Good day and thank you for standing by. Welcome to the InnovAge Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session.

[Operator Instructions] I would now like to hand the conference over to your speaker today, Ryan Kubota, Director of Investor Relations. Please go ahead..

Thank you, operator. Good afternoon and thank you all for joining InnovAge’s fiscal 2022 second quarter earnings call. With me today is Patrick Blair, the new President and CEO, who joined the Company on December 1st; Barb Gutierrez, CFO; and Dr. Melissa Welch, Chief Medical Officer, who will be joining the Q&A portion of the call.

Today, after the market closed, we issued a press release containing detailed information on our quarterly results. You may access the release on our Company website, innovage.com.

For those listening to the rebroadcast of this presentation, we remind you that the remarks made herein are as of today, Wednesday, February 9, 2022, and have not been updated subsequent to the initial earnings call. During this call, we will refer to certain non-GAAP measures.

A reconciliation of these measures to the most directly comparable GAAP measures can be found in our fiscal second quarter 2022 press release, which is posted on the Investor Relations section of our website. We will also be making forward-looking statements, including statements related to our growth prospects, regulatory, and other expectations.

Listeners are cautioned that all of our forward-looking statements involve certain assumptions that are inherently subject to risks and uncertainties that can cause our actual results to differ materially from our current expectations.

We advise listeners to review the risk factors discussed in our Form 10-K annual report for fiscal year 2021 and subsequent reports filed with the SEC. After the completion of our prepared remarks, we will open the call to take your questions. I will now turn the call over to our President and CEO, Patrick Blair.

Patrick?.

our people, quality and service. If our employees are properly positioned to deliver high-quality care and service, financial stability and growth will naturally result. With that, I’ll transition to review the second quarter business drivers. We ended the quarter serving approximately 7,050 participants.

This represents an increase of 5.6% compared to the second quarter of fiscal year 2021, after including the Sacramento census, which was not consolidated in the same fiscal quarter from a year ago.

We reported second quarter revenue of $175.4 million, an increase of nearly 11.5% compared to the previous fiscal year because of census growth and an increase in rates. We also reported a Center-level Contribution Margin of more than $41.4 million and a corresponding Center-level Contribution Margin ratio of 23.6%.

The Omicron variant has led to another surge in COVID infections among InnovAge employees and participants. This surge began in December and has continued into the fiscal third quarter of 2022.

As a result of this new wave, we’re seeing and anticipate seeing elevated participant cost trends, specifically inpatient, medical and social respite costs related to skilled nursing facilities are increasing due to higher morbidity resulting from COVID.

Increased morbidity is driving higher external provider costs, primarily related to specialty costs as COVID complicates underlying conditions.

Since we reopened our centers in early spring of 2021, we are continuing to see rising outpatient and specialist costs, as would be expected due to the delays in care experience across the health care system seen throughout 2020.

While a return to a pre-COVID baseline is an ideal scenario, we might not see a return to pre-COVID levels in the near term.

As we look to the second half of fiscal year 2022, we expect that center-level costs will remain elevated, associated with the need for more durable medical equipment, oxygen, personal protective equipment as well as incremental costs associated with COVID protocols at our centers as the surge continues.

While we have continued to grow our census, we’ve started to see enrollment growth pressure, particularly towards the end of the second quarter as a result of the recent surge of COVID.

Specifically, COVID has impacted our ability to interact directly with potential new participants, for instance, to verify eligibility documentation, and has caused associated delays in the enrollment process. Despite the surge in elevated cost, we’re not anticipating the level of disruption we experienced in the early days of the pandemic.

All centers remain open, and our employees are fully vaccinated. Labor will remain a key focus, though asymptomatic cases allow for employees to safely reenter work sooner, consistent with CDC guidelines and have helped us maintain more consistent staffing levels.

Now, I will turn the call over to Barb to provide some additional detail on our quarterly results.

Barb?.

one, outpatient and specialist care as participants catch up on services that were delayed as a result of the pandemic; two, increased inpatient and respite utilization as a result of the Omicron surge; and three, increased housing rates as mandated by certain states.

External provider costs in the second quarter of fiscal 2022 increased slightly by 1.1% compared to the first quarter. The pent-up demand for outpatient and specialist care that we experienced in the fourth quarter of fiscal 2021 and the first quarter of fiscal 2022 is leveling off, but is offset by costs associated with the Omicron surge.

Our cost of care, excluding depreciation and amortization, was $42.9 million for the second quarter, a 12.7% increase over the second quarter of fiscal year 2021, driven by an increase in census, an increase in the overall cost per participant.

Per member per month increase is associated with annual merit and market increases, coupled with an increase in operational costs due to the reopening of our centers. As reported in previous calls, the cost of care in the second quarter of fiscal 2021 was atypically low as a result of our center closures during the pandemic.

Cost of care increased by 5.4% over the first quarter of fiscal 2022, primarily due to wage inflation as a result of the current labor market conditions. Occupancy-related costs such as repair and maintenance, and an increase in fleet expenses that correlates to an increase in average daily attendance.

Center-level Contribution Margin, which we define as total revenue less external provider costs and cost of care excluding depreciation and amortization, was $41.4 million for the second quarter compared to $44.1 million in the second quarter of fiscal 2021 and $42.3 million in the previous quarter of fiscal 2022.

As a percentage of revenue, Center-level Contribution Margin for the quarter was 23.6% compared to 28% in the second quarter of fiscal 2021 and 24.5% in the previous quarter of fiscal 2022.

While leveling off, as we mentioned on the last earnings call, we continue to see elevated utilization levels as participants catch up on medical services delayed as a result of the pandemic.

This medical cost normalization dynamic coupled with the increased utilization and cost from the recent Omicron surge are the primary drivers of the year-over-year decline in Center-level Contribution Margin as a percent of revenue. We also experienced an increase in cost of care and other occupancy-related expenses.

Compared to the prior quarter, the major driver of the decline in Center-level Contribution Margin as a percent of revenue is related to an increase in cost of care as detailed earlier.

Sales and marketing expense for the second quarter was $6.7 million, an increase of $2 million compared to the second quarter of fiscal 2021, primarily due to an increase in headcount and costs associated with marketing campaigns to support bringing PACE services to more seniors.

Corporate, general and administrative expense for the second quarter was $28.5 million, an increase of $12.8 million compared to the second quarter of fiscal 2021.

The increase was primarily due to company growth, bringing PACE services to more seniors, additional costs associated with becoming a publicly traded company, compliance-related expenses, higher-than-expected legal expense during the quarter and executive recruiting and severance costs incurred during the quarter.

Net income for the second quarter was $1.1 million compared to net income of $9.6 million in the second quarter of fiscal 2021. We reported earnings per share for the fiscal second quarter of $0.01 on both a basic and diluted basis. Our fully diluted share count was 135,516,513 shares for the fiscal second quarter ending December 31, 2021.

Adjusted EBITDA, which we calculate by adding interest, taxes, depreciation and amortization, onetime adjustments for transaction and offering related costs and other nonrecurring or exceptional cost to net income was $14.8 million for the second quarter, a 34.5% decrease year-over-year and a 19% decrease quarter-over-quarter.

Our adjusted EBITDA margin was 8.4% for the second quarter compared to 14.5% for the second quarter of fiscal year 2021 and 10.5% for the first quarter of fiscal year 2022.

The quarter-over-quarter change in adjusted EBITDA and adjusted EBITDA margin is primarily a function of, one, increased cost of care; and two, higher SG&A as a result of growth and higher-than-anticipated legal expense in the quarter. We do not add back any losses incurred in connection with our de novo centers in the calculation of adjusted EBITDA.

De novo center losses, which we define as net losses related to preopening and start-up ramp through the first 24 months of de novo operations were $0.6 million for the second quarter. Turning to our balance sheet.

We ended the quarter with $218.5 million in cash and cash equivalents and had $87.1 million in total debt on the balance sheet, representing debt under our senior secured term loan plus capital leases and other commitments and a secured net leverage ratio of 0.95 times as calculated pursuant to our credit agreement.

For the second quarter ended December 31, 2021, we generated $11 million of cash from operations, and we had $8.6 million of capital expenditures. For the quarter, we had free cash flow of $2.4 million, defined as cash from operations less capital expenditures.

Late in the quarter, we announced that we withdrew guidance following the sanction we received in Colorado and the subsequent enrollment freeze. At this time, we do not believe it is prudent to provide updated guidance due to the existing audits.

We can, however, provide some insight into the trends we are seeing today, specifically related to the recent Omicron surge and the impact it is having on our business in several key areas. Starting with revenue.

The recent COVID surge is likely to lengthen the time it takes us to enroll participants into the program due to disruption from potential or actual exposure for employees and potential participants. From a medical expense perspective, we expect elevated external provider costs due to Omicron.

Specifically, we expect inpatient cost and medical and social respite costs at skilled nursing facilities to remain elevated due to higher morbidity of our participants.

In some of our markets, where assisted living facilities are locked down, participants who have transitioned to short-term skilled nursing facilities and are ready to return to assisted living are unable to do so.

Due to the frailty of the population that we serve, we also expect specialty costs to continue at current levels due to the existing underlying conditions that many of our participants already have.

Finally, from a cost of care perspective, COVID protocols that we have put in place such as enhanced cleaning requirements at each of our centers will also continue. In addition, the ongoing surge will exacerbate the negative impact of the existing tight labor market as we manage our employee base to meet the needs of our participants.

As a reminder, we included market wage adjustments when we provided our initial guidance. However, we are continuing to closely monitor wages to ensure we remain competitive.

As Patrick mentioned, participants and employee safety remain our top concern, and we are closely monitoring all aspects of the recent surge to ensure we can continue to provide high-quality care to our participants.

We believe the ongoing pandemic validates the need for PACE even more and that the PACE program will continue to grow as we build market awareness among eligible participants and the communities we serve. I will now turn the call back to Patrick for his comments on our path forward.

Patrick?.

Yes. Thank you, Barb. While our near-term attention will remain on remediating audit deficiencies, we remain steadfast in our commitment to in-process expansion plans. I recognize the potential dissonance of remediating efficiencies while also pursuing expansion efforts.

I want to reiterate, focusing on remediated audit findings is unquestionably our top priority. And fully separate teams are engaged to ensure that critical focus isn’t diminished in any way.

That said, the future mission of the organization also rests on expanding services, to the countless more individuals across the country who can benefit from PACE programs. We remain on track to open two de novo centers in Florida, Tampa and Orlando.

In addition, in November, we announced that we received approval from the State of Indiana to develop a program to serve eligible seniors in and around the Terre Haute area, and we expect this center will be operational in fiscal year 2024.

We’ve been evaluating additional de novo locations in California to further expand our existing state footprint. However, due to the current enrollment freeze in Sacramento, our regulator suspended our approval to expand pending the resolution of the sanction in Sacramento.

Just today, we also received notice from the regulator in Kentucky, stating that they no longer intend to enter into an agreement with us to be a PACE provider in the state. Given that we just received this notice, we don’t have more details to share at this point.

I intend to promptly meet with and work closely with the regulators to better understand and attempt to address the nature of the concerns that may have prompted this change of position. I’ll reinforce here that compliance will define our near-term priorities. This is where the greatest urgency exists.

We must restore confidence in InnovAge among all of our stakeholders and earn the right to restart enrollment as soon as possible in Sacramento and Colorado.

We also must and will address the long-term goals of building and scaling innovative capabilities that will enable us to better serve participants, better manage costs and quality and differentiate ourselves in the marketplace in which we seek to lead.

While this priority will be executed with purpose, in parallel, it cannot -- it will not be at the expense of near-term compliance priorities.

In tandem with these broader objectives, I will also be focused on a careful evaluation of our organizational structure, leaders, workforce, processes, tools and infrastructure, getting the right people in the most mission-critical jobs aligning the organization behind both our short-term objectives as well as a bold aspiration for the Company, building an even stronger care delivery culture, and creating a culture and mechanisms to execute flawlessly on a manageable set of focused priorities.

In the coming months, I’ll continue to meet with and seek input from leaders and frontline employees across the organization to deepen my knowledge of InnovAge’s strengths, weaknesses, opportunities and challenges to thoughtfully inform the path forward.

While we must be thorough, the speed of marketplace change requires us to be nimble, action-oriented and willing to reevaluate any aspect of our culture or our organization that inhibits our effectiveness. A quick but important thought on diversity, equity and inclusion.

We have an amazingly diverse organization, both at the senior leadership level and in our markets, and we’re very proud of this. This will be a critical factor in our future success. And it is my commitment to continue building on this strong foundation.

In summary, I strongly believe we’re starting down the right path, and I’m very encouraged by the goals we’re establishing and all the activity we have underway.

While we must address the issues we’re facing and we’ll do so with seriousness and discipline, we will also be dedicated to building scalable capabilities for the future to position us to serve more people. I’m prepared for and excited by this challenge as much today as I was when I decided to join the Company.

My confidence derives from believing the importance of what we do that our employees, participants and their families are counting on us, and from knowing that I have been an integral part of organizations that have successfully navigated periods like this and have gone on to be more successful. And now, operator, we’ll open the call for questions..

[Operator Instructions] Our first question will come from the line of Jason Cassorla from Citi..

I guess, just to start, I mean, given what’s happened with the Sacramento and Colorado audits, the initial read with the New Mexico audit.

And now with, I guess, the stop of the de novo facility in Kentucky, maybe can you just help with the lessons you’re learning at this point and from these audits and issues, and how you’re thinking about applying these lessons maybe to the rest of your centers? Do you see any of them at risk at this point, or do you believe that they’re adequately compliant? Any guess on the rest of your center footprint at this point would be helpful.

Thanks..

Well, thanks for your questions. There’s certainly a lot included in there. Let me start with, we definitely have issues we must address. And certainly, as someone new to the Company, I am keenly interested in trying to identify whether there are themes and what we’re seeing.

And as I mentioned in my opening remarks, I think there are areas certainly that we have to improve, specifically in the areas of care coordination and care documentation. Our regulators specifically identified these two areas as areas that we need to get much better at.

Clearly, we need to improve our ability to communicate and exchange information between our care teams and third parties. And then documentation plays an important role in all of this. there’s very high documentation standards for PACE programs that we’re fully committed to meeting those standards, exist both at the CMS level and the state level.

I would also say that the challenge posed by the pandemic and the workforce challenges have contributed to the challenges with care coordination and documentation. We clearly need to do better in both areas. I’ll reiterate that I believe these deficiencies are all addressable with strong leadership, focus and execution.

I’ve been through this in my prior life. It’s a very challenging and difficult. But for those of us who lived through it, we got to see that we become a better company. And I believe that’s exactly what’s going to happen at InnovAge. So, that’s sort of a perspective on what we’re seeing.

The question around do we expect to see different outcomes in other states. I think that the -- it’s important to take away that there are nuances in every state. So, it’s difficult to extrapolate outcomes from one state to the next.

Sacramento was a routine audit, and Colorado was as a result of a complaint and New Mexico was a routine audit like Sacramento. And so, we’re working hard to understand all the issues and with time and I have complete confidence that we’ll be able to figure it out. And I’m going to ask Melissa to weigh in as well..

Yes. I think one of the other parts of your question was what are we doing proactively in all of our regions. As you know, we added incremental resources to our compliance team as well as brought in a compliance officer. And one of the benefits of doing that is all around being proactive.

And so, we are proactively auditing, self-auditing in every region around all of our disciplines and all of our workflows and processes to make sure and anticipate that we’re not seeing the same systematic findings. And that if we do, we start intervening now and not waiting..

Okay, got it. Thanks. I really appreciate the color there. Maybe just to switch gears a little bit here. Just given the labor backdrop, and I know Barb, you talked a little bit about that.

But maybe can you just give us an update around employee retention and the recruitment efforts following your wage adjustments you discussed last quarter and on this call.

How are those sparing as the labor backdrop, I guess, is seeing incremental pressure? Are you seeing pressure or issues around retention or any incremental recruitment effort at this point, or in ways that you’re maybe helping to combat those would be helpful? Thanks..

Yes. This is Patrick. I’ll start. Thanks for the question. I’ll start and then hand it to Barb. Maybe I’ll start with hiring. With respect to recruiting and attracting talent, I don’t believe our situation is having a material impact on our ability to attract people to the Company. But it is something that we’ll have to watch.

It’s such a mission-driven company and people who work here want to improve the lives of seniors, and we haven’t come up short on finding people who sort of share those same goals.

And I also think for folks who have worked in Medicare and Medicaid for a while, I think they understand that the great company is to be out of compliance for a period of time and still be a great place to work. The larger headwind in my mind’s eye is related to the impacts from pandemic and the supply and demand dynamics around the workforce.

But overall, I think our turnover has ticked up a bit. We’ve quoted voluntary turnover around 25% in the past, and it’s ticked up, but I think we primarily attribute it to the strain of the pandemic and the supply issues. So, I’m looking closely at it and so is Barb. And so, I’ll ask her to say a few words..

Yes. So, as Patrick said, we believe it’s related to the strain of the pandemic and the overall tight labor market. We did indicate in the prepared remarks and wanted to flag for you that we are seeing some wage pressures that we incurred in the second quarter, and we believe it will continue a bit into the back half of the year.

And so, we are actively addressing that. As again, as we said in our guidance, we had included market adjustments some time ago, and we’re continuing to look at the -- especially the mission-critical positions and make sure we’re addressing those from a market perspective..

Our next question will come from the line of Sarah James from Barclays..

I wanted to go into more depth on the self audit. So, just understanding how you guys are institutionalizing this.

Did you implement any technology that flags the key metrics up to the corporate level? How often are you auditing each market? And how long is the data lag? So, I guess, I’m trying to understand how quickly you can catch and address issues if they happen in current challenged markets or new ones?.

Well, I’ll start, and I’ll have Melissa maybe weigh in. First, we made a lot of progress identifying the root cause of the deficiencies in Sacramento and Colorado. So that’s really where it all starts. And then, we’ve begun to execute on the work to fix the deficiencies, wherever they exist in the company.

In terms of sort of how we’ve done it, we’ve mobilized a cross-functional team at every level of the organization, representing compliance and quality and operations, technology and regulatory.

And we definitely created a variety tools that have helped with the tracking, auditing and monitoring of everything we’re learning from CMS and our state partners. And we’re making sure that we’re putting in place the right people and process and technology to address it.

We’ve also retained some highly experienced external partners to help us assist us in these efforts. And I’m very pleased with the agility and speed at which we’re moving. And I think Melissa will probably add some color to that..

Yes, I was going to extend those comments to say that we’ve taken the tools that, for example, we’ve submitted for the Sacramento CMS corrective action plan that has been recently accepted, and we’re applying those same tools across all of our markets in all the regions.

And this is being driven by our compliance department so that we’re going to be held accountable to the same standards that CMS are holding us accountable to in our proactive action plans that have been accepted..

Got it.

And then, can you walk us through the moving pieces and enrollment, how much churn or involuntary disenrollment did you see in the markets where you are sanctioned? And then, how should we think about the impact of growth from digital channels this quarter, and I guess, to your overall long-term organic growth rate?.

Sure. This is Barb. I’ll take the first part of that, and then Patrick can chime in on the digital. So, we’ve disclosed before that -- on average, our overall disenrollment rate on average is around 2%. It varies a little bit depending on the time of the year and a little bit depending on the markets.

So, as we -- as I indicated in the prepared remarks, we did see a little bit higher disenrollment rate toward the end of December and into the early part of Q3 related to deaths, which is not unusual in the winter months, coupled with some of the strength from the Omicron variant.

As it relates to what we expect in the markets like Colorado and Sacramento, we expect those typical attrition rates at roughly 2% a month, give or take, depending on the time of the year. So that’s what we expect during the time period we’re under sanction..

Yes. Thank you, Barb. I think I would just only add that as it relates to our digital marketing progress, we made some smart investments in new digital channels like programmatic display a video or two that I think we’re starting to see some sequential improvements in our acquisition cost per channel and sort of just spend efficiency.

It’s a little early, I think, in our capability build in this area. We need a couple more quarters to have confidence that we have the channels, the right KPIs and the right benchmarks.

But I probably would add to that that it’s important to note that friends and family continue to be our largest referral source, which speaks to how much of our service continues to impact the individuals and communities we care for..

Our next question will come from the line of Jeff Garro from Piper Sandler..

Maybe start off on a higher level. Patrick, you mentioned that you’ve been hearing from frontline workers and you’ve been reviewing the survey results, and you’ve also been getting input from state level partners in different geographies.

So maybe you could touch on what are some of the commonalities and some of the differences that you might have heard from those different areas?.

Thank you for the question. Let me start with what’s called state partners. As mentioned I earlier, it’s been the number one priority for me to engage with our regulatory partners and get out there and reinforce our commitment to advance the goals of the PACE program. They have, of course, expressed concerns about the audit findings.

But, I’ve also been highly encouraged by the discussions. The level of collaboration, the support of this, including of me personally, they clearly want us to be successful, but they also want to see us address the issues as soon as possible. We didn’t communicate with our partners as well as we should have in the past, and we’re going to fix that.

And I’m really excited about working with our states to help us become the best partner we can be. I think you asked about our employees. I’d say, first, I couldn’t be more pleased with just how welcoming and supportive the organization has been to me since joining the Company. It’s obviously a tough time for employees.

No one wants to be under sanction. But I’m humbled by how focused the organization is on doing everything we can to deliver great participant care. I see teams across the organization pulling together. There’s just such a strong commitment to making the necessary changes and working collaboratively with our regulatory partners.

There’s just a real desire to work closely with our partners to become a better company. I’ve spoken with hundreds of employees. And I just sense a really deep willingness to do whatever it takes within all hands on deck attitude. And I think the mission orientation of the Company is a big advantage.

It creates a genuine reciprocal emotional connection between the workforce and the company, and really excited to do this with them..

Excellent. That helps. And maybe to follow up, I want to ask about the -- really the blocking and tackling of remediating the deficiencies that have been identified and the consequences of that, mostly on the financial side.

So really, I guess, the question is, will improving care coordination or other deficiencies identified in the audits result in higher fixed cost and maybe more specifically, higher staffing levels?.

Thank you for the question. I think right now, my focus is really making sure that our centers have everything they need to address the deficiencies that we’re seeing. This is a super important area that we just ensure that everyone has everything they need people, process, technology to be successful in the market.

I think it’s a little too early for me to really know about did it change our cost structure. I think I’m certainly focused ensuring we just have the right people -- the right resources in place to do what we’re committed to do.

In the short time that I’ve been here, I’ve certainly identified opportunities to rebalance resources and to invest more in field-based functions and perhaps run a little more efficiently in some of the corporate areas.

And as you would expect, we’re looking very closely at non-center-level cost, non-labor cost, overhead cost, I mean, sort of all those categories just -- the goal here is to match our cost structure to our business conditions, and I’m committed to doing that..

Our next question will come from the line of Lisa Gill from JP Morgan..

inpatient specialty costs, inpatient respiratory due to COVID, and then increased housing costs. I want to focus on the first one, which is the outpatient specialty cost. As we think about Omicron, I would expect that those costs would have come down.

Are you thinking about this now that the centers are back open post 2020? Are we moving more towards the traditional baseline of those costs, or are you seeing accelerated cost because there were some type of pent-up demand? How do I think about those costs on a go-forward basis?.

Yes. It’s Dr. Welch. I’ll start, and then I’ll hand it over to Barb. So, one of the things that I think that people forgot because Omicron kind of took over the news as we did have Delta.

So, Delta came at a time when actually our trends were going downward and then Omicron hit the last part of December, predominantly and has continued to peak into the most of January and is now starting to subside. So, when you think about the expenditures that go with that, think about during COVID, everybody kind of went in doors.

We didn’t have a vaccine, and we couldn’t really do anything, right? We start opening up. We got a vaccine in early part of ‘21. We were able to start to open our centers, get everybody back in and all that pent-up demand of services started to happen and you start to see those costs about three months later start to hit.

So, that takes us to July ‘21, right? The summer, things start to come down, then you see Delta and Omicron hit. And then those costs are starting to go back up because of the complexity of our participants. And it’s going to be seen first in inpatient. So, they’re very sick, they go into the hospital.

Our people are all of their chronic conditions get more sick. They come out of the hospital and unlike pre-COVID where we could send them home with home support, they’re way too soon to go home.

So, we start to see those often shift to respite and skilled nursing facilities, while we’re still seeing the specialty cost because of the complexity of the cases. And with that, I’ll turn it over to Barb..

So, just to put the numbers to it. So, as Melissa said, we did see this leveling off. So, we saw the peaks in Q4 ‘21 and Q1 of ‘22 with that pent-up demand for outpatient specialists and other. We saw that kind of leveling off and then a new surge hit. So, there’s some other costs increased.

But quarter-over-quarter, our costs in that area were fairly flat, up about 1%, but they were fairly flat. So, what you’re seeing is really the offset of those two trends. As Melissa said, some carryover into January, but the good news is we’re also seeing that taper off already in this quarter..

And Barb, I know you’re not giving forward guidance, but how do I think about that trend as we move forward from here?.

Yes. We think some of that will continue to wane. That being said, there’s still a lot of -- our participants have a lot of chronic conditions. There’s still a lot of care, a lot of the high specialist care.

And the one thing I mentioned in the prepared remarks, some of the things that we’re facing is also this -- the medical and social respite as people are kind of trying to get back to their normal way of living. There is a delay there for us to be able to get those folks back into their community setting because of the third-party housing companies.

The last part of that is we don’t know what’s going to happen now that the Omicron is going down. Will there be another variant? We just can’t predict that. So that’s always an unknown out there..

Our next question is from the line of Jamie Perse from Goldman Sachs..

Hey. Good afternoon, and Patrick, welcome to the team. I wanted to start with a question maybe for you. You mentioned having identified root cause of some of these issues. Given that it’s now in four markets, it seems somewhat systemic.

So, I was hoping we could go back to like have you gotten your hands around what the root cause is? How did we kind of get to this point? Is it technology? Is it people, leadership? What were the kind of things that led to all these audits kind of returning similar findings? Just again, a question on the root cause analysis that you’ve done..

Well, I think I’m certainly still learning and processing, and learning what were some of the contributors to the challenges we have today. And I don’t have my sort of arms fully around all the history. What I did share about trying to simplify themes into buckets around care coordination, communications, there’s a lot that goes into those.

And -- but my job is to help people organize their thoughts and organize our resources around big buckets of sort of high-impact work. And I do believe those are two high-impact areas that can make a disproportionate impact to our company if we continue to address those two issues.

The other thing that I think I would say is when you read -- and I’m sure you do, when you look at audit finance, it is important to understand that audit findings are generally organized into higher-level categories.

And you can have findings that aligned to similar categories in different states, but the specific sort of participant case level details within those categories can vary significantly, and could ultimately lead to very different outcomes, the difference between having sanctions and just having corrective actions that you need to resolve in the course of your work with CMS in the state.

So, I believe whole hearted there’s a level of detail here that we have to be tuned into before assuming that we see in Sacramento or what we see in Colorado applies everywhere. But back to, I think we do a great job with documentation and care coordination, those two things can make a big impact going forward..

Okay. And then, just thinking about the model going forward. I know you’re not giving guidance, but with the enrollment freezes in place, and we know that this enrollment looks like for the patient population you serve.

What’s your ability to select the cost structure, how much variable costs are there to the extent that revenue comes down as you face some census pressure over this enrollment freeze period?.

Hi Jamie, it’s Barb. As you recall, with our model, it’s really a highly variable cost model. So, in round numbers, 50% of our revenue round numbers here relates to our external provider costs. So, that’s a very large variable component. And then, there’s about 25%, right, in cost of care. And of that 25%, most of it is variable.

And particularly in areas like Colorado and Sacramento, where we own the facilities, we’re not paying the lease payments. So, the things that are fixed will be things like insurance and property taxes and the like. So, it’s a very small, relatively small component that’s actually fixed at the center-level.

And we don’t believe that these sanctions will last forever. We don’t believe they’re permanent. And so, we’ll be able to grow back into those -- covering those fixed costs in the -- over the time period, once the sanctions are lifted..

Okay. Just a follow-up on that. I guess, I probably should have been more specific. I get that the external provider costs are completely sized to patients and so variable in nature.

The cost of care at the center, can you describe the fixed versus variable components there a little bit more? I mean, you still have to employ your whole disciplinary team and support the existing patients.

So, can you just help us understand for, I guess, cost of care, sales and marketing, G&A, how much of those costs are flexible over the next couple of quarters to the extent these enrollment freezes persist?.

Yes, sure. So in that cost of care component, our staff is based on staffing ratios. And so, it’s also variable to a large degree. Things like supplies are variable, things like fleet costs or fuel costs if we’re doing less transportation. So, in that cost of care bucket, it is largely variable. There’s really very little in terms of fixed costs.

So, the things I mentioned earlier, like insurance and property taxes and things of that nature are fixed at the center-level. In terms of sales and marketing, we also staff and have our advertising expenditures really relative to what we’re doing in those markets.

So, as we cannot enroll, we’re not going to be spending advertising dollars in those markets. So, that is somewhat variable as well. A lot of the G&A is variable, but there -- that’s where the component is.

And as Patrick said, we’re looking at our cost structure just to make sure that it aligns to the size of our business all the way from -- really from top to bottom..

Our next question will come from the line of Gary Taylor from Cowen..

A lot of my questions have been asked. I guess, maybe I wanted to start on just a few financial things. Barb, you’re talking about some revenue pressures from mortality and enrollment delays, some elevated medical costs and some higher center-level costs.

Are all of those things getting worse sequentially? It sounds like with Delta, a lot of those were impacting this fiscal quarter. Obviously, the Colorado enrollment freeze was not. That was very late in the quarter.

But are you telling us that we should be contemplating that some or all three of those are really deteriorating sequentially into the fiscal third quarter?.

So, clearly, the sanctions for Colorado actually start effective -- they really are effective in February because we were able to enroll through the end of December, which is enrolling in January. So that’s the impact there. So, in the third quarter.

We did see in the end of December and into January, some higher mortality, but that’s not necessarily atypical, and it’s also coupled with the Omicron surge and probably the tail end of the Delta surge as well. And then, I think you had a third thing. Sorry, Gary..

It was the center costs. You talked about some of the COVID protocols.

I mean, maybe that was more intense during delta and maybe continuing with Omicron, but just trying to get a sense of should we be looking at that higher sequentially or just staying at a higher level?.

Yes, not higher sequentially, just staying at a fairly consistent level..

And then two other just quick ones on financials. On the Virginia ARPA payment, it sounds like you were saying July through November was kind of five months of payment.

Is there a dollar amount you can share?.

It’s about $700,000. I will tell you the other way to think about it. And that was the catch-up payment, because that’s when we received it. We will receive it the entire year of ‘22, and it’s about a 2.5% increase for us. And then, we are in discussions with other states, active discussions, we’re trying to figure out how to allocate their ARPU funds..

And then my last 1 would just be Colorado, low single-digit rate decline. It sounds like you’re asking them to reconsider that.

Could you quantify what that dollar amount impact is?.

Yes. No, I don’t -- I probably won’t be able to quantify the dollar amount, but it’s California, not Colorado. And California on a fiscal year -- fiscal -- sorry, calendar year. And so, they -- it’s in the neighborhood of low-single-digit decline.

But again, we have asked the state to reconsider because they have used 2020 encounter data, which we believe is artificially low. So we’ve asked the state to reconsider CalPACE, which is the organization of PACE programs in California, have also asked the state to reconsider, though we just don’t have an update at this point.

And then, I will also tell you other states did not use 2020, nor did CMS. So, we’re just asking the state to reconsider..

Our last question will come from the line of Matt Larew from William Blair..

I first just want to tick through a couple of the other states. So, on New Mexico, given that the preliminary findings were similar to those in Colorado and Sacramento, should we expect that to be an enrollment freeze there.

On Virginia and Pennsylvania, could you let us know when the most recent and the next scheduled routine audits are?.

Yes. On New Mexico, it’s too early to know what the outcome of that audit would be. We are, of course, working very collaboratively with the state, or in a certain phase, the audit where we’re waiting for feedback and have no indication of what the outcome of that audit could be. The second question was related to the other states.

So, we have no information. The CMS is -- it’s entirely in their discretion of when to audit, and it could happen at any time based on their discretion. So, we have no information about audits..

Okay. And then, Patrick, you commented earlier in terms of corporate margins not really beyond the point where you can give your opinion as to what those might look like relative to historicals. But I’m curious, at least on the Center-level Contribution Margin.

We -- I think we asked this a couple of quarters ago, and I thought it was maybe they’d be consistent long term.

But just based on everything you’re saying about the need to add combinations of people, processes, technology, I guess, I’m trying to understand how the market profile would be lower at a center-level, given the investments that are going to require for you to come into compliance?.

Well, I think a couple of things. One, still work to be done to really understand what are onetime investments versus what are recurring investments, what investments could be amortized, so to speak, and more capital in nature versus ensuring we have a different level of staffing.

So, my view on just sort of the go-forward margin profile for the business is the last two years have been extraordinary times of the pandemic.

And I think we just got to be careful carrying forward too many assumptions in the future, even in the five years prior to the pandemic, the company has been able to achieve sufficient margins that allowed it -- allowed for robust investment in the business.

And when you couple this with the growing demand for PACE programs, I have a great deal of confidence that the margin profile of the business at the senior level and overall will continue to be attractive as the market grows..

Thank you. And this will conclude today’s Q&A as well as today’s conference. Thank you for joining, everybody. You may now disconnect. Everyone, have a great day..