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Section 1: 10-Q (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________________
FORM 10-Q
_________________________
  
(Mark One)
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended March 31, 2018
OR
 
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from              to               
 
Commission File Number:  001-37415
_________________________
 Evolent Health, Inc.
(Exact name of registrant as specified in its charter)
_________________________
Delaware
32-0454912
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
800 N. Glebe Road, Suite 500, Arlington, Virginia
22203
(Address of principal executive offices)
(Zip Code)
  
(571) 389-6000
(Registrant’s telephone number, including area code)
 
Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)
_________________________
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
  
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ☒ Accelerated filer ☐ Non-accelerated filer ☐ (Do not check if a smaller reporting company)
Smaller reporting company ☐ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act. ☐
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No  ☒
 
As of May 7, 2018, there were 77,065,740 shares of the registrant’s Class A common stock outstanding and 880,646 shares of the registrant’s Class B common stock outstanding.



Evolent Health, Inc.
Table of Contents

Item
 
Page
 
 
1.
2.
3.
4.
 
 
1.
1A.
2.
3.
4.
5.
6.
 





Explanatory Note

In this Quarterly Report on Form 10-Q, unless the context otherwise requires, “Evolent,” the “Company,” “we,” “our” and “us” refer to Evolent Health, Inc. and its consolidated subsidiaries. Evolent Health LLC, a subsidiary of Evolent Health, Inc. through which we conduct our operations, has owned all of our operating assets and substantially all of our business since inception. Evolent Health, Inc. is a holding company and its principal asset is all of the Class A common units of Evolent Health LLC.

FORWARD-LOOKING STATEMENTS - CAUTIONARY LANGUAGE
 
Certain statements made in this report and in other written or oral statements made by us or on our behalf are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”).  A forward-looking statement is a statement that is not a historical fact and, without limitation, includes any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain words like:  “believe,” “anticipate,” “expect,” “estimate,” “aim,” “predict,” “potential,” “continue,” “plan,” “project,” “will,” “should,” “shall,” “may,” “might” and other words or phrases with similar meaning in connection with a discussion of future operating or financial performance.  In particular, these include statements relating to future actions, trends in our businesses, prospective services, future performance or financial results and the outcome of contingencies, such as legal proceedings.  We claim the protection afforded by the safe harbor for forward-looking statements provided by the PSLRA.
 
These statements are only predictions based on our current expectations and projections about future events. Forward-looking statements involve risks and uncertainties that may cause actual results, level of activity, performance or achievements to differ materially from the results contained in the forward-looking statements.  Risks and uncertainties that may cause actual results to vary materially, some of which are described within the forward-looking statements, include, among others: 

the structural change in the market for health care in the United States;
uncertainty in the health care regulatory framework;
uncertainty in the public exchange market;
the uncertain impact of CMS waivers to Medicaid rules;
the uncertain impact the results of the 2018 congressional, state and local elections, as well as subsequent elections, may have on health care laws and regulations;
our ability to effectively manage our growth;
the significant portion of revenue we derive from our largest partners, and the potential loss, termination or renegotiation of customer contracts;
our ability to offer new and innovative products and services;
risks related to completed and future acquisitions, investments and alliances, including the acquisition of assets from New Mexico Health Connections (“NMHC”) and the acquisitions of Valence Health Inc., excluding Cicerone Health Solutions, Inc. (“Valence Health”), and Aldera Holdings, Inc. (“Aldera”), which may be difficult to integrate, divert management resources, result in unanticipated costs or dilute our stockholders;
certain risks and uncertainties associated with the acquisition of assets from NMHC and the acquisition of Valence Health, including future revenues may be less than expected, the timing and extent of new lives expected to come onto the platform may not occur as expected and the expected results of Evolent may not be impacted as anticipated;
the growth and success of our partners, which is difficult to predict and is subject to factors outside of our control, including premium pricing reductions, selection bias in at-risk membership and the ability to control and, if necessary, reduce health care costs, particularly in New Mexico;
our ability to attract new partners;
the increasing number of risk-sharing arrangements we enter into with our partners;
our ability to recover the significant upfront costs in our partner relationships;
our ability to estimate the size of our target market;
our ability to maintain and enhance our reputation and brand recognition;
consolidation in the health care industry;
competition which could limit our ability to maintain or expand market share within our industry;
risks related to governmental payor audits and actions, including whistleblower claims;
our ability to partner with providers due to exclusivity provisions in our contracts;
restrictions and penalties as a result of privacy and data protection laws;
adequate protection of our intellectual property, including trademarks;
any alleged infringement, misappropriation or violation of third-party proprietary rights;
our use of “open source” software;
our ability to protect the confidentiality of our trade secrets, know-how and other proprietary information;
our reliance on third parties and licensed technologies;
our ability to use, disclose, de-identify or license data and to integrate third-party technologies;
data loss or corruption due to failures or errors in our systems and service disruptions at our data centers;
online security risks and breaches or failures of our security measures;

1


our reliance on Internet infrastructure, bandwidth providers, data center providers, other third parties and our own systems for providing services to our users;
our reliance on third-party vendors to host and maintain our technology platform;
our ability to contain health care costs, implement increases in premium rates on a timely basis, maintain adequate reserves for policy benefits or maintain cost effective provider agreements;
the risk of a significant reduction in the enrollment in our health plan;
our dependency on our key personnel, and our ability to attract, hire, integrate and retain key personnel;
the risk of potential future goodwill impairment on our results of operations;
our indebtedness and our ability to obtain additional financing;
our ability to achieve profitability in the future;
the requirements of being a public company;
our adjusted results may not be representative of our future performance;
the risk of potential future litigation;
our holding company structure and dependence on distributions from Evolent Health LLC;
our obligations to make payments to certain of our pre-IPO investors for certain tax benefits we may claim in the future;
our ability to utilize benefits under the tax receivables agreement described herein;
our ability to realize all or a portion of the tax benefits that we currently expect to result from past and future exchanges of Class B common units of Evolent Health LLC for our Class A common stock, and to utilize certain tax attributes of Evolent Health Holdings and an affiliate of TPG;
distributions that Evolent Health LLC will be required to make to us and to the other members of Evolent Health LLC;
our obligations to make payments under the tax receivables agreement that may be accelerated or may exceed the tax benefits we realize;
different interests among our pre-IPO investors, or between us and our pre-IPO investors;
the terms of agreements between us and certain of our pre-IPO investors;
the potential volatility of our Class A common stock price;
the potential decline of our Class A common stock price if a substantial number of shares are sold or become available for sale or if a large number of Class B common units are exchanged for shares of Class A common stock;
provisions in our second amended and restated certificate of incorporation and second amended and restated by-laws and provisions of Delaware law that discourage or prevent strategic transactions, including a takeover of us;
the ability of certain of our investors to compete with us without restrictions;
provisions in our second amended and restated certificate of incorporation which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees;
our intention not to pay cash dividends on our Class A common stock;
our ability to remediate the material weakness in our internal control over financial reporting;
our expectations regarding the additional management attention and costs that will be required as we transition from an “emerging growth company” to a “large accelerated filer”; and
our lack of public company operating experience.

The risks included here are not exhaustive.  Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. Our Annual Report on Form 10-K for the year ended December 31, 2017 (the “2017 Form 10-K”), and other documents filed with the SEC include additional factors that could affect our businesses and financial performance.  Moreover, we operate in a rapidly changing and competitive environment. New risk factors emerge from time to time, and it is not possible for management to predict all such risk factors.
 
Further, it is not possible to assess the effect of all risk factors on our businesses or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.  Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.  In addition, we disclaim any obligation to update any forward-looking statements to reflect events or circumstances that occur after the date of this report.

2


PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
EVOLENT HEALTH, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except share data)

 
 
As of
 
 
As of
 
 
March 31,
December 31,
  
 
2018
 
 
2017
 
ASSETS
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 
$
200,316

 
 
$
238,433

 
Restricted cash and restricted investments
 
33,364

 
 
62,398

 
Accounts receivable, net (amounts related to affiliates: 2018 - $7,267; 2017 - $3,358)
 
66,138

 
 
48,947

 
Prepaid expenses and other current assets (amounts related to affiliates: 2018 - $12; 2017 - $25)
 
17,369

 
 
8,404

 
Notes receivable
 
16,000

 
 
20,000

 
Contract assets
 
4,092

 
 

 
Total current assets
 
337,279

 
 
378,182

 
Restricted cash and restricted investments
 
3,393

 
 
3,287

 
Investments in and advances to affiliates
 
5,521

 
 
1,531

 
Property and equipment, net
 
60,430

 
 
50,922

 
Prepaid expenses and other non-current assets
 
10,045

 
 
9,328

 
Contract assets
 
1,551

 
 

 
Contract cost assets
 
9,982

 
 

 
Intangible assets, net
 
242,863

 
 
241,261

 
Goodwill
 
635,246

 
 
628,186

 
Total assets
 
$
1,306,310

 
 
$
1,312,697

 
 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
Accounts payable (amounts related to affiliates: 2018 - $3,491; 2017 - $10,284)
 
$
22,445

 
 
$
42,930

 
Accrued liabilities (amounts related to affiliates: 2018 - $656; 2017 - $719)
 
37,955

 
 
29,572

 
Accrued compensation and employee benefits
 
16,508

 
 
35,390

 
Deferred revenue
 
33,328

 
 
24,807

 
Claims reserves
 
6,699

 
 

 
Total current liabilities
 
116,935

 
 
132,699

 
Long-term debt, net of discount
 
121,623

 
 
121,394

 
Other long-term liabilities
 
11,368

 
 
9,861

 
Deferred tax liabilities, net
 
1,470

 
 
2,437

 
Total liabilities
 
251,396

 
 
266,391

 
 
 
 
 
 
 
 
Commitments and Contingencies (See Note 9)
 

 
 

 
 
 
 
 
 
 
 
Shareholders' Equity (Deficit)
 
 
 
 
 
 
Class A common stock - $0.01 par value; 750,000,000 shares authorized; 76,979,298 and 74,723,597
 
 
 
 
 
 
shares issued and outstanding as of March 31, 2018, and December 31, 2017, respectively
 
770

 
 
747

 
Class B common stock - $0.01 par value; 100,000,000 shares authorized; 880,646 and 2,653,544
 
 
 
 
 
 
shares issued and outstanding as of March 31, 2018, and December 31, 2017, respectively
 
9

 
 
27

 
Additional paid-in-capital
 
953,322

 
 
924,153

 
Accumulated other comprehensive income (loss)
 

 
 

 
Retained earnings (accumulated deficit)
 
89,041

 
 
85,952

 
Total shareholders' equity (deficit) attributable to Evolent Health, Inc.
 
1,043,142

 
 
1,010,879

 
Non-controlling interests
 
11,772

 
 
35,427

 
Total shareholders' equity (deficit)
 
1,054,914

 
 
1,046,306

 
Total liabilities and shareholders' equity (deficit)
 
$
1,306,310

 
 
$
1,312,697

 

See accompanying Notes to Consolidated Financial Statements
3


EVOLENT HEALTH, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(unaudited, in thousands, except per share data)

 
For the Three
 
Months Ended
 
March 31,
 
2018

2017
Revenue
 
 
 
Transformation services (1)
$
6,505

 
$
10,235

Platform and operations services (1)
109,818

 
96,003

Premiums
23,391

 

Total revenue
139,714

 
106,238

 
 
 
 
Expenses
 
 
 
Cost of revenue (exclusive of depreciation and amortization
 
 
 
expenses presented separately below) (1)
71,975

 
67,528

Claims expenses
16,749

 

Selling, general and administrative expenses (1)
55,526

 
53,550

Depreciation and amortization expenses
9,496

 
6,615

Loss on change in fair value of contingent consideration
100

 

Total operating expenses
153,846

 
127,693

Operating income (loss)
(14,132
)
 
(21,455
)
Interest income
1,072

 
185

Interest expense
(853
)
 
(954
)
Income (loss) from affiliates
(131
)
 
(522
)
Other income (expense), net
(18
)
 
2

Income (loss) before income taxes and non-controlling interests
(14,062
)
 
(22,744
)
Provision (benefit) for income taxes
3

 
405

Net income (loss)
(14,065
)
 
(23,149
)
Net income (loss) attributable to non-controlling interests
(439
)
 
(5,137
)
Net income (loss) attributable to Evolent Health, Inc.
$
(13,626
)
 
$
(18,012
)
 
 
 
 
Earnings (Loss) Available for Common Shareholders
 
 
 
Basic
$
(13,626
)
 
$
(18,012
)
Diluted
(13,626
)
 
(18,012
)
 
 
 
 
Earnings (Loss) per Common Share
 
 
 
Basic
$
(0.18
)
 
$
(0.34
)
Diluted
(0.18
)
 
(0.34
)
 
 
 
 
Weighted-Average Common Shares Outstanding
 
 
 
Basic
75,375

 
52,599

Diluted
75,375

 
52,599

 
 
 
 
Comprehensive income (loss)
 
 
 
Net income (loss)
$
(14,065
)
 
$
(23,149
)
Other comprehensive income (loss), net of taxes, related to:
 
 
 
Foreign currency translation adjustment

 

Total comprehensive income (loss)
(14,065
)
 
(23,149
)
Total comprehensive income (loss) attributable to non-controlling interests
(439
)
 
(5,137
)
Total comprehensive income (loss) attributable to Evolent Health, Inc.
$
(13,626
)
 
$
(18,012
)

(1) See Note 16 for amounts related to affiliates included in these line items.



See accompanying Notes to Consolidated Financial Statements
4



EVOLENT HEALTH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)

 
For the Three
 
Months Ended
 
March 31,
  
2018
 
2017
Cash Flows from Operating Activities
 
 
 
Net income (loss)
$
(14,065
)
 
$
(23,149
)
Adjustments to reconcile net income (loss) to net cash and restricted cash
 
 
 
provided by (used in) operating activities:
 
 
 
Loss from affiliates
131

 
522

Change in fair value of contingent consideration
100

 

Depreciation and amortization expenses
9,496

 
6,615

Amortization of deferred financing costs
229

 
229

Stock-based compensation expense
3,795

 
5,104

Deferred tax provision (benefit)
(42
)
 
405

Contract cost amortization
570

 

Accretion of bond premium/discounts

 
57

Other
(206
)
 
159

Changes in assets and liabilities, net of acquisitions:
 
 
 
Accounts receivables, net
(16,937
)
 
(4,003
)
Prepaid expenses and other current and noncurrent assets
(12,610
)
 
(629
)
Contract assets
(198
)
 

Contract cost assets
(355
)
 

Accounts payable
2,334

 
4,222

Accrued liabilities
5,209

 
(6,727
)
Accrued compensation and employee benefits
(19,570
)
 
(21,424
)
Deferred revenue
10,869

 
4,581

Claims reserves
6,699

 

Other long-term liabilities
(154
)
 
(727
)
Net cash and restricted cash provided by (used in) operating activities
(24,705
)
 
(34,765
)
 
 
 
 
Cash Flows from Investing Activities
 
 
 
Cash paid for asset acquisitions or business combinations
(11,676
)
 

Principal repayment for implementation funding loan
4,000

 

Amount received from Vestica Healthcare LLC escrow
500

 

Maturities and sales of investments

 
10,600

Investments in and advances to affiliates
(4,000
)
 

Purchases of property and equipment
(9,553
)
 
(5,978
)
Maturities of restricted investments
8,044

 

Net cash and restricted cash provided by (used in) investing activities
(12,685
)
 
4,622

 
 
 
 
Cash Flows from Financing Activities
 
 
 
Change in restricted cash held on behalf of partners for claims processing
(22,268
)
 
(8,501
)
Proceeds from stock option exercises
1,461

 
542

Taxes withheld and paid for vesting of restricted stock units
(800
)
 
(667
)
Net cash and restricted cash provided by (used in) financing activities
(21,607
)
 
(8,626
)
Effect of exchange rate on cash and cash equivalents and restricted cash
(4
)
 

Net increase (decrease) in cash and cash equivalents and restricted cash
(59,001
)
 
(38,769
)
Cash and cash equivalents and restricted cash as of beginning-of-period
295,363

 
170,029

Cash and cash equivalents and restricted cash as of end-of-period
$
236,362

 
$
131,260


See accompanying Notes to Consolidated Financial Statements
5




EVOLENT HEALTH, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (DEFICIT)
(unaudited, in thousands)

 
 
 
 
 
 
 
 
 
 
 
 
Accum-
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ulated
 
 
Retained
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other
 
 
Earnings
 
 
 
 
 
Class A
 
Class B
 
Additional
 
Comprehensive
 
(Accum-
 
Non-
 
Total
 
Common Stock
 
Common Stock
 
Paid-in
 
 
Income
 
 
ulated
 
controlling
 
Equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Capital
 
 
(Loss)
 
 
Deficit)
 
Interests
 
(Deficit)
Balance as of December 31, 2016
52,587

 
$
506

 
15,347

 
$
153

 
$
555,250

 
 
$

 
 
$
146,617

 
$
209,588

 
$
912,114

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock-based compensation expense

 

 

 

 
20,437

 
 

 
 

 

 
20,437

Exercise of stock options
788

 
28

 

 

 
4,054

 
 

 
 

 

 
4,082

Restricted stock units vested, net of shares withheld for taxes
149

 
2

 

 

 
(1,274
)
 
 

 
 

 

 
(1,272
)
Shares released from Valence Health escrow
(310
)
 
(3
)
 

 

 
911

 
 

 
 

 

 
908

Exchange of Class B common stock
12,693

 
126

 
(12,693
)
 
(126
)
 
168,883

 
 

 
 

 
(168,883
)
 

Tax impact of 2017 Securities Offerings

 

 

 

 
12,857

 
 

 
 

 

 
12,857

Issuance of Class A common stock during August 2017 Primary
8,816

 
88

 

 

 
166,859

 
 

 
 

 

 
166,947

Reclassification of non-controlling interests

 

 

 

 
(3,824
)
 
 

 
 

 
3,824

 

Net income (loss)

 

 

 

 

 
 

 
 
(60,665
)
 
(9,102
)
 
(69,767
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of December 31, 2017
74,723

 
747

 
2,654

 
27

 
924,153

 
 

 
 
85,952

 
35,427

 
1,046,306

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cumulative-effect adjustment from adoption of ASC 606

 

 

 

 

 
 

 
 
16,715

 
594

 
17,309

Stock-based compensation expense

 

 

 

 
3,795

 
 

 
 

 

 
3,795

Exercise of stock options
354

 
4

 

 

 
1,457

 
 

 
 

 

 
1,461

Restricted stock units vested, net of shares withheld for taxes
129

 
1

 

 

 
(801
)
 
 

 
 

 

 
(800
)
Exchange of Class B common stock
1,773

 
18

 
(1,773
)
 
(18
)
 
23,805

 
 

 
 

 
(23,805
)
 

Tax impact of March 2018 Private Sale

 

 

 

 
908

 
 

 
 

 

 
908

Foreign Currency Translation Adjustment

 

 

 

 

 
 

 
 

 

 

Reclassification of non-controlling interests

 

 

 

 
5

 
 

 
 

 
(5
)
 

Net income (loss)

 

 

 

 

 
 

 
 
(13,626
)
 
(439
)
 
(14,065
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of March 31, 2018
76,979

 
$
770

 
881

 
$
9

 
$
953,322

 
 
$

 
 
$
89,041

 
$
11,772

 
$
1,054,914


See accompanying Notes to Consolidated Financial Statements
6


EVOLENT HEALTH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


1. Organization

Evolent Health, Inc. was incorporated in December 2014 in the state of Delaware, and is a managed services firm that supports leading health systems and physician organizations in their migration toward value-based care and population health management. The Company operates through two segments. The Company’s services segment (“Services”) provides our customers, who we refer to as partners, with a population management platform, integrated data and analytics capabilities, pharmacy benefit management (“PBM”) services and comprehensive health plan administration services. Together these services enable health systems to manage patient health in a more cost-effective manner. The Company’s contracts are structured as a combination of advisory fees, monthly member service fees, percentage of plan premiums and shared medical savings arrangements. The Company’s wholly-owned subsidiary, True Health New Mexico, Inc. (“True Health”) operates as a separate segment and is a commercial health plan we operate in New Mexico that focuses on small and large businesses. The Company’s headquarters is located in Arlington, Virginia.

Our predecessor, Evolent Health Holdings, Inc. (“Evolent Health Holdings”), merged with and into Evolent Health, Inc. in connection with the offering reorganization which occurred on June 4, 2015 (the “Offering Reorganization”), as discussed in our 2017 Form 10-K.

Prior to our initial public offering (“IPO”) in June 2015 and the offering reorganization we undertook in connection therewith, Evolent Health Holdings did not control Evolent Health LLC, our operating subsidiary company due to certain participating rights granted to our investor, TPG Global, LLC and certain of its affiliates (“TPG”). However, Evolent Health Holdings was able to exert significant influence on Evolent Health LLC and, accordingly, accounted for its investment in Evolent Health LLC using the equity method of accounting through June 3, 2015. Subsequent to the Offering Reorganization, the financial results of Evolent Health LLC have been consolidated in the financial statements of Evolent Health, Inc. Following the Offering Reorganization, the IPO, various securities offerings and sales (as described in Note 4) and acquisitions (as described in Note 4), as of March 31, 2018, Evolent Health, Inc. owned 98.9% of Evolent Health LLC, holds 100% of the voting rights, is the sole managing member and, therefore, controls its operations.

Since its inception, the Company has incurred losses from operations. As of March 31, 2018, the Company had cash and cash equivalents of $200.3 million. The Company believes it has sufficient liquidity for the next 12 months as of the date the financial statements were available to be issued.

2. Basis of Presentation, Summary of Significant Accounting Policies and Change in Accounting Principle

Basis of Presentation

In our opinion, the accompanying unaudited interim consolidated financial statements include all adjustments, consisting of normal recurring adjustments, which are necessary to fairly state our financial position, results of operations, and cash flows. The Consolidated Balance Sheet at December 31, 2017, has been derived from audited financial statements as of that date. The interim consolidated results of operations are not necessarily indicative of the results that may occur for the full fiscal year. Certain footnote disclosures normally included in financial statements prepared in accordance with United States of America generally accepted accounting principles (“GAAP”) have been omitted pursuant to instructions, rules, and regulations prescribed by the United States Securities and Exchange Commission (“SEC”). The disclosures provided herein should be read in conjunction with the audited financial statements and notes thereto included in our 2017 Form 10-K.

Summary of Significant Accounting Policies
 
Certain GAAP policies that significantly affect the determination of our financial position, results of operations and cash flows, are summarized below. See “Part II - Item 8. Financial Statements and Supplementary Data - Note 2” in our 2017 Form 10-K for a complete summary of our significant accounting policies.

Accounting Estimates and Assumptions

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses for the reporting period. Those estimates are inherently subject to change and actual results could differ from those estimates. In the accompanying consolidated financial statements, estimates are used for, but not limited to, the valuation of assets, liabilities, consideration related to business combinations and asset acquisitions, revenue

7


recognition including discounts and credits, estimated selling prices for performance obligations in contracts with multiple performance obligations, claims reserves, contingent payments, allowance for doubtful accounts, depreciable lives of assets, impairment of long lived assets (including equity method investments), stock-based compensation, deferred income taxes and valuation allowance, contingent liabilities, valuation of intangible assets (including goodwill), purchase price allocation in taxable stock transactions and the useful lives of intangible assets.

Principles of Consolidation
 
The consolidated financial statements include the accounts of Evolent Health, Inc. and its subsidiaries. All inter-company accounts and transactions are eliminated in consolidation.

Operating Segments

Operating segments are defined as components of a business that earn revenue and incur expenses for which discrete financial information is available that is evaluated, on a regular basis, by the chief operating decision maker (“CODM”) to decide how to allocate resources and assess performance. The Company operates through two segments: (1) Services, and (2) True Health. Our Services segment consists of our technology-enabled services platform that supports our various value-based operations, such as delivery network alignment, population health performance, integrated cost and revenue management solutions and financial and administrative management services. Our True Health segment consists of a commercial health plan we operate in New Mexico that focuses on small and large businesses. See Note 17 for a discussion of our operating results by segment.

Revenue Recognition

Our Services segment derives revenue from two sources: (1) transformation services and (2) platform and operations services. See Change in Accounting Principle below for our updated revenue recognition policy as a result of our adoption of Accounting Standards Update (“ASU”) 2017-04, Revenue from Contracts with Customers.

Our True Health segment derives revenue from premiums that are earned over the terms of the related insurance policies. The portion of premiums that will be earned in the future or are received prior to the effectiveness of the policy are deferred and reported as premiums received in advance. These amounts are generally classified as short-term deferred revenue on our Consolidated Balance Sheets.

8



Restricted Cash and Restricted Investments

Restricted cash and restricted investments include cash and investments used to collateralize various contractual obligations (in thousands) as follows:

 
 
As of
 
 
As of
 
 
March 31,
December 31,
 
 
2018
 
 
2017
 
Collateral for letters of credit
 
 
 
 
 
 
for facility leases (1)
 
$
3,812

 
 
$
3,812

 
Collateral with financial institutions (2)
 
18,030

 
 
24,725

 
Pharmacy benefit management
 
 
 
 
 
 
and claims processing services (3)
 
4,018

 
 
26,286

 
Collateral for reinsurance agreement (4)
 
10,000

 
 
10,000

 
Other
 
897

 
 
862

 
Total restricted cash
 
 
 
 
 
 
and restricted investments
 
36,757

 
 
65,685

 
 
 
 
 
 
 
 
Current restricted investments
 

 
 
8,150

 
Current restricted cash
 
33,364

 
 
54,248

 
Total current restricted cash
 
 
 
 
 
 
and restricted investments
 
33,364

 
 
62,398

 
 
 
 
 
 
 
 
Non-current restricted investments
 
711

 
 
605

 
Non-current restricted cash
 
2,682

 
 
2,682

 
Total non-current restricted cash
 
 
 
 
 
 
and restricted investments
 
$
3,393

 
 
$
3,287

 

(1) Represents restricted cash related to collateral for letters of credit required in conjunction with lease agreements. See Note 9 for further discussion of our lease commitments.
(2) Represents collateral held with financial institutions for risk-sharing arrangements. As of March 31, 2018, and December 31, 2017, approximately $18.0 million and $16.6 million of the collateral amount was in a trust account and invested in a money market fund. The amounts invested in money market funds are considered restricted cash and are carried at fair value, which approximates cost. See Note 15 for further discussion of our fair value measurement. As of December 31, 2017, approximately $8.2 million of the collateral amount was invested in restricted certificates of deposit with remaining maturities of less than 12 months. The restricted investments are classified as held-to-maturity and stated at amortized cost. Fair value of the certificates of deposit is determined using Level 2 inputs and approximates amortized cost as of December 31, 2017. See Note 9 for further discussion of our risk-sharing arrangements.
(3) Represents cash held by Evolent on behalf of partners to process PBM and other claims. These are pass-through amounts and can fluctuate materially from period to period depending on the timing of when the claims are processed.
(4) Represents restricted cash required as part of our capital only reinsurance agreement to provide balance sheet support to NMHC. There is no transfer of underwriting risk to Evolent and we are not at risk for any cash payments on behalf of NMHC as part of the agreement. The reinsurance agreement is further discussed in Note 9.


9


The following table provides a reconciliation of cash and cash equivalents and restricted cash reported within the consolidated balance sheets that sum to the total of the same such amounts shown in the statements of cash flows.

 
As of March 31,
 
2018
 
2017
Cash and cash equivalents
$
200,316

 
$
104,295

Restricted cash and restricted investments
36,757

 
31,915

Restricted investments included in
 
 
 
restricted cash and restricted investments
(711
)
 
(4,950
)
Total cash and cash equivalents and restricted cash
 
 
 
shown in the consolidated statements of cash flows
$
236,362

 
$
131,260


Notes Receivable

Notes receivable are carried at the face amount of each note plus respective accrued interest receivable, less received payments. The Company does not typically carry notes receivable in the course of its regular business, but contributed $20.0 million in the form of an implementation funding loan (the “Implementation Loan”) under an agreement with a current customer entered during the year ended December 31, 2017. The Implementation Loan is expected to support implementation services to assist the customer in expanding its Medicaid membership. The Implementation Loan carries a fixed interest rate of 2.5% per annum and the terms of the agreement governing the Implementation Loan require it to be repaid in ten equal monthly installments of $2.0 million, plus accrued interest, during 2018. As of March 31, 2018, the outstanding principal balance of the Implementation Loan was $16.0 million, excluding approximately $0.1 million of accrued interest. As of December 31, 2017, the outstanding principal balance of the Implementation Loan was $20.0 million, excluding approximately $0.1 million of accrued interest.

Intangible Assets, Net

Identified intangible assets are recorded at their estimated fair values at the date of acquisition and are amortized over their respective estimated useful lives using a method of amortization that reflects the pattern in which the economic benefits of the intangible assets are used. The Company acquired additional intangible assets in conjunction with a strategic acquisition made during 2018. Information regarding the determination and allocation of the fair value of the acquired assets and liabilities is further described within Note 4.

The following summarizes the estimated useful lives by asset classification:

Corporate trade name
20 years
Customer relationships
15-25 years
Technology
5 years
Provider network contracts
5 years

Intangible assets are reviewed for impairment if circumstances indicate the Company may not be able to recover the asset’s carrying value. The Company evaluates recoverability by determining whether the undiscounted cash flows expected to result from the use and eventual disposition of that asset or group exceed the carrying value at the evaluation date. If the undiscounted cash flows are not sufficient to cover the carrying value, the Company measures an impairment loss as the excess of the carrying amount of the long-lived asset or group over its fair value. See Note 7 for additional discussion regarding our intangible assets.

Goodwill

We recognize the excess of the purchase price, plus the fair value of any non-controlling interests in the acquiree, over the fair value of identifiable net assets acquired as goodwill. Goodwill is not amortized, but is reviewed at least annually for indications of impairment, with consideration given to financial performance and other relevant factors. We perform impairment tests of goodwill at a reporting unit level, which is consistent with the way management evaluates our business. Goodwill is assigned to the reporting unit that benefits from the synergies arising from each business combination.


10


Foreign Currency

The Company established an international subsidiary during the first quarter of 2018. The functional currency of our international subsidiary is the Indian Rupee. We translate the financial statements of this subsidiary to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive income (loss) as a component of shareholders' equity. We recorded an immaterial “Foreign currency translation adjustment” on our Consolidated Statement of Operations for the three months ended March 31, 2018, which resulted in an immaterial “Accumulated other comprehensive income (loss)” balance on our Consolidated Balance Sheet as of March 31, 2018.

Change in Accounting Principle

As discussed in Note 3, the Company adopted ASU 2014-09, Revenue from Contracts with Customers, effective January 1, 2018. The following is our updated accounting policy with respect to revenue recognition for our Services segment.

Our Services segment derives revenue from two sources: (1) transformation services and (2) platform and operations services. Revenue is recognized when control of the services is transferred to our customers. We use the following 5-Step model, outlined in ASC 606, to determine revenue recognition on our contracts with customers:

Identify the contract(s) with a customer
Identify of performance obligations in the contract
Determine the transaction price
Allocate the transaction price to performance obligations
Recognize revenue when (or as) the entity satisfies a performance obligation

Transformation Services Revenue

Transformation services consist of strategic assessments, or Blueprint contracts, and implementation services whereby we assist the customer in launching its population health or health plan strategy. The transformation services are usually completed within 12 months. We generally receive a fixed fee for transformation services and recognize revenue over time using an input method based on hours incurred compared to the total estimated hours required to satisfy our performance obligation.

Platform and Operations Services Revenue

Platform and operations services generally include multi-year arrangements with customers to provide various population health, health plan operations and PBM services on an ongoing basis. Our performance obligation in these arrangements is to provide an integrated suite of services, including access to our platform that is customized to meet the specialized needs of our customers. Generally we will apply the series guidance to the performance obligation as we have determined that each time increment is distinct. We primarily utilize a variable fee structure for these services that typically include a monthly payment that is calculated based on a specified per member per month rate, multiplied by the number of members that our partners are managing under a value-based care arrangement or a percentage of plan premiums. Our arrangements may also include other variable fees related to service level agreements, shared medical savings arrangements and other performance measures. Variable consideration is estimated using the most likely amount based on our historical experience and best judgment at the time. Due to the nature of our arrangements certain estimates may be constrained if it is probable that a significant reversal of revenue will occur when the uncertainty is resolved. We recognize revenue for platform and operations services over time using the time elapsed output method. Fixed consideration is recognized ratably over the contract term. In accordance with the series guidance, we allocate variable consideration to the period to which the fees relate.

Contracts with Multiple Performance Obligations

Our contracts with customers may contain multiple performance obligations, primarily when the customer has requested both transformation services and platform and operations services as these services are distinct from one another. When a contract has multiple performance obligations, we allocate the transaction price to each performance obligation based on the relative standalone selling price using the expected cost margin approach. This approach requires estimates regarding both the level of effort it will take to satisfy the performance obligation as well as fees that will be received under the variable pricing model. We also take into consideration customer demographics, current market conditions, the scope of services and our overall pricing strategy and objectives when determining the standalone selling price.


11


Principal vs Agent

We occasionally use third parties to assist in satisfying our performance obligations. In order to determine whether we are the principal or agent in the arrangement, we will review each third party relationship on a contract by contract basis. We are an agent when our role is to arrange for another entity to provide the services to the customer. In these instances, we do not control the service before it is provided and will recognize revenue on a net basis. We are the principal when we control the good or service prior to transferring control to the customer. We recognize revenue on a gross basis when we are the principal in the arrangement.

In accordance with the requirements under ASU 2014-09, the impact of adoption to our consolidated financial statements was as follows. See Note 5 for additional disclosures regarding Evolent's contracts with customers.

Condensed Consolidated Statements of Operations
 
 
 
 
 
 
 
 
 
(unaudited, in thousands)
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended March 31, 2018
 
 
 
 
 
Amounts without
Impact of
 
 
 
 
adoption of
adoption
 
As Reported
 
ASC 606
 
Higher/(Lower)
Revenue
 
 
 
 
 
 
 
 
 
Transformation services
 
$
6,505

 
 
$
5,787

 
 
$
718

 
Platform and operations services
 
109,818

 
 
109,974

 
 
(156
)
 
 
 
 
 
 
 
 
 
 
 
Expenses
 
 
 
 
 
 
 
 
 
Cost of revenue (exclusive of depreciation and amortization
 
 
 
 
 
 
 
 
 
presented separately below)
 
71,975

 
 
72,281

 
 
(306
)
 
Selling, general and administrative expenses
 
55,526

 
 
55,516

 
 
10

 
Income (loss) before income taxes and non-controlling interests
 
(14,062
)
 
 
(14,920
)
 
 
858

 

Condensed Consolidated Balance Sheets
 
 
 
 
 
 
 
 
 
(unaudited, in thousands)
 
 
 
 
 
 
 
 
 
 
As of March 31, 2018
 
 
 
 
 
Balances without
Impact of
 
 
 
 
adoption of
adoption
 
As Reported
 
ASC 606
 
Higher/(Lower)
Assets
 
 
 
 
 
 
 
 
 
Accounts receivable, net
 
$
66,138

 
 
$
64,478

 
 
$
1,660

 
Contract assets (current)
 
4,092

 
 

 
 
4,092

 
Contract assets (noncurrent)
 
1,551

 
 

 
 
1,551

 
Contract cost assets
 
9,982

 
 

 
 
9,982

 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity (Deficit)
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
Deferred revenue
 
$
33,328

 
 
$
34,381

 
 
$
(1,053
)
 
Other long-term liabilities
 
11,368

 
 
11,196

 
 
172

 
 
 
 
 
 
 
 
 
 
 
Shareholders' Equity (Deficit)
 
 
 
 
 
 
 
 
 
Retained earnings (accumulated deficit)
 
89,041

 
 
71,498

 
 
17,543

 
Non-controlling interests
 
11,772

 
 
11,149

 
 
623

 


12


The Company adopted ASU 2016-18, Statement of Cash Flows: Restricted Cash effective December 31, 2017, using the retroactive transition method, which resulted in the recast of our statement of cash flows for each period presented. See “Part II - Item 8. Financial Statements and Supplementary Data - Note 2” in our 2017 Form 10-K for further information about the adoption.

The amendments in the ASU require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows.

A significant portion of the Company’s restricted cash consists of cash held on behalf of partners to process PBM claims. These are pass-through amounts and can fluctuate materially from period to period depending on the timing of when the claims are processed. Under the previous standard, there was no net impact to the statement of cash flows related to these amounts as the change in accounts payable was offset by the change in restricted cash. Upon adoption of ASU 2016-18, the change in restricted cash held on behalf of PBM partners would no longer net to zero, thereby potentially having a significant impact on cash flows from operations period over period. Given the pass-through nature of these PBM claim payments, the change in restricted cash held on behalf of PBM partners will be presented within cash flows from financing activities on our statements of changes in cash flows under the updated requirements of ASU 2016-18.

The following table summarizes the impact of the change in accounting principle to the Company’s Consolidated Statements of Cash Flows for the three months ended March 31, 2017 (in thousands):

 
 
For the Three Months Ended March 31, 2017
 
 
As Originally
 
 
 
 
 
 
 
Reported
 
Adjustments
 
As Adjusted
Cash Flows from Financing Activities
 
 
 
 
 
 
 
 
Change in restricted cash held on behalf of partners for claims processing
 
$

 
 
$
(8,501
)
 
 
$
(8,501
)
Net cash and restricted cash provided by (used in) financing activities
 
(125
)
 
 
(8,501
)
 
 
(8,626
)
 
 
 
 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents and restricted cash
 
(30,268
)
 
 
(8,501
)
 
 
(38,769
)
Cash and cash equivalents and restricted cash as of beginning-of-period
 
134,563

 
 
35,466

 
 
170,029

Cash and cash equivalents and restricted cash as of end-of-period
 
104,295

 
 
26,965

 
 
131,260


3. Recently Issued Accounting Standards

Adoption of New Accounting Standards

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, in order to clarify the principles of recognizing revenue. This standard establishes the core principle of recognizing revenue to depict the transfer of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The FASB defines a five-step process that systematically identifies the various components of the revenue recognition process, culminating with the recognition of revenue upon satisfaction of an entity’s performance obligations. By completing all five steps of the process, the core principles of revenue recognition will be achieved. The new revenue standard (including updates) is effective for annual and interim reporting periods beginning after December 15, 2017, with early adoption permitted only as of annual reporting periods beginning after December 15, 2016. The guidance permits two methods of adoption: i) the full retrospective method applying the standard to each prior reporting period presented, or ii) the modified retrospective method with a cumulative effect of initially applying the guidance recognized at the date of initial application. The standard also allows entities to apply certain practical expedients at their discretion. The Company adopted the standard effective January 1, 2018, using the modified retrospective method for only contracts that were not completed at the date of initial application. Results for reporting periods beginning after January 1, 2018 are presented under Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”), while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under ASC Topic 605, Revenue Recognition (“ASC 605”). The adoption of this standard resulted in changes related to revenue recognition for contracts that contain certain features, such as variable consideration. These changes generally accelerate revenue recognition. In addition, certain customer setup costs, which have historically been expensed as incurred, will now be capitalized. Evolent recognized the cumulative effect of applying the new revenue standard as a $17.3 million adjustment to the opening balance of retained earnings in the first quarter of 2018, primarily as a result of deferral of expenses related to contract acquisition and fulfillment costs and acceleration of revenue due to variable consideration estimation. See Note 5 for additional disclosures regarding Evolent's contracts with customers. See Note 2 for updated revenue recognition accounting policy and the impact of adopting the new revenue recognition standard on Evolent’s financial statements.

13


Future Adoption of New Accounting Standards

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments. With respect to assets measured at amortized cost, such as held-to-maturity assets, the update requires presentation of the amortized cost net of a credit loss allowance. The update eliminates the probable initial recognition threshold that was previously required prior to recognizing a credit loss on financial instruments. The credit loss estimate can now reflect an entity’s current estimate of all future expected credit losses as opposed to the previous standard, when an entity only considered past events and current conditions. With respect to available for sale debt securities, the update requires that credit losses be presented as an allowance rather than as a write-down. The update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We intend to adopt the requirements of this standard effective January 1, 2020, and are currently evaluating the impact of the adoption on our financial condition and results of operations.

In February 2016, the FASB issued ASU 2016-02, Leases, in order to establish the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases. This update introduces a new standard on accounting for leases, including a lessee model that brings most leases on the balance sheet. The new standard also aligns many of the underlying principles of the new lessor model with those in ASC 606, the FASB’s new revenue recognition standard (e.g., those related to evaluating when profit can be recognized). The standard also requires lessors to increase the transparency of their exposure to changes in value of their residual assets and how they manage that exposure. The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. We intend to adopt the requirements of this standard effective January 1, 2019, and are currently evaluating the impact of the adoption on our financial condition and results of operations.

We have evaluated all other issued and unadopted ASUs and believe the adoption of these standards will not have a material impact on our results of operations, financial position, or cash flows.

4. Transactions

Business Combinations

New Mexico Health Connections

On January 2, 2018, the Company, through its wholly-owned subsidiary, True Health, completed its previously announced acquisition of assets related to NMHC’s commercial, small and large group business. The assets include a health plan management services organization with a leadership team and employee base with experience working locally with providers to run NMHC’s suite of preventive, disease and care management programs. The consideration paid by the Company in connection with the acquisition consisted of $10.3 million in cash (subject to certain adjustments), of which $0.3 million was deposited in an escrow account. This acquisition is expected to allow the Company to leverage its platform to support a value-based, provider-centric model of care in New Mexico.

The Company commenced operations of the commercial health plan and began reporting the results of True Health as a new reportable segment during the first quarter of 2018. See Note 17 for further information about the Company’s segment reporting. At the time of the acquisition, the Company also entered into a managed services agreement (“MSA”) with NMHC to support its ongoing business. During the fourth quarter of 2017, the Company also entered into a reinsurance arrangement with NMHC to provide balance sheet support. See Note 9 for further discussion of the reinsurance arrangement. The managed services agreement and reinsurance arrangement were considered separate transactions and accounted for outside of the business combination. Therefore, there is no allocation of purchase price to these arrangements.

The Company incurred approximately $1.2 million in transaction costs related to the NHMC transaction, materially all of which were recorded within “Selling, general and administrative expenses” on our Consolidated Statements of Operations for the year ended December 31, 2017. The transaction will be accounted for as a business combination using purchase accounting.


14


The purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values as of January 2, 2018, as follows (in thousands):

Purchase consideration
 
Cash paid to NMHC
$
10,000

Cash paid to escrow agent
252

Total consideration
$
10,252

 
 
Identifiable intangible assets acquired and liabilities assumed
 
Customer relationships
$
2,700

Provider network contracts
2,300

Above market lease
(100
)
Accrued compensation and employee benefits
474

 
 
Goodwill
5,826

Net assets acquired
$
10,252


Identifiable intangible assets associated with customer relationships and provider network contracts will be amortized on a straight-line basis over their estimated useful lives of 15 and 5 years, respectively. The customer relationships represent existing contracts in place to provide health plan services to a number of large and small group customers throughout the state of New Mexico. The provider network contracts represent a network of hospitals and physicians to service the health plan customers. The fair value of the customer relationship intangible asset was primarily determined using the income approach. The income approach estimates fair value for an asset based on the present value of cash flows projected to be generated by the asset. Projected cash flows are discounted at a required rate of return that reflects the relative risk of achieving the cash flows and the time value of money. The fair value of the provider network intangible asset was primarily determined using the cost approach. The cost approach estimates the fair value for an asset based on the amount it would cost to create or acquire a similar asset. Goodwill is calculated as the difference between the acquisition date fair value of the total consideration and the fair value of the net assets acquired, and represents the future economic benefits that we expect to achieve as a result of the acquisition. Goodwill associated with the acquisition of True Health is allocated entirely to the True Health segment, as all of the assets and liabilities of the acquired business are assigned to the True Health segment. The goodwill is attributable primarily to the acquired workforce and expected cost synergies, none of which qualify for recognition as a separate intangible asset. Goodwill is considered an indefinite lived asset. The transaction is an asset acquisition for tax purposes, and as such the tax-basis in the acquired assets is equal to the book-basis fair value calculated and is recorded at the True Health legal entity. Therefore, no opening balance sheet deferred tax liability was recorded.

The amounts above reflect management’s preliminary estimate of the fair value of the tangible and intangible assets acquired and liabilities assumed based on a valuation performed using currently available information. Any remaining adjustments are expected to be finalized within one year of the acquisition date.

True Health is a separate segment, and its results of operations are provided in Note 17 - Segment Reporting.

Pro Forma Financial Information (Unaudited)

The unaudited pro forma Consolidated Statements of Operations presented below gives effect to (1) the NMHC transaction as if it took place on January 1, 2017. The following pro forma information includes adjustments to:

record revenue and expenses related to the MSA beginning January 1, 2017; and
record amortization expenses related to intangible assets beginning January 1, 2017, for intangible assets acquired as part of the NMHC transaction.


15


This pro forma data is presented for informational purposes only and does not purport to be indicative of the results of future operations or of the results that would have occurred had the transactions described above occurred in the specified prior periods. The pro forma adjustments are based on available information and assumptions that the Company believes are reasonable to reflect the impact of these transactions on the Company’s historical financial information on a pro forma basis (in thousands, except per share data).
 
For the Three
 
Months Ended
 
March 31,
 
2018
 
2017
Revenue
$
139,714

 
$
127,625

Net income (loss)
(14,065
)
 
(26,852
)
Net income (loss) attributable to non-controlling interests
(439
)
 
(6,065
)
Net income (loss) attributable to Evolent Health, Inc.
(13,626
)
 
(20,787
)
 
 
 
 
Net income (loss) available to common shareholders
 
 
 
Basic
$
(0.18
)
 
$
(0.40
)
Diluted
(0.18
)
 
(0.40
)

Securities Offerings and Sales

Under an exchange agreement we entered into at the time of our IPO, we granted certain affiliates of TPG (“TPG”), The Advisory Board Company (“The Advisory Board”), UPMC and Ptolemy Capital, LLC (“Ptolemy Capital”) (together, the “Investor Stockholders”) an exchange right that allows receipt of newly-issued shares of the Company’s Class A common stock in exchange (a “Class B Exchange”) for an equal number of shares of the Company’s Class B common stock (which are subsequently canceled) and an equal number of Evolent Health LLC’s Class B common units (“Class B units”). Class B units received by the Company from relevant Investor Stockholders are simultaneously exchanged for an equivalent number of Class A units of Evolent Health LLC, and Evolent Health LLC cancels the Class B units it receives in the Class B Exchange. The cancellation of the Class B units results in an increase in the Company’s economic interest in Evolent Health LLC.

March 2018 Private Sale

In March 2018, The Advisory Board sold 3.0 million shares of the Company’s Class A common Stock in a private sale (the “March 2018 Private Sale”). The shares sold in the March 2018 Private Sale consisted of 1.2 million existing shares of the Company’s Class A common stock owned by The Advisory Board and 1.8 million newly-issued shares of the Company’s Class A common stock received by The Advisory Board pursuant to a Class B Exchange for all of its outstanding shares of the Company’s Class B common stock and Class B units. The Company did not receive any proceeds from the March 2018 Private Sale.

As a result of this Class B Exchange and Evolent Health LLC’s cancellation of the Class B units during the March 2018 Private Sale, the Company’s economic interest in Evolent Health LLC increased from 96.6% to 98.9% immediately following the March 2018 Private Sale, and, accordingly, we reclassified a portion of our non-controlling interests into shareholders’ equity attributable to Evolent Health, Inc.

August 2017 Primary Offering

In August 2017, the Company completed a primary offering of 8.8 million shares of its Class A common stock at a price to the public of $19.85 per share and a corresponding price to the underwriters of $19.01 per share (the “August 2017 Primary”). This offering resulted in net cash proceeds to the Company of approximately $166.9 million (gross proceeds of $175 million, net of $8.1 million in underwriting discounts and stock issuance costs). For each share of Class A common stock issued by Evolent Health, Inc., the Company received a corresponding Class A common unit from Evolent Health LLC in exchange for contributing the issuance proceeds to Evolent Health LLC. As a result of the Class A common stock and Class A common units issued during the August 2017 Primary, the Company’s economic interest in Evolent Health LLC increased from 96.1% to 96.6% immediately following the August 2017 Primary, and, accordingly, we reclassified a portion of our non-controlling interests into shareholders’ equity attributable to Evolent Health, Inc.


16


Secondary Offerings

The Investor Stockholders initiated several Class B Exchanges as part of various secondary offerings during 2017, thus increasing the Company’s economic interest in Evolent Health LLC, as discussed below. The Company did not receive any proceeds from the secondary offerings described below.

June 2017 Secondary Offering

In June 2017, the Company completed a secondary offering of 4.5 million shares of its Class A common stock at a price to the underwriters of $25.87 per share (the “June 2017 Secondary”).

The shares sold in the June 2017 Secondary consisted of 0.7 million existing shares of the Company’s Class A common stock owned and held by certain Investor Stockholders and 3.8 million newly-issued shares of the Company’s Class A common stock received by certain Investor Stockholders pursuant to Class B Exchanges.

As a result of these Class B Exchanges and Evolent Health LLC’s cancellation of the Class B units during the June 2017 Secondary, the Company’s economic interest in Evolent Health LLC increased from 90.5% to 96.1% immediately following the June 2017 Secondary, and, accordingly, we reclassified a portion of our non-controlling interests into shareholders’ equity attributable to Evolent Health, Inc.

May 2017 Secondary Offering

In May 2017, the Company completed a secondary offering of 7.0 million shares of its Class A common stock at a price to the underwriters of $24.30 per share (the “May 2017 Secondary”). The shares were sold by the Investor Stockholders and certain management selling stockholders (together with the Investor Stockholders, the “Selling Stockholders”).

The shares sold in the May 2017 Secondary consisted of 3.1 million existing shares of the Company’s Class A common stock owned and held by the Selling Stockholders, 3.8 million newly-issued shares of the Company’s Class A common stock received by certain Investor Stockholders pursuant to Class B Exchanges and 0.1 million shares issued upon the exercise of options by certain management selling stockholders.

As a result of these Class B Exchanges and Evolent Health LLC’s cancellation of the Class B units during the May 2017 Secondary, the Company’s economic interest in Evolent Health LLC increased from 84.9% to 90.5% immediately following the May 2017 Secondary, and, accordingly, we reclassified a portion of our non-controlling interests into shareholders’ equity attributable to Evolent Health, Inc.

March 2017 Secondary Offering

In March 2017, the Company completed a secondary offering of 7.5 million shares of its Class A common stock at a price to the underwriters of $19.53 per share (the “March 2017 Secondary”).

The shares sold in the March 2017 Secondary consisted of 3.1 million existing shares of the Company’s Class A common stock owned and held by the Investor Stockholders and 4.4 million newly-issued shares of the Company’s Class A common stock received by certain Investor Stockholders pursuant to Class B Exchanges.

As a result of these Class B Exchanges and Evolent Health LLC’s cancellation of the Class B units during the March 2017 Secondary, the Company’s economic interest in Evolent Health LLC increased from 77.4% to 83.9% immediately following the March 2017 Secondary, and, accordingly, we reclassified a portion of our non-controlling interests into shareholders’ equity attributable to Evolent Health, Inc.

In connection with the March 2017 Secondary, the underwriters exercised, in full, their option to purchase an additional 1.1 million shares of Class A common stock (the “March 2017 Option to Purchase Additional Shares”) from the Investor Stockholders at a price of $19.53 per share. The March 2017 Option to Purchase Additional Shares closed in May 2017.

The shares sold in the March 2017 Option to Purchase Additional Shares consisted of 0.5 million existing shares of the Company’s Class A common stock owned and held by certain Investor Stockholders. It also included 0.6 million newly-issued shares of the Company’s Class A common stock received by certain Investor Stockholders pursuant to Class B Exchanges.

As a result of the Class B Exchanges and Evolent Health LLC’s cancellation of the Class B units during the March 2017 Option to Purchase Additional Shares, the Company’s economic interest in Evolent Health LLC increased from 83.9% to 84.9% immediately

17


following the March 2017 Option to Purchase Additional Shares, and, accordingly, we reclassified a portion of our non-controlling interests into shareholders’ equity attributable to Evolent Health, Inc.

The June 2017 Secondary, May 2017 Secondary, March 2017 Secondary and March 2017 Option to Purchase Additional Shares are collectively referred to as the “2017 Secondary Offerings.”

The Company’s economic interest in Evolent Health LLC will increase if further Class B Exchanges occur.

Asset Acquisitions

Accordion Health, Inc.

On June 8, 2017, the Company entered into an agreement to acquire Accordion Health, Inc. (“Accordion”) for $3.2 million (the “Accordion Purchase Agreement”). Accordion provides technology that the Company believes enhances its risk-adjustment factor (“RAF”) services to its partners. In addition to technology assets, the software development team from Accordion joined Evolent as full-time employees. Under the terms of the Accordion Purchase Agreement, members of the software development team will be eligible for an additional $0.8 million earn-out, contingent upon the completion of specified software development targets.

We accounted for the transaction as an asset acquisition as substantially all of the fair value of the gross assets acquired was concentrated in a single identified asset, thus satisfying the requirements of the screen test introduced in ASU 2017-01. The assets acquired in the transaction were measured based on the amount of cash paid to Accordion, including transaction costs, as the fair value of the assets given was more readily determinable than the fair value of the assets received. We classified and designated the identifiable assets acquired as a $3.3 million technology intangible asset, inclusive of approximately $0.1 million of capitalized transaction costs. We also assessed and determined the useful life of the acquired intangible assets to be five years, subject to amortization. The Company will account for the contingent earn-out as a post-acquisition expense as the specified software development targets are achieved. The transaction was a taxable stock acquisition and the Company recognized deferred tax liability of $2.0 million related to the book-tax basis difference in the acquired asset, which resulted in a $2.0 million increase in the value of the intangible asset. The additional deferred tax liability represents a future source of taxable income that enables the Company to release some of its previously established valuation allowance, the reduction of which is accounted for outside of acquisition accounting, resulting in income tax benefit.

5. Revenue Recognition

As discussed in Note 3, we adopted ASU 2014-09, effective January 1, 2018, which introduces ASC 606. See Note 2 for the updated revenue recognition policy and the impact of adopting the new revenue recognition standard on the Company’s financial statements. Following are other relevant disclosures as required by the adoption of ASU 2014-09. Provisions within ASC 606 are only applicable to revenues derived from our Services segment.

Disaggregation of Revenue

The following table represents Evolent’s Services segment revenue disaggregated by revenue type for the three months ended March 31, 2018 (in thousands), excluding revenues from our True Health segment and from our downside risk sharing arrangements through our insurance subsidiary, which are accounted for under ASC 944.

  
For the Three
 
Months Ended
  
March 31,
 
 
2018
 
Services Revenue
 
 
 
Transformation services
 
$
6,505

 
Platform and operations services
 
108,420

 

18


Transaction Price Allocated to the Remaining Performance Obligations

For contracts with a term that is greater than one year, we have allocated approximately $132.7 million of transaction price to performance obligations that are unsatisfied or partially unsatisfied as of March 31, 2018. We do not include variable consideration that is allocated entirely to a wholly unsatisfied performance obligation accounted for under the series guidance in the calculation. As a result, the balance represents the value of the fixed consideration in our long-term contracts that will be recognized as revenue in a future period and excludes the majority of our platform and operations revenue, which is primarily derived based on variable consideration as discussed in Note 2. We expect to recognize 31% of this amount in 2018, with the remaining balance to be recognized through 2022. However, because our existing contracts may be canceled or renegotiated including for reasons outside our control, the amount of this revenue that we actually receive may be less than this estimate.

Contract Balances

Contract balances consist of accounts receivable, contract assets and deferred revenue. Contract assets are recorded when the right to consideration for services is conditional on something other than the passage of time. Contract assets relating to unbilled receivables are transferred to accounts receivable when the right to consideration becomes unconditional. We classify contract assets as current or noncurrent based on the timing of our rights to the unconditional payments. Our contract assets are generally classified as current and recorded within “Contract assets” on our consolidated balance sheets.

Deferred revenue includes advance customer payments and billings in excess of revenue recognized. We classify deferred revenue as current or noncurrent based on the timing of when we expect to recognize revenue. Our current deferred revenue is recorded within “Deferred revenue” on our consolidated balance sheets, and noncurrent deferred revenue is recorded within “Other long-term liabilities” on our consolidated balance sheets.

The following table provides information about receivables, contract assets and deferred revenue from contracts with customers (in thousands):

 
 
As of
 
 
As of
 
 
March 31,
January 1,
 
 
2018
 
2018
Receivables (1)
 
$
63,972

 
 
$
47,131

 
Short-term contract assets
 
4,092

 
 
3,710

 
Long-term contract assets
 
1,551

 
 
1,791

 
Short-term deferred revenue
 
33,328

 
 
26,147

 
Long-term deferred revenue
 
1,810

 
 
493

 
(1) Excludes pharmacy claims receivable and premiums receivable

During the three months ended March 31, 2018, the change in our contract asset balance was immaterial. During the three months ended March 31, 2018, our deferred revenue increased by $8.5 million, primarily as a result of new contracts and increased pre-billing for services.

The amount of revenue recognized during the three months ended March 31, 2018, from amounts included in deferred revenue at the beginning of the period was $8.8 million.

Contract Costs

Certain bonuses and commissions earned by our sales team are considered incremental costs of obtaining a contract with a customer that we expect to be recoverable. The capitalized contract acquisition costs are classified as noncurrent assets and recorded within “Contract cost assets” on our consolidated balance sheets. Amortization expense is recorded within “Selling, general and administrative expenses” on the accompanying consolidated statements of operations. As of March 31, 2018, the Company had $0.8 million of contract acquisition cost assets, net of accumulated amortization, and less than $0.1 million of amortization expense for the three months ended March 31, 2018.

In our platforms and operations arrangements, we incur certain costs related to the implementation of our platform before we begin to satisfy our performance obligation to the customer. The costs, which we expect to recover, are considered costs to fulfill a contract. Our contract fulfillment costs primarily include our employee labor costs and third party vendor costs. The capitalized contract fulfillment costs are classified as noncurrent and recorded within “Contract cost assets” on our consolidated balance sheets.

19


Amortization expense is recorded within “Cost of revenue” on the accompanying consolidated statements of operations. As of March 31, 2018, the Company had $9.2 million of contract fulfillment cost assets, net of accumulated amortization, and amortization expense of $0.5 million for the three months ended March 31, 2018.

The majority of the contract cost balance was recorded as part of the transition adjustment that was recorded upon implementation of ASC 606. These costs are deferred and then amortized on a straight-line basis over a period of benefit that we have determined to be five years. The period of benefit was based on our technology, the nature of our customer arrangements and other factors.

6. Property and Equipment, Net

The following summarizes our property and equipment (in thousands):
 
 
 
As of
 
 
As of
 
  
March 31,
December 31,
  
 
2018
 
 
2017
 
Computer hardware
 
$
6,473

 
 
$
5,667

 
Furniture and equipment
 
3,033

 
 
2,448

 
Internal-use software development costs
 
59,098

 
 
48,557

 
Leasehold improvements
 
9,849

 
 
8,708

 
Total property and equipment
 
78,453

 
 
65,380

 
Accumulated depreciation and amortization
 
(18,023
)
 
 
(14,458
)
 
Total property and equipment, net
 
$
60,430

 
 
$
50,922

 

The Company capitalized $10.5 million and $5.8 million of internal-use software development costs for the three months ended March 31, 2018 and 2017, respectively. The net book value of capitalized internal-use software development costs was $50.1 million and $42.1 million as of March 31, 2018, and December 31, 2017, respectively.

Depreciation expense related to property and equipment was $3.6 million for the three months ended March 31, 2018, of which amortization expense related to capitalized internal-use software development costs was $2.5 million. Depreciation expense related to property and equipment was $1.8 million for the three months ended March 31, 2017, of which amortization expense related to capitalized internal-use software development costs was $0.7 million.

7. Goodwill and Intangible Assets, Net

Goodwill

Goodwill has an estimated indefinite life and is not amortized; rather, it is reviewed for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.

The Company has two reporting units: Services and True Health. Our annual goodwill impairment review occurs during the fourth quarter of each fiscal year. In interim periods between annual goodwill reviews, we also evaluate qualitative factors that could cause us to believe our estimated fair value of each of our reporting units may be lower than the carrying value and trigger a quantitative assessment, including, but not limited to (i) macroeconomic conditions, (ii) industry and market considerations, (iii) our overall financial performance, including an analysis of our current and projected cash flows, revenue and earnings, (iv) a sustained decrease in share price and (v) other relevant entity-specific events including changes in strategy, partners, or litigation.

We did not identify any qualitative factors that would trigger a quantitative goodwill impairment test during the three months ended March 31, 2018. We will perform our annual impairment test as of October 31, 2018.

20


The following tables summarize the changes in the carrying amount of goodwill, by reportable segment, for the periods presented (in thousands):

 
 
For the Three Months Ended March 31, 2018
 
 
 
 
 
 
 
 
Total
 
 
Services
 
 
True Health
 
 
Company
Balance as of beginning-of-period (1)
 
$
628,186

 
 
$

 
 
$
628,186

Goodwill Acquired (2)
 
1,234

 
 
5,826

 
 
7,060

Balance as of end-of-period
 
$
629,420

 
 
$
5,826

 
 
$
635,246


(1) Net of cumulative inception to date impairment of $160.6 million.
(2) Represents goodwill acquired as a result of transactions completed during the first quarter of 2018.

 
 
For the Year
 
 
 
Ended
 
 
 
December 31,
 
 
2017 (1)
 
Balance as of beginning-of-period (2)
 
$
626,569

 
Measurement period adjustments (3)
 
1,617

 
Balance as of end-of-period
 
$
628,186

 

(1) All of the goodwill was allocated to the Services segment as of December 31, 2017, as the True Health segment was not established until the first quarter of 2018.
(2) Net of cumulative inception to date impairment of $160.6 million.
(3) Represents measurement period adjustments related to Valence Health and Aldera. See “Part II - Item 8. Financial Statements and Supplementary Data - Note 4” in our 2017 Form 10-K for further information regarding the Valence Health and Aldera transactions.

Intangible Assets, Net

Details of our intangible assets (in thousands) are presented below:

 
 
As of March 31, 2018
 
 
Weighted-
 
 
 
 
Average
 
Gross
 
 
 
Net
 
Remaining
Carrying
Accumulated
Carrying
  
Useful Life
Amount
Amortization
Value
Corporate trade name
 
17.2
 
$
19,000

 
$
2,691

 
$
16,309

Customer relationships
 
20.2
 
208,719

 
20,677

 
188,042

Technology
 
2.9
 
55,933

 
20,955

 
34,978

Below market lease, net
 
4.7
 
4,097

 
2,748

 
1,349

Provider network contracts
 
4.8
 
2,300

 
115

 
2,185

Total
 
 
 
$
290,049

 
$
47,186

 
$
242,863


(1) The increase in the gross carrying amount of the customer relationships intangible is attributable to $2.7 million of acquired customer relationships from the NMHC transaction and $2.5 million related the Vestica Healthcare LLC (“Vestica”) transaction. The Company acquired certain assets from Vestica in March 2016. The transaction included additional consideration of up to $4.0 million, which was being held in escrow and was recorded within “Prepaid expenses and other non-current assets” on our Consolidated Balance Sheets. In February 2018, the Company and Vestica reached an agreement to settle $3.5 million of the $4.0 million in escrow. Based on the terms of the settlement agreement, the Company reclassified the unamortized portion of the additional consideration from “Prepaid expenses and other non-current assets” into “Customer relationships” as of the settlement date. See Note 4 for further information about the NMHC transaction and see “Part II - Item 8. Financial Statements and Supplementary Data - Note 4” of our 2017 Form 10-K for further information about the Vestica transaction.


21


 
 
As of December 31, 2017
  
 
Weighted-
 
 
 
 
Average
 
Gross
 
 
 
Net
 
Remaining
Carrying
Accumulated
Carrying
 
Useful Life
Amount
Amortization
Value
Corporate trade name
 
17.4
 
$
19,000

 
$
2,454

 
$
16,546

Customer relationships
 
20.5
 
203,500

 
18,312

 
185,188

Technology
 
3.1
 
55,802

 
17,810

 
37,992

Below market lease, net
 
4.8
 
4,197

 
2,662

 
1,535

Total
 
 
 
$
282,499

 
$
41,238

 
$
241,261


Amortization expense related to intangible assets was $5.9 million and $4.8 million for the three months ended March 31, 2018 and 2017, respectively.

Intangible assets are reviewed for impairment if circumstances indicate the Company may not be able to recover the asset’s carrying value. We did not identify any circumstances during three months ended March 31, 2018, that would require an impairment test for our intangible assets.

8. Long-term Debt

In December 2016, the Company issued $125.0 million aggregate principal amount of its 2.00% Convertible Senior Notes due 2021 (the “2021 Notes”) in a private placement to qualified institutional buyers within the meaning of Rule 144A under the Securities Act of 1933, as amended. The 2021 Notes were issued at par for net proceeds of $120.4 million. We incurred $4.6 million of debt issuance costs in connection with the 2021 Notes, which we are amortizing to non-cash interest expense using the straight line method over the contractual term of the 2021 Notes, since this method was not materially different from the effective interest method. The closing of the private placement of the 2021 Notes occurred on December 5, 2016.

Holders of the 2021 Notes are entitled to cash interest payments, which are payable semiannually in arrears on June 1 and December 1 of each year, beginning on June 1, 2017, at a rate equal to 2.00% per annum. The 2021 Notes will mature on December 1, 2021, unless earlier repurchased or converted in accordance with their terms prior to such date. In addition, holders of the 2021 Notes may require the Company to repurchase their 2021 Notes upon the occurrence of a fundamental change at a price equal to 100.00% of the principal amount of the 2021 Notes being repurchased, plus any accrued and unpaid interest. Upon maturity, and at the option of the holders of the 2021 Notes, the principal amount of the notes may be settled via shares of the Company’s Class A common stock. For the three months ended March 31, 2018 and 2017, the Company recorded approximately $0.6 million and $0.6 million, respectively, in interest expense and $0.2 million and $0.2 million, respectively, in non-cash interest expense related to the amortization of deferred financing costs.

The 2021 Notes are convertible into shares of the Company’s Class A common stock, based on an initial conversion rate of 41.6082 shares of Class A common stock per $1,000 principal amount of the 2021 Notes, which is equivalent to an initial conversion price of approximately $24.03 per share of the Company’s Class A common stock. In the aggregate, the 2021 Notes are initially convertible into 5.2 million shares of the Company’s Class A common stock (excluding any shares issuable by the Company upon a conversion in connection with a make-whole provision upon a fundamental change under the indenture between Evolent Health, Inc. and U.S. Bank National Association, as trustee, related to the 2.00% convertible senior notes due 2021, dated as of December 5, 2016).

The 2021 Notes are convertible, in multiples of $1,000 principal amount, at the option of the holders at any time prior to the close of business on the business day immediately preceding the maturity date. Upon conversion, we will deliver for each $1,000 principal amount of notes converted a number of shares of our Class A common stock equal to the applicable conversion rate (together with a cash payment in lieu of delivering any fractional share) on the third business day following the relevant conversion date.

Convertible Senior Notes Carrying Value

While the 2021 Notes are recorded on our accompanying unaudited interim consolidated balance sheets at their net carrying value of $121.6 million as of March 31, 2018, the 2021 Notes are privately traded by qualified institutional buyers (within the meaning of Rule 144A under the Securities Act of 1933, as amended) and their fair value was $124.4 million, based on a traded price on April 3, 2018, a Level 2 input. The fair value as of December 31, 2017, was $120.4 million, based on a traded price on December 29, 2017, a Level 2 input. The 2021 Notes also have embedded conversion options and contingent interest provisions, which have not been recorded as separate financial instruments.


22


The following table summarizes the carrying value of the long-term debt (in thousands):

 
 
As of
 
 
As of
 
 
March 31,
December 31,
 
 
2018
 
 
2017
 
Carrying value
 
$
121,623

 
 
$
121,394

 
Unamortized discount
 
3,377

 
 
3,606

 
Principal amount
 
$
125,000

 
 
$
125,000

 
Remaining amortization period (years)
 
3.7

 
 
3.9

 

9. Commitments and Contingencies

UPMC Reseller Agreement

The Company and UPMC are parties to a reseller, services and non-competition agreement, dated August 31, 2011, which was amended and restated by the parties on June 27, 2013 (as amended through the date hereof, the “UPMC Reseller Agreement”). Under the terms of the UPMC Reseller Agreement, UPMC has appointed the Company as a non-exclusive reseller of certain services, subject to certain conditions and limitations specified in the UPMC Reseller Agreement. In consideration for the Company’s obligations under the UPMC Reseller Agreement and subject to certain conditions described therein, UPMC has agreed not to sell certain products and services directly to a defined list of 20 of the Company’s customers.

The Advisory Board Company Reseller Agreement

The Company and The Advisory Board were parties to a services, reseller, and non-competition agreement, dated August 31, 2011, which was amended and restated by the parties on June 27, 2013, and May 1, 2015 (as so amended, “The Advisory Board Company Reseller Agreement”), which terminated on July 20, 2017. Under the terms of The Advisory Board Company Reseller Agreement, The Advisory Board provided certain services to the Company on an as-requested basis.  In addition, The Advisory Board had a right of first offer to provide certain specified services during the term of the Agreement and had the right to collect certain fees for specified referrals. Pursuant to the Advisory Board Company Reseller Agreement, Evolent entered into a services agreement with The Advisory Board in October 2016 whereby The Advisory Board will provide certain services to the Company in conjunction with risk adjustment services provided to one of our customers.

Contingencies

Tax Receivables Agreement

In connection with the Offering Reorganization, the Company entered into the TRA with certain of its investors, which provides for the payment by the Company to these investors of 85% of the amount of the tax benefits, if any, that the Company is deemed to realize as a result of increases in our tax basis related to exchanges of Class B common units as well as tax benefits attributable to the future utilization of pre-IPO NOLs. These payment obligations are obligations of the Company. For purposes of the TRA, the benefit deemed realized by the Company will be computed by comparing its actual income tax liability to the amount of such taxes that the Company would have been required to pay had there been no increase to the tax basis of the assets of the Company as a result of the exchanges or had the Company had no NOL carryforward balance. The actual amount and timing of any payments under the TRA will vary depending upon a number of factors, including:
 
the timing of the exchanges and the price of the Class A shares at the time of the transaction, triggering a tax basis increase in the Company’s asset and a corresponding benefit to be realized under the TRA; and
the amount and timing of our taxable income - the Company will be required to pay 85% of the tax savings as and when realized, if any. If the Company does not have taxable income, it will not be required to make payments under the TRA for that taxable year because no tax savings were actually realized.

Due to the items noted above, and the fact that the Company is in a full valuation allowance position such that the deferred tax assets related to the Company’s historical pre-IPO losses and tax basis increase benefit from exchanges have not been realized, the Company has not recorded a liability pursuant to the TRA.


23


Litigation Matters

We are engaged from time to time in certain legal disputes arising in the ordinary course of business, including employment claims. When the likelihood of a loss contingency becomes probable and the amount of the loss can be reasonably estimated, we accrue a liability for the loss contingency. We continue to review accruals and adjust them to reflect ongoing negotiations, settlements, rulings, advice of legal counsel, and other relevant information. To the extent new information is obtained, and our views on the probable outcomes of claims, suits, assessments, investigations or legal proceedings change, changes in our accrued liabilities would be recorded in the period in which such determination is made. The Company is not aware of any legal proceedings or claims as of March 31, 2018, or December 31, 2017, that the Company believes will have, individually or in the aggregate, a material adverse effect on the Company’s financial position or result of operations.

Commitments

Letter of Credit

During the first quarter of 2017, the Company entered into an agreement to provide a letter of credit, for up to $5.0 million, to assist a customer in demonstrating adequate reserves to the customer’s state regulatory authorities. The letter of credit is effective from September 30, 2017 through June 30, 2019, and carries a quarterly facility rental fee of 0.8% per annum on the amount of the outstanding balance. The letter of credit will terminate after June 30, 2019. The letter of credit is presented at the face amount plus accrued facility rental fee, less received payments. There was no outstanding balance related to this letter of credit as of March 31, 2018, or December 31, 2017.

Lease Commitments

The Company has entered into lease agreements for its primary office locations in Arlington, Virginia, Lisle, Illinois, Riverside, Illinois, Chicago, Illinois, Albuquerque, New Mexico and Pune, India. Certain leases acquired as part of the Valence Health transaction included existing sublease agreements for office locations in Chicago, Illinois. The Company also has several smaller leases in various locations within Texas and California. Total rental expense, net of sublease income, on operating leases was $3.3 million and $2.6 million for the three months ended March 31, 2018 and 2017, respectively.

In connection with various lease agreements, the Company is required to maintain $3.8 million in letters of credit and, as such, held $3.8 million in restricted cash and restricted investments as collateral for the letters of credit as of March 31, 2018.

Indemnifications

The Company’s customer agreements generally include a provision by which the Company agrees to defend its partners against third-party claims (a) for death, bodily injury, or damage to personal property caused by Company negligence or willful misconduct, (b) by former or current Company employees arising from such managed service agreements, (c) for intellectual property infringement under specified conditions and (d) for Company violation of applicable laws, and to indemnify them against any damages and costs awarded in connection with such claims. To date, the Company has not incurred any material costs as a result of such indemnities and has not accrued any liabilities related to such obligations in the accompanying consolidated financial statements.

Registration rights agreement

We entered into a registration rights agreement with The Advisory Board, UPMC, TPG and another investor to register for sale under the Securities Act shares of our Class A common stock, including those delivered in exchange for Class B common stock and Class B common units. Subject to certain conditions and limitations, this agreement provides these investors with certain demand, piggyback and shelf registration rights. The registration rights granted under the registration rights agreement will terminate upon the date the holders of shares that are a party thereto no longer hold any such shares that are entitled to registration rights. Pursuant to our contractual obligations under this agreement, we filed a registration statement on Form S-3 with the SEC on July 28, 2016, which was declared effective on August 12, 2016.

Pursuant to certain terms of the registration rights agreement, certain Investor Stockholders sold 7.5 million shares of the Company’s Class A common stock during the March 2017 Secondary, as discussed in Note 4. Pursuant to the terms of the registration rights agreement, we incurred $0.3 million in expenses related to the March 2017 Secondary for the three months ended March 31, 2017. The expenses were recorded within “Selling, general and administrative expenses” on our Consolidated Statements of Operations.

We will continue to pay all expenses relating to any demand, piggyback or shelf registration, other than underwriting discounts and commissions and any transfer taxes, subject to specified conditions and limitations. The registration rights agreement includes customary indemnification provisions, including indemnification of the participating holders of shares of Class A common stock and

24


their directors, officers and employees by us for any losses, claims, damages or liabilities in respect thereof and expenses to which such holders may become subject under the Securities Act, state law or otherwise.

Guarantees

As part of our strategy to support certain of our partners in the Next Generation Accountable Care Program, we entered into upside and downside risk sharing arrangements. Our downside risk-sharing arrangements are limited to our fees and are executed through our wholly-owned captive insurance company. To satisfy the capital requirements of our insurance entity as well as state insurance regulators, Evolent entered into letters of credit of $18.0 million as of March 31, 2018, to secure potential losses related to insurance services. This amount is in excess of our actuarial assessment of loss.

Reinsurance Agreement

During the fourth quarter of 2017, the Company entered into a 15-month, $10.0 million capital-only reinsurance arrangement with NMHC, expiring on December 31, 2018. The purpose of the capital-only reinsurance is to provide balance sheet support to NMHC. There is no uncertainty to the outcome of the arrangement as there is no transfer of underwriting risk to Evolent or True Health, and neither Evolent nor True Health is at risk for any cash payments on behalf of NMHC. As a result, this arrangement does not qualify for reinsurance accounting. The Company will record a quarterly fee of approximately $0.2 million as non-operating income on its consolidated statements of operations and will maintain $10.0 million in restricted cash and restricted investments on its consolidated balance sheets for the duration of the reinsurance agreement.

Credit and Concentration Risk

The Company is subject to significant concentrations of credit risk related to cash and cash equivalents and accounts receivable. As of March 31, 2018, approximately 66.3% of our $236.4 million of cash and cash equivalents (including restricted cash) were held in bank deposits with FDIC participating banks, approximately 33.3% were held in money market funds and less than 1.0% were held in international banks. While the Company maintains its cash and cash equivalents with financial institutions with high credit ratings, it often maintains these deposits in federally insured financial institutions in excess of federally insured limits. The Company has not experienced any realized losses on cash and cash equivalents to date.

The Company is also subject to significant concentration of accounts receivable risk as a substantial portion of our trade accounts receivable is derived from a small number of our partners. The following table summarizes those partners who represented at least 10.0% of our trade accounts receivable for the periods presented:

 
 
As of
 
 
As of
 
 
March 31,
December 31,
 
 
2018
 
 
2017
 
Customer B
 
14.2
%
 
 
32.1
%
 
Customer C
 
*

 
 
11.8
%
 
Customer D
 
*

 
 
16.5
%
 

* Represents less than 10.0% of the respective balance

In addition, the Company is subject to significant concentration of revenue risk as a substantial portion of our revenue is derived from a small number of contractual relationships with our operating partners.

The following table summarizes those partners who represented at least 10.0% of our revenue for the periods presented:

 
For the Three
 
Months Ended
 
March 31,
 
2018
 
2017
Customer A
20.1
%
 
17.1
%
Customer B
10.6
%
 
*

Customer C
*

 
11.2
%

* Represents less than 10.0% of the respective balance


25


10. Earnings (Loss) Per Common Share
 
The following table sets forth the computation of basic and diluted earnings per share available for common stockholders (in thousands, except per share data):

 
For the Three
 
Months Ended
 
March 31,
 
2018
 
2017
Net income (loss)
$
(14,065
)
 
$
(23,149
)
Less:
 
 
 
Net income (loss) attributable to non-controlling interests
(439
)
 
(5,137
)
Net income (loss) available for common shareholders (1) (2)
$
(13,626
)
 
$
(18,012
)
 
 
 
 
Weighted-average common shares outstanding (2) (3)
75,375

 
52,599

 
 
 
 
Earnings (Loss) per Common Share
 
 
 
Basic
$
(0.18
)
 
$
(0.34
)
Diluted
(0.18
)
 
(0.34
)

(1) 
For periods of net loss, net income (loss) available for common shareholders is the same for both basic and diluted purposes.
(2) 
Each Class B common unit of Evolent Health LLC can be exchanged (together with a corresponding number of shares of our Class B common stock) for one share of our Class A common stock. As holders exchange their Class B common shares for Class A common shares, our interest in Evolent Health LLC will increase. Therefore, shares of our Class B common stock are not considered dilutive shares for the purposes of calculating our diluted earnings (loss) per common share as related adjustment to net income (loss) available for common shareholders would equally offset the additional shares, resulting in the same earnings (loss) per common share.
(3) 
For periods of net loss, shares used in the earnings (loss) per common share calculation represent basic shares as using diluted shares would be anti-dilutive.

Anti-dilutive shares (in thousands) excluded from the calculation of weighted-average common shares presented above are presented below:

 
For the Three
 
Months Ended
 
March 31,
 
2018
 
2017
Exchangeable Class B common stock
2,141

 
15,347

Restricted stock units ("RSUs")
627

 
485

Stock options and performance-based stock options
2,162

 
2,915

Convertible senior notes
5,201

 
5,201

Total
10,131

 
23,948



26


11. Stock-based Compensation

Total compensation expense by award type and line item in our consolidated financial statements were as follows (in thousands):

 
For the Three
 
Months Ended
  
March 31,
  
2018
 
2017
Award Type
 
 
 
Stock options
$
2,231

 
$
4,053

Performance-based stock options
110

 
110

RSUs
1,454

 
941

Total
$
3,795

 
$
5,104

 
 
 
 
Line Item
 
 
 
Cost of revenue
$
316

 
$
349

Selling, general and
 
 
 
administrative expenses
3,479

 
4,755

Total
$
3,795

 
$
5,104


No stock-based compensation in the totals above was capitalized as software development costs for the three months ended March 31, 2018 and 2017, respectively.

Stock-based awards granted were as follows:
 
 
For the Three</