Evolent Health, Inc. (EVH) Earnings Call Transcript & Summary

Good morning, and welcome to the Evolent Health update conference call. 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 next week via the webcast on the company's Investor Relations website, ir.evolenthealth.com. Here are 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. At this time, I will turn the call over to the company's Chief Executive Officer, Mr. Frank Williams. Please go ahead.

Good morning. I'm Frank Williams, CEO of Evolent Health. And I'm joined by our President, Seth Blackley; and our CFO, John Johnson. We wanted to provide a brief general update on Evolent and our partner, Passport Health Plan. As we've shared in our recent announcement, Passport received notification from the Kentucky Cabinet for Health and Family Services that it was not awarded a Kentucky Managed Care Organization contract for the next contract period commencing January 1, 2021. While we don't have a lot of detailed information about the decision, we wanted to communicate what we do know at this point and the potential implications for Evolent going forward. First of all, we're obviously disappointed in this decision and believe it is not in the best interest of Medicaid beneficiaries in Kentucky. Passport has been a leading community-focused health plan in the Commonwealth for 23 years and has consistently been among the top-rated plans throughout this time. Passport also has a unique provider and clinically centered model to ensure integrated care delivery and high levels of member engagement. Across the past year, in particular, Passport has delivered strong operational, clinical and financial results with substantial improvements in operating margins and the strength of its balance sheet. Most importantly, the plan has been an absolute standout in terms of its extraordinary response to member and community needs during the COVID-19 crisis. All in all, Passport is a highly unique provider-driven health plan that has a tradition of providing outstanding service and support to some of the Commonwealth of Kentucky's most vulnerable Medicaid members. Based on Passport's performance and reputation in the community, the strength of its RFP response and the inherent risks of creating member disruption in the midst of COVID, Passport intends to protest this decision, and we support them in doing so. All of the national Medicaid companies that participated in the Kentucky bid have lost significant Medicaid state bids in the last few years and many have also won protests, demonstrating the highly subjective nature of these processes. At this time, we know that the RFP itself and the scores were largely the same, but we do not have additional details on the evaluation process, how the scoring was implied, whether past results were shared with reviewers and clarity around final determinations. At a minimum, we feel strongly that the evaluation did not place appropriate value around Passport's extensive experience operating for 2 decades in Kentucky nor its highly effective community-based model. Accordingly, we intend to collect more information from the Commonwealth so we have as much transparency on all aspects of the process as soon as possible. While we await additional information through the appeal process, I did want to take a moment to provide an update on Evolent's focus and outlook for the remainder of the year and the potential implications for our 2021 performance in the event that this contract decision for Passport is not overturned. First, this decision does not impact our guidance for the second quarter of this year and for the full year 2020. We are reiterating our guidance and continue to anticipate total revenues of $935 million to $985 million and adjusted EBITDA of $24 million to $32 million for the year. The state's contract decision does not go in effect until January 1, 2021, and we will, at a minimum, continue to provide services to Passport until the new Medicaid contracts take effect on January 1, 2021. Second, our business continues to be very well-positioned in the market. Evolent's 3 core solutions, which include total cost of care management, specialty care management and administrative simplification are highly differentiated and aligned with the specific needs of payers and providers in today's health care market. Our total addressable market opportunity across these solution areas is over $130 billion, and our existing partners represent a small fraction of providers and payers that can benefit from our solutions. We continue to hold a leadership position in the core markets that we serve, and believe there is an opportunity to drive strong organic growth rates for several years to come. In addition, we believe this public health crisis has demonstrated that our platform and solutions remain highly relevant in today's environment. Given the impact of COVID on health outcomes and overall health care spending, the need for a proactive population health approach has never been more important. To that end, we continue to see significant interest in our service offerings as reflected in our recent partnership announcements and current pipeline. The pipeline, which is really about setting up 2021 and beyond, feels good relative to historical metrics, and we continue to see meaningful engagement across a number of pursuits that are targeted to close in the summer and fall time frame. We've added 3 new partners this year, which is right on track with our expectations at this point in the year. Excluding Passport, we continue to believe that we can drive mid-teens organic growth in the medium term. In terms of the outlook for 2021, while it's premature to give formal guidance at this time, and we all understand that we are in the midst of COVID-19, we wanted to give you an illustrative sense of our financial picture should Passport ultimately not be awarded a new contract. From a revenue standpoint, the midpoint of our guidance for 2020 across our entire business is $960 million in total revenue. If you remove considerably all of the revenues from Passport and assume that the remaining services business grows at a mid-teens growth rate, then we could see total 2021 revenues, including True Health, at around $900 million. From a bottom line standpoint, while it's difficult to provide precise estimates at this time, at a minimum, we would expect adjusted EBITDA margins similar to the midpoint of our 2020 guidance with a strong exit run rate in the back half. Both of these highly preliminary estimates for calendar year 2021 assume that the business maintains its current performance levels. Regarding Passport, our focus over the coming months will continue to be on providing strong clinical support to vulnerable members in the midst of the pandemic as well as continuing to drive strong operational and financial performance for the health plan. From a balance sheet perspective, Passport's risk-based capital level was over 200% as of April 30, 2020. In the event our appeal is unsuccessful, we currently estimate, based on historical claims utilization, that we will receive substantially all of our invested capital back in 2021 after meeting our claims and other commitments. This source of capital, along with our delayed draw facility from Ares, should position the company with sufficient capital to address any pending maturities and needs for the overall business. Evolent's liquidity remains strong with cash on hand of $87 million at the end of the first quarter. In closing, I'd like to leave you with a few key points. Along with our other provider owners, we're disappointed with this ruling and do not think it is in the best interest of Medicaid beneficiaries in Kentucky. We intend to support Passport in appealing this decision, and we'll know more as we gather information from the Commonwealth in the coming weeks. Second, regardless of the outcome, we're focused forward on meeting our ambitious goals for this year and continue to build a dynamic service business, addressing critical needs in today's health care environment. As I mentioned earlier, this decision does not impact our revenue and EBITDA guidance outlook for the second quarter of this year and full year 2020. We are reiterating our guidance of $935 million to $985 million and adjusted EBITDA of $24 million to $32 million for the year. Lastly, as we look ahead to 2021, we feel very good about our overall growth strategy given our solution portfolio, large addressable market and the renewed focus on population health coming out of the COVID-19 crisis. Given the overall pressure on the economy, there is an urgent need to drive lower cost, higher-value health care. And Evolent serves as a bridge between payers and providers in driving demonstrable improvements in health outcomes for patients. That includes -- concludes our formal remarks, and we'll be happy to take questions up until the top of the hour.

[Operator Instructions] The first question today comes from Robert Jones of Goldman Sachs.

Frank, I recall when this deal was originally -- came together, the company outlining some financial protections in the situation that a scenario like this was to play out, assuming that the -- if we assume the appeal maybe doesn't come back in your favor, could you just remind us what level of recouping of the original investment you think is possible for Evolent? And I know that there's probably some time frame around liquidating some of the assets at Passport. I think you mentioned there's $87 million in cash on hand. Just anything around the financial recouping of the investment would be helpful.

Hey, Bob, it's John. I'll take this one and the others can chime in. As we look at the total investment that we made in Passport, we still expect to recoup substantially all of that investment. The timing, as you indicate, will depend on timing of the wind down, and we would expect to recoup that across 2021. And right now, just to put a number on it, Passport had about $110 million -- a little north of $110 million of surplus cash on its books, which we expect will grow over the rest of the year. And that's the balance that will be distributed during a wind down.

And just to add, I think if you -- yes, if you look at performance of the plan, it's performed very well. We have a strong forecast for the remainder of this year. We feel in a very good position to return our capital based on what we see today.

That's helpful. And I guess just a follow-up as we think about this channel, if we think about Medicaid and your interest in continuing to pursue other Medicaid opportunities. I know there's -- you have the opportunity in Florida. Just anything you'd share today as far as maybe how your approach might differ in the wake of this?

I don't think so. I mean what I would say is Medicaid, as we all know, is subject to RFPs and bids every 3, every 5 years. And so every Medicaid plan in the country comes up for bid, and sometimes you win and sometimes you lose. We have a number of Medicaid clients that we feel are in a very strong position in their local markets. As you know, we have well over 1.5 million lives in Medicaid. We feel like we're delivering substantive and differentiated results. We think it's a growth segment and one that we can perform well in. And we have a relatively diverse base of partners. So I think for those that we lose, we're going to win other ones. We're obviously seeing growth in Medicaid substantially across our book with the recent economy. And so we think it's a strong segment for us. We also have a strong presence, obviously, in Medicare and a large number of commercial lives, but we think Medicaid is a good business for us. I think the one thing we have said is, I think our interest in starting de novo plans, where it's from scratch, there's probably less interest there because there's just lots of scalability issues in building members, but we have a number of provider-oriented organizations that have been in their markets for 10, 15 years with a large number of lives, and I think that's very good business for us.

The next question today comes from Jamie Stockton of Wells Fargo.

I guess, maybe first, just on an appeal. Can you talk about what your expectations would be around timing?

Well, I think our hope would be that it would be a fairly rapid process. And we have, from what I understand, it's roughly 14 days post the decision, just to bid the appeal somewhere in that range. We'll obviously submit an information request. So we have transparency into the process, how it was conducted. Hopefully, that will be turned around relatively quickly. We'll do the analysis. We'll try to understand was the evaluation criteria appropriately applied, does the scoring make sense. And we'd try to, again, adjust our appeal on that basis and hopefully hear back in a short period of time. So we're not looking for a long-drawn-out process. We obviously want it to be fair. We want it to be reflective of what we think Passport brings to the table and 20-plus years of experience. And hopefully, we can move through the process very quickly.

Okay. And then maybe my other question, just in the event that an appeal doesn't go your way and you're looking at a wind down for Passport, is there a scenario where you could see, because there is significant infrastructure there, I think they employ something like 600 people, obviously, have a lot of existing provider relationships, et cetera, is there a scenario where you could see one of the new entrants into the program taking that asset off your hands and maybe making it a smoother transition, especially when we think about the cost of a wind down in 2021?

Yes. I mean I would say, right now, we're obviously focused on operating the plan. We've got a lot going on just in general in the health care market. Second, on making sure we collect all the data we can to understand the process and the appeal. There are definitely assets related to Passport. There's a lot of focus on West Louisville and the center we were planning to invest in there. And we would obviously want to do anything to ensure the best transition for our members, for employees, for the vision we have around community-based health care. So I wouldn't say there's anything that we're actively focused on at this moment. But I think we always would want to make sure that we do the right thing for the members and the employees, and we'll always be open to different options there. But right now, we're largely focused on moving through what we hope will be a very quick appeal process.

The next question comes from Matthew Gillmor of Baird.

In a wind down process, could you just give us a sense for how the revenues would look? Would there be any revenues from Passport in 2021? Or do those just simply go away?

I mean as I said before, we would expect a normal flow of our revenues from now until the end of the year. There are some runout services because you'll have ongoing claims, and you'd obviously work out some arrangement there that would probably have some revenue associated with it. You'd still have some costs associated with it because you need to keep that aspect of your claims operation running. So I would imagine we would see some revenue there. I don't think it would be significant, but you would see some revenue going into next year during the runout period.

Got it. And then one more kind of guidance comment to confirm. Frank, I think you said you'd expect margins in 2021 to approximate what they were in 2020, which I think is around sort of 3% based on the midpoint of guidance. Was that correct? Or did -- was the commentary something different than that?

No, I think that's correct. And I think the logic, if you think about it, that's the range we projected for this year. We're obviously having some revenue come out. We have to maintain some of the cost structure in the runout period. So you'll have some lumpiness in the first half of the year. We obviously feel like we'll expand margins quarter-by-quarter and build a strong exit run rate in the second half. But sitting where we sit today, and again, some things could change to the positive, we feel like a similar range around the 3% that you talked about is a decent starting point at a minimum.

The next question comes from Sandy Draper of SunTrust.

Sandy, are you there?

Sorry, I had you on mute. I'm back.

No problem.

So just a couple of clarification questions. Am I correct, is there an additional -- do you have to buy out the other 30% owners? If I remember correctly, that was in there somewhere, but then you would recoup all of the capital. I'm just trying to think about the cash flow and balance sheet impacts. Just first, I wanted to clarify if there's any buyout you have to do for the partners?

I mean just to be clear, I mean, I think we've tried to keep it simple. We invested capital into the plan that had the initial investments and a note. And I think what we're saying is with all obligations, claims and there is a payout at the end to the owners, that with all of that, we will recoup substantially all of our capital. But it is correct and it's a payment we've taken into account. And given the strength of the balance sheet and how well the plans performed, we believe we'll be fine on our overall capital base.

Okay. Great. And then can you just -- in terms of the 2021 commentary, what is -- what sort of run rate are you assuming for Passport this year that you're pulling out?

Roughly $50 million a quarter. So if you think about it, yes, I mean -- and again, it's been a large client for us. I think the good news is we've had strong momentum in our core business, very high growth this year, obviously. But we feel like with growth across the portfolio as well as the new additions, we expect that we would be on track for traditional mid-teens growth rate. You do that math, and that's what gets us to the $900 million range in terms of total revenue.

The next question comes from Charles Rhyee of Cowen.

Frank, I understand we're going to get all our capital back, but can you talk about typically how long it takes for states to return risk-based capital? And I ask this because, if I'm not mistaken, you guys have a 2021 convert due in December of next year. Do you think you'll be in a position to be able to pay that back? Or would you look to roll it into another convert?

Hey, Charles, this is John. Obviously, we'll work with the state on this. The most important gating item is how quickly the other liabilities are paid out during the wind down process. And if you look at how this has happened in other plans, historically, 90%, 95% of the claims are paid out within the first 4 to 5 months. And so it would be our expectation that a substantial percentage of that capital would come back across '21 and be usable for the 2021 converts. And a combination of that and the $15 million delayed draw with Ares gives us a significant amount of capital coming into the business across the next 18 months.

Okay. So the risk-based capital from the state, it doesn't come in one lump sum. It comes over a period of time as they kind of -- do they measure against the outstanding claims left?

That's right.

Yes, that would be generally how it works, yes.

Okay. And then one last. So Frank, you talked about we have 2 weeks to protest the decision. When do you expect the scoring to be available?

The scoring has already been released. And as I said in my commentary, the scoring was largely the same as before. Now it was the same RFP and largely the same scoring. But a lot of the sub details, we don't have. So if you look at our full request and what you want to understand about the full process, we still have a lot of information to gather. That's something we're putting together right now and we'll obviously submit as part of the process so we can really understand how the evaluation criteria was applied, what the process was. A lot of times, you'd like to see more detailed comments on the scoring and things like that, and we're going to work to collect that information.

And you said at the beginning, right, one of the questions asked is whether a reviewer saw the previous scoring. Is that typically an anomaly for people to do that? Is that to get fresh eyes on it? Or is that a common practice where people do see previous -- those reviewers might see previous scoring?

Well, from our standpoint, obviously, that would bias the reviewer substantially if they had reviewed the previous scores, particularly given, I mean, a lot of times, you'll have a very different RFP in the second process. This was almost exactly the same RFP, and we just want to make sure that there wasn't bias relative to the scoring. In this process, we used numerous outside national experts. We had review councils. It was a substantially different RFP that we put together. And again, just very surprised that the results came out where they did. And we want to make sure it's not because they just simply repeated the same process 2 times and leveraged what we think was sort of a poor assessment, the first time, a second time around. So we've obviously got to look at it. And again, we want to gather information. We want to make sure it's a fair process that Passport's 20-year experience is valued and should be, obviously, and that there wasn't some sort of bias in the process for organizations that are national versus local. So that's where we're going to try to gather the information. We'll know a lot more. And again, we just want to make sure it's a fair process.

The last question today comes from Jessica Tassan of Piper Sandler.

Just interested to know like within the Kentucky scorecard, if there are any specific categories you might point us to where Passport scored suboptimally or kind of weaker and that you guys think are deserving of a higher score that ought to be reconsidered.

Well, I would say it's preliminary. We just got the scores. We're looking through it. Again, places like company experience, where an organization has had 23 years of experience in the state and where you see out-of-state examples, even for players that are in the state today, and they're citing out-of-state examples rather than ones in state, I think, is a poor application of the concept of experience. So I would say there are places like that and lots of points in those places where if you had just a fair interpretation of 20 years of experience in states, that I think you would get to different scores. And so I think if you look at places like that or things that are not consistent with the last review process, where you received a score that was a perfect score, your response was largely the same, and then suddenly, you've got a very, very different score. So I mean, we have a lot of analysis we need to do, but I think there are places where we would think based on the unbiased reviews we had done prior by outside experts where they thought we were particularly differentiated versus other plans given the long history and then where the scores don't reflect that and don't seem to make sense. I mean those are the areas that we're going to focus on.

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

Great. We appreciate everyone participating in the call. We have some up-and-coming conferences in the next couple of weeks, and we look forward to reconnecting with many of you. And again, thanks for participating in the call this morning. Thanks.

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