Item 1. Financial Statements
EVOLENT HEALTH, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
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| March 31, 2023 | | December 31, 2022 |
| (unaudited) | | |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 157,519 | | | $ | 188,200 | |
Restricted cash and restricted investments | 21,932 | | | 14,492 | |
Accounts receivable, net (1) | 262,764 | | | 254,684 | |
Prepaid expenses and other current assets (1) | 33,757 | | | 20,678 | |
Total current assets | 475,972 | | | 478,054 | |
Restricted cash and restricted investments | 12,519 | | | 12,466 | |
Investments in equity method investees | 4,112 | | | 4,475 | |
Property and equipment, net | 88,606 | | | 87,874 | |
Right-of-use assets - operating | 44,408 | | | 49,027 | |
Prepaid expenses and other noncurrent assets (1) | 3,543 | | | 2,378 | |
Contract cost assets | 16,497 | | | 17,461 | |
Intangible assets, net | 825,857 | | | 442,784 | |
Goodwill | 1,117,945 | | | 722,774 | |
Total assets | $ | 2,589,459 | | | $ | 1,817,293 | |
LIABILITIES, MEZZANINE EQUITY AND SHAREHOLDERS’ EQUITY | | | |
Liabilities | | | |
Current liabilities: | | | |
Accounts payable (1) | $ | 51,012 | | | $ | 57,174 | |
Accrued liabilities (1) | 170,236 | | | 111,198 | |
Operating lease liability - current | 4,608 | | | 7,122 | |
Accrued compensation and employee benefits | 27,527 | | | 52,460 | |
Deferred revenue | 7,069 | | | 5,758 | |
Reserve for claims and performance - based arrangements (1) | 197,197 | | | 199,730 | |
Total current liabilities | 457,649 | | | 433,442 | |
Long-term debt, net | 632,277 | | | 412,986 | |
Other long-term liabilities | 4,473 | | | 4,744 | |
Tax receivable agreement liability | 112,134 | | | 45,950 | |
Operating lease liabilities - noncurrent | 54,274 | | | 56,010 | |
Deferred tax liabilities, net | 36,284 | | | 4,744 | |
Total liabilities | 1,297,091 | | | 957,876 | |
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Commitments and Contingencies (See Note 10) | | | |
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Mezzanine Equity | | | |
Preferred class A common stock - $0.01 par value; 50,000,000 shares authorized; 175,000 shares issued | 170,625 | | | — | |
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Shareholders' Equity | | | |
Class A common stock - $0.01 par value; 750,000,000 shares authorized; 112,552,160 and 101,500,558 shares issued, respectively | 1,125 | | | 1,015 | |
Additional paid-in-capital | 1,768,999 | | | 1,486,857 | |
Accumulated other comprehensive loss | (1,122) | | | (1,178) | |
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Retained earnings (accumulated deficit) | (626,136) | | | (606,154) | |
Treasury stock, at cost; 1,537,582 shares issued, respectively | (21,123) | | | (21,123) | |
Total shareholders' equity | 1,121,743 | | | 859,417 | |
Total liabilities, mezzanine equity and shareholders' equity | $ | 2,589,459 | | | $ | 1,817,293 | |
(1) See Note 18 for amounts attributable to related parties included in these line items.
See accompanying Notes to Consolidated Financial Statements
2
EVOLENT HEALTH, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(unaudited, in thousands, except per share data)
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| | | For the Three Months Ended March 31, | | |
| | | | | 2023 | | 2022 | | |
Revenue(1) | | | | | $ | 427,690 | | | $ | 297,057 | | | |
Expenses | | | | | | | | | |
Cost of revenue (1) | | | | | 310,475 | | | 219,739 | | | |
Selling, general and administrative expenses (1) | | | | | 89,726 | | | 58,932 | | | |
Depreciation and amortization expenses | | | | | 29,275 | | | 15,106 | | | |
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Change in fair value of contingent consideration | | | | | 8,569 | | | 6,078 | | | |
Total operating expenses | | | | | 438,045 | | | 299,855 | | | |
Operating loss | | | | | (10,355) | | | (2,798) | | | |
Interest income | | | | | 1,060 | | | 117 | | | |
Interest expense | | | | | (12,895) | | | (2,241) | | | |
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Gain from equity method investees | | | | | 423 | | | 596 | | | |
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Change in tax receivable agreement liability | | | | | (66,184) | | | — | | | |
Other income (expense), net | | | | | (220) | | | 178 | | | |
Loss before income taxes | | | | | (88,171) | | | (4,148) | | | |
Provision for (benefit from) income taxes | | | | | (68,189) | | | 1,202 | | | |
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Loss before preferred dividends and accretion of Series A Preferred Stock | | | | | (19,982) | | | (5,350) | | | |
Dividends and accretion of Series A Preferred Stock | | | | | (6,276) | | | — | | | |
Net loss attributable to common shareholders of Evolent Health, Inc. | | | | | $ | (26,258) | | | $ | (5,350) | | | |
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Loss per common share | | | | | | | | | |
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Basic and diluted | | | | | $ | (0.24) | | | $ | (0.06) | | | |
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Weighted-average common shares outstanding | | | | | | | | | |
Basic and diluted | | | | | 107,783 | | | 89,509 | | | |
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Comprehensive loss | | | | | | | | | |
Net loss | | | | | $ | (26,258) | | | $ | (5,350) | | | |
Other comprehensive loss, net of taxes, related to: | | | | | | | | | |
Foreign currency translation adjustment | | | | | 56 | | | (132) | | | |
Total comprehensive loss attributable to common shareholders of Evolent Health, Inc. | | | | | $ | (26,202) | | | $ | (5,482) | | | |
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(1)See Note 18 for amounts attributable to unconsolidated related parties included in these line items.
See accompanying Notes to Consolidated Financial Statements.
3
EVOLENT HEALTH, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN MEZZANINE EQUITY AND SHAREHOLDERS’ EQUITY
(unaudited, in thousands)
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| For the Three Months Ended March 31, 2023 |
| Mezzanine Equity | | Shareholders’ Equity |
| Series A Preferred Stock | | Class A Common Stock | | Additional Paid-In Capital | | Accumulated Other Comprehensive Income (Loss) | | Retained Earnings (Accumulated Deficit) | | Treasury Stock | | Total Shareholders’ Equity |
| Shares | | Amount | | Shares | | Amount | | | | | |
Balance as of December 31, 2022 | — | | | $ | — | | | 101,501 | | | $ | 1,015 | | | $ | 1,486,857 | | | $ | (1,178) | | | $ | (606,154) | | | $ | (21,123) | | | $ | 859,417 | |
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Stock-based compensation expense | — | | | — | | | — | | | — | | | 10,710 | | | — | | | — | | | — | | | 10,710 | |
Exercise of stock options | — | | | — | | | 330 | | | 3 | | | 1,578 | | | — | | | — | | | — | | | 1,581 | |
Restricted stock units vested, net of shares withheld for taxes | — | | | — | | | 434 | | | 4 | | | (8,636) | | | — | | | — | | | — | | | (8,632) | |
Performance stock units vested, net of shares withheld for taxes | — | | | — | | | 202 | | | 2 | | | (3,977) | | | — | | | — | | | — | | | (3,975) | |
Leveraged stock units vested, net of shares withheld for taxes | — | | | — | | | 760 | | | 8 | | | (8) | | | — | | | — | | | — | | | — | |
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Shares issued for acquisition | — | | | — | | | 8,475 | | | 85 | | | 261,186 | | | — | | | — | | | — | | | 261,271 | |
Class A common stock issued for payment of earn-outs | — | | | — | | | 850 | | | 8 | | | 27,565 | | | — | | | — | | | — | | | 27,573 | |
Issuance of series A preferred stock, net of issuance costs | 175 | | | 168,000 | | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
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Foreign currency translation adjustment | — | | | — | | | — | | | — | | | — | | | 56 | | | — | | | — | | | 56 | |
Net loss attributable to common shareholders of Evolent Health, Inc. | — | | | 2,625 | | | — | | | — | | | (6,276) | | | — | | | (19,982) | | | — | | | (26,258) | |
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Balance as of March 31, 2023 | 175 | | | $ | 170,625 | | | 112,552 | | | $ | 1,125 | | | $ | 1,768,999 | | | $ | (1,122) | | | $ | (626,136) | | | $ | (21,123) | | | $ | 1,121,743 | |
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| For the Three Months Ended March 31, 2022 |
| Mezzanine Equity | | Shareholders’ Equity |
| Series A Preferred Stock | | Class A Common Stock | | Additional Paid-In Capital | | Accumulated Other Comprehensive Income (Loss) | | Retained Earnings (Accumulated Deficit) | | Treasury Stock | | Total Shareholders’ Equity |
| Shares | | Amount | | Shares | | Amount | | | | | |
Balance as of December 31, 2021 | — | | | — | | | 90,759 | | | $ | 908 | | | $ | 1,340,989 | | | $ | (362) | | | $ | (626,779) | | | $ | (21,123) | | | $ | 693,633 | |
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Cumulative-effect adjustment from adoption of ASC 2020-06 | — | | | — | | | — | | | — | | | (106,172) | | | — | | | 39,789 | | | — | | | (66,383) | |
Stock-based compensation expense | — | | | — | | | — | | | — | | | 5,346 | | | — | | | — | | | — | | | 5,346 | |
Exercise of stock options | — | | | — | | | 37 | | | — | | | 309 | | | — | | | — | | | — | | | 309 | |
Restricted stock units vested, net of shares withheld for taxes | — | | | — | | | 334 | | | 3 | | | (4,986) | | | — | | | — | | | — | | | (4,983) | |
Leveraged stock units vested, net of shares withheld for taxes | — | | | — | | | 458 | | | 5 | | | (11,236) | | | — | | | — | | | — | | | (11,231) | |
Foreign currency translation adjustment | — | | | — | | | — | | | — | | | — | | | (132) | | | — | | | — | | | (132) | |
Net loss attributable to common shareholders of Evolent Health, Inc. | — | | | — | | | — | | | — | | | — | | | — | | | (5,350) | | | — | | | (5,350) | |
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Balance as of March 31, 2022 | — | | | $ | — | | | 91,588 | | | $ | 916 | | | $ | 1,224,250 | | | $ | (494) | | | $ | (592,340) | | | $ | (21,123) | | | $ | 611,209 | |
See accompanying Notes to Consolidated Financial Statements
4
EVOLENT HEALTH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
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| For the Three Months Ended March 31, |
| 2023 | | 2022 | | |
Cash Flows Used In Operating Activities | | | | | |
Net loss before dividends declared and accretion of Series A preferred stock | $ | (19,982) | | | $ | (5,350) | | | |
Adjustments to reconcile net loss to net cash and restricted cash used in operating activities: | | | | | |
Change in fair value of contingent consideration | 8,569 | | | 6,078 | | | |
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Gain from equity method investees | (423) | | | (596) | | | |
Depreciation and amortization expenses | 29,275 | | | 15,106 | | | |
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Stock-based compensation expense | 10,710 | | | 5,346 | | | |
Deferred tax provision | (68,728) | | | (132) | | | |
Amortization of contract cost assets | 2,290 | | | 11,689 | | | |
Amortization of deferred financing costs | 911 | | | 539 | | | |
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Change in tax receivable agreement liability | 66,184 | | | — | | | |
Right-of-use operating assets | 4,620 | | | 1,718 | | | |
Operating lease liabilities | (4,250) | | | (1,992) | | | |
Other current operating cash outflows, net | (56) | | | (357) | | | |
Changes in assets and liabilities, net of acquisitions: | | | | | |
Accounts receivable, net and contract assets | 19,832 | | | (46,299) | | | |
Prepaid expenses and other current and non-current assets | (13,758) | | | (6,071) | | | |
Contract cost assets | (1,326) | | | (1,106) | | | |
Accounts payable | (13,585) | | | 426 | | | |
Accrued liabilities | 4,785 | | | 2,220 | | | |
Accrued compensation and employee benefits | (31,401) | | | (32,435) | | | |
Deferred revenue | 1,169 | | | 1,344 | | | |
Reserve for claims and performance-based arrangements | (2,533) | | | (7,056) | | | |
Other long-term liabilities | (277) | | | (514) | | | |
Net cash and restricted cash used in operating activities | (7,974) | | | (57,442) | | | |
Cash Flows Provided by (Used In) Investing Activities | | | | | |
Cash paid for asset acquisitions and business combinations | (386,724) | | | (70) | | | |
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Proceeds from transfer of membership and release of Passport escrow | — | | | 22,969 | | | |
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Return of equity method investments | 786 | | | 2,375 | | | |
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Investments in internal-use software and purchases of property and equipment | (9,055) | | | (8,508) | | | |
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Net cash and restricted cash provided by (used in) investing activities | (394,993) | | | 16,766 | | | |
Cash Flows Provided by (Used In) Financing Activities | | | | | |
Changes in working capital balances related to claims processing on behalf of partners | 7,576 | | | (34,371) | | | |
Proceeds from stock option exercises | 1,581 | | | 309 | | | |
Proceeds from issuance of long-term debt, net of offering costs | 256,330 | | | — | | | |
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Repayment of long-term debt | (37,500) | | | — | | | |
Distributions to Sponsors | — | | | (1,100) | | | |
Proceeds from issuance of preferred stock, net of offering costs | 168,000 | | | — | | | |
Payment of preferred dividends | (3,651) | | | — | | | |
Taxes withheld and paid for vesting of equity awards | (12,607) | | | (16,214) | | | |
Net cash and restricted cash provided by (used in) financing activities | 379,729 | | | (51,376) | | | |
Effect of exchange rate on cash and cash equivalents and restricted cash | 50 | | | (104) | | | |
Net decrease in cash and cash equivalents and restricted cash | (23,188) | | | (92,156) | | | |
See accompanying Notes to Consolidated Financial Statements
5
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| For the Three Months Ended March 31, |
| 2023 | | 2022 | | |
Cash and cash equivalents and restricted cash as of beginning-of-period | 215,158 | | | 354,942 | | | |
Cash and cash equivalents and restricted cash as of end-of-period | $ | 191,970 | | | $ | 262,786 | | | |
See accompanying Notes to Consolidated Financial Statements
6
EVOLENT HEALTH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization
Evolent Health, Inc. was incorporated in December 2014 in the state of Delaware and through its subsidiaries supports healthcare entities to improve the quality of care delivered for people with complex conditions through proven solutions that make health care simpler and more affordable.
The Company made organizational changes, including re-evaluating its reportable segments, as a result of growth in our value-based specialty care business, both organically and through acquisitions. Effective during the three months ended March 31, 2023, the Company changed its reportable segments to reflect changes in the way its chief operating decision maker evaluates the performance of its operations, develops strategy and allocates capital resources. Specifically, the Company collapsed its previous Evolent Health Services and Clinical Solutions segments into one segment. The Company's historical disclosures have been recast to be consistent with the current presentation.
As of March 31, 2023, the Company had unrestricted cash and cash equivalents of $157.5 million. The Company believes it has sufficient liquidity for at least 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 2022 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 2022 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 interim 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 interim 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:
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| March 31, 2023 | | December 31, 2022 |
Collateral for letters of credit for facility leases (1) | $ | 2,132 | | | $ | 2,269 | |
Collateral with financial institutions (2) | 10,966 | | | 10,912 | |
Claims processing services (3) | 21,353 | | | 13,777 | |
Total restricted cash and restricted investments | $ | 34,451 | | | $ | 26,958 | |
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Current restricted cash | $ | 21,932 | | | $ | 14,492 | |
Total current restricted cash and restricted investments | $ | 21,932 | | | $ | 14,492 | |
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Non-current restricted cash | $ | 12,519 | | | $ | 12,466 | |
Total non-current restricted cash and restricted investments | $ | 12,519 | | | $ | 12,466 | |
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(1)Represents restricted cash related to collateral for letters of credit required in conjunction with lease agreements. See Note 11 for further discussion of our lease commitments.
(2)Represents collateral held with financial institutions for risk-sharing and other arrangements which are held in a FDIC participating bank account. See Note 17 for discussion of fair value measurement and Note 10 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):
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| March 31, |
| 2023 | | 2022 |
Cash and cash equivalents | $ | 157,519 | | | $ | 210,158 | |
Restricted cash and restricted investments | 34,451 | | | 52,628 | |
Total cash and cash equivalents and restricted cash shown in the consolidated statements of cash flows | $ | 191,970 | | | $ | 262,786 | |
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. See Note 4 for additional discussion regarding business combinations.
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 on October 31 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). See Note 8 for additional discussion regarding the goodwill impairment tests conducted during 2022.
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:
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Corporate trade name | 2 - 20 years |
Customer relationships | 11 - 25 years |
Technology | 5 years |
Provider network contracts | 3 - 5 years |
As part of the organizational changes as a result of growth in our value-based specialty care business, we re-evaluated the useful lives of our intangible assets. As a result, we accelerated amortization such that all corporate trade names will be fully amortized by December 2024.
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 8 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 cost of revenue and selling, general and administrative expenses on our consolidated statements of operations and comprehensive income (loss).
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 19 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 both March 31, 2023 and December 31, 2022, approximately 47% of gross accounts receivable has been netted against claims payable in lieu of cash receipt. Furthermore, as of March 31, 2023, approximately 20% 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 11 for additional lease disclosures.
Revenue Recognition
Our revenue contracts are typically multi-year arrangements with customers to provide various clinical and administrative solutions. Our solutions are designed to lower the medical expenses of our partners and include our total cost of care and specialty care management services, provide comprehensive health plan operations and claims processing services, and also include transition or run-out services to 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 5 for further discussion of our policies related to revenue recognition.
Series A Senior Convertible Preferred Shares
In accordance with ASC 480, Distinguishing Liabilities from Equity, the shares of Series A Senior Convertible Preferred Shares are classified within temporary equity, as events outside the Company’s control triggers such shares to become redeemable. Costs associated with the issuance of redeemable preferred stock are presented as discounts to the fair value of the redeemable preferred stock and are amortized using the effective interest method, over the term of the respective series of preferred shares. Refer to Note 12 - Series A Senior Convertible Preferred Shares for further discussion.
Note 3. Recently Issued Accounting Standards
Adoption of New Accounting Standards
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.
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. This ASU clarifies that an acquirer of a business should recognize and measure contract assets and contract liabilities in a business combination in accordance with ASC Topic 606, Revenue from Contracts with Customers. The Company adopted this standard starting in the first quarter of 2023, which did not have a material impact on our consolidated financial statements.
Note 4. Transactions
Business Combinations
National Imaging Associates Inc.
On January 20, 2023, the Company completed its acquisition of NIA, including all of the issued and outstanding shares of capital stock of NIA as well as certain assets held by Magellan Health, Inc. (“Magellan”) and certain of its subsidiaries that were used in the Magellan Specialty Health Division. NIA is a specialty benefit management organization that focuses on managing cost and quality in the areas of radiology, musculoskeletal, physical medicine and genetics. The transaction is expected to accelerate our strategy to become a leading provider of value-based specialty care solutions as well as diversify our revenue streams with a larger customer portfolio.
Total acquisition consideration, net of cash on hand and certain closing adjustments, was $715.7 million, based on the closing price of the Company’s Class A common stock on the NYSE on January 20, 2023. The acquisition consideration consisted of approximately $387.8 million of cash consideration (inclusive of certain post-closing adjustments), 8,474,576 shares of the Company’s Class A common stock, fair valued at $261.3 million as of January 20, 2023, and an earn-out consisting of additional consideration of up to $150.0 million payable in cash and, at the Company’s election, up to 50% in shares of the Company’s Class A common stock (the “Contingent Consideration”). As of January 20, 2023, the Contingent Consideration is fair valued at $66.6 million. See Note 17 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 January 20, 2023, as follows (in thousands):
| | | | | |
Purchase consideration: |
Cash | $ | 387,823 | |
Fair value of Class A common stock issued | 261,271 | |
Fair value of contingent consideration | 66,600 | |
Total consideration | $ | 715,694 | |
| |
Tangible assets acquired: | |
Accounts receivable | 28,065 | |
Prepaid expenses and other current assets | 675 | |
| |
Total tangible assets acquired | 28,740 | |
| |
Identifiable intangible assets acquired: | |
Customer relationships | 345,100 | |
Technology | 50,700 | |
Corporate trade name | 8,200 | |
Total identifiable intangible assets acquired | 404,000 | |
| |
Liabilities assumed: | |
| |
Accrued liabilities | 5,409 | |
Accrued compensation and employee benefits | 6,173 | |
Deferred tax liabilities, net | 100,486 | |
Deferred revenue | 142 | |
| |
Total liabilities assumed | 112,210 | |
| |
Goodwill | 395,164 | |
Net assets acquired | $ | 715,694 | |
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 the corporate trade name will be amortized on a straight-line basis over their preliminary estimated useful lives of 15 years, 5 years, and 2 years, respectively. The customer relationships are primarily attributable to existing contracts with current customers. The technology consists primarily of proprietary software that supports NIA’s core business applications and specialty business. The corporate trade name reflects the value that we believe the NIA 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 Company received carryover tax basis in the assets and liabilities acquired; accordingly, the Company recognized net deferred tax liabilities associated with the difference between the book basis and the tax basis for the assets and liabilities acquired. The goodwill is not deductible for tax purposes. Additionally, a discrete tax benefit of $56.1 million was recorded in the consolidated statements of operations and comprehensive income (loss) for the three months ended March 31, 2023, to account for the valuation allowance release primarily related to the acquired intangible assets, which resulted in a deferred tax liability that provided a source of income supporting realization of other deferred tax assets.
The amounts above reflect management’s preliminary estimate of the fair value of the tangible and intangible assets acquired and liabilities assumed. As of March 31, 2023, we had not finalized the determination of fair values allocated to the acquired intangible assets and deferred tax liability. Any necessary adjustments will be finalized within one year from the date of acquisition.
We have included the financial results of NIA in our consolidated financial statements from January 20, 2023. The consolidated statements of operations and comprehensive income (loss) include $48.5 million of revenues and $(5.5) million of net loss attributable to NIA for the three months ended March 31, 2023.
Implantable Provider Group
On August 1, 2022, the Company completed its acquisition of IPG, including 100% of the voting equity interests. IPG is a leader in providing surgical management solutions for musculoskeletal conditions. The transaction is expected to accelerate our strategy to become a leading provider of value-based specialty care solutions as well as diversify our revenue streams with a larger customer portfolio. The transaction is expected to deepen our capabilities, allowing us to cross-sell across customers and enhance our value proposition to partners.
Total acquisition consideration, net of cash on hand and certain closing adjustments, was $461.7 million, based on the closing price of the Company’s Class A common stock on the NYSE on August 1, 2022. The acquisition consideration consisted of $256.5 million of cash consideration, 3.7 million shares of Class A common stock, fair valued at $130.2 million as of August 1, 2022, and an earn-out of up to $87.0 million, fair valued at $75.0 million as of August 1, 2022 is payable in cash and/or shares of the Company’s Class A Common Stock, at the Company’s option. See Note 17 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 August 1, 2022, as follows (in thousands):
| | | | | |
Purchase consideration: |
Cash | $ | 256,488 | |
Fair value of Class A common stock issued | 130,175 | |
Fair value of contingent consideration | 75,000 | |
Total consideration | $ | 461,663 | |
| |
Tangible assets acquired: | |
Accounts receivable | 34,155 | |
Prepaid expenses and other current assets | 636 | |
Other non-current assets | 1,393 | |
Total tangible assets acquired | 36,184 | |
| |
Identifiable intangible assets acquired: | |
Customer relationships | 154,000 | |
Technology | 23,900 | |
Corporate trade name | 17,800 | |
Total identifiable intangible assets acquired | 195,700 | |
| |
Liabilities assumed: | |
Accounts payable | 7,997 | |
Accrued liabilities | 8,083 | |
Accrued compensation and employee benefits | 423 | |
Deferred tax liabilities, net | 48,671 | |
Deferred revenue | 321 | |
Operating lease liabilities | 1,323 | |
Total liabilities assumed | 66,818 | |
| |
| | | | | |
Goodwill | 296,597 | |
Net assets acquired | $ | 461,663 | |
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 the corporate trade name will be amortized on a straight-line basis over their preliminary estimated useful lives of 20 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 customer relationship management and analytics platform that supports reporting to payors with respect to medical device pricing and associated analytics. The corporate trade name reflects the value that we believe the IPG 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 Company received carryover tax basis in the assets and liabilities acquired; accordingly, the Company recognized net deferred tax liabilities associated with the difference between the book basis and the tax basis for the assets and liabilities acquired. The goodwill is not deductible for tax purposes. Additionally, a discrete tax benefit of $46.8 million was recorded in the consolidated statements of operations and comprehensive income (loss) for the year December 31, 2022, to account for the valuation allowance release primarily related to the acquired intangible assets, which resulted in a deferred tax liability that provided a source of income supporting realization of other deferred tax assets.
The amounts above reflect management’s preliminary estimate of the fair value of the tangible and intangible assets acquired and liabilities assumed. As of March 31, 2023, we had not finalized the determination of fair values allocated to the deferred tax liability. Any necessary adjustments will be finalized within one year from the date of acquisition.
Pro forma financial information (unaudited)
The following unaudited condensed pro forma information presents combined financial information as if the acquisition of NIA had been effective as of January 1, 2022, the beginning of the 2022 fiscal year. The unaudited pro forma financial information includes adjustments to historical amounts including amortization of acquired intangible assets, depreciation of acquired property and equipment, interest expense for the financing of the transaction, alignment of NIA’s revenue recognition policy, and the associated income tax effects as if NIA had been included in the Company’s results of operations.
This pro forma data is presented for informational purposes only and does not purport to be indicative of the results of future operations or of the results that would have occurred had the transactions described above occurred in the specified prior periods. The pro forma adjustments are based on available information and assumptions that the Company believes are reasonable to reflect the impact of these transactions on the Company’s historical financial information on a pro forma basis (in thousands).
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2023 | | 2022 |
Revenue | $ | 446,740 | | | $ | 362,827 | |
| | | |
Net loss attributable to common shareholders of Evolent Health, Inc. | (15,730) | | | (10,240) | |
Pro forma financial information has not been presented for the IPG acquisition as the impact to the Company’s interim consolidated financial statements was not material.
Note 5. Revenue Recognition
Our revenue contracts are typically multi-year arrangements with customers to provide various clinical and administrative solutions. Our solutions are designed to lower the medical expenses of our partners and include our total cost of care and specialty care management services, provide comprehensive health plan operations and claims processing services, and also include transition or run-out services to customers.
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 over time using the time elapsed output method. Fixed consideration is recognized ratably over the contract term. In accordance with the series guidance, we allocate variable consideration to the period to which the fees relate.
Contracts with Multiple Performance Obligations
Our contracts with customers may contain multiple performance obligations, primarily when the customer has requested both implementation and on going 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 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 end-market and product type:
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | For the Three Months Ended March 31, |
| | | | | | | | | 2023 | | 2022 | | | | | | | | |
Medicaid | | | | | | | | | $ | 183,034 | | | $ | 130,501 | | | | | | | | | |
Medicare | | | | | | | | | 127,669 | | | 104,399 | | | | | | | | | |
Commercial and other | | | | | | | | | 116,987 | | | 62,157 | | | | | | | | | |
Total | | | | | | | | | $ | 427,690 | | | $ | 297,057 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Performance Suite | | | | | | | | | $ | 239,873 | | | $ | 171,164 | | | | | | | | | |
Specialty Technology and Services Suite | | | | | | | | | 65,316 | | | 13,580 | | | | | | | | | |
Administrative Services | | | | | | | | | 83,067 | | | 106,859 | | | | | | | | | |
Cases | | | | | | | | | 39,434 | | | 5,454 | | | | | | | | | |
Total | | | | | | | | | $ | 427,690 | | | $ | 297,057 | | | | | | | | | |
Transaction Price Allocated to the Remaining Performance Obligations
For contracts with a term greater than one year, we have allocated approximately $43.8 million of transaction price to performance obligations that are unsatisfied as of March 31, 2023. 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 revenue, which is primarily derived based on variable consideration as discussed in Note 2. We expect to recognize revenue on approximately 69%, 92% and 100% of these remaining performance obligations by December 31, 2023, 2024 and 2025, respectively. 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 more or less than this estimate and the timing of recognition may not be as expected.
Contract Balances
Contract balances consist of accounts receivable, contract assets and deferred revenue. Contract assets are recorded when the right to consideration for services is conditional on something other than the passage of time. Contract assets relating to unbilled receivables are transferred to accounts receivable when the right to consideration becomes unconditional. We classify contract assets as current or 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, 2023 and December 31, 2022 (in thousands):
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
Short-term receivables (1) | $ | 261,875 | | | $ | 246,209 | |
| | | |
Short-term deferred revenue | 7,069 | | | 5,758 | |
Long-term deferred revenue | 2,193 | | | 2,533 | |
————————
(1)Excludes pharmacy claims receivable and premiums receivable.
Changes in deferred revenue for the three months ended March 31, 2023, are as follows (in thousands):
| | | | | |
Deferred revenue | |
Balance as of beginning-of-period | $ | 8,291 | |
Reclassification to revenue, as a result of performance obligations satisfied | (3,987) | |
Cash received in advance of satisfaction of performance obligations | 4,958 | |
Balance as of end of period | $ | 9,262 | |
The amount of revenue, excluding customer discounts of $1.5 million, recognized from performance obligations satisfied (or partially satisfied) in a previous period was $4.8 million for the three months ended March 31, 2023, 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, 2023 and 2022, the Company had $3.4 million and $3.9 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 $0.3 million and $1.4 million for the three months ended March 31, 2023 and 2022, respectively.
In our revenue contracts, 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, 2023 and 2022, the Company had $13.1 million and $18.1 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 $2.0 million and $10.3 million for the three months ended March 31, 2023 and 2022, 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 6. Credit Losses
We are exposed to credit losses primarily through our accounts receivable from revenue transactions, investments held at amortized cost 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, current inflationary pressures 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, 2023. Given the nature of our business, our past collection experience during recessionary and pre-recessionary periods, we did not record material changes in our allowances during the three months ended March 31, 2023.
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, 2023, 70% were current, 23% were past due less than 60 days, with 26% past due less than 120 days and at December 31, 2022, 67% was current, 21% was past due less than 60 days, with 29% past due less than 120 days. As of March 31, 2023 and December 31, 2022, in total we reported on the consolidated balance sheet $284.7 million and $269.1 million of accounts receivable, certain non-trade accounts receivable included in prepaid expenses and other current assets, net of allowances of $15.1 million and $10.2 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 (in thousands):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2023 | | 2022 |
Balance as of beginning of period | $ | (10,180) | | | $ | (3,374) | |
NIA acquisition | (240) | | | — | |
Provision for credit losses | (5,482) | | | 1,203 | |
Charge-offs | 829 | | | — | |
Balance as of end of period | $ | (15,073) | | | $ | (2,171) | |
Note 7. Property and Equipment, Net
The following summarizes our property and equipment (in thousands):
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
Computer hardware | $ | 30,441 | | | $ | 30,092 | |
Furniture and equipment | 4,246 | | | 4,214 | |
Internal-use software development costs | 197,174 | | | 189,119 | |
Leasehold improvements | 15,390 | | | 14,926 | |
Total property and equipment | 247,251 | | | 238,351 | |
Accumulated depreciation and amortization expenses | (158,645) | | | (150,477) | |
Total property and equipment, net | $ | 88,606 | | | $ | 87,874 | |
The Company capitalized $8.1 million and $6.4 million for the three months ended March 31, 2023 and 2022, respectively, of internal-use software development costs. The net book value of capitalized internal-use software development costs was $75.1 million and $73.7 million as of March 31, 2023 and December 31, 2022, respectively.
Depreciation expense related to property and equipment was $8.1 million and $7.6 million for the three months ended March 31, 2023 and 2022, respectively, of which amortization expense related to capitalized internal-use software development costs was $6.7 million for both the three months ended March 31, 2023 and 2022, respectively.
Note 8. 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.
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, 2023. We will perform our annual impairment test of October 31, 2023.
2022 Goodwill Impairment Test
On October 31, 2022, the Company performed its annual goodwill impairment test for fiscal year 2022. As a result of BHG announcing its plan to exit its IFP line of business in 2023, thus negatively impacting the Company’s future revenues from such partner, the Company elected to forego the qualitative assessment and proceeded directly to the quantitative assessment of the goodwill impairment test for that specific reporting unit. In doing so, we estimated the fair value of the reporting unit by considering an income approach. In determining the estimated fair value using the income approach, we projected future cash flows based on management’s estimates and long-term plans and applied a discount rate based on the Company’s weighted average cost of capital. This analysis required us to make judgments about revenues, expenses, fixed asset and working capital requirements, capital market assumptions, cash flows and discount rates. The quantitative analysis of the Evolent Health Services reporting unit showed that the fair value exceeded the carrying value. Contracts with our customers may be cancelled or renegotiated and future revenue growth is dependent on winning new contracts. Further, the impairment analysis is particularly sensitive to changes in the projected revenue growth rates and expenses and the discount rate. Changes in these key assumptions such as a significant unfavorable change to our forecasted cash flows due to being unsuccessful in winning certain contracts or certain of our contracts being cancelled or renegotiated by our customers, could result in a revision of management’s estimates and could result in impairment charges in the future, which could be material to our results of operations. We will continue to monitor for such changes in facts or circumstances, which may be indicators of potential impairment triggers.
For the remaining reporting units, after assessing the totality of events and circumstances including the results of our previous valuations, no events occurred or circumstances changed during the period under consideration that would, more likely than not, reduce the fair value of any reporting unit below their carrying amount. Therefore, the Company concluded that the quantitative assessment was not required. For all reporting units, it was determined that as of October 31, 2022, no impairment of goodwill had occurred.
Change in Goodwill
The following table summarizes the changes in the carrying amount of goodwill, for the periods presented (in thousands):
| | | | | | | | | |
| | | | | |
Balance as of December 31, 2022(1) | | | | | $ | 722,774 | |
Goodwill acquired(2) | | | | | 395,164 | |
Foreign currency translation | | | | | 7 | |
Balance as of March 31, 2023 | | | | | $ | 1,117,945 | |
| | | | | |
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| | | | | |
| | | | | |
Balance as of December 31, 2021(1) | | | | | $ | 426,297 | |
| | | | | |
Foreign currency translation | | | | | (23) | |
Balance as of March 31, 2022 | | | | | $ | 426,274 | |
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(1)Net of cumulative inception to date impairment of $575.5 million as of December 31, 2022 and 2021.
(2)Goodwill acquired from the addition of NIA in January 2023.
Intangible Assets, Net
Details of our intangible assets (in thousands, except weighted-average useful lives) are presented below:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
| 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 | 1.8 | | $ | 51,965 | | | $ | 16,967 | | | $ | 34,998 | | | 12.7 | | $ | 43,600 | | | $ | 11,726 | | | $ | 31,874 | |
Customer relationships | 15.2 | | 810,119 | | | 103,694 | | | 706,425 | | | 15.8 | | 465,019 | | | 92,760 | | | 372,259 | |
Technology | 2.3 | | 162,522 | | | 83,970 | | | 78,552 | | | 2.7 | | 111,822 | | | 80,255 | | | 31,567 | |
Below market lease, net | 0.1 | | 1,218 | | | 1,200 | | | 18 | | | 0.3 | | 1,218 | | | 1,151 | | | 67 | |
Provider network contracts | 1.1 | | 18,861 | | | 12,997 | | | 5,864 | | | 1.3 | | 18,851 | | | 11,834 | | | 7,017 | |
Total intangible assets, net | | | $ | 1,044,685 | | | $ | 218,828 | | | $ | 825,857 | | | | | $ | 640,510 | | | $ | 197,726 | | | $ | 442,784 | |
Amortization expense related to intangible assets was $21.1 million and $7.5 million for the three months ended March 31, 2023 and 2022, respectively.
Future estimated amortization of intangible assets (in thousands) as of March 31, 2023, is as follows:
| | | | | |
2023 | $ | 69,945 | |
2024 | 87,529 | |
2025 | 63,641 | |
2026 | 63,293 | |
2027 | 60,552 | |
Thereafter | 480,897 | |
Total future amortization of intangible assets | $ | 825,857 | |
As part of the organizational changes as a result of growth in our value-based specialty care business, we re-evaluated the useful lives of our intangible assets. As a result, we accelerated amortization such that all corporate trade names will be fully amortized by December 2024.
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, 2023, that would require an impairment test for our intangible assets.
Note 9. Long-term Debt
Credit Agreement
On August 1, 2022 (the “IPG Closing Date”), 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, collateral agent and revolver agent (the “Existing Credit Agreement” and as modified by the Amendment (defined below), the “Credit Agreement”), pursuant to which the lenders agreed to extend credit to the Borrower in the form of (i) initial term loans in an aggregate principal amount of $175.0 million (the “Initial Term Loan Facility”) and (ii) revolving credit commitments in an aggregate principal amount of $50.0 million (the “Initial Revolving Facility”), the availability of which shall be determined by reference to the lesser of $50.0 million and a borrowing base calculation. The Borrowers borrowed full amount under the Initial Term Loan Facility and the Initial Revolving Facility on the IPG Closing Date. A closing fee of (a) 2.00% of the aggregate amount of the commitments in respect of the Initial Term Loan Facility and (b) 2.00% of the aggregate amount of the commitments in respect of the Initial Revolving Facility was paid as of the IPG Closing Date.
On January 20, 2023, (“the NIA Closing Date”), the Company entered into Amendment No. 1 to the Credit Agreement (the “Amendment”), pursuant to which the lenders agreed to extend credit to the Borrower in the form of (i) additional revolving commitments in an aggregate principal amount equal to $25.0 million (the “Incremental Revolving Facility” and together with the Initial Revolving Facility, the Revolving Facility”), and (ii) additional term loans in an aggregate principal amount equal to $240.0 million, (the “Incremental Term Loan Facility” and together with the Initial Term Loan Facility, the “Term Loan Facility”; the Revolving Facility and the Term Loan Facility are collectively referred to herein as the “Credit Facilities”). The Borrowers borrowed the full amount under the Incremental Term Loan Facility and the Incremental Revolving Facility on the NIA Closing Date to finance, together with the proceeds from the sale of the Series A Preferred Stock, the cash consideration payable in connection with the NIA acquisition on the NIA Closing Date and pay transaction fees and expenses. A closing fee of (a) 3.00% of the aggregate amount of the commitments in respect of the Incremental Term Loan Facility and (b) 3.00% of the aggregate amount of the commitments in respect of the Incremental Revolving Facility was paid as of the NIA Closing Date.
The Credit Facilities are guaranteed by the Company and the Company’s domestic subsidiaries, subject to certain customary exceptions. The Credit Facilities are secured by a first priority security interest in all of the capital stock of each borrower and guarantor (other than the Company) and substantially all of the assets of each borrower and guarantor, subject to certain customary exceptions.
All loans under the Credit Facilities will mature on the date that is the earliest of (a) the sixth anniversary of the NIA Closing Date, (b) the date on which the commitments are voluntarily terminated pursuant to the terms of the Credit Agreement, (c) the date on which all amounts outstanding under the Credit Agreement have been declared or have automatically become due and payable under the terms of the Credit Agreement and (d) the date that is ninety-one (91) days prior to the maturity date of any Junior Debt (as defined in the Existing Credit Agreement) unless certain liquidity conditions are satisfied.
The interest rate for the Loans is calculated, at the option of the Borrowers, (a) in the case of the Term Loan Facility, at either the Adjusted Term SOFR Rate (as defined in the Credit Agreement) plus 6.00%, or the base rate plus 5.00% and (b) in the case of the Revolving Facility, at either the Adjusted Term SOFR Rate plus 4.00%, or the base rate plus 3.00%. A closing fee of (a) 2.00% of the aggregate amount of the commitments in respect of the Incremental Term Loan Facility and (b) 2.00% of the aggregate amount of the commitments in respect of the Incremental Revolving Facility was paid as of the NIA Closing Date. The Company recorded $11.1 million in interest expense related to our Credit Agreement for the three months ended March 31, 2023.
Amounts outstanding under the Credit Facilities may be prepaid at the option of the Company, subject to the following prepayment premium (the “Prepayment Premium”): (1) 3.00% of the principal amount so prepaid after the NIA Closing Date but prior to the first anniversary of the NIA Closing Date; (2) 2.00% of the principal amount so prepaid after the first anniversary of the closing but prior to the second anniversary of the NIA Closing Date; (3) 1.00% of the principal amount so prepaid after the second anniversary of the NIA Closing Date but prior to the third anniversary of the NIA Closing Date; and (4) 0.00% of the principal amount so prepaid on or after the third anniversary of the NIA Closing Date. Amounts outstanding under the Credit Facility are subject to mandatory prepayment upon the occurrence of certain events and conditions, including non-ordinary course asset dispositions, receipt of certain casualty proceeds, issuances of certain debt obligations and a change of control transaction, in each case, subject to application of the Prepayment Premium.
The Credit Facilities contain customary borrowing conditions, affirmative, negative and reporting covenants, representations and warranties, and events of default, including cross-defaults to other material indebtedness. If an event of default occurs, the lenders would be entitled to take enforcement action, including foreclosure on collateral and acceleration of amounts owed under the Loans. We incurred $14.4 million of debt issuance costs in connection with the Loans, which was included in long-term debt, net of discount on our consolidated balance sheets and amortized into interest expense over the life of the Credit Agreement. The Company recorded $0.5 million in interest expense related to the amortization of the debt discount and the issuance costs for the three months ended March 31, 2023.
During the three months ended March 31, 2023, the Company repaid $37.5 million under the Revolving Facility.
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,
since this method was not materially different from the effective interest method. 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 $0.2 million, $1.0 million for the three months ended March 31, 2023 and 2022, 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 interest expense related to the amortization of the issuance costs of $0.2 million for the three months ended March 31, 2023 and 2022, 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.
On August 11, 2022, the Company entered into exchange agreements with certain holders of the 2024 Notes. Pursuant to the agreements, these holders exchanged $92.8 million in aggregate principal amount of such notes for shares of the Company’s Class A common stock. On August 17 and 18, 2022, the Company consummated the exchanges and issued an aggregate of 5,394,165 shares of Class A common stock to the holders.
The August 2022 exchanges of the 2024 Notes for Class A common stock resulted in a $10.2 million loss on extinguishment/repayment of debt, net, on the consolidated statements of operations and comprehensive income (loss).
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 2025 Notes will mature on October 15, 2025, unless earlier repurchased, redeemed or converted in accordance with their terms prior to such date. The Company recorded interest expense of $0.6 million for the three months ended March 31, 2023 and 2022, respectively.
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 interest expense related to the amortization of the issuance costs of $0.3 million for the three months ended March 31, 2023 and 2022, respectively.
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.
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, 2023. 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, 2023 and December 31, 2022 (in thousands):
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
2024 Notes | | | |
Carrying value | $ | 23,971 | | | $ | 23,925 | |
Unamortized debt discount and issuance costs | 310 | | | 356 | |
Principal amount | $ | 24,281 | | | $ | 24,281 | |
Remaining amortization period (years) | 1.7 | | 1.9 |
Fair value(1) | $ | 38,000 | | | $ | 38,000 | |
| | | |
2025 Notes | | | |
Carrying value | $ | 169,205 | | | $ | 168,885 | |
Unamortized debt discount and issuance costs | 3,295 | | | 3,615 | |
Principal amount | $ | 172,500 | | | $ | 172,500 | |
Remaining amortization period (years) | 2.5 | | 2.8 |
Fair value(1) | $ | 192,605 | | | $ | 185,546 | |
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(1)Fair values for notes are derived from available trading prices closest to the respective balance sheet date. The 2024 Notes have not been traded since December 31, 2022.
Note 10. Commitments and Contingencies
Commitments
Letters of Credit
As of both March 31, 2023 and December 31, 2022, the Company was party to irrevocable standby letters of credit with a bank for $13.1 million, respectively, for the benefit of regulatory authorities, real estate and risk-sharing agreements. As such, we held $13.1 million, respectively, in restricted cash and restricted investments as collateral as of March 31, 2023 and 2022, respectively. The letters of credit have current expiration dates between April 2023 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 interim 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, 2023 and 2022, 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 and 2022. 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, 2023, no amounts have been funded under this guarantee.
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. There were no expenses associated with the UPMC Reseller Agreement for the three months ended March 31, 2023, and $0.6 million for the three months ended March 31, 2022. The contract is currently being wound down.
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 reduction in the Company’s valuation allowance primarily resulting from deferred tax liabilities established as part of the NIA acquisition, the Company has recorded the remaining TRA liability of $66.2 million for the three months ended March 31, 2023, resulting in a total TRA liability of $112.1 million as of March 31, 2023.
We will assess the realizability of the deferred tax assets at each reporting period, and a change in our estimate of our liability associated with the tax receivable agreement may result as additional information becomes available, including results of operations in future periods. The realizability of the deferred tax assets is evaluated based on all positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent results of operations.
Contingencies
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 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. Plaintiffs filed a motion to dismiss the case without prejudice, which was granted by the Delaware Chancery Court on January 5, 2023. This matter is now resolved.
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, 2023, approximately 99.1% of our $192.0 million of cash and cash equivalents, restricted cash and restricted investments were held in bank deposits with FDIC participating banks and approximately 0.9% 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 is closely monitoring ongoing events involving limited liquidity, defaults, non-performance or other adverse developments that affect financial institutions or other companies in the financial services industry or the financial services industry generally. The Company has not experienced any realized losses on cash and cash equivalents to date; however, no assurances can be provided.
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, excluding pharmacy claims receivable and premiums receivable:
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
Cook County Health and Hospitals System | 34.6% | | 42.5% |
| | | |
Molina Healthcare | 17.8% | | 12.0% |
Bright Health Management, Inc. | * | | 11.3% |
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* Represents less than 10.0% of the respective balance.
In addition, the Company is subject to significant concentration of revenue risk as a substantial portion of our revenue is derived from a small number of contractual relationships with our operating partners.
The following table summarizes those partners who represented at least 10.0% of our consolidated revenue:
| | | | | | | | | | | | | | | | | |
| | | For the Three Months Ended March 31, |
| | | | | 2023 | | 2022 | | |
Cook County Health and Hospitals Systems | | | | | 17.2% | | 23.9% | | |
Florida Blue Medicare, Inc. | | | | | 11.9% | | 11.9% | | |
Molina Healthcare | | | | | 13.2% | | * | | |
| | | | | | | | | |
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* Represents less than 10.0% of the respective balance
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 11. 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 2032. 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 $2.1 million in letters of credit as of both March 31, 2023 and December 31, 2022, respectively. As of March 31, 2023 and December 31, 2022, the Company held $2.1 million and $2.3 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, 2023 (in thousands, other than term):
| | | | | | | | | | | | | | | | | | | | |
Location | | Lease Termination Term (in years) | | Future Minimum Lease Commitments | | Letter of Credit Amount Required |
Arlington, VA | | 8.8 | | $ | 28,960 | | | $ | 1,579 | |
Riverside, IL | | 8.0 | | 37,301 | | | 232 | |
Edison, NJ | | 3.1 | | 1,597 | | | 222 | |
Alpharetta, GA | | 2.5 | | 1,180 | | | — | |
Pune, India | | 0.2 | | 91 | | | — | |
Brea, CA | | 4.2 | | 4,004 | | | — | |
The following table summarizes the components of our lease expense (in thousands):
| | | | | | | | | | | | | | | | | |
| | | For the Three Months Ended March 31, |
| | | | | 2023 | | 2022 | | |
Operating lease cost | | | | | $ | 1,940 | | | $ | 2,274 | | | |
| | | | | | | | | |
| | | | | | | | | |
Variable lease cost | | | | | 1,556 | | | 1,326 | | | |
Total lease cost | | | | | $ | 3,496 | | | $ | 3,600 | | | |
Maturity of lease liabilities (in thousands) as of March 31, 2023, is as follows:
| | | | | |
| Operating lease expense |
2023 | $ | 5,694 | |
2024 | 10,436 | |
2025 | 10,052 | |
2026 | 8,997 | |
2027 | 8,685 | |
Thereafter | 31,692 | |
Total lease payments | 75,556 | |
Less: | |
Interest | 16,674 | |
Present value of lease liabilities | $ | 58,882 | |
Our weighted-average discount rate and our weighted remaining lease terms (in years) are as follows:
| | | | | | | | | |
| |
| March 31, 2023 | | | | |
Weighted average discount rate | 6.34 | % | | | | |
Weighted average remaining lease term | 8.0 | | | | |
Note 12. Convertible Preferred Equity
In connection with the NIA closing, on January 20, 2023, the Company entered into a Securities Purchase Agreement (Series A Convertible Preferred Shares) with the Purchasers listed on Schedule I thereto (the “Securities Purchase Agreement”) pursuant to which the Company offered and sold to the Purchasers an aggregate 175,000 shares of the Company’s newly created Cumulative Series A Preferred Shares, par value $0.01 (the “Series A Preferred Stock”), at a purchase price of $960.00 per share, resulting in total gross proceeds to the Company of $168.0 million. The proceeds from the offer and sale of the Series A Preferred Stock were used, together with the proceeds from the Priority ABL Incremental Facility and Term Loan Incremental Facility, to finance the cash consideration payable at Closing and pay transaction fees and expenses.
The Series A Preferred Stock ranks senior with respect to dividend and liquidation rights to the Company’s Class A common stock, par value $0.01 per share and all future series of the Company’s preferred stock. Each share of Series A Preferred Stock has an initial liquidation preference of $1,000.00 per share.
Regular dividends on the Series A Preferred Stock will be paid quarterly in cash in arrears at a rate per annum equal to Adjusted Term SOFR (as defined in the Certificate of Designations (as defined below)) plus 6.00%. The liquidation preference of the Series A Preferred Stock will increase on the last day of each calendar quarter by the amount of any accrued and unpaid regular dividends that have not been paid in cash on the relevant dividend payment date. The regular dividend rate will also increase by 2.0% per annum upon the occurrence and during the continuance of certain triggering events, including a breach of the protective covenants contained in the Investor Rights Agreement or the Company’s failure to pay any regular dividends in cash. Holders of Series A Preferred Stock are also entitled to participate in and receive any dividends declared or paid on the Class A Common Stock on an as-converted basis.
Each holder of Series A Preferred Stock has the right, at its option, to convert its shares of Series A Preferred Stock into shares of Class A Common Stock at an initial conversion price per share of $40.00 of the then-current liquidation preference per share, subject to customary anti-dilution adjustments.
Holders of Series A Preferred Stock are not entitled to vote on any matters, except as required by law and for certain consent rights set forth in the Certificate of Designations.
The Company may not redeem the Series A Preferred Stock at its option prior to January 20, 2025. At any time on or after January 20, 2025, the Company may redeem any or all of the Series A Preferred Stock then outstanding for cash at a redemption price per share equal to 165.00% of the then-current liquidation preference of the Series A Preferred Stock, plus all accrued and unpaid dividends on the Series A Preferred Stock being redeemed.
If not earlier redeemed, at any time on or after January 20, 2030, at the request of the holders of a majority of the convertible preferred stock, the Company will redeem all shares of Series A Preferred Stock then outstanding for cash at a redemption price per share equal to 150.00% of the then-current liquidation preference per share of the Series A Preferred Stock, plus all accrued and unpaid dividends on the Series A Preferred Stock being redeemed.
Upon the occurrence of a refinancing or replacement of the entirety of the indebtedness under the Credit Agreement prior to its maturity that is provided solely by lenders who are not affiliates or approved funds of Ares, the Company will be required to redeem all shares of Series A Preferred Stock then outstanding for cash at a redemption price per share equal to 165.00% of the then-current liquidation preference of the Series A Preferred Stock, plus all accrued and unpaid dividends on the Series A Preferred Stock being redeemed, plus, solely in the event such refinancing or replacement is consummated prior to January 20, 2025, the aggregate amount of dividends per share which would have otherwise been payable on the Series A Preferred Stock from the date of redemption until January 20, 2025.
If the Company undergoes a Change of Control (as defined in the Existing Credit Agreement), the Company will be required to redeem all shares of Series A Preferred Stock then outstanding for cash at a price per share equal to the greater of (x) 150.00% of the then-current liquidation preference per share of the Series A Preferred Stock, if such redemption occurs prior to January 20, 2025, and 135.00% of the then-current liquidation preference per share of the Series A Preferred Stock, if such redemption occurs on or after January 20, 2025, and (y) the value of the Class A Common Stock issuable upon conversion of a share of Series A Preferred Stock, which value shall be determined based on the value attributed to the Class A Common Stock in connection with such Change of Control.
In connection with the NIA closing, the Company entered into an Investors Rights Agreement with the Purchasers named in Schedule I thereto (the “Investors Rights Agreement”). The Investors Rights Agreement contains certain restrictions on the transfer of the Series A Preferred Stock and certain protective covenants in favor of the Purchasers. These covenants include, among other things, covenants limiting the incurrence of Funded Debt (as defined in the Investors Rights Agreement), the ability to make restricted payments and the ability to issue additional indebtedness senior to the Series A Preferred Stock. Each of these covenants is subject to certain exceptions set forth in the Investors Rights Agreement.
In connection with the NIA closing, on January 20, 2023, the Company entered into a Registration Rights Agreement with the Stockholders named in Schedule I thereto, which granted certain registration rights to Ares in respect of the shares of the Company’s Class A Common Stock issuable upon conversion of the Series A Preferred Stock.
During the three months ended March 31, 2023, the Company paid dividends of $3.7 million, or $20.86 per share of Series A Preferred Stock, and accreted $2.6 million of deferred issuance costs in additional paid-in-capital on the consolidated balance sheets.
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, |
| | | | | 2023 | | 2022 | | |
| | | | | | | | | |
| | | | | | | | | |
Net loss attributable to common shareholders of Evolent Health, Inc. | | | | | $ | (26,258) | | | $ | (5,350) | | | |
| | | | | | | | | |
Weighted-average common shares outstanding - basic and diluted | | | | | 107,783 | | | 89,509 | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
Loss per common share | | | | | | | | | |
| | | | | | | | | |
Basic and diluted | | | | | $ | (0.24) | | | $ | (0.06) | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
Basic net loss per common share is calculated using the weighted average number of common shares outstanding during the period. Diluted net earnings per common share, if any, gives effect to diluted stock options (calculated based on the treasury stock method), shares issuable upon debt conversion (calculated using an as-if converted method).
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, |
| | | | | 2023 | | 2022 | | |
Restricted stock units ("RSUs"), performance-based RSUs (“PSUs”) and leveraged stock units ("LSUs") | | | | | 1,923 | | | 2,161 | | | |
Stock options | | | | | 1,260 | | | 1,756 | | | |
Series A Preferred Stock | | | | | 4,375 | | | — | | | |
Convertible senior notes | | | | | 6,188 | | | 11,582 | | | |
Total | | | | | 13,746 | | | 15,499 | | | |
Note 14. Stock-based Compensation
Total compensation expense by award type and line item in our interim consolidated financial statements was as follows (in thousands):
| | | | | | | | | | | | | | | |
| | | For the Three Months Ended March 31, |
| | | | | 2023 | | 2022 |
Award Type | | | | | | | |
Stock options | | | | | $ | 60 | | | $ | 162 | |
RSUs | | | | | 7,489 | | | 3,301 | |
LSUs | | | | | 284 | | | 775 | |
PSUs | | | | | 2,877 | | | 1,108 | |
Total compensation expense by award type | | | | | $ | 10,710 | | | $ | 5,346 | |
| | | | | | | |
Line Item | | | | | | | |
Cost of revenue | | | | | $ | 1,540 | | | $ | 800 | |
Selling, general and administrative expenses | | | | | 9,170 | | | 4,546 | |
Total compensation expense by financial statement line item | | | | | $ | 10,710 | | | $ | 5,346 | |
No stock-based compensation was capitalized as software development costs during the three months ended March 31, 2023 and 2022, respectively.
Stock-based awards were granted as follows (in thousands):
| | | | | | | | | | | | | | | |
| | | For the Three Months Ended March 31, |
| | | | | 2023 | | 2022 |
RSUs | | | | | 996 | | | 917 | |
PSUs | | | | | 424 | | | 479 | |
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, adjusted for discrete items recognized during the interim period. Discrete items (e.g., significant or unusual items) are separately recognized in the quarter during which they occur and can cause the effective tax rate to vary from quarter to quarter.
An income tax provision (benefit) of $(68.2) million and $1.2 million was recognized for the three months ended March 31, 2023 and 2022, respectively, which resulted in effective tax rates of 77.3% and (29.0)%, respectively. The income tax benefit recorded during the three months ended March 31, 2023, primarily relates to $56.1 million for the reduction in the valuation allowance resulting from deferred tax liabilities established as part of the NIA acquisition accounting and $8.3 million for the TRA liabilities that will create current and future tax benefits upon settlement. The income tax expense recorded during the three months ended March 31, 2022, primarily related to state and foreign taxes.
As of March 31, 2023, the Company had unrecognized tax benefits of $1.6 million that, if recognized, would affect the overall effective tax rate. 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 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 10 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, 2023 and December 31, 2022, the Company’s economic interests in its equity method investments ranged between 4% and 38%, 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 $0.4 million and $0.6 million for the three months ended March 31, 2023 and 2022, 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 $4.8 million and $3.6 million for the three months ended March 31, 2023 and 2022, 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. These items are recorded in accrued liabilities on our consolidated balance sheets.
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, 2023 |
| Level 1 | | Level 2 | | Level 3 | | Total |
Liabilities | | | | | | | |
Contingent consideration(1) | $ | — | | | $ | — | | | $ | 122,100 | | | $ | 122,100 | |
Total fair value of liabilities measured on a recurring basis | $ | — | | | $ | — | | | $ | 122,100 | | | $ | 122,100 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 |
| Level 1 | | Level 2 | | Level 3 | | Total |
Liabilities | | | | | | | |
Contingent consideration | $ | — | | | $ | — | | | $ | 78,000 | | | $ | 78,000 | |
Total fair value of liabilities measured on a recurring basis | $ | — | | | $ | — | | | $ | 78,000 | | | $ | 78,000 | |
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(1) Represents the fair value of earn-out consideration related to the IPG and NIA transactions 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, 2023.
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.
The acquisitions of NIA and IPG include a provision for additional equity consideration, at the Company’s option, contingent upon the Company obtaining certain performance metrics. The earnout period for the NIA contingent consideration is the year ending December 31, 2023, and the earnout period for IPG is the nine months ended September 30, 2023. The fair value of the contingent equity considerations 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 measurements of the NIA and IPG contingent considerations 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, |
| 2023 | | 2022 |
Balance as of beginning of period | $ | 78,000 | | | $ | 28,700 | |
Additions | 69,761 | | | — | |
Settlements | (29,961) | | | — | |
Unrealized (gain) loss, net | 4,300 | | | 3,900 | |
Balance as of end of period | $ | 122,100 | | | $ | 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, 2023 |
| Fair | | Valuation | | Significant | | Assumption or |
| Value | | Technique | | Unobservable Inputs | | Input Ranges |
Contingent consideration | $ | 122,100 | | | Real options approach | | Risk-neutral expected earnout consideration | | $ | 122,100 | |
| | | | | Weighted average discount rate | | 8.80% - 16.64% |
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 |
| Fair | | Valuation | | Significant | | Assumption or |
| Value | | Technique | | Unobservable Inputs | | Input Ranges |
Contingent consideration | $ | 78,000 | | | Real options approach | | Risk-neutral expected earnout consideration | | $ | 77,946 | |
| | | | | Weighted average discount rate | | 9.85% - 10.01% |
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 9 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 interim 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 (in thousands):
| | | | | | | | | | | |
| |
| | | |
| March 31, 2023 | | December 31, 2022 |
Assets | | | |
Accounts receivable, net | $ | 9,360 | | | $ | 8,787 | |
| | | |
| | | |
| | | |
Liabilities | | | |
Accounts payable | $ | 2 | | | $ | 27 | |
Accrued liabilities | — | | | 192 | |
| | | |
The following table presents revenues and expenses attributable to our related parties (in thousands):
| | | | | | | | | | | | | | | | | |
| | | For the Three Months Ended March 31, |
| | | | | 2023 | | 2022 | | |
Revenue | | | | | $ | 54,721 | | | $ | 32,064 | | | |
| | | | | | | | | |
Expenses | | | | | | | | | |
Cost of revenue (exclusive of depreciation and amortization expenses) | | | | | 47,506 | | | 26,461 | | | |
Selling, general and administrative expenses | | | | | 242 | | | 66 | | | |
Note 19. 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 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 10.
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 based on authorizations per thousand members basis and assigning an average cost per authorization. This is also adjusted for the impact of copays, deductibles, unit cost and historic discontinuation rates for treatment are considered.
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, |
| 2023 | | 2022 |
Balance, beginning of period | $ | 199,730 | | | $ | 171,294 | |
Incurred health care costs: | | | |
Current year to date period | 180,675 | | | 102,664 | |
Prior year to date period | (19,914) | | | 6,511 | |
Total claims incurred | 160,761 | | | 109,175 | |
Claims paid related to: | | | |
Current year to date period | (64,870) | | | (47,724) | |
Prior year to date period | (98,424) | | | (59,491) | |
Total claims paid | (163,294) | | | (107,215) | |
Other adjustments (1) | — | | | (9,016) | |
Balance, end of period | $ | 197,197 | | | $ | 164,238 | |
————————
(1) 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 20. Supplemental Cash Flow Information
The following represents supplemental cash flow information (in thousands):
| | | | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2023 | | 2022 | | |
Supplemental Disclosure of Non-cash Investing and Financing Activities | | | | | |
Accrued property and equipment purchases | $ | 30 | | | $ | 670 | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
Class A common stock issued in connection with business combinations | 261,271 | | | — | | | |
| | | | | |
| | | | | |
Accrued net working capital adjustment with business combinations | 1,098 | | | — | | | |
Effects of Leases | | | | | |
Operating cash flows from operating leases | 3,528 | | | 3,830 | | | |
Leased assets disposed of (obtained in) exchange for operating lease liabilities | (3,076) | | | (3) | | | |
| | | | | |
| | | | | |
| | | | | |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand the Company’s financial condition and results of operations. The MD&A is provided as a supplement to, and should be read in conjunction with our interim consolidated financial statements and the accompanying notes to our interim consolidated financial statements presented in “Part I – Item 1. Financial Statements” of this Form 10-Q; our 2022 Form 10-K, including the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”; and our current reports on Form 8-K filed in 2023.
INTRODUCTION
Business Overview
We are a market leader in the new era of value-based care, in which the delivery of health care is increasingly funded by at-risk payment models. We provide integrated solutions to both health care providers, including independent physicians and health systems, as well as payers, including health plans and other risk-bearing organizations, with a common end: to improve health care quality and outcomes while reducing cost. We consider value-based care to be the necessary convergence of health care payment and delivery. We believe the pace of this convergence is accelerating, driven by price pressure in traditional FFS health care, a market environment that is incentivizing value-based care models, growth in consumer-focused insurance programs, such as Medicare Advantage and managed Medicaid, and innovation in data and technology.
We were an early innovator in value-based care, founded in 2011 by members of our management team, UPMC, an integrated delivery system based in Pittsburgh, Pennsylvania, and The Advisory Board Company.
Segment Update
Between 2020 and 2022, we significantly grew our value-based specialty care business, both organically and through acquisitions. Given the pace of our growth, what we believe to be our high level of competitive differentiation, and the size of potential opportunities in the specialty care market, we began a process in 2023 of revising the way we manage the business, evaluate performance and allocate resources, resulting in an updated segment structure comprised of one segment. We now provide a broad spectrum of specialty care management services in oncology, cardiology, musculoskeletal markets and holistic total cost of care improvement along with an integrated platform for health plan administration and value-based business infrastructure under one go to market package. We began reporting under this new segment structure as of January 1, 2023. Prior year information has been adjusted to reflect the change in segment reporting.
All of our revenue is recognized in the United States and substantially all of our long-lived assets are located in the United States.
Recent Events
Impact of Inflation
We experience pricing pressures in the form of competitive prices in addition to rising costs for certain inflation-sensitive operating expenses such as labor, employee benefits and facility leases. We do not believe these impacts were material to our revenues or net income during the year ended March 31, 2023. However, significant sustained inflation driven by the macroeconomic environment or other factors could negatively impact our margins, profitability and results of operations in future periods.
Customers
The following table summarizes those partners who represented at least 10.0% of our consolidated revenue:
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| | | For the Three Months Ended March 31, |
| | | | | 2022 | | 2022 | | |
Cook County Health and Hospitals Systems | | | | | 17.2% | | 23.9% | | |
Florida Blue Medicare, Inc. | | | | | 11.9% | | 11.9% | | |
Molina Healthcare | | | | | 13.2% | | * | | |
| | | | | | | | | |
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* Represents less than 10.0% of the respective balance
Transactions
The Company has undertaken several transactions, some of which may impact year-to-year comparisons. The following is a discussion of certain of those transactions.
Acquisition of NIA
On November 17, 2022, Evolent Health LLC, a wholly owned subsidiary of the Company, and the Company entered into a definitive agreement for the Company to acquire NIA. On January 20, 2023, we consummated the acquisition of NIA for $387.8 million in cash, $265.0 million in debt financing provided by Ares Capital Corporation and the issuance of 8.5 million shares of Class A common
stock. NIA reports into Evolent’s specialty care management offering, New Century Health. Refer to “Part I - Item 1. Financial Statements - Note 4” for additional discussion regarding the NIA acquisition.
Credit Agreement Amendment
On January 20, 2023, (“the NIA Closing Date”), the Company entered into Amendment No. 1 to the Credit Agreement (the “Amendment”), pursuant to which the lenders agreed to extend credit to the Borrower in the form (i) additional revolving commitments in an aggregate principal amount equal to $25.0 million (the “Incremental Revolving Facility” and together with the Initial Revolving Facility, the “Revolving Facility”), and (ii) additional term loans in an aggregate principal amount equal to $240.0 million (the “Incremental Term Loan Facility” and together with the Initial Term Loan Facility, the “Term Loan Facility”; the Revolving Facility and the Term Loan Facility are collectively referred to herein as the “Credit Facilities”). The Borrowers borrowed full amount under the Incremental Term Loan Facility and the Incremental Revolving Facility on the NIA Closing Date to finance, together with the proceeds from the sale of the Series A Preferred Stock, the cash consideration payable in connection with the NIA acquisition on the NIA Closing Date and pay transaction fees and expenses. A closing fee of (a) 3.00% of the aggregate amount of the commitments in respect of the Incremental Term Loan Facility and (b) 3.00% of the aggregate amount of the commitments in respect of the Incremental Revolving Facility was paid as of the NIA Closing Date. Refer to “Part I - Item 1. Financial Statements - Note 9” for additional discussion regarding the amendment to the Credit Agreement.
Series A Preferred Stock
In connection with the consummation of the acquisition of NIA, on January 20, 2023, we entered into a Securities Purchase Agreement pursuant to which the Company offered and sold an aggregate 175,000 shares of Series A Preferred Stock, at a purchase price of $960.00 per share, resulting in total gross proceeds to us of $168.0 million. The proceeds from the offer and sale of the Series A Preferred Stock were used, together with the proceeds from the Priority ABL Incremental Facility and Term Loan Incremental Facility, to finance the cash consideration payable for the acquisition of NIA and pay transaction fees and expenses. Refer to “Part II - Item 8. Financial Statements - Note 12” for additional discussion regarding the sale of Series A Preferred Stock.
Repositioning Costs
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. In the first quarter of 2023, 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 operational efficiency and cost-reduction initiatives that will provide future benefit to the Company. During 2023, we expect to terminate certain leases and recognize impairment charges in connection with the Repositioning Plan.
Critical Accounting Policies and Estimates
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 2022 Form 10-K for a complete summary of our significant accounting policies.
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. 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. Qualitative factors include macroeconomic, industry and market considerations, overall financial performance, industry, legal and other relevant events and factors affecting the reporting unit. Additionally, as part of this assessment, we may perform a quantitative analysis to support the qualitative factors above by applying sensitivities to assumptions and inputs used in measuring a reporting unit’s fair value.
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). We use discounted cash flow analyses and market multiple analyses in order to estimate reporting unit fair values. Discounted cash flow analyses rely on significant judgement and assumptions about expected future cash flows, weighted-average cost of capital, discount rates, expected long-term growth rates and operating margins. These assumptions are based on estimates of future revenue and earnings after considering such factors as general economic and market conditions which drive key assumptions of revenue growth rates, operating margins, capital expenditures and working capital requirements. The weighted average cost of capital is based on market-based factors/inputs but also considers the specific risk characteristics of the reporting unit’s cash flow forecast. A significant change to these estimates and assumptions could cause the estimated fair values of our reporting units and intangible assets to decline and increase the risk of an impairment charge to earnings. Intangible assets with finite lives are assessed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
On October 31, 2022, the Company performed its annual goodwill impairment test for fiscal year 2022. As a result of BHG announcing its plan to exit its IFP line of business in 2023, thus negatively impacting the Company’s future revenues from such partner, the Company elected to forego the qualitative assessment and proceed directly to the quantitative assessment of the goodwill impairment test for that specific reporting unit. In doing so, we estimated the fair value of the reporting unit by considering a discounted cash flow valuation approach (“income approach”). In determining the estimated fair value using the income approach, we projected future cash flows based on management’s estimates and long-term plans and applied a discount rate based on the Company’s weighted average cost of capital. This analysis required us to make judgments about revenues, expenses, fixed asset and working capital requirements, capital market assumptions, cash flows and discount rates. The quantitative analysis of the reporting unit showed that the fair value exceeded the carrying value. Contracts with our customers may be cancelled or renegotiated and future revenue growth is dependent on winning new contracts. Further, the impairment analysis is particularly sensitive to changes in the projected revenue growth rates and expenses and the discount rate. Changes in these key assumptions such as a significant unfavorable change to our forecasted cash flows due to being unsuccessful in winning certain contracts or certain of our contracts being cancelled or renegotiated by our customers, could result in a revision of management’s estimates and could result in impairment charges in the future, which could be material to our results of operations. We will continue to monitor for such changes in facts or circumstances, which may be indicators of potential impairment triggers.
For the remaining reporting units, after assessing the totality of events and circumstances including the results of our previous valuations, no events occurred or circumstances changed during the period under consideration that would, more likely than not, reduce the fair value of any reporting unit below their carrying amount. Therefore, the Company concluded that the quantitative assessment was not required. For all reporting units, it was determined that as of October 31, 2022, no impairment of goodwill had occurred.
We did not identify any qualitative factors that would trigger a quantitative goodwill impairment test during the three months ended March 31, 2023. We will perform our annual impairment test of October 31, 2023.
Adoption of New Accounting Standards
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 will not separately present in equity an embedded conversion feature of such debt. Instead, we will 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 as of January 1, 2022, with adjustments which reduced additional paid-in capital by $106.2 million and increased retained earnings by $39.8 million and increased the net carrying amount of the 2024 Notes and 2025 Notes by $25.1 million and $41.3 million.
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. This ASU clarifies that an acquirer of a business should recognize and measure contract assets and contract liabilities in a business combination in accordance with ASC Topic 606, Revenue from Contracts with Customers. The Company adopted this standard starting in the first quarter of 2023, which did not have a material impact on our consolidated financial statements.
RESULTS OF OPERATIONS
Evolent Health, Inc. is a holding company and its principal asset is all of the Class A common units in Evolent Health LLC, which has owned all of our operating assets and substantially all of our business since inception. The financial results of Evolent Health LLC are consolidated in the financial statements of Evolent Health, Inc.
Key Components of our Results of Operations
Revenue
Our revenue contracts are typically multi-year arrangements with customers to provide various clinical and administrative solutions. Our solutions are designed to lower the medical expenses of our partners and include our total cost of care and specialty care management services, provide comprehensive health plan operations and claims processing services, and also include transition or run-out services to customers.
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.
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.
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 services over time using the time elapsed output method. Fixed consideration is recognized ratably over the contract term. In accordance with the series guidance, we allocate variable consideration to the period to which the fees relate.
Contracts with Multiple Performance Obligations
Our contracts with customers may contain multiple performance obligations, primarily when the customer has requested both implementation and ongoing 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.
Cost of Revenue (exclusive of depreciation and amortization)
Our cost of revenue includes direct expenses and shared resources that perform services in direct support of clients. Costs consist primarily of claims expense, employee-related expenses (including compensation, benefits and stock-based compensation), expenses for TPA support and other services, as well as other professional fees. In certain cases, our cost of revenue also includes claims and capitation payments to providers and payments for pharmaceutical treatments and other health care expenditures through performance-based arrangements.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses consist of employee-related expenses (including compensation, benefits and stock-based compensation) for selling and marketing, corporate development, finance, legal, human resources, corporate information technology, professional fees and other corporate expenses associated with these functional areas. Selling, general and administrative expenses also include costs associated with our centralized infrastructure and research and development activities to support our network development capabilities, claims processing services, including PBM administration, technology infrastructure, clinical program development and data analytics.
Depreciation and Amortization Expense
Depreciation and amortization expenses consist of the amortization of intangible assets associated with the step up in fair value of Evolent Health LLC’s assets and liabilities for the Offering Reorganization, amortization of intangible assets recorded as part of our various business combinations and asset acquisitions and depreciation of property and equipment, including the amortization of capitalized software.
Lives on Platform and PMPM Fees
Performance Suite Lives on Platform are calculated by summing monthly members covered for oncology and cardiology specialty care services for contracts not under ASO arrangements, plus members managed by Evolent Care Partners in risk arrangements and divided by the number of months in the period. Specialty Technology and Services Suite Lives on Platform are calculated by summing monthly members covered for oncology, cardiology, musculoskeletal, advanced imaging and other diagnostics specialty care services for contracts under ASO arrangements divided by the number of months in the period. Administrative Services Lives on Platform are calculated by summing monthly members covered for EHS implementation and core performance services divided by the number of months in the period. Cases are calculated by summing the number of individuals receiving services through our IPG and Vital Decisions programs in a given period. Members covered for more than one category are counted in each category.
Performance Suite Average PMPM fee is defined as revenue pertaining to our Performance Suite during the period reported divided by Performance Suite Lives on Platform for the period divided by the number of months in the period. Specialty Technology and Services Suite Average PMPM fee is defined as revenue pertaining to the Specialty Technology and Services Suite during the period reported divided by Specialty Technology and Services Suite Lives on Platform for the period divided by the number of months in the period. Administrative Services Average PMPM fee is defined as revenue pertaining to the Administrative Services during the period reported divided by the Administrative Services Lives on Platform for the period divided by the number of months in the period. Revenue per Case is calculated by the revenue pertaining to IPG and Vital Decisions divided by the number of cases for a given period.
Average Unique Members are calculated by summing members covered by our Performance Suite, Specialty Technology and Services Suite and Administrative Services. In cases where clients cross between multiple products, we only capture members from the product with the maximum number of members.
Management uses Lives on Platform, PMPM fees, Cases, Revenue per Case and Average Unique Members because we believe that they provide insight into the unit economics of our services. We believe that these measures are also useful to investors because they allow further insight into the period over period operational performance. We believe that these measures are also useful to investors because they allow further insight into the period over period operational performance.
The Company has changed its calculation of Lives on Platform to more accurately reflect the membership that corresponds to quarterly revenue. The Company has recast prior periods to reflect the current presentation of Lives on Platform, PMPM fees, Cases and Revenue per Case. The current Performance Suite maps to the prior disclosure of the Clinical Solutions Performance Suite. The current Specialty Technology and Services Suite maps to the prior disclosure of the Clinical Solutions New Century Health Technology and Services Suite. The current Administrative Services maps to the prior disclosure of Evolent Health Services segment. There has been no change in the presentation of Cases from prior period.
Evolent Health, Inc. Consolidated Results
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(in thousands, except percentages) | For the Three Months Ended March 31, 2023 | | Change Over Prior Period | | | | |
2023 | | 2022 | | $ | | % | | | | | | | | |
Revenue | $ | 427,690 | | | $ | 297,057 | | | $ | 130,633 | | | 44.0% | | | | | | | | |
| | | | | | | | | | | | | | | |
Expenses | | | | | | | | | | | | | | | |
Cost of revenue (exclusive of depreciation and amortization expenses presented separately below) | 310,475 | | | 219,739 | | | 90,736 | | | 41.3% | | | | | | | | |
Selling, general and administrative expenses | 89,726 | | | 58,932 | | | 30,794 | | | 52.3% | | | | | | | | |
Depreciation and amortization expenses | 29,275 | | | 15,106 | | | 14,169 | | | 93.8% | | | | | | | | |
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| | | | | | | | | | | | | | | |
Change in fair value of contingent consideration | 8,569 | | | 6,078 | | | 2,491 | | | 41.0% | | | | | | | | |
Total operating expenses | 438,045 | | | 299,855 | | | 138,190 | | | 46.1% | | | | | | | | |
Operating loss | $ | (10,355) | | | $ | (2,798) | | | $ | (7,557) | | | (270.1)% | | | | | | | | |
| | | | | | | | | | | | | | | |
Cost of revenue as a % of revenue | 72.6 | % | | 74.0 | % | | | | | | | | | | | | |
Selling, general and administrative expenses as a % of revenue | 21.0 | % | | 19.8 | % | | | | | | | | | | | | |
Comparison of the Results for Three Months Ended March 31, 2023 to 2022
Revenue
Total revenue increased by $130.6 million, or 44.0%, to $427.7 million for the three months ended March 31, 2023, as compared to 2022. This increase is primarily due to $82.5 million from our acquisitions of and launches of new integrated products with NIA, IPG and Vital Decisions, and $48.1 million from the addition of new partners and expansion with existing partners.
The following table represents Evolent’s revenue disaggregated by end-market (in thousands):
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| | | | | For the Three Months Ended March 31, |
| | | | | 2023 | | 2022 |
Medicaid | | | | | $ | 183,034 | | | $ | 130,501 | |
Medicare | | | | | 127,669 | | | 104,399 | |
Commercial and other | | | | | 116,987 | | | 62,157 | |
Total | | | | | $ | 427,690 | | | $ | 297,057 | |
The following table represents the Company’s Lives on Platform, Cases, PMPM fees and revenue per case for the three months ended March 31, 2023 and 2022 (Lives on Platform in thousands):
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| Average Lives on Platform/ Cases | | Average PMPM Fees / Revenue per Case |
| For the Three Months Ended March 31, | | For the Three Months Ended March 31, |
| 2023 | | 2022 | | 2023 | | 2022 |
Performance Suite | 3,242 | | | 1,494 | | | $ | 24.66 | | | $ | 38.19 | |
Specialty Technology and Services Suite | 60,503 | | | 14,305 | | | 0.36 | | | 0.32 | |
Administrative Services | 1,857 | | | 2,054 | | | 14.91 | | | 17.34 | |
Cases | 15 | | | 5 | | | 2,555 | | | 1,052 | |
| | | | | | | |
Average Unique Members | 41,268 | | | 15,123 | | | | | |
Cost of Revenue
Cost of revenue increased by $90.7 million, or 41.3%, to $310.5 million for the three months ended March 31, 2023, as compared to 2022, principally as a result of the growth in our revenue. The increase included approximately $56.8 million from higher claims cost from acquisitions and transition from ASO to risk based contracts for certain customers, $25.8 million of higher personnel costs due to increased headcount, employee benefit, bonus accruals for employees and severance payments to former employees and $25.5 million of surgical management costs at IPG. These increases were offset in part by a decrease of $8.1 million in professional fees due primarily to lower costs incurred for contracts that went live during the quarter and third-party service fees for existing customers and a decrease of $8.4 million for the acceleration of amortization of contract costs for certain customers. Approximately $1.5 million and $0.8 million of total personnel costs in costs of revenue was attributable to stock-based compensation expense for the three months ended March 31, 2023, and 2022, respectively. Cost of revenue represented 72.6% and 74.0% of total revenue for the three months ended March 31, 2023, and 2022, respectively. We expect our cost of revenue to decrease as a percentage of total revenue over the longer-term subject to the composition of our growth.
Selling, General and Administrative Expenses
Selling, general, and administrative expenses increased by $30.8 million, or 52.3%, to $89.7 million for the three months ended March 31, 2023, as compared to 2022, principally as a result of the IPG and NIA acquisitions and employee costs across all business units. The increase was primarily driven by higher personnel fees due to increased headcount and expected benefit accruals to employees of $3.8 million, higher stock compensation of $4.6 million due to the achievement and change in projected achievement of certain performance measurements, higher bad debt expense of $4.6 million due to collection timing from our customers, technology services due to higher headcount of $1.4 million, $0.6 million of higher insurance costs, $0.3 million of severance costs and acquisition costs of $11.3 million, offset, in part by lower professional fees from cost savings initiatives of $1.5 million.
Approximately $9.2 million and $4.5 million of total personnel costs were attributable to stock-based compensation expense for the three months ended March 31, 2023, and 2022, respectively. Acquisition and severance costs accounted for approximately $12.3 million and $0.5 million of total selling, general and administrative expenses for the three months ended March 31, 2023, and 2022, respectively. Selling, general and administrative expenses represented 21.0% and 19.8% of total revenue for the three months ended March 31, 2023, as compared to 2022, respectively. While our selling, general and administrative expenses are expected to grow as we integrate NIA operations, we expect them to decrease as a percentage of our total revenue over the long-term due to cost saving initiatives.
Depreciation and Amortization Expenses
Depreciation and amortization expenses increased $14.2 million, or 93.8%, to $29.3 million for the three months ended March 31, 2023, as compared to 2022 due primarily to amortization of intangible assets acquired through our acquisitions. We expect depreciation and amortization expenses to increase in future periods as we continue to capitalize internal-use software and amortize intangible assets resulting from asset acquisitions and business combinations.
Change in Fair Value of Contingent Consideration
We recorded a loss on change in fair value of contingent consideration of $8.6 million for the three months ended March 31, 2023, related to the liabilities acquired as a result of the acquisitions of NIA in January 2023 and IPG in August 2022, and $6.1 million for the three months ended March 31, 2022, related to liabilities acquired as a result of the acquisition of Vital Decisions. See “Part I - Item 1. Financial Statements - Note 17” in this Form 10-Q for more information related to changes in the fair value of contingent consideration.
Discussion of Non-Operating Results
Interest Expense
Our interest expense is primarily attributable to our Credit Agreement with Ares Capital Corporation as well as the 2024 Notes and 2025 Convertible Notes. We recorded interest expense (including amortization of deferred financing costs) of approximately $12.9 million and $2.2 million for the three months ended March 31, 2023, and 2022, respectively. The increase in interest expense is driven primarily by the interest expense incurred on our Loans. We expect interest expense to increase during 2023, however, we are focused
on deleveraging the balance sheet in the long-term thereby decreasing interest expense. See “Part I - Item 1. Financial Statements - Note 9” in this Form 10-Q for more information related to interest expense.
Change in Tax Receivable Agreement Liability
Due to the reduction in the Company’s valuation allowance primarily resulting from deferred tax liabilities established as part of the NIA acquisition, the Company has recorded the remaining TRA liability of $66.2 million for the three months ended March 31, 2023, resulting in a total TRA liability of $112.1 million as of March 31, 2023.
Provision for (Benefit from) Income Taxes
A provision for (benefit from) income taxes of $(68.2) million and $1.2 million was recognized for the three months ended March 31, 2023, and 2022, respectively, which resulted in effective tax rates of 77.3% and (29.0)%, respectively.
REVIEW OF CONSOLIDATED FINANCIAL CONDITION
Liquidity and Capital Resources
The Company reported operating losses of $(10.4) million and $(2.8) million for the three months ended March 31, 2023, and 2022, respectively. Net cash and restricted cash used in operating activities was $(8.0) million and $(57.4) million for the three months ended March 31, 2023, and 2022, respectively.
As of March 31, 2023, the Company had $157.5 million of cash and cash equivalents and $34.5 million in restricted cash and restricted investments.
We believe our current cash and cash equivalents will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities and the timing and extent of our spending to support our investment efforts and expansion into other markets. We may also seek to invest in, or acquire complementary businesses, applications or technologies, which may require us to seek sources of financing.