Evolent Health (NYSE:EVH)
Q3 2017 Earnings Conference Call
November 2, 2017 05:00 PM ET
Executives
Frank Williams – CEO
Nicky McGrane – CFO
Analysts
Robert Jones – Goldman Sachs
Jamie Stockton – Wells Fargo
Ryan Daniels – William Blair
Matthew Gillmor – Robert Baird
David Larsen – Leerink
Mohan Naidu – Oppenheimer
Charles Rhyee – Cowen and Company
Richard Close – Canaccord Genuity
Donald Hooker – KeyBanc Capital Markets
Operator
Welcome to Evolent Health Earnings Conference Call for the quarter ended September 30, 2017. 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 website, in the section entitled Investor Relations.
Here is some important introductory information. This call contains forward-looking statements under the US 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. For additional information on the Company’s results and outlook, please refer to its third quarter news release.
As a reminder, reconciliations of non-GAAP measures discussed during today’s call to the most direct comparable GAAP measures are available in the Company’s press release issued today and posted on the Investor Relations section of the Company’s website ir.evolenthealth.com and the 8-K filed by the Company with the SEC earlier today.
At this time, I would like to turn the call over to the Company’s Chief Executive Officer, Mr. Frank Williams. Please go ahead.
Frank Williams
Thank you and good evening. I’m Frank Williams, Chief Executive Officer of Evolent Health and I’m joined today by Nicky McGrane, our Chief Financial Officer.
I’ll open the call this evening with the summary of our financial performance for the quarter and share our perspective on the overall market. I’ll then hand it to Nicky to take us through a detailed review of our third quarter results and I’ll close with an update on operations on our platform. As always, we’re happy to take questions at the end of the call.
Beginning now with our financial results, for the quarter ended September 30, 2017, total adjusted revenue increased 80% to 108.4 million from the comparable quarter of the prior year. Adjusted EBITDA for the quarter ended September 30, 2017 was 2.6 million compared to negative 3.1 million from the comparable quarter of the prior year. As of September 30, 2017, we had approximately 2.7 million total lives on the platform, an increase of 84.7% year over year.
Overall, we’re quite pleased with our results, having met our strategic, operational and financial objectives for the quarter. On the new business front, I’m pleased to share that we’ve entered into an agreement with Beacon Health, part of Eastern Maine healthcare systems or EMHS. The second largest system in the state, EMHS has eight integrated physician organizations, nine hospitals and nearly 40 primary care locations with over 1 million of Maine’s residents in its service area.
We will initially provide health plan management services for Beacon’s employee plan of approximately 18,000 lives with a plan to expand to a broader base of regional employers over time. We’re excited by the strategic vision of the Beacon leadership team and are looking forward to partnering to bring provider led value based care to the communities of Maine for several years to come.
I’m also pleased to announce the expansion of our partnership with Premier Health in Ohio. Premier has been a longstanding customer and we’ve been working with their leadership team on four key elements of their value strategy since 2013. The health plan for Premier’s 18,000 employees, the launch of large group commercial plans, the launch and expansion of Medicare Advantage plans and finally, payer partnerships including next generation ACO. Based on the strength of the relationship and market opportunity, we’ve entered into an agreement to acquire the MA and commercial assets of the Premier Health plan and we’ll also continue to serve Premier in a long-term arrangement to support their value based care arrangements and population health infrastructure.
Combined, we expect these Premier plans will have about 10,000 members in 2018 and total revenues will be approximately 90 million. We expect total revenues from Premier, including the health plan to be roughly comparable to revenues in 2017. Our excitement about expanding the partnership is largely based on our experience in Dayton as well as the current dynamics in Ohio where we see a clear long term opportunity to build a high performance provider led offering across several regions with Premier as our anchor partner.
While the leadership team at Premier is clearly committed to the value strategy based on its community mission focus in Dayton and priorities for growth capital, we mutually agree that Evolent would be the right source of growth capital for regional expansion, given the extent of the opportunity. From our perspective, this represents an excellent opportunity to take a plan that we know well, build around a strong committed provider in Premier, continue to drive performance improvement through the full deployment of our valued based care platform and ultimately scale the plan across multiple regions and populations. Premier has a fantastic reputation clinically and as a collaboration partner and we’re excited about the opportunity to deepen our relationship and to bring provider led value based solutions to more communities in Ohio in the years to come.
In terms of what we’re seeing in the overall market, we just completed our annual executive summit event in mid-October where we convened leaders from over 60 leading health systems and provider groups, including our operating early stage and prospective partners. In this forum, we get to hear directly from the market leaders in value based care, regarding their growth ambitions, early areas of success and specifically what they’re looking for from Evolent to power long term performance.
Amongst the health system attendees, health policy experts and industry luminaries, there was an overwhelming sense that the market movement to value based care is here to stay and accelerating, given the overall pressure on health care spending and the changing demographics of the population. While each organization has a different set of priorities in terms of Medicare or Medicaid in the commercial segments, there is also emerging evidence of improved quality and significant reductions in total cost of care in value based arrangements, particularly in high risk patient populations.
Given that over 60% of overall healthcare spending in the next five years is moving to chronic condition patients in Medicare and Medicaid, our partners are focused on harnessing inherent provider advantages in terms of the ability to leverage in depth clinical data for risk stratification as well as integrating employed and independent physicians in the development of clinical pathways and targeted interventions to more effectively improve the health of the population.
With greater pressure on reducing growth in healthcare spending, the emerging winners in the market will be those organizations that can truly impact quality and cost, given that it represents the vast majority of the premium dollar and the greatest opportunity for improved efficiency. The dialog at the event, which was facilitated by Evolent experts and representatives from CMS and other health policy organizations brought to life the emerging industry commitment to population health as well as the importance of moving to well-constructed risk based arrangements to capture the economic value from driving substantial improvements in patient outcomes.
The key themes that emerge from the summit this past month have also been reinforced by a number of our recent activities in the broader healthcare market. From recent policy statements from CMS, state based health initiatives, [indiscernible] performance, a broader commitment to accelerating value based care is emerging. The confluence evidence and support from key policy makers is an important step in driving market acceleration through a few stops and starts with the new administration in the first half of ’17.
For example, just this week, Seema Verma from CMS spoke at a meeting for the healthcare payment learning and action network in which we participate and clearly reinforced that value based reimbursement remains foundational to health policy and Medicare and Medicaid. She also emphasized that CMS wants to give providers and state government’s even greater flexibility to drive innovation and performance based initiatives. This openness to provider driven program innovation offers a clear opportunity for Evolent to organize a broader payment initiative across its national network with CMS in Medicare as well as at the state level with providers in Medicaid.
Many of you also may have seen the recent report from the Office of the Inspector General that ACO has achieved approximately $1 billion in savings from Medicare, while also improving performance on over 80% of key quality measures. It’s also worth noting that the most experienced organizations are consistently delivering the best outcomes, which suggest the momentum around performance is likely to build over time.
We’re also seeing similar results on the front lines with many of our partners in the next generation ACO and Medicare shared savings programs that are generating millions of dollars in savings, including one of our partner systems in the Midwest that is one of the top performing ACOs in the country and several systems that have reduced inpatient admissions for complex patients by over 38% and reduced readmissions in transition care by over 35%.
That same success is translating to the commercial segment, including one of our health system partners that achieved over 15 million in total cost reduction and improved quality performance for our commercial population, helping to build confidence with local employers in value based care models. Overall, when we look at the impact of Evolent and our partners across 2017 from a clinical perspective, we used our sophisticated stratification model to engage more than 26,000 patients in our clinical programs, have closed over 60,000 gaps in care across all populations and have helped patients spend over 25,000 days at home that without intervention would have likely been spent in the hospital.
That’s better care for the patient as well as substantial reductions in cost for avoiding unnecessary hospitalizations. This type of proven clinical performance and its resulting impact on our partner’s financial success is helping to extend our reputation as the market leader and the partner of choice, as organizations leverage our infrastructure, clinical knowledge base and deep expertise to create a differentiated physician and patient experience and associated outcomes.
In terms of our pipeline and overall progress in setting up 2018, we’ve had some good forward momentum across the last quarter. If you look across contract renewals, same store revenues, new partner additions and opportunities in our current pipeline. First of all, across our network of approximately 30 partners, we have several this year that have come up for extension or for formal renewal. The good news is that we anticipate renewing all of our large relationships as well as maintaining our estimated 90% plus unit renewal rate with our core operating partners. We’re in a good zone on maintaining our core base of partners and expanding our network with the pace of new customer additions.
In terms of anticipated growth across our existing partner base, we’ve successfully launched Passport and as of today an additional 150,000 plus lives for Cook County onto our health plan services platform, which should contribute meaningfully to our revenue in 2018. We also expect to close our expanded relationships in New Mexico and in Ohio late in 2017 or early ’18, both of which offer substantive long term growth opportunities.
On the other side of the ledger, we’ve had one partner in the Midwest that’s evaluating the potential to in-store several functions that we currently provide, which would have a modest impact on overall revenue for 2018. Across the vast majority of our partners, we anticipate maintaining our service space and therefore growth is dependent on discrete contracting decisions in Medicare ACOs, delegated payer arrangements and open enrollment periods and health plan arrangements. While a number of these contracts are largely in place and establish a strong base as we head into 2018, there’s still a number of decisions between now and the early part of next year, which will determine total lives on the platform and the associated revenue contribution from the existing customer base.
In terms of our pipeline and the macro environment overall, we feel good about our six new partner additions in 2017, which is at the midpoint of our anticipated range for new customers. Houston Methodist and Carilion Clinic are operating well today and Orlando Health, Community Care Cooperative, Crystal Run Healthcare and Beacon Health are all on track and progressing towards a 2018 launch. Our overall pipeline continues to be strong, particularly in next-gen and Medicaid and we’re confident that we should have additional signings to announce in 2017. In next-gen, on top of the 2017 cohort, we’ve been supporting a number of organizations in the application process and see the potential to add several new participants in 2018. We will not know final participation numbers on current and new cohort participants until the January timeframe when updated benchmarks are issued and final commitments are acquired.
In Medicaid, we continue to see a number of opportunities with innovative partners in several active states that are evolving their approach to value based reimbursement. Timing in Medicaid is more difficult to predict because our partners first need to be selected in the RFP and then begin the process of implementation for launch. We’re setting up some excellent opportunities for 2018 and 2019, but we’ll not have clear visibility on revenue timing until the early part of next year.
Finally related to our four health plan partnerships, we’re working diligently in New Mexico and with Premier in Ohio on open enrollment for 2018 and we’ll upgrade our visibility on covered lives in the January timeframe. We do not currently anticipate any additional health plan partnerships that would impact platform and operations revenues in 2018. Given all of the above, we’ve made good progress across the last quarter in a number of areas in terms of setting up 2018.
We enter Q4 with a strong base, a number of new partners and a focus on execution. Accordingly, our client service teams are diligently supporting our partners on discrete population decisions for our partners in next-gen and payer delegated risk arrangements, moving relatively complex Medicaid pursuits forward and hopefully reaching the high end of our target range on new partner additions. We anticipate that this focus combined with extensive work this year on driving efficiency and scalability in our core infrastructure will set up an attractive 2018 from a financial performance perspective.
With that overview, I’ll turn it over to Chief Financial Officer, Nicky McGrane to speak about our financial performance for the quarter.
Nicky McGrane
Thanks, Frank and good evening, everyone. Today, I will cover our financial results for the third quarter of 2017 and provide guidance on our outlook for the remainder of the year. I’m pleased to report that Evolent continued to deliver very strong results in the third quarter, exceeding our guidance on both the top and bottom lines and achieving positive adjusted EBITDA for the first time in the company’s history.
For the quarter, adjusted revenue was 108.4 million and adjusted EBITDA was 2.6 million. Adjusted revenue for the quarter represented 80% growth from the same period of the prior year, while adjusted EBITDA increased 5.8 million from the prior year. Adjusted loss available for Class A and Class B common shareholders was negative 3.2 million or negative $0.04 per share for the quarter compared to negative 6.6 million or negative $0.11 per share for the same period of the prior year. Finally, we managed approximately 2.7 million lives in our platforms during the quarter, an increase of 85% over the prior year.
Before I turn to a detailed review of results, I would first like to provide some additional detail on the transaction with Premier Health that we announced today. As laid out in the 8-K we filed today with the SEC, we are acquiring the MA and large group commercial plans from Premier. Based on expected membership in 2018 of approximately of 10,000 members combined, the purchase price will be approximately 31 million, subject to certain post-closing adjustments. Consideration for the transaction will be a mixture of cash and stock with approximately two-thirds cash and one-third stock. We expect the transaction to close in the first quarter of 2018.
Now, let’s turn to a more detailed review of our adjusted results for the quarter. As a reminder, we derive our revenue from two sources, transformation and platform and operations services. Adjusted transformation revenue accounted for 8.2 million or 7.6% of our total adjusted revenue for the quarter, representing an increase of 0.4 million compared to the same quarter last year. Transformation performance in Q3 was just above the range of 6 million to 8 million that we expected for each quarter in the back half of the year. Adjusted platform and operations revenue accounted for 100.2 million or 92.4% of our total adjusted revenue for the third quarter, representing an increase of 47.7 million or 91% compared to the same quarter last year.
This increase was driven primarily by an 85% increase in the number of lives managed on our platform from approximately 1.5 million to approximately 2.7 million during the third quarters of 2016 and 2017 respectively. The increase in lives in our platform was due primarily to the addition of new partners and growth in existing markets. Our average PMPM fee for the quarter was $12.20 compared to $12.22 in the same period of the prior year.
Adjusted cost of revenue increased to 65.7 million or 60.6% of adjusted revenue for the third quarter, compared to 33.7 million or 56% of adjusted revenue in the same quarter the prior year. Adjusted SGA expense increased to 40 million or 37% of adjusted revenue for the third quarter compared to 29.6 million or 49.2% of adjusted revenue in the same quarter the prior year. The increase in both adjusted cost to revenue and SGA expense year over year was due primarily to the cost that we assumed from the acquisitions of Valence and Aldera as well as additional personnel costs and third party support services across the organization tied to grow the membership and new partners.
This is the seventh consecutive quarter where we’ve seen a decline in adjusted SGA as percentage of adjusted revenue. We continue to expect total adjusted SGA expense to decreases as a percentage of our total adjusted revenue over time. Combined our total adjusted cost of revenue and adjusted SGA expense as a percentage of total adjusted revenue, declined to 97.6% in the third quarter of 2017 compared to 105.2% in the same quarter of the prior year and we are very pleased with the progression towards positive adjusted EBITDA in the quarter
Adjusted depreciation and amortization expense in the quarter was 5.4 million or 5% of adjusted revenue compared to 3.7 million or 6.2% of adjusted revenue in the same quarter the prior year. The increase was due primarily to the DA assumed as part of the acquisitions completed in 2016 as well as additional software assets being placed in service. We expect absolute adjusted depreciation and amortization expense dollars to increase in future periods as additional software assets are placed in service.
As of November 1, 2017, there were 74.7 million shares of our Class A common stock outstanding and 2.7 million shares of our Class B common stock outstanding. Our balance sheet remains strong with 287.1 million of combined cash and cash equivalents as of September 30, 2017, reflecting the proceeds from our 175 million primary offering of Class A common stock during this past August. For the third quarter, cash provided by operations was 6.9 million, cash provided by investing activities was 13.1 million and cash provided by financing activities was 167.2 million.
Now, on to guidance. The following comments are intended to fall into the Safe Harbor provisions outlined at the beginning of the call and are based on preliminary assumptions which are subject to change over time. For the fourth quarter, we are forecasting adjusted revenue to be in the range of approximately 110 million to 112 million and adjusted EBITDA to be in the range of approximately 3 million to 4 million. For the full year, we are taking up guidance and expect adjusted revenue to be in the range of 432 million and 434 million and adjusted EBITDA to be in the range of approximately negative 3 million to negative 2 million.
In summary, our Q3 results demonstrate the progress we’re making against our key objectives. This concludes the financial summary. I’ll now turn things back over to Frank.
Frank Williams
Thanks, Nicky. I want to close with a few updates on progress with our new partners on the year and product development overall. As I alluded to earlier, delivering a differentiated experience for providers and consumers continues to be a focus for health systems and health plans looking to grow market share through improved engagement, cost and quality. This is a core reason that we continue to invest in the technology and services platform that power our partners’ value businesses, including our health plan services platform and identify. Earlier this year, we spoke about the planned migration of Passport Health Plan to our health plan services platform.
As a reminder, we made this decision together for several reasons. First, we wanted to provide a higher level of service for Passport members and providers. By integrating our clinical and administrative platforms, we’ll be able to provide a differentiated and more efficient service for our members. Second, we recognize the opportunity to expand the depth of our strategic alliance, leveraging best practices from both entities to create value for Passport unmatched by a traditional vendor client relationship. Finally, it was important to all of us to build out new functions and teams in Louisville to continue growing the Medicaid Center of Excellence.
Teams across Evolent have been working full time on this data migration and operational integration throughout the year and went live on time in early October and will ramp across the fourth quarter. This includes the integration of administrative and clinical platforms, allowing the daily transmission of files between the Aldera and Identifi platforms to support claims, risk stratification, care management, authorizations and analytics. To ensure a seamless transition for providers and plan members, teams continue to monitor operations closely and report a smooth transition. In the month since go live, over 1.6 million enrolment transactions have been completed as we onboard more than 300,000 Passport health plan members across the quarter.
Also demonstrating the value of our health plan services offering, we announced earlier this year that County Care health plan, a subsidiary of Cook County health and hospital systems in Illinois would expand their total lives on the platform by more than 150,000 across the quarter for a total of approximately 300,000 lives as part of a Medicaid managed care expansion across the state. We’re pleased to share that this additional population went live on time and our teams are monitoring operations to ensure these new members receive high quality service as we work to improve the health and well-being of Medicaid beneficiaries in Illinois.
Across our partnerships announced on the year, many ACOs are operational with clinical programs underway to actively engage patients and others are finishing the late stages of implementation and are on track for ACO and planned launches in early-2018. As we look towards the future, we’ll continue to innovate and improve our platform to meet the changing needs of our partners and the demands of their providers, employees and patients in the modern era of healthcare.
In closing, we’re pleased with our results for the third quarter and remain focused on achieving our strategic and financial objectives in 2017. Thank you for participating in this evening’s call and we’re happy to take your questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Robert Jones of Goldman Sachs.
Robert Jones
Just wanted to start with the Premier transaction. When you guys announced the New Mexico deal, it felt like the message then was that that was kind of a one off situation. Here we are a month later with the purchase of another health plan, just curious how we should be thinking about you evaluating and considering these types of transactions as you engage with your customers, some of which are clearly evaluating the health of their owned and operated health plans, just wanted to kind of get a little bit more sense from you guys of how we should be thinking about this becoming part of the overall strategy.
Frank Williams
Yeah. I think as we said the time we announced New Mexico, I think we’re really only going to use this tool in targeted situations and that’s where we see an opportunity to drive growth where we see an opportunity to drive it across a region where we believe ownership allows us to control a number of important levers, both in terms of MLR and overall financial performance and we’re – again we feel we can scale the plan across multiple populations and lives. So if you look, again with New Mexico, it was an existing partner. Same thing with Premier who we have strong relationships, a lot of knowledge of the market where in both circumstances, it made sense for us to essentially drive growth outside the core region.
And I think as I stated in my earlier comments, these will be the only ones you’ll see that would have an impact on 2018 PL revenues. So it is well within our control and I think if you were to look long term, you might see these types of arrangements and again some of them may be co-ownership, some of them maybe full ownership, but maybe in 10% of our overall arrangement. So still again a relatively modest portion of our overall partnerships, but in the right market situations, I think a great opportunity for us to make the market, grow the plan and really build something pretty unique across the region.
Robert Jones
And I guess just a follow-up on the actual mechanics of Premier. Frank, I believe I heard you say the total revenues including the health plan would be roughly comparable to ’17, but then I thought you also mentioned the health plan representing 90 million in 2017, could you maybe just square those two things for us, how should we think about the net impact on the financials from this transaction as we look out to 2018?
Frank Williams
Yeah. Bob, we’re saying two separate things. We’re saying the health plan will have revenue of about 90 million. So the 10,000 members across I mean in commercial. What we’re saying then is that our revenues from Premier will be roughly equal as in services revenue from Premier will be roughly equal to what they are this year. And next year, a portion of those fees will be to the health plan and a portion of those fees will be to the health system. So two separate streams.
Robert Jones
That’s extremely helpful. And then I guess just one last one if I could, I know there’s a lot of decisions that seem yet to be made within your reporting client base, and I know you’re not in a position because of that to give specific guidance around ’18, but it does seem like there’s quite a wide range contemplated out there in the market. So is there any guideposts or levels that you would be comfortable pointing to at this point, maybe even just some of the major pushes and pulls as we think about relative growth next year to this year.
Frank Williams
Well, I think, what I’d say, I mean if you sort of take the information that I gave you, I think some important things progressed across the quarter. One, in terms of our large relationships, we feel very good about where we stand with our large partners. We believe substantially those relationships will continue as we head into next year, so that’s good from the renewal perspective. Same store as we’ve talked about has some natural variability. We have a number of current next-gen partners, a number of new potential cohort participants and those decisions aren’t made in the cycle until early next year because of the way the program works. So if you think, we’ll add some new to our existing six, that’s a portion of the revenue base.
Again, a lot of them are going well. We have to see where the data comes out, but hopefully we would maintain those as well. We have six new partners relatively on schedule. Some of those are up and running today and a number of them will come up in the next year and then as I mentioned, a number of what I would describe as very exciting Medicaid opportunities, fairly significant and again timing will determine how much impact those have on ’18 versus ’19. So I think what I can say is we have a strong base today. We feel like we’re going to be growing as we head into next year and our hope is that growth rate will be strong and consistent with where we want to be and given again, as I said, a lot of the efficiency work we’ve done well. So feel very good about driving strong bottom line expansion as we head into ’18 as well. So hopefully that gives people comfort in terms of at least bounding the bottom that will definitely be a growing organization as we go into next year. And as we’ve talked about we give guidance in February because we have very strong visibility. We can accurately predict our revenues with over 95% confidence on the year and that’s why we wait to give perception in terms of the actual growth rate.
Operator
Our next question comes from Jamie Stockton of Wells Fargo.
Jamie Stockton
Just to follow up on one of the thinks Bob asked about. The piece of the 90 million that is basically going to get netted out because you’re currently getting paid by the health plan, can you just throw a dollar number out there for that so that people don’t model in too much revenue for the next year.
Frank Williams
So the 90 million is the premium revenue in the plan. What you’re going to see is our revenue just to put a number out there, we get about 30 million from Premier plus or minus in services revenue this year. Next year we’ll continue to have that order of magnitude of revenue, about half of that will be to the plan and about half of that to the system.
Jamie Stockton
Nicky, the SGA number was down quite a bit sequentially and really helped the bottom line. I guess was the just, hey, we had resources that we’re supporting, go lives, plus maybe some overlap with Valence that was still around and now that’s evaporated and you shouldn’t expect it to snap back at some point. Or will we see maybe that SGA number bounce back up, could you just give us some color on that.
Nicky McGrane
Yeah, two points, I mean I would say we’ve been foreshadowing this for a couple of quarters now in terms of the path to breakeven and how we get there and you’re dead right, we talked about it being rolling off of resources that were brought in on both the two variables you talked about, supporting new client launches and also the integration. I would say, you know, what I would say is, in the short term we are going to be maintaining a strong cost discipline, so there might be some modest increase in SGA and I would say over time in our push to profitability, moderate really managing the growth, it’s going to grow as an absolute number, but really trying to drive that down both as a percentage of revenue and maintaining a very modest growth in SGA.
Jamie Stockton
Last question from me and you don’t have to answer it now if you [indiscernible], but if you’ve got a CapEx number during the quarter that would be great.
Nicky McGrane
About 8 million bucks.
Operator
Our next question comes from Ryan Daniels of William Blair.
Ryan Daniels
Nicky, quick one for you, lives on the platform are pretty close to our estimate, but can you just remind me why that was down a little bit sequential. I know nothing novel started during the period, but was that just some plans exiting certain markets or just noise with normal attrition?
Nicky McGrane
Yeah, I would say, listen, there is a 1% to 2% churn in the base Medicaid particularly, and so you’ve got a very modest churn, there was really very limited activity overall in the base this quarter. And so a little bit in churn and that’s was going up.
Ryan Daniels
And then Frank, when you talked about renewals, you made a comment, I think to the tune of 90% unit renewal rate and I’m not exactly sure what unit renewal rate means is that kind of 90% of the PL revenue or 90% of the lives on the platform, over 90% you were talking about. What exactly is that?
Frank Williams
I think there’s two ways to look at revenue. We obviously add substantial revenue on our existing partners if you look historically year-over-year. And then you also have an existing base. And so I think what we’ve said in general when people have asked us, will we ever lose a client, we’ve said, yes, we expect we’ll lose some clients, we’ll always add several clients in a given year. But that roughly over a several year period we would expect our unit rate to be roughly 90%, meaning if we had 40 partners over time, we would think we would lose four of those and obviously we’d be adding additional partners and our network would be growing over time.
In the instances where we’re tending to see potentially some attrition it’s largely with small partners that aren’t really investing in the overall strategy, we’re pushing hard to maintain profitability in our margins as we get past breakeven and want to continue to see scalability in the business and make mutual decisions about whether we want to continue the relationship given the current unit economics.
Ryan Daniels
So again it’s – your large partners you feel very good about there’s some smaller partners where perhaps the unit economics and small number of lives just don’t make sense to continue going forward. That’s the way to think about it?
Frank Williams
That’s correct.
Ryan Daniels
And then you said there may be one client that could in-source certain functions, but would they maintain the relationship with you, number one. And number two, any color on what specific functions could be in-sourced in the financial impact; I know you said it was modest.
Frank Williams
We will maintain a substantial relationship across several services firms, them going forward. in this particular relationship, we bagged over a number of employees and anticipated when we got to this point in the relationship that they might want to in-source those and that’s what we anticipated happening over time. Again that’s not finalized, but that’s the direction we see it going and it’s a valuable relationship for us and we see it continuing as we head into next year.
Ryan Daniels
This is kind of low margin revenue for you, isn’t it to begin with?
Frank Williams
In general that’s true, yes.
Ryan Daniels
And then lastly, just going to the market, it was encouraging to hear your tone change, I think talking about more accelerated momentum. And I guess more broadly just how are you as a management team thinking about the pressures facing health systems. I think if we look at the last few quarters, we’re seeing negative mix shift towards lower paying Medicare patients that’s going to continue with demographics, volumes been pretty weak perhaps with more high deductible plans, you’ve got rate cuts mostly recently the 430-B cuts. I guess kind of how would a system leader look at the future and say, we’re not going to move to value-based care, it almost seems like if the market outside of regulation is going to force them to face that reality. So, just any thoughts there? Thanks.
Frank Williams
Well, I think the exact run that you just did was really the thesis under which we launched the business. I mean, we recognized if you looked at all the demographic data, if you looked at reimbursement trends, if you looked at pressure on providers dividers a lot of things moving out of the hospital and to other settings. We believe very strongly that that financial pressure would force providers into value based arrangements. It’s very difficult to continue to maintain margins taking declining fee for service rates.
I think to your point, we’ve seen a kick up in sort of that pressure in the last couple of quarters. And that’s why if you look at our current pipeline, I would say the number of organizations we have in the pipeline that really feel they need to move to value based care, they need to get experience is quite robust. And it began as going past what I would call the innovator segment into the bulk of the market.
So I think where providers are under increasing financial pressure that’s good news for us because they need to move to new reimbursement arrangements and I think we’re seeing the beginnings of that in terms of just the number of providers, the types of providers, the breath in the pipeline. A big focus on Medicaid and Medicare that are under substantial reimbursement pressure and so providers are saying, look, I have to make this work and value is really my only path to do that. So we’re hopeful that the continued trend will obviously set us up well as we get into next year.
Operator
Our next question comes from Matthew Gillmor of Robert Baird.
Matthew Gillmor
Maybe a follow up on Ryan’s question on the Midwest client that you called out. Is there any way you can quantify either in terms of dollars or just the percent of that relationship sort of how much is that risk in terms of being in-sourced so we can think about puts and takes for next year.
Frank Williams
I mean we’re still in discussions. So we have not finalized the arrangement, but it would be on the order of a point or two of total revenue.
Matthew Gillmor
Sort of philosophically as you’re entering the health plan business, I was just curious how you’re thinking about these plans longer term. Are they plans that makes sense to retain a majority ownership in to sort of use center of excellence or would there be opportunities in these states maybe add hospital partners in terms of ownership to build out the network, just sort of wanted to get your sense for you think those relationships and those plans evolve.
Frank Williams
I mean I’d say one thing you’re seeing in the evolution of our strategy a bit is looking for ways to align with our partner network. Some of that can be in the way that we contract and sort of show confidence in our performance, so a small portion of our fees in performance based arrangements. Some of them can be in co-ownership arrangements and where we see the opportunity to build networks across a large geography we do feel that co-ownership is an excellent model to bring that alignment. We’re then viewed as a co-owner, as a long-term partner, the relationship has a [indiscernible] feel, it also allows us to have a seat at the table in terms of driving some of the key metrics that are going to be important for performance.
And so as a result when we see the right situation and again it has to be a committed partner, a situation where we see growth, where it is across a large region, so being the market maker makes sense. In those situations we really do like a co-ownership model. And again I don’t think you’ll see those in the substantial majority of our new arrangements, but you may see them in a select number across the next year or two.
Operator
Our next question comes from David Larsen of Leerink.
David Larsen
Can you talk a little bit about this Eastern Maine win, how many lives will you be rolling on the platform initially and what is the total potential for that client. Thanks.
Frank Williams
Initially we’ll be working with 18,000 employee lives. We really like this relationship because of the reputation of Eastern Maine. They are early pioneer participant, they cover about a million lives and their service area across the state of Maine. There is a lot of interest in the employer community and moving to more value based arrangements. And so we see this as an excellent opportunity in phase one to start with an existing employee base, deliver value based on their clinical network and our platform. And then use that experience to expand more broadly into the employer market and that would obviously be in the individual and small group and medium group market.
David Larsen
And then, I’m sorry Nicky, but with the Premier revenue, there is 90 million of premium revenue and there’s 30 million of I guess fee revenue that you’ve been generating. Does that mean there’s 120 million of total revenue you’ll be recognizing or is half of that 30 going to go back to the plan, which means it’s 105 million of total revenue.
Nicky McGrane
There is 90 million in the plan and then 30 million in the services co. And then about half of that revenue would be intercompany, so to your point, it would net out, it would be booked 120 gross and it would net out to 105 net of the intercompany.
David Larsen
And then can you be talk a bit about the profitability of Premier and also the New Mexico health plan like what are the earnings of these plans look like. And then what are doing to sort of cap your risk in the event of significant claims. Thanks.
Frank Williams
I would say in both instances there were a couple of factors that were quite important to us. One we have a committed partner who really believes in moving to value and that extends not only through the whole system, but all the way through the position network. That we believe there’s an opportunity to deliver substantial improvement in MLR. In the case of New Mexico, you’ve got a statewide network, you’ve got a very low cost position. In the case of premier, we believe we have a lot of levers to drive network performance that there’s a number of clinical areas, where we can drive substantial performance improvement. So we do a very in-depth analysis across the network, across the major clinical cost areas. We look at what the elements are that can drive growth.
And then we build confidence in the business case. And I think in both instances we want to make sure we can pull the appropriate levers to appropriately manage risk that we’ve got. We have some co-insurance models again to protect downside, but to make sure we have a good beat on the corridor around risk and that we can manage it within relatively tight tolerances. So I think if you look at the totality of those relationships we have the whole plan piece again pulling all those levers really trying to drive growth, improvement in MLR and profitability. We’re doing a number of things to manage downside. And then we have our overall service relationship in leveraging our infrastructure and technology platform which also has an element of contribution to it and it is working at the totality of those relationships and again feeling confident about the financials over the next few years.
Operator
Our next question comes from Mohan Naidu of Oppenheimer.
Mohan Naidu
Frank, on these plans that you’re taking over from Premier and True Health. Can you talk to us in high level how much influence do you continue to have or will you continue to have after you take over the plans on the providers to influence the outcome. I guess once the plans transition or from the providers to you, do they have a vested interest or a risk to make sure that they are aligning themselves with the profitability of these plans?
Frank Williams
Absolutely, and we’ve obviously spent a substantial amount of time in both of those markets, situations are different. If you look at New Mexico I think there is very strong performance, very strong allegiance to the whole plan and organizations wanting a third alternative in the market. We’ve done a lot of work to engage providers in a unique way and I think the team there deserves a huge amount of credit for building what I think is the best brand in the health plan world in the market. So I think we have commitments across the provider community to want to engage. Obviously we’ll develop more sophisticated compensation models, which continue to create that alignment. And again with historical relationships have a lot of confidence that we will have the levers that we need to drive performance across the network as well as fully implement our range of clinical programs, programs and pharmacy and things that ultimately will drive MLR.
With Premier, I mean this is an organization that is highly committed to value, it’s a big part of their strategy. We have a number of arrangements with them which I think demonstrate their long-term commitment to what we’re trying to build in the data market and beyond. And so those were very important components to the negotiation in both cases. And again feel confident that we have not only an aligned anchor partner that we have experience with and ones in both places that are quite collaborative, but also we have a roadmap to improve profitability and drive growth and scale across both of those regions.
Mohan Naidu
Maybe one quick question on the Midwest client who’s going to in-source some potential employees. What is driving that decision for them and what are they trying to get out of that. And you see risk of similar moves from other clients?
Frank Williams
I would say we haven’t seen a similar trend across our client base. In this particular instance it was fairly unusual for us to rebadge employees. So if anything it was a very unique relationship from the outset. I think the drivers of the decision for us it’s relatively low margin obviously rebadging. There are certain control elements that they can get by taking those employees back in-house and they can also use those employees not only on the value business but on other aspects of what they want to accomplish as a whole system.
So I think there were some natural control elements there that made sense. And the good news is we still are working with them across a number of pretty substantial areas. We believe we’ve added a tremendous amount of value there and that relationship will continue beyond next year. And we don’t see it as an ongoing trend and hence the reason why I mentioned the strong renewal performance and base of growth that we’re taking into next year.
Operator
Our next question comes from Charles Rhyee of Cowen and Company.
Charles Rhyee
Just wanted to go back on Premier, again to just to – I missed the very beginning. Can you give us a sense of why is Premier is looking to sell this plan here because it sounds like you’re saying it’s kind of integral to their strategy. And if really they’re gaining 30 million from you for health system to not be able to raise that kind of money. Can you give us what’s the decision making process from their end.
Frank Williams
I think two primary reasons. One reason is, we see a substantial opportunity to grow the plan within the data market, but also beyond in several regions. If you look at Premier’s community mission it is largely focused on Dayton and so in that sense there wasn’t a desire across the leadership team to really make that investment in regional expansion. So that is one reason.
The second is Premier has a number of capital needs to support the entire health system and when they sort of looked at investing growth capital in the plan, in supporting regional growth and a number of the things we felt that you needed to do to really scale and take it to the next level. I think the team came back and said, we’re committed to value, it’s a big part of our strategy we want to contribute on the clinical piece of that in engaging our network and ultimately delivering higher value health care.
But when we think about the ownership element, if getting to scale and going across multiple regions is sort of an important component of the strategy, we can see you, Evolent, sort of leading that piece of it. You guys have all the expertise to manage the whole plan, so why don’t you take back component and then we can focus on the core business – core value proposition both within the existing fee for service world that they operate in, but also as they move a number of arrangements towards value based care. So I think for those reasons, we looked at it, saw the opportunity and felt like it was a great growth opportunity and one that would continue to grow our relationship with them.
Operator
Our next question comes from Richard Close of Canaccord Genuity.
Richard Close
I was wondering if you could give us some dynamics in terms of the individual clients or potential clients in the pipeline. As you compare them to last year, are they interested in going bigger into value, are they more just interested in dipping their toe. Is there any specific changes you could talk about in terms of how it compares to past years?
Frank Williams
I don’t think there’s a general change in this year versus last. We do seem providers I think there’s been a learning lesson that it’s been very difficult to perform well in value based care when they’re upside only contracts or there’s not a substantial risk component. So I will say that a lot of the organizations stepping forward are looking for arrangements that have more downside and therefore more upside because a lot of what you hear is people sort of going sideways for not being able to capture the value that they’re adding in upside only arrangement.
So that’s – hence the interest in nextgen, where we have six cohort participants this year and several more going into next. I would say we have more Medicaid opportunities simply because of the investment we’ve made in the Medicaid Center of Excellence, in the Valence’s platform, I think that’s opened up a lot of opportunity for us across multiple states. But I think if you look at the – and then more, I’d say physician organization and ACOs because we’ve had a few arrangements there that have been quite successful. And I think that’s helped build our reputation in that segment of the market.
But in general I would say the average health system participant is probably evaluating roughly the same types of programs. And generally starting with one or two populations and then thinking about expanding over time as they build success in the market. So I wouldn’t say we have a lot that are leaping in off the high dive, all populations and that’s just symptomatic of people evolving into risk and wanting to do it in a comfortable way financially.
Richard Close
And as a follow up to that, you mentioned Medicaid, one of the things I was interested in was the timing of Medicaid – the Managed Medicaid and whether there’s anything we should know about the cadence of potential wins in Medicaid as it relates to maybe fiscal years for states or anything along those lines.
Frank Williams
I mean what I can say is that the good news is we have several opportunities that we’re fairly far along with. I think we have an excellent reputation in the provider community and for providers that are really looking to step forward into Medicaid risk. They need support and I think we are becoming a provider of choice. So the good news is several opportunities across several states. Frankly each state opportunity is dependent on a lot of factors, when does the RFP get issued, do they keep it on time, do they respond to the RFP on time. What’s the implementation schedule. You are dealing with large bureaucracies. So there can be variability and timing. And so it’s a little bit difficult to predict.
The good news is when they do go through their very large opportunities. Our hope is based on the number that we have out there. We’ll have some good news to report across the coming months. Some of those that might impact ’18, but surely that will have a pretty significant impact in setting up ’19. And that’s what we’re all about is continuing to build lives on the platform and continuing grow across major population areas and really setting up ’19. ’20 and beyond with what is a recurring revenue model. So that’s I wish I could give you specifics, but it really comes down to states and processes and I don’t think there’s a rule of thumb, but I can tell you that we’re well along in several of these discussions.
Operator
Our next question comes from Donald Hooker of KeyBanc Capital Markets.
Donald Hooker
I’ll just ask you a couple kind of high level questions real quick. Can you maybe give an update in terms of the competitive environment this year round versus prior year round in terms of any change in how you’re approaching clients or clients are asking for your services?
Frank Williams
I would say we haven’t seen any substantive changes in the competitive environment. We don’t run into a common competitor. Obviously in various market situations, we might run into a local player that is engaged in some way in talking with the health system or provider partner, so we might have a discrete organization that is being considered for some range of services. But in a lot of situations, we’ve got the relationship, we’re building on that relationship through our expertise and building confidence with the executive team and in many ways it feels sole-sourced from that perspective based on the various product areas that we’re focused on. So I would say that’s good news from our perspective that we haven’t seen substantial changes. Again a lot of this is really building the case with providers, the financial case getting very deep, getting them committed and then moving them through a process depending on whether it’s with the governmental Medicare program, Medicaid or commercial. But overall the competitive environment largely the same.
Donald Hooker
Last question from me, to what extent can you comment about the advisory board equity stake in the Company at this point with I guess United now looking to take over advisory board?
Frank Williams
The deal is not closed and we haven’t had any substantive discussions about it at all. Obviously once the deal closes then we’ll maybe have more information there, but nothing to report there now.
Operator
Our next question is a follow-up from Charles Rhyee of Cowen and Company.
Charles Rhyee
Nicky, I had a question for you regarding the increase in guidance on EBITDA and obviously we’re now starting to see a ramp here in the margins. Can you remind us sort of any kind of targets that you had in mind in terms of what type of profitability ranges we can think about over the next few years like what see the leverage going to sort of the near to medium term as we think about modeling out even beyond just ’18. Thanks.
Nicky McGrane
I would say Charles, the way I think about it from a modeling point of view is, again sort of fairly simplistically put, but we had a longer term 45% to 50% gross margin target, we’d be making sequential progress towards that this year. So I would expect to see us continue to growth couple points of gross margin improvement. And then as I discussed it’s about managing and maintaining a very modest SGA percentage increase year-over-year. And those two factors combined are kind of the sources. That’s what we’re managing too and that’s the target that we’re looking at. And so we could see that over the next couple years.
Charles Rhyee
Any reason not to see getting double digit EBITDA margins in the sort of the near term, near to medium term?
Nicky McGrane
Again, not to split hairs what definition of near to medium, but I mean I think we just crossed over and I expect it to be you know that to be at the double digits. You are talking two plus years out here I would say. But we’re always doing the yin yang on also sort of continuing to drive growth and being set up for the multitude of things we’re going after. But I would say we’re trying to make continued progress is what I would say. I’m not going out of couple of years on estimates at this point. But just continue to progress on those two variables should drive us towards good sustained profitability.
Frank Williams
I would just say from my perspective, we set a lot of these targets a long time ago believing that we would get scale in the business as we were able to amortize our fixed cost base over a larger number of lives. That’s actually played out on track if anything we pulled forward our original target on breakeven. I think we’ve seen nice EBITDA contribution that’s reflected in our guidance for the next quarter.
And so I feel really good about where we set from a business model perspective and continuing to drive scale. I think Nicky’s correct that making point estimates [indiscernible] conceptually everything that you said is accurate. We obviously need to make investment decisions across a year, mix has a big influence, scale of existing customers. There is no reason if those sort of things trend in our favor why we couldn’t have a double digit margins as you’re suggesting in a very short period of time.
But again a lot of that’s going to depend on mix, size of customer, the investment decisions that we’re making and those will play out based on the new business we bring on and again how the existing base build outs. But I think you should feel good about the scalability that we’ve seen. And again where we appear to be headed at least in the next quarter and hopefully into 2018.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Frank Williams for any closing remark.
Frank Williams
We appreciate everyone participating in the call. I know we’ll see a number of you at several conferences across the coming weeks. And I’ll look forward to seeing you and again thanks for participating.
Operator
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.
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