Evolent Health, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Unless otherwise noted, amounts are in U.S. dollars. Evolent provides technology, administration, analytics and related services to health-system and physician partners transitioning to value-based care. Results include the 2016 acquisitions of Valence Health and Aldera; year-over-year comparisons are therefore affected by acquired operations.
Financial performance and position
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Revenue | $106.2 million | $49.4 million |
| Operating income (loss) | $(21.5) million | $(175.1) million |
| Net income (loss) | $(23.1) million | $(173.8) million |
| Net loss attributable to Evolent Health, Inc. | $(18.0) million | $(122.7) million |
| Operating cash flow | $(34.8) million | $(20.8) million |
| Capital expenditures | $6.0 million | $3.4 million |
- Revenue increased 114.8%. Platform and operations revenue rose 132.3% to $96.0 million; transformation revenue increased 26.1% to $10.2 million. Management attributed platform growth mainly to acquisitions and a 124% increase in platform lives, from approximately 1.2 million to 2.8 million. The company reported more than 25 revenue-producing partners, compared with 12 a year earlier.
- Cost of revenue was 63.6% of revenue, versus 57.9%; SG&A was 50.4%, versus 64.6%. The operating loss was 20.2% of revenue in 2017. The prior-year operating loss included a $160.6 million goodwill impairment; excluding that charge, the prior-year operating loss was approximately $14.5 million.
- Cash and cash equivalents were $104.3 million at quarter-end, down from $134.6 million at December 31, 2016. Investments were $33.7 million and restricted cash and investments totaled $31.9 million. Current assets were $217.5 million and current liabilities $104.4 million.
- Long-term debt had a $120.7 million carrying value and $125.0 million principal balance. The 2.00% convertible notes mature in 2021; their reported fair value was $150.8 million at March 31, 2017.
- Management said available cash, short-term investments and other liquidity sources should meet working-capital and capital-expenditure needs for the next 12 months. This is not a projection of profitability: the company has incurred operating losses since inception and reported a $34.8 million operating cash outflow in the quarter.
Material changes and notable items
- The revenue increase and higher operating costs reflect, in part, the Valence Health and Aldera acquisitions completed in 2016. Management cited integration and growth-related spending; it expects cost of revenue to decline as a percentage of revenue going forward, while SG&A may decline as a percentage over the longer term. No quantified guidance was provided.
- Operating cash use increased year over year. Management cited annual bonus payments, customer and vendor payment timing, PBM-related pass-through payments, higher receivables, and decreases in accrued liabilities and compensation. Investment maturities partly offset capital spending in investing cash flows.
- A March 2017 secondary offering sold 7.5 million shares for selling stockholders; Evolent received no proceeds. Class B exchanges increased Evolent’s economic ownership of Evolent Health LLC from 77.4% to 83.9% at quarter-end. Following the underwriters’ additional-share option, which closed May 1, ownership rose to 84.9%; Evolent again received no proceeds.
- No goodwill impairment was recorded in Q1 2017, and management reported no interim indicators requiring an impairment test. Goodwill was $627.2 million. The company adopted a simplified one-step goodwill impairment method in 2017.
- The filing reports no legal proceedings or claims that management believed would have a material adverse effect. The company had $8.3 million of Passport contingent consideration recorded as a liability. It had not recorded a Tax Receivables Agreement liability because relevant tax benefits had not been realized.
Risks, controls and outlook
- Revenue is concentrated: two partners contributed 28.3% in aggregate in Q1 2017. Contracts may be terminable under specified conditions, and partner growth and healthcare-cost performance are outside Evolent’s full control.
- Management identified healthcare-market and regulatory uncertainty, acquisition integration and execution, continued losses and cash use, financing needs, indebtedness, and the ability to achieve profitability as risks. The company also noted that it may need additional capital, which may not be available on favorable terms or at all.
- Disclosure controls and procedures were deemed ineffective at March 31, 2017 because of a material weakness involving insufficient accounting resources and expertise for complex, non-routine transactions. Remediation was ongoing; management said the weakness would not be considered remediated until controls had operated effectively for a sufficient period and been tested.
- Management expects continued investment in partner support, geographic expansion and capabilities. It did not provide numerical revenue, earnings or cash-flow guidance in the supplied filing text.
Important facts for investors to verify
- How much of reported growth reflects acquired businesses versus organic growth, and whether management’s expected improvement in cost ratios materializes.
- Cash burn, working-capital timing and the adequacy of liquidity relative to ongoing losses and planned investment.
- Partner concentration, contract renewal and termination terms, and the sustainability of lives and revenue on the platform.
- Progress in integrating Valence Health and Aldera, and the carrying value and impairment sensitivity of goodwill and intangible assets.
- Remediation and testing of the material weakness in internal controls, plus potential dilution and ownership changes from convertible notes and further Class B exchanges.