Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q. 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. Readers are cautioned not to place undue reliance on any forward-looking statements, as forward-looking statements are not guarantees of future performance and the Company’s actual results may differ significantly due to numerous known and unknown risks and uncertainties, including those discussed below and in the section entitled “Cautionary Note on Forward-Looking Statements.” Those known risks and uncertainties include, but are not limited to, the risk factors identified in the section titled “Risk Factors” in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended June 30, 2022 (“2022 10-K”).
Overview
InnovAge Holding Corp. (“InnovAge”) became a public company in March 2021. As of September 30, 2022, the Company served approximately 6,540 PACE participants, and operated 18 PACE centers across Colorado, California, New Mexico, Pennsylvania, and Virginia.
Trends and Uncertainties Affecting the Company
During fiscal year 2022, the U.S. and global economies experienced adverse macroeconomic effects in part resulting from the ongoing effects of the COVID-19 pandemic, as discussed in more detail below. These effects included inflation and increased wages due to labor shortages. In fiscal year 2022, in response to high levels of inflation, we began to implement various mitigation strategies to reduce costs of operation, including consolidating services and price negotiations with providers and vendors. The effects of inflation, after accounting for these mitigation strategies, were immaterial to our financial results for the three months ended September 30, 2022. However, we expect inflation is likely to continue for most or all of fiscal year 2023, and even though we expect to continue mitigation efforts, there can be no assurance that our strategies will be sufficient.
In addition, the increased wage pressure, exacerbated by the labor shortage, increased the cost of providing care and our overall operating expenses. The combination of increased wage pressure and labor shortage amongst healthcare personnel, and specifically, trained personnel, has impacted and may continue to impact our expenses and ability to adhere to the complex government laws and regulations that apply to our business. Operating expenses increased $26.4 million, or 16.4%, for the three months ended September 30, 2022 compared to 2021 due to, in part, the increased cost of care and related cost per participant. We continue to evaluate increased costs and methods to mitigate or offset such costs.
Impact of Macroeconomic Conditions and COVID-19
The COVID-19 pandemic altered the behavior of businesses and people, the effects of which, to some extent, continue on federal, state and local economies.
Expenses . The virus has and continues to impact older adults, especially those with chronic illnesses, which describes our participants. The United States experienced supply chain issues with respect to personal protective equipment (“PPE”) and other medical supplies during the height of the pandemic. Global logistics network challenges resulted in higher prices for medical supplies we require. While uncertainties related to the magnitude and duration of global supply chain disruptions have adversely affected, and may continue to adversely affect, our business and outlook, supply chain disruptions have begun to alleviate and prices for certain medical supplies have begun to normalize.
Labor market . The COVID-19 pandemic has and continues to exacerbate difficulties to hire additional healthcare professionals, causing certain of our centers to be understaffed or staffed with personnel that requires training. In fiscal year 2022, we experienced workforce and labor shortages, within all of our centers. We recognize that our participant-facing staff is critical to delivering quality care. As such, we made market adjustments to certain roles to increase retention and improve our ability to hire. These adjustments resulted in an increase in cost of care further impacted by additional
25
Table of Contents
staffing related to compliance and remediation efforts. This increase in conjunction with higher headcount has contributed to increased cost of care for the three months ended September 30, 2022 as discussed in “Results of Operations” below. We continue to assess key roles and benchmarks to market while monitoring trends in the labor market.
For additional information on the various risks posed by macroeconomic events and the ongoing COVID-19 pandemic, please see the section entitled “Risk Factors” included in Part I, Item 1A of our 2022 10-K.
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 ability to effectively implement remediation efforts in our centers as a result of our recent audits. The Company’s priority is to remediate the deficiencies raised in the audit processes in California, Colorado and New Mexico. As part of its actions to do so, the Company has worked with the appropriate authorities to make the necessary changes within the Company to increase care coordination and care documentation among our centers, including working to fill critical personnel gaps at our centers, standardizing the process of our Interdisciplinary Care Teams (“IDTs”), strengthening our home care network and reliability, improving timelines of scheduling and coordinating care with providers outside our centers, among others. See “Audit Processes and Remediation Efforts” below.
● 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 risk adjustment factor (“RAF”) score of 2.35 based on InnovAge data as of September 30, 2022 ; 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 participant 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 per member, per month (“PMPM”) payments directly from Medicare and Medicaid, which provides recurring revenue streams and significant visibility into our revenue. 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 all seniors should have access to the type of all-inclusive care offered by the PACE model. Several factors can affect our ability to grow enrollment and capacity within existing centers, including sanctions issued by regulators. Currently, the Centers for Medicare and Medicaid Services (“CMS”) and state agencies have suspended new enrollments at our Sacramento, California center and at our centers in the State of Colorado.
● Our ability to maintain high participant satisfaction and retention. We achieved an 76% participant satisfaction rating as of July 1, 2022 and average participant tenure was 3.2 years as of September 30, 2022, 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 5.7% annually over the last three fiscal years. Approximately 75% of our historical disenrollments have been involuntary, due primarily to participant death or otherwise due 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
26
Table of Contents
care, excluding depreciation and amortization, represented approximately 87% of our revenue in the three months ended September 30, 2022. While we are liable for potentially large medical claims, 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.
● Center-level Contribution Margin . As we serve more participants in existing centers, we leverage our fixed cost base at those centers and the value of a center to our business increases over time . The enrollment sanctions in place in Sacramento, California and Colorado limit our ability to grow our participant census and impact Center-level Contribution Margin.
● Our ability to expand via acquisition or de novo centers within existing and new markets. Several factors can affect our ability to open de novo centers, including sanctions issued by regulators. On January 7, 2022, the Department of Health Care Services (“DHCS”) of the State of California notified us that it was suspending the State’s previously provided assurances that it would enter into a PACE program agreement with the Company (State Attestations) with respect to de novo centers in the State of California until such time as the corrective action plans (“CAPs”) and the remediation and validation processes for our Sacramento center have been successfully completed and the enrollment sanctions are lifted. In addition, on February 9, 2022, we received notice from the Cabinet for Health and Family Services of the State of Kentucky informing us that they no longer intend to enter into an agreement with us to be a PACE provider in the State of Kentucky. On February 14, 2022, CMS denied our application to develop the previously announced PACE center in Terre Haute, Indiana, which was projected to open in fiscal year 2024 based on deficiencies detected during CMS’ 2021 audits of our Sacramento and Colorado PACE programs. In addition, we have committed to CMS and the Agency for Healthcare Administration in the State of Florida, that we will proactively pause remaining steps with respect to de novo centers to focus on remediating deficiencies raised in the audit processes.
● Execute tuck-in acquisitions. From fiscal year 2019 through fiscal year 2021, we 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. Historically, when integrating acquired programs, we worked closely with key constituencies, including local governments, health systems and senior housing providers, to enable continuity of high-quality care for participants. Once restrictions on our ability to open de novo centers are lifted or resolved, we intend to resume execution of tuck-in acquisitions.
● 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 in existing markets as well as 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 also expect to incur additional expenses for the foreseeable future in connection with current and future audits to our centers, remediation plans and current and potential legal and regulatory proceedings. 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.
27
Table of Contents
● Seasonality of 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 Risk Adjustment Factor 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.
Audit Processes and Remediation Efforts
We are routinely subject to, and will continue to be subject to, various governmental inspections, reviews and audits. Set forth below is a summary of the ongoing audits at our centers and updates on such audit processes.
Colorado. In December 2021, each of CMS and the Colorado Department of Health Care Policy & Financing (“HCPF”) suspended new enrollments at the Company’s Colorado centers, based on deficiencies related to participant provision of services detected in the joint audit initiated in May and June 2021. In January and February 2022, we submitted corrective action plans (“CAP”) to each of these agencies, which have been accepted and, in June 2022, both CMS and HCPF began monitoring the implementation of the CAPs. In October 2022, the Company submitted an “Attestation” to CMS stating that it believes it has rectified the deficiencies and complied with the CAPs. CMS will begin validating compliance in December 2022. HCPF will collaborate with CMS but has not provided timing. Timing and results of validation are uncertain and there can be no assurance that the agencies will agree with us or release us from sanctions.
California. On May 10, 2021, CMS began an audit of our Sacramento, California center. In September 2021, CMS determined to suspend new enrollments at our Sacramento center based on deficiencies detected in the audit related to participant provision of services. In that same month, we were further notified that the Department of Health Care Services (“DHCS”) of the State of California had reached the same determination. In October 2021, we submitted a CAP to each of these agencies and have since been executing the CAPs. In October 2022, the Company submitted “Attestations” to CMS and DHCS, stating that it believes it has rectified the deficiencies and complied with the CAPs. CMS will begin validating compliance in November 2022. DHCS has not provided a start date. Timing and results of validation are uncertain and there can be no assurance that the agencies will agree with us or release us from sanctions.
In January 2022, DHCS notified us that it was suspending the State Attestations with respect to de novo centers in the State of California until such time as the enrollment sanctions are lifted.
In March 2022, CMS and DHCS began separate audits of our San Bernardino, California center. In September 2022, CMS issued a final audit report identifying certain deficiencies previously noted in preliminary results. CMS has verbally notified us that no enforcement actions will be taken. We are implementing corrective actions (“iCARs”), and are currently working on the audit close process.
New Mexico. In November 2021, CMS began an audit of our Albuquerque, New Mexico center. In July 2022, CMS verbally notified us that no enforcement actions will be taken, and in October 2022, CMS issued a final audit report. To address the deficiencies related to participant provision of services identified in the audit, we are implementing iCARs are currently working with CMS on the audit close out process.
Kentucky, Indiana and Florida . The States of Kentucky and Indiana have taken actions to suspend our ability to open de novo centers in those states, and we have committed to regulatory agencies in the State of Florida, that we will proactively pause remaining steps with respect to planned de novo centers in that state.
28
Table of Contents
The Company’s priority is to remediate the deficiencies raised in the audit processes and to return to growth as a company, both for the short- and long-term. We continue to work with the appropriate authorities to make the necessary changes within the Company to increase care coordination and care documentation among our centers.
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, Medicaid, Veterans Affairs (“VA”) and private pay sources.
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 amendments have been executed for the periods (i) January 1, 2021 through December 31, 2022 for California and (ii) July 1, 2022 through June 30, 2023 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 current amendment. For a discussion of our revenue recognition policies, please see Critical Accounting Estimates below and Note 2 “Summary of Significant Accounting Policies” to our consolidated financial statements included in our 2022 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. Prior to June 30, 2022 we generated fee-for-service revenue from providing home-care services to non-PACE patients in their homes, for which we billed the patient or their insurance plan on a fee-for-service basis. We no longer offer in-home care services. For a discussion of our revenue recognition policies, please see Critical Accounting Estimates below and Note 2, “Summary of Significant Accounting Policies” to our consolidated financial statements included in our 2022 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 and skilled nursing facility), 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 salaries, wages and benefits for IDT and other 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. Other 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, including our employee-related costs, is directly related to the number of participants cared for in a center. The remainder of our cost of care is fixed relative to the number of participants we serve, such as occupancy and insurance expenses. As a result, as revenue increases due to census growth, cost of care, excluding depreciation and amortization, moderately 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
29
Table of Contents
time as we continue to grow our participant census. We evaluate our sales and marketing expenses relative to our 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. 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 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.
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 our 2022 10-K.
30
Table of Contents
Results of Operations
The following table sets forth our consolidated results of operations for the periods presented:
Three months ended September 30,
2022
2021
in thousands
Revenues
Capitation revenue
$
170,931
$
172,554
Other service revenue
287
516
Total revenues
171,218
173,070
Expenses
External provider costs
96,237
90,012
Cost of care, excluding depreciation and amortization
53,557
40,728
Sales and marketing
4,413
6,293
Corporate, general and administrative
30,181
21,084
Depreciation and amortization
3,433
3,293
Total expenses
187,821
161,410
Operating Income (Loss)
$
(16,603)
$
11,660
Other Income (Expense)
Interest expense, net
(603)
(547)
Other income (expense)
37
(493)
Total other expense
(566)
(1,040)
Income (Loss) Before Income Taxes
(17,169)
10,620
Provision (Benefit) for Income Taxes
(3,470)
2,996
Net Income (Loss)
$
(13,699)
$
7,624
Less: net loss attributable to noncontrolling interests
(626)
(62)
Net Income (Loss) Attributable to InnovAge Holding Corp.
$
(13,073)
$
7,686
Revenues
Three months ended September 30,
2022
2021
$ Change
% Change
in thousands
Capitation revenue
$
170,931
$
172,554
$
(1,623)
(0.9)
%
Other service revenue
287
516
(229)
(44.4)
%
Total revenues
$
171,218
$
173,070
$
(1,852)
(1.1)
%
Capitation revenue. Capitation revenue was $170.9 million for the three months ended September 30, 2022, a decrease of $1.6 million, or 0.9%, compared to $172.6 million for the three months ended September 30, 2021. This decrease was driven by a 5.6% decrease in member months partially offset by a 4.9% increase in capitation rates. The decrease in member months is primarily due to disenrollments and our inability to enroll new participants at our Sacramento, California and Colorado centers as a result of the sanctions. The increase in capitation rates was primarily driven by an annual increase in Medicaid capitation rates as determined by the States and Medicare capitation rates as a result of increased risk score and county rates.
Other service revenue. Other service revenue was $0.3 million for the three months ended September 30, 2022, a decrease of $0.2 million, or 44.4%, from $0.5 million for the three months ended September 30, 2021. The decrease is primarily due to less fee-for-service revenue as a result of winding down our in-home care services during fiscal year 2022.
31
Table of Contents
Operating Expenses
Three months ended September 30,
2022
2021
$ Change
% Change
in thousands
External provider costs
$
96,237
$
90,012
$
6,225
6.9
%
Cost of care (excluding depreciation and amortization)
53,557
40,728
12,829
31.5
%
Sales and marketing
4,413
6,293
(1,880)
(29.9)
%
Corporate, general, and administrative
30,181
21,084
9,097
43.1
%
Depreciation and amortization
3,433
3,293
140
4.3
%
Total operating expenses
$
187,821
$
161,410
$
26,411
16.4
%
External provider costs. External provider costs were $96.2 million for the three months ended September 30, 2022, an increase of $6.2 million, or 6.9%, compared to $90.0 million for the three months ended September 30, 2021. The increase is primarily driven by an increase of $11.2 million, or 13.2%, in cost per participant partially offset by a decrease of $5.0 million, or 5.6%, in member months. The increase in cost per participant is primarily driven by a $7.7 million increase associated with increased housing utilization and cost per day as mandated by certain states.
Cost of care (excluding depreciation and amortization). Cost of care (excluding depreciation and amortization) expense was $53.6 million for the three months ended September 30, 2022, an increase of $12.8 million, or 31.5%, compared to $40.7 million for the three months ended September 30, 2021, primarily due to an increase of $15.1 million, or 39.3%, in cost per participant partially offset by a decrease of $2.3 million, or 5.6%, in member months. Of the total variance, the increase was primarily driven by (i) a $7.8 million increase salaries, wages and benefits associated with increased headcount and higher wage rates due to the ongoing competitive labor market, (ii) $1.0 million in third party audit and compliance support, (iii) $1.3 million in increased fleet and contract transportation as a result of higher average daily attendance, increase in external appointments, and higher fuel costs, and (iv) $0.6 million in de novo costs.
Sales and marketing. Sales and marketing expenses were $4.4 million for the three months ended September 30, 2022, a decrease of $1.9 million, or 29.9%, compared to $6.3 million for the three months ended September 30, 2021, primarily due to a $1.3 million reduction in marketing spend and $0.5 million associated with fewer headcount within the sales department, both as a result of sanctions in our Colorado and Sacramento centers.
Corporate, general and administrative. Corporate, general and administrative expenses were $30.2 million for the three months ended September 30, 2022, an increase of $9.1 million, or 43.1%, compared to $21.1 million for the three months ended September 30, 2021. The increase was primarily due to (i) a $3.1 million increase in employee compensation and benefits as the result of an increase in headcount, to support compliance and bolster organizational capabilities, and (ii) $5.1 million in third party costs associated with strengthening organizational capabilities, implementing our core provider initiatives, and assessing our risk-bearing payor capabilities.
Other Income (Expense)
Three months ended September 30,
2022
2021
$ Change
% Change
in thousands
Interest expense, net
$
(603)
$
(547)
$
(56)
10.2
%
Other income (expense)
37
(493)
530
107.5
%
Total other expense
$
(566)
$
(1,040)
$
474
45.6
%
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 $0.6 million for
32
Table of Contents
the three months ended September 30, 2022, an increase of $0.1 million, or 10.2%, compared to $0.5 million for the three months ended September 30, 2021. The increase was primarily due to a higher average interest rate, partially offset by a lower outstanding debt balance. For additional information regarding our outstanding indebtedness, see Note 8, “Long-Term Debt” to our condensed consolidated financial statements.
Other income (expense). Other income (expense) consists primarily of the net proceeds received from the sale of or disposal of property and equipment. Other income (expense) was $0.04 million for the three months ended September 30, 2022, an increase of $0.5 million, or 107.5%, compared to $(0.5 million) for the three months ended September 30, 2021. The increase is primarily due to the recognition of a loss on disposal of assets of $0.5 million during the three months ended September 30, 2021 related to the write off of certain assets in conjunction with a move to a new facility at our Roanoke, Virginia center.
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 condensed consolidated financial statements.
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 three months ended September 30, 2022 and 2021, we reported benefit for income taxes of $3.5 million and a provision for income taxes of $3.0 million, respectively. The decrease of $6.5 million is primarily due (i) our pretax book loss recognized during the three months ended September 30, 2022, as compared to pretax book income recognized during the three months ended September 30, 2021 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) income from entities not subject to tax, and (c) disallowed stock options related to profit unit interests.
Net Loss Attributable to Noncontrolling Interests.
InnovAge Senior Housing Thornton, LLC (“SH1”) is a Variable Interest Entity (“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 are recorded in the consolidated statements of operations and the share of the other noncontrolling interest holders’ earnings are recorded as net loss attributable to noncontrolling interests.
Our share of earnings are recorded in the consolidated statements of operations and the share of the other noncontrolling interest holders’ earnings are recorded as net loss attributable to noncontrolling interests.
Net Income (Loss)
During the three months ended September 30, 2022 and 2021, we reported net income (loss) of ($13.7 million) and $7.6 million, respectively, consisting of (i) income (loss) from operations of ($16.6 million) and $11.7 million,
33
Table of Contents
respectively, (ii) other expense of $0.6 million and $1.0 million, respectively, and (iii) a benefit for income taxes of $3.5 million and provision of $3.0 million, respectively, each as described above.
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.
Three months ended September 30,
2022
2021
dollars in thousands
Key Business Metrics:
Centers
18
18
Census (a)
6,540
6,990
Total Member Months (a)
19,740
20,910
Center-level Contribution Margin
$
21,424
$
42,330
Center-level Contribution Margin as a % of revenue
12.5
%
24.5
%
Non-GAAP Measures:
Adjusted EBITDA (b)
$
(3,815)
$
18,212
Adjusted EBITDA Margin (b)
(2.2)
%
10.5
%
(a) Amounts are approximate.
(b) 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 and Adjusted EBITDA Margin.”
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
34
Table of Contents
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 $21.4 million and $42.3 million for the three months ended September 30, 2022 and 2021, respectively.
Adjusted EBITDA and Adjusted EBITDA Margin
We define Adjusted EBITDA as net income (loss) 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, class action litigation, M&A transaction and integration, business optimization, and electronic medical record (“EMR”) implementation. Adjusted EBITDA margin is Adjusted EBITDA expressed as a percentage of our total revenue less any exceptional, one time revenue items. For the three months ended September 30, 2022 and 2021, net loss was $13.7 million and net income was $7.6 million, respectively, representing a year-over-year decrease of 279.7%. Adjusted EBITDA was ($3.8 million) and $18.2 million, for the three months ended September 30, 2022 and 2021, respectively, representing a year-over-year decrease of 120.9%. For the three months ended September 30, 2022, net loss margin was 8.0%, as compared to net income margin of 4.4% for the three months ended September 30, 2021. For the three months ended September 30, 2022, our Adjusted EBITDA margin was negative 2.2%, as compared to our Adjusted EBITDA margin for the three months ended September 30, 2021 of 10.5%. The decrease in Adjusted EBITDA and Adjusted EBITDA margin is primarily from (i) increased center-level headcount and wage rates associated with a competitive labor market, (ii) increased housing utilization and rates as mandated by the states, and (iii) higher corporate, general, and administrative expenses, primarily attributable to increased headcount to support compliance and to bolster our organizational capabilities.
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 and noncash expenses, 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. The use of the term Adjusted EBITDA varies from others in our industry.
35
Table of Contents
A reconciliation of Adjusted EBITDA to net income, the most directly comparable GAAP measure, for each of the periods is as follows:
Three months ended September 30,
2022
2021
Net income (loss)
$
(13,699)
$
7,624
Interest expense, net
603
547
Depreciation and amortization
3,433
3,293
Provision (benefit) for income tax
(3,470)
2,996
Stock-based compensation
1,300
958
Class action litigation (a)
(46)
—
M&A and de novo development (b)
286
327
Business optimization (c)
7,188
2,117
EMR implementation (d)
590
350
Adjusted EBITDA
$
(3,815)
$
18,212
(a) Reflects charges/(credits) related to litigation by stockholders.
(b) Reflects charges related to M&A transaction and integrations, and de novo center developments.
(c) Reflects charges related to business optimization initiatives. Such charges related to one-time investments in projects designed to enhance our technology and compliance systems, improve and support the efficiency and effectiveness of our operations, and third party support to address efforts to remediate deficiencies in audits. For the three months ended September 30, 2022 this includes (i) $0.7 million related to consultants and contractors performing audit and other related services at sanctioned centers, (ii) $1.6 million of charges related to government investigations, and (iii) $4.3 million of costs associated with third party consultants as we implement our core provider initiatives, assess our risk-bearing payor capabilities, and strengthen our enterprise capabilities.
(d) Reflects non-recurring expenses relating to the implementation of a new electronic medical record vendor.
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 from the sale of common stock in our IPO that occurred in March 2021. As of September 30, 2022, we had cash and cash equivalents of $188.2 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 8, “Long Term Debt” to the condensed 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 EMR vendor, with respect to which we expect to incur non-recurring implementation costs over the next 9 months, and ongoing costs through 2026, and third party support to address remediation efforts, and (iv) income tax payments, which are generally due on a quarterly and annual basis. We also will continue investing in the effective implementation of corrective remediation plans (CAPs) and other corrective initiatives as a result of deficiencies found during audits at some of our centers, and our ability to continually provide necessary and quality services to our participants. In the long term, 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 (next 12 months) and long-term (beyond 12 months) basis.
Our cash obligations consist of repayments of long-term debt and obligations under operating and capital leases. As of September 30, 2022, we had $72.6 million of long-term debt outstanding. As of September 30, 2022, we had future
36
Table of Contents
minimum operating lease payments under non-cancellable leases through the year 2032 of $30.4 million. We also had non-cancellable finance lease agreements with third parties through the year 2027 with future minimum payments of $14.5 million. For additional information, see Note 7, “Leases”, Note 8, “Long Term Debt”, and Note 9, “Commitments and Contingencies” in our condensed consolidated financial statements.
We believe that our cash and cash equivalents and our cash flows from operations, available funds, and access to financing sources, including our 2021 Credit Agreement and Revolving Credit Facility (each discussed and defined below), will be sufficient to fund our operating and capital needs for the next 12 months and beyond. 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, our ability to retain and grow the number of PACE participants, subject to our ability to effectively remediate deficiencies identified in our Colorado and Sacramento 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 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.
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. Principal on the Term Loan Facility is paid each calendar quarter in an amount equal to 1.25% of the initial term loan on closing date.
Any outstanding principal amounts under the 2021 Credit Agreement accrue interest at a variable interest rate. As of September 30, 2022, the interest rate on the Term Loan Facility was 3.38%. 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 September 30, 2022, 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 September 30, 2022, we also had $2.3 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 8 “Long-Term Debt” to our condensed consolidated financial statements.
We currently intend to retain all available funds and any future earnings to fund the development and growth of our business.
Condensed Consolidated Statements of Cash Flows
Our consolidated statements of cash flows for the three months ended September 30, 2022 and 2021 are summarized as follows:
Three months ended September 30,
2022
2021
$ Change
in thousands
Net cash provided by operating activities
$
13,127
$
20,559
$
(7,432)
Net cash used in investing activities
(7,666)
(5,042)
(2,624)
Net cash used in financing activities
(1,668)
(1,452)
(216)
Net change in cash, cash equivalents and restricted cash
$
3,793
$
14,065
$
(10,272)
37
Table of Contents
Operating Activities. The change in net cash provided by operating activities was primarily due to the net effect of (i) net loss of $13.7 million in the current year period compared to a net income of $7.6 million in the prior year period, as described further above, and (ii) a net increase in working capital primarily attributable to pre-payment for services.
Investing Activities. Investing activities were made up of approximately $7.7 million in purchases of property and equipment.
Financing activities. The increase in net cash used in financing activities was primarily due to an increase in principal payments on capital leases.
Emerging Growth Company and Smaller Reporting Company
We qualify as an “emerging growth company” pursuant to the provisions of the Jumpstart Our Business Startups (“JOBS”) Act and a “smaller reporting company” as defined by the Exchange Act. For as long as we are an “emerging growth company” or a “smaller reporting 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” or “smaller reporting 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 stockholder 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 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 Estimates
The discussion and analysis of our financial condition and results of operations are based upon our condensed 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 condensed 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 estimates 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 estimates to be critical accounting estimates. The estimates and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances.
For a description of our estimates regarding our critical accounting estimates, see “Critical Accounting Estimates” in the 2022 Annual 10-K. With the exception of the adoption of ASC 842 – Leases, as more thoroughly described in Note 7 “Leases”, there have been no significant changes in our critical accounting policies, estimates, or methodologies to our condensed consolidated financial statements .
38
Table of Contents
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.