Evolent Health, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Business context
Evolent provides technology-enabled services to health systems and physician organizations shifting toward value-based care. It reported two segments: Services and True Health, a commercial health plan in New Mexico launched after the January 2018 acquisition of assets related to New Mexico Health Connections (NMHC). The company reported more than 30 Services operating partners at quarter-end.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $149.9 | $107.9 | $434.0 | $321.2 |
| Operating loss | $(11.0) | $(14.0) | $(34.1) | $(54.6) |
| Net loss | $(12.6) | $(13.1) | $(36.7) | $(56.0) |
| Net loss attributable to Evolent | $(12.4) | $(12.6) | $(36.0) | $(47.5) |
| Adjusted EBITDA | $4.8 | $2.6 | $17.6 | $(5.7) |
| Operating cash flow | Not separately stated | Not separately stated | $4.3 | $(34.0) |
- Q3 revenue rose 39.0%; nine-month revenue rose 35.1%. Services platform and operations revenue increased 18.4% in Q3 and 14.7% year to date. True Health contributed $22.6 million of Q3 premiums and $68.8 million year to date; the prior-year periods had no premium revenue.
- Q3 cost of revenue was 49.3% of total revenue versus 63.3% a year earlier; SG&A was 39.7% versus 42.5%. True Health claims expenses were 75.1% of premiums in Q3 and 75.9% year to date.
- For the nine months, investing cash flow was $(24.9) million and financing cash flow was $(7.9) million. Cash, cash equivalents and restricted cash declined $28.5 million to $266.8 million, including $221.8 million of unrestricted cash and $45.7 million of restricted cash and investments.
- At September 30, long-term debt had a $125.0 million principal balance and $122.1 million net carrying value. The 2.00% convertible notes mature in December 2021; their reported fair value was $169.1 million.
- Total assets were $1.323 billion and total liabilities $274.1 million at September 30, 2018. Current assets were $348.6 million and current liabilities $139.4 million.
Changes, accounting and unusual items
- Operating losses narrowed versus the prior-year periods, while the company remained unprofitable. Adjusted EBITDA improved to positive $17.6 million for the first nine months, from negative $5.7 million.
- Comparability is affected by the NMHC health-plan acquisition and the January 2018 adoption of ASC 606 using the modified retrospective method. ASC 606 produced a $17.3 million opening retained-earnings adjustment. Nine-month 2018 adjusted segment revenue also included a one-time $4.5 million ASC 606 transition adjustment, not expected to recur.
- Management attributed Services growth primarily to higher average per-member-per-month fees, 16.4% aggregate growth in lives on platform, and net gain share. Q3 operating expenses rose 32.0%, including higher SG&A and depreciation and amortization; depreciation and amortization increased 34.1%.
- Management said it expected cost of revenue and SG&A to decline as a percentage of revenue over time, while depreciation and amortization was expected to increase as software investment and acquired-intangible amortization continued. It provided no specific numerical financial guidance in the supplied filing text.
Outlook, risks and contingencies
- Management stated that available liquidity was expected to cover working capital and capital expenditure needs for at least 12 months from the date the statements were available to be issued. It also cautioned that losses may continue and additional financing may be needed if growth and cost objectives are not achieved.
- After quarter-end, on October 1, Evolent completed its New Century Health acquisition for reported consideration of $221.6 million, including $117.2 million cash and equity consideration, with up to $20.0 million of contingent earn-out. On October 22 and 24, it issued $172.5 million principal of 1.50% convertible notes due 2025 for $167.3 million net proceeds before expenses; proceeds were loaned to Evolent Health LLC for working capital and general corporate purposes.
- Key risks include customer and revenue concentration (Passport represented 18.9% of nine-month revenue), contract termination or renegotiation, healthcare regulation and adoption of value-based care, performance-based contract pricing and medical-cost risk, acquisition integration, and the ability to achieve profitability. The company also noted liquidity risk if convertible-note conversion obligations require cash settlement.
- Claims reserves for True Health were $10.3 million at September 30 and depend on estimates of incurred-but-not-reported claims, completion factors and medical-cost trends. Evolent had $22.0 million of letters of credit supporting risk-sharing arrangements and $10.0 million of restricted cash for the NMHC capital-only reinsurance agreement, which expires December 31, 2018. Equity-method investee funding commitments were up to $2.6 million.
- The company reported no legal matters it believed would have a material adverse effect. Management stated that the previously identified material weakness in internal control had been remediated as of June 30, 2018; the 2018 year-end auditor assessment remained pending.
Important facts for investors to verify
- Whether reported revenue growth and positive Adjusted EBITDA translate into sustained operating cash generation and progress toward GAAP profitability.
- True Health’s claims experience, reserve adequacy and claims-to-premium ratio as the acquired New Mexico health plan develops.
- New Century Health integration, performance-based contract economics, earn-out conditions and the impact of acquisition financing and dilution.
- Revenue concentration, partner retention and contract renewal or termination terms, especially for large partners.
- The impact of ASC 606 and the one-time $4.5 million adjustment when comparing periods, and the results of the annual goodwill impairment review.
- Whether the material-weakness remediation is confirmed by the independent auditor and whether subsequent convertible debt creates cash-settlement or dilution exposure.