Evolent Health, Inc. quarterly report, Q2 FY2023

Evolent Health, Inc. — Q2 2023 Form 10-Q

Reporting period: Three and six months ended June 30, 2023. Evolent provides healthcare services and technology supporting value-based care. Results include NIA from its January 20, 2023 acquisition; comparisons also reflect IPG, acquired in August 2022. The company moved to a single reportable segment in 2023 and recast prior-period segment disclosures.

Financial performance

Metric	Q2 2023	Q2 2022	First half 2023	First half 2022
Revenue	$469.1 million	$319.9 million	$896.8 million	$617.0 million
Operating loss	$(21.6) million	$(4.6) million	$(31.9) million	$(7.4) million
Net loss attributable to common shareholders	$(41.4) million	$(4.6) million	$(67.7) million	$(9.9) million
Loss per diluted share	$(0.37)	$(0.05)	$(0.62)	$(0.11)
Operating cash flow	Not separately provided	Not separately provided	$(7.3) million	$(43.8) million

Q2 revenue grew 46.6%; management attributed $90.6 million of the increase to acquisitions and new integrated products, and $58.6 million to new partners and expansion with existing partners. First-half revenue grew 45.4%, with corresponding contributions of $172.6 million and $107.2 million.
Q2 cost of revenue was 75.0% of revenue versus 78.0% a year earlier, implying gross margins of approximately 25.0% and 22.0%, respectively. First-half cost of revenue was 73.9% versus 76.1%.
SG&A rose 53.3% in Q2 to $90.4 million and 52.8% in the first half to $180.1 million. SG&A was 19.3% of Q2 revenue versus 18.4%; first-half SG&A was 20.1% versus 19.1%.
Q2 operating loss included a $24.1 million impairment of the Chicago office lease right-of-use asset. Depreciation and amortization increased substantially, largely due to acquired intangible assets and accelerated trade-name amortization. Q2 also included a $7.8 million gain from remeasurement of contingent consideration.

Liquidity, cash flow and capital

At June 30, unrestricted cash and cash equivalents were $142.5 million; restricted cash and investments were $65.1 million, bringing total cash, cash equivalents and restricted amounts to $207.6 million. Restricted amounts include $46.9 million held for partner claims processing.
First-half investing cash outflow was $403.3 million, primarily reflecting $388.2 million for acquisitions and $15.9 million for software and property investment. Financing cash inflow was $403.1 million, principally from $256.1 million of net debt proceeds and $168.0 million from preferred stock, partly offset by debt repayment and preferred dividends.
Long-term debt, net, was $633.0 million. Principal outstanding included $415.0 million of secured term loans, $37.5 million of secured revolver borrowings, and $196.8 million of convertible notes. The credit facilities bear floating rates; term loans are priced at SOFR plus 6.00% or base rate plus 5.00%, and revolver borrowings at SOFR plus 4.00% or base rate plus 3.00%.
The company issued $168.0 million of Series A preferred stock to help fund NIA. Its dividends are payable at SOFR plus 6.00%; the filing reports $8.5 million of preferred dividends paid in the first half. Preferred shares have senior rights and conversion, redemption, and protective-covenant provisions.
Management said existing cash and cash equivalents should be sufficient for at least the next 12 months. The company reported a $112.1 million tax receivable agreement liability at quarter-end.

Material changes, outlook and risks

NIA was acquired for approximately $715.7 million of total consideration, including cash, 8.5 million shares and contingent consideration. NIA contributed $107.4 million of first-half revenue and a $2.8 million net loss. Purchase accounting remains preliminary; the acquisition added approximately $395.2 million of goodwill and $404.0 million of identifiable intangible assets.
First-half tax benefit was $69.2 million, including a $56.1 million discrete benefit from a valuation-allowance release related primarily to NIA acquisition accounting. A $66.2 million change in the tax receivable agreement liability was also recorded in the first half. These items materially affect reported earnings and should not be viewed as recurring operating performance.
Management expects 2023 interest expense to increase, while pursuing long-term deleveraging. It expects cost of revenue and SG&A to decline as a percentage of revenue over the longer term, subject to growth mix and integration costs. No numerical revenue or earnings guidance is provided in the supplied filing text.
A repositioning plan launched in Q2 is expected to cost approximately $25.3 million, including severance, integration-related employee costs and professional services; it is expected to be substantially complete in the first half of 2024. The company also plans to unify brands under Evolent, accelerating amortization of trade names through December 2024.
On August 2, 2023, the company announced it would redeem its remaining $24.3 million of 2024 Notes for cash on October 13, 2023, using cash on hand, subject to holders’ conversion rights before redemption.
Key risks include reliance on a limited number of partners (Cook County represented 17.6% of Q2 revenue; Molina 16.4%; Florida Blue Medicare 11.1%), healthcare-cost and claims-reserve estimation, performance-based contract underwriting, acquisition integration, floating-rate debt and preferred dividends, and potential partner contract loss or renegotiation. The company also cites cybersecurity and privacy exposure. No material cyber incident had been reported, and management concluded disclosure controls were effective; acquired IPG and NIA were excluded from the period’s internal-control assessment while integration proceeds.
A shareholder demand concerning an earlier derivative action remained under Board consideration; the company said it could not estimate any potential loss. The derivative action itself had been dismissed without prejudice in January 2023.

Investor verification priorities

Assess whether revenue growth from acquisitions and partner expansions translates into sustainable operating improvement, given higher SG&A and continuing operating losses.
Review NIA and IPG integration progress, preliminary purchase-price allocations, acquisition-related charges and expected earn-out payments.
Evaluate the quality and timing of cash conversion, including receivables growth, customer collection timing, restricted cash and claims-reserve adjustments.
Verify debt-service capacity and the cost of floating-rate borrowings and preferred dividends; monitor the planned 2024 Notes redemption and future deleveraging.
Separate recurring performance from the discrete tax benefit, tax receivable agreement liability change, lease impairment and contingent-consideration remeasurement.
Monitor partner concentration, contract renewals, claims-cost experience, repositioning costs and the October 2023 goodwill impairment test.