InnovAge Holding Corp. (NASDAQ:INNV) Q2 2023 Earnings Call Transcript
InnovAge Holding Corp. (NASDAQ:INNV) Q2 2023 Earnings Call Transcript February 7, 2023
Operator: Hello, and thank you for standing by. Welcome to InnovAge Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. I would like to hand the conference over to your speaker for today, Ryan Kubota, Investor Relations. You may begin.
Ryan Kubota: Thank you, operator. Good afternoon, and thank you all for joining the InnovAge fiscal 2023 second quarter 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 results. You may access the release on 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, February 7, 2023, and have not been updated subsequent to this call. During this call, we'll refer to certain non-GAAP measures.
A reconciliation of these measures to the most directly comparable GAAP measures can be found in our fiscal second quarter 2023 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, Florida de novo centers, 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 the fiscal year 2022 and our subsequent reports filed with the SEC, including our quarterly report on Form 10-Q for our fiscal second quarter 2023. After the completion of our prepared remarks, I'll open the call for questions. I will now turn the call over to our President and CEO, Patrick Blair. Patrick?
Patrick Blair: Thank you, Ryan, and good afternoon, everyone. I want to begin by expressing my gratitude to my InnovAge colleagues for everything they're doing to support our businesses, our communities, our participants who are a daily reminder of our higher purpose, and each other. I'd also like to share my appreciation for the investors who have stuck with us through a very challenging period. On behalf of all InnovAge employees, thank you. A lot has happened in the last 16 months. We have simultaneously navigated a pandemic and its associated disruptions, as well as federal and state compliance related enrollment restrictions. In Colorado and Sacramento, California. It is with great enthusiasm and responsibility we begin the next chapter at InnovAge.
As you may have seen in our press release on January 23, we have been released for sanction in the State of Colorado by both CMS in Colorado's Department of Healthcare Policy and Financing, which represented approximately 44% of our total census as of December 31. Although it has been an extraordinarily challenging 16 months, we've spent this time rebuilding the foundation of our business to improve standardization, quality, and compliance in each of our centers. We have added staff and meaningfully upgraded talent across the organization and expanded our compliance capabilities, applying the audit lessons every day at every center. We have invested in tools and technologies to help our employees function more efficiently, effectively, and compliantly.
Culturally, it has brought us together as one team, which we refer to as One InnovAge and are committed to a mindset of continual improvement to which we are holding ourselves accountable. The release of the sanction in Colorado is both the end of a difficult period and the beginning of the next chapter in this company's bright future. Simply, we are a different company than we were 16 months ago. And while our focus on compliance won't change, we're poised to help even more seniors with safely in an independent setting, as long as possible. And now more than ever, we believe there are meaningful tailwinds for the PACE model of care nationally. Over the last 15 years, we've seen rapid growth in managed Medicare plans in value-based primary care centers, the best of which make use of a sophisticated primary care model and care management strategies.
However, the front-end of the baby boomer population is now approaching the average age of PACE participants, which is about 77. We believe this population will require more intensive coordinated community based geriatric model of care that combines the best of both Medicare and Medicaid services like PACE. All that said, our focus in progress remained consistent with what we shared last quarter. And my comments today will encompass a regulatory update, focus areas in progress, and perspectives on the quarterly financial performance. I want to begin the regulatory update by acknowledging and thanking our government sponsors for the continued partnership and solution oriented approach as we work through the sanctions together. They have rightly pushed us on our thinking and on our commitment to ensure that compliance remains at the forefront as we resume growth in Colorado.
As I've shared with them, we are committed to responsible growth and we will remain vigilant to ensure that our rigorous compliance focus remains bedrock. As discussed in our press release, we have been released from the enrollment sanctions in Colorado by CMS and the state agency, which means we are free to begin enrolling new participants. Practically speaking, we don't expect to see our first new enrollee in this market until March. In conjunction with the sanction release, and as is typical in processes such as these, we will still have corrective actions to fulfill in post sanction monitoring requirements, including an annual audit conducted by the state for the next couple of years. Regarding Sacramento, recall we were released from the enrollment section by CMS in late November 2022.
We continue to await word from California's Department of Healthcare Services and expect resolutions soon. Though we expect to continue to work closely with our state and federal partners in existing markets, we also believe the conclusion of these formal audits is a meaningful catalyst for us. In addition to reopening organic growth in Colorado, it brings us an important step closer to opening our existing de novo sites in Florida reengaging with other states or de novo opportunities and becoming more intentional on the execution of our growth strategy, which we've been able to refresh during this period. Our compliance commitments to CMS and our state partners go beyond our existing centers. We are committed to bringing this dedication recent investments in technology and operations and lessons learned in each center and state going forward.
We believe that we are the only large multi-state paced program that has gone through such an expansive compliance audit and we're better for it. Frankly, we believe it should strengthen our value proposition to new states and potential partners and it has positioned us to be a more thoughtful acquirer in the future. Consistent with my remarks last quarter, our number one near term priority is responsible growth. And I can't express how enthusiastic we are to be at this inflection point. The hard work continues now as we shift our focus from closing important compliance gaps to achieving operational excellence and delivering consistent responsible, profitable growth. Our action plan for accelerated growth margin recapture in sustainability as five dimensions.
First, increased same center and de novo enrollment growth rate over historical levels. Two, increased revenue per participant through more effective rate setting discussions to ensure fair rates based on actuarial soundness, and ensuring our accurately reflect the acuity of our population. Three, strengthen payer capabilities to better manage utilization and external provider costs. Four, run center operations more efficiently and effectively. And five, enhance discipline at the corporate level to better leverage our fixed cost base. Starting with same center growth, I wanted to take a moment to highlight where we sit at this moment regarding center capacity. We currently have 6,460 participants across 18 centers as of December 31. While the growth runway varies by center and market, in the aggregate, we have embedded capacity of almost 50%.
Job 1 is to start filling this capacity responsibly. We have used this time under sanctions to improve our marketing messages and educational content, expand our go-to-market channels, train in onboard high caliber enrollment talent, redesign our compensation plans, and add new referral channels to expand our access to eligible seniors. Restarting growth in Colorado and accelerating growth in other markets will be a dial, not a switch, meaning we expect it will take a few months to ramp up our enrollment teams, marketing partners, and new referral partners before hitting our stride. Switching for a moment to de novos. Our two Florida centers have the capacity to serve 2,600 participants combined and the capital investments behind us. With the sanctions lifted, we are ready to resume the application process to become operational.
Though it is still too early to comment on the exact timing of opening, we expect to begin the administrative process this quarter and aim to be operational, as early as possible in fiscal year 2024. Next, we're focused on ensuring premium readouts we'll see for each participant. Like Medicaid managed care plans, we are more of a price taker than we are a price center. While rate methodologies vary by state, in general, states determine how much they would have paid for our participants if they were enrolled in an alternative Medicaid program. And then establish a pace rate that reflects a discount from what they would have otherwise paid. We need to improve at this actuarially driven process to ensure we can partner effectively with states and that we're paid a fair amount that reflects the true cost we've been experiencing caring for our participants.
We're already making great progress and plan to continue expanding our talent in preparation for the next rate cycle. The second dimension is ensuring our Medicare risk scores accurately reflect the acuity of our population. This is an area we have focused on over the last six months and I'm very pleased with the progress we've made. I believe our risk scores have lagged the underlying acuity of our population, particularly since the onset of COVID, and we're working hard to document all Medicare risk adjustment factors more completely and accurately. We have already executed on process improvements, which have increased our chronic condition recapture rates. As it relates to strengthening our payer capabilities, I continue to believe that we have a big opportunity to leverage the fundamentals used by the best managed care payers to improve quality and to lower the total cost of care.
We're coming at this from both the utilization and unit cost perspective. On the utilization side, we're taking steps to avoid unnecessary hospital admissions and readmissions and reducing skilled nursing facility admissions and length of stay by delivering more care in the center or the home. We are also refining our claims payment project to identify overpayment opportunities that represent lost money that can be recovered and avoided going forward. On the unit cost side, we're reviewing the size and composition of our external provider network relative to the needs of our population to ensure we balance the mutual goals of access to quality of care with network cost efficiency. The near-term impact within our portfolio of clinical value initiatives or CVIs as we call them is only a few million dollars today.
And while each of these initiatives will individually be additive, collectively, we believe they will become much more material with time. While we expect it will take a year more for this capability to mature, it is critical that we develop these muscles systematically as sophisticated managed care organizations do every day. You may recall that we identified 10 areas of operational excellence that were foundational to our success in resolving the audit deficiencies. I'm pleased to report that we are near complete with these initiatives and they have driven a strong improvement in participant experience and employee productivity, but we are by no means done. We will approach operational excellence with the same continuous improvement mindset that we are applying across the business.
Recall, we made a conscious decision to retain and even augment our participant facing staff in sanctioning markets, despite census in those markets declining roughly 20% relative to December of 2021. During this period, we invested in hiring additional staff at the clinical and local leadership levels to ensure that we emerge from sanctions stronger and retain the staffing capacity to serve more participants. We expect to grow back into this excess capacity, but it's going to take some time for us to fully understand and have confidence in a new baseline for center level cost structure and contribution margin. As growth increases post sanctions, we plan to redouble our G&A focus and discipline going forward. In particular, expect us to be intentional about achieving leverage over fixed cost.
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I anticipate our corporate headcount to look very similar for the foreseeable future as we scale the business. Additionally, there are several tools we are leveraging to help the centers become more efficient and more productive. The most prominent example is our recent implementation of the first ever PACE specific instance of the EPIC electronic medical record. Now live in two Virginia centers with the remaining Virginia and Pennsylvania centers expected to be live by the end of the quarter. We anticipate full implementation across all our sites in the first half of fiscal year 2024. As mentioned last quarter, this is the most important technology investment in our company's history and we're very enthusiastic about the clinical and financial value this will unlock over time.
We believe EPIC will be a cornerstone to operating more efficiently, ensuring standardized compliant processes at the point of care, and capturing the clinical information needed to deliver more targeted interventions. We expect these five focus areas: enrollment growth, revenue per participant, payer capabilities, center operations, and corporate costs, which we call our five to drive, to be key drivers of earnings growth moving forward. Now turning to the quarter, we reported revenue of $167.5 million, a sequential decline of approximately 2.2%, compared to last quarter, driven by census attrition in Colorado and Sacramento, which together represent approximately 45% of our total census. We ended the quarter serving approximately 6,460 participants.
For the second quarter, we reported center level contribution margin of 22.6 million, and a corresponding center level contribution margin ratio of 13.5%, compared to first quarter fiscal year 2023 center level contribution margin of 21.4 million, an increase of $1.2 million. As expected, the current quarter's financial performance is unremarkable. The inability to enroll in almost half of our center portfolio coupled with the intentional investments we've made at the centers has pressured both our margins and growth. However, we believe strongly this financial moment is more reflective of the conditions behind us than in front of us as we begin the exciting work of serving more seniors. It is worth emphasizing that growing participants within our existing centers from currently depressed census levels will have two primary disproportionately accretive impacts to the bottom line.
It will first employ the slack capacity. As I noted earlier, given the current census levels at approximately 50% of potential capacity, each incremental participant will drive center level contribution margin above our overall average and this will be true until we reach our optimal staffing ratios, which we don't expect to reach until sometime in our next fiscal year. Additionally, you'll recall that I stated we want our participant risk mix to mirror the communities we serve. A second order impact of the sanctions is that our risk pool has become time as we've been unable to balance it with newer healthier members. We anticipate that as the participant composition naturally , we'll see our participant expense improve. In closing, I'm extraordinarily proud of the team and the work we've accomplished to enable us to control our own destiny going forward and to continue to pursue our mission.
It is responsibility we assume with the utmost seriousness and focus. That said, our journey in the worthwhile hard work ahead has just begun. I'm more energized than ever to expand pace to the many deserving seniors in need who would benefit from this amazing program. I know we will continue to work tirelessly to execute on the strategies discussed and to unlock the full potential of this great organization. Now, I'm going to turn it over to Barb.
Barbara Gutierrez: Thank you, Patrick. I will provide some highlights from our second quarter fiscal year 2023 performance and some insights into the trends we are seeing through the first half of fiscal year 2023. As with our previous earnings calls, I will refer to sequential comparisons relative to the first quarter in order to provide a more meaningful picture of our performance. As of December 31, 2022, we served approximately 6,460 participants across 18 centers. Compared to the prior year period, this represents an ending census decrease of 8.4%. Compared to the first quarter of fiscal year 2023, this is a decrease of 1.2%. We reported approximately 19,470 member months for the second quarter, an 8.1% decrease over the prior year and a decrease of 1.4% over the first quarter of fiscal 2023.
Compared to the second quarter of fiscal 2022 and sequentially, the enrollment freeze in Colorado had the greatest impact on member months and census in the second quarter. In our non-sanctioned locations, ending census grew 5.1% over the prior year period and 1.7% over the first quarter. Total revenue declined by 4.5% to $167.5 million, compared to the second quarter of fiscal year 2022. The decrease is primarily due to lower member months as a result of the ongoing sanctions, partially offset by an increase in both Medicaid and Medicare rates, net of the full reinstatement of sequestration in July 2022. Revenue declined by 2.2%, compared to the first quarter of fiscal year 2023, primarily due to a decrease in member month associated with the sanctions, coupled with a decrease in Medicare Part D revenue commensurate with pharmacy rebates received during the quarter.
Due to the nature of the Part D program, this decrease has a negligible impact on pharmacy margins and center level contribution margin. External provider costs were $93.5 million, a 2.7% increase, compared to the second quarter of fiscal year 2022. Similar to last quarter, the primary driver was increased cost per participant, due to increased assisted living, and skilled nursing facility unit cost and utilization. As discussed in the past, de conditioning of our participants has led to higher rates of long-term placement coupled with increased unit costs as mandated by certain states. Sequentially, external provider costs decreased by 2.8% as a result of lower census, due to the ongoing sanction and lower per member per month pharmacy expenses, due to rebates as referenced earlier regarding Part D revenue.
Our cost of care, excluding depreciation and amortization of $51.4 million was 19.7% higher than the second quarter of fiscal year 2022. The primary cost drivers include the following three items: One, salaries, wages and benefits, which accounts for over 60% of the total variance, increased to higher headcount as a result of selling key vacancies, higher wage rates, and increased labor costs associated with ongoing audit remediation and compliance efforts. Two, third-party audit and client support as we work through the audits in our sanctioned markets and proactively continue to perform self-audits in our non-sanctioned markets. And three, fleet and contract transportation driven by higher average daily attendance in our centers, an increase in external appointments and higher fuel costs.
Cost of care decreased by 4.1% over the first quarter of fiscal 2023, primarily due to the higher than expected use of PTO during the holidays and lower building repair and maintenance. Additionally, from an overall staffing perspective, we have seen modest improvement with net new hiring declining quarter-over-quarter and we believe incremental staffing costs for our existing centers have largely plateaued. Center level contribution margin, which we define as total revenue less external provider costs and cost of care, excluding depreciation and amortization was $22.6 million for the second quarter, compared to $41.4 million in the second quarter of fiscal 2022 and $21.4 million in the first quarter of fiscal 2023. As a percentage of revenue, center level contribution margin for the first quarter was 13.5%, compared to 23.6% in the second quarter of fiscal 2022, and increased from 12.5% in the first quarter of fiscal 2023.
Our second quarter margin performance continues to reflect the transitory state of the business under sanctions. With the sanctions in Colorado now lifted, we expect to see margins begin to normalize over time as we resume participant enrollments in Colorado and grow into the central level staffing capacity that we have invested in through the audits. The census growth will also improve participant mix and re-balance the risk pool, which will offset the higher average cost of longer tenure, higher frailty participants. Additionally, as our clinical value initiatives or CVIs develop over the coming quarters, we anticipate a reduction in external provider costs as these initiatives mature. Sales and marketing expense was $3.8 million, a $2.9 million decrease, compared to the second quarter of fiscal 2022.
The decrease was primarily due to lower marketing spend and headcount count as a result of the sanctions, as well as the reduction in sales commission expense, due to the deferral of commission expense in accordance with ASC 606. Compared to the first quarter of fiscal year 2023, sales and marketing expense decreased by approximately $600,000, primarily due to the deferral of commission expense mentioned previously. Corporate, general and administrative expense was $28.8 million, an increase of $300,000, compared to the second quarter of fiscal 2022. The increase was primarily due to one, an increase in headcount to support compliance and bolster organizational capabilities; two, third-party costs associated with implementing core provider initiatives, expanding risk bearing payer capabilities, and strengthening organizational depth, including the transition to EPIC, which was successfully deployed in two of our Virginia centers during the quarter; and three, an increase in software license and maintenance fees.
These increases in costs are partially offset by a reduction in bad debt in the second quarter of fiscal 2023 and executive severance and recruiting costs that we incurred during the second quarter of fiscal year 2022. Sequentially, corporate, general and administrative expense decreased $1.4 million, primarily due to the tapering of certain third-party consultant expenses associated with laying the groundwork for strengthening organizational capabilities and a reduction in bad debt expense. These decreases were partially offset by an increase in costs associated with the EPIC implementation and legal fees. Net loss was $10.5 million, compared to net income of $1.1 million in the second quarter of fiscal 2022. We reported a net loss per share from the fiscal second quarter of $0.07 on both a basic and diluted basis.
Our weighted average share count was 135,578,888 shares for the second quarter on both a basic and fully diluted basis. Adjusted EBITDA, which we calculate by adding interest, taxes, depreciation, and amortization, one-time adjustments for transaction and offering related costs and other non-recurring or exceptional costs to net income was a negative $2 million, compared to $14.8 million in the second quarter of fiscal year 2022 and negative $3.8 million in the first quarter of fiscal year 2023. Our adjusted EBITDA margin was negative 1.2% for the second quarter, compared to 8.4% for the second quarter of fiscal year 2022 and negative 2.2% for the first quarter of fiscal year 2023. The sequential quarter-over-quarter improvement in adjusted EBITDA and adjusted EBITDA margin is primarily a function of reduced cost of care, the deferral of commission expense, and a net reduction in corporate G&A.
We do not add back any losses incurred in connection with our De Novo Centers in the calculation of adjusted EBITDA. De Novo Center losses, which we define as net losses related to pre-opening and start-up ramp through the first 24 months of De Novo operations were $845,000 for the second quarter, primarily related to centers in Florida. Turning to our balance sheet. We ended the quarter with $99.5 million in cash and cash equivalents after deploying $45 million in short-term investments to take advantage of rising interest rates. We had $84.6 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 second quarter ended December 31, 2022, we recorded cash flow from operations of negative $35.1 million and we had $7 million of capital expenditures.
Finally, with the enrollment sanctions in Colorado lifted and we begin to focus on responsible growth and margin expansion, I will provide some additional visibility around the following trends we are seeing as we head into the second half of fiscal year 2023. Regarding revenue, effective January 1, we experienced a low double-digit Medicare rate increase associated with an annual increase in county rates coupled with an increase in risk scores. This positive outcome is tempered by notification from the state of California that Calendar 2023 rates will experience a low-single-digit decrease. We believe these rates do not consider post-pandemic cost trends and we have requested the state revisit their rate setting methodology. Regarding census, we are pleased that the Colorado sanctions have been lifted and have immediately restarted our enrollment efforts for new participants.
As a reminder, we suspended all marketing activity in Colorado and Sacramento as a condition of the sanctions and participants can only enroll in pace at the beginning of each month. As a result, we anticipate it will take a few months to fully ramp up our enrollment levels as we responsibly restart the enrollment process. As Patrick indicated, we have additional physical capacity in each state for new participants. With existing , excluding our two Florida De Novos, we have physical capacity to more than double our current census. For example, in Colorado, we have the capacity to add approximately 1,900 new participants over time or a 40% increase from our current census. Additionally, we are also excited to re-engage with regulators and resume the application process in Florida, where our two new de novo centers in Tampa and Orlando have the combined capacity to serve 2,600 participants.
Similarly, as we start to ramp up enrollment, we expect that margins will begin to expand following the last several quarters of contraction. We believe that staffing, operational, and technology investments we have made across the organization in the last 12 plus months will allow us to grow into our operating structure without adding a significant number of new FTEs. Additionally, we continue to believe that there is room to reduce some of the temporary costs associated with the audits in the future. Finally, some saw some cost of care, external provider costs and overall center level margins. As we move forward, we continue to believe that we can obtain margins similar to what we experienced before the sanctions, although the composition of our center level costs may look slightly different going forward.
The investments that we have made, particularly in staff related costs, have elevated our cost of care expense compared to historical levels, but we are driving value through other focus areas, such as our payer initiatives and CVIs to bend the cost curve and deliver margin over time. Though it will take multiple quarters to return to expanded margins, our focus will be on the margin drivers. Specifically, accelerating census growth which serves to rebalance the participant risk pool, as well as to optimize staffing ratios, reducing temporary costs associated with the audits, and executing on clinical value initiatives to improve participant care and reduce unnecessary costs. In closing, we are excited to be entering a new chapter and extremely proud of the hard work and accomplishments of our team over the last year.
We believe InnovAge is now stronger and more competitive as a result of the commitments we have made and we look forward to expanding access to pace to the many seniors who could benefit from the program in the future. Operator, that concludes our prepared remarks. Please open the call for questions.
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