Evolent Health, Inc. quarterly report, Q2 FY2016

Evolent Health, Inc. — Q2 2016 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2016. Evolent provides technology and managed services supporting health systems and physician groups transitioning to value-based care. The company operates through Evolent Health LLC, in which it held 70.9% of the economic interest and 100% of voting rights at quarter-end.

Financial performance and position

Metric	Q2 2016	Six months 2016
Revenue	$56.5 million	$106.0 million
Operating loss	$12.6 million	$188.2 million
Net loss	$12.0 million	$186.3 million
Net loss attributable to Evolent Health, Inc.	$8.4 million	$131.5 million
Net loss per share, basic and diluted	$0.20	$3.10
Operating cash flow	Not separately provided for the quarter	$(21.9) million

Q2 revenue consisted of $10.4 million in transformation services and $46.1 million in platform and operations. For the first half, those categories contributed $18.5 million and $87.5 million, respectively.
First-half operating loss included a $160.6 million goodwill impairment recorded in Q1. Excluding that charge, reported operating loss was $27.6 million; management’s non-GAAP adjusted operating loss was $17.5 million for the first half and $7.5 million for Q2.
Management’s adjusted revenue was $56.5 million for Q2, up 55.0% from adjusted Q2 2015 revenue of $36.5 million. First-half adjusted revenue was $106.1 million, up 44.3% from $73.5 million. These non-GAAP comparisons adjust for the 2015 reorganization and are more comparable than reported GAAP year-over-year figures.
Adjusted platform and operations revenue rose 64.7% in Q2 and 60.0% for the first half year over year. Management attributed growth primarily to platform enrollment increasing 134.8%, from approximately 0.6 million to 1.4 million lives, and to having 13 partners in the platform and operations phase versus 10 a year earlier.
For Q2, adjusted cost of revenue was 56.9% of adjusted revenue, compared with 68.4% in the adjusted prior-year comparison. Adjusted SG&A was 50.0% of adjusted revenue, versus 59.7%. Management attributed the cost improvement primarily to scale with existing clients.
At June 30, cash and cash equivalents were $105.1 million; restricted cash, $3.8 million; and investments, $51.8 million. Current assets were $170.6 million and current liabilities $56.7 million. The company reported no outstanding debt.
Total assets were $852.8 million, including $459.7 million of goodwill and $165.4 million of net intangible assets. Total equity was $768.1 million.

Changes, outlook, risks, and unusual items

The 2015 reported comparison is not representative of a full operating period: Evolent consolidated Evolent Health LLC only after the June 2015 reorganization. The 2015 GAAP results also included a $414.1 million non-cash gain on consolidation. Management cautions that reported GAAP year-over-year comparisons are not meaningful; its adjusted measures are non-GAAP.
Cash and cash equivalents declined from $145.7 million at year-end 2015 to $105.1 million at June 30, 2016. First-half investing cash outflow was $18.5 million, including acquisition and investment spending and $7.3 million of property and equipment purchases.
Management said available cash, short-term investments, and other liquidity sources were sufficient for the next 12 months. It expects operating losses to continue for the foreseeable future, plans continued investment in growth, and may need additional capital. It gave no specific revenue or earnings guidance.
On July 12, 2016, Evolent agreed to acquire the majority of Valence Health for estimated consideration of $142.8–$144.1 million, including $35–$44 million cash and 5.3–5.8 million shares, plus a possible stock earn-out of up to $50 million. The deal remained subject to closing conditions and was expected to close before November 10, 2016; cash consideration was expected to be funded from cash on hand.
In February, Evolent entered a 10-year service arrangement with Passport Health Plan and issued 1.1 million shares for acquired capabilities and assets. Up to $10 million of additional equity consideration may be earned if new third-party Medicaid business is obtained. Passport contributed $9.7 million of Q2 revenue and $16.1 million for the first half.
Goodwill impairment followed a sustained share-price decline. The company warned that further impairment could be material. Revenue is concentrated: its three largest partners represented 47.2% of first-half revenue. Variable fees depend in part on partner enrollment, performance, payer programs, and reimbursement and funding levels.
Disclosure controls and procedures were deemed ineffective at quarter-end because of an unresolved material weakness in the financial statement close process, related to resources and expertise for complex, non-routine accounting. Management described ongoing remediation and additional review procedures.
The company reported no material litigation accruals and no off-balance-sheet arrangements other than operating leases. It reported $19.6 million of operating lease and purchase obligations, including $6.2 million due within one year.

Key investor verification points

Track adjusted revenue growth, enrollment, partner additions, margins, and the conversion of growth into operating cash flow; assess management’s non-GAAP adjustments alongside GAAP results.
Verify completion, financing impact, integration progress, and realized benefits of the Valence Health acquisition, including final consideration and any earn-out.
Monitor cash burn, available liquidity, and any need for additional financing as the company continues to report operating losses.
Assess partner concentration and exposure to changes in member enrollment, government reimbursement, payer programs, and partner health-plan economics.
Follow goodwill valuation and any further impairment indicators, as well as remediation of the material weakness and improvement in disclosure controls.
Evaluate potential share dilution from the Valence transaction, Class B unit exchanges, and shares registered for resale.