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| | |
UNITED STATES |
SECURITIES AND EXCHANGE COMMISSION |
WASHINGTON, D.C. 20549 |
_________________________
FORM 10-Q
_________________________
(Mark One)
S QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2022
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-37415
_________________________
Evolent Health, Inc.
(Exact name of registrant as specified in its charter)
_________________________
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Delaware | | | | | | | | 32-0454912 | |
| (State or other jurisdiction of incorporation or organization) | | | | | | | | (I.R.S. Employer Identification No.) | |
| | | | | | | | | | |
| 800 N. Glebe Road | , | Suite 500 | , | Arlington | , | Virginia | | 22203 | |
| (Address of principal executive offices) | | (Zip Code) | |
(571) 389-6000
Registrant’s telephone number, including area code
_________________________
Securities registered pursuant to Section 12(b) of the Act:
| | | | | | | | |
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Class A Common Stock of Evolent Health, Inc., par value $0.01 per share | EVH | New York Stock Exchange |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes S No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes S No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer S Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No S
As of October 28, 2022, there were 101,190,965 shares of the registrant’s Class A common stock outstanding.
Evolent Health, Inc.
Table of Contents
Explanatory Note
In this Quarterly Report on Form 10-Q, unless the context otherwise requires, “Evolent,” the “Company,” “we,” “our” and “us” refer to Evolent Health, Inc. and its consolidated subsidiaries. Evolent Health LLC, a subsidiary of Evolent Health, Inc. through which we conduct our operations, has owned all of our operating assets and substantially all of our business since inception. Evolent Health, Inc. is a holding company and its principal asset is all of the Class A common units of Evolent Health LLC.
FORWARD-LOOKING STATEMENTS - CAUTIONARY LANGUAGE
Certain statements made in this report and in other written or oral statements made by us or on our behalf are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”). A forward-looking statement is a statement that is not a historical fact and, without limitation, includes any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain words like: “believe,” “anticipate,” “expect,” “estimate,” “aim,” “predict,” “potential,” “continue,” “plan,” “project,” “will,” “should,” “shall,” “may,” “might” and other words or phrases with similar meaning in connection with a discussion of future operating or financial performance. In particular, these include statements relating to our ability to grow our impact significantly throughout this year and beyond, future actions, trends in our businesses, prospective services, new partner additions/expansions, our guidance and business outlook and future performance or financial results, and the closing of pending transactions and the outcome of contingencies, such as legal proceedings. We claim the protection afforded by the safe harbor for forward-looking statements provided by the PSLRA.
These statements are only predictions based on our current expectations and projections about future events. Forward-looking statements involve risks and uncertainties that may cause actual results, level of activity, performance or achievements to differ materially from the results contained in the forward-looking statements. Risks and uncertainties that may cause actual results to vary materially, some of which are described within the forward-looking statements, include, among others:
•the significant portion of revenue we derive from our largest partners, and the potential loss, non-renewal, termination or renegotiation of our relationship or contract with any significant partner, or multiple partners in the aggregate;
•evolution in the market for value-based care;
•uncertainty in the health care regulatory framework, including the potential impact of policy changes;
•our ability to offer new and innovative products and services;
•risks related to completed and future acquisitions, investments, alliances and joint ventures, including our acquisitions of Vital Decisions and the Implantable Provider Group, Inc., which could divert management resources, result in unanticipated costs or dilute our stockholders;
•the financial benefits we expect to receive as a result of the sale of certain assets of Passport may not be realized;
•the growth and success of our partners, which is difficult to predict and is subject to factors outside of our control, including governmental funding reductions and other policy changes, enrollment numbers for our partners’ plans, premium pricing reductions, selection bias in at-risk membership and the ability to control and, if necessary, reduce health care costs;
•risks relating to our ability to maintain profitability for our total cost of care and New Century Health’s performance-based contracts and products, including capitation and risk-bearing contracts;
•our ability to effectively manage our growth and maintain an efficient cost structure, and to successfully implement cost cutting measures;
•changes in general economic conditions nationally and regionally in our markets, including inflation and economic and business conditions and the impact thereof on the economy resulting from the COVID-19 pandemic and other public health emergencies;
•our ability to recover the significant upfront costs in our partner relationships;
•our ability to attract new partners and successfully capture new growth opportunities;
•the increasing number of risk-sharing arrangements we enter into with our partners;
•our ability to estimate the size of our target markets;
•our ability to maintain and enhance our reputation and brand recognition;
•consolidation in the health care industry;
•competition which could limit our ability to maintain or expand market share within our industry;
•risks related to governmental payer audits and actions, including whistleblower claims;
•our ability to partner with providers due to exclusivity provisions in our contracts;
•risks related to our offshore operations;
•our ability to contain health care costs, implement increases in premium rates on a timely basis, maintain adequate reserves for policy benefits or maintain cost effective provider agreements;
•our dependency on our key personnel, and our ability to attract, hire, integrate and retain key personnel;
•the impact of additional goodwill and intangible asset impairments on our results of operations;
•our indebtedness, our ability to service our indebtedness, and our ability to obtain additional financing;
•our ability to achieve profitability in the future;
•the impact of litigation, including the ongoing class action lawsuit;
•material weaknesses in the future may impact our ability to conclude that our internal control over financial reporting is not effective and we may be unable to produce timely and accurate financial statements;
•restrictions and penalties as a result of privacy and data protection laws;
•data loss or corruption due to failures or errors in our systems and service disruptions at our data centers;
•restrictions and penalties as a result of privacy and data protection laws;
•adequate protection of our intellectual property, including trademarks;
•any alleged infringement, misappropriation or violation of third-party proprietary rights;
•our use of “open source” software;
•our ability to protect the confidentiality of our trade secrets, know-how and other proprietary information;
•our reliance on third parties and licensed technologies;
•our ability to use, disclose, de-identify or license data and to integrate third-party technologies;
•our reliance on Internet infrastructure, bandwidth providers, data center providers, other third parties and our own systems for providing services to our partners;
•our reliance on third-party vendors to host and maintain our technology platform;
•our obligations to make payments to certain of our pre-IPO investors for certain tax benefits we may claim in the future;
•our ability to utilize benefits under the tax receivables agreement described herein;
•our obligations to make payments under the tax receivables agreement that may be accelerated or may exceed the tax benefits we realize;
•the terms of agreements between us and certain of our pre-IPO investors;
•the conditional conversion features of the 2024 and 2025 convertible notes, which, if triggered, could require us to settle the 2024 or 2025 convertible notes in cash;
•the potential volatility of our Class A common stock price;
•the potential decline of our Class A common stock price if a substantial number of shares are sold or become available for sale;
•provisions in our second amended and restated certificate of incorporation and third amended and restated by-laws and provisions of Delaware law that discourage or prevent strategic transactions, including a takeover of us;
•the ability of certain of our investors to compete with us without restrictions;
•provisions in our second amended and restated certificate of incorporation which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees; and
•our intention not to pay cash dividends on our Class A common stock.
The risks included here are not exhaustive. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. Our Annual Report on Form 10-K for the year ended December 31, 2021 (the "2021 Form 10-K") and other documents filed with the SEC include additional factors that could affect our businesses and financial performance. Moreover, we operate in a rapidly changing and competitive environment. New risk factors emerge from time to time, and it is not possible for management to predict all such risk factors.
Further, it is not possible to assess the effect of all risk factors on our businesses or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. In addition, we disclaim any obligation to update any forward-looking statements to reflect events or circumstances that occur after the date of this report.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
EVOLENT HEALTH, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except share data)
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 156,756 | | | $ | 266,280 | |
Restricted cash and restricted investments | 25,057 | | | 75,685 | |
Accounts receivable, net (1) | 187,633 | | | 130,604 | |
Prepaid expenses and other current assets (1) | 24,328 | | | 51,391 | |
Total current assets | 393,774 | | | 523,960 | |
Restricted cash and restricted investments | 13,005 | | | 12,977 | |
Investments in equity method investees | 5,222 | | | 5,458 | |
Property and equipment, net | 94,645 | | | 81,365 | |
Right-of-use assets - operating | 50,696 | | | 50,203 | |
Prepaid expenses and other noncurrent assets (1) | 3,064 | | | 6,790 | |
Contract cost assets | 24,588 | | | 32,624 | |
Intangible assets, net | 451,398 | | | 279,784 | |
Goodwill | 722,790 | | | 426,297 | |
Total assets | $ | 1,759,182 | | | $ | 1,419,458 | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | |
Liabilities | | | |
Current liabilities: | | | |
Accounts payable (1) | $ | 61,863 | | | $ | 96,084 | |
Accrued liabilities (1) | 132,238 | | | 107,241 | |
Operating lease liability - current | 7,053 | | | 7,069 | |
Accrued compensation and employee benefits | 37,646 | | | 51,861 | |
Deferred revenue | 7,524 | | | 11,944 | |
Reserve for claims and performance - based arrangements (1) | 135,698 | | | 171,294 | |
Total current liabilities | 382,022 | | | 445,493 | |
Long-term debt, net | 412,444 | | | 215,676 | |
Other long-term liabilities | 4,260 | | | 5,531 | |
Tax receivable agreement liability | 42,870 | | | — | |
Operating lease liabilities - noncurrent | 57,840 | | | 57,722 | |
Deferred tax liabilities, net | 3,608 | | | 1,403 | |
Total liabilities | 903,044 | | | 725,825 | |
Commitments and Contingencies (See Note 11) | | | |
Shareholders' Equity | | | |
Class A common stock - $0.01 par value; 750,000,000 shares authorized; 101,159,072 and 90,758,318 shares issued, respectively | 1,012 | | | 908 | |
Additional paid-in-capital | 1,472,098 | | | 1,340,989 | |
Accumulated other comprehensive loss | (1,044) | | | (362) | |
Retained earnings (accumulated deficit) | (594,805) | | | (626,779) | |
Treasury stock, at cost; 1,537,582 shares issued, respectively | (21,123) | | | (21,123) | |
Total shareholders' equity | 856,138 | | | 693,633 | |
Total liabilities and shareholders' equity | $ | 1,759,182 | | | $ | 1,419,458 | |
(1) See Note 18 for amounts attributable to related parties included in these line items.
See accompanying Notes to Consolidated Financial Statements.
1
EVOLENT HEALTH, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(unaudited, in thousands, except per share data)
| | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended September 30, | | For the Nine Months Ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
Revenue(1) | $ | 352,585 | | | $ | 222,471 | | | $ | 969,581 | | | $ | 659,599 | |
Expenses | | | | | | | |
Cost of revenue (exclusive of depreciation and amortization expenses presented separately below) (1) | 266,617 | | | 163,126 | | | 736,061 | | | 493,071 | |
Selling, general and administrative expenses (1) | 68,521 | | | 51,292 | | | 186,408 | | | 152,582 | |
Depreciation and amortization expenses | 17,196 | | | 14,859 | | | 47,414 | | | 44,962 | |
Change in fair value of contingent consideration | (12,700) | | | (225) | | | (5,822) | | | (819) | |
Total operating expenses | 339,634 | | | 229,052 | | | 964,061 | | | 689,796 | |
Operating income (loss) | 12,951 | | | (6,581) | | | 5,520 | | | (30,197) | |
Interest income | 425 | | | 120 | | | 765 | | | 311 | |
Interest expense | (4,754) | | | (6,367) | | | (9,143) | | | (18,978) | |
Gain from equity method investees | 1,392 | | | 63 | | | 3,940 | | | 12,725 | |
Gain on transfer of membership | — | | | — | | | — | | | 22,969 | |
Loss on extinguishment/repayment of debt | (10,192) | | | — | | | (10,192) | | | (19,158) | |
Change in tax receivable agreement liability | (42,870) | | | — | | | (42,870) | | | — | |
Other income (expense), net | (345) | | | (41) | | | 130 | | | (73) | |
Loss from continuing operations before income taxes | (43,393) | | | (12,806) | | | (51,850) | | | (32,401) | |
Provision for (benefit from) income taxes | (45,516) | | | 234 | | | (44,498) | | | 936 | |
Income (loss) from continuing operations | 2,123 | | | (13,040) | | | (7,352) | | | (33,337) | |
Income (loss) from discontinued operations, net of tax (2) | — | | | — | | | (463) | | | 1,383 | |
Net income (loss) attributable to common shareholders of Evolent Health, Inc. | $ | 2,123 | | | $ | (13,040) | | | $ | (7,815) | | | $ | (31,954) | |
| | | | | | | |
Income (loss) per common share | | | | | | | |
Basic: | | | | | | | |
Continuing operations | $ | 0.02 | | | $ | (0.15) | | | $ | (0.08) | | | $ | (0.39) | |
Discontinued operations | — | | | — | | | (0.01) | | | 0.02 | |
Basic income (loss) per share attributable to common shareholders of Evolent Health, Inc. | $ | 0.02 | | | $ | (0.15) | | | $ | (0.09) | | | $ | (0.37) | |
Diluted: | | | | | | | |
Continuing operations | $ | 0.02 | | | $ | (0.15) | | | $ | (0.08) | | | $ | (0.39) | |
Discontinued operations | — | | | — | | | (0.01) | | | 0.02 | |
Diluted income (loss) per share attributable to common shareholders of Evolent Health, Inc. | $ | 0.02 | | | $ | (0.15) | | | $ | (0.09) | | | $ | (0.37) | |
| | | | | | | |
Weighted-average common shares outstanding | | | | | | | |
Basic | 95,286 | | | 85,800 | | | 91,643 | | | 85,306 | |
Diluted | 99,308 | | | 85,800 | | | 91,643 | | | 85,306 | |
| | | | | | | |
Comprehensive income (loss) | | | | | | | |
Net income (loss) | $ | 2,123 | | | $ | (13,040) | | | $ | (7,815) | | | $ | (31,954) | |
Other comprehensive income (loss), net of taxes, related to: | | | | | | | |
Foreign currency translation adjustment | (262) | | | 4 | | | (682) | | | (85) | |
Total comprehensive income (loss) attributable to common shareholders of Evolent Health, Inc. | $ | 1,861 | | | $ | (13,036) | | | $ | (8,497) | | | $ | (32,039) | |
————————
(1)See Note 18 for amounts attributable to unconsolidated related parties included in these line items.
(2)Includes $(0.5) million loss on disposal of discontinued operations for the nine months ended September 30, 2022 and $1.9 million gain on disposal of discontinued operations for the nine months ended September 30, 2021, respectively.
See accompanying Notes to Consolidated Financial Statements.
2
EVOLENT HEALTH, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(unaudited, in thousands)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended September 30, 2022 |
| Class A Common Stock | | Additional Paid-In Capital | | Accumulated Other Comprehensive Income (Loss) | | Retained Earnings (Accumulated Deficit) | | Treasury Stock | | Total Shareholders’ Equity |
| Shares | | Amount | | | | | |
Balance as of June 30, 2022 | 91,657 | | | $ | 916 | | | $ | 1,231,005 | | | $ | (782) | | | $ | (596,928) | | | $ | (21,123) | | | $ | 613,088 | |
| | | | | | | | | | | | | |
Stock-based compensation expense | — | | | — | | | 6,992 | | | — | | | — | | | — | | | 6,992 | |
Exercise of stock options | 317 | | | 4 | | | 2,967 | | | — | | | — | | | — | | | 2,971 | |
Restricted stock units vested, net of shares withheld for taxes | 50 | | | 1 | | | (949) | | | — | | | — | | | — | | | (948) | |
Exchange of 2024 Notes | 5,394 | | | 54 | | | 101,945 | | | — | | | — | | | — | | | 101,999 | |
Shares issued for acquisition | 3,742 | | | 37 | | | 130,138 | | | — | | | — | | | — | | | 130,175 | |
Foreign currency translation adjustment | — | | | — | | | — | | | (262) | | | — | | | — | | | (262) | |
Net income | — | | | — | | | — | | | — | | | 2,123 | | | — | | | 2,123 | |
| | | | | | | | | | | | | |
Balance as of September 30, 2022 | 101,160 | | | $ | 1,012 | | | $ | 1,472,098 | | | $ | (1,044) | | | $ | (594,805) | | | $ | (21,123) | | | $ | 856,138 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| For the Three Months Ended September 30, 2021 |
| Class A Common Stock | | Additional Paid-In Capital | | Accumulated Other Comprehensive Income (Loss) | | Retained Earnings (Accumulated Deficit) | | Treasury Stock | | Total Shareholders’ Equity |
| Shares | | Amount | | | | | |
Balance as of June 30, 2021 | 87,195 | | | $ | 872 | | | $ | 1,242,900 | | | $ | (367) | | | $ | (608,092) | | | $ | (21,123) | | | $ | 614,190 | |
| | | | | | | | | | | | | |
Stock-based compensation expense | — | | | — | | | 4,395 | | | — | | | — | | | — | | | 4,395 | |
Exercise of stock options | 242 | | | 2 | | | 2,188 | | | — | | | — | | | — | | | 2,190 | |
Restricted stock units vested, net of shares withheld for taxes | 19 | | | — | | | (255) | | | — | | | — | | | — | | | (255) | |
Foreign currency translation adjustment | — | | | — | | | — | | | 4 | | | — | | | — | | | 4 | |
Net loss | — | | | — | | | — | | | — | | | (13,040) | | | — | | | (13,040) | |
| | | | | | | | | | | | | |
Balance as of September 30, 2021 | 87,456 | | | $ | 874 | | | $ | 1,249,228 | | | $ | (363) | | | $ | (621,132) | | | $ | (21,123) | | | $ | 607,484 | |
See accompanying Notes to Consolidated Financial Statements
3
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Nine Months Ended September 30, 2022 |
| Class A Common Stock | | Additional Paid-In Capital | | Accumulated Other Comprehensive Income (Loss) | | Retained Earnings (Accumulated Deficit) | | Treasury Stock | | Total Shareholders’ Equity |
| Shares | | Amount | | | | | |
Balance as of December 31, 2021 | 90,759 | | | $ | 908 | | | $ | 1,340,989 | | | $ | (362) | | | $ | (626,779) | | | $ | (21,123) | | | $ | 693,633 | |
| | | | | | | | | | | | | |
Cumulative-effect adjustment from adoption of ASC 2020-06 | — | | | — | | | (106,172) | | | — | | | 39,789 | | | — | | | (66,383) | |
Stock-based compensation expense | — | | | — | | | 19,350 | | | — | | | — | | | — | | | 19,350 | |
Exercise of stock options | 354 | | | 3 | | | 3,277 | | | — | | | — | | | — | | | 3,280 | |
Restricted stock units vested, net of shares withheld for taxes | 452 | | | 5 | | | (6,192) | | | — | | | — | | | — | | | (6,187) | |
Leveraged stock units vested, net of shares withheld for taxes | 459 | | | 5 | | | (11,237) | | | — | | | — | | | — | | | (11,232) | |
Exchange of 2024 Notes | 5,394 | | | 54 | | | 101,945 | | | — | | | — | | | — | | | 101,999 | |
Shares issued for acquisition | 3,742 | | | 37 | | | 130,138 | | | — | | | — | | | — | | | 130,175 | |
Foreign currency translation adjustment | — | | | — | | | — | | | (682) | | | — | | | — | | | (682) | |
Net loss | — | | | — | | | — | | | — | | | (7,815) | | | — | | | (7,815) | |
| | | | | | | | | | | | | |
Balance as of September 30, 2022 | 101,160 | | | $ | 1,012 | | | $ | 1,472,098 | | | $ | (1,044) | | | $ | (594,805) | | | $ | (21,123) | | | $ | 856,138 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| For the Nine Months Ended September 30, 2021 |
| Class A Common Stock | | Additional Paid-In Capital | | Accumulated Other Comprehensive Income (Loss) | | Retained Earnings (Accumulated Deficit) | | Treasury Stock | | Total Shareholders’ Equity |
| Shares | | Amount | | | | | |
Balance as of December 31, 2020 | 85,895 | | | $ | 859 | | | $ | 1,229,320 | | | $ | (278) | | | $ | (589,178) | | | $ | (21,123) | | | $ | 619,600 | |
| | | | | | | | | | | | | |
Stock-based compensation expense | — | | | — | | | 11,754 | | | — | | | — | | | — | | | 11,754 | |
Exercise of stock options | 1,142 | | | 11 | | | 11,555 | | | — | | | — | | | — | | | 11,566 | |
Restricted stock units vested, net of shares withheld for taxes | 419 | | | 4 | | | (3,401) | | | — | | | — | | | — | | | (3,397) | |
Foreign currency translation adjustment | — | | | — | | | — | | | (85) | | | — | | | — | | | (85) | |
Net loss | — | | | — | | | — | | | — | | | (31,954) | | | — | | | (31,954) | |
| | | | | | | | | | | | | |
Balance as of September 30, 2021 | 87,456 | | | $ | 874 | | | $ | 1,249,228 | | | $ | (363) | | | $ | (621,132) | | | $ | (21,123) | | | $ | 607,484 | |
See accompanying Notes to Consolidated Financial Statements
4
EVOLENT HEALTH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
| | | | | | | | | | | |
| For the Nine Months Ended September 30, |
| 2022 | | 2021 |
Cash Flows Used In Operating Activities | | | |
Net loss | $ | (7,815) | | | $ | (31,954) | |
Adjustments to reconcile net loss to net cash and restricted cash used in operating activities: | | | |
Change in fair value of contingent consideration | (5,822) | | | (819) | |
Loss (gain) on discontinued operations | 463 | | | (1,904) | |
Gain from equity method investees | (3,940) | | | (12,725) | |
Depreciation and amortization expenses | 47,414 | | | 45,122 | |
Stock-based compensation expense | 19,350 | | | 11,754 | |
Deferred tax benefit | (46,385) | | | (288) | |
Amortization of contract cost assets | 14,768 | | | 9,928 | |
Amortization of deferred financing costs | 1,762 | | | 13,399 | |
Gain on transfer of membership | — | | | (22,969) | |
Loss on extinguishment/repayment of debt, net | 10,192 | | | 19,158 | |
Change in tax receivable agreement liability | 42,870 | | | — | |
Other current operating cash inflows (outflows), net | 2,163 | | | 472 | |
Changes in assets and liabilities, net of acquisitions: | | | |
Accounts receivable, net and contract assets | (34,796) | | | (52,878) | |
Prepaid expenses and other current and non-current assets | (2,409) | | | (140) | |
Contract cost assets | (6,732) | | | (8,439) | |
Accounts payable | 5,936 | | | 8,164 | |
Accrued liabilities | (27,903) | | | (13,893) | |
Accrued compensation and employee benefits | (14,451) | | | (12,811) | |
Deferred revenue | (4,741) | | | 3,103 | |
Reserve for claims and performance-based arrangements | (35,596) | | | 16,784 | |
Right-of-use operating assets | 831 | | | 6,408 | |
Operating lease liabilities | (1,223) | | | (4,589) | |
Other long-term liabilities | (1,184) | | | 1,208 | |
Net cash and restricted cash used in operating activities | (47,248) | | | (27,909) | |
Cash Flows Provided by (Used In) Investing Activities | | | |
Cash paid for asset acquisitions and business combinations | (245,021) | | | (1,889) | |
Proceeds from transfer of membership and release of Passport escrow | 22,969 | | | 42,996 | |
Disposal of non-strategic assets and divestiture of discontinued operations, net | (9,164) | | | 3,490 | |
Return of equity method investments | 4,175 | | | 14,218 | |
Purchases of investments | — | | | (2,994) | |
Maturities and sales of investments | — | | | 500 | |
Investments in internal-use software and purchases of property and equipment | (27,618) | | | (17,739) | |
Net cash and restricted cash provided by (used in) investing activities | (254,659) | | | 38,582 | |
Cash Flows Provided by (Used In) Financing Activities | | | |
Changes in working capital balances related to claims processing on behalf of partners | (48,322) | | | 1,105 | |
Repayment of Credit Agreement including settlement of warrants | — | | | (98,420) | |
Proceeds from stock option exercises | 3,280 | | | 11,566 | |
Proceeds from issuance of long term debt, net of offering costs | 219,740 | | | — | |
Distributions to Sponsors | (14,884) | | | (1,300) | |
See accompanying Notes to Consolidated Financial Statements
5
| | | | | | | | | | | |
| For the Nine Months Ended September 30, |
| 2022 | | 2021 |
Taxes withheld and paid for vesting of equity awards | (17,419) | | | (3,397) | |
Net cash and restricted cash provided by (used in) financing activities | 142,395 | | | (90,446) | |
Effect of exchange rate on cash and cash equivalents and restricted cash | (612) | | | (53) | |
Net decrease in cash and cash equivalents and restricted cash | (160,124) | | | (79,826) | |
Cash and cash equivalents and restricted cash as of beginning-of-period (1) | 354,942 | | | 361,581 | |
Cash and cash equivalents and restricted cash as of end-of-period (1) | $ | 194,818 | | | $ | 281,755 | |
————————
(1)As a result of the closing of the sale of True Health during the first quarter of 2021, the consolidated statement of operations and related financial information reflect the Company’s operations and assets and liabilities of True Health as discontinued operations. Cash flows and comprehensive income have not been adjusted and are included in the consolidated statements of cash flows and consolidated statements of comprehensive income (loss) for the nine months ended September 30, 2021. See Note 5.
See accompanying Notes to Consolidated Financial Statements
6
EVOLENT HEALTH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Organization
Evolent Health, Inc. was incorporated in December 2014 in the state of Delaware and through its subsidiaries supports leading health systems and physician organizations to move their business models from traditional fee for service reimbursement to value-based care, which we consider to be an integrated clinical and financial responsibility for populations.
As of September 30, 2022, the Company had unrestricted cash and cash equivalents of $156.8 million. The Company believes it has sufficient liquidity for the next twelve months as of the date the financial statements were available to be issued.
The Company’s headquarters is located in Arlington, Virginia.
Evolent Health LLC Governance
Our operations are conducted through Evolent Health LLC. Evolent Health, Inc. is a holding company whose only business is to act as the sole managing member of Evolent Health LLC. As such, it controls Evolent Health LLC’s business and affairs and is responsible for the management of its business.
Note 2. Basis of Presentation, Summary of Significant Accounting Policies and Change in Accounting Principles
Basis of Presentation
In our opinion, the accompanying unaudited interim consolidated financial statements include all adjustments, consisting of normal recurring adjustments, which are necessary to fairly state our financial position, results of operations and cash flows. The interim consolidated results of operations are not necessarily indicative of the results that may occur for the full fiscal year. Certain footnote disclosures normally included in financial statements prepared in accordance with United States of America generally accepted accounting principles (“GAAP”) have been omitted pursuant to instructions, rules and regulations prescribed by the United States Securities and Exchange Commission (“SEC”). The disclosures provided herein should be read in conjunction with the audited financial statements and notes thereto included in our 2021 Form 10-K.
Summary of Significant Accounting Policies
Certain GAAP policies that significantly affect the determination of our financial position, results of operations and cash flows, are summarized below. See “Part II - Item 8. Financial Statements and Supplementary Data - Note 2” in our 2021 Form 10-K for a complete summary of our significant accounting policies.
Reclassification
Certain prior period amounts have been reclassified to conform to current period presentation specifically as it relates to the reclassification of assets, liabilities, operating results and cash flows.
Accounting Estimates and Assumptions
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses for the reporting period. Those estimates are inherently subject to change and actual results could differ from those estimates. In the accompanying consolidated financial statements, estimates are used for, but not limited to, the valuation of assets (including intangibles assets, goodwill and long-lived assets), liabilities, consideration related to business combinations and asset acquisitions, revenue recognition (including variable consideration), estimated selling prices for performance obligations in contracts with multiple performance obligations, reserves for claims and performance-based arrangements, credit losses, depreciable lives of assets, impairment of long-lived assets, stock-based compensation, deferred income taxes and valuation allowance, contingent liabilities, purchase price allocation in taxable stock transactions and useful lives of intangible assets.
Principles of Consolidation
The consolidated financial statements include the accounts of Evolent Health, Inc. and its subsidiaries. All intercompany accounts and transactions are eliminated in consolidation.
Cash and Cash Equivalents
We consider all highly liquid instruments with original maturities of three months or less to be cash equivalents. The Company holds materially all of our cash in bank deposits with FDIC participating banks, at cost, which approximates fair value. Cash and cash equivalents held in money market funds are carried at fair value, which approximates cost.
Restricted Cash and Restricted Investments
Restricted cash and restricted investments include cash and investments used to collateralize various contractual obligations (in thousands) as follows:
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
Collateral for letters of credit for facility leases (1) | $ | 2,269 | | | $ | 3,769 | |
Collateral with financial institutions (2) | 10,873 | | | 11,662 | |
Claims processing services (3) | 24,904 | | | 73,226 | |
Other | 16 | | | 5 | |
Total restricted cash and restricted investments | $ | 38,062 | | | $ | 88,662 | |
| | | |
Current restricted cash | 25,057 | | | 75,685 | |
Total current restricted cash and restricted investments | $ | 25,057 | | | $ | 75,685 | |
| | | |
Non-current restricted cash | 13,005 | | | 12,977 | |
Total non-current restricted cash and restricted investments | $ | 13,005 | | | $ | 12,977 | |
————————
(1)Represents restricted cash related to collateral for letters of credit required in conjunction with lease agreements. See Note 12 for further discussion of our lease commitments.
(2)Represents collateral held with financial institutions for risk-sharing and other arrangements which are held in a FDIC participating bank account. See Note 17 for discussion of fair value measurement and Note 11 for discussion of our risk-sharing arrangements.
(3)Represents cash held by the Company related to claims processing services on behalf of partners. These are pass-through amounts and can fluctuate materially from period to period depending on the timing of when the claims are processed.
The following table provides a reconciliation of cash and cash equivalents and restricted cash reported within the consolidated balance sheets that sum to the total of the same amounts shown in the consolidated statements of cash flows (in thousands):
| | | | | | | | | | | |
| September 30, |
| 2022 | | 2021 |
Cash and cash equivalents | $ | 156,756 | | | $ | 252,496 | |
Restricted cash and restricted investments | 38,062 | | | 29,259 | |
Total cash and cash equivalents and restricted cash shown in the consolidated statements of cash flows (1) | $ | 194,818 | | | $ | 281,755 | |
————————
(1)As a result of the closing of the sale of True Health during the first quarter of 2021, the consolidated statement of operations and related financial information reflect the Company’s operations and assets and liabilities of True Health as discontinued operations. Cash flows and comprehensive income have not been adjusted and are included in the consolidated statements of cash flows and consolidated statements of comprehensive income (loss) for the nine months ended September 30, 2021. See Note 5.
Business Combinations
Companies acquired during each reporting period are reflected in the results of the Company effective from their respective dates of acquisition through the end of the reporting period. The Company allocates the fair value of purchase consideration to the assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. Our estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Critical estimates used to value certain identifiable assets include, but are not limited to, expected long-term revenues, future expected operating expenses, cost of capital and appropriate discount rates.
The excess of the fair value of purchase consideration over the fair value of the assets acquired and liabilities assumed in the acquired entity is recorded as goodwill. Goodwill is assigned to the reporting unit that benefits from the synergies arising from the business combination. If the Company obtains new information about facts and circumstances that existed as of the acquisition date during the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded on the Company's consolidated statements of operations and comprehensive income (loss).
For contingent consideration recorded as a liability, the Company initially measures the amount at fair value as of the acquisition date and adjusts the liability, if needed, to fair value at each reporting period. Changes in the fair value of contingent consideration, other than measurement period adjustments, are recognized as operating income or expense. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred.
Goodwill
We recognize the excess of the purchase price, plus the fair value of any non-controlling interests in the acquiree, over the fair value of identifiable net assets acquired as goodwill. Goodwill is not amortized, but is reviewed at least annually for indications of impairment, with consideration given to financial performance and other relevant factors. We perform impairment tests of goodwill at a reporting unit level. Following the sale of True Health, the Company has three reporting units and our annual goodwill impairment review occurs during the fourth quarter of each year. We perform impairment tests between annual tests if an event occurs, or circumstances change, that we believe would more likely than not reduce the fair value of a reporting unit below its carrying amount.
Our goodwill impairment analysis first assesses qualitative factors to determine whether events or circumstances existed that would lead the Company to conclude it is more likely than not that the fair value of a reporting unit is below its carrying amount. If the Company determines that it is more likely than not that the fair value of a reporting unit is below the carrying amount, a quantitative goodwill assessment is required. In the quantitative evaluation, the fair value of the relevant reporting unit is determined and compared to the carrying value. If the fair value is greater than the carrying value, then the carrying value is deemed to be recoverable and no further action is required. If the fair value estimate is less than the carrying value, goodwill is considered impaired for the amount by which the carrying amount exceeds the reporting unit’s fair value and a charge is reported in goodwill impairment on our consolidated statements of operations and comprehensive income (loss).
Intangible Assets, Net
Identified intangible assets are recorded at their estimated fair values at the date of acquisition and are amortized over their respective estimated useful lives using a method of amortization that reflects the pattern in which the economic benefits of the intangible assets are used.
The following summarizes the estimated useful lives by asset classification:
| | | | | |
Corporate trade name | 10 - 20 years |
Customer relationships | 10 - 25 years |
Technology | 5 years |
Provider network contracts | 3 - 5 years |
Intangible assets are reviewed for impairment if circumstances indicate the Company may not be able to recover the asset’s carrying value. The Company evaluates recoverability by determining whether the undiscounted cash flows expected to result from the use and eventual disposition of that asset or group exceed the carrying value at the evaluation date. If the undiscounted cash flows are not sufficient to cover the carrying value, the Company measures an impairment loss as the excess of the carrying amount of the long-lived asset or group over its fair value. See Note 9 for additional discussion regarding our intangible assets.
Research and Development Costs
Research and development costs consist primarily of personnel and related expenses (including stock-based compensation and employee taxes and benefits) for employees engaged in research and development activities as well as third-party fees. All such costs are expensed as incurred. We focus our research and development efforts on activities that support our technology infrastructure, clinical program development, data analytics and network development capabilities. Research and development costs are recorded within cost of revenue and selling, general and administrative expenses on our consolidated statements of operations and comprehensive income (loss). Total research and development costs for the three and nine months ended September 30, 2022, was $3.8 million and $11.7 million, respectively, and, $4.2 million and $11.1 million for the three and nine months ended September 30, 2021, respectively.
Reserves for Claims and Performance-based Arrangements
Reserves for claims and performance-based arrangements reflect estimates of payments under performance-based arrangements and the ultimate cost of claims that have been incurred but not reported, including expected development on reported claims, those that have been reported but not yet paid (reported claims in process) and other medical care expenses and services payable that are primarily composed of accruals for incentives and other amounts payable to health care professionals and facilities. The Company uses actuarial principles and assumptions that are consistently applied in each reporting period and recognizes the actuarial best estimate of the ultimate liability along with a margin for adverse deviation. This approach is consistent with actuarial standards of practice that the liabilities be adequate under moderately adverse conditions.
The process of estimating reserves involves a considerable degree of judgment by the Company and, as of any given date, is inherently uncertain. The methods for making such estimates and for establishing the resulting liability are continually reviewed and adjustments are reflected in current results of operations in the period in which they are identified as experience develops or new information becomes known. See Note 21 for additional discussion regarding our reserves for claims and performance-based arrangements.
Right of Offset
Certain customer arrangements give the Company the legal right to net payment for amounts due from customers and claims payable. As of September 30, 2022, and December 31, 2021, approximately 47% and 42%, respectively, of gross accounts receivable was netted against claims payable in lieu of cash receipt. Furthermore, as of September 30, 2022, approximately 11% of our accounts receivable, net could ultimately be settled on a net basis, once the criteria for netting have been met.
Leases
The Company enters into various office space, data center and equipment lease agreements in conducting its normal business operations. At the inception of any contract, the Company evaluates the agreement to determine whether the contract contains a lease. If the contract contains a lease, the Company then evaluates the term and whether the lease is an operating or finance lease. Most leases include one or more options to renew or may have a termination option. The Company determines whether these options are reasonably certain to be exercised at the inception of the lease. The rent expense is recognized on a straight-line basis in the consolidated statements of operations and comprehensive income (loss) over the terms of the respective leases. Leases with an initial term of 12 months or less are not recorded on the consolidated balance sheets.
As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We use the implicit rate when readily determinable. Further, the Company treats all lease and non-lease components as a single combined lease component for all classes of underlying assets.
The Company also enters into sublease agreements for some of its leased office space. Rental income attributable to subleases is immaterial and is offset against rent expense over the terms of the respective leases.
Refer to Note 12 for additional lease disclosures.
Revenue Recognition
We derive revenue from two sources: (1) transformation services and (2) platform and operations services. Transformation services consist of implementation services whereby we assist the customer in launching its population health or health plan programs, or implement certain platform and operations services. In certain cases, transformation services can also include revenue associated with our support of certain one-time wind-down activities for clients who are exiting a line of business or population. Platform and operations services generally include multi-year arrangements with customers to provide various population health, health plan operations, specialty care management and claims processing services on an ongoing basis, as well as transition or run-out services to customers receiving primarily TPA services. Revenue is recognized when control of the services is transferred to our customers.
We use the following 5-step model, outlined in Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”), to determine revenue recognition from our contracts with customers:
• Identify the contract(s) with a customer
• Identify the performance obligations in the contract
• Determine the transaction price
• Allocate the transaction price to performance obligations
• Recognize revenue when (or as) the entity satisfies a performance obligation
See Note 6 for further discussion of our policies related to revenue recognition.
Note 3. Recently Issued Accounting Standards
Adoption of New Accounting Standards
In December 2019, the FASB issued ASU No. 2019-12, Simplifying the Accounting for Income Taxes. The amendments in the ASU remove certain exceptions to the intraperiod tax allocation of losses and gains from different financial statement components and to the method of recognizing income taxes on interim period losses and the recognition of deferred tax liabilities for outside basis differences. In addition, the new guidance simplifies aspects of the accounting for franchise taxes and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The Company adopted this standard starting in the first quarter of 2021, which did not have a material impact on our consolidated financial statements.
In August 2020, the FASB issued ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The ASU simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts in an entity’s own equity. Specifically, the ASU removes the separation models for convertible debt with a cash conversion feature or convertible instruments with a beneficial conversion feature and no longer permits the use of the treasury stock method from calculating earnings per share. As a result, after adopting the ASU’s guidance, we do not separately present in equity an embedded conversion feature of such debt. Instead, we account for a convertible debt instrument wholly as debt unless (i) a convertible instrument contains features that require bifurcation as a derivative or (ii) a convertible debt instrument was issued at a substantial premium. Additionally, the ASU removes certain conditions for equity classification related to contracts in an entity’s own equity (e.g., warrants) and amends certain guidance related to the computation of earnings per share for convertible instruments and contracts on an entity’s own equity. The Company adopted the standard using a modified retrospective method on January 1, 2022, with adjustments which increased retained earnings by $39.8 million, reduced additional paid-in capital by $106.2 million and increased the net carrying amount of the 2024 and 2025 Notes by $25.1 million and $41.3 million, respectively.
Recent Accounting Pronouncements Not Yet Effective
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which requires contract assets and contract liabilities acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, Revenue from Contracts with Customers. This approach differs from the current requirement to measure contract assets and contract liabilities acquired in a business combination at fair value. This new standard is effective for our interim and annual periods beginning after December 15, 2022, with early adoption permitted. We are currently evaluating the adoption impacts on our consolidated financial statements.
Note 4. Transactions
Business Combinations
Implantable Provider Group
On August 1, 2022, the Company completed its acquisition of Implantable Provider Group, Inc. (“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 merger 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 merger 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 goodwill is attributable primarily to cross-selling opportunities and the acquired assembled workforce and was all allocated to the Clinical Solutions segment. 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 three and nine months ended September 30, 2022, to account for the valuation allowance release p