Evolent Health Inc (EVH) 2017 Q4 法說會逐字稿

Welcome to Evolent Health Earnings Conference Call for the Quarter and Year-End December 31, 2017. 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 later this evening and for the rest of the week via the webcast on the company's website in the section entitled Investor Relations.

Here is some important introductory information. This call contains forward-looking statements under the U.S. 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 company's 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 third quarter (sic) [fourth quarter] news release. As a reminder, reconciliations of non-GAAP measures discussed during today's call to the most direct comparable GAAP measures are available in the company's press release issued today and posted on the Investor Relations section of the company's website, ir.evolenthealth.com, and the 8-K filed by the company with the SEC earlier today.

At this time, I will turn the call over to the company's Chief Executive Officer, Mr. Frank Williams. Please go ahead.

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 this evening with a summary of our recent financial results as well as an update on the market, our current pipeline and overall performance across the Evolent network. I'll then hand it to Nicky to take us through a more detailed financial review of the fourth quarter and full year 2017 results. I'll close with a few highlights from our recent product development activity and an update on our organization. As always, we'll be happy to take questions at the end of the call.

In terms of our results for the quarter, total adjusted revenue for the quarter ended December 31, 2017, increased 26.6% to $114 million from the comparable quarter of the prior year. Adjusted EBITDA for the quarter ended December 31, 2017, was $3.5 million compared to negative $7.7 million for the quarter ended December 31, 2016. Adjusted revenue increased 70.3% to $436.4 million for the year ended December 31, 2017, compared to $256.3 million for the prior year. Adjusted EBITDA for the year ended December 31, 2017, was negative $2.2 million compared to negative $21.4 million for the year ended December 31, 2016. As of December 31, 2017, we had approximately 2.7 million total lives on the platform, an increase of 34.8% year-over-year.

In terms of the overall market environment and our performance, we're pleased with our financial results for the quarter and the calendar year. We achieved a number of important operational and clinical milestones, exceeding our financial objectives on both the top and bottom line, and advanced our position as a leading partner for providers in their movement to value-based care. Our strong revenue performance this past year and continued growth in 2018 has come from 3 primary sources: existing partners, which add lives or services; expansion of our national network through the addition of new partners; and highly selective M&A activity.

In terms of some highlights on the year, we added approximately 700,000 lives in 2017 across Medicaid, Medicare and commercial populations, which is reflective of the investment we've made in a fully integrated platform to serve providers across their entire value business. We increased adjusted revenue by 70.3% and improved adjusted EBITDA from negative $21.4 million to negative $2.2 million across the year and met our goal of positive adjusted EBITDA in the third and fourth quarter. We came in at the high end of our range for anticipated new partnerships, having welcomed 6 new partners, including Beacon Health, Carilion Clinic, Community Care Cooperative, Crystal Run Healthcare, Houston Methodist and Orlando Health.

Across the year, we saw the payoff from our investment in the Medicaid Center of Excellence as we strengthened our platform and depth of our clinical programs and added several hundred thousand lives while establishing ourselves as a national leader in working with providers to build managed Medicaid solutions. With our partner base, we experienced strong and consistent operational performance and gained increased confidence in the effectiveness of our clinical programs in improving quality and reducing medical costs. Across the year, we estimate that our clinical interventions potentially kept people out of the hospital over 33,000 nights across the year, which is obviously better for the patient and better for our partners from a value-based care perspective.

The past year was also important in terms of integrating Valence into our broader health plan services offering and successfully scaling the organization with several large clients coming in across the year. While we still have work to do in fulfilling our long-term vision, the integration has gone incredibly well, and the Valence platform has enhanced our differentiation significantly in the marketplace.

Toward the end of the calendar year, we acquired the commercial health plan businesses from New Mexico Health Connections to take advantage of what we believe is an attractive growth opportunity in this state. Coming out of a busy open enrollment period, the plan is off to a good start as it grew its membership base while also implementing a significant price increase to be at parity with the market. This is a unique investment for us as we don't anticipate any additional health plan acquisitions for the foreseeable future, but we do believe that the plan represents a significant growth opportunity to serve providers with our core platform across the state and, ultimately, across multiple populations. In 2017, we also expanded to new geographies, working with new populations in Florida, Maine, Massachusetts, New York and New Mexico, and expanded our footprint in Illinois and Texas.

And finally on the product development front, we released several upgrades to our Identifi platform throughout the year, including initial launches of our patient-facing mobile application, enhanced reporting capabilities and significant functionality additions to Identifi Care and Identifi Practice.

All of this was accomplished with 2 notable headwinds in the market. First, the legislative environment was challenging with the new administration, repeal and replace, replace and repeal and limited communication from the new administrators at HHS and CMS across the bulk of the year. The lack of a clear direction has had some impact on both our current partners and their aggressiveness in expanding in value as well as new partners who, on average, were more conservative in their initial value-based care launches. Coming into the year, we remain encouraged by our recent conversations with CMS and several state governments on this front and believe that value-based reimbursement continues to be the policy centerpiece of both governmental and commercial payers. Increasing clarity in communication to the market, particularly related to specific program preferences across the first half of the year, would surely be a positive catalyst heading into 2019.

Second, we did see softness in our provider health plan segment, particularly where a single health system is the owner of the health plan. A few of our partners in this segment experienced financial pressure as a result of suboptimal pricing and benefit design dynamics as well as less aggressive approaches to network management. While this segment represents less than 10% of our total revenue base, we do believe that we're addressing this on a go-forward basis by requiring product configuration and transfer pricing in line with market norms and more aggressive medical management approaches upfront to ensure strong financial discipline in overall management of the health plan.

In terms of 2018, we're off to a very strong start on multiple fronts. First, we're pleased to welcome 4 additional partners to our national network: CoxHealth in Springfield, Missouri; St. Joseph's Health in New Jersey; FMOLHS Health Leaders Network in Louisiana; and South Shore Health System in Massachusetts. Cumulatively, these systems have a combined 16 hospitals, well over $12 billion in revenue and are viewed as leading innovators in their local markets. All 4 partners are joining our 2018 Next Generation ACO cohort, which is a group of provider partners participating in the CMS advanced risk payment model, in which providers have significant upside and downside exposure based on performance. This coming year, we expect to have more than 200,000 covered lives through our Next Gen network, one of the largest cohorts of its kind in the country.

Now in our third year of supporting health systems in Next Gen, we've developed targeted analytics, focused clinical programs and tools for engaging network physicians and patients in more effective management of care. We're also leveraging our experience base in making policy recommendations to CMS regarding program design and evolution, opportunities to improve provider participation and effective ways to enhance outcomes. With 4 additions towards our goal of 7 to 9 new partners for 2018, along with the recent expansion of our Passport and Cook County relationships, we feel well positioned for solid top line growth with over 90% visibility into our revenue for the coming year, and strong bottom line growth given the inherent scalability of our business model.

In terms of the macro environment, we're now well over a year under the new administration. And while there's still some uncertainty with the new secretary at HHS, we would say that the recent signs are quite encouraging on the value-based care front. Both at the federal and state level, it's been pretty clear in our direct conversations with providers and key government officials that policymakers are committed to performance-based reimbursement as a key lever to significantly reduce costs and improve quality. While there may be some evolutionary adjustments to current programs, and while the new administration may want to have their own brand and approach to health reform, all signs point to a strong emphasis on pushing providers into value-based care arrangements to address an ever-increasing health care budget problem. With total health care expenditures crossing $3.5 trillion and with competing priorities in the broader budget, we anticipate considerable action this year from CMS and state governments in particular, in evolving current programs and introducing more aggressive value-based approaches to stem the tide of health care spending growth.

In terms of our current pipeline, we entered the year with both a broad and deep pipeline across a number of key segments. Starting with Medicare, adding 4 partners to our Next Gen cohort is a great way to start the year in terms of providers moving aggressively into an advanced payment model with considerable upside and downside risk. In the overall market, we're seeing increased interest in advanced payment models to qualify for MACRA and MIPS and in delegated risk in Medicare Advantage given the impending age-in of the baby boomers across the next several years. Also, we see signs of CMS potentially ratcheting up downside risk requirements for APM qualification, which would serve as a significant catalyst to encourage providers to move aggressively to value.

On the Medicaid front, our investment in the Medicaid Center of Excellence and recent wins in several markets have increased our national prominence in this segment with providers. With more than 73 million people enrolled in Medicaid and CHIP and increased budget pressure, we're seeing significant movements in individual states to move to provider-driven solutions that can help to manage spiraling costs. We're in advanced discussions in several states and are confident we'll enter a few new markets in the first half of this year. We're also doing early advisory work with several states that can lead to some significant opportunities in 2019 and beyond. Overall, a large and high-growth market for what we do and our growing sophistication and asset base positions us well for expansion into several states with our provider partners.

The third area to note in our pipeline is increasing interest from the physician ACO segment. With our recent engagement with a number of physician-driven networks in delegated risk arrangements, we're working with a number of physician organizations that want to take on broader risk across multiple populations. This is an exciting area of development for us given that a number of these organizations have great track records historically at managing costs and outcomes in shared savings arrangements, and now we want a broader share of the economic value they're creating. While there is some customization of our platform to this segment, we're well positioned to help these organizations scale their capabilities across broader geographies and new populations given the depth of our clinical programs and network management tools.

Lastly, with the integration of Valence and Aldera into our health plan services platform, we're seeing strong success providing services to existing and larger scale provider-owned health plans. The integration of the back-office claims and network management system with our clinical platform and Identifi is highly differentiated in the market, and these organizations get to a higher level of performance in a more demanding market. We have a number of interesting opportunities in the current pipeline and are hoping to continue to build on some of our past wins with partners like Passport, Cook County, MDWise and C3. All in all, with high visibility into the coming year, we're feeling quite good about the depth and breadth of the pipeline and are in late-stage discussions in several markets. We continue to believe that providers are looking for an experienced partner that brings a level of expertise, clinical knowledge and proven results that enable them to perform against an array of operational, financial and regulatory requirements.

With that overview, I'll now turn it over to Nicky to speak about our financial performance on the quarter and the year.

Thanks, Frank, and good evening, everyone. We finished 2017 with strong results, and the progress we made against our strategic plan provides a solid foundation for 2018. Today, I will cover our financial results for the fourth quarter and full year ended December 31, 2017. This is also the time of year in which we have the highest visibility into our growth for the coming 12 months, and I look forward to sharing our outlook for 2018.

Overall, we're pleased with our results for full year 2017. We ended the year with approximately 2.7 million lives in our platform. We exceeded our initial guidance on the top line with adjusted revenue of $436.4 million, representing 70.3% growth from $256.3 million of adjusted revenue in '16. We achieved positive adjusted EBITDA for the first time in the company's history in Q3 and continued to expand our adjusted EBITDA margins through year-end. Adjusted EBITDA for the year was negative $2.2 million compared to negative $21.4 million in 2016. Operationally, we fully integrated the Valence and Aldera acquisitions that closed in late 2016, and we have organized the business for continued scale in 2018. Finally, we believe that the investments we have made in solution development, automation and client focus will continue to deliver measurable value to our partners in the coming years.

Turning to our adjusted results in the fourth quarter. Our adjusted revenue increased 26.6% to $114 million, up from $90 million in the same period of the prior year. Adjusted EBITDA for the quarter was $3.5 million, up $11.2 million from negative $7.7 million in the prior year. Adjusted loss available for Class A and Class B common shareholders was negative $3.1 million or negative $0.04 per share for the quarter compared to negative $12 million or negative $0.18 per share in the same period of the prior year.

Now let's turn to a detailed review of our adjusted results for the quarter. As a reminder, we derive our revenue from 2 sources: transformation and platform and operations services. Adjusted transformation revenue accounted for $5.7 million or 5% of our total adjusted revenue for the fourth quarter, representing a decrease of $6.4 million or 53.1% compared to the same quarter last year. We have previously talked about the longer-term trend of lower adjusted transformation revenues, and our performance in Q4 was in the range that we expected.

Adjusted platform and operations revenue accounted for $108.3 million or 95% of our total adjusted revenue for the fourth quarter, representing an increase of $30.4 million or 39% compared to the same quarter last year. This increase was driven primarily by a 34.8% increase in number of lives on our platform from approximately 2 million as of December 31, 2016, to approximately 2.7 million as of December 31, '17. The increase in lives on our platform was due primarily to the addition of new partners and growth in existing markets. On average, PMPM fee for the quarter was $13.30 compared to $12.87 in the same period of the prior year. Adjusted cost of revenue increased to $64.2 million or 56.3% of adjusted revenue for the fourth quarter compared to $55.7 million or 61.9% of adjusted revenue in the same quarter of the prior year. Adjusted SG&A expenses increased to $46.3 million or 40.6% of adjusted revenue for the fourth quarter compared to $42 million or 46.7% of adjusted revenue in the same quarter of the prior year. Combined, our total adjusted cost of revenue and adjusted SG&A expenses as a percentage of total adjusted revenue declined to 96.9% in the fourth quarter of 2017 compared to 108.6% in the same quarter of the prior year. Adjusted depreciation and amortization expenses in the quarter were $6.7 million or 5.9% of adjusted revenue compared to $4.2 million or 4.7% of adjusted revenue in the same quarter of the prior year. The increase was due primarily to additional software assets being placed in service.

As of February 27, 2018, there were 74.7 million shares of our Class A common stock outstanding and 2.7 million shares of our Class B common stock outstanding.

We continue to maintain a strong balance sheet, and we finished the year with $238.4 million in cash and investments. For the fourth quarter, cash provided by operations was $6 million, cash used in investing activities was $54.9 million and cash provided by financing activities was $0.2 million. Cash used in investing activities was largely attributable to the 2 previously announced funding arrangements with CountyCare and New Mexico Health Connections as well as reserve funding for our Next Gen ACO program.

Now let me turn to guidance. The following comments are intended to fall under the safe harbor provisions outlined in the beginning of the call and are based on preliminary assumptions, which are subject to change over time. Before we start, keep in mind -- keep the following in mind related to our financial outlook. Going forward, our financial statements will contain 2 reporting segments. The first is our services segment, and it's our traditional business we have reported on historically, incorporating transformation and platform and operations. In addition, the assets we acquired from New Mexico Health Connections are being contributed to a new entity, True Health New Mexico. This entity, a wholly owned subsidiary of Evolent Health, will become our second reporting segment and will contain the results of the commercial health plan assets we acquired from NMHC. We are separating these 2 segments from a reporting perspective given their different -- their significant differences in financial profile. Our services segment provides a range of services to True Health, and the revenues associated with these services will be eliminated in intercompany eliminations.

Now on to the numbers. In January, recall that we provided an outlook for revenue for the year. We remain comfortable with the estimates we provided across our various revenue components. For the full year 2018, we are forecasting adjusted revenue to be in the range of approximately $565 million to $585 million. The components of adjusted revenue are as follows: adjusted services revenue is forecasted to be approximately $495 million to $510 million, True Health premium revenue is forecasted to be approximately $90 million to $95 million and intercompany eliminations are forecasted to be approximately negative $20 million.

We are forecasting adjusted EBITDA to be in the range of approximately $18 million to $23 million. Within adjusted EBITDA, we expect that the True Health New Mexico -- that True Health New Mexico will provide a close to break-even contribution in full year 2018. Our revenue guidance for 2018 is based on the combination of same-store sales growth and the impact of our new partners who will be ramping up over the course of 2018. We expect that the flow of revenue and life growth over the course of the year will resemble our experience in 2017 and that we will see modest sequential growth for the first 3 quarters of the year, followed by a lift in the fourth quarter based on current expectations of the ramp in services we will provide to our current and new partner base. In the services segment, we expect life growth to be in line with revenue growth and that our PMPM in 2018 will also be in line with 2017.

On the cost side, we expect cost of revenue efficiencies to be recognized both sequentially and year-over-year through further labor improvements as well as continuing to implement planning and process-driven strategies. The benefits of many of these initiatives will be increasingly realized as the year progresses. As such, we expect that adjusted EBITDA will ramp across the year.

Looking ahead to the first quarter of 2018, we are forecasting adjusted revenue to be in the range of approximately $139 million to $143 million. The components of adjusted revenue in the first quarter are as follows: adjusted service revenue is forecasted to be approximately $122 million to $124 million, True Health premium revenue is forecasted to be approximately $22 million to $24 million and intercompany eliminations are forecasted to be approximately negative $5 million. Adjusted EBITDA in the first quarter is forecasted to be in the range of approximately $3 million to $5 million.

So in closing, in 2017, we laid the foundation for continued healthy growth. We remain focused on execution, working cross-functionally across the organization to drive performance across 2018.

This concludes our financial summary. I will now turn things back over to Frank.

Thanks, Nicky. I want to close with a few updates on our business and the overall organization, and then we'll be happy to take your questions.

One element that sets us apart in the marketplace is our singular focus on building an integrated value-based care platform that can drive strong financial and clinical outcomes for our partners. Across 2017, we experienced strong operational performance across the Evolent network as well as consistent and meaningful impact from our clinical programs and interventions. Our work starts with data integration, rules development, stratification and predictive algorithms, which help our partner organizations to focus their care management efforts on the most impactable patients. Our ability to predict the specific patients that will incur significant medical expenses without a focused intervention is gaining increasing precision and helping to drive higher returns from our care management interventions. Furthermore, it's our ability to embed our patient communication approach within the clinical organization that radically increases engagement rates once you identify the appropriate clinical program for an at-risk patient.

Now that we're several years into the effort, we've expanded far beyond complex care, hospital transition care, post-acute management and palliative care into several emerging clinical areas that are demonstrating improvements in quality along with significant reductions in medical costs. Creating early wins with partner organizations that deliver double-digit reductions in hospitalizations, readmissions and associated medical costs helps build the confidence to engage the entire clinical organization in a population health model. It's this confidence that then encourages organizations to leverage the clinical value they're creating through increasing participation in well-constructed performance-based arrangements. With more than 2.7 million lives on the platform at the end of 2017, there's an opportunity to generate enormous clinical and financial value across the network. And we're excited to continue to be on the forefront of clinical innovation in service to our partners.

Lastly, touching on the related subject of our organization, we continue to focus on creating a world-class destination for star talent in the industry. For us, that means building a values- and mission-driven culture, developing an industry-leading recruiting organization, investing in career pathing and employee development and focusing on communication and employee engagement to create a highly motivated workforce. Now that we're more than 3,000 employees strong, and with over 60,000 resumes received last year, we anticipate continued momentum for our brand in the health care talent market. With great talent, we have increasing confidence that we can achieve an ambitious growth agenda that continues to build on our position as the market leader in value-based care.

One of our focus areas in 2017 was ensuring the successful integration of the teams at Valence and Aldera to support extensive growth in our health plan services operations. I think the integration team did an amazing job bringing the organizations together. And we're on our way to having a health plan services platform that is well positioned for scale and continued innovation.

Finally, I'm inspired every day by our employees' commitment to improving the health of the nation with their work at Evolent and in the broader community. This past year, Evolent employees logged over 14,000 community service hours and donating clothing, food and much-needed support over the holiday season to more than 40 charities as part of our first-ever Season of Giving program. It's this focus of building a uniquely mission-focused organization that's ultimately our greatest competitive advantage in executing on what is a bold and ambitious vision.

Thank you for participating in tonight's call. Overall, we're pleased with our results for the fourth quarter and for the calendar year. Coming into 2018, we're excited about being at the forefront of the transformation that's occurring in the health care marketplace, and we remain focused on meeting our strategic and financial objectives for the year. With that, we'll end our formal remarks, and we're happy to take your questions.

(Operator Instructions) The first question comes from Robert Jones with Goldman Sachs.

Frank, you mentioned previously having a few large Medicaid RFPs in the pipeline, yet tonight's comments sound like you're even further along in the discussions with those several states, with an expectation for some first half wins. So I guess, first, maybe could you share any more on the number and size of these opportunities that you have pretty good line of sight on at this point? And then I guess, importantly, given your expectation for some first half wins, is there anything assumed in the guidance from these potential wins?

Yes, great question. I would say on the Medicaid side, as I suggested, there are several markets where we're in fairly advanced conversations and where we have a provider partner. We obviously need to work through the last stages of the negotiations that happen in finalizing those arrangements. But based on what I know today, I would think we will hopefully win a few of those. In terms of size, it really depends on the state and the market. I think, as you know, historically, the nice thing about Medicaid is it generally starts with a large bolus of lives. So if you think about our average contract being maybe in the $10 million to $15 million range, I think these would be on the higher end of that range on average. And again, some of them could potentially be large depending on when they phase in and, again, the size of the particular arrangement. Lastly, on impact in guidance, most of these will have some implementation but relatively light and back-weighted, and most would start on January 1 in '19. So I think you'd see the revenue impact in our growth in '19 but, obviously, a little implementation revenue across, which, normally, we have a plug for and we'd sort of fill in that line. So I don't think -- if we win a couple of these, I don't think you'd see any shift in our '18 guidance but, obviously, it would very good for setting up 2019.

Got it. That makes sense. And then I guess on the renewals, I know -- I think you said you were trying to target or expected to renew over 90% of your large customers from last year into 2018. Just curious how that ended up playing out for you. And then anything you can share on the size of the renewal cohort as we think about 2019 would be helpful.

Yes. I would say, overall, we felt pretty good about our renewal performance. Again, I mean, you look across the year and with a network of about 30 and now with our recent additions, 35 partners. As I mentioned, I thought we executed very well operationally, both in terms of financial performance for our providers but also clinical performance. I think we did hit our target. When you talked about the unit renewal rate in the 90% range, we did hit that. We did have softness in the one segment that I mentioned, which was the provider health plan segment where we saw some reduction in revenue there. But I would say, overall, we were quite pleased with where things came out on renewals. In terms of this year, if you just think about having a rolling cycle of contracts that are on average 4 to 5 years in length, we'll have a few contracts this year that come up for renewal. There's nothing major that we're concerned about in the first half of the year. Again, we entered the year in a very good position, and we're going to do everything we can to serve all of our partners at a high standard. And hopefully, we'll see similar performance to what we saw this past year, at least on the renewal side.

The next question comes from Anne Samuel with JPMorgan.

You touched on some of the moving pieces in the macro environment. What time frame do you expect to perhaps start to see some change in terms of willingness of health care providers to start spending again? And what, if any, improvement in the legislative environment is included within your guidance for the year?

Yes. I mean, again, I think we have to keep in mind that we came off a very strong growth year, so we have continued to see providers increasing their participation in value-based care arrangements. We are well within our range of new additions, and we're starting the year with 4 new partners, which feels very good, in the first quarter. I would say, in terms of our guidance, we're assuming a continuation of the environment as we see it today. We generally want to give guidance that we feel confident in and we feel that we can hit, and I think that's what we've tried to do. I would say on the legislative side, what would be helpful to us is the government, particularly in CMS or you think about state governments and Medicaid, just stepping forward with clear policy pronouncements, one, about a commitment to value, which we believe, at least in the conversations that we've had that we will hear from CMS and other organizations, and then also beginning to put some of their own mark from a program perspective. So if you take a program like Next Gen or you take Medicare Advantage, there's an opportunity for the new administration to come out with a renewal of those programs, an evolution of those programs with maybe a new brand on them, but clear encouragement to providers to be moving towards value and, again, innovations to these programs that make them more attractive for providers to participate. If the programs get tied to advanced payment models, which impact MACRA and MIPS, that would be a pretty major thing in terms of a catalyst for the market. So I think all of those things would be helpful to the macro environment. The good news is I think in the current environment, we feel very good about our ability to continue to grow. There's increasing financial pressure on providers. And as I mentioned, the breadth and depth of our pipeline looks very good right now. But again, in terms of a real catalyst, I think we want to see some new program introductions and, frankly, just some clear pronouncements from some of the key policymakers in both Medicare and Medicaid.

Great. That's very helpful. And then switching to margins, you crossed the breakeven mark last quarter. Can you walk us through the drivers to double-digit EBITDA margins over the next couple of years and how to think of the cadence of expansion? And then within that, how should we think about the split between growth and SG&A?

Yes, this is Nicky. I mean I think the path to double-digit is around -- there's 2 elements to it. You saw this year, I think in our guidance for next year, we have continued gross margin expansion, just the scale inherent in the business. And so we are driving gross margins. And then in this coming year, this past year, this coming year, continue to -- revenue growth in excess of SG&A. And so those 2 elements alone, it's kind of a balance of those 2 elements to drive double-digit growth. In terms of -- as I said, I mean in terms of SG&A growth relative to revenue growth, '17 over '16 was very strong performance in that regard and continues in the same vein in '18 and beyond. And we continue to set those 2 elements up well in '18, and we'll continue to do so going forward.

The next question comes from Jamie Stockton with Wells Fargo.

I guess maybe the first one is just around the lives picture, just so maybe people have reasonable expectations for 2018. Is there any color you can give us on how many lives you think you'll add, kind of what the cadence might look like? 2017 was pretty front-loaded. Anything there would be great.

Yes, Jamie. It's Nicky. In my commentary, I said that we expect lives and revenue to be in the same vein, so top line revenue growth implying sort of flat PMPM. And I think -- so lives will grow in line with revenue growth. In terms of the arc of the year, yes, I mean what we said was pretty similar to last year, more front-end weighted, some modest sequential revenue improvement across Q1 to Q3, slightly bigger lift in Q4 as certain specific programs get launched but similar in vein to last year.

Okay, that's great. And then on a separate topic, I think when you guys bought Valence, it was very adept with Medicaid but not so much with Medicare. And I think you've been making a lot of investments in being able to support Medicare Advantage plans with that platform. Can you talk about where you are there? Is that an opportunity in 2018 to bring some of your MA plans onto that platform? Or is that more of a 2019 event?

Yes, good question. I think you're correct that, in general, when we purchased Valence, they had a very strong platform in Medicaid and also had some commercial accounts. We've been able to scale the Medicaid platform tremendously and brought on some very large relationships, as you know. And the good news is the infrastructure has scaled well, it's performing well, and we feel we can continue to grow off that Medicaid base. On the Medicaid front, we do feel that there is a significant opportunity there, and that is something we're investing in across this year. It's not a 3-month development cycle but more on the order of a 9- to 12-month cycle, and so we wouldn't see the impact from that investment really until 2019 in our ability to support Medicare Advantage. If you think about Next Gen, again there, we're not providing the TPA services. So it still allows us to participate in advanced payment model programs. And traditionally, UPMC has provided support of the Medicare Advantage side, but across this year and going into 2019 that investment should pay off and we should be able to service that business directly through the Valence platform.

The next question comes from Ryan Daniels with William Blair.

This is Rob on for Ryan. Could you talk a little bit about your thoughts on Medicaid work requirements and then maybe how it might impact your clients?

Sure. I think as many of you are aware, the new administration has been pretty focused on, at least in certain states that make the request, having work requirements to continue to qualify for Medicaid. And again, that doesn't apply to the entire population, but it applies to a segment of the population that could actually work and would, therefore, be employable. It's hard to calculate the exact impact of work requirements. I mean, we've done a lot of work on it. We would guess that in states where it's deployed, it might have a 5% to 10% impact on enrollments. Very little of that would really happen this year. So most of it would really apply towards 2019 because it will be some time before those programs are implemented. I think some of those reductions would be counterbalanced by other things going on in those states that might offer increasing revenues for our provider partners, particularly in Kentucky and Indiana. So I think the overall impact is fairly muted for us surely in '18 and even going into '19. But if you were to just answer your question purely based on very specific analysis we've done on the populations associated with those providers, it would be about a 5% to 10% impact in lives.

Okay, great. And then switching gears a little bit. When you announced the capital raise, you guys mentioned M&A as kind of a priority for capital. We haven't really heard too much there yet. So I was just curious if you guys have anything on the horizon and then maybe what your priorities are there.

Yes. I think we've been pretty active historically, as you know, in M&A. I would say, again, largely tuck-in acquisitions, but Valence was a more significant merger for us. If you think about our priorities, which I think we talked about, is, one, can we add a new capability that significantly allows us to cross-sell across our larger network, can we in-source something which may allow for margin improvement, is there something that really enhances our competitive position or platform that might help with an existing relationship with a partner, et cetera. So I would say historically, if you think about Valence, Aldera, Accordion, these have been very high-return investments, well over 20%, 25% IRRs in terms of creating value. And so as we think about this year, we're trying to look for similar, either small tuck-ins which reflect the current priorities I just talked about, or occasionally, you'll see something more meaningful, again, that could advance our position in the marketplace. I think we did the capital raise because we saw a lot of live opportunities. I think, as you know, deal cadence, you can never predict, and we want to be very disciplined in terms of the deals that we do and the financial returns. So if we don't see the financial return in the negotiation, then we're going to step away and, again, be quite disciplined in terms of what we do and what we don't do. I would say right now, we've got a very good pipeline, we're active, we're in a number of conversations, several that we feel good about in terms of value that they could add as part of the Evolent portfolio. And it's a matter of seeing if we can get through the negotiation process in the right terms and it's something that we're going to feel good about that meets our return hurdles, which are high because we have a very strong organic track record as well. So active, a lot going on, hard to say if we'll have an announcement in the next couple of months. We very well could, but a lot of it's going to depend on the deal terms and the attractiveness of the potential target that we're looking at.

The next question comes from Sandy Draper with SunTrust.

Maybe a couple of quick questions and then a broader one. Maybe on the revenue side, I just want to make sure I understand, Nicky, the adjusted service revenue. Are you still going to be breaking out transformation and P&O within that? Or does that get put into one...

Yes.

You will. Okay, great. And then I don't know, Nicky, if you can talk to, just directionally, when you think about the 2018 versus 2017, in terms of just sort of how much of the growth is being driven by expansions from existing customers versus net new customers. I know you don't break that out, but would you generally say -- is there a market difference where '18 is more new customer-driven versus expansions versus last year? Any color that you can give us on that just so we think about that?

Yes, Sandy. I would say '18 is shaping up sort of in a similar vein to the past 2 years, in the range of 65%, 70% from new versus existing, so fairly similar to prior years.

Okay, great. And then from a high level, and I'm not sure, Nicky or Frank, who takes this one. So when I think about the guidance this year and look at what you guys have done prior, it looks like, to me, as I just make a very simple observation, it looks like the business is shaking out to be a sort of, and I'm talking service revenue here, a mid-teens grower. And then if you have really big new wins or you do something like the Valence transaction, obviously, you can juice that and numbers can get bigger. But with smaller expansions, smaller new wins and any normalized churn, we should sort of be thinking about this mid-teens baseline growth and then, longer term, if you can get big new wins or something substantial, that changes the growth profile. Is that, do you think, a reasonable way to be thinking about Evolent today?

Yes. I mean I guess what I'd say, Sandy, if you step back and think about the market size that we occupy of what we believe is a strong leadership position, I mean, this is a market growing over the next several years to $40 billion-plus in terms of the services market supporting provider organizations and their movement to value, so it continues to be a very large market. We've just come off a period of growth of north of 30% in revenue growth. I would agree with you that based on what we see today, and all we can really see is forward with clear visibility across the next 12 months, mid-teens -- mid- to high teens feels like the right range for the business this year. I think you're correct that we're a large size today. I mean, we will be, in total, an organization of $500 million -- high $500 million in terms of revenue. So definitionally, you're going to need some large wins in the mix, if you think about getting into the mid-20s in terms of growth just on that large base. So those large wins are out there, and some of the Medicaid opportunities that we look at or planning for, for the future have those characteristics. There are other Passport-like organizations and MDWises out there, and we hope to have some of those in our portfolio. We also think that with the government and more direction in terms of programs and really trying to push as providers have more financial pressure, that you will see more tailwinds in the market versus what we saw last year. So I think it's a fair characterization to say surely across the next 12 months of mid- to high teens is what we feel comfortable about. You could argue that unless you see some big catalysts that, that probably carries at least into the beginning of '19. But I do believe there are a number of things that can happen in the market: large wins, some policy directives from CMS and states and Medicaid, some opportunities with existing provider-owned plans that really needs the scale that we bring where we could add in some larger wins and see a growth rate beyond that range. But at least for the foreseeable 12 months, we obviously are comfortable with a mid- to high teens growth rate.

The next question comes from Matthew Gillmor with Robert Baird.

Frank talked about some of the clinical capabilities and the success you're having there. I was hoping you could kind of characterize the penetration rate for those capabilities within your client base. And is there an upsell opportunity to the existing clients, either getting them to go deeper in some of their contracts and arrangements? Or are those capabilities more about marketing to new clients and getting some confidence to converting new revenue?

Yes, great question. I would say it's very partner-dependent. We have a few partners that are just getting their toe in the water. They start relatively conservatively. There, we tend to start with a few programs that we believe are very high impact, maybe even provider groups within their network that have very large volumes. And the idea is you -- with sort of an 80-20 approach, you go after the most impactable patients in a very focused way, you demonstrate confidence. And then to your point, you have tremendous upsell opportunities both in rolling out additional clinical programs and getting new lives and new populations onto the platform. And so I do think the clinical capabilities we're developing have significant upsell opportunities. And I think we saw some of that with several partners across last year. In other situations, you might have a visionary CEO who really sees this as a linchpin to evolving their clinical organization. And in those cases, we might start out very involved in care management, really covering the broader network. And most of the growth there is going to come through new populations and increases in lives rather than deeper penetration of service. But as a cross-sell opportunity for us, I think it's significant and, again, something as we continue to demonstrate results, as people see the power of the platform, they'll want to apply to all of their value-based arrangements and, frankly, more broadly to their clinical organization.

Okay, that's helpful. And then one more on the -- you called out some softness with certain provider-sponsored health plans. And they hadn't adopted, I think, a clear set of requirements that you thought would lead to success. But can you maybe give us a flavor of what some of those requirements are? And then for the 10% of revenue that was folded in that bucket, how many have converted? Or how much has converted to a more stringent set of requirements versus what's on sort of the looser terms?

Yes. I would say from our experience, not surprisingly, you can do a number of things clinically to have an impact, as we discussed, but you also have to get the financing elements of the health plan right to ultimately drive financial performance. So things like transfer pricing for hospital days and how those get charged back to the health plan; what parts of the network are being included; are you including higher-priced settings that, in a normal health plan setting, you might remove from the network because they're higher cost than other choices you might have in the market; how you think about the mix of product and benefit design relative to the patients you're going to attract in the network; pricing from an actuarial perspective. All of those things -- your aggressiveness in medical management, are you really willing to be aggressive with a provider that may be a real outlier from a cost and quality perspective. So I think our learning, of course, is that all of those elements matter. I think we've been working very aggressively with our provider partners to address each one of those issues and to push for the right product and benefit design, the right transfer pricing and network inclusion relative to the market. And we feel pretty good about where we're headed. Some of these are political third-rail issues, so they don't happen overnight, but I feel like we've made a lot of progress on these topics. And I think what we've made very clear is when we enter into new arrangements, we're going to be very deliberate about saying that these 5, 6, 7 elements need to be present for us to really be able to sign up and work with these organizations because, ultimately, we want to have successful plans financially, we want those to be growing and scaling and we want to apply the learning to help our partners get there. So I think we're in a very different place than we were 18 months ago. We've made a lot of progress. Of course, we have continued work to do there, but I feel good about where we are.

The next question comes from Mohan Naidu with Oppenheimer.

So Frank, it looks like the macro environment could really become much more attractive this year given some stability in the government and what they talked about in the value-based models. Do you expect to see more providers take an aggressive approach this year than the last couple of years and your pipeline could be much better?

I think we still need to see. I -- what I would say is we have been in a number of very direct discussions with providers and with key policymakers at CMS, in state governments, and I feel good about what we're hearing. And there is a clear understanding that if we're really going to address the growth in spending and we really want providers to ultimately change behavior and we want better quality care and we want less variation in cost, particularly unnecessary variation, that, if anything, we need to ratchet up the performance bases of these programs. One of the big things out there that really has moved the market is the introduction of a set of physician incentive payments. And if you think about physicians being at the core of delivering care, of driving referrals, the ability for physicians to qualify as critical for other players that are trying to advance in a local market and, therefore, if the government sees that to drive performance, they ultimately need to ratchet up requirements for qualification for advanced payment models, that would be a huge catalyst in the market. So I would say, very encouraged by what we've heard. I do see, with a year under their belt and more experience and, frankly, a lot of work that's been done across the last year, I would hope that we'll hear more directly in terms of some of the things they want to do relative to advanced payment models, programs like Next Gen. I think those types of statements would be a major catalyst, but we still need to see those things happen in the first part of this year. So encouraged, still waiting and seeing and hoping that we'll see some very positive developments coming out of CMS and in some of the organizations that influence the providers that we work with.

That sounds great. Maybe one quick one on competitive landscape. Has it changed? Anything in the recent quarters, in 2017, any new competitors coming in beyond the niche product vendors in this market?

No. I would say we haven't seen a significant change at all in the competitive environment. We do not see common competition. Occasionally, when we're working with a provider organization, they may have another alternative like a local plan or a more focused point-solutions vendor that they're working with. But we have not seen any significant change in the competitive landscape.

The next question comes from Stephanie Davis with Citi.

Given the increasing number but the smaller size of recent wins, and then taking into account the growing momentum for value-based care, is there any opportunity to scale your annual client target beyond the historical 5 to 7 wins per year?

Yes, I think so. I mean, that's one of the reasons why we have increased our target to 7 to 9 this year. I think starting out with 4 wins in the first quarter, if we look at our historical pacing, we feel very good about the 7 to 9, a possibility of going outside that range if some things happen in the early part of this year. So yes, I think that's possible. Right now, we feel comfortable with the 7 to 9 range but could see that increasing based on some of the things we're working on today moving across the finish line.

Okay, good. Good to hear. And a bit of an unrelated follow-up. How should we think about the addition of the True Health businesses impact to your IPO targets? For example, the 20% operating margin target, is that still achievable?

Yes. I mean, I think the -- it's a break-even business this year. I think it's inherently -- there could be some -- I mean, there could be some drag. I mean, it's inherently a lower-margin business, if you look at the health plan business overall. As we continue to grow though, it will be a smaller part of the business overall. So -- and it could be a couple of points drag on the longer-term targets definitely just given the inherent nature of it, but I think we'll continue to drive margins in the services business as best we can. We also can see moving that business into profitability as well, but it -- just given that segment, it will -- it is a slightly lower-margin business. But in the aggregate, it could be a few points of drag just given the math.

Yes. And to that end, I don't think it impacts our original target in any way, we still feel comfortable with that range. But obviously, it will take a little bit of an investment period in that business to continue to grow and scale it. I think New Mexico is a very attractive market for us long term. And overall, if you think about the combination of what we're doing from a service perspective and the health plan side, it would be a very profitable market. But I don't think it would impact our long-term target, as you asked.

The next question comes from David Larsen with Leerink Partners.

So for the 4 new customers that you're adding, how many lives is that in total? And are they all starting 1/1/18?

Yes. So those would start 1/1 because they fit with the Next Gen performance year, which begins on January 1. I think across the 4, at least initially, it represents about 60,000 lives out of the gates. I think the good news is, if you look at the aggregate revenue across these systems, it's probably approaching $12 billion, $13 billion in revenue. So we see Next Gen as a great starting point into some other populations and other things we want to do with each of those systems. But out of the gates, probably about 60,000 Next Gen lives and then, hopefully, moving to some other populations and potentially growth in Next Gen as we head into '19.

Great. And then I was just a little bit unclear, Nicky, with the 70-30 split between new and existing clients. Is that 70% lives growth from new clients and 30% from the base?

Yes.

And then should we expect to see sequential growth in lives on platform as we progress through the year in 2018?

Yes. I think what I was saying, David, is, last year, if you look at last year, it all came in Q -- largely came in Q1, but modest across the year. I could see this year being a little bit more spread out between Q1 and Q2. But beyond Q2, it will be relatively flat across the year. The uptick in revenue in Q4 is more to do with services than life growth. So a little bit more spread out Q1, Q2 than last year but, fundamentally, most of the life growth will be in place by midyear.

Okay. And then from an SG&A perspective or an investing, [like you said], business perspective, client-facing individuals and considering the Valence integration, how are you thinking about the cost structure of the business? Are you taking costs out of the business? And does that include FTEs, generally speaking? Or are you putting FTEs into the business to support all of this top line growth that we're seeing?

Well, obviously, David, to support the level of growth, we're adding personnel to the business. Each new client, it comes with a certain level of staffing. And so with these big new contracts, we are adding staffing on the front line of the business continuously. And that's reflected in the headcount Q4, Q1 as we're supporting and driving those contracts. I would say if you look at 2017 and with the Valence and Aldera integration, we made a significant effort to drive synergies through those acquisitions. And that did result in some FTE savings just on the -- within the business. SG&A growth Q4 '17 versus Q4 '16 was high single digits compared to almost 30% top line growth. So you sort of saw that playing out in Q4, which is the most comparable quarter of the year. So there's a mix of both going on. We are driving personnel and the top line to support revenue but obviously driving efficiencies throughout the organization wherever we can, particularly last year.

And I would just add to that. If you think about it, we added 700,00 lives across the year. We grew revenues roughly 34% on the year. That's pretty significant growth. But in every aspect of the business, we are looking for efficiencies, for ways to scale, for ways to create greater repeatability in what we do. I mean, one nice thing, if you think about a program like Next Gen, once we've developed the program and infrastructure to support one partner, that now applies broadly across almost 9 or 10 partners. So the good news is I think we're getting a lot more repeatability, a lot more leverage out of SG&A, and we are seeing scale in the business. But in certain places, you do you need to add personnel just based on a new contract or feet on the street in a new market and those kinds of things.

Sure. And then just one more quick one. In terms of like Valence, it's my understanding that you're -- you can migrate some lives from like the legacy UPMC platform over to the Valence platform. Is that, in fact, the case? And if so, how far along are you in that? Are you like 50% converted, 20% converted? What's the incremental opportunity there?

Yes. I would say that's not been a big focus area for us. [EVA] conversions have some complexity to them. We don't have a huge number of lives on the UPMC platform today, and they're being reasonably well served. There, obviously, is an opportunity in '19, particularly if we're supporting organizations in MA and the platform's ready for MA to move those lives over. And again, we probably pick up some additional margin there and again something we want to do. But I wouldn't say it's a significant impact.

The next question comes from Sean Dodge with Jefferies.

Maybe just one question from me. Frank, on your existing client base, and along the lines of what you touched on in the last part of your prepared remarks, how much visibility or real-time understanding do you have into how your clients are performing in all of the value-based programs you're helping to administer for them on a day-to-day basis? And then I guess, can you give us a sense for what proportion of those are running on or ahead of the budgets or plans you all initially contemplated when you started down those paths?

Sure. It really depends on the program. But I would say, we've made a really significant investment in our analytics and actuarial team, in applying learning to all of our experience program by program, so we get very good at incorporating data as quickly as we can and then making accurate projections about performance against these value-based arrangements. There are some programs, Next Gen being an example, where you are at the mercy of CMS as to when you're able to access data, when you have a clear sense of performance. There are some changes that happen in rules across the year which are out of your control. So that would be an example of a program where we have a lot of experience, we've done a lot of work, we do our best to forecast, but you do suffer from time lag on information and potential shifts in some of the ways things are being calculated. In other areas where we have more control, as an example, we're processing the claims, we can generate the reporting right away, and we can have timely information and complete information. In those cases, we're going to have a much better sense of the real-time forecast and, again, do a lot of work to have the right estimates and have a sense of where the plan is. And then obviously, you want to take -- there's always opportunities for action somewhere in the value-based performance. And so it's really trying to align your programs immediately to have an impact. I would say if you look across our network of north of 30 partners, I'd say you probably see a bell curve. We have some that are outperforming the original targets and are doing quite well financially. We have some that are generally in the zone. Some that are still question marks, as an example, because you're still waiting for data from CMS in certain areas. And then I referenced a couple that were behind plan, particularly in our health plan segment. So I really view it as a bell curve. I would say, overall, we feel pretty good about where we are in seeing more consistent operational performance, more consistent clinical impact of our programs, and providers stepping forward and expanding into other areas, which obviously helps get to scale. But that's probably how I see the cohort today.

The next question comes from Richard Close with Canaccord Genuity.

Great. Appreciate you slipping me in. Just a really quick question, Frank. Encouraging commentary on the pipeline. What are your thoughts in terms of how quickly we need to hear something maybe out of CMS or the administration in terms of value before it potentially impacts the pipeline or triggers decisions?

Well, I would say if you look at where we sit today and our guidance for the year, right now we feel very good about mid- to high teens growth for this coming year. If you were to say that the environment stayed largely the same, and there really weren't any catalysts, we didn't get any of the larger wins, then my hope would be we would be in this range going into '19. So I do think we performed well relative to some of the headwinds that we had in the market. It was a very unusual year from a legislative perspective just given all that happened across the year and the immense uncertainty in the market. My hope is that, that improves. And that obviously would allow us to hopefully bring a few more organizations across the finish line, to have some of the larger Medicaid things we're working on come through and then we would potentially see a higher growth rate going into '19. But I don't feel like we need big changes in the environment to hit our current range of guidance. We, obviously, have very high visibility into this year. In setting up '19, as I said, I feel roughly comfortable in the current range, although we don't have perfect visibility there. And then if we have some good news, we could be on the high end of that range or outside of it.

The next question comes from Donald Hooker with KeyBanc Capital Markets.

Did you guys mention free cash flow? I see the EBIT, you guys are -- it's great you're adjusted EBITDA-positive, and that's trending well. How do we think about free cash -- you reaching true free cash flow breakeven? Have you talked about CapEx or working capital?

Yes. We didn't talk about it specifically this evening. I would say in 2017, we had EBITDA -- it was a negative EBITDA for the year, around negative $2 million, and CapEx is about $30 million. And working capital was a use of funds, in the $5 million to $7 million range. Going into the next year, those same statistics, I think working capital would be similar. I would see CapEx would be in the mid-30s next year with some increased investment in the integration of the platforms that Frank has talked about. And so mid-range of EBITDA would be sort of, call it, $20 million of mid-range in EBITDA. So EBITDA minus CapEx would be a use of funds of about $15 million next year before working capital, bringing it up to about a negative $20 million for '18.

Okay, that's helpful. And then one last question, if you don't mind, if I can indulge you. The Next Gen ACO, the members there, as that grows, do I think about that having a much higher profit margin? I assume you can industrialize your work there because I assume the ACOs are very similar. Is that my -- am I thinking about that right?

I think that's a fair statement. We obviously want to deliver very high levels of service, and we want to make the right investments in clinical programs and in performance of those programs because of the downside exposure. I would say now, having worked with several organizations, a few that had been some of the best performers in the country, I do think we're getting an experience base and repeatability to what we're doing that surely creates more efficiency. As you think about potentially getting the 10, 15, 20 partners, you surely would have more leverage in terms of the applicability of all of that investment across a larger base, so I do think that's a fair way to think about it.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Frank Williams for any closing remarks.

Well, we appreciate everyone participating in the call and look forward to seeing a number of you out in the market at a number of conferences coming up. And thanks again for participating in the call tonight. We appreciate it.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.