Evolent Health(EVH) - 2020 Q2 - Quarterly Report

Explanatory Note The company operates as a holding company with all business conducted through its primary subsidiary, Evolent Health LLC - Evolent Health, Inc is a holding company, with its operations conducted through its subsidiary Evolent Health LLC, which holds all operating assets and substantially all business since inception[8] Forward-Looking Statements - Cautionary Language The report contains forward-looking statements subject to significant risks and uncertainties that could cause actual results to differ - The report contains forward-looking statements, which are predictions based on current expectations and projections, subject to risks and uncertainties that may cause actual results to differ materially[10][11] - Key risks include the potential negative impact of the COVID-19 pandemic, the pending sale of Passport assets, significant revenue concentration from largest partners, and uncertainties in the healthcare regulatory framework[11] - Other risks involve managing growth, offering new products, integrating acquisitions, maintaining profitability for performance-based contracts, and the ability to attract new partners[11] PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) This section presents the unaudited consolidated financial statements and detailed notes for the quarter and six months ended June 30, 2020 Consolidated Balance Sheets The balance sheet reflects a significant decrease in total assets and shareholders' equity, primarily due to a goodwill impairment charge Consolidated Balance Sheet Highlights (in thousands) | Item | June 30, 2020 (Unaudited) | December 31, 2019 | | :------------------------------------- | :------------------------ | :------------------ | | Total current assets | $274,658 | $228,801 | | Total assets | $1,270,134 | $1,498,015 | | Total current liabilities | $245,122 | $192,769 | | Total liabilities | $623,270 | $568,968 | | Total shareholders' equity (deficit) | $646,864 | $929,047 | - Total assets decreased by approximately $227.9 million from December 31, 2019, to June 30, 2020, primarily due to a significant goodwill impairment charge[16] - Total shareholders' equity (deficit) decreased by approximately $282.2 million, largely influenced by the net loss and goodwill impairment[16] Consolidated Statements of Operations and Comprehensive Income (Loss) Revenue increased year-over-year, but a substantial goodwill impairment charge led to a significantly wider operating and net loss Consolidated Statements of Operations Highlights (in thousands, except per share data) | Item | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :------------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Total revenue | $238,632 | $191,959 | $485,917 | $389,715 | | Total operating expenses | $466,101 | $217,192 | $738,886 | $461,594 | | Operating loss | $(227,469) | $(25,233) | $(252,969) | $(71,879) | | Net loss | $(203,521) | $(31,900) | $(282,273) | $(80,549) | | Net loss attributable to common shareholders | $(203,521) | $(31,615) | $(282,273) | $(78,354) | | Basic and diluted loss per common share | $(2.38) | $(0.38) | $(3.32) | $(0.97) | - Total revenue increased by 24.3% for the three months and 24.7% for the six months ended June 30, 2020, compared to the prior year periods[17] - Operating loss significantly widened due to a $215.1 million goodwill impairment charge in the three and six months ended June 30, 2020[17] Consolidated Statements of Changes in Shareholders' Equity (Deficit) Shareholders' equity decreased substantially during the quarter, driven by a significant net loss that reduced retained earnings Changes in Shareholders' Equity (Deficit) (in thousands) | Item | Balance as of March 31, 2020 | Balance as of June 30, 2020 | | :-------------------------------------- | :--------------------------- | :-------------------------- | | Class A Common Stock Amount | $855 | $855 | | Additional Paid-In Capital | $1,180,288 | $1,183,605 | | Accumulated Other Comprehensive Income (Loss) | $(387) | $(391) | | Retained Earnings (Accumulated Deficit) | $(333,684) | $(537,205) | | Total Equity (Deficit) | $847,072 | $646,864 | - Net loss of $203.5 million for the three months ended June 30, 2020, significantly reduced retained earnings and total equity[19] - Additional paid-in capital increased due to stock-based compensation expense and exercise of stock options[19] Consolidated Statements of Cash Flows Cash flow from operations improved significantly year-over-year, driven by non-cash adjustments despite a larger net loss Consolidated Statements of Cash Flows Highlights (in thousands) | Item | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :------------------------------------------------- | :----------------------------- | :----------------------------- | | Net cash and restricted cash from (used in) operating activities | $17,125 | $(39,242) | | Net cash and restricted cash used in investing activities | $(18,382) | $(90,816) | | Net cash and restricted cash from (used in) financing activities | $25,910 | $(121,071) | | Net increase (decrease) in cash and restricted cash | $24,679 | $(251,158) | | Cash and restricted cash as of end-of-period | $153,210 | $137,167 | - Operating activities generated $17.1 million in cash for the six months ended June 30, 2020, a significant improvement from a $39.2 million outflow in the prior year, despite a larger net loss, primarily due to non-cash adjustments like goodwill impairment[22][366] - Financing activities provided $25.9 million in cash for the six months ended June 30, 2020, mainly from changes in working capital balances related to claims processing on behalf of partners[22][372] Notes to Consolidated Financial Statements This section provides detailed notes elaborating on accounting policies, significant transactions, and specific financial items Note 1. Organization The company supports healthcare providers in transitioning to value-based care through its Services and True Health segments - Evolent Health, Inc supports health systems, physician organizations, and health plans in transitioning to value-based care, operating through two segments: Services and True Health[24][25] - The Services segment offers clinical and administrative solutions, including total cost of care management, specialty care management, and comprehensive health plan administrative services[25] - The True Health segment is a physician-led health plan in New Mexico, serving commercial, individual, and federal employee markets[25] Note 2. Basis of Presentation, Summary of Significant Accounting Policies and Change in Accounting Principle The financial statements are unaudited but include all necessary adjustments and should be read with the 2019 Form 10-K - The unaudited interim consolidated financial statements include all necessary adjustments for fair presentation and should be read with the 2019 Form 10-K[30] - Key accounting estimates involve valuation of assets (including intangibles and long-lived assets), liabilities, revenue recognition, and reserves for claims[33] - The Company operates through two reportable segments: Services and True Health, with discrete financial information evaluated by the CODM[35] Note 3. Recently Issued Accounting Standards The company adopted new accounting standards for leases and credit losses, with the latter resulting in an adjustment to retained earnings - The Company adopted ASU 2016-02 (Leases) effective January 1, 2019, resulting in $51.4 million in right-of-use assets and $47.4 million in lease liabilities, with no material impact on results of operations[63] - ASU 2016-13 (Financial Instruments-Credit Losses) was adopted effective January 1, 2020, with a cumulative effect adjustment of $3.0 million to retained earnings, changing the credit loss measurement from 'incurred loss' to 'expected credit loss'[67] - The adoption of ASU 2018-15 (Internal Use Software) and ASU 2018-13 (Fair Value Measurement) did not have a material impact on the consolidated financial statements[64][68] Note 4. Transactions This note details the Passport transaction, the impact of its non-renewal of a key contract, and a loss on asset disposal - On December 30, 2019, Passport Buyer acquired substantially all assets and liabilities of Passport and PHS I for $70.0 million cash and a 30% equity interest to Sponsors; Evolent accounts for its 70% investment in Passport under the equity method[69] - Passport was not awarded a Kentucky managed Medicaid contract for the next period, leading to an expectation of no material revenue from Passport Buyer after December 31, 2020, and a requirement for Evolent to acquire the Sponsors' 30% interest for $20.0 million[71] - The Company recorded a $6.4 million loss on disposal of assets in Q1 2020 from selling its interest in a subsidiary providing services to providers[72] Note 5. Revenue Recognition Services segment revenue is disaggregated into transformation services and platform and operations services, recognized over time - Services segment revenue is derived from transformation services (fixed fee, recognized over time by input method) and platform and operations services (variable fee, recognized over time by output method)[73][74][76] - Contract assets and deferred revenue balances are reported, with $108.2 million of transaction price allocated to unsatisfied performance obligations as of June 30, 2020, primarily fixed consideration in long-term contracts[77][79][80] Services Revenue Disaggregation (in thousands) | Service Type | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :----------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Transformation services | $755 | $1,944 | $5,993 | $5,297 | | Platform and operations services: | | | | | | Clinical solutions | $161,774 | $94,573 | $321,582 | $191,204 | | Administrative solutions | $50,562 | $49,058 | $100,616 | $99,683 | Note 6. Credit Losses The company is exposed to credit losses from various financial instruments and estimates these losses based on historical and forward-looking data - The Company is exposed to credit losses from accounts receivable, investments, and customer advances, estimating losses based on past events, current conditions, and forecasts, including COVID-19 impact[87] - The Passport Note of $40.0 million (plus $2.7 million accrued interest) is due July 1, 2025, and its performance is not materially impacted by macroeconomic conditions due to sufficient risk-based capital[94][96][97] Allowance for Credit Losses on Accounts Receivables (in thousands) | Item | Six Months Ended June 30, 2020 | | :---------------------------------------- | :----------------------------- | | Balance as of December 31, 2019 | $(41) | | Cumulative transition adjustment | $(2,815) | | Provision for credit losses | $(260) | | Charge-offs | $1,575 | | Balance as of June 30, 2020 | $(1,541) | Note 7. Property and Equipment, Net Capitalized internal-use software development costs represent the largest component of property and equipment and continued to increase - Capitalized internal-use software development costs increased to $126.2 million as of June 30, 2020, from $112.5 million at December 31, 2019[104] - Depreciation expense for property and equipment was $13.9 million for the six months ended June 30, 2020, with $11.6 million related to internal-use software amortization[105] Property and Equipment, Net (in thousands) | Item | June 30, 2020 | December 31, 2019 | | :------------------------------------- | :------------ | :---------------- | | Computer hardware | $12,061 | $11,604 | | Internal-use software development costs | $126,203 | $112,501 | | Total property and equipment, net | $88,555 | $85,155 | | Accumulated depreciation and amortization | $(68,834) | $(55,014) | Note 8. Goodwill and Intangible Assets, Net A significant non-cash goodwill impairment charge was recorded due to Passport's failure to secure a key Medicaid contract - A non-cash goodwill impairment charge of $215.1 million was recorded for the three and six months ended June 30, 2020, due to Passport not being awarded a Kentucky managed Medicaid contract, reducing the fair value of one Services segment reporting unit[116][118] Goodwill Carrying Amount by Segment (in thousands) | Segment | Balance as of December 31, 2019 | Impairment | Balance as of June 30, 2020 | | :---------------- | :------------------------------ | :--------- | :-------------------------- | | Services | $566,359 | $(215,100) | $348,990 | | True Health | $5,705 | — | $5,705 | | Consolidated | $572,064 | $(215,100) | $354,695 | Intangible Assets, Net (in thousands) | Asset Type | Net Carrying Value (June 30, 2020) | Net Carrying Value (December 31, 2019) | | :-------------------------- | :--------------------------------- | :----------------------------------- | | Corporate trade name | $17,719 | $18,409 | | Customer relationships | $230,231 | $246,769 | | Technology | $24,718 | $33,162 | | Provider network contracts | $9,675 | $9,405 | | Total intangible assets, net | $282,913 | $308,459 | Note 9. Long-term Debt The company's long-term debt consists of a term loan facility and two series of convertible senior notes - The Company entered into a Credit Agreement on December 30, 2019, for an Initial Term Loan Facility of $75.0 million and a Delayed Draw Term Loan (DDTL) Facility of up to $50.0 million, maturing December 30, 2024[123][125] - The 2025 Notes (1.50% Convertible Senior Notes due 2025) have an aggregate principal of $172.5 million, convertible at $33.43 per share, with a debt component of $100.7 million and an equity component of $71.8 million[125][129][130] - The 2021 Notes (2.00% Convertible Senior Notes due 2021) have an aggregate principal of $125.0 million, convertible at $24.03 per share, maturing December 1, 2021[132][134] Convertible Senior Notes Carrying Value (in thousands) | Item | June 30, 2020 | December 31, 2019 | | :------------------------------------------------- | :------------ | :---------------- | | 2025 Notes Carrying value | $111,665 | $107,169 | | 2025 Notes Principal amount | $172,500 | $172,500 | | 2021 Notes Carrying value | $123,697 | $123,237 | | 2021 Notes Principal amount | $125,000 | $125,000 | Note 10. Commitments and Contingencies The company faces a commitment to acquire a Passport interest, a performance bond liability, a class action lawsuit, and significant customer concentration - The Company is committed to acquire the Sponsors' 30% ownership interest in Passport Buyer for $20.0 million within twelve months following December 31, 2020, due to Passport not being awarded a new Medicaid contract[140] - A performance bond of $25.0 million secures Passport's Medicaid contract, with Evolent and Passport jointly and severally liable; the expiry date was extended to December 31, 2020[144] - A class action lawsuit was filed against the Company alleging false or misleading statements regarding its business with Passport; the Company believes the case has little legal or factual merit[161] Significant Customer Revenue Concentration | Customer | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :----------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Passport | 25.2% | 13.2% | 23.6% | 13.1% | | New Mexico Health Connections | * | 13.2% | * | 13.6% | | Cook County Health and Hospitals Systems | 19.9% | * | 19.3% | * | * Represents less than 10.0% of the respective balance. Note 11. Leases The company's lease obligations primarily consist of operating leases for office space and data centers with varying terms - The Company leases office space, data centers, and equipment under operating lease agreements, with rent expense recognized on a straight-line basis[168][170] Lease Cost Components (in thousands) | Item | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :-------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Operating lease cost | $3,586 | $3,838 | $6,642 | $7,119 | | Variable lease cost | $1,465 | $1,121 | $2,517 | $2,576 | | Total lease cost | $5,202 | $4,959 | $9,461 | $9,695 | Maturity of Lease Liabilities (in thousands) as of June 30, 2020 | Year | Operating Lease Expense | | :--------- | :---------------------- | | 2020 | $6,039 | | 2021 | $11,726 | | 2022 | $9,801 | | 2023 | $9,376 | | 2024 | $8,833 | | Thereafter | $56,093 | | Total lease payments | $101,868 | | Present value of lease liabilities | $74,449 | Note 12. Earnings (Loss) Per Common Share This note details the calculation of basic and diluted loss per share, excluding a significant number of potentially dilutive securities Loss Per Common Share (in thousands, except per share data) | Item | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :------------------------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Net loss available for common shareholders | $(203,521) | $(31,615) | $(282,273) | $(78,354) | | Weighted-average common shares outstanding | 85,349 | 82,289 | 84,977 | 80,820 | | Basic and diluted loss per common share | $(2.38) | $(0.38) | $(3.32) | $(0.97) | Anti-dilutive Shares Excluded from EPS Calculation (in thousands) | Item | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :------------------------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Exchangeable Class B common stock | — | 1,080 | — | 2,129 | | Restricted stock units (RSUs), performance-based RSUs and leveraged stock units (LSUs) | 554 | 985 | 376 | 1,014 | | Stock options | 711 | 1,495 | 841 | 1,729 | | Convertible senior notes | 10,361 | 10,361 | 10,361 | 10,361 | | Total | 11,626 | 13,921 | 11,578 | 15,233 | Note 13. Stock-based Compensation Stock-based compensation expense decreased year-over-year, primarily due to the elimination of performance-based RSU awards - Total stock-based compensation expense decreased by $1.0 million for the three months and $2.1 million for the six months ended June 30, 2020, primarily due to the elimination of performance-based RSU awards[179][333][347] Total Stock-based Compensation Expense by Award Type (in thousands) | Award Type | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :-------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Stock options | $638 | $903 | $1,388 | $2,263 | | RSUs | $2,006 | $2,630 | $3,862 | $5,060 | | LSUs | $1,059 | $717 | $1,886 | $970 | | Total compensation expense | $3,703 | $4,750 | $7,211 | $9,287 | Note 14. Income Taxes The company recorded an income tax benefit in Q2 2020, primarily due to a valuation allowance reversal under the CARES Act - The income tax benefit in Q2 2020 primarily resulted from a $2.3 million valuation allowance reversal due to carrying back New Century Health's 2018 NOL under the CARES Act, and a $1.4 million benefit from federal tax rate differences[184] - The Company maintains a full valuation allowance against its net deferred tax asset, except for limited indefinite-lived components[185] Income Tax Provision (Benefit) (in thousands) | Item | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :-------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Income tax (benefit) expense | $(3,904) | $1,398 | $(3,634) | $902 | | Effective tax rate | 1.9% | (4.6)% | 1.3% | (1.1)% | Note 15. Investments In and Advances to Equity Method Investees The company recorded significant gains from equity method investees, offset by a large non-cash impairment charge on its GlobalHealth investment - The Company holds economic interests (4%-70%) and voting interests (25%-57%) in several equity method investees, recognizing its proportional share of earnings/losses[189] - Gains from equity method investees were $25.1 million for the three months and $24.7 million for the six months ended June 30, 2020, a significant increase from losses in prior periods[189] - A non-cash impairment charge of $47.1 million was recorded for the GlobalHealth investment in Q1 2020, as GlobalHealth, Inc transferred 100% equity interests to new investors for no consideration due to regulatory capital requirements[195] Note 16. Non-controlling Interests Non-controlling interests were fully reclassified into shareholders' equity as the company's economic interest in Evolent Health LLC reached 100% - The Company's economic interest in Evolent Health LLC increased to 100% during 2019 due to Class B Exchanges, leading to reclassification of non-controlling interests into shareholders' equity[200] Changes in Non-controlling Interests (in thousands) | Item | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :------------------------------------------------- | :----------------------------- | :----------------------------- | | Non-controlling interests balance as of beginning of period | $6,689 | $45,532 | | Decrease in non-controlling interests as a result of Class B Exchanges | — | $(33,946) | | Net loss attributable to non-controlling interests | — | $(2,195) | | Reclassification of non-controlling interests | $(6,689) | $187 | | Non-controlling interests balance as of end of period | — | $16,078 | Note 17. Fair Value Measurement The company's Level 3 liabilities, including contingent consideration and warrants, are measured using unobservable inputs - Fair value measurements are categorized into Level 1 (quoted prices), Level 2 (observable inputs), and Level 3 (unobservable inputs)[203][205] - Changes in contingent consideration, measured using Level 3 inputs, resulted in net realized and unrealized losses of $4.9 million for the six months ended June 30, 2020[211] Recurring Fair Value Measurements (in thousands) | Item | June 30, 2020 (Level 3) | December 31, 2019 (Level 3) | | :-------------------------- | :---------------------- | :------------------------ | | Contingent consideration | $3,600 | $9,883 | | Warrants | $4,900 | $7,092 | | Total Level 3 liabilities | $8,500 | $16,975 | Note 18. Related Parties The company generates significant revenue from service agreements with its equity-method investees - The Company has service agreements with equity-method investees, generating $71.4 million and $131.3 million in revenue for the three and six months ended June 30, 2020, respectively[217] Related Party Assets (in thousands) | Item | June 30, 2020 | December 31, 2019 | | :------------------------------------------------- | :------------ | :---------------- | | Accounts receivable | $7,597 | $8,781 | | Customer advance for regulatory capital requirements, net | $39,955 | $40,000 | Related Party Revenue and Expenses (in thousands) | Item | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :------------------------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Platform and operations services revenue | $73,885 | $16,874 | $141,833 | $29,818 | | Cost of revenue | $(2,171) | $6,657 | $1,076 | $14,487 | Note 19. Segment Reporting The company's performance is reported across two segments, Services and True Health, with management using Adjusted EBITDA to evaluate them - The Company operates in two reportable segments: Services (clinical and administrative solutions) and True Health (commercial health plan in New Mexico)[221] - Management uses revenue and Adjusted EBITDA to evaluate segment performance and allocate resources, as these metrics exclude items not indicative of core operating performance[223][225] Segment Revenue (in thousands) | Segment | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :---------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Services revenue | $217,299 | $149,543 | $438,732 | $303,246 | | True Health premiums | $25,541 | $45,764 | $57,928 | $93,140 | | Total revenue | $238,632 | $191,959 | $485,917 | $389,715 | Segment Adjusted EBITDA (in thousands) | Segment | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :---------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Services | $10,519 | $(8,797) | $14,395 | $(24,296) | | True Health | $(1,480) | $1,123 | $(1,729) | $1,844 | | Segments Total | $9,039 | $(7,674) | $12,666 | $(22,452) | Note 20. Reserve for Claims and Performance-Based Arrangements Reserves for claims are estimated using actuarial principles to account for incurred but not yet reported medical expenses - Reserves for claims and performance-based arrangements reflect estimates for incurred but not reported claims, reported claims in process, and other medical expenses, using actuarial principles and assumptions[231][232] - The liability is primarily calculated using historical completion factors adjusted for current trends and operational factors, with more recent months relying on medical cost trend and expected loss ratio analysis[234][235] Activity in Reserves for Claims and Performance-Based Arrangements (in thousands) | Item | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :------------------------------------------------- | :----------------------------- | :----------------------------- | | Beginning balance | $61,150 | $27,595 | | Incurred costs related to current year | $245,696 | $161,620 | | Paid costs related to current year | $200,989 | $100,254 | | Ending balance | $94,409 | $33,052 | Note 21. Investments The company's investment portfolio consists of fixed-income securities classified as held-to-maturity - Investments are classified as held-to-maturity, with the intent and ability to hold them until maturity[239] - No securities were held in an unrealized loss position for more than twelve months as of June 30, 2020 or December 31, 2019[240] Investments Held at Amortized Cost and Fair Value (in thousands) | Item | Amortized Cost (June 30, 2020) | Fair Value (June 30, 2020) | Amortized Cost (December 31, 2019) | Fair Value (December 31, 2019) | | :-------------------------------- | :----------------------------- | :------------------------- | :--------------------------------- | :----------------------------- | | U.S. Treasury bills | $8,909 | $9,401 | $10,784 | $11,054 | | Corporate bonds | $1,706 | $1,828 | $1,705 | $1,775 | | Collateralized mortgage obligations | $5,695 | $5,914 | $5,472 | $5,523 | | Yankees | $597 | $648 | $597 | $627 | | Total investments | $16,907 | $17,791 | $18,558 | $18,979 | Note 22. Supplemental Cash Flow Information This note discloses significant non-cash investing and financing activities, including stock issuance for earn-outs and lease liability exchanges Supplemental Disclosure of Non-cash Investing and Financing Activities (in thousands) | Item | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :------------------------------------------------- | :----------------------------- | :----------------------------- | | Increase to goodwill from measurement period adjustments/business combinations | $2,200 | $596 | | Class A common stock issued for payment of earn-outs | $4,185 | $800 | | Leased assets obtained in exchange for operating lease liabilities | $(1,354) | $30,181 | | Decrease in non-controlling interests as a result of Class B Exchanges | — | $33,946 | Note 23. Subsequent Events Subsequent to the quarter end, the company entered into an agreement to sell certain Passport assets to Molina Healthcare, Inc - On July 16, 2020, Evolent Health LLC and Passport Health Plan, Inc entered into an Asset Purchase Agreement (Molina APA) with Molina Healthcare, Inc for the sale of certain Passport assets[242] - Passport will sell intellectual property rights, its Medicaid contract with CHFS, D-SNP contract rights, and certain provider/vendor agreements and real property leases to Molina[245][246] - Molina will pay Passport $20.0 million in cash at closing, placed in escrow until January 1, 2021, and Passport is eligible for an additional $40.0 million Membership Payment based on enrollee numbers[250][251] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses financial results, highlighting revenue growth, the impact of the Passport contract loss, and COVID-19 effects Introduction Evolent is a market leader in value-based care that has incurred operating losses since inception while investing in growth - Evolent is a market leader in value-based care, providing integrated, technology-enabled services to health systems, physician organizations, and payers across Medicare, Medicaid, and commercial markets[261][262] - The Company manages operations through two segments: Services (clinical and administrative solutions) and True Health (commercial health plan in New Mexico)[263] - Evolent has incurred operating losses since inception due to heavy investment in growth and expects continued losses, with liquidity believed sufficient for the next 12 months[264][265] Services Overview The Services segment generates recurring revenue from multi-year contracts but faces significant customer concentration and the loss of Passport revenue - The Services segment offers total cost of care management (using Identifi® technology), specialty care management (oncology and cardiology), and comprehensive health plan administration services[266][267][268][269][270] - The majority of Services revenue comes from recurring multi-year platform and operations contracts, which accounted for 89.0% of consolidated revenue for the three months ended June 30, 2020[271] - Revenue concentration is significant, with Passport and Cook County Health and Hospitals Systems accounting for 25.2% and 19.9% of total revenue, respectively, for the three months ended June 30, 2020[273] - No material revenue is expected from Passport after December 31, 2020, due to the non-renewal of its Kentucky Medicaid contract, and Passport's assets are being sold to Molina Healthcare, Inc in a subsequent event[274][275] True Health The True Health segment is a commercial health plan in New Mexico whose future revenues will be diminished by a terminated reinsurance agreement - True Health is a physician-led commercial health plan in New Mexico, acquired in 2018, deriving revenue from premiums earned over insurance policy terms[277][278] - Revenue from reinsurance premiums assumed from NMHC terminated in Q4 2019, which will diminish future True Health revenues[279] Background and Recent Events Evolent Health, Inc is a holding company whose financial results consolidate its primary operating subsidiary, Evolent Health LLC - Evolent Health, Inc is a holding company, with Evolent Health LLC conducting substantially all operations and its financial results consolidated[281] Evolent Health's Response to COVID-19 The COVID-19 pandemic has not materially impacted financial results to date, though the company is actively managing its response - The COVID-19 pandemic has not materially impacted Evolent's financial condition or results of operations to date, with sufficient liquidity for the next 12 months[284] - Evolent's response focuses on employee health and safety, maintaining service quality, and monitoring compliance, with a multi-faceted approach overseen by its Emergency Preparedness Team[285] - The Services business expects a net benefit from increased Medicaid membership due to rising unemployment and state rule changes, while the True Health plan observed a decline in medical utilization due to state mandates[290][291][292] Transactions This section highlights the potential accounting impact of the Passport transaction, a major investment impairment, and a new credit agreement - Passport's unsuccessful bid for the Kentucky Medicaid contract may lead to a change in accounting for Evolent's investment, potentially requiring consolidation and materially impacting financial statements[297] - A non-cash impairment charge of $47.1 million was recorded for the GlobalHealth investment in Q1 2020, as GlobalHealth, Inc transferred 100% equity interests to new investors for no consideration due to regulatory capital requirements[298] - The Company entered into a Credit Agreement in December 2019 for $75.0 million (Initial Term Loan) and up to $50.0 million (DDTL Facility) to finance the Passport transaction and potential repayment of 2021 Notes[299] Critical Accounting Policies and Estimates Key accounting policies include the annual review of goodwill for impairment and the recent adoption of the expected credit loss model - Goodwill is reviewed for impairment at least annually or when circumstances indicate the fair value of a reporting unit may be below its carrying amount, leading to a quantitative assessment if necessary[304][306][307] - The Company adopted ASU 2016-13 (Credit Losses) effective January 1, 2020, changing the credit loss recognition model to an expected credit loss framework, resulting in a $3.0 million cumulative effect adjustment to retained earnings[308] Results of Operations This section details the components of the company's revenue and expenses and provides a comparative analysis of its consolidated results Key Components of our Results of Operations Revenue is derived from services and premiums, while costs include direct expenses, employee costs, and claims expenses - Revenue sources include transformation services (fixed fee, input method), platform and operations services (variable fee, output method), and premiums earned (True Health segment)[312][313][314][316] - Cost of revenue includes direct expenses, shared resources, employee-related costs, TPA support, and in some cases, claims and capitation payments[320] - Claims expenses for the True Health segment include direct medical expenses and estimated incurred but unpaid claims, recognized in the period services are provided[321] Evolent Health, Inc. Consolidated Results The consolidated results show revenue growth overshadowed by a massive goodwill impairment charge, leading to a substantial net loss Consolidated Results (in thousands, except percentages) | Item | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :------------------------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Total revenue | $238,632 | $191,959 | $485,917 | $389,715 | | Total operating expenses | $466,101 | $217,192 | $738,886 | $461,594 | | Operating loss | $(227,469) | $(25,233) | $(252,969) | $(71,879) | | Goodwill impairment | $215,100 | — | $215,100 | — | | Net loss available for common shareholders | $(203,521) | $(31,615) | $(282,273) | $(78,354) | | Basic and diluted loss per common share | $(2.38) | $(0.38) | $(3.32) | $(0.97) | Comparison of the Results for the three months ended June 30, 2020 to 2019 Quarterly revenue grew significantly, but a goodwill impairment charge caused the operating loss to widen dramatically - Total revenue increased by $46.7 million (24.3%) to $238.6 million, driven by a $67.9 million (46.9%) increase in platform and operations services revenue from existing partners, new additions, and cross-sells[326][329] - Premiums decreased by $20.0 million (43.9%) to $25.5 million, primarily due to the termination of the NMHC quota-share reinsurance agreement and premium rebate accruals from COVID-19 impact[330] - Operating loss significantly widened to $(227.5) million from $(25.2) million, primarily due to a $215.1 million non-cash goodwill impairment charge[325][336] Comparison of the Results for the Six Months Ended June 30, 2020 to 2019 For the six-month period, revenue grew strongly while SG&A expenses decreased, but a goodwill impairment drove a large operating loss - Total revenue increased by $96.2 million (24.7%) to $485.9 million, with platform and operations services revenue growing by $130.5 million (44.7%) to $422.3 million[339][341] - Premiums decreased by $35.0 million (37.7%) to $57.6 million, mainly due to the termination of the NMHC reinsurance agreement[342] - Selling, general, and administrative expenses decreased by $36.6 million (25.8%) to $105.2 million, driven by a $31.2 million reduction in personnel costs due to lower employee headcount and elimination of performance-based RSU awards[347] - A non-cash goodwill impairment charge of $215.1 million was recorded, contributing to a significant operating loss[349] Discussion of Non-Operating Results Non-operating results were impacted by lower interest income, higher interest expense, and a significant impairment charge on an equity method investment - Interest income decreased in 2020 due to lower income from the capital-only reinsurance agreement with NMHC, which terminated in Q4 2019[353] - Interest expense increased to $6.3 million for three months and $12.6 million for six months ended June 30, 2020, from $3.7 million and $7.1 million in prior periods, primarily due to the 2021 Notes, 2025 Notes, and the Credit Agreement[354][355] - A non-cash impairment charge of $47.1 million was recorded for equity method investments due to GlobalHealth, Inc's transfer of equity interests to new investors[356] Review of Consolidated Financial Condition This section reviews the company's liquidity, capital resources, and cash flows, confirming sufficiency for the next twelve months despite operating losses Liquidity and Capital Resources Despite continued operating losses, management believes current cash and liquidity sources are sufficient for the next twelve months - The Company incurred operating losses of $253.0 million and $71.9 million for the six months ended June 30, 2020 and 2019, respectively[362] - As of June 30, 2020, the Company had $98.3 million in cash and cash equivalents and $55.7 million in restricted cash and restricted investments[363] - Management believes current cash and other liquidity sources are sufficient for working capital and capital expenditure requirements for the next twelve months[364] Cash Flows Cash flow from operations turned positive, driven by non-cash impairment charges, while investing activities focused on internal-use software - Operating activities generated $17.1 million in cash for the six months ended June 30, 2020, primarily due to non-cash adjustments like goodwill and equity method investment impairments, despite a net loss[366] - Investing activities used $18.4 million, mainly for internal-use software and property/equipment purchases, offset by investment maturities[370] - Financing activities provided $25.9 million, primarily from an increase in working capital balances for claims processing services[372] Summary of Cash Flows (in thousands) | Item | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :------------------------------------------------- | :----------------------------- | :----------------------------- | | Net cash and restricted cash from (used in) operating activities | $17,125 | $(39,242) | | Net cash and restricted cash used in investing activities | $(18,382) | $(90,816) | | Net cash and restricted cash from (used in) financing activities | $25,910 | $(121,071) | Contractual Obligations The company has significant future contractual obligations related to debt repayment, operating leases, and a buyout commitment Estimated Contractual Obligations (in thousands) as of June 30, 2020 | Obligation Type | 2020 | 2021-2022 | 2023-2024 | 2025+ | Total | | :--------------------------------- | :----- | :-------- | :-------- | :------ | :------ | | Operating leases for facilities | $6,003 | $21,418 | $18,202 | $56,093 | $101,716 | | Passport buyout commitment | — | $20,000 | — | — | $20,000 | | Purchase obligations related to vendor contracts | $3,415 | $6,982 | $93 | — | $10,490 | | Commitments to equity-method investees | $3,600 | — | — | — | $3,600 | | Debt interest payments | $6,433 | $23,837 | $21,337 | $2,588 | $54,195 | | Debt principal repayment | — | $125,000 | $75,000 | $172,500 | $372,500 | | Contingent consideration | $3,600 | — | — | — | $3,600 | | Total contractual obligations | $23,051 | $197,237 | $114,632 | $231,181 | $566,101 | Restricted Cash and Restricted Investments A total of $55.7 million in cash and investments is restricted, primarily for claims management services and lease collateral - As of June 30, 2020, restricted cash and restricted investments totaled $55.7 million, including $44.9 million for claims management services and $3.6 million for facility lease collateral[377] Uses of Capital The company's primary uses of capital are for operations and strategic growth, with no plans for near-term cash dividends - Principal uses of cash are for business operations, expansion, and strategic acquisitions; the Company does not anticipate paying cash dividends on Class A common stock in the foreseeable future[378] Item 3. Quantitative and Qualitative Disclosures About Market Risk This section outlines the Company's exposure to market risks, including interest rate, foreign currency, and inflation risks Interest Rate Risk The company is exposed to interest rate risk through its cash equivalents and floating-rate debt, but not its fixed-rate notes - As of June 30, 2020, the Company had $153.9 million in cash and cash equivalents and restricted cash and investments, with $297.5 million in fixed-rate convertible notes and $75.0 million in floating-rate secured term loans[386][388] - Changes in interest rates affect interest earned on cash and cash equivalents, but held-to-maturity investments are not subject to interest rate risk[387] Foreign Currency Exchange Risk The company has minor foreign currency risk related to the Indian Rupee, resulting in a small translation loss - The Company has foreign currency risks primarily related to the Indian Rupee, as it is a net payor of non-U.S. dollar currencies, and recognized foreign currency translation losses of $0.2 million for the six months ended June 30, 2020[389] Inflation Risk Inflation has not had a material effect on the company's operations to date, but significant future inflation could pose a risk - Inflation has not had a material effect on the Company's business, financial condition, or results of operations to date, but significant inflationary pressures could harm future performance if not offset by price increases[390] Item 4. Controls and Procedures Management concluded disclosure controls were not effective due to material weaknesses in internal control over financial reporting, with remediation ongoing Evaluation of Disclosure Controls and Procedures Management concluded that disclosure controls and procedures were not effective as of June 30, 2020, due to material weaknesses - Management concluded that disclosure controls and procedures were not effective as of June 30, 2020, due to material weaknesses in internal control over financial reporting[392] - The COVID-19 pandemic has not materially impacted internal controls over financial reporting, despite most employees working remotely[393] Description of Material Weaknesses Material weaknesses were identified in user access controls and claims data management within a claims processing system - Material weaknesses were identified in user access role definitions and segregation of duties within a claims processing system, and inadequate controls over set-up and modifications of claims data[396][397] - These deficiencies could result in material misstatements to claims expense and cost of revenue, though no adjustments were made to 2019 or interim 2020 financial statements[398] Plan of Remediation to Address Material Weaknesses in Internal Controls over Financial Reporting Management has designed and is implementing system enhancements and updated policies to remediate the identified material weaknesses - Management designed and implemented system enhancements, role-based access, and updated policies for user access and segregation of duties within the claims processing system, with testing ongoing[399] - Remediation efforts also include expanding controls over claims data set-up/modification and enhancing procedures for monitoring control performance related to third-party claims data[399] Changes in Internal Control over Financial Reporting As part of remediation, new controls surrounding user access and segregation of duties have been implemented - Controls surrounding user access role definitions and segregation of duties within one claims processing system have been designed and implemented as part of remediation efforts[401] Inherent Limitations of Internal Controls Internal controls provide only reasonable, not absolute, assurance due to inherent limitations like human error or management override - Internal controls provide only reasonable assurance, not absolute, that objectives are met, due to inherent limitations such as faulty judgments, errors, circumvention by individuals, or management override[402] PART II Item 1. Legal Proceedings This section refers to the detailed discussion of legal proceedings within the financial statements notes - Information regarding legal proceedings, including a class action lawsuit, is detailed in Note 10 of the financial statements[405] Item 1A. Risk Factors This section highlights new or updated risks, particularly concerning the pending sale of Passport assets and the COVID-19 pandemic - The pending sale of Passport Health Plan, Inc assets to Molina Healthcare, Inc may not be consummated, or expected benefits may not be realized, due to conditions, governmental approvals, or other factors[407] - The ongoing COVID-19 pandemic poses risks including potential delays or non-payment of premiums for True Health, budget pressures on state Medicaid agencies, heightened security risks from remote work, and capital market volatility[408][409] - The full impact of COVID-19 is uncertain and could materially adversely affect the Company's business, financial position, results of operations, and cash flows[410] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds This item is not applicable for the reporting period Item 3. Defaults Upon Senior Securities This item is not applicable for the reporting period Item 4. Mine Safety Disclosures This item is not applicable for the reporting period Item 5. Other Information No other information is reported for this period Item 6. Exhibits This section lists the exhibits filed with the report, including the Molina Asset Purchase Agreement and Sarbanes-Oxley certifications - Exhibits include the Asset Purchase Agreement with Molina Healthcare, Inc, and certifications from the Chief Executive Officer and Chief Financial Officer pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act[417][418] Signatures The report was duly signed by the company's Chief Financial Officer and Controller on August 7, 2020 - The report is signed by John Johnson, Chief Financial Officer, and Aammaad Shams, Controller, on behalf of Evolent Health, Inc on August 7, 2020[421][422]