Signify Health (SGFY) 10-Q2022 Q3 Quarterly report

Signify Health, Inc. (referred to herein as “we”, “our”, “us”, “Signify Health” or the “Company”) was incorporated in the state of Delaware on October 1, 2020 and was formed for the purpose of completing an initial public offering (“IPO”) of its common stock and related reorganization transactions as described below. As a result of the reorganization transactions in February 2021, we control, and therefore consolidate the operations, of Cure TopCo, LLC (“Cure TopCo”) and its direct and indirect subsidiaries.

Cure TopCo is a Delaware limited liability company formed on November 3, 2017. Cure TopCo has adopted a holding company structure and is the indirect parent company of Signify Health, LLC (“Signify”), a Delaware limited liability company. Signify was formed on November 3, 2017. Operations are performed through our wholly-owned subsidiaries.

On February 16, 2021, we closed an initial public offering (“IPO”) of 27,025,000 shares of our Class A common stock at a public offering price of $24 per share, which included 3,525,000 shares issued pursuant to the full exercise of the underwriters’ over-allotment option. We received gross proceeds of $648.6 million, which resulted in net cash proceeds of $609.7 million after deducting underwriting discounts and commissions of $38.9 million and before fees and expenses incurred in connection with the IPO and paid for by Cure TopCo. We used the proceeds to purchase newly-issued membership interests from Cure TopCo at a price per interest equal to the IPO price of our Class A common stock, net of the underwriting discount and commissions.

In connection with the IPO, Signify Health and Cure TopCo completed a series of transactions (“Reorganization Transactions”), the effects of which included, among other things, Signify Health becoming the controlling shareholder of Cure TopCo.

As of September 30, 2022, we owned approximately 75.6% of the economic interest in Cure TopCo. The non-controlling interest, consisting of certain pre-IPO members who retained their equity ownership in Cure TopCo subsequent to the Reorganization Transactions, owned the remaining 24.4% economic interest in Cure TopCo.

These Condensed Consolidated Financial Statements are unaudited and have been prepared by us in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and following the rules and regulations of the Securities and Exchange Commission (the “SEC”). The financial statements included in this report should be read in conjunction with the Company’s audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2021. In our opinion, they reflect all adjustments, including normal recurring items, that are necessary to present fairly the results of interim periods. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted as permitted by such rules and regulations; however, we believe that the disclosures are adequate to make the information presented not misleading. Operating results for the periods presented herein are not necessarily indicative of the results that may be expected for future interim periods or the entire fiscal year. Our quarterly results of operations, including our revenue, income from operations, net loss and cash flows, have varied and may vary significantly in the future, and period-to-period comparisons of our results of operations may not be meaningful. Accordingly, our interim results should not be relied upon as an indication of future performance.

The accompanying Condensed Consolidated Financial Statements have been prepared in conformity with GAAP, which requires management to make estimates and assumptions affecting the reported amounts in our Condensed Consolidated Financial Statements and accompanying notes. These estimates are based on information available as of the date of the Condensed Consolidated Financial Statements; therefore, actual results could differ from those estimates. The significant estimates underlying our Condensed Consolidated Financial Statements include revenue recognition; allowance for doubtful accounts; recoverability of long-lived assets, intangible assets and goodwill; loss contingencies; accounting for business combinations, including amounts assigned to definite and indefinite lived intangible assets and contingent consideration; customer equity appreciation rights; and equity-based compensation.

We have not identified any incremental items that would be considered a component of comprehensive income (loss) and accordingly a statement of comprehensive income (loss) is not reflected in the Condensed Consolidated Financial Statements because net loss and comprehensive loss are the same.

Under our Master Agreement with the Centers for Medicare and Medicaid Services (“CMS”), we were required to place certain funds in escrow for the benefit of CMS. These amounts, known as a Secondary Repayment Source (“SRS”), were primarily based on the size of our participation in the legacy CMS Bundled Payments for Care Improvement (“BPCI”) program, the predecessor program of the Bundled Payments for Care Improvement - Advanced initiative (“BPCI-A”). These funds were available to CMS as a supplemental payment source if we failed to pay amounts owed to CMS. Under the agreement, the funds are returned to us 18 months after the conclusion of the effective period of the CMS Master Agreement, or when all financial obligations to CMS are fulfilled. As of December 31, 2021, there was $0.5 million in the SRS account included in restricted cash on the Condensed Consolidated Balance Sheets related to BPCI-A, all of which was released in the first quarter of 2022.

We also withhold a portion of shared savings to customers in a “holding pool” to cover any potential subsequent negative adjustments through CMS’s subsequent reconciliation true-up process. These funds are distributed to customers following the final true-up if there is no negative adjustment. These amounts represent consideration payable to the customer and therefore have reduced revenue in the period earned. The funds have been received by us from CMS and are held in a separate cash account, included as restricted cash on the Condensed Consolidated Balance Sheets. Since the funds are payable to the customer at the point the final CMS true-up is made or a negative adjustment is due to us, the amounts are also included in accounts payable and accrued expenses on the Condensed Consolidated Balance Sheets. As of September 30, 2022 and December 31, 2021, there was $1.8 million and $5.2 million of restricted cash in the holding pool, respectively.

In addition, as of September 30, 2022 we held $0.5 million in a separate cash account, included as restricted cash on the Condensed Consolidated Balance Sheets, in relation to an ACO owned by our subsidiary Caravan Health. This ACO is part of a risk model under the CMS Medicare Shared Savings Program (“MSSP”) where it shares in both the savings and losses. For the 2022 performance period, the ACO has a master letter of credit with CMS as the recipient where the letter of credit is used as protection against unpaid losses, should the ACO fail to remit payment in the event that losses occur. The letter of credit is collateralized by the ACO members, by either cash remitted or subordinated letters of credit. This restricted cash will only be used if an ACO member fails to remit payment in connection with a subordinated letter of credit.

The following table reconciles cash, cash equivalents, and restricted cash per the Condensed Consolidated Statements of Cash Flows to the Condensed Consolidated Balance Sheets:

Accounts receivable primarily consist of amounts due from customers and CMS and are stated at their net realizable value. Management evaluates all accounts periodically and an allowance is established based on the latest information available to management. Management considers historical realization data, accounts receivable aging trends and other operational trends to estimate the collectability of receivables. After all reasonable attempts to collect a receivable have been exhausted, the receivable is written off against the allowance for doubtful accounts. As of September 30, 2022 and December 31, 2021, we had an allowance for doubtful accounts of $10.2 million and $7.9 million, respectively.

Advertising and marketing costs are included in selling, general and administrative expenses (“SG&A”) and are expensed as incurred. Advertising and marketing costs totaled $0.2 million and $0.4 million for the three months ended September 30, 2022 and 2021, respectively, and $0.6 million and $0.9 million for the nine months ended September 30, 2022 and 2021, respectively.

Certain of our leases include variable lease costs to reimburse the lessor for real estate tax and insurance expenses and certain non-lease components that transfer a distinct service to us, such as common area maintenance services. We have elected not to separate the accounting for lease components and non-lease components for all leased assets.

We sublease portions of our office space where we do not use the entire space for our operations. Sublease income is recorded as a reduction of lease expense.

We are an “emerging growth company” under the Jumpstart Our Business Startups Act (“JOBS Act”). Pursuant to the JOBS Act, an emerging growth company has the option to adopt new or revised accounting standards that may be issued by FASB or the SEC either (i) within the same periods as those otherwise applicable to non-emerging growth companies or (ii) within the same time periods as private companies. We intend to take advantage of the exemption for complying with new or revised accounting standards within the same time periods as private companies. The effective dates below are the effective dates we expect to adopt the new accounting pronouncements, which are those permitted for a company that is not an issuer.

On September 2, 2022, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with CVS Pharmacy, Inc., a Rhode Island corporation (“Parent”), and Noah Merger Sub, Inc., a Delaware corporation and wholly owned subsidiary of Parent (“Merger Subsidiary”), pursuant to which, among other things, Merger Subsidiary will merge with and into the Company and whereupon Merger Subsidiary will cease to exist and the Company will be the surviving corporation in the Merger (the “Surviving Corporation”) and will continue as a wholly-owned subsidiary of Parent (the “Merger”).

As a result of the Merger, at the effective time of the Merger (the “Effective Time”), each share of our class A common stock, par value $0.01 per share (“Class A Common Stock”) (other than (i) common stock owned by the Company, Parent or Merger Subsidiary or any subsidiary thereof and (ii) any shares of Class A Common Stock and our class B common stock, par value $0.01 per share (“Class B Common Stock”, and, together with “Class A Common Stock”, “Company Stock”) owned by stockholders who properly exercise appraisal rights under Delaware law), including each share of Class A Common Stock resulting from the exchange of LLC Units (as defined below), outstanding immediately prior to the Effective Time, shall be canceled and converted into the right to receive $30.50 per share in cash, without interest (such per-share consideration, the “Per Share Consideration” and the aggregate consideration, the “Merger Consideration”).

Pursuant to the Merger Agreement, immediately prior to the Effective Time, in accordance with the Merger Agreement, the Third Amended and Restated Limited Liability Company Agreement of Cure TopCo LLC (“Cure

TopCo”), dated as of February 12, 2021 (the “Cure TopCo Amended LLC Agreement”) and our certificate of incorporation, (i) we will require each member of Cure TopCo (excluding the Company and the Company Holding Subsidiary (as defined in the Merger Agreement), but including Cure Aggregator, LLC) to effectuate a redemption of all of such Cure TopCo member’s LLC Units (as defined in the Cure TopCo Amended LLC Agreement) (“LLC Units”), pursuant to which such LLC Units will be exchanged for shares of Class A Common Stock on a one-for-one basis in accordance with the provisions of the Cure TopCo Amended LLC Agreement and the Merger Agreement and (ii) each share of Class B Common Stock shall automatically be canceled immediately upon the consummation of such redemptions, such that no shares of Class B Common Stock will remain outstanding immediately prior to the Effective Time.

Consummation of the Merger is subject to certain conditions, including, but not limited to, (i) our receipt of the approval of the Merger Agreement by stockholders holding a majority of the voting power of the outstanding shares of Company Stock, (ii) the expiration or early termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, (iii) the absence of any law or order prohibiting or making illegal the consummation of the Merger, (iv) the absence of any Material Adverse Effect (as defined in the Merger Agreement) on the Company and (v) the TRA Amendment (as defined below) being in full force and effect in accordance with its terms and not having been amended, repudiated, rescinded, or modified. On October 31, 2022, stockholders holding a majority of the voting power of the outstanding shares of Company Stock approved the Merger Agreement.

On September 19, 2022, each of the Company and Parent filed its respective Notification and Report Form with the U.S. Department of Justice (the “DOJ”) and the U.S. Federal Trade Commission (collectively, the “Agencies”) under the HSR Act. On October 19, 2022, the Company and Parent each received a request for additional information and documentary materials (collectively, the “Second Request”) from the DOJ in connection with the DOJ’s review of the Merger. The effect of the Second Request is to extend the waiting period imposed under the HSR Act until the 30th day after substantial compliance by the Company and Parent with the Second Request, unless the waiting period is terminated earlier by the DOJ or extended by the parties to the Merger.

The Company has made customary representations and warranties in the Merger Agreement and has agreed to customary covenants regarding the operation of the business of the Company and its subsidiaries prior to the Effective Time.

The Merger Agreement contains certain termination rights for each of the Company and Parent. Upon termination of the Merger Agreement in accordance with its terms, under certain specified circumstances, the Company will be required to pay Parent a termination fee in an amount equal to $228.0 million, including if the Merger Agreement is terminated due to the Company accepting a superior proposal or due to the Company’s Board of Directors (the “Board”) changing its recommendation to the Company’s stockholders to vote to approve the Merger Agreement.

The Merger Agreement further provides that Parent will be required to pay the Company a termination fee in an amount equal to $380.0 million in the event the Merger Agreement is terminated under certain specified circumstances and receipt of antitrust approval has not been obtained by such time.

If the Merger is consummated, the Company will cease to be a publicly traded company and will become a wholly owned subsidiary of Parent, and our common stock will be delisted from the NYSE and deregistered under the Exchange Act.

The foregoing description of the Merger Agreement does not purport to be complete and is subject to, and qualified in its entirety by, the full text of the Merger Agreement.

In connection with the Merger Agreement, certain affiliates of New Mountain Capital, L.L.C. ( “New Mountain”) entered into a voting agreement (the “Voting Agreement”) with Parent pursuant to which, among other things, New Mountain has agreed to vote its shares in favor of obtaining the Company Stockholder Approval (as defined in the Merger Agreement) and the Transactions, including the approval and adoption of the Merger, the Merger Agreement or any related action reasonably required in furtherance thereof, and against any acquisition proposal or any action that would reasonably be expected to prevent, materially delay or materially impair the consummation of the Merger or the Transactions. As of the date of the Merger Agreement, New Mountain collectively owned approximately 54.4% of the total outstanding Class A Common Stock and 74.7% of the total outstanding Class B Common Stock, or approximately 59.4% of the total voting power of the Company Stock.

New Mountain’s obligations under the Voting Agreement terminate upon the earliest to occur of (i) an Adverse Recommendation Change (as defined in the Merger Agreement), (ii) termination of the Merger Agreement and (iii) the Effective Time.

The foregoing description of the Voting Agreement does not purport to be complete and is subject to, and qualified in its entirety by, the full text of the Voting Agreement.

The Company, Cure TopCo and certain other parties thereto have entered into a Tax Receivable Agreement and LLC Agreement Amendment, dated as of September 2, 2022 (the “TRA Amendment”) which (i) amends (x) the Tax Receivable Agreement among the Company, Cure TopCo and certain other parties thereto (the “TRA”) and (y) the Cure TopCo Amended LLC Agreement and (ii) provides for certain covenants regarding tax reporting and tax-related actions.

The TRA Amendment provides for (i) the termination of all payments under the TRA from and after the Effective Time, (ii) the payment of any amounts due under the TRA prior to the Effective Time (other than payments resulting from an action taken by any party to the TRA after the date of the TRA Amendment, which will be suspended), in accordance with the terms of the TRA, which payments will be paid no earlier than 185 days following the filing of the U.S. federal income tax return of the Company, (iii) a prohibition on the Company terminating the TRA or accelerating obligations under the TRA after the date of the TRA Amendment and (iv) the termination of the TRA effective as of immediately prior to and contingent upon the occurrence of the Effective Time (including termination of all of the Company’s obligations thereunder and the obligation to make any of the foregoing suspended payments). The TRA Amendment also includes agreements among the parties thereto regarding the preparation of tax returns and limits actions that may be taken by the Company, Cure TopCo and certain of their controlled affiliates after the Effective Time.

The TRA Amendment also (i) suspends all tax distributions under the Cure TopCo Amended LLC Agreement from and after the Effective Time, and (ii) provides that from and after the Effective Time, no person or entity shall have any further payment or other obligation under the TRA or any obligation to make or pay tax distributions under the Cure TopCo Amended LLC Agreement.

In the event the Merger Agreement is terminated in accordance with its terms, (i) the TRA Amendment will become null and void ab initio (provided that any payments suspended as described above are required to be made), (ii) the TRA and the Cure TopCo Amended LLC Agreement will continue in full force and effect as if the TRA Amendment had never been executed (provided that any suspended payments as described above are required to be made), and (iii) all of the Company’s obligations under the Cure TopCo Amended LLC Agreement will continue in full force and effect as if the TRA Amendment had never been executed.

The foregoing description of the TRA Amendment does not purport to be complete and is subject to, and qualified in its entirety by, the full text of the TRA Amendment.

During the three months ended September 30, 2022, per the terms of the Caravan Health Merger Agreement we calculated the final net working capital adjustment to the initial purchase price resulting in an additional $0.9 million cash consideration due to the sellers. This additional amount due is primarily related to adjustments of the estimated contract assets, based on the final reconciliation received from CMS for the 2021 performance periods, and updated income tax estimates. We expect to pay the additional cash consideration in the fourth quarter of 2022.

The acquisition was not material to our Condensed Consolidated Statements of Operations. Therefore, pro forma results of operations related to this acquisition have not been presented. The financial results of Caravan Health have been included in our Condensed Consolidated Financial Statements since the date of the acquisition.

We earn revenue from our two operating segments, Home & Community Services and Episodes of Care Wind-down, under contracts that contain various fee structures. Through our Home & Community Services segment, we offer multiple solutions to our customers, including, among others, health evaluations performed either within the patient’s home, virtually or at a healthcare provider facility, primarily to Medicare Advantage health plans (and to some extent, Medicaid), diagnostic & preventive services, ACO enablement services, a provider enablement platform, 340B referrals and return to home services,

All of our revenue is generated in the United States.

There have been no material changes to our revenue recognition and estimates for our Home & Community Services segment, other than as described below related to the acquisition of Caravan Health.

Caravan Health enters into contracts with customers to provide multiple services around the management of the ACO model. These include, but are not limited to, population health software, analytics, practice improvement, compliance, marketing, governance, surveys and licensing. The overall objective of the services provided is to help the customer receive shared savings from CMS. Caravan Health enters into arrangements with customers wherein we receive a contracted percentage of each customer’s portion of shared savings if earned. We recognize shared savings revenue as performance obligations are satisfied over time, commensurate with the recurring ACO services provided to the customer over a 12-month calendar year period. The shared savings transaction price is variable, and therefore, we estimate an amount we expect to receive for each 12-month calendar year performance obligation period.

The remaining sources of Caravan Health revenue are recognized over time when, or as, the performance obligations are satisfied and are primarily based on a fixed fee or per member per month fee. Therefore, they do not require significant estimates and assumptions by management.

During the second quarter of 2022, we received a semiannual BPCI-A reconciliation from CMS. Within that reconciliation, CMS applied a negative retrospective price adjustment to the benchmark prices against which savings are measured for specific episodes under the BPCI-A program. Several BPCI-A participants, including us, disputed the price adjustment. Our dispute is based on independently collected price trend data that indicated a positive price adjustment should be applied and corresponded with inflation in the medical services industry. CMS subsequently recommended participants provide formal evidence of the pricing errors. We responded to the request in July 2022, and upon receipt of our submission of the calculation error notice, CMS deemed the reconciliation period to remain open. As a result of the open reconciliation period and our view that the information presented in the reconciliation was not accurate, we did not change our revenue estimates upon receipt of the second quarter semiannual reconciliation and awaited further resolution or clarity of this matter.

In October 2022, we and other BPCI-A participants received a memorandum from CMS providing a general response to questions raised related to the retrospective price adjustment as well as CMS’ plans for the future of the BPCI-A program. CMS indicated it had reviewed its own calculations and did not find errors in how it applied them but at the same time acknowledged a lack of transparency and the use of non-public data and proposed to make changes to the pricing formulas in subsequent model years. Later in October 2022, we received the required formal response to our calculation error notice submitted in July 2022, reiterating that following a comprehensive review and referencing the aforementioned memorandum, CMS did not find any errors in its calculations. This response indicated CMS deemed the original semiannual reconciliation provided in June 2022 to be correct. We are in the process of appealing this decision, which will further delay CMS deeming the semiannual reconciliation final and the related cash flows.

Due to the formal response to our calculation error notice received from CMS in October 2022 in regard to the most recent semiannual reconciliation, we revised our revenue estimates related to the performance period included in that reconciliation, as well as the subsequent two open performance periods. As a result, during the three months ended September 30, 2022, we recorded a reversal of revenue previously recorded of $38.6 million, $18.7 million and $6.9 million related to performance periods beginning in April 2021, October 2021 and April 2022, respectively. Additionally, we considered the negative trend factor adjustment imposed by CMS in our revenue estimates for the three months ended September 30, 2022. As a result of this negative adjustment, our revenue estimates are lower than they would have otherwise been and certain customers were in a negative overall revenue position for the performance period, and we therefore recorded expense of approximately $1.3 million included in Service expense for the three months ended September 30, 2022 on our Condensed Consolidated Statement of Operations. Further changes in management’s estimates, including a potential reversal of previously recorded revenue, could occur based on the outcome of the pending appeal process noted above and to the extent the final remaining semiannual reconciliations receive additional pricing adjustments.

Additionally, as a result of the change in estimates and our withdrawal from the BPCI-A program, we reduced revenue by $12.2 million during the three months ended September 30, 2022 related to administrative fee revenue recorded for performance obligations satisfied in prior periods. As a result of the pricing adjustments imposed by CMS and our planned exit from the BPCI-A program, it is unlikely these amounts will be collected from the customers, as they generally would be paid out of future savings earned.

Since the final determination of the semiannual reconciliation is pending appeal and we did not receive the formal response to our calculation error notice until late October 2022, the recognition of accounts receivable for our Episodes of Care Wind-down segment as of September 30, 2022 has not yet occurred. Estimated revenue related to this reconciliation period continues to be included in contract assets with corresponding shared savings expenses included in contract liabilities on our Condensed Consolidated Balance Sheets as of September 30, 2022. Historically, we received a final reconciliation in the second quarter of each year, thereby reducing the associated contract assets and recording accounts receivable for the amounts to be collected and reducing the corresponding contract liabilities and recording accounts payable for the amounts to be paid. Accordingly, the net cash collections from the delayed reconciliation, in addition to being significantly less than prior periods, will also deviate from historical cash collection seasonality trends.

Separately, we have revised our estimates of the time it will take to substantially complete our performance obligations from 13 months to 9 months for the open performance period that began in April 2022 as a result of our decision to wind down our Episodes of Care business. We expect our services and underlying performance obligations to be substantially satisfied by the end of 2022. This shorter period of time to complete our performance obligations resulted in approximately $1.8 million in additional revenue being recorded during the three months ended September 30, 2022.

The following table provides information about accounts included on the Condensed Consolidated Balance Sheets.

Property and equipment, net were as follows as of each of the dates presented:

Depreciation and amortization expense for property and equipment, inclusive of amounts subsequently written off or disposed from accumulated depreciation, was $2.7 million and $2.1 million for the three months ended September 30, 2022 and 2021, respectively, and $7.1 million and $6.2 million for the nine months ended September 30, 2022 and 2021, respectively. There was no impairment of property and equipment during the three or nine months ended September 30, 2022 or 2021.

We adopted ASC 842 as of January 1, 2022 using the optional transition method. Therefore, we did not restate comparative periods. Under this transition provision, we applied the legacy leases guidance, including its disclosure requirements, for the comparative periods presented.