In a recent article, I discussed my model for Catasys and how it shed light on the fact that Q3 billings were going to be flat versus the increase that investors had been anticipating. The process of going through creating a model was very helpful in terms of getting me comfortable that a delayed start in billings growth, coming in Q4 not Q3, was not a red flag. In my opinion, enrollee growth is picking up right now despite the lag in billings.
But, I still wanted to understand the process a little better. What was the root cause of the delay taking place? What are the factors bringing this about and how do we know they are only a one-quarter impact? Answers to these questions would either drive my confidence in the Q4 ramp starting, or make me question my investment thesis.
In search of these answers, I have really tried, through multiple conversations with both CEO Terren Peizer and CFO Christopher Shirley, to peel back the layers of the onion and get to the heart of the matter.
So, once again, I repeat for readers the question I was trying to answer: if Eligible Lives (ELs) increased to 24,000 in June, why didn’t billings increase in Q3?
The answer is rather straightforward and a three part answer. The sum of which definitively explains how ELs could increase at the end of Q2 but we won’t see the effect until Q4, and gives me greater confidence than ever that CATS is on track to be a blockbuster story in the near future.
Here are the three pieces to this puzzle:
1. Enrolling new members is not a linear ramp. In hindsight, this is obvious, but I admit to missing it on the first go around. Here’s the skinny…when CATS’ artificial intelligence program finds Eligible Members, they begin out reach. This outreach consists of mailings and phone calls. While the Company says it takes 12 months to reach their estimate of 20% enrollment of ELs, it really stands to reason that this would be back-end loaded. The initial outreach of a flyer wouldn’t land 1/12 of the target audience. Instead, it takes multiple points of contact to get enrollees. Thus, adding 18,000 Eligible Lives in June results in a slow ramp of new enrollees that gathers speed like a snowball, culminating in 20% enrollment, but very back-end weighted.
In Q3, it now makes sense that there were fewer new members added. It also makes sense that Q4 is when our expected ramp will start kicking in.
2. Aetna, the largest piece of the new ELs, has a different billing cycle. When an enrollee agrees to enter the program, in most cases, Catasys bills the health plan immediately. However, in Aetna’s case, they insist that Catasys not bill until the enrollee has appeared at their physical meetings with a care-provider. This also delays billings, but doesn’t change the thesis that billings will be going up with the new ELs. Once again, Q3 suffers, things start looking better in Q4.
It’s important to note that Aetna is the only healthcare company with this different billing cycle. And, it’s also important, from CATS’ perspective, to know that Aetna’s savings match their peers despite this difference in billing.
3. The final source of delay in billings results from unforeseen delays in getting patients into the actual first physical meeting with a care-provider. It turns out that, especially during the summer, care-providers and patients have been taking longer than expected to have their first in-person meeting. This was simply due to schedules, etc., and doesn’t portend any issue with the business. However, it does need to be reflected in a slight pushback of the model.
Once again, Catasys is not seeing any change in the enrollment trends as a result of this, it simply has taken longer to get to the first meeting than they had modeled. Resulting, yet again, in a delay that hurts Q3 numbers, but has no real impact on the long-term business model.
I now feel like I understand the CATS business model better than almost anyone. And, I’m further convinced that enrollments are increasing right now and will ramp into my 2018 baseline billings of $20M and a year-end exit rate of $32M.
This baseline of $20M is achievable solely on the current 24,000 Eligible Lives in their portfolio; a number that will likely increase if, as expected, more Eligible Lives get added to the platform.
CATS has a huge pipeline of expected business for 2018, including the delayed United Healthcare and Humana rollouts among others. But, for now, I’m very comfortable with the baseline numbers I have shown. Numbers which show an uptick in billings starting in Q4 and ramping through year-end 2018 based on current Eligible Lives.
Shares in CATS have been under pressure. This is due to investors extrapolating a flat Q3 billings with some sort of larger problem at Catasys. I believe this is certainly not the case. In Tailwinds’ opinion, the Company is on the brink of big things and recent weakness is nothing but a buying opportunity.
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