Document
 

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

 
FORM 10-Q

 
(Mark One)
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019  
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
 
90232
(Address of principal executive offices)
 
(Zip Code)
(310) 883-1300
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
o
Accelerated filer
x
 
 
 
 
Non-accelerated filer
o
Smaller reporting company
x
 
 
Emerging growth company
x

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   x
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

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.0001 per share
NH
Nasdaq Global Select Market
As of May 7, 2019, the registrant had 109,931,397 shares of common stock, par value $0.0001 per share, outstanding.
 



NantHealth, Inc.
Form 10-Q
As of and for the quarterly period ended March 31, 2019
Table of contents


 
 
Page
PART I.
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Condensed Consolidated Statements of Stockholders' Equity (Deficit)
 
 
 
 
 
 
 
 
 
 
 
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 GPS Cancer, Liquid GPS, DeviceConX, HBox, Vitality, VitalsConX, NaviNet, NaviNet Open, Eviti, Eviti | Connect, and other marks relating to our product lines 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, or this Quarterly Report, including, without limitation, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 1A, “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 and to accelerate commercial growth of our sequencing and molecular analysis solutions and our other products and services;
our plans or ability to obtain reimbursement for our sequencing and molecular analysis solutions, including expectations as to our ability or the amount of time it will take to achieve successful reimbursement from third-party payers, 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, including new features and functionality for our existing 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 expectations regarding the period during which we qualify as an emerging growth company under the Jumpstart Our Business Startups Act, or the JOBS Act;
our ability to obtain and maintain intellectual property protection for our solutions and not infringe upon the intellectual property of others;
our ability to implement our comprehensive restructuring plan that includes a wide range of organizational efficiency initiatives and other cost reduction opportunities; 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.

- 3 -


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 are within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These statements appear throughout this Quarterly Report 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 may affect our business, financial conditions, operating 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. 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, “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. 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, except as required by law.

- 4 -


PART I — FINANCIAL INFORMATION
Item 1. Financial Statements

- 5 -

NantHealth, Inc.
Condensed Consolidated Balance Sheets
(Dollars in thousands)

 
March 31,
2019
 
December 31,
2018
 
(Unaudited)
 
 
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
12,444

 
$
18,305

Accounts receivable, net
15,288

 
15,286

Inventories
416

 
496

Related party receivables, net
735

 
1,007

Prepaid expenses and other current assets
5,264

 
4,350

Total current assets
34,147

 
39,444

Property, plant, and equipment, net
20,673

 
22,978

Goodwill
115,930

 
115,930

Intangible assets, net
62,416

 
64,703

Investment in related party
37,810

 
40,000

Related party receivable, net of current
1,603

 
1,611

Operating lease right-of-use assets
11,099

 

Other assets
1,566

 
1,671

Total assets
$
285,244

 
$
286,337

 
 
 
 
Liabilities and Stockholders' Equity (Deficit)
 
 
 
Current liabilities
 
 
 
Accounts payable
$
2,335

 
$
1,650

Accrued and other current liabilities
15,293

 
13,832

Deferred revenue
16,892

 
16,263

Related party payables, net
4,856

 
4,791

Total current liabilities
39,376

 
36,536

Deferred revenue, net of current
7,091

 
6,704

Related party liabilities
19,313

 
17,708

Related party promissory note
112,666

 
112,666

Related party convertible note, net
8,494

 
8,378

Convertible notes, net
80,674

 
79,433

Deferred income taxes, net
2,600

 
2,437

Operating lease liabilities
12,404

 

Other liabilities
18,989

 
19,644

Total liabilities
301,607

 
283,506

 
 
 
 
Stockholders' equity (deficit)
 
 
 
Common stock, $0.0001 par value per share, 750,000,000 shares authorized; 109,921,647 and 109,491,277 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively (including 1 share of restricted stock at both dates)
11

 
11

Additional paid-in capital
887,963

 
887,289

Accumulated deficit
(904,045
)
 
(884,122
)
Accumulated other comprehensive loss
(292
)
 
(347
)
Total stockholders' equity (deficit)
(16,363
)
 
2,831

Total liabilities and stockholders' equity (deficit)
$
285,244

 
$
286,337

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

- 6 -

NantHealth, Inc.
Condensed Consolidated Statements of Operations
(Dollars in thousands, except per share amounts)
(Unaudited)

 
Three Months Ended 
 March 31,
 
2019
 
2018
Revenue:
 
 
 
Software-as-a-service related
$
17,802

 
$
16,166

Software and hardware related
1,027

 
1,455

Maintenance
2,493

 
2,446

Total software-related revenue
21,322

 
20,067

Sequencing and molecular analysis
814

 
840

Home health care services
1,593

 
1,356

Total net revenue
23,729

 
22,263

 
 
 
 
Cost of Revenue:
 
 
 
Software-as-a-service related
5,752

 
6,602

Software and hardware related
785

 
885

Maintenance
270

 
215

Amortization of developed technologies
1,233

 
1,173

Total software-related cost of revenue
8,040

 
8,875

Sequencing and molecular analysis
2,427

 
1,431

Home health care services
823

 
762

Total cost of revenue
11,290

 
11,068

 
 
 
 
Gross Profit
12,439

 
11,195

 
 
 
 
Operating Expenses:
 
 
 
Selling, general and administrative
16,789

 
20,737

Research and development
5,080

 
5,151

Amortization of acquisition-related assets
1,054

 
1,054

Total operating expenses
22,923

 
26,942

 
 
 
 
Loss from operations
(10,484
)
 
(15,747
)
Interest expense, net
(4,414
)
 
(4,197
)
Other (expense) income, net
(2,505
)
 
180

Loss from related party equity method investment
(2,210
)
 
(3,261
)
Loss from continuing operations before income taxes
(19,613
)
 
(23,025
)
Provision for (benefit from) income taxes
226

 
(1,050
)
Net loss from continuing operations
(19,839
)
 
(21,975
)
Loss from discontinued operations, net of tax
(84
)
 
(193
)
Net loss
$
(19,923
)
 
$
(22,168
)
 
 
 
 
Net loss per share:
 
 
 
Continuing operations
 
 
 
Basic and diluted - common stock
$
(0.18
)
 
$
(0.20
)
Discontinued operations
 
 
 
Basic and diluted - common stock
$

 
$

Total net loss per share
 
 
 
Basic and diluted - common stock
$
(0.18
)
 
$
(0.20
)
 
 
 
 
Weighted average shares outstanding:
 
 
 
Basic and diluted - common stock
109,904,336

 
108,579,271


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

- 7 -

NantHealth, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(Dollars in thousands)
(Unaudited)


 
Three Months Ended 
 March 31,
 
2019
 
2018
 
 
 
 
Net loss
$
(19,923
)
 
$
(22,168
)
  Other comprehensive income from foreign currency translation gain
55

 
110

Total other comprehensive income
55

 
110

Comprehensive loss
$
(19,868
)
 
$
(22,058
)

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


- 8 -

NantHealth, Inc.
Condensed Consolidated Statements of Stockholders’ Equity
(Dollars in thousands)
(Unaudited)

 
Common Stock
 
Additional
Paid-In Capital
 
Accumulated Deficit
 
Accumulated
Other
Comprehensive Income (Loss)
 
Total Stockholders' Equity (Deficit)
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2017
108,383,602

 
$
10

 
$
886,669

 
$
(693,233
)
 
$
(144
)
 
$
193,302

Modified retrospective adjustment on adoption of ASC 606

 

 

 
1,263

 

 
1,263

Stock-based compensation

 

 
2,655

 

 

 
2,655

Shares issued in connection with employee stock plans, net of shares withheld for employee taxes
208,344

 

 
(339
)
 

 

 
(339
)
Assignment of NantHealth Labs (see Note 20)

 

 
(3,785
)
 

 

 
(3,785
)
Other comprehensive income

 

 

 

 
110

 
110

Net loss

 

 

 
(22,168
)
 

 
(22,168
)
Balance at March 31, 2018
108,591,946

 
$
10

 
$
885,200

 
$
(714,138
)
 
$
(34
)
 
$
171,038

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2018
109,491,277

 
$
11

 
$
887,289

 
$
(884,122
)
 
$
(347
)
 
$
2,831

Stock-based compensation

 

 
707

 

 

 
707

Shares issued in connection with employee stock plans, net of shares withheld for employee taxes
430,370

 

 
(53
)
 

 

 
(53
)
Assignment of NantHealth Labs (see Note 20)

 

 
20

 

 

 
20

Other comprehensive income

 

 

 

 
55

 
55

Net loss

 

 

 
(19,923
)
 

 
(19,923
)
Balance at March 31, 2019
109,921,647

 
$
11

 
$
887,963

 
$
(904,045
)
 
$
(292
)
 
$
(16,363
)
    
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.


- 9 -

 NantHealth, Inc.
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)

 
Three Months Ended 
 March 31,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net loss
$
(19,923
)
 
$
(22,168
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
5,819

 
5,297

Amortization of debt discounts and deferred financing offering cost
1,357

 
1,194

Change in fair value of derivatives liability

 
(1
)
Change in fair value of Bookings Commitment
2,494

 

Stock-based compensation
650

 
2,718

Deferred income taxes, net
164

 
(1,177
)
Provision for bad debt expense
10

 
36

Loss from related party equity method investment
2,210

 
3,261

Changes in operating assets and liabilities, net of business combinations and divestitures:
 
 
 
Accounts receivable, net
(12
)
 
928

Inventories
80

 
34

Related party receivables, net
280

 
(37
)
Prepaid expenses and other current assets
(1,100
)
 
538

Deferred implementation costs

 
(13
)
Accounts payable
685

 
495

Accrued and other current liabilities
(80
)
 
(6,769
)
Deferred revenue
1,016

 
(588
)
Related party payables, net
1,727

 
2,720

Change in operating lease right-of-use assets and liabilities
(51
)
 

Other operating assets and liabilities
(159
)
 
239

Net cash used in operating activities
(4,833
)
 
(13,293
)
Cash flows from investing activities:
 
 
 
Purchases of property and equipment including internal use software
(973
)
 
(460
)
Assignment of NantHealth Labs (formerly Liquid Genomics), net of cash assigned (see Note 20)

 
68

Net cash used in investing activities
(973
)
 
(392
)
Cash flows from financing activities:
 
 
 
Tax payments related to stock issued, net of stock withheld, for vested equity awards
(58
)
 
(339
)
Net cash used in financing activities
(58
)
 
(339
)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
3

 
(110
)
Net decrease in cash, cash equivalents and restricted cash
(5,861
)
 
(14,134
)
Cash, cash equivalents and restricted cash, beginning of period (1)
19,441

 
62,010

Cash, cash equivalents and restricted cash, end of period (1)
$
13,580

 
$
47,876


- 10 -

NantHealth, Inc.
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)

 
Three Months Ended 
 March 31,
 
2019
 
2018
Supplemental disclosure of cash flow information:
 
 
 
Interest received

 
1

Noncash investing and financing activities:
 
 
 
Purchases of property and equipment including internal use software
57

 
1,570

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
(1) Cash and cash equivalents included restricted cash of $1,136 and $1,136 at December 31, 2018 and March 31, 2019, respectively, included in Other assets and $350 and $1,486 at December 31, 2017 and March 31, 2018, respectively. Restricted cash consists of funds that are contractually restricted as to usage or withdrawal related to the Company's security deposits in the form of standby letters of credit for leased facilities. No amounts have been drawn upon the letters of credit as of March 31, 2019.


- 11 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except 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 IT company converging science and technology. The Company works to transform clinical delivery with actionable clinical intelligence at the moment of decision, enabling clinical discovery through real-time machine learning systems. The Company markets certain of its solutions as a comprehensive integrated solution that includes its molecular sequencing and analysis services, clinical decision support, and payer engagement solutions. The Company also markets molecular sequencing and analysis services, clinical decision support, payer engagement and connected care solutions. 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 by and are led by Dr. Patrick Soon-Shiong.

On August 25, 2017, the Company sold substantially all of the assets of the Company’s provider/patient engagement solutions business (see Note 4). The sale enabled the Company to focus on its core competencies of genomic sequencing, clinical decision support, connected care, and payer engagement.
As of March 31, 2019, the Company conducted the majority of its operations in the United States, the United Kingdom, Singapore and Canada.
Basis of Presentation and Principles of Consolidation
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of NantHealth and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. These interim Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") 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 operations. These Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements for the fiscal year ended December 31, 2018. The results of operations of the entities disposed of are included in the unaudited Condensed Consolidated Financial Statements up to the date of disposal and, where appropriate, these operations have been reflected as discontinued operations. The accompanying Condensed Consolidated Balance Sheet as of December 31, 2018 has been derived from the audited Consolidated Financial Statements at that date, without retrospective application of ASC 842, Leases. The balance sheets do not include all of the disclosures required by GAAP. Operating results for interim periods are not necessarily indicative of the results that may be expected for a full fiscal year.
The Company believes its existing cash, cash equivalents and ability to borrow from affiliated entities will be sufficient to fund operations through at least 12 months following the issuance date of the financial statements based upon the Company’s Chairman and CEO’s intent and ability to support the Company’s operations with additional funds as required. The Company may also seek to sell additional equity, through one or more follow-on public offerings or in separate financings, or sell additional debt securities, or obtain a credit facility. However, the Company may not be able to secure such financing in a timely manner or on favorable terms. Without additional funds, the Company may choose to delay or reduce its operating or investment expenditures. Further, because of the risk and uncertainties associated with the commercialization of the Company's existing products as well as products in development, the Company may need additional funds to meet its needs sooner than planned. To date, the Company's primary sources of capital were private placement of membership interests prior to its IPO, debt financing agreements, including the promissory note with Nant Capital, LLC (“NantCapital”), convertible notes, and its IPO.
Note 2. Summary of Significant Accounting Policies
There have been no significant changes to the accounting policies as disclosed in the Company's Annual Report on Form 10-K, apart from the application of the new lease reporting standard issued by FASB as Accounting Standards Codification ("ASC") 842, Leases, and the new accounting guidance applicable to non-employee stock compensation, released as Accounting Standards Update ("ASU") No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-based Payment Accounting, described below. The other accounting policies, including the accounting policy for leases and non-employee stock compensation, applied to periods before January 1, 2019, are described in the Company’s Annual Report on Form 10-K.
Use of Estimates

- 12 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

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 Financial Statements and accompanying notes. Actual results may differ from those estimates.
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 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 unit level. Accordingly, management has determined that the Company operates in one reportable segment.
Leases

The Company determines if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets, other current liabilities, and operating lease liabilities on the consolidated balance sheets.

Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. The Company's leases do not provide an implicit rate; therefore, the Company uses the incremental borrowing rate based on the information available at commencement date, or at January 1, 2019 for the Company's leases on transition to ASC 842, in determining the present value of future payments. The operating lease ROU asset excludes lease incentives and initial direct costs incurred. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.

The Company has lease agreements with lease and non-lease components. For data center leases and real estate leases, the Company accounts for the lease and non-lease components as a single lease component.

The Company treats data center leases with lease terms of less than one year as short-term leases and recognizes the lease expense straight-line over the lease term.
Stock-Based Compensation

The Company accounts for stock-based compensation arrangements issued to nonemployees using the fair value approach prescribed by ASC 505-50, Equity-Based Payments to Non-Employees. Following the implementation of ASU No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, the value of nonemployee stock-based compensation is recorded by measuring the grant date fair value of the award and recognizing the resulting expense over the period during which the nonemployee provides the services.
Recently Adopted Accounting Pronouncements

Effective January 1, 2019, the Company adopted ASC 842, which 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 previously accounted for as operating leases. This led to the recognition upon adoption, of operating lease liabilities of $12,703, the short-term portion of which, $1,624 was recorded in accrued and other current liabilities. Operating lease right-of-use assets of $9,724 were recognized. The Company applied the new lease standard at the adoption date and did not restate comparative periods. There was no cumulative-effect adjustment recognized in retained earnings in the period of adoption. On adoption, the Company elected the package of transition practical expedients and therefore did not reassess: whether expired or existing contracts are or contain leases; the lease classification of expired or existing leases; initial direct costs for any existing leases (see Note 14.).

Effective January 1, 2019, the Company adopted ASU No. 2018-07, Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, to simplify accounting for non-employee stock-based compensation. The Company applied the new guidance to equity-classified nonemployee awards for which a measurement date had not been established, which were valued at adoption date fair value, there was no cumulative-effect adjustment to the Company's accumulated deficit.

Effective January 1, 2019, the Company adopted ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which provides the option to reclassify stranded tax effects within accumulated other comprehensive income to retained earnings in each period in which the effect of the

- 13 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act (or portion thereof) is recorded. The Company adopted this standard on January 1, 2019 with no impact on the consolidated financial statements.

The SEC issued Final Rule Release No. 33-10532, Disclosure Update and Simplification, effective for filings submitted on or after November 5, 2018. The guidance extended to interim periods the annual requirement in SEC Regulation S-X, Rule 3-04 to disclose changes in shareholders' equity. Under the requirements in SEC Regulation S-X, Rules 8-03(a)(5) and 10-01(a)(7), as amended by this new guidance, registrants must now analyze changes in shareholders' equity, in the form of a reconciliation, for the current and comparative year-to-date interim periods, with subtotals for each interim period. The Company has presented a separate Condensed Consolidated Statements of Stockholders' Equity (Deficit) to satisfy this new disclosure requirement.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants, and the SEC did not have, nor are believed by management to have, a material impact on the Company's present or future Consolidated Financial Statements.
Upcoming Accounting Standard Pronouncements

In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, to provide guidance on customer's accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. The standard provides guidance on a customer's accounting for implementation, set-up, and other upfront costs incurred in a cloud computing arrangement that is hosted by the vendor, i.e. a service contract. Under the new guidance, customers will apply the same criteria for capitalizing implementation costs as they would for an arrangement that has a software license. This ASU will become effective for annual periods beginning January 1, 2020, early adoption is permitted and should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is still evaluating the impact of this ASU.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, to simplify the accounting for goodwill impairment. This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit. Upon adoption of ASU No. 2017-04, goodwill impairment will be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This may result in more or less impairment being recognized than under current guidance. This ASU will become effective for the Company's annual and interim goodwill impairment tests beginning in the first quarter of 2020, and early adoption is permitted. The Company is still evaluating the impact of this ASU.

In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, 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 No. 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 Consolidated Financial Statements.

Note 3. Revenue Recognition

Contract Balances

The Company records deferred revenue when cash payments are received, or payment is due, in advance of its fulfillment of performance obligations. There were revenues of $5,611 and $4,070 recognized during the three months ended March 31, 2019 and 2018, respectively, that were included in the deferred revenue balance at the beginning of the respective period.

Contract assets are recognized when a contractual performance obligation has been satisfied, but payment is not due until the completion of additional performance obligations, or the right to receive payment becomes unconditional. Contract assets increased to $1,006 at March 31, 2019 from $434 at December 31, 2018, due to fulfillment of performance obligations.

Assets Recognized from the Costs to Obtain a Contract with a Customer

The Company recognizes an asset for the incremental costs to obtain a contract with a customer, where the stated contract term, with expected renewals, is longer than one year. The Company amortizes these assets over the expected period of benefit. These costs are generally employee sales commissions, with amortization of the balance recorded in selling, general and

- 14 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

administrative expenses. The value of these assets was $1,023 at March 31, 2019 and $1,163 at December 31, 2018, and amortization during the three months ended March 31, 2019 and 2018 was $187 and $35, respectively.

Performance Obligations

As of March 31, 2019, the Company has allocated a total transaction price of $16,709 to unfulfilled performance obligations that are expected to be fulfilled within three years. Excluded from this amount are contracts of less than one year and variable consideration that relates to the value of services provided.
Note 4. Discontinued Operations
Sale to Allscripts
On August 3, 2017, the Company entered into an asset purchase agreement (the “APA”) with Allscripts Healthcare Solutions, Inc. (“Allscripts”), pursuant to which the Company agreed to sell to Allscripts substantially all of the assets of the Company’s provider/patient engagement solutions business, including the Company’s FusionFX solution and components of its NantOS software connectivity solutions (the “Business”). On August 25, 2017, the Company and Allscripts completed the sale of the Business (the "Disposition") pursuant to the APA.

Allscripts conveyed to the Company 15,000,000 shares of Company's common stock at par value of $0.0001 per share that were previously owned by Allscripts as consideration for the acquired Business upon Disposition. Allscripts paid the Company $1,742 of cash consideration as an estimated working capital payment, and the Company recorded a receivable of $1,021 related to final working capital adjustments. The Company was also responsible for fulfilling certain customer service obligations of the Business post-closing. As of December 31, 2018, the Company accrued $1,372 in accrued and other current liabilities for these obligations, which included estimates for certain unresolved items. These and certain other outstanding amounts were settled by agreement of March 18, 2019 with a net payment to the Company from Allscripts of $435.

Concurrent with the closing of the Disposition and as contemplated by the APA, (a) the Company and Allscripts modified the amended and restated mutual license and reseller agreement dated June 26, 2015, which was further amended on December 30, 2017, such that, among other things, the Company committed to deliver a minimum of $95,000 of total bookings over a ten-year period (“Bookings Commitment”) from referral transactions and sales of certain Allscripts products; (b) the Company and Allscripts each licensed certain intellectual property to the other party pursuant to a cross license agreement; (c) the Company agreed to provide certain transition services to Allscripts pursuant to a transition services agreement; and (d) the Company licensed certain software and agreed to sell certain hardware to Allscripts pursuant to a software license and supply agreement. In the event of a Bookings Commitment shortfall at the end of the ten-year period, the Company may be obligated to pay 70% of the shortfall, subject to certain credits. The Company will earn 30% commission from Allscripts on each software referral transaction that results in a booking with Allscripts. The Company accounts for the Bookings Commitment at its estimated fair value over the life of the agreement. As of March 31, 2019 and December 31, 2018, the estimated fair value was $19,441 and $16,947, respectively.
Note 5. Accounts Receivable, net
Accounts receivable are included on the Condensed Consolidated Balance Sheets, net of the allowance for doubtful accounts. The allowance for doubtful accounts at March 31, 2019 and December 31, 2018 was $165 and $163, respectively.
Note 6. Inventories
Inventories as of March 31, 2019 and December 31, 2018 consisted of $416 and $496 of finished goods, respectively.

- 15 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

Note 7. Prepaid Expenses and Other Current Assets and Accrued and Other Current Liabilities
Prepaid expenses and other current assets as of March 31, 2019 and December 31, 2018 consisted of the following:
 
March 31,
2019
 
December 31,
2018
 
 
 
 
Prepaid expenses
$
1,591

 
$
1,485

Insurance receivable
1,802


306

Other current assets
1,871

 
2,559

Prepaid expenses and other current assets
$
5,264

 
$
4,350


Accrued and other current liabilities of March 31, 2019 and December 31, 2018 consisted of the following:
 
March 31,
2019
 
December 31,
2018
 
 
 
 
Payroll and related costs
$
5,168

 
$
5,803

NaviNet acquisition accrued earnout
425

 
1,700

Litigation expense payable
1,802


410

Operating lease liabilities
1,687

 

Other accrued and other current liabilities
6,211

 
5,919

Accrued and other current liabilities
$
15,293

 
$
13,832


Note 8. Property, Plant, and Equipment, net
Property, plant and equipment, net as of March 31, 2019 and December 31, 2018 consisted of the following:
 
March 31,
2019
 
December 31,
2018
 
 
 
 
Computer equipment and software
$
14,169

 
$
14,058

Furniture and equipment
3,739

 
3,732

Leasehold and building improvements
7,463

 
7,450

Property, plant, and equipment, excluding internal use software
25,371

 
25,240

Less: Accumulated depreciation and amortization
(18,686
)
 
(17,884
)
Property, plant and equipment, excluding internal use software, net
6,685

 
7,356

Internal use software
31,784

 
31,565

Construction in progress - Internal use software
1,577

 
903

Less: Accumulated depreciation and amortization, internal use software
(19,373
)
 
(16,846
)
Internal use software, net
13,988

 
15,622

Property, plant, and equipment, net
$
20,673

 
$
22,978

 
Depreciation and amortization expense from continuing operations was $3,346 for the three months ended March 31, 2019, of which $2,547 related to internal use software costs. Depreciation and amortization expense from continuing operations was $3,070 for the three months ended March 31, 2018, of which $2,126 related to internal use software costs.

Amounts capitalized to internal use software for the three months ended March 31, 2019 and 2018 were $912 and $1,626, respectively.


- 16 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

Note 9. Intangible Assets, net
The Company’s definite-lived intangible assets as of March 31, 2019 and December 31, 2018 consisted of the following:
 
March 31,
2019
 
December 31,
2018
 
 
 
 
Customer relationships
$
52,000

 
$
52,000

Developed technologies
36,700

 
36,700

Trade name
3,000

 
3,000

 
91,700

 
91,700

Less: Accumulated amortization
(29,284
)
 
(26,997
)
Intangible assets, net
$
62,416

 
$
64,703


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 definite-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 from continuing operations for the three months ended March 31, 2019 and 2018 was $2,287 and $2,227, respectively.
At February 28, 2018, the Company recorded $4,700 of definite-lived intangible assets and accumulated amortization of $271 related to the assignment of NantHealth Labs (see Note 20). These intangibles are amortized over a period of thirteen years.
The estimated future amortization expense over the next five years and thereafter for the intangible assets that exist as of March 31, 2019 is as follows:
 
Amounts
Remainder of 2019
$
6,862

2020
8,400

2021
8,400

2022
8,400

2023
3,828

Thereafter
26,526

Total future intangible amortization expense
$
62,416

Note 10. Goodwill
Goodwill as of March 31, 2019 and December 31, 2018 was $115,930.
On February 28, 2018, the Company recognized $1,305 of goodwill related to the assignment of NantHealth Labs (see Note 20).
Goodwill acquired in a business combination is tested for impairment annually as of October 1, or between annual tests when an impairment indicator exists.
Note 11. Investments
Equity method investment

Investment in NantOmics

In 2015, the Company purchased a total of 169,074,539 Series A-2 units of NantOmics, LLC (“NantOmics”), a related party of the Company, for an aggregate purchase price of $250,774. The Series A-2 units do not have any voting rights and, at the time of the purchase, represented approximately 14.28% 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.

- 17 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)


The Company applies 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. At the date of purchase, the Company attributed $28,195 and $14,382 of these differences to NantOmics’ developed technologies and its reseller agreement with the Company, respectively, prior to the application of developed technology intangibles included in NantOmics net assets, 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.

The investment in related party is assessed for possible impairment when events indicate that the fair value of the investment may be below the 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 the 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 the investment is not changed for subsequent recoveries in fair value.

The fair value of the Company's equity method investment is determined using the income approach. The income approach utilizes a discounted cash flow model incorporating management’s expectations for future revenue, operating expenses, and earnings before interest, taxes, depreciation and amortization, capital expenditures and an anticipated tax rate. The related cash flow forecasts are discounted using an estimated weighted-average cost of capital at the date of valuation.  Differences between the 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 our 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.

At December 31, 2018 and September 30, 2018, the Company determined that other than temporary impairments of $14,768 and $80,444, respectively, in the value of the investment in NantOmics had occurred, predominantly attributed to declines in the value of goodwill. The decline in fair value at December 31, 2018 was primarily caused by altered pricing assumptions for the reseller agreement between the Company and NantOmics. The decline in fair value at September 30, 2018, was primarily caused by changes in projected GPS Cancer revenue, due to delays in the Company’s GPS Cancer revenue growth and changes in the risk profile of the financial projections for NantOmics. The Company based its financial projections on information that the Company believed was reasonable; however, actual results may differ materially from those projections. The other than temporary impairments were based on judgments and estimates that were forward looking in nature and it is reasonably possible that the estimate of the impairments of the equity method investment in NantOmics will change in the near term due to the following: actual NantOmics cash distribution is materially lower than expected, significant adverse changes in NantOmics' operating environment, increase in the discount rate, and changes in other key assumptions. Risks and uncertainties are related to assumptions regarding future financial performance, commercial acceptance of product and service offerings, risk of reimbursement for the Company’s sequencing and molecular analysis solution, developments in the healthcare and molecular diagnostics industry, NantOmics' ability to integrate its business acquisitions, regulatory risks, and other general business risks including unanticipated adverse changes in NantOmics' operating environment.

At February 28, 2018, the Company transferred 9,088,362 of the Series A-2 units to NantOmics as consideration for the assignment of NantHealth Labs, Inc. (see Note 20). An additional 564,779 units were transferred by May 31, 2018. This reduced NantHealth's ownership of NantOmics to approximately 13.58%.


- 18 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except 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 months ended March 31, 2019 and March 31, 2018, the Company recognized equity losses of $2,210 and $3,261, respectively.

The Company used the following summarized financial information for NantOmics for the three months ended December 31, 2018 and 2017, to record its equity method losses for the three months ended March 31, 2019 and 2018:
 
Trailing three months ended December 31
 
2018
 
2017
Revenues
$
1,746

 
$
1,385

Gross loss
(520
)
 
(4,269
)
Loss from operations
(6,884
)
 
(13,454
)
Impairment on equity investments
(12,265
)
 
(19,976
)
Net loss
(17,851
)
 
(31,959
)
Net loss attributable to NantOmics
(17,752
)
 
(31,420
)
Investment in equity securities without readily determinable fair values

Investment in 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’ 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.

As of March 31, 2019 and December 31, 2018, 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.

During July 2018, the management of IOBS informed their board of directors that a transition plan had been agreed to migrate all current customers of the company to a business partner, as IOBS was unable to profitably serve those customers. The management of IOBS continues to seek ways to monetize the intellectual property held by the company, but future cash flows are uncertain. Therefore, the Company concluded that the investment in IOBS was impaired as of June 30, 2018. Given the level of uncertainty on future cash flows and the limited assets of IOBS available for distribution, the Company concluded the fair value of the investment was nil as of June 30, 2018 and recognized an impairment charge of $1,750 in other expenses. No other arrangements exist that could require the Company to provide additional financial support or otherwise expose the Company to a loss.
Note 12. Convertible Notes
In December 2016, the Company entered into the Purchase Agreement with J.P. Morgan Securities LLC and Jefferies LLC, as representatives of the several initial purchasers named therein (collectively, the “Initial Purchasers”), to issue and sell $90,000 in aggregate principal amount of its 5.50% senior convertible notes due 2021 ("Convertible Notes") in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”) and to non-U.S. persons pursuant to Regulation S under the Securities Act. In December 2016, the Company entered into a purchase agreement (the “Cambridge Purchase Agreement”) with Cambridge Equities, L.P., an entity affiliated with Dr. Patrick Soon-Shiong, the Company’s Chairman and Chief Executive Officer (“Cambridge”), to issue and sell $10,000 in aggregate principal amount of the Convertible Notes in a private placement pursuant to an exemption from the registration requirements of the Securities Act afforded by Section 4(a)(2) of the Securities Act. In December 2016, pursuant to the exercise of the overallotment by the Initial Purchasers, the Company issued an additional $7,000 principal amount of the Convertible Notes. The total net proceeds from this offering were approximately $102,714, $9,917 from Cambridge and $92,797 from the Initial Purchasers, after deducting the Initial Purchasers’ discount and debt issuance costs of $4,286 in connection with the Convertible Notes offering.

- 19 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

On December 21, 2016, the Company entered into an Indenture, relating to the issuance of the Convertible Notes (the “Indenture”), by and between the Company and U.S. Bank National Association, as trustee (the “Trustee”). The interest rates are fixed at 5.50% per year, payable semi-annually on June 15 and December 15 of each year, beginning on June 15, 2017. The Convertible Notes will mature on December 15, 2021, unless earlier repurchased by the Company or converted pursuant to their terms.
In connection with the offering of the Convertible Notes, on December 15, 2016, the Company entered into a Second Amended and Restated Promissory Note which amended and restated the Amended and Restated Promissory Note, dated May 9, 2016, between the Company and NantCapital, to, among other things, extend the maturity date of the promissory note to June 30, 2022 and to subordinate such promissory note in right of payment to the Convertible Notes (see Note 20).
The initial conversion rate of the Convertible Notes is 82.3893 shares of common stock per $1 principal amount of Convertible Notes (which is equivalent to an initial conversion price of approximately $12.14 per share). Prior to the close of business on the business day immediately preceding September 15, 2021, the Convertible Notes will be convertible only under the following circumstances:
(1) during any calendar quarter commencing after March 31, 2017 (and only during such calendar quarter), if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding calendar quarter, the last reported sale price of the Company’s common stock on such trading day is greater than or equal to 120% of the conversion price on such trading day;
(2) during the five-business day period after any five consecutive trading day period in which, for each day of that period, the trading price per $1 principal amount of the Convertible Notes for such trading day was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on such trading day; or
(3) upon the occurrence of specified corporate transactions as described in the Indenture agreement.
Upon conversion, the Convertible Notes will be settled in cash, shares of the Company’s common stock or any combination thereof at the Company’s option.
Upon the occurrence of a fundamental change (as defined in the Indenture), holders may require the Company to purchase all or a portion of the Convertible Notes in principal amounts of $1 or an integral multiple thereof, for cash at a price equal to 100% of the principal amount of the Convertible Notes to be purchased plus any accrued and unpaid interest to, but excluding, the fundamental change purchase date. The conversion rate will be subject to adjustment upon the occurrence of certain specified events.
On or after the date that is one year after the last date of original issuance of the Convertible Notes, if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending within the five trading days immediately preceding a conversion date is greater than or equal to 120% of the conversion price on each applicable trading day, the Company will make an interest make-whole payment to a converting holder (other than a conversion in connection with a make-whole fundamental change in which the conversion rate is adjusted) equal to the sum of the present values of the scheduled payments of interest that would have been made on the Convertible Notes to be converted had such Convertible Notes remained outstanding from the conversion date through the earlier of (i) the date that is three years after the conversion date and (ii) the maturity date if the Convertible Notes had not been so converted. The present values of the remaining interest payments will be computed using a discount rate equal to 2.0%. The Company may pay any interest make-whole payment either in cash or in shares of its common stock, at the Company’s election as described in the Indenture.

The Company accounts for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) by recording the liability and equity components of the convertible debt separately. The liability component is computed based on the fair value of a similar liability that does not include the conversion option. The liability component includes both the value of the embedded interest make-whole derivative and the carrying value of the Convertible Notes. The equity component is computed based on the total debt proceeds less the fair value of the liability component. The equity component is also recorded as debt discount and amortized as interest expense over the expected term of the Convertible Notes.
The liability component of the Convertible Notes on the date of issuance was computed as $83,079, consisting of the value of the embedded interest make-whole derivative of $1,499 and the carrying value of the Convertible Notes of $81,580. Accordingly, the equity component on the date of issuance was $23,921. If the debt will be considered current at the balance sheet date, the liability component of the convertible notes will be classified as current liabilities and presented in current portion of convertible notes debt and the equity component of the convertible debt will be considered a redeemable security and presented as redeemable equity on the Company's Condensed Consolidated Balance Sheet.

- 20 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

Offering costs of $4,286 related to the issuance of the Convertible Notes were allocated to the liability and equity components in proportion to the allocation of the proceeds and accounted for as deferred financing offering costs and equity issuance costs, respectively. Approximately $972 of this amount was allocated to equity and the remaining $3,314 was capitalized as deferred financing offering costs.
The debt discounts and deferred financing offering costs on the Convertible Notes are being amortized to interest expense over the contractual terms of the Convertible Notes, using the effective interest method at an effective interest rate of 12.82%.
As of March 31, 2019, the remaining life of the Convertible Notes is approximately 33 months.

The following table summarizes how the issuance of the Convertible Notes is reflected in the Company's Condensed Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018.
 
Related party
 
Others
 
Total
Balance as of March 31, 2019
 
 
 
 
 
Gross proceeds
$
10,000

 
$
97,000

 
$
107,000

Unamortized debt discounts and deferred financing offering costs
(1,506
)
 
(16,326
)
 
(17,832
)
Net carrying amount
$
8,494

 
$
80,674

 
$
89,168

 
 
 
 
 
 
Balance as of December 31, 2018
 
 
 
 
 
Gross proceeds
$
10,000

 
$
97,000

 
$
107,000

Unamortized debt discounts and deferred financing offering costs
(1,622
)
 
(17,567
)
 
(19,189
)
Net carrying amount
$
8,378

 
$
79,433

 
$
87,811

 
The following tables set forth the Company's interest expense recognized in the Company's Condensed Consolidated Statements of Operations:
 
Three Months Ended March 31, 2019
 
Related party
 
Others
 
Total
Accrued coupon interest expense
$
137

 
$
1,334

 
$
1,471

Amortization of debt discounts
113

 
1,088

 
1,201

Amortization of deferred financing offering costs
3

 
154

 
157

Total convertible notes interest expense
$
253

 
$
2,576

 
$
2,829

 
Three Months Ended March 31, 2018
 
Related party
 
Others
 
Total
 
 
 
 
 
 
Accrued coupon interest expense
$
137

 
$
1,334

 
$
1,471

Amortization of debt discounts
100

 
957

 
1,057

Amortization of deferred financing offering costs
3

 
135

 
138

Total convertible notes interest expense
$
240

 
$
2,426

 
$
2,666


- 21 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

Note 13. Fair Value Measurements
Assets and liabilities measured at fair value on a recurring basis as of March 31, 2019 and December 31, 2018 consisted of the following:
 
March 31, 2019
 
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 and cash equivalents
$
12,444

 
$
12,444

 
$

 
$

Liabilities
 
 
 
 
 
 
 
Bookings Commitment
19,441

 

 

 
19,441

 
December 31, 2018
 
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 and cash equivalents
$
18,305

 
$
18,305

 
$

 
$

Liabilities
 
 
 
 
 
 
 
Bookings Commitment
16,947

 

 

 
16,947


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. Cash is valued at nominal value. 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.
Level 3 Inputs

Bookings Commitment

The Company values the Bookings Commitment, assumed upon the disposal of the provider/patient engagement solutions business (see Note 4), using a Monte Carlo Simulation model to calculate average payments due under the Bookings Commitment, based on management's estimate of its performance in securing bookings and resulting annual payments, discounted at the cost of debt based on a yield curve. The cost of debt used for discounting was between 15% and 18% at March 31, 2019 and between 17% and 20% at December 31, 2018. The change in fair value is recorded as an unrealized gain or loss through earnings within other (expense) income, net in the Company's Condensed Consolidated Statements of Operations.

The fair value of the Bookings Commitment is dependent on management's estimate of the probability of success on individual opportunities and the cost of debt applied in discounting the liability. The higher the probability of success on each opportunity, the lower the fair value of the Bookings Commitment liability. The lower the cost of debt applied, the higher the value of the liability.

The fair market value for level 3 securities may be highly sensitive to the use of unobservable inputs and subjective assumptions. Generally, changes in significant unobservable inputs may result in significantly lower or higher fair value measurements.

The following tables set forth a summary of changes in the fair value of Level 3 liabilities for the three months ended March 31, 2019:

- 22 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

 
 
December 31, 2018
 
Additions
 
Change in fair value
 
March 31, 2019
Bookings Commitment
 
$
16,947

    
$

    
$
2,494

 
$
19,441

Fair Value of Convertible Notes held at amortized cost
As of March 31, 2019 and December 31, 2018, the fair value and carrying value of the Company's Convertible Notes were:
 
 
 
Fair value
 
Carrying value
 
Face value
5.5% convertible senior notes due December 15, 2021:
 
 
 
 
 
 
Balance as of March 31, 2019
 
 
 
 
 
 
Related party
 
$
5,992

    
$
8,494

    
$
10,000

Others
 
58,125

 
80,674

 
97,000

 
 
$
64,117

 
$
89,168

 
$
107,000

Balance as of December 31, 2018
 
 
 
 
 
 
Related party
 
$
5,879

    
$
8,378

    
$
10,000

Others
 
57,031

 
79,433

 
97,000

 
 
$
62,910

 
$
87,811

 
$
107,000


The fair value shown above represents the fair value of the debt instrument, inclusive of both the debt and equity components, but excluding the derivative liability. The carrying value represents only the carrying value of the debt component.

The fair value of the Convertible Notes was determined by unobservable inputs that are supported by minimal non-active market activity and that are significant to determining the fair value of the debt instrument. The fair value is level 3 in the fair value hierarchy.
14. Leases
The Company has operating leases for corporate offices, data centers, and certain equipment. The Company's leases have remaining lease terms of one year to ten years years, some of which include options to extend the leases for up to 5 years, and some of which include options to terminate the leases within 1 year. NantWorks, a related party, subleases one of the Company's data centers on the same terms the Company agreed with the lessor. Options to extend are included in the lease term where the Company is reasonably certain to exercise the options. Variable payments on the Company's leases are expensed as incurred, as they do not depend on an index, or rate. The Company concluded certain leases for data centers had a term of less than 1 year at inception, as arrangements are only renewed following marketplace assessments and negotiations with vendors.

The Company's leases do not indicate the rate implicit in the lease. As such, the Company has used its incremental borrowing rate, determined based on market indications of the rate at which the Company could borrow, adjusted for the term, value and payment schedule of individual leases, at the effective date for ASC 842 or at the lease commencement date for leases entered into after January 1, 2019.

Lease expense, charged to selling, general and administrative expense, for the three months ended March 31, 2019 consisted of:
 
Three Months Ended 
 March 31,
 
2019
Operating lease cost
$
636

Short-term lease cost
276

Variable cost
79

Sublease income
(52
)
Total lease cost
$
939



- 23 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

For the three months ended March 31, 2018, rental expense was charged to selling, general and administrative expense in the amount of $964.

Other information regarding the Company's leases:
 
Three Months Ended March 31,
 
2019
Operating cash flows for operating leases
$
(633
)
Right-of-use assets obtained in exchange for new operating lease liabilities
$
1,837

Operating lease liabilities arising from obtaining right-of-use assets
$
1,837

Weighted average remaining lease term - operating leases
6.4 years

Weighted average discount rate - operating leases
11
%

As of December 31, 2018, the Company had no material capital leases and the remaining lives of its operating leases ranged from one to ten years.

Future minimum lease payments under the Company's operating leases at March 31, 2019 were:
Maturity Analysis
Amounts
2019
$
2,301

2020
3,189

2021
3,040

2022
3,081

2023
3,122

Thereafter
5,031

Total future minimum lease payments
19,764

Less imputed interest
(5,673
)
Total
$
14,091

As reported in the Consolidated Balance Sheet
 
Accrued and other current liabilities
$
1,687

Operating lease liabilities
12,404

 
$
14,091

Note 15. Commitments and Contingencies
The Company's principal commitments consist of obligations under its outstanding debt obligations, non-cancelable leases for its office space, data centers and certain equipment and vendor contracts to provide research services, and purchase obligations under license agreements and reseller agreements.
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.

- 24 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

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. Except as discussed below, 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 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.
Securities Litigation
In March 2017, a number of putative class action securities complaints were filed in U.S. District Court for the Central District of California, naming as defendants the Company and certain of our current or former executive officers and directors. These complaints have been consolidated with the lead case captioned Deora v. NantHealth, Inc., 2:17-cv-01825. ("Deora") In June 2017, the lead plaintiffs filed an amended consolidated complaint, which generally alleges that defendants violated federal securities laws by making material misrepresentations in NantHealth’s IPO registration statement and in subsequent public statements. In particular, the complaint refers to various third-party articles in alleging that defendants misrepresented NantHealth’s business with the University of Utah, donations to the university by non-profit entities associated with our founder Dr. Soon-Shiong, and orders for GPS Cancer. The lead plaintiffs seek unspecified damages and other relief on behalf of putative classes of persons who purchased or acquired NantHealth securities in the IPO or on the open market from June 1, 2016 through May 1, 2017. In March 2018, the court largely denied Defendants’ motion to dismiss the consolidated amended complaint. In September 2018, the lead plaintiffs filed a motion for certification of two plaintiff classes. In April 2019, Defendants filed an opposition to class certification. We believe that the claims lack merit and intend to vigorously defend the litigation.

In May 2017, a putative class action complaint was filed in California Superior Court, Los Angeles County, asserting claims for violations of the Securities Act based on allegations similar to those in Deora. That case is captioned Bucks County Employees Retirement Fund v. NantHealth, Inc., BC 662330. The parties have agreed to stay the case until the next case management conference, scheduled for September 17, 2019. We believe that the claims lack merit and intend to vigorously defend the litigation.

In April 2018, two putative shareholder derivative actions-captioned Engleman v. Soon-Shiong, Case No. 2018-0282-AGB, and Petersen v. Soon-Shiong, Case No. 2018-0302-AGB were filed in the Delaware Court of Chancery.  The plaintiff in the Engleman action previously filed a similar complaint in California Superior Court, Los Angeles County, which was dismissed based on a provision in the Company’s charter requiring derivative actions to be brought in Delaware. The Engleman and Petersen complaints contain allegations similar to those in Deora but assert causes of action on behalf of NantHealth against various of the Company’s current or former executive officers and directors for alleged breaches of fiduciary duty, abuse of control, gross mismanagement, and unjust enrichment. The Company is named solely as a nominal defendant. In July 2018, the court issued an order consolidating the Engleman and Petersen actions as in re NantHealth, Inc. Stockholder Litigation, Lead C.A. No. 2018-0302-AGB, appointing Petersen as lead plaintiff, and designating the Petersen complaint as the operative complaint. On September 20, 2018, the defendants moved to dismiss the complaint. In October 2018, in response to the motion to dismiss, Petersen filed an amended complaint. In November 2018, the defendants moved to dismiss the amended complaint. In January 2019, the defendants filed their opening brief in support of the motion to dismiss the amended complaint. We believe that the claims lack merit and intend to vigorously defend the litigation.

In April 2018, a putative shareholder derivative action captioned Shen v. Soon-Shiong was filed in U.S. District Court for the District of Delaware. The complaint contains allegations similar to those in Deora but asserts causes of action on behalf of NantHealth against various of the Company’s current or former executive offers and directors for alleged breaches of fiduciary duty and unjust enrichment, as well as alleged violations of the federal securities laws based on alleged misstatements or omissions in the Company’s 2017 proxy statement. The parties have agreed to stay the case pending a decision on defendants’ motion to dismiss in the derivative action in the Delaware Court of Chancery.
We are from time to time subject to claims and litigation that arise in the ordinary course of our business. We intend to defend vigorously any such litigation that may arise under all defenses that would be available to us. Except as discussed below, in the opinion of management, the ultimate outcome of proceedings of which management is aware, even if adverse to us, would not have a material adverse effect on our Consolidated Financial Condition or Results of Operations. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.
Real Estate Litigation
On March 9, 2018, PayPal, Inc. (“PayPal”) commenced an action against the Company in the Superior Court Department of the Trial Court of the Commonwealth of Massachusetts, for Suffolk County. The action was originally captioned PayPal, Inc. v.

- 25 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

NantHealth, Inc., Civil Action No. 18-0780-E. On April 10, 2018, the Superior Court transferred the case to its Business Litigation Section, where it is currently pending and captioned as PayPal, Inc. v. NantHealth, Inc., Civil Action No. 18-0780-BLS1. This action arises out of a Sublease Agreement that PayPal and the Company entered into on or about November 30, 2017. The Sublease Agreement pertained to commercial real estate that PayPal leased at One International Place in Boston, Massachusetts. On January 25, 2018, the Company notified PayPal that we were electing to terminate the Sublease Agreement.
 
In its Verified Complaint, and a contemporaneous notice of default that the Company disputed, PayPal alleges that the Company breached the Sublease Agreement. In addition, PayPal asserts claims for breach of the covenant of good faith and fair dealing, and violations of Massachusetts General Laws, Chapter 93A, sections 2 and 11, and seeks a declaratory judgment recognizing and enforcing the terms of the Sublease Agreement. Among other relief, PayPal seeks damages, treble damages, interest, costs, and attorneys’ fees. PayPal has recently asserted that its damages are in excess of $3 million.
 
On April 12, 2018, the Company filed its answer and jury demand in the action. On August 2, 2018, PayPal requested a status conference with the court in order to discuss PayPal’s potential filing of a motion for partial judgment on the pleadings pursuant to Mass. R. Civ. P. 12(c). A Rule 16 Litigation Control Conference (“Rule 16 Conference”) was held on August 22, 2018. During the Rule 16 Conference, the court denied PayPal’s request for leave to file a motion for partial judgment on the pleadings. Following the Rule 16 Conference, the court issued a tracking order setting deadlines and other procedures that would apply to this action.
 
On September 26, 2018, the Company filed its Assented to Motion for Leave to Amend Its Answer. The court granted the Company's motion on October 3, 2018. On October 9, 2018, the Company filed and served its amended answer and jury demand.
 
On January 8, 2019, the parties filed a joint motion to extend certain of the tracking order deadlines, which motion the court granted by endorsed order dated January 9, 2019.

On April 4, 2019, PayPal filed a motion to add NantWorks, LLC as a defendant in the litigation, which motion was filed together with the Company's opposition. The court denied PayPal's motion on April 16, 2019.
 
The parties are currently engaged in discovery, including non-party discovery.
 
The Company denies any liability to PayPal and intends to vigorously defend the action.
Note 16. Income Taxes
The provision for income taxes for the three months ended March 31, 2019 was an expense of $226. For the three months ended March 31, 2018 the benefit for income taxes was $1,050. The tax provision for income taxes for the three months ended March 31, 2019 and the benefit from income taxes for the three months ended March 31, 2018 included an income tax provision for the consolidated group based on an estimated annual effective tax rate.

The effective tax rate for the three months ended March 31, 2019 was 1.12%. The effective tax rate for the three months ended March 31, 2018 was a benefit of 4.56%. The effective tax rates for the three months ended March 31, 2019 and March 31, 2018 differed from the U.S. federal statutory rates of 21% primarily as a result of a reduction to the deferred tax liability related to an indefinite lived intangible, an increase of purchase accounting deferred tax liabilities that cannot be absorbed by the deferred tax assets, nondeductible expenses, state income taxes, foreign income tax rate differential and the impact of valuation allowance on its deferred tax assets.

The Company has evaluated all available evidence supporting the realization of its deferred tax assets, including the amount and timing of future taxable income, and has determined that it is more likely than not that its net deferred tax assets will not be realized in the U.S. and certain foreign jurisdictions. Due to uncertainties surrounding the realization of the deferred tax assets, the Company maintains a full valuation allowance against substantially all deferred tax assets. If/when the Company determines that it will be able to realize some portion or all of its deferred tax assets, an adjustment to its valuation allowance on its deferred tax assets would have the effect of increasing net income in the period(s) such determination is made. The Company files income tax returns in the U.S. Federal jurisdiction, various U.S. state jurisdictions and certain foreign jurisdictions. The Company is no longer subject to income tax examination by the U.S. federal, state or local tax authorities for years ended December 31, 2013 or prior, however, its tax attributes, such as net operating loss (“NOL”) carryforwards and tax credits, are still subject to examination in the year they are used.

- 26 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

Note 17. Stockholders’ Equity (Deficit)
Amended Certificate of Incorporation
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 March 31, 2019 and December 31, 2018, 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 March 31, 2019, and December 31, 2018, there were no outstanding shares of preferred stock.
Note 18. Stock-Based Compensation
The following table reflects the components of stock-based compensation expense recognized in the Company's Condensed Consolidated Statements of Operations:
 
Three Months Ended 
 March 31,
 
2019
 
2018
Restricted Stock:
 
 
 
Research and development
$

 
$
25

Phantom units:
 
 
 
Cost of revenue
22

 
132

Selling, general and administrative
22

 
253

Research and development
(13
)
 
174

Total phantom units stock-based compensation expense
31

 
559

Restricted Stock Units:
 
 
 
Cost of revenue
3

 
9

Selling, general and administrative
606

 
1,954

Research and development
10

 
78

Total restricted stock units stock-based compensation expense
619

 
2,041

Total stock-based compensation expense
650

 
2,625

Amount capitalized to internal-use software
57

 
105

Total stock-based compensation cost
$
707

 
$
2,730

Retired 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.

- 27 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except 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 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 (see Restricted Stock below).
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 March 31, 2019, there were 283,852 phantom units outstanding under the Phantom Unit Plan. 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 Balance Sheet. Awards held by participants who are based outside of the United States will be settled in cash and are classified within accrued and other current liabilities on the Condensed Consolidated Balance Sheet as of March 31, 2019 and December 31, 2018.

The following table summarizes the activity related to the unvested phantom units during the three months ended March 31, 2019:
 
Number of Units
 
Weighted
Average Grant
date value per
phantom unit
Unvested phantom units outstanding December 31, 2018
588,852

 
$
14.95

   Vested
(287,500
)
 
$
15.79

   Forfeited
(17,500
)
 
$
14.05

Unvested phantom units outstanding - March 31, 2019
283,852

 
$
14.16


The Company has previously granted phantom units to employees of related companies who are providing services to the Company under the shared services agreement with NantWorks (see Note 20) as well as certain consultants of the Company. No phantom units were granted during the three months ending March 31, 2019 or 2018. Stock-based 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 March 31, 2019, the Company had $592 of unrecognized stock-based compensation expense related to phantom units which will be recognized over a weighted-average period of 1.0 year. Of that amount, $484 of unrecognized expense is related to employee grants with a weighted-average period of 1.0 year and $108 of unrecognized expense is related to non-employee grants with a weighted-average period of 1.0 year.

During the three months ended March 31, 2019, the Company issued 191,075 shares, of common stock to participants of the Phantom Unit Plan based in the United States, after withholding approximately 96,358 shares, to satisfy tax withholding obligations. The Company made cash payments of $52 to cover employee withholding taxes upon the settlement of these vested phantom units during the three months ended March 31, 2019. During the three months ended March 31, 2019, the Company also cash-settled 67 vested phantom units held by participants of the Phantom Unit Plan based outside of the United States and to pay cash in lieu of fractional shares for vested units held by participants based in the United States.

- 28 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

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.

In April 2018, the Company’s Board of Directors adopted, and, in June 2018, the Company’s stockholders approved an amendment to the 2016 Plan, to reserve a further 6,800,000 shares of common stock for issuance pursuant to the 2016 Plan. Following the approval of the amendment, a total of 12,800,000 shares of common stock were reserved for issuance pursuant to the 2016 Plan.
Restricted Stock
The Company issued 10,462 shares of restricted stock under the 2016 Plan on June 1, 2016, in connection with the conversion of the Series C units. No units were vested and converted into unrestricted common stock during the three months ending March 31, 2019 or 2018. As of March 31, 2019, there were no shares of restricted stock outstanding under the 2016 plan. As of December 31, 2018, there were 3,490 shares of restricted stock outstanding under the 2016 Plan.
Restricted Stock Units

The Company intends to settle all vested restricted stock 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 Balance Sheet. Awards held by participants who are based outside of the United States will be settled in cash and are classified within accrued and other current liabilities on the Condensed Consolidated Balance Sheet as of March 31, 2019 and December 31, 2018.

The following table summarizes the activity related to the unvested restricted stock units during the three months ended March 31, 2019:
 
Number of Units
 
Weighted-Average Grant-Date
Fair Value
Unvested restricted stock units outstanding - December 31, 2018
1,812,961

 
$
2.74

Granted
60,000

 
$
0.98

Vested
(38,967
)
 
$
1.65

Forfeited
(43,812
)
 
$
3.39

Unvested restricted stock units outstanding - March 31, 2019
1,790,182

 
$
2.66

Unrecognized compensation expense related to unvested restricted stock units was $2,768 at March 31, 2019, which is expected to be recognized as expense over the weighted-average period of 1.4 years.

During the three months ended March 31, 2019, the Company issued 23,967 shares, of common stock to participants of the 2016 Plan based in the United States.

- 29 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

Note 19. 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 months ended March 31, 2019 and 2018:
 
Three Months Ended 
 March 31,
 
2019
 
2018
 
Common Stock
 
Common Stock
Net loss per share numerator:
 
 
 
Net loss from continuing operations
$
(19,839
)
 
$
(21,975
)
Net loss from discontinued operations
(84
)
 
(193
)
Net loss for basic and diluted net loss per share
$
(19,923
)
 
$
(22,168
)
Weighted-average shares for basic net loss per share
109,904,336

 
108,579,271

Effect of dilutive securities

 

Weighted-average shares for dilutive net loss per share
109,904,336

 
108,579,271

Basic and diluted net loss per share from continuing operations
$
(0.18
)
 
$
(0.20
)
Basic and diluted net loss per share from discontinued operations
$

 
$

Basic and diluted total net loss per share
$
(0.18
)
 
$
(0.20
)
The following number of potential common shares at the end of each period were excluded from the calculation of diluted net loss per share attributable to common stockholders because their effect would have been anti-dilutive for the periods presented:
 
March 31,
 
2019
 
2018
Unvested restricted stock
1

 
3,490

Unvested phantom units
283,852

 
938,065

Unvested restricted stock units
1,790,182

 
2,916,121

Unexercised stock options

 
500,000

Convertible notes
8,815,655

 
8,815,655


Note 20. 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 is 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. NantHealth also bills NantWorks and affiliates for services such as information technology and cloud services, finance and risk management, and facilities management, on the same basis. During the three months ended March 31, 2019 and March 31, 2018, the Company incurred $364 and $1,043, respectively of expenses related to selling, general and administrative services provided to the Company by NantWorks and affiliates, net of services provided to NantWorks and affiliates. Additionally, the Company incurred $210 of expenses during the three months ended March 31, 2019, related to research and development services provided by NantWorks and affiliates.
Related Party Receivables and Payables

- 30 -

NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

As of March 31, 2019, and December 31, 2018, the Company had related party receivables, net of related party payables of $2,338 and $2,618, respectively, primarily consisting of a receivable from Ziosoft KK of $1,915 at both dates, which was related to the sale of Qi Imaging. As of March 31, 2019, and December 31, 2018, the Company had related party payables, net of receivables balances, and related party liabilities of $24,169 and $22,499, respectively, which primarily relate to amounts owed to NantWorks pursuant to the Shared Services Agreement, amounts owed to NantOmics under the Second Amended Reseller Agreement (defined below) and interest payable. 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 300,000 tests between June 19, 2015 and June 30, 2020; (ii) the second renewal option can be exercised if the Company completes at least 570,000 tests between July 1, 2020 and June 30, 2023; and (iii) the third renewal option can be exercised if the Company completes at least 760,000 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 noncancelable 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.
On December 18, 2017, the Company and NantOmics executed Amendment No. 1 to the Second Amended Reseller Agreement. The Second Amended Reseller Agreement was amended to allow fee adjustments with respect to services completed by NantOmics between the amendment effective date of October 1, 2017 to June 30, 2018.
On April 23, 2019, the Company and NantOmics executed Amendment No. 2 to the Second Amended Reseller Agreement. The Second Amended Reseller Agreement was amended to set a fixed fee with respect to services completed by NantOmics between the amendment effective date and the end of the Initial Term, December 31, 2020.
As of March 31, 2019, and December 31, 2018, the Company has $301 and $394, respectively, of outstanding related party payables under the Second Amended Reseller Agreement. During the three months ended March 31, 2019, direct costs of $1,068 were recorded as cost of revenue related to the Second Amended Reseller Agreement. During the three months ended March 31, 2018, direct costs of $1,176 were recorded as cost of revenue related to the Second Amended Reseller Agreement.
Cambridge Purchase Agreement
On December 15, 2016, the Company entered into the Cambridge Purchase Agreement with Cambridge, an entity affiliated with the Company's Chairman and CEO Dr. Patrick Soon-Shiong, to issue and sell $10,000 in aggregate principal amount of the Convertible Notes in a private placement pursuant to an exemption from the registration requirements of the Securities Act afforded by Section 4(a)(2) of the Securities Act. The Cambridge Purchase Agreement includes customary representations, warranties and covenants by the Company and customary closing conditions (see Note 12). The accrued and unpaid interest on the Convertible Notes held by Cambridge was $162 and $24 at March 31, 2019 and December 31, 2018, respectively, as part of current related party liabilities on the Condensed Consolidated Balance Sheet.

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NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

Assignment of NantHealth Labs, Inc. (formerly Liquid Genomics, Inc.)
On July 5, 2018 Liquid Genomics, Inc. filed a certificate of amendment to its certificate of incorporation with the secretary of state for Delaware to change its name to NantHealth Labs, Inc. ("NantHealth Labs").

On February 28, 2018, the Company acquired 100% of the equity of NantHealth Labs, a company that provides liquid biopsy analysis of gene expressions and mutations using cell-free RNA and DNA, pursuant to an assignment agreement dated February 1, 2018 between the Company and NantOmics, a related party. The purchase price for the acquisition consisted of 9,088,362 Series A-2 units of NantOmics previously owned by the Company that were transferred at the closing plus 564,779 of Series A-2 units of NantOmics owned by the Company that were transferred to NantOmics during May 2018.

The Company and NantOmics are controlled by the Company's Chairman and CEO, therefore no gain or loss was recognized on the transaction. The difference in the purchase price and the historical cost of the assets and liabilities acquired was recorded as a distribution from equity at the assignment date. The transaction did not cause a material change in the reporting entity, and the Company has not retrospectively adjusted its previously issued financial statements.
 
 Amounts
NantOmics Series A-2 shares transferred, or to be transferred, to NantOmics
$
8,956

Assets and liabilities of NantHealth Labs at assignment:
 
Goodwill
1,305

Intangible asset
4,429

Other assets
251

Liabilities assumed
(814
)
Net assets acquired at assignment
5,171

Recorded as distribution from additional paid-in capital
$
3,785

Liquid Tumor Profiling Services Agreements
In March 2018, NantHealth Labs, a wholly-owned subsidiary of the Company, and NantKwest, Inc. ("NantKwest"), an affiliate, entered into agreements whereby NantHealth Labs is providing liquid tumor profiling services to NantKwest for clinical trials, on an annual, stand-ready, basis from the date of the first test of each participant, with revenues recognized ratably over time for the period of the stand-ready obligation.

In June 2018, NantHealth Labs entered into similar agreements to provide liquid tumor profiling services to Altor BioScience ("Altor"), NantCell, Inc. ("NantCell"), and NantBioScience, Inc. ("NantBio"), all affiliates of the Company.

Under these agreements, the Company recorded $349 and $45 of revenue during the three months ended March 31, 2019 and March 31, 2018, respectively. As of March 31, 2019, the Company has $260 of accounts receivable from related parties and $106 of deferred revenue due to these agreements.

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NantHealth, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)

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 were 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. On December 15, 2016, in connection with the offering of the Convertible Notes, the Company entered into a Second Amended and Restated Promissory Note which amends and restates the Amended and Restated Promissory Note, dated May 9, 2016, between the Company and NantCapital, to, among other things, extend the maturity date of the Promissory Note to June 30, 2022 and to subordinate the Promissory Note in right of payment to the Convertible Notes (see Note 12). No other terms of the promissory note were changed. As of March 31, 2019, and December 31, 2018, the total principal and interest outstanding on the note amounted to $131,979 and $130,374, respectively. The accrued and unpaid interest on the note was $19,313 and $17,708, respectively, as of March 31, 2019 and December 31, 2018, as part of noncurrent related party liabilities on the Condensed Consolidated Balance Sheets. 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 of 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 March 31, 2019, there was no outstanding balance on the promissory note.
On August 8, 2018, the Company executed a promissory note in favor of NantCapital, with a maturity date of June 15, 2022. The note bears interest at a per annum rate of 9.75% and is compounded annually, with interest payments on outstanding amounts due on June 15 and December 15 of each calendar year. No advances have currently been made under the note. The note allows the Company to request advances, up to a maximum commitment of $100,000. Advances can be requested of up to $10,000 per calendar quarter until March 31, 2019 and, following that, up to $20,000 per calendar quarter until December 31, 2020, after which no further advances can be requested. The promissory note is subordinated to the Convertible Notes (see Note 12). The promissory note includes customary negative covenants and a Performance to Plan - Adjusted EBITDA covenant, that stipulates, in order for the Company to draw on the promissory note, the profit measure, as defined in the agreement, may not negatively deviate from board approved financial plans by more than 25%. At March 31, 2019, the Company was in compliance with the covenants.
Note 21. Subsequent Events
On May 6, 2019, we received a notice from Nasdaq stating that we were not in compliance with Nasdaq Listing Rule 5450(a)(1) (the “Minimum Bid Price Rule”) because our common stock failed to maintain a minimum closing bid price of $1.00 for 30 consecutive business days. If we fail to regain compliance with the minimum bid price requirement, our stock may be delisted.





- 33 -


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 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 Annual Report on Form 10-K, particularly in Item 1A, “Risk Factors”.
Overview
We are a leading next-generation, evidence-based, personalized healthcare company focused on enabling our clients to fundamentally change the diagnosis and treatment 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 molecular sequencing and analysis services (including our unique, comprehensive GPS Cancer test, for which we obtained exclusive rights from an affiliate that provides sequencing and analysis of tumor & normal samples and our liquid/blood-based tumor profiling test service, Liquid GPS, which analyzes cell-free DNA (cfDNA) and cell-free RNA (cfRNA)), and from selling software solutions to healthcare payers, self-insured employers and healthcare systems.
We market certain of our solutions as a comprehensive integrated solution that includes our molecular sequencing and analysis services, Clinical Decision Support, and Payer Engagement solutions. We also market our molecular sequencing and analysis services, Clinical Decision Support, Payer Engagement and Connected Care solutions on a stand-alone basis. To accelerate our commercial growth and enhance our competitive advantage, we intend to continue to:
introduce new marketing, education and engagement efforts and foster relationships across the oncology community to drive adoption of molecular sequencing and analysis services;
pursue reimbursement of molecular sequencing and analysis services from regional and national third-party payers and government payers;
publish scientific and medical advances;
strengthen our commercial organization to increase our NantHealth solutions client base and to broaden usage of our solutions by existing clients; and
develop new features and functionality for NantHealth solutions to address the needs of current and future healthcare provider and payer, self-insured employer and biopharmaceutical company clients.
Since our inception, we have devoted substantially all of our resources to the development and commercialization of NantHealth solutions, as well as the commercial launch and expansion of our molecular sequencing and analysis 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 March 31, 2019, our accumulated deficit was approximately $904.0 million. We expect to continue to incur operating losses over the near term as we drive adoption of our molecular sequencing and analysis solutions (including GPS Cancer), expand our commercial operations, and invest further in NantHealth solutions.
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.




- 34 -


2018 Acquisition of NantHealth Labs (formerly Liquid Genomics, Inc.)
On February 28, 2018, we acquired 100% of the equity of NantHealth Labs, Inc. (“NantHealth Labs”, formerly Liquid Genomics, Inc.), a company that provides liquid biopsy analysis of gene expressions and mutations using cell free RNA and DNA, pursuant to an assignment agreement dated February 1, 2018 between the Company and NantOmics, LLC a related party. The purchase price for the acquisition consisted of 9,088,362 Series A-2 units of NantOmics previously owned by the Company that were transferred at the closing plus 564,779 of Series A-2 units of NantOmics owned by the Company that were transferred to NantOmics as of May 31, 2018.

We believe that we have a substantial opportunity to leverage NantHealth Labs' testing as a complementary offering to our current portfolio of sequencing and molecular analysis solutions. There are significant synergies available and we intend to leverage our current sales and marketing efforts to drive provider acceptance and adoption. A key value proposition for liquid biopsy tests is ease of use (e.g., no tissue biopsy necessary, and fast delivery time). This complements our GPS Cancer test by enabling repeated measurement and monitoring of select biomarker response to therapy. NantHealth Labs services are provided under the "Liquid GPS" brand.
2018 Impact of Hurricane Michael
On October 10, 2018, our leased Panama City, Florida office was hit by Hurricane Michael. Due to the geographic spread of our customers, no revenue was lost. However, certain implementation revenues for our software and hardware related business were delayed until later in the fourth quarter and into 2019, due to the disruption caused to our personnel living in the region. Personnel costs for time not worked by our employees in the region during the initial period of recovery totaled $0.7 million. Our office suffered water damage, which temporarily disabled our on-site servers, and delayed filing of our Form 10-Q for the period ended September 30, 2018. We spent $0.1 million directly on maintaining operations and repairing our office.
Evolution of GPS Cancer Test Platform
NantHealth and NantOmics, LLC (our exclusive technology partner for the GPS Cancer test) are continually taking steps to optimize the utility and value of our tests for physicians and their patients. To this end, we have leveraged our deep experience with RNA sequencing, bioinformatics and statistics to expand the clinical utility of the GPS Cancer test, while also streamlining and improving our lab workflow by consolidating to next-generation sequencing as our sole testing platform. A fundamental result of this work is that the key cancer treatment biomarkers previously assessed using our proprietary quantitative proteomics platform are, beginning in April 2018, now assessed solely via RNA sequencing, gene expression and statistical analysis. This change is based on the established clinical and scientific utility of tumor RNA sequencing. The tumor RNA transcriptome reveals gene and somatic variant expression, identifies gene fusions and validates their expression, and determines the relevance of gene copy number alterations. GPS Cancer currently assesses RNA expression of over 19,000 genes in a tumor sample and we have shown significant concordance between our RNA and proteomics expression platforms. We believe this change will result in operational efficiencies, an improved cost structure and more rapid transfer of scientific advancements in expression analysis to our clinical report. We also believe that our proprietary quantitative proteomics platform remains the most advanced technology available and a strategic asset of NantOmics. This platform continues to have potential commercial and research applications going forward.
Non-GAAP Net Loss from Continuing Operations and Non-GAAP Net Loss Per Share from Continuing Operations
Adjusted net loss from continuing operations and adjusted net loss per share from continuing operations are financial measures that are not prepared in conformity with United States generally accepted accounting principles (U.S. GAAP). Our 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 our core business. Additionally, it provides a basis for the comparison of the financial results for our 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.

Non-GAAP net loss from continuing operations excludes the effects of (1) loss from equity method investments including impairment losses, (2) stock based compensation expense, (3) intangible amortization, (4) corporate restructuring expenses, (5) acquisition related sales incentives, which have been recorded as contra revenue, (6) change in fair value of derivatives liability, (7) change in fair value of the Bookings Commitment, (8) non-cash interest expense related to convertible notes, (9) securities litigation costs, (10) impairment of investments without readily determinable fair value, and (11) the impacts of certain income tax benefits and provisions from non-cash activity.


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The following table reconciles Net loss from continuing operations to Net loss from continuing operations - Non-GAAP and Shares outstanding to Shares outstanding - Non-GAAP for the three months ended March 31, 2019 and 2018 (Unaudited):
(Dollars in thousands, except per share amounts)
Three Months Ended 
 March 31,
 
2019
 
2018
Net loss from continuing operations
$
(19,839
)
 
$
(21,975
)
Adjustments to GAAP net loss:


 


Loss from related party equity method investment
2,210

 
3,261

Stock-based compensation expense from continuing operations
650

 
2,718

Acquisition related sales incentive

 
145

Change in fair value of derivatives liability

 
(1
)
Change in fair value of Bookings Commitment
2,494

 

Noncash interest expense related to convertible notes
1,357

 
1,194

Intangible amortization from continuing operations
2,287

 
2,227

Securities litigation costs

 
73

Tax provision (benefit) resulting from certain noncash tax items
111

 
(1,123
)
Total adjustments to GAAP net loss from continuing operations
9,109

 
8,494

Net loss - Non-GAAP from continuing operations
$
(10,730
)
 
$
(13,481
)
 
 
 
 
Weighted average shares outstanding
109,904,336

 
108,579,271

 
 
 
 
Net loss per share from continuing operations - Non-GAAP
$
(0.10
)
 
$
(0.12
)

The following table reconciles net loss from continuing operations per common share to net loss per common share from continuing operations Non-GAAP for the three months ended March 31, 2019 and 2018 (Unaudited):
(Dollars in thousands, except per share amounts)
Three Months Ended 
 March 31,
 
2019
 
2018
Net loss per common share from continuing operations
$
(0.18
)
 
$
(0.20
)
Adjustments to GAAP net loss per common share from continuing operations:
 
 
 
Loss from related party equity method investment
0.02

 
0.03

Stock-based compensation expense from continuing operations
0.01

 
0.03

Acquisition related sales incentive

 

Change in fair value of derivatives liability

 

Change in fair value of Bookings Commitment
0.02

 

Noncash interest expense related to convertible notes
0.01

 
0.01

Intangible amortization from continuing operations
0.02

 
0.02

Securities litigation costs

 

Tax provision (benefit) resulting from certain noncash tax items

 
(0.01
)
Total adjustments to GAAP net loss per common share from continuing operations
0.08

 
0.08

Net loss per common share from continuing operations - Non-GAAP
$
(0.10
)
 
$
(0.12
)



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Components of Our Results of Operations
Revenue
We generate our revenue from the sale of software-as-a-service ("SaaS"), software licenses, maintenance, hardware and services. Our systems infrastructure and platforms support the delivery of both personalized comprehensive sequencing and molecular analysis and the implementation of value-based care models across the healthcare continuum. We generate revenue from the following sources:

Software-as-a-service related - SaaS related revenue is generated from our clients’ access to and usage of our hosted software solutions on a subscription basis for a specified contract term. In SaaS arrangements, the customer cannot take possession of the software during the term of the contract and generally only 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 our Eviti platform solutions and NaviNet.

Software and hardware related - Software and hardware related revenue is generated from the license of our software, on a perpetual basis, the sale of hardware and professional services that are complementary to the software and may or may not be required for the software to function as desired by the customer. The services are generally provided in the form of implementation and training services and do not include maintenance revenue. The software is installed on the customer's site or the customer's designated vendor’s site and is not hosted by us or by a vendor contracted by us. We also generate revenue from the resale of third-party software and hardware to our clients. Our software license and hardware solutions include DeviceConX software and HBox. Software and hardware related also includes revenue from professional services we provide that are generally complementary to our software solutions and may or may not be required for the solution to function as desired by the customer.

Maintenance - Maintenance revenue includes ongoing post contract client support ("PCS") or maintenance on software and hardware during the PCS term. Additionally, PCS includes ongoing development of software updates and upgrades provided to the customer on a when-and-if-available basis. We sell our DeviceConX solution with maintenance contracts.

Sequencing and molecular analysis - Sequencing and molecular analysis revenue is generated by providing customers with reports of the results of performing sequencing and analysis of whole genome DNA, RNA, and/or proteomic testing under our reseller agreement with NantOmics, LLC ("NantOmics"), and from blood samples via our liquid/blood-based tumor profiling platform through our subsidiary, NantHealth Labs, Inc. ("NantHealth Labs", formerly Liquid Genomics, Inc.). Revenue is recognized at a point in time, when reports of results are transferred to the ordering physician or institution, or on a cash basis; or ratably over time for the period of a stand-ready obligation to provide blood-based tumor profiling services.

Home health care services - Home health care services revenue includes revenue related to nursing and therapy services provided to patients in a home care setting.
Cost of Revenue
Cost of revenue includes associated salaries and fringe benefits, stock-based compensation, consultant costs, direct reimbursable travel expenses, depreciation related to software developed for internal use, depreciation related to lab equipment, and other direct engagement costs associated with the design, development, sale and installation of systems, including system support and maintenance services for customers. System support includes ongoing customer assistance for software updates and upgrades, installation, training and functionality. All service costs, except development of internal use software and deferred implementation costs, are expensed when incurred. Amortization of deferred implementation costs are also included in cost of revenue. Cost of revenue associated with each of our revenue sources consists of the following types of costs:

Software-as-a-service related - SaaS related cost of revenue includes personnel-related costs, amortization of deferred implementation costs, depreciation of internal use software, and other direct costs associated with the delivery and hosting of our subscription services.

Software and hardware related - Software and hardware related cost of revenue includes third-party software and hardware costs directly associated with solutions, including purchasing and receiving costs, and includes direct costs associated with software implementation services provided to our customers. Software and hardware related cost of revenue also includes hardware costs directly related to bringing manufactured products to their final selling destination.


- 37 -


Maintenance - Maintenance cost of revenue includes personnel-related costs and other direct costs associated with the ongoing support or maintenance provided to our customers.

Sequencing and molecular analysis - Sequencing and molecular analysis cost of revenue includes personnel-related costs associated with fulfillment of these services, including those of our subsidiary, NantHealth Labs, and amounts due to NantOmics under the reseller agreement for the sequencing and analysis of whole genome, DNA, RNA, and/or proteomic results. It also includes depreciation of internal use software and lab equipment.

Home health care services - Home health care services cost of revenue includes direct expenses relating to our nursing and therapy services provided to patients in a home care setting.
We plan to continue to expand our capacity to support our growth, which will result in higher cost of revenue in absolute dollars. We expect cost of revenue to decrease as a percentage of revenue over time as we expand NantHealth solutions and realize economies of scale.
Operating Expenses
Our operating expenses consist of selling, general and administrative, research and development, and amortization of acquisition-related assets.

Selling, general and administrative

Selling, general and administrative expense consists primarily of personnel-related expenses for our sales and marketing, finance, legal, human resources, and administrative associates, stock-based compensation, advertising and marketing promotions of NantHealth solutions, and corporate shared services fees from NantWorks. It also includes trade show and event costs, sponsorship costs, point of purchase display expenses and related amortization as well as legal costs, facility costs, consulting and professional fees, insurance and other corporate and administrative costs.

We continue to review our other selling, general and administrative investments and expect to drive cost savings through greater efficiencies and synergies across our company. Additionally, we expect to continue to incur additional costs for legal, accounting, insurance, investor relations and other costs associated with operating as a public company. These increases include additional costs we expect to incur associated with compliance with the Sarbanes-Oxley Act and other regulations governing public companies as well as increased costs for directors’ and officers’ liability insurance and an enhanced investor relations function. However, we expect our selling, general and administrative expense to decrease as a percentage of revenue over the long term as our revenue increases and we realize economies of scale.

Research and development

Research and development expenses consist primarily of personnel-related costs for associates working on development of solutions, including salaries, benefits and stock-based compensation. Also included are non-personnel costs such as consulting and professional fees to third-party development resources.
Substantially all of our research and development expenses are related to developing new software solutions and improving our existing software solutions.
We expect our research and development expenses to continue to increase in absolute dollars and as a percentage of revenue as we continue to make significant investments in developing new solutions and enhancing the functionality of our existing solutions with a focus on cancer care. However, we expect our research and development expenses to decrease as a percentage of revenue over the long term as we realize economies of scale from our developed technology.

Amortization of acquisition related assets

Amortization of acquisition related assets consists of noncash amortization expense related to our non-revenue generating technology as well as amortization expense that we recognize on intangible assets that we acquired through our investments.
Interest Expense, net
Interest expense, net primarily consists of interest expense associated with our outstanding borrowings, including coupon interest expense, amortization of debt discounts and amortization of deferred financing offering cost, offset by interest income earned on our cash and cash equivalents and marketable securities.

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Other Income (Expense), net
Other income (expense), net consists primarily of unrealized and realized gains (losses), change in the fair value of Bookings Commitment, dividend income on our cash equivalent financial instruments, change in fair value of derivative liability, impairment of equity securities and other non-recurring items.
Loss from Equity Method Investment
Loss from equity method investment consists of our pro rata share of losses of a company that we own an ownership interest in and account for under the equity method of accounting. We regularly evaluate our investments, which are not carried at fair value, for other than temporary impairment in accordance with U.S. GAAP.
Provision for (Benefit from) Income Taxes
Provision for income taxes consists of U.S. federal and state and foreign income taxes. We are required to allocate the provision for income taxes between continuing operations and other categories of earnings, such as discontinued operations. To date, we have no significant U.S. federal, state and foreign cash income taxes because of our current and accumulated net operating losses.
We record a valuation allowance when it is more likely than not that some portion or all of a deferred tax asset will not be realized. In making such a determination, we consider all the available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, and ongoing prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. When we establish or reduce the valuation allowance against the deferred tax assets, our provision for income taxes will increase or decrease, respectively, in the period such determination is made.

- 39 -


Results of Operations
The following table sets forth our Condensed Consolidated Statements of Operations data for each of the periods indicated (Unaudited):
(Dollars in thousands, except per share amounts)
Three Months Ended 
 March 31,
 
2019
 
2018
Revenue:
 
 
 
Software-as-a-service related
$
17,802

 
$
16,166

Software and hardware related
1,027

 
1,455

Maintenance
2,493

 
2,446

Total software-related revenue
21,322

 
20,067

Sequencing and molecular analysis
814

 
840

Home health care services
1,593

 
1,356

Total net revenue
23,729

 
22,263

 
 
 
 
Cost of Revenue:
 
 
 
Software-as-a-service related
5,752

 
6,602

Software and hardware related
785

 
885

Maintenance
270

 
215

Amortization of developed technologies
1,233

 
1,173

Total software-related cost of revenue
8,040

 
8,875

Sequencing and molecular analysis
2,427

 
1,431

Home health care services
823

 
762

Total cost of revenue
11,290

 
11,068

 
 
 
 
Gross Profit
12,439

 
11,195

 
 
 
 
Operating Expenses:
 
 
 
Selling, general and administrative
16,789

 
20,737

Research and development
5,080

 
5,151

Amortization of acquisition-related assets
1,054

 
1,054

Total operating expenses
22,923

 
26,942

 
 
 
 
Loss from operations
(10,484
)
 
(15,747
)
Interest expense, net
(4,414
)
 
(4,197
)
Other (expense) income, net
(2,505
)
 
180

Loss from related party equity method investment
(2,210
)
 
(3,261
)
Loss from continuing operations before income taxes
(19,613
)
 
(23,025
)
Provision for (benefit from) income taxes
226

 
(1,050
)
Net loss from continuing operations
(19,839
)
 
(21,975
)
Loss from discontinued operations, net of tax
(84
)
 
(193
)
Net loss
$
(19,923
)
 
$
(22,168
)
 
 
 
 
Net loss per share:
 
 
 
Continuing operations
 
 
 
Basic and diluted - common stock
$
(0.18
)
 
$
(0.20
)
Total net loss per share
 
 
 
Basic and diluted - common stock
$
(0.18
)
 
$
(0.20
)
Weighted average shares outstanding:
 
 
 
Basic and diluted - common stock
109,904,336

 
108,579,271


- 40 -


The following table sets forth our Condensed Consolidated Statements of Operations data as a percentage of revenue for each of the periods indicated (Unaudited):

Three Months Ended 
 March 31,
 
2019
 
2018
Revenue:
 
 
 
Software-as-a-service related
75.0
 %
 
72.6
 %
Software and hardware related
4.3
 %
 
6.5
 %
Maintenance
10.5
 %
 
11.0
 %
Total software-related revenue
89.9
 %
 
90.1
 %
Sequencing and molecular analysis
3.4
 %
 
3.8
 %
Home health care services
6.7
 %
 
6.1
 %
Total net revenue
100.0
 %
 
100.0
 %
 
 
 
 
Cost of Revenue:
 
 
 
Software-as-a-service related
24.2
 %
 
29.7
 %
Software and hardware related
3.3
 %
 
4.0
 %
Maintenance
1.1
 %
 
1.0
 %
Amortization of developed technologies
5.3
 %
 
5.3
 %
Total software-related cost of revenue
33.9
 %
 
39.9
 %
Sequencing and molecular analysis
10.2
 %
 
6.4
 %
Home health care services
3.5
 %
 
3.4
 %
Total cost of revenue
47.6
 %
 
49.7
 %
 
 
 
 
Gross Profit
52.4
 %
 
50.3
 %
 
 
 
 
Operating Expenses:
 
 
 
Selling, general and administrative
70.8
 %
 
93.2
 %
Research and development
21.4
 %
 
23.1
 %
Amortization of acquisition-related assets
4.4
 %
 
4.7
 %
Total operating expenses
96.6
 %
 
121.0
 %
 
 
 
 
Loss from operations
(44.2
)%
 
(70.7
)%
Interest expense, net
(18.6
)%
 
(18.9
)%
Other (expense) income, net
(10.6
)%
 
0.8
 %
Loss from related party equity method investment
(9.3
)%
 
(14.6
)%
Loss from continuing operations before income taxes
(82.7
)%
 
(103.4
)%
Provision for (benefit from) income taxes
0.9
 %
 
(4.7
)%
Net loss from continuing operations
(83.6
)%
 
(98.7
)%
Loss from discontinued operations, net of tax
(0.4
)%
 
(0.9
)%
Net loss
(84.0
)%
 
(99.6
)%





- 41 -



Comparison of Three Months Ended March 31, 2019 and 2018 (Unaudited)
Revenue