InnovAge Holding Corp. Q3 FY2024 Earnings Call

Thank you, operator. Good afternoon and thank you all for joining the InnovAge fiscal 2024 third quarter earnings call. With me today is Patrick Blair, President and CEO; and Ben Adams, CFO; Dr. Rich Feifer, Chief Medical Officer, will also be joining in the Q&A portion of the call. Today, after the market closed, we issued a press release containing detailed information on our quarterly results for our fiscal third quarter 2024. You may access the release on the Investor Relations section of our company website, innovage.com. For those listening to the rebroadcast of this call, we remind you that the remarks made herein are as of today, Tuesday, May 7, 2024 and have not been updated subsequent to this call. During our call, we will refer to certain non-GAAP measures. A reconciliation of these measures to the most directly comparable GAAP measures can be found in our earnings press release posted on our website. We will also be making forward-looking statements, including statements related to our full fiscal year projections, future growth prospects, Florida de novo centers, our acquisition of ConcertoCare PACE, our payer capabilities and clinical value initiatives, the status of current and future regulatory actions and other expectations. Listeners are cautioned that all of our forward-looking statements involve certain assumptions that 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 2023 and our subsequent reports filed with the SEC, including our most recent quarterly report on Form 10-Q. 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.

Thank you, Ryan, and good afternoon, everyone. I want to begin by expressing my gratitude to our colleagues, participants, government partners in the investor community who support InnovAge. I'd also like to thank those of you who attended our first Investor Day in late February. We believe it effectively reintroduced the company, including the investment thesis, how we are different from other value-based care models and this unique inflection point in the company's history given the internal transformation over the last 2 years. The company's third quarter results were largely consistent with our expectations. We continue to see ongoing performance improvement in every facet of our operations, which is driving greater stability in our financial results and increased confidence in our ability to deliver high-quality care and a great participant experience while also growing our top and bottom lines. As discussed on prior earnings calls, we normally experience seasonality in the third quarter. This year, it was exacerbated due to what we believe to be a few moment-in-time drivers which I'll cover in a moment. Critically, when we look at the momentum of our business from the top down, we're pleased to see the steady growth in the demand for PACE services. We're confident in the industry tailwinds and the unique benefits to the stakeholders that PACE offers. With respect to quarterly financials, we reported revenue of $193 million for the quarter, an increase of approximately 2% compared to the second quarter and center-level contribution margin of $34 million which represents a 17.6% margin and is generally consistent with the second quarter. Adjusted EBITDA was $3.6 million for the quarter. Importantly, in the quarter, we incurred increased de novo losses as we're now open in Tampa and Orlando. And you'll recall last quarter's results included a one-time risk adjustment true-up benefit, making the sequential progression less comparable. On a year-over-year basis, quarterly revenue has increased by approximately 12% and adjusted EBITDA is up $5.6 million from a quarterly loss of approximately $2 million in the third quarter of fiscal year '23. Census increased to 6,820, which represents a quarter-over-quarter improvement of approximately 1%. Overall, our results reflect solid performance in the areas of top line growth, medical cost management, center-level staffing costs, and SG&A. We remain focused on day-to-day execution and exiting fiscal year '24 with solid earnings momentum. The portfolio of initiatives that we've launched over the past 2 years are creating a tangible impact that we're seeing translate into earnings. As we discussed at our Investor Day, we continue to challenge ourselves to continuously identify new value creation opportunities at the center level, aiming for an overall center-level contribution margin of 20% or more over time. While we now operate 20 centers across 6 states, including the opening of our Orlando center which occurred on April 1, health care is delivered locally, and there are differentiated opportunities and challenges to address at each center. We are bringing the best practices to centers and to departments within centers that we believe can be improved. We are pleased with our recent work in this area. We are starting to see the contribution margin impact, and we have confidence that we will achieve our future goals. We also remain focused on our 5-pillar performance management framework which uses a balanced scorecard to assess our delivery of high-quality, compliant care in a financially responsible way. Our strong performance against our target metrics continued this quarter. For example, our participant experience measured by Net Promoter Score, was 46 in fiscal year '24 against a target of 35. Our proprietary quality composite score was 4.2, which is slightly above our target level of 4 out of 5 stars. We believe that continued strong performance in employee engagement, participant satisfaction, care quality, and compliance are excellent leading indicators for future growth and financial performance. Now turning to the details of the quarter. You'll recall last quarter and during our Investor Day, we touched on anticipated third quarter seasonality. This quarter, seasonality was exacerbated by several moment-in-time factors. We continue to experience ongoing enrollment processing delays in Colorado, in part due to the competing priorities of Medicaid redetermination. As a reminder, the barriers we're experiencing include state enrollment resource constraints, post-public health emergency policy changes that now require in-person level of care assessments rather than telephonic, and new state vendors who are still ramping up to targeted service levels. While these delays do not affect the eligibility of potential participants, the protracted nature of the enrollment processing delays have resulted in some prospects opting to pursue other service options. We continue to work with the state to resolve these issues as quickly as possible. Additionally, due to physician and nurse practitioner staffing vacancies and recruitment challenges in our Sacramento and San Bernardino centers, we made the proactive decision to temporarily slow the rate of enrollment despite market demand surpassing expectations to ensure the workload of onboarding new enrollment matched our primary care staffing levels. While certainly more seniors remain a top priority, ensuring we deliver a high-quality participant experience is bedrock to our responsible growth strategy. We have now filled the open positions and have resumed normal enrollment tempos. This year, we also experienced an unusually competitive environment due to the richness of the Medicare Advantage supplemental benefits in comparison to past annual enrollment periods. The amount has increased materially from previous years, and the breadth of where cash benefits can be spent has expanded as well. As a result, we believe this had a marginal impact on both our ability to enroll new participants and a higher number of existing participants who disenrolled for alternative plans. We have strong conviction that the integrated and personalized nature of the PACE model offers a superior value proposition to frail seniors struggling to maintain their independence compared to other Medicare-needed options. Our enrollment and operation teams are working to educate both our participants and potential participants on the benefits of PACE. We also believe that margin pressure which has recently materialized across the MA industry will result in a reduction of MA value-added benefits in 2025 which will only enhance our relative competitiveness. Despite these temporary headwinds, the overall demand for our services has continued to grow, as evidenced by a sequential increase in sales qualified leads of 10%, with the total number reaching over 1,600 leads in the third quarter. This underpins our ongoing confidence that far more individuals are interested in PACE than we are enrolling today. On the de novo front, we're excited to announce that we're operational at our new Orlando center. Like Tampa, this new state-of-the-art facility has the capacity to serve approximately 1,300 participants at maturity. Enrollment efforts are underway, and job number one is to begin expanding access to the many deserving eligible participants in the community. We're hosting a grand opening on May 29 to bring awareness and to celebrate this important milestone in Orlando. In our recently acquired Crenshaw, California center, we're encouraged to see momentum build under our ownership as Q3 enrollment began to ramp in line with our expectations. On the regulatory front, we're pleased to report that our post-sanction monitoring in Colorado which was initiated in January of 2023 has been closed out by CMS. We continue to engage with the state of Colorado to finalize the outstanding process improvements. On our last call, we touched on the ongoing activities in our San Bernardino center with the California Department of Health Care Services. DHCS conducted their targeted medical review in March, and we await notification on a date for the exit interview. Regarding Sacramento, we submitted proposed corrective actions to DHCS in March. At the beginning of this month, CMS officially closed its portion of the audit; we are awaiting feedback from DHCS. Following resolution of the audits and corrective actions in California, we expect to resume discussions with the state regarding our Downey and Bakersfield expansion plans. Turning to operating performance. We continue to see improvement in our management of external medical costs, evidenced by a sequential decrease in participant expense PMPM from $3,903 last quarter to $3,823 this quarter, representing an approximate 2% improvement. The largest driver of our sequential improvement was the decrease of permanent placement nursing home costs. As discussed on previous calls, our goal is to have our population reflect the demographics of the communities we serve. Those communities are made up of a mix of people living independently, those receiving some type of supportive housing, and those in institutional settings. As we continue to enroll new participants who are living independently in the community, we're seeing a decrease in the percentage of our participants permanently residing in nursing homes. We believe this change in the composition of living situations demonstrates a modest improvement in risk mix relative to where we were under enrollment restrictions. Said differently, our mix is migrating back in line with the underlying assumptions used to derive our rates. Over time, the improved mix should help offset external medical cost trends while supporting the independent living goals of CMS and our state partners. Additionally, we've piloted an end-of-life comfort care program in Denver, which supports our participants with palliative care expertise and 24/7 access to our team of nurses, as a means of improving the participant experience while reducing lower-value external hospice costs. In addition to better coordination with our interdisciplinary care team and participant satisfaction, the program reduced external spend by 43% from the baseline in November while improving overall quality of care. We're currently developing the business case to scale this program to other markets. Our portfolio of clinical value initiatives, or CVIs, as we refer to them internally, are performing in line with our expectations. As you would expect, some are ahead of plan, while a few are delayed, and we don't anticipate seeing the run rate benefits until fiscal year 2025. Further, we're seeing improvement in our center-level staffing ratios, which have improved by approximately 5% relative to where we started the fiscal year while holding our quality and compliance resources constant during the period with the same level of CMS and state auditing activity. Recall, center-level staffing ratios were negatively impacted by the effect sanctions had on our centers and the additional resources required to meet audit demands. In summary, we believe we are continuing to improve the business every quarter. The combined effect of our broad set of initiatives in the areas of top line growth, cost management, quality, and compliance over the past 2 years is accelerating as evidenced by our improving results. We will continue our tireless efforts to make each center better every day as the centers are the heart of our business. And with that, I'll turn it over to Ben to walk through our quarterly financial performance.

Thank you, Patrick. Today, I'll provide some highlights from our third quarter fiscal year 2024 financial performance and insight into some trends we are seeing in the quarter. Although it is still early in our margin improvement initiatives, we continue to track to our internal targets and we are pleased with our progress and the opportunity for additional margin recapture over time. Starting with census, we served approximately 6,820 participants across 19 centers as of March 31, 2024, which represents quarter-over-quarter growth of 0.7%. We reported 20,360 member months in the third quarter, a 1.2% increase over the second quarter. This reflects the anticipated third quarter enrollment softness that Patrick discussed. Total revenue of $193.1 million increased 2.2% compared to the second quarter, primarily due to an increase in member months coupled with an increase in Medicare capitation rates. This was partially offset by a California rate decrease of approximately 2.5% effective January 1, 2024, and a one-time Medicare true-up outside the regular payment cycle that was recorded in the second quarter. We incurred $100 million of external provider costs during the third quarter of fiscal 2024, a 1% decrease compared to the second quarter. The sequential decrease was primarily driven by lower permanent nursing facility utilization, resulting in a decrease in cost per participant, partially offset by an increase in member months. Cost of care, excluding depreciation and amortization, of $59.1 million, increased 8.8% compared to the second quarter. The increase was due to higher cost per participant, coupled with an increase in member months. The cost per participant increase was driven by an increase in salaries, wages, and benefits due to higher headcount and increased wage rates associated with the annual reset of employee benefits and taxes, an increase in software license fees associated with a new pharmacy software program that we rolled out in January, de novo occupancy and administrative costs associated with our new Crenshaw and Bakersfield centers acquired in the ConcertoCare PACE acquisition, and third-party expenses associated with the annual Part D bid creation and retrospective coding review. Center-level contribution margin—which we define as total revenue less external provider costs and cost of care, excluding depreciation and amortization—was $34 million for the quarter compared to $33.6 million in the second quarter. As a percentage of revenue, center-level contribution margin of 17.6% was relatively unchanged compared to 17.8% in the second quarter. Sales and marketing expense was $7.2 million, an increase of approximately $1.3 million compared to the prior quarter. The increase was primarily due to increased headcount and marketing spend for our newly opened Tampa center and recently acquired Crenshaw center. Corporate, general, and administrative expense increased to $27.5 million, a $2.3 million increase compared to the second quarter. The increase was primarily due to an increase in benefits expense from the annual reset of employee benefits and taxes, an increase in bad debt, an increase in software license and maintenance costs, including user licensing costs associated with Epic, and an increase in third-party legal expenses. The increase was partially offset by a decrease in costs associated with the Epic conversion completed in the second quarter. Net loss was $5.9 million compared to a net loss of $3.8 million in the second quarter. We reported a net loss per share of $0.04 on both the basic and diluted basis, and our weighted average share count was approximately 135.9 million shares for the quarter on both a basic and fully diluted basis. Adjusted EBITDA, which we calculate by adding net interest expense, taxes, depreciation and amortization, M&A and de novo center development expenses, and other nonrecurring or exceptional costs to net loss, was $3.6 million for the quarter compared to $7.8 million in the second quarter. The decrease was due to the one-time Medicare true-up payment in the second quarter as well as the increase in de novo costs associated with Tampa, Orlando, and Crenshaw in the third quarter. Our adjusted EBITDA margin was 1.9% for the third quarter compared to 4.1% in the second quarter. De novo losses, which we define as net losses related to pre-opening and start-up ramp through the first 24 months of de novo operation for the third quarter, were $4.1 million, primarily related to the recently acquired Bakersfield and Crenshaw centers and our centers in Florida. This compares to $2.2 million of de novo losses in the second quarter. Turning to our balance sheet, we ended the quarter with $54.1 million in cash and cash equivalents, plus $45.2 million in short-term investments. We had $81.3 million in total debt on the balance sheet, representing debt under our senior secured term loan plus finance lease obligations and other commitments. For the third quarter, we reported cash flow from operations of $3.5 million and had $450,000 of capital expenditures. We are reaffirming our fiscal 2024 guidance which, as we said last quarter, includes the ConcertoCare PACE acquisition. Based on the information as of today, we expect our ending census for the year 2024 to be between 6,800 and 7,400 participants, and member months to be in the range of 79,000 to 83,000. We are projecting total revenue in the range of $725 million to $775 million and adjusted EBITDA in the range of $12 million to $18 million. Finally, we anticipate that de novo losses for fiscal 2024 will be in the $10 million to $12 million range, which again, is inclusive of our recently acquired Bakersfield and Crenshaw centers. In closing, I want to reiterate Patrick's comments as we believe we are continuing to make improvements to the business every quarter. We remain focused on day-to-day operational execution and exiting fiscal 2024 with solid earnings momentum.

I saw you guys maintain '24 guidance. Given year-to-date trends, are you considering how the fourth quarter would shake out at least towards the higher end of the range just given where you're at? Or are there offsets that we should be thinking about for the fourth quarter? And then just as a follow-up, as you have that 7% to 9% kind of margin target over the next 2 to 4 years, I know recognizing you're not providing fiscal '25 guidance yet but can you maybe give us a sense on the puts and takes to margin progression for next year?

This is Patrick. Good to hear from you, Jason. I'll get it started and then maybe kick it over to Ben. As Ben said, we remain focused on exiting fiscal year '24 with as much momentum as possible as we head into fiscal year '25. I think we're trending in that direction. We're pleased with where we are. If you recall, we did intentionally set a larger range for guidance. We're still comfortable that we're going to fall within that range. At the same time, we're also awaiting some outcomes on a few risk adjustment payments which also underpins our current expanded range given the lack of uncertainty at the moment. We are, in some ways, a turnaround story, and there's still a lot of unknowns in the business. I think of it as we're taking premium from both the federal government and the state government. We're a small business. And so building in some conservatism for the one-timers that kind of naturally flow through a business of this sort of profile, I think for those reasons, we feel comfortable maintaining our guidance. And I'll let Ben add a little extra color here maybe on the range.

Yes. Look, I think Patrick actually pretty much nailed it for you. Because we are a business that had sort of a complex history over the last year or so, there are a number of items that can roll in, in any one particular quarter. Some of them are related to prior periods; some of them are related to current periods. There is that natural variability in the business still. I think as we continue to evolve and look and move into the future, we'll have greater and greater precision around our estimates. But we've started this year with what we thought was a pretty straight down the middle of the fairway guidance range. We kept it a little wide to account for any variability. We think we're tracking nicely against that guidance range. As Patrick said, our real goal here is to make sure that we're operating as well as possible by the end of this fiscal year, so we can move into '25 with a lot of positive momentum. Obviously, we haven't put out '25 guidance yet. We'll reserve that until we get to our year-end earnings release. But I think if you were to look at our business, we would expect a lot of the progress you've seen over the course of this year to sort of continue going into 2025 and beyond. We put out those margin targets, both for the intermediate term and the longer term, at the Investor Day presentation in a thoughtful way based on what we think the business is really going to do over time. So I think if you look at what we've done this year, sort of extending that forward, looking at those guidance ranges for margin down the road, that should give you a pretty good sense of the trajectory of the business.

Yes. I might maybe make one final punctuation to that, that when we think about the rate of margin improvement and we consider the drivers of that, we're very focused right now on enrollment growth. Obviously, third quarter came in a bit below what we had hoped due to some seasonality that was exacerbated. Medical cost trends have been looking good. There are a number of drivers for that. We've talked about just the ongoing improvements in our staffing ratios. As we grow, that's one aspect of our business that we anticipate getting some leverage from. How we sort of end the year in each of those will play a significant role in what we're expecting for fiscal year '25.

Great. That's super helpful. And maybe just to your point around the census side of the fence. I know you called out MA plan development switching. It sounds like census came in a little bit below your expectations. You noted Colorado specifically, the processing delays. I guess, with the bottleneck being there, I mean, would you expect a bolus of numbers coming online as those issues are resolved? Or I guess, in the meantime, how should we think about the impacts of the Colorado dynamics against the fourth quarter census development as you see it, just any risks or otherwise to consider?

What I would say, Jason, is we are working through it with the state. There are some good examples of where the constraints we've experienced, to a degree, in the second quarter and third quarter are starting to resolve. It's going to take some time before it sort of flows through but there were system elements in this. I know there's already some system changes underway that are going to relieve some of the constraints. There are two case management organizations through which our enrollments flow. One is showing steady improvement, but it was still an impact in this quarter. Q4 is going to be a good predictor of the rate of change in that situation, but it's not going to change overnight. I think we’re doing a good job on generating strong demand in Colorado, and both InnovAge and the state are focused on ensuring those individuals get the services they need as quickly as possible. So I believe we'll navigate through it.

Okay. Great. And if I could just ask one more. On the census acuity mix, it sounds like you're seeing improvement there which is certainly encouraging. Can you give us a sense of where your current acuity mix stands today against where it needs to be to reflect underlying reimbursement? Do you think this is something that's going to take multiple quarters to come to fruition? Or how would you frame the lead time to balance, assuming like a normalized census growth going forward?

Yes. I think if you look at our incoming participants, our freshmen who come into the program, they've got a good mix between folks that are higher acuity, lower acuity, and a good mix by living situation. They are gradually changing the mix of our patients and acuity as you would expect it to happen. One of the challenges is if you look at the number of people that enroll with us every single month and compare it to the overall census, you'll see that it takes a bit of time for this to wash through the system. We’re seeing a gradual improvement in those metrics, but it will take some time before it goes through fully. As we come into the right mix, we're aligning with the assumptions that underlie PACE rates from the beginning, so we're moving in the right direction; it just needs time.

I'd just like to say again how much we appreciate your interest in the organization. We're excited about our progress and momentum, and we'll be back with you next quarter to discuss additional progress we're making. Have a terrific evening.

This does conclude today's conference call. You may all disconnect.