Evolent Health, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Amounts below are in U.S. dollars; financial statement amounts are shown in millions unless stated otherwise.
Business context and financial performance
Evolent provides technology, administration and related services to health-system and physician partners moving toward value-based care. Revenue comes from transformation services and platform and operations services. The company reported one operating segment and operates in the United States.
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $107.9 | $60.2 | $321.2 | $166.2 |
| Operating loss | $(14.0) | $(15.8) | $(54.6) | $(203.5) |
| Net loss | $(13.1) | $(15.8) | $(56.0) | $(201.6) |
| Net loss attributable to Evolent Health, Inc. | $(12.6) | $(11.2) | $(47.5) | $(142.3) |
| Loss per common share | $(0.18) | $(0.26) | $(0.78) | $(3.34) |
- Q3 revenue rose 79.2%; nine-month revenue rose 93.3%. Platform and operations revenue grew 90.1% in Q3 and 112.6% year to date, supported by acquisitions and an 84.7% increase in platform lives, from about 1.5 million to 2.7 million. The company had over 25 revenue-producing partners, compared with 13 a year earlier.
- Transformation revenue increased 5.8% in Q3 but declined 9.4% for the nine-month period. Platform and operations accounted for 92.4% of Q3 revenue, versus 87.1% a year earlier.
- Cost of revenue increased faster than Q3 revenue and rose to 63.3% of revenue from 56.3%; for nine months it was 63.4%, versus 57.3%. Management attributed the increase to growth and integration of recently acquired businesses, and expected this ratio to decline going forward.
- SG&A rose 19.4% in Q3 and 45.9% for nine months, but declined as a share of revenue: 42.5% versus 63.8% in Q3 and 46.8% versus 62.0% year to date. Management expected SG&A to decline as a percentage of revenue over the long term.
- Operating loss improved year over year, particularly for the nine-month period, which included a $160.6 million goodwill impairment in 2016 and none in 2017. The company nevertheless remained loss-making.
Cash flow, balance sheet and debt
- At September 30, cash and cash equivalents were $287.1 million, compared with $134.6 million at December 31, 2016. Restricted cash and investments totaled $16.9 million. Management said available liquidity was sufficient for at least the next 12 months.
- For the first nine months, operating cash outflow was $34.0 million, versus $14.0 million in 2016. Investing activities provided $17.0 million, principally reflecting $44.2 million of investment maturities, partly offset by $21.3 million of property and equipment purchases. Financing provided $169.6 million, primarily from the August primary stock offering.
- Long-term debt had a $125.0 million principal balance and $121.2 million net carrying value. The 2.00% convertible notes mature in 2021; their reported fair value was $142.4 million at September 29, 2017.
- Total assets were $1.299 billion, including $628.3 million of goodwill. Current assets were $352.3 million and current liabilities $105.5 million.
Material changes, outlook and notable items
- Equity financing and ownership: The August 2017 primary offering raised $166.9 million net. Secondary offerings included exchanges of Class B interests that increased Evolent’s economic ownership of Evolent Health LLC from 77.4% at year-end 2016 to 96.6% at September 30, 2017. The secondary sales themselves generated no proceeds for the company.
- Transactions: Evolent agreed to acquire commercial-business assets from New Mexico Health Connections for about $10.3 million, subject to closing conditions. After quarter-end, it agreed to acquire Premier Health Plan for about $31 million, subject to regulatory and other conditions. Also after quarter-end, it provided a customer a $20 million implementation loan at 2.5%, repayable in ten equal installments during 2018.
- Goodwill and amortization: No interim goodwill impairment trigger was identified through September 30, but management said post-quarter share-price levels, if sustained, could trigger testing and a potentially material impairment. Effective September 1, the estimated useful lives of internal-use software and technology intangibles were shortened to five years, increasing Q3 net loss by approximately $0.2 million and $0.3 million, respectively.
- One-time lease item: Evolent paid $4.4 million to cancel a Chicago lease acquired with Valence Health; no related abandonment liability remained at quarter-end. The 2017 nine-month results also included a $0.5 million reduction in rent expense from a lease-liability adjustment.
- Controls and reporting: Management concluded disclosure controls were not effective at quarter-end because of an unremediated material weakness involving accounting resources and complex, non-routine transactions. The company corrected an immaterial cash-flow classification error in its prior-period presentation; it said remediation and effectiveness testing were ongoing.
- Other risks: Revenue is concentrated among a small number of partners: the two largest contributed 28.5% of nine-month revenue. Contracts may be terminable or renegotiated. The company cited healthcare regulatory uncertainty, acquisition integration, growth execution, funding needs and its continuing operating losses among relevant risks.
- Outlook: The filing gives no quantified financial guidance. Management expected depreciation and amortization to increase as software investment and acquired intangibles are amortized, while expecting cost of revenue and SG&A ratios to improve over time. It also said losses could continue for the foreseeable future.
Most important facts for investors to verify
- Whether revenue growth and enrollment gains translate into improving operating margins and lower operating cash burn.
- Whether customer concentration, partner contract renewals and shared-risk arrangements create material revenue or loss exposure.
- Whether goodwill testing results in an impairment, particularly given the company’s $628.3 million goodwill balance and post-quarter share-price risk.
- Whether the material weakness is remediated and controls operate effectively; review the corrected cash-flow presentation in subsequent filings.
- Whether the NMHC and Premier transactions close as expected, and how the $20 million implementation loan is repaid.
- The terms and potential dilution of the convertible notes, future share exchanges and any obligations under the tax receivables agreement.