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Section 1: 10-Q (10-Q)

Document

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, 2019
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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ 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,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ☒ Accelerated filer ☐ Non-accelerated filer ☐
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  ☒
 
Securities registered pursuant to Section 12(b) of the Act:

Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Class A Common Stock of Evolent Health, Inc., par value $0.01 per share
EVH
New York Stock Exchange

As of May 6, 2019, there were 81,963,259 shares of the registrant’s Class A common stock outstanding and 713,517 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 significant portion of revenue we derive from our largest partners, and the potential loss, termination or renegotiation of customer contracts;
uncertainty relating to expected future revenues from and our relationship with our largest customer, Passport, including as a result of ongoing litigation pertaining to rate adjustments and Passport’s ability to remain solvent, which among other things could result in significantly reduced fees or a significant customer loss in 2019;
the structural change in the market for health care in the United States;
uncertainty in the health care regulatory framework, including the potential impact of policy changes;
uncertainty in the public exchange market;
the uncertain impact of CMS waivers to Medicaid rules and changes in membership and rates;
the uncertain impact the results of elections may have on health care laws and regulations;
our ability to effectively manage our growth and maintain an efficient cost structure;
our ability to offer new and innovative products and services;
risks related to completed and future acquisitions, investments, alliances and joint ventures, including the pending partnership with GlobalHealth, the acquisition of assets from New Mexico Health Connections (“NMHC”), and the acquisitions of Valence Health Inc., excluding Cicerone Health Solutions, Inc. (“Valence Health”), Aldera Holdings, Inc. (“Aldera”) and NCIS Holdings, Inc. (“New Century Health”), which may be difficult to integrate, divert management resources, or result in unanticipated costs or dilute our stockholders;
our ability to consummate opportunities in our pipeline;
certain risks and uncertainties associated with the acquisition of assets from NMHC and the acquisitions of Valence Health, Aldera and New Century 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;
risks relating to our ability to maintain profitability for our and New Century Health’s performance-based contracts and products, including capitation and risk-bearing contracts;
the growth and success of our partners, which is difficult to predict and is subject to factors outside of our control, including enrollment numbers for our partners’ plans (including in Florida), 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 and successfully capture new growth opportunities;
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 markets;
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 payer 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;

1


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, including with respect to privacy of health information;
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 ability to accurately underwrite performance-based risk-bearing contracts;
risks related to our offshore operations;
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;
the impact of changes in accounting principles and guidance on our reported results;
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 Global, LLC (along with its affiliates, “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 conditional conversion feature of the 2025 Notes, which, if triggered, could require us to settle the 2025 Notes in cash;
the impact of the accounting method for convertible debt securities that may be settled in cash;
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 maintain effective internal control over financial reporting;
our expectations regarding the additional management attention and costs that will be required as we have transitioned 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, 2018 (the “2018 Form 10-K”), this Form 10-Q 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,
  
 
2019
 
 
2018
 
ASSETS
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 
$
170,817

 
 
$
228,320

 
Restricted cash and restricted investments
 
50,920

 
 
154,718

 
Accounts receivable, net (amounts attributable to related parties: 2019 - $8,701; 2018 - $8,519)
 
65,626

 
 
80,208

 
Prepaid expenses and other current assets (amounts attributable to related parties: 2019 - 0; 2018 - $85)
 
30,495

 
 
22,618

 
Investments, at amortized cost
 
2,046

 
 

 
Contract assets
 
1,282

 
 
2,102

 
Total current assets
 
321,186

 
 
487,966

 
Restricted cash and restricted investments
 
7,036

 
 
6,105

 
Investments, at amortized cost
 
11,743

 
 
10,010

 
Investments in and advances to equity method investees
 
6,188

 
 
6,276

 
Property and equipment, net
 
77,379

 
 
73,628

 
Right-of-use assets - operating
 
63,855

 
 

 
Prepaid expenses and other noncurrent assets (amounts attributable to related parties: 2019 - $3,500; 2018 - $2,500)
 
11,264

 
 
15,028

 
Contract assets
 
1,695

 
 
961

 
Contract cost assets
 
22,463

 
 
19,147

 
Intangible assets, net
 
336,231

 
 
335,036

 
Goodwill
 
770,334

 
 
768,124

 
Total assets
 
$
1,629,374

 
 
$
1,722,281

 
 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
Accounts payable (amounts attributable to related parties: 2019 - $2,496; 2018 - $1,564)
 
$
39,007

 
 
$
146,760

 
Accrued liabilities (amounts attributable to related parties: 2019 - $1,462; 2018 - $798)
 
53,018

 
 
48,957

 
Operating lease liabilities - current
 
3,439

 
 

 
Accrued compensation and employee benefits
 
15,872

 
 
25,460

 
Deferred revenue
 
22,320

 
 
20,584

 
Reserve for claims and performance-based arrangements
 
30,019

 
 
27,595

 
Total current liabilities
 
163,675

 
 
269,356

 
Long-term debt, net of discount
 
223,320

 
 
221,041

 
Other long-term liabilities
 
10,490

 
 
17,090

 
Operating lease liabilities - noncurrent
 
57,197

 
 

 
Deferred tax liabilities, net
 
24,566

 
 
25,438

 
Total liabilities
 
479,248

 
 
532,925

 
 
 
 
 
 
 
 
Commitments and Contingencies (See Note 9)
 

 
 

 
 
 
 
 
 
 
 
Shareholders' Equity (Deficit)
 
 
 
 
 
 
Class A common stock - $0.01 par value; 750,000,000 shares authorized as of March 31, 2019 and December 31, 2018;
 
 
 
 
 
 
79,428,728 and 79,172,118 shares issued and outstanding as of March 31, 2019 and December 31, 2018, respectively
 
794

 
 
792

 
Class B common stock - $0.01 par value; 100,000,000 shares authorized as of March 31, 2019 and December 31, 2018;
 
 
 
 
 
 
3,190,301 shares issued and outstanding as of March 31, 2019 and December 31, 2018
 
31

 
 
31

 
Additional paid-in capital
 
1,096,089

 
 
1,093,174

 
Accumulated other comprehensive income (loss)
 
(158
)
 
 
(182
)
 
Retained earnings (accumulated deficit)
 
3,270

 
 
50,009

 
Total shareholders' equity (deficit) attributable to Evolent Health, Inc.
 
1,100,026

 
 
1,143,824

 
Non-controlling interests
 
50,100

 
 
45,532

 
Total shareholders' equity (deficit)
 
1,150,126

 
 
1,189,356

 
Total liabilities and shareholders' equity (deficit)
 
$
1,629,374

 
 
$
1,722,281

 

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,
 
2019

2018
Revenue
 
 
 
Transformation services (1)
$
3,353

 
$
6,505

Platform and operations services (1)
147,292

 
109,818

Premiums
47,111

 
23,391

Total revenue
197,756

 
139,714

 
 
 
 
Expenses
 
 
 
Cost of revenue (exclusive of depreciation and amortization
 
 
 
expenses presented separately below) (1)
117,441

 
71,975

Claims expenses
37,757

 
16,749

Selling, general and administrative expenses (1)
74,838

 
55,526

Depreciation and amortization expenses
14,266

 
9,496

Change in fair value of contingent consideration
100

 
100

Total operating expenses
244,402

 
153,846

Operating income (loss)
(46,646
)
 
(14,132
)
Interest income
1,060

 
1,072

Interest expense
(3,562
)
 
(853
)
Income (loss) from equity method investees
(424
)
 
(131
)
Other income (expense), net
427

 
(18
)
Income (loss) before income taxes and non-controlling interests
(49,145
)
 
(14,062
)
Provision (benefit) for income taxes
(496
)
 
3

Net income (loss)
(48,649
)
 
(14,065
)
Net income (loss) attributable to non-controlling interests
(1,910
)
 
(439
)
Net income (loss) attributable to Evolent Health, Inc.
$
(46,739
)
 
$
(13,626
)
 
 
 
 
Earnings (Loss) Available for Common Shareholders
 
 
 
Basic and Diluted
$
(46,739
)
 
$
(13,626
)
 
 
 
 
Earnings (Loss) per Common Share
 
 
 
Basic and Diluted
$
(0.59
)
 
$
(0.18
)
 
 
 
 
Weighted-Average Common Shares Outstanding
 
 
 
Basic and Diluted
79,335

 
75,375

 
 
 
 
Comprehensive income (loss)
 
 
 
Net income (loss)
$
(48,649
)
 
$
(14,065
)
Other comprehensive income (loss), net of taxes, related to:
 
 
 
Foreign currency translation adjustment
24

 

Total comprehensive income (loss)
(48,625
)
 
(14,065
)
Total comprehensive income (loss) attributable to non-controlling interests
(1,910
)
 
(439
)
Total comprehensive income (loss) attributable to Evolent Health, Inc.
$
(46,715
)
 
$
(13,626
)

(1) See Note 17 for amounts related to related parties 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,
  
2019
 
2018
Cash Flows from Operating Activities
 
 
 
Net income (loss)
$
(48,649
)
 
$
(14,065
)
Adjustments to reconcile net income (loss) to net cash and restricted cash
 
 
 
provided by (used in) operating activities:
 
 
 
(Income) loss from equity method investees
424

 
131

Change in fair value of contingent consideration
100

 
100

Depreciation and amortization expenses
14,266

 
9,496

Amortization of deferred financing costs
2,279

 
229

Stock-based compensation expense
4,537

 
3,795

Deferred tax provision (benefit)
(492
)
 
(42
)
Amortization of contract cost assets
1,250

 
570

Other
427

 
(206
)
Changes in assets and liabilities, net of acquisitions:
 
 
 
Accounts receivables, net and contract assets
14,796

 
(17,135
)
Prepaid expenses and other current and noncurrent assets
(4,174
)
 
(12,610
)
Contract cost assets
(4,565
)
 
(355
)
Accounts payable
(204
)
 
2,334

Accrued liabilities
3,605

 
5,209

Accrued compensation and employee benefits
(9,591
)
 
(19,570
)
Deferred revenue
1,736

 
10,869

Reserves for claims and performance-based arrangements
2,424

 
6,699

ROU operating assets
(12,493
)
 

Operating lease liabilities
13,233

 

Other long-term liabilities
(4,618
)
 
(154
)
Net cash and restricted cash provided by (used in) operating activities
(25,709
)
 
(24,705
)
 
 
 
 
Cash Flows from Investing Activities
 
 
 
Cash paid for asset acquisitions or business combinations
(6,000
)
 
(11,676
)
Customer advance for regulatory capital requirements
(5,400
)
 

Principal repayment of implementation funding loan

 
4,000

Amount received from escrow in asset acquisition

 
500

Purchases of investments
(3,779
)
 

Investments in and advances to equity method investees
(337
)
 
(4,000
)
Investments in internal-use software and purchases of property and equipment
(9,462
)
 
(9,553
)
Purchases of restricted investments
(500
)
 

Maturities of restricted investments

 
8,044

Net cash and restricted cash provided by (used in) investing activities
(25,478
)
 
(12,685
)
 
 
 
 
Cash Flows from Financing Activities
 
 
 
Changes in working capital balances related to claims processing on behalf of partners
(107,500
)
 
(22,268
)
Amount received from escrow in asset acquisition
500

 

Deferred financing costs related to 2025 Notes
(608
)
 

Proceeds from stock option exercises
123

 
1,461

Taxes withheld and paid for vesting of restricted stock units
(2,180
)
 
(800
)
Net cash and restricted cash provided by (used in) financing activities
(109,665
)
 
(21,607
)
Effect of exchange rate on cash and cash equivalents and restricted cash
(19
)
 
(4
)
Net increase (decrease) in cash and cash equivalents and restricted cash
(160,871
)
 
(59,001
)
Cash and cash equivalents and restricted cash as of beginning-of-period
388,325

 
295,363

Cash and cash equivalents and restricted cash as of end-of-period
$
227,454

 
$
236,362


See accompanying Notes to Consolidated Financial Statements
5




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

 
Three Months Ended March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
 
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, 2018
79,172

 
$
792

 
3,190

 
$
31

 
$
1,093,174

 
 
$
(182
)
 
 
$
50,009

 
$
45,532

 
$
1,189,356

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock-based compensation expense

 

 

 

 
4,152

 
 

 
 

 

 
4,152

Exercise of stock options
11

 

 

 

 
123

 
 

 
 

 

 
123

Restricted stock units vested, net of shares withheld for taxes
203

 
2

 

 

 
(2,182
)
 
 

 
 

 

 
(2,180
)
Class A common stock issued for Passport earn-out
43

 

 

 

 
800

 
 

 
 

 

 
800

Amount attributable to NCI from 2019 business combination

 

 

 

 

 
 

 
 

 
6,500

 
6,500

Foreign currency translation adjustment

 

 

 

 

 
 
24

 
 

 

 
24

Net income (loss)

 

 

 

 

 
 

 
 
(46,739
)
 
(1,910
)
 
(48,649
)
Reclassification of non-controlling interests

 

 

 

 
22

 
 

 
 

 
(22
)
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of March 31, 2019
79,429

 
$
794

 
3,190

 
$
31

 
$
1,096,089

 
 
$
(158
)
 
 
$
3,270

 
$
50,100

 
$
1,150,126

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
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, 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 Class B Exchanges

 

 

 

 
908

 
 

 
 

 

 
908

Foreign Currency Translation Adjustment

 

 

 

 

 
 

 
 

 

 

Net income (loss)

 

 

 

 

 
 

 
 
(13,626
)
 
(439
)
 
(14,065
)
Reclassification of non-controlling interests

 

 

 

 
5

 
 

 
 

 
(5
)
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 care 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 health management platform, integrated data and analytics capabilities, claims processing services, pharmacy benefit management, specialty care management 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.

As of March 31, 2019, Evolent Health, Inc. owns 96.1% of Evolent Health LLC, holds 100% of the voting rights, is the sole managing member and controls its operations. Therefore, the financial results of Evolent Health LLC have been consolidated in the financial statements of Evolent Health, Inc.

Since its inception, the Company has incurred losses from operations. As of March 31, 2019, the Company had cash and cash equivalents of $170.8 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, 2018, 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 2018 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 2018 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 (including intangibles and long-lived assets), liabilities (including IBNR), consideration related to business combinations and asset acquisitions, revenue recognition including variable consideration, estimated selling prices for performance obligations in contracts with multiple performance obligations, reserves for claims and performance-based arrangements, 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.


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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 may recognize 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 value-based care services, specialty care management services and comprehensive health plan administration 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 18 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. Transformation services consist of implementation services whereby we assist the customer in launching its population health or health plan strategy. In certain cases, transformation services can also include revenue associated with our support of certain one-time wind-down activities for clients who are exiting a line of business or population. Platform and operations services generally include multi-year arrangements with customers to provide various population health, health plan operations, specialty care management (through performance-based arrangements) and claims processing services on an ongoing basis, as well as transition or run-out services to customers receiving primarily third-party administration (“TPA”) services. Revenue is recognized when control of the services is transferred to our customers.

We use the following 5-step model, outlined in Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”), to determine revenue recognition for our Services segment from our contracts with customers:

Identify the contract(s) with a customer
Identify the 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

Our True Health segment derives revenue from premiums that are earned over the terms of the related insurance policies. True Health also derives revenue from reinsurance premiums assumed from NMHC under the terms of the Reinsurance Agreement (as defined in Note 9). 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.

See Note 5 for further discussion of our policies related to revenue recognition.

Leases
As discussed in Note 3, we adopted Accounting Standards Update (“ASU”) 2016-02 effective January 1, 2019. The following reflects our updated policy for leases.

The Company enters into various office space, data center, and equipment lease agreements in conducting its normal business operations. At the inception of any contract, the Company evaluates the agreement to determine whether the contract contains a lease. If the contract contains a lease, the Company then evaluates the term and whether the lease is an operating or finance lease. Most leases include one or more options to renew or may have a termination option. The Company determines whether these options are reasonably certain to be exercised at the inception of the lease. The rent expense is recognized on a straight-line basis in the consolidated statements of operations and comprehensive income (loss) over the term of the lease. Leases with an initial term of 12 months or less are not recorded on the balance sheet.

As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We use the implicit rate when readily determinable. Further, the Company treats all lease and non-lease components as a single combined lease component for all classes of underlying assets.


8


The Company also enters into sublease agreements for some of its leased office space. Rental income attributable to subleases is offset against rent expense over the terms of the respective leases.

Refer to Note 10 for additional lease disclosures.

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,
 
 
2019
 
 
2018
 
Collateral for letters of credit for facility leases (1)
 
$
3,710

 
 
$
3,710

 
Collateral with financial institutions (2)
 
37,691

 
 
34,142

 
Claims processing services (3)
 
14,939

 
 
122,439

 
Other
 
1,616

 
 
532

 
Total restricted cash and restricted investments
 
57,956

 
 
160,823

 
 
 
 
 
 
 
 
Current restricted investments
 
711

 
 
211

 
Current restricted cash
 
50,209

 
 
154,507

 
Total current restricted cash and restricted investments
 
50,920

 
 
154,718

 
 
 
 
 
 
 
 
Noncurrent restricted investments
 
608

 
 
607

 
Noncurrent restricted cash
 
6,428

 
 
5,498

 
Total noncurrent restricted cash and
 
 
 
 
 
 
restricted investments
 
$
7,036

 
 
$
6,105

 

(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 and other arrangements. As of March 31, 2019, and December 31, 2018, approximately $34.8 million and $31.2 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 16 for discussion of our fair value measurement and Note 9 for discussion of our risk-sharing arrangements. As of March 31, 2019, and December 31, 2018, approximately $2.9 million of the collateral amount was held in FDIC participating bank accounts, primarily related to a line of credit.
(3) Represents cash held by Evolent related to claims processing services on behalf of partners. These are pass-through amounts and can fluctuate materially from period to period depending on the timing of when the claims are processed.

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,
 
 
 
2019
 
 
2018
 
Cash and cash equivalents
 
$
170,817

 
 
$
200,316

 
Restricted cash and restricted investments
 
57,956

 
 
36,757

 
Restricted investments included in
 
 
 
 
 
 
restricted cash and restricted investments
 
(1,319
)
 
 
(711
)
 
Total cash and cash equivalents and restricted cash
 
 
 
 
 
 
shown in the consolidated statements of cash flows
 
$
227,454

 
 
$
236,362

 


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Business Combinations

Companies acquired during each reporting period are reflected in the results of the Company effective from their respective dates of acquisition through the end of the reporting period. The Company allocates the fair value of purchase consideration to the assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. Our estimates of fair value are based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Critical estimates used to value certain identifiable assets include, but are not limited to, expected long-term revenues, future expected operating expenses, cost of capital, and appropriate discount rates.

The excess of the fair value of purchase consideration over the fair value of the assets acquired and liabilities assumed in the acquired entity is recorded as goodwill. Goodwill is assigned to the reporting unit that benefits from the synergies arising from the business combination. If the Company obtains new information about facts and circumstances that existed as of the acquisition date during the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the Company's consolidated statements of operations and comprehensive income (loss).

For contingent consideration recorded as a liability, the Company initially measures the amount at fair value as of the acquisition date and adjusts the liability, if needed, to fair value each reporting period. Changes in the fair value of contingent consideration, other than measurement period adjustments, are recognized as operating income or expense. Acquisition-related expenses and post-acquisition restructuring costs are recognized separately from the business combination and are expensed as incurred.

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. The Company has three reporting units: Legacy Services, New Century Health and True Health. Our annual goodwill impairment review occurs during the fourth quarter of each year. We perform impairment tests between annual tests if an event occurs, or circumstances change, that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

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. Information regarding the determination and allocation of the fair value of recently acquired assets and liabilities is further described within Note 4.

The following summarizes the estimated useful lives by asset classification:

Corporate trade name
10-20 years
Customer relationships
10-25 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.

Reserves for claims and performance-based arrangements

Reserves for claims and performance-based arrangements for our Services and True Health segments reflect estimates of payments under performance-based arrangements and the ultimate cost of claims that have been incurred but not reported, including expected development on reported claims, those that have been reported but not yet paid (reported claims in process), and other medical care expenses and services payable that are primarily comprised of accruals for incentives and other amounts payable to health care professionals and facilities. Reserves for claims and performance-based arrangements also reflect estimated amounts owed to NMHC

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under a reinsurance agreement as discussed further in Note 9. The Company uses actuarial principles and assumptions that are consistently applied in each reporting period and recognizes the actuarial best estimate of the ultimate liability along with a margin for adverse deviation. This approach is consistent with actuarial standards of practice that the liabilities be adequate under moderately adverse conditions.

The process of estimating reserves involves a considerable degree of judgment by the Company and, as of any given date, is inherently uncertain. The methods for making such estimates and for establishing the resulting liability are continually reviewed, and adjustments are reflected in current results of operations in the period in which they are identified as experience develops or new information becomes known. See Note 19 for additional discussion regarding our reserves for claims and performance-based arrangements.

Foreign Currency

The Company formed a subsidiary in India 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 monthly average rates of exchange for revenue and expenses. Translation gains and losses are recorded in accumulated other comprehensive income (loss) as a component of shareholders' equity. Foreign currency translation gains and losses did not have a material impact on our consolidated statements of operations and comprehensive income (loss) for the three months ended March 31, 2019 and 2018.

3. Recently Issued Accounting Standards

Adoption of New Accounting Standards

In February 2016, the Financial Accounting Standards Board (“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. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. In July 2018, the FASB issued ASU 2018-11, which is intended to make targeted improvements to ASU 2016-02. The amendments in ASU 2018-11 provide entities with an additional (and optional) transition method to adopt the new leases standard using an effective date method rather than the earliest comparative period. The requirements of ASU 2018-11 are effective on the same date as the requirements of ASU 2016-02. We adopted ASU 2016-02 as of January 1, 2019, using the modified retrospective approach. Further, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward the historical lease classification. Adoption of the new standard resulted in the recording of additional right-of-use assets and lease liabilities of approximately $51.4 million and $47.4 million, respectively, on our consolidated balance sheet as of January 1, 2019. The standard had no impact on our results of operations.

In August 2018, the FASB issued ASU 2018-15, Intangibles-Goodwill and Other-Internal Use Software: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Services Contract. The amendments in this ASU align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The update is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. The amendments in this update should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. We adopted the requirements of ASU 2018-15 effective January 1, 2019. There was no impact to our consolidated balance sheets or results of operations as of or for the three months ended March 31, 2019.

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 ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with our

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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, including non-controlling interests, in the first quarter of 2018, primarily as a result of capitalization 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.

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.

4. Transactions

Business Combinations

New Century Health
 
On October 1, 2018, the Company completed its acquisition of New Century Health, including 100% of the voting equity interests. New Century Health is a technology-enabled, specialty care management company focused primarily on cancer and cardiac care and its assets include a proprietary technology platform which brings together clinical capabilities, pharmacy management and physician engagement to assist New Century Health’s customers in managing the large and complex specialties of cancer and cardiac care. We expect that the transaction will allow Evolent to enhance its clinical capabilities and enable it to offer a more integrated set of services to its current provider partners.
Total merger consideration, net of cash on hand and certain closing adjustments, was $205.1 million, based on the closing price of the Company’s Class A common stock on the NYSE on October 1, 2018. The merger consideration consisted of $118.7 million of cash consideration, 3.1 million shares of Evolent Health LLC’s Class B common units and an equal number of the Company’s Class B common stock and an earn-out of up to $11.4 million, fair valued at $3.2 million as of October 1, 2018. The merger agreement includes an earn-out of up to $20.0 million, $11.4 million of which is payable to the former owners of New Century Health and $8.6 million of which is payable to former employees of New Century Health that became employees of the Company. The amount payable to the former owners of New Century Health is considered merger consideration. The amount payable to the former employees of New Century Health requires continued employment with the Company and is therefore considered post-combination compensation expense. See Note 16 for additional information regarding the fair value determination of the earn-out consideration and “Part II - Item 8. Financial Statements and Supplementary Data - Note 11” within our 2018 Form 10-K for additional information about the portion of the earn-out that is classified as post-combination compensation expense. The Evolent Health LLC Class B common units, together with a corresponding number of the Company’s Class B common stock, can be exchanged for an equivalent number of the Company’s Class A common stock, and were valued at $83.2 million using the closing price of the Company’s Class A common stock on the NYSE on October 1, 2018.
As a result of the Class B common stock issued for the New Century Health transaction, the Company’s ownership in Evolent Health LLC decreased from 99.0% to 95.3%, immediately following the acquisition. The Company incurred approximately $1.6 million of transaction costs related to the New Century Health transaction during 2018, which are recorded within “Selling, general and administrative expenses” on our consolidated statements of operations and comprehensive income (loss). The Company accounted for the transaction as a business combination using the acquisition method of accounting.
 

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The purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values as of October 1, 2018, as follows (in thousands):

Purchase consideration:
 
Cash
$
124,652

Fair value of Class B common stock issued
83,173

Fair value of contingent consideration
3,200

Total consideration
$
211,025

 
 
Tangible assets acquired:
 
Cash and cash equivalents
$
5,963

Accounts receivable
5,559

Prepaid expenses and other current assets
7,901

Property and equipment
381

Other noncurrent assets
148

 
 
Identifiable intangible assets acquired:
 
Customer relationships
72,500

Technology
27,000

Corporate trade name
4,300

Provider network contracts
9,600

 
 
Liabilities assumed:
 
Accounts payable
1,167

Accrued liabilities
1,494

Accrued compensation and employee benefits
3,966

Reserves for claims and performance-based arrangements
18,631

Deferred tax liabilities
24,041

Other long-term liabilities
6,138

 
 
Goodwill
133,110

Net assets acquired
$
211,025


The fair value of the receivables acquired, as shown in the table above, approximates the gross contractual amounts and is expected to be collectible in full. Identifiable intangible assets associated with customer relationships will be amortized on a straight-line basis over their preliminary estimated useful lives of 15 years. Identifiable intangible assets associated with technology, corporate trade name and provider network contracts will be amortized on a straight-line basis over their preliminary estimated useful lives of 5, 10 and 5 years, respectively. The customer relationships are primarily attributable to long-term existing contracts with current customers. The technology consists of a clinical rules engine portal, data warehouse and claims system that New Century Health uses to provide services to its customers. The corporate trade name reflects the value that the New Century Health brand name carries in the market. The provider network contracts represents the established provider network that New Century Health relies on to provide services to its customers. The fair value of the intangible assets was determined using the income approach, the relief from royalty approach and the cost 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 relief from royalty approach estimates the fair value of an asset by calculating how much an entity would have to spend to lease a similar asset. The cost approach estimates the fair value of an asset by determining the amount that would be required currently to replace the service capacity of an 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. The goodwill is attributable primarily to cross-selling opportunities and the acquired assembled workforce and was all allocated to the Services segment. Goodwill is considered to be an indefinite lived asset.

The merger was structured as a tax-free reorganization and therefore the Company received carryover basis in the assets and liabilities acquired; accordingly, the Company recognized net deferred tax liabilities associated with the difference between the book basis and the tax basis for the assets and liabilities acquired. The goodwill is not deductible for tax purposes.


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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 necessary adjustments will be finalized within one year from the date of acquisition.

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 Company paid cash consideration of $10.3 million in connection with the acquisition. 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 18 for further information about the Company’s segments. 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 agreement with NMHC to provide balance sheet support. See Note 9 for further discussion of the reinsurance agreement. The MSA and reinsurance agreement were considered separate transactions and accounted for outside of the business combination. Therefore, there is no allocation of purchase price to these agreements at fair value.

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 and comprehensive income (loss) for the year ended December 31, 2017. The transaction was accounted for as a business combination using the acquisition method of accounting.

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 replace the 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 assets from NMHC is allocated entirely 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

14


recorded at the True Health legal entity. Therefore, no opening balance sheet deferred tax liability was recorded. The amount of goodwill determined for tax purposes is deductible.
 
The amounts above reflect management’s estimate of the fair value of the tangible and intangible assets acquired and liabilities assumed based on a valuation performed using information available at the date of the transaction.

True Health is a separate segment, and its results of operations are provided in Note 18 - Segment Reporting.

Pro Forma Financial Information (Unaudited)

The unaudited pro forma consolidated statements of operations presented below gives effect to the New Century Health and True Health transactions as if they took place on January 1, 2017. The following pro forma information includes adjustments to:

Remove transaction costs related to the New Century Health transaction of $1.6 million recorded during 2018 and reclassify such amounts to 2017;
Record amortization expenses related to intangible assets beginning on January 1, 2017, for intangibles acquired as part of the New Century Health and True Health transactions;
Record revenue and expenses related to the NMHC MSA beginning January 1, 2017;
Record stock-based compensation expense beginning on January 1, 2017, for equity awards granted as part of the New Century Health transaction; and
Record the issuance of Class B common shares as part of the New Century Health transaction as of January 1, 2017.

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,
 
2019
 
2018
Revenue
$
197,756

 
$
184,630

Net income (loss)
(48,649
)
 
(14,885
)
Net income (loss) attributable to non-controlling interests
(1,881
)
 
(972
)
Net income (loss) attributable to Evolent Health, Inc.
(46,768
)
 
(13,913
)
 
 
 
 
Net income (loss) per Common Share available to common shareholders
 
 
 
Basic and Diluted
$
(0.59
)
 
$
(0.18
)

Securities Offerings and Sales

Under an exchange agreement we entered into at the time of our IPO, we granted TPG, The Advisory Board Company (“The Advisory Board”) 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.

2018 Private Sales

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. Subsequent to this Class B Exchange, in

15


June 2018, The Advisory Board sold all of their remaining shares of the Company’s Class A common stock and no longer owns any shares of our Class A common stock, Class B common stock or Class B units held by the Advisory Board at the time of the IPO.

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.

In November 2018, TPG sold 0.8 million shares of the Company’s Class A common stock in a number of private sales (the “November 2018 Private Sales”). The shares sold in the November 2018 Private Sales consisted of 0.1 million existing shares of the Company’s Class A common stock owned by TPG and 0.7 million newly-issued shares of the Company’s Class A common stock received by TPG pursuant to Class B Exchanges. The Company did not receive any proceeds from the November 2018 Private Sales. These sales represented all of TPG’s remaining equity interest in the Company and TPG no longer owns any of the shares of the Company’s Class A common stock, Class B common stock or Evolent Health LLC Class B common units held by TPG at the time of the IPO.

As a result of these Class B Exchanges and Evolent Health LLC’s cancellation of the Class B common units during the November 2018 Private Sales, the Company’s economic interest in Evolent Health LLC increased from 95.3% to 96.1% immediately following the November 2018 Private Sales, and, accordingly, we reclassified a portion of our non-controlling interests into shareholders’ equity attributable to Evolent Health, Inc.

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

5. Revenue Recognition

Our Services segment derives revenue from two sources: (1) transformation services and (2) platform and operations services.

Transformation Services Revenue
 
Transformation services consist of implementation services whereby we assist the customer in launching its population health or health plan strategy. In certain cases, transformation services can also include revenue associated with our support of certain one-time wind-down activities for clients who are exiting a line of business or population. 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, specialty care management (through performance-based arrangements) and claims processing services on an ongoing basis, as well as transition or run-out services to customers receiving primarily TPA services. 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 and members. 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

16


consideration customer demographics, current market conditions, the scope of services and our overall pricing strategy and objectives when determining the standalone selling price.
 
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 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 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.
 
Disaggregation of Revenue
 
The following table represents Evolent’s Services segment revenue disaggregated by revenue type (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, Financial Services-Insurance.
 
  
 
For the Three
 
 
Months Ended
  
 
March 31,
 
 
2019
 
2018
Services Revenue
 
 
 
 
Transformation services
 
$
3,353

 
$
6,505

Platform and operations services
 
147,292

 
108,420


Transaction Price Allocated to the Remaining Performance Obligations

For contracts with a term that is greater than one year, we have allocated approximately $84.6 million of transaction price to performance obligations that are unsatisfied or partially unsatisfied as of March 31, 2019. 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 we expect 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 revenue on approximately 56% and 88% of these remaining performance obligations by December 31, 2019, and December 31, 2020, respectively, with the remaining balance to be recognized thereafter. 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 and the timing of recognition may not be as expected.

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. Our current accounts receivable are classified within “Accounts receivable, net” on our consolidated balance sheets and our noncurrent accounts receivable are classified within “Prepaid expenses and other noncurrent 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.


17


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

 
 
As of
 
 
As of
 
 
March 31,
December 31,
 
 
2019
 
2018
Short-term receivables (1)
 
$
63,886

 
 
$
78,380

 
Long-term receivables (1)
 
6,550

 
 
6,550

 
Short-term contract assets
 
1,282

 
 
2,102

 
Long-term contract assets
 
1,695

 
 
961

 
Short-term deferred revenue
 
22,320

 
 
20,584

 
Long-term deferred revenue
 
443

 
 
1,502

 
(1) Excludes pharmacy claims receivable and premiums receivable

Changes in contract assets and deferred revenue for the three months ended March 31, 2019, were as follows (in thousands):

Contract assets
 
 
Balance as of beginning-of-period
 
$
3,063

Reclass to receivables, as the right
 
 
to consideration becomes unconditional
 
(1,183
)
Contract assets recognized, net of
 
 
reclass to receivables
 
1,097

Balance as of end-of-period
 
$
2,977

Deferred revenue
 
 
Balance as of beginning-of-period
 
$
22,086

Reclass to revenue, as a result
 
 
of performance obligations satisfied
 
(11,807
)
Cash received in advance of satisfaction
 
 
of performance obligations
 
12,484

Balance as of end-of-period
 
$
22,763


The amount of revenue recognized during the three months ended March 31, 2019, from performance obligations satisfied (or partially satisfied) in previous periods was immaterial.

Contract Cost Assets

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 and comprehensive income (loss). As of March 31, 2019 and December 31, 2018, the Company had $2.5 million and $1.5 million of contract acquisition cost assets, net of accumulated amortization. The Company recorded amortization expense of $0.1 million and less than $0.1 million for the three months ended March 31, 2019 and 2018, respectively.

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. Amortization expense is recorded within “Cost of revenue” on the accompanying consolidated statements of operations and comprehensive income (loss). As of March 31, 2019 and December 31, 2018, the Company had $20.0 million and 17.6 million of contract fulfillment cost assets, net of accumulated amortization. The Company recorded amortization expense of $1.2 million and $0.5 million for the three months ended March 31, 2019 and 2018, respectively.


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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,
  
 
2019
 
 
2018
 
Computer hardware
 
$
10,850

 
 
$
10,421

 
Furniture and equipment
 
3,226

 
 
3,187

 
Internal-use software development costs
 
90,284

 
 
81,640

 
Leasehold improvements
 
10,011

 
 
10,118

 
Total property and equipment
 
114,371

 
 
105,366

 
Accumulated depreciation and amortization
 
(36,992
)
 
 
(31,738
)
 
Total property and equipment, net
 
$
77,379

 
 
$
73,628

 

The Company capitalized $8.7 million and $10.5 million of internal-use software development costs for the three months ended March 31, 2019 and 2018, respectively. The net book value of capitalized internal-use software development costs was $67.4 million and $62.8 million as of March 31, 2019, and December 31, 2018, respectively.

Depreciation expense related to property and equipment was $5.2 million for the three months ended March 31, 2019, of which amortization expense related to capitalized internal-use software development costs was $4.1 million. 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.

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 three reporting units: Legacy Services, New Century Health 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 the 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, revenues 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, 2019. We will perform our annual impairment test as of October 31, 2019.


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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, 2019
 
 
 
Services
 
 
True Health
 
Consolidated
Balance as of beginning-of-period (1)
 
$
762,419

 
 
$
5,705

 
 
$
768,124

 
Goodwill Acquired
 
2,200

 
 

 
 
2,200

 
Measurement period adjustments
 

 
 

 
 

 
Foreign currency translation
 
10

 
 

 
 
10

 
Balance as of end-of-period
 
$
764,629

 
 
$
5,705

 
 
$
770,334

 

(1) Net of cumulative inception to date impairment of $160.6 million.

 
 
For the Year Ended December 31, 2018
 
 
 
Services
 
 
True Health
 
Consolidated
Balance as of beginning-of-period (1)
 
$
628,186

 
 
$

 
 
$
628,186

 
Goodwill Acquired (2)
 
134,343

 
 
5,826

 
 
140,169

 
Measurement period adjustments (3)
 
4

 
 
(121
)
 
 
(117
)
 
Foreign currency translation (4)
 
(114
)
 
 

 
 
(114
)
 
Balance as of end-of-period
 
$
762,419

 
 
$
5,705

 
 
$
768,124

 

(1) Net of cumulative inception to date impairment of $160.6 million.
(2) Goodwill acquired primarily as a result of the New Century Health and True Health transactions, as discussed in Note 4.
(3) Measurement period adjustments related to transactions completed during the first quarter of 2018.
(4) Foreign currency translation related to a transaction completed during the first quarter of 2018.

Intangible Assets, Net

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

 
 
As of March 31, 2019
 
 
Weighted-
 
 
 
 
 
 
 
 
Average
 
Gross
 
 
 
Net
 
Remaining
Carrying
Accumulated
Carrying
  
Useful Life
Amount
Amortization
Value
Corporate trade name
 
14.9
 
$
23,300

 
$
3,856

 
$
19,444

Customer relationships
 
17.6
 
291,519

 
32,818

 
258,701

Technology
 
2.7
 
82,922

 
36,261

 
46,661

Below market lease, net
 
3.8
 
4,097

 
3,037

 
1,060

Provider network contracts
 
4.4
 
11,900

 
1,535

 
10,365

Total
 
 
 
$
413,738

 
$
77,507

 
$
336,231


 
 
As of December 31, 2018
  
 
Weighted-
 
 
 
 
 
 
 
 
Average
 
Gross
 
 
 
Net
 
Remaining
Carrying
Accumulated
Carrying
 
Useful Life
Amount
Amortization
Value
Corporate trade name
 
15.2
 
$
23,300

 
$
3,511

 
$
19,789

Customer relationships
 
18.1
 
281,219

 
29,184

 
252,035

Technology
 
3.0
 
82,922

 
31,764

 
51,158

Below market lease, net
 
4.0
 
4,097

 
3,003

 
1,094

Provider network contracts
 
4.6
 
11,900

 
940

 
10,960

Total
 
 
 
$
403,438

 
$
68,402

 
$
335,036



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Amortization expense related to intangible assets was $9.1 million and $5.9 million for the three months ended March 31, 2019 and 2018, respectively.

Future estimated amortization of intangible assets (in thousands) as of March 31, 2019, is as follows:

2019
$
28,419

2020
33,309

2021
29,173

2022
25,292

2023
22,528

Thereafter
197,510

Total
$
336,231


Intangible assets are reviewed for impairment if circumstances indicate the Company may not be able to recover the assets’ carrying value. We did not identify any circumstances during three months ended March 31, 2019, that would require an impairment test for our intangible assets.

8. Long-term Debt

2025 Notes

In October 2018, the Company issued $172.5 million aggregate principal amount of its 1.50% Convertible Senior Notes due 2025 in a private placement to qualified institutional buyers within the meaning of Rule 144A under the Securities Act of 1933, as amended. The 2025 Notes were issued at par for net proceeds of $166.6 million. We incurred $5.9 million of debt issuance costs in connection with the 2025 Notes. The closing of the private placement of $150.0 million aggregate principal amount of the 2025 Notes occurred on October 22, 2018, and the Company completed the offering and sale of an additional $22.5 million aggregate principal amount of the 2025 Notes on October 24, 2018, pursuant to the initial purchasers’ exercise in full of their option to purchase additional notes.

Holders of the 2025 Notes are entitled to cash interest payments, which are payable semiannually in arrears on April 15 and October 15 of each year, beginning on April 15, 2019, at a rate equal to 1.50% per annum. The Company recorded interest expense of $0.6 million related to the 2025 Notes for the three months ended March 31, 2019. The 2025 Notes will mature on October 15, 2025, unless earlier repurchased, redeemed or converted in accordance with their terms prior to such date.

Prior to the close of business on the business day immediately preceding April 15, 2025, the 2025 Notes will be convertible at the option of the holders only upon the satisfaction of certain conditions, as described in the indenture, dated as of October 22, 2018, between the Company and U.S. Bank National Association, as trustee. At any time on or after April 15, 2025, until the close of business on the business day immediately preceding the maturity date, holders may convert, at their option, all or any portion of their notes at the conversion rate.

The 2025 Notes will be convertible at an initial conversion rate of 29.9135 shares of Class A common stock per $1,000 principal amount of notes, which is equivalent to an initial conversion price of approximately $33.43 per share of the Company’s Class A common stock. In the aggregate, the 2025 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 fundamental change or a notice of redemption as described in the governing indenture). The conversion rate may be adjusted under certain circumstances. The 2025 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, the Company will pay or deliver, as the case may be, cash or shares of the Company’s Class A common stock, or a combination of cash and shares of the Company’s Class A common stock, at the Company’s election.

The option to settle the 2025 Notes in cash or shares of the Company’s Class A common stock, or a combination of cash and shares of the Company’s Class A common stock, at the Company’s election, resulted in a bifurcation of the carrying value of the 2025 Notes into a debt component and an equity component. The debt component was determined to be $100.7 million, before issuance costs, based on the fair value of a nonconvertible debt instrument with the same term. The equity component was determined to be $71.8 million, before issuance costs, and was recorded within additional paid-in capital. The equity component is the difference between the aggregate principal amount of the debt and the debt component. Issuance costs of $5.9 million are also allocated to the debt and equity components in proportion to the allocation of proceeds. Of the $5.9 million in issuance costs, $3.4 million of issuance costs is allocated to the debt component which, along with the equity component of $71.8 million, will be amortized to non-cash interest expense using the effective interest method over the contractual term of the 2025 Notes. The equity component recorded within

21


additional paid-in capital will not be remeasured as long as it meets the conditions for equity classification. For the three months ended March 31, 2019, the Company recorded $2.0 million in non-cash interest expense related to the amortization of the debt discount and the issuance costs allocated to the debt component.

Holders of the 2025 Notes may require the Company to repurchase all or part of their notes upon the occurrence of a fundamental change at a price equal to 100.0% of the principal amount of the notes being repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date. The Company may not redeem the 2025 Notes prior to October 20, 2022. The Company may redeem for cash all or any portion of the 2025 Notes, at its option, on or after October 20, 2022, if the last reported sale price of the Company’s Class A common stock has been at least 130.0% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which the Company provides notice of redemption, at a redemption price equal to 100.0% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.

2021 Notes

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 100.0% 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, 2019 and 2018, the Company recorded approximately $0.6 million in interest expense and $0.2 million 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

The 2025 Notes and 2021 Notes are recorded on our accompanying unaudited interim consolidated balance sheets at their net carrying values of $100.8 million and $122.5 million, respectively, as of March 31, 2019. However, the 2025 Notes and 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 values as of March 31, 2019, were $136.7 million and $121.4 million, respectively, based on traded prices on April 3, 2019, and March 28, 2019, respectively, which are Level 2 inputs. The fair values of the 2025 Notes and 2021 Notes as of December 31, 2018, were $158.8 million and $133.6 million, respectively, based on traded prices on December 28, 2018, and December 26, 2018, respectively, which are Level 2 inputs. The 2025 Notes and 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,
 
 
2019
 
 
2018
 
2025 Notes
 
 
 
 
 
 
Carrying value
 
$
100,779

 
 
$
98,730

 
Unamortized debt discount and
 
 
 
 
 
 
issuance costs allocated to debt
 
71,721

 
 
73,770

 
Principal amount
 
$
172,500

 
 
$
172,500

 
Remaining amortization period (years)
 
6.5

 
 
6.8

 
 
 
 
 
 
 
 
2021 Notes
 
 
 
 
 
 
Carrying value
 
$
122,541

 
 
$
122,311

 
Unamortized issuance costs
 
2,459

 
 
2,689

 
Principal amount
 
$
125,000

 
 
$
125,000

 
Remaining amortization period (years)
 
2.7

 
 
2.9

 

9. Commitments and Contingencies

Commitments

Commitments to Equity-Method Investees

The Company has contractual arrangements with certain equity-method investees that will require the Company to provide operating capital and reserve support in the form of debt financing of up to $11.0 million as of March 31, 2019 and December 31, 2018, in accordance with the Company’s contribution agreements with certain equity-method investees. These obligations are outside of Company’s control and payment could be requested during 2019.

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 on June 30, 2019. The letter of credit is presented at the face amount plus accrued facility rental fee, less received payments. There were no outstanding balances related to this letter of credit as of March 31, 2019, or December 31, 2018.

Lease Commitments

The Company enters into various office space, data center, and equipment lease agreements in conducting its normal business operations. In connection with certain office space lease agreements, the Company is required to maintain $3.7 million in letters of credit and, as such, held $3.7 million in restricted cash and restricted investments as collateral for the letters of credit as of March 31, 2019. Refer to Note 10 for additional discussion regarding leases.

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.


23


Pre-IPO Investor Registration Rights Agreement

We entered into a registration rights agreement with The Advisory Board, the University of Pittsburgh Medical Center (“UPMC”), TPG and another investor to register for sale under the Securities Act of 1933, as amended, 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.

We will 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 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 of 1933, as amended, state law or otherwise. We did not incur any expenses related to secondary offerings or other sales of shares by our Investor Stockholders for the three months ended March 31, 2019 and 2018.

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 captive insurance entity as well as state insurance regulators, Evolent entered into letters of credit of $34.8 million as of March 31, 2019, to secure potential losses related to insurance services. This amount is in excess of our actuarial assessment of loss.

Reinsurance Agreements
 
During the fourth quarter of 2017, the Company had entered into a 15-month, $10.0 million capital-only reinsurance agreement with NMHC, which expired on December 31, 2018. The purpose of the capital-only reinsurance was to provide balance sheet support to NMHC. There was no uncertainty to the outcome of the agreement as there was no transfer of underwriting risk to Evolent or True Health, and neither Evolent nor True Health was at risk for any cash payments on behalf of NMHC. As a result, this agreement did not qualify for reinsurance accounting. The Company recorded a quarterly fee of approximately $0.2 million as non-operating income on its consolidated statements of operations and comprehensive income (loss) and maintained $10.0 million within “Restricted Cash and Restricted Investments” on its consolidated balance sheets for the duration of the reinsurance agreement.

During the fourth quarter of 2018, the Company terminated its prior reinsurance agreement with NMHC and entered into a 15-month quota-share reinsurance agreement with NMHC (“Reinsurance Agreement”). Under the terms of the Reinsurance Agreement, NMHC will cede 90% of its gross premiums to the Company and the Company will indemnify NMHC for 90% of its claims liability. The maximum amount of exposure to the Company is capped at 105% of premiums ceded to the Company by NMHC. The Reinsurance Agreement qualified for reinsurance accounting due to the deemed risk transfer and, as such, the Company will record the full amount of the gross reinsurance premiums and claims assumed by the Company within “Premiums” and “Claims Expenses,” respectively, and record claims-related administrative expenses within “Selling, general and administrative expenses” on our consolidated statements of operations and comprehensive income (loss) from the legal effective date of the Reinsurance Agreement. Amounts owed to NMHC under the Reinsurance Agreement are recorded within “Reserves for claims and performance-based arrangements” on our consolidated balance sheets. Amounts owed by NMHC under the Reinsurance Agreement are recorded within “Accounts receivable, net” on our consolidated balance sheets.


24


The following table summarizes premiums and claims assumed under the Reinsurance Agreement for the three months ended March 31, 2019 (in thousands):

Reinsurance premiums assumed
$
25,441

Claims assumed
21,151

Claims-related administrative expenses
4,282

(Increase) decrease in reserves for claims and performance-based
 
arrangements attributable to the Reinsurance Agreement
8

Reserves for claims and performance-based arrangements
 
attributable to the Reinsurance Agreement at the beginning of the period
1,243

Reinsurance payments
1,243

Receivables for claims and performance-based arrangements
 
attributable to the Reinsurance Agreement at the end of the period
$
8


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.

Contingencies

Tax Receivables Agreement

In connection with the Offering Reorganization (as described in our 2018 Form 10-K), the Company entered into the Tax Receivables Agreement (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 Evolent Health, Inc. 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.

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, 2019, 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.

25



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, 2019, approximately 80.3% of our $227.5 million of cash and cash equivalents (including restricted cash) were held in bank deposits with FDIC participating banks, approximately 19.3% 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,
 
 
2019
 
 
2018
 
Customer C
 
15.4
%
 
 
23.3
%
 

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,
 
 
2019
 
2018
Customer A
 
14.0
%
 
*

Customer B
 
13.1
%
 
20.1
%
Customer C
 
*

 
10.6
%
 
* Represents less than 10.0% of the respective balance

10. Leases

The Company enters into various office space, data center, and equipment lease agreements in conducting its normal business operations. At the inception of any contract, the Company evaluates the agreement to determine whether the contract contains a lease. If the contract contains a lease, the Company then evaluates the term and whether the lease is an operating or finance lease. Most leases include one or more options to renew or may have a termination option. The Company determines whether these options are reasonably certain to be exercised or not at the inception of the lease. The rent expense is recognized on a straight-line basis in the consolidated statements of operations and comprehensive income (loss) over the term of the lease. Leases with an initial term or 12 months or less are not recorded on our consolidated balance sheets.
As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We use the implicit rate when readily determinable. Further, the Company treats all lease and non-lease components as a single combined lease component for all classes of underlying assets.
The Company also enters into sublease agreements for some of its leased office space. Rental income attributable to subleases is offset against rent expense over the terms of the respective leases.

26


The following table summarizes the components of our lease expense (in thousands):

  
For the Three
 
Months Ended
  
 
March 31,
 
 
 
2019
 
Operating lease cost
 
$
3,281

 
Variable lease cost
 
1,455

 
Total lease cost
 
$
4,736

 

As discussed in Note 3, the Company adopted ASU 2016-02 effective January 1, 2019, which resulted in accounting for leases under ASC 842. Prior to the adoption, we accounted for leases under ASC 840. In accordance with ASC 840, rent expense, net of sublease income, on operating leases was $3.3 million for the three months ended March 31, 2018.

Maturity of lease liabilities (in thousands) as of March 31, 2019, is as follows:

 
Operating lease
 
expense (1)
2019
 
$
5,226

 
2020
 
8,613

 
2021
 
8,719

 
2022
 
7,563

 
2023
 
7,414

 
2024 and thereafter
 
47,118

 
Total lease payments
 
84,653