Evolent Health, Inc. — FY 2019 Form 10-K
Reporting period: Year ended December 31, 2019. The filing also reports fourth-quarter results; it is an annual report, not a standalone quarterly filing. All figures are U.S. dollars.
Business context
Evolent provides technology-enabled clinical and administrative services to health plans and providers shifting toward value-based care. Its two reportable segments are Services and True Health, a commercial health plan in New Mexico. At year-end, it had 39 operating partners and approximately 3,400 employees.
Financial performance and liquidity
| Metric | FY 2019 | FY 2018 |
|---|---|---|
| Total revenue | $846.4 million | $627.1 million |
| Operating loss | $306.6 million | $47.5 million |
| Net loss | $305.6 million | $54.2 million |
| Net loss attributable to Evolent common shareholders | $302.0 million | $52.7 million |
| Loss per share, basic and diluted | $3.67 | $0.68 |
| Net cash used in operating activities | $42.6 million | $20.7 million |
| Adjusted EBITDA, segments total | $(11.0) million | $23.2 million |
Revenue mix: Services revenue was $674.6 million, up 26.5%; platform and operations services contributed $659.4 million, while transformation services fell 53.8% to $15.2 million. True Health premiums were $171.7 million, up 82.8%, partly reflecting reinsurance premiums assumed from NMHC.
Margins and costs: Cost of revenue rose to 76.0% of Services revenue from 61.5%. True Health claims expenses were 79.1% of premiums, compared with 75.4%. SG&A declined to 30.4% of consolidated revenue from 37.5%. These comparisons reflect acquisitions and changes in business mix.
Cash and debt: Cash and cash equivalents were $101.0 million at year-end; restricted cash and investments were $28.3 million. Investing activities used $181.6 million, including $46.4 million of advances for regulatory capital requirements and $87.5 million of investments in and advances to equity-method investees. Long-term debt, net of discounts, was $293.7 million; disclosed principal obligations included $125.0 million of 2021 Notes, $172.5 million of 2025 Notes, and a $75.0 million secured term loan. Management said available liquidity was sufficient for the next 12 months as of the financial statements’ issuance date.
Material changes and unusual items
- Revenue increased 35.0%, driven by acquired businesses, partner additions and growth in covered lives; lives on platform grew 35.5%.
- The company recorded a $199.8 million non-cash goodwill impairment in 2019, compared with none in 2018. The charge followed a significant share-price decline and uncertainty over Passport’s Kentucky Medicaid contract renewal; fourth-quarter net loss was $199.3 million.
- On December 30, 2019, a subsidiary acquired substantially all of Passport’s assets and liabilities for $70.0 million cash, with provider sponsors retaining a 30% interest. Evolent accounts for its interest under the equity method because control is shared.
- Evolent advanced Passport $40.0 million for regulatory capital and agreed to provide additional support if needed to meet specified capital levels. The Passport investment, note and guarantee create material exposure beyond the stated purchase price.
- The NMHC quota-share reinsurance agreement was terminated effective in the fourth quarter of 2019. It contributed $83.3 million of assumed premiums and $72.6 million of claims in 2019; management expects future True Health revenue to be lower as a result.
- The new secured credit agreement included a $75.0 million initial term loan and up to $50.0 million in delayed-draw financing, subject to conditions. It bears interest at a floating benchmark plus 8.0% or base rate plus 7.0%, and is secured by substantially all assets of the borrower and guarantors. Warrants cover 1.51 million shares at $8.05 per share.
Outlook, risks and contingencies
Management expects continued operating losses in the foreseeable future and says profitability depends on revenue growth and cost management. It expects platform and operations to remain the core recurring revenue stream, transformation revenue to decline as a share of total revenue, and long-term SG&A to decline as a percentage of revenue. No specific consolidated revenue or earnings guidance is provided.
Passport is a major uncertainty: it represented 18.7% of 2019 revenue. Its Kentucky Medicaid contract expires December 31, 2020; it was not initially awarded a contract in the state’s rebid, but the process reopened and a revised proposal was submitted in early 2020. Management expected an announcement in the second quarter of 2020. Failure to win could eliminate material management-services revenue after 2020 and impair the investment and goodwill. Depending on the award outcome, Evolent may be required to acquire the sponsors’ 30% interest for $20 million or may face a $60 million put/call option.
Other key risks include partner and receivables concentration (Cook County Health represented 48.4% of year-end trade receivables), medical-cost and performance-contract risk, changing healthcare policy and regulation, competition, acquisition integration, cybersecurity and privacy exposure, debt service and covenant compliance, and potential additional goodwill impairment. A securities class action alleging misleading statements about Passport was pending; the company moved to dismiss and could not estimate a loss. The 2025 Notes may require cash settlement upon certain conversions.
Management identified material weaknesses in controls over user access and claims-data setup and modifications in an acquired claims-processing system. It reported no resulting adjustments to 2019 financial statements, but stated the weaknesses could permit a material misstatement. Management was remediating the issues. The auditor issued an unqualified opinion on the financial statements but an adverse opinion on internal control over financial reporting; disclosure controls were also deemed ineffective.
Important facts for investors to verify
- The final Kentucky Medicaid RFP outcome, Passport enrollment and contract economics, and any resulting change in Evolent’s consolidation treatment or impairment estimates.
- Cash needs and additional support obligations for Passport, including the $40.0 million note, the $25.0 million performance-bond indemnity, and conditional purchase obligations for the remaining ownership interest.
- Whether Services margins and segment Adjusted EBITDA recover after acquisition integration and the end of NMHC reinsurance activity.
- Claims reserves and performance-based contract estimates, which are sensitive to claims completion factors, medical-cost trends and operating assumptions.
- Remediation and independent testing of the claims-system material weaknesses, and any effect on claims expense, cost of revenue or future reporting reliability.
- Debt maturities, the high-cost secured facility and covenants, availability of the delayed-draw facility, and potential dilution or cash settlement from warrants and convertible notes.