Alignment Healthcare, Inc. ($ALHC)

[Audio Gap] Bank of America. I have the pleasure of hosting John Kao, CEO of Alignment Healthcare; and CFO, Jim Head. So [ do you want to join ] a quick intro? Do you want to go straight to Q&A? How do you want to handle that?

I'll just do Q&A.

Q&A. All right. Sounds great. So why don't we start with the guide, maybe 2Q. So can you just clear up something for us. So can you explain sort of why the step down in MBR between 1Q and 2Q, sort of what happens in a typical year to drive that improvement? And then maybe what about this year? The seasonality is different versus 2025.

Okay. I'll take that one. So let's start with the Q2 guide in the first half. So we came out with a very strong first quarter, as you know. Q2, we also predicted a pretty strong improvement for the first half year-over-year, 60 basis points MBR improvement, 40 basis points SG&A and then almost 100 basis points in adjusted EBITDA. So very strong performance, 80% growth year-over-year. Now what Craig is asking about is there's a step down in the MBR between Q1 and Q2. And that is typical, okay? We have a step down. There's 2 reasons why there's an annual step down. Number one, utilization is just different in Q2 versus Q1. So you're going to see that seasonality. Number two, Part D influences that step down quite a bit. What folks are looking at right now is the step down is even greater than the past. And so it's about 140 basis points. In the past, it's been a little bit less. But if you strip out, just factor in a couple of things. The ADK or the UM headwind we had in January, just take that out. Part D, again, this year is influencing the MBR step down, too. And last year, we had a little bit of heaviness in Q2 MBR because of some of the other medical costs. So actually, when you kind of harmonize those, it's pretty consistent. So we feel pretty good about our second quarter guide and how that's playing out.

Okay. Great. So thanks for clarifying that. So Jim, maybe to follow up, I think you're about 1 year in now. I think maybe this time was last year was kind of your first foray into this job. So maybe 1 year in, what surprised you the most and why is you most excited?

It's interesting. It's been quite a year in the market, the Medicare Advantage, and that's an understatement. But what actually the -- call it, the underwriting I did when I came in is, I knew this model was different, and I knew the opportunity was distinctive. That hasn't -- I only feel better about that a year later. I think what is required to be successful in the market is getting more well defined. You got to have the right model and you got to execute. And I think what John really focuses on, and I've learned very, very quickly is it is about being operationally focused, visibility and control. And so we're just relentless about it. And so that's probably one of the key learnings in the last years. Visibility and control is everything in this business.

Okay. Yes. Sounds great. So maybe then let's transition to trend. Now you've had some historically great visibility there. So it seems like everyone is pretty cautiously optimistic maybe this year might be pretty good. So maybe what have you seen in trend in 2026 versus '25? What do you expect going into the year? And kind of how has that trended year-to-date?

I'll start with our guide kind of suggests that we've got a good sense of what the trend is. And I'd say, in a word, stable, okay? We've got a clinical model. We're very focused on, obviously, inpatient admissions as one of the big indicators, and that's been stable. We've had a slightly different book this year because we have some more -- we have new members that are probably a little bit more acute. But having said that, the trend versus our expectations has been very stable. And as we walk down the various categories of costs, admissions per 1,000, inpatient acute, inpatient non-acute, supplementals, Part D, all performing in line with expectations. So in some ways, our clinical model gives us that stability, and we haven't seen anything different this year.

Okay. Yes, you called out a few areas there. Is there anything that even though it's in line with expectations, maybe has moderated versus last year? Or is everything kind of in line?

We're always mindful that trend can bite. So if things are moderating, we're not ready to call that. And that's one of the reasons why we just -- we march through the year and deliver and make sure we hit our expectations because there's always going to be something that's going to be different throughout the year.

No, totally fair. All right. So maybe let's look back to the last few years. It seems like you've got a better sort of visibility on trend like you mentioned earlier, versus a lot of your peers. So what is it about the tech stack and the model that really enables you to forecast, it seems like so much more accurately.

It's a bottoms-up build. I mean we have data at the member level that kind of aggregate up to the group level to the market and then we consolidate it all. And so we have very detailed actionable data. And when we take that data, we have boots on the ground to actually execute if we see any kind of negative variance, whatever that is from a financial point of view. And so it's always starting with the member. We're looking at member satisfaction. We're looking at admissions per 1,000. We're looking at readmission rates. We're looking at ER rates. We're looking at all the data that would suggest kind of prevention. -- and then quality. So from day 1, we always said high quality, low cost. What does that really mean? It means you got to do good at starts. You got to have good clinical medical management. And I think this notion of transparency, visibility and control lead to durability. Well, that's something we just live by. And the bigger we get, the kind of the more we have to reinforce that everywhere. And I don't think others have the degree of actionable data that we have, partially because their back-end systems require reconciliation, which takes 30 or 45 days. We actually have data that we can look at on a daily basis. And then we meet daily as a management team and identify hotspots if there are any, negative variances if there are any on a PMPM basis, and we put action plans together to address it. And there's no other way you can run this business.

Yes. No, that makes sense. All right. Maybe switching to final rate notice. So '27 rate notice came in about 2.5% better than the preliminary, which was great to see. And a lot of that was due to the delay of the new risk adjustment data. And while it sounds like this is going to be help over '27 and potentially just we're delaying this until '28, right? So with that 1.8% headwind that got delayed, if it were implemented in '28, how would that hit alignment, would be more or less? And any color you can add there?

Yes. Our read was that the -- they didn't implement the recalibration because of the whole skin substitute double dipping. So I thought that was appropriate. I think the overall rate increase of 2.48% heading into the year is something we think we're probably going to do better. And it just kind of this whole -- I'm braincrapping, but this whole area around risk adjustment and kind of unlinked chart reviews, I think it was worth 1.53%. I think our -- the inherent nature of our career model, our care centricity, I think we're going to do better than that. So I think that's fundamentally an advantage for us. It's still less than overall trend. And I think that I think it's going to continue to put pressure on a lot of our competitors. And I think as we found out, as you all have found out and learned starting in '24, '25 and then I would even suggest '26, that plays to our advantage because we're the lowest cost producer. And so the business model was built on you have to be successful irrespective of what happens to the rates. Rates go up, all boats rise in a rising tide, rates go kind of are flattish or go down, we're going to have a competitive advantage. Having said that, to the second part of your question, we were in D.C. last week spending a lot of time with all the guys. It's unclear to me if there's going to be any material change to the risk model. And that's different than what I've said in the past. And they were pretty -- they were not saying one way or the other. So they're being pretty coy about it. But there was suggestions that there's just not enough time to actually implement the full magnitude of the risk changes that I think they know and they want to do. So I think it will be interesting heading into next year. And what I've said in the past is I would have thought there would be some material changes coming in this new technical notice that usually we get in November, December. You get comments on the events rate in January, you get the final in kind of April. And I was thinking there's going to be some material changes. I'm not sure there is.

So even -- so maybe we don't get the full big, I think, implied or the implied risk model...

[indiscernible] risk model versus [indiscernible].

Even like some kind of maybe middle step around health risk assessments or lean chart review, anything like that? Anything there might be helpful.

Yes. there may be -- but to me, that is not a wholesale change. I know the discussions have been -- this is a 22-year-old program now. And so when they initiated this risk adjustment and they look at the fee-for-service data, Medicare Advantage represented like 10% of the market share of all seniors. Now you're 52% or 53%. So the fundamental data, I think that fact pattern would suggest it is time to kind of retool this. I just don't know if they're going to have enough time to implement it. Having said that, we actually agree with their logic that the [ planner ] shouldn't be spending as much time on this topic is my humble opinion. And as we found out, it creates all kinds of opportunities for misalignment and gaming, if you will. And so this notion of kind of inferred diagnosis, looking at the actual data, both fee-for-service and MA data and then having the new AI tools that are out there, inferred diagnosis and then pay people on that, I think it's the right way to go. I just don't know that's going to happen operationally. And so if you're kind of left with kind of this current state, the first thing I would think is focus on this -- extend the logic on this discussion on program integrity, right? You've heard a lot of them say that. So focus on program integrity, I think they've beaten that one to the ground. I don't think there's much blood to squeeze out of that rock, much more for the plans. But extend -- think about what they're doing, pharmacy, right? They're going after pharmacy. They're trying to create value for the consumer in pharmacy. Fraud, waste and abuse, right? There's all the stuff you're reading about in hospice, home health, all this stuff. They're looking hard at all of that. And so implement program integrity through the entire supply chain. And so if you got these health systems and kind of integrated delivery networks that represent 50% to 60% of your costs in your MLR, you'll start looking at billing, apply the same degree of program integrity throughout the supply chain to ensure accurate billing, hold everybody to the same standard, accurate billing. And I think you're going to find a lot of opportunity so that the trend and this whole topic, the next topic you're going to hear about is affordability. What that means is, okay, look down into the supply chain. We kind of looked at the plans, V28 kind of linking charts, et cetera, all that, I think, is the exact thing they should have done. Now start looking down the supply chain. Who's looking at billing accuracy of the integrated delivery networks. I told them, I said, what if we give you a basket full of RAS scores, HCC codes and said, you guys figure it out, right? So the same kind of RADV intensity that was applied to the plans and whatever, 3% margins should be applied to the hospitals with their 20% margins. That's what's coming next.

All right. Well, that will be fun to watch. So maybe let's pivot to expanding outside of California now. So you've got about 20% of your members there outside of California. Your total enrollment, I think, just about doubled. So nice share gains. And you've talked previously about wanting to use free cash flow to fund growth. You got the free cash flow now. So how should we think about growth outside of California from here on now?

We're happy with the growth. We're making sure that we get the same kind of margin and kind of embedded earnings from the mix of members that we have, ex California, I think it will pay off. We were intentional about capturing share with respect to C-SNP, D-SNP members this year. Those have been the most profitable for us, I think, largely because of the care model. And I feel good about it. We -- it's kind of natural to think that our ex-California MLRs are higher than California just because of the amount of new growth that we've had this past year. But I think consistent with what we experienced inside California, that cohort maturation and the embedded earnings will start paying off in future years. I think that the deployment of capital and -- which we have and because of the free cash flow still has to kind of be bumped up against certain filters that I think about, which do we have the right providers that understand our model, want to work with this model and or not. And we're going to be entering markets in '27 where we found those like-minded providers. And also, interestingly enough, health systems that want us, they like our model. They like the care delivered. They like the fact that, that yields market share gains, so we can push market share to them. They don't like some of the big guys. And so that's cracked the door open for us to really provide an alternative for them. But the main thing is the doctors, the PCPs, we still think the PCP is very central to the equation, and we don't think we have to own them to get them to behave in an aligned way with us.

Okay. So maybe a follow-up there on the PCP relationship outside of California. So California is more of the delegated model. What has the differences been when you're contracting and partnering with these providers outside of California? What's the -- any dynamics there you could give us?

Yes, yes. No, So it's a great question. the markets outside of California, we are the IPA. So we're the ones engaging with the individual practices themselves and helping them with Star gap closures and risk adjustment gap closures and integration of our Care Anywhere clinical model. That's why you get 5 stars on all these ex-California markets. And we've been challenging caps inside California. That's number one. Number two is inside California, you have these IPAs, right? These medical groups that are either taking global cap and we've shared that it's about 25% or 30% of our business in California. 75%, 80% of our business, 75% of our business is kind of shared risk or directly contracted. Even when you have a shared risk deal with an IPA, there's margin implications that are accrued to the benefit of the IPA. Outside of California, because we're the IPA, there's more margin opportunity for us, right, because we're doing all the work and thus have the ability to drive margin expansion and richer benefits. There's no middleman taking a piece of the pie. And so I think the Stars Rating and the MRA kind of engagement is -- are 2 proof points for you that ex-California businesses are businesses that we can do better at. And so now we're taking all of our care models and the utilization metrics and the ADK metrics in these new markets are also pretty good. We just need some time for the maturation of the cohort RAS scores and kind of ADK to come down even more just given the growth that we've had. But I think the key for us is finding the like-minded doctors. And the -- just kind of this grand experiment about kind of global cap value-based providers, it was kind of your parlance. So of it -- it's -- jury is still out if there's enough money in that supply chain with V28. And I think it's V28, when you can't do the coding that some of these guys have done and/or have bought providers to incentivize them to do the coding, to get the coding to support a global cap arrangement, when that kind of financial engineering doesn't exist anymore, puts a lot of pressure on those guys. And so in that kind of world, our model stands to be even better because it's a more durable model.

Yes, it's great to have the longer-term margin capture opportunity outside of California. So maybe in the near term, as you are ramping, is there any incremental OpEx that you should be thinking about around startup costs, marketing, anything as you get to breakeven?

That's really embedded in the investments we're making back into the business. And so when we talk about SG&A, we do -- we are incorporating investments back in the business, investments in people like yesterday, investments in our process and technology and things like that. So we're trying to balance between giving investors a better SG&A as a percentage of sales versus firming up our foundation for the future. And so that's always going to be part of our philosophy.

[ To hire more people ], Mr. Chairman, do you want to add any color on the new hires?

Yes. Yes. So this whole idea of AVA Healthcare Partners, that is the IPA kind of really enterprise-wide, but really focused ex California. We do have members that we directly contract with inside California. But that's what -- that's the primary focus of Mark Kent, who's a great guy. You'll get to know him. and very, very experienced in this. He's run IPAs. He understands the payer side. He understands the provider side and nothing [indiscernible] them. And so he's going to be great. But that's kind of linked to the kind of this ex-California management and growth discussion. Shane Hochradel, really Chief Operations Officer, scale experience, experience with claim systems, experience with provider data, experience with end-to-end provider engagement at scale at -- from Elevance. And so he's joining us. So those are 2 key hires. The third person that you may not have heard of, but he's really our current Chairman of the Board, Joseph Konowiecki. And Joseph has been the strategic leader. And I asked him. I said, I really want you to leverage your experience and to help us grow and scale this business. So I asked him to do that, and he graciously accepted. And then to make sure that the governance structure maintained its integrity, I agreed to be Chairman. And I think the message to really the investment community is we're all in. We're all in. I shared with you 300,000 lives, $5 billion in revenue, $150 million EBITDA is, to me, a proof of concept. It's literally a proof of concept. And so we are now looking at strengthening all the foundational pieces we have in place and making them better to scale. And attitudinally, incentive-wise, I'm all in, Jim is all in, our Board is all in to get this to the next level. And that's really the signaling of that. It's a very positive thing that I think you should all think about. It's we all recommitting and committing to take this to the next level. I've said we're going to get to at least 1 million members. You all are asking by when. I'm going to say, I'm not going to tell you, but we're going to get there. And -- sorry. So it's a very positive thing.

That's great to hear. So maybe let's hit on AI really quick. So it's everywhere. You've had this AVA tech stack for a while. It's been kind of revolutionary right in the model. Maybe give us some use cases, where you are in that AI evolution. And then how much of this is sort of enhancing what you've already built in AVA versus ground-up kind of tools?

Yes. You probably noticed we've been intentionally quiet about AVA for the last couple of quarters. And we're doing that because of the intensity of work we are focusing on rebuilding the tech stack, taking what we have, which I still think is best-in-class and even making it better. We're not talking much about the details because we don't want anybody to know what we're doing. That's the net of it. We will share with you all the applications very shortly. But the stuff, the new technologies and the new models can do for us, it's staggering, both on MLR and G&A. I think the machine learning predictive analytical tools we have in terms of Care Anywhere and our stratification model feel pretty good. I think the new large language models are going to help us in all of the workflows that provide faster, more accurate, more timely data. And that data is going to help us have better outcomes within the predictive analytics. But I think you're just going to see the deployment of use cases everywhere in the company, you're going to start hearing us start using the word AI first. soon, and I'll give you a glimpse of that. But I think the opportunities there are going to be dramatic. I'll resuscitate a phrase that I heard from somebody a couple of years ago, which is, there's a lot of low-hanging fruit that we're going after, and there's watermelons rolling around the ground, remember that one? Well, I'm telling you, these AI tools are going to help us get those watermelons. And I think that will be reflected in better MLR and even tighter G&A, all of which are foundational for the bids. And I don't -- honestly, I don't know if there's anybody that can catch us once we can pull all this together.

All right. Well, that leads to, I think, what probably would be our final question here. So your '26 guide got you from an EBITDA perspective, kind of already in line with your national peers. They're growing faster than most of them. They kind of talk about margins in the 2% to 4% range now long term versus maybe 3% to 5%. Previously, you're already at 3%. You're still subscale. So what is it -- how do you -- how are you driving these structural advantages from a tech stack over your peers? And how high can these margins go longer term?

I think we've said 5% to 6%, right, Harrison. But you got to remember, you got this 85% rule thing hanging out there, right? So you can't -- you got to hit that 85%, and I think on a GAAP basis, closer to like 83.5%. But I think there's margin opportunity for us. But because of that, the way we get to the 85% are 2 ways, which is you got to have richer benefits, better supplemental benefits that foster growth and/or deeper partnership and with providers to pay providers more. And there's different ways you can do that, that just strengthen -- the key words should be durability, durability, right? So if you have great networks, great provider partners, and they're going to want to partner with you, which is what's happening in California. They all want to work with us because we're growing market share. That dynamic, I think you'll start seeing kind of get more and more real ex California, the more we grow. And for those of you that have been with us from the beginning, it's going to be more of the same. It's going to be balanced growth and margin, opportunistic depending upon what we see market by market. I think it's -- there's going to be the next generation of technology that we embed in our workflows. And we're getting people that have both the missional aspect that is very important to us and will always be central to our culture, but also have scale experience. And I'll close on just one point, Craig, which is I think we're proving that, that you can be mission-oriented and provide great returns for your shareholders. And I can tell you, our private equity guys, Warburg and GA are really pretty happy with their financial outcomes. And I think that when we get to where we want to be with all these changes that we've just talked about, you're going to be really happy with this as well.

All right. Well, thank you. I think this [indiscernible] time we have here.

Thank you, Craig. Thanks guys.