NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Organization
Evolent Health, Inc. was incorporated in December 2014 in the state of Delaware and through its subsidiaries supports leading health systems and physician organizations to move their business models from traditional fee for service reimbursement to value-based care, which we consider to be an integrated clinical and financial responsibility for populations.
Since its inception, the Company has incurred losses from operations. As of March 31, 2022, the Company had unrestricted cash and cash equivalents of $210.2 million. The Company believes it has sufficient liquidity for the next twelve months as of the date the financial statements were available to be issued.
The Company’s headquarters is located in Arlington, Virginia.
Evolent Health LLC Governance
Our operations are conducted through Evolent Health LLC. Evolent Health, Inc. is a holding company whose only business is to act as the sole managing member of Evolent Health LLC. As such, it controls Evolent Health LLC’s business and affairs and is responsible for the management of its business.
Note 2. Basis of Presentation, Summary of Significant Accounting Policies and Change in Accounting Principles
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 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 2021 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 2021 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 assets, goodwill and long-lived assets), liabilities, 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, credit losses, depreciable lives of assets, impairment of long-lived assets, stock-based compensation, deferred income taxes and valuation allowance, contingent liabilities, purchase price allocation in taxable stock transactions and useful lives of intangible assets.
Principles of Consolidation
The consolidated financial statements include the accounts of Evolent Health, Inc. and its subsidiaries. All intercompany accounts and transactions are eliminated in consolidation.
Cash and Cash Equivalents
We consider all highly liquid instruments with original maturities of three months or less to be cash equivalents. The Company holds materially all of our cash in bank deposits with FDIC participating banks, at cost, which approximates fair value. Cash and cash equivalents held in money market funds are carried at fair value, which approximates cost.
Restricted Cash and Restricted Investments
Restricted cash and restricted investments include cash and investments used to collateralize various contractual obligations (in thousands) as follows:
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
Collateral for letters of credit for facility leases (1) | $ | 2,269 | | | $ | 3,769 | |
Collateral with financial institutions (2) | 11,499 | | | 11,662 | |
Claims processing services (3) | 38,855 | | | 73,226 | |
| Other | 5 | | | 5 | |
| Total restricted cash and restricted investments | $ | 52,628 | | | $ | 88,662 | |
| | | |
| Current restricted cash | 39,647 | | | 75,685 | |
| Total current restricted cash and restricted investments | $ | 39,647 | | | $ | 75,685 | |
| | | |
| Non-current restricted cash | 12,981 | | | 12,977 | |
| Total non-current restricted cash and restricted investments | $ | 12,981 | | | $ | 12,977 | |
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(1)Represents restricted cash related to collateral for letters of credit required in conjunction with lease agreements. See Note 12 for further discussion of our lease commitments.
(2)Represents collateral held with financial institutions for risk-sharing and other arrangements. As of March 31, 2022 and December 31, 2021, approximately $11.5 million and $11.7 million, respectively, of the collateral amounts were held in a FDIC participating bank account. See Note 17 for discussion of fair value measurement and Note 11 for discussion of our risk-sharing arrangements.
(3)Represents cash held by the Company 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 amounts shown in the consolidated statements of cash flows (in thousands):
| | | | | | | | | | | |
| March 31, |
| 2022 | | 2021 |
| Cash and cash equivalents | $ | 210,158 | | | $ | 236,032 | |
| Restricted cash and restricted investments | 52,628 | | | 67,737 | |
| Restricted investments included in restricted cash and restricted investments | — | | | — | |
Total cash and cash equivalents and restricted cash shown in the consolidated statements of cash flows (1) | $ | 262,786 | | | $ | 303,769 | |
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(1)As a result of the closing of the sale of True Health during the first quarter of 2021, the consolidated statement of operations and related financial information reflect the Company’s operations and assets and liabilities of True Health as discontinued operations. Cash flows and comprehensive income have not been adjusted and are included in the consolidated statements of cash flows and consolidated statements of comprehensive income (loss) for the three months ended March 31, 2021. See Note 5.
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 on 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 at 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 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. Following the sale of True Health, the Company has three reporting units and 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 we believe would more likely than not reduce the fair value of a reporting unit below its carrying amount.
Our goodwill impairment analysis first assesses qualitative factors to determine whether events or circumstances existed that would lead the Company to conclude it is more likely than not that the fair value of a reporting unit is below its carrying amount. If the Company determines that it is more likely than not that the fair value of a reporting unit is below the carrying amount, a quantitative goodwill assessment is required. In the quantitative evaluation, the fair value of the relevant reporting unit is determined and compared to the carrying value. If the fair value is greater than the carrying value, then the carrying value is deemed to be recoverable and no further action is required. If the fair value estimate is less than the carrying value, goodwill is considered impaired for the amount by which the carrying amount exceeds the reporting unit’s fair value and a charge is reported in goodwill impairment on our consolidated statements of operations and comprehensive income (loss).
Intangible Assets, Net
Identified intangible assets are recorded at their estimated fair values at the date of acquisition and are amortized over their respective estimated useful lives using a method of amortization that reflects the pattern in which the economic benefits of the intangible assets are used.
The 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 | 3 - 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 9 for additional discussion regarding our intangible assets.
Research and Development Costs
Research and development costs consist primarily of personnel and related expenses (including stock-based compensation and employee taxes and benefits) for employees engaged in research and development activities as well as third-party fees. All such costs are expensed as incurred. We focus our research and development efforts on activities that support our technology infrastructure, clinical program development, data analytics and network development capabilities. Research and development costs are recorded within selling, general and administrative expenses on our consolidated statements of operations and comprehensive income (loss) and were $4.1 million and $3.4 million for the three months ended March 31, 2022 and 2021, respectively.
Reserves for Claims and Performance-based Arrangements
Reserves for claims and performance-based arrangements 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 composed of accruals for incentives and other amounts payable to health care professionals and facilities. 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 21 for additional discussion regarding our reserves for claims and performance-based arrangements.
Right of Offset
Certain customer arrangements give the Company the legal right to net payment for amounts due from customers and claims payable. As of March 31, 2022 and December 31, 2021, approximately 35% and 42% of gross accounts receivable was netted against claims payable in lieu of cash receipt. Furthermore, as of March 31, 2022, approximately 39% of our accounts receivable, net could ultimately be settled on a net basis, once the criteria for netting have been met.
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 terms of the respective leases. Leases with an initial term of 12 months or less are not recorded on the 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 immaterial and is offset against rent expense over the terms of the respective leases.
Refer to Note 12 for additional lease disclosures.
Revenue Recognition
We derive 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 programs, or implement certain platform and operations services. 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 and claims processing services on an ongoing basis, as well as transition or run-out services to customers receiving primarily 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 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
See Note 6 for further discussion of our policies related to revenue recognition.
Note 3. Recently Issued Accounting Standards
Adoption of New Accounting Standards
In December 2019, the FASB issued ASU No. 2019-12, Simplifying the Accounting for Income Taxes. The amendments in the ASU remove certain exceptions to the intraperiod tax allocation of losses and gains from different financial statement components and to the method of recognizing income taxes on interim period losses and the recognition of deferred tax liabilities for outside basis differences. In addition, the new guidance simplifies aspects of the accounting for franchise taxes and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The Company adopted this standard starting in the first quarter of 2021, which did not have a material impact on our consolidated financial statements.
In August 2020, the FASB issued ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The ASU simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts in an entity’s own equity. Specifically, the ASU removes the separation models for convertible debt with a cash conversion feature or convertible instruments with a beneficial conversion feature and no longer permits the use of the treasury stock method from calculating earnings per share. As a result, after adopting the ASU’s guidance, we do not separately present in equity an embedded conversion feature of such debt. Instead, we account for a convertible debt instrument wholly as debt unless (i) a convertible instrument contains features that require bifurcation as a derivative or (ii) a convertible debt instrument was issued at a substantial premium. Additionally, the ASU removes certain conditions for equity classification related to contracts in an entity’s own equity (e.g., warrants) and amends certain guidance related to the computation of earnings per share for convertible instruments and contracts on an entity’s own equity. The Company adopted the standard using a modified retrospective method on January 1, 2022, with adjustments which increased retained earnings by $39.8 million, reduced additional paid-in capital by $106.2 million and increased the net carrying amount of the 2024 and 2025 Notes by $25.1 million and $41.3 million, respectively.
Recent Accounting Pronouncements Not Yet Effective
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which requires contract assets and contract liabilities acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, Revenue from Contracts with Customers. This approach differs from the current requirement to measure contract assets and contract liabilities acquired in a business combination at fair value. This new standard is effective for our interim and annual periods beginning after December 15, 2022, with early adoption permitted. We are currently evaluating the adoption impacts on our consolidated financial statements.
Note 4. Transactions
Business Combinations
Vital Decisions
On October 1, 2021, the Company completed its acquisition of Vital Decisions, including 100% of the voting equity interests. Vital Decisions is a leading provider of technology-enabled advance care planning services, ensuring that the care of individuals with serious illness aligns with their values and changing preferences throughout their health journey and, in particular, as they approach end-of-life decisions. The transaction is expected to deepen our capabilities, allowing us to cross-sell across customers and enhance our value proposition to partners.
Total merger consideration, net of cash on hand and certain closing adjustments, was $117.7 million, based on the closing price of the Company’s Class A common stock on the NYSE on October 1, 2021. The merger consideration consisted of $46.5 million of cash consideration, 1.8 million shares of Class A common stock, fair valued at $56.6 million as of October 1, 2021, and an earn-out of up to $45.0 million, fair valued at $14.6 million as of October 1, 2021. See Note 18 for additional information regarding the fair value determination of the earn-out consideration.
The purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values as of October 1, 2021, as follows (in thousands):
| | | | | |
| Purchase consideration: |
| Cash | $ | 46,500 | |
| Fair value of Class A common stock issued | 56,626 | |
| Fair value of contingent consideration | 14,600 | |
| Total consideration | $ | 117,726 | |
| | | | | |
| |
| Tangible assets acquired: | |
| Cash and cash equivalents | $ | 1,430 | |
| Accounts receivable | 3,301 | |
| Prepaid expenses and other current assets | 78 | |
| Other non-current assets | 2,564 | |
| Total tangible assets acquired | 7,373 | |
| |
| Identifiable intangible assets acquired: | |
| Customer relationships | 32,500 | |
| Technology | 5,000 | |
| Corporate trade name | 2,500 | |
| Total identifiable intangible assets acquired | 40,000 | |
| |
| Liabilities assumed: | |
| Accounts payable | 93 | |
| Accrued liabilities | 661 | |
| Accrued compensation and employee benefits | 970 | |
| Deferred tax liabilities, net | 499 | |
| Deferred revenue | 2,000 | |
| Operating lease liabilities | 2,712 | |
| Total liabilities assumed | 6,935 | |
| |
| Goodwill | 77,288 | |
| Net assets acquired | $ | 117,726 | |
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, technology and corporate trade names will be amortized on a straight-line basis over their preliminary estimated useful lives of 13 years, 5 years, and 15 years, respectively. The customer relationships are primarily attributable to existing contracts with current customers. The technology consists primarily of a proprietary advance care planning documentation portal where patients can input information, and doctor/patient conversations are populated for later reference. The corporate trade name reflects the value that we believe the Vital Decisions brand name carries in the market. The fair value of the intangible assets was determined using the income approach and the relief from royalty 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. 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 Clinical Solutions segment. Goodwill is considered to be an indefinite lived asset. $69.6 million of the goodwill recorded on the transaction is deductible for tax purposes.
The amounts above reflect management’s preliminary estimate of the fair value of the tangible and intangible assets acquired and liabilities assumed. Any necessary adjustments will be finalized by the end of the third quarter of 2022.
Note 5. Discontinued Operations
On January 11, 2021, Evolent Health LLC, EH Holdings and True Health, each wholly owned subsidiaries of the Company, entered into a Stock Purchase Agreement (the “True Health SPA”) with Bright Health Management, Inc. (“Bright HealthCare”), pursuant to which EH Holdings agreed to sell all of its equity interests in True Health to Bright HealthCare. Closing of the transactions contemplated by the True Health SPA occurred on March 31, 2021 (the “True Health Closing”) and the Company has had no continuing involvement with True Health subsequent to the closing except a pre-existing services agreement for claims processing and other health plan administrative functions.
As of the first quarter of 2021, the Company determined that True Health met the discontinued operations criteria under ASC 205, and as such, True Health assets and liabilities as of December 31, 2020, and the results of operations for all periods presented are classified as discontinued operations and are not included in continuing operations in the consolidated financial statements.
The following table summarizes the results of operations of the Company’s True Health business, which are included in income from discontinued operations in the consolidated statements of operations and comprehensive income (loss) for the three months ended March 31, 2021:
| | | | | |
| Revenue | |
| Platform and operations | $ | 38 | |
| Premiums | 44,795 | |
| Total revenue | 44,833 | |
| |
| Expenses | |
Cost of revenue (exclusive of depreciation and amortization expenses presented separately below) (1) | 5,885 | |
| Claims expenses | 33,954 | |
Selling, general and administrative expenses (2) | 5,764 | |
| Depreciation and amortization expenses | 160 | |
| Total operating expenses | 45,763 | |
| Operating loss | (930) | |
| Interest income | 112 | |
| Interest expense | (4) | |
| Other loss | (25) | |
| Loss before income taxes and non-controlling interests | (847) | |
| Provision for income taxes | (326) | |
| Net loss | $ | (521) | |
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(1)Cost of revenue includes intercompany expenses between the Company and True Health that are recorded in income from continuing operations in the consolidated statements of operations and comprehensive income (loss) related to an existing services agreement for claims processing and other health plan administrative functions of $2.8 million for the three months ended March 31, 2021.
(2)Selling, general and administrative expenses includes intercompany expenses between the Company and True Health that are recorded in income from continuing operations on the consolidated statements of operations and comprehensive income (loss) related to an existing services agreement for claims processing and other health plan administrative functions of $1.1 million for the three months ended March 31, 2021.
The consolidated statements of cash flows for all periods have not been adjusted to separately disclose cash flows related to discontinued operations. Cash flows related to the True Health business during the three months ended March 31, 2021:
| | | | | |
| Cash flows provided by operating activities | $ | 5,002 | |
| Cash flows used in investing activities | (2,494) | |
Note 6. Revenue Recognition
We derive 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 programs. 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. Transformation revenue is 0.7% of total revenue for the three months ended March 31, 2022.
Platform and Operations Services Revenue
Platform and operations services are typically multi-year arrangements with customers to provide various clinical and administrative solutions. In our Clinical Solutions segment, our solutions are designed to lower the medical expenses of our partners and include our total cost of care and specialty care management services. In our Evolent Health Services segment, our solutions are designed to provide comprehensive health plan operations and claims processing services, and also include transition or run-out services to customers receiving primarily third-party administration (“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 includes 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 from 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.
In our Clinical Solutions segment, we enter into capitation arrangements that may include performance-based arrangements and/or gainshare features. We recognize capitation revenue on a gross basis when we have established control over the services within our scope and recognize capitation revenue on a net basis when we do not have control over the services within our scope.
Contracts with Multiple Performance Obligations
Our contracts with customers may contain multiple performance obligations, primarily when the customer has requested both transformation services and platform and operations services as these services are distinct from one another. When a contract has multiple performance obligations, we allocate the transaction price to each performance obligation based on the relative standalone selling price using the expected cost margin approach. This approach requires estimates regarding both the level of effort it will take to satisfy the performance obligation as well as fees that will be received under the variable pricing model. We also take into consideration customer demographics, current market conditions, the scope of services and our overall pricing strategy and objectives when determining the standalone selling price.
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. As we integrate goods and services provided by third parties into our overall service, we control the goods and services provided to the customer prior to its delivery. As such, we are the principal and we will recognize revenue on a gross basis. In certain cases, we act as an agent and do not control the services from third parties before it is delivered to the customer thereby recognizing revenue on a net basis.
Disaggregation of Revenue
The following table represents Evolent’s revenue disaggregated by segment and end-market for (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Evolent Health Services | | Clinical Solutions |
| Medicaid | $ | 66,914 | | | $ | 60,929 | | | $ | 63,587 | | | $ | 43,339 | |
| Medicare | 4,833 | | | 8,338 | | | 99,566 | | | 85,783 | |
| Commercial and other | 35,111 | | | 15,571 | | | 27,046 | | | 1,111 | |
| Total | $ | 106,858 | | | $ | 84,838 | | | $ | 190,199 | | | $ | 130,233 | |
Transaction Price Allocated to the Remaining Performance Obligations
For contracts with a term greater than one year, we have allocated approximately $162.0 million of transaction price to performance obligations that are unsatisfied as of March 31, 2022. 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 37%, 64% and 84% of these remaining performance obligations by December 31, 2022, 2023 and 2024, 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 revenue that we actually receive may be less or greater 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 non-current based on the timing of our rights to the unconditional payments. Our contract assets are generally classified as current and recorded within prepaid expenses and other current assets on our consolidated balance sheets. Our current accounts receivables are classified within accounts receivable, net on our consolidated balance sheets and our non-current accounts receivable are classified within prepaid expenses and other non-current 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 non-current 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 non-current deferred revenue is recorded within other long-term liabilities on our consolidated balance sheets.
The following table provides information about receivables, contract assets and deferred revenue from contracts with customers as of March 31, 2022 and December 31, 2021 (in thousands):
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
Short-term receivables (1) | $ | 176,300 | | | $ | 129,012 | |
Long-term receivables (1) | 4,958 | | | 4,877 | |
| Short-term deferred revenue | 13,288 | | | 11,944 | |
| Long-term deferred revenue | 4,019 | | | 4,437 | |
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(1)Excludes pharmacy claims receivable and premiums receivable.
Changes in deferred revenue for the three months ended March 31, 2022 are as follows (in thousands):
| | | | | |
| Deferred revenue | |
| Balance as of beginning-of-period | $ | 16,381 | |
| Reclassification to revenue, as a result of performance obligations satisfied | (10,124) | |
| Cash received in advance of satisfaction of performance obligations | 11,050 | |
| Balance as of end of period | $ | 17,307 | |
The amount of revenue recognized from performance obligations satisfied (or partially satisfied) in a previous period was $26.5 million for the three months ended March 31, 2022 due primarily to net gain share as well as changes in other estimates.
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 non-current 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, 2022 and December 31, 2021, the Company had $3.9 million and $5.2 million, respectively, of contract acquisition cost assets, net of accumulated amortization recorded in contract cost assets on the consolidated balance sheets. In addition, the Company recorded amortization expense of $1.4 million and $0.4 million for the three months ended March 31, 2022 and 2021, respectively.
In our platform 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 non-current 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, 2022 and December 31, 2021, the Company had $18.1 million and $27.4 million, respectively, of contract fulfillment cost assets, net of accumulated amortization recorded in contract cost assets on the consolidated balance sheets. In addition, the Company recorded amortization expense including the acceleration of amortization of contract costs for certain customers of $10.3 million and $2.7 million for the three months ended March 31, 2022 and 2021, respectively.
These costs are deferred and then amortized on a straight-line basis over a period of benefit that we have determined to be the shorter of the contract term or five years. The period of benefit was based on our technology, the nature of our customer arrangements and other factors.
Note 7. Credit Losses
We are exposed to credit losses primarily through our accounts receivable from revenue transactions, investments held at amortized cost and customer advances for regulatory capital and other notes receivable. We estimate expected credit losses based on past events, current conditions and reasonable and supportable forecasts. Expected credit losses are measured over the remaining contractual life of these assets. As part of our consideration of current and forward-looking economic conditions, we considered the impact of the COVID-19 pandemic on our customers’ and other third parties’ ability to pay. We did not observe notable increases in delinquencies during the three months ended March 31, 2022. Given the nature of our business, our past collection experience during recessionary and pre-recessionary periods and our forecasted impact of the COVID-19 pandemic on our business, we did not record material changes in our allowances due to the COVID-19 pandemic during the three months ended March 31, 2022.
Accounts Receivable from Revenue Transactions
Accounts receivable represent the amounts owed to the Company for goods or services provided to customers or third parties. Current accounts receivables are classified within accounts receivable, net on the Company’s consolidated balance sheets, while non-current accounts receivables are classified within prepaid expenses and other noncurrent assets on the Company’s consolidated balance sheets.
We monitor our ongoing credit exposure through active review of counterparty balances against contract terms, due dates and business strategy. Our activities include timely account reconciliation, dispute resolution and payment confirmation. We may employ legal counsel to pursue recovery of defaulted receivables. In addition, the Company will establish a general reserve based on delinquency rates. Historical loss rates are determined for each delinquency bucket in 30-day past-due intervals and then applied to the composition of the reporting date balance based on delinquency. The allowance implied from application of the historical loss rates is then adjusted, as necessary, for current conditions and reasonable and supportable forecasts.
Based on an aging analysis of our trade accounts receivable, non-trade accounts receivable and contract assets as of March 31, 2022, 87% were current, 4% were past due less than 60 days, with 6% past due less than 120 days and at December 31, 2021, 90% was current, 2% was past due less than 60 days, with 3% past due less than 120 days. As of March 31, 2022 and December 31, 2021, in total we reported on the consolidated balance sheet $194.8 million and $171.5 million of accounts receivable, certain non-trade accounts receivable included in prepaid expenses and other assets, net of allowances of $2.2 million and $3.4 million, respectively. The following table summarizes the changes in allowance for credit losses on our accounts receivables, certain non-trade accounts receivable and contract assets for the three months ended March 31, 2022 and 2021 (in thousands):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 |
| Balance as of beginning of period | $ | (3,374) | | | $ | (7,056) | |
| Provision for credit losses | 1,203 | | | (2,327) | |
| Balance as of end of period | $ | (2,171) | | | $ | (9,383) | |
Note 8. Property and Equipment, Net
The following summarizes our property and equipment (in thousands):
| | | | | | | | | | | |
| | March 31, 2022 | | December 31, 2021 |
| Computer hardware | $ | 24,409 | | | $ | 21,970 | |
| Furniture and equipment | 3,769 | | | 3,581 | |
| Internal-use software development costs | 166,033 | | | 159,587 | |
| Leasehold improvements | 15,075 | | | 15,325 | |
| Total property and equipment | 209,286 | | | 200,463 | |
| Accumulated depreciation and amortization expenses | (126,409) | | | (119,098) | |
| Total property and equipment, net | $ | 82,877 | | | $ | 81,365 | |
The Company capitalized $6.4 million and $5.5 million of internal-use software development costs for the three months ended March 31, 2022 and 2021, respectively. The net book value of capitalized internal-use software development costs was $70.9 million and $71.2 million as of March 31, 2022 and December 31, 2021, respectively.
Depreciation expense related to property and equipment was $7.6 million and $7.8 million for the three months ended March 31, 2022 and 2021, respectively, of which amortization expense related to capitalized internal-use software development costs was $6.7 million, $6.7 million, respectively.
Note 9. 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, each with discrete financial information. Our assets and liabilities are employed in and relate to the operations of our reporting units. Therefore, the equity carrying value and future cash flows must be estimated each time a goodwill impairment analysis is performed on a reporting unit. As a result, our assets, liabilities and cash flows are assigned to reporting units using reasonable and consistent allocation methodologies.
Our annual goodwill impairment review occurs on October 31 of each fiscal year. We 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 management, 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, 2022. We will perform our annual impairment test of October 31, 2022.
2021 Goodwill Impairment Test
On October 31, 2021, the Company performed its annual goodwill impairment review for fiscal year 2021. Based on our qualitative assessment, we did not identify sufficient indicators of impairment that would suggest the fair value of any of our three reporting units was below their respective carrying values. As a result, a quantitative goodwill impairment analysis was not required.
Change in Goodwill
The following table summarizes the changes in the carrying amount of goodwill, by reportable segment, for the periods presented (in thousands):
| | | | | | | | | | | | | | | | | |
| EHS | | Clinical Solutions | | Consolidated |
Balance as of December 31, 2021(1) | $ | 214,334 | | | $ | 211,963 | | | $ | 426,297 | |
| Foreign currency translation | (23) | | | — | | | (23) | |
| Balance as of March 31, 2022 | $ | 214,311 | | | $ | 211,963 | | | $ | 426,274 | |
| | | | | |
Balance as of December 31, 2020(1) | $ | 214,354 | | | $ | 134,675 | | | $ | 349,029 | |
| Foreign currency translation | (7) | | | — | | | (7) | |
| Balance as of March 31, 2021 | $ | 214,347 | | | $ | 134,675 | | | $ | 349,022 | |
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(1)Net of cumulative inception to date impairment of $575.5 million as of both December 31, 2021 and 2020.
Intangible Assets, Net
Details of our intangible assets (in thousands, except weighted-average useful lives) as of March 31, 2022 and December 31, 2021 are presented below:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
| | Weighted- Average Remaining Useful Life | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Value | | Weighted- Average Remaining Useful Life | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Value |
| Corporate trade name | 12.2 | | $ | 25,800 | | | $ | 8,079 | | | $ | 17,721 | | | 12.4 | | $ | 25,800 | | | $ | 7,693 | | | $ | 18,107 | |
| Customer relationships | 14.7 | | 311,019 | | | 76,912 | | | 234,107 | | | 14.9 | | 311,019 | | | 72,697 | | | 238,322 | |
| Technology | 1.7 | | 87,922 | | | 75,254 | | | 12,668 | | | 2.0 | | 87,922 | | | 73,378 | | | 14,544 | |
| Below market lease, net | 1.1 | | 1,218 | | | 1,000 | | | 218 | | | 1.3 | | 1,218 | | | 950 | | | 268 | |
Provider network contracts (1) | 1.9 | | 16,236 | | | 8,737 | | | 7,499 | | | 2.2 | | 16,417 | | | 7,874 | | | 8,543 | |
| Total intangible assets, net | | | $ | 442,195 | | | $ | 169,982 | | | $ | 272,213 | | | | | $ | 442,376 | | | $ | 162,592 | | | $ | 279,784 | |
Amortization expense related to intangible assets for both the three months ended March 31, 2022 and 2021 was $7.5 million, excluding $0.2 million of amortization expense related to discontinued operations for the three months ended March 31, 2021.
Future estimated amortization of intangible assets (in thousands) as of March 31, 2022, is as follows:
| | | | | |
| 2022 | $ | 21,675 | |
| 2023 | 26,760 | |
| 2024 | 20,875 | |
| 2025 | 19,330 | |
| 2026 | 19,153 | |
| Thereafter | 164,420 | |
| Total future amortization of intangible assets | $ | 272,213 | |
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 the three months ended March 31, 2022, that would require an impairment test for our intangible assets.
Note 10. Long-term Debt
2024 Notes
In August 2020, the Company issued $117.1 million aggregate principal amount of its 3.50% Convertible Senior Notes due 2024 (the “2024 Notes”) in privately negotiated exchange and/or subscription agreements, with certain holders of its outstanding 2021 Notes and certain new investors. The Company issued $84.2 million aggregate principal amount of 2024 Notes in exchange for $84.2 million aggregate principal amount of the 2021 Notes and an aggregate cash payment of $2.5 million, and issued $32.8 million aggregate principal amount of New Notes for cash at par. We incurred $3.0 million of debt issuance costs in connection with the 2024 Notes, which we are amortizing to non-cash interest expense using the straight-line method over the contractual term of the 2024 Notes. The closing of the private placement of the 2024 Notes occurred on August 19, 2020.
Holders of the 2024 Notes are entitled to cash interest payments, which are payable semiannually in arrears on June 1 and December 1 of each year, beginning on December 1, 2020, at a rate equal to 3.50% per annum. The 2024 Notes will mature on December 1, 2024, unless earlier repurchased, redeemed or converted in accordance with their terms prior to such date. Upon maturity the principal amount of the notes may be settled via shares of the Company’s Class A common stock. We recorded interest expense of $1.0 million and $1.0 million for the three months ended March 31, 2022 and 2021, respectively.
The 2024 Notes are convertible into cash, 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, based on an initial conversion rate of 54.8667 shares of Class A common stock per $1,000 principal amount of the 2024 Notes, which is equivalent to an initial conversion price of approximately $18.23 per share of the Company’s Class A common stock. In the aggregate, the 2024 Notes are initially convertible into 6.4 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 or a notice of redemption under the governing indenture). The conversion rate may be adjusted under certain circumstances. 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 2024 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 2024 Notes into a debt component and an equity component prior to the adoption of ASU 2020-06. The debt component was determined to be $78.9 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 $38.1 million before issuance costs and was recorded within additional paid-in capital. Issuance costs of $1.7 million and $1.3 million were allocated to the debt and equity components in proportion to the allocation of proceeds. Along with the equity component of $38.1 million, $1.7 million of issuance costs was amortized to interest expense on the consolidated statements of operations and comprehensive income (loss) using the effective interest method.
On January 1, 2022, we adopted ASU 2020-06 using the retrospective transition method. As a result, prior period financial information and disclosures are not adjusted and continue to be reported under the accounting standards that were in effect prior to the adoption of ASU 2020-06. The adoption of ASU 2020-06 resulted in the combination of the debt and equity components of the 2024 Notes into a single debt instrument recorded in long term debt, net on the consolidated balance sheet. This resulted in a $38.1 million decrease in additional paid-in capital and a $1.3 million increase in additional paid-in capital from the previously bifurcated equity component from deferred financing fees, respectively, and an $11.7 million decrease to the January 1, 2022 accumulated deficit, representing the cumulative non-cash interest expense recognized related to the amortization of the debt discount associated with the bifurcated equity component of the 2024 Notes. These adjustments resulted in an increase of $25.1 million to the debt component of the 2024 Notes. Additionally, the allocation of the issuance costs to the equity component and all issuance costs related to the 2024
Notes are being amortized to interest expense using the effective interest method over the contractual term of the 2024 Notes which is included in the cumulative adjustment to the opening balance of accumulated deficit. The Company recorded $0.2 million and $1.9 million of interest expense related to the amortization of the issuance costs for the three months ended March 31, 2022 and 2021, respectively.
Holders of the 2024 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 2024 Notes prior to March 1, 2023. The Company may redeem for cash all or any portion of the 2024 Notes, at its option, on or after March 1, 2023, 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.
Credit Agreement
On December 30, 2019, the Company entered into a credit agreement, by and among the Company, Evolent Health LLC, as the borrower (the “Borrower”), certain subsidiaries of the Company, as guarantors, the lenders from time to time party thereto, and Ares Capital Corporation, as administrative agent and collateral agent, together with the Company (the “Credit Agreement”), pursuant to which the lenders agreed to extend credit to the Borrower in the form of (i) an initial secured term loan in the aggregate principal amount of $75.0 million (the “Initial Term Loan Facility”) and (ii) a delayed draw secured term loan facility in the aggregate principal amount of up to $50.0 million (the “DDTL Facility” and, together with the Initial Term Loan Facility, the “Senior Credit Facilities”), subject to the satisfaction of specified conditions. The Borrower borrowed the loan under the Initial Term Loan Facility on December 30, 2019. The proceeds of the Initial Term Loan were used to finance the transactions contemplated by the Passport APA and pay fees and expenses incurred in connection therewith.
On August 19, 2020, an amendment to the Company's Credit Agreement became effective. The amendment effected changes to, among other things, permit the Company's use of cash in the exchange transactions in connection with the issuance of the 2024 Notes, permit the issuance of the 2024 Notes and permit certain note repurchases, as well as to implement amendments to certain minimum liquidity thresholds.
On January 8, 2021, the Company repaid all outstanding amounts owed under and terminated the Credit Agreement with Ares Capital Corporation. The total amount paid to Ares Capital Corporation under the Credit Agreement in connection with the prepayment was $98.6 million, which included $9.7 million for the make-whole premium as well as $0.2 million in accrued interest. As a result of this transaction, the Company recorded a loss on the repayment of debt of $19.2 million, representing the remaining unamortized debt issuance costs of $9.5 million, the make-whole premium and $35 thousand of legal expenses.
Warrant Agreement
In conjunction with the Company’s entry into the Credit Agreement, the Company entered into warrant agreements whereby it agreed to sell to the holders of the warrants an aggregate of 1,513,786 shares of Class A common stock at a per share purchase price equal to $8.05. The holders could exercise the warrants at any time until thirty days after the maturity of the Credit Agreement. The Company, at its sole discretion, could elect to pay the holders in cash in an amount determined based on the fair market value of the Class A common stock for the shares of Class A common stock issuable upon exercise of the warrants in lieu of delivering the shares.
On January 8, 2021, the Company settled the outstanding warrants associated with the Credit Agreement for $13.7 million.
2025 Notes
In October 2018, the Company issued $172.5 million aggregate principal amount of its 1.50% Convertible Senior Notes due 2025 (the “2025 Notes”) in a private placement to qualified institutional buyers within the meaning of Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”). 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 for the three months ended March 31, 2022 and 2021 respectively. 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. 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 prior to the adoption of ASU 2020-06. 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 $3.4 million and $2.5 million are allocated to the debt and equity components in proportion to the allocation of proceeds. Along with the equity component of $71.8 million, $3.4 million of issuance costs will be amortized to interest expense on the consolidated statements of operations and comprehensive income (loss) using the effective interest method over the contractual term of the 2025 Notes.
On January 1, 2022, we adopted ASU 2020-06 using the retrospective transition method. As a result, prior period financial information and disclosures are not adjusted and continue to be reported under the accounting standards that were in effect prior to the adoption of ASU 2020-06. The adoption of ASU 2020-06 resulted in the combination of the debt and equity components of the 2024 Notes into a single debt instrument recorded in long term debt, net on the consolidated balance sheet. This resulted in a $71.8 million decrease in additional paid-in capital and a $2.5 million increase in additional paid-in capital from the previously bifurcated equity component from deferred financing fees, respectively, and a $28.1 million decrease to the January 1, 2022 accumulated deficit, representing the cumulative non-cash interest expense recognized related to the amortization of the debt discount associated with the bifurcated equity component of the 2025 Notes. These adjustments resulted in an increase of $41.3 million to the debt component of the 2025 Notes. Additionally, the allocation of the issuance costs to the equity component and all issuance costs related to the 2025 Notes are being amortized to interest expense using the effective interest method over the contractual term of the 2025 Notes which is included in the cumulative adjustment to the opening balance of accumulated deficit. The Company recorded $0.3 million and $2.4 million for the three months ended March 31, 2022 and 2021 respectively, in interest expense related to the amortization of the issuance costs.
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. 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 amortized 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.
In August 2020, as part of the issuance of the 2024 Notes, the Company issued $84.2 million aggregate principal amount of the 2024 Notes in exchange for $84.2 million aggregate principal of its 2021 Notes. There was no cash consideration in these exchanges outside of an aggregate cash payment of $2.5 million paid to exchanging noteholders. These exchanges were accounted for as an extinguishment resulting in a net loss on extinguishment of debt of $4.8 million, including an aggregate cash payment of $2.5 million paid to exchanging noteholders.
In August 2020, we also repurchased $14.0 million of the 2021 Notes with $13.9 million of cash and recorded an immaterial gain on extinguishment of debt.
Upon maturity of the 2021 Notes on December 1, 2021, outstanding 2021 Notes with a principal amount of $26.7 million were settled, at the option of the holders, by converting $26.3 million aggregate principal amount of 2021 Notes to common shares and cash repayment of $0.4 million aggregate principal amount of 2021 Notes. Shares issued were valued based on the quoted trading prices on the conversion date for a total fair value of $28.5 million resulting in a loss on debt extinguishment of $2.2 million which was recorded in loss on repayment of debt on our consolidated statements of operations and comprehensive income (loss) for the year ended December 31, 2021.
Convertible Senior Notes Carrying Value
The 2024 Notes and 2025 Notes are recorded on our accompanying consolidated balance sheets at their net carrying values as of March 31, 2022. However, the 2024 Notes and 2025 Notes are privately traded by qualified institutional buyers (within the meaning of Rule 144A under the Securities Act) and their fair values are Level 2 inputs. The 2024 Notes and 2025 Notes also have embedded conversion options and contingent interest provisions, which have not been recorded as separate financial instruments. The following table summarizes the carrying value of the long-term convertible debt as of March 31, 2022 and December 31, 2021 (in thousands):
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
| 2024 Notes | | | |
| Carrying value | $ | 114,672 | | | $ | 89,361 | |
| Unamortized debt discount and issuance costs | 2,379 | | | 27,690 | |
| Principal amount | $ | 117,051 | | | $ | 117,051 | |
| Remaining amortization period (years) | 2.7 | | 2.9 |
Fair value(1) | $ | 209,973 | | | $ | 195,445 | |
| | | |
| 2025 Notes | | | |
| Carrying value | $ | 167,926 | | | $ | 126,315 | |
| Unamortized debt discount and issuance costs | 4,574 | | | 46,185 | |
| Principal amount | $ | 172,500 | | | $ | 172,500 | |
| Remaining amortization period (years) | 3.5 | | 3.8 |
Fair value(1) | $ | 203,648 | | | $ | 177,251 | |
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(1)Fair values for notes are derived from available trading prices closest to the respective balance sheet date.
Note 11. Commitments and Contingencies
Commitments
Letters of Credit
As of March 31, 2022 and December 31, 2021, the Company was party to irrevocable standby letters of credit with a bank for $13.7 million and $15.4 million, respectively, for the benefit of regulatory authorities, real estate and risk-sharing agreements. As such, we held $13.7 million and $15.4 million, respectively, in restricted cash and restricted investments as collateral as of March 31, 2022 and December 31, 2021. The letters of credit have current expiration dates between June 2022 and March 2032 and will automatically extend without amendment for an additional one-year period and will continue to automatically extend after each one-year term from the expiry date unless the bank elects not to extend beyond the initial or any extended expiry date.
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.
Pre-IPO Investor Registration Rights Agreement
We entered into a registration rights agreement with The Advisory Board, UPMC, TPG and another investor to register for sale under the Securities Act shares of our Class A common stock, including those delivered in exchange for Class B common stock and Class B common units. Subject to certain conditions and limitations, this agreement provides these investors with certain demand, piggyback and shelf registration rights. The registration rights granted under the registration rights agreement will terminate upon the date the holders of shares that are a party thereto no longer hold any such shares that are entitled to registration rights. Pursuant to our contractual obligations under this agreement, we filed a registration statement on Form S-3 with the SEC on July 28, 2016, which was declared effective on August 12, 2016.
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, state law or otherwise. We did not incur any expenses related to secondary offerings or other sales of shares by our investor stockholders during the three months ended March 31, 2022 and 2021, respectively.
Guarantees
On July 16, 2020, EVH Passport, Evolent Health LLC and Molina Healthcare, Inc. (“Molina”) entered into an Asset Purchase Agreement (the “Molina APA”), which contemplated the sale by EVH Passport to Molina of certain assets, including certain intellectual property rights of EVH Passport and EVH Passport’s rights under the Passport Medicaid Contract. On September 1, 2020, EVH Passport and Molina consummated the transactions contemplated by the Molina APA (the “Molina Closing”) and the Passport Medicaid Contract was novated to Molina. In connection with the Molina Closing, the Company continued to provide administrative support services relating to the Passport Medicaid Contract to Molina through the end of 2020. Following the Molina Closing, EVH Passport began working with regulatory authorities including the Kentucky Department of Insurance (“KY DOI”) regarding the wind down of its operations throughout 2021. As part of that wind down process, the Company, as the parent of EVH Passport, entered into a guarantee for the benefit of the KY DOI to satisfy any EVH Passport liability or obligation in the event EVH Passport is not able to meet its wind down liabilities or obligations. As of March 31, 2022, no amounts have been funded under this guarantee.
Reinsurance Agreements
On December 30, 2019, UHC, PHS I, the Company and EVH Passport consummated the transactions contemplated by the Passport APA (the “Passport Closing”). As part of the Passport Closing, EVH Passport and UHC entered into an agreement that provided for the administration and assumption of the financial risks by EVH Passport of the D-SNP Business until such time as EVH Passport became certified as a Medicare Advantage Organization and the D-SNP Business could be transferred to EVH Passport. On October 1, 2020, the D-SNP Business was transferred from UHC to EVH Passport.
At the Molina Closing, Molina and EVH Passport entered into an agreement that provided for the assumption of the financial risks by Molina of the D-SNP Business until such time as Molina’s Kentucky health plan becomes certified as a Medicare Advantage Organization and the D-SNP Business is transferred to Molina. The Company and EVH Passport continued to administer the D-SNP Business until January 1, 2021, at which time Molina became responsible for its administration until the D-SNP Business was officially transferred to Molina effective September 1, 2021.
The following summarizes premiums and claims assumed under the Reinsurance Agreements (in thousands):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 |
| Reinsurance premiums assumed | $ | (2) | | | $ | 8,845 | |
| Claims assumed | (37) | | | 10,494 | |
| Claims-related administrative expenses | — | | | 545 | |
| Increase (decrease) in reserves for claims and performance-based arrangements attributable to the Reinsurance Agreement | 35 | | | (2,194) | |
| Reserves for claims and performance-based arrangements attributable to the Reinsurance Agreement at the beginning of the period | 90 | | | 4,002 | |
| Impact of consolidation on payable for claims and performance-based arrangements attributable to the Reinsurance Agreement | — | | | — | |
| Reinsurance payments paid (received) | (330) | | | — | |
| Payable for claims and performance-based arrangements attributable to the Reinsurance Agreement at the end of the period | $ | 455 | | | $ | 1,808 | |
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, 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.
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.
On August 8, 2019, a shareholder of the Company filed a class action complaint against the Company, asserting claims under Section 10(b) and 20(a) of the Securities Exchange Act of 1934, in the United States District Court, Eastern District of Virginia, Alexandria Division. An amended complaint was filed on January 10, 2020, a second amended complaint was filed on June 8, 2020, and a third amended complaint, now titled Plymouth County Retirement System v. Evolent Health, Inc., Frank Williams, Nicholas McGrane, Seth Blackley, was filed on December 2, 2021. The case alleges that the Company’s executives made false or misleading statements regarding its business with Passport. The Company filed a motion to dismiss the second amended complaint, and the Eastern District of Virginia granted in part and denied in part the motion on March 24, 2021. The case entered the discovery phase, and was again stayed pending a decision on the Company’s third motion to dismiss. The Eastern District of Virginia granted in part and denied in part the motion to dismiss the third amended complaint on March 18, 2022. The case is again in discovery phase. Based on the Company’s investigation, we believe the case has little legal or factual merit. However, the outcome of any litigation is uncertain.
On June 8, 2021, a shareholder of the Company filed a derivative action in the Delaware Chancery Court against some current and former Board members and against the Company as a nominal defendant, alleging that the Company’s Board was negligent in its oversight of the Company’s relationship with Passport Health Plan. The case is Lincolnshire Police Pension Fund, derivatively on behalf of Evolent Health, Inc., v. Blackley, Williams, Scott, Holder, Farner, D’Amato, Duffy, Felt, Samet, Hobart, and Payson, and Evolent Health, Inc. (“Derivative Action”). The Company and the Director-Defendants filed a motion to dismiss the complaint on August 27, 2021, and Plaintiffs responded by filing an amended complaint on October 26, 2021. Defendants filed a motion to dismiss the amended complaint on December 17, 2021. The case had been stayed until the decision on the Company’s motion to dismiss the third amended was decided on March 18, 2022 in Plymouth County Retirement System v. Evolent Health., Frank Williams, Nicky McGrane, and Seth Blackley, in federal district court. Briefing on the motion to dismiss is ongoing and will be completed in July. Based on the Company’s investigation, we believe the case has little legal or factual merit. However, the outcome of any litigation is uncertain.
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, 2022, approximately 99.6% of our $262.8 million of cash and cash equivalents, restricted cash and restricted investments were held in bank deposits with FDIC participating banks and approximately 0.4% 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 the partners who represented at least 10.0% of our consolidated short-term trade accounts receivable as of March 31, 2022 and December 31, 2021:
| | | | | | | | | | | |
| | March 31, 2022 | | December 31, 2021 |
| Florida Blue Medicare, Inc. | 35.3% | | 46.4% |
| Cook County Health and Hospitals System | 27.9% | | * |
| Molina Healthcare | * | | 10.4% |
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 consolidated revenue for the three months ended March 31, 2022 and 2021:
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 (1) |
| Cook County Health and Hospitals Systems | 23.9% | | 28.8% |
| Florida Blue Medicare, Inc. | 11.9% | | 14.7% |
————————
(1)The denominator excludes $44.8 million of True Health premium revenue reclassified to discontinued operations for the three months ended March 31, 2021.
We derive a significant portion of our revenues from our largest partners. The loss, termination or renegotiation of our relationship or contract with any significant partner or multiple partners in the aggregate could have a material adverse effect on the Company's financial condition and results of operations.
Note 12. 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. In addition, some leases contain escalation clauses. 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 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. Immaterial rental income attributable to subleases is offset against rent expense over the terms of the respective leases.
The Company leases office space and computer and other equipment under operating lease agreements expiring at various dates through 2031. Under the lease agreements, in addition to base rent, the Company is generally responsible for operating and maintenance costs and related fees. Several of these agreements include tenant improvement allowances, rent holidays or rent escalation clauses. When such items are included in a lease agreement, we record a deferred rent asset or liability on our consolidated balance sheets equal to the difference between rent expense and future minimum lease payments due. The rent expense related to these items is recognized on a straight-line basis over the terms of the leases. The Company’s primary office location is in Arlington, Virginia, which has served as its corporate headquarters since 2013. The Arlington, Virginia office lease expires in January 2032. Certain leases acquired as part of the Valence Health transaction included existing sublease agreements for office locations in Chicago, Illinois.
In connection with various lease agreements, the Company is required to maintain $2.3 million and $3.8 million in letters of credit as of March 31, 2022 and December 31, 2021. As of March 31, 2022 and December 31, 2021, the Company held $2.3 million and $3.8 million in restricted cash and restricted investments on the consolidated balance sheet as collateral for the letters of credit, respectively.
The following table summarizes our primary office leases as of March 31, 2022 (in thousands, other than term):
| | | | | | | | | | | | | | | | | | | | |
| Location | | Lease Termination Term (in years) | | Future Minimum Lease Commitments | | Letter of Credit Amount Required |
| Arlington, VA | | 9.8 | | $ | 34,798 | | | $ | 1,579 | |
| Riverside, IL | | 9.0 | | 40,569 | | | 232 | |
| Edison, NJ | | 4.1 | | 2,081 | | | 222 | |
| Pune, India | | 1.5 | | 1,130 | | | — | |
| Brea, CA | | 0.2 | | 185 | | | — | |
The following table summarizes the components of our lease expense (in thousands):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 |
| Operating lease cost | $ | 2,274 | | | $ | 4,818 | |
| Variable lease cost | 1,326 | | | 1,321 | |
| Total lease cost | $ | 3,600 | | | $ | 6,139 | |
Maturity of lease liabilities (in thousands) as of March 31, 2022, is as follows:
| | | | | |
| Operating lease expense |
| 2022 | 7,921 | |
| 2023 | 9,258 | |
| 2024 | 8,968 | |
| 2025 | 8,653 | |
| 2026 | 7,988 | |
| Thereafter | 39,972 | |
| Total lease payments | 82,760 | |
| Less: | |
| Interest | 19,961 | |
| Present value of lease liabilities | $ | 62,799 | |
Our weighted-average discount rate and our weighted remaining lease terms (in years) are as follows:
| | | | | |
| March 31, 2022 |
| Weighted average discount rate | 6.40 | % |
| Weighted average remaining lease term | 8.6 |
Note 13. Loss Per Common Share
The following table sets forth the computation of basic and diluted earnings per share available for common stockholders (in thousands, except per share data):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 |
| Loss from continuing operations | $ | (5,350) | | | $ | (11,190) | |
| Income from discontinued operations, net of tax | — | | | 1,383 | |
| Net loss available for common shareholders - basic and diluted | $ | (5,350) | | | $ | (9,807) | |
| | | |
| Weighted-average common shares outstanding - basic and diluted | 89,509 | | | 84,670 | |
| | | |
| Loss per common share | | | |
| Basic and diluted | | | |
| Continuing operations | $ | (0.06) | | | $ | (0.13) | |
| Discontinued operations | — | | | 0.01 | |
| Basic and diluted loss per share attributable to common shareholders of Evolent Health, Inc. | $ | (0.06) | | | $ | (0.12) | |
Anti-dilutive shares excluded from the calculation of weighted-average common shares presented above are presented below (in thousands):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 |
| Restricted stock units ("RSUs"), performance-based RSUs (“PSUs”) and leveraged stock units ("LSUs") | 2,161 | | | 1,531 | |
| Stock options | 1,756 | | | 1,865 | |
| Convertible senior notes | 11,582 | | | 12,696 | |
| Total | 15,499 | | | 16,092 | |
Note 14. Stock-based Compensation
Total compensation expense by award type and line item in our consolidated financial statements was as follows (in thousands):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| | 2022 | | 2021 |
| Award Type | | | |
| Stock options | $ | 162 | | | $ | 404 | |
| RSUs | 3,301 | | | 1,974 | |
| LSUs | 775 | | | 1,085 | |
| PSUs | 1,108 | | | 243 | |
| Total compensation expense by award type | $ | 5,346 | | | $ | 3,706 | |
| | | |
| Line Item | | | |
| Cost of revenue | $ | 800 | | | $ | 595 | |
| | | | | | | | | | | |
| Selling, general and administrative expenses | 4,546 | | | 3,111 | |
| Total compensation expense by financial statement line item | $ | 5,346 | | | $ | 3,706 | |
No stock-based compensation was capitalized as software development costs for the three months ended March 31, 2022 and 2021.
Stock-based awards were granted as follows (in thousands):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 |
| RSUs | 917 | | | 939 | |
| PSUs | 479 | | | 319 | |
Note 15. Income Taxes
For interim periods, we recognize an income tax provision (benefit) based on our estimated annual effective tax rate expected for the full year.
An income tax expense of $1.2 million and $0.6 million was recognized for the three months ended March 31, 2022 and 2021, respectively, which resulted in effective tax rates of (29.0)% and (5.8)%, respectively. The Company and its U.S. subsidiaries continue to record a valuation allowance against its net deferred tax assets, with the exception of indefinite lived components. The income tax expense recorded during the three months ended March 31, 2022 primarily relates to foreign taxes.
As of December 31, 2021, the Company had unrecognized tax benefits of $0.6 million that, if recognized, would not affect the effective tax rate due to the valuation allowance against its net deferred tax asset. As of March 31, 2022, there are no changes to the unrecognized tax benefits. The Company is not currently subject to income tax audits in any U.S., state, or foreign jurisdictions for any tax year.
Tax Receivables Agreement
In connection with the Offering Reorganization, the Company entered into the TRA with certain of its investors, which provides for the payment by the Company to these investors of 85% of the amount of the tax benefits, if any, that the Company is deemed to realize as a result of increases in our tax basis related to exchanges of Class B common units as well as tax benefits attributable to the future utilization of pre-IPO NOLs. See Note 11 above for discussion of our TRA.
Note 16. Investments in Equity Method Investees
The Company holds ownership interests in joint ventures and other entities which are accounted for under the equity method. The Company evaluates its interests in these entities to determine whether they meet the definition of a VIE and whether the Company is required to consolidate these entities. A VIE is consolidated by its primary beneficiary, which is the party that has both (i) the power to direct the activities that most significantly impact the economic performance of the VIE and (ii) a variable interest that could potentially be significant to the VIE. To determine whether or not a variable interest the Company holds could potentially be significant to the VIE, the Company considers both qualitative and quantitative factors regarding the nature, size and form of the Company's involvement with the VIE. The Company has determined that its interests in these entities meet the definition of a variable interest, however, the Company is not the primary beneficiary since it does not have the power to direct activities, therefore, the Company did not consolidate the VIEs.
As of March 31, 2022 and December 31, 2021, the Company’s economic interests in its equity method investments ranged between 4% and 38% and 4% and 39%, respectively, and voting interests in its equity method investments ranged between 25% and 40%, respectively. The Company determined that it has significant influence over these entities but that it does not have control over any of the entities. Accordingly, the investments are accounted for under the equity method of accounting and the Company is allocated its proportional share of the entities’ earnings and losses for each reporting period. The Company’s proportional share of the gain from these investments was approximately $0.6 million and $7.8 million for the three months ended March 31, 2022 and 2021, respectively.
The Company signed services agreements with certain of the aforementioned entities to provide certain management, operational and support services to help manage elements of their service offerings. Revenue related to these services agreements were $3.6 million and $6.3 million for the three months ended March 31, 2022 and 2021, respectively.
Note 17. Fair Value Measurement
GAAP defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability (an exit price) assuming an orderly transaction in the most advantageous market at the measurement date. GAAP also establishes a hierarchical disclosure framework which prioritizes and ranks the level of observability of inputs used in measuring fair value. These tiers include:
•Level 1 - inputs to the valuation methodology are quoted prices available in active markets for identical instruments as of the reporting date;
•Level 2 - inputs to the valuation methodology are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date and the fair value can be determined through the use of models or other valuation methodologies; and
•Level 3 - inputs to the valuation methodology are unobservable inputs in situations where there is little or no market activity for the asset or liability.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the particular asset or liability being measured.
Recurring Fair Value Measurements
In accordance with GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring basis (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2022 |
| Level 1 | | Level 2 | | Level 3 | | Total |
| Liabilities | | | | | | | |
Contingent consideration(1) | $ | — | | | $ | — | | | $ | 32,600 | | | $ | 32,600 | |
| Total fair value of liabilities measured on a recurring basis | $ | — | | | $ | — | | | $ | 32,600 | | | $ | 32,600 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Level 1 | | Level 2 | | Level 3 | | Total |
| Liabilities | | | | | | | |
Contingent consideration(1) | $ | — | | | $ | — | | | $ | 28,700 | | | $ | 28,700 | |
| Total fair value of liabilities measured on a recurring basis | $ | — | | | $ | — | | | $ | 28,700 | | | $ | 28,700 | |
(1) Represents the fair value of earn-out consideration related to the Vital Decisions transaction as described in Note 4.
The Company recognizes any transfers between levels within the hierarchy as of the beginning of the reporting period. There were no transfers between fair value levels during the three months ended March 31, 2022 and 2021, respectively.
In the absence of observable market prices, the fair value is based on the best information available and involves a significant degree of judgment, taking into consideration a combination of internal and external factors, including the appropriate risk adjustments for non-performance and liquidity risks.
As discussed in Note 4, the acquisition of Vital Decisions includes a provision for additional equity consideration contingent upon the Company obtaining certain annualized performance metrics during the three months ending December 31, 2022. The fair value of the contingent equity consideration was estimated based on the real options approach, a form of the income approach, which estimated the probability of the Company achieving future revenues under the agreement. The significant unobservable inputs used in the fair value measurement of the Vital Decisions contingent consideration are the risk-neutral (probability weighted) earnout consideration and the applicable discount rate. A significant increase in the risk-neutral (probability weighted) earnout consideration or decrease in discount rate in isolation would result in a significantly higher fair value of the contingent consideration.
The changes in our liabilities measured at fair value for which the Company uses Level 3 inputs to determine fair value are as follows (in thousands):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 |
| Balance as of beginning of period | $ | 28,700 | | | $ | 13,730 | |
| Settlements | — | | | (13,730) | |
| Realized and unrealized losses, net | 3,900 | | | — | |
| Balance as of end of period | $ | 32,600 | | | $ | — | |
The following table summarizes the fair value (in thousands), valuation techniques and significant unobservable inputs of our Level 3 fair value measurements as of the periods presented:
| | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2022 |
| Fair | | Valuation | | Significant | | Assumption or |
| Value | | Technique | | Unobservable Inputs | | Input Ranges |
| Contingent consideration | $ | 32,600 | | | Real options approach | | Risk-neutral expected earnout consideration | | $ | 35,185 | |
| | | | | Discount rate | | 7.43 | % |
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Fair | | Valuation | | Significant | | Assumption or |
| Value | | Technique | | Unobservable Inputs | | Input Ranges |
| Contingent consideration | $ | 28,700 | | | Real options approach | | Risk-neutral expected earnout consideration | | $ | 30,935 | |
| | | | | Discount rate | | 6.04 | % |
Nonrecurring Fair Value Measurements
In addition to the assets and liabilities that are recorded at fair value on a recurring basis, the Company records certain assets and liabilities at fair value on a nonrecurring basis as required by GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges. This includes assets and liabilities recorded in business combinations or asset acquisitions, goodwill, intangible assets, property, plant and equipment, held-to-maturity investments and equity method investments. While not carried at fair value on a recurring basis, these items are continually monitored for indicators of impairment that would indicate current carrying value is greater than fair value. In those situations, the assets are considered impaired and written down to current fair value.
Other Fair Value Disclosures
The carrying amounts of cash and cash equivalents (those not held in a money market fund), restricted cash, receivables, prepaid expenses, accounts payable, accrued liabilities and accrued compensation approximate their fair values because of the relatively short-term maturities of these items and financial instruments.
See Note 10 for information regarding the fair value of the 2024 Notes and 2025 Notes.
Note 18. Related Parties
The entities described below are considered related parties and the balances and/or transactions with them are reported in our consolidated financial statements.
As discussed in Note 16, the Company had economic interests in several entities that are accounted for under the equity method of accounting. The Company has allocated its proportional share of the investees’ earnings and losses each reporting period. In addition, Evolent has entered into services agreements with certain of the entities to provide certain management, operational and support services to help the entities manage elements of their service offerings.
The Company also works with UPMC, one of its founding investors. The Company’s relationship with UPMC is a subcontractor relationship where UPMC has agreed to execute certain tasks (primarily TPA services) relating to certain customer commitments. This relationship is currently in wind-down.
The following table presents assets and liabilities attributable to our related parties as of March 31, 2022 and December 31, 2021 (in thousands):
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
| Assets | | | |
| Accounts receivable, net | $ | 3,225 | | | $ | 2,719 | |
| Prepaid expenses and other current assets | 11 | | | 15 | |
| Prepaid expenses and other noncurrent assets | 4,958 | | | 4,877 | |
| | | |
| Liabilities | | | |
| Accounts payable | $ | 334 | | | $ | 1,967 | |
| Accrued liabilities | 1,222 | | | 1,120 | |
| Reserve for claims and performance-based arrangements | 550 | | | 734 | |
The following table presents revenues and expenses attributable to our related parties (in thousands):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 |
| Revenue | $ | 32,064 | | | $ | 15,575 | |
| | | |
| Expenses | | | |
| Cost of revenue (exclusive of depreciation and amortization expenses) | 26,461 | | | 493 | |
| Selling, general and administrative expenses | 66 | | | 31 | |
Note 19. Repositioning and Other Changes
We continually assess opportunities to improve operational effectiveness and efficiency to better align our expenses with revenues, while continuing to make investments in our solutions, systems and people that we believe are important to our long-term goals. Across 2020, we divested or agreed to divest a majority of our health plan assets, including certain assets of EVH Passport, which represented a significant revenue stream for the Company. In parallel with these divestitures, we contracted with a third-party vendor to review our operating model and organizational design in order to improve our profitability, create value through our solutions and invest in strategic opportunities in future periods.
In the fourth quarter of 2020, we committed to certain operational efficiency and profitability actions that we are taking in order to accomplish these objectives (“Repositioning Plan”). These actions included making organizational changes across our business as well as other profitability initiatives expected to result in reductions in force, re-aligning of resources as well as other potential operational efficiency and cost-reduction initiatives that will provide future benefit to the Company. The Repositioning Plan concluded in the fourth quarter of 2021.
The following table provides a summary of our total costs associated with the Repositioning Plan by major type of cost (in thousands):
| | | | | | | | | | | | | | |
| Cumulative Costs Incurred through December 31, 2021 | | Incurred For the Three Months Ended March 31, 2021 | |
| Severance and termination benefits | $ | 185 | | | $ | 109 | | |
| Office space consolidation | 2,742 | | | 2,071 | | |
| Professional services | 5,666 | | | 3,200 | | |
| Total | $ | 8,593 | | | $ | 5,380 | | |
Note 20. Segment Reporting
We define our reportable segments based on the way the CODM, the chief executive officer, manages the operations for purposes of allocating resources and assessing performance. We classify our operations into two reportable segments as follows:
•Evolent Health Services, which houses our Administrative Simplification solution and certain supporting population health infrastructure; and
•Clinical Solutions, which includes our specialty care management and physician-oriented total cost of care solutions, along with the New Century Health and Evolent Care Partners brands.
In the ordinary course of business, our reportable segments enter into transactions with one another. While intersegment transactions are treated like third-party transactions to determine segment performance, the revenues and expenses recognized by the segment that is the counterparty to the transaction are eliminated in consolidation and do not affect consolidated results.
The CODM uses revenue in accordance with U.S. GAAP and Adjusted EBITDA as the relevant segment performance measures to evaluate the performance of the segments and allocate resources.
Adjusted EBITDA is a segment performance financial measure that offers a useful view of the overall operation of our businesses and may be different than similarly-titled segment performance financial measures used by other companies.
Adjusted EBITDA is defined as net loss attributable to common shareholders of Evolent Health, Inc. before interest income, interest expense, provision for income taxes, depreciation and amortization expenses, adjusted to exclude gain on transfer of membership, loss on repayment of debt, net, gain from equity method investees, changes in fair value of contingent consideration, other income (expense), net, repositioning costs, stock-based compensation expense, severance costs, amortization of contract cost assets, strategy and shareholder advisory services, acquisition-related costs and gain from discontinued operations.
Management considers revenue and Adjusted EBITDA to be the appropriate metrics to evaluate and compare the ongoing operating performance of our segments on a consistent basis across reporting periods as they eliminate the effect of items which are not indicative of each segment's core operating performance.
The following tables present our segment information (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Evolent Health Services | | Clinical Solutions | | Intersegment
Eliminations | | Subtotal | | Corporate (1) | | Consolidated Total |
| Revenue | | | | | | | | | | | |
| For the Three Months Ended March 31, 2022 | | | | | | | | |
| Total revenue | $ | 107,318 | | | $ | 190,199 | | | $ | (460) | | | $ | 297,057 | | | $ | — | | | $ | 297,057 | |
| | | | | | | | | | | |
| For the Three Months Ended March 31, 2021 | | | | | | | | |
| Total revenue | $ | 85,286 | | | $ | 130,223 | | | $ | (438) | | | $ | 215,071 | | | $ | — | | | $ | 215,071 | |
| | | | | | | | | | | |
| Evolent Health Services | | Clinical Solutions | | Subtotal | | Corporate (1) | | Consolidated Total | | |
| For the Three Months Ended March 31, 2022 | | | | | | | | |
| Adjusted EBITDA | $ | 8,217 | | | $ | 22,196 | | | $ | 30,413 | | | $ | (6,158) | | | $ | 24,255 | | | |
| | | | | | | | | | | |
| For the Three Months Ended March 31, 2021 | | | | | | | | |
| Adjusted EBITDA | $ | 5,942 | | | $ | 15,976 | | | $ | 21,918 | | | $ | (7,011) | | | $ | 14,907 | | | |
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(1)Corporate includes various finance, human resources, legal, executive and other corporate infrastructure expenses.
The following table presents our reconciliation of consolidated segments total Adjusted EBITDA to net loss attributable to common shareholders of Evolent Health, Inc. (in thousands):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 |
| Net loss attributable to common shareholders of Evolent Health, Inc. | $ | (5,350) | | | $ | (9,807) | |
| Less: | | | |
| Interest income | 117 | | | 123 | |
| Interest expense | (2,241) | | | (6,337) | |
| Provision for income taxes | (1,202) | | | (611) | |
| Depreciation and amortization expenses | (15,106) | | | (15,187) | |
| Gain on transfer of membership | — | | | 22,969 | |
| Loss on repayment of debt, net | — | | | (19,158) | |
| Gain from equity method investees | 596 | | | 7,783 | |
| Change in fair value of contingent consideration | (6,078) | | | 594 | |
| Other income (expense), net | 178 | | | (14) | |
| Repositioning costs | — | | | (5,380) | |
| Stock-based compensation expense | (5,346) | | | (3,706) | |
| Severance costs | (39) | | | (52) | |
| Amortization of contract cost assets | (27) | | | (127) | |
| Strategy and shareholder advisory expenses | — | | | (5,000) | |
| Acquisition costs | (457) | | | (1,994) | |
Gain from discontinued operations (1) | — | | | 1,383 | |
| Adjusted EBITDA | $ | 24,255 | | | $ | 14,907 | |
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(1)Includes $1.9 million gain on disposal of discontinued operations for the three months ended March 31, 2021.
Asset information by segment is not a key measure of performance used by the CODM. Accordingly, we have not disclosed asset information by segment.
Note 21. Reserve for Claims and Performance-Based Arrangements
The Company maintains reserves for its liabilities related to payments to providers and pharmacies under performance-based arrangements related to its total cost of care and specialty care management services.
Reserves for claims and performance-based arrangements for our EHS and Clinical Solutions segments reflect actual 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 composed 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 under the reinsurance agreements, as discussed further in Note 11.
The Company uses actuarial principles and assumptions that are consistently applied 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.
This liability predominately consists of incurred but not reported amounts and reported claims in process including expected development on reported claims. The liability for reserves related to its total cost of care and specialty care management services is primarily calculated using "completion factors" developed by comparing the claim incurred date to the date claims were paid. Completion factors are impacted by several key items including changes in: 1) electronic (auto-adjudication) versus manual claim processing, 2) provider claims submission rates, 3) membership and 4) the mix of products.
The Company’s policy for reserves related to its total cost of care and specialty care management services is to use historical completion factors combined with an analysis of current trends and operational factors to develop current estimates of completion factors. The Company estimates the liability for claims incurred in each month by applying the current estimates of completion factors to the current paid claims data. This approach implicitly assumes that historical completion rates will be a useful indicator for the current period.
For more recent months, and for newer lines of business where there is not sufficient paid claims history to develop completion factors, the Company expects to rely more heavily on medical cost trend and expected loss ratio analysis that reflects expected claim payment patterns and other relevant operational considerations, or authorization analysis. Medical cost trend is primarily impacted by medical service utilization and unit costs that are affected by changes in the level and mix of medical benefits offered, including inpatient, outpatient and pharmacy, the impact of copays and deductibles, changes in provider practices and changes in consumer demographics and consumption behavior. Authorization analysis projects costs on an authorization-level basis and also accounts for the impact of copays and deductibles, unit cost and historic discontinuation rates for treatment.
For each reporting period, the Company compares key assumptions used to establish the reserves for claims and performance-based arrangements to actual experience. When actual experience differs from these assumptions, reserves for claims and performance-based arrangements are adjusted through current period net income. Additionally, the Company evaluates expected future developments and emerging trends that may impact key assumptions. The process used to determine this liability requires the Company to make critical accounting estimates that involve considerable judgment, reflecting the variability inherent in forecasting future claim payments. These estimates are highly sensitive to changes in the Company's key assumptions, specifically completion factors and medical cost trends.
Activity in reserves for claims and performance-based arrangements was as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2022 | | 2021 |
| EHS (1) | | Clinical Solutions (1) | | Total | | EHS (1) | | Clinical Solutions (1) | | Total |
| Beginning balance | $ | 25,618 | | | $ | 145,676 | | | $ | 171,294 | | | $ | 122,532 | | | $ | 56,295 | | | $ | 178,827 | |
| | | | | | | | | | | |
| Incurred costs related to current period | — | | | 102,664 | | | 102,664 | | | 104,098 | | | 4,189 | | | 108,287 | |
| Incurred costs related to prior period | (8,465) | | | 14,976 | | | 6,511 | | | 24 | | | 4,151 | | | 4,175 | |
| Less: | | | | | | | | | | | |
| Paid costs related to current period | — | | | 47,724 | | | 47,724 | | | 30,761 | | | 11,164 | | | 41,925 | |
| Paid costs related to prior period | (483) | | | 59,974 | | | 59,491 | | | 38,053 | | | 10,200 | | | 48,253 | |
| Change during the year | (7,982) | | | 9,942 | | | 1,960 | | | 35,308 | | | (13,024) | | | 22,284 | |
| | | | | | | | | | | |
| Impact of consolidation on reserves for claims and performance-based arrangements | — | | | — | | | — | | | — | | | — | | | — | |
Other adjustments (2) | — | | | (9,016) | | | (9,016) | | | 2,658 | | | 4,224 | | | 6,882 | |
| Ending balance | $ | 17,636 | | | $ | 146,602 | | | $ | 164,238 | | | $ | 160,498 | | | $ | 47,495 | | | $ | 207,993 | |
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(1)Costs incurred to provide specialty care management and EVH Passport are recorded within cost of revenue in our statement of operations.
(2)Other adjustments to reserves for claims and performance-based arrangements reflect changes in accrual for amounts payable to facilities and amounts owed to our payer partners for claims paid on our behalf.
Note 22. Supplemental Cash Flow Information
The following represents supplemental cash flow information (in thousands):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| | 2022 | | 2021 |
| Supplemental Disclosure of Non-cash Investing and Financing Activities | | | |
| Accrued property and equipment purchases | $ | 670 | | | $ | 124 | |
| Effects of Leases | | | |
| Operating cash flows from operating leases | 3,830 | | | 3,410 | |
| Leased assets obtained in exchange for operating lease liabilities | (3) | | | (2,157) | |