InnovAge Holding Corp. (INNV) Q3 2022 Earnings Call Transcript

InnovAge Holding Corp. (INNV -0.98%)
Q3 2022 Earnings Call
May 10, 2022, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and thank you for standing by, and welcome to the InnovAge fiscal third quarter 2022 earnings conference call. [Operator instructions] Please be advised that this call is being recorded. [Operator instructions] I would now like to hand the conference over to your host today, Ryan Kubota, director of investor relations. You may begin.

Ryan Kubota -- Director of Investor Relations

Thank you, operator. Good afternoon, and thank you all for joining InnovAge's fiscal 2022 third-quarter earnings call. With me today is Patrick Blair, president and CEO; and Barb Gutierrez, CFO. Dr.

Melissa Welch, chief medical officer, will also be joining the Q&A portion of the call. Today, after the market close, we issued a press release containing detailed information on our quarterly results. You may access the release on our company website, innovage.com. For those listening to the rebroadcast of this call, we remind you that the remarks made herein are as of today, Tuesday, May 10th, 2022, and have not been updated subsequent to this call.

During this call, we will refer to certain non-GAAP measures. A reconciliation of these measures to the most directly comparable GAAP measures can be found in our third quarter 2022 press release, which is posted on the Investor Relations section of our website. We will also be making forward-looking statements, including statements related to our remediation measures, including scaling our capabilities as a provider, expanding our payer capabilities and strengthening our enterprise functions, future growth prospects, the status of current and future regulatory actions, and other expectations. Listeners are cautioned that all of our forward-looking statements involve certain assumptions and are inherently subject to risks and uncertainties that can cause our actual results to differ materially from our current expectations.

We advise listeners to review the risk factors discussed in our Form 10 [Audio gap] annual report for fiscal year 2021 and our subsequent reports filed with the SEC, including our quarterly report on Form 10-Q for our fiscal third quarter 2022. After the completion of our prepared remarks, we will open the call for questions. I will now turn the call over to our president and CEO, Patrick Blair. Patrick?

Patrick Blair -- President and Chief Executive Officer

Good morning. Thank you, Ryan, and thank you all for joining us today. Before jumping in, I'd like to again express my gratitude to our InnovAge employees who put our participants at the core of what we do every day and for their selfless contributions during a difficult time, our federal and state partners for their partnership and support as we work through the audits, and to our shareholders for their continued interest in the company. There's a lot to cover today, so our prepared remarks will be a bit longer than usual.

It's a challenging period for InnovAge, and this quarter's results reflect the significant transformation we're undertaking. I'm confident we'll manage our situation the right way, and we're optimistic about the company's future, both in terms of the markets we serve and the solutions we offer. While the current sanctions represent a major challenge, I'm genuinely excited about the market opportunity, the foothold we have in important markets are incredible paced clinical expertise and the amazing employees who are proud to work at InnovAge. I've been encouraged by our progress over the last 90 days.

And while it's certainly requiring a lot from them, it's clear that our employees have the motivation and ability to overcome the challenges we're facing. Their efforts are frankly inspiring and the improvements, while still early, are becoming visible. As you know, we're currently under sanction in our Sacramento Center as well as our six centers in the state of Colorado. As a result of these sanctions, we're currently unable to grow our census in these markets.

We're following the lead of CMS and state government partners and working with them to ensure they're satisfied completely with the work we're doing to address the audit findings. The regulators determine the time line for the audit process, and we're doing everything we can to satisfy the requirements to lift the sanctions. I will provide a detailed overview for each of our markets, but suffice it to say, these learnings through a difficult period will make this organization a more disciplined and compliant organization in the long term. Today's discussion is going to focus on near-term operational execution and mid- to long-term capability development.

These are the core drivers of horizons necessary to comprehensively remediate the deficiencies identified in our recent audits. And equally important, they are the foundational building blocks to ensure we're well-positioned for scalable, sustainable, long-term growth. As a leadership team, an organization and with the full commitment of our board, we're defining success and holding ourselves accountable across both horizons. My objective today is to delineate and to put into context the full portfolio of actions we're taking.

On our last call, I've been in the CEO seat for 30 days. It's now been a little over four months. So I'm going to begin with some current reflections and follow that with updates on the critical work underway and the progress to date along three dimensions of remediation and transformation, which encompasses what we're calling One InnovAge. The status in each of our markets with our regulators, perspectives on the quarter, and concluding thoughts.

I'll then turn it over to Barb to provide a detailed financial overview before we open it up for questions. To help bridge from our last call, I'd like to anchor back to some observations shared in February as I was first immersing myself in the audit results and business operations. I committed then that my immediate highest priority was to address the audit findings and to restore our regulators' trust in InnovAge. Now with an additional 90 days under my belt, I'm in a much better position to provide additional granularity on what must change.

I've spoken with employees, government partners, and reached out via personalized letter to all 6,800 participants asking them for feedback on how we're doing. This has led to not only a more detailed understanding of identified audit deficiencies and associated root causes, but also the specific transformational actions required to support the lifting of sanctions. The PACE program is unique, and the core program design requires both provider and payer competencies to participate. We're assuming both full underwriting risk for our participants and managing the delivery of care for a very high-acuity population.

I want to distinguish between the provider and payer attributes as the capabilities to be best-in-class differ. And in the case of InnovAge, each dimension needs to be robust and seamlessly orchestrated to be successful at a national scale. On our last call, I communicated my belief that InnovAge possesses a sturdy foundation and tremendous potential. I still believe this.

But now with more time in the business, it's also clear that to enable a consistent, scalable platform, our capabilities as a provider and a payer, respectively, require enhancements and need to evolve. I also believe that payer capability enhancements represent incremental opportunity, and I will share more detail on our plans to execute against this dimension. Now for the critical work underway. The portfolio remediation and transformation work, what we're calling One InnovAge, has three key dimensions, and I'll use these as a framework to provide progress updates on this in future calls.

They include: first, creating operational excellence as a provider by formalizing a repeatable blueprint to deliver personalized, integrated, yet distributed care in our centers, virtually and in the home; second, expanding our payer capabilities to ensure we're effectively managing the total cost and quality of care and that our revenue accurately reflects the acuity of the populations we serve; third, strengthening enterprise functions to enable our centers to reach their full potential through robust talent management, data and analytics, sales and marketing, and government relations, underpinned by a uniform way of working and success metrics. Let me walk through each of these dimensions in more detail to give you a flavor of our key areas of focus and where we are currently. First, operational excellence as a provider. First and foremost, our primary focus continues to be addressing the deficiencies identified in recent audits in as rapid a time line as possible and returning to growth in the mid- to long term.

The audit results have found gaps in our performance when compared against regulatory and our own expectations. In February, I categorized the nature of our compliance deficiencies into two broad buckets: care coordination and care documentation. Over the past 90 days, my understanding of each identified deficiency, the root causes and the critical capabilities needed to become compliant, have come into a much sharper focus. To elaborate, I've established eight initiatives that are intended to support the remediation of audit identified deficiencies and earn back the trust of all stakeholders: one, filling critical personnel gaps at each of the centers.

It all begins here; two, standardizing the process of our interdisciplinary care teams who plan and coordinate and deliver care; three, strengthening our home care network and reliability; four, improving timeliness of scheduling and coordinating care with providers outside the centers; five, improving our telephonic channel response times and closing critical communication groups; six, improving the efficiency and reliability of transportation for our participants; seven standardizing our wound care program across the enterprise; and eight, reducing documentation outside of the EMR. Importantly, we've been proactive in the broad implementation of these consistent operational processes at each of our centers to ensure identified deficiencies are resolved and do not recur anywhere in our portfolio. We're making solid progress on all fronts and expect to complete our short-term objectives for these initiatives by calendar year-end. Second, dimension two is expanding our payer capabilities.

As mentioned earlier, PACE is a unique, value-based, risk-bearing model that requires excellence at both provider and payer competencies to serve this population at scale. Historically, PACE programs are primarily focused on care delivery side of the equation, and the same is true at InnovAge. This creates an opportunity to better manage total cost of care and ensure we receive appropriate payment for services provided. The core payer capabilities I'm describing include effectively managing provider networks and contracting to optimizing the costs, leveraging evidence-based guidelines and rigorously optimizing quality, value, and utilization of services, ensuring we're paying external providers appropriately for billed procedures, and accurately matching risk-based payments with the acuity level of our participants, to name a few.

To be clear, these capabilities exist within InnovAge today, but the scorecard is mixed. We compare well to other PACE programs on utilization measures like ER visits, admits, conversion of inpatient days to observation days, and we're proud of this. But we're also looking to benchmark ourselves on quality outcomes and cost against all other best-in-class, value-based providers serving frail senior populations on a fully capitated basis. Given its importance, we're actively starting down the path of building a comprehensive payer capability road map and an actionable portfolio of quick hit and longer-term initiatives with help from a specialized consulting partner.

This outside-in perspective is important, and it will take time to size, implement and for its benefits to fully materialize in our P&L. We'll provide further updates on future calls as we continue to get our arms around the range of incremental value at stake and what's needed to begin to capture it. Three, building the right enabling enterprise capabilities to empower the centers. Lasting gains from remediation and transformation efforts will hinge on the development of a handful of critical enabling capabilities at the enterprise level.

Starting with talent. Focusing on talent will be core to everything we do as our success starts and ends with having the best people in every job. Therefore, we're building a robust talent engine to attract, retain, develop, and recognize our people. To that end, we've made progress this quarter in adding key executives to our team to help broaden and deepen our leadership across several important areas.

Enterprisewide, we've added approximately a hundred net-new FTEs despite the tight labor market for healthcare talent. As is also natural at times of major change, we have had a few leaders who have left our team or will be leaving imminently. As referenced in the press release, Dr. Melissa Welch, InnovAge's chief medical officer, has announced her intent to pursue opportunities outside the organization.

To ensure a smooth transition, Dr. Welch has agreed to remain in her current role through mid-June. Dr. Ann Wells, our current chief medical officer for population health and quality, will assume the role of interim CMO upon Lisa's departure while the company completes its external and internal search for a permanent replacement.

I want to personally thank Melissa for her numerous contributions to the organization, especially during COVID, and meaningful impact on our participants. I wish her the very best in her future endeavors, and I would also like to thank Ann for assuming this critically important interim role. Next, technology. With people as our True North, our initial focus is on technology to make our people more productive and efficient.

Right now, we're focused on the basics: reducing fragmentation across systems and tools, infusing more data and insights into decision-making, and automating manual tasks. Marketing and enrollment. Once the audit-identified deficiencies have been fully remediated and our operational processes are all in place in all centers, it's imperative to our mission to continue to serve more PACE-eligible participants. I'm confident our transformative efforts on this front will position us well to increase our center-level organic growth rates in a postsanction environment.

Government and public affairs. I spent considerable time engaging with our regulatory partners to ensure they have full access to me, have regular opportunities to provide input and direction, and can readily observe the results of the changes we're making. We recognize that some of our state partners were disappointed in us, and it's our job to restore their trust and confidence. We're doing this through a commitment to transparency, responsiveness, and accountability, and I'm highly encouraged by the collaboration and positive feedback from CMS and our state partners.

Culture, communication, and organizational alignment. Chief among building an aligned and engaged workforce is cultivating the One InnovAge mindset and organizational culture, providing regular transparent and inspiring employee communications, establishing easy-to-understand organizational priority pillars and connecting everything to a balanced scorecard to measure collective success as an organization. Cost structure. Lastly, as you would expect, we've identified opportunities to better align our cost structure to support the self-funding where possible of new investments, investing more in field-based functions and running more efficiently in some corporate areas, for example.

We're looking very closely at non-center level cost, nonlabor and overhead cost, procurement contracts and capital assets to ensure we're operating at optimum efficiency. We believe there is opportunity, and every bucket is under scrutiny. To this end, we've already begun to streamline our teams and reporting structures, creating clear lines of accountability across the P&L, which we expect will result in faster decision-making, greater focus, accountability, and operating together as One InnovAge. I'll now provide a brief regulatory status by market.

In Sacramento, we continue to execute against the corrective action plan that was accepted in January. Since February, we've progressed significantly in our performance against the key criteria that CMS and DHCS will use to measure our progress against the audit findings. In Colorado, we're pleased to share that CMS accepted our corrective action plan in late April. We're responding to the state of Colorado's remaining questions on our submitted cap, and we believe that our plan will be soon accepted.

If approved, the activities are likely to follow a similar time line to that of Sacramento, which began three months prior. In New Mexico, we received formal feedback from CMS in March that based on the results of the audit, which are consistent with those of Sacramento and Colorado, we have been referred to enforcement. We're currently awaiting feedback from CMS on next steps. In San Bernardino, we received an audit request from CMS and DHCS in February and received preliminary findings in mid-April.

The high-level findings are consistent with the deficiency cited in Sacramento, Colorado, and New Mexico, and we're working with both agencies on the specific timing of a corrective action plan. At this time, our Pennsylvania and Virginia centers have not received request for audits. However, we are proactively enacting enhanced compliance ahead of any formal request. In Florida, we've committed to CMS and AHCA that we'll proactively pause the remaining steps in the expansion process to allow us to focus exclusively on resolving our active audit issues and cannot yet determine if a launch in fiscal year '23 remains viable.

We're still not able to estimate when existing or forthcoming sanctions will be lifted or the timing of future audits in Pennsylvania and Virginia. Our regulators will determine the timing of audits and sanction release once we've met all the criteria. As mentioned earlier, we're in regular communication with our agency partners around the status of existing audits and how best to collaborate with respect to our other centers. In the meantime, we plan to focus on proactively remediating deficiencies across our entire portfolio.

With that, I'll transition to a review of the third-quarter business results and drivers. We reported revenue of $177.4 million, which represents a sequential increase of 1.1% compared to last quarter. We ended the quarter serving approximately 6,800 participants, which represents a sequential decline of 3.5% compared to last quarter. We also reported a center-level contribution margin of $28 million and a corresponding center-level contribution margin ratio of 15.8%, which represents a decrease of 32% sequentially when compared to second quarter fiscal year 2022 and center-level contribution margin of $41.4 million.

We spent the last month analyzing the attribution of these results, and I will summarize the core drivers as net census decline resulting from the sanctions. Elevated external medical expenses, which were primarily driven by the lingering impacts of the omicron variant. Specifically, omicron increased the utilization and unit cost of inpatient days and ER visits and noncommunity respite stays and skilled nursing and assisted living facilities relative to historical averages. We are also seeing the impacts of higher acuity.

Given the frail nature of our population, average acuity rises with the passage of time. The risk pool of our population has become more acute as we have not replenished our population mix with newer, lower-acuity participants. Higher general and administrative expenses as a result of investments we're making on the provider side to accelerate the remediation of the identified audit deficiencies and onetime costs associated with third parties and restructuring. These results are disappointing and frankly below our expectations.

As a leadership team, we understand that we must do better. We are set up to benefit from scale, and this will be a great attribute for InnovAge in the future. However, performance this quarter highlights the financial impact of not growing our participant base coupled with elevated direct and indirect costs that are largely attributable to COVID. Given what we've observed in the quarter, along with larger initiatives in flight, I wanted to spend a minute on our margin profile.

In the near term, we are making investments across the eight provider initiatives referenced earlier to strengthen the platform as rapidly as possible to ensure our centers have the people and tools needed to be compliant and successful. Somewhat offsetting these additional expenses in the near term will be the efforts across our G&A reductions. As transparency is my ongoing commitment to you, I want to acknowledge that I expect there to be net margin compression in the near term until we close critical gaps and strengthen the foundation. What I can say is that the company is putting in place strong SG&A controls and the discipline to leverage our fixed cost base.

It remains too early to forecast exactly how these will net out in the long term, particularly since we have not yet quantified the potential long-term impact of the payer initiatives, but we will continue to hold ourselves accountable to an attractive long-term margin profile. I began the call noting that our priorities encompass both near-term operational execution and mid- to long-term capability development. So to summarize, job one and my commitment to our participants, employees, government partners, and shareholders continues to be doing everything necessary to be released from sanctions and to avoid future sanctions by proactively fortifying our foundational operational processes on an organizationwide basis. This work is largely about becoming a better provider, and we're making measurable progress on this objective.

Second, the opportunities to manage the total cost of care by becoming a more sophisticated payer will be a mid- to long-term objective. Further, as an additional part of this horizon, we're committed to building the tools, technology, and cultural elements needed for a highly engaged workforce. While our confidence increases by the day, it's important to acknowledge that we have a long way to go. As I said before, with the right leadership, focus, execution, and ownership and accountability, we will build a stronger InnovAge.

I've been fortunate to have been associated with organizations that have successfully navigated periods like this, and the businesses emerge stronger. There's nothing more important than ensuring we are consistently delivering outstanding care to our participants. What's more, I believe, an unwavering focus on people, service, and quality will lead us to the performance we aspire to and earnest the right to serve more deserving PACE participants across the country. Again, I want to sincerely thank you, our regulatory partners and our employees for your support.

And with that, I'll hand it over to Barb.

Barb Gutierrez -- Chief Financial Officer

Thank you, Patrick. I will provide some highlights from our third-quarter fiscal year 2022 performance. Given the impact of omicron during the period, in some cases, I will refer to sequential comparison to our second quarter of fiscal 2022 in order to provide a more meaningful view of our performance. As of March 31st, 2022, we served approximately 6,800 participants across 18 sectors.

Compared to the prior-year period, this represents an ending census increase of 2.1%. Compared to the second quarter of fiscal year 2022, this is a decrease of 3.5%. We reported approximately 20,630 member months for the third quarter, a 3.4% increase over the prior year and a decrease of 2.6% over the second quarter of fiscal 2022. Sequentially, the enrollment freeze in Colorado has the greatest impact on member months in centers in the third quarter.

Additionally, as we indicated in our second quarter remarks, toward the end of the second quarter and continuing into the third, we experienced an increase in total deaths. While not uncommon during the winter months, total deaths, coupled with added enrollment growth pressure as a result of the omicron surge also impacted our census growth. The omicron surge affected our ability to interact directly with potential new participants and caused delays and lengthening of the enrollment process. Revenue in the third quarter of fiscal year 2022 increased to $177.4 million or approximately 13.5% compared to the third quarter of fiscal year 2021.

Year-over-year growth drivers include an increased incentives, the calendar-year increase in Medicare rates effective January 1st, 2022, and an increase in Medicaid rates, which include temporary rate increases from the American Rescue Plan Act or ARPA in Virginia and Colorado. Specific to Colorado, we recorded a true-up of ARPA funds for the first half of fiscal year 2022 in the third quarter, and we are still in discussions with other states regarding further ARPA rate increases. As we mentioned last quarter, we received a mid-single-digit rate decrease in our California Medicaid rate effective January 1st, 2022. The decrease is the result of California's experience-based rate-setting methodology and the inclusion of our calendar year 2020 experience, which is understated due to the shutdowns during the pandemic.

While we cannot predict what our rates will be next year, we have encountered higher utilization in calendar year 2021 as our centers reopened, which will be factored into the rate-setting methodology for calendar year 2023. External provider costs in the third quarter were $103.3 million, a 37% increase compared to the third quarter of fiscal year 2021. While some of this variance is due to census growth, the main drivers of the increase are: one, an increase in inpatient and medical respite utilization and acuity as a result of the omicron surge; two, increased housing utilization; and three, increased housing rates as mandated by certain states, including an ARPA-funded public policy adjustment in Colorado that increased assisted living rates by more than 30% effective January 1st, 2022. This assisted living rate increase in Colorado was not offset by a direct increase to our reimbursement rates.

Additionally, while outpatient and specialist utilization has leveled off, utilization was higher compared to the prior year as a result of the pent-up demand of healthcare services that were delayed during the pandemic. Inpatient utilization has improved in the back half of the quarter following the omicron surge. However, the number of and cost per COVID admit has increased year over year. Additionally, participants that have recovered from COVID have a higher acuity due to the inherent frailty of our population.

External provider costs in the third quarter of fiscal 2022 increased by 13.4% compared to the second quarter. The sequential quarter increase is driven by the omicron surge and its impact on inpatient and medical respite utilization and cost and the increase in Colorado assisted living facility rates effective January 1st, 2022. We are in discussions with the state of Colorado regarding fiscal year 2023 rates. Our cost of care, excluding depreciation and amortization, was $46.1 million for the third quarter, a 16.5% increase over the third quarter of fiscal year 2021, driven by an increase in census and an increase in the overall cost per participant.

The 12.7% per member per month increase is primarily due to: one, higher wage rates associated with a competitive labor market; two, additional labor costs associated with ongoing audit remediation and compliance; three, greater operational costs due to the reopening of our centers that were closed during the pandemic; and four, preopening losses associated with de novo locations. Cost of care increased by 7.4% over the second quarter of fiscal 2022, primarily due to additional labor costs associated with ongoing audit remediation and compliance, onetime costs of approximately $400,000 associated with organizational redesign, increased headcount as we make significant progress in filling vacancies, and costs associated with the annual reset of employee benefits and taxes. Center-level contribution margin, which we define as total revenue less external provider costs and cost of care, excluding depreciation and amortization, was $28.0 million for the third quarter, compared to $41.4 million in the third quarter of fiscal 2021 and $41.4 million in the previous quarter of fiscal 2022. As a percentage of revenue, center-level contribution margin for the quarter was 15.8%, compared to 26.5% in the third quarter of fiscal 2021 and 23.6% in the previous quarter of fiscal 2022.

The primary drivers of the year-over-year decline in center-level contribution margin as a percent of revenue are: one, the impact of the omicron surge on inpatient and medical respite utilization and costs; two, increased housing utilization; three, state-mandated housing rate increases; and four, medical cost normalization. We also experienced an increase in cost of care due to wage pressures and additional staffing related to compliance and remediation efforts and other occupancy-related expenses. Sales and marketing expense for the third quarter was $6.1 million, an increase of approximately $600,000 compared to the third quarter of fiscal 2021 and was primarily due to increased headcount over the prior year, coupled with onetime costs related to organizational realignment partially offset by a reduction in marketing spend associated with the ongoing enrollment sanctions. Sales and marketing expense decreased sequentially from the second quarter of fiscal year 2022 by approximately $500,000.

This decline was primarily due to a reduction in marketing spend associated with the ongoing enrollment sanctions partially offset by onetime costs related to organizational realignment. Corporate, general, and administrative expense for the third quarter was $24.7 million, an increase of $6.1 million compared to the third quarter of fiscal 2021. The increase was primarily due to an increase in headcount, increased costs associated with being a publicly traded company, and onetime compliance-related costs and costs associated with organizational realignment of approximately $1.4 million. Net loss for the third quarter was $3.2 million, compared to a net loss of $10.9 million in the third quarter of fiscal 2021.

We reported a net loss per share for the fiscal third quarter of negative $0.02 on both a basic and diluted basis. Our average fully diluted share count was 135,516,608 shares for the third quarter. Adjusted EBITDA, which we calculate by adding interest, taxes, depreciation, and amortization, onetime adjustments for transaction and offering related costs and other nonrecurring or exceptional costs to net income was $1.9 million for the third quarter, compared to $20.3 million in the third quarter of fiscal year 2021 and $14.8 million in the previous quarter of fiscal year 2022. Our adjusted EBITDA margin was 1.1% for the third quarter, compared to 13% for the third quarter of fiscal year 2021 and 8.4% from the second quarter of fiscal year 2022.

The quarter-over-quarter change in adjusted EBITDA and adjusted EBITDA margin is primarily a function of increased external provider costs and increased cost of care, offset by reduced marketing spend and lower corporate, general, and administrative expense as a result of onetime costs associated with leadership changes in the second quarter. We do not add back any losses incurred in connection with our de novo centers in the calculation of adjusted EBITDA. De novo center losses, which we define as net losses related to preopening and start-up ramp through the first 24 months of de novo operations were $1.0 million for the third quarter. This includes expenses for centers in [Inaudible] California; Louisville, Kentucky; and our Tampa and Orlando centers in Florida.

Per Patrick's remarks with respect to Florida, we have committed to CMS and the Agency for Health Care Administration, or AHCA, that we will proactively pause the remaining steps in the expansion process to allow us to focus exclusively on resolving our active audit issues and cannot yet determine if a launch in fiscal year 2023 remains viable. Turning to our balance sheet. We ended the quarter with $199.5 million in cash and cash equivalents and had $88 million in total debt on the balance sheet, representing debt under our senior secured term loan plus capital leases and other commitments. For the third quarter ended March 31st, 2022, we recorded negative cash flow from operations of $7.5 million, and we had $9.9 million of capital expenditures.

Free cash flow, defined as cash from operations less capital expenditures, was negative $17.4 million for the quarter and positive $2.5 million for the nine-month period ended March 31st, 2022. In late December, we announced we were withdrawing guidance following the sanctions we received in Colorado and subsequent enrollment fees. At this time, we do not believe it is prudent to provide new or updated guidance due to the ongoing audit and continuing remediation efforts. As Patrick indicated, we plan to focus on proactively remediating deficiencies across all of our portfolios.

We can, however, provide some insight into the trends we are seeing today and the impact to our business in several key areas. Starting with revenue. We have already begun to streamline our teams and reporting structure, realign the sales and marketing functions, and add new leadership. Although the recent COVID surge lengthened the time it took us to enroll participants into the program due to disruption from potential or actual exposure for employees and prospective participants in the second and third quarters, we are beginning to see enrollment levels in our non-sanctioned centers return to pre-omicron levels, and our mortality rate is returning to average levels.

From a medical expense perspective, we expect elevated external provider costs due to omicron to continue in the near term. Specifically, we expect inpatient and specialty costs and medical respite costs at skilled nursing facilities to remain elevated due to the increased risk of severe illness from existing underlying conditions when contracting cohort. In some of our markets, participants are returning to assisted living facilities at pre-COVID levels and above. Finally, from a cost-of-care perspective, we continue to experience a tight labor market as we manage our employee base to meet the needs of our participants.

As a reminder, we included market wage adjustments when we provided our initial guidance last summer, and we continue to closely monitor wages to ensure we remain competitive. We have seen elevated wage rates in certain critical positions beginning late in the second quarter, and we expect additional labor costs associated with the ongoing audit remediation and compliance to continue in the near term. As Patrick highlighted in his remarks, we are at an inflection point for the company as we emerge from the pandemic and address the challenges of the current sanctions. However, I believe that the transformation we are undertaking will solidify our foundation to ensure that we are focused on people, service, and quality and that we are well-positioned for scalable and sustainable growth for the long term.

Operator, that concludes our prepared remarks. Please open the call for questions.

Questions & Answers:

Operator

And thank you. [Operator instructions] And our first question comes from Jeff Garro from Piper Sandler. Your line is now open.

Jeff Garro -- Piper Sandler -- Analyst

Yeah. Good afternoon, and thanks for taking the questions. I guess I'll start on the cost side of things. You cited five items pressuring center level contribution margins.

Could you help us categorize which ones of those you feel are near term and which ones might persist for some time?

Patrick Blair -- President and Chief Executive Officer

Yes. Thank you for the question. I'll get started and then I'll hand it over to Barb. Yes, first thing I'd point out is the COVID-related cost, clearly one where we saw a spike in January, I think, with roughly half the population that contracted COVID in January.

And those admissions were up for us as well as some of the increases in utilization of skilled nursing days and some of the ancillary costs surrounding that. I'm going to let Barb go a little bit deeper into the drivers.

Barb Gutierrez -- Chief Financial Officer

Yes. Hi, Jeff. It's Barb. Thanks for the question.

So as Patrick said, certainly in the third quarter, a significant portion of our higher costs as it relates to external provider costs were related to the omicron surge. So of those excess costs, about 50% of those excess costs in some way, form or fashion were attributable to that surge, whether that was inpatient medical respite, ongoing specialty care. And while we have seen the same COVID abate going into the fourth quarter, we expect those costs to come down in the short term but not completely go away. As you know, our participants are inherently frail and have a number of comorbidities.

And so what we are experiencing is a long tail, if you will, as it relates to those external provider costs for those participants. So the good news is we have seen the COVID rate decrease toward the end of the third quarter and into the fourth quarter. But again, those costs won't go to zero in the fourth quarter. There is a tail associated with that.

Secondly, the wage increases were a factor as well. And like I think everyone in the healthcare industry, we're seeing a lot of pressure and a tight labor market, and we've done a number of increases related to our staff as well as trying to close the gap on some of our staffing. So that will continue as well. We did have some more onetime costs in nature related to organizational realignment that will not reoccur in the fourth quarter or in the near term.

And then just some of the overall other costs, we foresee sales and marketing are nearly flat quarter over quarter, and that really results from the sanctions. We see that being pretty constant. And our G&A are really investments in transformational activities as well as some compliance activities, and we'll see that continue a bit into the fourth quarter as well. I think I hit them all.

Jeff Garro -- Piper Sandler -- Analyst

Yes. Great. Super helpful. Maybe to follow up a little bit, focusing on the cost of care line and just trying to think about -- I think great in the tight labor market, you're able to add a hundred net new FTEs.

So I'm curious what roles you were able to hire people for? And just trying to parse out how much of the increased cost of care despite where census has trended is related to wage pressures and how much is related to all of those efforts that Patrick discussed around becoming a stronger provider and delivering a stronger value for your members?

Barb Gutierrez -- Chief Financial Officer

It's a bit of each of those items. We have seen in terms of the wage pressures in the high single digits compared to a year ago. And I think that's been consistent with what we reported on other calls, that kind of high single digits. And so that is definitely a factor.

And then adding the new -- sorry, the new employees is another factor. We are continuing to work on that and strengthening our recruiting. So I think it's a bit of both.

Patrick Blair -- President and Chief Executive Officer

I just add on and just reinforce that we've identified a core set of physicians that we really put into the critical hiring bucket. They include nurses and CNAs, personal care workers in various therapies and social workers. And if memory serves me, the last couple of months or at least not in the last quarter, we've had roughly about 200 or so of those that we sort of carried as a vacancy. And I think we've made progress of at least 30% of those just in the last six weeks to two months.

So we're making -- we've got a very focused effort on these critical positions and are really, I think, doing a great job attracting people at the company and attracting people to the mission and purpose of the business. And so we're starting to see some improvement in the recruitment of these critical roles.

Jeff Garro -- Piper Sandler -- Analyst

Good to hear. Thanks for taking the questions again.

Operator

Thank you. And our next question comes from Sarah James from Barclays. Your line is now open.

Sarah James -- Barclays Capital -- Analyst

Thank you. I wanted to go back to the comment that Barb made earlier about the ARPA regulatory change in Colorado. Just want to confirm that was 30%, 3-0, cost increase with no rate offset? And then I was going through the last couple of calls. I guess you guys flagged a 5.3% rate increase for Colorado and Virginia in November related to housing costs.

So I just want to understand, if we look at this as like a two-year run rate, what exactly is going on with housing costs? And how should we think about that as a percent of your total cost structure?

Barb Gutierrez -- Chief Financial Officer

Hey, Sarah. Clarifying the Colorado ARPA. Sorry, I paused there because it was a little bit of an echo. Let me just clarify that.

So I think in the remarks, I said there was no direct reimbursement. There's definitely some indirect reimbursement. And so we received some ARPA funds we received as a matter of public policy adjustment related to ARPA. So we've received a couple increases there, but the structure of it is not a direct one-for-one reimbursement.

And the philosophy there is we are being reimbursed through some of the ARPA and inherently through our rate structure. So we are still in discussions with the state of Colorado as it relates to FY '23 rates. And you did understand correctly. It was a very significant increase for ALFs.

It was over 30% and a significant portion of our participants in Colorado actually live in ALFs, which is why it's pretty significant for us. The other increases, we mentioned in previous quarters, we also received from Virginia about a 2.5% increase related to ARPA. And in some part, that covers some of that housing increase. We do not have the same level of housing in Virginia.

So it's not the same issue from a reimbursement perspective.

Sarah James -- Barclays Capital -- Analyst

Great. Can you size housing costs for us? Like what percentage of your cost of care line is it? Or how should we think about factoring in some of these increases into the model?

Barb Gutierrez -- Chief Financial Officer

Yes. So probably not off the top of my head. But again, think about over a third of our participants in Colorado reside in ALF. And I think that's the way to think about it.

Sarah James -- Barclays Capital -- Analyst

OK. Thank you.

Operator

And thank you. And our next question comes from Jamie Perse from Goldman Sachs. Your line is now open.

Jamie Perse -- Goldman Sachs -- Analyst

Hey. Good afternoon, Patrick and Barb. Patrick, maybe to just start with you on the eight initiatives you outlined, obviously, a lot going on to remediate the audits and just improve quality of care overall. How would you kind of characterize where you are in terms of establishing these initiatives, the timing that we should be thinking about for some of the different initiatives, where the easier lifts are versus some of the more challenging longer-term lifts? Just a little bit more color on how we should think about, I don't know, phasing or implementation of these key initiatives going forward?

Patrick Blair -- President and Chief Executive Officer

Sure. Thanks for the question. I would start by saying that we're making progress on all of these. I mean, clearly, there's different impact and value for all of them, but we are simultaneously executing sort of full speed ahead on all eight.

If I think about where it all starts, clearly, the critical personnel gaps is the foundation for everything. And as I mentioned, we've identified the critical personnel and are making significant progress. I think I said 30% of some of what's been sort of in our vacancy run rate we have have been able to fill. When I think in terms of those that I think are having the greatest near-term impact.

Two I would call out would be one scheduling care with outside providers. We've made a lot of progress on building our tools and our processes to ensure that our people are being scheduled and external providers as quickly as possible and as timely as possible. So that is an area where getting people to their provider really starts the care delivery model for us. And so that's critically important.

We're making great progress. Our -- the telephonic channel with our phones just being available to our participants and their caregivers and make sure that every call that comes into the center, we're returning that call on a timely basis and then we're documenting the needs of the population. I think that's an area where we're making really good progress on. One of the areas, I think, is going to have a longer tail on it.

It probably won't surprise you is sort of strengthening your home care network and the reliability. This really ties back to the people constraint is finding the right number and the right skill set within the personal care worker is really important to us, and it's an important part of what we need to do to keep people living independently in their homes. And I think that's an example of one of our initiatives that's going to take longer. But for the most part, I would say we're expecting all like, let's call it, phase one of all eight of these to be in very solid footing.

And by phase one, I mean, we will have addressed the compliance issues. So if I had to break it up into sort of phase one is really about making the changes necessary to address the audit findings and to remediate those issues everywhere they exist. I think we will be complete with that by the end of this year. And the next phase is really more transformational in nature, and it's really taking each of these eight areas to the next level of efficiency, using technology, using more automated business processes, etc.

So I think that that's probably more on the 18-month, two-year time frame to take things to the sort of the next level, but certainly remediating the deficiencies by the end of this year across all eight initiatives is an expectation we have.

Jamie Perse -- Goldman Sachs -- Analyst

OK. Got it. Thanks. That's really helpful.

I wanted to follow up just on the status of the Sacramento facility. I know the cap is in place there and your -- I guess the question is, what's the level of oversight right now by auditors? Are they monitoring you on a kind of day-to-day basis? Or what does that look like? And is it still right to think that there'll be a phase you go through where they're moderating pretty closely and then they let you operate more independently for a while and then beyond that is when the enrollment freeze might be lifted? And then if I could just sneak in one more, just if Virginia and Pennsylvania, what the status of conversations is like there, what their familiarity is with your other audits and how you kind of characterize the risk of change there?

Patrick Blair -- President and Chief Executive Officer

Great question. Just starting with Sacramento, I think you articulated sort of the audit cycle well. There's always a great deal of engagement with CMS in the state. But you're correct in that we're I'll say at the precipice of where CMS' level of monitoring is done much more through reporting oversight.

So there are specific measures, which -- nine of them, that we are being measured against in Sacramento, and we're reporting that information to CMS in terms of a biweekly or monthly basis. And we're very pleased with the progress we're making. And if we can keep that progress up, you're correct in that the next step would be for CMS to give us some time to make sure those changes and those results are sticking and then come back in and do an audit again, a quick audit, to see where we are to make sure the changes are stuck. And it's our understanding if that all goes well, then we are positioning ourselves for sanctions to be lifted.

But of course, that's always in the discretion of CMS. So I would just say, really pleased with the team's progress in Sacramento. As it relates to Virginia and Pennsylvania, however we describe that is, our close work with CMS across multiple markets now and the themes they are seeing across our markets and the progress we're making across addressing those deficiencies. I believe CMS is acknowledging that we are making good progress.

We're focused on the right issues. We're remediating things timely. We've got a strong communication -- open communication channels between this. And as a result, we have not received any notice from CMS or the state of Virginia or Pennsylvania on any planned audits.

Of course, they can happen at any time, but we always receive a notice in advance, and we have not received anything yet. So I think our belief is we're working closely with CMS and they're very aware of our themes and our progress. And we're trying to learn to all the markets. So anything we learn in Sacramento, New Mexico, Colorado, we are bringing those same things to Virginia and Pennsylvania proactively.

Jamie Perse -- Goldman Sachs -- Analyst

Got it. Thanks for the update.

Operator

And thank you. And our next question comes from Matt Larew with William Blair. Your line is now open.

Matt Larew -- William Blair and Company -- Analyst

Hi. Thanks. Good afternoon. Barb, I wanted to follow up on your comments.

Obviously, you're not giving guidance, but you did kind of describe what you're seeing in terms of current trends with enrollment at nonsanction centers returning. I do want to clarify, though, with about two-thirds of your census following into sort of Colorado, New Mexico and the California centers and 2% attrition per month. I mean we should be expecting sequential declines in census for some period of time here. Is that fair to say? I just want to make sure that we're not misreading the commentary about enrollment returning to the nonsanction centers into something that's not going out companywide.

Barb Gutierrez -- Chief Financial Officer

Yes. So thanks for the question, Matt. The only clarification I would make is that the centers on sanction are Sacramento currently. Currently on sanctions, Sacramento and the Colorado centers.

So I know in your question there, you included other California centers and New Mexico, which are not currently on sanction. And then in addition to that, there's Virginia and Pennsylvania.

Matt Larew -- William Blair and Company -- Analyst

Right. But I guess just to clarify, your sort of internal expectation given that they're following the paths of Sacramento, Colorado is that is that they will eventually be on sanction you there a similar process or sort of what's in your operating model for that?

Barb Gutierrez -- Chief Financial Officer

That's not what we're assuming, especially in the comments that I gave just a bit ago. So the comment is, again, in the nonsanctioned centers.

Patrick Blair -- President and Chief Executive Officer

Yes. This is Patrick. I think I might just punctuate the point in terms of internal expectations. As I've said before, this is entirely in the discretion of our regulators.

But I think internally, we recognize that both CMS and states have a broad range of options available to them when it comes to enforcement of audit deficiencies. And a corrective action plan with an enrollment freeze is just one of the several options that CMS or state has available to them. So I think as we think about each market, we think about it on its own merits, and we think about the latitude that CMS has and that each market that while the themes may be similar, the actual severity and frequency that the deficiencies could vary by market and could lead to very different outcomes. And so that's sort of how we're thinking about it.

And then I think as we think more broadly to markets that are under sanction in addition, we also think about the proactive nature of our work to address audit deficiencies that maybe audit hasn't occurred yet, but we're already at that location, looking at the opportunities, looking at what we've learned from the other markets, and seeing if there's an opportunity to get ahead of it. So I would just add that color to Barb's thoughts.

Matt Larew -- William Blair and Company -- Analyst

OK. That's really helpful, Patrick. And then, Patrick, maybe just sticking with some additional commentary. You referenced some of the corrective actions that you've taken.

You also said you identified sort of root cause for all them. I'm curious, could you share with us what, in your view, the root cause a lot of these issues were? And the reason I'm asking is, I think it would be helpful to understand if it was deficiencies and people or processes or technologies in order to help frame what the type of investments are that are going to be required to really solve not a service level but at a root cause across the organization?

Patrick Blair -- President and Chief Executive Officer

Sure. I'd be happy to. I would first say that for any deficiency, I always think of it, we always think of it in terms of people, process and technology. And although business process automation or introducing new technology can be expensive, I think what we're finding in more cases than not, is that simple technological advancements or automation can make a big difference in the deficiencies we need to close.

It very much is about the fundamentals of having the right people, having solid business processes and policies and procedures that are followed and having tools that help our employees be efficient and enable them in the work that they're doing. In terms of the root causes, just working from sort of top of mind here, it's things like ensuring our medical records are documented with all the required data elements, much more people and policy procedure focused, ensuring that our care plans are complete and kept timely a lot about training and people in process. The heart of our business is this multifaceted interdisciplinary care team at the center level, making sure that team is each day capturing input from all other team members. Whenever that information is available, has been documented in the EMR or in other tools that feed the EMR.

There, you're getting to get it, training of people, process and tools to capture data, making sure that our service orders are being scheduled on a timely basis, making sure that when a participant or a caregiver requests a service that we're identifying that appropriately, and we're documenting it. So see you can get a feel for it. Those would be the things that I would say our root causes of our compliance deficiencies. They're the fundamentals of basic blocking and tackling and the eight initiatives that I articulated.

I have a great deal of confidence that if we execute flawlessly on those initiatives by the end of the year, they substantially account for, and it will address all of our audit deficiencies. And then next year and the year after, we begin thinking about how do we take those to the next level and become more efficient, more automated, more controlled. I hope that's helpful.

Matt Larew -- William Blair and Company -- Analyst

That's really helpful, Patrick. Thanks for all the commentary.

Operator

And thank you. And our last question comes from Andrew [Inaudible] from J.P. Morgan. Your line is now open.

Unknown speaker -- J.P. Morgan -- Analyst

Hi. Good evening. This is Andrew on for Lisa Gill. I just wanted to go back to your comments on patient acuity going up over time.

So in light of the freezes, I was wondering how you're thinking about driving growth in existing markets given the compressed marketing spend. The limited growth would probably seem to indicate that cost of care would remain a bit elevated relative to historical patterns. So I was wondering if you had any incremental color on that. Thank you.

Patrick Blair -- President and Chief Executive Officer

Well, I can share a little bit on the sales side and someone else on the team wants to weigh in. As it relates to our sales and marketing costs, we're very cognizant of our ratios for sales and marketing, and we're going to be very -- we've been very smart about how much of a cost structure we maintained given that we have markets under sanction. And we've taken steps already to reduce costs in the markets in the markets today. And then on the marketing side, because these are highly variable costs, we've already taken cost out of the marketing side of the equation, which is going to allow us to move more quickly.

We're also deploying sales resources in sanction markets to let's call it participant experience and retention efforts in both sanctioned markets and non-sanction markets. And that's relevant because we're very much focused on that portion of our disenrollment rate that we can control, and we're using those resources from a participant experience perspective to help with some of that disenrollment. And I think as Barb mentioned, we're starting to see some of that play through in the current period. As it relates to the risk pool, I'm going to ask Melissa to say a little bit about that, but you're exactly right that we've had quite a few participants contract code as they leave the hospital, many of them were no longer able to be at home and reside in higher cost settings and especially in a market like Colorado, where it's one of our largest markets where we have the highest degree of sort of ALF utilization, we clearly have a challenge of not bringing in enough new lower acuity participants into the pool.

And that's something that we're very focused on and looking for every opportunity to manage that population as well as we can. But let me ask Melissa to weigh in too.

Melissa Welch -- Chief Medical Officer

Hi, Andrew. It's Melissa Welch. Yes. I think Patrick captured the cause of the increased acuity.

Certainly in this last quarter, COVID had a huge impact on our participants acuity for the quarter. Mix is important to us. So it is going to be important for us to continue to bring in newer, ideally less sticker participants on some aspects to help dilute that. But our real focus is going to be on being able to predict the acuity.

And some of the technology investments that were identified by Patrick earlier will help us to do that. Our new EMR technology is also going to help us to do that. And I think that that ability to really predict our cohort of acuity and manage it upfront more accurately is going to be a significant value for us in the long term.

Patrick Blair -- President and Chief Executive Officer

Yes. I might just add one last thought to that. And naturally, we have a number of initiatives that run on a daily basis where we're focused on things like the short stay and skilled nursing facility and the length of stay, as Melissa mentioned, a variety of site of care strategies that we have in place to try to address the utilization, a number of things around the use of ER and trying to reduce the unnecessary use of ER. And all these things, I think, also play to highlight -- really highlight the importance of a more sophisticated payer strategy and capabilities going forward, which I mentioned in my opening remarks.

Unknown speaker -- J.P. Morgan -- Analyst

Thanks for the color.

Operator

[Operator signoff]

Duration: 70 minutes

Call participants:

Ryan Kubota -- Director of Investor Relations

Patrick Blair -- President and Chief Executive Officer

Barb Gutierrez -- Chief Financial Officer

Jeff Garro -- Piper Sandler -- Analyst

Sarah James -- Barclays Capital -- Analyst

Jamie Perse -- Goldman Sachs -- Analyst

Matt Larew -- William Blair and Company -- Analyst

Unknown speaker -- J.P. Morgan -- Analyst

Melissa Welch -- Chief Medical Officer

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