NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1
. Organization
Evolent Health, Inc. was incorporated in December 2014 in the state of Delaware, and is a managed services firm that supports integrated health systems in their migration toward value-based care and population health management. The Company’s services include providing our customers, which we refer to as partners, with a population management platform, integrated data and analytics capabilities, pharmacy benefit management ("PBM") services and comprehensive health plan administration services. Together these services enable health systems to manage patient health in a more cost-effective manner. The Company’s contracts are structured as a combination of advisory fees, monthly member service fees, percentage of plan premiums and shared medical savings arrangements. The Company's headquarters is located in Arlington, Virginia.
Our predecessor, Evolent Health Holdings, Inc. ("Evolent Health Holdings"), merged with and into Evolent Health, Inc. in connection with the Offering Reorganization. As a result, the consolidated financial statements of Evolent Health, Inc. reflect the historical accounting of Evolent Health Holdings.
Prior to the organizational transactions noted below, due to certain participating rights granted to our investor, TPG Global, LLC and its affiliates (“TPG”), Evolent Health Holdings did not control Evolent Health LLC, our operating subsidiary company, but was able to exert significant influence and, accordingly, accounted for its investment in Evolent Health LLC using the equity method of accounting through June 3, 2015. Subsequent to the organizational transactions and initial public offering (“IPO”) described below, we own
70.8%
of Evolent Health LLC, hold
100%
of the voting rights, are the sole managing member and, therefore, control its operations. Accordingly, the financial results of Evolent Health LLC are consolidated in the financial statements of Evolent Health, Inc. subsequent to the Offering Reorganization.
Initial Public Offering
On June 5, 2015, we completed an IPO of
13,225,000
shares of our Class A common stock at a public offering price of
$17.00
per share. We received
$209.1 million
in proceeds, net of underwriting discounts and commissions. Offering expenses incurred were
$3.2 million
which were recorded as a reduction of proceeds from the offering. We used the net proceeds to purchase newly-issued Class A common units from Evolent Health LLC, our consolidated subsidiary. Evolent Health LLC will use the net proceeds for working capital and other general corporate purposes. See Note 4 for further details surrounding the IPO and related transactions.
Organizational Transactions
In connection with the IPO, we completed the following organizational transactions (the “Offering Reorganization”) as further described in Note 4:
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•
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We amended and restated our certificate of incorporation to, among other things, authorize two classes of common stock - Class A common stock and Class B exchangeable common stock. Both classes of stock will vote together as a single class.
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•
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We acquired, by merger, an affiliate of a member of Evolent Health LLC, for which we issued
2,051,468
shares of Class A common stock.
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|
•
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We issued shares of our Class B exchangeable common stock to certain existing members of Evolent Health LLC.
|
Since its inception, the Company has incurred significant losses from operations. As of
March 31, 2016
, the Company had cash and cash equivalents of
$111.3 million
. The Company believes it has sufficient liquidity for the next twelve months as of
March 31, 2016
.
2
. Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation
In our opinion, the accompanying unaudited interim consolidated financial statements include all adjustments, consisting of normal recurring adjustments, which are necessary to fairly state our financial position, results of operations, and cash flows. The consolidated balance sheet at December 31, 2015, has been derived from audited financial statements as of that date. The interim consolidated results of operations are not necessarily indicative of the results that may occur for the full fiscal year. Certain footnote disclosure normally included in financial statements prepared in accordance with United States of America generally accepted accounting principles ("GAAP") has been omitted pursuant to instructions, rules, and regulations prescribed by the United States Securities and Exchange Commission ("SEC"). We believe that the disclosures provided herein are adequate to make the information presented not misleading when these unaudited interim consolidated financial statements are read in conjunction with the audited
financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015, as amended, filed with the SEC on February 29, 2016 ("2015 Form 10-K").
As discussed in Note 4, amounts for the
three
months ended
March 31, 2015
, presented in our unaudited consolidated financial statements and notes to unaudited consolidated financial statements represent the historical operations of our predecessor entity, Evolent Health Holdings, which did not consolidate the operations of Evolent Health LLC. The amounts as of and for the three months ended
March 31, 2016
, reflect our operations, which consolidate the operations of Evolent Health LLC.
All inter-company accounts and transactions have been eliminated in consolidation.
Summary of Significant Accounting Policies
Certain GAAP policies, which significantly affect the determination of our financial position, results of operations and cash flows, are summarized in our 2015 Form 10-K unless otherwise updated below.
Restricted Cash
Restricted cash is carried at cost, which approximates fair value, and includes cash used to collateralize various contractual obligations (in thousands) as follows:
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|
|
|
|
As of
|
|
As of
|
|
|
March 31,
|
December 31,
|
|
2016
|
|
2015
|
|
Letters of credit for facility leases
|
$
|
2,516
|
|
|
$
|
3,710
|
|
|
Pharmacy benefit management services
|
5,685
|
|
|
2,479
|
|
|
Other
|
125
|
|
|
96
|
|
|
Total restricted cash
|
8,326
|
|
|
6,285
|
|
|
Non-current restricted cash
|
1,579
|
|
|
1,582
|
|
|
Current restricted cash
|
$
|
6,747
|
|
|
$
|
4,703
|
|
|
3
. Recently Issued Accounting Standards
Future Adoption of New Accounting Standards
In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-09,
Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting.
The update simplifies several aspects of the accounting for employee share-based payment transactions, including accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. This standard is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption permitted for any interim or annual period. We plan to adopt the requirements of this standard in 2016, and are currently evaluating the impact of the adoption on our financial condition and results of operations.
In February 2016, the FASB issued ASU 2016-02,
Leases
, in order to establish the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases.
This update introduces a new standard on accounting for leases, including a lessee model that brings most leases on the balance sheet. The new standard also aligns many of the underlying principles of the new lessor model with those in ASC 606, the FASB’s new revenue recognition standard (e.g., those related to evaluating when profit can be recognized). Furthermore, the ASU addresses other concerns related to the current leases model. The standard also requires lessors to increase the transparency of their exposure to changes in value of their residual assets and how they manage that exposure. The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. We will adopt the requirements of this standard effective January 1, 2019, and are currently evaluating the impact of the adoption on our financial condition and results of operations.
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers
, in order to clarify the principles of recognizing revenue. This standard establishes the core principle of recognizing revenue to depict the transfer of promised goods or services in an amount that reflects the consideration the entity expects to be entitled in exchange for those goods or services. The FASB defines a five-step process that systematically identifies the various components of the revenue recognition process, culminating with the recognition of revenue upon satisfaction of an entity’s performance obligation. By completing all five steps of the process, the core principles of revenue recognition will be achieved. In March 2016, the FASB issued an update to the new revenue standard (ASU 2014-09) in the form of ASU 2016-08, which amended the principal-versus-agent implementation guidance and illustrations in
the new revenue guidance. The update clarifies that an entity should evaluate whether it is the principal or the agent for each specified good or service promised in a contract with a customer. In April 2016, the FASB issued another update to the new revenue standard in the form of ASU 2016-10, which amends the guidance on identifying performance obligations and the implementation guidance on licensing. The new revenue standard (including updates) will be effective for annual and interim reporting periods beginning after December 15, 2017, with early adoption permitted only as of annual reporting periods beginning after December 15, 2016. We will adopt the requirements of this standard effective January 1, 2018, and are currently evaluating the impact of the adoption on our financial condition and results of operations.
In August 2014, the FASB issued ASU 2014-15,
Presentation of Financial Statements – Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
. This standard requires management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards by requiring an assessment for a period of one year after the date that the financial statements are issued. Further, based on certain conditions and circumstances, additional disclosures may be required. This standard is effective beginning with the first annual period ending after December 15, 2016, and for all annual and interim periods thereafter. Early application is permitted. The Company does not expect this standard to have an impact on the Company’s financial statements or related disclosures.
We have evaluated all other issued and unadopted ASUs and believe the adoption of these standards will not have a material impact on our results of operations, financial position, or cash flows.
4
. Acquisitions and Business Combinations
Business Combinations
Passport
On February 1, 2016, the Company entered into a strategic alliance with University Health Care d/b/a Passport Health Plan (“Passport”), a nonprofit community-based and provider-sponsored health plan administering Kentucky Medicaid and federal Medicare Advantage benefits to over
280,000
Kentucky Medicaid and Medicare Advantage beneficiaries. As part of the transaction, we issued
1,067,271
Class A common shares to acquire capabilities and assets from Passport to enable us to build out a Medicaid Center of Excellence based in Louisville, Kentucky. Additional equity consideration of up to
$10.0 million
may be earned by Passport should we obtain new third party Medicaid businesses in future periods. This transaction also includes a
10
-year arrangement under which we will provide various health plan management and managed care services to Passport. The Company has accounted for the transactions with Passport as a business combination using purchase accounting.
The fair value of the total consideration transferred in connection with the close of the transaction was
$18.2 million
, of which the Class A common shares were valued at
$10.5 million
and the contingent equity consideration was valued at
$7.7 million
. The fair value of the shares issued was determined based on the closing price of the Company’s Class A common stock on the NYSE as of February 1, 2016. The quantity of shares issued was determined under a pricing collar set forth in the purchase agreement. The fair value of the contingent equity consideration was estimated based on the real options approach, a form of the income approach, which estimated the probability of the Company achieving future revenues under the agreement. Key assumptions include the discount rate and the probability-adjusted recurring revenue forecast. The purchase price was allocated to the assets acquired based on their estimated fair values as of February 1, 2016, as follows (in thousands):
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|
|
|
|
|
Purchase price
|
$
|
18,200
|
|
|
Less amount allocated to prepaid asset
|
6,900
|
|
|
Goodwill
|
$
|
11,300
|
|
|
The prepaid asset is related to an acquired facility license agreement as the Company was provided with leased facilities which house the acquired Passport employees at no future cost. The fair value of the acquired facility license agreement was determined by comparing the current market value of similar lease spaces to the facilities occupied by the acquired Passport personnel to obtain a market value of the occupied space, with the present value of the determined market value of the occupied space classified as the acquired facility license agreement prepaid asset. The goodwill is attributable partially to the acquired assembled workforce. The transaction was a taxable event for the Company and the amount of goodwill determined for tax purposes is deductible.
The above allocation of fair values is based upon preliminary valuations and other analyses that have not been completed as of the date of this filing. Any changes in the estimated fair values of the net assets recorded upon the finalization of more detailed analyses of the facts and circumstances that existed at the date of the business combination will change the allocation of the fair value. Any subsequent changes identified during the measurement period will be adjusted in the reporting period in which the adjustment amounts are determined.
Results for the three months ended March 31, 2016, include revenue and related expenses from our services agreement with Passport and amortization of the acquired intangibles for the period February 1, 2016, through March 31, 2016. The Consolidated Statements of Operations includes
$6.4 million
of revenue and
$(0.4) million
of net income (loss) attributable to Passport for the three months ended March 31, 2016.
The Offering Reorganization
Evolent Health, Inc. was incorporated as a Delaware corporation on December 12, 2014, for the purpose of pursuing the Company’s IPO. Immediately prior to the completion of the IPO in June 2015, we amended and restated our certificate of incorporation to, among other things, authorize
two
classes of common stock, Class A common stock and Class B common stock. Each share of our Class A common stock and Class B common stock entitles its holder to
one
vote on all matters to be voted on by stockholders, and holders of Class A common stock and holders of Class B common stock vote together as a single class on all matters presented to stockholders for their vote or approval (except as otherwise required by law). Pursuant to the Offering Reorganization:
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•
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Evolent Health Holdings merged with and into Evolent Health, Inc. and the surviving corporation of the merger was Evolent Health, Inc.;
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•
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An affiliate of TPG merged with and into Evolent Health, Inc. and the surviving corporation of the merger was Evolent Health, Inc.;
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•
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Each of the then-existing stockholders of Evolent Health Holdings received
four
shares of our Class A common stock and the right to certain payments under the Tax Receivables Agreement ("TRA") in exchange for each share of Class A common stock held in Evolent Health Holdings;
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•
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TPG received
2,051,468
shares of Class A common stock of Evolent Health, Inc., together with the right to certain payments under the TRA in exchange for
100%
of the equity that it held in its affiliate that was merged with Evolent Health, Inc.; and
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•
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We issued shares of our Class B common stock and the right to certain payments under the TRA to The Advisory Board Company ("The Advisory Board"), TPG and another investor each of which was a member of Evolent Health LLC prior to the Offering Reorganization.
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The existing shareholders of Evolent Health Holdings held the same economic and voting interest before and after the merger of Evolent Health Holdings with and into Evolent Health, Inc., which represents a transaction among entities with a high degree of common ownership. As such, the merger is viewed as non-substantive and the consolidated financial statements of Evolent Health, Inc. reflect the historical accounting of Evolent Health Holdings except that the legal capital reflects the capital of Evolent Health, Inc.
In addition, in connection with the Offering Reorganization, Evolent Health LLC amended and restated its operating agreement to establish
two
classes of equity (voting Class A common units and non-voting Class B common units); after the amendment, the pre-reorganization members of Evolent Health LLC (other than Evolent Health, Inc.) hold
100%
of the Class B common units and Evolent Health, Inc. holds the Class A voting common units. Evolent Health LLC’s Class B common units can be exchanged (together with a corresponding number of shares of our Class B common stock) for one share of our Class A common stock.
As of March 31, 2016, we own
70.8%
of the economic interests and
100%
of the voting rights in Evolent Health LLC. Our operations will continue to be conducted through Evolent Health LLC and subsequent to the Offering Reorganization the financial results of Evolent Health LLC are consolidated in the financial statements of Evolent Health, Inc. Evolent Health, Inc. is a holding company whose principal asset is all of the Class A common units it holds in Evolent Health LLC, and its only business is to act as sole managing member of Evolent Health LLC.
Pro Forma Financial Information (Unaudited)
The unaudited pro forma statement of operations data presented below gives effect to (1) the Passport transaction as if it had occurred on January 1, 2015, and (2) the consolidation of Evolent Health LLC as if it had occurred on January 1, 2014. The following pro forma information includes adjustments to:
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•
|
Remove transaction costs related to the Passport transaction of
$0.2 million
recorded in the first quarter of 2016 and reclassify said amounts to the first quarter of 2015;
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•
|
Remove transaction costs related to the Passport transaction of
$0.2 million
recorded in the fourth quarter of 2015 and reclassify said amounts to the first quarter of 2015;
|
|
|
•
|
Remove transaction costs related to the Offering Reorganization of
$1.2 million
in 2015 and reclassify said amount to 2014;
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|
•
|
Record amortization expenses related to intangible assets beginning January 1, 2014, for intangibles related to the Offering Reorganization and beginning January 1, 2015, for intangibles related to the Passport transaction; and
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|
•
|
Record adjustments of income taxes associated with these pro forma adjustments.
|
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 were 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).
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For the Three
|
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Months Ended
|
|
March 31,
|
|
2016
|
|
2015
|
Revenue
|
$
|
52,642
|
|
|
$
|
45,150
|
|
Net income (loss)
|
(171,850
|
)
|
|
(14,595
|
)
|
Net income (loss) attributable
|
|
|
|
to non-controlling interests
|
(50,180
|
)
|
|
(6,103
|
)
|
Net income (loss) attributable
|
|
|
|
to Evolent Health, Inc.
|
(121,670
|
)
|
|
(8,492
|
)
|
|
|
|
|
Net income (loss) available to
|
|
|
|
common shareholders:
|
|
|
|
Basic
|
(2.86
|
)
|
|
(0.32
|
)
|
Diluted
|
(2.86
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)
|
|
(0.32
|
)
|
Acquisitions
Vestica
On March 1, 2016, the Company entered into an Asset Purchase Agreement between Vestica Healthcare, LLC ("Vestica") and Evolent Health, LLC. As part of the transaction, we paid
$7.5 million
to acquire certain assets from Vestica to further align our interests with one of our existing partners. In addition, Vestica can earn an additional
$4.0 million
based on certain future events, which is being held in escrow. This transaction also includes an arrangement under which Vestica will continue to perform certain services on our behalf related to the acquired assets.
We accounted for the transaction as an asset acquisition where the assets acquired were measured based on the amount of cash paid to Vestica as well as transaction costs incurred as the fair value of the assets given was more readily determinable than the fair value of the assets received. We classified and designated identifiable assets acquired and we assessed and determined the useful lives of the acquired intangible assets subject to amortization. As a result, we recorded a
$7.5 million
customer relationship intangible asset with a useful life of
thirteen
years. The transaction was a taxable event.
5
. Investments
The amortized cost, gross unrealized gains and losses, and fair value of our investments as measured using Level 2 inputs (in thousands) were as follows:
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|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2016
|
|
|
As of December 31, 2015
|
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
Amortized
|
Unrealized
|
Unrealized
|
|
Fair
|
|
Amortized
|
Unrealized
|
Unrealized
|
|
Fair
|
|
|
Costs
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
Costs
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
U.S. Treasury bills
|
|
$
|
28,260
|
|
|
|
$
|
40
|
|
|
|
$
|
33
|
|
|
|
$
|
28,267
|
|
|
|
$
|
28,306
|
|
|
|
$
|
115
|
|
|
|
$
|
181
|
|
|
|
$
|
28,240
|
|
Corporate bonds
|
|
25,715
|
|
|
|
97
|
|
|
|
9
|
|
|
|
25,803
|
|
|
|
25,757
|
|
|
|
110
|
|
|
|
80
|
|
|
|
25,787
|
|
Total investments
|
|
$
|
53,975
|
|
|
|
$
|
137
|
|
|
|
$
|
42
|
|
|
|
$
|
54,070
|
|
|
|
$
|
54,063
|
|
|
|
$
|
225
|
|
|
|
$
|
261
|
|
|
|
$
|
54,027
|
|
The amortized cost and fair value of our investments by contractual maturities (in thousands) were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2016
|
|
As of December 31, 2015
|
|
Amortized
|
|
Fair
|
|
Amortized
|
|
Fair
|
|
Cost
|
|
Value
|
|
Cost
|
|
Value
|
Due in one year or less
|
$
|
20,096
|
|
|
$
|
20,163
|
|
|
$
|
9,445
|
|
|
$
|
9,451
|
|
Due after one year through five years
|
33,879
|
|
|
33,907
|
|
|
44,618
|
|
|
44,576
|
|
Total
|
$
|
53,975
|
|
|
$
|
54,070
|
|
|
$
|
54,063
|
|
|
$
|
54,027
|
|
As of March 31, 2016, and December 31, 2015, the Company did not hold any securities in an unrealized loss position for more than 12 months. The aggregate fair value of securities held by the Company in an unrealized loss position for less than 12 months as of March 31, 2016, and December 31, 2015, was
$46.2 million
and
$49.9 million
, respectively. As of March 31, 2016, securities held by the Company which were in an unrealized loss position for less than 12 months consisted of
7
U.S. Treasury bills and
10
corporate bonds.
Our investments are classified as held-to-maturity as we have both the intent and ability to hold the investments until their individual maturities. There were no identified events or changes in circumstances that had a significant adverse effect on the values of these investments. If there was evidence of a decline in fair value below the amortized cost basis which is other than temporary the cost basis of the individual security would be written down to fair value as a new cost basis and the amount of the write-down would be included in earnings. The new cost basis would not be changed for subsequent recoveries in fair value.
6
. Property and Equipment, Net
The following summarizes our property and equipment (in thousands):
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|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
As of
|
|
|
March 31,
|
|
December 31,
|
|
2016
|
|
|
2015
|
|
Computer hardware
|
$
|
251
|
|
|
|
$
|
232
|
|
|
Furniture and equipment
|
1,604
|
|
|
|
1,604
|
|
|
Internal-use software development costs
|
9,787
|
|
|
|
6,363
|
|
|
Leasehold improvements
|
5,830
|
|
|
|
5,830
|
|
|
Total property and equipment
|
17,472
|
|
|
|
14,029
|
|
|
Accumulated depreciation and amortization
|
(1,935
|
)
|
|
|
(1,233
|
)
|
|
Total property and equipment, net
|
$
|
15,537
|
|
|
|
$
|
12,796
|
|
|
We had
no
property and equipment prior to the Offering Reorganization.
The Company capitalized
$3.4 million
and
zero
of internal-use software development costs for the
three
months ended
March 31, 2016
and 2015, respectively. The net book value of capitalized internal-use software development costs was
$9.5 million
and
$6.3 million
as of
March 31, 2016
and
December 31, 2015
, respectively.
Depreciation expense related to property and equipment was
$0.7 million
and
zero
for the
three
months ended
March 31, 2016
and 2015, respectively, of which amortization expense related to capitalized internal-use software development costs was
$0.2 million
and
zero
for the
three
months ended
March 31, 2016
and 2015, respectively.
7
. Goodwill and Intangible Assets, Net
Goodwill
As part of the Offering Reorganization, we recorded
$608.9 million
in goodwill on our Consolidated Balance Sheets. 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.
In interim periods between annual goodwill reviews, we also evaluate qualitative factors that could cause us to believe our estimated fair value of our single reporting unit may be lower than the carrying value and trigger a Step 1 test including, but not limited to (i) macroeconomic conditions, (ii) industry and market considerations, (iii) our overall financial performance including an analysis of our current and projected cash flows, revenue and earnings, (iv) a sustained decrease in share price and (v) other relevant entity-specific
events including changes in strategy, partners, or litigation. As a result of the Offering Reorganization, we revalued our consolidated balance sheet to the market value of our IPO share price of
$17.00
.
Subsequent to our 2015 annual impairment testing in the fourth quarter of 2015, our common stock price declined significantly, reaching our historic low in the first quarter of 2016. During the three months ended March 31, 2016, our common stock traded between
$8.48
and
$12.32
, or an average common stock price of
$10.33
compared to an average common stock price of
$19.51
and
$14.73
during the three month periods ended September 30, 2015, and December 31, 2015, respectively. A sustained decline in our common stock price and the resulting impact on our market capitalization is one of several qualitative factors we consider each quarter when evaluating whether events or changes in circumstances indicate it is more likely than not that a potential goodwill impairment exists. We concluded that the further decline in common stock price observed during the first quarter of 2016 did represent a sustained decline and that triggering events occurred during this period requiring an interim goodwill impairment test as of March 31, 2016. As such, we performed a Step 1 impairment test of our goodwill as of March 31, 2016.
Step 1 Results
To determine the implied fair value for our single reporting unit, we used both a market multiple valuation approach (“market approach”) and a discounted cash flow valuation approach (“income approach”). In determining the estimated fair value, we considered the level of our Class A common stock price and assumptions that we believed market participants would make in valuing our reporting unit, including a control premium, as well as discounted cash flow calculations of management’s estimates of future financial performance and management’s long-term plans. This analysis also required us to make judgments about revenues, expenses, fixed asset and working capital requirements, the timing of exchanges of our Class B common shares, capital market assumptions and discount rates.
In our March 31, 2016, Step 1 test, our most sensitive assumption for purposes of the market approach was our estimate of the control premium, and the most sensitive assumption related to the income approach, other than our cash flows, was the discount rate. As of March 31, 2016, our single reporting unit failed the Step 1 analysis as we determined that its implied fair value was less than its carrying value based on the weighting of the fair values determined under both the market and income approaches. As fair value was less than carrying value, we performed a Step 2 test to determine the implied fair value of our goodwill.
Step 2 Results
In our March 31, 2016, Step 2 test, the fair value of all assets and liabilities were estimated, including our tangible assets (corporate trade name, customer relationships and technology) for the purpose of deriving an estimate of the implied fair value of goodwill. The implied fair value of goodwill was then compared to the carrying amount of goodwill resulting in an impairment charge of
$160.6 million
on our Consolidated Statements of Operations.
The impairment was driven primarily by the sustained decline in our share price as our estimates of our future cash flows and the control premium have remained consistent, combined with an increase in the discount rate period over period. As noted above, our determination of fair value used a weighting of the fair values determined under both the market and income approaches, with the market approach driving the significant reduction in overall firm value and related impairment of goodwill.
Intangible Assets, Net
Details of our intangible assets (in thousands) are presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2016
|
|
|
Weighted-
|
|
|
|
|
Average
|
|
Gross
|
|
|
|
|
|
Net
|
|
Remaining
|
Carrying
|
Accumulated
|
Carrying
|
|
Useful Life
|
Amount
|
Amortization
|
Value
|
Corporate trade name
|
|
19.2
|
|
$
|
19,000
|
|
|
|
$
|
791
|
|
|
|
$
|
18,209
|
|
Customer relationships
|
|
23.5
|
|
127,500
|
|
|
|
4,068
|
|
|
|
123,432
|
|
Technology
|
|
6.2
|
|
30,000
|
|
|
|
3,569
|
|
|
|
26,431
|
|
Total
|
|
|
|
$
|
176,500
|
|
|
|
$
|
8,428
|
|
|
|
$
|
168,072
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2015
|
|
|
Weighted-
|
|
|
|
|
Average
|
|
Gross
|
|
|
|
|
|
Net
|
|
Remaining
|
Carrying
|
Accumulated
|
Carrying
|
|
Useful Life
|
Amount
|
Amortization
|
Value
|
Corporate trade name
|
|
19.4
|
|
$
|
19,000
|
|
|
|
$
|
554
|
|
|
|
$
|
18,446
|
|
Customer relationships
|
|
24.4
|
|
120,000
|
|
|
|
2,797
|
|
|
|
117,203
|
|
Technology
|
|
6.4
|
|
30,000
|
|
|
|
2,497
|
|
|
|
27,503
|
|
Total
|
|
|
|
$
|
169,000
|
|
|
|
$
|
5,848
|
|
|
|
$
|
163,152
|
|
We had
no
intangible assets prior to the Offering Reorganization.
We recorded additional customer relationship intangible assets of
$7.5 million
in relation to the closing of the Vestica transaction during the first quarter of 2016.
Amortization expense related to intangible assets for the
three
months ended
March 31, 2016
and 2015, was
$2.6 million
and
zero
, respectively.
8
. Commitments and Contingencies
UPMC Reseller Agreement
The Company and the University of Pittsburgh Medical Center ("UPMC") are parties to a Reseller, Services and Non-Competition Agreement, dated August 31, 2011 (the “Original UPMC Reseller Agreement”), which was amended and restated by the parties on June 27, 2013 (as so amended, 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 the Company’s customers and top prospects.
The Advisory Board Company Reseller Agreement
The Company and The Advisory Board are parties to a Services, Reseller, and Non-Competition Agreement, dated August 31, 2011 (the “Original Advisory Board Reseller Agreement”), which was amended and restated by the parties on June 27, 2013, and May 1, 2015 (as so amended, the “Advisory Board Company Reseller Agreement”). Under the terms of the Advisory Board Company Reseller Agreement, The Advisory Board shall provide certain services to the Company on an as-requested basis. In addition, The Advisory Board has a right of first offer to provide certain specified services during the term of the Agreement and has the rights to collect certain fees for specified referrals.
Contingencies
Tax Receivables Agreement
In connection with the Offering Reorganization, the Company entered into the TRA with certain of its investors, which provides for the payment by the Company to these investors of
85%
of the amount of the tax benefits, if any, that the Company is deemed to realize as a result of increases in our tax basis related to exchanges of Class B common units as well as tax benefits attributable to the future utilization of pre-IPO net operating losses ("NOL"s). These payment obligations are obligations of the Company. For purposes of the TRA, the benefit deemed realized by the Company will be computed by comparing its actual income tax liability to the amount of such taxes that the Company would have been required to pay had there been no increase to the tax basis of the assets of the Company as a result of the exchanges or had the Company had no NOL carryforward balance. The actual amount and timing of any payments under the TRA will vary depending upon a number of factors, including:
|
|
•
|
The timing of the exchanges and the price of the Class A shares at the time of the transaction, triggering a tax basis increase in the Company's asset and a corresponding benefit to be realized under the TRA; and
|
|
|
•
|
The amount and timing of our taxable income - the Company will be required to pay 85% of the tax savings as and when realized, if any. If the Company does not have taxable income, it will not be required to make payments under the TRA for that taxable year because no tax savings were actually realized.
|
Due to the items noted above, the fact that no share exchanges have occurred as of March 31, 2016, and that the Company’s historical losses have not been utilized, the Company has not recorded a liability pursuant to the TRA.
Litigation Matters
We are engaged from time to time in certain legal disputes arising in the ordinary course of business, including employment claims. When the likelihood of a loss contingency becomes probable and the amount of the loss can be reasonably estimated, we accrue a liability for the loss contingency. We continue to review accruals and adjust them to reflect ongoing negotiations, settlements, rulings, advice of legal counsel, and other relevant information. To the extent new information is obtained, and our views on the probable outcomes of claims, suits, assessments, investigations, or legal proceedings change, changes in our accrued liabilities would be recorded in the period in which such determination is made. We had no material accruals as of March 31, 2016 and December 31, 2015.
Commitments
Lease Commitments
The Company has entered into lease agreements for its office location in Arlington, Virginia. In connection with these lease agreements, the Company is required to maintain a
$2.5 million
letter of credit, which declines annually throughout the term of the lease. As of
March 31, 2016
, the restricted funds held in connection with the lease were
$2.5 million
.
Total rental expense on operating leases for the
three
months ended
March 31, 2016
and 2015, was
$1.1 million
and
zero
, respectively.
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 financial statements.
Registration rights agreement
We entered into a registration rights agreement with The Advisory Board, UPMC, TPG and another investor to register for sale under the Securities Act of 1933, as amended ("Securities Act"), shares of our Class A common stock, including those delivered in exchange for Class B common units in the circumstances described above. 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.
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 will include 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.
Credit and Concentration Risk
The Company is subject to significant concentrations of credit risk related to cash and cash equivalents, investments and accounts receivable. The Company's cash and cash equivalents and investments are held at financial institutions that management believes to be of high credit quality. While the Company maintains its cash and cash equivalents and investments with financial institutions with high credit ratings, it often maintains these deposits in federally insured financial institutions in excess of federally insured limits. The Company has not experienced any losses on cash and cash equivalents or investments to date.
The following table summarizes those partners who represented at least 10% of our revenue for the
three
months ended
March 31, 2016
:
|
|
|
|
Customer A
|
18.3
|
%
|
Customer B
|
14.2
|
%
|
Customer C
|
12.9
|
%
|
Customer D
|
11.4
|
%
|
The following table summarizes those partners who represented at least 10% of our accounts receivable for the periods presented:
|
|
|
|
|
|
|
|
|
As of
|
|
As of
|
|
|
March 31,
|
December 31,
|
|
2016
|
|
2015
|
|
Customer A
|
12.6
|
%
|
|
12.9
|
%
|
|
Customer B
|
16.6
|
%
|
|
*
|
|
|
Customer D
|
30.8
|
%
|
|
28.1
|
%
|
|
Customer E
|
12.5
|
%
|
|
23.2
|
%
|
|
Customer F
|
11.5
|
%
|
|
11.4
|
%
|
|
* Represents less than 10.0% of the respective balance
The Company is also subject to significant concentration risk as a significant portion of our revenue is derived from services provided to our partners on our behalf by UPMC. UPMC is a founding investor in our organization and we have entered into a long-term agreement with them to conduct these services on our behalf; however, in the event of a disruption in service from UPMC, our revenue would be adversely impacted while we obtained a replacement vendor.
The Company is also subject to significant concentration risk as materially all of our cash and cash equivalents are held in a single money market fund. As of
March 31, 2016
,
$81.2 million
of cash and cash equivalents were held in a money market fund.
9
. Earnings (Loss) Per Common Share
The following table sets forth the computation of basic and diluted earnings per share available for common stockholders (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
For the Three
|
|
Months Ended
|
|
March 31,
|
|
2016
|
|
2015
|
Net income (loss)
|
$
|
(173,912
|
)
|
|
$
|
(11,319
|
)
|
Less:
|
|
|
|
Net income (loss) attributable to non-controlling interests
|
(51,100
|
)
|
|
—
|
|
Undeclared cumulative preferred dividends
|
—
|
|
|
1,290
|
|
Net income (loss) available for common shareholders
(1)
|
$
|
(122,812
|
)
|
|
$
|
(12,609
|
)
|
|
|
|
|
Weighted-average common shares outstanding
(1)(2)
|
42,185
|
|
|
2,988
|
|
|
|
|
|
Earnings (Loss) per Common Share
|
|
|
|
Basic
|
$
|
(2.91
|
)
|
|
$
|
(4.22
|
)
|
Diluted
|
(2.91
|
)
|
|
(4.22
|
)
|
|
|
(1)
|
Both our Class A and Class B common shares participate equally in the earnings or losses of Evolent Health, Inc.; therefore, shares of our Class B common stock are not considered dilutive shares for the purposes of calculating our diluted earnings (loss) per common share as the related adjustment to net income (loss) available for common shareholders would equally offset the additional shares resulting in the same earnings (loss) per common share.
|
|
|
(2)
|
For periods of net loss, shares used in the earnings (loss) per common share calculation represent basic shares as using diluted shares would be anti-dilutive.
|
Anti-dilutive shares (in thousands) excluded from the calculation of weighted-average common shares presented above are presented below:
|
|
|
|
|
|
|
|
|
|
For the Three
|
|
|
Months Ended
|
|
|
March 31,
|
|
|
2016
|
|
2015
|
Convertible preferred stock
|
|
—
|
|
|
22,128
|
|
Restricted stock and restricted stock units
|
|
12
|
|
|
605
|
|
Options
|
|
457
|
|
|
1,159
|
|
Total
|
|
469
|
|
|
23,892
|
|
10
. Stock-based Compensation
Total compensation expense (in thousands) by award type and line item in our consolidated financial statements (in thousands) were as follows:
|
|
|
|
|
|
|
|
For the Three
|
|
Months Ended
|
|
|
March 31,
|
|
|
|
2016
|
|
Award Type
|
|
|
|
|
Stock options
|
|
$
|
3,929
|
|
|
Restricted stock units ("RSU")
|
|
507
|
|
|
Total
|
|
$
|
4,436
|
|
|
|
|
|
|
Line Item
|
|
|
|
Cost of revenue
|
|
$
|
395
|
|
|
Selling, general and
|
|
|
|
administrative expenses
|
|
4,041
|
|
|
Total
|
|
$
|
4,436
|
|
|
No stock-based compensation in the totals above was capitalized as software development costs for the
three
months ended
March 31, 2016
. We did not recognize stock compensation in 2015 prior to the Offering Reorganization.
Stock-based awards granted were as follows:
|
|
|
|
|
|
|
|
|
|
For the Three
|
|
Months Ended
|
|
|
March 31,
|
|
|
|
2016
|
|
2015
|
|
Stock options
|
|
1,124,900
|
|
|
986,000
|
|
|
RSUs
|
|
385,713
|
|
|
—
|
|
|
11
. 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.
The Company recorded
$1.0 million
in income tax benefit for the
three
months ended
March 31, 2016
, which resulted in an effective tax rate of
0.6%
. Of the
$1.0 million
in tax benefit,
$0.3 million
was recorded in connection to the reduction in the portion of the indefinite book tax basis difference deferred tax liability related to an increase in ownership of our partnership interest in Evolent Health LLC. As of December 31, 2015,
$6.2 million
of our book and tax basis difference deferred tax liability was expected to reverse outside of our NOL carryforward period. Current tax losses generated in 2016 by the Company allow this deferred tax liability to become a source of income for the realization of our deferred tax assets, which resulted in recording a tax benefit of
$0.4 million
as of March 31, 2016. The remaining
$0.3 million
tax benefit was related to a change in the effective state rate. For the
three
months ended
March 31, 2015
, the effective tax rate was
0%
, due to the impact of the full valuation allowance recorded against the Company’s net deferred tax assets; therefore, the Company recorded no provision or benefit for income taxes for these periods.
As of each applicable period-end, the Company has not recognized any uncertain tax positions, penalties or interest as we have concluded that no such positions exist. The Company is not currently subject to income tax audits in any U.S. or state jurisdictions for any tax year.
Tax Receivables Agreement
In connection with the Offering Reorganization, the Company entered into the TRA with certain of its investors, which provides for the payment by the Company to these investors of
85%
of the amount of the tax benefits, if any, that the Company is deemed to realize as a result of increases in our tax basis related to exchanges of Class B common units as well as tax benefits attributable to the future utilization of pre-IPO NOLs. See Note 11 in our 2015 Form 10-K for a detailed discussion of our TRA.
12
. Equity Method Investment
Prior to the Offering Reorganization, we did not control Evolent Health LLC, but were able to exert significant influence and, accordingly, accounted for our investment in Evolent Health LLC using the equity method of accounting. Subsequent to the Offering Reorganization, the Company consolidates the results of operations of Evolent Health LLC.
The allocation of profits and losses to the shareholders of Evolent Health LLC were based upon the second amended and restated operating agreement of Evolent Health LLC. As part of recording our equity portion of the losses of Evolent Health LLC, the Company applied the hypothetical liquidation at book value basis of accounting which allocates profits and losses to the members based upon the value that would accrue to each member at each period end based upon a theoretical liquidation at book value at that time.
During the
three
months ended
March 31, 2015
, Evolent Health, Inc.'s proportional share of the losses of Evolent Health LLC was
$11.3 million
, which included
$0.5 million
related to the amortization of a basis differential.
The following is a summary of the operating results of Evolent Health LLC (in thousands) for the periods that it was accounted for as an equity method investment:
|
|
|
|
|
|
|
|
For the Three
|
|
Months Ended
|
|
|
March 31,
|
|
|
|
2015
|
|
Total revenue
|
|
$
|
37,041
|
|
|
Cost of revenue (exclusive of
|
|
|
|
depreciation and amortization)
|
|
26,454
|
|
|
Gross profit
|
|
10,587
|
|
|
Operating income (loss)
|
|
(19,347
|
)
|
|
Net income (loss)
|
|
(19,315
|
)
|
|
13
. Non-controlling Interests
Prior to the Offering Reorganization, we did not consolidate Evolent Health LLC, and therefore did not allocate our profits and losses to non-controlling interests. As of
March 31, 2016
, we owned
70.8%
of Evolent Health LLC. Changes in non-controlling interests (in thousands) were:
|
|
|
|
|
|
|
|
For the Three
|
|
Months Ended
|
|
|
March 31,
|
|
|
|
2016
|
|
Non-controlling interests as of beginning-of-period
|
|
$
|
285,238
|
|
|
Net income (loss) attributable to non-controlling interests
|
|
(51,100
|
)
|
|
Non-controlling interests as of end-of-period
|
|
$
|
234,138
|
|
|
14
. Related Parties
The Company works closely with both of its founding investors, The Advisory Board and UPMC. The relationship with The Advisory Board is centered on providing certain specified services and making valuable connections with CEOs of health systems that could become partners. The Company’s relationship with UPMC is a subcontractor relationship where UPMC has agreed to execute certain tasks (primarily third-party administration or “TPA” services) necessary to deliver on the Company’s customer commitments. We also conduct business with a company in which UPMC holds a significant equity interest.
Additionally, prior to the Offering Reorganization, we issued shares of our stock to certain of our partners while concurrently entering into revenue contracts with those partners. Those partners were considered related parties and the balances and/or transactions with them were reported on our consolidated financial statements for the periods in which they held an equity interest in Evolent Health, Inc. Subsequent to December 31, 2015, only
one
of our partners holds an equity interest in Evolent Health, Inc. That same partner represents a significant portion of our revenue and has a member of their management on our board of directors. That partner, our founding investors and their related businesses are considered related parties and the balances and/or transactions with them are reported on our consolidated financial statements.