Evolent Health Inc (EVH) 2016 Q2 法說會逐字稿

Welcome to Evolent Health's earnings conference call for the quarter ended June 30, 2016. As a reminder, this conference call is being recorded. Your host for the call today is Mr. Frank Williams, Chief Executive Officer of Evolent Health. This call will be archived and available beginning later this evening for the next 90 days via the webcast on the Company's website in the section entitled Investor Relations.

Here are some important introductory information. This call contains forward-looking statements under the US federal securities laws. These statements are subject to risks and uncertainties that could cause actual results to differ materially from historical experience or present expectations. A description of some of the risks and uncertainties can be found in the reports that are filed with the Securities and Exchange Commission, including cautionary statements included in the current and periodic filings. For additional information on the Company's results and outlook, please refer to its second quarter news release. As a reminder, the financial statements of Evolent Health, Inc. for the three months ended June 30, 2015 do not reflect a complete view of the operational results for those periods due to the reorganization completed in connection with our initial public offering in June 2015. Prior to the reorganization, Evolent Health, Inc. had no operations and accounted for Evolent Health LLC as an equity method investment. In order to provide consistent and comparable metrics for the periods before and after June 4, 2015, the adjusted results of Evolent Health, Inc. presented and discussed in our press release and during this call reflect the reorganization as if it had occurred on January 1, 2015 and therefore include the results of Evolent Health LLC for the entire three and six months ended June 30, 2015, and other adjustments. Reconciliations of adjusted results to GAAP results are available in the press release and the 8-K we filed earlier today. At this time, I will turn the call over to the Company's chief executive officer, Mr. Frank Williams. Please go ahead, sir.

Thank you, and good evening. I'm Frank Williams, Chief Executive Officer of Evolent Health, and I'm joined by Nicky McGrane, our Chief Financial Officer. I'll open the call today with a summary of our performance for the quarter and our overall perspective on the market and pipeline. I'll then hand it over to Nicky to take us through a detailed review of our second quarter results. I'll then close with some additional detail on our product development and organizational focus. As always, we'll be happy to take questions at the end of the call.

For our financial perspective, our total adjusted revenue for the quarter ended June 30, 2016, increased 55% to $56.5 million compared to adjusted revenue of $36.5 million for the quarter ended June 30, 2015. Adjusted EBITDA for the quarter ended June 30, 2016 was negative $3.9 million compared to adjusted EBITDA of negative $10.2 million for the quarter ended June 30, 2015. We now have approximately 1.4 million total lives on the platform as of June 30, 2016, an increase of 135% year-over-year. We are pleased with our results for the quarter and continue to see growth within our existing client base, as well as a number of high-quality prospects in our current pipeline.

Overall, market forces continue to move at a steady pace as governmental and commercial payers continue to look for value-based solutions. We see this particularly with government programs, like Medicare and Medicaid, as well as employers and commercial payers who are seeking high value, high performance networks.

In terms of growth, you will remember our two primary sources -- growth from our existing partners and new business development. Our partners continue to pursue opportunities with us to increase lives on the platform and expand our scope of services to support their business objectives. To that end, we recently enhanced our service offering with an existing partner to provide support in risk adjustment, additional resources in care management, and comprehensive support in ensuring additional lives under Medicare value-based contracts. Across our customer base, we added 147,000 lives on a variety of existing and new populations in the second quarter alone. Expanding the number of lives in value-based arrangements helps our clients to achieve scale economies and drive meaningful behavior change across their respective organizations while also enhancing Evolent's return on investment in a local market.

On the new business side, we're pleased to announce our third definitive agreement this year with St. Luke's Health Partners, the risk-bearing entity of St. Luke's Health System based on Boise, Idaho. St. Luke's has a strong clinical reputation and with more than $1.7 billion in revenue, seven hospitals, 150 clinics, and 2,100 physician partners, it is a leading innovator across the entire state of Idaho. Our long-term operating partnership is expected to add more than 150,000 lives to the identified platform initially, which we expect will grow over time as opportunities to pursue additional populations emerge. In the near term, the focus of the partnership will be on laying the groundwork for measurable clinical outcomes through the implementation of Identifi and our suite of clinical programs, while also working collaboratively to engage physicians and their care teams in an enhanced important approach to population health management.

In the market more broadly, we also continue to garner interest from a number of health systems and independent physician groups that need support in evaluating their readiness to take on risk-based contracts which drives demand for our transformation services. We continue to see consistent interest across the country from a number of prospects that are actively engaged in early implementation work at this time of year preparing for January 2017, as well as 2018 launches.

At this point in the year, we feel good about our current pipeline and believe we are well positioned as we enter the second half of the year with high visibility into our transformation revenues, existing partner growth, and the potential for new long-term partnerships. As a result of our financial and operational performance year-to-date, we are raising our guidance, which Nicky will speak to momentarily.

Turning for a moment to Evolent's position in the large emerging market for value-based care technology and services, we are excited about our recent announcement to acquire Valence Health and believe it strengthens our offering and differentiation in the marketplace. The rationale for the strategic combination is pretty straightforward and based on four key principles. First, we believe it will strengthen our operational capabilities and expertise, particularly in the Medicaid and pediatric space. Second, it will improve our ability to scale through a combination of greater efficiency in operations, and a larger base of revenue to spread our upfront investment in the national support platform. Third, it will continue to diversify our customer base by adding 10 long-term partners to our network, and more than 90 healthcare organizations that have a relationship with Valence today. And lastly and specifically, we expect it will accelerate our path to adjusted EBITDA break-even by one to two quarters next year, which will allow us to meet an important financial objective for the business.

One of the reasons we're excited about bringing the organizations together is the inherent benefit of broadening and deepening our provider-centric, clinically oriented platform across all lines of business in all types of patient populations. We foresee immediate benefit in the richness of the data collection methodology, the sophistication of the analytics we can deploy, the robustness of our approach to physician engagement, and the depth of our clinical programs in driving improved health outcomes. Clinical value is ultimately what the market is asking for and what enables our partners to win in their local markets. What makes the Evolent model attractive to partners is that we bring a foundation of operational experience in leading technology that we're constantly refining as we analyze what works and what does not at a rigorous level to drive continue performance improvement.

What we've learned so far from our investment in Identifi and the development of a sophisticated clinical is that there are four ingredients that any health system or physician group must have in place in order to create and sustain measurable success. First, you need a combination of clinical data, administrative data, and other personal health data that are integrated in clinically relevant constructs to give you a full view of the patient so you can identify the right intervention. To give you a sense for what we've accomplished in this realm, Identifi is connected to more than 35 payer and administrative systems and just 17 datatypes and can interface with a variety of inpatient and physician practice EMRs.

Second, to be successful, you need sophisticated machine learning techniques that accurately predict potential adverse outcomes for individual patients so you can focus on high yield interventions. In this regard, Identifi churns through over 1,400 clinical rules that comprise our rules engine. We have a feedback loop for testing and proving how those rules are working that we iterate over time. This means the platform is learning as we take in more data from our growing customer base.

The third ingredient you need for sustained success is a high-performing network of physicians who are supported by a broad and integrated care team, and we're onboard to quarterback the care delivery process as well as the process for measuring success. Accordingly, we have developed an approach to physician engagement that includes developing the right governance structure, ongoing training and education, physician-led care program development, and data-driven performance management.

Lastly, the fourth ingredient you must have is well-developed programs with infrastructure to effectively implement them. Identifi not only embeds the care program into workflow, it allows physicians, care teams and administrators to monitor all the follow-up steps for every patient. This is hugely valuable when attempting to manage care across disparate geographies, networks and populations. We've gone through 19 EMR integration efforts to date to support physician workflow, and that becomes more scalable and replicable with each implementation.

Overall, our ongoing investment in making the platform and program smarter and more effective is paying off, literally and figuratively. Earlier this year we were recognized by the Care Innovations Validation Institute, a third-party organization comprised of statistical and population health experts who independently validate the integrity and performance of companies who provide population health services. The institute, as well as Al Lewis, who many in the industry consider to be the leading authority on population health, and the greatest critic of case study methodologies, has said that our approach to analyzing clinical programs, improving results is among the best they've seen.

When we're in conversations out in the market, our goal is to help providers to step back, to look at the rigor of our case studies, how they tie to Identifi, and how that relates to financial and clinical results. When we tell that story effectively, providers begin to understand what an extensive investment they would need to make on their own in order to achieve this same level of success in risk arrangements. It is these proven methodologies and replicable experience that continue to attract innovative health systems to Evolent. We don't believe there is anyone in the industry with as comprehensive of an offering around driving clinical performance improvement that is also willing to commit to clinical and financial outcomes. As a result, our initial vision of leading health systems coming together in a national network is becoming a reality.

Since the start of 2016, we have added more than 677,000 lives, signed three new health system partners, and have announced our plan to expand our footprint and advance the comprehensiveness of our platform with a pending combination with Valence Health. With all of these market forces in action, we remain focused on driving strong execution and delivering value to our partners as the key tenets to driving strong, long-term financial performance. With that, let me turn it over to our chief financial officer, Nicky McGrane, to walk you through the financial details of performance in the second quarter.

Thanks, Frank, and good evening, everyone. Today I will cover our financial results for the second quarter and our outlook for the third quarter and the remainder of 2016. We continue to drive strong results in the second quarter including adjusted revenue growth of 55% over the same quarter in the prior year. Additionally, we continue the momentum in leveraging the investments we have made to capitalize on the long-term opportunities we see ahead.

Overall, our second quarter adjusted results exceeded our expectations. Adjusted revenue increased 55% to $56.5 million, up from $36.5 million in the same period of the prior year. Adjusted EBITDA for the quarter was negative $3.9 million, up from negative $10.2 million in the prior year, and adjusted loss available for common shareholders was negative $7.2 million, or negative $0.12 per share for the quarter, compared to negative $13.3 million, or negative $0.36 per share in the same period of the prior year. The reconciliations of our GAAP results to adjusted results are available in the press release in the 8-K that was filed earlier today.

As a reminder, we derive our revenue from two sources -- transformation and platform and operation services. Adjusted transformation revenue accounted for $10.4 million, or 18.4% of our total adjusted revenue for the second quarter, representing an increase of $1.9 million, or 23% compared to the same quarter last year. We continue to see strong demand for transformation services. In addition, we had a handful of contracts that were completed in the second quarter ahead of expectations. As we have noted in the past, transformation revenue can fluctuate from quarter-to-quarter based on the timing of when contracts are executed with new and existing partners, the scope of delivery, and the timing of work being performed.

Adjusted platform and operations revenue accounted for $46.1 million, or 81.6% of our total adjusted revenue for the second quarter, representing an increase of $18.1 million, or 64.7% compared to the same quarter last year. The increase was driven primarily by a 134.8% increase in the number of lives in our platform, from approximately 600,000 as of June 30, 2015, to almost 1.4 million as of June 30, 2016, resulting from our increased partner count as well as growth in our existing markets. Our average PMPM fee for the quarter was $11.64 compared to $17.41 in the same period of the prior year. We ended the quarter with 13 P&O partners and, as Frank mentioned, added one additional partner after the close of the quarter, St. Luke's Health Partners, bringing the current count to 14.

Adjusted cost of revenue increased to $32.1 million, or 56.9% of adjusted revenue for the second quarter compared to $24.9 million or 68.4% of adjusted revenue in the same quarter of the prior year. The increase in expense year-over-year was primarily related to additional personnel costs and third-party support services. The decrease in adjusted cost of revenues as a percentage of adjusted revenue period-over-period illustrates the scale we are driving in the business.

Adjusted selling, general and administrative expenses increased to $28.3 million, or 50% of adjusted revenue for the second quarter compared to $21.8 million, or 59.7% of adjusted revenue in the same quarter of the prior year. Additional expenses incurred with SG&A have been focused on those areas we expect will ultimately drive our long-term growth, specifically in our business development and marketing efforts, as well as our Identifi platform development.

On a percentage basis, adjusted SG&A for the quarter grew 29.8% over the second quarter of last year. This is the fourth consecutive quarter where SG&A as a percentage of adjusted revenues has declined versus the same metric in the prior year, and reflects the fact that the majority of our investments are now in place. We continue to expect total adjusted SG&A expenses to decrease as a percentage of our total adjusted revenue over time. Combined, our total adjusted cost of revenue and adjusted SG&A expenses as a percentage of total adjusted revenue declined to 106.9% in the second quarter of 2016 compared to 128.1% in the same quarter of the prior year.

Adjusted depreciation and amortization expenses in the quarter were $3.6 million, or 6.4% of adjusted revenue compared to $2.1 million, or 5.9% of adjusted revenue in the same quarter of the prior year. The increase was primarily due to $2.5 million in amortization of intangible assets recorded as a result of our offering reorganization. We expect adjusted depreciation and amortization expense to increase in future periods as additional software assets are placed in service.

As of August 2, 2016, there were 42.6 million shares of our Class A common stock outstanding, and 17.5 million shares of our Class B common stock outstanding. Our balance sheet remains strong with $156.9 million of combined cash, cash equivalents and investments as of June 30, 2016.

Looking at cash flow, cash used in operations was $1.1 million, and cash used in investing activities was $4.8 million for the quarter ended June 30, 2016, and we had no material financing activities during the quarter.

Finally, with respect to guidance, the following comments are intended to fall under the Safe Harbor provisions outlined at the beginning of the call and are based on preliminary assumptions, which are subject to change over time. For the third quarter we are forecasting adjusted revenue to be in the range of approximately $58 million to $59 million, and adjusted EBITDA to be in the range of approximately negative $5 million to negative $4 million. We are increasing our full-year guidance with adjusted revenue in the range of approximately $224 million to $226 million, and adjusted EBITDA in the range of approximately negative $21 million to negative $19 million. The measures discussed here do not take into account any potential impact as a result of our pending acquisition of Valence Health. With respect to Valence Health, if the transaction were to close such that the results of Valence were to be included in our full fourth quarter results, we expect that it would add approximately $20 million in revenue for the quarter and increase our projected adjusted EBITDA loss. However, we expect to reach adjusted EBITDA break-even one or two quarters earlier than originally projected due to the additional growth expected from Valence in 2017, and synergies from the combination.

In summary, we entered the second half of the year with a solid financial and market position, and we remain focused on delivering a successful year. The strength of our business not only reflects the results of the investments we've made in our product offering and teams, but more importantly, it allows us to continue on our path to drive long-term profitable growth to Evolent and our shareholders. This concludes the financial summary and I will now turn things back over to Frank.

Thanks, Nicky. I want to close with a few updates on our product development focus and organization overall. We spoke earlier about how our providers need to go from raw data all the way to reaching the physician and the patient across many population groups to achieve financial and clinical results. The investment we've made in Identifi integrates and brings those interactions together in a way that allows a health system to execute successfully across a very diverse patient population. The tool is SaaS-based with single sign-on capability. For physicians it pushes alerts into the EMR, pulls data from multiple sources, has applications for care management, utilization management, physician reporting, and a half-dozen other critical use cases. Ultimately, it serves as the control center for scaling clinical knowledge and interventions across the health system.

In addition to the need for an integrated technology platform and day-to-day operational know-how, we have also seen that health system leaders need support in understanding the implications of rapid changes in the healthcare policy landscape at the federal and state level. As a result, we've made a concerted effort to be the conduit between policymakers and healthcare delivery systems in assessing the implications of policy changes on an operational and financial performance as well as from a long-term strategic perspective.

Accordingly, we work with Capitol Hill to assess the reality of how policy might play out in the market so that policymakers can achieve their desired objectives. And we're also helping health system executives respond strategically and operationally to rapidly evolving market trends. The coming months are sure to present a litany of new implications for healthcare leaders with the proposed MACRA rule being finalized this fall, continued budget pressure on government healthcare spending, and the pending presidential election. This constant fluidity creates yet another example of the drivers of momentum in the market. Through our involvement in the Healthcare Transformation Task Force and the Department of Health and Human Services Learning Action Network, we are helping our customers understand the new regulations and implications of a variety of scenarios. Beyond our involvement in assessing these larger healthcare trends, we have also cultivated talent within our organization that brings deep industry and policy knowledge to assist our partners in near-term operational decision-making. We look forward to putting these emerging policy insights on display at our fall partner summit in Arizona in October, where we anticipate more than 150 leading CXOs from across the country in attendance to learn and share best practices in value-based care.

In closing, we are pleased with our results for the second quarter and remain confident about achieving our key strategic and financial objectives for calendar year 2016. The Evolent team is committed to being at the forefront of the transformation that is occurring in the healthcare marketplace and is collectively focused on delivering strong and consistent results for our partner organizations. Thank you again for participating in tonight's call, and now we'll be happy to take your questions.

Thank you, Mr. Williams. We are now open for your questions and answers. (Operator Instructions) And the first question will come from Robert Jones of Goldman Sachs. Please go ahead.

Frank, as we think about the mix of the significant wins you have had this year, or customers that you'll be serving as, you know, increasingly go forward, like Passport or some of Valence customers, you know, Georgia Physicians last quarter, St. Luke's this quarter. How should we be thinking about the PMPM trend? Is there any direction you can give us? Obviously, as the mix continually changes as you bring on new customers, anything you can point to from a PMPM and maybe when you would expect to hit a steady state or an equilibrium on that metric?

Hey, Bob, it's Nicky. I'll take that one. I would say overall as we look -- we've had the visibility into PMPM and we talked about the $10 to $12 range for a while. We came into that range in the second quarter here. As you know, we added over 500,000 lives in the first quarter and saw some of the impact of that in the second quarter. In terms of steady state, I would say we expect to be in this zone the remainder of this year. I think we'll have to revisit that when we look at 2017. When we think about the addition of Valence, I think we'll have to relook at that. But I would say the $10 to $12 range feels like a good outlook for the rest of this year, and so leave it at that, I would say.

Got it. And I guess just a bigger picture question as we think about CMS and they continue to implement new value-based models, like CJR and the two new cardiac bundle programs. I mean, has this accelerated the conversations that you're having with clients? And I guess maybe potential clients, I should say. And then I guess of existing clients, how are they approaching these new initiatives?

Yes, I would say the level of government activity has definitely pushed the market. We're seeing a number of systems stepping forward for lots of different reasons. Some interested in bundled programs, some interested in Track3 or next-generation ACO programs. Some are beginning to look at the new MACRA legislation and trying to figure out how do we actually help our physicians achieve their performance targets, and we really need to build this as a core competency. So, I would say the good news is there are a variety of factors, and what I love about that is it means there's a different angle into every conversation. We might find an organization that is really interested specifically in next-generation ACO; we might find another organization that, again, has a big Medicaid opportunity in their state, and so it gives us a lot to talk about, a lot to engage new organizations with. And then if you look at our growth across this year, we've seen a lot of it come from our existing clients that are selectively adding many of these programs and wanting to build scale in their core value-based business. So, all in all, it's good news for us. It gives us a lot to talk about, and that's driving both new business but also same-store growth.

Got it. Okay, that's so much.

The next question will come from Lisa Gill of JPMorgan. Please go ahead.

As we think about St. Luke's and 150,000, how do we think about, Nicky, as to how it will come on to the platform?

We wouldn't expect to see anything this year, Lisa, in terms of lives on the platform.

Okay. So, that's more of a 2017. And then, secondly, the recent shelfs that you filed, can you just give us some color around what your thoughts are there?

Yes, Lisa, this is Frank. I think this is normal course a year post-IPO. I think as you are aware, our major shareholders haven't sold any shares up to this point and naturally are going to be looking for some liquidity across time. They remain highly committed to our business and to the vision of what we're building, but this is a step in the process. And, again, I would imagine that they would be getting some liquidity over time.

Okay, that makes sense. And then I guess my last question just to be -- you know, you each kind of commented around leveraging some of the opportunities now that you're in with multiple different EMRs, can you just give us some indication as to how we start to think about how you leverage that knowledge base and start to leverage those costs?

Sure. If you think about one of the most difficult things in healthcare clinical work, it is really aggregating data from multiple sources. It takes a lot of work to work with the new EMR system, whether it's Cerner, Epic or Meditech or a number of different providers. You're also going to have that spread across a number of different physician organizations. So, you can imagine in our first implementation, we were building those connection points for the first time, right? So, it's new work, getting familiar with the systems. How do we pull data? How do we clean the data? Now that we've done that for several EMR systems, it makes it incredibly efficient as we work with a new client, again that has similar EMR systems that they're working with. So, it allows us to (1) implement much faster; (2) do it more rapidly; and (3) know that the quality of data that we're working with is going to have a lot of integrity and therefore can have an impact on our clinical programs almost immediately.

And so as we think about it from our side, at this point, EMR is working, I would assume, with all the major vendors and probably even some of the smaller vendors. So, you would have to assume that almost every implementation now you've worked with that vendor in the past. Am I thinking about that correctly?

It's probably not quite that extensive, but I think you're correct that most of the major vendors we have experience with. It is making sort of the quality speed of our implementations much better. There is still work to be done. We obviously have to work with individual practices. We have to map the data elements. Some organizations have data in different fields, etc., but you're absolutely right, that most of the time now we've seen the system, we've worked with it, and it makes it a lot easier in terms of generating quality data.

Okay, great. Thank you.

Our next question will come from Ryan Daniels of William Blair. Please go ahead.

Maybe two quick ones for Nicky. You mentioned first that the transformation revenue was a little bit greater in the quarter as some project completed. Should we therefore expect a bit of a sequential drop in that revenue stream in the back half of the year, or is there kind of outstanding demand that you can keep your capacity high and keep that level pretty consistent?

I would say, Ryan, we think about this more on an annual basis than quarterly, so if projects that we thought were going to spread out over the back half of the year completed earlier, I think there is some chance that you can see a bit of a sequential downdraft in the second half of the year. But we generally think about this, as we've talked about, as sort of a flat year-over-year business.

Okay, okay. No, that's helpful. And then given the PMPM expectations you've laid out, doing some quick math it looks like maybe there is another 150,000, 175,000 lives yet to come on the platform, so we should think about year-end maybe 1.5 million or a little bit above that. Is that a fair assumption?

Well, I'd remember, Ryan, there's two elements, right? We could have an organization take on additional services on lives that we're already serving, so that is a way to grow that doesn't necessarily correlate with increase in lives. As you suggested, we'll also probably see some additional contracts come on an expansion. So, we're not setting a specific target around lives, but feel very comfortable with the new guidance range that we laid out.

Okay. No, that's very fair. And then, Frank, maybe a bigger picture one for you. I'm curious, although it's still very nascent what the market response has been to the Valence announcement, meaning, have you had the opportunity to talk to your customers about some of the capabilities that that will afford you as a combined organization and vice-versa, and what's been the initial response, if so?

Yes. I mean, obviously we took the time to communicate with our current customers and a number of the prospects that we have in the pipeline. Valence has a great reputation. We were able to explain the rationale for coming together with them pretty clearly, and I think everyone we talked to felt it was a great decision, that it would enhance our service offering, that it continues to support our position as an organization with a leading platform that can delivery results for our customers. So, I would say universally it was well received because of the reputation they have in the market. And having heard from them and the discussions they had with their customers, I think it was well received on that end as well, and we made it clear that we're in the market for the long haul. We're continuing to invest and build out the platform that we feel we're in a very strong position together, and I think most everyone we talk to agreed with that conclusion.

Okay, perfect. Thanks for the color and congrats on the strong first half of the year.

The next question will come from Jamie Stockton of Wells Fargo. Please go ahead.

I guess maybe the first one, to follow-up on something Bob was asking about earlier, the bundled payment initiative, Frank, can you tell us whether you actually have these lives where you're getting paid to manage those today, or is this more just (inaudible)?

We have obviously programs today that apply to patients in bundled payment arrangements, so you obviously need to manage the continuum of care. There are a lot of transitions involved in those types of procedure areas, and our clinical model clearly applies to those. We also have the ability to support the administration of aspects of bundled payments. We do see it as an area of growth, although I would say if you look at our current customer base, the main focus has been on more delegated capitation or accessing lives through provider-sponsored health plans or participation in specific government programs. So, I wouldn't say bundles today are a big portion of our revenue base, but we do provide clinical support to those types of patients.

And if you look to the future, what we really promoted is one integrated platform to handle all of a systems value-based business. Because if you want to get to scale in efficiency, you don't want to have certain set of things for bundled payments, another thing for Medicare, another thing for Medicaid, because it will be inefficient and very difficult to manage. I think that integrated message has resonated really well in the market and obviously we are building out our platform not only to accommodate things like bundled payments, but Medicaid, Medicare, next-generation ACO programs, delegated risk arrangements with different quality metrics across different payers. You know, a centralized system to truly manage all of that efficiently, and that's really what we're trying to promote in the market.

Okay, that's great. Maybe just one more for you. It's obvious that CMS needs to be pushing the ball down the field when it comes to value-based care. I would be curious to hear what your thoughts are on kind of what the commercial carriers are doing with their kind of non-Medicare Advantage lives given all the distractions that are occurring right now as a result (inaudible). Have we seen the real inflection from them yet, a focus on value-based care, or do you feel it's more of a, you know, one or two years from now when the M&A environment cools down?

I would say the government really has been the leader in the market. If you look at their level of aggressiveness or the amount of business and payments that they want to move under value-based contracts, the mechanisms they are providing to support that, the willingness to share economically in a way that really incents providers to participate. I think if you look in both Medicare and even in Medicaid, that has really been the largest catalyst in the marketplace. In terms of commercial payers, I think you've seen a lot of activity. So, definitely promotion of narrow networks; you've seen ACO-shared savings arrangements. But in most cases I don't think we've seen aggressive delegation of risk and delegation of clinical functions to providers.

So, I would say, yes, there is activity there and the market is continuing to head in that direction as employers are asking for higher value alternatives, as employers are willing to trade off larger networks for lower cost, you know, narrower network offerings. That will continue to take hold, but I would agree that it's still in its nascent stages, so that's going to be another area of growth. Again, with cost pressure, the Cadillac tax, again which may be delayed but still has helped employers to begin rethinking their benefit structures and being more aggressively in managing costs, I think we'll see the commercial side pick up as the government continues to push very aggressively with the number of things that they're doing.

Okay. And maybe just a quick one, Nicky. I think your guidance implies that maybe the EBITDA possibly is a little higher sequentially. Maybe it's what Ryan asked earlier was the transformation, why it's coming down a little bit. But is there any other color [you can give on that]?

I would say it sort of implies it's pretty flat the back half of the year on an EBITDA basis overall. The only thing I would say is, yes, I think you touched on the transformation piece. And then we do generally see some hiring ahead of revenue in 2017. So, starting in the third quarter and the fourth quarter, we are sort of bringing some folks on ahead of that revenue, so you'll see some of that impact. That's probably the bigger thing in the back half of the year.

Okay. Thank you.

The next question will come from Charles Rhyee of Cowen and Company. Please go ahead.

As we look out to next year and we bring on Valence here, can you talk about what are the main kind of guideposts we should be thinking about? And I'm not really talking about guidance, per se; I'm thinking about what are the key sort of opportunities you're looking to go after as a combined entity and do you think are sort of the nearest sort of opportunities for you?

Well, as I think we've said from the very beginning, we have an aspiration to be the market leader in what we think is a very, very large emerging market. You can size it different ways, but we believe it's a $40 billion to $50 billion market. We believe that the combination with Valence will strengthen our service offerings. I think one of the first things we want to do is take advantage of that, make sure our teams are working together collaboratively, that we're best of breed in terms of our approach to analytics and clinical programs, that we're bringing that fresh offering out to the marketplace and demonstrating the results that both organizations have generated thus far. I think in doing that, as we talked about, we see big opportunities in Medicare, where the government is being very aggressive in introducing a number of value-based programs that have a lot of interest in the market today. So, we'd like to continue to work with organizations that want to be on the leading edge when it comes to population health with Medicare populations. Same thing with Medicaid. There are a number of states that we feel are under budget pressure, that are looking for better solutions and that want provider-oriented solutions, that are very integrated into the community. So, Medicaid would be a second area you would see us focus.

And then, third, as we just talked about, we are seeing examples of employers stepping forward with local health systems that want creative narrow network solutions. We believe we have combined a very strong offering there. So, what's nice is, I think it's a continuation of the current strategy, which really is to provide extreme value for our clients, to continue building out the platform, to add a number of new health systems, and continue to grow our existing relationships, to see strong topline growth and the bottom line growth that will come with that. And position ourselves at the end of 2017 as a very clear market leader and one that is based on the level of results that we're generating for our clients.

Great, that's helpful. And then one question I have about, like, BPCI, for example, and my understanding of some of these programs is that it's really about post-acute discharge, proper post-acute discharge planning. How are you there to help people? Because my understanding is that the issue is not -- everyone kind of recognizes that's where there savings are, but there is not a lot of good data on where the best MIPS are and who to really discharge to. Can you talk about what needs to be done to actually improve that and what kind of capabilities that you might have to really, to help your health plan partners, health system partners. Thanks.

Sure. I mean, I think we would attack that from multiple dimensions. And first of all, through our analytics there are certain patients that are at high risk for very poor post-acute experiences and frankly very high cost. We have a lot of experience looking at the data elements and then concentrating our clinical resources on those patients. Not just sending them off into the post-acute wilderness, but tracking them very carefully to make sure they are getting the right interventions when they need the interventions. The fact that we're involving mental health, we're involving pharmacy, and taking an integrated care approach to those patients also makes a big difference, because those factors can lead to higher costs and very poor quality. In terms of network development, we absolutely spend time upfront with our provider partners finding the most efficient providers and then using financial mechanisms, network contracting to make sure that we're sending patients ultimately to the right places.

And then the identified platform really tracks a patient through that entire episode. We're able to manage workflow. We're able to make sure the home health visit happens. We're able to make sure that someone, the discharge coordinator and the instructions that exist for the primary care physicians, that all of those things happen. A lot of this is ultimately blocking and tackling, and the system we've developed enables you to manage that very effectively. So, one being smart about where you put resources but then making sure you execute successfully. So, all of those things will make a big difference in managing the post-acute world.

And is that a function that, I guess in the past, the discharge nurse or whoever, the hospitals we're used to, we send patients down to the end of the street and now it's really -- sorry -- to the nursing home down the street. But now it's really through the data and information that we're collecting to identify the other services and we can kind of understand better who needs to go to the nursing home versus maybe who can go home; is that fair?

Absolutely. And this applies to all of our clinical program areas, which, one is presenting good comprehensive clinical and financial data to all of the providers that are involved in the care process. When you do that and a provider sees that maybe they're sending people to a place that is high cost and low quality, where certain follow-up steps aren't happening, they will shift their behavior to other organizations. And that's part of the process that is constantly going on is how do you look at that data? How do you act on it? How do you hone it and improve it over time, and that's absolutely what we would do.

Great. Thanks a lot.

The next question will come from Sean Dodge of Jefferies. Please go ahead.

Hi. Good afternoon. Going back to some of the earlier questions about the mix of opportunity in government lives versus commercial. From Evolent's standpoint, does it make much difference -- once the lives are on the platform, is there much difference in contribution margin between a commercial life versus an MA life versus Medicaid?

You know, there's really not. You might see some slight benefits in contribution to pair delegated lives, but I think to your point you'll see differences in PMPM, right? If we're doing a full health plan, Medicare at the very high PMPM obviously because of the overall PMPMs in Medicare, very profitable. And same thing with the lower PMPM; you'll generally have more lives but very strong contribution margins from those as well.

Okay. So, you continue to drive some nice leverage on SG&A, Nicky, you said you expect this to continue for some time. What's the right way to think about the level investment needed here going forward? Can you carry this momentum or pace ahead, or should we expect to see some tapering over the next year or two if we think about SG&A as a percentage of revenue?

We've got a core financial target of EBITDA break-even next year, late next -- you know, the fourth quarter of next year. And so in order to achieve that there is an implied further leveraging of SG&A across that next year. So, yes, so we do expect to see the continued leverage in SG&A. Our growth rate, strong growth rate in the top line and leveraging SG&A. So, yes, we do expect to see that continuing.

All right. Thanks again.

And our next question will come from Richard Close of Canaccord Genuity. Please go ahead.

If you can talk a little bit about the St. Luke's win that you just announced. Was that competitive? Were you bidding against anyone on that business and was there any existing relationship that you had with them previously?

You know, St. Luke's I think is an example of how our relationships unfold over time. It's an organization that we've known just from our experience working in the industry and always admired them as a leader in that part of the country. We had talked to them early on. They were quite interested in what we were doing. They weren't quite ready to move forward. We continued to build the relationship. And then as their lives and ambitions in value-based care began to grow, they felt that they could use some support in executing and realizing their growth strategy. And so we began interacting with them. We began sort of looking at their market and strategic planning process, what their needs were operationally, and that's really how the relationship ultimately unfolded. I think it's a great opportunity. It's a large system, a great footprint throughout the state of Idaho, about 150,000 lives in delegated risk arrangements that we will move into in 2017. And then beyond that a real opportunity to grow and expand back across multiple patient populations and we're incredibly excited about the relationship.

A question on the pipeline. In the past, Frank, I think at the analyst meeting back in May and exiting the first quarter call you talked about the pipeline being extremely strong, bigger than it ever has. I was wondering if you could just give us an update there? And then has the Valence transaction meaningfully changed that at all?

Yes. I would say we're off to a good start this year. It feels good to have added three great organizations to our long-term operating partner list, and so we're very happy about that. I would say the overall activity level remains strong because of all the factors that we talked about. So, the government's continued push. It's very hard for a provider to sort of avoid the need to really begin gaining experience and moving in this direction. So, we are in a number of very high quality conversations right now. I feel very good about where we are relative to our objectives for the year. And in setting up 2017, we've still got a lot of work to do. But the overall market environment feels very good and I think the teams are doing a great job. My hope is that we'll have some great new systems to welcome across the coming months, but I feel like we're in a very good position consistent with where we were when we spoke a few months ago.

Okay, thank you.

And our next question will come from David Larsen of Leerink. Please go ahead.

Can you maybe talk a bit about your relationship with Passport? How is that progressing and what incremental investments are being made into your Medicaid capabilities coming from that relationship? Thanks.

Sure. You know, what's really nice is when you begin working with an organization and you see a lot of consistency in terms of mission, values, orientation. And I would say, to start, the teams have been working really well together. So, it doesn't feel like two teams; it feels like one team working very closely together. There has obviously been a lot of focus on driving improvements in cost and quality, enhancing some of the clinical programs where we've had some knowledge and know-how there. We're wanting to make sure that we perform well on overall medical costs, which are under a lot of pressure across multiple populations, so a lot of work right now. Identifying areas of opportunity, and then working through the many steps that you need to do to actually realize that. And I would say we're feeling very good about the relationship. Our ability to expand some of our work there, and we're finding additional areas where we can provide value. And they've just been a fabulous partner up to this point, so a very, very good start.

In terms of Medicaid, obviously the relationship with Valence is going to enhance our work in Medicaid and in pediatrics. Passport, as well, as we mentioned from the outset, has a very strong set of capabilities, some very unique things that they do in managing, particularly across disparate geographies. We have the Medicaid Center of Excellence in Louisville, which we put an initial investment into and we've already hosted a number of health systems and state governments that are interested in applying some of those lessons in their markets. And so I would say off to a really good start from a business development perspective and a number of things we're quite excited about as we head into 2017.

Great. Thank you very much.

And, ladies and gentlemen, this will conclude our question-and-answer session. I would like to hand the conference back over to Frank Williams for his closing thoughts.

Well, we appreciate everyone participating in the call, and great questions, and look forward to seeing many of you on the road across the coming weeks and at various healthcare conferences. And, again, we appreciate you participating on the call. Thank you.

Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.