Item 7. Management’s Discussion and Analysis
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis summarizes the significant factors affecting the consolidated operating results, financial condition, liquidity and cash flows of our company as of and for the periods presented below. The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes
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thereto included elsewhere in this Annual Report on Form 10-K. The discussion contains forward-looking statements that are based on the beliefs of management, as well as assumptions made by, and information currently available to, our management. Our historical results are not necessarily indicative of the results that may occur in the future and actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors, including those discussed below and in the sections entitled “Risk Factors” and “Forward-Looking Statements” included in this Annual Report on Form 10-K.
Overview
General
InnovAge Holding Corp. (“InnovAge”), formerly TCO Group Holdings, Inc., became a public company in March 2021. The Company serves approximately 6,850 PACE participants, making it the largest PACE provider in the United States of America (the U.S.) based upon participants served, and operates 18 PACE centers across Colorado, California, New Mexico, Pennsylvania and Virginia.
Operations
InnovAge aims to allow frail seniors to live life on their terms by aging in place, in their own homes and communities, for as long as safely possible. Through our Program of All-Inclusive Care for the Elderly (“PACE”), we manage, and in many cases directly provide, a broad range of medical and ancillary services for seniors, including in-home care services (skilled, unskilled and personal care); in-center services such as primary care, physical therapy, occupational therapy, speech therapy, dental services, mental health and psychiatric services, meals, and activities; transportation to the PACE center and third-party medical appointments; and care management. The Company manages its business as one reportable segment, PACE.
We are the leading healthcare delivery platform by number of participants focused on providing all-inclusive, capitated care to high-cost, dual-eligible seniors. Our programs directly address two of the most pressing challenges facing the U.S. healthcare industry: rising costs and poor outcomes. Our participant-centered care delivery approach meaningfully improves the quality of care our participants receive, while keeping them in their homes for as long as safely possible and reducing over-utilization of high-cost care settings such as hospitals and nursing homes. Our participant-centered approach is led by our Interdisciplinary Care Teams (“IDTs”), who design, manage and coordinate each participant’s personalized care plan. We directly manage and are responsible for all healthcare needs and associated costs for our participants. We directly contract with government payors, such as Medicare and Medicaid, and do not rely on third-party administrative organizations or health plans. We believe our model aligns with how healthcare is evolving, namely (i) the shift toward value-based care, in which coordinated, outcomes-driven, high-quality care is delivered while reducing unnecessary spend, (ii) eliminating excessive administrative costs by contracting directly with the government, (iii) focusing on the participant experience and (iv) addressing social determinants of health.
Impact of COVID-19
The rapid spread of COVID-19 around the world and throughout the United States has altered the behavior of businesses and people, with significant negative effects on federal, state and local economies, the duration of which continues to be unknown at this time. The virus has and continues to disproportionately impact older adults, especially those with chronic illnesses, which describes our participants. To date, we have experienced or expect to experience the following impacts on our business model due to COVID-19.
Care Model . Though the COVID-19 pandemic altered the mix of settings where we deliver care, our multimodal model ensured that our participants continued to receive the care they needed. We closed all our centers in March 2020 and transitioned to a 100% in-home and virtual care model that allowed for seamless delivery of care while increasing participant visit volume and maintaining continuity of care. Our telehealth solution received high satisfaction among participants, caregivers and IDTs. In February 2021, as the prevalence of COVID-19 decreased in the communities we serve, we began re-opening our centers using a phased approach to ensure the safety of both our staff and participants. In addition, community assisted living and skilled nursing facilities began to open to allow in-person visits by all members
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of our IDT. By June 2021, we fully opened all our centers and transitioned to a predominantly in-person, center-based care model, supplemented by telehealth. We expect telehealth care delivery to remain a part of our ongoing care model.
Growth . As a result of the COVID-19 pandemic, at the end of March 2020, we pivoted to a virtual enrollment model due to safety concerns for our employees and participants and to comply with local government ordinances. We also realigned our marketing strategy to increase our focus on digital channels during the COVID-19 pandemic and to reach those searching for senior care alternatives. During our fiscal fourth quarter, as we continue to recover from the pandemic, enrollment growth continued to improve and has returned to pre-COVID levels.
Revenue. Our revenue is capitated and not determined by the number of times we interact with our participants face-to-face. As of June 30, 2021, we had not experienced a decline in revenue as a result of the COVID-19 pandemic. The capitation payments we receive from Medicare are risk-adjusted based on documented encounters and diagnosed conditions. Government payors require that participants’ health issues be documented annually regardless of the permanence of the underlying causes. Historically, this documentation has been required to be completed during an in-person visit with a participant, but due to COVID-19 and going forward, CMS is now allowing documentation of conditions identified during qualifying telehealth visits with participants. Thus far, we have been able to document the health conditions of our participants during telehealth visits as well as we did during in-person visits prior to COVID-19; however, any issues with documenting such conditions could adversely impact Medicare RAF scores and our resulting revenue for future periods.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into legislation. The CARES Act, in addition to other provisions, provided for the temporary suspension of the automatic 2% reduction of Medicare claim reimbursements (sequestration) for the period of May 1, 2020 through December 31, 2021, which positively impacted our revenue during the year ended June 30, 2021.
Expenses. For the year ended June 30, 2021, as compared to the year ended June 30, 2020, on a PMPM basis, our internal care delivery costs decreased, while our external provider costs increased, as further described in Results of Operations , in part due to the impact of COVID-19 on our care delivery costs as we executed our participants’ care plans through a different mix of care settings. On a PMPM basis, we did not experience material changes in our aggregate participant-related care expenses.
The United States continues to experience supply chain issues with respect to personal protective equipment (“PPE”) and other medical supplies used to prevent transmission of COVID-19. During the years ended June 30, 2021 and 2020, we acquired significantly greater quantities of medical supplies at significantly higher prices than pre-pandemic rates to ensure the safety of our employees and our participants. Costs related to PPE medical supplies represented approximately 0.6% and 2.1% of our total cost of care for the years ended June 30, 2021 and 2020, respectively. While the price of PPE may remain higher than historical levels for the foreseeable future, we do not expect these incremental costs to be material as a percentage of our total expenses.
See Item 1A. Risk Factors included in Part I of this Annual Report on Form 10-K for further discussion of the possible impact of the COVID-19 pandemic on our business.
Key Factors Affecting Our Performance
Our historical financial performance has been, and we expect our financial performance in the future to be, driven by the following factors:
● Our participants. We focus on providing all-inclusive care to frail, high-cost, dual-eligible seniors. We directly contract with government payors, such as Medicare and Medicaid, through PACE and receive a capitated risk-adjusted payment to manage the totality of a participant’s medical care across all settings. InnovAge manages participants that are, on average, more complex and medically fragile than other Medicare-eligible patients, including those in Medicare Advantage (“MA”) programs. As a result, we receive larger payments for our participants compared to MA participants. This is driven by two factors: (i) we manage a higher acuity population, with an average RAF score of 2.45 based on InnovAge data as of June 30, 2021, compared to an average RAF score of 1.08 for Medicare fee-for-service non-dual enrollees, as
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calculated in an analysis by Avalere Health in June 2020 of a cohort of individuals enrolled in Medicare Fee-for-Service in 2019 ; and (ii) we manage Medicaid spend in addition to Medicare. Our participants are managed on a capitated, or at-risk, basis, where InnovAge is financially responsible for all of their medical costs. Our comprehensive care model and globally capitated payments are designed to cover participants from enrollment until the end of life, including coverage for participants requiring hospice and palliative care. For dual-eligible participants, we receive PMPM payments directly from Medicare and Medicaid, which provides recurring revenue streams and significant visibility into our revenue growth trajectory. The Medicare portion of our capitated payment is risk-based on the underlying medical conditions and frailty of each participant.
● Our ability to grow enrollment and capacity within existing centers. We believe our demonstrated ability to drive sustained, organic census growth is a key indicator of the attractiveness of the InnovAge Platform to our key constituents: participants; their families and government payors. We have driven 10% annual, organic census growth over the last four years. Awareness of PACE programs remains low among potential participants, despite high levels of participant satisfaction. To improve awareness of InnovAge and attract new participants, our sales and marketing teams educate prospective participants and their families on our powerful value proposition, superior health outcomes and participant satisfaction. We have a large, embedded growth opportunity within our existing center base. As of June 30, 2021, our eligible participant penetration rate was, on average, 13% across our existing markets, and as the only designated PACE provider in most of the MSAs that we serve, we believe there is significant runway for further growth. We also believe that we will continue to conduct a portion of visits via telehealth after the COVID-19 pandemic subsides, which could potentially increase the average capacity of our centers.
● Our ability to maintain high participant satisfaction and retention. Our comprehensive individualized care model and frequency of interaction with participants generates high levels of participant satisfaction. We have multiple touch points with participants and their families, which enhances participant receptivity to our services, leading to an 86% participant satisfaction rating as of January 1, 2021 and average participant tenure of 3.0 years as of June 30, 2021, measured as tenure from enrollment to disenrollment, among our centers that have been operated by us for at least five years. Furthermore, we experience low levels of voluntary disenrollment, averaging 5% annually over the last three fiscal years. Approximately 75% of our historical disenrollments have been involuntary, due primarily to participant death and otherwise to participants moving out of our service areas.
● Effectively managing the cost of care for our participants . We receive capitated payments to manage the totality of a participant’s medical care across all settings. Because our participants are among the most frail and medically complex individuals in the U.S. healthcare system, our external provider costs and cost of care, excluding depreciation and amortization, represented approximately 73% of our revenue in the year ended June 30, 2021. Our care model focuses on delivering high-quality medical care in cost efficient, community-based settings as a means of avoiding costly inpatient and outpatient services. However, our participants retain the freedom to seek care at sites of their choice, including hospitals and emergency rooms; we do not restrict participant access to care, therefore, we are liable for potentially large medical claims should we not effectively manage our participants’ health.
● Center-level Contribution Margin . Over time, we plan to both expand our number of centers and grow the number of participants at each center. As we add participants to existing centers, we further leverage our fixed cost base at those centers and the value of a center to our business increases over time . We have a history of achieving profitable Center-level Contribution Margin, as defined and described below under Key Business Metrics and Non-GAAP Measures .
● Our ability to expand via acquisition or de novo centers within existing and new markets. We have a large addressable market and believe we serve a very small portion of PACE-eligible participants in those markets, reflecting significant unmet demand for PACE services and creating opportunities for us to grow in new and existing markets. We have proven our ability to integrate and improve acquired organizations, as well as expand and operationalize new centers across multiple geographies while generating consistent center-level
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performance. Based upon our success to date, we believe our innovative care model can scale nationally, and we expect to continue selectively and strategically expanding into new geographies.
● Execute tuck-in acquisitions. We believe there is a sizeable landscape of potential tuck-in acquisitions to supplement our organic growth strategy. Over the past three fiscal years, we have acquired and integrated three PACE organizations, expanding our InnovAge Platform to one new state and four new markets through those acquisitions. We are disciplined in our approach to acquisitions and have executed multiple types of transactions, including turnarounds and non-profit conversions. When integrating acquired programs, we work closely with key constituencies, including local governments, health systems and senior housing providers, to ensure continuity of high-quality care for participants. Based on our experience, joining the InnovAge Platform enables revenue growth and improved operational efficiency and care delivery post-integration. We believe our track record of and reputation for integrating and improving acquired organizations, while continuing to prioritize high-quality patient care, positions us as the acquirer of choice in this market.
● Contracting with government payors . Our economic model relies on our capitated arrangements with government payors, namely Medicare and Medicaid. We view the government not only as a payor but also as a key partner in our efforts to expand into new geographies and access more participants in our existing markets. Maintaining, supporting and growing these relationships, particularly as we enter new geographies, is critical to our long-term success.
● Investing to support growth . We intend to continue investing in our centers, value-based care model, and sales and marketing organization to support long-term growth. We expect our expenses to increase in absolute dollars for the foreseeable future to support our growth and due to additional costs we are incurring and expect to incur as a public company, including expenses related to compliance with the rules and regulations of the SEC and the listing standards of Nasdaq, additional corporate and director and officer insurance, investor relations and increased legal, audit, reporting and consulting fees. We plan to invest in future growth judiciously and maintain focus on managing our results of operations. Accordingly, in the short term we expect the activities noted above to increase our expenses as a percentage of revenue, but in the longer term, we anticipate that these investments will positively impact our business and results of operations.
● Seasonality to our business . Our operational and financial results, including medical costs and per-participant revenue true-ups, will experience some variability depending upon the time of year in which they are measured. Medical costs vary most significantly as a result of (i) the weather, with certain illnesses, such as the influenza virus, being more prevalent during colder months of the year, which generally increases per-participant costs and (ii) the number of business days in a period, with shorter periods generally having lower medical costs all else equal. Per-participant revenue true-ups represent the difference between our estimate of per-participant capitation revenue to be received and actual revenue received by CMS, which is based on CMS’s determination of a participant’s RAF score as measured twice per year and is based on the evolving acuity of a participant. Based on the difference between our estimate and the final determination from CMS, we may receive incremental true up revenue or be required to repay certain amounts. Historically, these true-up payments typically occur between May and August, but the timing of these payments is determined by CMS, and we have neither visibility nor control over the timing of such payments.
Components of Results of Operations
Revenue
Capitation Revenue . In order to provide comprehensive services to manage the totality of a participant’s medical care across all settings, we receive fixed or capitated fees per participant that are paid monthly by Medicare,
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Medicaid, Veterans Affairs (“VA”) and private pay sources. The concentration of revenue from our various payors was:
2021
2020
Medicaid
53
%
55
%
Medicare
47
%
44
%
Private pay and other
*
%
1
%
Total
100
%
100
%
* denotes less than 1%
Medicaid and Medicare capitation revenues are based on PMPM capitation rates under the PACE program. The PACE state contracts between us and the respective state Medicaid administering agency are amended annually each June 30 in all states other than California and Pennsylvania, which contract on a calendar-year basis. New agreements have been executed for the periods (i) January 1, 2021 through December 31, 2021 for California and (ii) July 1, 2021 through June 30, 2022 for all other states except Pennsylvania, for which we are currently operating in good standing under the 2020 amended agreement while the agency finalizes its 2021 amendment . For a discussion of our revenue recognition policies, please see Critical Accounting Policies and Estimates below and Note 2 “Summary of Significant Accounting Policies” to our consolidated financial statements included in this Annual Report on Form 10-K .
Other Service Revenue. Other service revenue primarily consists of revenues derived from fee-for-service arrangements, state food grants, rent revenues and management fees. We generate fee-for-service revenue from providing home-care services to non-PACE patients in their homes, for which we bill the patient or their insurance plan on a fee-for-service basis. For a discussion of our revenue recognition policies, please see Critical Accounting Policies and Estimates below and Note 2 “Summary of Significant Accounting Policies” to our consolidated financial statements included in this Annual Report on Form 10-K .
Operating Expenses
External Provider Costs. External provider costs consist primarily of the costs for medical care provided by non-InnovAge providers. We separate external provider costs into four categories: inpatient (e.g., hospital), housing (e.g., assisted living), outpatient and pharmacy. In aggregate, external provider costs represent the largest portion of our expenses.
Cost of Care, Excluding Depreciation and Amortization. Cost of care, excluding depreciation and amortization, includes the costs we incur to operate our care delivery model. This includes costs related to IDTs, salaries, wages and benefits for center-level staff, participant transportation, medical supplies, occupancy, insurance and other operating costs. IDT employees include medical doctors, registered nurses, social workers, physical, occupational, and speech therapists, nursing assistants, and transportation workers. Center-level employees include clinic managers, dieticians, activity assistants and certified nursing assistants. Cost of care excludes any expenses associated with sales and marketing activities incurred at a local level as well as any allocation of our corporate, general and administrative expenses. A portion of our cost of care is fixed relative to the number of participants we serve, such as occupancy and insurance expenses. The remainder of our cost of care, including our employee-related costs, is directly related to the number of participants cared for in a center. As a result, as revenue increases due to census growth, cost of care, excluding depreciation and amortization, typically decreases as a percentage of revenue. As we open new centers, we expect cost of care, excluding depreciation and amortization, to increase in absolute dollars due to higher census and facility related costs.
Sales and Marketing. Sales and marketing expenses consist of employee-related expenses, including salaries, commissions, and employee benefits costs, for all employees engaged in marketing, sales, community outreach and sales support. These employee-related expenses capture all costs for both our field-based and corporate sales and marketing teams. Sales and marketing expenses also include local and centralized advertising costs, as well as the infrastructure required to support our marketing efforts. We expect these costs to increase in absolute dollars over time as we continue to grow our participant census. We evaluate our sales and marketing expenses relative to our
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participant growth and will invest more heavily in sales and marketing from time-to-time to the extent we believe such investment can accelerate our growth without negatively affecting profitability.
Corporate, General and Administrative Expenses. Corporate, general and administrative expenses include employee-related expenses, including salaries and related costs. In addition, general and administrative expenses include all corporate technology and occupancy costs associated with our regional corporate offices. We expect our general and administrative expenses to increase in absolute dollars following the closing of this offering due to the additional legal, accounting, insurance, investor relations and other costs that we incur as a public company, as well as other costs associated with continuing to grow our business. However, we anticipate general and administrative expenses to decrease as a percentage of revenue over the long term, although such expenses may fluctuate as a percentage of revenue from period to period due to the timing and amount of these expenses.
Depreciation and Amortization. Depreciation and amortization expenses are primarily attributable to our buildings and leasehold improvements and our equipment and vehicles. Depreciation and amortization are recorded using the straight-line method over the shorter of estimated useful life or lease terms, to the extent the assets are being leased.
Equity Loss. Equity loss relates to our equity method investment in InnovAge Sacramento, which began operations in July 2020 and subsequently became a consolidated entity effective January 1, 2021.
Other Operating Expenses (Income). Other operating expenses (income) consists of the payment and re-measurement of contingent consideration to fair value relating to our acquisition of NewCourtland.
For more information relating to the components of our results of operations, see Results of Operations below and Note 2 “Summary of Significant Accounting Policies” to our consolidated financial statements included in this Annual Report on Form 10-K for more detailed information regarding our critical accounting policies.
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Results of Operations
The following table sets forth our results of operations for the periods presented. For comparisons of the results of operations for the fiscal year ended June 30, 2020 to the fiscal year ended June 30, 2019, refer to the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our IPO prospectus, dated March 3, 2021 filed with the Securities and Exchange Commission on March 5, 2021.
Year ended June 30,
2021
2020
in thousands
Revenues
Capitation revenue
$
635,322
$
564,834
Other service revenue
2,478
2,358
Total revenues
637,800
567,192
Expenses
External provider costs
309,317
272,832
Cost of care, excluding depreciation and amortization
154,403
153,056
Sales and marketing
22,236
19,001
Corporate, general and administrative
132,333
58,481
Depreciation and amortization
12,294
11,291
Equity loss
1,343
678
Other operating expense
18,211
920
Total expenses
650,137
516,259
Operating Income (Loss)
$
(12,337)
$
50,933
Other Income (Expense)
Interest expense, net
(16,787)
(14,619)
Loss on extinguishment of debt
(14,479)
—
Gain on equity method investment
10,871
—
Other expense
(2,237)
(681)
Total other expense
(22,632)
(15,300)
Income (Loss) Before Income Taxes
(34,969)
35,633
Provision for Income Taxes
9,771
9,868
Net Income (Loss)
$
(44,740)
$
25,765
Less: net loss attributable to noncontrolling interests
(754)
(513)
Net Income (Loss) Attributable to InnovAge Holding Corp.
$
(43,986)
$
26,278
Revenues
Year ended June 30,
2021
2020
$ Change
% Change
in thousands
Capitation revenue
$
635,322
$
564,834
$
70,488
12.5
%
Other service revenue
2,478
2,358
120
5.1
%
Total revenues
$
637,800
$
567,192
$
70,608
12.4
%
Capitation revenue. Capitation revenue was $635.3 million for the year ended June 30, 2021, an increase of $70.5 million, or 12.5%, compared to $564.8 million for the year ended June 30, 2020. This increase was driven by (i) an increase in capitation rates and (ii) a 6.1% increase in member months (as defined below). The increase in capitation rates was primarily driven by the net effect of (a) an increase in Medicare rates due to (1) a 5.3% increase in average risk score and (2) the temporary suspension of the automatic 2% reduction of Medicare claim reimbursements (sequestration) beginning May 1, 2020 and, to a lesser extent, (b) an increase in Medicaid rates across the majority of our markets.
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Other service revenue. Other service revenue was $2.5 million for the year ended June 30, 2021, an increase of $0.1 million, or 5.1%, from $2.4 million for the year ended June 30, 2020.
Expenses
Year ended June 30,
2021
2020
$ Change
% Change
in thousands
External provider costs
$
309,317
$
272,832
$
36,485
13.4
%
Cost of care (excluding depreciation and amortization)
154,403
153,056
1,347
0.9
%
Sales and marketing
22,236
19,001
3,235
17.0
%
Corporate, general, and administrative
132,333
58,481
73,852
126.3
%
Depreciation and amortization
12,294
11,291
1,003
8.9
%
Equity loss
1,343
678
665
98.1
%
Other operating expenses
18,211
920
17,291
1,879.5
%
Total operating expenses
$
650,137
$
516,259
$
133,878
25.9
%
External provider costs. External provider costs were $309.3 million for the year ended June 30, 2021, an increase of $36.5 million, or 13.4%, compared to $272.8 million for the year ended June 30, 2020. The increase is primarily driven by (i) an increase of 6.8% in cost per participant and (ii) an increase of 6.1% in member months. The increase in cost per participant is primarily driven by the net effect of an increase in pharmacy expenses, inpatient expenses (due to the increased cost of COVID-19 admissions), and outpatient expenses, partially offset by a decrease in specialist expenses due to the lower utilization during the pandemic.
Cost of care (excluding depreciation and amortization). Cost of care (excluding depreciation and amortization) expense was $154.4 million for the year ended June 30, 2021, an increase of $1.3 million, or 0.9%, compared to $153.1 million for the year ended June 30, 2020, primarily due to the net effect of (i) an increase of 6.1% in member months and (ii) a decrease of 4.9% in cost per participant. The decrease in cost per participant was driven by a decrease in transportation costs due to the closures of our centers due to the COVID-19 pandemic and lower employee compensation and benefit costs, due to employee attrition while our centers were closed during the pandemic.
Sales and marketing. Sales and marketing expenses were $22.2 million for the year ended June 30, 2021, an increase of $3.2 million, or 17.0%, compared to $19.0 million for the year ended June 30, 2020, primarily due to an increase in (i) employee compensation and benefits due to an increase in FTEs and (ii) costs associated with certain new advertising campaigns to raise PACE awareness and accelerate growth.
Corporate, general and administrative. Corporate, general and administrative expenses were $132.3 million for the year ended June 30, 2021, an increase of $73.9 million, or 126.3%, compared to $58.5 million for the year ended June 30, 2020. The increase was primarily due to the fees incurred as a result of the Apax Transaction (as defined below) and the IPO. In connection with the Apax Transaction, $45.4 million was recorded related to the cancellation of 16,994,975 common stock options outstanding under the Company’s 2016 Equity Incentive Plan and $13.1 million of transaction related costs were recorded as corporate, general and administrative expenses. In connection with the IPO transaction, $1.5 million of transaction costs were recorded as corporate, general and administrative expenses.
Depreciation and amortization. Depreciation and amortization expenses are primarily attributable to our buildings and leasehold improvements and our equipment and vehicles. Depreciation and amortization are recorded using the straight-line method over the shorter of estimated useful life or lease terms, to the extent the assets are being leased. Depreciation and amortization expense was $12.3 million for the year ended June 30, 2021, an increase of $1.0 million, or 8.9%, compared to $11.3 million for the year ended June 30, 2020. This increase is due to an increase in depreciation expense as a result of capital additions in the normal course of business.
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Equity loss. Equity loss was $1.3 million for the year ended June 30, 2021, an increase of $0.7 million compared to $0.7 million for the year ended June 30, 2020. Our equity loss relates to our equity method investment in InnovAge Sacramento, which began operations in July 2020 and subsequently became a consolidated entity effective January 1, 2021.
Other operating expenses. Other operating expenses were $18.2 million for the year ended June 30, 2021, an increase of $17.3 million compared to $0.9 million for the year ended June 30, 2020 primarily due to the payment of $20.0 million, and related change in fair value of contingent consideration, made under the acquisition agreement of the NewCourtland LIFE Program during the year ended June 30, 2021. There were no such payments during the year ended June 30, 2020.
Other Income (Expense)
Year ended June 30,
2021
2020
$ Change
% Change
in thousands
Interest expense, net
$
(16,787)
$
(14,619)
$
(2,168)
(14.8)
%
Loss on extinguishment of debt
(14,479)
—
(14,479)
N/A
Gain on equity method investment
10,871
—
10,871
N/A
Other expense
(2,237)
(681)
(1,556)
(228.5)
%
Total other expense
$
(22,632)
$
(15,300)
$
(7,332)
(47.9)
%
Interest expense, net. Interest expense, net, consists primarily of interest payments on our outstanding borrowings, net of interest income earned on our cash and cash equivalents and restricted cash. Interest expense, net was $16.8 million for the year ended June 30, 2021, an increase of $2.2 million, or 14.8%, compared to $14.6 million for the year ended June 30, 2020. The increase was primarily due to (i) a higher average outstanding debt balance and (ii) to a lesser extent, a higher average interest rate. For additional information regarding our outstanding indebtedness, see Note 10 to our consolidated financial statements.
Loss on extinguishment of debt. We recognized a loss on extinguishment of debt of $14.5 million for the year ended June 30, 2021 and no loss on extinguishment of debt for the year ended June 30, 2020. On July 27, 2020, we amended and restated our 2016 Credit Agreement, which led to an extinguishment of debt for certain lenders and a modification of debt for other lenders. The total debt structure extinguishment for certain lenders led to the write-off of $1.0 million in debt issuance costs. On March 8, 2021, we entered into the 2021 Credit Agreement, which led to an extinguishment of debt of $13.5 million, including $6.0 million of a prepayment penalty.
Gain on equity method investment. We recognized a gain on equity method investment of $10.9 million for the year ended June 30, 2021, which was related to InnovAge Sacramento becoming a consolidated entity as of January 1, 2021.
Other . Other expense was $2.2 million for the year ended June 30, 2021, an increase of $1.6 million, or 228.5%, compared to $0.7 million for the year ended June 30, 2020, due primarily to an amendment of the warrants issued by the Company to Adventist Health System/West (“Sacramento Warrants”) resulting in additional expense of $2.3 million in 2021.
Provision for Income Taxes.
The Company and its subsidiaries calculate federal and state income taxes currently payable and for deferred income taxes arising from temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured pursuant to enacted tax laws and rates applicable to periods in which those temporary differences are expected to be recovered or settled. The impact on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment. The members of SH1 and Sacramento have elected to be taxed as partnerships, and no provision for income taxes for SH1 or Sacramento is included in these consolidated financial statements.
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A valuation allowance is provided to the extent that it is more likely than not that deferred tax assets will not be realized. Tax benefits from uncertain tax positions are recognized when it is more likely than not that the position will be sustained upon examination based on the technical merits of the position. The amount recognized is measured as the largest amount of benefit that has a greater than 50% likelihood of being realized upon settlement. The Company recognizes interest and penalty expense associated with uncertain tax positions as a component of provision for income taxes.
During the year ended June 30, 2021 and 2020, we reported provision for income taxes of $9.8 million and $9.9 million, respectively. The decrease of $0.1 million is primarily due to (i) our pretax book loss recognized during the year ended June 30, 2021, as compared to pretax book income recognized during the year ended June 30, 2020 and (ii) certain permanent differences between the financial and tax accounting treatment of (a) the Section 162(m) limitation on compensation of five highest paid officers, (b) transaction costs associated with the Apax Transaction and (c) the change in our valuation allowance.
Net Loss Attributable to Noncontrolling Interests.
InnovAge Senior Housing Thornton, LLC (“SH1”) is a VIE. The Company is the primary beneficiary of SH1 and consolidates SH1. The Company is the primary beneficiary of SH1 because it has the power to direct the activities that are most significant to SH1 and has an obligation to absorb losses or the right to receive benefits from SH1. The most significant activity of SH1 is the operation of the housing facility. The Company has provided a subordinated loan to SH1 and has provided a guarantee for the convertible term loan held by SH1. The SH1 interest is reflected within equity as noncontrolling interests. Our share of earnings is recorded in the consolidated statements of operations as net loss attributable to noncontrolling interests.
Net Income (Loss)
During the year ended June 30, 2021 and 2020, we reported net income (loss) of ($44.7 million) and $25.8 million, respectively, consisting of (i) income (loss) from operations of ($12.3 million) and $50.9 million, respectively, (ii) other expense of $22.6 million and $15.3 million, respectively, and (iii) provision for income taxes of $9.8 million and $9.9 million, respectively, each as described above.
For more information relating to our accounting policies, see Note 2 “Summary of Significant Accounting Policies” to our consolidated financial statements included in this Annual Report on Form 10-K .
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Key Business Metrics and Non-GAAP Measures
In addition to our GAAP financial information, we review a number of operating and financial metrics, including the following key metrics and non-GAAP measures, to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans and make strategic decisions. We believe these metrics provide additional perspective and insights when analyzing our core operating performance from period to period and evaluating trends in historical operating results. These key business metrics and non-GAAP measures should not be considered superior to, or a substitute for, and should be read in conjunction with, the GAAP financial information presented herein. These measures may not be comparable to similarly-titled performance indicators used by other companies.
Year ended June 30,
2021
2020
dollars in thousands
Key Business Metrics:
Centers (a)
18
16
Census (a)(b)
6,850
6,400
Total Member Months (a)
79,430
74,900
Center-level Contribution Margin
$
174,080
$
141,304
Center-level Contribution Margin as a % of revenue
27.3
%
24.9
%
Non-GAAP Measures:
Adjusted EBITDA (c)
$
85,333
$
65,909
Adjusted EBITDA Margin (c)
13.4
%
11.7
%
(a) For the fiscal year 2021, includes InnovAge Sacramento, which the Company owns and controls through a joint venture and is consolidated in our financial statements.
(b) Participant numbers are approximate.
(c) Adjusted EBITDA and Adjusted EBITDA margin are non-GAAP measures. For a definition and reconciliation of these non-GAAP measures to the most closely comparable GAAP measures for the period indicated, see below under “—Adjusted EBITDA.”
Centers
We define our centers as those centers open for business and attending to participants at the end of a particular period.
Census
Our census is comprised of our capitated participants for whom we are financially responsible for their total healthcare costs.
Total member months
We define Total Member Months as the total number of participants multiplied by the number of months within a year in which each participant was enrolled in our program. We believe this is a useful metric as it more precisely tracks the number of participants we serve throughout the year.
Center-level Contribution Margin
We define Center-level Contribution Margin as total revenues less external provider costs and cost of care, excluding depreciation and amortization, which includes all medical and pharmacy costs. For purposes of evaluating Center-level Contribution Margin on a center-by-center basis, we do not allocate our sales and marketing expense or corporate, general and administrative expenses across our centers. Center-level Contribution Margin was $174.1 million
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and $141.3 million for the years ended June 30, 2021 and 2020, respectively. For more information relating to Center-level Contribution Margin, see Note 17 to our consolidated financial statements.
Adjusted EBITDA
We define Adjusted EBITDA as net income adjusted for interest expense, depreciation and amortization, and provision for income tax as well as addbacks for non-recurring expenses or exceptional items, including charges relating to management equity compensation, final determination of rates, M&A transaction and integration, business optimization, electronic medical record (“EMR”) implementation, special employee bonuses, gain on consolidation of equity investee, financing-related fees and contingent consideration. For the years ended June 30, 2021 and 2020, our net income (loss) was ($44.7 million) and $25.8 million, respectively, representing a year-over-year decline of 273.6%, and Adjusted EBITDA was $85.3 million and $65.9 million, respectively, representing a year-over-year growth of 29.5%.
A reconciliation of Adjusted EBITDA to net income, the most directly comparable GAAP measure, for each of the periods is as follows:
Year ended June 30,
2021
2020
in thousands
Net income (loss)
$
(44,740)
$
25,765
Interest expense, net
16,787
14,619
Depreciation and amortization
12,294
11,291
Provision for income tax
9,771
9,868
Stock-based compensation
1,664
543
Rate determination (a)
(2,158)
(3,372)
M&A diligence, transaction and integration (b)
67,606
2,718
Business optimization (c)
1,829
1,171
EMR implementation (d)
461
1,078
Special employee bonus (e)
—
1,278
Gain on consolidation of equity investee (f)
(10,871)
—
Financing-related (g)
14,479
30
Contingent consideration (h)
18,211
920
Adjusted EBITDA
$
85,333
$
65,909
(a) For the year ended June 30, 2021, this reflects the CMS settlement payment of approximately $2.2 million related to end-stage renal disease beneficiaries for calendar years 2010 through 2020. For the year ended June 30, 2020, this reflects the final determination of certain rates for capitation payments from the State of California, all of which we consider non-recurring.
(b) For the year ended June 30, 2021, this primarily represents (i) $45.4 million related to the cancellation of options and the redemption of shares and (ii) $13.1 million of transaction fees and expenses recognized in connection with the July 27, 2020 transaction between us, an affiliate of Apax Partners and our then existing equity holders entering into a Securities Purchase Agreement (the “Apax Transaction”).
(c) Reflects charges related to business optimization initiatives. Such charges relate to one-time investments in projects designed to enhance our technology systems and improve the efficiency and effectiveness of our operations.
(d) Reflects non-recurring expenses relating to the implementation of a new electronic medical record vendor.
(e) Reflects non-recurring special bonuses paid to certain of our employees of the Company relating to shareholder dividend transactions that occurred in fiscal years 2018 and 2019.
(f) Reflects non-recurring expense related to the gain on consolidation of InnovAge Sacramento.
(g) Reflects fees and expenses incurred in connection with amendments to our credit agreements. See Note 10 to the consolidated financial statements.
(h) Reflects the contingent consideration fair value adjustment made during the reporting period associated with our acquisition of NewCourtland.
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Adjusted EBITDA margin
Adjusted EBITDA margin is Adjusted EBITDA expressed as a percentage of our total revenue less any exceptional, one-time revenue items. In the years ended June 30, 2021 and 2020, we recognized (i) the CMS settlement payment related to end stage renal disease beneficiaries for calendar years 2010-2020 in the amount of approximately $2.2 million and (ii) final determination of certain rates for capitation payments from the State of California in the amount of approximately $3.4 million, respectively, each of which is deducted from total revenue solely for purposes of calculating Adjusted EBITDA margin in each respective reporting period. For the year ended June 30, 2021, our net loss margin was 7.0%, as compared to our net income margin of 4.5% for the year ended June 30, 2020. For the year ended June 30, 2021, our Adjusted EBITDA margin was 13.4%, as compared to our Adjusted EBITDA margin for the year ended June 30, 2020 of 11.7%.
Adjusted EBITDA and Adjusted EBITDA margin are supplemental measures of operating performance monitored by management that are not defined under GAAP and that do not represent, and should not be considered as, an alternative to net income (loss) and net income (loss) margin, respectively, as determined by GAAP. We believe that Adjusted EBITDA and Adjusted EBITDA margin are appropriate measures of operating performance because the metrics eliminate the impact of revenue and expenses that do not relate to our ongoing business performance, allowing us to more effectively evaluate our core operating performance and trends from period to period. We believe that Adjusted EBITDA and Adjusted EBITDA margin help investors and analysts in comparing our results across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. These non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation from, or as a substitute for, the analysis of other GAAP financial measures, including net income (loss) and net income (loss) margin. In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of Adjusted EBITDA should not be construed to imply that our future results will be unaffected by the types of items excluded from the calculation of Adjusted EBITDA. Our use of the term Adjusted EBITDA varies from others in our industry.
Liquidity and capital resources
General
To date, we have financed our operations principally through cash flows from operations and through borrowings under our credit facilities, and most recently from the sale of common stock in our IPO that occurred in March 2021. As of June 30, 2021, we had cash and cash equivalents of $201.5 million. Our cash and cash equivalents primarily consist of highly liquid investments in demand deposit accounts and cash.
Our capital resources are generally used to fund (i) debt service requirements, the majority of which relate to the quarterly principal payments of the Term Loan Facility (as defined in Note 10 to the consolidated financial statements) due 2026, (ii) capital and operating lease obligations, which are generally paid on a monthly basis and include maturities through 2025 and 2032, respectively, (iii) the operations of our business, including special projects such as our transition to a new electronic medical record vendor, with respect to which we expect to incur non-recurring implementation costs over the next 18 months, and ongoing costs through 2026, and (iv) income tax payments, which are generally due on a quarterly and annual basis. We also expect to use capital resources for capital additions, which we expect to primarily relate to the development of de novo centers to the extent and if they are opened. Collectively, these obligations are expected to represent a significant liquidity requirement of our Company on both a short-term and long-term basis. For additional information regarding our lease obligations, debt and commitments, see Notes 9, 10 and 12 to our consolidated financial statements.
We believe that our cash and cash equivalents and our cash flows from operations will be sufficient to fund our operating and capital needs for at least the next 12 months. We have based this estimate on assumptions that may prove to be wrong, and we could use our available capital resources sooner than we currently expect. Our actual results could vary because of, and our future capital requirements will depend on, many factors, including our growth rate, the timing and extent of spending to open new centers and the expansion of sales and marketing activities. We may in the future enter into arrangements to acquire or invest in complementary businesses, services and technologies. We may be required to
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seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, or if we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, results of operations, and financial condition would be adversely affected.
On May 13, 2016, we entered into a credit agreement with Capital One Financial Corporation (together with all amendments thereto, the “2016 Credit Agreement”). In March 2020, we borrowed $25.0 million under the revolving credit facility to ensure sufficient funds available due to the uncertainty relating to the COVID-19 pandemic and for general corporate purposes. Those borrowings were repaid in full in connection with the entry into the 2021 Credit Agreement (as defined and discussed below) and the closing of our IPO.
On March 8, 2021, concurrently with the closing of the IPO, the Company entered into a new credit agreement (the “2021 Credit Agreement”) that replaced the 2016 Credit Agreement. The 2021 Credit Agreement consists of a senior secured term loan (the “Term Loan Facility”) of $75.0 million principal amount and a revolving credit facility (the “Revolving Credit Facility”) of $100.0 million maximum borrowing capacity, each as defined and described in Note 10 to the consolidated financial statements. Principal on the Term Loan Facility is paid each calendar quarter beginning September 2021 in an amount equal to 1.25% of the initial term loan on closing date. Proceeds of the Term Loan Facility, together with proceeds from the IPO, were used to repay amounts outstanding under the 2016 Credit Agreement.
Any outstanding principal amounts under the 2021 Credit Agreement accrue interest at a variable interest rate. As of June 30, 2021, the interest rate on the Term Loan Facility was 1.84%. Under the terms of the 2021 Credit Agreement, the Revolving Credit Facility fee accrues at 0.25% of the average daily unused amount and is paid quarterly. As of June 30, 2021, we had no borrowings outstanding under the Revolving Credit Facility and, therefore, had full capacity thereunder, subject to applicable covenant compliance restrictions and any other conditions precedent to borrowing. As of June 30, 2021, we also had $2.4 million principal amount outstanding under our convertible term loan. Monthly principal and interest payments are approximately $0.02 million, and the loan bears interest at an annual rate of 6.68%. The remaining principal balance is due upon maturity, which is August 20, 2030.
For more information about our debt, see Note 10 to our consolidated financial statements.
We currently intend to retain all available funds and any future earnings to fund the development and growth of our business and to repay indebtedness and, therefore, we do not anticipate paying any cash dividends in the foreseeable future.
Consolidated Statements of Cash Flows
Our consolidated statements of cash flows for the year ended June 30, 2021 and 2020 are summarized as follows:
Year ended June 30,
2021
2020
$ Change
in thousands
Net cash provided by (used in) operating activities
$
(7,548)
$
43,828
$
(51,376)
Net cash used in investing activities
(19,541)
(11,691)
(7,850)
Net cash provided by financing activities
116,224
21,232
94,992
Net change in cash, cash equivalents and restricted cash
$
89,135
$
53,369
$
35,766
Operating Activities. The change in net cash provided by (used in) operating activities was primarily due to the net effect of (i) a decrease in net income (loss) of $70.5 million, as described further above, (ii) the $14.5 million loss on extinguishment of long-term debt recognized during 2021, as described further above, with no loss recognized in 2020, (iii) the $10.9 million gain on equity method investment recognized during 2021, as described further above, with no gain recognized in 2020, (iv) an increase of $7.2 million in the change in accounts payable and accrued expenses due to timing of payments and the impact of the completion of HCPF’s reconciliation, as described below, (v) an increase of $7.1 million in the change in accounts receivable, including the impact of the completion of HCPF’s reconciliation, as defined and described below, and (vi) a decrease of $5.6 million in the change in income tax receivable.
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In fiscal year 2021, the Company and the Colorado Department of Health Care Policy & Financing (“HCPF”) completed the reconciliation for fiscal years 2018 and 2019. The reconciliation resulted in a reduction of accounts receivable of $17.0 million and due to Medicaid of $13.6 million, which was recorded in fiscal year 2021. The Company does not expect adjustments related to the reconciliation to be significant in future periods.
Investing Activities. The increase in net cash used in investing activities was primarily due to an increase in cash used of $5.7 million for growth-related capital expenditures.
Financing activities. The increase in net cash provided by financing activities was primarily due to the net effect of (i) an increase in cash provided of $370.5 million related to the net proceeds received from our IPO, (ii) a decrease in cash provided of $160.7 million due to higher net repayments on long-term debt, (iii) a decrease in cash provided of $77.6 million related to treasury stock purchases and (iv) a decrease in cash provided of $29.2 million related to stock option cancellation payments.
Contractual Obligations and Commitments
Our principal commitments consist of repayments of long-term debt and obligations under operating and capital leases. The following table summarizes our contractual obligations as of June 30, 2021:
Payments due by period
2022
2023
2024
2025
2026
Thereafter
Total
in thousands
Long-term debt (excluding interest) (1)
$
3,790
$
3,793
$
3,796
$
3,799
$
60,052
$
2,137
$
77,367
Operating leases (2)
3,550
4,289
3,926
3,450
3,371
13,909
32,495
Capital leases (excluding interest)
2,074
2,163
1,783
1,116
133
—
7,269
Total
$
9,414
$
10,245
$
9,505
$
8,365
$
63,556
$
16,046
$
117,131
(1) Represents principal amounts related to the credit agreements.
(2) We have not adopted ASU 2016-02, which requires lessees to recognize almost all of their leases on the balance sheet. We will be adopting this guidance for the annual reporting period beginning July 1, 2022, and interim reporting periods within the annual reporting period beginning July 1, 2023. See Note 2 “Summary of Significant Accounting Policies--Recent Accounting Pronouncements” to our consolidated financial statements included in this Annual Report on Form 10-K
Off Balance Sheet Arrangements
We did not have any off balance sheet arrangements as of June 30, 2021 .
JOBS Act
We qualify as an “emerging growth company” pursuant to the provisions of the Jumpstart Our Business Startups (“JOBS”) Act. For as long as we are an “emerging growth company,” we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies,” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, only being required to present two years of audited financial statements, plus unaudited condensed consolidated financial statements for applicable interim periods and the related discussion in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” reduced disclosure obligations regarding executive compensation in our periodic reports, proxy statements and registration statements, exemptions from the requirements of holding non-binding advisory “say-on-pay” votes on executive compensation and shareholder advisory votes on golden parachute compensation.
In addition, under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We intend to take advantage of the longer phase-in periods for the adoption of new or revised financial accounting standards under the JOBS Act until we are no longer an emerging
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growth company. Our election to use the phase-in periods permitted by this election may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the longer phase-in periods permitted under the JOBS Act and who will comply with new or revised financial accounting standards. If we were to subsequently elect instead to comply with public company effective dates, such election would be irrevocable pursuant to the JOBS Act.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions or conditions, impacting our reported results of operations and financial condition.
Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of assets and liabilities and the recognition of income and expenses. We consider these accounting policies to be critical accounting policies. The estimates and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances.
While our significant accounting policies are described in more detail in Note 2 “Summary of Significant Accounting Policies” to our consolidated financial statements, we believe the following discussion addresses our most critical accounting policies, which are those that are most important to our financial condition and results of operations and require management to make subjective and complex judgments and estimates in the preparation of our consolidated financial statements.
Revenue recognition
Revenue for the year ended June 30, 2020 is presented under Accounting Standards Codification (“ASC”) 605, Revenue Recognition (“ASC 605”). Under ASC 605, we recognized revenue when all of the following criteria were met: (i) persuasive evidence of an arrangement exists; (ii) the sales price is fixed or determinable; (iii) collection is reasonably assured; and (iv) services have been rendered. The judgement of when to recognize revenue is linked to the period in which eligible members are entitled to receive benefits.
In May 2014, the FASB issued Accounting Standards Update 2014-09 (“ASU 2014-09”), and has since issued various amendments which provide additional clarification and implementation guidance, to Topic 606, Revenue from Contracts with Customers , which superseded revenue recognition guidance in ASC 605. ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This guidance is effective for the annual reporting period beginning July 1, 2020, and interim reporting periods within the annual reporting period beginning July 1, 2021. Effective July 1, 2020, the Company adopted ASU 2014-09 using the modified retrospective method applied to those contracts which were not completed as of June 30, 2020. As a result of electing the modified retrospective adoption approach, results for reporting periods beginning after July 1, 2020 are presented under ASC 606. There was no material impact upon the adoption of ASC 606, therefore the Company did not record any adjustments to retained earnings at July 1, 2020 or for any periods previously presented. Accordingly, comparative periods have not been adjusted and continue to be reported under FASB ASC Topic 605, Revenue Recognition .
Capitation revenue
Our PACE operating unit provides comprehensive health care services to participants on the basis of estimated PMPM amounts we expect to be entitled to receive from the capitated fees per participant that are paid monthly by Medicare, Medicaid, the VA, and private pay sources. We recognize capitation revenues based on the estimated PMPM transaction price to transfer the service for a distinct increment of the series (i.e. month). We recognize revenue in the month in which participants are entitled to receive comprehensive care benefits during the contract term. Medicaid and Medicare capitation revenues are based on PMPM capitation rates under the PACE program, and Medicare rates can fluctuate throughout the
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contract based on the acuity of each individual participant. In certain contracts, PMPM rates also include “risk adjustments” based on various factors.
For certain capitation payments, the Company is subject to retroactive premium risk adjustments based on various factors. The Company estimates the amount of the adjustment and records it monthly on a straight-line basis. These adjustments are not expected to be material.
Capitation revenues may be subject to adjustment as a result of examination by government agencies or contractors. The audit process and the resolution of significant related matters often are not finalized until several years after the services are rendered. Any adjustments resulting from these examinations are recorded in the period we are notified of them.
At times, we accept participants into the program pending final authorization from Medicaid. If Medicaid coverage is later denied and there are no alternative resources available to pay for services, the participant is disenrolled. Costs incurred on behalf of such participants were nominal in the fiscal years ended June 30, 2021 and 2020.
Certain third party payor contracts include a Medicare Part D payment related to pharmacy claims, which is subject to risk sharing through accepted risk corridor provisions. Under certain agreements the fund risk allocation is established whereby we, as the contracted provider, receive only a portion of the risk and the associated surplus or deficit. We estimate and recognize an adjustment monthly to Part D capitation revenues related to these risk corridor provisions based upon pharmacy claims experience to date, as if the annual risk contract were to terminate at the end of the reporting period.
For our capitation revenue arrangements, we record revenue on a gross basis, as we are acting as a principal in providing for or overseeing comprehensive care for our participants.
Goodwill and other intangible assets
Intangible assets consist of customer relationships acquired through business acquisitions. Goodwill represents the excess of consideration paid over the fair value of net assets acquired through business acquisitions. Goodwill is not amortized but is tested for impairment at least annually.
We test goodwill for impairment annually on April 1 or more frequently if triggering events occur or other impairment indicators arise which might impair recoverability. These events or circumstances would include a significant change in the business climate, legal factors, operating performance indicators, competition, sale, disposition of a significant portion of the business, or other factors. Impairment of goodwill is evaluated at the reporting unit level. A reporting unit is defined as an operating segment (i.e. before aggregation or combination), or one level below an operating segment (i.e. a component).
A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. We have three reporting units for evaluating goodwill impairment.
ASC 350, Intangibles—Goodwill and Other (“ASC 350”), allows entities to first use a qualitative approach to test goodwill for impairment. When the reporting units where we perform the quantitative goodwill impairment are tested, we compare the fair value of the reporting unit, which we primarily determine using an income approach based on the present value of discounted cash flows, to the respective carrying value, which includes goodwill. Management estimates and assumptions are used when we determine fair value using widely accepted valuation techniques, including discounted cash flow. These techniques are also used when assigning the purchase price to acquired assets and liabilities. These types of analyses require us to make assumptions and estimates regarding industry and economic factors and the profitability of future business strategies. It is our policy to conduct impairment testing based on our current business strategy in light of present industry and economic conditions, as well as future expectations. If the fair value of the reporting unit exceeds its carrying value, the goodwill is not considered impaired. If the carrying value is higher than the fair value, the difference would be recognized as an impairment loss. There were no goodwill impairments recorded during the years ended June 30, 2021 and 2020.
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Additionally, the customer relationships represent the estimated values of customer relationships of acquired businesses and have definite lives. We amortize these intangible assets on a straight-line basis over their ten-year estimated useful life. ASC 360, Property, Plant, and Equipment (“ASC 360”), provides guidance for impairment related to definite life assets including, customer relationships, for which we reviewed for impairment in conjunction with long-lived assets. We test for recoverability of the customer relationships whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. There were no intangible asset impairments recorded during the years ended June 30, 2021 and 2020.
Reported and estimated claims
Reported and estimated claims expenses are costs for third-party healthcare service providers that provide medical care to our participants for which we are contractually obligated to pay (through our full-risk capitation arrangements). The estimated reserve for unpaid claims liability is included in the liability for reported and estimated claims in the consolidated balance sheets. Actual claims expense will differ from the estimated liability due to differences in estimated and actual member utilization of health care services, unit cost trends, participant acuity, changes in net census, known outbreaks of disease, including COVID-19 or increased incidence of illness such as influenza and other factors. We periodically assess our estimates with an independent actuarial expert to ensure our estimates represent the best, most reasonable estimate given the data available to us at the time the estimates are made.
We have included incurred but not reported claims of approximately $33.2 million and $30.3 million on our balance sheet as of June 30, 2021 and 2020, respectively. Our recorded medical claims expense estimate are approximately within +/- 5-10% of actual medical claims expense incurred, or less than 1% of our total operating expense.
The following tables provide information about incurred and paid claims reporting and development as of June 30, 2021 (except as otherwise noted). The expenses recorded table reflects the amount of claims reported in our consolidated statements of operations as of the end of the applicable fiscal year based on our best and most reasonable estimates and actuarial assessment at the time of such determination. The cumulative actual incurred claims table represents the actual amount of claims incurred by the Company with the benefit of the passage of time. The variance between the expense recorded and the cumulative actual incurred claims ranges between approximately 1% and 3% of actual total incurred claims over the periods presented, and such variance may vary based on the factors described above in this section.
Expenses Recorded for the Fiscal Years Ended June 30,
2017
2018
2019
2020
2021
in thousands
Claims incurred year:
FY 2017
$
102,832
FY 2018
$
123,821
FY 2019
$
171,128
FY 2020
$
211,381
FY 2021
$
234,070
Total
$
102,832
$
123,821
$
171,128
$
211,381
$
234,070
Pharmacy expense
75,247
External provider costs
$
309,317
Cumulative Actual Incurred Claims for the Fiscal Years Ended June 30,
2017
2018
2019
2020
2021
in thousands
Claims incurred year:
FY 2017
$
101,386
$
101,386
$
101,386
$
101,386
$
101,376
FY 2018
119,687
119,687
119,687
119,862
FY 2019
173,047
173,061
172,855
FY 2020
210,512
205,633
FY 2021
239,207
Total
$
101,386
$
221,073
$
394,120
$
604,646
$
838,933
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Cumulative Actual Paid Claims for the Fiscal Years Ended June 30,
2017
2018
2019
2020
2021
in thousands
Claims incurred year:
FY 2017
$
88,020
$
101,572
$
101,450
$
101,386
$
101,376
FY 2018
109,022
119,759
119,687
119,862
FY 2019
144,943
173,048
172,855
FY 2020
179,616
205,601
FY 2021
205,356
Total
$
88,020
$
210,594
$
366,152
$
573,737
$
805,050
Other claims-related liabilities
(649)
Reported and estimated claims
$
33,234
Stock-based compensation
ASC 718, Compensation—Stock Compensation (“ASC 718”) requires the measurement of the cost of the employee services received in exchange for an award of equity instruments based on the grant-date fair value or, in certain circumstances, the calculated value of the award. We maintained the 2016 Equity Incentive Plan pursuant to which various stock-based awards may be granted to employees, directors, consultants, and advisers.
Under our 2016 Equity Incentive Plan, we were able to reward employees with various types of awards, including but not limited to stock options on a service-based or performance-based schedule. We have elected to account for forfeitures as they occur.
2016 Equity Incentive Plan
The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model, which requires inputs based on certain subjective assumptions, including fair value of the underlying common stock, the expected stock price volatility, the expected term of the option, the risk-free interest rate for a period that approximates the expected term of the option, and our expected dividend yield.
Changes in these assumptions can materially affect the estimate of fair value and ultimately how much stock-based compensation expense is recognized, and the resulting change in fair value, if any, is recognized in our statement of operations and comprehensive loss during the period the related services are rendered.
These inputs are subjective and generally require significant analysis and judgment to develop.
For service-vesting awards, we recognize stock-based compensation expense over the requisite service period, which is generally the vesting period of the respective award, on a straight-line basis. For performance-vesting awards, we recognize stock-based compensation expense when it is probable that the performance condition will be achieved. We will analyze if a performance condition is probable for each reporting period through the settlement date for awards subject to performance vesting. For service-vesting awards, we recognize stock-based compensation expense over the requisite service period for each separately vesting portion of the awards as if the award was, in substance, multiple awards.
The 2016 Equity Incentive Plan was canceled in July 2020 and we subsequently established the 2020 Equity Incentive Plan, as described below, pursuant to which interests in TCO Group Holdings, L.P. in the form of Class B Units were granted to employees, directors, consultants, and advisers.
2020 Equity Incentive Plan
Profits Interests Units
The Company uses the Monte Carlo option model to determine the fair value of the granted profits interests units, which requires inputs based on certain subjective assumptions, including fair value of the underlying common stock, the
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expected stock price volatility, the expected term of the option, the risk-free interest rate for a period that approximates the expected term of the option, and our expected dividend yield.
Changes in these assumptions can materially affect the estimate of fair value and ultimately how much stock-based compensation expense is recognized, and the resulting change in fair value, if any, is recognized in our statement of operations and comprehensive loss during the period the related services are rendered.
These inputs are subjective and generally require significant analysis and judgment to develop.
We concluded that the performance-vesting units are subject to a market condition and assessed the market condition as part of the determination of the grant date fair value. For performance-vesting units, we recognized unit-based compensation expense when it was probable that the performance condition would be achieved. We will analyze if a performance condition was probable for each reporting period through the settlement date for units subject to performance vesting. For service-vesting units, we will recognize unit-based compensation expense over the requisite service period for each separately vesting portion of the profits interest as if the unit was, in-substance, multiple units.
Restricted Stock Units
We recognize expense related to restricted stock units based on their grant-date fair values, which is based upon the closing share price of the Company’s common stock on the date of grant. We recognize stock-based compensation expense, using the straight-line method, as a charge to operations over the vesting period based on the grant-date fair value of outstanding awards, which may differ from the fair value of such awards on any given date.
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements “Summary of Significant Accounting Policies—Recent Accounting Pronouncements” for more information.