Medical Facilities Corporation
Annual Report 2015

Plain-text annual report

Providing the Facilities . . . for Exceptional Healthcare 2015 ANNUAL REPORT Corporate Profile Medical Facilities Corporation owns majority interests in four specialty surgical hospitals located in Arkansas, Oklahoma and South Dakota, and an ambulatory surgery center located in California. Our facilities, which are owned in partnership with physicians, offer a range of surgical, imaging, diagnostic, pain management and other ancillary services such as urgent and primary care and occupational health. Revenue is derived from fees charged for the usage of our facilities. Medical Facilities is publicly traded on the Toronto Stock Exchange under the symbol “DR”. In 2015, the Company paid a monthly dividend of $0.09375 per common share. Since April 2004, the Company has paid over 140 consecutive dividends. Medical Facilities has a Dividend Reinvestment and Share Purchase Plan for shareholders resident in Canada. ABOUT MFC TABLE OF CONTENTS 1 2015 Financial Highlights 2 Letter from the CEO 4 Our Facilities Map 6 Black Hills Surgical Hospital 8 Sioux Falls Specialty Hospital 10 Oklahoma Spine Hospital 12 Arkansas Surgical Hospital 14 The Surgery Center of Newport Coast 16 Patient Care 17 Performance 18 Our Markets 20 Directors and Officers MFC at a Glance Our facilities provide a competitive alternative to larger, traditionally-run hospitals. We offer an unsurpassed standard of care to our patients, efficiently and cost-effectively. Our streamlined processes minimize disruptions to our patients while enhancing the professional and personal lives of our physician partners. Physicians are attracted to our facilities which are managed with a physician focus. Acquisitions and Opportunities In January 2016, Medical Facilities added an accretive asset to its healthcare focused portfolio which complements our strategic direction and vision. This diversified healthcare service company provides third-party business solutions to healthcare entities such as physician practices, facilities, and insurance companies. With more than 6000 ambulatory surgery centers and over 200 specialty hospitals in the United States, there are attractive opportunities for potential acquisitions. 2015 FINANCIAL HIGHLIGHTS 2015 generated year-over-year revenue growth of 3.8% and an increase in income from operations of 12.0% Repurchased 300,600 common shares at an average price of C$15.05 Since April 2004, over 140 consecutive monthly dividends paid to our shareholders Revenue 2015 2014 1 $308.8M $297.4M Cash Available for Distribution 2 2015 2014 C$45.9M C$41.4M Income from Operations 2015 2014 1 $74.7M $66.7M Payout Ratio 2 2015 2014 76.7% 85.2% Operating Margin 2015 2014 1 24.2% 22.4% Strategies for Growth Acquisition of specialty surgical hospitals and ambulatory surgery centers Adding new service lines and increasing the complement of physicians with medical staff privileges at our facilities Creating purchasing efficiencies and synergies by leveraging our aggregate purchasing power Acquisition or development of healthcare related ventures that are accretive and enhance the value proposition for our physician partners All figures in US$ unless otherwise stated. Figures have been restated for the classification of Dakota Plains Surgical Center, LLP as discontinued operation. Refer to Note 4 of Medical 1 Facilities’ 2015 audited consolidated financial statements. Non-IFRS Financial Measures. Refer to Medical Facilities’ 2015 Management’s Discussion and Analysis. 2 1 2015 ANNUAL REPORT Providing the Facilities . . . for a Solid Company Our facilities are highly ranked, state-of-the-art facilities for scheduled short stay and outpatient surgeries and provide a foundation for our plans to capitalize on further opportunities in this fast-growing industry. LETTER FROM THE CEO Celebrating 12 years as a publicly listed company on the Toronto Stock Exchange, Medical Facilities Corporation (“MFC”) is pleased to report revenue of $308.8 million and income from operations of $74.7 million, representing a year-to-year change of 3.8% and 12.0%, respectively. The Future is Bright: a Thriving Healthcare Industry MFC is positioned to capitalize on the robust demand for medical services. The U.S. $2.2 trillion healthcare market is projected to double in size over the next decade. As well, the healthcare sector is relatively resistant to economic fluctuations. Healthcare is one of the fastest growing sectors in the U.S. economy. SEYMOUR TEMKIN Chair of the Board & Interim CEO 2 2015 ANNUAL REPORT Capitalizing on Short Stay and Outpatient Surgeries The growth in short stay and outpatient procedures represents an increasing trend in healthcare. These procedures have grown at a compound annual rate of more than 8.5% since 1981. The popularity and efficiencies of short stay and outpatient surgeries attract both physicians and patients to MFC facilities. New and more complex surgical procedures are expected to increase growth, revenues, and efficiencies. Industry Leading Standard of Care and Efficiencies MFC combines the highest standard of care with a fine hospitality environment. We provide quality services that address every aspect of our patients’ stays. From spacious, state-of-the-art operating facilities to some of the best nurse patient ratios in the industry, our comfortable facilities are welcoming to family members and visitors. Standard of care and efficiency are central to every aspect of our business. Our facilities specialize in a specific range of inpatient and outpatient surgeries. MFC's facilities compare favourably with the larger, traditional hospitals, which often exhibit costly and frustrating inflexibility for physicians and their patients. High standards in our facilities are corroborated by rigorous and neutral third-party evaluations that rank us against the best hospitals in the nation. The data consistently shows that our facilities are equivalent to, or surpass the highest customer satisfaction regarding our medical teams, facilities, services, and communications with our patients. Strengthening Local Communities MFC’s facilities are distinguished in each of their respective marketplaces. They provide services in smaller communities that boost the local economy, while serving as medical destinations which draw visitors from neighboring towns, cities and states. The MFC Model: Physician Investors To ensure an alignment of management and investors, a majority of MFC physicians are significant investors in their local facility. Besides retaining a financial interest, the physicians are actively involved in managing our facilities, in contrast with the model used in most large hospital systems in the United States. The MFC physicians’ expertise in their respective fields of medicine is key to attracting the best medical teams, as well as leading technologies, in a context of quality care, efficiencies and responsiveness. Stable Income Distributions MFC pays out a majority of its free cash flows from operations in the form of a monthly dividend to common shareholders. To build value throughout our facilities and our organization, MFC keeps a keen eye on business metrics. We monitor our operations and procedures to enhance our standard of care, and to ensure efficiencies that reduce waiting times, minimize costs, and improve outcomes. This disciplined focus builds value for our shareholders in the context of stable cash flows. Our overall strategy is to return a stable and secure income for our shareholders. With a proven track record, MFC has a promising future in a growing industry. By improving its standards of care, efficiencies and services, increasing profitability, and using a disciplined acquisition strategy, the future for MFC and its shareholders is bright. Thank you for your continued confidence and support of Medical Facilities Corporation. SEYMOUR TEMKIN Chair of the Board & Interim CEO 3 2015 ANNUAL REPORT Our Facilities Black Hills Surgical Hospital Sioux Falls Specialty Hospital Oklahoma Spine Hospital Arkansas Surgical Hospital The Surgery Center of Newport Coast Black Hills Surgical Hospital Rapid City, South Dakota The Surgery Center of Newport Coast Newport Beach, California 4 2015 ANNUAL REPORT Sioux Falls Specialty Hospital Sioux Falls, South Dakota Arkansas Surgical Hospital North Little Rock, Arkansas Oklahoma Spine Hospital Oklahoma City, Oklahoma 5 2015 ANNUAL REPORT Providing the Facilities . . . for Exceptional Healthcare 95% of patients would recommend our hospital. Awarded CMS 5 star rating One of the top 100 spine hospitals in the U.S. (www.healthgrades.com) Black Hills Surgical Hospital Rapid City, South Dakota 6 2015 ANNUAL REPORT Operating as a licensed specialty hospital since 1997. Ranked 6th in clinical care and service out of more than 3,000 hospitals by Modern Healthcare, a premiere weekly medical journal in the United States. BHSH is a multi-specialty facility with a large component of orthopedic and neurosurgical procedures. The hospital features approximately 75,000 square feet with 11 operating rooms, 26 private recovery suites, 97 physicians with medical staff privileges and a clinical staff of 283. BHSH utilizes the 3T MRI, the world’s most powerful imaging tool. BHSH offers one nurse for every 3 patients, a hotel-like ambiance, and quality food. 7 2015 ANNUAL REPORT The health services industry in Sioux Falls is one of the city's primary industries Sioux Falls Specialty Hospital Sioux Falls, South Dakota Originally built in 1985, the 76,000 square feet hospital features 13 operating rooms, 35 overnight rooms and a clinical staff of 187. SFSH has 224 physicians with medical staff privileges. A recovery care department addresses patient’s postoperative needs. Primary care and occupational health clinics are also available. 8 2015 ANNUAL REPORT A full complement of radiology and diagnostic services, including 3T and open upright MRI's 91% of patients would recommend our hospital. Awarded CMS 5 star rating To assure recovery, SFSH has a high nurse to patient ratio 9 2015 ANNUAL REPORT 88% of patients would recommend our hospital. Awarded CMS 5 star rating Number one rank of all hospitals in Oklahoma for spinal surgery (www.carechex.com) 10 2015 ANNUAL REPORT Oklahoma Spine Hospital Oklahoma City, Oklahoma On-site, the OSH features pharmacy, laboratory and dietary services. As part of its comprehensive care program, OSH features a 7,500 square feet, off-site, physical therapy service owned and operated by the hospital. In a 61,000 square foot facility, OSH is a licensed specialty hospital with a focus on a limited number of clinical and surgical specialties, including neurosurgery and pain management. OSH features 7 large operating rooms, 25 private patient beds and a clinical staff of 200. 96 physicians have medical staff privileges. 11 2015 ANNUAL REPORT Arkansas Surgical Hospital North Little Rock, Arkansas ASH opened in 2005 as a physician-owned specialty hospital. The hospital is at the forefront of orthopedic, spine and reconstructive surgeries. Expertise is provided in breast oncology and pain management procedures. X-ray, CT, MRI and myelography services are also provided. The hospital features 11 operating rooms, 41 overnight rooms and a clinical staff of 208. There are currently 209 physicians with medical staff privileges at ASH. 12 2015 ANNUAL REPORT Recovery is facilitated with quality, caring Registered Nurses ASH is a leading facility for orthopedic, spine and reconstructive surgeries, as well as breast oncology. 91% of patients would recommend our hospital. Awarded CMS 5 star rating 13 2015 ANNUAL REPORT SCNC is an accredited Medicare Deemed Multi-Specialty Facility by the Accreditation Association for Ambulatory Health Care. The Surgery Center of Newport Coast Newport Beach, California Since 2004, this 7,000 square foot facility specializes in orthopedics, pain management, general surgery, gastroenterology, gynecology, and cosmetic surgery. Focusing on same-day surgeries, the facility has two large operating rooms and a special procedure room, as well as private and comfortable pre-operative and post-operative recovery rooms. 14 2015 ANNUAL REPORT Our medical director consults with our physicians and director of nursing to ensure quality care SCNC is the premiere hip arthroscopy center in Orange County, CA. Patients from all over the United States visit Dr. Warren Kramer and his team for hip arthroscopy. 15 2015 ANNUAL REPORT PATIENT CARE Providing the Facilities . . . for Optimal Patient Outcomes Surgeons, registered nurses and medical support staff at our facilities help ensure that their patients are provided quality care during their operation, post-operation, and rehabilitation phases. OPERATION POST-OPERATION REHABILITATION The physicians and staff at our facilities provide medical and surgical expertise focused on a limited number of specialized procedures. To facilitate quality care, our facilities utilize state- of-the-art medical equipment. Positive outcomes are enhanced with high nurse to patient coverage ratios. Our expertise provides faster turnaround times in operating rooms, and in post-operative care. Surveys show that our facilities have low infection rates and post-operative complications. Our facilities are designed to ensure a pleasant stay, for patients and families alike. Patients enjoy our high standards, equivalent to a fine hospitality service. Facilities include private suites, coupled with guest rooms for family members and caregivers. Amenities may include flowers, robes, complimentary bath products and toiletries, flat screen TVs with DVD players, newspapers and magazines, iPads and complimentary Internet. Our facilities receive excellent feedback about their amenities and tasty and nutritious food. Our facilities provide services and procedures to help patients return to optimal functionality in a timely manner. Services include customized rehabilitation programs and on-going monitoring. Board-certified pain and rehabilitation specialists, multispecialty therapists, and professional support staff incorporate innovative products and best-practice procedures. 16 2015 ANNUAL REPORT PERFORMANCE A Proven Business Model Increasing revenue, income from operations, and generation of free cash flow demonstrate the efficacy of Medical Facilities’ business model. 1 Revenue (US$M) Income from Operations and Operating Margin US$M 1 100 400 300 200 100 0 293.2 297.4 308.8 75 70.7 72.9 66.8 66.7 74.7 225.4 203.3 2011 2012 2013 2014 2015 50 25 0 34.7 32.3 22.8 22.4 24.2 2011 2012 2013 2014 2015 Operating Margin (%) Income from Operations (US$M) All figures in US$ unless otherwise stated. 1 Figures have been restated for the classification of Dakota Plains Surgical Center, LLP as discontinued operation. Refer to Note 4 of Medical Facilities’ 2015 audited consolidated financial statements. % 100 75 50 25 0 Cash Available for Distribution , Dividends Paid, Payout Ratio C$M 2 2 50 92.3 83.3 84.3 85.2 41.4 45.9 76.7 35.2 40.8 37.8 33.8 31.2 31.5 34.4 35.3 25 0 2011 2012 2013 2014 2015 Payout Ratio (%) Cash Available for Distribution (C$M) Dividends Paid (C$M) 2 Non-IFRS Financial Measures. Refer to Medical Facilities’ 2015 Management’s Discussion and Analysis. % 100 75 50 25 0 Share Price Performance* (C$) Total Return* (C$) 25 20 15 10 5 0 $14.39 2011 2012 2013 2014 2015 * Share price as at market close. 300 240 180 120 60 0 $195.98 $96.78 2011 2012 2013 2014 2015 Medical Facilties S&P/TSX Composite Index * Assumes C$100 investment with dividends reinvested in Medical Facilities’ common shares. 17 2015 ANNUAL REPORT OUR MARKETS Providing the Facilities . . . for Exceptional Growth Potential 2015 PAYOR MIX Gross Billings (%) Net Revenue (%) Our facilities operate in markets where Blue Cross/Blue Shield and affiliates comprise the largest portions of their payor mix. Our facilities actively negotiate with payors for improved re-imbursement rates, contract terms and access to large patient populations covered by payor contracts. Emphasizing cost advantages, efficiencies, and high standard of care, our facilities market their hospitals directly to payors. Blue Cross/Blue Shield Medicare/Medicaid Worker's Comp Other Private Insurers Other HEALTHCARE REFORM Medical Facilities’ track record of efficiently delivering the highest standard of care to our patients is being rewarded under the Patient Protection and Affordable Care Act. Payors demand efficient, cost-effective services, with excellent outcomes, which align with the strategic focus and best practices of Medical Facilities. Our strategic, disciplined and efficient approach positions us to be attractively compensated by payors and to address the future challenges of healthcare reform. With our excellent performance on the 20 factors used by Medicare to evaluate hospital inpatient stays, our facilities qualified for incentive payments. 18 2015 ANNUAL REPORT HEALTH EXPENSES BY SOURCE 2013 (%) 2024E (%) Medical Facilities has a track record of high levels of patient satisfaction while generating profit within Medicare rates. Total health spending growth in the United States is expected to average 5.8% over 2014-2024. 1 The insured rate is expected to rise from 86.0% to 92.4% as the number of uninsured is projected to fall by 18 million over the next 11 years. 1 The enrollment of baby boomers, coupled with reform mandated changes, are projected to increase Medicare and Medicaid expenditures from 35% in 2012 to 40% by 2023. 1 Source: Centers for Medicare & Medicaid Services, 2014-2024 Projections of National Health Expenditures Data Release, Press Release of July 28, 2015. Medicare/Medicaid Private Health Insurance Other Third-Party Payors Out of Pocket Other Health Insurance Source: Center for Medicare & Medicaid Services, National Health Expenditures, December 2015. REGIONAL TABLE 11 UUnneemmppllooyymmeenntt RRaattee ((%%)) UU..SS.. SSoouutthh DDaakkoottaa OOkkllaahhoommaa AArrkkaannssaass Strategically located in smaller regional metropolitan areas, our Facilities are the preferred choice of residents in the local and surrounding areas. 2015 2014 5.0 5.6 2.9 3.3 4.1 3.9 4.7 5.7 22 6655 aanndd OOvveerr ((%% ooff ppooppuullaattiioonn)) 2014 14.5 15.3 14.5 15.7 1 2 Source: The Bureau of Labour Statistics of the US Department of Labor. Source: U.S. Census Bureau, Population Estimates as of July 1, 2014. Release Date: June 2015. POPULATION PROJECTIONS The 45+ population is expected to drive demand for the services provided by our facilities. 19 2015 ANNUAL REPORT 2020 Projections ~335M U.S. Population 2030 Projections ~356M U.S. Population Source: U.S. Census Bureau, National Population Projections, December 2014. ~46% of Population 45+ ~44% of Population 45+ DIRECTORS & OFFICERS Expert Guidance and Strong Leadership Seymour Temkin Interim CEO and Chair of the Board David Bellaire Director Marilynne Day-Linton Lead Director Stephen Dineley Director Dr. Gil Faclier Director Irving Gerstein Director Dale Lawr Director Jeffrey Lozon Director John Perri Director Dr. Donald Schellpfeffer Director Michael Salter Chief Financial Officer 20 2015 ANNUAL REPORT MANAGEMENT’S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE MONTHS AND YEAR ENDED DECEMBER 31, 2015 March 16, 2016 The following Management’s Discussion and Analysis (“MD&A”) is intended to assist readers in understanding Medical Facilities Corporation (the “Corporation”), its business environment, strategies, performance, outlook and the risks applicable to the Corporation. It is supplemental to and should be read in conjunction with the consolidated financial statements and accompanying notes (the “financial statements”) of the Corporation for the year ended December 31, 2015, which have been prepared in accordance with International Financial Reporting Standards (“IFRS”). Substantially all of the Corporation’s operating cash flows are in U.S. dollars and all amounts presented in the financial statements and herein are stated in thousands of U.S. dollars, unless indicated otherwise. Additional information about the Corporation and its annual information form are available on SEDAR at www.sedar.com. Table of Contents Caution Concerning Forward-Looking Statements ............................................................................ 2  1.  Non-IFRS Financial Measures ............................................................................................................ 3  2.  Business Overview .............................................................................................................................. 3  3.  Financial and Performance Highlights ................................................................................................ 5  4.  Consolidated Operating and Financial Review ................................................................................... 7  5.  Quarterly Operating and Financial Results ....................................................................................... 17  6.  Reconciliation of Non-IFRS Financial Measures ............................................................................. 19  7.  Subsequent Event .............................................................................................................................. 21  8.  Outlook .............................................................................................................................................. 21  9.  Liquidity and Capital Resources ....................................................................................................... 23  10.  Share Capital and Dividends ............................................................................................................. 26  11.  Financial Instruments ........................................................................................................................ 27  12.  13.  Related Party Transactions ................................................................................................................ 29  14.  Critical Accounting Judgments and Estimates .................................................................................. 31  15.  Recently Announced Accounting Pronouncements .......................................................................... 34  16.  Disclosure Controls and Procedures and Internal Controls over Financial Reporting ..................... 34  17.  Risk Factors ....................................................................................................................................... 35  1 1. CAUTION CONCERNING FORWARD-LOOKING STATEMENTS Certain information in this MD&A may constitute “forward‐looking information” within the meaning of applicable securities legislation. All information contained in this MD&A, other than statements of current and historical fact, is forward‐looking information. Forward‐looking information includes information that relates to, among other things, objectives, strategies and intentions, and future financial and operating performance and prospects. Generally, forward‐looking information can be identified by use of words such as “may”, “will”, “could”, “should”, “would”, “expect”, “believe”, “plan”, “believe”, “anticipate”, “intend”, “forecast”, “objective” and “continue” (or the negative thereof) and other similar terminology. All of the forward‐looking information in this MD&A is qualified by this cautionary statement. Forward‐looking information includes, but is not limited to, the discussion of the Corporation’s business and operating initiatives, focuses and strategies, expectations of future performance and consolidated financial results, and expectations with respect to cash flows and level of liquidity. Forward‐looking information is not, and cannot be, a guarantee of future results or events. Forward- looking information is based on, among other things, opinions, assumptions, estimates and analyses that, while considered reasonable at the date the forward‐looking information is provided, inherently are subject to significant risks, uncertainties, contingencies and other factors that may cause actual results, performance or achievements, industry results or events to be materially different from those expressed or implied by the forward‐looking information. The material factors or assumptions that were identified and applied in drawing conclusions or making forecasts or projections set out in the forward-looking information include, but are not limited to: the successful execution of business strategies, consistent and stable economic conditions or conditions in the financial markets, consistent and stable legislative environment in which the Corporation operates, and the opportunity to acquire accretive businesses. Inherent in the forward‐looking information are known and unknown risks, uncertainties and other factors that could cause actual results, performance or achievements, or industry results, to differ materially from any results, performance or achievements expressed or implied by such forward‐looking information. Those risks, uncertainties and other factors that could cause actual results to differ materially from the forward‐looking information include, but are not limited to: ability to obtain and maintain contractual arrangements with insurers and other payors, ability to attract and retain qualified physicians, availability of qualified personnel or management, legislative and regulatory changes, capital expenditures, general state of the economy, competition in the industry, integration of acquisitions, currency risk, interest rate risk, success of new service lines introductions, ability to maintain profitability and manage growth, revenue and cash flow volatility, credit risk, operating risks, performance of obligations/maintenance of client satisfaction, information technology governance and security, risk of future legal proceedings, insurance limits, income tax matters, ability to meet solvency requirements to pay dividends, leverage and restrictive covenants, unpredictability and volatility of common share price, capital investment, and issuance of additional common shares diluting existing shareholders’ interests, and other factors set forth under the heading “Risk Factors” in this MD&A and under the heading “Risk Factors” in the Corporation’s most recently filed annual information form (which is available on SEDAR at www.sedar.com). 2 Given these risks, uncertainties and other factors, investors should not place undue reliance on forward- looking information as a prediction of actual results. The forward‐looking information reflects management’s current expectations and beliefs regarding future events and operating performance and is based on information currently available to management. Although management has attempted to identify important factors that could cause actual results to differ materially from the forward‐looking information contained herein, there are other factors that could cause results not to be as anticipated, estimated or intended. The forward‐looking information contained herein is current as of the date of this MD&A and, except as required under applicable law, the Corporation does not undertake the obligation to publicly revise these forward-looking statements to reflect subsequent events or circumstances. 2. NON-IFRS FINANCIAL MEASURES The Corporation uses certain non-IFRS financial measures which it believes provide useful measures for evaluation and assessment of the Corporation’s performance. Non-IFRS financial measures do not have any standard meaning prescribed by IFRS, are unlikely to be comparable to similar measures presented by other issuers, and should not be considered as alternatives to comparable measures determined in accordance with IFRS as indicators of the Corporation’s financial performance, including its liquidity, cash flows, and profitability. The Corporation uses the following non-IFRS financial measures which are presented in Section 7 of this MD&A under the heading “Reconciliation of Non-IFRS Financial Measures” and reconciled to the applicable IFRS measures:  Cash available for distribution is a non-IFRS financial measure of cash generated from operations during a reporting period which is available for distribution to common shareholders. Cash available for distribution is derived from cash flows from operations before changes in non-cash working capital, less maintenance capital expenditures, interest and principal repayments on non- revolving debt obligations, non-controlling interest in cash flows at the Center level and gains or losses on foreign exchange forward contracts matured in the relevant periods. The Corporation presents cash available for distribution in U.S. dollars and translates it into Canadian dollars using the average exchange rate applicable during the period.  Cash available for distribution per common share is a non-IFRS financial measure calculated as the cash available for distribution divided by the weighted average number of common shares outstanding during the period. The Corporation also presents this amount exclusive of realized gains or losses on foreign exchange forward contracts.  Payout ratio is a non-IFRS financial measure calculated as total distributions per common share in Canadian dollars divided by cash available for distribution per common share in Canadian dollars. The Corporation also presents this amount exclusive of realized gains or losses on foreign exchange forward contracts. 3. BUSINESS OVERVIEW The Corporation is a British Columbia corporation. The capital of the Corporation is in the form of publicly traded common shares and 5.9% convertible unsecured subordinated debentures (“convertible debentures”). The Corporation’s current monthly dividend on its common shares is Cdn$0.09375 per share. 3 The Corporation’s operations are based in the United States. Through its wholly-owned U.S.-based subsidiaries, Medical Facilities America, Inc. (“MFA”) and Medical Facilities (USA) Holdings, Inc. (“MFH”), the Corporation owns controlling interests in, and derives substantially all of its income from, six limited liability entities (each a “Center” and, collectively, the “Centers”), five of which own either a specialty surgical hospital (an “SSH”) or an ambulatory surgery center (an “ASC”). The SSHs are located in South Dakota, Oklahoma and Arkansas and the ASC is located in California. ASCs are specialized surgical centers that only provide outpatient procedures, whereas SSHs are licensed for both inpatient and outpatient surgeries. The Centers provide facilities, including staff, surgical materials and supplies, and other support necessary for scheduled surgical, pain management, imaging, and diagnostic procedures and derive their revenue primarily from the fees charged for the use of these facilities. The Centers mainly focus on a limited number of clinical specialties such as orthopedic, neurosurgery, pain management and other non-emergency elective procedures. In addition, three of the SSHs provide primary and urgent care to their communities. On June 4, 2015, Dakota Plains Surgical Center, LLP (“DPSC”), the Corporation’s 65% owned subsidiary, entered into an asset purchase agreement to sell the assets related to the operation of its SSH in Aberdeen, South Dakota, to Avera St. Luke’s. The transaction was completed on June 30, 2015 for net proceeds of $33.8 million. For the year ended December 31, 2015, results for DPSC, including gain on sale of DPSC’s assets, are presented in “Income for the year from discontinued operation” in the statement of comprehensive income. The Corporation’s share of the gain on disposal of assets of DPSC amounted to $9.3 million on an after-tax basis. For additional information on the discontinued operation, please see Note 4 in the Corporation’s financial statements. Facility service revenue (“revenue”) for any given period is dependent on the volume of the procedures performed as well as the acuity and complexity of the procedures (“case mix”) and composition of payors (“payor mix”), including federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies and employers. Various payors have different reimbursement rates for the same type of procedure which are generally based on either predetermined rates per procedure or discounted fee-for-service rates. Medicare and Medicaid typically have lower reimbursement rates than other payors. Revenue is recorded in the period when healthcare services are provided based upon established billing rates less adjustments required by contractual arrangements with the payors. Estimates of contractual adjustments under payor arrangements are based upon the payment terms specified in the related contractual agreements and payment history. The volume of procedures performed at the Centers depends on (among other things): (i) the Centers’ ability to deliver high quality care and superior services to patients and their family members; (ii) the Centers’ success in encouraging physicians to perform procedures at the Centers through, among other things, maintenance of an efficient work environment for physicians as well as availability of facilities; and (iii) established relationships with major third-party payors in the geographic areas served. The case mix at each Center is a function of the clinical specialties of the physicians and medical staff and is also dependent on the equipment and infrastructure at each Center. Non-controlling interests in the Centers are indirectly owned primarily by physicians practicing at the Centers. Upon acquisition by the Corporation of indirect controlling interests in the SSHs located in South Dakota, Oklahoma and Arkansas, the non-controlling interest owners were granted the right to exchange 4 up to 14% (5% in the case of Arkansas Surgical Hospital) of the ownership interest in their respective Centers for common shares of the Corporation. The non-controlling interest owners of several Centers have exercised portions of their exchangeable interests. Summary of Center Information as of December 31, 2015 Location Year Opened Year Acquired by the Corporation Ownership Interest Non-controlling Interest Exchangeable Interest Size Operating Rooms Overnight Rooms (1) Licensed for 49 beds. Black Hills Surgical Hospital (“BHSH”) Rapid City South Dakota 1997 2004 54.2% 45.8% 10.8% 75,000 sq ft 11 26 Sioux Falls Specialty Hospital (“SFSH”) Sioux Falls South Dakota 1985 2004 51.0% 49.0% 14.0% 76,000 sq ft 13 35 Oklahoma Spine Hospital (“OSH”) Oklahoma City Oklahoma 1999 2005 60.3% 39.7% 4.7% 61,000 sq ft 7 25 Arkansas Surgical Hospital (“ASH”) North Little Rock Arkansas 2005 2012 51.0% 49.0% 5.0% 126,000 sq ft 11 41(1) The Surgery Center of Newport Coast (“SCNC”) Newport Beach California 2004 2008 51.0% 49.0% - 7,000 sq ft 2 - 4. FINANCIAL AND PERFORMANCE HIGHLIGHTS Selected Financial Information from Continuing Operations In thousands of U.S. dollars, except per share amounts and as indicated otherwise Facility service revenue Operating expenses Income from operations Income for the year from continuing operations Attributable to: Owners of the Corporation Non-controlling interest(1) Earnings per share attributable to owners of the Corporation Basic Fully diluted Cash available for distribution(2) Distributions Cash available for distribution per common share(2) Distributions per common share 2015 308,778 234,086 74,692 70,179 37,018 33,161 $ 1.18 $ 0.53 C$ 45,853 C$ 35,186 C$ 1.466 C$ 1.125 For the Years Ended December 31, 2013 293,160 226,402 66,758 39,250 2014 297,382 230,695 66,687 51,151 21,245 29,906 8,137 31,113 $ 0.68 $ 0.51 C$ 41,366 C$ 35,261 C$ 1.320 C$ 1.125 $ 0.27 $ 0.27 C$ 40,823 C$ 34,402 C$ 1.340 C$ 1.129 Payout ratio(2) 76.7% 85.2% 84.3% Total assets Total long-term financial liabilities(3) At December 31, 2015 At December 31, 2014 At December 31, 2013 382,952 58,194 409,709 71,799 439,253 59,141 (1) Income from continuing operations attributable to non-controlling interest represents the interest of the Centers’ non-controlling interests in the net income of the Centers on a stand-alone basis and, therefore, varies in direct relation to the operating results of the Centers. On the other hand, income from continuing operations attributable to owners of the Corporation fluctuates significantly between the periods due to variations in finance costs, primarily in the values of convertible debentures and exchangeable interest liability, and income taxes; these charges are incurred at the corporate level rather than at Center level. 5 (2) Non-IFRS financial measure. Please refer to Section 2 under the heading “Non-IFRS Financial Measures” for a discussion of such measures and to Section 7 under the heading “Reconciliation of Non-IFRS Financial Measures” for a reconciliation to the equivalent IFRS measure. (3) Consists of long-term debt and convertible debentures. Selected Financial Information from Continuing Operations for the Year Ended December 31, 2015 Compared to the Year Ended December 31, 2014 For the year ended December 31, 2015, revenue was $308.8 million, an increase of 3.8% over 2014 due to the growth in revenue recorded by all Centers. Income from operations increased by 12.0% to $74.7 million, or 24.2% of revenue, compared to $66.7 million, or 22.4% of revenue, in 2014. Income for the year from continuing operations was $70.2 million compared to $51.2 million in 2014. The increase in income from continuing operations was primarily due to the positive impact of declines in the values of exchangeable interest liability and convertible debentures, and higher income from operations, which were partially offset by an increase in income tax expense. The Corporation generated cash available for distribution of Cdn$45.9 million, an increase of 10.9% over the prior year. Distributions per common share remained consistent between the years at Cdn$1.125, while the payout ratio was 76.7% compared to 85.2% for the year ended December 31, 2014. For a reconciliation of the foregoing non-IFRS financial measures to the applicable IFRS measures, see Section 7 under the heading “Reconciliation of Non-IFRS Financial Measures”. Selected Financial Information from Continuing Operations for the Year Ended December 31, 2014 Compared to the Year Ended December 31, 2013 For the year ended December 31, 2014, revenue was $297.4 million, an increase of 1.4% over 2013, primarily due to the growth recorded by BHSH and ASH, offset by the decline in revenue at all other Centers. Income from operations declined by 0.1% to $66.7 million, or 22.4% of revenue, compared to $66.8 million, or 22.8% of revenue, in 2013. Income for the year from continuing operations of $51.2 million increased by 30.3%, primarily due to a decline in the value of exchangeable interest liability which was partially offset by the increase in income tax expense. The Corporation generated cash available for distribution of Cdn$41.4 million, an increase of 1.3% over 2013. Distributions per common share declined by 0.4%, while the 2014 payout ratio was 85.2% compared to 84.3% in 2013. 6 5. CONSOLIDATED OPERATING AND FINANCIAL REVIEW Three Months Ended December 31, 2015 The following table and discussion compare operating and financial results of the Corporation from continuing operations for the three months ended December 31, 2015 to the three months ended December 31, 2014. Unaudited In thousands of U.S. dollars, except per share amounts Facility service revenue Operating expenses Salaries and benefits Drugs and supplies General and administrative expenses Depreciation of property and equipment Amortization of other intangibles Three Months Ended December 31, 2015 89,760 2014 82,457 $ Change % Change 8.9% 7,303 22,145 24,138 9,768 2,119 3,796 61,966 20,259 22,791 11,524 2,361 3,408 60,343 1,886 1,347 (1,756) (242) 388 1,623 9.3% 5.9% (15.2%) (10.2%) 11.4% 2.7% Income from operations 27,794 22,114 5,680 25.7% Finance costs Decrease in value of convertible debentures Decrease (increase) in value of exchangeable interest liability Interest expense on exchangeable interest liability Interest expense, net of interest income Loss on foreign currency Income before income taxes Income tax expense Income for the period from continuing operations Attributable to: Owners of the Corporation Non-controlling interest (2,077) (8,249) 2,263 753 293 (7,017) (242) 8,017 2,069 895 1,705 12,444 (1,835) (16,266) 194 (142) (1,412) (19,461) 758.3% (202.9%) 9.4% (15.9%) (82.8%) (156.4%) 34,811 9,670 25,141 259.8% 9,500 2,923 6,577 225.0% 25,311 6,747 18,564 274.9% 13,343 11,968 (2,561) 9,308 15,904 2,660 (621.0%) 28.6% Basic earnings (loss) per share attributable to owners of the Corporation Fully diluted earnings (loss) per share attributable to owners of the Corporation $ 0.43 $ 0.22 ($ 0.08) ($ 0.08) $ 0.51 $ 0.30 (637.5%) (375.0%) Revenue Unaudited In thousands of U.S. dollars BHSH SFSH OSH ASH SCNC Facility service revenue Three Months Ended December 31, 2014 21,687 26,158 16,853 15,783 1,976 82,457 2015 22,539 29,988 17,625 17,447 2,161 89,760 $ Change 852 3,830 772 1,664 185 7,303 % Change 3.9% 14.6% 4.6% 10.5% 9.4% 8.9% For the three months ended December 31, 2015, consolidated revenue of $89.8 million increased by $7.3 million or 8.9% from the same period in 2014 primarily due to the growth in case volume ($7.2 million), a favourable shift in payor mix ($0.8 million), and higher ancillary revenue from pain 7 management, imaging and urgent and primary care cases ($0.5 million), which were partially offset by an unfavourable shift in case mix ($1.4 million). Total surgical cases increased by 9.3%, a large portion of which was for outpatient cases which have a lower fee schedule. Total pain management procedures increased by 3.6%. The payor mix reflected a higher proportion of cases which were funded by commercial insurance and self-pay patients. The above factors are reflected in each Center’s revenue as follows:  BHSH recorded growth in surgical case volume and more favourable payor mix, which were partially offset by changes in case mix, primarily related to smaller cases that generate lower revenue per case.  SFSH recorded an increase in surgical cases, a favourable shift in payor mix, and growth in pain management, imaging, and primary care revenue, which were partially offset by changes in case mix and electronic health records (“EHR”) incentive payments.  OSH’s revenue increased primarily due to an increase in surgical cases and the addition of urgent care revenue, partially offset by changes in payor mix and EHR incentive payments.  ASH recorded an increase in surgical case volume which was partially offset by changes in case mix.  SCNC’s revenue was positively impacted by a more favourable case mix attributable to increased women’s health and complex orthopedic cases and billings due to flow-through charges for implants, along with favourable changes to payor mix, which were partially offset by a decline in surgical cases. Operating Expenses Consolidated operating expenses, including salaries and benefits, drugs and supplies, general and administrative expenses, depreciation of property and equipment, and amortization of other intangibles, (“operating expenses”) totaled $62.0 million, an increase of $1.6 million or 2.7%. As a percentage of revenue, operating expenses decreased to 69.0% from 73.2% in the same period a year earlier. Unaudited Three Months Ended December 31, In thousands of U.S. dollars BHSH SFSH OSH ASH SCNC Corporate Operating expenses 2015 14,003 16,958 13,648 9,829 1,636 5,892 61,966 Percentage of Revenue 62.1% 56.5% 77.4% 56.3% 75.7% n/a 69.0% 2014 14,178 14,607 13,523 11,542 1,574 4,919 60,343 Percentage of Revenue 65.4% 55.8% 80.2% 73.1% 79.7% n/a 73.2% $ Change (175) 2,351 125 (1,713) 62 973 1,623 % Change (1.2%) 16.1% 0.9% (14.8%) 3.9% 19.8% 2.7% Consolidated salaries and benefits increased by $1.9 million or 9.3%. Salaries and benefits at the Center level increased primarily due to annual salary increases and employee profit sharing at ASH which together totaled $0.7 million, increased staffing levels at BHSH ($0.2 million), increased urgent care and pain management staffing at OSH ($0.2 million), and administrative salary increases and incentive pay changes at SFSH ($0.3 million). Salaries and benefits at the corporate level were higher compared to the same period in 2014 due to retirement allowance and incentive compensation. As a percentage of revenue, consolidated salaries and benefits increased to 24.7% from 24.6% a year earlier. 8 Consolidated drugs and supplies increased by $1.3 million or 5.9% primarily due to higher case volumes ($2.0 million) and an accrual at SFSH for performance fees of $0.4 million in relation to the orthopedic service line management agreement (refer to Section 13 of this MD&A under the heading “Related Party Transactions”), which were partially offset by changes in case mix and cost savings amounting to $1.1 million. As a percentage of revenue, consolidated cost of drugs and supplies declined to 26.9% from 27.6% a year earlier. Consolidated general and administrative expenses (“G&A”) decreased by $1.8 million or 15.2% primarily due to a non-cash reversal of an accrued rent liability by ASH ($2.7 million) that resulted from the early termination of ASH’s premises lease, and declines in contributions ($0.5 million), which were made in 2014 to Patient Choice for South Dakota in support of Initiated Measure 17, and purchased services ($0.2 million). These decreases were partially offset by $0.5 million in payments by SFSH for management services related to the orthopedic service line management agreement and $0.2 million in accountable care organization costs (refer to Section 13 of this MD&A under the heading “Related Party Transactions”), and $0.7 million in professional fees, consulting fees, information technology costs and repairs and maintenance costs. As a percentage of revenue, consolidated G&A decreased to 10.9% from 14.0% a year earlier. Consolidated depreciation of property and equipment declined by $0.2 million or 10.2% primarily due to certain assets being fully depreciated at the Centers. As a percentage of revenue, consolidated depreciation of property and equipment declined to 2.4% from 2.9% a year earlier. Consolidated amortization of other intangibles increased by $0.4 million or 11.4%. As a percentage of revenue, consolidated amortization of other intangibles increased to 4.2% from 4.1% a year earlier. Income from Operations Consolidated income from operations of $27.8 million was $5.7 million or 25.7% higher than consolidated income from operations recorded a year earlier, representing 31.0% of revenue compared to 26.8% in the same period in 2014. The increase in consolidated income from operations reflects the growth in consolidated revenue, coupled with lower G&A at ASH due to the non-cash reversal of an accrued rent liability. Unaudited Three Months Ended December 31, In thousands of U.S. dollars BHSH SFSH OSH ASH SCNC Corporate Income from operations Finance Costs 2015 8,536 13,030 3,977 7,618 525 (5,892) 27,794 Percentage of Revenue 37.9% 43.5% 22.6% 43.7% 24.3% n/a 31.0% 2014 7,509 11,551 3,330 4,241 402 (4,919) 22,114 Percentage of Revenue 34.6% 44.2% 19.8% 26.9% 20.3% n/a 26.8% $ Change 1,027 1,479 647 3,377 123 (973) 5,680 % Change 13.7% 12.8% 19.4% 79.6% 30.6% 19.8% 25.7% Change in Value of Convertible Debentures The convertible debentures are recorded as a financial liability at fair value and re-measured at each reporting date and the changes in fair value are included in net income for the respective periods. Changes 9 in the recorded value of the convertible debentures are driven by the changes in the market price of the Corporation’s convertible debentures and fluctuations in the value of the Canadian dollar against the U.S. dollar. The following table provides calculations of the changes in values of the convertible debentures for the reporting periods: In thousands of U.S. dollars, except as indicated otherwise Face value of convertible debentures outstanding in thousands of Canadian dollars December 31, 2015 September 30, 2015 Unaudited Change December 31, 2014 September 30, 2014 Unaudited Change C$41,743 C$41,755 (C$12) C$41,786 C$41,786 - Closing price of convertible debentures outstanding Closing exchange rate of U.S. dollar to Canadian dollar Market value of convertible debentures outstanding Repurchase of convertible debentures under C$101.50 C$1.3840 C$104.51 (C$3.01) C$105.50 C$102.50 C$3.00 C$1.3345 C$0.0495 C$1.1601 C$1.1200 C$0.0401 30,614 32,700 (2,086) 38,000 38,242 (242) normal course issuer bid Change in value of convertible debentures 9 (2,077) - (242) Change in Value of Exchangeable Interest Liability The liability for the exchangeable interest is recorded at fair value, which is re-measured at each reporting date, and the changes in fair value are included in net income for the respective periods. Changes in the recorded value of the exchangeable interest liability between the reporting periods are attributable to (i) changes in the number of common shares to be issued for the exchangeable interest liability, which are driven by the distributions to the non-controlling interest during the twelve-month period ending on the reporting date, (ii) changes in the market price of the Corporation’s common shares, and (iii) fluctuations of the value of the Canadian dollar against the U.S. dollar. The following table provides calculations of the changes in values of the exchangeable interest liability for the reporting periods: In thousands of U.S. dollars, except as indicated otherwise Number of common shares to be issued for exchangeable interest liability Less number of common shares to be issued for exchangeable interest liability attributable to discontinued operation Number of common shares to be issued for exchangeable interest liability attributable to continuing operations Closing price of the Corporation’s common shares Closing exchange rate of U.S. dollar to Canadian dollar Exchangeable interest liability December 31, 2015 September 30, 2015 Unaudited Change December 31, 2014 September 30, 2014 Unaudited Change 5,932,340 5,940,296 (7,956) 5,851,799 6,009,415 (157,616) - - - - (17,716) 17,716 5,932,340 5,940,296 (7,956) 5,851,799 5,991,699 (139,900) C$14.39 C$15.71 (C$1.32) C$18.41 C$15.86 C$2.55 C$1.3840 61,681 C$1.3345 69,930 C$0.0495 (8,249) C$1.1601 92,864 C$1.1200 84,847 C$0.0401 8,017 10 Interest on Exchangeable Interest Liability For the three months ended December 31, 2015, interest expense on the exchangeable interest liability increased by $0.2 million over the same period in 2014, primarily due to the variation in distributions from the Centers between the reporting periods. Interest Expense For the three months ended December 31, 2015, interest expense, net of interest income, decreased by $0.1 million from the same period in 2014, primarily due to lower interest expense at Center level and a decline in Canadian dollar interest expense on the convertible debentures due to the changes in foreign exchange rates. Foreign Currency Losses The Corporation’s functional and reporting currency is U.S. dollars; however, certain public company expenses and payments to holders of common shares and convertible debentures are made in Canadian dollars. The decline in foreign currency losses of $1.4 million compared to the same period in 2014 is attributable to the fluctuations in the value of the Canadian dollar in relation to U.S. dollar during the three months ended December 31, 2015 compared to the same period in 2014, as well as the expiry and settlement of foreign exchange forward contracts in the respective periods. Income Tax Current and deferred tax components of the income tax expense for the reporting periods are as follows: Unaudited In thousands of U.S. dollars Current income tax expense Deferred income tax expense Income tax expense Three Months Ended December 31, 2014 2015 2,801 6,699 9,500 1,905 1,018 2,923 $ Change % Change 896 5,681 6,577 47.0% 558.1% 225.0% The increase in current income taxes was primarily attributable to the increase in taxable income. The increase in deferred income tax expense was primarily attributable to the tax effect of the change in exchangeable interest liability and the utilization of the deferred tax asset related to the Canadian cumulative tax operating losses. Income from Continuing Operations The $18.6 million increase in income from continuing operations for the three months ended December 31, 2015 over the same period in 2014 was primarily due to the impact of a decline in the value of exchangeable interest liability and improved performance of the Centers. 11 Year Ended December 31, 2015 The following table and discussion compare operating and financial results of the Corporation from continuing operations for the year ended December 31, 2015 to the year ended December 31, 2014. In thousands of U.S. dollars, except per share amounts Facility service revenue Operating expenses Salaries and benefits Drugs and supplies General and administrative expenses Depreciation of property and equipment Amortization of other intangibles Years Ended December 31, 2015 308,778 2014 297,382 80,223 84,810 44,995 8,909 15,149 234,086 77,331 84,537 43,882 9,573 15,372 230,695 $ Change % Change 3.8% 11,396 2,892 273 1,113 (664) (223) 3,391 3.7% 0.3% 2.5% (6.9%) (1.5%) 1.5% Income from operations 74,692 66,687 8,005 12.0% Finance costs Decrease in value of convertible debentures Decrease in value of exchangeable interest liability Interest expense on exchangeable interest liability Interest expense, net of interest income Loss on foreign currency Income before income taxes Income tax expense Income for the year from continuing operations Attributable to: Owners of the Corporation Non-controlling interest Basic earnings per share attributable to owners of the Corporation Fully diluted earnings per share attributable to owners of the Corporation (7,353) (30,036) 9,172 3,024 4,987 (20,206) (3,253) (12,757) 8,591 3,538 5,091 1,210 (4,100) (17,279) 581 (514) (104) (21,416) 126.0% 135.4% 6.8% (14.5%) (2.0%) (1,769.9%) 94,898 65,477 29,421 44.9% 24,719 14,326 10,393 72.5% 70,179 51,151 19,028 37.2% 37,018 33,161 21,245 29,906 $ 1.18 $ 0.53 $ 0.68 $ 0.51 15,773 3,255 $ 0.51 $ 0.03 74.2% 10.9% 73.5% 3.9% Revenue In thousands of U.S. dollars BHSH SFSH OSH ASH SCNC Facility service revenue Years Ended December 31, 2015 78,749 95,773 63,363 63,061 7,832 308,778 2014 76,687 88,118 63,913 60,450 8,214 297,382 $ Change 2,062 7,655 (550) 2,611 (382) 11,396 % Change 2.7% 8.7% (0.9%) 4.3% (4.7%) 3.8% For the year ended December 31, 2015, consolidated revenue of $308.8 million increased by $11.4 million or 3.8% over 2014. Consolidated revenue growth was attributable to higher case volumes, which generated additional revenue of $14.1 million, and increased ancillary (imaging, and primary and urgent care) revenue of $2.3 million, which were partially offset by changes in case mix of $3.9 million and a decline in EHR incentive payments of $1.1 million. 12 Total surgical cases increased by 4.5%, a large portion of which was due to outpatient cases. Total pain management procedures increased by 6.6%. The above factors are reflected in each Center’s revenue as follows:  BHSH recorded revenue growth due to a favourable shift in payor mix, increases in urgent care, pain management and imaging revenue, and pharmacy fee increases, which were partially offset by changes in EHR incentive payments.  SFSH recorded an increase in surgical cases, favourable changes in payor mix, and growth in imaging, pain management and primary care revenue, which were partially offset by changes in case mix and EHR incentive payments.  OSH’s revenue decreased primarily due to unfavourable changes in payor mix and EHR incentive payments, which were partially offset by growth in case volumes.  ASH recorded growth in case volumes and EHR incentive payments, which were partially offset by changes in case mix.  SCNC’s revenue was negatively impacted by a decline in surgical cases and unfavourable changes in payor mix, which were partially offset by a favourable change in case mix attributable to increases in women’s health and complex orthopedic cases. Operating Expenses Consolidated operating expenses totaled $234.1 million, an increase of $3.4 million or 1.5%. As a percentage of revenue, operating expenses declined to 75.8% from 77.6% a year earlier. In thousands of U.S. dollars BHSH SFSH OSH ASH SCNC Corporate Operating expenses Years Ended December 31, Percentage of Revenue 68.1% 59.6% 80.4% 71.4% 78.8% n/a 75.8% 2014 53,577 51,988 52,244 46,061 6,043 20,782 230,695 Percentage of Revenue 69.9% 59.0% 81.7% 76.2% 73.6% n/a 77.6% 2015 53,662 57,035 50,941 45,054 6,174 21,220 234,086 $ Change 85 5,047 (1,303) (1,007) 131 438 3,391 % Change 0.2% 9.7% (2.5%) (2.2%) 2.2% 2.1% 1.5% Consolidated salaries and benefits increased by $2.9 million or 3.7% compared to 2014. Salaries and benefits at the Center level increased primarily due to $1.8 million of annual salary increases at the Centers and higher employee profit sharing at ASH, $0.8 million relating to higher administrative salaries, primary care staffing and incentive payment at SFSH, increased staffing at BHSH ($0.5 million), and increased urgent care and pain management staffing at OSH ($0.3 million), which were partially offset by lower benefits costs ($0.8 million). Salaries and benefits at the corporate level increased compared to 2014 primarily due to retirement allowance ($0.7 million), which was partially offset by the changes in the value of the directors’ deferred share unit plan ($0.5 million). As a percentage of revenue, consolidated salaries and benefits remained unchanged at 26.0%. 13 Consolidated drugs and supplies increased by $0.3 million or 0.3% compared to 2014 primarily due to higher case volume ($4.1 million) and a $1.4 million expense at SFSH for performance fees in relation to the orthopedic service line management agreement (refer to Section 13 of this MD&A under the heading “Related Party Transactions”), which were partially offset by changes in case mix and cost savings aggregating to $5.2 million. As a percentage of revenue, consolidated cost of drugs and supplies declined to 27.5% from 28.4% a year earlier. Consolidated G&A increased by $1.1 million or 2.5%, from a year earlier. The increase in G&A was attributable to a number of factors, the most significant of which were $1.8 million in payments by SFSH for management services related to the orthopedic service line management agreement and $0.6 million in accountable care organization costs (refer to Section 13 of this MD&A under the heading “Related Party Transactions”), $0.5 million in repairs and maintenance costs, $0.4 million in information technology costs and $0.4 million in consulting fees. These increases were partially offset by the non-cash reversal of an accrued rent liability by ASH ($2.7 million). As a percentage of revenue, consolidated G&A decreased to 14.6% from 14.8% a year earlier. Consolidated depreciation of property and equipment declined by $0.7 million or 6.9% primarily due to the full depreciation of certain property and equipment at certain Centers. As a percentage of revenue, consolidated depreciation of property and equipment declined to 2.9% from 3.2% a year earlier. Consolidated amortization of other intangibles declined by $0.2 million or 1.5% primarily due to the full amortization of certain referral source assets. As a percentage of revenue, consolidated amortization of other intangibles declined to 4.9% from 5.2% a year earlier. Income from Operations Consolidated income from operations of $74.7 million was $8.0 million or 12.0% higher than consolidated income from operations recorded a year earlier, representing 24.2% of revenue compared to 22.4% in 2014. In thousands of U.S. dollars BHSH SFSH OSH ASH SCNC Corporate Income from operations Finance Costs Years Ended December 31, 2015 25,087 38,738 12,422 18,007 1,658 (21,220) 74,692 Percentage of Revenue 31.9% 40.4% 19.6% 28.6% 21.2% n/a 24.2% 2014 23,110 36,130 11,669 14,389 2,171 (20,782) 66,687 Percentage of Revenue 30.1% 41.0% 18.3% 23.8% 26.4% n/a 22.4% $ Change 1,977 2,608 753 3,618 (513) (438) 8,005 % Change 8.6% 7.2% 6.5% 25.1% (23.6%) 2.1% 12.0% Change in Value of Convertible Debentures The convertible debentures are recorded as a financial liability at fair value and re-measured at each reporting date and the changes in fair value are included in net income for the respective year. Changes in the recorded value of the convertible debentures are driven by the changes in the market price of the Corporation’s convertible debentures and fluctuations in the value of the Canadian dollar against the U.S. dollar. 14 The following table provides calculations of the changes in values of the convertible debentures for the reportable years: In thousands of U.S. dollars, except as indicated otherwise Face value of convertible debentures outstanding in thousands of Canadian dollars Closing price of convertible debentures outstanding Closing exchange rate of U.S. dollar to Canadian dollar Market value of convertible debentures outstanding Effect of conversion Repurchase of convertible debentures under normal course issuer bid December 31, 2015 December 31, 2014 Change December 31, 2014 December 31, 2013 Change C$41,743 C$41,786 (C$43) C$41,786 C$41,800 (C$14) C$101.50 C$105.50 (C$4.00) C$105.50 C$105.00 C$0.50 C$1.3840 C$1.1601 C$0.2239 C$1.1601 C$1.0636 C$0.0965 30,614 38,000 (7,386) - 33 (7,353) 38,000 41,266 (3,266) 13 - (3,253) Change in value of convertible debentures Change in Value of Exchangeable Interest Liability The liability for the exchangeable interest is recorded at fair value, which is re-measured at each reporting date, and the changes in fair value are included in net income for the respective year. Changes in the recorded value of the exchangeable interest liability between the reportable years are attributable to (i) changes in the number of common shares to be issued for the exchangeable interest liability, which are driven by the distributions to the non-controlling interest during the twelve-month period ending on the reporting date, (ii) changes in the market price of the Corporation’s common shares, and (iii) fluctuations of the value of the Canadian dollar against the U.S. dollar. The following table provides calculation of the changes in values of exchangeable interest liability for the reportable years: In thousands of U.S. dollars, except as indicated otherwise Number of common shares to be issued for exchangeable interest liability Less number of common shares to be issued for exchangeable interest liability attributable to discontinued operation Number of common shares to be issued for exchangeable interest liability attributable to continuing operations Closing price of the Corporation’s common shares December 31, 2015 December 31, 2014 Change December 31, 2014 December 31, 2013 Change 5,932,340 5,851,799 80,541 5,851,799 6,274,969 (423,170) - - - - (13,091) 13,091 5,932,340 5,851,799 80,541 5,851,799 6,261,878 (410,079) C$14.39 C$18.41 (C$4.02) C$18.41 C$17.94 C$0.47 Closing exchange rate of U.S. dollar to C$1.3840 Canadian dollar 61,681 Exchangeable interest liability Exercise of exchangeable rights by non-controlling interests Change in value of exchangeable interest liability C$1.1601 92,864 C$0.2239 (31,183) 1,147 (30,036) C$1.1601 92,864 C$1.0636 105,621 C$0.0965 (12,757) - (12,757) Interest on Exchangeable Interest Liability Interest expense on the exchangeable interest liability increased by $0.6 million primarily due to the variation in distributions from the Centers between the reporting years. 15 Interest Expense Interest expense, net of interest income, decreased by $0.5 million primarily due to lower interest expense at Center level and a decline in Canadian dollar interest expense on the convertible debentures due to the changes in foreign exchange rates. Foreign Currency Losses The Corporation’s reporting currency is U.S. dollars; however, certain public company expenses and payments to holders of common shares and convertible debentures are made in Canadian dollars. The decrease in foreign currency losses of $0.1 million compared to 2014 is attributable to the fluctuations in the value of the Canadian dollar in relation to the U.S. dollar during 2015 compared to 2014. Income Tax Current and deferred tax components of the income tax expense for the reporting years are as follows: In thousands of U.S. dollars Current income tax expense Deferred income tax expense Income tax expense Years Ended December 31, 2015 1,015 23,704 24,719 2014 1,637 12,689 14,326 $ Change % Change (622) 11,015 10,393 (38.0%) 86.8% 72.5% The decrease in current income tax expense is primarily attributable to increased tax deductible expenses compared to the prior year. The increase in deferred income tax expense is primarily attributable to the tax effect of the change in exchangeable interest liability and the utilization of the deferred tax asset related to the Canadian cumulative tax operating losses. Income from Continuing Operations A $19.0 million increase in income from continuing operations was primarily due to the impact of the declines in the respective values of the exchangeable interest liability and convertible debentures, as well as to the improved performance of the Centers, which were partially offset by an increase in income tax expense. 16 6. QUARTERLY OPERATING AND FINANCIAL RESULTS Summary of Quarterly Operating and Financial Results from Continuing Operations Unaudited In thousands of U.S. dollars, except per share amounts Facility service revenue 2015 2014 Q4 89,760 Q3 73,137 Q2 73,636 Q1 72,245 Q4 82,457 Q3 74,218 Q2 71,231 Q1 69,476 Operating expenses Salaries and benefits Drugs and supplies General and administrative expenses Depreciation of property and equipment Amortization of other intangibles 22,145 24,138 9,768 2,119 3,796 61,966 19,680 20,734 11,990 2,209 3,791 58,404 19,240 20,450 11,914 2,234 3,817 57,655 19,158 19,488 11,323 2,347 3,745 56,061 20,259 22,791 11,524 2,361 3,408 60,343 18,729 21,799 10,659 2,426 4,034 57,647 19,119 20,003 10,503 2,408 3,988 56,021 19,224 19,944 11,196 2,378 3,942 56,684 Income from operations 27,794 14,733 15,981 16,184 22,114 16,571 15,210 12,792 Finance costs Increase (decrease) in value of convertible debentures Increase (decrease) in value of exchangeable interest liability Interest expense on exchangeable interest liability Interest expense, net of interest income Loss (gain) on foreign currency (2,077) (1,567) (677) (3,031) (242) (2,933) (971) 893 (8,249) 2,263 753 293 (7,017) (2,338) 2,019 774 1,620 508 (4,953) 2,143 747 (567) (3,307) (14,496) 2,747 750 3,641 (10,389) 8,017 2,069 895 1,705 12,444 (19,692) 1,851 874 2,876 (17,024) (12,065) 2,117 853 (2,598) (12,664) 10,983 2,554 916 3,108 18,454 Income (loss) before income taxes 34,811 14,225 19,288 26,573 9,670 33,595 27,874 (5,662) Income tax expense (recovery) 9,500 3,614 2,882 8,723 2,923 8,600 5,489 (2,686) Income (loss) for the period from continuing operations Attributable to: Owners of the Corporation Non-controlling interest 25,311 10,611 16,406 17,850 6,747 24,995 22,385 (2,976) 13,343 11,968 3,663 6,948 9,279 7,127 10,733 7,117 (2,561) 9,308 17,512 7,483 15,422 6,963 (9,128) 6,152 Earnings (loss) per share attributable to owners of the Corporation: Basic Fully diluted $ 0.43 $ 0.22 $ 0.12 $ 0.08 $ 0.30 $ 0.20 $ 0.34 $ 0.04 ($ 0.08) ($ 0.08) $ 0.56 $ 0.11 $ 0.49 $ 0.23 ($ 0.29) ($ 0.29) During the last eight quarters, the following items have had a significant impact on the Corporation’s financial results:  Revenue varies directly in relation to the number of cases performed as well as to the type of cases performed and the payor. For example, revenue for orthopedic cases will typically be higher than ear, nose and throat cases and cases funded by Medicare or Medicaid will result in lower revenue than those paid for by private insurance. Changes in case volumes, case mix and payor mix are normal and expected due to the nature of the Corporation’s business. Surgical cases are mainly elective procedures and the volume of cases performed in any given period is subject to medical necessity and patient and physician preferences in scheduling (e.g., work schedules and vacations). The Corporation generally records higher revenue in the fourth quarter as many patients tend to seek medical procedures at the end of the year, primarily as a result of their inability to carry over unused insurance benefits into the following calendar year. During the course of the last eight quarterly reporting periods, revenue has also been impacted by the periodic receipt of EHR incentive payments and the development of urgent and primary care service lines.  The changes in operating expenses are consistent with fluctuations in case volumes and case mix as well as costs related to the Corporation’s strategic move into urgent and primary care. During the last 17 four quarterly reporting periods, operating expenses have been impacted by costs related to the establishment of an accountable care organization by SFSH as well as the entering by SFSH into a management agreement for its orthopedic service line (refer to Section 13 of this MD&A under heading “Related Party Transactions”). In addition, in the fourth quarter of 2015, ASH recorded a non-cash reversal of an accrued rent liability of $2.7 million that resulted from the early termination of its premises lease.  The changes in the recorded value of the convertible debentures have been driven by the changes in the market price of the Corporation’s convertible debentures and fluctuations in the value of the Canadian dollar against the U.S. dollar.  The changes in the recorded value of the exchangeable interest liability have been driven by (i) the changes in the number of common shares issuable for the exchangeable interest liability, which are in turn driven by the distributions to the non-controlling interest during the twelve-month period ending on the reporting date, (ii) the changes in the market price of the Corporation’s common shares, and (iii) the fluctuations of the value of the Canadian dollar against the U.S. dollar.  The fluctuations in interest expense on the exchangeable interest liability are due to the variation in distributions from the Centers between the reporting periods.  The fluctuations in loss (gain) on foreign currency have been driven by the movements of the exchange rate of the Canadian dollar in relation to U.S. dollar.  Fluctuations in current income taxes have been driven by changes in operating performance of the Centers, the deductibility of corporate expenses, intercompany interest expense deductions and taxable (deductible) foreign exchange gains (losses). Fluctuations in deferred income taxes have been driven primarily by changes in the exchangeable interest liability and Canadian cumulative tax operating losses. 18 7. RECONCILIATION OF NON-IFRS FINANCIAL MEASURES The following table presents reconciliation of cash available for distribution to the cash provided by operating activities: In thousands of U.S. dollars, except as indicated otherwise CASH PROVIDED BY OPERATING ACTIVITIES Non-controlling interest in cash flows of the Centers(1) Interest expense on exchangeable interest liability(2) Difference between straight-line rent expense and actual payments made(3) Maintenance capital expenditures(4) Difference between accrual based amounts and actual cash flows related to interest and taxes(5) Change in non-cash operating working capital items(6) Realized losses on foreign exchange forward contracts which matured in the current period(7) Repayment of non-revolving debt(8) CASH AVAILABLE FOR DISTRIBUTION Realized losses on matured foreign exchange forward contracts, net of taxes CASH AVAILABLE FOR DISTRIBUTION EXCLUDING REALIZED LOSSES ON FOREIGN EXCHANGE FORWARD CONTRACTS DISTRIBUTIONS CASH AVAILABLE FOR DISTRIBUTION PER COMMON SHARE(9) Including realized losses on foreign exchange forward contracts Excluding realized losses on foreign exchange forward contracts Three Months Ended December 31, 2015 Unaudited 23,346 2014 Unaudited 27,197 Years Ended December 31, 2015 2014 80,240 88,000 USD (14,667) 2,263 (2,535) (862) (13,739) 2,064 123 (1,062) (45,706) 9,172 (2,175) (2,780) (44,344) 8,603 563 (2,984) 63 4,384 (1,690) (892) 9,410 12,566 1,242 10,652 14,225 (2,930) 912 (981) (836) 10,748 12,205 579 11,327 12,863 5,631 1,517 (6,475) (3,565) 35,859 45,853 4,759 40,618 51,938 (1,270) (3,840) (3,034) (4,242) 37,452 41,366 1,790 39,242 43,343 8,766 8,808 35,186 35,261 $ 0.403 $ 0.456 $ 0.390 $ 0.411 $ 1.466 $ 1.660 $ 1.320 $ 1.383 USD CDN USD USD CDN CDN CDN CDN TOTAL DISTRIBUTIONS PER COMMON SHARE(9) CDN $ 0.281 $ 0.281 $ 1.125 $ 1.125 PAYOUT RATIO Including realized losses on foreign exchange forward contracts Excluding realized losses on foreign exchange forward contracts 69.7% 61.6% 72.1% 68.4% 76.7% 67.8% 85.2% 81.3% Average exchange rate of Cdn$ to US$ for the period Weighted average number of common shares outstanding 1.3354 31,185,411 1.1356 31,317,912 1.2787 31,287,313 1.1045 31,344,891 (1) Non-controlling interest in cash flows of the Centers is deducted in determining cash available for distribution as distributions from the Centers to the non- controlling interest holders are required to be made concurrently with distributions from the Centers to the Corporation. (2) Interest expense on exchangeable interest liability represents a notional amount of interest expense deducted in the determination of net income attributable to owners of the Corporation. It is added back to determine cash available for distribution as it is a non-cash charge and is not distributable to the holders of the non-controlling interest. (3) Difference between straight-line rent expense and actual payments made represents the difference between rent expense recorded using the straight-line method over the life of the lease versus actual payments made. As a non-cash adjustment, this item is added back in the calculation of cash available for distribution. The results for the three months and year ended December 31, 2015 include the non-cash reversal of a $2,692 accrual that resulted from the early termination of a premises lease. (4) Maintenance capital expenditures at the Center level reflect expenditures incurred to maintain the current operating capacities of the Centers and are deducted in the calculation of cash available for distribution. (5) Cash flows from operating activities, as presented in the Corporation’s consolidated statements of cash flows, represent actual cash inflows and outflows, while calculation of cash available for distribution is based on the accrued amounts and, therefore, the difference between the accrual based amounts and actual cash inflows and outflows related to interest, income and withholding taxes are included in the above table. (6) While changes in non-cash operating working capital are included in the calculation of cash provided by operating activities, they are not included in the calculation of cash available for distribution as they represent only temporary sources or uses of cash due to the differences in timing of recording revenue and corresponding expenses and actual receipts and outlays of cash. Such changes in non-cash operating working capital are financed from the available cash or credit facilities of the Centers. (7) Realized losses (gains) on foreign exchange forward contracts which matured in the current period are adjusted in the determination of cash available for distribution while they are excluded from cash provided by operating activities. 19 (8) Repayment of non-revolving debt at the Center level reflects contractual obligations of the Centers and is deducted in the calculation of cash available for distribution. (9) Calculated based on the weighted average number of common shares outstanding. Cash available for distribution for the year ended December 31, 2015 includes the interest of the Corporation in the cash flows from the operations of DPSC up to the date of disposal of the operating assets, but excludes the gain on disposal, net of tax, on those assets. Cash available for distribution in the three-month period ended December 31, 2015 (Cdn$12.6 million) exceeded the total amount of distributions in the same period (Cdn$8.8 million) by Cdn$3.8 million. On a per common share basis, cash available for distribution of Cdn$0.403 was Cdn$0.122, or 43.4%, higher than distributions of Cdn$0.281, resulting in a payout ratio of 69.7% as compared to a payout ratio of 72.1% in the same period in 2014. Cash available for distribution in the year ended December 31, 2015 (Cdn$45.9 million) exceeded the total amount of distributions in 2014 (Cdn$35.2 million) by Cdn$10.7 million. On a per common share basis, cash available for distribution of Cdn$1.466 was Cdn$0.341, or 30.3%, higher than distributions of Cdn$1.125, resulting in a payout ratio of 76.7% as compared to a payout ratio of 85.2% in 2014. The Corporation’s cash available for distribution comes solely from the Centers. The following table provides a reconciliation of cash generated at the Center level to the Corporation’s cash available for distribution: In thousands of U.S. dollars Cash flows from the Centers: Income before interest expense and depreciation Debt service costs: Interest Repayment of non-revolving debt Maintenance capital expenditures Difference between straight-line rent expense and actual payments made Cash available for distribution at Center level Non-controlling interest in cash available for distribution at Center level Corporation’s share of the cash available for distribution at Center level Corporate expenses Interest expense on convertible debentures Realized losses on foreign exchange forward contracts which matured in the current period Provision for current income taxes Cash available for distribution Three Months Ended December 31, 2015 Unaudited 2014 Unaudited Years Ended December 31, 2015 2014 35,674 31,930 106,656 102,481 (269) (892) (862) (2,535) 31,116 (14,667) 16,449 (2,106) (465) (1,690) (2,778) 9,410 (362) (836) (1,062) 123 29,793 (13,739) 16,054 (1,514) (547) (981) (2,264) 10,748 (1,080) (3,565) (2,780) (2,175) 97,056 (45,706) 51,350 (6,128) (1,930) (6,475) (958) 35,859 (1,381) (4,242) (2,984) 563 94,437 (44,344) 50,093 (5,441) (2,237) (3,034) (1,929) 37,452 Compared to the three months ended December 31, 2014, the cash available for distribution decreased by US$1.3 million or 12.5% primarily due to higher foreign currency losses on foreign exchange forward contracts, corporate expenses and provision for current income taxes. Compared to the year ended December 31, 2014, the cash available for distribution decreased by US$1.6 million or 4.2% primarily due to higher foreign currency losses on foreign exchange forward contracts and corporate expenses, partially offset by stronger cash flows from the Centers and a lower provision for current income taxes. 20 The chart below shows the Corporation’s cash available for distribution, distributions and payout ratios for the last twelve quarters: Cash Available for Distribution C$mill 16.000 14.000 12.000 10.000 8.000 6.000 4.000 2.000 - 120.0% 100.0% 80.0% 60.0% 40.0% 20.0% 0.0% 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 Generated C$ Distributed C$ Payout Ratio 8. SUBSEQUENT EVENT On January 14, 2016, the Corporation, through its wholly-owned U.S.-based subsidiary, Medical Facilities IMD Holdings, Inc. (“MF IMD”), acquired 51% interest in Integrated Medical Delivery, LLC (“IMD”), for a cash purchase price of $1.8 million. IMD is a diversified healthcare service company located in Oklahoma City, Oklahoma that provides third-party business solutions to healthcare entities such as physicians, facilities, and insurance companies. 9. OUTLOOK As noted in the cautionary language concerning forward-looking disclosures in Section 1 of this MD&A under the heading “Caution Concerning Forward-Looking Statements”, this section contains forward- looking statements including with respect to the overall impact of the U.S. and local economies, ongoing changes in the healthcare industry and management strategies of the Corporation. Such statements involve known and unknown risks, uncertainties and other factors outside of management’s control, including the risk factors set forth in Section 17 under the heading “Risk Factors” in this MD&A and the Corporation’s most recently filed annual information form, that could cause results to differ materially from those described or anticipated in the forward-looking statements. The outlook for the Corporation is influenced by many inter-related factors including the economy, the healthcare industry and the management strategies of the Corporation. The Economy Management’s expectations could be impacted by the general state of the U.S. economy. The strength of the local economies of the areas served by the Corporation’s facilities is an important factor in the Corporation’s outlook. Management believes that the current growth of the U.S. economy, and in 21 particular, growth in the service areas of its Centers, if it continues, will reflect positively on the Corporation’s financial performance. Healthcare Industry While impossible to currently quantify, ongoing implementation of the Patient Protection and Affordable Care Act (“PPACA”), demographic changes and growing healthcare costs present numerous challenges and opportunities, including:  the challenge of continuing pressure on reimbursement levels from government-funded plans (Medicare, Medicaid and similar plans) and private insurance companies;  the opportunity arising from reimbursement incentives which reward healthcare entities that meet specified quality and operational goals and operate in the most efficient and low cost manner;  the opportunity for an increase in the number of patients with health insurance which is expected to lead to an increase in surgical cases and a reduction in uncompensated care; and  an increased demand for services provided by the Corporation’s Centers due to the increasing average age and life expectancy of the U.S. population, overall population growth and advances in science and technology. It is still unclear what the final outcome will be for the expansion in Medicaid beneficiaries which was envisioned under the PPACA. South Dakota and Oklahoma have not implemented an expansion of their Medicaid plans. Management Strategies Management intends to continue to capitalize on the unique attributes of its Centers, including a physician-centric focus complemented by physician ownership and an active role in Center management. The Corporation will, in conjunction with its Centers, continue to focus on:  Expanding the complement of physicians practicing at the Centers;  Reviewing and adjusting service lines;  Reviewing and expanding regions serviced;  Achieving benefits of corporate-wide purchasing programs; and  Sharing and implementing best practices and cost reduction strategies. Management of the Corporation believes that implementation of these strategies combined with a strong balance sheet, a proven management track record and continuing search for suitable accretive acquisition opportunities will help sustain the Corporation’s operating performance and ability to continue its cash distribution practices. 22 The Corporation’s dividends, interest on its convertible debentures and certain corporate expenses are paid in Canadian dollars. All of the Corporation’s revenue and the majority of its expenses are domiciled in U.S. dollars. The Corporation does not currently have any outstanding foreign exchange forward contracts in place covering its Canadian dollar requirements. The impact on the Corporation’s cash available for distribution in Canadian dollars and its calculated payout ratios will reflect fluctuations in the exchange rate of the Canadian dollar in relation to U.S. dollar. 10. LIQUIDITY AND CAPITAL RESOURCES As noted in the cautionary language concerning forward-looking disclosures in Section 1 of this MD&A under the heading “Caution Concerning Forward-Looking Statements”, this section contains forward- looking statements including with respect to cash flows and future contractual payments. Such statements involve known and unknown risks, uncertainties and other factors outside of management’s control, including the risk factors set forth in Section 17 under the heading “Risk Factors” in this MD&A and the Corporation’s most recently filed annual information form, that could cause results to differ materially from those described or anticipated in the forward-looking statements. Cash Balances The Corporation’s cash and cash equivalents balances and short-term and long-term investments are as follows: In thousands of U.S. dollars Cash and cash equivalents at Center level Cash and cash equivalents at corporate level Cash and cash equivalents Short-term investments Long-term investments Cash and cash equivalents and short-term and long-term investments December 31, 2015 13,024 44,945 57,969 12,975 - 70,944 December 31, 2014 15,830 25,479 41,309 9,305 3,559 54,173 Cash Flow Activity Cash Flow In thousands of U.S. dollars Cash provided by operating activities Cash generated by (used in) investing activities Cash used in financing activities Increase in cash and cash equivalents Effect of exchange rate fluctuations on cash balances Cash and cash equivalents, beginning of the year Cash and cash equivalents, end of the year Years Ended December 31, 2015 80,240 29,427 (84,393) 25,274 (8,614) 41,309 57,969 2014 88,000 (8,630) (69,660) 9,710 (4,273) 35,872 41,309 $ Change % Change (7,760) 38,057 (14,733) 15,564 (4,341) 5,437 16,660 (8.8%) (441.0%) 21.1% 160.3% 101.6% 15.2% 40.3% The Corporation expects to fund operations with cash derived from operating activities. Deficiencies arising from short-term working capital requirements and capital expenditures may be financed on a short‐term basis with bank indebtedness as all Centers have lines of credit available to them or on a permanent basis with offerings of securities. Negative changes in the general state of the U.S. economy could affect the Corporation’s liquidity by reducing cash generated from operating activities or by limiting access to short‐term financing as a result of tightening credit markets. Included in the balance of 23 cash and cash equivalents as at December 31, 2015 is $21.5 million in proceeds to the Corporation from the sale of DPSC’s assets completed on June 30, 2015. Operating Activities and Working Capital Cash from operating activities in the year ended December 31, 2015 decreased by $7.8 million compared to 2014 primarily due to a $5.9 million increase in income taxes, including withholding taxes, and negative changes in non-cash working capital ($5.4 million), which were partially offset by higher operating income from the Centers. As at December 31, 2015, the Corporation recorded consolidated net working capital of $85.7 million compared to $61.9 million as at December 31, 2014. The level of working capital, including financing required to cover any deficiencies, is dependent on operating performance of the Centers and fluctuates from period to period. The increase in working capital since December 31, 2015 is primarily the result of increased cash balances due to the sale of DPSC’s assets in the second quarter of 2015. As at December 31, 2015, accounts receivable were $48.8 million (December 31, 2014: $47.0 million), accounts payable and accrued liabilities totaled $33.3 million (December 31, 2014 $32.2 million), total assets were $383.0 million (December 31, 2014: $409.7 million) and total long-term liabilities were $58.2 million (December 31, 2014: $71.8 million). Investing Activities The $38.1 million increase in cash from investing activities in the year ended December 31, 2015, compared to 2014 was primarily due to $36.9 million in gross proceeds received from the sale of DPSC’s assets. DPSC distributed $33.3 million of net proceeds from disposal of the assets to its partners, including $21.5 million to the Corporation and $11.8 million to the holders of the non-controlling interest in the Center. Financing Activities Cash used in financing activities in the year ended December 31, 2015 increased by $14.7 million compared to 2014 primarily due to an increase in distributions to non-controlling interest ($13.6 million) of which $11.8 million related to the sale DPSC, discharge of a real estate loan at DPSC ($3.2 million) and an increase in the repurchase of the Corporation’s common shares ($2.6 million), partially offset by lower dividends paid ($4.3 million) primarily attributable to a favourable variance in the Canadian dollar exchange rate. The Centers have credit facilities in place, excluding capital leases, in the aggregate amount of $57.7 million, of which $33.4 million was utilized as at December 31, 2015. The balances available under the credit facilities, combined with cash and cash equivalents as at December 31, 2015, are available to manage the Centers’ accounts payable, supply inventory and other short-term cash requirements. The Center’s access to available financing resources, including those with fixed interest rates, is sufficient to manage its exposure to changes in interest rates on the Centers’ revolving credit facilities, which are on a floating basis. The partnership or operating agreements governing each of the respective Centers do not permit the Corporation to access the assets of the Centers to settle the liabilities of other subsidiaries of the Corporation, and the Centers have no obligation to (and could not, without the approval of the holders of 24 the non-controlling interest) take any steps to settle the liabilities of the Corporation or its other subsidiaries. The Corporation has in place a Cdn$100.0 million line of credit with a Canadian chartered bank which matures on December 31, 2018 (“credit facility”). The credit facility can be used for general corporate purposes, including working capital and capital expenditures, finance of acquisitions, repayment of convertible debentures, and/or repurchase of the Corporation’s common shares. No amount was drawn under the credit facility as of December 31, 2015. The Corporation’s convertible debentures are denominated in Canadian dollars and are reflected in the financial statements in U.S. dollars at fair value at the rate of exchange in effect at the balance sheet date. As at December 31, 2015, the Corporation had Cdn$41.7 million aggregate principal amount of convertible debentures outstanding while the market value of the convertible debentures was $30.6 million. The convertible debentures pay interest semi-annually in arrears on June 30 and December 31 of each year. The convertible debentures mature on December 31, 2019 (“Maturity Date”) and are convertible into 52.3286 common shares per Cdn$1,000 principal amount of convertible debentures, at any time, at the option of the holder, representing a conversion price of Cdn$19.11 per common share (“Conversion Price”). If the holders of the convertible debentures do not exercise the right to convert their holdings into the Corporation’s common shares prior to the Maturity Date, the principal amount is due and payable in full. The convertible debentures are subordinate to all other existing and future senior unsecured indebtedness of the Corporation. The convertible debentures contain a provision whereby, in connection with a change in control transaction, holders of the convertible debentures would be entitled to convert their debentures within a specified time period and would receive, in addition to the number of shares on conversion, additional shares calculated as a function of the change of control offer price and time remaining to maturity. After December 31, 2015 and prior to December 31, 2017, the convertible debentures may be redeemed by the Corporation, in whole or in part from time to time, at a redemption price equal to the principal amount plus accrued and unpaid interest up to but excluding the redemption date, provided that the volume weighted average trading price of the common shares on the Toronto Stock Exchange for the 20 consecutive trading days ending five trading days preceding the date on which notice of redemption is given is at least 125% of the Conversion Price. On or after December 31, 2017 but prior to the Maturity Date, the convertible debentures may be redeemed in whole or in part from time to time at the option of the Corporation, at a redemption price equal to the principal amount plus accrued and unpaid interest up to but excluding the redemption date. In December 2014, the Corporation received regulatory approval for a normal course issuer bid under which the Corporation could purchase up to Cdn$522,325 aggregate principal amount of its outstanding convertible debentures during the period from December 30, 2014 to December 29, 2015. During the three-month period ended December 31, 2015, the Corporation purchased Cdn$12,000 aggregate principal amount of its outstanding convertible debentures for a total consideration of $9. During the twelve-month period ended December 31, 2015, the Corporation purchased Cdn$43,000 aggregate principal amount of its outstanding convertible debentures for a total consideration of $33. 25 Contractual Obligations The mandatory repayments under the credit facilities and other contractual obligations and commitments including expected interest payments, on a non-discounted basis, as of December 31, 2015, are as follows: Future payments (including principal and interest) In thousands of U.S. dollars Interest payable Dividends payable Accounts payable Accrued liabilities Revolving credit facilities Notes payable and term loans Finance lease obligations Convertible debentures Operating leases and other Carrying values at December 31, 2015 2,107 19,035 14,307 849 4,500 28,861 2,067 30,614 Total 2,107 19,035 14,307 849 4,520 31,575 2,158 37,838 commitments (not recorded in the financial statements) Total contractual obligations - 102,340 77,292 189,681 Less than 1 year 1-3 years 4-5 years Thereafter 2,107 19,035 14,307 849 4,520 3,239 984 1,806 7,357 54,204 - - - - - 8,557 978 3,612 12,644 25,791 - - - - - 19,501 196 32,420 9,919 62,036 - - - - - 278 - - 47,372 47,650 The Corporation anticipates renewing, extending, repaying or replacing its credit facilities which fall due over the next twelve months and expects that cash flows from operations and working capital will be adequate to meet future payments on other contractual obligations over the next twelve months. 11. SHARE CAPITAL AND DIVIDENDS As noted in the cautionary language concerning forward-looking disclosures in Section 1 of this MD&A under the heading “Caution Concerning Forward-Looking Statements”, this section contains forward- looking statements including with respect to the Corporation’s expected payment of dividends. Such statements involve known and unknown risks, uncertainties and other factors outside of management’s control, including the risk factors set forth in Section 17 under the heading “Risk Factors” in this MD&A and the Corporation’s most recently filed annual information form, that could cause results to differ materially from those described or anticipated in the forward-looking statements. As at December 31, 2015, the Corporation had 31,113,445 common shares outstanding. In the event that all Cdn$41.7 million aggregate principal amount of convertible debentures outstanding were converted into the common shares of the Corporation prior to their Maturity Date, the total number of additional common shares issuable would be 2,184,353. Normal Course Issuer Bids The Corporation’s current normal course issuer bid for its common shares is in effect from May 15, 2015 to May 14, 2016. During the three-month period ended December 31, 2015, the Corporation purchased 124,900 of its common shares for a total consideration of $1,387. During the twelve-month period ended December 31, 2015, the Corporation purchased 300,600 of its common shares for a total consideration of $3,448. During the three-month period ended December 31, 2014, the Corporation purchased 1,500 of its twelve-month period ended common shares for a total consideration of $21. During the 26 December 31, 2014, the Corporation purchased 55,600 of its common shares for a total consideration of $872. All common shares acquired under the bids were cancelled. Cancellation of common shares purchased in 2015 reduced the annual dividends paid by the Corporation by Cdn$267,200 (at a current rate of Cdn$1.125 per common share). Dividends Dividend declarations are determined based on monthly reviews of the Corporation’s earnings, capital expenditures and related cash flows by a sub-committee of the board of directors. Such declarations take into account that the cash generated in the period is to be distributed to the maximum extent considered prudent after (i) debt service obligations, (ii) other expense and tax obligations, and (iii) reasonable reserves for working capital and capital expenditures. The Corporation maintained a consistent level of monthly distributions since its formation (in aggregate Cdn$1.10 per common share annually) until September 2012, when the monthly distribution was increased to Cdn$0.09375 per common share (or Cdn$1.125 per common share annually). The Corporation expects, subject to its monthly performance reviews as explained above and the judgment of the board of directors, to maintain the current level of dividends on its common shares. Cash distributions declared in the period from January 1, 2015 to December 31, 2015 totaled Cdn$1.125 per common share. Dividend Reinvestment and Share Purchase Plan The Corporation has a Dividend Reinvestment and Share Purchase Plan which allows shareholders resident in Canada to automatically re-invest, in a cost-effective manner, the monthly cash dividends on their common shares into additional common shares of the Corporation. In 2015, 140,901 common shares were purchased with reinvested dividends totaling Cdn$2.3 million on the open market. 12. FINANCIAL INSTRUMENTS Financial instruments held in the normal course of business included in the consolidated balance sheet as at December 31, 2015 consist of cash and cash equivalents, short-term and long-term investments, accounts receivable, other assets, dividends payable, accounts payable, accrued liabilities, borrowings (including long‐term debt and convertible debentures) and exchangeable interest liability. The fair values of convertible debentures and exchangeable interest liability are determined based on the closing trading price of the securities at each reporting period. The fair values of long‐term debt (notes payable and term loans) are not significantly different than their carrying values, as these instruments bear interest at rates comparable to current market rates. The fair values of all other financial instruments of the Corporation, due to the short-term nature of these instruments, approximate their carrying values. Foreign Exchange Risk The Centers derive revenues, incur expenses and make distributions to their owners, including the Corporation, in U.S. dollars. The Corporation pays dividends to common shareholders and interest on its convertible debentures and incurs a portion of its expenses in Canadian dollars. The amounts of distributions from the Centers to their owners, including the Corporation and non-controlling interest, are 27 dependent on the results of the operations and cash flows generated by the Centers in any particular period. Strengthening of the Canadian dollar against the U.S. dollar negatively impacts currency translation differences with respect to the funds available for the Corporation’s Canadian dollar denominated dividends, interest payments, and expenses. A weakening Canadian currency in relation to U.S. currency has the opposite effect. The graph below shows the movement of the monthly average exchange rates between Canadian and U.S. dollars since February 2011: Canadian Dollars per 1 U.S. Dollar $1.45 $1.40 $1.35 $1.30 $1.25 $1.20 $1.15 $1.10 $1.05 $1.00 $0.95 $0.90 The Corporation from time to time may enter into foreign exchange forward contracts depending upon actual or anticipated company performance and currency market conditions. As of December 31, 2015, the Corporation did not hold any foreign exchange forward contracts. Credit Risk The substantial portion of the Corporation’s accounts receivable balance is with governmental payors and health insurance companies which are assessed as having a low risk of default and is consistent with the Centers’ history with these payors. Management reviews reimbursement rates and aging of the accounts receivable to monitor its credit risk exposure. On an ongoing basis, management assesses the circumstances affecting the recoverability of its accounts receivable and adjusts allowances based on changes in those factors. Monthly, actual bad debts for a trailing period are compared with the Corporation’s allowance to support the estimate of recoverability. Considerations related to historical experience are also factored into the valuation of the current period accounts receivable. From time to time, the Corporation may enter into foreign exchange forward contracts and may place excess funds for investment with certain financial institutions. Investment of excess funds is guided by the investment policy of the Corporation that, among other things, (i) prescribes the eligible types of 28 investments and (ii) establishes limits on the amounts that can be invested with any one financial institution. Interest Rate Risk The Corporation and the Centers are exposed to interest rate fluctuations which can impact their borrowing costs. The Corporation’s Centers use floating rate debt facilities for operating lines of credit that fund short-term working capital needs and use fixed rate debt facilities to fund investments and capital expenditures. Price Risk The Corporation’s convertible debentures and exchangeable interest liability are measured on quoted market prices in active markets and, therefore, the Corporation is exposed to variability in net income as prices change. Price risk includes the impact of foreign exchange. The Corporation does not have any hedges against price risk. Liquidity Risk Liquidity risk is the risk that the Corporation, including its Centers, will not be able to meet its financial obligations as they fall due. The Corporation manages liquidity risk through the management of its capital structure and financial leverage. The Corporation also manages liquidity risk by continuously monitoring actual and projected cash flows and by taking into account the receipts and maturity profile of financial assets and liabilities. The board of directors of the Corporation reviews and approves operating and capital budgets, as well as any material transactions out of the ordinary course of business. 13. RELATED PARTY TRANSACTIONS The Centers routinely enter into transactions with certain related parties. These parties are considered related through ownership in them by the holders of non-controlling interest in the respective Centers. Such transactions are in the normal course of operations and are measured at the exchange amount, which is the amount of consideration established and agreed by the related parties. In February 2015, SFSH incorporated a wholly-owned subsidiary which is designed to function as an accountable care organization (“ACO”). The ACO has applied for acceptance and participation in the Medicare Shared Savings Program, which is an incentive program established under the provisions of the PPACA. As one of the initiatives of the ACO, SFSH entered into an agreement with Great Plains Surgical, LLC (“Great Plains”), an entity controlled by certain indirect non-controlling owners of SFSH, for the provision of management services in relation to the orthopedic service line at SFSH to improve the quality of services provided and realize savings on implants and other supplies used in that service line. In addition to the payment of fees for providing management of the orthopedic service line, Great Plains is entitled to receive performance payments for realized cost savings and the attainment of quality levels. 29 The Centers had transactions with the following related parties during the reporting periods: Related Party Nature of Relationships Nature of Transactions In thousands of U.S. dollars Entity BHSH Black Hills Orthopedic and Spine Center (“BHOSC”) Certain indirect non-controlling owners of BHSH are also owners of BHOSC. Neurosurgical & Spinal Surgery Associates (“NSSA”) Certain indirect non-controlling owners of BHSH are also owners of NSSA. Years Ended December 31, 2015 $ 2014 $ 264 239 92 165 4 2 - - 3 3 - 392 182 182 Provision of physical therapy services to BHSH and physician professional fees in relation to South Dakota State Employee Health Plan. Provision of physical therapy and intraoperative monitoring services to BHSH. As of June 30, 2014, intraoperative monitoring services agreement was mutually terminated by BHSH and NSSA. NSSA pays rental income for parking to BHSH. Physician professional fees in relation to South Dakota State Employee Health Plan. Physician professional fees in relation to South Dakota State Employee Health Plan. Provision of dietary and nutrition counselling. Reimbursement by DPSC of salaries and benefits expenses incurred on behalf of DPSC. This arrangement was terminated in February 2014. Provision of certain physician services to DPSC. This arrangement was terminated in February 2014. Provision of anesthesia services to SFSH. Provision of laundry services to SFSH. 246 216 Provision of management services in relation to orthopedic service line at SFSH. Purchase of medical products and inventory from GPSD by SFSH and payment of rental income by GPSD to SFSH. Purchase of medical products from Medical Designs by SFSH. Lease of space for SFSH’s primary care operations. This arrangement was discontinued in August 2014. Provision of lithotripter services to SFSH. Provision of physical and occupational therapy services to SFSH and lease of space for SFSH’s primary care operations. 3,208 - 884 1,379 748 1,080 - 6 182 219 237 269 Rapid City Medical Center Certain indirect non-controlling Dr. Tim and Kim Watt DPSC Orthopedic Center of the Dakotas (“OCD”) owner of BHSH is also owner of Rapid City Medical Center. Indirect non-controlling physician owners. Certain indirect non-controlling owners of DPSC are also owners of OCD. Orthopedic Surgery Specialists (“OSS”) Certain indirect non-controlling owners of DPSC are also owners of OSS. SFSH Center Inn Anesthesiology Associates Certain indirect non-controlling owner of SFSH is also owner of Anesthesiology Associates. Certain indirect non-controlling owners of SFSH are also owners of Center Inn. Certain indirect non-controlling owners of SFSH are also owners of GPS. Certain indirect non-controlling owners of SFSH are also owners of GPSD. Great Plains Surgical Distributorship, LLC (“GPSD”) Great Plains Surgical, LLC (“GPS”) Medical Designs Midwest Medical Care PC (“MMC”) Midwest Urologic Stone Unit LP (“MUSU”) Orthopedic Institute Indirect non-controlling physician owner of SFSH is also owner of Medical Designs. Certain indirect non-controlling owners of SFSH are also owners of MMC. Certain indirect non-controlling owners of SFSH are also owners of MUSU. Certain indirect non-controlling owners of SFSH are also owners of Orthopedic Institute. 30 In thousands of U.S. dollars Entity Related Party Nature of Relationships Nature of Transactions Renovis South Dakota Interventional Pain Institute, LLC (“SDIPI”) Surgical Management Professionals, LLC (“SMP”) and Sioux Falls Surgical Physicians, LLC (“Surgical Physicians”) Various professional medical practices(1) OSH IMD Memorial Property Holdings, LLC (“MPH”) MM Property Holdings, LLC (“MM Property”) Parkway Medical Center, LLC (“PMC”) A.S.H. Land & Development, LLC (“ASH L&D”) A.S.H. Imaging Partners, LLC (“ASH Imaging”) ASH Certain indirect non-controlling owner of SFSH is also an owner of Renovis. Surgical Physicians and the Corporation own equity interest in SDIPI. Surgical Physicians own 49% of SFSH. SMP is owned by certain indirect non-controlling owners of SFSH. Certain indirect non-controlling owners of SFSH are also owners of various professional medical practices. To the end of 2015, certain indirect non-controlling owners of OSH were also owners of IMD. The majority of owners of MPH are also indirect non-controlling owners of OSH. MM Property is owned by two physicians who are indirect non- controlling owners in OSH. MPH owns an equity share of PMC. Certain indirect non-controlling owners of ASH are also owners of ASH L&D. Certain indirect non-controlling owners of ASH are also owners of ASH Imaging. Related party expenses Key management and governance compensation Total Years Ended December 31, 2015 $ 477 2014 $ - 659 767 1,573 1,481 290 377 2,940 3,000 Purchase of implants. Use of a facility and related equipment by SFSH. SFSH pays to and receives reimbursements from SMP for various shared services, such as utilities, computer software, travel, etc. SMP provides billing and coding services to SFSH and management services to DPSC. Physician professional fees in relation to SFSH’s agreement with South Dakota Bureau of Personnel to provide outpatient surgeries under bundled billing arrangements and other bundled cases. Provision of accounting and management services to OSH. Lease of hospital building by OSH. 1,488 1,488 Lease of additional office space by OSH. This lease terminated in first quarter of 2015. Lease of additional office space by OSH. 33 78 130 - Lease of facility building by ASH. 1,110 3,585 Sub-lease of MRI equipment by ASH. 594 594 15,291 2,927 18,218 15,575 2,338 17,913 (1) SFSH has an agreement with South Dakota Bureau of Personnel to provide specified outpatient surgical procedures including the use of facility, anesthesia, radiology, labs, and physician professional fees. SFSH is reimbursed for these outpatient surgeries based on a fixed fee schedule, which includes the facility and physician professional fees. SFSH entered into fee-for-service agreements for the physician professional fee component with various professional medical practices owned by individuals having an indirect non-controlling ownership in SFSH. 14. CRITICAL ACCOUNTING JUDGMENTS AND ESTIMATES The Corporation estimates certain amounts reflected in its consolidated financial statements based on historical experience, current trends and other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from those estimates because of the uncertainties inherent in making assumptions and estimates regarding unknown future outcomes. Note 21 to the consolidated financial statements of the Corporation for the year ended December 31, 2015 details critical accounting judgments and estimates used in the preparation of the Corporation’s financial statements. 31 The accounting estimates discussed below are highlighted because they require difficult, subjective, and complex management judgments. The Corporation believes that each of its assumptions and estimates is appropriate to the circumstances and represents the most likely future outcome. Revenue Revenue is recorded in the period when healthcare services are provided based on actual amounts received and the estimated net realizable amounts due from patients and payors. The amounts due are estimated using established billing rates less adjustments required by contractual arrangements with the payors. Estimates of contractual adjustments are based on the payment terms specified in the related contractual agreements and payment history. Payor contractual payment terms are generally based on predetermined rates per procedure or discounted fee-for-service rates. For payors for which the Centers do not have contracts, the Centers estimate the necessary adjustments based on a twelve-month history of reimbursements on closed cases. If payments from third-party payors were reduced, the revenue and profitability of the Corporation may be adversely affected. Allowance for Non-Collectible Receivable Balances The Corporation maintains an allowance for non-collectible receivable balances for estimated losses resulting from the inability to collect on its accounts receivable. To arrive at allowance for non-collectible receivable balances, management uses estimates that are based on the age of the outstanding accounts receivable and on historical collection and loss experience. Future collections of accounts receivable that differ from current estimates would affect the results of operations in future periods. The allowance for non-collectible receivable balances is subject to change as general economic, industry and customer specific conditions change. Impairment of Non-Financial Assets Non-financial assets that have an indefinite useful life, such as goodwill and trade names, are tested at least annually for impairment and when events or changes in circumstances indicate that the carrying amount may not be recoverable. Non-financial assets that have definite useful life and are subject to amortization are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. The methodology used to test for impairment includes significant judgment, estimates, and assumptions. Impairment exists when the carrying amount of an asset or cash generating unit (“CGU”) exceeds its recoverable amount, which is the higher of an asset’s fair value less cost to dispose and value in use. Value in use is based on the estimated future cash flows, discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. As a result, any impairment losses are a result of management’s best estimates of expected revenues, expenses, cash flows, and discount rates at a specific point in time. These estimates are subject to measurement uncertainty as they are dependent on factors outside of management’s control. In addition, by their nature, impairment tests involve a significant degree of judgment as expectations concerning future cash flows and the selection of appropriate market inputs are subject to considerable risks and uncertainties. Management is required to use judgment in determining the grouping of assets to identify their CGUs for the purposes of testing fixed assets for impairment. Judgment is further required to determine appropriate groupings of CGUs for the level at which goodwill and indefinite life intangible assets are tested for 32 impairment. Each Center represents a separate CGU for the purposes of testing impairment of non- financial assets. In addition, judgment is used to determine whether a triggering event has occurred requiring an impairment test to be completed. Factors considered by management in determining a triggering event include: deterioration in market and economic conditions, volatility in the financial markets causing declines in the Corporation’s share price, increases in the Corporation’s weighted-average cost of capital, changes in valuation multiples, changes to healthcare legislation in the United States both federally and in the jurisdictions in which the Centers operate, changes to the physician complement at the Centers, decreases in expected future reimbursement rates, declining patient referrals, physical conditions of facilities and equipment, and increased costs of inputs, such as drugs, supplies, and labour. When considered significant, management incorporates changes to these factors in its estimated future cash flows to assess the impact on the recoverable value of its non-financial assets. Management calculates the recoverable amount of each CGU using earnings before income taxes, depreciation and amortization (“EBITDA”) specific to each CGU by a multiple determined using market data, such as EBITDA to market capitalization ratios of comparable publicly traded companies and recent prices for capital transactions within the industry. Management has estimated cost to dispose to be 1% of the fair value of the CGUs, based on recent market data. To ensure reasonableness of recoverable amounts, management reconciles the recoverable amounts of its CGUs to the enterprise value of the Corporation as at December 31 based on (i) the market capitalization of the outstanding common shares, taking into account a 20% equity control premium attributable to the common shares, (ii) the fair value of convertible debentures outstanding, and (iii) the Corporation’s portion of the Centers’ long-term debt, less (iv) cash on hand. Management performed its annual impairment tests for goodwill and other intangibles with indefinite lives as at December 31, 2015 and concluded that the recoverable amount of the CGUs exceeded their carrying amount and, therefore, there was no impairment. Taxes Uncertainties exist with respect to the interpretation of complex tax regulations and the amount and timing of deferred taxable income. The Corporation’s income tax assets and liabilities are based on interpretations of income tax legislation across various jurisdictions in Canada and the United States. The Corporation’s effective tax rate can change from year to year based on the mix of income among different jurisdictions, changes in tax laws in these jurisdictions, and changes in the estimated value of deferred tax assets and liabilities. The Corporation’s income tax expense reflects an estimate of the cash taxes the Corporation is expected to pay for the current year and a provision for changes arising in the values of deferred tax assets and liabilities during the year. The carrying value of these assets and liabilities is impacted by factors such as accounting estimates inherent in these balances, management’s expectations about future operating results, and previous tax audits and differing interpretations of tax regulations by the taxable entity and the responsible tax authorities. Such differences in interpretation may arise on a wide variety of issues depending on the conditions prevailing in the respective legal entity’s domicile. On a regular basis, management assesses the likelihood of recovering value from deferred tax assets, such as loss carry forwards, as well as from the depreciation of capital assets, and adjusts the tax provision accordingly. 33 Deferred tax assets are recognized for all unused tax losses to the extent that it is probable that taxable profit will be available against which the losses can be used. Significant management judgment is required to determine the amount of deferred tax assets that can be recognized, based on the likely timing and the level of future taxable profits together with future tax-planning strategies. If management’s estimates or assumptions change from those used in current valuation, management may be required to recognize an adjustment in future periods that would increase or decrease deferred income tax asset or liability and increase or decrease income tax expense. 15. RECENTLY ANNOUNCED ACCOUNTING PRONOUNCEMENTS The following are IFRS changes that have been issued by the International Accounting Standards Board (“IASB”) which may affect the Corporation, but are not yet effective: IFRS 9 Financial Instruments (“IFRS 9”) The IASB has issued the complete IFRS 9 in 2014, replacing the multiple rules in IAS 39 Financial Instruments – Recognition and Measurement. The mandatory effective date of IFRS 9 is for annual periods beginning on or after January 1, 2018 and must be applied retrospectively with some exemptions. The Corporation intends to adopt IFRS 9 for the annual period beginning on January 1, 2018. The extent of the impact of adoption of the standard has not yet been determined. IFRS 15 Revenue from Contracts with Customers (“IFRS 15”) IFRS 15 establishes a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The new standard is effective for annual periods beginning on or after January 1, 2018. Earlier application is permitted. The Corporation intends to adopt IFRS 15 for the annual period beginning on January 1, 2018. The extent of the impact of adoption of the standard has not yet been determined. IFRS 16 Leases (“IFRS 16”) In January 2016, the IASB issued IFRS 16 which provides guidance for leases whereby lessees will recognize a liability for the present value of future lease liabilities and record a corresponding right of use asset on the balance sheet. There are minimal changes to lessor accounting. IFRS 16 is effective for annual periods beginning on or after January 1, 2019. Early adoption is permitted, provided IFRS 15 has been adopted. The Corporation intends to adopt IFRS 16 for the annual period beginning on January 1, 2019. The extent of the impact of adoption of the standard has not yet been determined. 16. DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL REPORTING Management is responsible for the financial information published by the Corporation. In accordance with National Instrument 52-109 Certification of Disclosure in Issuers’ Annual and Interim Filings, the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”) have certified that annual filings fairly present in all material respects the financial condition, results of operations and cash flows and have also certified regarding controls as described below. By their nature, controls, no matter how well conceived or operated, provide reasonable assurance, but not absolute assurance, that the objectives of the control systems will be met. 34 Under the supervision of, and with the participation of the CEO and the CFO, management has designed disclosure controls and procedures (“DC&P”) to provide reasonable assurance that (i) material information relating to the Corporation, including its consolidated subsidiaries, is made known to the CEO and the CFO by others within those entities for the period in which the annual and interim filings of the Corporation are being prepared, and (ii) information required to be disclosed by the Corporation in its annual filings, interim filings or other reports filed or submitted by it under securities legislation is recorded, processed, summarized and reported within the time periods specified in applicable securities legislation. In addition to DC&P, under the supervision of, and with the participation of the CEO and the CFO, management has designed internal controls over financial reporting (“ICFR”) using the 2013 Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) framework to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements for external purposes in accordance with IFRS. Management, including the CEO and the CFO, performed an evaluation of the effectiveness of DC&P as of December 31, 2015, and has concluded that the design and effectiveness of these controls and procedures at December 31, 2015 provide reasonable assurance that material information relating to the Corporation, including its subsidiaries, was made known to the CEO and CFO on a timely basis to ensure adequate disclosure. Management, including the CEO and the CFO, performed an evaluation of the effectiveness of its ICFR as of December 31, 2015 using the COSO framework. Management has concluded that the overall design and effectiveness of these controls at December 31, 2015 provide reasonable assurance of the reliability of financial reporting and the preparation of the consolidated financial statements for external purposes in accordance with IFRS. There have been no changes in the Corporation’s ICFR during the period beginning on October 1, 2015 and ended on December 31, 2015, that have materially affected, or are reasonably likely to materially affect, the Corporation’s ICFR. From time to time, to supplement a small corporate office, the Corporation engages various outside experts and advisors to assist with various accounting, controls and tax issues in the normal course. 17. RISK FACTORS The following information is a summary of risk factors and is qualified in its entirety by reference to, and must be read in conjunction with the detailed information appearing in the Corporation’s most recently filed annual information form available on SEDAR at www.sedar.com. Risks Related to the Business and the Industry of the Corporation The revenue and profitability of the Corporation and its subsidiaries, including the Centers, depend heavily on payments from third-party payors, including government healthcare programs (Medicare and Medicaid) and managed care organizations, which are subject to frequent regulatory changes and cost containment initiatives. Changes in the terms and conditions of, or reimbursement levels under, insurance or healthcare programs, which are typically short-term agreements, could adversely affect the revenue and profitability of the Corporation. The Corporation’s revenue and profitability could be impacted by its 35 ability to obtain and maintain contractual arrangements with insurers and payors active in its service areas and by changes in the terms of such contractual arrangements. The revenue and profitability of the Centers is dependent upon physician relationships. There can be no assurance that physician groups performing procedures at the Centers will maintain successful medical practices, or that one or more key members of a particular physician group will continue practicing with that group or that the members of that group will continue to perform procedures at the Centers at current levels or at all. Healthcare facilities, such as the Centers, are subject to numerous legal, regulatory, professional and private licensing, certification and accreditation requirements. Receipt and renewal of such licenses, certifications and accreditations are often based on inspections, surveys, audits, investigations or other reviews, some of which may require affirmative compliance actions by the Centers that could be burdensome and expensive. There are a number of U.S. federal and state regulatory initiatives, which apply to healthcare providers, and in particular to SSHs, including the Centers. Among the most significant are the federal Anti- Kickback Statute, the federal physician self-referral law (commonly referred to as the Stark Law), the PPACA, the False Claims Act and the federal rules relating to management and protection of patient records and patient confidentiality. The PPACA contains provisions that prohibit the formation or development of any new physician owned hospitals in the United States after a specified date. However, the grandfathering provisions of the law that permit existing physician owned hospitals, such as the Centers, to continue their operations and billings to government payors like Medicare and Medicaid for hospital services, provided they meet certain investment and patient transparency requirements. The law, among other things: (a) prohibits the existing or grandfathered hospitals from expanding the baseline number of overnight beds, operating rooms or procedure rooms from the number of such rooms that the existing hospital had as of the date of enactment of the legislation, unless certain narrowly-drawn growth criteria are met; (b) prohibits increases in the aggregate percentage value of physician ownership or investment in physician owned hospitals, or in entities whose investments include the hospitals; (c) imposes restrictions on the manner of physician investment in physician owned hospitals; and (d) requires disclosure to patients of physician ownership and requires hospitals to obtain a signed patient acknowledgement as to whether the hospital has physicians present 24 hours a day, seven days a week. The full impact of the PPACA on the Corporation is not clear, as the roll-out of the law continues to develop. The Corporation has undertaken an extensive review to ensure that the Centers’ operating agreements and procedures are in compliance with the provisions and limitations of the PPACA. As a consequence of its reviews, all Centers have updated the operating agreements and procedures to conform to the requirements of the PPACA. 36 While the Centers carry general and professional liability insurance against claims arising in the ordinary course of business, the insurance market is dynamic and there can be no assurance that adequate coverage will be available in the future or that any coverage in place will be adequate to cover claims. Any major capital expenditures at the Centers will require additional capital, which may be funded through additional debt or equity financings. These funding sources could result in significant additional interest expense or ownership dilution to current holders of the Corporation’s securities. There is significant competition in the healthcare business. The Centers compete with other healthcare facilities in providing services to physicians and patients, contracting with managed care payors and recruiting qualified staff. The Centers may be vulnerable to economic downturns and may be limited in their ability to withstand such financial pressures. Increased unemployment or other adverse economic conditions may impact the volume of services performed, cause shifts to payors with lower reimbursements (e.g., Medicare) and/or result in higher uncollectible accounts. Maintenance capital expenditures, which are deducted in the calculation of cash available for distribution (please refer to Section 2 under the heading “Non-IFRS Financial Measures” and Section 7 under the heading “Reconciliation of Non-IFRS Financial Measures” above), represent expenditures that are required to maintain the productive capacity of the Centers. Historically, such expenditures have represented on average 1.4% of revenue of the Centers. Management believes that such level of maintenance capital expenditures will continue in the future and, accordingly, will not adversely impact the cash available for distribution generated by the Corporation. Risks Related to the Structure of the Corporation The Corporation is entirely dependent on the operations and assets of the Centers through the indirect ownership of between 51.0% and 65.0% of these Centers. Future dividend payments by the Corporation are not guaranteed and are totally dependent upon the operating results and related cash flows from the Centers and the limitations of applicable laws. The payout by the Centers and the Corporation of a substantial majority of their operating cash flows will make additional capital and operating expenditures dependent on increased cash flows or additional financing in the future. The Corporation’s dividend payments to its shareholders are denominated in Canadian dollars, whereas all of its revenue is denominated in U.S. dollars. To the extent that future dividend payments are not covered by foreign exchange forward contracts, the Corporation is exposed to currency exchange risk. There can be no assurance that the Corporation will be able to repay the principal amount outstanding on its convertible debentures when due. Additionally, the convertible debentures are payable in Canadian dollars and, therefore, the Corporation is exposed (at maturity and/or repayment) to currency exchange risk with respect to the principal amounts of these instruments. Non-competition agreements executed by physician owners of the non-controlling interests in the Centers may not be enforceable, which lack of enforceability could impact the revenue and profitability of the Centers. 37 The Corporation does not have the ability to direct day-to-day governance or management inputs in respect of the Centers, except in certain limited circumstances. The degree to which the Corporation is leveraged on a consolidated basis could have important consequences to the holders of the common shares, including: (a) The Corporation’s and Centers’ ability in the future to obtain additional financing for working capital, capital expenditures, acquisitions or other purposes may be limited. (b) The Corporation or Centers being unable to refinance indebtedness on terms acceptable to the Corporation or at all. (c) A portion of the Corporation’s cash flow (on a consolidated basis) from operations is likely to be dedicated to the payment of the principal of and interest on its indebtedness, thereby reducing funds available for future operations, capital expenditures, acquisitions and/or dividends on its common shares. The Corporation has a credit facility that contains restrictive covenants which limit the discretion of the Corporation or its management with respect to certain matters. Furthermore, the Centers have credit facilities that contain restrictive covenants which may limit the Centers’ abilities to make distributions. Additional common shares may be issued by the Corporation pursuant to exchange agreements with the holders of the non-controlling interests in the Centers, in connection with future financing or acquisitions by the Corporation or in connection with the exercise of the conversion option by the holders of the convertible debentures. The issuance of common shares may dilute an investor’s investment in the Corporation and reduce distributable cash per common share. MFA, MFH and MF IMD are organized under the laws of the State of Delaware. The Centers that are located in South Dakota are formed under the laws of the State of South Dakota. The Center located in Oklahoma is formed under the laws of the State of Oklahoma, the Center located in Arkansas is formed under the laws of the State of Arkansas and the Center located in California is formed under the laws of the State of Delaware. All of the assets of the Centers are located outside of Canada and certain of the directors and officers of the Corporation and its subsidiaries are residents of the United States. As a result, it may be difficult or impossible for investors to effect service within Canada upon the Corporation’s subsidiaries, the Centers, or their directors and officers who are not residents of Canada, or to realize against them in Canada upon judgments of courts of Canada predicated upon the civil liability provisions of applicable Canadian provincial securities laws. The market price of the common shares may be subject to general volatility. Payment of Dividends is not Guaranteed Dividends to shareholders are paid at the discretion of the Corporation’s board of directors and are not guaranteed. The Corporation may alter its dividend level and dividends from the Corporation, if any, will depend on, among other things, the results of operations, cash requirements, financial condition, contractual restrictions, business opportunities, provisions of applicable law, and other factors that the board of directors may deem relevant. The directors may decrease the level of dividends provided for in their existing dividend policies, or discontinue dividends at any time, and without prior notice. 38 Eligibility for Investment There can be no assurance that the common shares will continue to be qualified investments for trusts governed by registered retirement savings plans, registered retirement income funds, deferred profit sharing plans, registered education savings plans, tax-free savings accounts and registered disability savings plans. The Corporation is Subject to Canadian Tax As a Canadian corporation, the Corporation is generally subject to Canadian federal, provincial and other taxes. The Corporation is required to include in computing its taxable income the interest received by the Corporation on the two promissory notes issued by MFA to the Corporation (“MFA Promissory Notes”). Management expects that the Corporation’s existing tax attributes will be available initially to offset this income inclusion such that it will not result in an immediate material increase to the Corporation’s liability for Canadian taxes. However, once the Corporation fully utilizes its existing tax attributes (or if, for any reason, these attributes were not available to the Corporation), the Corporation’s Canadian tax liability would materially increase. Although management intends to explore potential opportunities in the future to preserve the tax efficiency of the Corporation’s structure, no assurances can be given that the Corporation’s Canadian tax liability will not materially increase at that time. There can be no assurance that Canadian federal income tax laws and Canada Revenue Agency’s administrative policies respecting the Canadian federal income tax consequences generally applicable to the Corporation or to a holder of common shares will not be changed in a manner which adversely affects holders of the Corporation’s common shares. The Corporation’s Structure may be Subject to Additional U.S Federal Income Tax Liability MFA is subject to U.S. federal income tax on its income at regular corporate rates (currently 35%, plus state and local taxes). MFA will claim interest deductions with respect to the MFA Promissory Notes in computing its income for U.S. federal income tax purposes. To the extent this interest expense is disallowed or is otherwise not deductible, the U.S. federal income tax liability of MFA will increase, which could materially affect the after-tax cash available to distribute to the Corporation and therefore to holders of common shares. While the Corporation has received advice from an independent third party, based on certain representations by the Corporation and MFA and determinations made by the Corporation’s independent financial advisors, that the MFA Promissory Notes should be treated as debt for U.S. federal income tax purposes, it is possible that the Internal Revenue Service (“IRS”) could successfully challenge that position and assert that the MFA Promissory Notes should be treated as equity rather than debt for U.S. federal income tax purposes. The determination of whether the MFA Promissory Notes are debt or equity for U.S. federal income tax purposes is based on an analysis of the facts and circumstances. There is no clear statutory definition of debt for U.S. federal income tax purposes, and its characterization is governed by principles developed in case law, which analyzes numerous factors that are intended to identify the economic substance of the purported creditor’s interest in the corporation. Furthermore, not all courts have applied this analysis in the same manner, and some courts have placed more emphasis on certain factors than other courts have. Moreover, subsequent changes in fact or subsequent actions or inactions by the Corporation or MFA could impact this analysis or could be used by the IRS to call into question this analysis or the facts as of the date such indebtedness was incurred. A successful challenge of this position would increase the U.S. federal income tax liability of MFA for the applicable open tax years, which would affect the ability of 39 MFA to make interest and principal payments on the MFA Promissory Notes and would reduce the amount of after-tax cash generated by MFA that could otherwise be available to make distributions to the Corporation. In addition, otherwise deductible payments of interest would be re-characterized as non- deductible equity distributions and would be subject to U.S. withholding tax to the extent MFA had current or accumulated earnings and profits. Alternatively, the IRS could argue that the interest on the MFA Promissory Notes exceeds an arm’s length rate, in which case only the portion of the interest expense that does not exceed an arm’s length rate may be deductible and the remainder would be subject to U.S. withholding tax to the extent that MFA had current or accumulated earnings and profits. The Corporation has received advice from independent financial advisors that the interest rates on the MFA Promissory Notes are commercially reasonable in the circumstances. However, the advice received by the Corporation is not binding on the IRS. Furthermore, MFA’s deductions attributable to the interest expense on the MFA Promissory Notes may be limited by the amount by which its net interest expense (the interest paid by MFA on all debt, including the MFA Promissory Notes, less its interest income) exceeds 50% of its adjusted taxable income (generally, U.S. federal taxable income before net interest expense, depreciation, amortization and taxes). Any disallowed interest expense may currently be carried forward to future years. Proposed legislation has been introduced, though not enacted, several times in recent years that would further limit the 50% of adjusted taxable income cap described above to 25% of adjusted taxable income, although recent proposals in the U.S. Federal Fiscal Year Budget for 2015 would only apply the revised rules to certain foreign corporations that were expatriated. Furthermore, other limitations on the deductibility of interest under U.S. federal income tax laws, potentially including limitations applicable to certain high-yield debt obligations, could apply under certain circumstances to defer and/or eliminate all or a portion of the interest deduction that MFA would otherwise be entitled to with respect to interest on such indebtedness. United States Investment Company Act of 1940 While the Corporation believes that through its subsidiaries and affiliates it is actively engaged in operating businesses and does not meet the definition of an investment company for purposes of the United States Investment Company Act of 1940 (the “1940 Act”), depending on the composition and valuation of the Corporation’s assets and the sources of the Corporation’s income from time to time, the Corporation could fall within the technical definition of the term “investment company” in the 1940 Act. Moreover, the determination of whether a company like the Corporation is an investment company involves complex analysis of regulations and facts, and the Corporation has not sought and does not anticipate seeking confirmation from the Securities and Exchange Commission (the “SEC”) that it agrees with the Corporation’s analysis. If the SEC were to disagree with the Corporation’s analysis or the Corporation otherwise were to determine that it is an investment company as defined in the 1940 Act, the Corporation may, among other steps, prudently acquire or sell assets in order to avoid remaining an “investment company” as defined under the 1940 Act. Such acquisitions or sales could be on terms other than those on which it would otherwise acquire or sell such assets or the timing of such transactions could be disadvantageous to the Corporation. If the Corporation were unable to avoid being an investment company and were therefore required to register as such under the 1940 Act, the Corporation would become subject to substantial regulation with respect to its capital structure (including its ability to use leverage), management, operations, transactions with affiliated persons, portfolio composition (including restrictions with respect to diversification), and other matters. 40 Consolidated Financial Statements of MEDICAL FACILITIES CORPORATION December 31, 2015 and 2014 (In U.S. dollars) FINANCIAL STATEMENTS TABLE OF CONTENTS Management’s Responsibility for Financial Reporting ............................................................................ 3 Independent Auditors’ Report .................................................................................................................. 4 Consolidated Balance Sheets ................................................................................................................. 5 Consolidated Statements of Changes in Equity ...................................................................................... 6 Consolidated Statements of Comprehensive Income ............................................................................. 7 Consolidated Statements of Cash Flows................................................................................................. 8 Page NOTES TO THE FINANCIAL STATEMENTS Page 1.  Reporting entity .............................................................................................................................. 9  2.  Statement of compliance ................................................................................................................ 9  3.  Basis of presentation ...................................................................................................................... 9  4.  Discontinued operation ................................................................................................................. 10  5.  Property and equipment ............................................................................................................... 12  6.  Goodwill and other intangibles ..................................................................................................... 13  7.  Long-term debt ............................................................................................................................. 14  8.  Convertible debentures ................................................................................................................ 15  9.  Share capital ................................................................................................................................. 16  10.  Non-controlling interest ................................................................................................................ 19  11.  Net changes in non-cash working capital ..................................................................................... 21  12.  Financial instruments and risk management ................................................................................ 21  13.  Capital .......................................................................................................................................... 29  14.  Employee future benefits .............................................................................................................. 30  15.  Income taxes ................................................................................................................................ 30  16.  Interest expense, net of interest income from continuing operations ........................................... 32  17.  Loss on foreign currency .............................................................................................................. 32  18.  Related party transactions and balances ..................................................................................... 33  19.  Commitments and contingencies ................................................................................................. 35  20.  Significant accounting policies ..................................................................................................... 35  21.  Use of judgments and estimates .................................................................................................. 46  22.  Subsequent event......................................................................................................................... 47  2 Management’s Responsibility for Financial Reporting The accompanying consolidated financial statements of Medical Facilities Corporation (the “Corporation”) are the responsibility of management and have been approved by the Board of Directors of the Corporation. This responsibility includes the selection and consistent application of appropriate accounting principles and methods in addition to making judgments and estimates necessary to prepare the consolidated financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board. The Corporation maintains appropriate systems of internal control, policies and procedures, which provide management with reasonable assurance that assets are safeguarded from loss or unauthorized use and financial records are reliable and form a proper basis for the preparation of the consolidated financial statements. The Board of Directors of the Corporation ensures that management fulfills its responsibilities for financial reporting and internal control through an Audit Committee. The Board of Directors appoints the Audit Committee, all members of which are independent members of the Board of Directors. The Audit Committee meets periodically with management and the Corporation’s auditors to discuss the results of the audit, the adequacy of internal accounting controls and financial reporting matters. On the recommendation of the Audit Committee, the consolidated financial statements are forwarded to the Board of Directors for their approval. “Seymour Temkin” “Michael Salter” Seymour Temkin, CPA, CA, FMCA Interim Chief Executive Officer Michael Salter, CPA, CA Chief Financial Officer Toronto, Canada March 16, 2016 3 KPMG LLP Bay Adelaide Centre 333 Bay Street Suite 4600 Toronto ON M5H 2S5 Canada Telephone Fax Internet (416) 777-8500 (416) 777-8818 www.kpmg.ca Independent Auditors’ Report To the Shareholders of Medical Facilities Corporation: We have audited the accompanying consolidated financial statements of Medical Facilities Corporation, which comprise the consolidated balance sheets as at December 31, 2015 and 2014, the consolidated statements of comprehensive income, changes in equity and cash flows for the years then ended, and notes, comprising a summary of significant accounting policies and other explanatory information. Management’s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of Medical Facilities Corporation as at December 31, 2015 and December 31, 2014 and its consolidated financial performance and its consolidated cash flows for the years then ended in accordance with International Financial Reporting Standards. Chartered Professional Accountants, Licensed Public Accountants March 16, 2016 Toronto, Canada 4 MEDICAL FACILITIES CORPORATION Consolidated Balance Sheets (In thousands of U.S. dollars) ASSETS Current assets Cash and cash equivalents Short-term investments Accounts receivable Supply inventory Prepaid expenses and other Total current assets Non-current assets Long-term investments Deferred income tax assets Property and equipment Goodwill Other intangibles Other assets Total non-current assets TOTAL ASSETS LIABILITIES AND EQUITY Current liabilities Dividends payable Accounts payable Accrued liabilities Income tax payable Foreign exchange forward contracts Current portion of long-term debt Total current liabilities Non-current liabilities Long-term debt Deferred income tax liabilities Convertible debentures Exchangeable interest liability Total non-current liabilities Total liabilities Equity Share capital Deficit Equity attributable to owners of the Corporation Non-controlling interest Total equity Commitments and contingencies TOTAL LIABILITIES AND EQUITY Note 12.5.2 15 5 6.1 6.2 18.2 15 12.1 7 7 15 8 12.2 9.1 10 19 December 31, 2015 $ 2014 $ 57,969 12,975 48,754 6,031 4,160 129,889 - 18,286 61,121 102,714 70,103 839 253,063 382,952 2,107 19,035 14,307 849 - 7,848 44,146 27,580 4,249 30,614 61,681 124,124 168,270 41,309 9,305 46,994 5,841 3,450 106,899 3,559 38,168 66,517 105,189 88,604 773 302,810 409,709 2,532 15,192 17,026 151 3,627 6,438 44,966 33,799 - 38,000 92,864 164,663 209,629 398,166 (232,312) 165,854 48,828 400,467 (252,110) 148,357 51,723 214,682 200,080 382,952 409,709 The accompanying notes are an integral part of these consolidated financial statements. On behalf of the Board: Marilynne Day-Linton Dale Lawr 5 MEDICAL FACILITIES CORPORATION Consolidated Statements of Changes in Equity (In thousands of U.S. dollars) Note Attributable to Owners of the Corporation Non- controlling Interest Total Equity Share Capital $ 400,467 - - - Deficit $ Total $ $ $ (252,110) 47,127 (27,329) - 148,357 47,127 (27,329) - 51,723 45,416 - (48,311) 200,080 92,543 (27,329) (48,311) 1,147 - 1,147 - 1,147 9.3 (3,448) 398,166 - (232,312) (3,448) 165,854 - 48,828 (3,448) 214,682 401,033 - - - (243,594) 23,308 (31,824) - 293 13 - - 157,439 23,308 (31,824) - 293 13 54,716 31,673 - (34,666) 212,155 54,981 (31,824) (34,666) - - 293 13 9.3 (872) 400,467 - (252,110) (872) 148,357 - 51,723 (872) 200,080 2015 Balance at January 1, 2015 Net income for the year Dividends to owners of the Corporation Distributions to non-controlling interest Acquisition of additional interest in Oklahoma Spine Hospital, LLC Purchase of common shares under normal course issuer bids Balance at December 31, 2015 2014 Balance at January 1, 2014 Net income for the year Dividends to owners of the Corporation Distributions to non-controlling interest Acquisition of additional interest in Dakota Plains Surgical Center, LLP Conversion of convertible debentures into common shares Purchase of common shares under normal course issuer bids Balance at December 31, 2014 The accompanying notes are an integral part of these consolidated financial statements. 6 MEDICAL FACILITIES CORPORATION Consolidated Statements of Comprehensive Income (In thousands of U.S. dollars, except per share amounts) Facility service revenue Operating expenses Salaries and benefits Drugs and supplies General and administrative Depreciation of property and equipment Amortization of other intangibles Income from operations Finance costs Decrease in value of convertible debentures Decrease in value of exchangeable interest liability Interest expense on exchangeable interest liability Interest expense, net of interest income Loss on foreign currency Income before income taxes Income tax expense Note 5 6.2 8 12.2 12.2 16 17 Years Ended December 31, 2015 $ 2014 $ 308,778 297,382 80,223 84,810 44,995 8,909 15,149 234,086 77,331 84,537 43,882 9,573 15,372 230,695 74,692 66,687 (7,353) (30,036) 9,172 3,024 4,987 (20,206) (3,253) (12,757) 8,591 3,538 5,091 1,210 94,898 65,477 15 24,719 14,326 Income for the year from continuing operations 70,179 51,151 Discontinued operation Income for the year from discontinued operation, net of tax 4.4 22,364 3,830 Net income for the year Attributable to: Owners of the Corporation Non-controlling interest Earnings per share From continuing and discontinued operations Basic Fully diluted From continuing operations Basic Fully diluted 92,543 54,981 47,127 45,416 92,543 23,308 31,673 54,981 $ 1.51 $ 0.79 $ 0.74 $ 0.56 $ 1.18 $ 0.53 $ 0.68 $ 0.51 10 9.2 9.2 9.2 9.2 The accompanying notes are an integral part of these consolidated financial statements. 7 MEDICAL FACILITIES CORPORATION Consolidated Statements of Cash Flows (In thousands of U.S. dollars) Cash flows from operating activities Net income for the year Adjustments for: Depreciation of property and equipment Amortization of other intangibles Share of equity income in an associate Decrease in value of convertible debentures Decrease in value of exchangeable interest liability Interest expense, net of interest income, including interest expense on exchangeable interest liability Gain on sale of Dakota Plains Surgical Center, LLP’s assets, included in discontinued operation, net of tax Loss on foreign currency Income tax expense Changes in non-cash operating working capital Interest paid Income and withholding taxes paid Net cash provided by operating activities Cash flows from investing activities Purchase of property and equipment, net of disposals Gross proceeds from the sale of Dakota Plains Surgical Center, LLP’s assets included in discontinued operation Investment in Black Hills Surgical Physicians, LLC Net investment in short-term investments Net redemption of long-term investments Net cash generated by (used in) investing activities Cash flows from financing activities Net proceeds from revolving credit facilities at the Centers Repayments of notes payable and obligations under lease arrangements at the Centers Discharge of real estate loan at Dakota Plains Surgical Center, LLP Distributions, return of capital and loan receivable from an associate Distributions to non-controlling interest Dividends paid Purchase of common shares under the terms of normal course issuer bids Purchase of convertible debentures under the terms of normal course issuer bid Net cash used in financing activities Increase in cash and cash equivalents Effect of exchange rate fluctuations on cash balances Cash and cash equivalents, beginning of the year Cash and cash equivalents, end of the year Non-cash transactions: Acquisition of additional interest in Oklahoma Spine Hospital, LLC Acquisition of additional interest in Dakota Plains Surgical Center, LLP Conversion of convertible debentures into common shares Note 5 6.2 18.2 8 12.2 4.3 17 15 11 5 4.1 18.2 7 7 4.1 18.2 10 9.3 8 17 The accompanying notes are an integral part of these consolidated financial statements. 8 Years Ended December 31, 2015 $ 2014 $ 92,543 54,981 9,083 15,460 (135) (7,353) (30,036) 9,980 16,018 (128) (3,253) (12,684) 12,265 12,286 (20,953) 4,987 24,750 100,611 (1,517) 99,094 (12,266) (6,588) 80,240 - 5,091 14,815 97,106 3,840 100,946 (12,278) (668) 88,000 (7,385) (8,297) 36,923 - (2,903) 2,792 29,427 - (341) (240) 248 (8,630) 1,806 2,060 (3,565) (3,157) 69 (48,311) (27,754) (3,448) (33) (84,393) 25,274 (8,614) 41,309 57,969 1,147 - - (4,242) - 117 (34,666) (32,057) (872) - (69,660) 9,710 (4,273) 35,872 41,309 - 293 13 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 1. REPORTING ENTITY Medical Facilities Corporation (the “Corporation”) is a British Columbia corporation. The address of the Corporation’s head office is 45 St. Clair Avenue West, Suite 200, Toronto, Ontario, Canada. The common shares of the Corporation are listed on the Toronto Stock Exchange under the ticker symbol “DR”. The Corporation’s operations are based in the United States. Through its wholly-owned subsidiaries, the Corporation owns controlling interests in six limited liability entities (the “Centers”), five of which own a specialty hospital or an ambulatory surgery center. On June 30, 2015, Dakota Plains Surgical Center, LLP, the Corporation’s 65% owned subsidiary, sold assets related to the operation of its specialty hospital to Avera St. Luke’s (note 4). The Centers, their locations and the Corporation’s ownership interest in each are as follows: Centers Black Hills Surgical Hospital, LLP (“BHSH”) Sioux Falls Specialty Hospital, LLP (“SFSH”) Oklahoma Spine Hospital, LLC (“OSH”) Arkansas Surgical Hospital, L.L.C. (“ASH”) The Surgery Center of Newport Coast, LLC (“SCNC”) 2. STATEMENT OF COMPLIANCE Location Rapid City, South Dakota Sioux Falls, South Dakota Oklahoma City, Oklahoma North Little Rock, Arkansas Newport Beach, California Ownership Interest December 31, 2015 2014 54.2% 51.0% 60.3% 51.0% 51.0% 54.2% 51.0% 58.8% 51.0% 51.0% These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) and Interpretations of the International Financial Reporting Interpretations Committee. The Corporation’s significant accounting policies are presented in note 20 to these consolidated financial statements. These consolidated financial statements were approved by the Corporation’s Board of Directors on March 16, 2016. 3. BASIS OF PRESENTATION These consolidated financial statements include the accounts of the Corporation and all its subsidiaries and have been prepared on the historical cost basis except for certain financial instruments, which are measured at fair value (note 20.14). These consolidated financial statements are presented in United States dollars. 9 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 4. DISCONTINUED OPERATION On June 4, 2015, Dakota Plains Surgical Center, LLP (“DPSC”), the Corporation’s 65% owned subsidiary, entered into an asset purchase agreement to sell its assets related to the operation of its specialty hospital in Aberdeen, South Dakota, to Avera St. Luke’s and to discharge any encumbrances related to the assets sold. The transaction was completed on June 30, 2015. 4.1 Consideration received Gross proceeds from the sale of DPSC’s assets Less discharge of real estate loan Net proceeds from the sale of DPSC’s assets $ 36,923 (3,157) 33,766 Subsequent to June 30, 2015, DPSC distributed $11,776 to the holders of non-controlling interest in DPSC. The remaining amount was retained the Corporation. As at in December 31, 2015, the non-controlling interest in DPSC remains outstanding. the subsidiaries of 4.2 Analysis of DPSC assets disposed Prepaid expenses and other Property and equipment Goodwill Other intangibles Total assets disposed of 4.3 Gain on sale of DPSC’s assets Gross proceeds from the sale of DPSC’s assets Assets disposed of Transaction costs Gain on sale of DPSC’s assets before income taxes Income tax expense Total gain on sale of DPSC’s assets 10 $ 16 3,697 2,475 3,041 9,229 $ 36,923 (9,229) (73) 27,621 (6,668) 20,953 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 4. DISCONTINUED OPERATION (Continued) 4.4 Results of discontinued operation The comparative statement of comprehensive income has been re-presented to show the discontinued operation separately from continuing operations. Facility service revenue Operating expenses Income from operations Finance costs Income before income taxes Income tax expense Gain on sale of DPSC’s assets, net of tax Income for the year from discontinued operation 4.5 Cash flows from discontinued operation Net cash provided by operating activities Net cash generated by (used in) investing activities Net cash used in financing activities Net cash flow for the year Years Ended December 31, 2015 $ 6,213 4,701 1,512 70 1,442 31 20,953 22,364 2014 $ 14,452 9,903 4,549 234 4,315 485 - 3,830 Years Ended December 31, 2015 $ 2014 $ 1,899 36,913 (17,033) 21,779 7,264 (62) (2,610) 4,592 11 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 5. PROPERTY AND EQUIPMENT Cost Balance at January 1, 2014 Additions Reclassifications Disposals Balance at December 31, 2014 Additions Reclassifications Disposals Sale of DPSC’s assets Balance at December 31, 2015 Accumulated Depreciation Balance at January 1, 2014 Charged for the year Disposals Balance at December 31, 2014 Charged for the year Disposals Sale of DPSC’s assets Balance at December 31, 2015 Carrying Amounts At December 31, 2014 At December 31, 2015 Land and Improvements $ Construction in Progress $ Building and Improvements $ Equipment and Furniture $ 5,143 279 - - 5,422 925 - - (394) 5,953 (40) (25) - (65) (26) - - (91) 39 3,378 (856) - 2,561 2,160 (2,602) - - 2,119 - - - - - - - 62,485 971 640 - 64,096 238 1,916 - (4,792) 61,458 (20,267) (4,810) - (25,077) (3,206) - 1,849 (26,434) 49,508 3,672 216 (814) 52,582 4,061 686 (1,930) (3,274) 52,125 (28,668) (5,145) 811 (33,002) (5,851) 1,930 2,914 (34,009) Total $ 117,175 8,300 - (814) 124,661 7,384 - (1,930) (8,460) 121,655 (48,975) (9,980) 811 (58,144) (9,083) 1,930 4,763 (60,534) 5,357 5,862 2,561 2,119 39,019 35,024 19,580 18,116 66,517 61,121 Included in the equipment and furniture for the years 2015 and 2014 is certain equipment under finance lease agreements as follows: Equipment Less accumulated depreciation Total 2015 $ 7,320 (4,336) 2,984 2014 $ 8,909 (4,714) 4,195 12 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 6. GOODWILL AND OTHER INTANGIBLES 6.1 Goodwill carrying The amount (December 31, 2014: $105,189) (see note 4.2). goodwill of as at December 31, 2015 was $102,714 6.2 Other intangibles Cost Balance at January 1, 2014 Balance at December 31, 2014 Sale of DPSC’s assets Balance at December 31, 2015 Accumulated Amortization Balance at January 1, 2014 Amortization charges Balance at December 31, 2014 Amortization charges Sale of DPSC’s assets Balance at December 31, 2015 Carrying Amounts At December 31, 2014 At December 31, 2015 Amortization period (years) 6.3 Impairment Hospital Operating Licenses $ 1,714 1,714 (238) 1,476 (931) (200) (1,131) (199) 238 (1,092) 583 384 5 Medical Charts and Records $ 7,981 7,981 (582) 7,399 (7,198) (200) (7,398) (199) 582 (7,015) 583 384 5-10 Referral Sources $ 206,127 206,127 (10,204) 195,923 (112,897) (15,618) (128,515) (15,062) 7,861 (135,716) 77,612 60,207 10-15 Trade Names $ 9,826 9,826 (698) 9,128 - - - - - - Total $ 225,648 225,648 (11,722) 213,926 (121,026) (16,018) (137,044) (15,460) 8,681 (143,823) 9,826 9,128 88,604 70,103 N/A (indefinite life) The Corporation performed its annual impairment tests for goodwill and other intangibles with indefinite lives as at December 31, 2015 and December 31, 2014 and determined that there was no impairment. The Corporation identified five cash generating units (“CGUs”) for which impairment testing was performed. Management calculated the recoverable amount of each CGU using earnings before income taxes, depreciation and amortization (“EBITDA”) specific to each CGU by a multiple determined using market data, such as EBITDA to market capitalization ratios of comparable publicly traded companies and recent prices for capital transactions within the industry. Management has estimated cost to dispose to be 1% of the fair value of the CGUs, based on recent market data. For the December 31, 2015 impairment test, enterprise value to EBITDA multiples of 10.1 to 11.1 (2014: 9.7 to 10.7) were determined to be appropriate based on the factors specific to each CGU and a comparison to market information available at the time of the test. 13 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 6. GOODWILL AND OTHER INTANGIBLES (Continued) To ensure reasonableness of recoverable amounts, management reconciles the recoverable amounts of its CGUs to the enterprise value of the Corporation as at December 31 based on (i) the market capitalization of the outstanding common shares, taking into account a 20% equity control premium attributable to the common shares, (ii) the fair value of convertible debentures outstanding, and (iii) the Corporation’s portion of the Centers’ long-term debt, less (iv) cash on hand. 7. LONG-TERM DEBT Authorized Balance 2015 Effective Interest Rate 2014 Maturity Balance Effective Interest Rate December 31, Revolving credit facilities BHSH SFSH OSH ASH SCNC Notes payable BHSH DPSC SFSH ASH Capital leases SFSH ASH Less current portion $ 9,000 7,000 6,350 4,000 2,500 $ - - 4,500 - - 28,850 4,500 11,201 11,201 - 16,330 1,330 28,861 - - - 16,330 1,330 28,861 1,528 539 2,067 35,428 (7,848) 27,580 % 2.8 1.4 3.0 3.3 3.5 3.0 - 2.9 4.3 2016 – 2017 2019 2016 2016 2016 2018 – 2020 - 2016 – 2019 2021 2.3 5.7 2016 – 2019 2018 – 2020 % 3.0 1.9 2.7 3.0 3.5 3.5 4.5 2.9 - 2.7 5.6 $ - - 4,400 1,000 - 5,400 12,086 3,116 16,497 - 31,699 2,464 674 3,138 40,237 (6,438) 33,799 Each credit facility and note payable is secured by an interest in all property and a mortgage on real property owned by the respective Center. These credit facilities and notes payable contain certain restrictive financial and non-financial covenants. As at December 31, 2015, the Centers were in compliance with their covenants. 14 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 7. LONG-TERM DEBT (Continued) The following are the future maturities of long-term debt, including capital leases, for the years ending December 31: 2016 2017 2018 2019 2020 2021 Future maturities of long-term debt 8. CONVERTIBLE DEBENTURES $ 7,848 2,702 5,401 18,580 629 268 35,428 issued, the Corporation On December 21, 2012, in a public offering, Cdn$41,800 (US$42,042) aggregate principal amount of 5.9% convertible unsecured subordinated debentures (“convertible debentures”). The convertible debentures pay interest semi-annually in arrears on June 30 and December 31 of each year, mature on December 31, 2019 (“Maturity Date”), and are convertible into 52.3286 common shares per Cdn$1,000 principal amount of convertible debentures at the option of the holder, representing a conversion price of Cdn$19.11 per common share (“Conversion Price”). If the holders of the convertible debentures do not exercise the right to convert their holdings into the Corporation’s common shares prior to the Maturity Date, the principal amount is due and payable in full. The convertible debentures are subordinate to all other existing and future senior unsecured indebtedness of the Corporation. The convertible debentures contain a provision whereby, in connection with a change of control transaction, holders of the convertible debentures would be entitled to convert their debentures within a specified time period and would receive, in addition to the number of shares on conversion, additional shares calculated as a function of the change of control offer price and time remaining to maturity. After December 31, 2015 and prior to December 31, 2017, the convertible debentures may be redeemed by the Corporation, in whole or in part from time to time, at a redemption price equal to the principal amount plus accrued and unpaid interest up to but excluding the redemption date, provided that the volume weighted average trading price of the common shares on the Toronto Stock Exchange for the 20 consecutive trading days ending five trading days preceding the date on which notice of redemption is given is at least 125% of the Conversion Price. On or after December 31, 2017, but prior to the Maturity Date, the convertible debentures may be redeemed in whole or in part from time to time at the option of the Corporation, at a redemption price equal to the principal amount plus accrued and unpaid interest up to but excluding the redemption date. 15 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 8. CONVERTIBLE DEBENTURES (Continued) The Corporation’s normal course issuer bid for its convertible debentures was in effect from December 30, 2014 to December 29, 2015. In 2015, the Corporation purchased Cdn$43,000 aggregate principal amount of its outstanding convertible debentures for a total consideration of $33. The Corporation did not purchase any of its convertible debentures under the normal course issuer bid which terminated on December 29, 2014. The following table represents changes in the convertible debentures for the years 2015 and 2014: Balance at January 1, 2014 Conversion of convertible debentures into common shares Decrease in fair value of convertible debentures at market price Balance at December 31, 2014 Convertible debentures purchased under the terms of normal course issuer bid Decrease in fair value of convertible debentures at market price Balance at December 31, 2015 9. SHARE CAPITAL 9.1 Share capital $ 41,266 (13) (3,253) 38,000 (33) (7,353) 30,614 The following table represents changes in the number and value of common shares issued and outstanding for the years 2015 and 2014: Balance at January 1, 2014 Common shares issued for acquisition of additional interest in DPSC Common shares issued on exchange of convertible debentures Common shares purchased and cancelled under the terms of normal course issuer bids (note 9.3) Balance at December 31, 2014 Common shares issued for acquisition of additional interest in OSH Common shares purchased and cancelled under the terms of normal course issuer bids (note 9.3) Balance at December 31, 2015 Number of Common Shares 31,366,750 17,716 732 (55,600) 31,329,598 84,447 (300,600) 31,113,445 $ 401,033 293 13 (872) 400,467 1,147 (3,448) 398,166 16 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 9. SHARE CAPITAL (Continued) 9.2 Earnings per share Basic earnings per share attributable to owners of the Corporation are calculated as follows: Year Ended December 31, 2015 Year Ended December 31, 2014 Continuing Operations Discontinued Operation Total Continuing Operations Discontinued Operation Total $ 37,018 10,109 47,127 21,245 2,063 23,308 31,287,313 31,287,313 31,287,313 31,344,891 31,344,891 31,344,891 Net income for the year attributable to owners of the Corporation Divided by weighted average number of common shares outstanding for the period Basic earnings per share attributable to owners of the Corporation $ 1.18 0.32 1.51 0.68 0.07 0.74 17 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 9. SHARE CAPITAL (Continued) Fully diluted earnings per share attributable to owners of the Corporation are calculated as follows: Year Ended December 31, 2015 Year Ended December 31, 2014 Continuing Operations Discontinued Operation Total Continuing Operations Discontinued Operation Total $ 37,018 10,109 47,127 21,245 2,063 23,308 (7,353) 1,419 (19,223) 9,172 - - - - (7,353) (3,253) 1,419 1,644 - - (3,253) 1,644 (19,223) (8,164) 45 (8,119) 9,172 8,591 19 8,610 $ 21,033 10,109 31,142 20,063 2,127 22,190 Net income for the year attributable to owners of the Corporation Decrease in value of convertible debentures Interest expense on convertible debentures (tax effected) Decrease in value of exchangeable interest liability (tax effected) Interest expense on exchangeable interest liability Modified net income for the year attributable to owners of the Corporation Divided by weighted average number of common shares: Outstanding for the period 31,287,313 - 31,287,313 31,344,891 - 31,344,891 Deemed to be issued on the conversion of the outstanding convertible debentures Deemed to be issued on the exchange of the outstanding exchangeable interest liability Weighted average number of common shares Fully diluted earnings per 2,185,478 - 2,185,478 2,186,969 - 2,186,969 5,892,069 39,364,860 - - 5,892,069 6,047,980 15,404 6,063,384 39,364,860 39,579,840 15,404 39,595,244 share $ 0.53 0.79 0.51 0.56 9.3 Normal course issuer bids Pursuant to the terms of the Corporation’s normal course issuer bids, in 2014, the Corporation purchased 55,600 of its common shares for a total consideration of $872 (note 9.1). In 2015, the Corporation purchased 300,600 of its common shares for a total consideration of $3,448 (note 9.1). The purchases under the bids are recorded in share capital. All common shares acquired under these bids were cancelled. 18 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 10. NON-CONTROLLING INTEREST The following tables summarize financial information in respect of the non-controlling interest of each Center. The summarized intra-group eliminations. information below represents amounts before financial December 31, 2015 Non-controlling interest percentage Current assets Non-current assets Current liabilities Non-current liabilities Equity attributable to owners of the Corporation Non-controlling interest Facility service revenue Operating expenses Net income attributable to owners of the Corporation Net income attributable to non-controlling interest Net income BHSH $ SFSH $ 35% 35% 14,130 24,349 11,823 9,983 10,837 5,836 78,749 53,662 16,058 8,647 24,705 24,505 24,120 13,915 16,089 12,104 6,517 95,773 57,035 24,834 13,372 38,206 OSH $ 35% 16,737 4,138 10,497 343 6,523 3,512 63,363 50,941 8,001 4,308 12,309 ASH $ 44% 11,962 6,871 9,360 1,572 4,425 3,477 63,061 45,055 10,093 7,930 18,023 SCNC $ 49% 3,337 997 296 - 2,059 1,979 7,832 6,174 846 812 1,658 Distributions to non-controlling interest 8,551 12,845 4,575 7,582 841 Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities(1) Net cash inflow (outflow) 27,380 (3,993) (25,316) (1,929) 38,390 (1,342) (37,802) (754) 12,651 (823) (12,720) (892) 18,854 (907) (16,134) 1,813 2,457 (1,717) (219) 521 (1) Cash flows from financing activities include distributions paid to the Corporation and non-controlling interest. 19 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 10. NON-CONTROLLING INTEREST (Continued) December 31, 2014 BHSH $ DPSC $ SFSH $ Non-controlling interest percentage 35% 35% 35% Current assets Non-current assets Current liabilities Non-current liabilities Equity attributable to owners of the Corporation Non-controlling interest Facility service revenue Operating expenses Net income attributable to owners of the Corporation Net income attributable to non-controlling interest Net income 15,457 23,203 13,096 8,868 10,852 5,844 76,687 53,577 14,652 7,889 22,541 4,930 3,860 1,954 2,981 2,506 1,349 14,452 9,258 3,282 1,767 5,049 21,891 25,362 13,001 17,036 11,190 6,025 88,118 51,988 23,043 12,408 35,451 OSH $ 35% 16,783 4,884 6,379 4,743 6,854 3,691 63,913 52,244 7,474 4,025 11,499 ASH $ 44% 9,059 7,501 7,571 2,781 3,477 2,732 60,450 46,061 8,161 6,412 14,573 SCNC $ 49% 3,376 1,004 283 - 2,089 2,008 8,214 6,043 1,107 1,064 2,171 Distributions to non- controlling interest 7,735 2,462 11,823 4,553 6,975 1,120 Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities(1) Net cash inflow (outflow) 25,602 (1,926) (22,776) 900 6,529 (62) (7,137) (670) 38,529 (2,742) (34,282) 1,505 14,211 (332) (14,243) (364) 17,406 (2,728) (14,275) 403 2,580 (34) (2,285) 261 (1) Cash flows from financing activities include distributions paid to the Corporation and non-controlling interest. 10.1 Significant restrictions The partnership or operating agreements governing each of the respective Centers (each, a “Partnership Agreement”) do not permit the Corporation to access the assets of the Centers to settle the liabilities of other subsidiaries of the Corporation, and the Centers have no obligation to (and could not, without the approval of the holders of the non-controlling interest) take any steps to settle the liabilities of the Corporation or its other subsidiaries. The Corporation’s rights in respect of each Center are limited to representation on the management committee and approval rights over certain fundamental decisions. The Partnership Agreements require that each Center distribute its available cash to the maximum extent possible, subject to applicable law and compliance with their existing credit facilities, by way of monthly distributions on its partnership interests or other distributions on its securities, after (i) satisfying its debt service obligations under its credit facilities or any other agreements with third parties, (ii) satisfying its other expense obligations, including withholding and other applicable taxes, and (iii) retaining reasonable working capital or other reserves, including amounts on account of capital expenditures and such other amounts as may be considered appropriate by its management committee. 20 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 11. NET CHANGES IN NON-CASH WORKING CAPITAL The following table summarize net changes in non-cash working capital for the years 2015 and 2014: Accounts receivable Supply inventory Prepaid expenses and other Accounts payable Accrued liabilities Total net changes in non-cash working capital 12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT 12.1 Foreign exchange forward contracts 2015 $ (1,362) (588) (726) 3,843 (2,684) (1,517) 2014 $ 3,338 (314) 596 227 (7) 3,840 At December 31, 2015, the Corporation did not hold any foreign exchange forward contracts. As of December 31, 2014, the fair value of the then outstanding contracts was a liability of $3,627. 12.2 Exchangeable interest liability Concurrent with the acquisition of its interests in the Centers located in Arkansas, Oklahoma and South Dakota, the Corporation entered into exchange agreements with the vendors who originally retained a 49% non-controlling interest in these Centers. Pursuant to the terms of these exchange agreements, the non-controlling interest holders in each of the Centers received the right to exchange a portion of their interest (“Exchangeable Interest”) in their respective Centers for common shares of the Corporation. Such exchanges may only take place quarterly and are based on the exchange formulae stipulated in the exchange agreements and are subject to certain limitations, including a limitation of exchanging not more than three percent per quarter. The number of common shares issuable under the Exchangeable Interest is determined by application of a formula which takes into account the number of partnership units being tendered for exchange and an exchange ratio based upon the distributions from the Centers over the prior twelve months. The exchange agreements between the Corporation and the non-controlling interest holders in each of the Centers contain the details of the exchange rights. 21 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (Continued) The Corporation accounts for the Exchangeable Interest as a financial liability. Under this method, the Exchangeable Interest is reflected in the financial statements as follows: (i) (ii) (iii) (iv) (v) The exchange right is considered to have been fully exchanged at the original dates of acquisition of each of the five Centers in which Exchangeable Interest is held, resulting in the purchase of a further 14% interest in each such Center, except for ASH where 5% can be purchased, for an amount (the “imputed purchase price”) proportionate to the price paid for the original 51% interest in such Centers. The imputed purchase price was allocated to the fair value of the assets acquired, including goodwill and other intangibles, consistent with the acquisition of the initial 51% interest. The corresponding amount of the imputed purchase price relating to the 14% interest (5% in the case of ASH) is reflected as exchangeable interest liability. The exchangeable interest liability is carried at fair value, as determined at each reporting date by applying the closing common share price on the last trading day of the period, converted into U.S. dollars at the closing exchange rate, to the total number of common shares issuable under the outstanding Exchangeable Interest. Changes in the fair value of the exchangeable interest liability, including their effect on the deferred tax position, are included in net income. Amortization of other intangibles and fair market value of property and equipment in excess of underlying book values are consistent with the amortization of the assets that arose on acquisition of the initial 51% interest in each Center. The distributions made by each Center, that relate to the ownership interest therein that is the subject of the outstanding Exchangeable Interest, are treated as interest expense in the Corporation’s consolidated statement of comprehensive income. The calculation of fully diluted earnings per share involves certain modifications, if applicable, to net income as reported and the number of issued and outstanding common shares as set out in note 9.2. The number of common shares to be potentially issued for the exchangeable interest liability and the fair value of the exchangeable interest liability as at December 31, 2015 and December 31, 2014 are as follows: Number of common shares to be potentially issued for exchangeable interest liability Fair value of the exchangeable interest liability thousands of U.S. dollars Fair value of the exchangeable interest liability in thousands of Canadian dollars December 31, 2014 2015 5,851,799 5,932,340 US$ 61,681 US$ 92,864 Cdn$ 85,367 Cdn$ 107,732 22 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (Continued) 12.3 Fair values and classification of financial instruments The Corporation obtained the fair value of foreign exchange forward contracts from the counterparties to such contracts. The fair values of the convertible debentures and exchangeable interest liability are determined based on the closing trading price of the securities at each reporting period. The fair values of notes payable and revolving credit facilities at the Centers’ level approximate their book values as the interest rates are similar to prevailing market rates. The fair values of all other financial instruments of the Corporation, due to the short-term nature of these instruments, approximate their book values. The following table presents the carrying values and classification of the Corporation’s financial instruments as at December 31, 2015 and December 31, 2014: Financial assets Fair value through profit or loss Cash and cash equivalents Short-term investments Held-to-maturity (carried at amortized cost) Short-term investments Long-term investments Loans and receivable (carried at amortized cost) Accounts receivable Other assets Financial liabilities Fair value through profit or loss Foreign exchange forward contracts Convertible debentures Exchangeable interest liability Other liabilities (carried at amortized cost) Dividends payable Accounts payable Accrued liabilities Long-term debt December 31, 2015 $ 57,969 3,496 9,479 - 48,754 839 - 30,614 61,681 2,107 19,035 14,307 35,428 2014 $ 41,309 - 9,305 3,559 46,994 773 3,627 38,000 92,864 2,532 15,192 17,026 40,237 23 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (Continued) The financial instruments of the Corporation that are recorded at fair value have been classified into levels using a fair value hierarchy (note 20.16). The following tables represent the fair value hierarchy of the Corporation’s financial instruments that were recognized at fair value as of December 31, 2015 and December 31, 2014. It does not include fair value information for financial instruments not measured at fair value if the carrying amount is a reasonable approximation of fair value. Financial assets Cash and cash equivalents Short-term investments Financial liabilities Convertible debentures Exchangeable interest liability Total Financial assets Cash and cash equivalents Financial liabilities Foreign exchange forward contracts Convertible debentures Exchangeable interest liability Total 12.4 Measurement of fair values Level 1 $ 57,969 3,496 30,614 - 92,079 Level 1 $ December 31, 2015 Level 2 $ Level 3 $ - - - 61,681 61,681 - - - - - December 31, 2014 Level 2 $ Level 3 $ 41,309 - - 38,000 - 79,309 3,627 - 92,864 96,491 - - - - - Total $ 57,969 3,496 30,614 61,681 153,760 Total $ 41,309 3,627 38,000 92,864 175,800 The following are the valuation techniques used in measuring Level 2 fair values (the Corporation does not have any Level 3 fair values). Financial Instrument Foreign exchange forward contracts Market comparison technique: The fair values are obtained from the counterparties to such contracts. Similar contracts are traded in an active market and the quotes reflect the actual transactions in similar instruments. Valuation Technique Exchangeable interest liability Market comparison technique: The number of the Corporation’s common shares to issue is based on the contractual agreements with the holders of non-controlling interest that have exchange agreements with the Corporation and take into account the distributions to the non-controlling interest over the prior twelve months. The liability is valued based on the market price of the Corporation’s common shares converted to the reporting currency as of the reporting date. 24 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (Continued) 12.5 Financial risk management In the normal course of its operations, the Corporation faces a number of risks that might have an impact on results of its operations and values of the financial instruments presented in the financial statements. Financial risks are outlined below as well as policies and procedures established by the Corporation for monitoring and controlling these risks. 12.5.1 Foreign Exchange Risk Dividends to common shareholders of the Corporation, exchangeable interest liability, interest on convertible debentures and a portion of the Corporation’s expenses are settled in Canadian dollars while all of its revenues are in U.S. dollars. To mitigate this risk, from time to time, the Corporation may enter into foreign exchange forward contracts to economically hedge its exposure to the fluctuation of the exchange rate between U.S. and Canadian dollars. The Corporation has foreign exchange hedging policies in place and the execution of these policies is monitored by a designated sub-committee of the Board of Directors. As at December 31, 2015, no foreign exchange contracts existed. The values of Canadian dollar cash and cash equivalents, investments, foreign exchange forward contracts, interest paid and received, convertible debentures and exchangeable interest liability, as reported in the Corporation’s financial statements, are dependent on the movement of the exchange rate between U.S. and Canadian dollars. A 1% change in the value of the Canadian dollar against the U.S. dollar would have had the following impact on net income for the years reported: Exchange rate change 1% strengthening of the Canadian dollar 1% weakening of the Canadian dollar 12.5.2 Credit Risk The Corporation faces the following credit risks. Revenue and Accounts Receivable 2015 $ 161 (161) 2014 $ (59) 59 The Centers receive payment for services rendered from U.S. federal and state agencies, private insurance carriers, employers, managed care programs and individual patients. As such, the Corporation’s accounts receivable principally fall into five categories: (i) governmental payors, (ii) health and workers’ compensation insurance companies, 25 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (Continued) (iii) recoveries from other responsible third parties such as automobile and general liability insurance, (iv) recoveries for revision surgery from manufacturers of surgical devices subsequently found ineffective or defective, and (v) co-pay and deductibles due from patients. Revenue and accounts receivable from health insurance companies are further segregated between those that are independent members of the Blue Cross and Blue Shield System, workers’ compensation lines and all others. Services to the beneficiaries of Medicare and Medicaid and other governmental insurance programs as well as independent members of the Blue Cross and Blue Shield System are reimbursed primarily based on the established amounts, service codes and fees schedules subject to certain limitations. Reimbursements from other private insurance companies are based on the discounts from the rate established at the Centers in accordance with the contracts with such companies (see note 20.20). The majority of the Corporation’s accounts receivable balance is from governmental payors and health insurance companies. Health insurance companies are regulated by State Insurance Departments in the U.S. and are assessed as having a low risk of default, consistent with the Centers’ history with these payors. The table below summarizes the percentages of facility service revenue generated from and accounts receivable balances with each primary third-party payor group in 2015 and 2014: Medicare and Medicaid – category (i) Blue Cross and Blue Shield – category (ii) Workers’ compensation – category (ii) Other private insurance – category (iii) Other insurance and self-pay – categories (iv) and (v) 2015 2014 Facility Service Revenue by Payor % Accounts Receivable at December 31 by Payor % Facility Service Revenue by Payor % Accounts Receivable at December 31 by Payor % 27.5 32.5 10.4 18.7 10.9 100.0 13.2 28.3 14.6 22.5 21.4 26.5 31.1 12.2 19.9 10.3 100.0 100.0 11.4 26.0 13.8 27.4 21.4 100.0 Recoverability of amounts due in respect of categories (iii) and (iv) above often involves insurance litigation and is difficult to determine, in which case the full amounts due may be reserved. A very small portion of the facility service revenue is received directly from patients (including those with no insurance and those paying deductibles or co-payments). Recoverability of amounts receivable directly from patients is assessed based on historical experience and amounts considered impaired are provided for in the allowance for non-collectible receivable. 26 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (Continued) Management reviews reimbursement rates and aging of the accounts receivable to monitor its credit risk exposure. On an ongoing basis, management assesses the circumstances affecting the recoverability of its accounts receivable and adjusts allowances based on changes in those factors. Monthly, actual bad debts for a trailing period are compared with the Corporation’s allowance to support the accuracy of the estimate of recoverability. Considerations related to historical experience are also factored into the valuation of the current period accounts receivable. The table below summarizes the aging of the Corporation’s accounts receivable and related allowance for non-collectible receivable balances as at December 31, 2015 and December 31, 2014: Accounts receivable Neither past due nor impaired Past due 61-90 days Past due 91-120 days Past due 121-150 days Past due more than 151 days Allowance for non-collectible receivable balances Net accounts receivable December 31, 2015 $ 48,754 39,888 4,364 2,275 2,435 7,526 (7,734) 48,754 2014 $ 46,994 38,384 4,129 2,615 1,804 8,350 (8,288) 46,994 A significant portion of the accounts receivable older than 151 days relates to auto insurance cases that have historically favourable reimbursement rates but may be subject to variations in the timing of collections and may involve insurance litigation. Management believes that the unimpaired amounts that are past due by more than 60 days are still collectible, in full, based on the historical payment behaviour and extensive analysis of customer credit risk, including underlying customers’ credit ratings, if they are available. Concentration of Financial Institutions From time to time, the Corporation enters into foreign exchange forward contracts and places excess funds for investment with certain financial institutions. Historically, the counterparties to the foreign exchange forward contracts were banking institutions and the Corporation considered their risk of default on the contracts to be minimal. Investment of excess funds is guided by the investment policy of the Corporation that, among other things, (i) prescribes the eligible types of investments and (ii) establishes limits on the amounts that can be invested with any one financial institution. 27 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (Continued) 12.5.3 Interest Rate Risk The Corporation and the individual Centers enter into certain long-term credit facilities that expose them to the risk of interest rate fluctuations. The Corporation uses floating rate debt facilities for operating lines of credit that fund short-term working capital needs and uses fixed rate debt facilities to fund investments and capital expenditures. The interest rate profile of the Corporation’s interest-bearing financial liabilities as at December 31, 2015 and December 31, 2014 was: Facilities with fixed interest rates Facilities with variable interest rates Total December 31, 2015 $ 61,542 4,500 66,042 2014 $ 73,837 4,400 78,237 A change of 100 basis points in the interest rates in the reporting period would have led to an increase or a decrease in interest expense of $13 (2014: $12) on facilities with variable interest rates. This does not include the impact of the adjustment of fair value of the convertible debentures since these are fixed- rate instruments. 12.5.4 Price Risk The Corporation’s convertible debentures and exchangeable interest liability are measured on quoted market prices in active markets and, therefore, the Corporation is exposed to variability in net income as prices change. Price risk includes the impact of foreign exchange because common shares are quoted in Canadian dollars. 28 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (Continued) 12.5.5 Liquidity Risk The mandatory repayments under the credit facilities, notes payable, and other contractual obligations interest payments, on a non-discounted basis, as of and commitments December 31, 2015, are as follows: including expected Contractual Obligations Dividends payable Accounts payable Accrued liabilities Income tax payable Revolving credit facilities Notes payable and term loans Finance lease obligation Convertible debentures Operating leases and other commitments (not recorded in the financial statements) Total contractual obligations Carrying values at Dec 31, 2015 $ 2,107 19,035 14,307 849 4,500 28,861 2,067 30,614 Future payments (including principal and interest) Total $ 2,107 19,035 14,307 849 4,520 31,575 2,158 37,838 Less than 1 year $ 1-3 years $ 4-5 years $ After 5 years $ 2,107 19,035 14,307 849 4,520 3,239 984 1,806 - - - - - 8,557 978 3,612 - - - - - 19,501 196 32,420 - - - - - 278 - - - 102,340 77,292 189,681 7,357 54,204 12,644 25,791 9,919 62,036 47,372 47,650 The Corporation’s Cdn$100.0 million credit facility, which matures on December 31, 2018, was undrawn as at December 31, 2015. The Corporation anticipates renewing, extending or replacing its revolving credit facilities which fall due during 2016 and expects that cash flows from operations and working capital will be adequate to meet future payments on other contractual obligations during 2016. 13. CAPITAL The Corporation’s objective when managing capital is to (i) safeguard the Corporation's ability to continue as a going concern and make acquisitions, (ii) ensure sufficient liquidity to fund current operations and its growth strategy, and (iii) maximize the return to common shareholders. The capital of the Corporation is defined to include common shares (note 9.1), convertible debentures (note 8) and other debt facilities at the corporate level. The Corporation manages its liquidity and capital structure by monitoring its cash and cash equivalents, short-term and long-term investments, its current indebtedness and future financing and funding needs. 29 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 13. CAPITAL (Continued) In addition, the Corporation regularly monitors current and forecasted debt levels and key ratios to ensure compliance with debt covenants. As of the reporting date, the Corporation is in compliance with the covenants. The Corporation’s long-term debt and revolving lines of credit require the maintenance of various financial ratios. Under the terms of the line of credit, the Corporation must meet two pro forma financial ratios at the time of incurring new debt. In order to maintain or adjust the capital structure, the Corporation may enter into or repay credit facilities, adjust the amount of dividends paid to common shareholders, repurchase its publicly traded securities or twelve-month period ended December 31, 2015, the Corporation has returned capital to shareholders through the repurchase and cancellation of 300,600 common shares under the normal course issuer bids (note 9.3). issue new shares or convertible debt. During the 14. EMPLOYEE FUTURE BENEFITS Benefits programs at the Centers include qualified 401(k) retirement plans which cover all employees who meet eligibility requirements. Each participating Center makes matching contributions subject to certain limits. In 2015, contributions made by the five (2014: six) Centers to such plans were $1,476 (2014: $1,754). 15. INCOME TAXES The U.S. tax return for the Corporation is prepared on a consolidated basis for U.S. entities and includes balances and amounts attributable to these entities. The Canadian income tax return for the Corporation is prepared on a stand-alone basis and includes non-consolidated balances attributable to the Canadian entity only. Income taxes from continuing operations reported in these consolidated financial statements are as follows: Provision for Income Taxes Current Deferred Total income tax expense from continuing operations 2015 $ 1,015 23,704 24,719 2014 $ 1,637 12,689 14,326 The Corporation pays tax instalments on its estimated U.S. income taxes. The Corporation’s income tax provision is reduced by the instalments for the current income taxes as follows: Income Tax Income tax instalments deposited Provision for current income taxes Income tax payable 2015 $ 6,438 (7,287) (849) 2014 $ 1,778 (1,929) (151) 30 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 15. INCOME TAXES (Continued) The following table reconciles income taxes, calculated at the U.S. combined federal and state tax rate and the Canadian combined federal and provincial income tax rate, to the income tax expense reported in the consolidated statement of comprehensive income: Net income for the year from continuing operations attributable to the owners of the Corporation Income tax expense from continuing operations Income before income taxes Income taxes at the statutory rate in Canada Effect of: Impact of differences between statutory tax rates in Canada and U.S. Other including non-taxable and non-deductible amounts Change in value of exchangeable interest liability Change in value of convertible debentures Foreign exchange losses Changes in previously recognized deferred tax asset Income tax expense from continuing operations 2015 $ % 2014 $ % 37,018 24,719 61,737 16,360 2,171 (1,067) 5,201 (1,948) 248 3,754 24,719 21,245 14,326 35,571 9,426 1,603 965 919 (862) 466 1,809 14,326 100.0 26.5 3.5 (1.7) 8.4 (3.2) 0.4 6.1 40.0 100.0 26.5 4.5 2.7 2.6 (2.4) 1.3 5.1 40.3 As of December 31, 2015, the Corporation had net operating loss carry forwards for Canadian tax purposes totalling $68,415 that are scheduled to expire in the following years: 2027 2028 2029 2030 2031 Net operating loss carry forwards $ 6,016 21,536 20,501 19,351 1,011 68,415 Losses related to the Canadian entity may be used to offset the future income of the Canadian entity for Canadian income tax purposes. As of December 31, 2015, the Corporation has recognized deferred income tax assets of $18,130 in respect of net operating loss carry forwards that will be offset against future taxable income in the Canadian entity. 31 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 15. INCOME TAXES (Continued) The components of deferred income tax balances are as follows: Deferred income tax assets Allowance for non-collectible receivable balance Accrued liabilities and other Goodwill and other intangibles Cumulative change in the value of exchangeable interest liability Net operating losses and deductions carry forwards Total deferred income tax assets Deferred income tax liabilities Property and equipment Prepaid expenses and other Goodwill and other intangibles Total deferred income tax liabilities Net deferred income tax assets 2015 $ 1,398 1,549 5,798 4,383 18,130 31,258 (3,666) (110) (13,445) (17,221) 14,037 2014 $ 1,575 1,719 5,798 15,196 28,091 52,379 (2,808) (91) (11,312) (14,211) 38,168 16. INTEREST EXPENSE, NET OF INTEREST INCOME FROM CONTINUING OPERATIONS Interest expense, net of interest income, from continuing operations included in the statement of comprehensive income consists of the following: Interest expense at Centers’ level Interest expense on convertible debentures Amortization of available credit facility stand-by fees Interest income at Centers’ level Interest income at corporate level Interest expense, net of interest income, from continuing operations 17. LOSS ON FOREIGN CURRENCY 2015 $ 1,144 1,930 277 (133) (194) 3,024 2014 $ 1,471 2,237 330 (235) (265) 3,538 Loss on foreign currency included in the statement of comprehensive income consists of the following: Unrealized loss on foreign exchange forward contracts Realized loss on foreign exchange forward contracts which matured in the current period Translation loss on cash balances denominated in Cdn$ Change in unrealized gain on foreign exchange forward contracts Loss on foreign currency 2015 $ - 6,475 2,139 8,614 (3,627) 4,987 2014 $ 818 3,034 1,239 5,091 - 5,091 32 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 18. RELATED PARTY TRANSACTIONS AND BALANCES 18.1 Transactions in the normal course of operations The Centers routinely enter into transactions with certain related parties. These parties are considered related through common ownership by the holders of non-controlling interest in the respective Centers. Such transactions are in the normal course of operations and are measured at the exchange amount, which is the amount of consideration established and agreed by the related parties. The expenses resulting from the Centers’ transactions with related parties for the years 2015 and 2014 were as follows: BHSH DPSC SFSH OSH ASH Total related party expenses 2015 $ 362 - 8,686 4,539 1,704 15,291 2014 $ 407 395 5,976 4,618 4,179 15,575 BHSH’s related party transactions relate primarily to the provision of physical therapy, intra-operative monitoring, and dietary and nutritional counselling services as well as bundled payments to surgeons for professional fees under health plan arrangements. SFSH’s related party transactions were primarily in respect of purchase of medical products, billing and coding services, provision of management services, the use of magnetic resonance imaging (“MRI”) facility and related equipment, and bundled payments to surgeons for professional fees under health plan arrangements. OSH’s related party transactions were in respect of facility building lease, management services, and software equipment rental. ASH’s related party transactions relate to the lease of a building facility, which was sold to a third-party in November 2015, and the sub-lease of MRI equipment. The amounts payable to the related parties as at December 31, 2015 and December 31, 2014 were as follows: BHSH DPSC SFSH OSH Total payable to related parties December 31, 2015 $ 26 25 715 109 875 2014 $ 47 - 392 204 643 33 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 18. RELATED PARTY TRANSACTIONS AND BALANCES (Continued) In November 2015, SFSH entered into an agreement with Renovis Surgical Technologies, Inc. (“Renovis”) to purchase $485 of medical inventory. This was recorded as prepaid expense on the consolidated balance sheet as the amount would be used to offset future purchases of medical products from Renovis. As of December 31, 2015, SFSH had $378 in prepaid expenses remaining from the transaction. 18.2 Other transactions Certain of the physicians, who indirectly own the non-controlling interest in each of the Centers, routinely provide professional services directly to patients utilizing the facilities of the Centers and reimburse the Centers for the space and staff utilized. Also, certain of the physicians serve on the boards of management of the Centers and two such individuals perform the duties of Medical Director at the respective Centers and are compensated in recognition of their contribution to the Centers. Also, a physician with non-controlling interest in SFSH is its Chief Executive Officer. The Corporation owns a 34.2% equity interest in an associate. The Corporation has significant influence over the associate because of its equity position and it has representation on the board of the associate. The investment in and loan receivable from the associate as of December 31, 2015 were $391 and $107, respectively (December 31, 2014: $302 and $130, respectively). The Corporation also has a 0.35% ownership interest in an entity that holds an indirect interest in BHSH for a total consideration of $341, for which the investment is accounted for at cost in the consolidated financial statements. Both investments comprise the ‘Other assets’ on the consolidated balance sheet. 18.3 Key management and governance compensation Key management and governance personnel are comprised of executive officers and the directors of the Corporation. Key management and governance compensation for the years 2015 and 2014 was as follows: Salaries and other short-term employee benefits for executive officers Director compensation Total key management and governance compensation 2015 $ 1,913 1,014 2,927 2014 $ 1,271 1,067 2,338 Salaries and other short-term employee benefits for executive officers include payments to executive officers for their base salaries, bonuses, social security payments, medical and workers’ compensation insurance payments, retirement allowance, and payments under the Corporation’s long-term incentive plan. Director compensation consists of retainers, meeting fees and fees for special projects where a director is asked to undertake such special projects. 34 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 19. COMMITMENTS AND CONTINGENCIES 19.1 Commitments In the normal course of operations, the Centers lease certain equipment under non-cancellable long- term leases and enter into various commitments with third parties. In addition, certain of the Centers lease their facility space from related (note 18) and non-related parties. Minimum payments for these leases are detailed in “Liquidity risk” section in note 12.5.5. 19.2 Contingencies In the normal course of business, the Centers are, from time to time, subject to allegations that may result in litigation. Certain allegations may not be covered by the Centers’ commercial and liability insurance. The Centers evaluate such allegations by conducting investigations to determine the validity of each potential claim. Based on the advice of the legal counsel, management records an estimate of the amount of the ultimate expected loss for each of these matters. Events could occur that would cause the estimate of the ultimate loss to differ materially from the amounts recorded. In 2012, ASH recorded an accrued liability of approximately $780 for the estimated cost of surgeries to replace a recalled hip implant product (“revision surgeries”). ASH has received denials from third-party payors for the revision surgeries performed and anticipates having to perform additional revision surgeries that will result in no reimbursement. As at December 31, 2015, this accrued liability had decreased to $533. 20. SIGNIFICANT ACCOUNTING POLICIES The accounting policies set out below have been applied consistently to all periods presented in these consolidated financial statements and have been applied consistently by the Centers. 20.1 Functional and presentation currency The Corporation’s financial statements are reported in U.S. dollars which is its functional and presentation currency. All financial information presented in U.S. dollars has been rounded to the nearest thousand, unless otherwise indicated. The Corporation translates monetary assets and liabilities denominated in Canadian dollars, principally its convertible debentures, exchangeable interest liability and certain of its cash balances, which are all denominated in Canadian dollars, at exchange rates in effect at the reporting date. Non-monetary items are translated at rates of exchange in effect when the assets were acquired or obligations were incurred. Revenue and expenses are translated at rates in effect at the time of the transactions. Foreign exchange gains and losses, including translation adjustments, are included in the determination of net income. 35 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 20. SIGNIFICANT ACCOUNTING POLICIES (Continued) 20.2 Basis of consolidation Subsidiaries are entities controlled by the Corporation. Control exists when the Corporation (a) has the power over the entity, (b) is exposed, or has rights, to variable returns from its involvement with the entity, and (c) has the ability to use its power to affect its returns. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases. Non-controlling interest represents the portion of a subsidiary’s net earnings and net assets that are attributable to shares of such subsidiary not held by the Corporation. The non-controlling interest in the equity of the Corporation’s subsidiaries is included as a separate component of equity. All intra-company balances and transactions have been eliminated in preparing these consolidated financial statements. The accounting policies of subsidiaries have been changed when necessary to align them with the policies adopted by the Corporation. 20.3 Business combinations Business combinations are accounted for using the acquisition method as of the date when control is transferred to the Corporation. The Corporation measures goodwill as the excess of the sum of the fair value of the consideration transferred over the net identifiable assets acquired and liabilities assumed, all measured as at the acquisition date. Transaction costs that the Corporation incurs in connection with a business combination, other than those associated with the issue of debt or equity securities, are expensed as incurred. Any contingent consideration is measured at fair value at the date of acquisition. If an obligation to pay contingent consideration that meets the definition of a financial instrument is classified as equity, then it is not re-measured and settlement is accounted for within equity. Otherwise, subsequent changes in the fair value of the contingent consideration are recognized in net income. At the date of the acquisition, the non-controlling interest is measured at the non-controlling interest’s proportionate share of the fair value of identifiable assets of the acquiree. Contingent consideration in respect of those acquisitions, accounted for as exchangeable interest liability, is recorded on the balance sheet with periodic changes in fair value of that liability reflected in net income. 20.4 Segment information The operations and productive capacity of the Centers revolve around the provision of surgical procedures. Each Center is organized as an individual entity and separate financial statements are prepared for each entity. The chief operating decision makers of the Corporation, being the Chief Executive Officer and the Chief Financial Officer, regularly review performance of each individual Center to make decisions about resources to be allocated to each Center and assess their performance. Therefore, each Center represents an operating segment as defined by IFRS 8 Operating Segments. 36 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 20. SIGNIFICANT ACCOUNTING POLICIES (Continued) Management of the Corporation has concluded that the operating segments of the Corporation meet the criteria for aggregation pursuant to IFRS 8, paragraph 12 and, therefore, discloses a single reportable segment. In forming its conclusion about the aggregation of the Centers, management of the Corporation evaluated the long-term economic characteristics of each Center, the comparative nature of the Centers’ operations, and the level of regulation of each Center. The service delivered by each Center and the patients who use those services are similar. The vast majority of patients are insured through private insurance or government insurance programs (i.e., Medicaid or Medicare), which allows for a wide group of patients electing to have their procedures performed at one of the Centers. The Centers principally provide surgical facilities, support staff and pre- and post-surgical care related to surgeries. Finally, the Centers have similar economic characteristics, which management defines as comparable long-term operating margins, recognizing differences between the Centers in payor mix, surgical specialties and local healthcare markets. 20.5 Discontinued operations A discontinued operation is a component of the Corporation’s business which can be clearly distinguished from the rest of the Corporation, both operationally and for financial reporting purposes. Classification as a discontinued operation occurs at the earlier of disposal or when the operation meets the criteria to be classified as held for sale. When an operation is classified as a discontinued operation, the comparative statements of comprehensive income are re-presented as if the operation has been discontinued from the start of the comparative year. Discontinued operations are excluded from the results of continuing operations and are presented as a single amount net of tax as net income from discontinued operations in the statement of comprehensive income. 20.6 Cash and cash equivalents Cash and cash equivalents consist of cash on hand and all liquid investments purchased with a maturity of three months or less from the purchase date and which can be redeemed by the Corporation. 20.7 Short-term and long-term investments Investments represent liquid investments purchased with a maturity of three months or more. Investments with maturities of more than three months but less than twelve months are classified as short-term and investments with maturities of twelve months or more are classified as long-term. The Corporation limits its exposure to credit risk through application of its investment policy. The policy permits investment of its cash and cash equivalents and short-term and long-term investments in (i) liquid securities issued or guaranteed by the Governments of Canada and the United States of America, or political subdivisions thereof and with (ii) certain Canadian chartered banks or banks regulated by the United States of America as listed in the policy. The carrying amount of investments represents the Corporation’s maximum exposure to credit risk for such investments. 37 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 20. SIGNIFICANT ACCOUNTING POLICIES (Continued) 20.8 Accounts receivable Accounts receivable are recorded at the time services are rendered at the amounts estimated to be recoverable from third-party payors and patients, by applying the following policies: (i) (ii) Amounts billed are reduced by an allowance for third-party payor adjustments which are maintained at a level management believes reflects the estimated adjustments that will be applied upon collection of the amounts billed. The allowance is established using the third-party payor contracts effective at period end and/or based on historical payment rates. An allowance for non-collectible receivable balances is recognized at a level management believes is adequate to absorb probable losses. Management determines the adequacy of the allowance based on historical data, current economic conditions, and other pertinent factors for the respective Center. Patient receivables are written off as non-collectible when all reasonable collection efforts have been exhausted. Payments from third-party payors are generally received within 60 days of the billing date. However, accounts involving non-contracted payment sources, such as auto and general liability insurance, are subject to recovery efforts, including rebilling and insurance litigation, until they are collected or considered not collectible. Residual amounts due from patients, such as co-payments and deductibles, are considered past due 30 days after receiving payment from third-party payors. 20.9 Supply inventory Supply inventory consists of medical supplies, including implants and pharmaceuticals. It is stated at the lower of cost or net realizable value, using the first-in, first-out valuation method. 20.10 Property and equipment Property and equipment are stated at cost less accumulated depreciation. Cost includes expenditures that are directly attributable to the acquisition of the asset. Depreciation of property and equipment is computed using the straight-line and declining balance methods over the estimated useful lives of the assets. Assets under finance leases are depreciated over the shorter of the lease term and their useful lives unless it is reasonably certain that the Centers will obtain ownership by the end of the lease term. Land is not depreciated. The estimated useful lives of property and equipment are as follows: Building and improvements Equipment and furniture 3-40 years 3-20 years 38 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 20. SIGNIFICANT ACCOUNTING POLICIES (Continued) Leases that substantially transfer the risk and benefits of ownership are capitalized with the cost included in property and equipment and the related liability recorded in long-term debt. Depreciation methods, useful lives and residual values are reviewed on an annual basis. 20.11 Goodwill Goodwill arises on the acquisition of subsidiaries and represents the excess of cost over the fair value of identifiable net assets acquired. For business acquisitions occurring after the date of transition to IFRS (January 1, 2010), goodwill is also recognized on non-controlling interest. Goodwill is stated at cost less accumulated impairment losses. Goodwill is not amortized but is reviewed at least annually for impairment and when events or changes in circumstances indicate that the carrying amount may not be recoverable. 20.12 Other intangibles Other intangibles are recognized only when it is probable that the expected future economic benefits attributable to the assets will be realized by the Corporation and the cost can be reliably measured. Other intangibles represent the value of the hospital operating licenses, medical charts and records, referral sources, and trade names. Other intangibles are stated at cost less accumulated amortization and accumulated impairment losses, when applicable. Upon recognition of an intangible asset, the Corporation determines if the asset has a definite or indefinite life. In making the determination, the Corporation considers the expected use, expiry of agreements, nature of assets, and whether the value of the assets decreases over time. Amortization is recognized on a straight-line basis over the estimated useful lives of other intangibles, other than trade names, from the date they are available for use. The estimated useful lives of other intangibles are as follows: Hospital operating licenses Medical charts and records Referral sources 5 years 5-10 years 10-15 years Trade names represent the value assigned to the reputation of the hospitals and their standing in the business and local community which allow them to earn higher than average returns. Trade names are not amortized as there is no foreseeable limit to the period over which trade names are expected to generate cash inflows for the Corporation. 39 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 20. SIGNIFICANT ACCOUNTING POLICIES (Continued) 20.13 Impairment of non-financial assets Non-financial assets that have an indefinite useful life, such as goodwill and trade names, are tested at least annually for impairment and when events or changes in circumstances indicate that the carrying amount may not be recoverable. Non-financial assets that have a definite useful life which are subject to amortization are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. For the purposes of assessing impairment, assets are grouped at the CGU level, which is the lowest level for which there are separately identifiable cash flows. Management considers each Center as a CGU. An impairment loss is recognized for the amount by which the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less cost to dispose and value in use. Value in use is based on the estimated future cash flows, discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. An impairment loss is recognized in net income. It is allocated first to reduce the carrying amount of any goodwill allocated to the respective Center and, then, to reduce the carrying amount of the other assets of the respective Center on a pro rata basis. 20.14 Financial assets and liabilities The Corporation initially recognizes financial assets on the date that they originate or on the trade date at which the Corporation becomes a party to the contractual provisions of the instrument. The Corporation derecognizes a financial asset when the contractual rights to the cash flows from the asset expire, or it transfers the rights to receive the contractual cash flows on the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred. The Corporation assesses financial assets for impairment at each reporting date. The Corporation initially recognizes financial liabilities on the date that they originate or on the trade date at which the Corporation becomes a party to the contractual provisions of the instrument. The Corporation derecognizes a financial liability when its contractual obligations are discharged, cancelled, or expire. 40 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 20. SIGNIFICANT ACCOUNTING POLICIES (Continued) All financial assets and liabilities are initially recorded at fair value and designated into one of the following categories: (i) Fair value through profit or loss (“FVTPL”) Cash and cash equivalents, certain short-term investments, foreign exchange forward contracts, convertible debentures and exchangeable interest liability are designated as FVTPL and are carried at fair value with unrealized gains or losses recognized through net income. (ii) Held-to-maturity Certain short-term and long-term investments are designated as held-to-maturity and are carried at amortized cost using the effective interest rate method. (iii) Loans and receivables Accounts receivable and other assets are designated as loans and receivables and are carried at amortized cost using the effective interest rate method. (iv) Other liabilities Dividends payable, accounts payable, accrued liabilities and long-term debt are designated as other liabilities and are carried at amortized cost using the effective interest rate method. 20.15 Impairment of non-derivative financial assets Financial assets not designated as FVTPL, including interest in an equity-accounted investee, are assessed at each reporting date to determine whether there is objective evidence of impairment. 20.15.1 Financial assets measured at amortized cost The Corporation considers evidence of impairment for financial assets measured at amortized cost on both an individual and collective basis. In assessing impairment, the Corporation uses historical information on the timing of recoveries and the amount of loss incurred, and makes an adjustment if current economic and credit conditions are such that actual losses are likely to be greater or lesser than suggested by historical trends. An impairment loss is calculated as the difference between an asset’s carrying amount and the present value of the estimated future cash flows discounted at the asset’s original effective interest rate. Losses are recognized in net income and reflected in an allowance account. If the amount of an impairment loss subsequently decreases, then the amount is reversed through net income. 41 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 20. SIGNIFICANT ACCOUNTING POLICIES (Continued) 20.15.2 Equity-accounted investee An impairment loss in respect of an equity-accounted investee is measured by comparing the recoverable amount of the investment with its carrying amount. An impairment loss is recognized in net income and is reversed if there has been a favourable change in the estimates used to calculate that recoverable amount. 20.16 Measurements of fair value A number of the Corporation’s accounting policies and disclosures require the measurement of fair value, for both financial and non-financial assets and liabilities. The Corporation has an established control framework with respect to the measurement of fair values. The valuation of all fair value measurements is overseen directly by the Chief Financial Officer. Management of the Corporation regularly reviews significant unobservable inputs and valuation adjustments. If third-party information, such as broker quotes or pricing services, is used to measure fair values, then management assesses the evidence obtained from these sources to support the conclusion that such valuations meet the requirements of IFRS, including the level in the fair value hierarchy in which such valuations should be classified. When measuring the fair value of an asset or a liability, the Corporation uses observable market data to the extent possible. Fair values are categorized into different levels in a fair value hierarchy based on the inputs used in the valuation technique as follows: Level 1 – unadjusted quoted prices available in active markets for identical assets or liabilities; Level 2 – inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly (i.e., as prices) or indirectly (i.e., derived from prices); and Level 3 – inputs for the asset or liability that are not based on observable market data (unobservable inputs). If the inputs used to measure the fair value of an asset or liability fall into different levels of the fair value hierarchy, then the fair value measurement is categorized in its entirety in the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement. The Corporation recognizes transfers between levels of the fair value hierarchy at the end of the reporting period during which the change has occurred. 42 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 20. SIGNIFICANT ACCOUNTING POLICIES (Continued) 20.17 Provisions A provision is recognized if, as a result of a past event, the Corporation has a present legal or constructive obligation that can be estimated reliably and it is probable that an outflow of economic benefits will be required to settle the obligation. Provisions are measured at the estimated expenditures required to settle the present obligation, based on the most reliable evidence available at the reporting date, including the risks and uncertainties associated with the present obligation. Provisions are discounted to their present values where the time value of money is material. All provisions are reviewed at each reporting date and adjusted to reflect the current best estimate. 20.18 Convertible debentures The Corporation’s convertible debentures are convertible into a fixed number of common shares at the option of the holder. The number of common shares to be issued does not vary with changes in the market value of the convertible debentures. The convertible debentures are denominated in Canadian dollars while the Corporation’s functional currency is U.S. dollars, which requires the Corporation to deliver a variable amount of cash to settle the obligation. Because the conversion option requires the Corporation to deliver a fixed number of common shares to settle a variable liability, the convertible debentures are considered hybrid financial instruments. The Corporation elected to account for the convertible debentures as financial liability measured at FVTPL. The changes in the recorded amounts of the liability, resulting from the changes in the fair value of the convertible debentures and fluctuations in foreign exchange rates between the periods, are reflected in net income. 20.19 Exchangeable interest liability Exchangeable interest liability represents an estimated liability for the remaining portion of the interest in the Centers held by the non-controlling interest which can be exchanged, subject to certain restrictions, for common shares of the Corporation. The exchangeable interest liability has been designated as FVTPL and accordingly is re-measured at the end of each reporting period taking into account (i) the calculated amount of common shares potentially issuable for the remaining portion of the exchangeable interest in the Centers held by the non-controlling interest, (ii) the market value of common shares, and (iii) the exchange rate between Canadian and U.S. dollars at the end of the reporting period. The change in value of the exchangeable interest liability is included in net income for the respective periods. 43 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 20. SIGNIFICANT ACCOUNTING POLICIES (Continued) 20.20 Facility service revenue Facility service revenue consists of the actual amounts received and the estimated net realizable amounts receivable from patients and third-party payors. Facility service revenue is derived from the provision of the facilities and ancillary services for the performance of scheduled (as opposed to emergency) surgical, imaging, and diagnostic procedures. The Centers bill either their patients or the patients’ third-party payors as of the date of service upon completion of the procedure. Facilities service revenue is recognized as of the date of the service when the recovery of consideration is probable and the Corporation is satisfied with the performance objectives. A small amount of facility service revenue is received directly from self-paying patients while the majority of facility service revenue is received from third-party payors that provide insurance and coverage to patients. Each Center has agreements with third-party payors that provide for payments at amounts different from the Center’s established rates. Payment arrangements include pre-determined rates per diagnosis, reimbursed costs, discounted charges, and per diem payments. As a result of established agreements with third-party payors, settlements under reimbursement arrangements are determined with a high degree of accuracy and are accrued on an estimated basis in the period the services are rendered, and are adjusted in future periods, as final settlements are determined. Differences between the estimated amounts accrued and interim and final settlements are reported in operations in the period of settlement. 20.21 Income taxes Income tax expense consists of current and deferred taxes. Income tax expense is recognized in the statement of comprehensive income except to the extent that it relates to a business combination or items recognized directly in equity, in which case it is recognized in equity or in other comprehensive income. Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted on the reporting date, and any adjustment to tax payable in respect of previous years. The Corporation calculates deferred income taxes using the asset and liability method on temporary differences between the carrying amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are calculated, without discounting, at tax rates that are expected to apply to their respective period of realization, provided they are enacted or substantively enacted at the end of the reporting period. The effect on tax assets and liabilities of a change in tax rates is recognized in net income in the period that includes the date of enactment or substantive enactment. 44 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 20. SIGNIFICANT ACCOUNTING POLICIES (Continued) A deferred tax asset is recognized to the extent that it is probable that future taxable profits will be available against which the temporary difference can be utilized. Deferred tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will be realized. Deferred tax liabilities are always recognized in full. Deferred tax assets and liabilities are offset when they relate to income taxes levied by the same taxation authority and the Corporation intends to settle its current tax assets and liabilities on a net basis. Deferred tax is provided on temporary differences arising on investments in subsidiaries, expect where the timing of the reversal of temporary differences is controlled by the Corporation and it is probable that the temporary differences will not reverse in the foreseeable future. 20.22 New and revised IFRS not yet adopted The Corporation has not applied the following new and revised IFRS that have been issued but are not yet effective: 20.22.1 IFRS 9 Financial Instruments In July 2014, the IASB issued the complete IFRS 9 Financial Instruments (“IFRS 9 (2014)”). The mandatory effective date of IFRS 9 (2014) is for annual periods beginning on or after January 1, 2018 and must be applied retrospectively with some exemptions. The Corporation intends to adopt IFRS 9 (2014) the annual period beginning on financial statements January 1, 2018. The extent of the impact of adoption of the standard has not yet been determined. its consolidated for in 20.22.2 IFRS 15 Revenue from Contracts with Customers IFRS 15 will supersede In May 2014, the IASB issued IFRS 15 Revenue from Contracts with Customers which establishes a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. including IAS 11 Construction Contracts, IAS 18 Revenue, and the related Interpretations when it becomes effective. The new standard is effective for annual periods beginning on or after January 1, 2018. Earlier application is permitted. The Corporation intends to adopt IFRS 15 in its consolidated financial statements for the annual period beginning on January 1, 2018. The extent of the impact of adoption of the standard has not yet been determined. recognition guidance the current revenue 45 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 20. SIGNIFICANT ACCOUNTING POLICIES (Continued) 20.22.3 IFRS 16 Leases In January 2016, the IASB issued IFRS 16 Leases, which provides guidance for leases whereby lessees will recognize a liability for the present value of future lease liabilities and record a corresponding right of use asset on the balance sheet. There are minimal changes to lessor accounting. IFRS 16 is effective for annual periods beginning on or after January 1, 2019. Early adoption is permitted, provided IFRS 15 Revenue from Contracts with Customers has been adopted. The Corporation intends to adopt IFRS 16 in its consolidated financial statements for the annual period beginning on January 1, 2019. The extent of the impact of adoption of the standard has not yet been determined. 21. USE OF JUDGMENTS AND ESTIMATES The preparation of financial statements requires management to make judgments, estimates, and assumptions that affect the application of accounting policies, reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the period. On an ongoing basis, management evaluates its judgments and estimates in relation to assets, liabilities, facility service revenue, and expenses. Management uses historical experience and various other factors it believes to be reasonable under the circumstances as the basis for its judgments and estimates. Actual results may differ from these estimates. Such differences in estimates are recognized when realized on a prospective basis. 21.1 Judgments Information about management’s judgments made in applying accounting policies that have the most significant effect on the amounts recognized in the consolidated financial statements is included in the following notes: (i) functional currency (discussed in note 20.1), (ii) consolidation of investees (discussed in note 20.2), (iii) segment information (discussed in note 20.4), (iv) discontinued operations (discussed in notes 4 and 20.5), (v) classification of leases (discussed in note 20.10), and (vi) recognition of deferred tax assets and liabilities (discussed in notes 15 and 20.21). 46 MEDICAL FACILITIES CORPORATION Notes to Consolidated Financial Statements (In thousands of U.S. dollars, except per share amounts and where otherwise indicated) For the years ended December 31, 2015 and 2014 21. USE OF JUDGMENTS AND ESTIMATES (Continued) 21.2 Estimates Information about assumptions and estimation uncertainties that have a significant risk of resulting in a material adjustment in the year ending December 31, 2015 is included in the following notes: (i) timing of recognition of facility service revenue (discussed in note 20.20) and recovery of accounts receivable (discussed in notes 12.5.2 and 20.8), (ii) valuation of supply inventory (discussed in note 20.9), (iii) useful lives of property and equipment (note 20.10) and other intangibles (note 20.12), (iv) fair value measurements and valuation of financial instruments (discussed in notes 12.4 and 20.16), (v) key assumptions regarding the valuation of acquired and disposed assets and liabilities, primarily goodwill and other intangibles (discussed in notes 4.2 and 6), (vi) impairment test, including key assumptions underlying the recoverable amounts of goodwill and other intangibles (discussed in notes 6.3 and 20.13), (vii) provision for potential liabilities and contingencies and the assessment of the likelihood and magnitude of outflow of resources (discussed in note 19) and (viii) recognition of deferred tax assets and the availability of future income against which carry forward tax losses can be used (discussed in notes 15 and 20.21). 22. SUBSEQUENT EVENT On January 14, 2016, the Corporation acquired a 51% controlling interest in Integrated Medical Delivery, L.L.C. (“IMD”) for a cash purchase price of $1,750. IMD is a diversified healthcare service company located in Oklahoma City, Oklahoma that provides third-party business solutions to healthcare entities such as physicians, facilities, and insurance companies. 47 Contact MFC Head Office 45 St. Clair Avenue West Suite 200 Toronto, Ontario Canada M4V 1K6 www.medicalfacilitiescorp.ca Tel: 416-848-7380 Toll Free: 1-877-402-7162 Investor Information Shareholders or other interested parties seeking information about the Company are invited to contact: Renée Lam NATIONAL Equicom 416-848-1405 rlam@national.ca Annual Meeting May 12, 2016 at 2:00 pm ET TMX Broadcast Centre, The Exchange Tower 130 King Street West Toronto, Ontario Canada M5X 1J2 Stock Exchange Listing The Toronto Stock Exchange Common Shares: DR Convertible Debentures: DR.DB.A Auditor KPMG LLP 333 Bay Street, Suite 4600 Toronto, Ontario Canada M5H 2S5 Transfer Agent and Registrar Computershare Investor Services Inc. 100 University Avenue Toronto, Ontario Canada M5J 2Y1 1-800-564-6253 Contact MFC Head Office 45 St. Clair Avenue West Suite 200 Toronto, Ontario Canada M4V 1K6 www.medicalfacilitiescorp.ca Tel: 416-848-7380 Toll Free: 1-877-402-7162 

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