Evolent Health, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Evolent provides technology, administration and advisory services to health-system and physician partners transitioning to value-based care. It reports as one operating segment.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Revenue | $107.1 million | $56.5 million | $213.3 million | $106.0 million |
| Operating income (loss) | $(19.1) million | $(12.6) million | $(40.6) million | $(187.7) million |
| Net income (loss) | $(19.7) million | $(12.0) million | $(42.8) million | $(185.8) million |
| Net loss attributable to Evolent Health, Inc. | $(16.9) million | $(8.4) million | $(34.9) million | $(131.1) million |
| Loss per share, basic and diluted | $(0.28) | $(0.20) | $(0.62) | $(3.09) |
Platform and operations revenue was $101.7 million in Q2, up 120.5%, while transformation revenue was $5.4 million, down 48.4%. For the first half, platform and operations revenue rose 126.0% to $197.7 million and transformation revenue fell 15.7% to $15.6 million. Management attributed platform growth principally to acquisitions and a 98.2% increase in lives on the platform, from about 1.4 million to 2.8 million; revenue-producing partners increased from 13 to more than 25.
Q2 cost of revenue was 63.5% of revenue, versus 58.0% a year earlier; reported gross margin was therefore approximately 36.5%, versus 42.0%. First-half cost of revenue was 63.5% of revenue, versus 57.9% (gross margin approximately 36.5% versus 42.1%). Management said integration costs pressured cost of revenue and expected it to decline as a share of revenue over time. SG&A was 47.7% of Q2 revenue and 49.1% for the first half; management expects SG&A to decline as a share of revenue over the long term.
The prior-year first-half operating and net losses included a $160.6 million goodwill impairment. Thus, the much smaller 2017 first-half loss does not by itself indicate improved underlying operating performance: excluding that prior-year impairment, 2016 operating loss was approximately $27.1 million, compared with $40.6 million in 2017.
Cash and cash equivalents were $100.0 million at June 30, 2017, down from $134.6 million at year-end. First-half operating cash use was $44.7 million, compared with $21.9 million a year earlier; investing activities provided $7.7 million and financing activities provided $2.4 million. Restricted cash and investments were $22.1 million, and investments were $24.0 million. Management stated that available cash, short-term investments and other liquidity sources were sufficient for the next 12 months; the filing also notes continued losses and possible need for additional capital.
Current assets were $192.6 million and current liabilities $101.8 million. Long-term debt, net of discount, was $120.9 million; the $125.0 million principal amount of 2.00% convertible notes is due December 2021. The notes’ reported fair value was $162.2 million. Goodwill was $628.7 million and net intangible assets were $254.5 million.
Material changes and notable items
- Growth reflects, in part, the 2016 Valence Health and Aldera acquisitions, alongside increased platform enrollment. Acquisitions and integration contributed to higher operating costs, amortization and transaction expenses.
- Three secondary offerings and related Class B exchanges increased Evolent’s economic ownership of Evolent Health LLC from 77.4% to 96.1%. The secondary sales generated no proceeds for the company; the exchanges increased Class A shares and reduced non-controlling interests.
- In June, Evolent acquired Accordion Health for $3.2 million, recording a $3.3 million technology intangible asset, and may owe an additional $0.8 million earn-out if development targets are met.
- The company recorded a $0.2 million first-half loss from remeasuring Passport contingent consideration. A lease termination agreement for former Valence Health space is effective September 2017; remaining estimated cash outflows were $4.8 million at quarter-end.
Outlook, risks and controls
No quantified revenue, earnings or cash-flow guidance is provided. Management expects continued investment in partner success, geographic expansion and capabilities; it cautioned that losses may continue and profitability depends on revenue growth and cost management. It expects depreciation and amortization to rise as software development is capitalized and acquired intangibles are amortized.
Key disclosed risks include uncertainty in health-care regulation and policy, partner concentration and contract renegotiations or termination, dependence on partner enrollment and government-funded programs, risk-sharing arrangements, acquisition integration, competition, data privacy and security, and the ability to fund ongoing losses. The two largest partners accounted for 29.0% of first-half revenue. Evolent reported no legal matters expected to have a material adverse effect.
Disclosure controls and procedures were deemed ineffective as of June 30, 2017, due to the previously identified material weakness involving insufficient accounting resources and expertise for complex, non-routine transactions. Management reported remediation work and control testing in progress; the weakness was not yet considered remediated. The company also reported a full valuation allowance against most net deferred tax assets. Its tax receivables agreement generally requires payment of 85% of realized tax benefits to specified investors; no liability was recorded at quarter-end.
Important facts for investors to verify
- Whether platform enrollment and acquisition-driven revenue growth translate into improved margins and lower operating cash use.
- Cash runway and capital needs, considering the $44.7 million first-half operating cash outflow and ongoing losses.
- Partner contract renewals, renegotiations, concentration and exposure to changes in Medicaid, Medicare and other health-care policies.
- Integration progress and realized benefits from Valence Health, Aldera and Accordion, including remaining acquisition-related costs and earn-outs.
- Remediation and independent testing of the material weakness before the company’s applicable public-company control deadlines.
- Potential dilution and economic effects from Class B exchanges, convertible notes and future tax receivables agreement payments.