Aveanna Healthcare - Q2 2023

Transcript

Operator (participant)

Greetings! Welcome to the Aveanna Healthcare Holdings, Inc. Second Quarter 2023 Earnings Call. At this time, all participants are on a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note, this conference is being recorded. I'll now turn the conference over to your host, Shannon Drake. You may begin.

Shannon Drake (Chief Legal Officer and Corporate Secretary)

Thanks, Shamali. Good morning, everyone, and welcome to Aveanna's Second Quarter 2023 Earnings Call. My name is Shannon Drake. I'm the company's Chief Legal Officer and Corporate Secretary. With me today is Jeff Shaner, our Chief Executive Officer, Matt Buckhalter, our Interim Chief Financial Officer, and Debbie Stewart, our Chief Accounting Officer. During this call, we will make forward-looking statements. Risk factors that may impact those statements and can cause actual future results to differ materially from currently projected results are described in this morning's press release and the reports we file with the SEC. The company does not undertake any duty to update such forward-looking statements. Additionally, during today's call, we will discuss certain non-GAAP measures, which we believe can be useful in evaluating our performance.

The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation of these measures can be found in this morning's press release, which is posted on our website at www.aveanna.com, and in our most recent quarterly report on Form 10-Q, filed with the SEC. With that, I will turn the call over to Aveanna's Chief Executive Officer, Jeff Shaner. Jeff?

Jeff Shaner (CEO)

Thank you, Shannon. Good morning, and thank you for joining us today. We appreciate each of you investing your time this morning to better understand our second quarter results and how we are continuing to progress against our near and longer-term objectives for 2023 and beyond.

My initial comments will briefly highlight our second quarter results, along with the progress we are making in addressing the labor markets and our ongoing efforts with government and managed care payers to create additional capacity. I will then provide some thoughts regarding our liquidity and refreshed outlook for 2023, prior to turning the call over to Matt to provide further details into the quarter and full year guidance.

Starting with some highlights for the quarter. Revenue was approximately $471.9 million, representing a 6.5% increase over the prior year period and a 1.2% sequential improvement. Gross margin was $155.3 million, or 32.9%, which is essentially flat when compared to the comparable prior year period, but a 7.5% sequential improvement.

Finally, Adjusted EBITDA was $35.8 million, representing a 3.2% decrease when compared to the prior year period, primarily due to the costs associated with the current labor environment. However, a 25.6% sequential improvement, reflecting the improved payer rating environment as well as cost reduction efforts taking hold. As we have previously discussed, the labor environment remains the primary challenge that we are aggressively addressing in 2023 to see Aveanna resume the growth trajectory that we believe our company can achieve. As a reminder, we do not have a demand problem. Demand for home and community-based care has never been higher, with both state and federal governments and managed care organizations asking for solutions that can create more clinical capacity. As communicated in our previous quarter, our ability to recruit and retain the best talent is a function of rate.

Our business model offers a preferred work setting that is mission-driven, providing a deep sense of purpose for our teammates. Our caregivers need to be able to provide for themselves and their families in this inflationary environment, and we must offer a competitive wage. Since our first quarter earnings call, I am pleased with the progress we have made on several of our rate improvement initiatives with both government and managed care payers. Specifically, as it relates to our Private Duty Services business, our goal for 2023 was to execute a legislative strategy that would increase rates by double-digit % across our various states, with particular emphasis on California, Texas, and Oklahoma, which represent approximately 25% of our total PDS revenue. Year to date, 2023, we obtained double-digit PDS rate increases in six key states, including Oklahoma.

We have also achieved rate wins in an additional 11 states that were either in line or slightly better than our expectations. These combined 17 states represent approximately 50% of our PDS footprint. We should continue to see positive progress throughout 2023 and into 2024 as we continue to focus on the remaining states. As a point of reference, the majority of the rate increases are effective in the second half of 2023. We will get a full year benefit as we head into 2024. Finally, we were successful in expanding the family caregiver benefit in 2 additional states, which should help ease caregiver capacity constraints. While we're pleased with our PDS legislative messaging is being well received by state legislators, we still have much work to do.

As an example of the work ahead, we received a modest increase in Texas, effective September first, and do not anticipate being included in the California budget until mid-2024. While we believe we have made significant strides with both Texas and California legislature, demonstrating the importance of rate increases and how they support an overall lower healthcare cost, improve patient satisfaction, and quality outcomes, it is clear that we need to further accelerate our preferred payer strategy and continue to focus on opportunities within our current infrastructure to allow us to pass meaningful wages through to our caregivers. This allows us to become a solution for overcrowded children's hospitals and distraught parents who want their children to be cared for in the comfort of their home. Moving on to our progress with preferred payers.

Our goal for 2023 was to double our PDS preferred payer volumes from approximately 10% to 20% by year-end 2023. In the second quarter, we added one additional preferred payer agreement in a key market. Our preferred payer volumes increased to approximately 16% of total PDS volumes, as compared to 13% at the end of Q1. We have since signed an additional preferred payer agreement in early July and are optimistic we will continue to execute this strategic initiative throughout 2023. While we are taking a national approach to our PDS preferred payer strategy, we are placing particular focus on the state of Texas due to the moderate rate increase and intensifying our ability to shift capacity to our preferred payers.

As of June 30th, we now have over 50% of our Texas PDN volumes with preferred payers and believe we have an opportunity to further improve this trend to approximately 70% by the end of the year. Finally, we discussed the need to shift our current labor capacity to those payers that value our services and appropriately reimburse us for the care we provide. We continued several initiatives to shift caregiver capacity to our preferred payers to optimize staffing rates while minimizing days in an acute care facility. In the second quarter, our preferred payer relationships benefited from accelerated caregiver hires of 2.5-3 times more than our other payers, and we continue to experience staffing rates approximately 20% greater, with significantly higher patient admissions. The value proposition is straightforward.

Preferred payers reimburse us a fair rate. We pay market-competitive wage rates while also earning value-based payments for achieving positive clinical outcomes and improved staff hours. We are encouraged by our 2023 rate increases and the subsequent recruiting results and believe our business can rebound quickly as we achieve our rate goals previously discussed. Home and community-based care will continue to grow. Aveanna is a comprehensive platform with a diverse payer base, providing a cost-effective, high-quality alternative to higher cost care settings. Most importantly, we provide this care in the most desirable setting, the comfort of the patient's home. Before I turn the call over to Matt, let me briefly comment on our liquidity and refreshed outlook for 2023.

We recently renewed and extended our AR securitization facility for an additional 3-year term, effective July 31st, 2023, maintaining our ability to access up to $175 million in cash proceeds associated with our ongoing recurring receivable balances. I am pleased with the work of the entire team in finalizing this agreement and allowing us to maintain our focus on running the business. On the liquidity front, more broadly, we continue to make progress on improving our cash flow by focusing on obtaining adequate reimbursement rates and growing our volumes. We have also implemented several initiatives to rightsize our corporate cost structure while optimizing our collections. As Matt will discuss further, we have ample liquidity to operate our business while we work with government and payers to improve the reimbursement rates to reflect the inflationary environment.

As it relates to our refreshed outlook for the year, based on the strength of our first six months results and the rate increases that will impact the back half of the year, we are comfortable raising our full-year revenue guidance to a range of $1.85 billion-$1.86 billion and an Adjusted EBITDA guidance range of $132 million-$135 million, respectively. We believe it is important to continue to set expectations that acknowledge the environment that we are operating in and the time it will take to transform our company and return to sustainable growth. We believe our revised outlook provides a prudent view, considering the challenges we face with the current inflationary labor environment, and hopefully, it proves to be conservative as we execute throughout the remainder of the year.

Finally, I am proud of our Aveanna team as we continue to execute on our 2023 strategic objectives. The power and efficiency of the home as a healthcare setting remains critical to our patients, families, payers, referral sources, and government partners. The value of our clinical workforce continues to be recognized through various rate increases across the country and through our expanding preferred payer relationships. I look forward to updating you on our results at the end of Q3. Let me turn the call over to Matt to provide further details on the quarter and our 2023 outlook. Matt?

Matt Buckhalter (Interim CFO)

Thanks, Jeff. Good morning. I'll first talk about our second quarter financial results and liquidity before providing additional details on our refreshed outlook for 2023. Starting with the top line, we saw revenues rise 6.5% over the prior year period to $471.9 million. We experienced revenue growth in both our Private Duty Services and Medical Solutions segments, which grew by 8.5% and 15.9%, respectively. Our Home Health & Hospice segment declined by 9.7% as compared to the prior year quarter. Consolidated Adjusted EBITDA was $35.8 million, a 3.2% decrease as compared to the prior year, but a 25.6% sequential improvement, reflecting the improved payer rating environment as well as cost reduction efforts taking hold.

Now, taking a deeper look into each of our segments. Starting with Private Duty Services, revenue for the quarter was approximately $378 million, an 8.5% increase, and was driven by approximately 9.9 million hours of care, a volume increase of 2.7% over the prior year. While volumes improved over the prior year, we continue to be constrained in our top-line growth due to the shortage of available caregivers, although we are beginning to see signs of improvement in the labor markets. Q2 revenue per hour of $38.28 was up $2.04, or 5.8%, as compared to the prior year quarter.

We expect to see continued improvements in 2023 as we execute on our rate increase initiatives, and we continue to be encouraged with our ability to hire and attract caregivers and address the market demand for our services when we obtain acceptable reimbursement rates. Turning to our cost of labor and gross margin metrics, we achieved $111.5 million of gross margin, or 29.5%, a 0.4% increase from the prior year quarter. Our cost of revenue rate of $26.98, which is a 5.2% increase as compared to the prior year, represents the rate pressures we continue to experience in the labor markets. That being said, our cost of revenue rate improved in the second quarter by $0.49, or 1.7% on a sequential basis.

Our Q2 spread per hour was $11.30, representing a 7.3% year-over-year improvement. Our Q2 spread did benefit from some timing-related items and should normalize in the $10-$10.50 range in the back half of the year. Moving on to our Home Health & Hospice segment. Revenue for the quarter was approximately $55.4 million, a 9.7% decrease over the prior year. Revenue was driven by 9,900 total admissions, with approximately 69% being episodic, and 11,100 total episodes of care. Medicare revenue per episode for the quarter was $3,051, up 2.8% sequentially from Q1. We have intentionally focused on right-sizing our approach to growth in the near term by focusing on preferred payers that reimburse us on an episodic basis.

This episodic focus has accelerated our margin expansion and improved our clinical outcomes. With episodic admissions approaching 70%, we have achieved our goals of right-sizing our margin profile and enhancing our clinical offerings. We think about Q3, we expect relatively flat admission growth, with improvements in growth coming in Q4. We are committed to a disciplined approach to growth while shifting our capacity to those payers that value our clinical resources. We were pleased with the gross margin improvement from 44.6% in Q1 of 2023 to 48.6% in Q2, demonstrating our continued focus on cost initiatives to achieve our targeted gross margins. Despite the challenging challenges faced by our Triple H segment in 2022, we hold a strong belief in this business and its lasting value proposition.

Our Home Health & Hospice platform, which is primed for growth, is dedicated to creating value through effective operational management and delivery of exceptional patient care. We'd expect to see improvements throughout 2023 as our direct and indirect cost initiatives continue to take hold. To our Medical Solutions segment results for Q2. During the quarter, we produced revenue of $38.9 million, a 15.9% increase over the prior year. Revenue was driven by approximately 85,000 unique patients served and revenue per UPS of $457.26. Gross margins were $16.8 million, a $2.8 million or 19.7% improvement over the prior year period.

Gross margins, which were 43.3% in the quarter, represented a 1.4% increase as compared to the prior year period. We continue to evaluate ways to be more effective and efficient in our back office to leverage our overhead as we continue to grow. While other interim providers decided to exit the market, we see this as an opportunity to expand our national interim presence and to further our payer partnerships. In summary, we continue to fight through a difficult labor and inflationary environment while keeping our patients' care at the center of everything we do. It is clear to us that shifting caregiver capacity to those preferred payers who value our partnership is the path forward at Aveanna. As Jeff stated, our primary challenge is reimbursement rates.

With the positive momentum we saw in Q2, we're optimistic that such trends will continue into the second half of 2023. We make progress in 2023 with the rate environment, we will pass through wage improvements and other benefits to our caregivers and the ongoing efforts to better improve volumes. Moving to our balance sheet and liquidity. At the end of the second quarter, we had liquidity in excess of $205 million, representing cash on hand of approximately $28 million, $50 million of availability under our securitization facility, and approximately $162 million of availability on our revolver, which was undrawn as of the end of the quarter. We had $38 million of outstanding letters of credit at the end of Q2.

While we analyze the 2023 earnings timetable and their related cash flows, there's a possibility of us utilizing the revolver for the short term due to timing related needs. Our primary goals are to have the revolver undrawn as of the end of the year and achieve positive operating cash flows during the latter half of 2023. On the debt service front, we had approximately $1.48 billion of variable rate debt at the end of Q2. Of this amount, $520 million is hedged with fixed rate swaps, and $880 million is subject to interest rate cap, which further limits our exposure to increases in SOFR above 2.96%. Substantially all of our variable rate debt is hedged.

Our interest rate swaps extend through June 2026, and our interest rate caps extend through February 2027. One last item I will mention related to our debt is that we have no material term loan maturities until July 2028. Looking at cash flow, cash provided by operating activities was negative $3 million for the quarter as a result of certain one-time working capital items. Free cash flow was approximately negative $9.5 million. We also expect to see cash flow benefits throughout 2023 as our top line and cost management initiatives come to fruition. Before I hand the call over to the operator for Q&A, let me take a moment to address our refreshed outlook for 2023.

As Jeff mentioned, we are comfortable raising our full year revenue guidance to a range of $1.85 billion-$1.86 billion and Adjusted EBITDA guidance range of $132 million-$135 million, respectively. If the trends we saw in the second quarter continue, and we are successful in obtaining our additional rate increases, along with expanded preferred payer arrangements, we would expect to further update our guidance in the back half of the year. As we think about seasonality, we expect our revenue to grow as rate increases are implemented throughout the year, which drives our volumes. As we now have more clarity into the annual rate increases we will receive and their effective dates, we now expect approximately 25%-26% of our full year guided Adjusted EBITDA to be recognized in the third quarter.

Our EBITDA is expected to further ramp in the fourth quarter as we realize the benefits of our cost savings initiatives. I'm proud of all of our Aveanna team members and their hard work achieving these results. I look forward to the continued execution of our 2023 strategic plans and updating you further at the end of Q3. With that, let me turn the call over to the operator.

Operator (participant)

Thank you. At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. To participants using speaker equipment, it may be necessary to pick up your handset before pressing these star keys. We also ask everyone in the Q&A queue to please limit themselves to one question and one follow-up question to allow everyone to ask a question. Our first question comes from the line of Joanna Gajek with Bank of America. Please proceed with your question.

Mia Munoz (Analyst)

Hi, thanks for taking the question. This is Mia Muñoz on for Joanna Gajek. The first question we had was just about operating cash flow being negative this quarter. Just wanted to get a sense for what your outlook was for the year, and if you still expect it to be negative in the third quarter, but positive in the fourth?

Jeff Shaner (CEO)

Yeah, good morning, and thanks, thanks for joining us. You know, as we said last quarter, we expected our second quarter to be slightly negative in our operating cash flow, and it was at negative $3 million. You know, our goal all year has been to reach positive operating cash flow by the end of the year, and I think everything that we know today tells us we're still on that trend. You know, we'll have some certain one-timing things that will play through Q3 and Q4, but we still feel very optimistic on reaching that positive operating cash flow, and ultimately, heading into 2024 as a positive operating cash flow and free cash flow company as we really move through 2024. Matt, anything you'd add to?

Matt Buckhalter (Interim CFO)

No, I think you said it well, Jeff. A couple one-time, you know, working capital items this quarter, you know, results in that negative $3 million that we saw. But, you know, given our outlook of where we're looking at with continued rate improvements as well as our continued cost initiatives that we will, you know, continue to take, I think, you know, improvements in the business will continue, and from there, you know, we should see positive operating cash flow going forward.

Mia Munoz (Analyst)

Okay, perfect. Thank you. I just have one follow-up question, or well, separate question on PDS volumes and how, I guess, the 10-Q listed, that it was primarily attributable to growth in demand for non-clinical services. What was the volume change year-over-year and quarter-over-quarter for these clinical services, and where do you expect the volumes to be for the rest of the year? Thank you.

Jeff Shaner (CEO)

Yeah. No, that's, that's a great question, and yes, we saw a nice uptick in some of our lower skilled and some of our, you know, less, less nurse-driven businesses. I would tell you that first of all, positive 2.7% year-over-year growth for us is a good thing, cause it's been a couple of years since we've had positive growth in our PDS business. I'll take us back to our preferred payers, that at the end of the day, we see our preferred payer strategy working both in rate and beginning to work in volume.

Obviously, we've, we've made a strong commitment to shifting caregiver capacity to those payers that, that are leaning into us, both in our PDS, and I think you heard it in our Home Health and Hospice line of business as well, that we're, we're committing to those payers that are paying us either on an episodic basis or, or an aligned preferred payer. You know, I think as we think of the back half of the year, you know, we, we see continued progress in our PDS business, both in rate and volume. And, we're, we're just really proud of our, our PDS team, and that they have recovered well in 2023 from, from, you know, the COVID hang, hang around.

I think we just see a clear path forward with our preferred payers to really driving the business forward. We're, we're, we're really pleased with where we're sitting today. Thank you.

Mia Munoz (Analyst)

Thank you.

Operator (participant)

Our next question comes from the line of Brian Tanquilut with Jefferies. Please proceed with your question.

Speaker 7

Hi, good morning. You've got Taji on for Brian. Thank you for taking my question. My first one relates to the raised guidance, right? Just looking at revenue first, if we're looking at first half or second half, that implies a ramp down in the back half. At the same time, we're hearing some strong momentum in PDS and your other segments. Maybe if you can just kinda talk through the moving pieces, and, you know, what's informing the, I guess, ramp down on the back half?

Then on EBITDA as well, I know that you guys have kinda called out a couple cost savings, as we reconcile this with, like, the different margin profiles for PDS, Triple H, and MS, just curious if you can talk about the areas where you have, you know, more leverage to improve the margin profile across the three different segments, especially in PDS, because I know that you guys said, you expect that to normalize. I think, you know, if I factor that into my model, I'm still getting to the lower end of the margin you guys had kind of loosely, commented on. Just we'll start there.

Jeff Shaner (CEO)

Awesome. Well, good morning, Taji. That's a lot to unpack there, we'll, we'll do our best. I, let's start with Q3. From a seasonality standpoint, I would say from the first time since COVID hit, we see a seasonal impact of our Q3 business. Pre, pre-COVID, Q3 for us was when schools are out, and both our, our PDN, our PDS business, schools being out is a little bit less volume for us, and we're, we're experiencing that in Q3. We expect Q3 to be seasonally a little bit light on revenue and ultimately probably relatively in line with earnings as we think of, think of Q2, maybe a little bit softer. I think Matt, in his prepared remarks, kinda led you to what we think Q3 EBITDA will ultimately be.

I, I think to the second half of your question, you know, the back half of the year, the rate increases, majority of our rate increases were either effective July 1st or September or October 1st, both on the PDS as well as obviously the hospice rate increase coming. So we will see a lift, and I'll call it the back 4 months of the year. So I'll call it September, kind of through December. We'll see a nice volume lift in our- in all 3 of our businesses, as well as continued rate lifts. So yeah, I, I think where we sit today, Taji, it's still early in our transformation story. I think we use words like prudent, conservative on purpose, that, that we understand that this, this guidance, guidance revision is, is prudent in nature.

I think Matt ended his comments by saying, if things play out the way we think they will, that we would plan to, to readdress guidance in our November earnings call as well. you know, I, I would tell you, you're not missing anything other than just keep in mind, Q3 is our seasonally low period, and I think everything we know today tells us that it will play out to be that way, both in, both in our PDS business as well as our Home Health & Hospice business. It's our seasonal, seasonal low point. Matt, anything you want to address on the cost side of it or margin side?

Matt Buckhalter (Interim CFO)

No, I, I, I think, Taji, it's a great question altogether. I think there's improvements throughout all three business segments in there, and I'm gonna say that's above gross margin and below that we're focusing on. So I think as we continue to kind of dig into it and, you know, be transformational in nature and, and lean into technology in certain segments, but then also make sure that we're delivering the appropriate amount of care, the right amount of care, with the right amount of overhead supporting it as well. We'll continue to be prudent in that one and all portions of our business, and I think that will lead to your little bit of margin expansion as well.

Jeff Shaner (CEO)

Anything else, Taji?

Speaker 7

I appreciate the de- Oh, yes, just one more question for me, and I appreciate the detail-

Jeff Shaner (CEO)

Sure.

Speaker 7

-on my first question. Then kind of getting to this conversation around labor, maybe you can provide a couple key KPIs as to how your labor force stands today in terms of recruitment, retention, turnover, things like that, and how that's trend over the past year. Then 1 follow-up to that, you know, I know you mentioned, Jeff, that it's not a demand issue, it's really capacity. If you had a sufficient labor, how much more volume, percentage-wise, do you think you can field?

Jeff Shaner (CEO)

Yeah, good, great, great follow-up, Taji. You know, I think we think of labor as a function of rate, and, and a lot of people try to drive us towards what's the inflation rate of, of caregivers in, on both the PDS as well as Home Health & Hospice. We just, we just refuse to think of it that way because we don't control inflation. We do control reimbursement rate, and we do control where, what partners we ultimately put our labor capacity with. It just brings us back to our preferred payer and government affairs strategy, which is, as we've been crystal clear with, you know, the last two quarters, our job is to drive appropriate reimbursement rates, both on the government affairs side and the, and the preferred payer strategy, and in turn, invest those caregiver wages.

In those relationships, we're demonstrating we can grow the business and be a good business partner. The flip side of, though, that is true, Taji, in markets or payers who are not paying us above market preferred rates, we're not seeing incremental hires, we're not seeing better staffing rates. So it just drives us, and I'll use Texas as the example we used in this call. You know, it just drives us to align our capacity, both current and the future, with those payers that want to be long-term business partners of ours. We talked in Texas, you know, 50% of our PDN volumes in Texas are now aligned with a preferred payer. We are aggressively driving that towards the end of the year to be 70% of our Texas PDN business to be aligned with a preferred payer.

Because the only way we can truly live out the story that we tell, which is to improve clinical outcomes, lower total cost of care, and just staff more hours, which our, which our payers want us to, is to partner with those, those payers that will, will ultimately give us higher rates and include us in value-based bonus payments as we earn them. I do want to touch last because you, you brought up the idea of Home Health & Hospice, and I think it's important. You know, we, we were, we were pretty crystal clear in this, that we have, we have committed to also aligning our home health clinical workforce with preferred payers. Obviously, episodic payers in home health is, is, is the way we measure preferred payers, but, you know, we're approaching 70%.

Some weeks we've been in low 70s on episodic admissions. Even though our admissions are down year-over-year, even quarter-over-quarter sequentially, even though our revenue is down year-over-year, we have made a commitment in home health to not give away our capacity to low-dollar, low-margin payers. I think you'll find us, you know, firing, terminating more contracts as we align ourselves in home health to those payers who will ultimately pay us a fair rate, market fair rate, and/or an episodic rate. I'm really, really proud of our home health team and hospice team. They, they have turned our business around in the last 2 quarters. Matt talked about, you know, 48.6% gross margin. That, that for Aveanna is, is as good as it's gotten in the last year.

Equally important, we can now see our clinical outcomes also improve in Home Health & Hospice because we're not chasing low-dollar, low-margin business. Again, I think you're hearing us just beat the same drum, which is, in all three of our businesses, our resources are scarce in nature, and we're going to align them with the payers who want to partner with us on a long-term basis and be a good, good business partner, and we're gonna be a good business partner to them in return. Thanks, Taji.

Speaker 7

Thank you.

Operator (participant)

Our next question comes from the line of Pito Chickering with Deutsche Bank. Please proceed with your question.

Pito Chickering (Director and Senior Equity Research Analyst)

Hey, good morning, guys. Looking at guidance, can you help us quantify the headwinds and tailwinds on the rate increases versus your prior guidance? I believe that you're looking for mid-high, single-digit rate, rate increases in California and Texas. It sounds like that's a headwind, but you also get rate increases from others. Can you just, you know, help us, you know, I guess, model sort of, you know, these moving parts between what was better versus worse versus your last guidance? On Texas, do you assume that about 70% of those payers will be in the preferred network within guidance in Texas? Thanks.

Jeff Shaner (CEO)

Thanks, Peter. Good morning. Yeah, you know, I think, let me start with, clearly, we're disappointed that we were not included in the fiscal year 2023 California budget, because that was a big deal for us. I'm, I'm gonna flip that to a positive, though, Peter. You know, we're the largest provider of PDN in the state of California. We've been in California for over a decade. We're gonna be in California a decade from now. We are committed to the long-term success of California, and we're going to get a rate increase for PDN in California. It's the right thing to do. We've made really nice inroads with both the legislature and the governor's staff, and we're gonna continue to lead into the governor and his, and his key leadership as we move into 2024.

I think as you, as you think about the timing of California, which as we talked about going into the year, was, is a big mover for Aveanna. I, I think of it now in the back half of 2024, and potentially as late as January 1st of 2025, that, that, that rate improvement. How it plays out in our 2023 guidance compared to the rate increases that we did get, and some, Peter, that we were not expecting, some came in significantly higher than we expected on a per stay basis. It's, it's roughly a wash for us in, in 2023. I think as we, as we think of the back half of the year, it'll be roughly a wash.

We won't have the 7/1 of 2023 California rate increase, so we didn't have that step, you know, in Q3 of 2023, we didn't have that immediate step up. It's a little bit more of a layered-in approach as we move from Q3 into Q4. Then I think as Matt talked about, Peter, the nice part for us right now is we have a couple of levers we can pull. You know, our, our cost, our, our cost tenacity has significantly ramped up. We, we just, we just found within the company there were some areas that we, we really could address overall contribution margin in the businesses. I, I think as you think about its impact on guidance, you know, ultimately, I think we'll land in about the same place in 2023.

Then, you know, we're still, we're still early on 2024, right? We're still probably 3 months early from really, really focusing on 2024. We won't have the California rate increase in early 2024, right? We'll, so we'll look at other measures like the continued acceleration of the preferred payer strategy to make sure that as we roll into 2024, we really have good momentum on our preferred payer mixes. I think I got most of the question there.

Pito Chickering (Director and Senior Equity Research Analyst)

Yeah, perfect. Sort of sticking, I guess, you know, on the same topic, and I, you get that every contract is different here, but because preferred networks are becoming increasingly important sort of for your growth engine, can you help quantify us, you quantify us for us how much a preferred partner pays versus sort of a standard contract? Sticking with Texas again, just 'cause you brought up earlier, you know, like you said in script, that demand remains very high, and if the patients are not being treated, are they, are they just being stuck in, in acute hospitals, or what's happening with patients specifically in Texas today?

Jeff Shaner (CEO)

Yeah, no, that's a fantastic question. You know, it goes back to. We've got studies to prove it, both in California and in Texas, and we've presented those studies to both the governor, governor's offices as well as Medicaid department and many legislatures. PDN saves between $5,000-$6,000 a day compared to acute care, acute care setting, right? Holistic cost, cost to cost. You know, you know, it takes time to kinda get that messaging through legislators. It doesn't take time to get that through to MCOs. They absolutely understand that. I'll use Texas to your question.

Our MCO partners in Texas understand that they have to get these kids out of the hospitals, and that, you know, some studies are suggesting that medically fragile children are remaining in hospitals up to 54 days on average, longer than they need to be there. You, you just do the math. It's $200,000-$300,000 per stay, you know, greater or slightly more. Yes, we feel our MCO partners understand that. In the markets like Texas, where we have scale and size and true sophistication, we really are the market mover, right? You need Aveanna to partner with you from a nursing standpoint. Again, we've gone into this wanting to be good long-term business partners with our payer partners. We don't wanna flip partners, payer partners every quarter.

Our goal was to align with partners over a multi-year period to really build sustainable relationships. The fact that we already had 50% of our volume in Texas with an MCO preferred payer, I think demonstrates that we were already well aligned there. The fact that we only got a 2% rate increase, the fact that September 1, you know, was almost embarrassing from the state of Texas. It just highlighted that the preferred payer strategy was the path forward, and, you know, our MCO partners have graciously aligned. We talked about signing an additional preferred payer. It was in Texas in July. And I think we'll sign one or two more by the end of the year and ultimately be somewhere around 70%. Lastly, Peter, you asked kind of what's the market difference?

When we're earning our value-based payments, most of those are established on a quarterly basis. When we're earning not only the rate, the higher market rate, but also the value-based payment, it's material in nature compared to the Medicaid rate. it's in range of, you know, 25%-30% greater than the Medicaid market rate. it's important for us not only to have the preferred rate, it's also important for us to have value-based components so that the preferred payer sees that we're aligned with them long term. Hopefully, that was helpful.

Pito Chickering (Director and Senior Equity Research Analyst)

Perfect. I'll just one super fact, cash flow question, just to follow up to the previous question. You're negative in 3Q, you're positive in 4Q. Is the difference there simply this rate increases flowing through the last four months of the year, or, or is it something else you know, that we should, you know, be thinking about as you shift from cash flow negative to cash flow positive?

Jeff Shaner (CEO)

No, it's just a little bit of the volume. As you think about the business itself, Pito, we're a little bit light in volumes in Q3, primarily in the core businesses of Home Health and, and PDN. That ramps kinda back up September through the end of the year. So, so if you follow the revenue there and, and earnings, it's just, you know, it, it we expect Q4 to, to be, you know, very, very strong quarter for us, and we expect to end the year on a, on a, on a great trajectory. But Q3 is just a little bit lighter for us, and, and, that, that, that's how we've laid out the cash flow for Q3 and Q4.

Pito Chickering (Director and Senior Equity Research Analyst)

All right, great. Thanks so much.

Jeff Shaner (CEO)

Thank you.

Operator (participant)

Our next question comes from the line of Ben Hendrix with RBC Capital Markets. Please proceed with your question.

Ben Hendrix (VP and Equity Research Analyst)

Hey, thanks, guys. Definitely appreciate the commentary about your preferred payer mix in Texas. I think for overall, you had noted that you were expecting preferred payers to account for 18%-20% of nursing hours for the year. I'm wondering if this July contract in Texas gets you there, or there's still kind of wood to chop on that front? That's, that's my first question.

Jeff Shaner (CEO)

Yeah, no, Ben, it's, you know, as, as we think of, as we think of the year, right? We started the year at 10%. We were about 13% by the end of Q1. I think our actual number was 16.5% by the end of Q2. Yes, that one agreement we signed in Q, both Q2 and the one we signed in July is helpful, but no, we, we still have wood to chop. You know, we, we, we will sign another 3 or 4 between now and the end of the year.

I, I believe, you know, Matt may hedge at me a little bit, but I believe we'll, we'll comfortably be at that 20% by the end of the year. Then we'll reset and, you know, we'll reset that goal for 2024 to continue to push that story. You know, so we're, we're not done. We're not stopping at 20%. We wanna continue to drive that to be the more and more meaningful part of our business. Matt, anything you'd add to Ben?

Matt Buckhalter (Interim CFO)

No, I think that's well said, Jeff. I mean, preferred payers are the answer for Aveanna. It's the answer for our caregivers, and it's the answers for our patients. Moving that to 20% above is what we're focused on as an organization because it allows us to pay that higher wage rate to our caregivers, which allows us to drive more volume and provide more clinical care for them. As we kind of check the box on that 18%-20% in the back half of the year and say, "That's, that's where we're gonna be," we'll set a new goal for 2024 as well and continue to push forward.

Ben Hendrix (VP and Equity Research Analyst)

Thank you. Just to follow up on 1 of your prepared comments, you mentioned for Texas and California that they plan to include you in state budgets next year. How much visibility does that realistically give you? Is that something that kind of the negotiation process just starts all over, or is there a kind of a real indication that those double-digit, that those double-digit increases will be realistically considered next year?

Jeff Shaner (CEO)

Yep, that's a great question, Ben, and let me separate the 2. Texas is a biannual, let's say, a process. Texas is done for the next 2 years, and our strategy in Texas is what we just talked about, working with the MCO. We're not waiting on any, any rate increase in Texas. We're driving our own destiny. California, we are in active conversations continuing every, every day. We will spend time this fall with the governor and the governor's key leadership team as we continue to move forward this story. California is in every single year, right? January resets another legislative process for us. And, and we, you know, we're, we're 15, 16 months in California now, focused on this. You know, there's still plenty of wood to chop, using your words, plenty of wood to chop in California.

Ben, I, I don't think of it as if, I just think of it as when and how long it will have taken us to tell our full story. We are an absolute total healthcare cost saver to California, and our studies show that, and I think that's resonated really well. We've gotten good feedback from the governor's staff, and I, I think partnering with them this fall as they go into the 2024 legislative cycle is the best thing that we could do as both a company and an industry in California. It is the right thing to do. We need to be on the governor's key legislative initiatives to really see this rate increase through. As I said to Taja, Peto, you know, that would be a late 2024.

As you think about when would that come to fruition, the earliest would be July of 2024. The more likely outcome would be probably 1/1/2025, as most rate initiatives or rate investments from California start on the first day of the following fiscal year. Just step back, Ben. You know, as we, as we talked in our prepared remarks, we've had a great year from, from a government affairs advocacy standpoint. 17 state rate increases, and we got 33 states total. You know, 17 states, slightly better than we expected. Certainly, would have loved California to be on that list, but, you know, I think it, I think it sets up well for us as most of those rate increases will flow into 2024. Really, I'm kind of excited that California is kind of on that horizon, right?

Because it gives us the next step, and, and, you know, as Matt, as Matt reminded us, you know, at the end of the day, the only way we can pay the caregivers the fair rate and to truly take patients home and fulfill our mission is to have an appropriate rate. I, I, I feel confident that we'll see that through with California here over the next, next six months. Anything else, Ben?

Ben Hendrix (VP and Equity Research Analyst)

Thank you.

Operator (participant)

We have reached the end of the question and answer session. I'll now turn the call back over to Jeff Shaner for closing remarks.

Jeff Shaner (CEO)

Awesome. Thank you, thank you so much for joining our earnings call, and, and more importantly, thank you for your interest in our Aveanna story. We certainly look forward to updating you on our continued progress at the end of Q3 in November. Thank you, and have a great day.

Operator (participant)

This concludes today's conference, and you may disconnect your line at this time. Thank you for your participation.