Basis of Presentation, Summary of Significant Accounting Policies and Changes in Accounting Principles

Basis of Presentation

In our opinion, the accompanying unaudited interim consolidated financial statements include all adjustments, consisting of normal recurring adjustments, which are necessary to fairly state our financial position, results of operations, and cash flows. The Consolidated Balance Sheet at December 31, 2017, 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 disclosures normally included in financial statements prepared in accordance with United States of America generally accepted accounting principles (“GAAP”) have been omitted pursuant to instructions, rules, and regulations prescribed by the United States Securities and Exchange Commission (“SEC”). The disclosures provided herein should be read in conjunction with the audited financial statements and notes thereto included in our 2017 Form 10-K.

Summary of Significant Accounting Policies

Certain GAAP policies that significantly affect the determination of our financial position, results of operations and cash flows, are summarized below. See “Part II - Item 8. Financial Statements and Supplementary Data - Note 2” in our 2017 Form 10-K for a complete summary of our significant accounting policies.

Accounting Estimates and Assumptions

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses for the reporting period. Those estimates are inherently subject to change and actual results could differ from those estimates. In the accompanying consolidated financial statements, estimates are used for, but not limited to, the valuation of assets, liabilities, consideration related to business combinations and asset acquisitions, revenue recognition including variable consideration, discounts and credits, estimated selling prices for performance obligations in contracts with multiple performance obligations, claims reserves, contingent payments, allowance for doubtful accounts, depreciable lives of assets, impairment of long lived assets (including equity method investments), stock-based compensation, deferred income taxes and valuation allowance, contingent liabilities, valuation of intangible assets (including goodwill), purchase price allocation in taxable stock transactions and the useful lives of intangible assets.

Principles of Consolidation

The consolidated financial statements include the accounts of Evolent Health, Inc. and its subsidiaries. All inter-company accounts and transactions are eliminated in consolidation.

Operating Segments

Operating segments are defined as components of a business that earn revenue and incur expenses for which discrete financial information is available that is evaluated, on a regular basis, by the chief operating decision maker (“CODM”) to decide how to allocate resources and assess performance. The Company operates through two segments: (1) Services, and (2) True Health. Our Services segment consists of our technology-enabled services platform that supports our various value-based operations, such as delivery network alignment, population health performance, integrated cost and revenue management solutions and financial and administrative management services. Our True Health segment consists of a commercial health plan we operate in New Mexico that focuses on small and large businesses. See Note 17 for a discussion of our operating results by segment.

Revenue Recognition

Our Services segment derives revenue from two sources: (1) transformation services and (2) platform and operations services. See “Changes in Accounting Principles” below for our updated revenue recognition policy as a result of our adoption of Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers.

Our True Health segment derives revenue from premiums that are earned over the terms of the related insurance policies. The portion of premiums that will be earned in the future or are received prior to the effectiveness of the policy are deferred and reported as premiums received in advance. These amounts are generally classified as short-term deferred revenue on our Consolidated Balance Sheets.

Restricted Cash and Restricted Investments

Restricted cash and restricted investments include cash and investments used to collateralize various contractual obligations (in thousands) as follows:



		As of			As of
	September 30,			December 31,
		2018			2017
Collateral for letters of credit
for facility leases ⁽¹⁾		$	3,710		$	3,812
Collateral with financial institutions ⁽²⁾		22,028			24,725
Claims processing services ⁽³⁾		8,942			26,286
Collateral for reinsurance agreement ⁽⁴⁾		10,000			10,000
Other		1,042			862
Total restricted cash
and restricted investments		45,722			65,685

Current restricted investments		—			8,150
Current restricted cash		42,328			54,248
Total current restricted cash
and restricted investments		42,328			62,398

Noncurrent restricted investments		712			605
Noncurrent restricted cash		2,682			2,682
Total noncurrent restricted cash
and restricted investments		$	3,394		$	3,287

⁽¹⁾ Represents restricted cash related to collateral for letters of credit required in conjunction with lease agreements. See Note 9 for further discussion of our lease commitments.

⁽²⁾Represents collateral held with financial institutions for risk-sharing arrangements. As of September 30, 2018, and December 31, 2017, approximately $22.0 million and $16.6 million of the collateral amount was in a trust account and invested in a money market fund. The amounts invested in money market funds are considered restricted cash and are carried at fair value, which approximates cost. See Note 15 for further discussion of our fair value measurement. As of December 31, 2017, approximately $8.2 million of the collateral amount was invested in restricted certificates of deposit with remaining maturities of less than 12 months. The restricted investments are classified as held-to-maturity and stated at amortized cost. Fair value of the certificates of deposit is determined using Level 2 inputs and approximates amortized cost as of December 31, 2017. See Note 9 for further discussion of our risk-sharing arrangements.

⁽³⁾ Represents cash held by Evolent on behalf of partners for claims processing services. These are pass-through amounts and can fluctuate materially from period to period depending on the timing of when the claims are processed.

⁽⁴⁾ Represents restricted cash required as part of our capital only reinsurance agreement to provide balance sheet support to NMHC. There is no transfer of underwriting risk to Evolent and we are not at risk for any cash payments on behalf of NMHC as part of the agreement. The reinsurance agreement is further discussed in Note 9. As of September 30, 2018, the full $10.0 million amount was invested in a money market fund. The amount invested in the money market fund is considered restricted cash and is carried at fair value, which approximates cost. As of December 31, 2017, the full $10.0 million amount was held in a FDIC participating bank account.

The following table provides a reconciliation of cash and cash equivalents and restricted cash reported within the consolidated balance sheets that sum to the total of the same such amounts shown in the statements of cash flows.



	As of September 30,						As of December 31,
	2018			2017			2017			2016
Cash and cash equivalents	$	221,837		$	287,143		$	238,433		$	134,563
Restricted cash and restricted investments	45,722			16,932			65,685			40,416
Restricted investments included in
restricted cash and restricted investments	(712		)	(8,150		)	(8,755		)	(4,950		)
Total cash and cash equivalents and restricted cash
shown in the consolidated statements of cash flows	$	266,847		$	295,925		$	295,363		$	170,029

Notes Receivable

Notes receivable are carried at the face amount of each note plus respective accrued interest receivable, less received payments. The Company does not typically carry notes receivable in the course of its regular business, but contributed $20.0 million in the form of an implementation funding loan (the “Implementation Loan”) under an agreement with a current customer entered during the year ended December 31, 2017. The Implementation Loan is expected to support implementation services to assist the customer in expanding its Medicaid membership. The Implementation Loan carries a fixed interest rate of 2.5% per annum and the terms of the agreement governing the Implementation Loan require it to be repaid in ten equal monthly installments of $2.0 million, plus accrued interest, during 2018. As of September 30, 2018, the outstanding principal balance of the Implementation Loan was $6.0 million, excluding approximately $0.1 million of accrued interest. As of December 31, 2017, the outstanding principal balance of the Implementation Loan was $20.0 million, excluding approximately $0.1 million of accrued interest.

Intangible Assets, Net

Identified intangible assets are recorded at their estimated fair values at the date of acquisition and are amortized over their respective estimated useful lives using a method of amortization that reflects the pattern in which the economic benefits of the intangible assets are used. The Company acquired additional intangible assets in conjunction with a strategic acquisition made during 2018. Information regarding the determination and allocation of the fair value of the acquired assets and liabilities is further described within Note 4.

The following summarizes the estimated useful lives by asset classification:



Corporate trade name	20 years
Customer relationships	15-25 years
Technology	5 years
Provider network contracts	5 years

Intangible assets are reviewed for impairment if circumstances indicate the Company may not be able to recover the asset’s carrying value. The Company evaluates recoverability by determining whether the undiscounted cash flows expected to result from the use and eventual disposition of that asset or group exceed the carrying value at the evaluation date. If the undiscounted cash flows are not sufficient to cover the carrying value, the Company measures an impairment loss as the excess of the carrying amount of the long-lived asset or group over its fair value. See Note 7 for additional discussion regarding our intangible assets.

Goodwill

We recognize the excess of the purchase price, plus the fair value of any non-controlling interests in the acquiree, over the fair value of identifiable net assets acquired as goodwill. Goodwill is not amortized, but is reviewed at least annually for indications of impairment, with consideration given to financial performance and other relevant factors. We perform impairment tests of goodwill at a reporting unit level, which is consistent with the way management evaluates our business. Goodwill is assigned to the reporting unit that benefits from the synergies arising from each business combination.

Foreign Currency

The Company established an international subsidiary during the first quarter of 2018. The functional currency of our international subsidiary is the Indian Rupee. We translate the financial statements of this subsidiary to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive income (loss) as a component of shareholders' equity. We recorded a foreign currency translation loss of $0.1 million and $0.3 million on our Consolidated Statements of Operations for the three and nine months ended September 30, 2018, which resulted in an “Accumulated other comprehensive loss” of $0.3 million on our Consolidated Balance Sheet as of September 30, 2018.

Changes in Accounting Principles

Adoption of ASU 2014-09, Revenue from Contracts with Customers

As discussed in Note 3, the Company adopted ASU 2014-09, Revenue from Contracts with Customers, effective January 1, 2018. The following is our updated accounting policy with respect to revenue recognition for our Services segment.

Our Services segment derives revenue from two sources: (1) transformation services and (2) platform and operations services. Revenue is recognized when control of the services is transferred to our customers. We use the following 5-Step model, outlined in Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”), to determine revenue recognition on our contracts with customers:


•	Identify the contract(s) with a customer


•	Identify the performance obligations in the contract


•	Determine the transaction price


•	Allocate the transaction price to performance obligations


•	Recognize revenue when (or as) the entity satisfies a performance obligation

Transformation Services Revenue

Transformation services consist of strategic assessments, or Blueprint contracts, and implementation services whereby we assist the customer in launching its population health or health plan strategy. In certain cases, transformation services can also include revenue associated with our support of certain one-time wind-down activities for clients who are exiting a line of business or population. The transformation services are usually completed within 12 months. We generally receive a fixed fee for transformation services and recognize revenue over time using an input method based on hours incurred compared to the total estimated hours required to satisfy our performance obligation.

Platform and Operations Services Revenue

Platform and operations services generally include multi-year arrangements with customers to provide various population health, health plan operations and claims processing services on an ongoing basis, as well as transition or run-out services to customers receiving primarily third-party administration (“TPA”) services. Our performance obligation in these arrangements is to provide an integrated suite of services, including access to our platform that is customized to meet the specialized needs of our customers. Generally we will apply the series guidance to the performance obligation as we have determined that each time increment is distinct. We primarily utilize a variable fee structure for these services that typically include a monthly payment that is calculated based on a specified per member per month rate, multiplied by the number of members that our partners are managing under a value-based care arrangement or a percentage of plan premiums. Our arrangements may also include other variable fees related to service level agreements, shared medical savings arrangements and other performance measures. Variable consideration is estimated using the most likely amount based on our historical experience and best judgment at the time. Due to the nature of our arrangements certain estimates may be constrained if it is probable that a significant reversal of revenue will occur when the uncertainty is resolved. We recognize revenue for platform and operations services over time using the time elapsed output method. Fixed consideration is recognized ratably over the contract term. In accordance with the series guidance, we allocate variable consideration to the period to which the fees relate.

Contracts with Multiple Performance Obligations

Our contracts with customers may contain multiple performance obligations, primarily when the customer has requested both transformation services and platform and operations services as these services are distinct from one another. When a contract has multiple performance obligations, we allocate the transaction price to each performance obligation based on the relative standalone selling price using the expected cost margin approach. This approach requires estimates regarding both the level of effort it will take to satisfy the performance obligation as well as fees that will be received under the variable pricing model. We also take into consideration customer demographics, current market conditions, the scope of services and our overall pricing strategy and objectives when determining the standalone selling price.

Principal vs Agent

We occasionally use third parties to assist in satisfying our performance obligations. In order to determine whether we are the principal or agent in the arrangement, we review each third-party relationship on a contract by contract basis. We are an agent when our role is to arrange for another entity to provide the services to the customer. In these instances, we do not control the service before it is provided and recognize revenue on a net basis. We are the principal when we control the good or service prior to transferring control to the customer. We recognize revenue on a gross basis when we are the principal in the arrangement.

In accordance with the requirements under ASU 2014-09, the impact of adoption to our consolidated financial statements was as follows. See Note 5 for additional disclosures regarding Evolent's contracts with customers.



Condensed Consolidated Statements of Operations
(unaudited, in thousands)
	For the Three Months Ended September 30, 2018
					Amounts without				Impact of
					adoption of				adoption
	As Reported					ASC 606			Higher/(Lower)
Revenue
Transformation services		$	9,230			$	9,556			$	(326	)
Platform and operations services		118,094				117,942				152

Expenses
Cost of revenue (exclusive of depreciation and amortization
presented separately below)		73,967				77,409				(3,442		)
Selling, general and administrative expenses		59,566				59,676				(110		)
Income (loss) before income taxes and non-controlling interests		(12,420		)		(15,798		)		3,378

	For the Nine Months Ended September 30, 2018
					Amounts without				Impact of
					adoption of				adoption
	As Reported					ASC 606			Higher/(Lower)
Revenue
Transformation services		$	23,950			$	25,272			$	(1,322	)
Platform and operations services		341,258				339,485				1,773

Expenses
Cost of revenue (exclusive of depreciation and amortization
presented separately below)		214,945				218,786				(3,841		)
Selling, general and administrative expenses		172,495				173,644				(1,149		)
Income (loss) before income taxes and non-controlling interests		(36,622		)		(42,063		)		5,441



Condensed Consolidated Balance Sheets
(unaudited, in thousands)
	As of September 30, 2018
				Balances without			Impact of
				adoption of			adoption
	As Reported				ASC 606		Higher/(Lower)
Assets
Accounts receivable, net		$	60,054		$	57,848		$	2,206
Contract assets (current)		3,705			—			3,705
Contract assets (noncurrent)		1,000			—			1,000
Contract cost assets		14,252			—			14,252

Liabilities and Shareholders' Equity (Deficit)

Liabilities
Deferred revenue		$	22,360		$	24,100		$	(1,740	)
Other long-term liabilities		10,885			10,746			139

Shareholders' Equity (Deficit)
Retained earnings (accumulated deficit)		66,696			44,580			22,116
Non-controlling interests		10,008			9,361			647

Adoption of ASU 2016-18, Statement of Cash Flows: Restricted Cash

The Company adopted ASU 2016-18, Statement of Cash Flows: Restricted Cash, effective December 31, 2017, using the retroactive transition method, which resulted in the recast of our statement of cash flows for each period presented. See “Part II - Item 8. Financial Statements and Supplementary Data - Note 2” in our 2017 Form 10-K for further information about the adoption.

The amendments in the ASU require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows.

A significant portion of the Company’s restricted cash consists of cash held on behalf of partners for claims processing services. These are pass-through amounts and can fluctuate materially from period to period depending on the timing of when the claims are processed. Under the previous standard, there was no net impact to the statement of cash flows related to these amounts as the changes in accounts payable and accounts receivable were offset by the change in restricted cash. Upon adoption of ASU 2016-18, the change in restricted cash held on behalf of partners for claims processing would no longer net to zero, thereby potentially having a significant impact on cash flows from operations period over period. Given the pass-through nature of these claim payments, the change in restricted cash held on behalf of partners for claims processing is presented within cash flows from financing activities on our statements of changes in cash flows.

The following table summarizes the impact of the change in accounting principle to the Company’s Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 (in thousands):



	For the Nine Months Ended September 30, 2017
	As Reported				Adjustments				As Adjusted
Cash Flows from Investing Activities
Purchases and maturities of restricted investments		$	—			$	(3,200	)		$	(3,200	)
Change in restricted cash and restricted investments		(2,164		)		2,164				—
Net cash and restricted cash provided by
(used in) investing activities		17,003				(1,036		)		15,967

Cash Flows from Financing Activities
Change in restricted cash held on behalf of
partners for claims processing		—				(25,648		)		(25,648		)
Net cash and restricted cash provided by
(used in) financing activities		169,570				(25,648		)		143,922

Net increase (decrease) in cash and cash
equivalents and restricted cash		152,580				(26,684		)		125,896
Cash and cash equivalents and
restricted cash as of beginning-of-period		134,563				35,466				170,029
Cash and cash equivalents and
restricted cash as of end-of-period		$	287,143			$	8,782			$	295,925