What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-02-07 compared with 2022-11-08 · 135 added, 106 removed, 278 unchanged (46% of the section changed)

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(“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.

As of December 31, 2022, the Company served approximately 6,460 PACE participants, and operated 18 PACE centers across Colorado, California, New Mexico, Pennsylvania, and Virginia.

Trends and Uncertainties Affecting the Company

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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.

While inflationary pressures eased slightly during the three and six months ended December 31, 2022, inflation has continued during the first half of fiscal 2023 and is expected to continue through the remainder of the fiscal year.

As a result, the Company has continued the mitigation strategies discussed during the six months ended December 31, 2022.

The effects of inflation, after accounting for these mitigation strategies, were immaterial to our financial results for the three and six months ended December 31, 2022.

Although 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 during the six months ended December 31, 2022.

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.

Furthermore, operating expenses increased $35.2 million, or 10.5%, for the six months ended December 31, 2022 compared to 2021 due to, in part, the increased cost of care and related cost per participant as a result of increased salaries, wages and benefits associated with increased headcount and higher wage rates, third party audit and compliance support, increased fleet and contract transportation, increase in external appointments, and higher fuel costs.

We expect to experience elevated operating expenses for the remainder of fiscal 2023.

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.

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, including as a result of new virus variants that have resulted in renewed mask mandates in certain circumstances.

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.

Global logistics network challenges resulted in higher prices

for medical supplies we require.

While supply chain disruptions have adversely affected, and may continue to adversely affect, our business and outlook, supply chain disruptions have improved to almost pre-pandemic level during the course of the first half of fiscal 2023.

As a result, prices for most medical supplies have normalized.

Labor market .

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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

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.

This labor pressure has eased slightly during the six months ended December 31, 2022.

While the labor pressure and related costs have eased slightly, the Company continues to be affected by the increased competition in the labor market and market adjustments to increase retention and improve our ability to hire.

These adjustments contributed, in part, to an increase in cost of care for the six months ended December 31, 2022, further impacted by additional staffing related to compliance and remediation efforts.

This increase in conjunction with higher headcount has contributed to increased cost of care for the six months ended December 31, 2022 compared to the six months ended December 31, 2021 as discussed in “Results of Operations” below.

We continue to assess key roles and benchmarks to market while monitoring trends in the labor market.

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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 ;

(i) we manage a higher acuity population, with an average risk adjustment factor (“RAF”) score of 2.31 based on InnovAge data as of December 31, 2022 ;

and (ii) we manage Medicaid spend in addition to Medicare.

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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.

Even though enrollment sanctions have been released in the State of Colorado, our ability to enroll Medicaid recipients, which is required to enroll seniors with both Medicare and Medicaid, remain suspended at our Sacramento, California center by the Department of Health Care Services (“DHCS”) of the State of California.

● 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.

We achieved a 79% participant satisfaction rating as of October 1, 2022 and average participant tenure was 3.2 years as of December 31, 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.

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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 87% of our revenue in the three months ended September 30, 2022.

healthcare system, our external provider costs and cost of care, excluding depreciation and amortization, represented approximately 87% of our revenue in the six months ended December 31, 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.

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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.

The enrollment sanctions in Sacramento, California and Colorado limited our ability to grow our participant census and impact Center-level Contribution Margin in fiscal 2022 and the first half of fiscal 2023.

● 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.

On January 7, 2022, 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.

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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 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.

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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.

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 into nor control over the timing of such payments.

Audit Processes and Remediation Efforts

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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.

On January 23, 2023, both CMS and HCPF released the enrollment sanctions for all Colorado centers.

CMS and HCPF require that we conduct post-sanction corrective action and monitoring activities to address any issues identified during the validation audits.

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 September 2021, CMS suspended 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 DHCS had reached the same determination.

In October 2021, we submitted a CAP to each of these agencies and began executing the CAPs.

Effective November 21, 2022, CMS released the enrollment sanction for Medicare-eligible participants.

The DHCS has not lifted the state sanction.

The DHCS audit outcome determines our ability to enroll Medicaid recipients, which is required to enroll seniors with both Medicare and Medicaid.

Timing and results of validation from DHCS are uncertain, and there can be no assurance that the agency will agree with us or release us from sanction.

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 its 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.

On January 11, 2023, CMS closed its audit.

There has been no additional activity related to the DHCS audit;

however, DHCS has not officially closed the audit.

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.

To address the deficiencies related to participant provision of services identified in the audit, we implemented iCARs and CARs and are currently working with CMS on the audit close out process.

Kentucky, Indiana and Florida .

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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.

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 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 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.

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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.

In addition, general and administrative expenses include all corporate technology and occupancy costs associated with our corporate office.

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.

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The following table sets forth our consolidated results of operations for the periods presented:

Three months ended September 30,

Three Months Ended

Six Months Ended

Capitation revenue

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Net Income (Loss) Attributable to InnovAge Holding Corp.

Three months ended September 30,

Three Months Ended

Six Months Ended

Capitation revenue

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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.

Capitation revenue was $167.1 million for the three months ended December 31, 2022, a decrease of $7.8 million, or 4.5%, compared to $175.0 million for the three months ended December 31, 2021.

This decrease was driven by a 8.1% decrease in member months partially offset by a 4.0% 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.

Capitation revenue was $338.1 million for the six months ended December 31, 2022, a decrease of $9.4 million, or 2.7%, compared to $347.5 million for the six months ended December 31, 2021.

This decrease was driven by a 6.9% decrease in member months partially offset by a 4.4% increase in capitation rates, primarily due to the factors discussed above.

Operating Expenses

Three months ended September 30,

Three Months Ended

Six Months Ended

External provider costs

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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.

External provider costs were $93.5 million for the three months ended December 31, 2022, an increase of $2.5 million, or 2.7%, compared to $91.0 million for the three months ended December 31, 2021.

The increase was primarily driven by an increase of $9.9 million, or 11.8%, in cost per participant partially offset by a decrease of $7.4 million, or 8.1%, in member months.

The increase in cost per participant was primarily driven by a $8.3 million increase associated with increased housing utilization and cost per day as mandated by certain states.

External provider costs were $189.7 million for the six months ended December 31, 2022, an increase of $8.7 million, or 4.8%, compared to $181.0 million for the six months ended December 31, 2021.

The increase is primarily driven by an increase of $21.1 million, or 12.5%, in cost per participant partially offset by a decrease of $12.4 million, or 6.9%, in member months.

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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.

Cost of care (excluding depreciation and amortization) expense was $51.4 million for the three months ended December 31, 2022, an increase of $8.5 million, or 19.7%, compared to $42.9 million for the three months ended December 31, 2021, primarily due to an increase of $11.9 million, or 30.0%, in cost per participant partially offset by a decrease of $3.5 million, or 8.1%, in member months.

The increase was primarily driven by (i) a $5.4 million increase in 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, and (iii) $0.9 million in increased fleet and contract transportation as a result of higher average daily attendance, increase in external appointments, and higher fuel costs.

Cost of care (excluding depreciation and amortization) expense was $104.9 million for the six months ended December 31, 2022, an increase of $21.3 million, or 25.5%, compared to $83.6 million for the six months ended December 31, 2021, primarily due to an increase of $27.0 million, or 34.7%, in cost per participant partially offset by a decrease of $5.7 million, or 6.9%, in member months.

The increase was primarily driven by (i) a $13.2 million increase in salaries, wages and benefits associated with increased headcount and higher wage rates due to the ongoing competitive labor market, (ii) $2.1 million in third party audit and compliance support, (iii) $2.2 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) $0.9 million in de novo costs due primarily to rent expense.

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.

Sales and marketing expenses were $3.8 million for the three months ended December 31, 2022, a decrease of $2.9 million, or 43.5%, compared to $6.7 million for the three months ended December 31, 2021, primarily due to a (i) $1.3 million reduction in marketing spend and $0.6 million reduction in costs associated with fewer headcount within the sales department, both as a result of sanctions in our Colorado and Sacramento centers and (ii) a $0.8 million reduction in sales commission expense due to the deferral of commissions.

Sales and marketing expenses were $8.2 million for the six months ended December 31, 2022, a decrease of $4.8 million, or 36.9%, compared to $13.0 million for the six months ended December 31, 2021, primarily due to a $2.6 million

reduction in marketing spend and $1.2 million reduction in costs associated with fewer headcount within the sales department, both as a result of sanctions in our Colorado and Sacramento centers and (ii) a $0.8 million reduction in sales commissions expense due to the deferral of commissions.

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.

Corporate, general and administrative expenses were $28.8 million for the three months ended December 31, 2022, an increase of $0.3 million, or 1.2%, compared to $28.5 million for the three months ended December 31, 2021.

The increase was primarily due to (i) a $1.9 million increase in employee compensation and benefits as the result of an increase in headcount, to support compliance and bolster organizational capabilities, (ii) $2.7 million in third party costs associated with implementing our core provider initiatives, assessing our risk-bearing payor capabilities, and strengthening organizational capabilities including the transition to a new EMR, and (iii) a $0.6 million increase in software license and maintenance expense.

These increases in cost are partially offset by (i) a $0.9 million reduction in bad debt expense and (ii) $4.1 million in executive severance and recruiting recognized during the three months ended December 31, 2021.

Corporate, general and administrative expenses were $59.0 million for the six months ended December 31, 2022, an increase of $9.4 million, or 19.0%, compared to $49.6 million for the six months ended December 31, 2021.

The increase was primarily due to (i) a $5.0 million increase in employee compensation and benefits as the result of an increase in headcount, to support compliance and bolster organizational capabilities, (ii) $6.8 million in third party costs associated with implementing our core provider initiatives, assessing our risk-bearing payor capabilities, and strengthening organizational capabilities including the transition to a new EMR, (iii) $0.8 million in increased legal spend, and (iv) $1.1 million increase in software license and maintenance expense.

These increases in cost were partially offset by (i) a $0.6 million reduction in bad debt expense and (ii) $4.1 million in executive severance and recruiting recognized during the six months ended December 31, 2021.

Other Income (Expense)

Three months ended September 30,

Three Months Ended

Six Months Ended

Interest expense, net

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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

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.

Interest expense, net was $0.2 million for the three months ended December 31, 2022, a decrease of $0.5 million, or 66.9%, compared to $0.7 million for the three months ended December 31, 2021.

The decrease was primarily due to interest income of $0.8 million from money market funds offsetting interest expense of $1.1 million for the three months ended December 31, 2022.

Interest income during the three months ended December 31, 2021 was negligible.

Interest expense, net was $0.8 million for the six months ended December 31, 2022, a decrease of $0.4 million, or 32.4%, compared to $1.2 million for the six months ended December 31, 2021.

The decrease was primarily due to interest income of $1.2 million from money market funds offsetting interest expense of $2.1 million during the six months ended December 31, 2022.

Interest income during the six months ended December 31, 2021 was negligible.

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.

Other income (expense) consists primarily of the net proceeds received from the sale of or disposal of property and equipment and unrealized gains and losses related to short-term investments.

Other income (expense) for the three months ended December 31, 2022 increased $0.4 million, or 1,485.7%, when compared to the three months ended December 31, 2021.

The increase is primarily due to the recognition of $0.4 million in unrealized gains related to short-term investments.

Other income (expense) was $0.5 million for the six months ended December 31, 2022,

an increase of $1.0 million, or 203.2%, compared to a loss of $0.5 million for the six months ended December 31, 2021.

The increase is due to the recognition of unrealized gains on short-term investments of $0.4 million during the six months ended December 31, 2022 in addition to the recognition of a loss on disposal of assets of $0.5 million during the six months ended December 31, 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

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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.

During the three months ended December 31, 2022 and 2021, we reported benefit for income taxes of $2.9 million and a provision for income taxes of $1.2 million, respectively.

During the six months ended December 31, 2022 and 2021, we reported benefit for income taxes of $6.4 million and a provision for income taxes of $4.2 million, respectively.

The decrease of $10.6 million is primarily due (i) our pretax book loss recognized during the six months ended December 31, 2022, as compared to pretax book income recognized during the six months ended December 31, 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.

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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,

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.

During the six months ended December 31, 2022 and 2021, we reported net income (loss) of ($24.2 million) and $8.7 million, respectively, consisting of (i) income (loss) from operations of ($30.3 million) and $14.6 million, respectively, (ii) other expense of $0.3 million and $1.7 million, respectively, and (iii) a benefit for income taxes of $6.4 million and provision of $4.2 million, respectively, each as described above.

Key Business Metrics and Non-GAAP Measures

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These measures may not be comparable to similarly-titled performance indicators used by other companies.

Three months ended September 30,

Six months ended December 31,

dollars in thousands

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Center-level Contribution Margin as a % of revenue

GAAP Measures:

Net income (loss)

Net loss margin

Non-GAAP Measures:

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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 $21.4 million and $42.3 million for the three months ended September 30, 2022 and 2021, respectively.

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 $44.0 million and $83.7 million for the six months ended December 31, 2022 and 2021, respectively.

Adjusted EBITDA and Adjusted EBITDA Margin

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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%.

For the six months ended December 31, 2022 and 2021, net loss was $24.2 million and net income was $8.7 million, respectively, representing a year-over-year decrease of 377.7%.

Adjusted EBITDA was ($5.8 million) and $33.0 million, for the six months ended December 31, 2022 and 2021, respectively, representing a year-over-year decrease of 117.5%.

For the six months ended December 31, 2022, net loss margin was 7.2%, as compared to net income margin of 2.5% for the six months ended December 31, 2021.

For the six months ended December 31, 2022, our Adjusted EBITDA margin was negative 1.7%, as compared to our Adjusted EBITDA margin for the six months ended December 31, 2021 of 9.5%.

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.

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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,

Three months ended December 31,

Six months ended December 31,

Net income (loss)

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Stock-based compensation

Class action litigation (a)

M&A and de novo development (b)

Business optimization (c)

EMR implementation (d)

Executive severance and recruitment (a)

Class action litigation (b)

M&A and de novo development (c)

Business optimization (d)

EMR implementation (e)

Adjusted EBITDA

(a) Reflects charges/(credits) related to litigation by stockholders.

(b) Reflects charges related to M&A transaction and integrations, and de novo center developments.

(a) Reflects charges related to executive severance and recruiting.

(b) Reflects charges/(credits) related to litigation by stockholders.

(d) 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.

For the three months ended December 31, 2022 this includes (i) $0.5 million related to consultants and contractors performing audit and other related services at sanctioned centers, (ii) $1.4 million of charges related to government investigations, (iii) $0.8 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, and (iv) $0.1 million related to other non-recurring projects aimed at reducing costs and improving efficiencies.

For the six months ended December 31, 2022 this includes (i) $1.2 million related to consultants and contractors performing audit and other related services at sanctioned centers, (ii) $3.0 million of charges related to government investigations, (iii) $5.1 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, and (iv) $0.7 million related to other non-recurring projects aimed at reducing costs and improving efficiencies..

(e) Reflects non-recurring expenses relating to the implementation of a new electronic medical record (“EMR”) vendor.

Liquidity and Capital Resources

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.

As of December 31, 2022, we had cash and cash equivalents of $99.5 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 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.

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 six 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.

We also have and expect to continue using capital resources for capital additions, which include costs relating to the development of de novo centers.

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

minimum operating lease payments under non-cancellable leases through the year 2032 of $30.4 million.

Our cash obligations consist of repayments of long-term debt and obligations under operating and finance leases.

As of December 31, 2022, we had $71.7 million of long-term debt outstanding.

As of December 31, 2022, we had future minimum operating lease payments under non-cancellable leases through the year 2032 of $29.4 million.

We also had non-cancellable finance lease agreements with third parties through the year 2027 with future minimum payments of $15.2 million.

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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.

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 Sacramento center 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.

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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.

The borrowing capacity under the Revolving Credit Facility is subject (i) any issued amounts under our letters of credit and (ii) applicable covenant compliance restrictions and any other conditions precedent to borrowing.

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%.

As of December 31, 2022, the interest rate on the Term Loan Facility was 6.14%.

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%.

As of December 31, 2022, we had no borrowings outstanding, $2.8 million of letters of credit issued, and $97.2 million of

remaining capacity under the Revolving Credit Facility.

As of December 31, 2022, we also had $2.3 million principal amount outstanding under our convertible term loan.

Monthly principal and interest payments for the convertible term loan 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.

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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,

Net cash provided by operating activities

Our consolidated statements of cash flows for the six months ended December 31, 2022 and 2021 are summarized as follows:

Six months ended December 31,

Net cash provided (used) by operating activities

Net cash used in investing activities

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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.

The change in net cash provided (used) by operating activities was primarily due to the net effect of (i) net loss of $24.2 million in the current year period compared to a net income of $8.7 million in the prior year period, as described further above, and (ii) a net decrease in working capital primarily attributable to payments for operating leases and reported and estimated claims.

Investing Activities.

Investing activities were made up of approximately $7.7 million in purchases of property and equipment.

Investing activities were made up of approximately $14.6 million in purchases of property and equipment and $45.0 million for purchases of short-term investments.

Financing activities.

The increase in net cash used in financing activities was primarily due to an increase in principal payments on capital leases.

The increase in net cash used in financing activities was primarily due to an increase in principal payments on finance leases.

Emerging Growth Company and Smaller Reporting Company

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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.

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.

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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.

For a description of our estimates regarding our critical accounting estimates, see “Critical Accounting Estimates” in the 2022 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 .

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis