Evolent Health, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020; filed August 7, 2020. Amounts below are in U.S. dollars unless stated otherwise.
Business context
Evolent provides technology-enabled clinical and administrative services supporting value-based care, with reportable segments in Services and True Health, its New Mexico health plan. Services revenue primarily comes from recurring, multi-year platform and operations contracts; True Health earns insurance premiums. The quarter’s results also reflect the Passport investment and the termination of a reinsurance agreement that had contributed premiums and claims in the prior-year period.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $238.6 million | $192.0 million | $485.9 million | $389.7 million |
| Operating loss | $(227.5) million | $(25.2) million | $(253.0) million | $(71.9) million |
| Net loss attributable to common shareholders | $(203.5) million | $(31.6) million | $(282.3) million | $(78.4) million |
| Diluted loss per share | $(2.38) | $(0.38) | $(3.32) | $(0.97) |
| Adjusted EBITDA | $9.0 million | $(7.7) million | $12.7 million | $(22.5) million |
- Q2 revenue rose 24.3%, led by platform and operations services, up 46.9% to $212.4 million. Premiums declined 43.9% to $25.5 million; transformation services were $0.8 million.
- Q2 included a $215.1 million non-cash goodwill impairment charge. The six-month period also included a $47.1 million non-cash impairment of the GlobalHealth equity-method investment and a $6.4 million loss on disposal of assets.
- For Q2, cost of revenue was 77.8% of Services revenue, versus 74.0% a year earlier; SG&A was 21.2% of total revenue, versus 34.9%. Claims expenses were 71.1% of premiums, versus 79.3%. These ratios are not consolidated gross margins.
- Six-month operating cash flow was positive $17.1 million, compared with use of $39.2 million in 2019. Cash flow benefited from non-cash charges and working-capital movements, including higher accounts payable and claims reserves; it is not equivalent to earnings.
- At June 30, cash and cash equivalents were $98.3 million; restricted cash and investments were $55.7 million, much of it held for partner claims processing. Current assets were $274.7 million and current liabilities were $245.1 million.
- Long-term debt, net of discount, was $299.7 million on the balance sheet. Convertible-note principal totaled $297.5 million and the secured term loan had $75.0 million outstanding, for $372.5 million aggregate principal. The $50 million delayed-draw facility was subject to conditions. The company reported compliance with applicable credit covenants.
Material changes and outlook
- Management attributed Services growth to existing and new partners, cross-selling and higher average per-member-per-month fees. The company had 34 operating partners at quarter-end, compared with 35 a year earlier.
- Passport was not awarded a new Kentucky Medicaid contract; Evolent expects no material Passport management-services revenue after December 31, 2020. Evolent also expects reduced medium- and long-term cash-flow projections and recorded the Q2 goodwill impairment following the contract outcome.
- After quarter-end, Passport agreed to sell certain assets and contract rights to Molina. The agreement provides for a $20 million escrowed payment and potential additional membership-based consideration of up to approximately $40 million, subject to stated terms and approvals. If Medicaid novation does not occur by January 1, 2021, Passport must repay Molina $7.5 million of the closing payment. A related real-property agreement provides for an $8 million purchase, subject to conditions. Closing and economic benefits are not assured.
- The company is obligated to acquire the Sponsors’ 30% interest in Passport for $20 million following expiry of the existing Medicaid contract, under the disclosed terms.
- Management said COVID-19 had not materially affected results or outlook to date. It reported modestly higher Medicaid membership and lower non-essential medical utilization, with a modest near-term business benefit; the duration and net effects remain uncertain. Management expects sufficient liquidity for the next 12 months but provided no specific numerical earnings or revenue guidance.
- Management expects cost of revenue and depreciation and amortization to rise with growth and investment, while SG&A is expected to decline as a percentage of revenue over the longer term. It also cautioned that future goodwill impairments could be material.
Risks, contingencies and unusual disclosures
- Revenue and receivables are concentrated: Passport represented 25.2% of Q2 revenue and Cook County Health and Hospitals System 19.9%; Cook County represented 56.7% of trade receivables at June 30.
- Passport-related exposure includes a $25 million performance-bond indemnity, a capital-support guarantee with no funding under it at quarter-end, and the $20 million Sponsor-interest purchase obligation. The filing reports maximum Passport exposure of $160.5 million across the listed investment, loan, and guarantee exposures.
- A shareholder class action alleges misleading statements concerning Passport. The company moved to dismiss and said it could not estimate the probability or amount of any loss.
- Disclosure controls and procedures were deemed ineffective at June 30 because of material weaknesses involving access and segregation of duties in a claims system, claims-data changes, and evidence of controls over third-party data. Remediation was underway and not yet considered complete.
- Key uncertainties include COVID-19 effects, partner concentration and contract renewals, Medicaid policy and funding, Passport transaction approvals and performance, claims-reserve estimates, debt service and refinancing, and the company’s ability to achieve profitability. The $125 million 2.00% convertible notes mature in December 2021.
Important facts for investors to verify
- Whether Molina and Passport obtain required approvals, complete the contract transfers, retain membership, and realize the disclosed consideration and real-property proceeds.
- How the Passport contract loss affects recurring Services revenue, cash flows, the investment’s value and any additional impairment or consolidation decisions.
- Whether operating cash generation persists after separating non-cash impairment add-backs and volatile partner claims-processing balances.
- Liquidity, covenant compliance, and plans for the 2021 notes’ maturity, including whether conditional delayed-draw financing is available.
- Whether claims-system control remediation is tested and deemed effective, and how customer concentration and the pending litigation evolve.