Earnings Call Transcript
Alignment Healthcare, Inc. (ALHC)
Earnings Call Transcript - ALHC Q1 2026
Operator, Operator
Good afternoon, and welcome to Alignment Healthcare's First Quarter 2026 Earnings Conference Call and Webcast. Please note that this event is being recorded. Leading today's call are John Kao, Founder and CEO, and Jim Head, Chief Financial Officer. Before we begin, we would like to remind you that certain statements made during this call will be forward-looking statements as defined by the Private Securities Litigation Reform Act. These forward-looking statements are subject to various risks and uncertainties and reflect our current expectations based on our beliefs, assumptions, and information currently available to us. Descriptions of some of the factors that could cause actual results to differ materially from these forward-looking statements are discussed in more detail in our filings with the SEC, including the Risk Factors section of our annual report on Form 10-K for the fiscal year ended December 31, 2025. Although we believe our expectations are reasonable, we undertake no obligation to revise any statements to reflect changes that occur after this call. In addition, please note that the company will be discussing certain non-GAAP financial measures that we believe are important in evaluating performance. Details on the relationship between these non-GAAP measures and the most comparable GAAP measures and reconciliation of historical non-GAAP financial measures can be found in the press release posted on the company's website and in our Form 10-Q for the fiscal quarter ended March 31, 2026. I would now like to hand the conference over to CEO John Kao. Please go ahead.
John Kao, CEO
Hello, and thank you for joining us on our first quarter earnings conference call. For first quarter 2026, health plan membership of 284,800 represented year-over-year membership growth of approximately 31%, which supported total revenue of $1.2 billion, which increased 33% year-over-year. Adjusted gross profit of $146 million represented an adjusted MBR of 88.2%, which improved by 20 basis points year-over-year. Meanwhile, adjusted SG&A of $108 million improved as a percentage of revenue by 60 basis points year-over-year to 8.7%. Our adjusted EBITDA was $38 million, which grew by 88% compared to the prior year. This result exceeded the high end of our guidance range and implies an adjusted EBITDA margin of 3.1%. Our results this quarter reflect strong execution across sales and member retention as well as our clinical operations. Our performance in our SG&A ratio also reflects the early outcomes of investments we've made to scale our infrastructure. Progress we are making across each of these areas is giving us even more confidence today that we are on the right path towards our goal of 1 million members. Growing and scaling a business as rapidly as we are in an industry as complex as Medicare Advantage is not a straight line. That being said, we are progressing very nicely as we continue to scale the company and achieve our near-term growth and margin expansion objectives. Importantly, our operational discipline and unique model gives us swift visibility across the organization. This enables us to identify issues quickly and take actions to manage their near-term impact. We focus deeply on continuously identifying opportunities to improve and deploy solutions to create even greater durability across our company. For example, the CMS rule change impacted our observation determination process and drove inpatient admissions per 1,000 towards the higher end of our expectations in Q1. This process change was resolved by the end of February, but impacted our first quarter inpatient admissions per 1,000, which was in the high 150s this quarter. We absorbed this headwind within our Q1 adjusted EBITDA beat and are well positioned as we enter the second quarter. As we build upon our culture of continuous improvement, this year we are scrutinizing and revalidating every aspect of our people, process, technology and clinical culture to ensure they are positioned to scale. Through this process, we focused on opportunities to deliver more cost efficiencies through claims automation, improvements to our contract management infrastructure and scalability of our provider data management. For example, just 12 months ago, our claims auto adjudication rate was less than 15%. Now our year-to-date auto adjudication rate is over 60%, and we expect to drive even higher claims automation as we progress throughout this year. Meanwhile, we are also deploying contract management solutions that leverage AI to create a more dynamic contract management platform and taking the next leap forward in our AVA AI risk stratification models to create even greater precision in our clinical engagement efforts. We are also investing in our talent by adding team members who will drive greater scalability within our technology infrastructure. These are just a few of the actions we are taking to support our near-term results and accelerate progress to our long-term growth and margin objectives. Finally, before I turn the floor over to Jim, I'd like to spend a few minutes discussing the 2027 final rate notice, which was announced earlier this month. At a high level, we are encouraged by the administration's continued pursuit of actions that drive sustainability within the MA program. In a continuation of meaningful policy changes like the Wiser pilot program that tackle overspending in traditional Medicare, we also applaud the administration's actions to address overutilization of skin substitute products in fee-for-service. By taking action to create more accountability across every stakeholder in the health care ecosystem, we believe the program will increasingly reward those who deliver true, measurable value to members over the long term. Importantly, these dynamics continue to reinforce a core point, Medicare Advantage is a durable program that is here to stay. In that context, we also believe Alignment is particularly well positioned to succeed regardless of the rate environment. Our clinical-first approach enables us to deliver high-quality outcomes at a low cost and forms the sustainable competitive moat that sets us apart from our competitors. In closing, our first quarter results reinforce the strength and durability of our model. We are executing with discipline, scaling thoughtfully and continuing to translate our clinical approach into consistent financial performance. We're continuing to invest in the scalability of our platform, including automation, AI-enabled workflows and enhancements to our clinical infrastructure, all of which position us to drive further efficiency and growth over time. With a path toward 1 million members and unique opportunity to take share and grow profitably across all of our markets, we believe we are well positioned for the years ahead. With that, I'll turn the call over to Jim to further discuss our financial results and outlook. Jim?
James Head, CFO
Thanks, John. I'll dive straight into our first quarter results. For the quarter ended March 2026, health plan membership of 284,800 increased 31% year-over-year, driven by strong execution on sales and retention. Increase in membership supported revenue of $1.2 billion in the quarter, representing 33% growth year-over-year. First quarter adjusted gross profit of $146 million represented an MBR of 88.2%, which reflects an improvement of approximately 20 basis points year-over-year. Our adjusted gross profit performance this quarter was underpinned by strong engagement from our clinical teams. Their disciplined execution held inpatient admissions per 1,000 within our range of expectations despite the temporary disruption to our utilization management process that John previously discussed. Meanwhile, the remainder of our medical costs were in line with supplemental benefit costs and Part D running modestly favorable through the first 3 months of the year. Moving on to operating expenses. Our SG&A discipline and scalability initiatives such as back-office automation supported outperformance in our operating cost ratio. For the first quarter, GAAP SG&A was $121 million. Our adjusted SG&A was $108 million, an increase of 24% year-over-year. Adjusted SG&A as a percentage of revenue declined from 9.4% in the first quarter of '25 to 8.7% in the first quarter of 2026. This represents approximately 60 basis points of improvement year-over-year and outperformed the midpoint of our implied guidance range by 50 basis points even as we continue to make focused investments. Taken together, first quarter adjusted EBITDA of $38 million produced an adjusted EBITDA margin of 3.1%, which represents 90 basis points of margin expansion year-over-year. Turning to our balance sheet. We generated strong operating cash flow in the quarter and concluded with $726 million in cash, cash equivalents and short-term investments. Our liquidity profile remains strong with ample cash available to the parent company. The funded leverage ratio at the end of Q1 improved to 2.6x trailing 12-month EBITDA. Turning to our guidance. For the full year 2026, we expect health plan membership to be between 294,000 and 299,000 members. Revenue to be in the range of $5.16 billion to $5.21 billion. Adjusted gross profit to be between $620 million and $650 million and adjusted EBITDA to be in the range of $138 million to $163 million. For the second quarter, we expect health plan membership to be between 288,000 and 290,000 members, revenue to be in the range of $1.30 billion to $1.32 billion, adjusted gross profit to be between $167 million and $177 million and adjusted EBITDA to be in the range of $50 million to $60 million. As it pertains to our full year guidance, we are increasing our membership growth expectation given continued strength within our sales operations and outperformance in member retention through the open enrollment period. We believe our disciplined approach to sales growth and focus on retention is serving us well this year, particularly as we absorb the impact of the third and final phase-in of V28. In conjunction with the increase in our membership outlook, we are also raising our full year revenue guidance to approximately $5.2 billion at the midpoint, which reflects 31% growth year-over-year. With respect to our profitability metrics, we are raising the low end of each of our adjusted gross profit and adjusted EBITDA guidance ranges by $5 million to reflect confidence in our full year objectives following the strong start to the year. Within our outlook expectations, we continue to assume that inpatient admissions per 1,000 will run higher year-over-year. As a reminder, this is primarily due to changes in our mix of membership. In 2026, we intentionally focused on growth amongst high acuity populations, whom we believe will benefit most from our clinical model. Consistent with past years, we also do not incorporate any assumption for final suite pickup from new members into our outlook assumptions. Taken together, our implied first half guidance reflects confidence that the strong performance we delivered in Q1 will continue into Q2. The midpoint of our guidance implies that approximately 60% of our full year EBITDA will be generated in the first half of 2026. This compares to approximately 55% of the full year EBITDA in the first half of 2025, excluding new member final suites. Further, on that same basis, this represents nearly 100 basis points of first half adjusted EBITDA margin expansion year-over-year. In closing, we continue to deliver upon our promises each quarter as we assess, refine and scale our core workflows and processes. Each of the transformational projects we are investing in and deploying today are establishing the foundation upon which we can scale to achieve our ultimate potential. Our meticulous and disciplined execution to date leaves us even more encouraged about the opportunities ahead. With that, let's open the call to questions. Operator?
Operator, Operator
Our first question will come from the line of Matthew Gillmor with KeyBanc.
Matthew Gillmor, Analyst
Maybe following up on the hospital observation issue. It sounds like this was temporary, but can you just walk us through what changed, how it was resolved and give us some sense for how hospital utilization trended now that it's been resolved?
John Kao, CEO
Yes. Matt, it's John. Yes, basically, we paid authorizations at full acute rates when we should have paid them at observation rates. It was a workflow problem, and we, of course, corrected it, but it impacted our January numbers, a couple of million dollars, I think it was. And inpatient admissions per 1,000-wise, we were a little bit higher by a couple of admissions. And we wanted to share that with everybody. And it's really part of how we are kind of looking at every part of our company to just continuously get better. And we'll talk about that a little bit more, I think. But I don't think it's a systemic problem. I think it was a one-month blip, and we'll have that course correct. We have it course corrected.
Matthew Gillmor, Analyst
Got it. And just to confirm, John, this is an internal thing that you all caught...
John Kao, CEO
Yes, yes, exactly. It's an internal workflow issue. It's not a utilization issue. Yes, utilization I think declined. And Jim's got the insights.
James Head, CFO
Matt, I'll jump in on the utilization because I think that's important, and there's lots of points of reference out there. But utilization was, notwithstanding what John described, which I kind of call a one-time course correction, tracking very closely to what we expected. And as you're aware, we had admits in the high 150s. Absent that issue that John described, we probably would have been in the mid-150s, and that is pretty much what we thought was going to happen. The flu is one thing that everybody is talking about. It wasn't a big driver, positive or negative in our numbers. We track admits with respiratory problems. We look at our Part D costs, et cetera, and it was pretty much in line. So we've got our eyes on all those categories, and it felt like things were tracking pretty nicely to what we expected, and we see that in April as well.
Operator, Operator
Our next question comes from the line of John Stansel with JPMorgan Securities.
John Stansel, Analyst
I just want to talk a little bit about 2Q MBR. I mean stripping out sweeps, it seems like it improves by a pretty decent amount and that's even after adjusting for a couple of million of incremental pressure that's not going to recur in 1Q. Can you just talk about what's assumed for year-over-year improvement in the second quarter that is maybe different from the first quarter?
John Kao, CEO
Yes, John. The second quarter is usually our stronger seasonal quarter, so we naturally see a decline in MBR. That's expected and positive. I want to step back and describe that we're presenting the actuals for the first quarter and guiding on the second quarter, and overall we're projecting a pretty strong first half. We set a reasonably high bar this year. Over the first half we expect improvements across all margins, MBR, SG&A and EBITDA: MBR improvement of 40 basis points, SG&A 40 basis points, and EBITDA 90 to 100 basis points. That represents a really strong first half on an apples-to-apples, pre-suite basis. As we noted on the call, 60% of our profits are in the first half versus 55% previously. At the same time, we're investing to scale the business, hiring talented people across the enterprise and investing in systems and processes, while staying focused on improving clinical execution and raising margins. This is a continuation of what we were doing in 2025 as we move into 2026. The first half feels very good.
John Stansel, Analyst
Great. And then maybe just taking a step back and thinking about some of the changes in the final rate notice, I'll call it, deferral of a new risk model. How are you thinking about maybe reasons why that didn't make it in? And then as we think about potentially a new risk model in, say, '28 or '29, what we can take away from what was proposed versus what might actually be implemented?
John Kao, CEO
Yes. John, I personally think there is going to be some changes. I think there is going to be more normalization, if you will. I don't think there's enough outcomes feedback that CMS has yet to have initiated it in this past final notice. I think they will be working on this as a topic of focus in the advance notice coming up, and then we'll see something in the '27 to maybe be implemented by '29, something like that. But I think CMS has been pretty consistent with their message of ensuring that coding is not some form of a gamified competitive advantage for people. And obviously, I think that's a good thing for the industry, and I think it serves us really, really well. It really puts the purest form of who's got the highest quality at the lowest price point in those organizations should be rewarded to succeed. Does that answer your question, John?
Operator, Operator
Our next question comes from the line of Scott Fidel with Goldman Sachs.
Scott Fidel, Analyst
Could I get a bit more detail on the inpatient issue so we fully understand? From the call, Jim mentioned a CMS rule change and it sounds like you needed to adjust internal systems, which may have caused the disruption. Can you confirm that or explain any other causes? Two follow-ups: is this an internal system change that affects all your markets or only California? And if it caused you to pay full acute rather than observation, can you recover any of those excess reimbursements, or is there no resolution yet?
John Kao, CEO
That was my first question, Scott, but the answer is unfortunately no. Yes. No, it's a rule change that requires us to basically make authorizations a little bit more timely. And the backdrop of it is we've shared this with you guys in the past, which is we've kind of moved from this world of capitation and delegation. And even in our shared risk businesses, we've had certain administrative functions that were delegated to the IPAs. And one of the things we've shared with you in the past is we have started de-delegating certain IPAs. That strategy has been phenomenal for us and the IPA. We just have a good process. But there's more and more of the de-delegation of the acute authorization process, or we would call that concurrent review process. And it's a competency that we are getting better and better at. And it's a competency that we need to make sure that we have the more we scale outside of California. Because I think a lot of the networks that are being constructed are really going to be with the direct providers, practices, et cetera, without having an IPA or an MSO like we have in California. And so I think that's the context.
James Head, CFO
Yes. Scott, given that, we put this up as an example of corrective action and how quickly we act. By the end of January we saw a small anomaly in our numbers and then went and found the root cause. We were going through a changeover at the beginning of the year and had staffed up, but by February we had identified and already corrected it. It was a slight drag on our adjusted gross profit, so we wanted to call it out. This is the kind of maniacal attention to detail John talks about and what you have to do to successfully execute. We've corrected it; admissions per 1,000 are exactly where we expected them to be by February and March. We've perfected that workflow and are now ready to move ahead.
John Kao, CEO
Yes. Last point is we shared that with you because we want to signal that a lot of the performance we are achieving now was driven by operational decisions made two years ago. The most obvious example is SG&A being below 9%. We are continually refining our workflows, and this is a major focus across the company. The message is we are preparing to grow and to support that growth in the same way we have so far. That was the one line I mentioned. It is not going to be a straight line, but I feel really good about this year. Even for '27, '28 is a little far out, but I think we have proven that we do what we say we are going to do.
Scott Fidel, Analyst
Got it. If I could just follow up, we appreciate you calling that out instead of us being in the dark about it. Just to clarify one thing: John, it sounds like the skew may have been toward some markets outside California in terms of how this flows through to some of the delegation. And the other follow-up for Jim: you mentioned a separate dynamic that sounded like a mix impact on inpatient from a product mix change. Is that D-SNP, or is it the new markets? Could you clarify what specific mix change impacted that?
John Kao, CEO
It's not just an ex-California issue. It really was just a corporate function that we're really scaling and growing, putting new systems in, putting in new workflows, all of that. It's really limited to that. And it's not just a function of the ex-California markets.
James Head, CFO
As it pertains to admissions per 1,000 being slightly higher, that is a mix issue. It's both a growth and a mix issue, Scott. In this case there's a lot of growth outside of California and in more acute populations, and we had planned for that. On our fourth quarter call we said admissions per 1,000 would be a little higher this year. It will tick up because we are investing in that population, which we know has significant embedded gross margin, and we're willing to make that investment. All of that is baked into our guidance at the beginning of the year and our first-half outlook. So we're tracking exactly what we expected to happen.
Scott Fidel, Analyst
Okay. So it's new member sort of mix and then it's sort of some of the new markets and then sort of both of the product sets in terms of sort of traditional HMO and then D-SNP or sort of skewed just towards one of those?
James Head, CFO
No, we talked about a lot of our AEP growth being in the C-SNP and D-SNP population, like about 50% growth. That's what we're talking about in terms of mix.
Scott Fidel, Analyst
Yes, that's what I was trying to clarify.
Operator, Operator
Our next question will come from the line of Whit Mayo with Leerink.
Benjamin Mayo, Analyst
Maybe just a follow-up on that. How you're feeling about risk adjustment versus expectations given this focus on the more medically complex members this year?
James Head, CFO
I think we're going to break it into two pieces: our loyal population, which we really have a good line of sight on. We're very good at predicting that and tracking it. As it pertains to risk adjustment on the new members, we call them the newbies, that's where we're very cautious. So we book to the paid MMR, which means what CMS pays us will be recorded as revenues. Now what that does is provide opportunity for upside in the second quarter when we get the final suites. So I think you'll get more information when we get more information in the second quarter on that. But we are probably a little bit different than others in that we take a cautious stance on our new members until CMS is giving us paid files that recognize that upside.
Benjamin Mayo, Analyst
Okay. And maybe just my follow-up. I don't think we've talked about RADV in a while. I just wanted to give your take, John, on the 2020 audit methodology that was issued a few weeks ago. Just what's different you see about the 2020 audits versus maybe the 2018 and '19?
John Kao, CEO
Well, the big one is the kind of the ongoing litigation around the extrapolation methodology, which is a huge deal with respect to potential financial exposure. And for those of you that don't know, that part of the extrapolation methodology is no longer in the 2020 audits. Not to say that they won't come back down sometime in the future. And we feel very good about that entire process. We've scrubbed that area very tightly, and I'm not worried about that.
Operator, Operator
And our next question is going to come from the line of Michael Ha with Baird.
Michael Ha, Analyst
So it sounds like this inpatient admit issue is fully resolved, but it sounds like you realized anomalies in end of January. So would you say you knew about it by the time you reported earnings? And then secondly, I just wanted to ask about the LIS SNP members, it sounds like they were in line this quarter. But I was wondering if you could actually talk more about like higher mix of these members, how it might impact your cohort maturation into '27? Because if I'm thinking about it correctly, right, year 1 year to year 2 generally larger step-up in MLR improvement. Is it more pronounced next year given higher LIS SNP member mix, meaning if you're getting, say, like a 30 bps, 40 bps headwind in MLR this year, does that turn around into a larger tailwind next year?
John Kao, CEO
Yes. I can take this, and Jim can provide color commentary. I think we have to wait a little bit in terms of getting the sweep data in. It's kind of linked to the prior question. We got to get the sweep data in on the newbies. I think from an MLR point of view, it's kind of consistent depending upon market, it's kind of in the high 80s, low 90s on the newbies that we got, inclusive of the numbers. So I don't think it's like ramping. But your point on the opportunity for us to improve embedded earnings once we have more time with these newbie members, particularly the SNP members, I think, is a good call out. And the way I'm looking at this is when you look at the overall consolidated MLR, we are then kind of looking at, well, how much of the MLR is supplemental benefits. And we've kind of shared in the past, it's in that 5% to 6% range. And so your medical MLR is kind of 82%, 83% that's the way we think about it. And then you say, okay, of that, how much is newbie versus how much is loyal? And to your point, the bigger proportion of our membership that becomes loyal, that embedded earnings is going to get stronger and stronger. And then when you add on top of that, some of these people, process and technology changes that we're making that impact both MLR and SG&A, that's kind of where we're striving to get to, where we just are so good at all this, there's nobody that can compete with us with respect to bids. And then we start taking this thing out and expanding aggressively. That's kind of how I'm thinking about it.
James Head, CFO
Michael, you asked about were we aware of when we did earnings at the end of the fourth quarter earnings call in February, were we aware of what was going on? The answer is yes. When you turn the page every year, there's always a little bit of ambiguity in January in terms of how you're predicting the rest of the year. And so when we did our guidance, et cetera, we understood the issue and incorporated that into our guidance. And I think corrective action is the right way to describe it. We fixed it fast. It didn't take months. It took 30 days to fix it. And I think you're seeing in our first half guide that we feel pretty good that we've got line of sight on the first 6 months of the year, and things are performing quite well.
Michael Ha, Analyst
Great. And just a quick clarification. What would MLR have been if you did not have that issue in January? And then on DCPs...
James Head, CFO
I would say it's probably maybe 30 basis points lower, something like that.
Michael Ha, Analyst
Got it. And if I could ask just one on DCPs. They're up a lot again this quarter. I think like 10 days year-to-year. Last quarter it was up 6 days, which I love to see that. Also noticing claims payable is tracking well, down year-to-year. But I know last quarter, there were some timing dynamics around claims payment. So I was just wondering, were there any unique dynamics this quarter that might explain the large increase? And just would love to get your thoughts on the level of conservatism in your reserve methodology recently because it feels like there's a nice cushion.
James Head, CFO
Generally speaking, our reserve methodology is exactly the same. We're conservative and consistent. We haven't really changed our processes or our stance. It's not like we were conservative last year, we're less conservative this year. We're growing fast. But that's all part of it. The DCP did pick up a little bit. There is some Part D components in there, call it CMS Part D type stuff, which makes it a little bit anomalous. But generally speaking, the classic IBNR days claims payable has been moving upwards. Over the last three or four quarters, there's been a little bit of volatility in the pace, but we're working through that. But I wouldn't read this as building conservatism, and I would certainly not say that we've changed anything and we're less conservative at this point. So it feels like it's a good quality of earnings this quarter on that.
Operator, Operator
Our next question will come from the line of Jessica Tassan with Piper Sandler.
Jessica Tassan, Analyst
I'm curious to know how you're thinking about supporting the bridge model for GLP-1s that launches this summer. I know the economics are separate from Part D, but just in terms of getting people who can benefit on the drug and adherent, retaining them into '27 and possibly capturing some trend benefit. Just interested to know how you're thinking about that launch this summer?
John Kao, CEO
The kind of voluntary pilot is what you're asking about? We actually said we would participate with certain conditions. As you know, they didn't get the 80% participation that they wanted. And so they're kind of extending that time period. That kind of gets into a little bit of our product strategy for the '27 bids, which I'd like to not discuss at this point. I'm not sure of all the operational specifics to share here on the call.
Jessica Tassan, Analyst
It's all right. I can come back in a few months. Maybe then just on '27, to the extent that you guys are willing to comment, it sounds like the message for '26 is we're really happy with the growth for '27 sustained growth. So can you just update us on new market plans for '27 post rate announcement? Are you still planning to add at-market? And then just whether you guys consider the '27 rates adequate? And if not, should we just expect kind of marginal benefit cuts to offset whatever the delta might be?
John Kao, CEO
I won't comment on any bid tactics for competitive reasons. I will say that we will be expanding into new markets, some large markets next year. I'm not going to comment yet where and/or if we're getting new states. We think about all of this as a portfolio of assets. And it's fair to say for us to expand where we have risk-based capital in a capital-efficient way is probably still the best way for us to grow, whether that be California, Texas, North Carolina, Vegas, it's doing great, et cetera. The other part of what's driving our decisioning is the operational framework and whether it can support the level of growth in the new markets. I think the answer is yes, given our performance. But I probably want to see another year of outcomes. I think we can continue getting the growth. I think you'll see us getting good margin expansion. And I think you'll start seeing that in some of the discussions around '27. We'll talk about that in the fall after the bids are in.
Operator, Operator
Our next question will come from the line of Ryan Langston with TD Cowen.
Ryan Langston, Analyst
Just on the G&A, I appreciate the comments on the benefits from investments and some automation. But was there any impact from timing in the first quarter that might sort of reverse out in the rest of the year? Should we maybe expect that level of performance to kind of carry through the back half of the year?
James Head, CFO
I think there is always a little bit of timing in the first quarter where you want to make sure that you've got cushion for hiring, spending, things like that. But I think there was just a lot of good performance across all the categories, even beyond labor, for instance. Now, as it pertains to whether we're going to pass that along, it's early in the year. And as John and I have been talking about, we're really making investments in the business. So I suspect that we're not going to just turn that into a beat on the year just yet. On the other hand, it gives us a little bit of comfort that we can continue to make investments in the business. And obviously, we're monitoring this holistically from a margin perspective, percentage of revenues and whether we're going to meet our commitments. So it's nice to have an early good start, but that doesn't mean we're ready to give it all back and put it into the margin.
Ryan Langston, Analyst
Okay. And then can you just maybe talk a little bit about capital expenditures for 2026 and beyond? I mean, is there sort of an opportunity or maybe even a desire to push that up a little bit just given where the free cash flow generation is now?
James Head, CFO
Our capital expenditures are largely software development, with a little bit of hardware. We have a roadmap where this year we're probably in the roughly $40 million spend range. We're coming out of the block a little bit softer than that, but that will accelerate, and it's well within our means. On the other hand, the ability to spend the dollars depends on getting the right projects, the right bandwidth, and ensuring we're getting the right returns out of it, so that is a constraint versus simply capital availability. We feel pretty good about the $40 million range; my guess is that could tick up a little bit, but it's going to come down as a percentage of revenues over time as we accelerate our revenues.
John Kao, CEO
We have not shared, and we won't on this call, all the details of how we're deploying AI. The opportunities for us in terms of our clinical operations, our provider data, our Stars, our risk adjustment, every part of the company can benefit from AI and we will continue to drive down SG&A and MLR. To maximize the benefit of AI and the tools available, which I think are just amazing, we need to make sure we understand and validate all of the data. I think we have the best data in the industry, and we're going to get that even better. Our workflows, our end-to-end provider workflows, our end-to-end member workflows, our end-to-end Stars workflows, all of that is getting documented at a molecular level now so that we can apply AI tools on top of that. That's where the CapEx is going towards.
Operator, Operator
Our next question will come from the line of Justin Lake with Wolfe Research.
Dylan (for Justin Lake), Analyst
From a trend perspective, some of your peers have talked about a moderation beyond weather and flu. Have you seen any early signs there? And then also curious on the churn rate you're seeing early in 2026 compared to 2025?
James Head, CFO
Retention is tracking really nicely. That's been one of the helpful components of our membership growth year-to-date, OEP, et cetera. So we feel pretty good about that. As it pertains to trends, I mentioned earlier, we track flu and other trends and they are not jumping out as anything anomalous per se. That's our book of business and how we think about things. We look across the major categories of medical spend and the trends seem very consistent for us. Part D is tracking very nicely this year; we had a little bit of outperformance in Q1 in the margins. That was a good thing. We're not ready to turn that into a full-year expectation increase, but Part D is doing really, really well and that's been a big watch item over the last couple years. We feel pretty good about that. Trend-wise, we have a different rhythm than some of the other MCOs, which is driven by how we set up our utilization management and how we work with providers. There is also some capitation in our mix that cushions some flu season trends.
Operator, Operator
Our next question will come from the line of Andrew Mok with Barclays.
Andrew Mok, Analyst
Alignment is predominantly an HMO business, but you leaned a little bit more into the PPO product this year. Can you walk us through the rationale behind that decision? And how are you thinking about the relative attractiveness of the PPO product given some of the recent plan exits across the market? And do you expect PPO to become a larger driver of your growth over time?
James Head, CFO
Part of the reason we were willing and able to do PPO last year and this year is over half of the business is globally capitated, and that factored into the way we think about it. The logic around stratifying members and caring for members through our Care Anywhere program and positioning that part of the clinical business could work as we extend products, particularly outside of California. I don't think we have figured out a secret sauce yet. I think the only way to deal with that is probably going to be with higher member premiums going in the future. I'm not going to discuss 2027 bids here, but long term from an industry perspective, that whole part of the world was supported by high RAS scores, and I don't think that's going to happen going forward. The unit economics are going to be tough for people. If anybody can do it, it should be us, but candidly, I don't think we've fully cracked that code yet.
Operator, Operator
Our next question comes from the line of Jonathan Yong with UBS.
Jonathan Yong, Analyst
I recall last quarter, we talked about you still had some provider engagement negotiations outstanding in some states that you were thinking about entering. Has that progressed any further? And does the final rate update make any difference in terms of those negotiations? So you were negotiating when the advance came out and then obviously, the final is out. Does that change that negotiation process?
John Kao, CEO
I wouldn't characterize it as negotiation. I think the negotiations part was fine. It was more around the engagement, the provider engagement model. In some markets, the answer is yes; in some markets, the answer is no. That will dictate where we expand into certain markets or new states. Delivery systems want an alternative; they want a payer that's willing to move market share to them without high denial rates. Our model is very different and requires a high degree of engagement with clinically integrated networks that are typically owned by integrated delivery networks. It's really important that we find the right doctors and practices we can work with, and we're leaning into that significantly as we think about more scale outside of California.
Jonathan Yong, Analyst
Great. And just a follow-up on the denial portion of it. Given MCOs broadly are reducing the amount of prior authorizations and denials, does this make it harder to contract within that context?
John Kao, CEO
No, it's going to be really interesting. I think it's where the emphasis is. A lot of the AHIP discussions and what CMS is pushing the large plans on is really around commercial. There's a little bit that the exchanges and Medicaid care are dragged into that as well. Our denial rates are less than 2%, and some larger plans are 13% to 15% by comparison. The data we pulled was interesting. As an industry, when hospital CEOs and CFOs say Medicare Advantage pays them 85% or 86% of traditional Medicare, the inference is plans are denying care. From our experience, we are paying health systems what they are contractually due. When we talk about program integrity, we also need to apply scrutiny to hospital billing practices. If 100% of claims and authorizations that hospitals submit are coded as 'acute' rather than 'observation,' we need to ensure accuracy of those billings submitted to plans. Traditional Medicare does not edit submissions to the same degree. That's a policy issue. If you heard hospital CEOs in front of Congress recently, it's all criticism of plans. I would reject that broad characterization. We pay hospitals what they contractually show, and our denial rates are very low. That's my soapbox on that.
Operator, Operator
Our next question will come from the line of Craig Jones with Bank of America.
Craig Jones, Analyst
So I want to follow up on the final rate notice. Chris Klump was out with some comments after the final rate notice was published that you were happy with that 2.5% number as it is roughly in line with where general inflation comes in and thought that, that should be a target for just health care spend increases going forward. So do you think that 2% to 3% is where we will continue to see these rate notices going forward? And if that's the case, what level of unmanaged trend could you manage without having to cut benefits if that's where the rate notice comes in?
John Kao, CEO
It's pretty insightful. Overall trend nationally as an industry is way higher than 2.48%. The default scenario for many plans is to modulate the delta through tougher unit economics with providers or benefit reductions. For us, you need to look at geographic impact. For example, L.A. County's rate increases are closer to 6%, which benefits us. Those factors are being considered as we do business plans market by market in preparation for bids. I feel pretty good about where we're positioned for '27 bids. But no way trend is going to be at 2.48% nationally; it's much higher, which speaks to affordability and hospital billing dynamics.
Operator, Operator
Our last question will come from the line of Ryan Daniels with William Blair.
Ryan Daniels, Analyst
John, you talked a little bit about ancillary benefits and the impact on MLR. And Jim, you've talked about capital deployment. Let's tie those two together and get your latest thoughts on maybe deploying some capital to bring some of that in-house, especially as you approach that 300,000 member number and think about going into new markets. Is that another strategy along with AI to kind of help the cost profile of the organization?
John Kao, CEO
Absolutely, Ryan. Supplemental benefits — as we get larger, some competitors have captives for behavioral health, dental, vision, transportation, etc. Right now we pay external vendors. There is an opportunity to lower MLR by bringing some of that in-house. I've alluded to focusing M&A dollars in those areas, which are relatively low risk, low capital, high return. Whether it's a dental PPO or a dental HMO, those are decisions we're weighing. If we bought something or started something, you'd likely see it when we have 300,000 customers. That would be an additional upside in the future, but it's not embedded in our first half guidance.
Operator, Operator
Thank you. This will conclude today's question-and-answer session. Ladies and gentlemen, this will also conclude today's conference call. Thank you for participating, and you may now disconnect. Everyone, have a great day.
John Kao, CEO
Thank you.