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May 28, 2020, 6:06 a.m. EDT

10-Q: EVOLENT HEALTH, INC.

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(EDGAR Online via COMTEX) -- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand the Company's financial condition and results of operations. The MD&A is provided as a supplement to, and should be read in conjunction with our consolidated financial statements and the accompanying notes to consolidated financial statements presented in "Part 1 - Item 1. Financial Statements" of this Form 10-Q; our 2019 Form 10-K, including the sections entitled "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations"; and our current reports on Form 8-K filed in 2020.

INTRODUCTION

Business Overview

We are a market leader in the new era of value-based care, in which leading health systems and physician organizations, which we refer to as providers, as well as health plans, which we refer to as payers, are moving their business models from traditional FFS reimbursement to an increasingly integrated clinical and financial responsibility for populations. We refer to our provider and payer customers as partners. We consider value-based care to be the necessary convergence of health care payment and delivery. We believe the pace of this convergence is accelerating, driven by price pressure in traditional FFS health care, a market environment that is incentivizing value-based care models, growth in consumer-focused insurance programs, such as Medicare Advantage and managed Medicaid, and innovation in data and technology.

We were founded in 2011 by members of our management team, UPMC, an integrated delivery system based in Pittsburgh, Pennsylvania, and The Advisory Board Company. We provide integrated, technology-enabled services to our national network of leading health systems, physician organizations and national and regional payers across Medicare, Medicaid and commercial markets.

We manage our operations and allocate resources across two reportable segments, our services segment and our True Health Segment. The Company's services segment provides our customers, who we refer to as partners, two clinical solutions: (i) total cost of care services and (ii) specialty care management services, and one administrative solution: comprehensive health plan administration services. These services enable payers and providers to manage patient health in a more cost-effective manner. The Company's contracts are structured as a combination of monthly member service fees, percentage of plan premiums, shared medical savings arrangements and other performance based arrangements including taking responsibility for all or substantially all of the cost of care. Our True Health segment consists of a commercial health plan we operate in New Mexico that focuses on small and large businesses. All of our revenue is recognized in the United States and substantially all of our long-lived assets are located in the United States.

We have incurred operating losses since our inception, as we have invested heavily in resources to support our growth. We intend to continue to invest aggressively in the success of our partners, expand our geographic footprint and further develop our capabilities, including through acquisitions and other investments. We also expect to continue to incur operating losses for the foreseeable future and if we are unable to achieve our revenue growth and cost management objectives, we may not be able to achieve profitability. In the event that Passport is not awarded a contract under the RFP, we expect that our medium-term and long-term cash flow projections will be reduced and the recent decline in our stock price may be further prolonged, resulting in additional impairments to goodwill that would be material to our results of operations.

As of the date the financial statements were available to be issued, we believe we have sufficient liquidity for the next 12 months.

Services Overview

Our services segment includes clinical and administrative solutions designed to help our partners manage and administer patient health in a more cost-effective manner. We have two clinical solutions: (i) total cost of care management, and

Core elements of our total cost of care management services include:

Our specialty care management services support a broad range of specialty care delivery stakeholders during their transition from fee-for-service to value-based care, independent of their stage of maturation and specific market dynamics. We focus on the oncology and cardiology markets with the objective of helping providers and payers deliver higher quality, more affordable care and we provide comprehensive quality management, including diagnostics and treatment, for oncology and hematology patients.

Our comprehensive health plan administration services help providers assemble the complete infrastructure required to operate, manage and capitalize on a variety of financial and administrative management services, such as health plan services, risk management, analytics and reporting and leadership and management.

The majority of our services revenue is derived from recurring multi-year contracts, which we refer to as platform and operations. Platform and operations services accounted for 84.9% and 74.5% of our consolidated revenue for the three months ended March 31, 2020 and 2019, respectively. We believe the recurring, multi-year nature of our platform and operations contracts enables us to have strong visibility into future revenue. The amount of revenue in a given platform and operations contract is typically driven by: (i) the number of members that Evolent is contracted to manage, (ii) the population types being served (e.g., Medicare, Medicaid, Commercial), and (iii) the depth and breadth of the services and technology applications that our partners utilize from us. In situations involving clinical solutions, we typically elect to: (iv) participate alongside or co-own risk-sharing arrangements with our partners whereby we share in a portion of the upside and downside clinical performance, or by owning a portion of the underwriting results. We believe performance-based contracts align our partners' incentives with our own and enables us to capture greater value from our contracts. We believe we are in the early stages of capitalizing on these aligned operating partnerships. We believe our health system partners' current value-based care arrangements represent a small portion of the health system's total revenue each year.

Our services business model benefits from scale, as we leverage our purpose-built technology-enabled solutions and centralized resources in conjunction with the growth of our partners' membership base. While our absolute investment in our centralized resources and technologies will increase over time, we expect it will decrease as a percentage of revenue as we are able to scale this investment across a broader group of partners. We expect to grow with current partners as they increase membership in their existing value-based operations, through expanding the number of services we provide to our existing partners, by adding new partners and by capturing value through risk-sharing arrangements.

As of March 31, 2020, we had contractual relationships with 36 operating partners, and a significant portion of our revenue is concentrated with two partners. For the three months ended March 31, 2020 and 2019, our revenue from Passport accounted for 22.0% and 13.1% of our total revenue, respectively, and our revenue from Cook County Health and Hospitals Systems accounted for 18.7% and less than 10.0% of total revenue, respectively. As of March 31, 2020 and December 31, 2019, our receivables from Passport accounted for 5.6% and 3.3%, respectively, of our accounts receivable our receivables from Cook County Health and Hospitals Systems accounted for 55.4% and 48.4% of our accounts receivable, respectively. We expect the outcome of the RFP in Kentucky for Passport to have a material impact on our revenue from our management services agreement with Passport beyond the current contract period. In the event that Passport is not awarded a contract under the RFP, we expect that we will not receive any material revenue under our management services agreement from Passport subsequent to December 31, 2020, and the value of our pending investment in Passport will be negatively impacted.

True Health

True Health is a physician-led health plan in New Mexico available through the commercial market for employer-sponsored health coverage. On January 2, 2018, Evolent acquired certain assets from New Mexico Health Connections, one of the first Consumer Operated and Oriented Plans established following the implementation of the ACA, including a commercial plan and health plan management services organization. The acquired assets were contributed to a new entity, True Health New Mexico, Inc., a wholly-owned subsidiary of Evolent. Our True Health segment derives revenue from premiums earned over the terms of the related insurance policies. True Health also derives revenue from reinsurance premiums assumed from NMHC under the terms of the reinsurance agreement.

Our True Health segment operates a commercial health plan in New Mexico. We believe True Health provides an opportunity for us to leverage our services offerings to support True Health and transform the health plan into a value-based provider-centric model of care. True Health's largest partner, New Mexico Health Connections, comprised less than 10.0% and 14.0% of our revenue for the three months ended March 31, 2020 and 2019, respectively.

Background and Recent Events

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. Substantially all of our operations are conducted through Evolent Health LLC and its consolidated subsidiaries. The financial results of Evolent Health LLC are consolidated in the financial statements of Evolent Health, Inc.

Evolent Health's Response to COVID-19

On March 11, 2020, the World Health Organization declared the novel strain of coronavirus (COVID-19) a global pandemic and recommended containment and mitigation measures worldwide. While response to the COVID-19 outbreak continues to rapidly evolve, it has led to aggressive actions to reduce the spread of the disease that have seriously disrupted activities in large segments of the economy. We are continuing to monitor the COVID-19 outbreak and its impact on our business.

Because of the nature of the services we provide, market dynamics in our end markets and with our significant customers, to date the COVID-19 pandemic has not materially impacted our financial condition or results of operations or our outlook. As of March 31, 2020 we had cash and cash equivalents of $67.9 million and as of the date the financial statements were available to be issued we believe our current cash balance is sufficient to meet our liquidity needs for the next twelve months. The COVID-19 crisis has also adversely impacted global access to capital and caused significant volatility in financial markets. Significant deterioration of the U.S. and global economies could have a significant adverse impact on our investment income, the value of our investments, or future liquidity needs. Although the impact of the COVID-19 pandemic on our business has not been severe to date, the long-term impact of the pandemic on our partners and the global economy is uncertain and will depend on various factors, including the scope, severity and duration of the pandemic. A prolonged economic downturn or recession resulting from the pandemic could adversely affect many of our partners which could, in turn, adversely impact our business, financial condition and results of operations.

Evolent's focus throughout this pandemic has been the health and safety of its employees and their families, as well as ensuring that we continue to furnish high quality service to our partners. Evolent has deployed a multi-faceted response to COVID-19, overseen by its Emergency Preparedness Team, led by the General Counsel and Chief Compliance Officer, that focuses on maintaining its workforce in a manner that does not disrupt service delivery or operations. Evolent is closely monitoring and overseeing any issues of noncompliance or deficiencies with client operational service level agreements and continuing to review contractual business requirements in light of state and federal mandates, emergency laws and orders, and available financial support opportunities. Evolent is also mindful of the impact COVID-19 has on its vendors and subcontractors, and we will continue to work with them regarding our collective obligations to Evolent's clients. We required a COVID-19 Business Continuity Attestation from subcontractors and vendors in April, confirming that operational and financial obligations will be met and aiming to ensure that privacy and security risks or incidents can be mitigated and disclosed in a timely manner.

Summary of Impact of COVID-19

In evaluating the impact of COVID-19 on our services business, we considered, among other factors, the nature of the services we provide, end market trends and outlook and customer-specific trends. In evaluating our health plan businesses, we focused on possible changes in membership and medical utilization trends.

Services Business

Our two most significant service offerings in terms of revenue are specialty care management and administrative health services. Because both of these services offerings provide critical services to our clients and their members and have relatively long lead times to implement such services, we currently do not anticipate any material near-term disruption to the relevant contracts as a result of the pandemic.

The three key end-markets we serve are Medicaid, Medicare and Commercial.

We expect to see changes in membership and medical utilization in our end-markets as a result of the COVID-19 pandemic. The pandemic has resulted in a significant increase in unemployment in the United States. Historically, Medicaid enrollment has increased during periods of rising unemployment as individuals lose access to employer sponsored healthcare and turn to government sponsored healthcare. In addition, with respect to Medicaid, many states (including Florida, Kentucky and Illinois) put in place new rules during the pandemic eliminating the ability of Medicaid health plans to dis-enroll non-paying members, as well as waiving certain eligibility requirements, which together we expect will result in higher membership during the period of the pandemic. We expect to see the opposite trend in the commercial market, where employees who are made redundant lose access to employer sponsored healthcare. We do not expect to see meaningful changes in membership in the Medicare market as a result of COVID-19. In aggregate, as more than 50% of the lives on our platform are currently in Medicaid and we generally earn revenue with respect to those lives based on a PMPM model, we expect to see a net benefit in our business from increased membership in that market in the near-term. We cannot predict the magnitude of this potential benefit, or how long it will last.

With respect to medical utilization, following the declaration of the pandemic by the WHO, many state-wide mandates deferred non-essential medical procedures to allow hospitals to focus on providing care to COVID-19 patients. Across all markets, our partners are experiencing declines in non-essential care, offset in part by increased costs for care of COVID-19 patients. We will continue to monitor medical utilization trends closely as the mandates are lifted and deferred care comes back on-line. Beginning late in the first quarter after declaration of the pandemic and continuing into the second quarter, we have seen a modest benefit in our business from lower utilization trends. However, we cannot predict with any certainty the net impact of lower utilization on our business, as it is possible we will experience a surge in utilization once the mandates are lifted.

Our two largest customers in terms of revenue, Passport and Cook County Health and Hospitals Systems, together accounted for approximately 28% and 41%, respectively, of revenue for the twelve months ended December 31, 2019 and the three months ended March 31, 2020, respectively, and both participate in the Medicaid market. During the three months ended March 31, 2020, we did not see a material change in the membership at both health plans however, an increase in unemployment in Kentucky or Illinois could result in higher Medicaid enrollments in the future. In addition, towards the end of the quarter we saw modestly lower claims volume at both clients tied to State mandates curtailing non-essential care.

Health Plans

Our True Health plan serves approximately 17,000 members in the small and large group market in New Mexico as well as 6,700 members in the individual market in New Mexico. At the end of March 2020, the membership in group plans was not meaningfully changed relative to the year ended December 31, 2019. Beginning at the end of the three months ended March 31, 2020, we observed a decline in medical utilization tied to a state-wide mandate prohibiting non-essential care in the period from March 13, 2020, resulting in slightly lower than expected claims expenses. Of our four equity method health plans, three are in Medicaid and one is in Medicare. In our Medicaid equity method investees (Passport Health in Kentucky, Lighthouse Health Plan and Miami Children's Health Plan in Florida), we did not see modest increases in membership in the last part of March however reduced medical utilization resulted in reduced claims expenses in the same period. In Medicare, GlobalHealth, Inc. in Oklahoma also saw lower medical utilization following declaration of the pandemic. While we cannot estimate the magnitude of reduced medical utilization and its impact on our business, we expect this trend to continue until the COVID-19 pandemic moderates.

Overall, we are unable to determine or predict the nature, duration, or scope of the overall impact the COVID-19 pandemic will have on our business, results of operations, liquidity, or capital resources. We plan to actively monitor the ongoing situation and may take further actions that change our operations if required by law or that we determine are in the best interests of our employees or partners.

Transactions

During 2019, the Company undertook several transactions, some of which may impact year-to-year comparisons. The following is a discussion of certain of those transactions.

Passport

On December 30, 2019, Passport, PHS I, the Company and Passport Buyer, closed a transaction whereby Passport Buyer acquired substantially all of the assets and assumed substantially all of the liabilities of Passport and PHS I for $70.0 million in cash and issued a 30% equity interest in the Passport Buyer to the Sponsors. As of December 30, 2019, Justify Holdings, Inc. became Passport Health Plan, Inc.

The Company accounts for its investment in Passport under the equity method of accounting because while it has significant influence over Passport, it shares control over the activities of Passport that most significantly impact Passport's economic performance. These activities include approval of the annual budget, material provider network additions or deletions and the development of Passport's amended proposal in the rebid process to the Commonwealth of Kentucky. The annual budget drives the operating decisions of Passport and primarily relates to managing the Kentucky Medicaid contract. The Kentucky Medicaid contract is critical to the success of Passport. Accordingly, the approval of the final budget of Passport for a fiscal year significantly impacts Passport's economic performance. Depending on a number of factors including the timing of any exercise of the put option or the call option, and in particular in a scenario where Passport is awarded a new contract in the ongoing RFP process, our accounting for our investment in Passport may change in the future. If we determine that we are required to consolidate Passport's results in future periods, it will have a material impact on our consolidated balance sheets and statements of operations and other comprehensive income (loss). Refer to "Part I

GlobalHealth

On May 24, 2019, we completed the acquisition of approximately a 45% ownership interest in MHG, the sole owner of MHA, which is the sole owner of GHH, which is the sole owner of GlobalHealth, Inc., a health maintenance organization based in the State of Oklahoma that offers, among other things, Medicare Advantage products in the State of Oklahoma. At closing, we contributed approximately $15.0 million in cash and 1,577,841 shares of our Class A common stock to MHG, together with certain of our other assets. The Company recognized a $9.6 million non-cash gain on disposal of assets upon the contribution. We also recognized a short-term contingent consideration liability of $6.7 million related to the transaction. At the time of the transaction, our economic interest in GlobalHealth was approximately 45% and our voting interest was approximately 29%. As of March 31, 2020, we hold approximately a 43% ownership interest in MHG. Pursuant to a security holders' agreement among MHG and certain equity holders of MHG party thereto, we hold customary governance rights in MHG for a minority investor, including the right to appoint two of seven directors to MHG's board of directors.

The Company determined that it has significant influence over the entity, but that it does not have control over the entity. Accordingly, the investment is accounted for under the equity method of accounting and the Company is allocated its proportional share of the entity's earnings and losses for each reporting period. The Company also entered into services agreements with GlobalHealth to provide certain management, operational and support services to help manage elements of their service offerings.

As of March 31, 2020, the Oklahoma Insurance Division ("OID") informed GlobalHealth, Inc. that in response to the COVID-19 pandemic, the OID required GlobalHealth, Inc. to increase its regulatory capital surplus by May 15, 2020. It would otherwise be placed into

receivership if additional financing could not be secured. Certain investors agreed to provide liquidity as necessary to increase statutory capital reserves to no lower than 300%. In connection with the investment, GlobalHealth, Inc. transferred 100% of the equity interests in GlobalHealth, Inc. to the new investors for no consideration. Closing of this transaction occurred on May 13, 2020. As a result of this transaction, we have recorded a non-cash impairment charge of approximately $47.1 million, representing the total value of our investment, in impairment of equity method investments on the consolidated statements of operations for the three months ended March 31, 2020.

Credit Agreement and Warrants

On December 30, 2019, the Company entered into the Credit Agreement, pursuant to which the lenders agreed to extend credit to the Borrower in the form of the Senior Credit Facilities, subject to the satisfaction of specified conditions. The Borrower borrowed the loan under the Initial Term Loan Facility on December 30, 2019 (the "Initial Term Loan"). The proceeds of the Initial Term Loan were used to finance the Passport transaction, fees and expenses incurred in connection therewith. The proceeds of the DDTL Facility may be used, subject to our satisfaction of specified conditions, to finance the repayment or repurchase of the 2021 Notes and to fund permitted acquisitions.

In conjunction with the Company's entry into the Credit Agreement, the Company entered into warrant agreements whereby it agreed to sell to the holders of the warrants an aggregate of 1,513,786 shares of Class A common stock at a per share purchase price equal to $8.05. Refer to "Part I - Item 1. Financial Statements - Note 9" for additional discussion relating to the Senior Credit Facilities and warrant agreements.

2019 Class B Exchanges

During 2019, all remaining holders of Class B units executed Class B Exchanges. These Class B Exchanges resulted in the issuance of 3.1 million shares of the Company's Class A common stock. As a result of these Class B Exchanges and Evolent Health LLC's cancellation of the related Class B units, the Company's economic interest in Evolent Health LLC increased to 100% immediately following the final Class B Exchange during the quarter, and, accordingly, we reclassified a portion of our non-controlling interests into shareholders' equity attributable to Evolent Health, Inc.

Critical Accounting Policies and Estimates

The MD&A included in our 2019 Form 10-K contains a detailed discussion of our critical accounting policies and estimates. There have been no material changes to our critical accounting policies and estimates since our 2019 Form 10-K, except as discussed below. See "Item 1. Financial Statements - Note 2" in this Form 10-Q for a summary of our significant accounting policies and see "Item 1. Financial Statements - Note 3" in this Form 10-Q for information regarding the Company's adoption of new accounting standards.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and subsequently issued additional guidance that modified ASU 2016-13. The standard requires an entity to change its accounting approach for measuring and recognizing credit losses on certain financial assets measured at amortized cost, including trade receivables, certain non-trade receivables, customer advances and certain off-balance sheet credit exposures, by replacing the existing "incurred loss" framework with an expected credit loss recognition model. The new standard results in earlier recognition of credit losses based on past events, current conditions, and reasonable and supportable forecasts. The standard is effective for entities with fiscal years beginning after December 15, 2019, including interim periods within such fiscal years. We adopted the requirements of this standard effective January 1, 2020 using the modified retrospective approach and recorded a cumulative effect adjustment of $3.0 million to January 1, 2020 retained earnings (accumulated deficit). In our previous accounting policy for trade receivables and non-trade receivables, we maintained an allowance for doubtful accounts based on specific identification. Under the new accounting standard, we utilize several factors to develop historical losses, including aging schedules, customer creditworthiness, and historical payment experience, which are then adjusted for current conditions and reasonable and supportable forecasts in measurement of the allowance. In addition, for customer advances and certain off-balance sheet credit exposures, . . .

May 28, 2020

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