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, 2020  
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)
 
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

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
o
 
 
 
 
Non-accelerated filer
x
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
As of May 8, 2020, the registrant had 110,619,678 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, 2020
Table of contents


 
 
Page
PART I.
 
 
 
 
Item 1.
 
 
 
 
Consolidated Balance Sheets
 
 
 
 
Consolidated Statement of Operations
 
 
 
 
Consolidated Statements of Comprehensive Income (Loss)
 
 
 
 
Consolidated Statements of Stockholders' Equity (Deficit)
 
 
 
 
Consolidated Statements of Cash Flows
 
 
 
 
Notes to Consolidated Financial Statements
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II.
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
Exhibits Index
 
 
 

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, Omics Core, NaviNet, Eviti, Navinet Open, Eviti Connect, Eviti | IQ, 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;
any impact of the COVID-19 pandemic, or responses to the pandemic, on our operations or personnel, or on commercial activity or demand across our and our customers’ businesses;
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;
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; and
our expectations regarding our ability to comply with Nasdaq continued listing standards.
We caution you that the foregoing list does not contain all of the forward-looking statements made in this Quarterly Report.

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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 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.
Consolidated Balance Sheets
(Dollars in thousands)

 
March 31,
2020
 
December 31,
2019
 
(Unaudited)
 
 
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
47,478

 
$
5,243

Accounts receivable, net
6,816

 
6,179

Related party receivables, net
657

 
823

Prepaid expenses and other current assets
3,680

 
19,341

Current assets of discontinued operation

 
6,327

Total current assets
58,631

 
37,913

Property, plant, and equipment, net
13,755

 
14,985

Goodwill
97,307

 
97,307

Intangible assets, net
49,838

 
51,848

Investment in related party
29,918

 
31,702

Related party receivable, net of current
1,274

 
1,108

Operating lease right-of-use assets
8,092

 
8,470

Other assets
2,144

 
1,818

Noncurrent assets of discontinued operation

 
21,336

Total assets
$
260,959

 
$
266,487


 
 
 
Liabilities and Stockholders' Equity
 
 
 
Current liabilities
 
 
 
Accounts payable
$
3,314

 
$
3,377

Accrued and other current liabilities
17,033

 
31,988

Deferred revenue
5,523

 
7,098

Related party payables, net
4,552

 
4,120

Notes payable

 
238

Current liabilities of discontinued operation

 
10,680

Total current liabilities
30,422

 
57,501

Deferred revenue, net of current
1,148

 
1,129

Related party liabilities
25,931

 
24,227

Related party promissory note
112,666

 
112,666

Related party convertible note, net
8,994

 
8,864

Convertible notes, net
86,060

 
84,648

Deferred income taxes, net
1,654

 
1,669

Operating lease liabilities
9,264

 
9,728

Other liabilities
18,411

 
21,542

Noncurrent liabilities of discontinued operation

 
1,649

Total liabilities
294,550

 
323,623

Commitments and Contingencies (Note 14)

 

 
 
 
 
Stockholders' deficit
 
 
 
Common stock, $0.0001 par value per share, 750,000,000 shares authorized; 110,619,678 and 110,619,678 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively
11

 
11

Additional paid-in capital
890,623

 
889,955

Accumulated deficit
(923,819
)
 
(946,884
)
Accumulated other comprehensive loss
(406
)
 
(218
)
Total stockholders' deficit
(33,591
)
 
(57,136
)
Total liabilities and stockholders' deficit
$
260,959

 
$
266,487


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

- 6 -



NantHealth, Inc.
Consolidated Statements of Operations
(Dollars in thousands, except per share amounts)
(Unaudited)
 
Three Months Ended 
 March 31,
 
2020
 
2019
Revenue
 
 
 
Software-as-a-service related
$
18,121

 
$
17,802

Total software-related revenue
18,121

 
17,802

Sequencing and molecular analysis
59

 
814

Home health care services

 
1,593

Total net revenue
18,180

 
20,209

 
 
 
 
Cost of Revenue:
 
 
 
Software-as-a-service related
5,701

 
5,708

Maintenance

 
70

Amortization of developed technologies
1,143

 
1,233

Total software-related cost of revenue
6,844

 
7,011

Sequencing and molecular analysis
352

 
2,427

Home health care services

 
823

Total cost of revenue
7,196

 
10,261

 
 
 
 
Gross Profit
10,984

 
9,948

 
 
 
 
Operating Expenses
 
 
 
Selling, general and administrative
12,427

 
15,324

Research and development
3,550

 
3,850

Amortization of acquisition-related assets
867

 
1,054

Total operating expenses
16,844

 
20,228

 
 
 
 
Loss from operations
(5,860
)
 
(10,280
)
Interest expense, net
(4,657
)
 
(4,414
)
Other income (expense), net
3,454

 
(2,505
)
Loss from related party equity method investment
(1,784
)
 
(2,210
)
Loss from continuing operations before income taxes
(8,847
)
 
(19,409
)
Provision for income taxes
93

 
226

Net loss from continuing operations
(8,940
)
 
(19,635
)
Income (loss) from discontinued operations, net of tax
32,005

 
(288
)
Net income (loss)
$
23,065

 
$
(19,923
)
 
 
 
 
Basic and diluted net income (loss) per share
 
 
 
Continuing operations - common stock
$
(0.08
)
 
$
(0.18
)
Discontinued operations - common stock
$
0.29

 
$

Total net income (loss) per share - common stock
$
0.21

 
$
(0.18
)
 
 
 
 
Weighted average shares outstanding
 
 
 
Basic and diluted - common stock
110,619,780

 
109,904,336


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

- 7 -

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


 
Three Months Ended 
 March 31,
 
2020
 
2019
Net income (loss)
$
23,065

 
$
(19,923
)
Other comprehensive (loss) income from foreign currency translation
(188
)
 
55

Total other comprehensive (loss) income
(188
)
 
55

Comprehensive income (loss)
$
22,877

 
$
(19,868
)

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

- 8 -

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

 
Common Stock
 
Additional
Paid-In Capital
 
Accumulated
Deficit
 
Accumulated Other
Comprehensive Loss
 
Total Stockholders' Equity (Deficit)
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2019
110,619,678

 
$
11

 
$
889,955

 
$
(946,884
)
 
$
(218
)
 
$
(57,136
)
Stock-based compensation expense

 

 
668

 

 

 
668

Other comprehensive loss

 

 

 

 
(188
)
 
(188
)
Net income

 

 

 
23,065

 

 
23,065

Balance at March 31, 2020
110,619,678

 
11

 
890,623

 
(923,819
)
 
(406
)
 
(33,591
)


- 9 -

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

 
Common Stock
 
Additional
Paid-In Capital
 
Accumulated
Deficit
 
Accumulated Other
Comprehensive Loss
 
Total Stockholders' Equity (Deficit)
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2018
109,491,277

 
$
11

 
$
887,289

 
$
(884,122
)
 
$
(347
)
 
$
2,831

Stock-based compensation expense

 

 
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 Consolidated Financial Statements.


- 10 -

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

 
Three Months Ended 
 March 31,
 
2020 (2)
 
2019 (2)
Cash flows from operating activities:
 
 
 
Net income (loss)
$
23,065

 
$
(19,923
)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
 
 
Gain on sale of businesses
(32,211
)


Depreciation and amortization
4,271

 
5,819

Amortization of debt discounts and deferred financing offering cost
1,542

 
1,357

Change in fair value of derivatives liability
5

 

Change in fair value of Bookings Commitment
(3,128
)
 
2,494

Stock-based compensation
653

 
650

Deferred income taxes, net
(227
)
 
164

Provision for bad debt expense
6

 
10

Loss from related party equity method investment
1,784

 
2,210

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
937

 
(12
)
Inventories
(18
)
 
80

Related party receivables, net

 
280

Prepaid expenses and other current assets
15,444

 
(1,100
)
Accounts payable
(282
)
 
685

Accrued and other current liabilities
(14,884
)
 
(80
)
Deferred revenue
(1,433
)
 
1,016

Related party payables, net
1,937

 
1,727

Change in operating lease right-of-use assets and liabilities
(95
)
 
(51
)
Other operating assets and liabilities
(109
)
 
(159
)
Net cash used in operating activities
(2,743
)
 
(4,833
)
Cash flows from investing activities:
 
 
 
Net proceeds from sale of businesses
46,401

 

Purchases of property and equipment, including internal-use software
(935
)
 
(973
)
Net cash provided by (used in) investing activities
45,466

 
(973
)
Cash flows from financing activities:
 
 
 
Repayments of insurance promissory note
(238
)


Tax payments related to stock issued, net of stock withheld, for vested equity awards

 
(58
)
Net cash used in financing activities
(238
)
 
(58
)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(11
)
 
3

Net increase (decrease) in cash, cash equivalents and restricted cash
42,474

 
(5,861
)
Cash, cash equivalents and restricted cash, beginning of period (1)
6,379

 
19,441

Cash, cash equivalents and restricted cash, end of period (1)
$
48,853

 
$
13,580

 
 
 
 
(1) Cash and cash equivalents included restricted cash of $1,136 and $1,375 at December 31, 2019 and March 31, 2020, respectively, included in other assets and $1,136 and $1,136 at December 31, 2018 and March 31, 2019, 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 and funds held in an escrow account related to the sale of the Connected Care Business (see Note 4). No amounts have been drawn upon the letters of credit as of March 31, 2020.
(2) The statements for the three months ended March 31, 2020 and 2019 include the Connected Care Business (see Note 4).
The accompanying notes are an integral part of these Consolidated Financial Statements.

- 11 -

NantHealth, Inc.
Notes to 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, and payer engagement solutions on a stand-alone basis. 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 June 7, 2019, the Company sold its home health care services business (see Note 4).

On February 3, 2020, the Company sold certain of its assets related to its Connected Care Business (see Note 4).

The sales will enable the Company to focus on its core competencies of genomic sequencing, clinical decision support, and payer engagement.
As of March 31, 2020, the Company conducted the majority of its operations in the United States, the United Kingdom, Singapore and Canada.
COVID-19 Pandemic
In March 2020, the World Health Organization declared the novel coronavirus (COVID-19) a pandemic. In the same month, the President of the United States declared a State of National Emergency due to the COVID-19 outbreak. Many jurisdictions, particularly in North America (including the United States), Europe and Asia, as well as U.S. states in which the Company operates, including California, have adopted or are considering laws, rules, regulations or decrees intended to address the COVID-19 outbreak, including implementing travel restrictions, closing non-essential businesses and/or restricting daily activities. In addition, many communities have limited, and are considering to further limit, social mobility and gathering. To date, there have been no material adverse impact to the Company's business from the COVID-19 pandemic. Given the unprecedented and evolving nature of the pandemic, the future impact of these changes and potential changes on the Company and its contractors, consultants, customers, resellers and partners are unknown at this time.

However, in light of the uncertainties regarding economic, business, social, health and geopolitical conditions, the Company’s revenues, earnings, liquidity, and cash flows could be adversely affected, whether on an annual or quarterly basis. Continued impacts of the COVID-19 pandemic could materially adversely affect the Company’s current and long-term accounts receivable collectibility, as its negatively impacted customers from the pandemic may request temporary relief, delay, or not make scheduled payments. In addition, the deployment of the Company’s solutions may represent a large portion of its customers' investments in software technology. Decisions to make such an investment are impacted by the economic environment in which the customers operate. Uncertain global geopolitical, economic and health conditions and the lack of visibility or the lack of financial resources may cause some customers to reduce, postpone or terminate their investments, or to reduce or not renew ongoing paid services, adversely impacting the Company’s revenues or timing of revenue. Health conditions in some geographic areas where the Company’s customers operate could impact the economic situation of those areas. These conditions, including the COVID-19 pandemic, may present risks for health and limit the ability to travel for Company employees, which could further lengthen the Company’s sales cycle and delay revenue and cash flows in the near-term.
For information on the CARES Act, refer to Note 15.

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

Basis of Presentation and Principles of Consolidation
The accompanying unaudited Consolidated Financial Statements include the accounts of NantHealth and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. These interim 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. In accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as issued by the Securities and Exchange Commission ("SEC"), these Consolidated Financial Statements do not include all of the information and disclosures required by GAAP for complete financial statements. These Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements for the fiscal year ended December 31, 2019. The results of operations of the entities disposed of are included in the unaudited Consolidated Financial Statements up to the date of disposal and, where appropriate, these operations have been reflected as discontinued operations. The accompanying Consolidated Balance Sheet as of December 31, 2019 has been derived from the audited Consolidated Financial Statements at that date. Assets and liabilities of the discontinued operations are presented separately in the asset and liability sections of the prior period balance sheet. 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, the $47,250 received from sale of the Connected Care Business in February 2020 (see Note 4), and its 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. The Company continues to have its 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. The Company may also consider selling off components of its business. 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 have been the private placement of membership interests prior to its IPO, debt financing agreements, including the promissory note with Nant Capital, LLC (“NantCapital”) and its convertible notes, its IPO, and proceeds from the sale of components of its business.

Note 2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported on the 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 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 consolidated unit level. Accordingly, management has determined that the Company operates in one reportable segment.
Recently Adopted Accounting Pronouncements

Effective January 1, 2020, the Company adopted ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Value Measurement (“ASU 2018-13”), which modifies the disclosure requirements on fair value measurements. The adoption of this guidance has no impact on the Consolidated Financial Statements.

Effective January 1, 2020, the Company adopted, on a prospective basis, 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, which aligns the requirement for capitalizing implementation costs incurred by a customer in a cloud clouding arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software and hosting arrangements that include an internal-use software license. The adoption of this guidance did not have a material impact on the Consolidated Financial Statements.


- 13 -

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

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, to simplify the accounting for income taxes. The new guidance eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. It also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. This ASU is effective for the Company's annual and interim periods beginning in January 1, 2021, and early adoption is permitted. The Company early adopted, on a prospective basis, this ASU in the first quarter of 2020. One of the provisions in this ASU is the change from the intraperiod tax allocation exception in ASC 740-20-45-7 to the incremental approach when there is a current period loss from continuing operations. ASU No. 2019-12 removed this exception, which impacted the Company's tax provision for (benefit from) income taxes between continuing operations and discontinued operations.
Upcoming Accounting Standard Pronouncements

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, 2022 and must be adopted as a cumulative effect adjustment to retained earnings. Early adoption is permitted. The Company is still evaluating the effects of this ASU.

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.

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. During the three months ended March 31, 2020 and 2019, there were revenues of $1,828 and $2,244 recognized, respectively, that were included in the deferred revenue balance at the beginning of the period.

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 administrative expenses. The value of these assets was $1,394 at March 31, 2020 and $1,455 at December 31, 2019. During the three months ended March 31, 2020 and 2019, the Company recorded amortization of $242 and $170, respectively.
Performance Obligations
As of March 31, 2020, the Company has allocated a total transaction price of $6,904 to unfulfilled performance obligations that are expected to be fulfilled within six years. Excluded from this amount are contracts of less than one year and variable consideration that relates to the value of services provided.

- 14 -

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

Note 4. Discontinued Operations and Divestitures
Discontinued Operations
Sale of Connected Care Business

On January 13, 2020, the Company entered into an asset purchase agreement (the “Purchase Agreement”) with Masimo Corporation (“Masimo”), VCCB Holdings, Inc., a wholly owned subsidiary of Masimo (collectively with Masimo, the “Purchaser”), and, solely with respect to certain provisions of the Purchase Agreement, NantWorks, LLC, an affiliate of the Company. Pursuant to the Purchase Agreement, the Company agreed to sell to the Purchaser certain of its assets related to its Connected Care business, including the products known as DCX (formerly DeviceConX), VCX (formerly VitalsConX), HBox and Shuttle Cable (collectively, the “Connected Care Business”).

On February 3, 2020, the Company completed the sale of the Connected Care Business for $47,250 of cash consideration in exchange for assets primarily related to the Connected Care Business (as defined under the terms of the Purchase Agreement). The cash consideration is subject to adjustment based upon the final amount of working capital as of the closing date.

The sale of the Connected Care Business qualified as a discontinued operation because it comprised operations and cash flows that could be distinguished, operationally and for financial reporting purposes, from the rest of the Company. The disposal of the Connected Care Business, which represented the Company's medical device interoperability solutions, represented a strategic shift in the Company’s operations as the sale enables the Company to focus on genomic sequencing, clinical decision support, and payer engagement.

The total gain on sale of the Connected Care Business consisted of the following:
Cash received as consideration
$
47,250

Less: Carrying value of net assets sold
(14,190
)
Less: Costs to sell
(849
)
Gain on sale of the Connected Care Business
$
32,211


The carrying amounts of the major classes of assets and liabilities of the Company's discontinued operation as of December 31, 2019 were as follows:
 
December 31,
2019
Accounts receivable, net
$
4,739

Inventories
798

Prepaid expenses and other current assets
790

Current assets of discontinued operation
6,327

Property, plant, and equipment, net
1,110

Goodwill
18,623

Operating lease right-of-use assets
1,603

Total assets of discontinued operation
$
27,663

 
 
Accounts payable
$
574

Accrued and other current liabilities
456

Deferred revenue
9,650

Current liabilities of discontinued operation
10,680

Deferred revenue, net of current
157

Deferred income taxes, net
210

Operating lease liabilities
$
1,282

Total liabilities of discontinued operation
$
12,329



- 15 -

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

The operating results of the Company's discontinued operation are as follows:
 
Three Months Ended 
 March 31,
 
2020
 
2019
Major classes of line items constituting pretax income (loss) of discontinued operations


 


Net revenue
$
1,165

 
$
3,520

Cost of revenue
(467
)
 
(1,029
)
Selling, general and administrative
(524
)
 
(1,465
)
Research and development
(592
)
 
(1,230
)
Other expense, net
(5
)
 

Pretax loss from discontinued operations related to major classes of pretax income (loss)
(423
)
 
(204
)
Pretax gain on sale of the Connected Care Business
32,211

 

Total pretax income (loss) from discontinued operations
31,788

 
(204
)
Benefit from income taxes
(223
)
 

Total income (loss) from discontinued operations, net of tax
$
32,011

 
$
(204
)

The significant operating and investing cash and noncash items of the discontinued operation included on the Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019 were as follows:
 
Three Months Ended 
 March 31,
 
2020
 
2019
Cash flows from operating activities:
 
 
 
Depreciation and amortization
$
10

 
$
100

Gain on sale of the Connected Care Business
32,211

 

Cash flows from investing activities:
 
 
 
Net proceeds from sale of the Connected Care Business
46,401

 

Purchases of property and equipment, including internal-use software
76

 

Divestitures
Sale of Home Health Care Services Business

On June 7, 2019, the Company completed the divestiture of its home health care services business in exchange for cash proceeds of $300, which resulted in a loss on sale of business of $582. The home health care services business does not qualify as a discontinued operation as its divestiture does not represent a strategic shift that has had a major impact on the Company's operations or financial results.
Note 5. Accounts Receivable, net
Accounts receivable are included on the Consolidated Balance Sheets, net of the allowance for doubtful accounts. The allowance for doubtful accounts at March 31, 2020 and December 31, 2019 was $101 and $95, respectively.
Note 6. Prepaid Expenses and Other Current Assets and Accrued and Other Current Liabilities
Prepaid expenses and other current assets as of March 31, 2020 and December 31, 2019 consisted of the following:
 
March 31,
2020
 
December 31,
2019
Prepaid expenses
$
2,468

 
$
1,794

Securities litigation insurance receivable
330

 
16,627

Other current assets
882

 
920

Prepaid expenses and other current assets
$
3,680

 
$
19,341


- 16 -

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

Accrued and other current liabilities as of March 31, 2020 and December 31, 2019 consisted of the following:
 
March 31,
2020
 
December 31,
2019
Payroll and related costs
$
8,750

 
$
8,106

Securities litigation expense payable
330

 
17,127

Operating lease liabilities
1,613

 
1,617

Other accrued and other current liabilities
6,340

 
5,138

Accrued and other current liabilities
$
17,033

 
$
31,988


Note 7. Property, Plant and Equipment, net
Property, plant and equipment, net as of March 31, 2020 and December 31, 2019 consisted of the following:
 
March 31,
2020
 
December 31,
2019
Computer equipment and software
$
12,144

 
$
12,144

Furniture and equipment
2,224

 
2,292

Leasehold and building improvements
7,135

 
7,160

Construction in progress - PPE
32

 

Property, plant, and equipment, excluding internal-use software
21,535

 
21,596

Less: Accumulated depreciation and amortization
(17,375
)
 
(17,078
)
Property, plant and equipment, excluding internal-use software, net
4,160

 
4,518

Internal-use software
33,738

 
33,278

Construction in progress - Internal-use software
3,344

 
2,973

Less: Accumulated depreciation and amortization, internal-use software
(27,487
)
 
(25,784
)
Internal-use software, net
9,595

 
10,467

Property, plant, and equipment, net
$
13,755

 
$
14,985

 
Depreciation and amortization expense from continuing operations was $2,008 for the three months ended March 31, 2020, of which $1,635 related to internal use software costs. Depreciation and amortization expense from continuing operations was $3,264 for the three months ended March 31, 2019, of which $2,547 related to internal-use software costs.

Amounts capitalized to internal-use software for the three months ended March 31, 2020 and 2019 were $1,210 and $912, respectively.
Note 8. Intangible Assets, net
The Company’s definite-lived intangible assets as of March 31, 2020 and December 31, 2019 consisted of the following:
 
March 31,
2020
 
December 31,
2019
Customer relationships
$
52,000

 
$
52,000

Developed technologies
32,000

 
32,000

Trade name
3,000

 
3,000

 
87,000

 
87,000

Less: Accumulated amortization
(37,162
)
 
(35,152
)
Intangible assets, net
$
49,838

 
$
51,848



- 17 -

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

Amortization of definite-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, 2020 and 2019 was $2,010 and $2,287, respectively.

During the three months ended June 30, 2019, the Company identified an indicator of impairment with respect to the NantHealth Labs, Inc. definite-lived intangible assets given the decline in sales and the Company's decision to cease commercial sales of its liquid biopsy test offering to focus on performing a study to measure the clinical utility of the AR-V7 analyte for informing treatment in patients with castration-resistant prostate cancer. Although the Company will continue this study while also pursuing other strategically aligned clinical studies that support its liquid biopsy platform, the Company determined that the assets were not recoverable given the significant amount of costs required to further build evidence of clinical utility while also ceasing commercial sales of the Liquid GPS product. Therefore, the Company fully impaired the intangible assets as of June 30, 2019 and recorded an impairment loss of $3,977 within operating expenses.

The estimated future amortization expense over the next five years and thereafter for the intangible assets that exist as of March 31, 2020 is as follows:
 
Amounts
Remainder of 2020
$
6,029

2021
8,038

2022
8,038

2023
3,467

2024
3,467

2025
3,467

Thereafter
17,332

Total future intangible amortization expense
$
49,838

Note 9. Goodwill
Goodwill as of both March 31, 2020 and December 31, 2019 was $97,307, net of goodwill allocated to the discontinued operation of $18,623. The goodwill allocated to the discontinued operation was based on the fair value of the Connected Care Business as a percentage of the total fair value of the Connected Care Business and the Company that remains after the sales transaction (see Note 4).
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 10. 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 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.


- 18 -

NantHealth, Inc.
Notes to 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 time of the 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.

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 19). An additional 564,779 units were transferred by May 31, 2018. This reduced NantHealth's ownership of NantOmics to approximately 13.58%.

Pertaining to the Company's share of NantOmics' income or loss and amortization of basis differences, for the three months ended March 31, 2020 and 2019, the Company recognized losses of $1,784 and $2,210, respectively.

The Company reports its share of NantOmics’ income or loss and the amortization of basis differences using a one quarter lag. The Company used the following summarized financial information for NantOmics for the three months ended December 31, 2019 and 2018, to record its equity method losses for the three months ended March 31, 2020 and 2019:
 
Three Months Ended
December 31
 
2019
 
2018
Revenues
$
223

 
$
1,746

Gross loss
(1,163
)
 
(520
)
Loss from operations
(3,856
)
 
(6,884
)
Impairment on equity investments

 
(12,265
)
Net loss
(1,360
)
 
(17,851
)
Net loss attributable to NantOmics
(1,329
)
 
(17,752
)
Note 11. 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. (“Cambridge”), an entity affiliated with Dr. Patrick Soon-Shiong, the Company’s Chairman and Chief Executive Officer, 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, comprised of $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.
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 15, 2022 and to subordinate such promissory note in right of payment to the Convertible Notes (see Note 19).

- 19 -

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

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 is 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 Consolidated Balance Sheet.
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, 2020, the remaining life of the Convertible Notes is approximately 21 months.


- 20 -

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

The following table summarizes how the issuance of the Convertible Notes is reflected in the Company's Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019.
 
Related Party
 
Others
 
Total
Balance as of March 31, 2020
 
 
 
 
 
Gross proceeds
$
10,000

 
$
97,000

 
$
107,000

Unamortized debt discounts and deferred financing offering costs
(1,006
)
 
(10,940
)
 
(11,946
)
Net carrying amount
$
8,994

 
$
86,060

 
$
95,054

 
 
 
 
 
 
Balance as of December 31, 2019
 
 
 
 
 
Gross proceeds
$
10,000

 
$
97,000

 
$
107,000

Unamortized debt discounts and deferred financing offering costs
(1,136
)
 
(12,352
)
 
(13,488
)
Net carrying amount
$
8,864

 
$
84,648

 
$
93,512

 
The following tables set forth the Company's interest expense recognized in the Company's Consolidated Statements of Operations:
 
Three Months Ended 
 March 31, 2020
 
Related Party
 
Others
 
Total
Accrued coupon interest expense
$
137

 
$
1,334

 
$
1,471

Amortization of debt discounts
127

 
1,238

 
1,365

Amortization of deferred financing offering costs
3

 
174

 
177

Total convertible notes interest expense
$
267

 
$
2,746

 
$
3,013

 
Three Months Ended 
 March 31, 2019
 
Related Party
 
Others
 
Total
Accrued coupon interest expense
$
137

 
$
1,334

 
$
1,471

Amortization of debt discounts
113

 
1,087

 
1,200

Amortization of deferred financing offering costs
3

 
154

 
157

Total convertible notes interest expense
$
253

 
$
2,575

 
$
2,828


- 21 -

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


Note 12. Fair Value Measurements
Liabilities measured at fair value on a recurring basis as of March 31, 2020 and December 31, 2019 consisted of the following:
 
March 31, 2020
 
Total
 fair value
 
Quoted price in active markets for identical assets
 (Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
 (Level 3)
Liabilities
 
 
 
 
 
 
 
Bookings Commitment
$
18,854

 
$

 
$

 
$
18,854

Interest make-whole derivative
5

 

 

 
5

 
December 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)
Liabilities
 
 
 
 
 
 
 
Bookings Commitment
$
21,983

 
$

 
$

 
$
21,983

Interest make-whole derivative

 

 

 


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.
Level 3 Inputs
Bookings Commitment
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.

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.

The Company values the Bookings Commitment 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 18% and 21% at March 31, 2020 and between 15% and 17% at December 31, 2019. The change in fair value is recorded within other income (expense), net in the Company's Consolidated Statements of Operations.


- 22 -

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

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.

Management believes the assumptions used on projected financial information is reasonable, but those assumptions require judgment and are forward looking in nature. However, actual results may differ materially from those projections. The fair value of the Bookings Commitment is most sensitive to management's estimate of the discount rate applied to present value the liability. If the discount rate applied was 2% lower at March 31, 2020, the fair value of the liability would increase by $2,633.
Convertible Note derivative liability
In December 2016, the Company issued $107,000 in aggregate principal amount of Convertible Notes due December 15, 2021, of which $10,000 issued to a related party (see Note 11). The Convertible Notes include an interest make-whole feature whereby if a noteholder converts any of the Convertible Notes one year after the last date of original issuance of the Convertible Notes, they are entitled, in addition to the other consideration payable or deliverable in connection with such conversion, to an interest make-whole payment equal to the sum of the present values of the scheduled payments, computed using a discount rate equal to 2.0%, 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 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 has determined that this feature is an embedded derivative and have recognized the fair value of this derivative as a liability in the Company's Consolidated Balance Sheets, with subsequent changes to fair value recorded through earnings at each reporting period in the Company's Consolidated Statements of Operations as change in fair value of derivative liability.

The fair value of the derivative liability includes the estimated volatility and risk-free rate. The higher/lower the estimated volatility, the higher/lower the value of the liability. The higher/lower the risk-free interest rate, the higher/lower 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.


- 23 -

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

The following tables set forth a summary of changes in the fair value of Level 3 liabilities for the three months ended March 31, 2020:
 
December 31, 2019
 
Additions
 
Change in fair value
 
March 31, 2020
Liabilities
 
 
 
 
 
 
 
Interest make-whole derivative - related party and others
$

 
$

 
$
5

 
$
5

Bookings Commitment
21,983

    

    
(3,129
)
 
18,854

 
$
21,983

 
$

 
$
(3,124
)
 
$
18,859

Fair Value of Convertible Notes held at amortized cost
As of March 31, 2020 and December 31, 2019, 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, 2020
 
 
 
 
 
Related party
$
8,906

    
$
8,994

    
$
10,000

Others
86,388

 
86,060

 
97,000

 
$
95,294

 
$
95,054

 
$
107,000

Balance as of December 31, 2019
 
 
 
 
 
Related party
$
6,727

    
$
8,864

    
$
10,000

Others
65,257

 
84,648

 
97,000

 
$
71,984

 
$
93,512

 
$
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 using 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.
Note 13. Leases
The Company has operating leases for corporate offices, data centers, and certain equipment. The Company's leases have lease terms of 1 year to 11 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.


- 24 -

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

Lease expense, charged to selling, general and administrative expense, for the three months ended March 31, 2020 and 2019 consisted of:
 
Three Months Ended March 31,
 
Three Months Ended March 31,
 
2020
 
2019
Operating lease cost
$
616

 
598

Short-term lease cost
255

 
276

Variable cost
78

 
49

Sublease income
(52
)
 
(52
)
Total lease cost
$
897

 
871


Other information regarding the Company's leases:
 
Three Months Ended March 31,
 
Three Months Ended March 31,
 
2020
 
2019
Operating cash flows for operating leases
(679
)
 
(586
)
Weighted average remaining lease term - operating leases
5.8 years

 
6.6 years

Weighted average discount rate - operating leases
11
%
 
11
%

As of March 31, 2020 and December 31, 2019, the Company had no material capital leases. The remaining lives of its operating leases ranged from one to ten years as of March 31, 2020.

Future minimum lease payments under the Company's operating leases at March 31, 2020 were:
Maturity Analysis
Amounts
Remainder of 2020
$
2,040

2021
2,570

2022
2,611

2023
2,652

2024
2,509

2025
656

Thereafter
1,679

Total future minimum lease payments
14,717

Less: imputed interest
(3,840
)
Total
$
10,877

As reported on the Consolidated Balance Sheet
 
Accrued and other current liabilities
$
1,613

Operating lease liabilities
9,264

 
$
10,877

Note 14. Commitments and Contingencies
The Company's principal commitments consist of obligations under its outstanding debt obligations, noncancelable 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.
Related Party Promissory Note
On January 4, 2016, the Company executed a $112,666 demand promissory note in favor of NantCapital to fund the acquisition of NaviNet. On May 9, 2016 and December 15, 2016, the Promissory Note with NantCapital was amended to provide that all outstanding principal and accrued interest is due and payable on June 15, 2022, and not on demand and the Company subordinated the Promissory Note in right of payment to the Convertible Notes (see Note 11).

- 25 -

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

Indenture Obligations Under Convertible Notes
On December 21, 2016, the Company entered into the Indenture relating to the issuance of the $107,000 Convertible Notes, by and between the Company and U.S. Bank National Association 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 (see Note 11).
Purchase Obligations Under License Agreements and Reseller Agreements
In September 2016, the Company entered into a Second Amended and Restated Reseller Agreement for genomic and proteomic sequencing services and related bioinformatics and analysis services with NantOmics, with an effective date of June 19, 2015 (see Note 19).
Regulatory Matters
The Company is subject to regulatory oversight by the U.S. Food and Drug Administration and other regulatory authorities with respect to the development, manufacturing, and sale of some of the solutions. In addition, the Company is subject to the Health Insurance Portability and Accountability Act (“HIPAA”), the Health Information Technology for Economic and Clinical Health Act and related patient confidentiality laws and regulations with respect to patient information. The Company reviews the applicable laws and regulations regarding effects of such laws and regulations on its operations on an on-going basis and modifies operations as appropriate. The Company believes it is in substantial compliance with all applicable laws and regulations. Failure to comply with regulatory requirements could have a significant adverse effect on the Company’s business and operations.
Legal Matters
The Company is, from time to time, subject to claims and litigation that arise in the ordinary course of its business. The Company intends to defend vigorously any such litigation that may arise under all defenses that would be available to it. Except as discussed below, in the opinion of management, the ultimate outcome of proceedings of which management is aware, even if adverse to the Company, would not have a material adverse effect on the Company’s 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 the Company's founder Dr. Patrick 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. On July 30, 2019, the court certified the case as a class action. On October 23, 2019, the parties notified the court that they had reached a settlement in principle to resolve the action on a classwide basis in the amount of $16,500, which was included in accrued and other current liabilities on the Consolidated Balance Sheet at December 31, 2019. The court granted preliminary approval of the settlement on January 31, 2020, and a hearing for final approval of the settlement is scheduled for June 15, 2020. The $16,500 settlement was paid into a settlement fund prior to the payment deadline of March 2, 2020. The majority of the settlement amount was funded by the Company’s insurance carriers, and a portion was funded by the Company. The settlement is contingent upon certain matters, including final approval by the court. Also, the parties have the right to terminate the settlement in certain circumstances.

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. The next case management conference is scheduled for July 31, 2020. The Company believes that the claims lack merit and intends to vigorously defend the litigation.


- 26 -

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

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. A hearing on the defendants’ motion was held on September 25, 2019. On January 14, 2020, the court issued an order granting in part and denying in part the defendants’ motion to dismiss. The court dismissed all claims except one claim against Dr. Patrick Soon-Shiong for breach of fiduciary duty. Dr. Soon-Shiong and the Company filed answers to the amended complaint on March 30, 2020.

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 officers 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 agreed to stay the case pending a decision on defendants’ motion to dismiss in the derivative action in the Delaware Court of Chancery. The stay has been lifted due to the court’s January 14, 2020 decision granting in part and denying in part the motion to dismiss.
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. 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.

On April 12, 2018, the Company filed its answer and jury demand in the action, denying liability. 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 PayPal’s supporting memorandum, the Company’s opposition to that motion and PayPal’s reply. In its memorandum supporting that motion, PayPal stated that “PayPal’s damages are in excess of $3M,” without further explanation as to its damages calculations. The court denied PayPal's motion on April 16, 2019.


- 27 -

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

PayPal served a motion for summary judgment on June 5, 2019. In that motion, PayPal asserted that its actual damages are in excess of $2,300, which it suggested the court should treble pursuant to the provisions of Massachusetts General Laws, Chapter 93A. The Company served its opposition on July 12, 2019. PayPal responded with a reply to the Company’s opposition on July 18, 2019 and the fully briefed motion for summary judgment was filed that same day.

The parties completed fact discovery on May 10, 2019 and completed expert discovery on August 22, 2019.

A hearing on PayPal’s motion for summary judgment was held on October 17, 2019. At the hearing, the court indicated its intention to issue a written decision (1) granting PayPal’s motion for summary judgment regarding its claim for breach of the Sublease Agreement, as to liability only and not as to damages; (2) denying PayPal’s motion for summary judgment regarding its claim for unfair and deceptive trade practices in violation of Massachusetts General Laws, Chapter 93A, sections 2 and 11; and (3) finding PayPal’s claim for breach of the covenant of good faith and fair dealing to be irrelevant or moot and denying its motion for summary judgment as to that claim.

At the October 17, 2019 hearing, PayPal orally withdrew its claim for attorneys’ fees on its breach of the Sublease Agreement claim only and left uncertain whether it intends to pursue its claim for a declaratory judgment.

On December 6, 2019, PayPal served a motion seeking a preliminary injunction that would enjoin and restrain the Company, its officers, agents, attorneys and employees from transferring, conveying, or encumbering, or in any way attempting to pass out of their control any of the Company’s assets or property other than in the ordinary course of business, including but not limited to cash, bonuses, and dividends. In the papers submitted in support of that motion, PayPal asserted that it has a strong likelihood of success in seeking to recover over $2,900 on its claim for breach of the Sublease Agreement, inclusive of pre-judgment interest at the statutory rate. On January 3, 2020, the Company served its opposition to PayPal’s motion for preliminary injunction. On January 9, 2020, PayPal served its reply in support of its motion for preliminary injunction and filed all motion papers with the court.

On January 23, 2020, the court issued its written Decision and Order regarding PayPal’s motion for summary judgment. In the Decision and Order, which was docketed on January 27, 2020, the court (1) granted PayPal’s motion for summary judgment regarding its claim for breach of the Sublease Agreement, as to liability only and not as to damages; (2) denied PayPal’s motion for summary judgment regarding its claim for unfair and deceptive trade practices in violation of Massachusetts General Laws, Chapter 93A, sections 2 and 11; (3) denied PayPal’s motion for summary judgment regarding its claim for breach of the covenant of good faith and fair dealing, finding there was no need or basis to impose any additional liability on the Company for conduct that does not give rise to a cause of action independent of the underlying breach of contract claim; and (4) denied PayPal’s motion for summary judgment regarding its request for a declaratory judgment because it added little or nothing of substance to the relief PayPal is entitled to obtain, if at all.

Based on the court’s January 23, 2020 Decision and Order, the issue of damages on PayPal’s claim for breach of the Sublease Agreement remains to be determined. The Company has asserted, among other things, that PayPal failed to mitigate any damages that PayPal claims the Company owes. PayPal’s claim for unfair and deceptive practices in violation of Massachusetts General Laws, Chapter 93A, sections 2 and 11, and its requests for treble damages and attorneys’ fees on that claim, as well as its requests for interest and costs on the breach of the Sublease Agreement and Chapter 93A claims, also remain to be determined.

A hearing on PayPal’s motion for preliminary injunction was held on January 30, 2020. At the hearing, the court took the motion for preliminary injunction under advisement and scheduled the following: (1) a status conference on September 9, 2020; (2) a final trial conference on January 6, 2021; and (3) a jury trial start date on January 12, 2021.

On February 24, 2020, the Company filed a Petition for Interlocutory Relief. The petition sought relief from the Decision and Order granting PayPal’s motion for summary judgment regarding its claim for breach of the Sublease Agreement as to liability only. On March 2, 2020, a single justice of the Massachusetts Appeals Court denied the Company’s Petition for Interlocutory Relief.

Starting in late January 2020, PayPal and its attorneys and brokers began producing additional documents that had not been produced during the fact discovery period. These supplemental productions continued through April 2020 and may be ongoing.

The Company denies any liability to PayPal and intends to continue vigorously defending the action.

- 28 -

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

Insurance Recoveries
The Company has reflected its right to insurance recoveries, limited to the extent of incurred or probable losses, as a receivable when such recoveries have been agreed to with the Company’s third-party insurers and receipt is deemed probable. This includes instances where the Company’s third-party insurers have agreed to pay, on the Company’s behalf, certain legal defense costs and settlement amounts directly to applicable law firms and a settlement fund. The amount of such receivable related to the securities litigation recorded at March 31, 2020 and 2019 was $330 and $16,627, respectively, and is included in prepaid expenses and other current assets on the Consolidated Balance Sheets.

Note 15. Income Taxes

The provision for income taxes for the three months ended March 31, 2020 and 2019 from continuing operations was $93 and $226, respectively. The tax provision for income taxes for the three months ended March 31, 2020 and 2019 from continuing operations included an income tax provision for the consolidated group based on an estimated annual effective tax rate.

The effective tax rates for the three months ended March 31, 2020 and 2019 were a provision from continuing operations of 1.05% and 1.16%, respectively. The effective tax rates for the three months ended March 31, 2020 and 2019 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 asset, 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 the Company's 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. 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 has recently completed an IRS audit for the tax year 2016 with no adjustments. 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, 2014 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.

On March 27, 2020, the United States enacted the Coronavirus Aid, Relief and Economic Security Act (CARES Act). The CARES Act is an emergency economic stimulus package that includes spending and tax breaks to strengthen the United States economy and fund a nationwide effort to curtail the effect of COVID-19. While the CARES Act provides sweeping tax changes in response to the COVID-19 pandemic, some of the more significant provisions which are expected to impact the Company's financial statements include removal of certain limitations on utilization of net operating losses, increasing the loss carryback period for certain losses to five years, and increasing the ability to deduct interest expense, as well as amending certain provisions of the previously enacted Tax Cuts and Jobs Act. Consistent with prior years, the Company expects to continue to generate net losses for the foreseeable future. The Company currently has significant federal and state deferred tax assets attributed to prior net operating losses and research and experimentation tax credits. These deferred tax assets are fully reserved. As the Company has never generated taxable income, the CARES Act feature allowing NOLs originating in 2018, 2019 or 2020 to be carried back five years is not expected to have a significant impact. Management does not expect any other provisions of the CARES Act to have a material impact in 2020.

- 29 -

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

Note 16. Stockholders’ Equity
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, 2020 and December 31, 2019, 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, 2020, and December 31, 2019, there were no outstanding shares of preferred stock.
Note 17. Stock-Based Compensation
The following table reflects the components of stock-based compensation expense recognized in the Company's Consolidated Statements of Operations:
 
Three Months Ended March 31,
 
2020
 
2019
Phantom units:
 
 
 
Cost of revenue
$
16

 
$
19

Selling, general and administrative
9

 
16

Research and development
17

 
(15
)
Total phantom units stock-based compensation expense
42

 
20

Stock options:
 
 
 
Cost of revenue
15

 

Selling, general and administrative
237

 

Research and development
24

 

Total stock options stock-based compensation expense
276

 

Restricted stock units:
 
 
 
Cost of revenue
7

 
3

Selling, general and administrative
389

 
592

Research and development
18

 
10

Total restricted stock units stock-based compensation expense
414

 
605

 
 
 
 
Discontinued operations
(79
)
 
25

Total stock-based compensation expense
653

 
650

Amount capitalized to internal-use software
19

 
57

Total stock-based compensation cost
$
672

 
$
707

Phantom Unit Plan
The following table summarizes the activity related to the unvested phantom units during the three months ended March 31, 2020:

- 30 -

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

 
Number of
Units
 
Weighted-
Average Grant
Date Value Per
Phantom Unit
Unvested phantom units outstanding - December 31, 2019
120,562

 
$
11.49

Forfeited
(5,454
)
 
$
14.24

Unvested phantom units outstanding - March 31, 2020
115,108

 
$
11.38


As of March 31, 2020, the Company had $46 of unrecognized stock-based compensation expense related to phantom units which will be recognized over a weighted-average period of 0.2 years.
2016 Equity Incentive Plan
Stock Options
The following table summarizes the activity related to stock options during the three months ended March 31, 2020:
 
Number of 
Shares
 
Weighted-Average 
Exercise Price
Stock options outstanding - December 31, 2019
5,815,724

 
$
0.56

Forfeited
(270,000
)
 
$
0.55

Stock options outstanding - March 31, 2020
5,545,724

 
$
0.56

Stock options exercisable - March 31, 2020
137,500

 
$
0.55

As of March 31, 2020, the Company had $1,270 of unrecognized stock-based compensation expense related to the stock options. This cost is expected to be recognized over a weighted-average period of 2.3 years.
Restricted Stock Units
The following table summarizes the activity related to the unvested restricted stock units during the three months ended March 31, 2020:
 
Number of
Units
 
Weighted-Average Grant Date
Fair Value
Unvested restricted stock units outstanding - December 31, 2019
705,415

 
$
2.68

Granted
179,558

 
$
1.81

Forfeited
(10,954
)
 
$
3.39

Unvested restricted stock units outstanding - March 31, 2020
874,019

 
$
2.49

Unrecognized compensation expense related to unvested restricted stock units was $610 at March 31, 2020, which is expected to be recognized as expense over the weighted-average period of 0.6 years.
Note 18. Net Income (Loss) Per Share
Basic and diluted net income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the respective periods, without consideration of common stock equivalents. If there is a net loss from continuing operations, diluted net income (loss) per share is computed in the same manner as basic net income (loss) per share is computed, even if the Company reports net income as a result of discontinued operations.

- 31 -

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

The following table sets forth reconciliations of the numerators and denominators used to compute basic and diluted net loss per share of common stock for the three months ended March 31, 2020 and 2019:
 
Three Months Ended 
 March 31,
 
2020
 
2019
 
Common Stock
 
Common Stock
Net income (loss) per share numerator:
 
 
 
Net loss from continuing operations
$
(8,940
)
 
$
(19,635
)
Net income (loss) from discontinued operations
32,005

 
(288
)
Net income (loss) for basic and diluted net income (loss) per share
$
23,065

 
$
(19,923
)
Weighted-average shares for basic net income (loss) per share
110,619,780

 
109,904,336

Effect of dilutive securities

 

Weighted-average shares for dilutive net income (loss) per share
110,619,780

 
109,904,336

 
 
 
 
Basic and diluted net income (loss) per share
 
 
 
Continuing operations - common stock
$
(0.08
)
 
$
(0.18
)
Discontinued operations - common stock
$
0.29

 
$

Total net income (loss) per share - common stock
$
0.21

 
$
(0.18
)

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,
 
2020
 
2019
Unvested restricted stock

 
1

Unvested phantom units
115,108

 
283,862

Unvested restricted stock units
874,019

 
1,790,182

Unexercised stock options
5,545,724

 

Convertible notes
8,815,655

 
8,815,655

Note 19. Related Party Transactions
NantWorks Shared Services Agreement
In October 2012, the Company entered into a shared services agreement with NantWorks that provides for ongoing services from NantWorks in areas such as public relations, information technology and cloud services, human resources and administration management, finance and risk management, environmental health and safety, sales and marketing services, facilities, procurement and travel, and corporate development and strategy (the "Shared Services Agreement"). The Company 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, 2020, the Company incurred $486 of expenses recognized in selling, general and administrative expenses for services provided to the Company by NantWorks and affiliates, net of services provided to NantWorks and affiliates. During the three months ended March 31, 2019, the Company incurred $574 of expenses recognized in selling, general and administrative expenses for services provided to the Company by NantWorks and affiliates, net of services provided to NantWorks and affiliates.

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

Related Party Receivables and Payables
As of both March 31, 2020 and December 31, 2019, the Company had related party receivables, net of related party payables of $1,931, primarily consisting of a receivable from Ziosoft KK of $1,658, which was related to the sale of Qi Imaging. As of March 31, 2020 and December 31, 2019, the Company had related party payables, net of related party receivables, and related party liabilities of $30,483 and $28,347, 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, 2020 and December 31, 2019, the Company had $108 and $197, respectively, of outstanding related party payables under the Second Amended Reseller Agreement. During the three months ended March 31, 2020, direct costs of $36 were recorded as cost of revenue related to 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.
Cambridge Purchase Agreement
On December 15, 2016, the Company entered into the Cambridge Purchase Agreement with Cambridge (“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 11). The accrued and unpaid interest on the Convertible Notes held by Cambridge was $162 and $24 at March 31, 2020 and December 31, 2019, respectively, as part of current related party payables, net on the Consolidated Balance Sheets.

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

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"), ImmunityBio, Inc. ("ImmunityBio", formerly NantCell, Inc.), and NantBioScience, Inc. ("NantBio"), all affiliates of the Company.

During the three months ended March 31, 2020, the Company did not record any revenue under these agreements. During the three months ended March 31, 2019, the Company recorded revenues of $349 under these agreements. As of both March 31, 2020 and December 31, 2019, the Company had $110 of accounts receivable from related parties due to these agreements.
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 15, 2022 and to subordinate the promissory note in right of payment to the Convertible Notes (see Note 11). No other terms of the promissory note were changed. As of March 31, 2020 and December 31, 2019, the total principal and interest outstanding on the promissory note amounted to $138,597 and $136,893, respectively. The accrued and unpaid interest on the promissory note as of March 31, 2020 and December 31, 2019 was $25,931 and $24,227, respectively, included as part of noncurrent related party liabilities on the Consolidated Balance Sheets. The Company can request additional advances subject to NantCapital approval. NantCapital has the option, but not the obligation, to require the Company to repay any such amount in cash, Series A-2 units of NantOmics (based on a per unit price of $1.484) held by the Company, 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. As of March 31, 2020, 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 11). 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, 2020, the Company was in compliance with the covenants.


- 34 -


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is a discussion and analysis of our financial condition and the results of operations as of and for the periods presented below. The following discussion and analysis should be read in conjunction with the “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
NantHealth, Inc. (“NantHealth” or the “Company”) is a next-generation, evidence-based, personalized healthcare technology company that is transforming the way critical diseases, such as cancer, are known and treated. We employ precision medicine, data and software-as-a-service (SaaS) solutions to give physicians, payers, pharma and patients actionable information that drives improved patient outcomes and economics across the healthcare ecosystem.

NantHealth’s product portfolio comprises the latest technology in molecular analysis (GPS Cancer), and payer/provider collaboration platforms for real-time coverage decision support (NaviNet and Eviti). Each of these business lines are leaders in their respective market segment. Altogether, we generally derive revenue from SaaS subscription fees, support services, professional services, and molecular analysis services (including GPS Cancer).

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, and payer engagement 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 health care community to drive adoption of NantHealth products and services;
strengthen our commercial organization to increase our NantHealth solutions client base and to broaden usage of our solutions by existing clients;
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;
pursue reimbursement of molecular sequencing and analysis services from regional and national third-party payers and government payers; and
publish scientific and medical advances.
Since our inception, we have devoted substantially all 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, 2020, our accumulated deficit was approximately $923.8 million. We expect to continue to incur operating losses over the near term as we support 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.

- 35 -


COVID-19 Pandemic
In March 2020, the World Health Organization declared the novel coronavirus (COVID-19) a pandemic. In the same month, the President of the United States declared a State of National Emergency due to the COVID-19 outbreak. Many jurisdictions, particularly in North America (including the United States), Europe and Asia, as well as U.S. states in which we operate, including California, have adopted or are considering laws, rules, regulations or decrees intended to address the COVID-19 outbreak, including implementing travel restrictions, closing non-essential businesses and/or restricting daily activities. In addition, many communities have limited, and are considering to further limit, social mobility and gathering. To date, there have been no material adverse impact to our business from the COVID-19 pandemic. Given the unprecedented and evolving nature of the pandemic, the future impact of these changes and potential changes on the Company and our contractors, consultants, customers, resellers and partners are unknown at this time.

However, in light of the uncertainties regarding economic, business, social, health and geopolitical conditions, our revenues, earnings, liquidity, and cash flows could be adversely affected, whether on an annual or quarterly basis. Continued impacts of the COVID-19 pandemic could materially adversely affect our current and long-term account receivable collectibility, as our negatively impacted customers from the pandemic may request temporary relief, delay, or not make scheduled payments. In addition, the deployment of our solutions may represent a large portion of our customers' investments in software technology. Decisions to make such an investment are impacted by the economic environment in which the customers operate. Uncertain global geopolitical, economic and health conditions and the lack of visibility or the lack of financial resources may cause some customers to reduce, postpone or terminate their investments, or to reduce or not renew ongoing paid services, adversely impacting our revenues or timing of revenue. Health conditions in some geographic areas where our customers operate could impact the economic situation of those areas. These conditions, including the COVID-19 pandemic, may present risks for health and limit the ability to travel for our employees, which could further lengthen our sales cycle and delay revenue and cash flows in the near-term.
For information on the CARES Act, refer to Note 15 to the accompanying Consolidated Financial Statements.
2020 Sale of the Connected Care Business
On January 13, 2020, we entered into an asset purchase agreement (the “Purchase Agreement”) with Masimo Corporation (“Masimo”), VCCB Holdings, Inc., a wholly owned subsidiary of Masimo (collectively with Masimo, the “Purchaser”), and, solely with respect to certain provisions of the Purchase Agreement, NantWorks, LLC, an affiliate of ours. Pursuant to the Purchase Agreement, we agreed to sell to the Purchaser certain of our assets related to our “Connected Care” business, including the products known as DCX (formerly DeviceConX), VCX (formerly VitalsConX), HBox and Shuttle Cable (collectively, the “Connected Care Business”). On February 3, 2020, we completed the sale of the Connected Care Business for $47.25 million of cash consideration in exchange for assets primarily related to the Connected Care Business (as defined under the terms of the Purchase Agreement). The cash consideration is subject to adjustment based upon the final amount of working capital as of the closing date.

The sale of the Connected Care Business qualified as a discontinued operation because it comprised operations and cash flows that could be distinguished, operationally and for financial reporting purposes, from the rest of the Company. The disposal of the Connected Care Business represented a strategic shift in our operations as the sale enables us to focus on genomic sequencing, clinical decision support, and payer engagement.
2018 Acquisition of NantHealth Labs, Inc. (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 ("NantOmics"), a related party. The purchase price for the acquisition consisted of 9,088,362 Series A-2 units of NantOmics previously owned by us that were transferred at the closing plus 564,779 of Series A-2 units of NantOmics owned by us that were transferred to NantOmics as of May 31, 2018.

In June 2019, we pivoted from a commercial liquid biopsy test offering to focus on performing a study to measure the clinical utility of the AR-V7 analyte for informing treatment in patients with castration-resistant prostate cancer. We will continue this study while also pursuing other strategically aligned clinical studies that support our liquid biopsy platform. As such, we identified an indicator of impairment with respect to the NantHealth Labs definite-lived intangible assets given the decline in sales and our decision to cease commercial sales of our liquid biopsy test product. We determined that the assets were not recoverable given the significant amount of costs required to further build evidence of clinical utility while also ceasing commercial sales of the Liquid GPS product. Therefore, we fully impaired the intangible assets as of June 30, 2019 and recorded an impairment loss of $4.0 million within operating expenses.

- 36 -


Evolution of GPS Cancer Test Platform
NantHealth and NantOmics (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.
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) change in fair value of derivatives liability, (4) change in fair value of the Bookings Commitment, (5) noncash interest expense related to convertible notes, (6) intangible amortization, (7) securities litigation costs, (8) transaction contingency fees, and (9) the impacts of certain income tax benefits and provisions from noncash activity.

The following table reconciles Net loss from continuing operations to Net loss from continuing operations - Non-GAAP for the three months ended March 31, 2020 and 2019 (Unaudited):
(Dollars in thousands, except per share amounts)
Three Months Ended 
 March 31,
 
2020
 
2019
Net loss from continuing operations
$
(8,940
)
 
$
(19,635
)
Adjustments to GAAP net loss from continuing operations:
 
 
 
Loss from related party equity method investment
1,784

 
2,210

Stock-based compensation expense from continuing operations
732

 
625

Change in fair value of derivatives liability
5

 

Change in fair value of Bookings Commitment
(3,128
)
 
2,494

Noncash interest expense related to convertible notes
1,542

 
1,357

Intangible amortization from continuing operations
2,010

 
2,287

Securities litigation costs
(103
)
 

Tax provision resulting from certain noncash tax items

 
111

Total adjustments to GAAP net loss from continuing operations
2,842

 
9,084

Net loss from continuing operations - Non-GAAP
$
(6,098
)
 
$
(10,551
)
 
 
 
 
Weighted average shares outstanding
110,619,780

 
109,904,336

 
 
 
 
Net loss per share from continuing operations - Non-GAAP
$
(0.06
)
 
$
(0.10
)


- 37 -


The following table reconciles Net loss per common share from continuing operations to Net loss per common share from continuing operations - Non-GAAP for the three months ended March 31, 2020 and 2019 (Unaudited):
(Dollars in thousands, except per share amounts)
Three Months Ended 
 March 31,
 
2020
 
2019
Net loss per common share from continuing operations
$
(0.08
)
 
$
(0.18
)
Adjustments to GAAP net loss per common share from continuing operations:
 
 
 
Loss from related party equity method investment
0.01

 
0.02

Stock-based compensation expense from continuing operations
0.01

 
0.01

Change in fair value of derivatives liability

 

Change in fair value of Bookings Commitment
(0.03
)
 
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 resulting from certain noncash tax items

 

Total adjustments to GAAP net loss per common share from continuing operations
0.02

 
0.08

Net loss per common share from continuing operations - Non-GAAP
$
(0.06
)
 
$
(0.10
)



- 38 -


Components of Our Results of Operations
Revenue
We generate our revenue from the sale of software-as-a-service ("SaaS") 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.

Sequencing and molecular analysis - Sequencing and molecular analysis revenue is generated by providing customers with reports of the results of performing sequencing and molecular analysis of DNA and RNA (and previously proteomic testing) under our reseller agreement with NantOmics and from blood samples via our liquid/blood-based tumor profiling platform through our subsidiary, NantHealth Labs, 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. On June 7, 2019, we completed the divestiture of our home health care services business. See Note 4 to the accompanying Consolidated Financial Statements.
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.

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 molecular analysis of DNA and RNA (and previously 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. On June 7, 2019, we completed the divestiture of our home health care services business. See Note 4 to the accompanying Consolidated Financial Statements.
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.

- 39 -


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, including costs 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 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 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.
Impairment of intangible assets

Impairment of intangible assets consists entirely of the impairment loss from the NantHealth Labs definite-lived intangible assets. In June 2019, we pivoted from a commercial liquid biopsy test offering to focus on performing a study to measure the clinical utility of the AR-V7 analyte for informing treatment in patients with castration-resistant prostate cancer. We will continue this study while also pursuing other strategically aligned clinical studies that support our liquid biopsy platform. As such, we identified an indicator of impairment with respect to the NantHealth Labs definite-lived intangible assets given the decline in sales and our decision to cease commercial sales of our liquid biopsy test product. We determined that the assets were not recoverable given the significant amount of costs required to further build evidence of clinical utility while also ceasing commercial sales of the Liquid GPS product.
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), changes in the fair value of the Bookings Commitment, interest income on our cash equivalent financial instruments, changes in the fair value of our 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 have an ownership interest in and account for under the equity method of accounting, amortization of basis differences, and other than temporary impairments in the value of our investment. We regularly evaluate our investment, which is 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 ("NOLs").
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.
Income (Loss) from Discontinued Operations, net of Tax
Income (loss) from discontinued operations, net of tax consists of earnings or losses related to the disposition of components of our business.

- 41 -


Results of Operations
The following table sets forth our Consolidated Statements of Operations data for each of the periods indicated (Unaudited):
(Dollars in thousands, except per share amounts)
Three Months Ended 
 March 31,
 
2020
 
2019
Revenue
 
 
 
Software-as-a-service related
$
18,121

 
$
17,802

Total software-related revenue
18,121

 
17,802

Sequencing and molecular analysis
59

 
814

Home health care services

 
1,593

Total net revenue
18,180

 
20,209

 
 
 
 
Cost of Revenue
 
 
 
Software-as-a-service related
5,701

 
5,708

Maintenance

 
70

Amortization of developed technologies
1,143

 
1,233

Total software-related cost of revenue
6,844

 
7,011

Sequencing and molecular analysis
352

 
2,427

Home health care services

 
823

Total cost of revenue
7,196

 
10,261

 
 
 
 
Gross Profit
10,984

 
9,948

 
 
 
 
Operating Expenses
 
 
 
Selling, general and administrative
12,427

 
15,324

Research and development
3,550

 
3,850

Amortization of acquisition-related assets
867

 
1,054

Total operating expenses
16,844

 
20,228

 
 
 
 
Loss from operations
(5,860
)
 
(10,280
)
Interest expense, net
(4,657
)
 
(4,414
)
Other income (expense), net
3,454

 
(2,505
)
Loss from related party equity method investment
(1,784
)
 
(2,210
)
Loss from continuing operations before income taxes
(8,847
)
 
(19,409
)
Provision for income taxes
93

 
226

Net loss from continuing operations
(8,940
)
 
(19,635
)
Income (loss) from discontinued operations, net of tax
32,005

 
(288
)
Net income (loss)
$
23,065

 
$
(19,923
)
 
 
 
 
Basic and diluted net income (loss) per share
 
 
 
Continuing operations - common stock
$
(0.08
)
 
$
(0.18
)
Discontinued operations - common stock
$
0.29

 
$

Total net income (loss) per share - common stock
$
0.21

 
$
(0.18
)
 
 
 
 
Weighted average shares outstanding
 
 
 
Basic and diluted - common stock
110,619,780

 
109,904,336


- 42 -


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

Three Months Ended 
 March 31,
 
2020
 
2019
Revenue
 
 
 
Software-as-a-service related
99.7
 %
 
88.1
 %
Total software-related revenue
99.7
 %
 
88.1
 %
Sequencing and molecular analysis
0.3
 %
 
4.0
 %
Home health care services
 %
 
7.9
 %
Total net revenue
100.0
 %
 
100.0
 %
 
 
 
 
Cost of Revenue
 
 
 
Software-as-a-service related
31.4
 %
 
28.2
 %
Maintenance
 %
 
0.3
 %
Amortization of developed technologies
6.2
 %
 
6.2
 %
Total software-related cost of revenue
37.6
 %
 
34.7
 %
Sequencing and molecular analysis
2.0
 %
 
12.0
 %
Home health care services
 %
 
4.1
 %
Total cost of revenue
39.6
 %
 
50.8
 %
 
 
 
 
Gross Profit
60.4
 %
 
49.2
 %
 
 
 
 
Operating Expenses