Evolent Health, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Evolent provides technology-enabled value-based care, specialty-care management and health-plan administration services; it also operates True Health, a commercial health plan in New Mexico.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $220.1 million | $149.9 million | $609.9 million | $434.0 million |
| Operating income (loss) | $(20.1) million | $(11.0) million | $(92.0) million | $(34.1) million |
| Net income (loss) attributable to Evolent | $(25.5) million | $(12.4) million | $(103.9) million | $(36.0) million |
| Loss per share, basic and diluted | $(0.30) | $(0.16) | $(1.27) | $(0.47) |
| Adjusted EBITDA, non-GAAP | $3.3 million | $4.8 million | $(19.1) million | $17.6 million |
| Operating cash flow | Not provided for the quarter | $(55.8) million | $4.3 million |
Q3 revenue grew 46.8%; nine-month revenue grew 40.5%. Platform and operations services drove growth, increasing 45.2% in Q3 and 35.7% year to date. Premiums rose 92.4% in Q3 and 98.0% year to date, largely reflecting the NMHC reinsurance agreement. Transformation services revenue declined as Evolent’s offering became more product-oriented.
Profitability weakened despite higher revenue. Cost of revenue rose to 74.6% of Services revenue in Q3 from 58.1% a year earlier, reflecting the New Century Health acquisition and performance-based arrangement costs. Claims expense was 80.0% of premiums in Q3 versus 75.1%. SG&A was 26.7% of consolidated revenue in Q3, down from 39.7%; management expects SG&A to decline as a share of revenue over the long term. Nine-month results included $14.8 million of severance costs and a $9.6 million non-cash gain on disposal of assets. Management’s Adjusted EBITDA measure excludes specified items and is not GAAP net income.
At September 30, cash and cash equivalents were $96.7 million; restricted cash and investments were $109.8 million, much of which related to partner claims processing and collateral. The company reported total assets of $1.714 billion, total liabilities of $589.6 million, and equity of $1.124 billion. Long-term debt, net of discount, was $228.0 million; convertible-note principal totaled $297.5 million ($125.0 million due 2021 and $172.5 million due 2025). Operating lease liabilities totaled $76.0 million. Management stated that available liquidity was sufficient for at least 12 months from the date the statements were available for issuance.
Cash and restricted cash fell by $182.6 million during the first nine months, to $205.8 million. Investing cash outflow was $102.5 million, including a $46.4 million advance for Passport regulatory capital, $26.4 million of property and equipment purchases, and acquisition and equity-investment spending. Operating cash use reflected the net loss and working-capital movements.
Material changes and notable items
- GlobalHealth: In May 2019, Evolent acquired an approximately 43% economic interest, contributing $15.0 million cash, 1.58 million shares and True Health Indiana assets. It recognized a $9.6 million non-cash disposal gain; its share of equity-method losses was $6.2 million year to date.
- Passport: Evolent agreed to acquire substantially all Passport assets and liabilities for $70 million cash and issue the provider sponsors a 30% equity interest in the buyer. Closing was expected in Q4 2019, subject to conditions. Evolent advanced $40 million to Passport at 6.5%, repayable in a single payment in 2025 subject to regulatory approval.
- NMHC reinsurance: Evolent terminated the quota-share reinsurance agreement effective in Q4 2019. Management expects premiums to decline as a percentage of revenue following termination. True Health planned an individual-exchange product launch in 2020.
- Leases: Adoption of the new lease standard added approximately $51.4 million of right-of-use assets and $47.4 million of lease liabilities at January 1, 2019, with no reported effect on earnings.
Outlook, risks and contingencies
Management expects continued operating losses for the foreseeable future and says profitability depends on revenue growth and cost management. It expects transformation revenue and premiums from the NMHC reinsurance agreement to decline as a proportion of revenue; it expects Services cost of revenue to improve with scale and efficiencies, although the pace depends on growth mix. No specific companywide revenue or earnings guidance is provided in the filing.
The Kentucky Medicaid RFP for Passport is a major uncertainty. Passport’s current contract expires June 30, 2020; if it does not win a new contract, Evolent expects no material management-services revenue from Passport after that date and warns the value of its pending investment could be adversely affected. If Passport wins, the sponsors and Evolent have reciprocal options relating to the sponsors’ remaining interest at $60 million; if Passport does not win, Evolent is required to acquire that interest for an additional $20 million within 12 months after the current contract expires. The Passport transaction itself is not conditional on the RFP outcome.
The company reported no goodwill impairment at September 30, 2019, despite a 42% decline in average share price from January–April to May–September. Management warned that an unsuccessful Passport RFP outcome could lower projected cash flows and lead to a material impairment. Other risks include customer and partner concentration, regulatory and Medicaid policy changes, claims-reserve estimation, execution of acquisitions and investments, and ongoing cash burn. Passport accounted for 16.4% of nine-month revenue; Customer B accounted for 16.4% and Customer A for 12.8%. A putative securities class action filed in August 2019 seeks unspecified remedies; Evolent said it believes the case is without merit and intends to defend it, but cannot estimate potential loss.
Investor facts to verify
- Outcome and timing of the Kentucky Medicaid RFP, Passport transaction closing, and related capital, option and indemnity obligations.
- Whether operating cash use moderates and management’s 12-month liquidity assessment remains supportable, considering restricted funds and planned investment needs.
- Services margins, performance-based contract costs, True Health claims ratios and the adequacy of claims reserves.
- Effects of ending the NMHC reinsurance agreement and the performance of True Health’s planned exchange product.
- Convertible-note settlement terms and maturities, as well as potential goodwill impairment if Passport or other business prospects deteriorate.
- Resolution or developments in the securities class action and any resulting financial exposure.