LifeStance Health Group, Inc. (NASDAQ:LFST) Q3 2023 Earnings Call Transcript

LifeStance Health Group, Inc. (NASDAQ:LFST) Q3 2023 Earnings Call Transcript November 11, 2023

Operator: Ladies and gentlemen, Thank you for standing by. My name is Desiree, and I will be your conference operator today. At this time, I would like to welcome everyone to the LifeStance Health Third Quarter 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. I would now like to turn the conference over to Monica Prokocki, Vice President of Investor Relations. Please go ahead.

Monica Prokocki: Good morning, everyone and welcome to LifeStance Health’s third quarter 2023 earnings conference call. I am Monica Prokocki, Vice President of Investor Relations. Joining me today are Ken Burdick, Chief Executive Officer, Dave Bourdon, Chief Financial Officer; and Danish Qureshi, Chief Operating Officer. We issued the earnings release and presentation before the market opened this morning. Both are available on the Investor Relations section of our website, investor.lifestance.com. In addition, a replay of this conference call will be available following the call. Before turning the call over to management for their prepared remarks, please direct your attention to the disclaimers about forward-looking statements included in the earnings press release and SEC filings.

Today’s remarks contain forward-looking statements, including statements about our financial performance outlook, business model, and strategy. Those statements involve risks, uncertainties, and other factors, as noted in our periodic filings with the SEC, that could cause actual results to differ materially. In addition, please note that we report results using non-GAAP financial measures, which we believe provide additional information for investors to help facilitate comparison of current and past performance. A reconciliation to the most directly comparable GAAP measures is included in the earnings press release tables and presentation appendix. Unless otherwise noted, all results are compared to the prior year. At this time, I’ll turn the call over to Ken Burdick, CEO of LifeStance.

Ken?

Ken Burdick: Thanks, Monica, and thank you all for joining us today. The work that we’ve been doing to invest in the business, fortify our foundation, and standardize our operations is beginning to bear fruit, both operationally and financially. This quarter, we met or exceeded our expectations across all key financial metrics. And for the first time in our young history as a public company, we are raising our guidance for each of these metrics for full year 2023. As I reflect on my first year at LifeStance, three themes rise to the top of my list. First, after having spent 40 years on the payer side, I am struck by the degree to which payers have underinvested in mental health and the access issues that have resulted. Far too many individuals are still required to self-pay for their outpatient mental health treatment.

Despite the headlines, the ever-increasing demand for outpatient mental health treatment, and unprecedented levels of depression, anxiety, and suicide, we as a country continue to underinvest in building clinical capacity and funding clinical research for mental health care. Second, I feel stronger than ever that the founders of LifeStance developed the right business model. In-network mental health care, delivered both in-person and virtually by employed clinicians with a broad physical footprint and diverse professional credentials and experience. Third, I continue to be incredibly impressed and inspired by the dedication and passion of our employees throughout the organization. Their connection to our purpose and commitment to our mission is evident in every conversation I have had since my first day at LifeStance.

We are resolutely committed to putting patients and clinicians at the forefront of everything we do. We spend a great deal of time speaking with you about financial metrics. However, I assure you that we never lose sight of the reason this business was founded to make outpatient mental health care more accessible, affordable, and unified with physical healthcare so individuals are treated holistically. While we are focused on initiatives to improve our operational performance, it’s important to recognize that our clinician’s delivery of care to our patients has been and continues to be exceptional. As a result, our patient net promoter score is over 80, and our average reviews for all LifeStance centers across Google searches are currently at 4.5 out of 5 stars, reflecting the quality of our patient experience.

In addition to patient satisfaction, now that we are on a single EHR, we are working to aggregate our clinical results and share them to quantify our clinical outcomes and the positive impact on our patient’s mental health. I’d also like to note the steps that we are taking toward a more deliberate and selective payer engagement model. We are still in the early stages of this strategy. You’ll recall that in the first phase, we focused on eliminating low-volume payer contracts to reduce the administrative burden on the organization. Earlier this year, we terminated the bottom 30% or so of our hundreds of payer contracts with minimal to no impact on visit volume. We will continue to actively evaluate and streamline the number of payer contracts to allow our internal teams to operate more efficiently.

We are also in the midst of a second phase in our payer strategy, in which we are becoming more assertive in demanding appropriate reimbursement for our services. We’ve begun to see positive early results and are focused on aligning only with payer partners who share our vision of expanding access to in-network mental health care and who invest in that vision with rates and terms commensurate with the value that LifeStance clinicians provide. Before closing, I would like to provide an update on the shareholder lawsuit. While we expressly deny the claims alleged in the lawsuit, we’ve decided to enter into a settlement to avoid incurring additional legal expense and management distraction from continued litigation. We will be able to fund this settlement with our existing financial capacity without raising capital and this will not impair our ability to make the necessary investments to build a great business.

We believe that putting this matter behind us is in the best interest of the company and will ensure that we remain focused on our core mission of caring for patients and building a business that addresses one of the greatest needs in our country today, affordable and accessible mental health care. With that, I will turn it over to Dave to provide additional commentary on our financial performance and outlook. Dave?

Dave Bourdon: Thanks, Ken. Like Ken, I’m pleased with the team’s solid operational and financial performance. In the third quarter, we achieved robust performance in our top-line results with revenue of $263 million, representing growth of 21% year-over-year. This outperformance was primarily driven by increased visit volumes as a result of better-than-expected productivity during the vacation season. Visit volumes of $1,714,000 increased 20% year-over-year, primarily driven by higher clinician count and higher productivity. Total revenue per visit increased 1% year-over-year to $153, primarily driven by modest payer rate increases. For the full year, rates continue to be aligned with our expectations of a low single-digit increase year-over-year.

When it comes to profitability, the outperformance on revenue flowed through to Center margin. Center margin of $76 million in the quarter increased by 26% year-over-year. Adjusted EBITDA of $15 million was consistent with our expectations. Turning to liquidity, in the third quarter, free cash flow was negative $35 million. This was primarily driven by approximately $20 million from intentionally holding payer claims and approximately $8 million in legal costs paid related to the shareholder lawsuit. As expected, DSO increased sequentially from 43 days to 52 days. As announced on our last call, we anticipated an increase in DSO this quarter as we chose to hold claims for several large payers due to positive updates from rate negotiations. We decided to hold claims until the payers had loaded the new rate into their systems to avoid underpayment and excess rework on over 100,000 claims.

We continue to expect DSO to meaningfully improve in the fourth quarter and have already seen a significant improvement in October as we release the hold claims. We are now on track to see DSO that is closer to Q2 levels by the end of the year. We exited the third quarter with cash of $43 million and net long-term debt of $248 million. At the end of Q3, we had additional debt capacity from a delayed draw term loan of $41 million as well as a $50 million revolving debt facility. As Ken touched on earlier, we recently entered into a settlement of the shareholder lawsuit to put this matter behind us and avoid the cost and the distraction of continued litigation. I’ll now share the P&L and cash impacts of the litigation and the settlement. First, the settlement was $50 million with $20 million of that covered by insurance.

In addition to the settlement, we expect to have approximately $20 million in legal fees related to the litigation. From a P&L perspective, in the third quarter, this settlement plus legal expenses of $14 million resulted in a $44 million expense for LifeStance. Prior to this, we incurred approximately $3 million in legal expenses in Q2 and expect around $2 to $3 million more in the fourth quarter. In terms of cash, the total outlay will be $50 million. In the second and third quarters, we paid approximately $8 million in legal fees. In the fourth quarter, we expect to pay approximately $17 million, which is comprised of $5 million for the settlement and $12 million in legal fees. Finally, in the first quarter of 2024, we will be responsible for the final $25 million settlement payment.

We have sufficient capacity to fund these payments and run the company until we reach positive free cash flow, and we do not intend to raise additional debt or equity capital. In terms of our outlook for 2023, we are narrowing our full-year revenue range and raising it by $10 million at the midpoint to $1.30 billion to $1.40 billion. The midpoint of this guidance puts us at approximately 20% revenue growth. This is above our original mid-teens guidance was driven by the power of our organic growth engine combined with clinician productivity. We are narrowing our full-year Center margin range and raising it by $6 million at the midpoint to $292 million to $300 million. We are narrowing our full-year adjusted EBITDA guidance range and raising it by $2 million at the midpoint to $56 million to $60 million.

In the fourth quarter, we expect revenue of $255 million to $265 million, Center margin of $73 to $81 million, and adjusted EBITDA of $17 to $21 million. As a reminder, your seasonality reflected in our fourth quarter guidance as a result of the holidays, which has historically resulted in lower total clinician capacity in the quarter. Now I’d like to spend a minute discussing 2024. We are still conducting our business planning process, and therefore it is premature to provide specifics on next year’s guidance. However, I want to give you some perspective on our thinking. We continue to expect mid-teens organic revenue growth driven primarily by growth in clinician count and higher rates per visit. As with the initial 2023 full-year guidance, the mid-teens growth does not include any assumptions for improved clinician productivity.

We expect to see margin expansion from operating leverage and modest contribution from rate improvement. As I mentioned in the second quarter earnings call, the margin improvement in 2024 and 2025 will not be linear, and we anticipate greater margin expansion in 2025 as we will have the benefit of a full year of returns on our foundational investments. We continue to expect to exit 2025 with double-digit adjusted EBITDA margins. In regards to free cash flow, even with the $25 million settlement payment in the first quarter next year, we expect to approach positive free cash flow in 2024. Before I turn it over to Danish, I would like to say that the unprecedented demand for mental health access and affordability will continue to provide a tailwind for LifeStance.

We look forward to sharing our 2024 guidance with you on our next earnings call. With that, I’ll turn it over to Danish for additional color with respect to operation.

Danish Qureshi: Thank you, Dave. This year, we have focused on solidifying the foundation of our business. We have made significant upgrades in our senior operations leadership across the country and brought far more focus, prioritization, and data-driven decision-making to the organization in 2023. We’ve also simplified and streamlined the business, setting us up for operating leverage in 2024 and beyond. As an example, we continue to evaluate the in-person usage levels across our centers to identify where we have opportunities for consolidation. On our last earnings call, we announced that we have consolidated 36 centers with little to no disruption to our patients or clinicians. Since then, we identified an additional 35 to 40 centers for consolidation, bringing the total to over 70 centers in 2023.

This consolidation project is largely complete, and we feel that our real estate footprint is now better optimized. Our ability to deliver in-person care across more than 500 locations continues to be a key differentiator. In terms of de novo, we also continue to intentionally moderate our pace of openings. We remain on track to open no more than 36 this year and expect to open fewer de novo next year. Optimizing our real estate footprint will allow us to drive margin improvement over time as we continue to scale. Turning to growth, in terms of net clinician ads, we grew by 286 in the third quarter, bringing our total to 6,418 clinicians, an increase of 18% year-over-year. Importantly, this growth remains 100% organic. This is a record number of organic net clinician ads in a single quarter, and is a testament to the amazing work performed by our recruiting and operations teams, as well as the strength of our value proposition to clinicians.

As a reminder, there is variability in clinician starts throughout the year, and we do expect a lower number of net clinician ads in Q4. In terms of productivity, we continue to drive operational discipline to optimize utilization of clinician schedules at the top, middle, and bottom of the patient funnel. At the top of the funnel, we are attracting new patients above the growth of our clinician base, demonstrated by our growing wait list for services. Our boost on the ground primary care referral team continues to expand local relationships in conjunction with continued growth in online organic patient traffic and increased brand awareness. Next, at the middle of the funnel, we continue to improve patient matching and scheduling, both over the phone and through our online digital capabilities, leading to a higher number of inbound patient inquiries converting to scheduled appointments.

Finally, at the bottom of the funnel, a higher number of scheduled appointments are converting to completed visits, with our cancellation and no-show rates improving from 10.4% in Q2 to 9.6% in Q3. This represents five points of improvement from a year ago, which has had a significant positive impact on the ability of our clinicians to use their time productively. As a reminder, late cancellations and no-shows are a loss to LifeStance to clinicians, and to patients. Visits that are scheduled but not completed result in lower revenue to LifeStance, an unfilled appointment slot, and lower compensation to clinicians, and reduced access to care for patients who could have received much needed mental health services during that time. They are a net negative to all parties, and we will continue to focus on reducing patient late cancellations and no-shows.

Over the last year, our efforts to optimize utilization at the top, middle, and bottom of the patient funnel, have been the primary driver of productivity improvement. While we will continue to focus on operational enhancements in this area, we expect benefits to be more incremental going forward, given the progress made so far. We therefore feel that now we can shift our focus to the other side of the productivity equation, capacity. It is still early, but we are exploring initiatives to grow overall clinician capacity, and we’ll share more on this on future earnings calls. As we continue to focus on our growth priorities of net clinician ads and productivity, our top priority remains delivering an amazing patient and clinician experience.

For example, we know how complex understanding health insurance can be for patients, including differentiating between co-pays, deductibles, patient responsibilities, in-network versus out-of-network benefits, and appointment no-show or late cancellation fees. To that end, we have continued to invest in our billing solutions call center to improve the overall experience and help patients get answers to their questions faster. Additionally, we are piloting a digital patient checking tool. If successful, this tool will allow us to collect and verify patient insurance information up front, as well as allow patients to pay their co-pay and pass-through balances more easily. This will reduce stress for our patients and manual complexity for our operations teams, delivering an improved patient experience and streamlined operations.

We are also refining our new nationwide phone system and increasing our front-office staffing levels to create better support for our clinicians locally and to ensure that our patients have the easier access to our staff. In closing, I’m impressed with what our teams have accomplished this year. We have made progress in our two-year plan to strengthen and solidify the foundation of our business, whether that be through improvements in the utilization of clinician schedules, moving to a single EHR phone system and online booking tool, optimization of a real-estate footprint, or the myriad of other behind-the-scenes ways that we are driving a more efficient and standardized operating model. All of this is a testament to the hard work of our clinicians and teammates around the country.

With that, I’ll turn it back over to Ken for his closing remarks.

Ken Burdick: Thank you, guys. In closing, I’m proud of the team’s progress this year. This is the fourth straight quarter that LifeStance has met or exceeded expectations. And with continued disciplined execution, we are well-positioned to deliver on our full-year commitments. In addition to achieving solid financial results, we also continue to attract high-quality clinical and operational talent. The heavy lifting that we are doing this year and next to streamline and standardize our systems and processes was sorely needed after nearly 100 acquisitions over six years. I am encouraged by our progress and momentum, yet recognize that our work is far from done. I look forward to continuing to demonstrate the tangible benefits of this work when we share our 2024 guidance. We will now take your questions. Operator?

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Q&A Session

Operator: Thank you. The floor is now open for your questions. [Operator Instructions] Your first question comes from the line of Craig Hettenbach with Morgan Stanley. Your line is open.

Craig Hettenbach: Yes, thank you. I have a two-part question on margins. The first part is just on Center margin improvement. If you can just expand on some of the things you’re seeing there, and perhaps it’s some of the productivity improvements. Then the second part is the increased investment that you’ve driven the business this year, particularly around technology and operating initiatives. How do you expect that to trend into 2024?

Dave Bourdon: Good morning, Craig. It’s Dave. On the Center margins, we did see the increase, and we expect that to be stable in the fourth quarter. That was really driven by two things. Scale, so the higher revenue relative to the fixed costs. And then the second thing is seeing some efficiencies in areas like the contribution from the real estate consolidation. And then in regards to technology investments in 2024, I would expect that to be a modest increase year-over-year as we implement things like the virtual check-in for patients and things like that, that Danish represented in his prepared remarks, but not a meaningful increase year-over-year.

Craig Hettenbach: Got it. And then just as a follow-up for Ken, any updates on some of the partnerships you’re driving with companies like Gennev and how that’s influencing the overall opportunity set?

Ken Burdick: Yes, Craig, thanks for the question. I continue to be encouraged by the discussions, but a little frustrated that it’s taking longer than we would have expected to sort of close and finalize some of these deals. So there’s still good momentum. I look forward to the opportunity in the future to share more specifics, but it’s going to continue to be an important part of our strategy going forward, and we are not daunted, just a little impatient.

Craig Hettenbach: Got it. Thank you.

Operator: Next question comes from the line of Lisa Gill with JP Morgan. Your line is open.

Lisa Gill: Great. Thanks very much, and good morning. I just want to understand two things on the payer side. Ken, I appreciate your opening comments when you talked about payers under-investing in mental health, too much self-pay, et cetera. Are you seeing any changes in plan design for 2024 that’s going to drive improvement in that? And secondly, when you talked about 2024, you talked about an increase in rates. You also talked about an increase in rates for 2023. Is it just simply the rate increase when 2023 is carrying forward to 2024? Or are you expecting an incremental increase in rates as we move into 2024?

Ken Burdick: Yes. We’re not really seeing changes in plan design. To your question about the rates, we’re in the early stages, but where we are seeing progress, as I mentioned in my prepared remarks, in the latter half of 2023, and we expect that to continue. So 2024 should represent more than just the annualization of 2023 contract negotiations. We’re going to have a concerted effort to make sure that as we deliver a great experience to our patients and the insured members that we receive reimbursement that’s commensurate with that. And commensurate, frankly, with the step up in demand that we’ve seen for our patient mental health services now for several years.

Q – Lisa Gill: Okay, great. And then just as a quick follow-up, I know in the past you’ve given us virtual versus in-person. Can you just update us on the percentage of each for the quarter?

Danish Qureshi: Hey, Lisa, this is Danish. I can provide that update. So, virtual visits in Q3 represented approximately 73% of our total visits. That was relatively in line with the previous quarter. Obviously, as we’ve mentioned prior to that – prior to Q2, we have seen a slow shift back towards in-person. And so, like we’ve mentioned before, we’ll see where this eventually plateaus. We don’t believe that we’re at a plateau. When you look at the number of inbound inquiries from prospective patients looking for in-person, that continues to grow, which gives us an indication that we will continue to see our mix shift more towards in-person over time.

Lisa Gill: Okay, great. Thank you.

Operator: Our next question comes from the line of Ryan Daniels with William Blair. Your line is open.

Jack Senft: Yes. Hey, this is Jack Senft for Ryan Daniels. Thanks for taking my question. Looking at cash flows, it looks like free cash flow took a pretty significant step down sequentially. And I think in prior calls, you suggested that free cash flow should be positive in second half 2023. So first, is this still the expectation given where it came in this quarter? And then two, can you just talk about the impact of the payer contract you terminated earlier this year and the early findings of how that has impacted the RCM functions and free cash flow as of late? Thanks.

Dave Bourdon: Sure. Jack, this is Dave. There is a couple of things there. So first, let’s talk about free cash flow. So when we gave guidance at the beginning of the year, we did say that we expected free cash flow to be positive in the second half of the year. That’s no longer going to happen. And it’s the result of two things. The first is the settlement and the legal costs associated with the shareholder litigation. And then the second is, as you pointed out in the third quarter, we had negative free cash flow. And that was the result of us choosing to hold claims for payers where we were getting rate increases until they uploaded those new rates in their system. And that’s just taking a little while to work through. So the combination of that impacted us in the third quarter.

And as a result, I do not expect free cash flow positive for the second half of the year. In regards to payer, our initiative that we did this year was around more of an efficiency play rather than an improvement in rates. We called the lowest 30% payer contracts from a volume perspective to be able to become more efficient for our billing, credentialing, the payer teams, those areas, rather than looking for rate improvement. And we are seeing the benefits of that. So it’s played out as we expected. And I would expect another tranche similar to that of reducing our payer contracts in 2024.

Jack Senft: Okay, great. Thanks. Just a quick follow-up into how should we think about net clinician ads going forward, given that you’re 100% organic now. Do you have a baseline target per quarter on organic hires? And then given you are adding all of these clinicians and onboarding them, can you just talk about the ramp for these clinicians and kind of how that ramp has trended and improved over time?

Danish Qureshi: Sure. This is Danish. I can comment on that. So as we mentioned in our prepared remarks, we had a very strong quarter of 286 net clinician ads, which was 100% organic and the strongest organic quarter that we have had to date in terms of net clinician ads. You will see quarter-to-quarter variability there. And I indicated in the prepared remarks that you should expect a lower number in Q4. As Dave mentioned as well, we are not at a point in providing specific guidance on 2024. We will do that on our next call, and we typically do not guide on clinician ads. But as Dave did mention, we expect to see mid-teens organic revenue growth next year. Obviously, a significant component of that will be our growth in our clinician base.

Ken Burdick: Jack, in terms of ramping?

Danish Qureshi: Sorry. In terms of ramping, as we talked about, optimization of our patient funnel or just optimization of utilization, that continues to play out in terms of overall improvements in productivity and particularly plays out in the speed to be able to ramp new clinicians. We continue to see overall new patient demand exceed our supply of clinicians as indicated by our grown wait list. And that will continue to be a positive as it comes to both ramping new clinicians as well as keeping existing clinician schedules filled to the caseloads that they desire.