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Fair Value Measurement

12 Months Ended

Dec. 31, 2019

GAAP defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability (an exit price) assuming an orderly transaction in the most advantageous market at the measurement date. GAAP also establishes a hierarchical disclosure framework which prioritizes and ranks the level of observability of inputs used in measuring fair value. These tiers include:


•	Level 1 - inputs to the valuation methodology are quoted prices available in active markets for identical instruments as of the reporting date;


•	Level 2 - inputs to the valuation methodology are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date and the fair value can be determined through the use of models or other valuation methodologies; and


•	Level 3 - inputs to the valuation methodology are unobservable inputs in situations where there is little or no market activity for the asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the particular asset or liability being measured.

Recurring Fair Value Measurements

In accordance with GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring basis (in thousands):



	As of December 31, 2019
	Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents ⁽¹⁾	$	3,698	—		—		$	3,698
Restricted cash and restricted investments ⁽¹⁾	1,004		—		—		1,004
Total fair value of assets measured on a recurring basis	$	4,702	$	—	$	—	$	4,702

Liabilities
Contingent consideration ⁽²⁾	$	—	$	—	$	9,883	$	9,883
Warrants ⁽³⁾	—		—		7,092		7,092
Total fair value of liabilities measured on a recurring basis	$	—	$	—	$	16,975	$	16,975



	As of December 31, 2018
	Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents ⁽¹⁾	$	11,391	$	—	$	—	$	11,391
Restricted cash and restricted investments ⁽¹⁾	31,226		—		—		31,226
Total fair value of assets measured on a recurring basis	$	42,617	$	—	$	—	$	42,617

Liabilities
Contingent consideration ⁽²⁾	$	—	$	—	$	8,800	$	8,800

⁽¹⁾ Represents the cash and cash equivalents and restricted cash and restricted investments that were held in money market funds as of December 31, 2019 and 2018, as presented in the tables above.

⁽²⁾ Represents the fair value of earn-out consideration related to the Passport, Global Health and other transactions, as described in Note 4. As of December 31, 2019, $3.7 million is attributable to Passport, $5.2 million to Global Health and $1.0 million is attributable to other transactions. As of December 31, 2018, $5.6 million is attributable to Passport and $3.2 million is attributable to New Century Health.

⁽³⁾Represents the fair value of 1,513,786 shares issuable under the warrant agreements discussed in Note 8.

The Company recognizes any transfers between levels within the hierarchy as of the beginning of the reporting period. There were no transfers between fair value levels for the years ended December 31, 2019 and 2018, respectively.

In the absence of observable market prices, the fair value is based on the best information available and involves a significant degree of judgment, taking into consideration a combination of internal and external factors, including the appropriate risk adjustments for non-performance and liquidity risks.

The strategic alliance with Passport included a provision for additional equity consideration contingent upon the Company obtaining new third-party Medicaid business in future periods. The fair value of the contingent equity consideration was estimated based on the real options approach, a form of the income approach, which estimated the probability of the Company achieving future revenues under the agreement. The significant unobservable inputs used in the fair value measurement of the Passport contingent consideration are the five-year risk-adjusted recurring revenue compound annual growth rate (“CAGR”) and the applicable discount rate. A significant increase in the assumed five-year risk-adjusted recurring revenue CAGR projection or decrease in discount rate in isolation would result in a significantly higher fair value of the contingent consideration.

The acquisition of New Century Health includes an earn-out of up to $11.4 million, contingent upon New Century Health achieving certain levels of operating results during 2019. The fair value of the earn-out was estimated based on the real options approach, a form of the income approach, which estimated the probability of New Century Health achieving certain levels of operating results during 2019. The significant unobservable inputs used in the fair value measurement of the New Century Health earn-out are the risk neutral probabilities that the 2019 operating results for New Century Health are sufficient to either exceed the minimum earn-out threshold or meet the earn-out target cap. A significant increase in either one of these metrics, in isolation, would result in a significantly higher fair value of the contingent consideration.

The GlobalHealth transaction includes a provision for additional consideration contingent upon the Company’s future share price payable in cash or stock at the Company’s election. The fair value of the contingent consideration was estimated based on the closing market price of the common stock for a one-year look-back. The significant unobservable input used in the fair value measurement of GlobalHealth contingent consideration is the stock price volatility. A significant decrease in the stock price, would result in a significantly higher fair value of the contingent consideration.

The changes in our contingent consideration, measured at fair value, for which the Company uses Level 3 inputs to determine fair value are as follows (in thousands):



	For the Years Ended December 31,
	2019			2018
Balance as of beginning of year	$	8,800		$	8,700
Additions ⁽¹⁾	12,992			3,200
Settlements	(800		)	—
Realized and unrealized gains, net	(4,017		)	(3,100		)
Balance as of end of year	$	16,975		$	8,800

⁽¹⁾ Addition is related to the GlobalHealth and credit agreement transactions.

The following table summarizes the fair value (in thousands), valuation techniques and significant unobservable inputs of our Level 3 fair value measurements as of the periods presented:



	As of December 31, 2019
	Fair		Valuation	Significant	Assumption or
	Value		Technique	Unobservable Inputs	Input Ranges
Passport contingent consideration	$	3,700	Real options approach	Risk-adjusted recurring revenue CAGR	93.9		%	⁽¹⁾
				Discount rate/time value	4.8% - 5.3%

GlobalHealth contingent consideration	$	5,200	Monte Carlo simulation	Stock price volatility	80.0		%	⁽²⁾

Other contingent considerations	$	983	Management estimate	Adjusted EBITDA	$	19,235

Warrants	$	7,092	Black-Scholes	Stock price volatility	55.0		%
				Annual risk free rate	1.7		%



	As of December 31, 2018
	Fair		Valuation	Significant	Assumption or
	Value		Technique	Unobservable Inputs	Input Ranges
Passport contingent consideration	$	5,600	Real options approach	Risk-adjusted recurring revenue CAGR	103.9	%	⁽¹⁾
				Discount rate	5.5% - 6.5%

New Century Health contingent consideration	$	3,200	Real options approach	Risk-neutral probability exceeds threshold	39.0	%	⁽³⁾
				Risk-neutral probability meets earn-out cap	24.0	%	⁽³⁾


⁽¹⁾	The risk-adjusted recurring revenue CAGR is calculated over the five-year period 2017-2021. Given that there was no recurring revenue in 2016 and 2017, the calculation of the 2017 and 2018 growth rates is based on theoretical 2016 and 2017 recurring revenue of $1.0 million, resulting in a higher growth rate.


⁽²⁾	Equity volatility based on Evolent’s daily stock price returns for a look-back period corresponding to the time until the Second Test Date. The large one-day stock price drop on November 27, 2019, was excluded from the volatility calculation. The contingent liability expires on June 30, 2020.

⁽³⁾

These amounts represent 1) the probability that New Century Health will achieve at least the minimum level of operating results in 2019 to earn any contingent consideration (39.0%) and 2) the probability that New Century Health will achieve 2019 operating results in excess of the maximum amount of contingent consideration payable (24.0%). The risk-neutral probability rates were determined by projecting theoretical 2019 operating results using a simulation with one-million trials.

Nonrecurring Fair Value Measurements

In addition to the assets and liabilities that are recorded at fair value on a recurring basis, the Company records certain assets and liabilities at fair value on a nonrecurring basis as required by GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges. This includes assets and liabilities recorded in business combinations or asset acquisitions, goodwill, intangible assets, property, plant and equipment, held-to-maturity investments and equity method investments. While not carried at fair value on a recurring basis, these items are continually monitored for indicators of impairment that would indicate current carrying value is greater than fair value. In those situations, the assets are considered impaired and written down to current fair value.

Other Fair Value Disclosures

The carrying amounts of cash and cash equivalents (those not held in a money market fund), restricted cash, receivables, prepaid expenses, accounts payable, accrued liabilities and accrued compensation approximate their fair values because of the relatively short-term maturities of these items and financial instruments.

See Note 8 for information regarding the fair value of the 2025 Notes and 2021 Notes.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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