Evolent Health, Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. Evolent provides value-based care, specialty care management and health plan administration services. In January 2023, it acquired National Imaging Associates (NIA) and began reporting as one operating segment.
Key financial results
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Revenue | $511.0m | $352.6m | $1,407.8m | $969.6m |
| Operating income (loss) | $(17.9)m | $13.0m | $(49.9)m | $5.5m |
| Net income (loss) attributable to common shareholders | $(33.2)m | $2.1m | $(100.9)m | $(7.8)m |
| Basic and diluted loss per share | $(0.30) | $0.02 | $(0.91) | $(0.09) |
| Operating cash flow | Not separately stated for Q3 | $53.2m | $(47.2)m |
Q3 gross margin, calculated as revenue less cost of revenue, was approximately 24.3% (versus 24.4%); nine-month gross margin was approximately 25.5% (versus 24.1%). Operating margin was approximately (3.5)% in Q3 and (3.5)% for the nine-month period, compared with 3.7% and 0.6%, respectively, in 2022.
- Revenue growth: Q3 revenue rose 44.9%; nine-month revenue rose 45.2%. Management attributed the nine-month increase to $243.2m from acquisitions and launches of integrated products, and $195.1m from new partners and expansions with existing partners. NIA contributed $167.5m of revenue from its acquisition date through September 30.
- Expenses and earnings: Nine-month cost of revenue increased 42.5%, while SG&A increased 48.4% and depreciation and amortization increased 97.9%. Higher amortization, acquisition-related expenses and contingent-consideration remeasurement weighed on operating results. Q3 included an $11.3m contingent-consideration loss.
- Cash and liquidity: September 30 cash and cash equivalents were $184.5m; restricted cash and investments were $40.0m. Operating cash flow was $53.2m for nine months, versus a $47.2m outflow in 2022. Investing cash outflow was $409.5m, including $388.2m for acquisitions; financing cash inflow was $365.7m. Management said liquidity was sufficient for at least 12 months.
- Debt and preferred equity: At September 30, gross secured borrowings comprised $405.0m of term loans and $37.5m drawn on the revolving facility. Convertible notes had $173.5m principal outstanding, including $1.0m of 2024 Notes and $172.5m of 2025 Notes. The 2024 Notes were fully settled on October 13, 2023. The company also had $175.0m of Series A preferred shares, with quarterly cash dividends at a floating rate of SOFR plus 6.00%. Balance-sheet debt, net, was $600.9m, including $1.0m short-term and $599.9m long-term.
- Balance sheet: Total assets were $2,669.6m, including $1,117.5m goodwill and $777.7m net intangible assets. Current liabilities were $615.3m, including $299.7m in claims and performance-based reserves. The tax receivables agreement liability was $112.1m.
Material changes and unusual items
- The NIA acquisition was funded with cash, shares, additional borrowings and $168.0m gross proceeds from Series A preferred stock. The preliminary purchase accounting recorded $395.2m goodwill and $404.0m identifiable intangible assets.
- Nine-month results included a $24.1m impairment charge for the decommissioned Chicago lease. A $6.5m penalty was recorded for terminating part of the Arlington lease.
- A $74.7m nine-month income tax benefit primarily reflected a $56.1m valuation-allowance release associated with deferred tax liabilities recorded in the NIA acquisition. The company also recorded a $66.2m increase in its tax receivables agreement liability during the period.
- Repositioning charges were estimated at $38.6m in total, of which $19.4m had been incurred by September 30. The program was expected to be substantially complete in the first half of 2024.
- Receivables increased to $394.2m from $254.7m at year-end 2022. Management cited customer payment timing and acquired NIA receivables. Nine-month operating cash flow also benefited from a $100.0m increase in claims and performance-based reserves.
Outlook, commentary and risks
Management expects cost of revenue and SG&A to decline as a percentage of revenue over the longer term, subject to the mix of growth and successful cost initiatives. It expects depreciation and amortization to increase as acquired intangibles are amortized, and interest expense to increase during 2023; it stated that it is focused on long-term deleveraging. The filing does not provide a clear numerical revenue or earnings guidance range.
- Results depend on retaining and expanding partner relationships; revenue and receivables are concentrated among a small number of customers. Cook County represented 16.8% of nine-month revenue and 41.2% of short-term trade receivables at September 30.
- Performance-based contracts expose the company to medical-cost, utilization, claims-development and pricing risks. Reserve estimates depend on actuarial assumptions and may change as claims experience develops.
- Integration of NIA, acquisition-related costs, contingent earn-outs and the realization of anticipated acquisition benefits remain execution and valuation risks. Goodwill was subject to its annual impairment test scheduled for October 31, 2023; management reported no interim trigger through September 30.
- Floating-rate secured debt and preferred dividends create interest-rate exposure. Management estimated that a 1% SOFR increase would add about $4.4m annual interest expense and $1.8m annual preferred dividends.
- The company disclosed a shareholder demand concerning alleged oversight of the former Passport relationship; it could not estimate a loss range. It also highlighted cybersecurity, privacy, bank-deposit, regulatory and partner-renewal risks.
Important facts for investors to verify
- Whether organic partner growth and NIA/IPG integration sustain revenue growth while improving operating profitability and cash conversion.
- Claims reserve development, receivables collections and the effects of customer concentration on liquidity and operating cash flow.
- Actual total repositioning costs and savings, and whether the expected completion timeline is met.
- Debt repayment capacity, floating-rate costs, preferred dividends and the treatment or settlement of acquisition earn-outs.
- Final NIA purchase accounting, the October 2023 goodwill impairment assessment and realization of tax benefits underlying the tax receivables agreement.
- Management reported disclosure controls were effective, but excluded NIA from its internal-control assessment while integration continued; NIA represented 32.1% of assets and 11.9% of nine-month revenue in the stated assessment comparison.