements, the client cannot take possession of the software during the term of the contract and generally has the right to access and use the software and receive any software upgrades published during the subscription period. Solutions sold under a SaaS model include the NantOS Interoperability cancer decision support solution (formerly known as eviti), NantOS Interoperability and NaviNet.

- 12 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

Maintenance— Maintenance revenue includes ongoing post contract client support (“PCS”) or maintenance during the paid PCS term. Additionally, PCS includes ongoing development of software updates and upgrades provided to the client on a when and if available basis.
Sequencing and molecular analysis— Sequencing and molecular analysis revenue is generated by the process of performing sequencing and analysis of whole genome DNA, RNA and proteomic results under the Company's reseller agreement with NantOmics, LLC ("NantOmics") (See Note 19).
Other services— Other services includes revenue from professional services provided that are generally complementary to the software and may or may not be required for the software to function as desired by the client. The services are generally provided in the form of training and implementation services during the software license period and do not include PCS. Other services revenue also includes the sale of nursing and therapy services provided to patients in a home care setting and any other services not included in the preceding revenue sources.
Revenue is recognized when persuasive evidence of an arrangement exists, services or products have been provided to the client, fees are fixed or determinable, and collectability is reasonably assured. While most of the Company’s arrangements include short-term payment terms, the Company on occasion provides payment terms to clients in excess of one year from the date of contract signing. The Company does not recognize revenue for arrangements containing these extended payment terms until such payments become due. Certain of the Company’s customer arrangements allow for termination for convenience with advanced notice. Such termination rights do not allow for refunds other than prepaid PCS or other services. These provisions do not affect when the Company commences revenue recognition. The Company also has certain arrangements which allow for termination and refunds of fees in the event that software acceptance by the customer has not occurred. In these instances, the Company will defer all revenue until software acceptance has occurred.

The Company's sequencing and molecular analysis revenue is primarily generated from payments received from commercial third-party payors, hospitals and other provider networks and patients. The Company reports revenue from arrangements with these customers on a gross basis in accordance with Financial Accounting Standards Board (“FASB") Accounting Standards Update ("ASC") No. 605-45, Principal Agent Considerations. The Company recognizes revenue from these arrangements when all revenue recognition criteria have been met or on a cash basis when it cannot conclude that the fees are fixed or determinable and collectability is reasonably assured. The Company uses judgment in its assessment of whether the fees are fixed or determinable and whether collectability is reasonably assured in determining when to recognize revenue in the future as it continues to gain payment experience with its customers. Accordingly, the Company expects to recognize revenue on a cash basis when it cannot conclude that the fees from a particular customer are fixed or determinable and collectability is reasonably assured until it has a sufficient history to reliably estimate payment patterns from such customer.

The Company engages in various multiple-element arrangements, which may generate revenue across any of the sources noted above. For multiple-element software arrangements that involve the sale of the Company’s proprietary software, PCS and other software-related services, vendor-specific objective evidence (“VSOE”) of fair value is required to allocate and recognize revenue for each element. VSOE of fair value is determined based on the price charged in which each deliverable is sold separately. The Company has established VSOE for PCS on certain of its software solutions using the Stated Renewal Method. In this instance, the Company has determined that its stated renewals are substantive and appropriate for use in the Stated Renewal Method. The Company has not yet established VSOE of fair value for any element other than PCS for a portion of its arrangements. In situations where VSOE of fair value exists for PCS but not a delivered element (typically the software license and services elements), the residual method is used to allocate revenue to the undelivered element equal to its VSOE value with the remainder allocated to the delivered elements. In situations in which VSOE of fair value does not exist for all of the undelivered software-related elements, revenue is deferred until only one undelivered element remains (typically the PCS element) and then recognized following the pattern of delivery of the final undelivered element. The Company’s multiple element arrangements typically provide for renewal of PCS terms upon expiration of the original term. The amounts of these PCS renewals are recognized as revenue ratably over the specified PCS renewal period.
For non-software arrangements that include multiple-elements, primarily consisting of the Company’s SaaS agreements, revenue recognition involves the identification of separate units of accounting after consideration of combining and/or segmenting contracts and allocation of the arrangement consideration to the units of accounting on the basis of their relative selling price. The selling price used for each deliverable is based on VSOE of fair value, if available, third party evidence (“TPE”) of fair value if VSOE is not available, or the Company’s best estimate of selling price (“BESP”) if neither VSOE nor TPE is available. In determining the units of accounting for these arrangements, the Company evaluates whether each deliverable has stand-alone value as defined in the FASB’s guidance. The Company’s SaaS arrangements are treated as a single unit of accounting as the professional services do not have standalone value. As a result, the Company recognizes initial system implementation and deployment fees ratably over a period of time from when the system implementation or deployment services are completed and accepted by the customer over the longer of the life of the agreement or the estimated customer life.

- 13 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

If an arrangement to deliver software requires significant production, modification or customization of the licensed software, the Company accounts for the arrangement as a construction-type contract. The Company currently recognizes revenue for these arrangements using the completed-contract method as it does not currently have sufficient information to reliably estimate the percentage of completion for these projects. The Company considers these arrangements to be substantially complete upon the clients’ acceptance of the software and related professional services and consistently applies this policy to all contract accounting arrangements.
Transaction processing fees are recognized on a monthly basis based on the number of transactions processed and the fee per transaction.
Revenue derived from reseller arrangements is recognized when the resellers, in turn, sell the software solution to their clients and installation of the software solution has occurred, provided all other revenue recognition criteria are met. This is commonly referred to as the sell-through method and the Company defers recognition until there is a sell-through by the reseller to an actual end user clients and acceptance by the end user has occurred.
Investments in Related Parties
Investments in and advances to related parties in which the Company has a substantial ownership interest of approximately 20% to 50%, or for which the Company exercises significant influence but not control over policy decisions, are accounted for by the equity method. Investments in limited liability companies that are similar to partnerships are also accounted for under the equity method if more than minor influence over the operation of the investee exists (generally through more than 3-5% ownership). As part of that accounting, the Company recognizes gains and losses that arise from the issuance of stock by a related party that results in changes in the Company’s proportionate share of the dollar amount of the related party’s equity.
Investments in related parties are assessed for possible impairment when events indicate that the fair value of the investment may be below the Company’s carrying value. When such a condition is deemed to be other than temporary, the carrying value of the investment is written down to its fair value, and the amount of the write-down is included in net loss. In making the determination as to whether a decline is other than temporary, the Company considers such factors as the duration and extent of the decline, the investee’s financial performance, and the Company’s ability and intention to retain its investment for a period that will be sufficient to allow for any anticipated recovery in the investment’s market value. The new cost basis of investments in these equity investees is not changed for subsequent recoveries in fair value.

Differences between the Company’s carrying value of an equity investment and its underlying equity in the net assets of the related party are assigned to the extent practicable to specific assets and liabilities based on the Company’s analysis of the various factors giving rise to the difference. When appropriate, the Company’s share of the related party’s reported earnings is adjusted quarterly to reflect the difference between these allocated values and the related party’s historical book values. 
Business Combinations
Business combinations are accounted for using the acquisition method of accounting. Under the acquisition method, assets acquired and liabilities assumed are recorded at their respective fair values as of the acquisition date. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. Management routinely monitors the factors impacting the acquired assets and liabilities. Transaction related costs are expensed as incurred. The operating results of the acquired business are reflected in the Company’s Condensed Consolidated and Combined Financial Statements as of the acquisition date. 
Deferred Revenue
The Company records deferred revenue when it receives cash from clients prior to meeting the applicable revenue recognition criteria. The Company uses judgment in determining the period over which the deliverables are recognized as revenue. As of September 30, 2016 and December 31, 2015, current and non-current deferred revenue are comprised of deferrals for fees related to software licenses, SaaS arrangements, PCS services, non-PCS services and other revenue. Non-current deferred revenue is expected to be recognized on or over 12 month period following September 30, 2016.

- 14 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

Deferred Implementation Costs
The Company provides SaaS and information technology management services under long-term arrangements which require the Company to perform system implementation activities. In some cases, the arrangements either contain provisions requiring customer acceptance of the setup activities prior to commencement of the ongoing services arrangement or the system implementation services do not have separate value from the service revenue. Up-front fees billed during the setup phase for these arrangements are deferred and setup costs that are direct and incremental to the contract are capitalized. The costs deferred consist of employee compensation (including stock based compensation) and benefits for those employees directly involved with performing system implementation or deployment services, as well as other direct and incremental costs.
The Company defers costs estimated to be realizable based on contracted implementation revenue and estimated margin from the service contract. The Company periodically reviews the deferred implementation contracts for recoverability. The costs are amortized to cost of revenue ratably over a period of time from when the system implementation or deployment services are completed and accepted to the end of the contract term or the expected customer life, whichever is longer.
Software Developed for Internal Use
The Company accounts for the costs of computer software obtained or developed for internal use in accordance with FASB ASC 350, "Intangibles — Goodwill and Other " ("ASC 350"). Computer software development costs are expensed as incurred, except for internal use software costs that qualify for capitalization as described below, and include employee related expenses, including salaries, benefits and stock-based compensation expenses; costs of computer hardware and software; and costs incurred in developing features and functionality. These capitalized costs are included in property and equipment on the Condensed Consolidated and Combined Balance Sheets. The Company expenses costs incurred in the preliminary project and post implementation stages of software development and capitalizes costs incurred in the application development stage and costs associated with significant enhancements to existing internal use software applications. Software costs are amortized using the straight-line method over an estimated useful life of three years commencing when the software project is ready for its intended use.
Research and Development Expenses
Research and development (“R&D”) costs incurred to establish the technological feasibility of software to be sold are expensed as incurred. These expenses include the costs of the Company’s proprietary R&D efforts, as well as costs incurred in connection with certain licensing arrangements.
Development costs, consisting primarily of employee salaries and benefits, incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any software development costs are capitalized.
Costs incurred to acquire or create a computer software product are expensed when incurred as research and development until technological feasibility has been established for the product, at which point such costs are capitalized. Technological feasibility is normally established upon completion of a detailed program design or, in its absence, a working model of the software product.
Capitalization of computer software costs ceases when the product is available for general release to customers. As of September 30, 2016, the Company has not capitalized software costs as no significant costs have been incurred in developing software products and technological feasibility has not been established for new software products and enhancements to existing software.
Stock Based Compensation
The Company accounts for stock based compensation arrangements granted to employees in accordance with ASC 718, "Compensation: Stock Compensation", by measuring the grant date fair value of the award and recognizing the resulting expense over the period during which the employee is required to perform service in exchange for the award.

The Company accounts for stock based compensation arrangements issued to non-employees using the fair value approach prescribed by ASC 505-50, “Equity-Based Payments to Non-Employees". The value of non-employee stock based compensation is re-measured at the end of each reporting period until the award vests and is recognized as stock based compensation expense over the period during which the non-employee provides the services.

Stock based compensation expense for both employee and non-employee awards is recognized on a straight-line basis over the appropriate service period for awards that are only subject to service conditions and is recognized using the accelerated attribution method for awards that are subject to performance conditions. Stock based compensation expense is only recognized for awards subject to performance conditions if it is probable that the performance condition will be achieved.

- 15 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)


The Company early adopted FASB ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”) related to stock based compensation, beginning July 1, 2016, simplifying the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory withholding requirements, as well as the related classification in the statement of cash flows. All excess tax benefits and tax deficiencies are recognized as income tax benefit or expense in the income statement as discrete items in the reporting period in which they occur, and such tax benefits and tax deficiencies are not included in the estimate of an entity’s annual effective tax rate, applied on a prospective basis. The recognition of excess tax benefits is not deferred until the benefit is realized through a reduction to taxes payable. When the Company applies the treasury stock method, in calculating diluted earnings per share, excess tax benefits, if applicable, are excluded and deficiencies from the calculation of assumed proceeds since such amounts are recognized in the income statement. Excess tax benefits if applicable, are classified as operating activities in the same manner as other cash flows related to income taxes on the statement of cash flows. Per ASU 2016-09, an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur. The Company has elected to account for forfeitures when they occur. Cash paid by the Company when directly withholding shares for tax withholding purposes should be classified as a financing activity in the Statement of Cash Flows (See Note 14 and Note 17).
Net Loss Per Share
Basic net loss per share is computed by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period, adjusted to give effect to potentially dilutive securities. However, potentially dilutive securities are excluded from the computation of diluted net loss per share to the extent that their effect is anti-dilutive.
Segment Reporting
The chief operating decision maker for the Company is its Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a Condensed Consolidated and Combined basis for purposes of allocating resources and evaluating financial performance. The Company has one business activity and there are no segment managers who are held accountable for operations, operating results, or plans for levels or components below the Condensed Consolidated and Combined unit level. Accordingly, management has determined that the Company operates in one reportable segment.
Recent Accounting Pronouncements
In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments." This standard update was issued to address diversity in practice in how certain cash receipts and cash payments are presented and classified. The provisions of ASU 2016-15 will be effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted. The adoption of this standard update is not expected to have a material impact on the Company's Condensed Consolidated and Combined Financial Statements.

In June 2016, the FASB issued ASU No. 2016-13, "Measurement of Credit Losses on Financial Instruments" (“ASU 2016-13”), which changes how companies measure credit losses on most financial instruments measured at amortized cost, such as loans, receivables and held-to-maturity debt securities. Rather than generally recognizing credit losses when it is probable that the loss has been incurred, the revised guidance requires companies to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument's contractual life. ASU 2016-13 is effective for fiscal periods beginning after December 15, 2019 and must be adopted as a cumulative effect adjustment to retained earnings. Early adoption is permitted. The Company is evaluating the potential effects of the adoption of this guidance on the Company's Condensed Consolidated and Combined Financial Statements.

In May 2016, the FASB issued ASU No. 2016-12, "Revenue from Contracts with Customers (Topic 606)". The amendments, which address transition, collectability, non-cash consideration and the presentation of sales and other similar taxes, do not change the core principles of ASU 2014-09, but rather address implementation issues and are intended to result in more consistent application. The Company intends to adopt this standard on January 1, 2018. The Company is evaluating the potential effects of the adoption to the Company's Condensed Consolidated and Combined Financial Statements.


- 16 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

In April 2016, the FASB issued ASU No. 2016-10, "Identifying Performance Obligations and Licensing", which amends certain aspects of ASC 606, Revenue from Contracts with Customers. ASU No. 2016-10 amends step two of the new revenue standard’s five-step model to include guidance on immaterial promised goods or services, shipping and handling activities and identifying when promises represent performance obligations. ASU No. 2016-10 also provides guidance related to licensing such as, but not limited to, sales-based and usage-based royalties and renewals of license that provide a right to use intellectual property. The Company intends to adopt this standard on January 1, 2018. The Company is evaluating the potential effects of the adoption of this guidance on the Company's Condensed Consolidated and Combined Financial Statements.

In March 2016, the FASB issued ASU No. 2016-09, "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting". ASU 2016-09 changes certain aspects of the accounting for share-based payment awards, including: accounting and cash flow classification for excess tax benefits and deficiencies; income tax withholding obligations; forfeitures; and cash flow classification. ASU 2016-09 is effective for the Company in the first quarter of 2017, with early adoption permitted. As mentioned above, the Company early adopted this guidance effective July 1, 2016, see Note 14 and Note 17 .   
In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)" (“ASU 2016-02”). The update is aimed at making leasing activities more transparent and comparable, and requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including leases currently accounted for as operating leases. This guidance will become effective for interim and annual reporting periods beginning with the year ending December 31, 2019. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of this guidance will have on its Condensed Consolidated and Combined Financial Statements and related disclosures.

In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" (“ASU 2016-01”), which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments, including a provision that requires equity investments (except for investments accounted for under the equity method of accounting) to be measured at fair value, with changes in fair value recognized in current earnings. ASU 2016-01 is effective for the Company in the first quarter of 2018, with early adoption permitted. The Company is currently evaluating the effect that ASU 2016-01 will have on its Condensed Consolidated and Combined Financial Statements and related disclosures.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants, and the Securities and Exchange Commission ("SEC") did not have, or are not believed by management to have, a material impact on the Company's present or future Condensed Consolidated and Combined financial Statements.
Note 3. Business Combinations and Investments
2016 Acquisitions
NaviNet, Inc.
On November 30, 2015, NantHealth entered into a definitive agreement with 3BE Holdings, LLC (“3BE”) to acquire 100% of the outstanding equity interest of NaviNet, Inc. (“NaviNet”) in exchange for $83,529 in cash, subject to working capital adjustments, 15,513,726 newly issued Series H units with a fair value of $52,500 and contingent arrangements or earnouts of up to $12,250, which was effective on January 1, 2016. The contingent arrangements or earnouts require the Company to pay up to a total of $12,250 to certain of NaviNet’s former shareholders if NaviNet’s revenues to those former shareholders exceed certain thresholds during the years ended December 31, 2016 and 2017. These contingent amounts or earnouts have been excluded from the purchase price consideration and are accounted for as sales incentives as certain predefined targets are met and are reflected as contra revenue. The cash portion of the acquisition was financed through a promissory note with NantCapital, LLC (“NantCapital”), an affiliate of the Company (See Note 19). In June 2016, the Company paid an additional $455 to 3BE as the final working capital adjustment and accounted for the payment as an increase to the purchase price of NaviNet.
 

- 17 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

The following table summarizes the total purchase consideration for the acquisition, subject to the finalization of the Company's purchase price accounting for the transaction.
 
 Amounts
Cash paid to seller at closing
$
74,823

Cash paid to option holders after closing
2,580

Cash paid to escrow account
6,126

Working capital settlement payment
455

Fair value of Series H units
52,500

Total consideration
$
136,484


The total consideration was allocated to the net assets acquired based upon their estimated fair values. The Company continues to monitor potential fair value adjustments to property, plant and equipment as well as activity against the escrow account that provide security for any seller indemnifications, obligations, including severance matters:
 
 Amounts
Cash and restricted cash
$
4,804

Accounts receivable, net
10,693

Property, plant and equipment, net
7,953

Other assets and liabilities, net
3,830

Accounts payable
(4,585
)
Accrued expenses
(3,488
)
Deferred revenue
(2,603
)
Deferred tax liability
(19,533
)
Assumed indebtedness
(23,324
)
Trade names
3,000

Developed technology
32,000

Customer relationships
52,000

Goodwill
75,737

Total fair value of net assets acquired
$
136,484

 The estimated life of the acquired trade names is four years, the estimated life of customer relationships is fifteen years and the estimated life of the developed technology is seven years. The excess of the purchase price over the net tangible and intangible assets of $75,737 was recorded as goodwill, and considered non-deductible for income tax purpose.
At the closing of the acquisition, the Company repaid all $23,324 of assumed indebtedness presented in the table above.
Immediately prior to the closing, the board of directors of NaviNet approved the acceleration of all unvested stock options of NaviNet. The equity incentive plan governing these stock options stated that NaviNet’s board of directors had the right, at its sole discretion, to accelerate vesting of all outstanding stock options in connection with a change of control. The option holders received a payout of $7,394 immediately following the closing which represented the fair value of all vested and unvested stock options. The Company recognized in its post-acquisition results $4,814 of compensation expense during the nine months ended September 30, 2016 since the Company received post-combination benefits resulting from the accelerated vesting.

During the three months ended September 30, 2016, the Company recognized a $697 measurement period adjustment, which decreased goodwill and increased research and development grant receivable. As a result, during the nine months ended September 30, 2016, the Company recognized a net increase of $1,361 measurement period adjustments, which increased goodwill. The measurement period adjustments also included a $953 decrease to goodwill related to a decrease in deferred revenue, a $4,234 increase to goodwill related to a deferred tax liability increase due to tax changes, a $455 increase to goodwill for working capital adjustments, and a $1,678 decrease to goodwill, representing the Company’s right to be reimbursed from 3BE for severance benefits if their employment is terminated by the Company without cause or by the employee for good reason within 12 months after the closing date, which is expected to be settled through the escrow account in 2017. 


- 18 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

2015 Acquisitions
NantCloud
On May 31, 2015, NantHealth purchased 100% of the outstanding equity interests in NantCloud Services, LLC ("NantCloud") from NantWorks in exchange for $7,227 in cash, the amount invested in that business by NantWorks without any markup. NantCloud offers a secure cloud infrastructure for hosting sensitive healthcare data as well as information technology security services tailored for the healthcare industry. The Company accounted for its purchase of NantCloud as an arrangement between entities under common control. As a result, the acquisition was recorded and presented at carryover basis and the historical statements of operations and cash flows of NantCloud have been combined with the Company beginning on the date of inception of common control of each respective entity, which started February 10, 2014.
Healthcare Solutions from Harris Corporation
On June 16, 2015, the Company entered into a definitive agreement with Harris Corporation (“Harris”) to acquire certain assets and assume certain liabilities related to its Healthcare Solutions (“HCS”) business in exchange for $50,556 in cash, subject to working capital adjustments. The acquired assets comprise a business that helps complex healthcare delivery organizations achieve better patient outcomes, clinical and administrative workflow efficiency and stronger collaboration across the continuum of care. The acquisition of HCS closed on July 1, 2015 and furthered the Company’s mission to provide patients with a fully integrated and personalized approach to the delivery of care.
The purchase consideration included $7,500 of funds held in escrow for the settlement of net working capital and other indemnifications. In March 2016, and in accordance with the definitive agreements, the Company received $2,494 out of the escrow account for the settlement of the final net working capital adjustment.
The following table summarizes the total purchase consideration for the acquisition, including the effects of the final net working capital adjustment:
 
 Amounts
Cash paid to Harris at closing
$
43,056

Cash paid to escrow account
7,500

Working capital released from escrow
(2,494
)
Total consideration
$
48,062


The fair value of the identifiable assets acquired and liabilities assumed for the HCS business is shown in the table below:
 
 Amounts
Accounts receivable, net
$
13,119

Other liabilities and assets, net
(2,205
)
Deferred revenue
(16,076
)
Trademarks
2,400

Developed technology
14,400

Customer relationships
8,900

Backlog
3,900

Goodwill
23,624

Total fair value of net assets acquired
$
48,062


 The estimated lives of the acquired trademark, customer relationships and backlog are five years and the estimated life of the developed technology is seven years. The excess of the purchase price over the net tangible and intangible assets of $23,624 was recorded as goodwill, and considered deductible for income tax purpose. During the nine months ended September 30, 2016, the Company recognized $274, of measurement period adjustments, which increased goodwill.

- 19 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

2015 Investments
IOBS
On June 16, 2015, the Company invested $1,750 in Innovative Oncology Business Solutions, Inc. (“IOBS”) in exchange for 1,750,000 shares of IOBS’s Series A preferred stock. IOBS offers community oncology practices an alternative medical home model for oncology patients that improves health outcomes, enhances patient care experiences and significantly reduces costs of care. The shares of preferred stock represent 35.0% of the outstanding equity of IOBS on an as-converted basis. The Company applied the cost method to account for its investment because the preferred stock is not considered in-substance common stock, is not considered a debt instrument as the Company cannot unilaterally demand redemption of the preferred stock and the preferred stock does not have a readily determinable fair value.
Investment in TRM and sale to NantCRO
On September 8, 2015, the Company completed a Contribution Agreement with the members of Translational Research Management, LLC (“TRM”) whereby those members contributed their 54% equity interest in TRM in exchange for $250 in cash and 267,905 of the Company’s Series A units. TRM is a management services organization committed to building a nationwide network of community based medical oncology professionals dedicated to offering research studies to their patients. On June 1, 2016, the Series A units issued to TRM were converted into 44,778 shares of the Company’s common stock.
On the same day, the Company sold its 54% equity interest in TRM to NantCRO, LLC, a wholly owned subsidiary of NantOmics, in exchange for $250 in cash and 610,928 of NantOmics’ Series A-2 units, which is equivalent in value to the purchase price paid by the Company. As a result, the Company’s ownership percentage in NantOmics is approximately 14.3% (See Note 10).
Pro Forma Financial Information (Unaudited)
The historical operating results of neither NaviNet nor HCS have been included in the Company’s historical Condensed Consolidated and Combined operating results prior to the respective acquisition dates. The following financial information presents the combined results of continuing operations for the three and nine months ended September 30, 2015, as if the acquisitions had been completed on January 1, 2015. There are no pro forma adjustments for the three and nine months ended September 30, 2016 since the results of NaviNet and HCS are included in the Company’s Condensed Consolidated and Combined Financial Statements beginning on January 1, 2016 and July 1, 2015, respectively. The unaudited pro forma results do not reflect any material adjustments, operating efficiencies or potential cost savings that may result from the consolidation of operations.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2015
Revenue
$
27,678

 
$
93,793

Net loss
$
(26,831
)
 
$
(68,148
)

Note 4. Accounts Receivable, net
Accounts receivable, net excludes amounts related to PCS and other services that were billed but not yet delivered at each period end. These undelivered services are also excluded from the deferred revenue balances on the accompanying Condensed Consolidated and Combined Balance Sheets. The amount of outstanding and unpaid invoices excluded from both the accounts receivable and deferred revenue balances as of September 30, 2016 and December 31, 2015 was $8,343 and $12,643, respectively.
 
Accounts receivable are included on the consolidated balance sheets net of the allowance for doubtful accounts. The allowance for doubtful accounts at September 30, 2016 and December 31, 2015 was $1,185 and $956, respectively.

- 20 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

Note 5. Inventories
Inventories, net as of September 30, 2016 and December 31, 2015 consisted of the following:
 
September 30,
2016
 
December 31,
2015
 
(Unaudited)
 
 
 
 
 
 
Finished goods
$
1,638

 
$
2,005

Raw Materials
164

 
141

Inventories
$
1,802

 
$
2,146


Note 6. Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets as of September 30, 2016 and December 31, 2015 consisted of the following:
 
September 30,
2016
 
December 31,
2015
 
(Unaudited)
 
 
 
 
 
 
Prepaid expenses
$
3,807

 
$
2,161

Restricted cash (1)
100

 

Deferred offering costs

 
3,902

Escrow receivable
1,678

 
2,494

Other current assets
218

 
150

 
$
5,803

 
$
8,707


(1)
Additional $250 of non-current restricted cash is included in the Company’s Condensed Consolidated and Combined balance sheets as part of Other assets.
Note 7. Property, Plant and Equipment, net
Property, plant and equipment, net as of September 30, 2016 and December 31, 2015 consisted of the following:
 
September 30,
2016
 
December 31,
2015
 
(Unaudited)
 
 
 
 
 
 
Computer equipment and software
$
28,390

 
$
9,865

Furniture and equipment
8,235

 
6,772

Leasehold and building improvements
4,081

 
1,433

Internal use software
11,188

 
1,018

Construction in progress
2,210

 
1,462

 
54,104

 
20,550

Less: accumulated depreciation and amortization
(24,692
)
 
(6,651
)
Property, plant and equipment, net
$
29,412

 
$
13,899

 

- 21 -

NantHealth, Inc.
Condensed Consolidated and Combined Statements of Operations
(In thousands, except share and per share amounts)
(Unaudited)

Depreciation expense was $1,995 and $5,664 for the three and nine months ended September 30, 2016, respectively, of which $410 and $686, respectively related to internal use capitalized software development costs. Depreciation expense was $976 and $2,639 for the three and nine months ended September 30, 2015, respectively, of which none related to internal use capitalized software development costs.

Note 8. Intangible Assets, net
The Company’s definite-lived intangible assets as of September 30, 2016 and December 31, 2015 consisted of the following:
 
September 30, 2016
 
Customer
Relationships
 
Developed Technologies
 
Software
License
 
Intellectual Property
 
Trade Name
 
Total
Gross carrying amount
$
65,200

 
$
98,930

 
$
5,000

 
$
2,400

 
$
3,000

 
$
174,530

Accumulated amortization
(6,200
)
 
(41,272
)
 
(1,250
)
 
(600
)
 
(563
)
 
(49,885
)
Intangible assets, net
$
59,000

 
$
57,658

 
$
3,750

 
$
1,800

 
$
2,437

 
$
124,645

 
December 31, 2015
 
Customer
Relationships
 
Developed Technologies
 
Software
License
 
Intellectual Property
 
Trade Name
 
Total
Gross carrying amount
$
13,200

 
$
66,930

 
$
5,000

 
$
2,400

 
$

 
$
87,530

Accumulated amortization
(1,680
)
 
(30,326
)
 
(313
)
 
(240
)
 

 
(32,559
)
Intangible assets, net
$
11,520

 
$
36,604

 
$
4,687

 
$
2,160

 
$

 
$
54,971


Amortization of finite-lived intangible assets is provided over their estimated useful lives on a straight-line basis or the pattern in which economic benefits are consumed, if reliably determinable. The Company reviews its finite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Amortization expense was $5,520 and $17,326 for the three and nine months ended September 30, 2016, respectively. Amortization expense was $3,649 and $8,228 for the three and nine months ended September 30, 2015, respectively.
During the nine months ended September 30, 2016, the Company recorded $87,000 of definite-lived intangible assets related to the acquisition of NaviNet (See Note 3). These intangibles are amortized over a period of four to fifteen years.
On September 29, 2015, the Company entered into an exclusive license agreement with NorthShore University Health System (“NorthShore”) to further develop their Health Heritage software platform and to license the software to customers. As part of the agreement, the Company paid NorthShore a one-time license fee of $5,000 and will pay royalties of at least $750 annually for the first four years of the agreement. The Company will have no obligation to pay any additional royalties after 7 years or once aggregate royalties reach $5,000.
The estimated future amortization expense over the next five years and thereafter for the intangible assets that exist as of September 30, 2016 is as follows:
 
Amounts
2016
$
5,519

2017
19,078

2018
18,478

2019
18,166

2020
14,958

Thereafter
48,446

Total
$
124,645


- 22 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

Note 9. Goodwill
Goodwill activity during the nine months ended September 30, 2016 is shown as follows:
 
Amounts
Balance at December 31, 2015
 
Goodwill
$
63,668

Accumulated impairment losses
(6,950
)
Net balance
56,718

 
 
Activity during the year (Unaudited):
 
Acquisitions (See Note 3)
74,376

Measurement period adjustments (See Note 3)
1,635

Net activity during the period
76,011

 
 
Balance at September 30, 2016 (Unaudited):
 
Goodwill
139,679

Accumulated impairment losses
(6,950
)
Net balance
$
132,729

The Company added $75,737 of goodwill related to the acquisition of NaviNet on January 1, 2016 (See Note 3).

On July 1, 2015, the Company added $23,624 of goodwill related to the acquisition of the HCS business (See Note 3).  

Measurement period adjustments during three and nine months ended September 30, 2016 were a decrease of $697 and an increase of $1,635, respectively (See Note 3). No measurement period adjustments were recorded during three and nine months ended September 30, 2015.

Goodwill is tested for impairment annually as of October 1 or between annual tests when evidence of potential impairment exists.

Note 10. Investment in Related Party
On June 19 and June 30, 2015, the Company purchased a total of 168,463,611 Series A-2 units of NantOmics, LLC (“NantOmics”) for an aggregate purchase price of $250,774. Additionally, NantOmics issued 610,928 of its Series A-2 units to the Company on September 8, 2015 in exchange for NantOmics' subsidiary's purchase of NantHealth’s equity interests in TRM. The Series A-2 units do not have any voting rights and represent approximately 14.3% of NantOmics’ issued and outstanding membership interests. NantOmics is majority owned by NantWorks and delivers molecular diagnostic capabilities with the intent of providing actionable intelligence and molecularly driven decision support for cancer patients and their providers at the point of care. The Company applied the equity method to account for its investment in NantOmics as the interest in the equity is similar to a partnership interest. Further, the Company has the ability to exert significant influence over the operating and financial policies of the entity since NantWorks controls both NantHealth and NantOmics. The difference between the carrying amount of the investment in NantOmics and the Company’s underlying equity in NantOmics’ net assets relate to both definite- and indefinite-lived intangible assets. The Company attributed $28,195 and $14,382 of these differences to NantOmics’ developed technologies and its reseller agreement with the Company, respectively, and the remaining basis differences were attributed to goodwill. The Company amortizes the basis differences related to the definite-lived intangible assets over the assets’ estimated useful lives and records these amounts as a reduction in the carrying amount of its investment and an increase in its equity method loss.


- 23 -

NantHealth, Inc.
Condensed Consolidated and Combined Statements of Operations
(In thousands, except share and per share amounts)
(Unaudited)

The Company reports its share of NantOmics’ income or loss and the amortization of basis differences using a one quarter lag. For the three and nine months ended September 30, 2016, the Company recognized $2,604 and $7,893 of loss related to this investment, respectively. From the date of the initial investment at June 19, 2015 through September 30, 2015, the Company recognized $145 of loss related to this investment.

The Company used the following summarized financial information for NantOmics for the trailing nine months ended June 30, 2016 to record its equity method losses for the nine months ended September 30, 2016:
 
Trailing Nine Months Ended June 30, 2016
Sales
$
2,936

Gross loss
(3,113
)
Loss from operations
(25,693
)
Net loss
(21,841
)
Net loss attributable to NantOmics
$
(20,273
)
Note 11. Variable Interest Entities
On June 16, 2015, the Company invested $1,750 in IOBS’ Series A preferred stock and therefore has a variable interest in IOBS. The shares of preferred stock represent 35.0% of the outstanding equity of IOBS on an as-converted basis. The Company applied the cost method to account for its investment because the preferred stock is not considered in-substance common stock, is not considered a debt instrument as the Company cannot unilaterally demand redemption of the preferred stock and the preferred stock does not have a readily determinable fair value.
 
As of September 30, 2016, IOBS was considered a variable interest entity. The Company is not the primary beneficiary of IOBS because it only has the right to elect two of five directors. All major decisions of IOBS require the majority vote by the members of the board of directors, including decisions made to manage the business including hiring and firing of officers and other critical management functions. Therefore, the Company does not consolidate IOBS.
Note 12. Fair Value Measurements
Assets and liabilities measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015 consisted of the following:
 
September 30, 2016
 
Total
 fair value
 
Quoted price in active markets for identical assets
 (Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
 (Level 3)
Assets
 
 
 
 
 
 
 
Cash equivalents
$
63,404

 
$
63,404

 
$

 
$

Marketable securities

 

 

 

 
December 31, 2015
 
Total
 fair value
 
Quoted price in active markets for identical assets
 (Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
 (Level 3)
Assets
 
 
 
 
 
 
 
Cash equivalents
$
630

 
$
630

 
$

 
$

Marketable securities
1,243

 
1,243

 

 


- 24 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)


The Company’s intangible assets and goodwill are initially measured at fair value and any subsequent adjustment to the initial fair value occurs only if an impairment charge is recognized. The fair values of the Company’s marketable securities and cash equivalents (consisting of mainly money market accounts) are based on quoted market prices in active markets with no valuation adjustment (See Note 8).
Note 13. Commitments and Contingencies
The Company's principal commitments consist of obligations under its outstanding debt obligations, non-cancelable leases for its office space and certain equipment and vendor contracts to provide research services, and purchase obligations under license agreements and reseller agreements.
Lease Arrangements
The Company leases both real estate and equipment used in its operations and classifies those leases as either operating or capital leases for accounting purposes. As of September 30, 2016 and December 31, 2015, the Company had no material capital leases and the remaining lives of its operating leases ranged from one to ten years.
Rental expense associated with operating leases is charged to expense in the year incurred and is included in the Condensed Consolidated and Combined Statements of Operations. For the three and nine months ended September 30, 2016, the rental expense was charged to selling, general and administrative expense in the amount of $1,111 and $3,351, respectively. For the three and nine months ended September 30, 2015, rental expense was charged to selling, general and administrative expense in the amount of $686 and $1,475, respectively.

As of September 30, 2016, the Company’s future minimum rental commitments under its non-cancellable operating leases are as follows:
 
Amounts
2016
$
1,161

2017
4,246

2018
2,249

2019
650

2020
521

Thereafter
1,643

Total minimum rental commitments
$
10,470

Related Party Promissory Note
On January 4, 2016, the Company executed a $112,666 demand promissory note in favor of NantCapital to fund the acquisition of NaviNet, On May 9, 2016, the promissory note with NantCapital was amended to provide that all outstanding principal and accrued interest is due and payable on June 30, 2021, and not on demand (See Note 19).
Purchase obligations Under License Agreements and Reseller Agreements
In September 2016, the Company entered into a Second Amended and Restated Reseller Agreement for genomic and proteomic sequencing services and related bioinformatics and analysis services with NantOmics, with an effective date of June 19, 2015 (See Note 19).
Obligations Under Exclusive License Agreement with Northshore
On September 29, 2015, the Company entered into an exclusive license agreement with NorthShore to further develop their Health Heritage software platform ("Health Heritage"), and to license the software to customers (See Note 8).

- 25 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

Regulatory Matters
The Company is subject to regulatory oversight by the U.S. Food and Drug Administration and other regulatory authorities with respect to the development, manufacturing, and sale of some of the solutions. In addition, the Company is subject to the Health Insurance Portability and Accountability Act (“HIPAA”), the Health Information Technology for Economic and Clinical Health Act and related patient confidentiality laws and regulations with respect to patient information. The Company reviews the applicable laws and regulations regarding effects of such laws and regulations on its operations on an on-going basis and modifies operations as appropriate. The Company believes it is in substantial compliance with all applicable laws and regulations. Failure to comply with regulatory requirements could have a significant adverse effect on the Company’s business and operations.

Legal Matters
The Company is, from time to time, subject to claims and litigation that arise in the ordinary course of its business. The Company intends to defend vigorously any such litigation that may arise under all defenses that would be available. In the opinion of management, the ultimate outcome of proceedings of which management is aware, even if adverse to them, would not have a material adverse effect on the Company’s Condensed Consolidated and Combined Financial Condition or Results Of Operations. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion of management resources and other factors.

Note 14. Income Taxes
The provision for income taxes for the three and nine months ended September 30, 2016 was $256 of expense and $18,353 of benefit, respectively. The provision for income taxes for the three and nine months ended September 30, 2015 was $1 and $2, respectively. The 2016 year to date benefit from income taxes consists of three components, income tax provision from January 1 through May 31, 2016 for the corporate subsidiaries of NantHealth; income tax benefit resulting from the LLC conversion of NantHealth on June 1, 2016; and income tax provision for the consolidated group for June to September 2016 based on the annual effective tax rate.

The effective tax rates for the three months ended September 30, 2016 and 2015 were a provision of 0.70% and a provision of 0.2%, respectively. The effective tax rates for the nine months ended September 30, 2016 and 2015 were a benefit of 12.88% and a provision of 0.2%, respectively. The effective tax rate for the three and nine months ended September 30, 2016 differed from the federal statutory rate primarily due to the fact that Nant Health, LLC converted from a pass-through entity to a C corporation, NantHealth, Inc., on June 1, 2016. Prior to the LLC Conversion, the tax provision represents that of Nant Health, LLC’s corporate subsidiaries. The effective tax rate for the three and nine months ended September 30, 2015 differed from the Federal statutory rate primarily due to Nant Health LLC’s pass through status. The increase in the Company's effective tax rates for the three and nine months ended September 30, 2016 as compared to the three and nine months ended September 30, 2015 was also attributable to the LLC Conversion (See Note 16). 
The Company regularly evaluates the likelihood of the realization of the Company's deferred tax assets and reduces the carrying amount of those deferred tax assets by a valuation allowance to the extent the Company believes a portion will not be realized. The Company considers many factors when assessing the likelihood of future realization of the Company's deferred tax assets, including recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income, the carryforward periods available to us for tax reporting purposes and other relevant factors. Significant judgment is required in making this assessment.  As a result, the Company establishes a full valuation allowance against its deferred tax assets.
One or more of the Company's legal entities file income tax returns in the U.S. Federal jurisdiction, various U.S. state jurisdictions and certain foreign jurisdictions.  The Company currently is not under any federal, state or foreign income tax audits and is no longer subject to U.S. federal income tax examinations for years ended on or before December 31, 2012, or to California state income tax examinations for years ended on or before December 31, 2012.  During the nine months ended September 30, 2016, the gross amount of the Company’s unrecognized tax benefits (“UTB”) increased by approximately $219, as a result of tax positions taken during the current year. During the three months ended September 30, 2016 and the three and nine months ended September 30, 2015, no UTB were recorded.

- 26 -

NantHealth, Inc.
Condensed Consolidated and Combined Statements of Operations
(In thousands, except share and per share amounts)
(Unaudited)


As described in Note 2, the Company early adopted ASU 2016-06, Improvements to Employee Share-Based Payment Accounting, simplifying the accounting for employee share-based payment transactions, including the accounting for income taxes and statutory withholding requirements. Due to the Company’s partnership status prior to June 1, 2016 without any stock based compensation related deferred tax assets or stock windfall-related additional paid in capital pool as of June 30, 2016, the adoption did not result in any increase in retained earnings or deferred tax assets in the Condensed Consolidated and Combined Balance Sheet as of June 30, 2016 related to the prior years' unrecognized excess tax benefits. Because of the Company's current valuation allowance position, the adoption of ASC 2016-09 did not result in current tax expense or benefit related to vested stock awards during the three and nine months ended September 30, 2016. As a result, the Company did not exclude any excess tax benefits from the calculation of diluted earnings per share three and nine months ended September 30, 2016, and there was no method change to the cash flow presentation as required by ASU 2016-09.
Note 15. Redeemable Series F Units / Common Stock
On June 20, 2014, the Kuwait Investment Office (“KIO”) purchased 53,580,996 Series F units of the Company through a Delaware blocker corporation, KHealth Holdings, Inc. (“KHealth”), at a purchase price of $2.7995 per unit for an aggregate amount of $150,000. KIO is the London Office of the Kuwait Investment Authority (“KIA”). As part of the investment, KIO had the right and option, but not the obligation, to require NantHealth to redeem 100% of the outstanding shares of KHealth at an amount equal to the original purchase price of $150,000 plus accrued annual interest of 7.0% if the Company had not (i) filed a registration statement on Form S-1 with the Securities and Exchange Commission on or before December 20, 2015 or (ii) had not completed a qualified initial public offering on or before June 20, 2016 (the “Put Right”). KIO did not exercise the Put Right, and it expired as of June 20, 2016.
As of December 31, 2015, the Company determined that the redemption of the Series F units was probable due to the uncertainty of completing a qualified initial public offering under prong (ii) and, as such, accrued $16,042 of interest as a reduction to members’ equity. Prior to December 31, 2015, the Company had concluded that redemption was not probable and had not adjusted the carrying value of such units to redemption value. The Series F units were classified in the Condensed Consolidated and Combined balance sheet as of December 31, 2015 as temporary equity as a result of the contingent redemption feature.
As part of the LLC Conversion, the Series F units converted to 10,714,285 shares of redeemable common stock as of June 1, 2016. Since the Put Right expired unexercised on June 20, 2016, the shares of common stock owned by KIO are no longer redeemable and are included in Stockholders’ equity.

The change in net carrying amount of the Series F units and common stock owned by KIO for the nine months ended September 30, 2016 consisted of the following:
 
Redeemable Series F Units
 
Redeemable Common Stock
 
Common Stock and Additional-Paid-in-Capital
Balance at December 31, 2015
$
166,042

 
$

 
$

Accretion to redemption value
4,375

 

 

Balance at June 1, 2016 pre-LLC Conversion
170,417

 

 

LLC Conversion
(170,417
)
 
170,417

 

Balance at June 1, 2016 post-LLC Conversion

 
170,417

 

Accretion to redemption value

 
583

 

Balance at June 20, 2016 pre expiration of Put Right

 
171,000

 

Expiration of Put Right at June 20, 2016

 
(171,000
)
 
171,000

Balance at June 20, 2016 post expiration of Put Right and at September 30, 2016
$

 
$

 
$
171,000

Letter Agreement with NantWorks
On May 22, 2016, the Company signed a letter agreement with NantWorks whereby NantWorks agreed to purchase directly from KIO all of the outstanding shares of KHealth if KIO had elected to exercise its Put Right. KIO did not exercise its Put Right (which expired by its terms on June 20, 2016) and NantWorks, therefore did not purchase these shares.

- 27 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

Note 16. Stockholders’ Equity
Initial Public Offering
On June 7, 2016, the Company completed its IPO of 6,500,000 shares of common stock at a public offering price of $14.00 per share. Additionally, on June 9, 2016, the underwriters partially exercised their overallotment option to purchase an additional 400,000 shares of the common stock at $14.00 per share. The Company received $83,566 in proceeds from its IPO, after deducting underwriting discounts and commissions and offering costs of $13,034.

In connection with the pricing of the Company’s IPO on June 1, 2016, $40,590 of principal and accrued interest on the Company’s related party promissory notes with NantOmics was converted into 2,899,297 shares of the Company’s common stock.

On July 25, 2016, the Company issued 1,056,689 shares of common stock, after withholding of approximately 538,794 shares to satisfy tax withholding obligations, to participants of the Phantom Unit Plan based in the United States who’s phantom units vested as a result of the IPO.  The Company made a cash payment of $5,738 to cover employee withholding taxes upon the settlement of these vested phantom units.  The Company also paid $235 on August 9, 2016 to cash-settle 16,818 vested phantom units held by participants of the Phantom Unit Plan at the time of the IPO who were based outside of the United States.
LLC Conversion and Reverse Split
Upon completion of the LLC Conversion on June 1, 2016, (a) all of the Company’s outstanding units automatically converted into shares of common stock, based on the relative rights of the Company's pre-IPO equityholders as set forth in the Company's limited liability company agreement (the "LLC Agreement") and (b) the Company adopted and filed a certificate of incorporation with the Secretary of State of the state of Delaware and adopted bylaws. The Company adopted and filed an amendment to its certificate of incorporation (the "Amended Certificate of Incorporation") with the Secretary of State of the state of Delaware to effect a 1-for-5.5 reverse stock split of its common stock on June 1, 2016.

Below is a summary of the number of member units pre LLC Conversion as converted into common shares:
 
Pre Conversion
(Units)
Former Series A Unit Holders
420,255,676

Former Series B Unit Holders
19,109,603

Former Series C Unit Holders
3,470,254

Former Series D Unit Holders
3,572,066

Former Series E Unit Holders
35,720,664

Former Series G Unit Holders
59,099,908

Former Series H Unit Holders
15,513,726

Total Member Units
556,741,897


The units in the table above were converted to 99,651,444 shares of common stock and 10,462 shares of restricted stock. The members’ equity balance of $525,388 was reclassified into common stock and additional paid-in capital in the Condensed Consolidated and Combined Balance Sheet as of September 30, 2016.
LLC Agreement and Amended Certificate of Incorporation
Prior to the LLC Conversion, the Company’s operations were governed by its LLC Agreement. Upon the consummation of the LLC Conversion, the Company converted into a corporation, and the LLC Agreement no longer governs the Company's operations or the rights of its equityholders.

- 28 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

The LLC Agreement provided that the board of directors had the power and discretion to manage and control the business, property and affairs of the company, but that certain actions required the consent of certain of the Company's former members. Under the LLC Agreement, the Company had units authorized, including Series A through H units. Each equityholder holding Series A, B, D, E, F, G or H units had one vote for each unit held. Profits interests units awarded under the Nant Health, LLC Profits Interests Plan (the "Profits Interests Plan") took the form of Series C units of the Company. Holders of Series C units did not have the right to vote. The LLC Agreement also set forth the rights of and restrictions on unitholders, including certain rights of first refusal and preemptive and co-sale rights. The LLC Agreement also provided that, upon the LLC Conversion, the allocation of shares of the Company's common stock among the pre-IPO equityholders was dependent upon the IPO price of its common stock, based on the relative rights of the pre-IPO equityholders as set forth in the LLC Agreement. As a result, as part of the LLC Conversion, the Company set the actual allocation of shares among its pre-IPO equityholders based upon the IPO price of its common stock.
Concurrently with the consummation of the LLC Conversion, the LLC Agreement was terminated, other than certain provisions relating to certain pre-termination tax matters and certain liabilities.

In accordance with the Company’s amended and restated certificate of incorporation, which was filed immediately following the closing of its IPO, the Company is authorized to issue 750,000,000 shares of common stock, with a par value of $0.0001 per share, and 20,000,000 shares of undesignated preferred stock, with a par value of $0.0001 per share. Holders of the Company’s common stock are entitled to one vote for each share held on all matters submitted to a vote of its stockholders. Holders of the Company’s common stock have no cumulative voting rights. Further, as of September 30, 2016, holders of the Company’s common stock have no preemptive, conversion, redemption or subscription rights and there are no sinking fund provisions applicable to the Company’s common stock. Upon liquidation, dissolution or winding-up of the Company, holders of the Company’s common stock are entitled to share ratably in all assets remaining after payment of all liabilities and the liquidation preferences of any outstanding shares of preferred stock. Subject to preferences that may be applicable to any outstanding shares of preferred stock, holders of the Company’s common stock are entitled to receive dividends, if any, as may be declared from time to time by the Company’s board of directors. As of September 30, 2016, there were no outstanding shares of preferred stock.
2016 Equity Issuances
NaviNet
On January 1, 2016, the Company issued 15,513,726 Series H units to 3BE Holdings, LLC for the acquisition of NaviNet at a purchase price of $3.3841 per unit for an aggregate amount of $52,500. The Series H units had substantially the same rights and preferences as the former Series B, D, E, F and G units that were outstanding at the time. On June 1, 2016, the Series H units issued to 3BE Holdings, LLC were converted into 3,749,998 shares of the Company’s common stock.
2015 Equity Issuances
Allscripts Investment
On June 29, 2015, the Company issued 59,099,908 Series G units to Allscripts Healthcare Solutions, Inc. (“Allscripts”), at a purchase price of $3.3841 per unit for an aggregate amount of $200,000. The Series G units had substantially the same rights and preferences as the former Series B, D, E and F units that were outstanding at the time. On June 1, 2016, the Series G units issued to Allscripts were converted into 14,285,714 shares of the Company’s common stock.
Note 17. Stock Based Compensation
Profits Interests Plan
On December 3, 2013, the Company adopted the Profits Interests Plan under which it had reserved an aggregate of 63,750,000 Series C units for issuance to associates, consultants and contractors of the Company in consideration for bona fide services provided to the Company.
The Series C units were considered profits interests of the Company and did not entitle their holders (the “Series C Members”) to receive distributions if the Company were liquidated immediately after the grant. Instead, the Series C Members were entitled to receive an allocation of a portion of the profit and loss of the Company arising after the date of the grant and, subject to vesting conditions, distributions made out of a portion of the profits of the Company arising after the grant date of the Series C units. Grants of the Series C units were either fully vested, partially vested, or entirely unvested at the time of the grant as determined by the Board.

- 29 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

Series C Members were not entitled to receive any distributions until the aggregate distributions made by the Company exceeded a hurdle amount applicable to those Series C units. The hurdle amount for each grant was determined by the Board at the date of issuance of such units. After all other members received their applicable hurdle amount, the Series C Members were entitled to receive their percentage interest of such excess distributions.
As of December 31, 2015 and through the date of the LLC Conversion, the Company had 3,470,254 Series C units outstanding.
Upon the LLC Conversion (See Note 16) on June 1, 2016, the Company issued 28,973 shares of common stock to holders of vested Series C units and 10,462 shares of restricted stock to holders of unvested Series C units. The shares of restricted stock issued to holders of unvested profits interests are subject to forfeiture until becoming fully vested in accordance with the terms of the original Series C unit grant agreements.
During the three and nine months ended September 30, 2016 and 2015, the Company recognized stock based compensation for the Series C units/restricted stock expense of $43, a benefit of $225, an expense of $319 and an expense of $1,350, respectively. Total stock-based compensation expense of $316 is expected to be recognized on a straight-line basis over approximately the next 2 years for the unvested restricted stock outstanding as of September 30, 2016. The unrecognized stock compensation relates to nonemployees and the awards are being accounted for pursuant to ASC 505-50. Stock compensation expense for the Series C units/restricted stock issued to the nonemployees is calculated based on the fair value of the award on each balance sheet date and the attribution of that cost is being recognized ratably over the vesting period.
Phantom Unit Plan
On March 31, 2015, the Company approved the Nant Health, LLC Phantom Unit Plan (the “Phantom Unit Plan”). The maximum number of phantom units that may be issued under the Phantom Plan is equal to 11,590,909 minus the number of issued and outstanding Series C units of the Company. As of September 30, 2016, there were 4,426,171 phantom units outstanding under the Phantom Unit Plan, after giving effect to the 1-for-5.5 reverse stock split. Each grant of phantom units made to a participant under the Phantom Unit Plan vests over a defined service period, subject to completion of a liquidity event. The Company’s IPO satisfied the liquidity event condition and the phantom units now entitle their holders to cash or non-cash payments in an amount equal to the number of vested units held by that participant multiplied by the fair market value of one share of the Company’s common stock on the date each phantom unit vests. After the Company’s IPO, the Company will no longer issue any units under the Phantom Unit Plan.

The Company intends to settle all vested phantom unit payments held by United States-based participants in shares of the Company’s common stock and classifies these awards as equity awards in its Condensed Consolidated and Combined Balance Sheet. Awards held by participants who are based outside of the United States will be settled in cash and are classified within accrued expenses on the Condensed Consolidated and Combined Balance Sheet as of September 30, 2016.

Stock-based compensation cost related to phantom units is included in the following line items in the accompanying Condensed Consolidated and Combined Statement of Operations and Balance Sheet for and as of the three and nine months ended September 30, 2016 and 2015:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Cost of revenue
$
442

 
$

 
$
7,474

 
$

Selling, general and administrative
2,771

 

 
26,348

 

Research and development
1,936

 

 
15,385

 

Total stock-based compensation expense
5,149

 

 
49,207

 

Amount capitalized to internal-use software and deferred implementation costs
1,594

 

 
1,594

 

Total stock-based compensation cost
$
6,743

 
$

 
$
50,801

 
$


- 30 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

The following table summarizes the activity related to the unvested phantom units during the nine months ended September 30, 2016:
 
Number of Units
 
Weighted
Average Grant
date value per
phantom unit
Unvested phantom units outstanding - December 31, 2015
3,653,008

 
$15.78
   Granted
3,094,335

 
$14.57
   Vested
(1,612,421
)
 
$15.71
   Forfeited
(573,667
)
 
$15.21
Unvested phantom units outstanding - June 30, 2016
4,561,255

 
$15.18
   Granted

 
$—
   Vested
(21,651
)
 
$15.37
   Forfeited
(113,433
)
 
$15.12
Unvested phantom units outstanding - September 30, 2016
4,426,171

 
$15.18

During the nine months ended September 30, 2016, the Company granted 1,043,450 phantom units to employees of related companies who are providing services to the Company under the shared services agreement with NantWorks (See Note 19) as well as certain consultants of the Company. Stock compensation expense for the phantom units issued to these participants is re-measured at the end of each reporting period until the awards vest. All other grants of phantom units have been made to employees of the Company. The Company uses the accelerated attribution method to recognize expense for all phantom units since the awards’ vesting was subject to the completion of a liquidity event. The grant date fair value of the phantom units granted prior to LLC Conversion was estimated using both an option pricing method and a probability weighted expected return method.
 
As of September 30, 2016, the Company had $38,942 of unrecognized stock based compensation expense related to phantom units which will be recognized over a weighted-average period of 3.2 years. Of that amount, $33,600 of unrecognized expense is related to employee grants with a weighted-average period of 3.2 years and $5,342 of unrecognized expense is related to non-employee grants with a weighted-average period of 3.5 years.

During the three and nine months ended September 30, 2016, the Company issued 1,071,647 shares of common stock to participants of the Phantom Unit Plan based in the United States, after withholding approximately 545,485 shares to satisfy tax withholding obligations. The Company made a cash payment of $5,822 to cover employee withholding taxes taxes upon the settlement of these vested phantom units. During the three and nine months ended September 30, 2016 the Company also paid $235 to cash-settle 16,818 vested phantom units held by participants of the Phantom Unit Plan based outside of the United States.

As described in Note 2, the Company early adopted ASU 2016-06 Improvements to Employee Share-Based Payment Accounting related to stock based compensation. The new standard simplifies the accounting for employee share-based payment transactions, including the accounting for forfeitures. The adoption of this standard had no material effect to the Company's Condensed Consolidated and Combined Financial Statements.
2016 Equity Incentive Plan
In May and June of 2016, the Company’s Board of Directors adopted and the Company’s stockholders approved the 2016 Equity Incentive Plan (“the 2016 Plan”) in connection with the Company’s IPO. The 2016 Plan provides for the grant of incentive stock options, non-statutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance units and performance shares to employees, directors and consultants. A total of 6,000,000 shares of common stock are reserved for issuance pursuant to the 2016 Plan.
The Company issued 10,462 shares of restricted stock under the 2016 Plan during the nine months ended September 30, 2016 in connection with the conversion of the Series C units. No awards have been issued during the three months ended September 30, 2016 pursuant to the 2016 Plan.

- 31 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

Note 18. Net Loss Per Share
The following table sets forth reconciliations of the numerators and denominators used to compute basic and diluted net loss per share of common stock and redeemable common stock for the three and nine months ended September 30, 2016 and 2015:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
2015
 
2016
 
2015
 
Common Stock
 
Common Stock
 
Common Stock
 
Redeemable Common Stock
 
Common Stock
Loss per share numerator
 
 
 
 
 
 
 
 
 
Net loss
$
(36,874
)
 
$
(22,958
)
 
$
(124,151
)
 
$

 
$
(54,159
)
Accretion to redemption value of series F/redeemable common stock

 

 
(4,958
)
 
4,958

 

Net (loss)/income for basic/diluted loss per share
$
(36,874
)
 
$
(22,958
)
 
$
(129,109
)
 
$
4,958

 
$
(54,159
)
 
 
 
 
 
 
 
 
 
 
Loss per share denominator:
 
 
 
 
 
 
 
 
 
Weighted-average shares for basic net loss per share
121,245,440

 
95,906,797

 
108,359,973

 
6,686,653

 
86,696,282

Effect of dilutive securities

 

 

 

 

Weighted-average shares for dilutive net loss per share
121,245,440

 
95,906,797

 
108,359,973

 
6,686,653

 
86,696,282

 
 
 
 
 
 
 
 
 
 
Basic & Diluted net loss per share
$
(0.30
)
 
$
(0.24
)
 
$
(1.19
)
 
$
0.74

 
$
(0.62
)
The net loss per share and weighted-average shares outstanding have been computed to give effect to the LLC Conversion (See Note 16) that occurred June 1, 2016 prior to the Company’s initial public offering.  In conjunction with the LLC Conversion, (a) all of the Company’s outstanding units automatically converted into shares of common stock, based on the relative rights of the Company's pre-IPO equityholders as set forth in the limited liability company agreement and (b) the Company adopted and filed a certificate of incorporation with the Secretary of State of the state of Delaware and adopted bylaws. The Company filed an amended certificate of incorporation to effect a 1-for-5.5 reverse stock split of its common stock on June 1, 2016.

As of December 31, 2015, the Company determined that the redemption of the Series F units was probable due to the uncertainty of completing a qualified initial public offering and, as such, accrued interest as a reduction to members’ equity. Prior to December 31, 2015, the Company had concluded that redemption was not probable and had not adjusted the carrying value of such units to redemption value. As of June 1, 2016 as part of the LLC Conversion, the Series F units converted to shares of redeemable common stock. The Put Right on redeemable common stock expired unexercised on June 20, 2016, and as of that date, the shares of common stock owned by KIO are no longer redeemable and are included in common shares (See Note 15).

For the three and nine months ended September 30, 2016, 4,426,171 shares of common stock issuable to holders of unvested phantom units were outstanding at September 30, 2016, but were not included in the computation of diluted net loss per share applicable to common stockholders because they would have an antidilutive effect on the diluted net loss per share.

For the three and nine months ended September 30, 2015, 3,761,348 shares of common stock issuable to holders of unvested phantom units, respectively were outstanding at September 30, 2015, but were not included in the computation of diluted net loss per share applicable to common stockholders because they would have an antidilutive effect on the diluted net loss per share.



- 32 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

Note 19. Related Party Transactions
NantWorks Shared Services Agreement
In October 2012, the Company entered into a shared services agreement with NantWorks that provides for ongoing services from NantWorks in areas such as public relations, information technology and cloud services, human resources and administration management, finance and risk management, environmental health and safety, sales and marketing services, facilities, procurement and travel, and corporate development and strategy (the "Shared Services Agreement"). The Company was billed quarterly for such services at cost, without mark-up or profit for NantWorks, but including reasonable allocations of employee benefits, facilities and other direct or fairly allocated indirect costs that relate to the associates providing the services. The Company incurred $2,106 and $7,692 of expenses during the three and nine months ended September 30, 2016, respectively, related to selling, general and administrative services provided to the Company by NantWorks and affiliates, net of services provided to NantWorks and affiliates. The Company incurred $2,255 and $7,698 of expenses during the three and nine months ended September 30, 2015 related to selling, general and administrative services provided by NantWorks. Additionally, the Company incurred $204 and $414 of expenses during the three and nine months ended September 30, 2016, respectively, related to research and development services provided by NantWorks and its subsidiaries. The Company incurred $274 and $937 of expenses during the three and nine months ended September 30, 2015, respectively, related to research and development services provide by NantWorks.

Related Party Receivables and Payables
As of September 30, 2016 and December 31, 2015, the Company had related party receivables, net of $2,869 and $2,545, respectively. The related party receivables, net as of September 30, 2016 and December 31, 2015 primarily consisted of a receivable from Ziosoft KK of $2,126 and $2,150, respectively, which was related to the sale of Qi Imaging. As of September 30, 2016 and December 31, 2015 the Company had related party payables of $7,530 and $10,166, respectively. The related party payables, net balances primarily relate to amounts owed to NantWorks pursuant to the Shared Services Agreement and amounts owed to NantOmics under the Second Amended Reseller Agreement (defined below). The balance of the related party receivables and payables represent amounts paid by affiliates on behalf of the Company or vice versa.

Amended Reseller Agreement
On June 19, 2015, the Company entered into a five and a half year exclusive Reseller Agreement with NantOmics for sequencing and bioinformatics services (the "Original Reseller Agreement"). NantOmics is a majority owned subsidiary of NantWorks and is controlled by the Company's Chairman and CEO. On May 9, 2016, the Company and NantOmics executed an Amended and Restated Reseller Agreement (the “Amended Reseller Agreement”), pursuant to which the Company received the worldwide, exclusive right to resell NantOmics’ quantitative proteomic analysis services, as well as related consulting and other professional services, to institutional customers (including insurers and self-insured healthcare providers) throughout the world. The Company retained its existing rights to resell NantOmics’ genomic sequencing and bioinformatics services. Under the Amended Reseller Agreement, the Company is responsible for various aspects of delivering its sequencing and molecular analysis solutions, including patient engagement and communications with providers such as providing interpretations of the reports delivered to the physicians and resolving any disputes, ensuring customer satisfaction, and managing billing and collections. On September 20, 2016, the Company and NantOmics further amended the Reseller Agreement (the "Second Amended Reseller Agreement"). The Second Amended Reseller Agreement permits the Company to use vendors other than NantOmics to provide any or all of the services that are currently being provided by NantOmics and clarifies that the Company is responsible for order fulfillment and branding.

The Second Amended Reseller Agreement grants to the Company the right to renew the agreement (with exclusivity) for up to three renewal terms, each lasting three years, if the Company achieves projected volume thresholds, as follows: (i) the first renewal option can be exercised if the Company completes at least 300 tests between June 19, 2015 and June 30, 2020; (ii) the second renewal option can be exercised if the Company completes at least 570 tests between July 1, 2020 and June 30, 2023; and (iii) the third renewal option can be exercised if the Company completes at least 760 tests between July 1, 2023 and June 30, 2026. If the Company does not meet the applicable volume threshold during the initial term or the first or second exclusive renewal terms, the Company can renew for a single additional three year term, but only on a non-exclusive basis.
The Company agreed to pay NantOmics non-cancellable annual minimum fees of $2,000 per year for each of the calendar years from 2016 through 2020 and, subject to the Company exercising at least one of its renewal options described above, the Company is required to pay annual minimum fees to NantOmics of at least $25,000 per year for each of the calendar years from 2021 through 2023 and $50,000 per year for each of the calendar years from 2024 through 2029.
As of September 30, 2016 and December 31, 2015, the Company has $2,009 and $3,111, respectively, of outstanding related party payables under the Second Amended Reseller Agreement.

- 33 -

NantHealth, Inc.
Notes to Condensed Consolidated and Combined Financial Statements
(In thousands, except share and per share amounts)
(Unaudited)

In January 2015, the Company entered into an agreement to provide certain research related sequencing services to a university which is engaged in researching the genetic causes of certain hereditary diseases. The agreement provides that the university pay the Company $10,000 in exchange for the Company providing sequencing services.
At the request of the university, certain public and private charitable 501(c)(3) non-profit organizations provided partial funding for the sequencing and related bioinformatics costs associated with the project. The Company’s Chairman and CEO serves as the CEO and a member of the board of directors of each of the non-profit organizations and by virtue of these positions he may have influence or control over these organizations. The university was not contractually or otherwise required to use the Company’s molecular profiling solutions or any of the Company’s other products or services as part of the charitable gift, however, the university did not have a requirement to order or pay for the services unless it first received private donor funding for the project. As a result, the Company does not classify the fees related to this project as revenue but instead classifies the amounts as deemed capital contributions from the Company's Chairman and CEO. During the three and nine months ended September 30, 2016, $1,800 and $3,420, respectively, was recorded as a deemed capital contribution within members' equity or stockholders' equity. During the three and nine months ended September 30, 2015, $4,300 and $4,790, respectively, was recorded as a deemed capital contribution within members' equity. During the three and nine months ended September 30, 2016, $1,080 and $2,052 of costs, respectively, were recorded as other services cost of revenue related to the service performed. During the three and nine months ended September 30, 2015, $2,580 and $2,874, respectively of costs were recognized as other services cost of revenue related to the service performed.
Related Party Promissory Notes
On January 4, 2016, the Company executed a $112,666 demand promissory note in favor of NantCapital to fund the acquisition of NaviNet. The note bears interest at a per annum rate of 5.0%, compounded annually and computed on the basis of the actual number of days elapsed and a year of 365 or 366 days, as the case may be. The unpaid principal and any accrued and unpaid interest on the note was originally due and payable on demand in either (i) cash, (ii) shares of the Company's common stock based on per share price of $18.6126, (iii) Series A-2 units of NantOmics based on a per unit price of $1.484 to the extent such equity is owned by the Company or (iv) any combination of the foregoing, all at the option of NantCapital. Subject to the preceding sentence, the Company may prepay the outstanding amount at any time, either in whole or in part, without premium or penalty and without the prior consent of NantCapital. On May 9, 2016, the promissory note with NantCapital was amended to provide that all outstanding principal and accrued interest is due and payable on June 30, 2021, and not on demand. No other terms of the promissory note were changed. As of September 30, 2016, the total principal and interest outstanding on the note amounted to $116,837. The accrued and unpaid interest on the note is classified as related party interest payable on the Condensed Consolidated and Combined Balance Sheet. The Company can request additional advances subject to NantCapital approval. The NantCapital Note bears interest at a per annum rate of 5.0% compounded annually and computed on the basis of the actual number of days in the year. NantCapital has the option, but not the obligation, to require us to repay any such amount in cash, Series A-2 units of NantOmics (based on a per unit price of $1.484) held by us, shares of the Company's common stock based on a per share price of $18.6126 (if such equity exists at the time of repayment), or any combination of the foregoing at the sole discretion of NantCapital.
On January 22, 2016, the Company executed a demand promissory note in favor of NantOmics. The principal amount of the initial advance totaled $20,000. On March 8, 2016, NantOmics made a second advance to the Company for $20,000. The note bears interest at a per annum rate is 5.0% and is compounded annually. In May and June of 2016, the Company executed amendments to the demand promissory note with NantOmics, which provide that all unpaid principal of each advance owed to NantOmics and any accrued and unpaid interest would convert automatically into shares of the Company’s common stock after pricing of the Company’s IPO and immediately after conversion of the Company from a limited liability company to a corporation. On June 1, 2016, approximately $40,590 of principal and accrued interest under the promissory note with NantOmics was converted into 2,899,297 shares of the Company’s common stock in connection with the IPO. The Company can request additional advances subject to NantOmics approval, and as of September 30, 2016, there was no outstanding balance on the promissory note.

- 34 -


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is a discussion and analysis of our financial condition and the results of operations as of and for the periods presented below. The following discussion and analysis should be read in conjunction with the “Condensed Consolidated and Combined Financial Statements” and notes thereto included elsewhere in this Quarterly Report on Form 10-Q, or Quarterly Report. This discussion contains forward-looking statements that are based on the beliefs, assumptions, and information currently available to our management, and are subject to known and unknown risks, uncertainties, and other factors that may cause our actual results to differ materially from those expressed or implied by such forward-looking statements. These risks, uncertainties, and other factors include, among others, those described in greater detail elsewhere in this Quarterly Report and in our Registration Statement on Form S-1, as amended, particularly in the section entitled “Risk Factors”.
Overview
We are a leading next-generation, evidence-based, personalized healthcare company focused on enabling our clients to fundamentally change the diagnosis, treatment and pharmacoeconomics of cancer and other critical illnesses. We believe a molecular-driven, systems-based approach to making clinical treatment decisions based on large-scale, real time biometric and phenotypical data will become the standard of care initially for patients with cancer and, ultimately, other critical illnesses. We derive revenue from selling GPS Cancer (our Genomic Proteomic Spectrometry Cancer test, a unique, comprehensive molecular test and decision support solution that measures the proteins present in the patient's tumor tissue, combined with whole genomic and transcriptomic sequencing of tumor & normal samples), to which we obtained exclusive access from an affiliate, and NantOS and NantOS apps to healthcare providers and payors, self-insured employers and biopharmaceutical companies. NantOS and NantOS apps include proprietary methods and algorithms for enabling healthcare providers to make better treatment decisions to improve patient outcomes and lower the cost of care, and allow healthcare payors to ensure that their dependents receive high quality care in a cost-effective manner. We believe that as healthcare providers and payors migrate to value-based reimbursement models and implement advances in precision medicine, our offerings position us at the forefront of multiple significant market opportunities.
We market CLINICS (our Comprehensive, Learning, Integrated, NantHealth, Intelligent, Clinical System) as a comprehensive integrated solution that includes GPS Cancer, NantOS and the NantOS apps. We also market our NantOS, individual NantOS apps and suites of NantOS apps as stand-alone solutions. To accelerate our commercial growth and enhance our competitive advantage, we continue to:

introduce new marketing, education and engagement efforts and foster relationships across the oncology community to drive adoption of GPS Cancer;
pursue reimbursement of GPS Cancer from regional and national third-party payors and government payors;
publish scientific and medical advances;
strengthen our commercial organization to increase our CLINICS and GPS Cancer client base and to broaden usage of our solutions by existing clients who currently use only NantOS, specific NantOS apps or suites of NantOS apps; and
develop new features and functionality for CLINICS to address the needs of current and future healthcare provider and payor, self-insured employer and biopharmaceutical company clients.
We estimate that GPS Cancer and CLINICS, including the NantOS and NantOS apps, address a potential market opportunity in excess of $50 billion globally.
Since our inception, we have devoted substantially all of our resources to the development and commercialization of CLINICS, including NantOS and the NantOS apps, as well as the commercial launch of our GPS Cancer business. To complement our internal growth and expertise, we have made several strategic acquisitions of companies, products and technologies. We have incurred significant losses since our inception, and as of September 30, 2016 our accumulated deficit was approximately $415.3 million. We expect to continue to incur operating losses over the near term as we drive adoption of GPS Cancer, expand our commercial operations, and invest further in CLINICS.


- 35 -


We plan to (i) continue investing in our infrastructure, including but not limited to solution development, sales and marketing, implementation and support, (ii) continue efforts to make infrastructure investments within an overall context of maintaining reasonable expense discipline, (iii) add new clients through maintaining and expanding sales, marketing and solution development activities, (iv) expand our relationships with existing clients through delivery of add-on and complementary solutions and services and (v) continue our commitment of service in support of our client satisfaction programs. We believe that our growing client base using our NantOS and NantOS apps on a daily basis is a strategic asset, and we intend to expand sales of CLINICS offerings towards this client base in order to leverage this strategic asset.
Recent Acquisitions and Investments
We have made several significant acquisitions and investments in 2015 and 2016, which have expanded the features and functionality of CLINICS, including the following:
 
NantOmics In June 2015, we invested a substantial portion of our available capital in NantOmics, a majority owned subsidiary of NantWorks. Our investment represents approximately 14.3% of the issued and outstanding membership interests of NantOmics. Our relationship with NantOmics provides us with access to what we believe is the nation’s only CAP- and CLIA-certified whole genome and quantitative proteomics laboratory.
Healthcare Solutions (“HCS”) In July 2015, we acquired certain assets related to HCS business from Harris Corporation. Once integrated with our systems, we believe the acquired assets will help complex healthcare delivery organizations achieve better patient outcomes, clinical and administrative workflow efficiency and stronger collaboration across the continuum of care.
NaviNet In January 2016, we acquired NaviNet, which provides a secure collaboration network connecting approximately 36 health plans and which is estimated to be utilized in more than 70% of the nation’s physicians’ offices as of the first quarter of 2016. NaviNet Open will serve as a nationwide scalable and secure web-based portal for patients and providers.
Non-GAAP Net Loss Per Share
Adjusted net loss and adjusted net loss per share are financial measures that are not prepared in conformity with United States generally accepted accounting principles (U.S. GAAP). The Company’s management believes that the presentation of Non-GAAP financial measures provides useful supplementary information regarding operational performance, because it enhances an investor’s overall understanding of the financial results for the Company’s core business. Additionally, it provides a basis for the comparison of the financial results for the Company’s core business between current, past and future periods . Other companies may define these measures in different ways. Non-GAAP financial measures should be considered only as a supplement to, and not as a substitute for or as a superior measure to, financial measures prepared in accordance with U.S. GAAP. All loss per share numbers contained in this news release are calculated based on one class of common stock and do not incorporate the effects, if any, of using the two-class method.

Adjusted net loss excludes the effects of (1) loss from equity method investments, (2) stock based compensation expense, (3) intangible amortization, (4) corporate restructuring expenses, (5) acquisition related compensation expense, and (6) acquisition-related sales incentives, which have been recorded as contra revenue. Provision for income taxes excludes the impact of the conversion from a limited liability corporation to a corporation.
 
Adjusted shares outstanding include Series F redeemable shares as if converted on January 1, 2015.

The following table reconciles Net Loss to Net Loss-Non-GAAP and Shares Outstanding to Shares Outstanding-Non-GAAP for the three and nine months ended September 30, 2015 and 2016:

- 36 -


(In thousands except share and per share amounts)
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Loss before Income taxes
$
(36,618
)
 
$
(22,957
)
 
$
(142,504
)
 
$
(54,157
)
 
 
 
 
 
 
 
 
Loss from related party equity method investment
2,604

 

 
7,893

 
145

Stock-based compensation expense
5,192

 
319

 
48,982

 
1,350

Corporate restructuring
401

 
778

 
2,546

 
1,764

Acquisition related compensation expense

 

 
4,814

 

Sales incentive
567

 

 
2,027

 

Intangible amortization
5,520

 
3,649

 
17,326

 
8,228

Total adjustments to GAAP loss before provision for income taxes
14,284

 
4,746

 
83,588

 
11,487

Provision from income taxes
93

 
1

 
398

 
2

Net loss - Non-GAAP