InnovAge Holding Corp. Q4 FY2022 Earnings Call

Thank you, operator. Good afternoon and thank you all for joining InnovAge's fiscal 2022 fourth earnings call. With me today is Patrick Blair, President and CEO; and Barbara Gutierrez, CFO. Dr. Rich Feifer, Chief Medical Officer, will also be joining the Q&A portion of the call. Today, after the market closed, we issued a press release containing detailed information on our quarterly and annual results. You may access the release on our company website, innovage.com. For those listening to the rebroadcast of this presentation, we remind you that the remarks made herein are as of today, Tuesday, September 13, 2022, and have not been updated subsequent to the initial earnings call. During this call, we will refer to certain non-GAAP measures. A reconciliation of these measures with the most directly comparable GAAP measures can be found in our fiscal fourth quarter 2022 press release, which is posted on the Investor Relations section of our website. We will also be making forward-looking statements, including statements related to our remediation measures, including scaling our capabilities as a provider, expanding our payer capabilities and strengthening our enterprise functions, future growth prospects, the status of current and future regulatory actions and other expectations. Listeners are cautioned that all of our forward-looking statements involve certain assumptions and are inherently subject to risks and uncertainties that can cause our actual results to differ materially from our current expectations. We advise listeners to review the risk factors discussed in our Form 10-K annual report for fiscal year 2022 and our subsequent reports filed with the SEC. After the completion of our prepared remarks, we will open the call for questions. I will now turn the call over to our President and CEO, Patrick Blair. Patrick?

Good afternoon. Thank you, Ryan, and thank you everyone for joining us this afternoon. I want to start by expressing my continued appreciation for our InnovAge employees across the country for everything they are doing to support our participants, each other in our business during these challenging times, and our federal and state partners for their ongoing collaboration and support, and to our shareholders for their ongoing interest in the company. This quarter represents a continuation of the transformational journey in InnovAge. I remain confident that we're pursuing the right foundational actions to keep the business strong and healthy while navigating this difficult moment. Our primary focus continues to be resolving the issues that led to the enrollment sanctions in Sacramento and Colorado. This includes following the lead of our regulators, ensuring they are completely satisfied with our improvements we're making and the quality of healthcare we're delivering. We're tackling these opportunities across every InnovAge center, whether in the audit process or not. I'm genuinely encouraged by our progress in the last 90 days. By some measures, we are even ahead of our expected timeline for near-term operational improvements and medium-term capability development. The financial results for the quarter highlight needed investments in the core, which we've made, and the economic realities of frozen enrollment across roughly half our business. While some of these costs are temporary, some will be permanent as we believe they're critical to ensuring a highly compliant and effective care delivery model going forward. The results also served to crystallize the opportunity and importance of accelerating the development of our payer capabilities to effectively manage total cost of care. While disappointing, we do not believe the results reflect the strategic and operational progress made across the enterprise. I will go into detail later in my prepared remarks. Last quarter, I introduced the three key dimensions of our transformational work: achieving operational excellence as a provider; expanding our core payer capabilities; and strengthening critical enterprise functions. Regarding operational excellence as a provider, we're making meaningful progress across eight core initiatives, which I'll expand on shortly. These initiatives are designed to help us earn the right to be released from sanctions and return to accepting new participants in Sacramento and Colorado, while also providing the blueprint for a standardized and scalable PACE platform. Regarding our risk-bearing payer capabilities, we've concluded the assessment of our current state across the areas of provider network management, evidence-based side of care management, resource management of third-party care delivery, claims payment, and risk score accuracy. What’s more? We've already begun to strengthen these core business processes, have identified quick wins, and developed a robust pipeline of initiatives that we believe will improve quality and lower medical cost. We've also made large strides in strengthening our enterprise capabilities, and we are adding new talent and performance standards to the organization. Success in the business starts with great participant care delivered by purpose-driven individuals. To guide and align our leaders, we've launched a five-pillar performance management framework, which defines operational success in clear and measurable key results across the pillars of people, service, quality, growth, and financials. As an example, we're measuring service through a quarterly participant satisfaction score. In the fourth quarter, it was 81%. We look forward to improving this metric along with others in fiscal year '23. We will have implementation work ahead of us, but my leadership team and I will be held to the performance standards this fiscal year. On the talent front, we've made tremendous progress adding both leadership and center-level caregiving roles. The momentum and culture we're building, coupled with the inspiring mission of PACE, is attracting top caliber talent to InnovAge. In August, we welcomed Dr. Rich Feifer who joined us as Chief Medical Officer. This month, Kathy Andreasen assumed the role of Chief People Officer. Rich brings significant experience focused on optimizing performance across both the provider and payer domains. Kathy brings decades of experience as a CPO from high-growth technology and service industries, where she was instrumental in scaling talent management capabilities. I would also like to note the addition of Jim Carlson as our new Board Chairman. Jim brings decades of both public company leadership and board experience that I believe will be instrumental in accelerating our strategy and execution. To begin today's discussion, I'd like to start with a regulatory update by market, updates on our eight key operational excellence initiatives, perspectives on the quarter with a specific focus on the interplay of operating and medical cost, and then I'll share some concluding thoughts. On the regulatory front, we're continuing our work to resolve the audit findings, working closely with CMS and our state partners. Our job is to ensure every requirement is fulfilled and every question from the regulators is answered. We're making excellent progress systematically remediating the deficiencies that led to the sanctions, and as I mentioned earlier, proactively making these operational changes broadly across the organization. We're measuring our progress monthly against a set of jointly developed audit performance measures. Importantly, we have been intentional to build the performance measures into a dynamic dashboard for efficient communication in progress reports. The regulators are using our performance against these measures to assess our progress and to determine when to begin the audit validation process, which is the final audit step before sanctions can be released. As we said before, the actual timing of sanction release will ultimately be determined by our regulatory partners. Starting with Sacramento, we have achieved five consecutive months of target performance against key audit measures. CMS and the state have acknowledged our progress, and we are working closely to determine the remaining steps before entering the validation process. We don't know the date when sanctions will be released, but we are confident we're on the right path. In Colorado, CMS accepted our corrective action plan in April, and the Colorado Department of Health Care Policy and Financing accepted our plan in June. We've taken what we've learned in Sacramento, and we're applying it to Colorado. And we're very pleased with our progress. We are working intensely to satisfy all the requirements as quickly and as thoroughly as possible, and our performance over the next few months will be critical to reaching the validation stage. In New Mexico, the audit began in October 2021. In July, we were verbally notified that no enrollment sanction would be taken. There are immediate corrective actions that we must take to remediate all aspects of the audit, and we are working with CMS in the state, all while continuing to enroll participants. Similarly, in San Bernardino, the audit began in March 2022. We were verbally notified by CMS in August that no enrollment sanction would be taken. But again, while continuing to enroll new participants, we are implementing immediate corrective actions in working with CMS in the California Department of Health Care Services and all remaining aspects of the audit. For our two markets that are not under active audit, Pennsylvania and Virginia, we are currently not aware of planned audits but proactively deployed self-audits based on our learnings in California, Colorado, and New Mexico. In Florida, we remain on pause in our Tampa and Orlando de novo centers until we have greater clarity on when our current sanctions will be released. To sum up, we believe we've identified the root causes that led to the sanctions and are addressing them wherever they exist. We're not only making progress across markets under sanction, but we're also beginning to see some evidence that we're earning back the trust from our government partners. In May, I shared with you that we were focused on eight operational process improvement initiatives to address the root causes of the audit deficiencies, which began in earnest in February. We believe excellence in these areas will not only reduce future compliance risk, but it's also the bedrock to a repeatable operating playbook. We communicated that we expected to complete these initiatives by calendar year-end and I'm pleased to report that we're making strong progress and are largely tracking ahead of schedule. Specifically, as of September 1st, we've made progress among the following dimensions: Filling critical personnel gaps in each of the centers. We've reduced the number of critical open positions by approximately 60%. Physicians, nurses, and home care workers continue to be the most challenging areas, but we're making steady headway. We've also increased our overall FTE headcount by approximately 150 over the last six months to approximately 2000, including 1,300 clinicians. Standardizing the process of our interdisciplinary care teams who plan, coordinate and deliver care. We've implemented new processes and tools for these mission-critical care teams across all 18 centers. Our focus now is continuous performance monitoring and training. Improving the timeliness of scheduling and coordinating care with external providers outside the centers. Approximately 95% of participants are being scheduled within the target timeframes and backlogs have been largely eliminated. We're now optimizing staffing, productivity measures, and tools. Improving the efficiency and reliability of transportation for our participants. Driver open positions have been reduced by approximately 90%. Additionally, transportation is running at an on-time percentage of approximately 80%. We are also in the process of implementing new scheduling and routing tools, which we believe will meaningfully improve efficiency. Standardizing our wheelchair program across the enterprise. We've secured local and network contracts across all centers, and we are finalizing a few national partnerships with the goal to further improve quality and reduce costs in this area. Reducing documentation outside of the EMR. We've completed training and proficiency examinations on how best to utilize EMR for care documentation across all targeted centers. Improving our telephonic response times and strengthening our home care network and reliability. It's taking us longer to achieve our targeted results for these two initiatives due to the reliance on technology enhancements and the inherent challenges of the homecare workforce shortage. In the near term, we've made solid progress through improved processes resulting in increased productivity. Within homecare, these open positions are included in our critical hiring initiative discussed earlier. We're pleased with our progress and in the coming months, we'll be focused on ensuring we have the structure in place to sustain and continuously improve in all of these areas. Now turning to the quarter, we reported revenue of $172.9 million, which represents a sequential decline of 2.5% compared to last quarter. We ended the quarter serving approximately 6,650 participants. For the fourth quarter, we reported a center-level contribution margin of $23.6 million and a corresponding center-level contribution margin ratio of 13.6%, which represents a decrease of 2.2% sequentially when compared to the third quarter fiscal year 2022 center-level contribution margin of $28 million. To be clear, we're working through a unique transitional period as we return to a sense of normalcy, in the heights of COVID, while also navigating the odds. We're focused on getting participants back into the centers consistent with pre-COVID levels, and we're making long-term investments to fundamentally transform our ability to execute at scale. Starting with revenue, net census overall is down approximately 2% sequentially, driven by a decline of approximately 6% in sanctioned markets. The sanctions in Colorado have heavily impacted the overall picture, as it represents approximately 47% of our total census. We have invested resources to improve our overall enrollment in non-sanctioned markets to help offset these dynamics. These investments are bearing fruit, as we have seen gross enrollment increases of 34% in non-sanctioned markets, resulting in net census growth of approximately 3% in these markets over the same period. As you know, most of our rates are contractually determined in factory and healthcare inflation. Our Medicare rates in fiscal year 2022 were approximately $3,900 PMPM, which represents an increase of 4.5% versus fiscal year 2021. Regarding Medicaid rates, we recently received updated rates for Colorado, Virginia, and Pennsylvania. Barb will provide more detail in a few minutes. We appreciate that our Medicaid rates are set with some discretion by state agencies and believe the process is intended to address the cost pressures we’ve experienced, caring for our frail participants. Center level costs were up sequentially impacting center level contribution margin due to increasing headcount and higher wages for some roles. We also made staffing investments to address a unique period where participants are returning to our centers, causing stress on our organization to provide care and fully reopen centers, while also covering the needs of many participants who are uncomfortable returning in person. We have invested meaningfully in our centers as noted earlier, believing strongly in the ROI of this approach. Both in terms of long-term compliance and reduced provider costs, including inpatient, post-acute stays, and long-term care borne from optimal center staffing. Separately, we also continue to observe elevated external provider costs. On a sequential basis, overall, external provider costs were lower by approximately $4.5 million due to lower census and a decrease of $90 PMPM but remain above historical levels. As we dug further into the data, we've learned a lot more about our costs than we knew a quarter ago. As with most healthcare cost trends, the drivers are multifaceted and include lower average daily attendance in our centers due to COVID, prolonged staff vacancies, turnover, and productivity loss during audit periods, and fewer new participants entering the risk pool and the deconditioning of participants post-COVID. Let me spend a couple of minutes on each. Average daily attendance. PACE is a center-based model for good reason. Our ability to engage daily with our participants in proactively managed early warning signals is impaired when participants do not come into the center. While COVID subsided in the fourth fiscal quarter, participant fear and concerns on returning to the center did not. This had a negative impact on our external provider costs. We can't quantify the precision, but believe it was a factor. To address this we quickly and actively dedicated initiative focused on increasing daily attendance, which in the last three months improved by approximately 50% from when we began a focused effort in May. We believe getting participants back in the centers will improve our ability to manage these costs. Staffing turnover and loss productivity. A critical factor in optimizing care efficiency, including the total cost of care, is the focused attention of our frontline caregivers. Two continuing factors have created challenges. The first involves caregiver staffing turnover and vacancies. This is a challenge all provider organizations are facing. The second involves the significant time and energy devoted to audit remediation, which we estimate is occupying approximately 15% of our caregivers' time and approximately 30% of center-focused leadership time, thus requiring incremental temporary staffing to compensate. As we stabilize our staffing and emerge from the audits, we expect these temporary costs to gradually reduce. Risk pool and deconditioning. Enrolling new participants is critical to maintain a balanced risk pool. Because we have been unable to enroll younger, healthier community-based participants, we have not been able to offset the cost of longer-tenure participants. To better understand these dynamics, we engaged a third-party to review the specific impact of COVID on our business. Among their findings, the percentage of our participants in the first two years of their InnovAge tenure decreased from 46% pre-COVID to 41% when comparing participants from the first quarter 2022 with fourth quarter 2019, which skewed our risk pool toward longer-tenure frailer participants. Further, we have also confirmed that after a COVID diagnosis, our participants often experienced higher costs over pre-COVID levels. The analysis referenced earlier indicated that participant expenses were approximately 88% higher on average in the calendar year post-COVID diagnosis. This is consistent with emerging medical literature that people are more susceptible to a range of other conditions post-COVID. In many cases, this deconditioning of our participants has led to higher rates of long-term care placement. Like other risk-bearing government program payers, the capabilities to improve quality and lower medical costs trend is a core part of the operating model and a key reason why government payers are increasingly working with private companies. As I referenced in the last call, these capabilities exist within InnovAge today, but their effectiveness is mixed. We weren't prepared to handle such a multifaceted set of trend drivers at once. Since we've gotten our arms around the drivers, we've developed a set of initiatives that we call Clinical Value Initiatives or CVIs to mitigate the cost trends in key service categories like inpatient, assisted living, and SNF. For example, we've begun to action initiatives to reduce unnecessary readmissions within 30 days, ensure care is delivered in the most appropriate side of care, and that our risk scores reflect the acuity of the populations we serve. Additionally, the largely untapped advantage that PACE organizations have over traditional managed care organizations is that we're also delivering the care and approximately one-third of the total cost of care occurs within our four walls. While we admittedly need to start with the basics, we believe at maturity, we can generate a meaningful reduction in annual medical cost. Taken together, the results of the fourth quarter reflect continuous investment in the business. Remember, we're making material investments in the centers because we firmly believe in the power of the center-based PACE model to keep participants out of higher-cost settings. It may cost more to operate our PACE centers going forward than it has in the past, but we're building capabilities that will enable us to better manage external provider costs, which we believe will allow us to maintain an attractive long-term margin profile. And with that, I'll turn it over to Barb to review the quarter in detail.

Thank you, Patrick. I will provide some highlights from our fourth quarter and fiscal year-end financial performance for 2022 and an update on Medicare and Medicaid rates for fiscal year 2023 and some insights into the trends we are seeing as we head into the new fiscal year. As with our previous earnings calls, I will refer to sequential comparisons relative to the third quarter in order to provide a more meaningful picture of our performance. We ended the fourth quarter and fiscal year 2022 with 18 centers and a census of just over 6,650 participants as of June 30, 2022. Compared to the prior year, this represents an ending census decrease of 2.8% compared to the fiscal third quarter census decline of 4.4%. We recorded over 82,800 member months in fiscal year 2022, a 3.9% increase compared to the prior year after including the Sacramento census, which was not consolidated until the second half of fiscal year 2021. Revenue grew 9.5% to $698.6 million for fiscal year 2022, primarily driven by member month growth and a mid-single-digit increase in both Medicare and Medicaid rates. Medicaid rates in fiscal year 2022 include a temporary rate increase from the American Rescue Plan Act or ARPA in Colorado and Virginia. Fourth-quarter revenue decreased by 2.5% to $172.9 million compared to the previous quarter, primarily due to decreased member months as a result of the ongoing enrollment sanctions in Colorado and Sacramento. External provider costs for the full year were $383 million, 23.8% higher than the prior year, and $98.7 million for the fourth quarter, a decrease of 4.4% compared to the fiscal third quarter of 2022. The year-over-year increase was primarily due to an increase in member months, coupled with higher costs per participant. The cost per participant drivers include: the lingering effects of COVID from the third quarter kept inpatient costs elevated associated with higher acuity and drove greater post-acute care utilization, increased housing utilization in assisted living and nursing facilities, increased permanent housing rates as mandated by certain states, and increased outpatient and specialist care expenses, in part as a result of our participants seeking healthcare services that were delayed during the onset of the pandemic in fiscal year 2021. During the quarter, external provider costs declined 4.4% from the fiscal third quarter of 2022, due to a decline in post-acute utilization, as the impact of increased utilization in the third quarter, particularly from COVID, began to subside. Our cost of care, excluding depreciation and amortization of $180.2 million, was 16.7% higher year-over-year, driven by an increase in member months and the overall cost per participant. The primary cost drivers include increased headcount as we continue to make progress filling vacancies, adding approximately 150 new employees over the last six months, higher wage rates, and temporary labor associated with the ongoing competitive labor market, the financial impact on operations as a result of all centers being opened for a full year and pre-opening losses associated with new de novo locations. Sequentially, cost of care increased 9.5% to $50.5 million due to increased headcount as we continue to fill vacancies and increased labor costs associated with ongoing audit remediation and compliance efforts, some of which will be temporary in nature. Center-level contribution margin, which we define as revenue less external provider costs and cost of care, excluding depreciation and amortization, was $135.4 million for the fiscal year ended June 30, 2022, compared to $174.1 million in the prior year. For the fiscal fourth quarter, we reported a center-level contribution margin of $23.6 million, compared to $28 million in the fiscal third quarter of 2022. Sales and marketing expense was $24.2 million for the fiscal year ended June 30, 2022, increasing 8.8% year-over-year, primarily due to an increase in headcount and costs associated with organizational realignment. For the fourth quarter, sales and marketing expense of $5.1 million decreased approximately $1.1 million, or 17.2%, compared to the third quarter, primarily due to lower marketing spend as a result of the sanctions. Corporate, general, and administrative expense was $101.7 million for the fiscal year ended June 30, 2022, a decrease of 23.2% year-over-year. The full-year decrease is primarily due to $58.5 million in fees incurred during fiscal year 2021 as a result of the Apax transaction. Offsetting the decrease related to the Apax transaction included an increase in headcount to bolster our organizational capabilities, costs associated with organizational realignment, and full-year financial costs associated with regulatory requirements of being a publicly traded company. These increases in expense are partially offset by lower bad debt expense compared to fiscal year 2021. For the fourth quarter, corporate, general, and administrative expense increased 11% to $27.4 million. The increase over the third quarter was primarily due to cost associated with third-party consultants to develop and implement our eight core provider initiatives, assess our risk-bearing payer capabilities, and strengthen our enterprise capabilities that Patrick touched on previously, as well as increased legal costs. Net loss for the fiscal year ended June 30, 2022, was $8 million compared to prior fiscal year net loss of $44.7 million. For the fourth quarter, we reported a net loss of $13.5 million. For the fiscal year ended June 30, 2022, we reported an earnings per share loss of $0.05, both basic and diluted. Our basic and fully diluted weighted average share count for fiscal year 2022 was 135,519,970 shares. Adjusted EBITDA, which we calculate by adding interest, taxes, depreciation, and amortization and one-time adjustments for transaction and offering-related costs, and other nonrecurring or exceptional costs to net income, was $34.3 million for the fiscal year ended June 30, 2022, compared to $85.3 million in fiscal year 2021. Adjusted EBITDA for the fiscal fourth quarter was negative $0.6 million compared to positive $1.9 million in the fiscal third quarter of 2022. Adjusted EBITDA margin for the fiscal year ended June 30, 2022, was 4.9%, compared to 13.4% in the prior year. For the fiscal fourth quarter, we reported an adjusted EBITDA margin of negative 0.4% compared to positive 1.1% in the third quarter of 2022. The decrease to adjusted EBITDA compared to the third quarter was due to elevated inpatient costs as a result of higher acuity, increased housing costs, additional costs associated with audit remediation and compliance efforts, higher costs of care due to a competitive labor market, and increased headcount. De novo center losses, which we define as net losses related to pre-opening and startup ramp through the first 24 months of de novo operations, were $2.3 million for the fourth quarter, primarily related to our Tampa and Orlando centers in Florida. As Patrick mentioned, we have committed to CMS and the Agency for Health Care Administration or AHCA that we have proactively paused the remaining steps in the expansion process to allow us to focus exclusively on resolving our active audit issues before proceeding in Florida. Turning to our balance sheet, we ended the quarter with $184.4 million in cash and cash equivalents and had $86.4 million in total debt on the balance sheet, representing debt under our senior secured term loan, convertible term loan, plus capital leases and other commitments. For the fiscal year ended June 30, 2022, we had $38.2 million of capital expenditures. Finally, while we have been making progress on our remediation efforts associated with the sanctions, the inherent uncertainty and open timeline around sanction release prevents us from providing forward-looking guidance for fiscal year 2023. That said, we do want to provide some additional visibility around the following areas where we are able. First, regarding census, we are continuing to enroll new participants in our non-sanctioned centers, resulting in net census growth in the low single digits, and expect those trends to continue into fiscal year 2023. As a reminder, we lose approximately 2% of our center census on a monthly basis, primarily driven by involuntary disenrollment. While the majority of these losses are involuntary, we have repurposed our sales teams in sanction markets to focus on retention efforts to reduce voluntary disenrollment. Regarding revenue, as you know, our rates are contractually determined and are based on costs for PACE or comparable populations. Our Medicare rates are based on county rates as determined each calendar year by CMS, coupled with prospective risk or adjustments made by CMS in January and July. When converted to a fiscal year basis, Medicare rates increased 4.5% in fiscal year '22 over fiscal year '21. For fiscal year 2023, we are expecting a combined net mid-single-digit rate increase comprised of the following: A low single-digit Medicare Part C increase partially as a result of sequestration fully resuming in July; a mid-single-digit Medicare Part D increase; and for Medicaid, a mid-single-digit rate increase inclusive of 10% in Colorado, which includes go-forward funding effective July 1 that offsets the increase in assisted living facility rates that went into effect in January; 5% in Virginia; 3% in Pennsylvania, effective January; no rate increase in fiscal year 2023 in New Mexico; and as previously disclosed, a mid-single-digit rate decrease in California effective January 1, 2022. Next, and external provider cost perspective. We expect external provider costs to remain elevated compared to historical levels, in part due to the post-COVID acuity effect on our participants, although tapering in the near-term relative to the second half of fiscal year 2022. For our cost of care, we expect cost pressures to also remain elevated as we continue to work through audit remediation and add to our workforce. However, we do anticipate that these costs will begin to moderate as our New Mexico and San Bernardino centers receive corrective action plans from their respective audits without enrollment sanction. Regarding corporate G&A, we are continuing to evaluate the organization to optimize the business and refine our payer capability roadmap. As Patrick indicated earlier, we are focused on eight key provider operational excellence initiatives and building up our payer capabilities. Going forward, we want to ensure that we have the structure in place to sustain and continuously improve the ongoing effectiveness of these initiatives. Regarding sales and marketing, we continue to make prudent decisions as we balance staff retention with our need and desire to grow, only after our remediation efforts are complete. With new leadership in place, we are making investments in our sales and marketing capabilities, while closely managing our cost structure and will utilize our sales teams in non-sanctioned markets for participant outreach and voluntary disenrollment mitigation in the near-term. We believe the recent financial results reflect a transitory period for the business, influenced by several factors, including our participant profile, audit remediation efforts, and labor market dynamics. As Patrick stated, some of the costs reflected in our quarterly results will be temporary, while some will be permanent. We believe that all the investments we are making into the core of our business, coupled with the development of our payer capabilities, will help us to effectively manage the total cost of care while simultaneously working to ensure we have a highly compliant and effective care delivery model for the future. I will now turn the call back to Patrick for his concluding thoughts.

Thank you, Barb. My ongoing commitment to all stakeholders continues to be doing everything in our power to proactively strengthen our operations organization-wide to earn the right to be released from sanctions, to avoid future issues, and to be a sustainably high performing PACE provider able to serve participants for years to come even in more locations across the country. While I'm pleased with our strategic and operational progress over the last three months, I'm correspondingly disappointed with the quarter financially, but remain resolute. I'm confident that we're on the right path, are working hard on it across the organization, and are making genuine progress on all the important fronts. I'm particularly pleased with our great team, including our new center-based and enterprise leaders. As with all significant transformations, solid outcomes are always preceded by a compelling strategy, laser focus, effective execution, and a team with the right attitude and perseverance. It may take time. But thanks to the efforts and support of our internal team and partners, my conviction that we will succeed grows every day. Operator, with that, we can now open the line for Q&A.

Thank you. Our first question comes from Jason Cassorla at Citi.

Regarding the census, I understand there was a 6% decline in sanctioned markets compared to a 3% growth in non-sanctioned markets. You mentioned investing in resources in those non-sanctioned markets to boost census. Can you elaborate on these investments in non-sanctioned markets? Will similar investments be possible in sanctioned markets once restrictions are lifted? Additionally, what capacity do you have in those non-sanctioned centers to maintain growth at that level? Should we expect the 2% sequential decline to continue until audits are resolved, or is there any insight on future census trends that would be helpful for us to consider?

Thank you, Jason. Great question to get us started. I'll start with some of the investments we've made in our non-sanctioned markets to help drive growth, while we're under sanctions in a couple of our key buckets. The first I'd point to is we've been very selective in adding a few sales leaders to the organization. We added a new Chief Sales and Marketing Officer that comes with a long track record of driving growth in senior programs. And he's done a great job of really sizing up the sales organization, and making changes where appropriate, as well as building a much stronger accountability model as it relates to making sure we're out in the market, and we're doing everything we can to make seniors in the community aware of PACE. We've also made a number of investments in our CRM system, which just again helps with accountability helps with throughput and the acceleration of sales activity from building awareness all the way through to enrollment. And I'm also really excited about the work that our sales team is doing now with our clinical leaders to make sure that we are very focused on making sure that every individual that joins InnovAge is a good fit for the program. So a lot of great work and a lot of great investment in that area. I think these are investments that we've also started to make and apply to other markets. So while we're still under sanctioned in Colorado and Sacramento, we still begin to roll out these changes to ensure that once the sanctions are lifted, we're really committed to a faster ramp-up back to historical levels of productivity than we've seen in the past. So there's a very focused effort to get to ramming speed, so to speak, for our sanctioned markets once they're released from concession. So let me ask Barb to comment as well.

Yes, hi Jason, it's Barb. I want to make sure I address all your questions, so please let me know if I miss anything. One of your questions was about the disenrollment rate and whether it differs between sanctioned and non-sanctioned locations. It does not; the average rate is about 2% per month, which is typical for all our centers, regardless of their status. Your second question pertained to capacity in our centers. As we've stated since going public, we do have capacity in our existing centers. This is part of our growth strategy focused on organic growth. The capacity varies by center and size, but overall we have about 50% capacity across the enterprise to facilitate growth, providing us with significant opportunities for organic growth.

And then just really quickly, on a follow-up there, just the 2% level of sequential decline in aggregate, is that a fair way to think about the steady state kind of declines until we kind of get on the other side of these sanctions at this point? Or are there other nuances that we should be thinking about, just as we think about the go forward?

Yes, I think it’s in that range; it's in that range to a little bit more neutral. So I think to really bifurcate what's going on, right, is that we have natural disenrollment in every center, and in about half of our business, we're not enrolling new participants, but we are growing in the other half of our business. So, I think, Patrick referred to those low single-digit kind of increases net-net. So it's kind of in that range going forward.

And then just as my follow-up here, just on your balance sheet and cash position. Maybe just to start, it looks like CapEx spending in the fourth quarter almost doubled compared to what you've done in the previous nine months leading up to the fourth quarter. So maybe just to start, where was that CapEx allocated? It was generally just related to the audit remediation activities, or was it for other areas? And then, just as a follow-up, obviously, your remediation is top of mind, but you're hanging out right now with over $180 million in cash, only about $86 million of debt on the balance sheet. Are there ways you can leverage that cash position for investments or otherwise? Or will you kind of be taking more of a wait and see approach perhaps until the audits are completely remedied at this point? Just any color on spending priorities just given your pretty hefty cash position and the audit remediation considerations? Anything there would be helpful. Thanks.

Yes, sure. So one thing on the de novo is, just to clarify, I used the wrong preposition. So the 2.7 million should have been through the fourth quarter, not in the fourth quarter. So that 2.7 million related to de novo, the senior related to most primarily in Tampa and Orlando. So that's where the investments are being made. In terms of the cash position, yes, you're right. We're fortunate we have a fair bit of cash on the balance sheet. We are always looking to optimize how we invest that. And we definitely are looking at ways how to optimize that investment. But I think in terms of what we do long-term, it is a little bit more of that wait and see. We're really, really trying to be focused on investing in the business and stabilizing the business so we can turn around and grow. And so it is a little bit more of that wait and see in terms of the cash approach.

Our next question comes from Sarah James from Barclays.

So it sounds like you guys are having a lot of productive conversations with regulators at the state and federal level. And I'm wondering if they're giving you a sense of what went on? How much of it was really across the industry in COVID versus what was company-specific?

Thank you, Sarah. This is Patrick. Our discussions with our regulators, primarily CMS and the states, are highly concentrated on InnovAge and the efforts we're making to address the issues highlighted in the audit. We are not concentrating on the broader industry context related to PACE or the effects of COVID and any similar deficiencies. We are committed to our interactions with regulators and are very pleased with the progress our teams are making. The collaboration we are receiving from our regulators has been outstanding.

And then it sounds like you guys are making a number of changes that are going to have a long-term impact. There's some on the staffing and wage side that could be a longer-term headwind, but then it sounds like there's a lot of efficiency and cost of care initiatives that can be a tailwind. How do you think about your long-term margin evolving?

Maybe I'll start, and hand over to Barb. Well, I think we still hold a lot of confidence that we can achieve a very attractive margin profile for the company going forward. As we discussed before, our center-level costs are a smaller percentage of our total cost than our external provider cost. And so the notion is, yes, it may require more investment in our centers than we've made in the past. But we feel very confident that there's a significant opportunity for us to get an ROI from those investments by doing a much better job on managing our external provider costs. And so we feel very confident that that's a formula that we can execute on. And we're already starting to see some wonderful progress on the part of our teams. Barb, anything you'd like to add?

To summarize, we experienced some challenges in fiscal year 2022 due to COVID-related expenses and labor market issues, similar to what the industry as a whole faced. We are concentrating on various initiatives, particularly payer and operational strategies, to improve our margin in the future. While it's still early to determine the exact impact on our margin, we are moving from assessment and planning into execution, and we remain confident about our margin outlook.

Great. And last question is just on the contract labor you guys talked about. Could you give us an idea of what percent of your clinical staff is contract labor now versus pre-COVID? And is there any way to size the dollar impact from that?

I'll make some just real high-level estimation. So I think that we don't think that it's any higher now than I think it was previously. I mean, I think it's just proportional to the overall labor market. I think as a percent, it's probably about under 10% of our overall force. So I think it's just one component, obviously, it's a more expensive component. And we've obviously used that to backfill in places for critical roles.

Our next question of line of Jamie Perse from Goldman Sachs.

I was hoping we could start with Sacramento and some of your comments there. First, the five months of being on target with performance. What specifically are you tracking there and maybe incremental color you can give on what the metrics you're tracking and how the key ones are faring versus your targets?

Sure. Thank you, Jamie. I would start with my opening remarks that we are using a set of measures that we jointly developed with CMS and our state partners. The sorts of things that you would see in those measures are things related to ensuring service orders are scheduled and provided timely, that participant or caregiver requests are identified and appropriately documented. There are measures related to care plan timeliness, and completion. There's measures related to the frequency of our assessments, consistent with our care plan development with our members, and then things related to just the responsiveness of our interdisciplinary team overall. So it's a variety of measures that we jointly developed with our regulatory partners that really have formed the foundation for understanding our progress in a common language between InnovAge and our partners. And as you mentioned, in Sacramento in particular, we've had some very strong and consistent performance over the last several months, and that progress has been acknowledged by our regulatory partners. And we're in close conversations to determine what are the next steps necessary to enter the validation phase, which is the final phase before sanctions can be released. But the timing of that, as we've said many times, still resides with the regulators.

One other quick one, just on the comments related to higher costs associated with longer-tenured patients on the platform. My sense is that the revenue associated with those patients is also higher. So can you talk to what the margin profile or patient contribution profiles of patients looks the first couple years on the platform versus as they are more tenured on the platform? Any color on that would be great.

Yes. Hey, Jamie. It’s Barb. To address your point, there’s really nothing new here upon analysis over time. As participants age in the program, they tend to become more frail, need additional services, and often find themselves in more expensive care settings. That’s what we are referencing. While I won't provide specific numbers, it's clear that these higher-cost settings impact our margins negatively. Regarding your question about whether we see increased revenue from this, there is some correlation. In Medicare, their risk scores are rising, which does yield increased revenue to some extent. However, with Medicaid, which covers those costly skilled nursing facility expenses, the payments are not adjusted for risk. Therefore, we do see some revenue growth, but it doesn’t fully align with the needs of that population.

Our last question comes from the line of Madeline Mollman from William Blair.

I just have two things. One is, we're curious about the impact of inflation on your costs, particularly related to fuel and transportation. And I know that you said the 2023 rate is pretty much set. But going forward with inflation remaining elevated, is there any room for you to negotiate rates or to work with CMS to take inflation into account?

Yes, this is an important part of our discussions with our state partners, actually throughout the year. And certainly as we're in the midst of a rate-setting cycle is to ensure that the discretion that states have to address the cost that we're experiencing, inflationary costs as you refer to, is a critical part of all those conversations. It's something we pushed very hard for. I think Colorado was probably a good example of very successful discussions with our partners on what's driving our cost. But with that, let me ask Barb to punctuate.

Yes. In addition to what Patrick mentioned, some states have actually utilized ARPA funds to help us manage inflationary costs, including wage rates. The states have some flexibility in how they allocate these funds, and we have received ARPA funds from several states, particularly Colorado, which incorporated those funds into our rates starting in July. This is one of the ways we are addressing these costs.

I might just add one closing thought on that is that it's important to recognize there can be some lag between when we're experiencing those costs and reporting those costs and when they're actually recognized in our rates. So sometimes we will have a tight matching between our inflation and the state's rates. So I just wanted to add that as well.

I have one quick question. I know you mentioned that you voluntarily paused progress on your centers in Florida, but I'm curious, when you decide to continue pursuing new locations, will you try to regain approval in states like Indiana, California, and Kentucky that you had previously planned to? Or will you focus on new states?

Well, I’d like to separate those into different buckets. California being an existing state, I would just reinforce, there are several markets in California that are very attractive to us. And we've made inroads and progress in a handful of markets. And when we're in a position to be released from sanctions, we'll certainly be pushing to move quickly on opportunities that may exist. Still work to do, but California is a priority that they're looking to accomplish with long-term care type services, and we're going to be a great partner to them. Kentucky and Indiana are also a bit different, though Kentucky is a market where we've actually already invested in the center there. And we're beginning to see, think through what are our options, and what is the timing in Kentucky, but still a very attractive center for us. And then Indiana is another market that’s certainly attractive, but we've not made final decisions about how to proceed in Indiana. And we're working through that as we speak now. But very much interested in de novo expansion when the time is right, and when we feel confident we have the support of our regulatory partners.

Now I'd like to turn the call back over to Patrick Blair for any closing remarks.

Well, thank you very much, operator. And before we close, I just wanted to take a minute to just reinforce how much we've accomplished as an organization over the last seven to nine months. I'm just extraordinarily proud of our team and their unwavering commitment to the company that continues today. I believe our future is very bright and the path forward is clear. It's our commitment to continue to bring clarity during this transitional period to all of our stakeholders as we have relevant updates to share. And with that I'll close and thank everyone for their continued interest in InnovAge. Have a good evening.

And this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.