Cano Health, Inc. (NYSE:CANO) Q4 2022 Earnings Call Transcript

Cano Health, Inc. (NYSE:CANO) Q4 2022 Earnings Call Transcript March 1, 2023

Operator: Good afternoon, and welcome to Cano Health’s Fourth Quarter 2022 Earnings Call. Currently, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. Hosting today’s call are Dr. Marlow Hernandez, Chairman and Chief Executive Officer; and Brian Koppy, Chief Financial Officer. The Cano Health press release, webcast link and other related materials are available on the Investor Relations section of Cano Health’s website. As a reminder, this call contains forward-looking statements regarding future events and financial performance, including our guidance for the 2023 fiscal year. Investors are cautioned not to unduly rely on forward-looking statements and such statements should not be read or understood as a guarantee of future performance or results.

We intend these forward-looking statements to be covered by the Safe Harbor provisions for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. We caution you that the forward-looking statements reflect our best judgment as of today based on factors that are currently known to us and such statements are subject to risks, uncertainties and assumptions that could cause actual future events or results to differ materially from those discussed as a result of various factors, including, but not limited to, risks and uncertainties discussed in our SEC filings. We do not undertake or intend to update any forward-looking statements after this call or as a result of new information, except as may be required by law.

During the call, we will also discuss non-GAAP financial measures. The non-GAAP financial measures we will discuss today are not prepared in accordance with GAAP. A reconciliation of the GAAP and non-GAAP results is provided in today’s press release and on the Investor Relations section of our website. With that, I’ll turn the call over to Dr. Marlow Hernandez, Chairman and Chief Executive Officer of Cano Health. Please go ahead, sir.

Marlow Hernandez: Thank you, and welcome to the call. We appreciate you joining us today. 2022 was an important growth year for Cano Health. Our total membership reached nearly 310,000 members growing 36% from the prior year. We achieved full year revenue of over $2.7 billion and adjusted EBITDA of approximately $153 million, all while growing in new markets and service lines and, most importantly, providing our patients with excellent clinical care that measurably improve their outcomes. We continued on our journey to be one of the nation’s leading primary care providers. During 2022, we opened 24 de novo medical centers and added another 18 centers on a net basis through acquisitions in existing markets. We ended the year with 172 medical centers in Florida, Texas, Nevada, Illinois, New Mexico, California and Puerto Rico.

Our Medicare membership grew to just under 180,000 members, a 42% year-over-year increase. At the same time, Cano Health maintained its clinical excellence and high service standards, which continued to improve patient outcomes. Our full year medical cost ratio, or MCR, was 79.1%. Excluding the Medicare Direct Contracting program now called ACO REACH. Our full year MCR was 75.1%, a significant improvement from 79.7% in the prior year. Our admissions per thousand members, or APT, were approximately 7% lower in 2022 compared to 2021. Our ability to keep patients healthy and out of the hospital is an important component of our model of care, which emphasizes frequent primary care visits and member engagement. When you combine our clinical outcomes with the growth in membership, we generated considerable value for payor partners and all stakeholders.

We have great momentum in our business. However, 2022 was not without its challenges. The organization’s rapid growth pressure revenue on a per member basis, particularly in our Medicare Advantage business. Factors negatively impacting Medicare Advantage revenue in 2022, included new members with lower than expected first year revenue per member per month or PMPM, growth in geographies with lower revenue PMPM, and a higher percentage of non-risk members with a lower PMPM. Importantly, our medical center member disenrollment rates were comparable to prior years. Consequently, lower than expected Medicare Advantage revenue negatively impacted our operating performance and our cash flow. And as a result, liquidity was not at the level needed to fund the growth we have planned for 2023.

And we took decisive actions at the end of 2022 and into 2023 that have and will continue to improve cash flow and liquidity. We made the decision to delve back the addition of de novo medical centers in 2023, which is expected to reduce cash used for capital expenditures by approximately $35 million. A 13 de novos we plan to add this year, our medical centers that are generally completed at the end of 2022 and require limited capital investment in 2023. We’re also merging 8 smaller medical centers into nearby larger existing centers to improve center level economics for an expected total of 177 medical centers at the end of 2023, compared to 172 at the end of 2022. In addition, we reduced our headcount aligning to our revised growth plans, implemented tighter spending controls and negotiate better contracts with our vendors.

These actions are projected to generate approximately $70 million in annual SG&A cost reductions for 2023. We also terminated underperforming affiliate physicians, and renegotiated payor agreements to improve our medical cost ratio, resulting in expected benefit of approximately $20 million. Collectively, these initiatives put us on a path to meaningfully improve cash from operations as we move through this year and into 2024. That said, we will continue to evolve our organization to create sustainable growth for our patients, employees and shareholders. At Cano Health, our purpose is to help our patients live their best lives. We’re inspired and fulfilled through this pursuit, which we define as our mission, quality of care and lifelong bonds.

Simply put, our goal to provide superior care and deliver better health outcomes for our patients is achieved when we optimize our financial performance to fulfill our mission in ever greater ways. In 2023, our financial objectives are to: one, capitalize the business; two, unlock embedded profitability by increasing capacity utilization at existing medical centers; and three, optimize our value-based platform to further improve the balance sheet and cash from operations. We made a significant step toward a first objective by closing our recently announced $150 million term loan with Diameter Capital Partners and Rubicon Founders. This financing provides liquidity to strengthen and grow our operations. As we discussed in the past, scale and density are critically important to our operational success.

In 2022, we build significant scale and density, particularly in our home state of Florida, where we have a leading position in value-based care. We have the ability to roughly double our membership at our existing medical centers without incurring significant additional expenses. And, thus, by filling this available capacity, we expect to unlock significant profitability. Moreover, we are committed to reviewing all aspects of our platform to further improve cash flow and liquidity. This is part of our focus on capital management by better allocating resources. Our scorecard for success this year will be a simplified and more efficient operating model with improved cash from operations and a stronger balance sheet. As we continue to execute on these objectives, we expect the results to better reflect the strong fundamentals of our value-based platform.

Lastly, I want to take this opportunity to thank our associates for their commitment to our mission and vision. It is during challenging times when the character of a team is revealed, and our team rose to the occasion. In addition to measurably improving the quality of care, our team’s cultural ability to find solutions in difficult situations, differentiated us in 2022, and defines us as a company. With that, I’ll turn the call over to Brian Koppy, our CFO, who will walk you through our 2022 financial results and guidance for 2023.

Brian Koppy: Thank you, Marlow, and thanks everyone for joining us today. Before I get started today, I’d like to let you know that we will file an extension for 2022 10-K. We expect our 10-K to be filed on or about March 10. Given our team’s efforts to reach an agreement on a new term loan and close that transaction. We required more time to finalize related information in the Form 10-K. As a result, all financial information presented today is subject to completion of the audit of the company’s financial statements and filing of the 10-K. Total membership increased 36% year-over-year to approximately 310,000 members in the fourth quarter. This represents an increase of approximately 83,000 members from the fourth quarter of 2021.

At the end of 2022, 45% of our members were Medicare Advantage, 13% were Medicare DCE, 25% were Medicaid, and 17% were ACA. I would also like to highlight that in December of 2022, we completed an acquisition that included 9 medical centers and an MSO business in Florida for initial consideration of approximately $31 million in equity and $1 million in cash with future cash earn out payments based on achieving certain measures. This acquisition added approximately 7,400 Medicare Advantage members. Total revenue for the quarter was approximately $680 million, up from approximately $492 million a year ago and $665 million in the third quarter. Total capitated revenue in the quarter was approximately $651 million in line with our expectations.

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In the quarter, Medicare Advantage PMPM was $1,084, down 4% sequentially due to the increased mix of new membership. Fourth quarter Medicare DCE PMPM was $1,374, up 13% sequentially, based on the latest Medicare DCE benchmark data. Additional information about our membership mix and our PMPM is available in our press release and updated financial supplement posted this evening on our website. Our medical cost ratio, or MCR, in the fourth quarter was 76.1% compared to 78.1% in the fourth quarter of 2021. While the full year 2022 MCR was 79.1% compared to 80.5% in 2021. The year-over-year improvements in the quarter and full year were driven primarily by lower MCRs and our non-DCE service lines. As we have said on prior calls, Medicare DCE has a higher MCR than our capitated revenue.

So the increasing mix of Medicare DCE members increases our total MCR. Excluding Medicare DCE, our MCR was approximately 71.7% in the fourth quarter of 2022 compared to approximately 77.7% in the fourth quarter of 2021. While the full year 2022 MCR, excluding DCE was approximately 75.1% versus approximately 79.7% in 2021. Direct patient expense in the fourth quarter of 2022 was 11.4% of total revenue. This was above the third quarter of 9.6% and reflects higher performance related payments to affiliates, which was due to favorable performance. SG&A expense in the fourth quarter of 2022 was approximately $108 million, down from approximately $112 million in the third quarter. SG&A was 15.8% of total revenue in the quarter, compared to 19% in the fourth quarter of 2021 and 16.8% in the third quarter of 2022.

We expect further improvements in our SG&A ratio in 2023 as we realize the full impact of operating efficiencies from actions taken in the fourth quarter of 2022 and early 2023. As Marlow mentioned, these actions include a reduction of headcount to align with our revised plans for growth, implementation of tighter controls on spending, and better contract terms with our vendors. The impact of these items is projected to generate approximately $70 million in cost reductions in 2023, which are offset by costs associated with the growth in our operations during 2022 and 2023. Adjusted EBITDA in the quarter was $35.7 million, up from $11.1 million a year ago. The fourth quarter adjusted EBITDA included a lower add back for de novo losses, reflecting the roll off of the novos that have been opened for more than 1 year.

Now, let me turn to our cash flow and liquidity. We ended the fourth quarter with about $27 million in cash. Total debt at the end of the fourth quarter was approximately $1 billion, and included current and long-term debt, capital leases and payments due to sellers. Our total net debt defined as total debt less cash was $987 million as of December 31. Cash used in operating activities was approximately $146 million for the full year and approximately $62 million in the fourth quarter. The fourth quarter use of cash was primarily due to higher working capital requirements related to higher accounts receivable. At the end of 2022, we drew $84 million of our revolver, and through the end of February 2023, we had an outstanding balance of $99 million.

As we move into 2023, we remain focused on improving cash from operations and free cash flow. I will provide further details shortly. Earlier this week, we announced the closing of $150 million term loan with Diameter Capital Partners and Rubicon Founders. We intend to use the net proceeds of approximately $140 million from the transaction for general corporate purposes, including the repayment of outstanding amounts on our revolving credit facility. Importantly, in 2023, we intend to pay the interest on the term loan in kind instead of cash. Details on the 2023 term loan are provided in the 8-K filed on Monday, February 27. This financing provides Cano Health with the capital needed to optimize our existing capacity and unlock the embedded profitability with our medical centers.

Now, let me touch on our outlook for 2023 and the strategic changes we are making to improve cash flow and profitability. We are focused on leveraging our market leading scale and density, particularly in Florida. Growing membership will increase capacity utilization at the existing centers, which we expect to improve margins. 2023 year-end total membership is expected to be in the range of 375,000 to 385,000 members. We expect Medicare Advantage membership to grow 7% to 9% year-over-year. We expect Medicare DCE or ACO REACH membership to increase approximately 55% year-over-year. We received most of our new ACO REACH membership in January of each year from CMS claims-based alignment. On January 1, we had approximately 68,000 ACO REACH members.

We expect this membership to decline slowly throughout the year due to natural attrition and in the year approximately 10% lower than January 2023. We expect Medicaid membership to be flattened 2023, as redeterminations are expected to offset underlying growth. We expect ACA membership to increase approximately 70% year-over-year. Note that we had approximately 80,000 ACA members in January 2023 due to expanded relationships with ACA payors. We expect modest increases throughout the year. Total revenue is expected to be in the range of $3.1 billion to $3.25 billion, which represents growth of approximately 16% at the midpoint. We expect Medicare Advantage revenue to be flat year-over-year, as membership increases are largely offset by a 10% to 15% decline in full year Medicare Advantage or MA PMPM.

We expect the MA PMPM in the first quarter of 2023 to be generally in line with the MA PMPM in the fourth quarter of 2022 and declined sequentially throughout the year as we add more new members, who start with a lower PMPM. During 2023, we expect to have a higher proportion of non-risk MA members compared to 2022. In 2022 non-risk members represented approximately 5% of total MA members. In 2023, we expect non-risk members to represent approximately 10% of total MA members. Non-risk members have a lower PMPM than at risk members. The higher mix of non-risk is due to growth in non-Florida markets and the impact of our December 2022 acquisition, which added about 7,400 members, the significant majority of which are currently non-risk. We anticipate converting this membership to risk over time as we integrate this acquisition into our business.

We do not expect material differences in the full year revenue PMPM for our ACO REACH, Medicaid, or ACA service lines compared to full year 2022. Turning now to MCR, we expect the full year 2023 total MCR to be in the range of 81% to 82%. In 2022, we recorded a reduction in third-party medical costs of approximately $44 million related to claims assigned to a third party. We do not expect this reduction to continue in 2023. Excluding this benefit, the normalized 2022 MCR was approximately 81%. Moreover, as in previous years, we expect MCR to be materially better in the second half compared to the first half of the year. The higher 2023 MCR guidance versus normalized 2022 MCR is primarily driven by a higher mix of ACO REACH members, which typically have a higher MCR than our other service lines.

The full year 2023 ACO REACH MCR is expected to be approximately 93% compared to approximately 91% in 2022. Moving to adjusted EBITDA. As you know, we have been adding back de novo losses as part of our adjusted EBITDA calculation. This adjustment was helpful to management in evaluating the business, when we were rapidly building out our center footprint, particularly in new markets where new medical centers ramp more slowly. Given our current strategy to significantly reduce the number of de novos’ adds, we have revised our definition of adjusted EBITDA to no longer add back de novo losses, which makes it more comparable to cash earnings. This is the only change we have made to the adjusted EBITDA calculation. Please see our earnings release and financial supplement and posted to our website this evening for more information about this change.

Excluding de novo loss add backs, we now expect our newly modified full year 2023 adjusted EBITDA to be in the range of $75 million to $85 million. By comparison, had we excluded de novo loss add backs in 2022, the full year 2022 adjusted EBITDA would have been approximately $74 million using the new definition of adjusted EBITDA. And as a reminder, 2022 results include the reduction of third-party medical costs of $44 million that we do not expect to continue in 2023. Additionally, we expect 2023 interest expects to be approximately $100 million, which includes approximately $90 million of cash interest and approximately $10 million of non-cash interest related to the 2023 term loan. Stock-based compensation in 2023 is expected to be approximately $50 million.

For reference, de novo losses, which as we said are no longer added back to adjusted EBITDA, are expected to be approximately $45 million, compared to approximately $79 million in 2022. Also, we expect capital expenditures to be approximately $15 million in 2023, compared to approximately $50 million in 2022, reflecting fewer additional de novos in 2023. In 2023, we expect cash used in operating activities will be in the range of $70 million to $80 million compared to 2022 cash used in operating activities of $146 million, a projected $71 million improvement at the midpoint. As Marlow mentioned, a key objective for 2023 is to optimize our value-based platform with the goal of improving the balance sheet and cash from operations. As you know, our non-Florida Medical Centers are generating losses.

In 2023, we expect non-Florida Medical Centers to generate approximately $100 million in revenue and approximately $40 million of adjusted EBITDA losses, excluding corporate expenses, compared to approximately $70 million of revenue and $60 million of adjusted EBITDA losses, excluding corporate expenses in 2022. Note, we are using adjusted EBITDA under our newly modified definition for both periods. While we have made progress towards achieving profitability for the centers, we are committed to accelerate in the company’s path towards positive free cash flow. In conclusion, during 2023, we expect to continue to generate solid revenue growth. We are taking important steps to improve our cost structure and unlock and better profitability within our medical centers to meet our goals of improving adjusted EBITDA and cash flow, and maximizing long-term value for our shareholders.

With that, I will ask the operator to open the call to your questions.

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Q&A Session

Operator: Thank you. Your first question is from the line of Gary Taylor with Cowen. Your line is open.

Gary Taylor: Okay. That was a ton of detail, Brian. So I have to pick and choose where I want to ask, but maybe let me just start with liquidity, so make sure, I have this correct. So $27 million in cash, there’s another $21 million available on the revolver, and then you have $150 million term loans just closed. So that’s $198 million basically available the set up against the cash from ops guide you just gave?

Brian Koppy: That’s right, based on the fourth quarter.

Gary Taylor: Okay. And one other question I’ve asked, how are you looking at the 2024 advanced notice and that risk score model change? Obviously, the way they’re moving the weightings around on the HCCs that are removing some of the diagnosis codes. There’s some underlying current that some providers would be impacted more than €“ some plans more than the 3% that CMS sizes for that risk score headwind, do you have a thought on that yet?

Brian Koppy: Marlow, do you want to take that?

Marlow Hernandez: Let me take that, Gary, and I apologize to you and the rest of the audience, I’m just getting over a cold, so my voice is a bit hoarse. But please feel free to ask again, if I’m not clear. So on the right notice, this is something we’ve been looking at and feel it’s too early to really give you anything definitive; first, the rates are not finalized. But as we look into our data, we’ve looked at large representative sample of our data from 2022 working with our market leaders and payors. We found that some of our members had a lower score, some members have a higher score, net-net in the absence of changes, or mitigating factors, it may have a potential of a 2% headwind on our MRA scores, which is highly correlated to MA revenue PMPM.

Important to note that mitigating factors to that roughly 2% headwind include changes to the payor bids, the payor mix itself, what happens ultimately with the star ratings, and that is also going to be embedded within our own payor mix. The growth in our MA population provide a risk share type of assets, and risks trend among are €“ specifically MRA risk trend among other operating type of adjustments. So there’s a lot that would go into answering the question once those rates are finalized. Direct answer is, if you just look at the MRA component by itself, which should not be looked at in a vacuum, you’re looking at a potential 2% headwind. We also have the benefit of starting from a much lower place than many others. And as you can see, we’re taking a very cautious view as to our revenue rates PMPM this year with impact of new membership and new geographies.

Therefore, don’t expect at this point material impact.

Gary Taylor: I appreciate that’s helpful. I was just reading recently the American Physicians Group that sent a letter to CMS saying that the risk or model change could disproportionately impact population €“ minority populations of color just because of some of the diagnosis codes, they’re pulling out of that. And given your larger Hispanic population, I guess, it kind of flies €“ it’s good news, it’s sort of flies against what they’re saying? So I appreciate

Marlow Hernandez: Well, Gary, let me expand on that. And part of the reason is that there was significant changes to diabetes codes, and those rates are quite high in an underserved population and minority populations. At the same time, you have adjustments to the normalization factor, as you know, and adjustments to CHF, chronic kidney disease, and other codes. And it does really depend on the specific provider population and where scores are at and which specific codes are utilized. But, yes, in populations that are hyper specific to a particular diagnosis code, which is more common in minority populations, it may have indeed a disproportionate impact.