Yeah. Okay, great. Thank you. Welcome, everyone. My name is Michael Ha, the managed care and healthcare facilities analyst at Baird. Our next session is with Alignment Health, a technology-enabled managed care company focused on the Medicare Advantage business. I am very pleased to have with us today Chief Executive Officer, John Kao, and Chief Financial Officer, Jim Head, as well as Head of IR, Harrison Zhou. Thank you all for being here. With that said, no intro comments. We will jump right into the Q&A.
Thanks for having us, Michael. Good morning, everybody.
Great. A hot topic, you now have the final cut points and visibility into your measure level performance. Can you characterize how you feel about your overall positioning? Has your level of confidence changed at all since second quarter?
No. No. No, everybody, seriously, I think CMS this year is very sensitive about anybody commenting around the Plan Preview 2. I cannot talk about it at all from a regulatory point of view. You have heard me say in the past, I thought we were close. You have heard me say we were not happy about the HEI decisioning, particularly that that decision was after the actual implementation period. But other than that, I just cannot comment it. I think this year is different than prior years, and we do not want to be the one poking the bear.
Got it. That's fair. I guess follow up on cut points to the extent you're able to comment. In previous years, you've been pretty aggressive, right? I guess this year, do they make more sense this year than prior years?
Nice try, Michael. I love you, but I honestly cannot even go there at all. I would acknowledge, in the past, we have been much more open. This year's different, and I think part of it is just all the scrutiny around Stars itself, all the policy discussions, all the legal discussions. Again, we don't want to be the ones that go there.
Got it. Fair. I have to try. Thank you.
Just wait a couple of weeks, and we'll roll it all out when it comes out, whenever it's mid-October.
Okay. Thank you. Okay, stepping back, Alignment delivered strong membership growth, revenue growth, EBITDA margin expansion in the second quarter, but the stock reaction suggests investors remain focused on things like second half cadence, the unfavorable development, investment spending, Stars.
Yep.
I was wondering if you would help frame what you believe investors may be overlooking and what upcoming, call it, milestones should provide greater confidence.
Yeah. No. I think after last quarter's call, the consistent question was, "Look, you guys have been so pristine over the past five years. You have always beaten raise. You have had a lot of consistency. You have set that expectation. What is different?" There seems to be noise now. That was the consistent discussion we got. Let me connect the dots for everybody. The other things we have said include, number one, the proof of concept of getting to 300,000 members, $5 billion, our clinical MLRs producing, has given us a lot of confidence. The proof of concept works. That is number one. Number two is we have also said we are scaling the company. What that really means to investors, you should understand it. It is doing a diagnostic on every part of our company when the company was doing really well.
We did not wait until the you know what hit the fan. We actually started looking at ourselves, making changes at every functional area of the company in order to make ourselves not just a big small company, but we needed to be a small big company. That required a lot of changes, aggressive change management agenda over the past couple of years. We looked at our claim systems. We looked at our medical management capabilities. We looked at our data architecture. We looked hard at AVA. We looked at all of these things, and we started making investments to change all of those, in order to also, point three, get to where we needed to get to, which we said we want to get to at least 1 million members.
As we did that, I looked at our core systems, our workflows, and we needed to make these investments. Anything that I think people are pointing to now is, in my mind, noise resulting from those change management initiatives. Okay? We are largely through a lot of it. Specifically, whenever you go through a claims application implementation, those are messy and noisy. We are pretty much through the end of that, and there is a lot of data points that would suggest that, all in terms of claims throughput, inventory, lag days, adjustments, all that noise is starting to settle down. I think there are other areas that are still yet to be fully complete. I think the last thing I would say that I have said is I really think there is a lot of low-hanging fruit, resulting from the diagnostic.
We have not picked up all that low-hanging fruit yet, but we will. In the next couple of quarters, we will get that done. That is the point. I would not confuse the integrity of the business model with the short-term noise resulting from a very, very aggressive change management agenda. We can talk about that in greater depth in the breakouts.
Great. Thank you. I guess on that topic, the past year investors have been so accustomed to these large beats and raises, as you mentioned, and now walking away from the quarter, they are coming out with the impression that you are reinvesting more of that outperformance. You mentioned you are largely through those investments, but there may be some areas yet to be complete. I was wondering if you could unpack that a bit. What areas are still left to be complete and of the additional double-digit millions of second half investment, how much of that would you say is part of the ongoing cost base versus more temporary?
I think it was about $10 million or $11 million that we are talking about, right, Jim?
Yep.
I think it leads to what is your long-term guidance philosophy? Is the other way, I think, to ask the question. I would say nothing has fundamentally changed. We are still very conservative. We are still looking at what we've done for the first five years. We need to get through this kind of transformation phase, and then we'll get back to that cadence. The investments were literally investments that I think are going to extend way beyond any of these short term kind of implementation issues that are creating the noise. I think all these investments are positioning us for multi-year growth. I also said this in the past, if you look at that last 10K, the management team is very motivated to get the stock up. To get the stock up, we need to scale and replicate reliably and consistently.
The fundamental business model is working. I need to be able to reproduce that everywhere. If anybody tells you scaling is easy, scaling is not easy. Scaling is hard. I'm very happy with the progress that we're making. There is going to be noise, and Jim will get into some of that. We can talk about what that noise looks like. Michael, to answer your question, I think the other thing to think about is we've got three new leaders. We've got four new leaders actually, that have been with us less than a year. Those folks are starting to hit their strides. I'm very happy with the work they are going through, and they are adding value in a very short period of time.
As we look at the people, the process, the technology changes, we're addressing all three of them at once. That's the overarching view of what's happening. Like what we have done for the first five years, which is very consistent, call it guidance philosophy, I think we're going to get there again very shortly. I got to get through this transformation phase.
Great. Thank you. Now with us well into third quarter, I was wondering if you could update us on how MBR medical costs trends have tracked relative to your expectations across outpatient position, inpatient, all.
Okay. Why don't we contextualize the quarter in a couple things since we talked to investors after Q2. Couple things on the positive side. Number one, as John said, we're getting through the claims transformation, which is a big deal internally. That is settling down very nicely, even over the last couple months. What that leads to is much more stability in our reserves. I know that's a thought on your mind, Michael, and investors. As we start seeing stability in the claims environment, and we're giving ourselves a little bit more time to run out and get payment integrity recoveries, our reserves are in a good position right now. I'm talking about both prior year, 2025 dates of service, as well as 2026.
With the benefit of a little extra time and a little bit more recoveries, we're actually feeling even better. Okay, so it was a smart move to put ourselves in that position, and we think we're well positioned for the rest of the year. That's number two. Number three, we continue to execute really well on growth and retention. It's a common theme, but it is something worth noting. In the quarter, we're also doing what we thought we were going to do with respect to solid performance on supplementals Part D. Okay. The headwind right now is in institutional costs. Okay? There's a headwind here, and that's real. Is that temporal or is it structural? The headwinds we're seeing are in institutional acute, very specifically, hospital billing. What do I mean by hospital billing? Appeals and disputes, reaching back from 2025 all the way to current.
It's just getting more disputes, higher level of disputes, and aggressive billing practices. Okay? What we're trying to do against that is ramp up, which we've always intended to do, ramp up our payment integrity activities. That will get to equilibrium over the next couple quarters. The second thing that we're seeing to a lesser extent is in skilled nursing. Okay? That's pretty fixable. Okay? We're seeing length of stay go up, and one of the things that we're doing is, and we talked about it on the call, is putting more clinical resources against. That's the investment to make sure that we're managing transitions of care and getting those length of stay down. Okay, so we're seeing a little bit of heat in those two categories, but we think it's fixable.
That's kind of the update in terms of where we're faring on the quarter. We want to be transparent about when we see hotspots, we address them.
Got it. Thank you. The recap, supplemental benefits, outpatient, they are trending well. Inpatient, a little bit hotter, both on SNFs and acute hospitals because of billing. But your reserves, you feel good about 2025, 2026, which incorporates the operational execution stuff back earlier in the year. Okay. I guess from second quarter into third quarter, on those two institutional cost items, how has that tracked? Has that ramped up from second quarter into July, August?
Yeah, we did see a little bit in July and August. We are calling that out right now. It is not something we think is going to persist into 2027, but we have got to address it.
Okay. Got it. When it comes to 2026 guide, what you expect for third quarter net net, do you still feel comfortable with where your target guide is?
Well, where we are at right now is we are not changing our guidance.
Okay. Got it. Now, I would love to double click again into that prior year development, just to unpack it a little more. A little over $6 million.
Yep.
Back in the second quarter, I know you were going through this claims management system transition. How much is related to that disruption with the transition or other factors?
Very much related to that.
Okay.
The claims transition. To be more specific, we were continuing to see, we call them adjustments, but it's basically lagging bills from hospitals on dates of service from 2025. That was a long tail given the claims transformation. What we've seen since is our payment integrity activity, which lagged a little bit, is continuing to ramp up against that. So the positive adjustments are coming down. The payment integrity efforts are moving up. So what we're doing is netting out to a better reserve position. It was the right thing to do in Q2 to kind of put ourselves in a better position. But it was related to the claims transformation versus kind of getting the underlying trend wrong in the first place. We weren't wrong on the trend. We were just wrong on the timing of all that in ways.
Got it. Just another follow-up on the institutional cost. Since you recognized those issues and you put in actions, have you seen any signs of stabilization in recent weeks or even days into September?
Answer is yes, and it takes time. It certainly takes time. I think the payment integrity opportunity we think is real. Low hanging fruit is probably too strong a word, but we definitely have not reached our potential in what we're doing, and that's just implementing more programs. It's not being overly aggressive. It's more like putting it together like everybody else does and operating the business with prepayment claims integrity, second, third pass, things like that. Just all the programs that our new management team actually has done multiple times. So the good news is we've got a team that knows how to do it.
Okay, great. Thinking about 2027 bid submitted, second half investments are intended to generate returns next year. How should investors think about the major puts, takes the 2027 profitability? Without getting ahead of formal guidance, do cohort maturation, SG&A leverage, another year of EBITDA margin expansion, is that possible even if you pursue strong membership growth next year?
Yeah. I'll answer that. The answer is yes. I think we've proven that our ability to properly manage growth and margin with respect to the bids has been pretty good. I mean, like spot on. I think your point's a fair one given kind of the noise associated with what we were just talking about this year. I think the real question is, given that noise, do you still have the same degree of confidence in your bid assumptions? We anticipated all of that and baked that into the 2027 numbers, added the appropriate level of conservatism. So I feel just fine about that. It's obviously too early to comment on 2027 bid strategy, but we'll be talking about that during the Q3 call significantly. I think at this point, we feel fine about that.
Okay. Got it. Bids were submitted June. You're seeing some heightened institutional costs. Is any of this related to the new member mix this year being more LIS, SNF related?
I think so. I think part of it is related to that. As you all know, if we have proportionally more C-SNF members year one, you're going to get the full benefit of that after year two when you get the proper and accurate and compliant coding put forth. I think we've done a pretty good job with that as well. C-SNF members are our most profitable members because of the care model. We kind of factor that into the 2027 thinking as well.
Got it. So then, 50% was higher than your typical year. I guess when you think about that, do you view it as more of like an opportunistic 2026 outcome, or could this higher acuity member strategy remain a larger component going forward of your year one new member growth?
Yeah, no. What we've said in the past is it was opportunistic given what we looked at a market by market level, as what we thought our competitors were doing, how our networks are set up, our own level of maturation in terms deploying the care model in each specific market. Those are the different factors we considered. I would not make an assumption that that's going to be consistent going forward. It may in certain markets, but it's really an amalgamation of very different business strategies for each market that happen to consolidate up to get that outcome. I would not assume that in a blanket statement.
Okay. And John, you've mentioned this embedded earnings power.
Yep.
880 million of embedded just the gross profit potential within current membership. That is versus roughly, I think, 640 at the midpoint of your guide this year. Can you help us bridge, how do you unlock that 240 million of incremental profit? How do we think about the sources, the timing, like milestones to unlock that?
Jim. Do you want to answer that, or you want me to take it?
Well, the embedded value, so call it a couple of hundred million added, in the future, and it is almost mathematical. What you have to do is execute against it, which we feel pretty good about. The sources of it are more like time versus anything we are making a bet on, so to speak. California is a good example. California is a more mature market. Even though it is growing, grew 24% last year, it is growing, but you are seeing that embedded margin inside a more mature book of members. In the newer states, many of these states are almost 80% year one, year two. What you are going to see over time is just the latent opportunity manifest itself in those states. But it is truly, you got to execute well, but it is more about getting into year two, into year three.
If you think about milestone, the real milestone is getting into year two, year three, where you start seeing that improvement.
The other way to add to what Jim said is, based on what we said at the conference in January, in terms of embedded earnings, I think we have realized that plus some. I think it is real. I think, the question we ask ourselves is, given your continued growth rate, whatever it is, what is this year? 27% or something like that. Given that growth rate, given the nature and the magnitude of the transformation, do we still feel confident that the historical trend around MLR improvement still holds true? I would say the answer to that is yes. I see things that we are doing in the transformation. I see things that we are still not optimizing. I see things that we are still leaving on the table that we are not going to have on the table going forward.
When we start getting all of these things optimized, I just think you are going to have a much stronger scalable, reproducible company. I feel very good about that.
Got it. As more of your members mature into year two, year three, everyone knows your sort of cohort maturation economics, MLR, MBR starting at 93%, coming down to 82% by year five. After V28, after these newer, higher acuity members and all these factors, does that still hold as the right framework?
Yeah. Yeah. Big picture, philosophically, we've always said, in order to be successful in this business, you have to be clinically centric. It's not just a financial engineering game. It's not just about coding. It's not just about global cap. It's not just about denials. I don't think any of those things are going to be acceptable in this market going forward. I think that, if CMS makes changes with respect to Star Ratings and risk adjustment, it's going to tighten up, not get better. Therefore, the companies that have the ability to consistently manage costs, I think, are going to be the ultimate winners. I think that's what we do. It's all about having high quality at low cost to create that value proposition for the consumer. I don't think MA's going anywhere.
I think we've seen these kinds of starts and stops with MA over the last 40 years. At the end of the day, MA always comes back, and there's pricing adjustments. That's what we're going through. If you can still create that value relative to everybody else without just exiting, you're going to end up being the winner. That's our goal. We want to be the market leader in this whole thing. It's just not going to happen next quarter.
Got it. I guess, on the topic of hospital billing, coding, based on our checks, we've seen signs of Two-Midnight Rule, right? The AI catalyzing this huge hospital billing increase. But that had happened mainly in 2024 and 2025, and we're seeing signs of it actually flattening this year. But it's interesting that you guys are actually seeing it begin to spike. Is there any way to reconcile what might be happening between.
I just think with the One Great Beautiful Bill, it's going to create a lot of changes for hospital systems in January with respect to Medicaid and ACA. I think they are doing exactly what you said. We are feeling that. I think that broader trend is something we're feeling specifically with respect to disputes and appeals. We are trying to sort out how much of that is kind of total true trend versus how much of it is our own internal execution that we just talked about. I think it's a little bit of both. I think we can do better on the payment integrity. That's maturing. I think the team's doing a great job. I think we can do better in transitions of care, as we call it, pre-service work. I think those are areas that are getting stronger and stronger internally.
If we look at skilled nursing readmissions, I think we can do better in those areas. I'm comfortable because the team's really, really focused on getting that work done, particularly with some of the new leadership we have. I would still say that external reality is going to be something that you're going to hear more of.
Okay. Admits per thousand has been just one of the clearest illustrations of Alignment's medical cost differentiation. I understand it can be a very noisy metric quarter-over-quarter. I understand your rationale for moving away from it.
Yeah.
But I guess, are there any alternative indicators you plan on introducing to help
Let me take that one. Yeah.
Sort of track other Alignment trends?
Yeah. As part of this whole transformation, part of this whole self-diagnostic, we're going to get more precise, and it's not just going to be looking at ADK as a predictive analytic for all institutional costs, which is what we've done. We're going to get very specific around ADK for inpatient, ADK for obs, ADK for SNF. I just think through this process, we're going to get more visibility, more control. It's going to be even tighter than what you've experienced in the past that we've shared with you. It's just one example of where I think we're just going to get stronger. And again, I'm very aware of the fact, what we need to do is reproduce this at scale. And the performance that we have in our ex California markets with respect to the care model is giving us confidence to make these investments.
These investments are in the form of additional clinical resources, IT resources, market management, feet on the ground resources. These are the kinds of things we are making investments in. Once we get this kind of rebase, you are going to see us get back to where we were, in terms of the guidance philosophy.
Okay.
Except the numbers are going to be a lot bigger.
Love to hear it. Maybe a couple more questions. 2028, that is the year you are targeting new state expansion. As you consider that, what have the lessons been learned from your time in Florida and Texas a few years ago that helps you influence a new market playbook into 2028?
Yeah. I would say two things. One is really it starts with doctors. The name Alignment is really born from the fact that you create alignment with the doctors, individual doctors, not just providers or IPAs that are taking risk. I think the pressure to not be dependent on that, I think is a function of what V28 created. I have always said this. There is not enough room in the supply chain to have two insurance companies. So the ability to work directly with doctors, put incentives aligned with the doctors, is paramount. To the extent that you have hospitals also that you can create more alignment with, even better.
The hospitals we are talking to are ones that have capacity of about 120%, meaning they are over capacity. So when you are over capacity, you talk to us and say, "Look, you guys have been very good at managing admissions. If you can grow share without filling beds and beds, that gives us, we, the hospital, the opportunity to still get market share for our ambulatory businesses, market share in terms of some kind of a gain share, pseudo call it partnership agreement with Alignment. But because we're over capacity, we want to fill those beds with commercial members, which we're getting paid, whatever, 180%-200% of Medicare."
That's kind of the win-win. Those are the kinds of hospitals we're talking with. I think getting aligned with the doctors is number one. Number two is related to the transformation. All of our corporate shared services have to be at a level where they can scale everything, and we're getting really dangerously close to that. Those are the two things that we're working on. I think that's the big picture.
Got it. I know we're at time. Maybe one last one. You have a lot going on right now. In 12 months from now, what do you believe investors will be underappreciating about, like today, about the story 12 months from now?
Yeah. Same thing that you underappreciated two years ago. We do what we say we're going to do, and I'm telling you right now that don't misinterpret the short-term noise for the long-term opportunity. I think that's the big takeaway. I have direct visibility of what's going on operationally. I love our new leaders. I really, really, really like them. They have scale experience. When you combine that scale experience with the missional passion around serving seniors, which everybody has, I think we're going to be in a real position. Michael, I think 12 months from now, if I'm an investor, I'm going to be like, "Damn, I wish I bought back then." I'm telling you. For those of you that did that a couple of years ago, I think you did very well.
The goal now is get out of this, whatever, $3 billion-$6 billion market. How do we get further up that chain? That's what we're working toward.
Wonderful. That is all the time we have now. Thank you, John, Jim, Harrison, and have a great rest of your day, everyone.
Thanks, everybody.