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

This is Cheri Mowrey. I am co-head of the U.S. Healthcare Investment Banking business at Morgan Stanley. Thrilled to have with me today, Seth Blackley, the CEO and Co-Founder of Evolent Health; as well as John Johnson, the Chief Financial Officer. Before we get started, I'm going to read a quick disclaimer. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. All right. With that over with, let's just dive in. I know you've had conversations with the investors over the last couple of months, but partnerships have been a really strong point of performance for you guys. Can you talk a little bit about the recent momentum that you've had in the market? And any details that you can share with us around Molina, that partnership, and the estimated long-term opportunity there.

Sure. Thanks again for having us, Cheri. Yes, I think overall, we're very pleased with the top line performance of the business. And when we think about the recent partnerships, there are a couple of things I'd highlight. One is just the balance across the 3 different businesses that we have. We've have good success with New Century, but also with Evolent Care Partners and with Evolent Health Services. Second, just in general, I'd say the macro environment, Cheri, has been quite strong. There's a couple of different factors. The general value-based care environment has been great, but I'd say also the pressure that many of the payers are feeling right now, particularly with some of the dynamics of COVID bounce-back and the like have really just set up a very good selling environment for us in general. I think that's a segue into your specific question about Molina, and they've been a fabulous partner for us. We've started working with them last year and have had a good start to the relationship. And I think the expansion that we just announced with Ohio is an important one for us just that it's a large state, an important state and the like, but also that it is a proof case for sort of shifting from our technology product to our full performance suite on the New Century side. And we talked about the $75 million kind of annualized run rate opportunity for Molina by kind of early to mid next year. So that kind of range finds it for next year, but certainly, it could be a much larger relationship over time, and we're working hard to get it to the larger end of the spectrum.

That's great. Thank you. So you mentioned the conversion from the technology and services solution to the higher-margin full New Century Health Performance suite. Can you tell us a little bit about exactly how you're planning to accelerate the transition here?

Yes. What's interesting for those who are a little bit new to the Evolent story, within the New Century product, we do have these 2 versions. One is a technology, lighter Software-as-a-Service model. The other is what we call the Full Performance Suite, which is over 10x the size from a revenue perspective, a little bit lower on a margin percentage basis, but higher in terms of total margin dollars and higher savings yield as well for the client, for the partner. And so what's nice about that setup is, often, we can go live very quickly with the technology product and we scale across the country very quickly as we've done over the last couple of years with that solution. It gives us a chance to get in and get going, but then have the data to frankly have the conversation with the health plan partner or the risk-bearing physician group about, hey, here's what we could do if we actually converted this to the full performance side. So it's a nice way to get going, move quickly and then you can expand the product. And so we're happy that the Molina Ohio opportunity gives us a proof case for that, and I think we'll have lots of opportunities similar to that around the country.

That sounds great. Let's talk for a minute about CountyCare. Just give us a sense for how you guys are thinking about approaching the renewal discussions. And any dynamics you can share with us around the probabilities and the dynamics on that?

Yes. So obviously, CountyCare, an important relationship for us, given the way that the County procurement rules work. We've been in the relationship for about 5 years now. It's sort of standard operating procedure for them to run a process to look at our contract after this period of time. We feel really good about our chances in terms of winning the renewal here, and I think that comes down to a very strong track record with them as a partner if you look at the cost and quality of the service that we provide and then the cost and the quality of the health plans serviced to the market, and then as always, our ability to kind of add, enhance what we do in terms of the ability to improve our cost and quality of the service each year. So we feel like we're in a very good spot. As we talked about to your question on process, we expect the procurement process across the fall. At some point, we don't know the exact timing, but across the fall and have a good sense that we'll know headed into next year how we did in the procurement. And again, we feel very good about our opportunity. I think the only thing just to clarify for everybody, sometimes we get the question about, hey, what is this in terms of what's being procured. It's just for our Evolent Health Services piece of our relationship, which is about 1/3 of our CountyCare relationship, and the other 2/3 is the New Century part, and that's not part of the procurement.

Great. Thanks. You guys have been posting very impressive results and taking guidance upward. And in spite of that, investors are concerned about cash burn. So can you talk a little bit about how are you thinking about balancing growth versus this cash burn? And any investment initiatives that you'll be making in near term?

Yes. I'll take that one, Cheri. This is John. It's an important question. And the first thing to focus on in our financial statements as it regards to cash is because we consolidated Passport's balance sheet when we sold the assets of that plan or certain assets of that plan back in September, over the last several months, we've been paying out claims from the Passport Health Plan -- from Passport's bank account, which is consolidated into our cash balance. That's an ongoing use of cash but is not part of our normal operating results in terms of our ongoing business. And so if you -- I like to point investors to our available cash number, which quarter-to-quarter from Q1 to Q2 was approximately flat, around $140 million, and we expect that to grow from here as we're now cash flow positive on an ongoing basis.

That's great. Thanks. We've also seen not just the strong earnings, but we've seen meaningful margin expansion. So as it relates to that, the Street is crediting the growth in Clinical Solutions and the integration of automation and machine learning and administration. Can you just discuss a little bit more about the margin expansion story from here going forward?

Yes. Yes, absolutely. So we've identified 3 core areas that drive our margin expansion. The first is around cost reductions, which, as you mentioned, are -- in part come from automation and machine learning and so forth, principally within our Evolent Health Services business, which is a large opportunity to deploy those sorts of initiatives. We also have an opportunity in front of us. It's a bit of a tailwind for our margin. where the significant growth that we've brought on board from New Century over the past 18 months, the way that those risk contracts shape over time is the initial margin for, say, the first 12 months is at a lower rate than the ongoing margin because it takes a certain amount of time for our network initiatives and our performance to raise the quality of care throughout the network, which is associated also with that decrease in costs and ultimately an increase in our margins. The last component of margin expansion for us is simple SG&A leverage of around 10% of our costs being fixed costs that as we're growing in the mid-teens will drop about 1 point of margin expansion to our bottom line here. The 3 of those together, we believe, puts us in the mid-teens from an adjusted EBITDA percentage perspective in 2024.

That's great. Thanks. Let's switch a little bit to the strategic road map here. You guys have had great receptivity from investors on the Vital Decisions acquisition, Tell us a little bit about the strategic fit and how you're thinking about that business in the context of the growth story going forward.

Yes. Happy to talk about it. So a couple of things on Vital. First, one thing that we're excited about is just with respect to the space that Vital is focused on, is the end-of-life space. And unfortunately, it's an area of health care that is under-addressed today and a place where as 1 stat, 90% of patients would like to have an end-of-life conversation with their physician or caregiver, but I think only about 20% of patients end up having those conversations. As a result, of the 30% of total cost is at the end of life, and yet 20% to 30% of that cost are things that the patient ultimately doesn't even want to care, they don't even want to incur. And so you've got this dynamic where you have -- and we've all seen it sadly and from a personal perspective. You have this dynamic, where at the end of life, there's a lot of excess cost that doesn't extend life and certainly increases suffering and increases costs. So big opportunity is kind of point 1. Point 2 is that about 50% of all end of life is either cardiology- or oncology-related. And obviously, those are the 2 specialties where New Century is focused in. Today, Vital Decisions does all of their work and the great work that they do directly with the patient and the consumer. We believe, particularly for the 50% where it's cardiology and oncology, that we can enhance the level of engagement and the value of the cardiologists and the oncologists, the provider are more engaged in the care planning decision around end of life. And sadly, many of these oncologists, cardiologists, between not having time or training or the expertise to have one of these end-of-life conversations, they're just not having them, and again, that's yielding a result that is not what the patient wants ultimately. So Cheri, the basic idea is to help address this human issue and this cost issue by using the capability of Vital, but really integrating it with the cardiologists and oncologists primarily. And so the product will be integrated into New Century. It will be sold with the New Century product. It will also be made available with capability to our existing New Century clients and used in those environments. We think it will enhance the ability to -- for New Century to grow, it will enhance the profitability of New Century and it will improve patient quality along the way. So we're very passionate about it. It's something that needs to happen. It's an opportunity that we think is one of those win-wins in health care and good for patient and a big cost savings opportunity.

And the market agrees, which is great.

Yes. It's good.

Good validation of the strategy. Just discussing a little bit more on the capital deployment side. You referenced $45 million in product development for software that was expected to be deployed this year. What are some of the strategic objectives in deploying that capital on the technology side?

Yes. I'm happy to start there. And Seth, chime in as well. As we think about deploying capital for product development, Cheri, we really do try to take an ROI-focused approach, and that can come in a number of different ways. As an example, within our clinical R&D work, we're constantly digesting enormous sums of data and incoming journal articles and so on to identify and improve our Level 1 pathways that ultimately drive improved quality and performance in the product. Another example is driving unit cost efficiencies within the products sort of across the business, whether that's the CarePro platform within New Century, making it easier to navigate or automating claims adjudication on the other side in the Services business. The last thing that I would just highlight around the internal product development is this sort of discipline that we seek to instill to sort of stay ahead of the curve. We believe that we have been able to develop over the last decade a real industry-leading set of products around risk stratification, around oncology and cardiovascular care and so forth. And so they're constantly seeking to remain ahead of the curve, to keep them industry-leading is an important part of our investment strategy there.

That sounds good. That leads me to the next logical question which is, where are you going to invest in the future? Will there be more of a focus on reinvesting in your current verticals where you're specialized already? Or is there another specialty that you'll pursue to add on to the portfolio?

Seth, why don't you take that one?

Yes. So I think the way we think about that question, Cheri, is within New Century today, we have sub-5% market share. It's kind of the way we think about it. And it's on a dollar basis, on a life basis, on how many cancer/cardiology patients we're treating than the U.S. And given that fact and given that we think we have the market-leading product in those areas, in our mind, the most logical thing is to drive market share first. Meaning, let's go from 5% to 10% to 15% to 20% over time and do that through enhancing the value proposition, things like Vital that improve the quality of the service that we're providing, enhance the savings, make our product more sticky and more valuable. And let's invest and focus there. And once we're getting to those higher market share levels, then I think that's a logical time to think about broadening. But for now, I'd say deep rather than broad is our strategic focus. Now one thing we like about Vital is it does slightly broaden what we're doing. We'll absolutely focus on depth, and that's -- those are particularly interesting to us when you can do a little bit of both at the same time. And certainly, we'll keep our eye out for other opportunities like that.

Makes a ton of sense. Just taking a step back and looking at the broader landscape, what are the catalysts that you guys are expecting to see or particularly focused on that could impact your business, let's say, over the next year or so?

Yes. I'd just say, in general, the biggest things for us are around needs that risk-bearing organizations have. So when one of our large payer partners has a need around managing costs, and many of those issues, Cheri, could be evergreen, right, the cost of cancer care is an evergreen issue; higher-quality, lower-cost care evergreen, an issue, those are always going to be the biggest driver. We like that because those are not subject to any policy changes. It's not subject to the wham of given administration's change. And they're going to be around, I think, for decades to come. So that's the main driver. I think around the edges, things like enhanced pressure on the managed care space are positive for us from a sales pipeline perspective. So some of the dynamics that you read about, you track the large managed care organizations, a lot of MLR pressure right now due to COVID and the like, and that is helpful for us. I'd say, in addition, the policy-driven actions that you see coming out of the Biden administration are very consistent with what Obama and Trump did around value-based care, and they're probably accelerating those a little bit even. As a for instance there, Cheri, there's a product that's in development within CMMI, the Center for Medicare and Medicaid Innovation, around oncology, and that could be very interesting for us. So those things are nice tailwinds. But in general, we like the fact that we've got, I think, a very stable selling environment kind of regardless of policy.

Yes, and it certainly looks like it's going to sustain itself for a period of time here. Can you discuss a little bit the recent announcement on exceeding quality standards when you're saving Medicare with that $21 million? What are the lessons learned? And what are the key drivers of reaching that milestone?

Yes. So that -- the opportunity you referenced is with our care partners business, which is our primary care-based business unit, which for those again who are a little bit newer to the story is more akin to some other primary care -- public primary care comps that exists. We're not an employment model, so we're not like an Oak Street, but like some of the other network-based primary care models, helping work with the independent primary care physicians and driving savings and quality improvement back to the payer. In that -- in this case, the one you referenced, obviously, the payer is CMS, and the programmatic opportunity is around the Pathways to Success program. It's an ACO. We're thrilled with the performance. It's the first full year of performance for that business unit. We started this unit back in 2019. 2020 was the first full performance year, and really happy with the results. Both the $20 million of savings, which helps drive our revenue and EBITDA, probably equally importantly to your point, the quality to the patient. And then the physician, we noted in our press release, the average physician of the first year making $25,000-plus of incremental income, which is what makes the product sticky and interesting and gives us a growth opportunity. So that business unit today, about 1,000 providers that are in that network and close to $1 billion of total premium, we're managing and growing. So really important part of the strategy for us. Doesn't show up on the top line of Evolent in a huge way given the rev rec model, which is gain share-oriented and not gross revenue-related. But the EBITDA potential is very significant, and I think the team is very passionate about what we're accomplishing here.

That's great. Thanks. Look, with such strong second quarter performance and the market receptivity that you've received on the second quarter performance, what are the key focus areas to sustain the momentum as you finish out the year here?

Yes. So a couple of things, Cheri, on that question. One is, as is always the case, continuing to fire on all cylinders operationally in terms of delivering quality and the product that we deliver to each of our clients across the 3 areas. That's obviously important. Second, this is kind of the time of the year where you close out the pipeline from a revenue perspective instead at 2022, and we feel very good about where we are on that front. Third is kind of an evergreen issue, but I think it's important in every quarter of the year, which is around product and strategy. And so integration of the Vital transaction after that closes and continuing to be, what I would say on our front of our toes, around being able to expand the value of our products and that we have from a values perspective. Really focused on being best in the world at each of our 3 solutions and being the market leader, so continuing to stay aggressive there. And then fourth and finally is talent, and we think we have a phenomenal team and a great culture and very high engagement scores focused on diversity, equity, inclusion, all the things that I think make for a high-performing team. And you can't take a minute off on that front either, and we're staying very focused on trying to have the best team in the market.

Sounds great. We're getting here near the end of our session. Anything else that you'd like the investors to be focused on as they think about Evolent and the opportunity to invest in the company going forward?

The only other thing I'd just highlight, and maybe John would add something, too, but in our conversations with investors, this work we're doing in value-based care, there's this $1 trillion of waste and all these quality opportunities that we talked about, and there are a number of companies running at that, I think we're particularly proud of having a strong growth rate and translating that to the bottom line and being very disciplined about doing both of those things. And we think we have a long pathway ahead. As John mentioned earlier, on margin expansion, while continuing to be mission-oriented and growth-oriented and all those sorts of things, also translated to the bottom line from an EBITDA and cash perspective. So -- and that's clearly a key message that resonates a lot with investors.

Absolutely, absolutely. Look, thank you so much for being with us today. We really appreciate this discussion and look forward to seeing your continued success.

Thank you, Cheri.

Thank you.

Thank you, Cheri.

Bye.