LifeStance Health Group, Inc. (LFST) Earnings Call Transcript & Summary

All right. Good morning, everyone. Welcome to the Goldman Sachs Healthcare Conference. I'm Jamie Perse, the healthcare provider analyst here. Our next session is with LifeStance Health, and we have Dave Bourdon, the CFO; and Monica Prokocki, VP of Finance and IR. Thank you, both, for joining.

Yes. Thanks for having us.

So I wanted to start just with a big picture question on where we are. We've been through kind of several phases of the company, very rapid growth as you guys scaled. The new management team has come in and really focused on operations and building a longer-term foundation. And then you've talked about longer-term acceleration. So where are we in that transition, specifically on the focus on building the foundation and what that's going to set up going forward?

Yes. We're -- I mean we're in the midst of it, right? So we've talked about the company as having 2 chapters. As you referenced, the first chapter was about explosive growth getting to scale, and that's what the founders, the original leadership team did, and they did a great job. And that got us to about a couple of years ago. And then what Ken and I, the CEO, talked about is we're in that second chapter and for us right now, it's fortifying the foundation, simplifying standardization and that getting to that operational excellence. And we're in the middle of that second chapter. We talked about 2023 and 2024 as invest years and again, fortifying that foundation. Here we're halfway through the second year. And we're still plugging away. And we've had some really great successes, we've -- from a people, process and tools perspective. We've made great strides in people. So we strengthened the leadership team with especially our practice operation. So the team that runs the business, the Vice President, Senior Vice President levels, all new leaders in the last couple of years. We brought them in from healthcare places like DaVita, places that they're used to running a multisite healthcare company. And they replaced what were previously founders who are used to really being entrepreneurial small sites. So we've done a lot with people. Process, I would say we're early stages, depends on what parts of the business, I'm sure we'll get into that more. And then on the tool side, 2 big things that we discussed previously were an HRIS system, which I know it's not very sexy, but to be a company of almost 9,000 to 10,000 employees and not have an HRIS system was causing all kinds of issues. We just delivered that on April 1 of this year. And then the second big investment is our credentialing onboarding platform that is in pilot phase in a few markets, and it's rolling out this summer.

Okay. Great. I guess where is this all leading to in terms of -- you've talked about once you have the operational infrastructure in place, then you could maybe go back on offense, maybe M&A, more sustainable margin expansion. Where is all this leading in terms of what it's setting up in 2025 and beyond? And is 2025 the year to think about that next stage?

Yes. Well, there's a couple of things there. There's margin expansion and then there's the growth aspect, the M&A. So first of all, from a margin perspective, 2023 and 2024 being invest years but we said 2023 actually stepped back from a margin perspective. We had the opposite of operating leverage. And we said that will be the last time that our expenses will grow at a rate faster than revenue. So we've -- we said as we get into '24 and beyond, we expect to deliver operating leverage and you saw that in the first quarter, which exceeded our -- even our expectations, but this was the year where it was the first time where we were going to prove it that we could grow margins and we did that in the first quarter. And I think we've put a pretty attractive guide out there for the full year. So overall, adjusted EBITDA margins will grow over 200 bps year-over-year. So that's that first deposit and margin expansion. We expect that to continue. And as we get into 2025, where we're able to reap even more benefits from the investments that we've been making. So that's on the margin side. On the growth side, what we had talked about last year when we were giving guidance for 2023. 2023, 2024, 2025, we expected to be able to do mid-teens organic growth. And so we turned off the M&A engine because we were -- again, we wanted to fortify the foundation and acquisitions were introducing a lot of disruption. And we wanted to really get the foundation strong before we consider those again, number one. And then number two is, we said we'd be free cash flow positive in 2025. And once we are free cash flow positive, we would become more acquisitive. We've now accelerated that to where we believe we'll be free cash flow positive this year. So as we get into next year, what are we going to do around deployment of capital, which is I think really the heart of your question is. I think I've been in priorities. It's fund internal growth, it's inorganic and then the last would be if we can't find a high ROI opportunity, then we return excess cash to shareholders. So I think next year is the year where we will become acquisitive and one thing I would highlight is, it will not look like it did in the early days of LifeStance. It's not going to be scaled, practice scale buys. This is going to be -- it will be much more strategic. We already feel like we have the scale that we need, where it's now about growing density in the place of the 33 states that we're in. And we'll -- and so we'll be much more disciplined in what we buy, if we're buying a practice. I could see us doing -- also doing things like some acquisitions around the adjacencies. So your neuropsych testing, TMS, ketamine, Spravato. Things that are those higher revenue, higher-margin services, better adjacencies that kind of round out what we're able to deliver to the patient. I could see us doing things in those spaces to accelerate growth.

Okay. Great. Let's talk about the clinician piece for a minute. That's -- obviously the core of the company is clinicians. It's a very competitive market for these folks. They have a lot of alternatives in terms of where they could work, how they can generate an income. One of the early challenges coming out of the IPO was turnover and the early pitch was the value proposition to clinicians. And I guess with a high rate of turnover of clinicians, it's not obvious that that's super differentiated versus the market. So where do you think you are in terms of delivering on that promise of a value proposition to clinicians? And how do you measure that internally?

All right. I'm happy to take that. So we do expect to see improvements eventually from the efforts and the investments that we've been making. And totally agree with you that while turnover hasn't gotten better, it has been what we would describe as stubbornly stable. So there are several key elements to the value proposition that we provide for clinicians. One of those is flexibility for clinicians to determine their hours, working remotely versus in one of our centers. Additionally, we provide administrative support. So acquiring patients for our clinicians, billing, scheduling, they can really focus on patient care. Additionally, we also have the multidisciplinary model where clinicians can refer internally to one of our other thousands of clinicians and the unique benefits that we offer, including health benefits, 401(k) match, and long-term incentive program. And our benefits are really focused towards our full-time clinicians. So our value proposition has resonated and that's been demonstrated through our continued clinician growth, but we still have more work to do. And so for example, on the administrative support side of things, we continue to invest in billing. We're making major investments in our front office staff. And one thing that we would also want to note is that there are some things that we are doing that clinicians may not love. So for example, on the health benefits enforcing that the hours for that need to be full time or raising the bar in terms of our long-term incentive program. Those are things that can kind of offset some of the areas that we're actually enhancing the clinician experience. So in the long run, we really want to focus on being the employer of choice and we'd like to see retention continue to improve over time, but that's a bit of a long game. And again, within the market, I don't know that our retention is any worse than other players; potentially better.

I guess if we're to break it down into 2 buckets, there's sort of just day-to-day and then there's a financial component, is the right way to think about it that clinicians can make a competitive compensation, no real differentiation versus the market long term, but competitive. And then all the clinician benefits are on the operational day-to-day side, administrative support, a network of clinicians they can refer to internally, that sort of thing. Is that the right way to think about it? Or any more color on the financial side?

Yes, that's a good way to think about it. So our model is unique in terms of our clinicians being W-2 employed paid on a fee-for-service basis and for the full-time clinicians being offered the benefits as well. So compared to salaried models, one of the advantages that we offer is greater flexibility compared to clinicians who are in private practice. We provide that additional administrative support so they can focus on the clinician care and then also provide insurance coverage. So as you know, much of the market is still cash pay. We don't view that as sustainable in the long term. I think more and more patients are going to demand that they be able to pay for their mental healthcare the same way they pay for the rest of their healthcare with -- through insurance. And so those are some of the things that we offer clinicians, but we really focus on being market competitive when it comes to compensation overall.

Okay. And I guess, where are we in the -- there were a couple of buckets of focusing on improving clinician productivity, their capacity, the pipeline. What's the status of the strategy in terms of recruiting clinicians, building the pipeline, bringing them on internally and then supporting kind of steady capacity growth in terms of the hours they're able to offer?

Yes. So first of all, the recruiting engine remains strong, right? So we grew our clinician base over 1,000 clinicians last year and with turnover being stable, you can think of that as that's new starts and really being the strength there. Stepping into the first quarter of this year, same thing, 220-ish clinicians added, again, not because of higher retention but because of stronger recruiting. So that pipeline and that engine is still going really well, which, again, validates that our value proposition is strong in regards to the recruiting of clinicians. In regards to capacity, first of all, as we're recruiting new clinicians, we are recruiting full-time clinicians. So they're giving us -- by contract they're supposed to be giving us 35 to 40 hours, depends on the market, at about 35 to 40 hours. We define for benefit purposes that they have to give us at least 30 hours. But that is who we're targeting. So unlike many of our competitors, that they're willing to take a couple of hours a month or a couple of hours a week, we're focused on getting those full-time clinicians. And then where the new work is for us from an operational perspective is then working with that clinician to make sure that we're effectively ramping their calendar when they join and that they continue to give us those hours. And so that's from an operational perspective. Sure, we're doing things like for the first time in the history of the company, enforcing the full-time requirement to be able to get benefits. So previously, if you were a part time, you got a 401(k) match. It didn't matter how many hours you did, and you were supposed to work full time to be able to get health benefits, but we didn't really define that for the clinicians and we didn't enforce it. So those are examples of things we're doing to really get to driving increased capacity. Once we have that increased capacity, then we have to match the patient demand into that to be able to get the improvement in productivity.

Okay. Let's talk about just the recent financial performance, broader operational performance, just reported 1Q 19% top line growth. I think that's the sixth quarter of upside from revenue since the new management team took over really. I guess talk about the sustainability of that, especially in the context of how you've talked about the cadence for the year. It sounds like we should be modeling a slowdown in the back half of the year and then you've guided to the mid-teens organic growth. We're above that -- just talk about the drivers of the pressure you expect for the rest of the year and sustainability of the top line cadence?

So I'll kick off with just the drivers for the first quarter. And then maybe Dave can kind of add in terms of how that plays out for the rest of the year and some of the dynamics there. But in the first quarter, we grew revenue 19%. One component of that was 15% year-over-year visit growth, which was primarily the result of a 15% growth in net clinician adds. The remainder of that was driven by a 4% rate increase from payer negotiations. Dave, do you want to...

Yes. We can -- I mean so first of all, as we think about the year, Jamie, what we usually talk about roughly is revenue being 50-50 first half, second half, all other things being equal. And the reason for that is our model is unique. Again, we are W-2 -- our clinicians are W-2, but they're a fee-for-service, so they get paid for the visits they do. So what you end up happening in the back half of the year, you have the summer vacation season, which straddles a little bit of Q2, but it's mostly a Q3 dynamic. And then you have Thanksgiving through New Year's holidays. And so while we're continuing to grow our clinicians throughout the year, the productivity will dip in the back half of the year naturally because of the vacation season. So that's the first thing is when you start with the kind of the revenue at 50-50, all of the things being equal. And then the other dynamic that we have this year that's unique that we talked about on the earnings call is we do have a large national payer whose reimbursement level is going to go down. They're at a very high premium to their peer group today, and they'll be coming down to at par with their peers, and that really kicks in at the beginning of the third quarter. So that's a dynamic. Puts a little bit of revenue pressure, obviously, but that revenue is also dollar for dollar hit to the bottom line. So that's why the margins in the back half of the year, while again at 7% is consistent with our initial guide for the year, it's not as attractive as what we saw in the first quarter.

I'm going to come back to the payer thing in 1 second. But just on the cadence in 2Q, you guys talked about lower clinician adds. And I think the average has been right around 220 the last 4 quarters or so. I can already imagine the calls when it's 150 or whatever in the second quarter. Talk about the seasonality dynamic with lower clinician adds in 2Q. What should we be expecting, and your level of confidence that would reaccelerate in the second half?

Sure. So this is a bit of a similar dynamic that we saw last year where Q1 stepped down to Q2 in terms of the net clinician adds. And one of the drivers of that is that while new grads aren't the majority of our clinician base, there is a seasonality to when they join. So they're one of our sources of clinicians. So they'll typically finish their programs in Q4 and then start in the first quarter or they'll sign with us in the first quarter, finish their programs in Q2 and then start in Q3. And so we see a little bit of a dip in terms of some of the clinicians who are starting in Q1 or Q3 that are coming out of their programs. We did see that reverse last year, and we expect similar this year in terms of those new grads who are finishing in Q2, starting in Q3.

So would the -- would looking at last year's agents give us a good indication of...

Directionally, it should. It provides.

Okay. And then on the payer step-down in rates, I guess, first, big picture, are there any other rates that are out of proportion with others, either positively or negatively? And then on this specific payer, I don't imagine you want to talk in too much detail about very specific payers. But what can you say in terms of the magnitude of the step-down or how this sort of developed in terms of them identifying this opportunity and the negotiation process?

Yes. So the -- so you're right. So we won't use any payer names, but think of it as a big national payer. And -- what -- I mean, I think everybody who follows that space knows that majority of them that have large MA books are under a lot of pressure right now with loss ratio. And so I think that they were reviewing all of their provider contracts and realized that we were out of market relative to their reimbursement level to other mental health providers by significant amount. And so they exercise the contractual right they had, and we ended up -- we negotiated. And again, they're coming down to being on par with their peers. It's -- from a magnitude perspective, I would say it's significant because if it wasn't, we wouldn't be talking about it, right? And so you will see a step-down in our rate per visit in the back half of the year and it's the result of this payer contract. Otherwise, you wouldn't expect our total rate per visit or TRPV to have a step-down from first half to second half. And it's also why we were saying that the margin performance in the first quarter isn't enduring through the remainder of the year. So it's significant. And it is what it is. Now in regards to overall payer contracting, our batting average has been really good. So this is the only payer whose rates have gone down or will go down in my 1.5 years as CFO. The -- so this is -- we just say this is a bit of a unicorn scenario to have a large national payer whose reimbursement level is so out of whack with everybody, all of their peer group, I mean that just doesn't happen that often. So that's -- so it is a bit of a unicorn. I would say there's no other national payer whose situation is like that. Now your -- other part of your question was kind of the variability of rates. So is there -- are there others that are out there that are really good or really bad. I talked about the -- there's not others that are -- have a dislocation from a really good perspective. There are low-paying providers, so -- low-paying payers. And at our market level, so if you look at it from a state perspective, we still have a tremendous amount of variability, more variability than we would like. And obviously, our goal is to bring the ones that are low up and improve the average. And so that's what we've been focused on. And we've been successful in large part doing that. And again, we've only been at this for 1.5 years. So we didn't have a payer contracting or engagement team. That was one of the investments we made last year. And so it's still early days on payer, but we have a lot of successes, which are partially mitigating this one situation, but obviously not enough to be able to fully cover it.

Okay. And Ken talked about meaningful upside opportunity in rates longer term. Is what he was talking about this narrowing the variability, bringing the low end up? Or just talk to us about the broader market dynamics. I think those who appreciate the supply and demand dynamics and that there's a lot of demand for mental health, how does that -- just along with your scale as well, how do those dynamics factor into the long-term negotiating power you have and how that translates to [ rates ].

Yes. So this year, we'll do -- maybe go back to last year. Last year was a low single-digit rate increase. And that was really -- we had some benefit from our payer team, especially as we got into the end of the year where we saw some lift in rate per visit. The -- but it was -- we just started doing it. So that was -- we had low single-digit rate increase last year. We come into this year first quarter, it was up. Our rate per visit was up 4% year-over-year. So we're starting to get into that mid-single digits. Now it's going to come back down for the full year to low single digits because of this one payer that we've talked about. But for that, we would have been into the mid-single digits, and that's where Ken and I think will be long term. We're going to have a bit of a hangover on this one contract negotiation into 2025. Next year, I would expect, again, like low single digits. But as we get into 2026 and beyond, we do expect that we'd be up into that mid-single digits, and that will give us opportunities for margin expansion.

Okay. Let's go to profitability, the performance in 1Q. You guys beat by $8 million. You raised guidance by $8 million. So the rest of the trajectory is unchanged. I guess there's 2 pieces of it. I think maybe you can fill in some of the gaps. You've got this payer issue you've talked about that's pretty obvious. And then you said you had some delayed expenses that my understanding is the run rate expenses. They didn't happen in 1Q. They're coming online in 2Q. So you just -- you got an extra quarter of benefit from this delay. Are those the 2 pieces in terms of the margin guidance being down for the balance of the year relative to the -- and any help on kind of sizing those 2 pieces?

Sure. That's a fair way to think about it. So as you said in the first quarter, we achieved adjusted EBITDA of $28 million versus our guidance of $20 million. That was primarily driven by our center margin beat, which was primarily driven by spend savings. There are a few elements there, but I would say the biggest thing that I would point to is the front office investment kicking in more in the second quarter versus Q1. And when you think about Q1 to Q2 and how you bridge between those, it's really a combination of that front office investment kicking into the second quarter as well as the annual pay increases that we provide to our clinicians and team members where the full effect is in that second quarter. So the way that I would think about it and I think as Dave has communicated, the remainder of the year is just still very on track with what we originally guided, and we're flowing through that Q1 benefit.

Okay. And I guess just to make sure I understand, the step-down in -- embedded in guidance is about 170 basis points from 1Q to 2Q. It sounds like the payer rate is more of a 3Q timing. So the investments, the center level spending, that's what's driving the...

Yes. Center level spending. So it's a combination of the annual pay increases as well as the front office investment.

Okay. Okay. That's helpful. And then implied margins are, I think, 8.5% for the second half of the year. I guess -- is that the right run rate to think about stepping into 2025? Or how should we think about the trajectory as you get to this exiting 2025 with a 10% margin?

Yes. So I think of -- so I have a little different number. I would think of the back half of the year at around 7%.

8.5% for first half, 7%?

Yes. You're getting ahead of me on the margin level there. So 8.5% in the front half, 7% in the back half, and we talked about earlier was that a lot of that is the payer rate impact that we've discussed. It's also that you just had this outperformance in the first quarter that's not going to repeat. So that gets us to the 7%, which is consistent with our original guidance for the year. So again, we're playing out as we expected, and so I think of that as that's -- yes, that's our stepping off into next year. Again, we're very comfortable with the -- with our guidance -- our multiyear guidance of saying we'll exit next year with double-digit margin.

And that's not a peak. That's -- you'll continue to expand margins beyond that exiting 10%.

That's right. So all we've done is given 3 years. So it was my first earnings call, it was the fourth quarter call last year, and we wanted to give a little bit of a view into the multiyear because the last time we had done anything was the IPO and that math -- Ken and I didn't agree with that picture. So we want to at least set the stage for '23 through '25, '25 exiting double-digit margins coming from like 5.5% last year. So meaningful step-up. A lot of the drivers of the margin expansion, whether that's payer rate increases, operating leverage or a growth in these higher revenue, higher-margin specialty services, those that are driving this through 2025, those remain and will continue into '26 and for years after that. So we feel really good about the opportunity to expand margins for the future.

Okay. And what's your assessment of just the real estate footprint and how it fits into the broader strategy of telehealth versus in-person? Are there still centers you think you can identify that where you can consolidate around a market and then the longer-term kind of forward view on opening new centers. How does that all kind of fit together?

Yes. So last year, we did a big initiative around rationalizing our real estate footprint. So we started with over 600 centers for the year. We added 35, but we [indiscernible] closed over 80. And that was [indiscernible] done anything like that. For the most part [indiscernible] take footprint. So almost all the other centers [indiscernible] necessary based on our view of clinician and patient needs. Now where we still have a lot of opportunity because we're at roughly 70% -- a little over 70% virtual right now is that we still have the opportunity at centers to add more clinicians without having to add more real estate footprint, right? So [indiscernible] days pre-COVID, every clinician had an office because they were at almost 100% in-person. So if you wanted to add a clinician, you had to add real estate. That's no longer the case anymore. So we are being very measured in our adding of new centers. We'll add less than 20 this year, whereas if you go back to pre-COVID and early COVID, we were doing, let's say, 100 -- over 100 a year. So we'll be below 20 this year. And again, we're only adding when we're running out of space.

And is that mix of in-person versus telehealth, is that what you expect to persist long term? Or is there any benefit to trying to shift it in one direction or the other? How are you thinking about the long term?

Yes. We're letting it naturally take its course. So we are not trying to push it. What we are seeing is patients -- the demand from patients is increasing for in-person, especially for that first appointment. So the first appointment in-person level is about 10% higher than our overall book virtual versus in-person. So we're seeing that demand for in-person for that first appointment to be really strong. And again, and it's just continuing to gradually creep up. We don't know where it lands. Is it like -- is it 50-50? Is it -- we'll see, but we have the flexibility with our current footprint and with our continued clinician growth to kind of see where it goes. But that's a big -- it's a big differentiator for us with hiring of clinicians, and it's a big differentiator with patients, too.

Okay. Last few minutes here. I want to touch on some of these financial commitments and then just the capital allocation discussion. So we've talked about the mid-teens revenue trajectory that you've committed to through 2025. The back half guidance is low double digits and then an implied acceleration. Just give us [indiscernible] the mid-teens growth trajectory? And then we've been kind of discussing what things look like beyond that is, where do you go beyond 2025 when you're starting some of the deliberate M&A, not like the early days of LifeStance, but give us a sense of how to think about that.

We feel good organic engine can deliver mid-teens growth. Now last 23% [indiscernible] organic was above our expectations. But we feel good that our engine can deliver mid-teens organic. Remember, we're -- in the scheme of things of all the clinicians that are out there, we're still in the single digit from a market share perspective. So we have a lot of room for growth. So we feel good about that from an organic engine perspective. And then obviously, M&A is then on top of that.

Okay. And if you're growing mid-teens, I mean, what do you components of expense need to grow to support that longer term? So thinking about the 10% exit point of 2025, what does G&A need to grow? Obviously, you've got a lot of variable expenses with the clinician side of things. But how do we think about just starting from 10% and what operating leverage looks like.

And you're talking about like 10% margins? Is that...

Yes. Yes.

So I think about -- so I'll flip your question a little bit. So talking about margin expansion after we get through 2025. And we touched on it a little earlier that payer rates, operating leverage and the specialty services, those will continue to drive higher margins. That will show up -- a lot of that will show up in center margin, right? So it's actually going to -- so you'll see center margins, which are right now in the 30%-ish, low 30s, you'll see that will actually improve, which will obviously improve EBITDA margins. And then yes, we will see operating leverage with G&A. We haven't like -- we said, all right, well, is G&A growth going to be half of revenue growth or 3 quarters of revenue growth. It will depend on the year and rate and pace of investments. But what we have pledged is that we will deliver operating leverage every year.

Okay. One very quick one, just the change health dynamics. How is recovery of the AR day build in 1Q?

Yes. So we talked about in the last earnings call that we expected it to be primarily a Q2 recovery bleeding a little bit into Q3. And to be clear, we view it as a timing issue. It's not a -- other than some additional administrative expense, we expect to fully recover the revenue that's due to us. We had a strong start to the quarter as far as recovering that cash. But it's taking time. I mean, there are still payers today that are not fully connected back to change. So that obviously -- that impacts whether it creates an administrative burden as there's extra steps or we have to find a different mechanism other than change to get the reimbursement. But we feel good that it is a timing thing and it will play out over the coming months.

Okay. Last question, I'll sneak in. You've reiterated the free cash flow positive this year and 2.5x levered. That's a pretty good position to be in. How should we think about use of free cash flow and as you get into the longer term with a clean balance sheet and free cash flow positive?

Yes. I mean it's the -- again, you're back to is, first, we'll fund internal growth. I mean I think of the things like the de novo, the new center builds, but we'll fund internal growth, and then we'll look for M&A opportunities and we expect that they'll be out there. But if there's not high returning ones that meet our bar, then we'll look at other sources or other ways to deploy the capital. Normally, you'd think of returning it to shareholders. We have had some investors suggest -- our interest rates on our debt right now are pretty high. You do something there even though the leverage ratios are healthy or will be healthy as we get to the end of the year. But we're still working through that. But I think of the first 2, funding internal growth and M&A, is likely where we're going to be going in deploying of capital.

Okay. Great. I think we can leave it there. Thank you both for joining.

Thank you.

Thank you.