Alignment Healthcare, Inc. (ALHC) Earnings Call Transcript

Good afternoon, and welcome to Alignment Healthcare's Third Quarter 2026 Earnings Conference Call and Webcast. [Operator Instructions] Today's call is being recorded. Leading the call today are John Kao, Chairman and CEO, and James Head, Chief Financial Officer. Before we begin, we would like to remind you that certain statements made during this call will be forward-looking statements as defined by the Private Securities Litigation Reform Act. These forward-looking statements are subject to various risks and uncertainties and reflect our certain expectations based on our belief and information currently available to us. Descriptions of some of the factors that may cause actual results to differ materially from these forward-looking statements are discussed in more detail in our filings with the SEC, including the Risk Factors sections of our Annual Report on Form 10-K for the fiscal year ended December 31, 2025, and our Form 10-Q for the fiscal quarter ended September 30, 2026. Although we believe our projections are reasonable, we undertake no obligation to revise any statements to reflect changes that occur after this call. In addition, please note that the company will be discussing non-GAAP financial measures that they believe are important in evaluating performance. Details on the relationship between these non-GAAP measures and the most comparable GAAP measures and the reconciliation of historical non-GAAP financial measures can be found in a press release that is posted on the company's website and our filing Form 10-Q for the fiscal quarter ended September 30, 2026.

Good afternoon and thank you for joining us on our third quarter earnings conference call. Total third quarter 2026 health plan membership of 301,200 represented growth of 31% year-over-year and drove overall revenue of approximately $1.4 billion, a 37% increase year-over-year. Adjusted gross profit of $142 million represented an adjusted MLR of 89.5%, a 240 basis point increase year-over-year. Meanwhile, adjusted SG&A of $120 million represented an SG&A ratio of 8.9%, which improved by 60 basis points year-over-year. Taken together, adjusted EBITDA was $22 million, within the range of our guidance. I'd like to spend a few minutes on the headwinds that emerged this quarter and actions we have taken in response. As part of our broader scaling initiatives, we began a comprehensive claims system migration last year, designed to improve our payment speed, auto-adjudication rates, and payment integrity capabilities. During the transitional period, we experienced greater volatility in claims processing. As the volatility normalized, we identified a notable increase in aggressive provider appeals and disputes in our paid claims data, which resulted in a higher cost trend. Separately, during the quarter, we saw pockets of higher cost in areas such as catastrophic cases and skilled nursing, which also pressured medical expenses. To address the headwinds we experienced, we acted swiftly over the past several months to build out a more robust payment integrity function, including industry-standard pre-pay claims edits and more rigorous post-pay review. Additionally, we have moved quickly to manage and deploy our clinical resources expectantly and are making targeted investments to ensure our clinical best practices and operating rigor are applied systematically across our markets to reduce the variability of member outcomes. We are confident that the actions we're taking to scale our clinical programs will enable us to achieve the level of clinical effectiveness that we are accustomed to. We are pleased with the progress we have made across our multiple initiatives and saw institutional acute care cost trend stabilize as we closed out September and entered October. Furthermore, we've experienced positive momentum across other cost categories. Despite our progress, we're taking a prudent approach to the increased trend seen in Q3 and assume that higher costs in the third quarter will continue to weigh on our results for the remainder of the year. Given this position, we lowered our annual guidance to no less than adjusted gross profit of $575 million and adjusted EBITDA of $100 million. I want to emphasize that the guidance we have provided today is a guidance that we are confident in delivering. Furthermore, we have thoroughly reviewed each market to identify the issues that impacted our financial performance this year and mobilized quickly with plans to address them. Our revised guidance reflects both a prudent posture toward the cost pressures we're seeing today and a disciplined approach to forecasting the balance of the year. Our focus is now on execution, delivering against the commitments we are making today and positioning ourselves well for 2027. As we enter 2027, we feel well-positioned to achieve our top-line growth target of at least 20%, given the early results of this AEP. Importantly, we did prudently reconcile those assumptions in the bids to the trends we're seeing today and made adjustments in areas where we saw room for improvement. At this time, we have a firm grasp of the underlying market dynamics we faced in 2026 and the actions required to address them. Taken together, we believe we will strike the right balance between growth and margins for 2027. We will share our thoughts in greater detail following AEP results in January. I'd like to take a moment to address our Star Ratings for payment year 2028, which reflects performance for 2025 dates of service. We maintain a 4-star or higher rating in 6 of 7 eligible plans, demonstrating our ability to deliver strong Stars performance across much of our portfolio. At the same time, our California HMO contract earned a 3.5-star rating, which is below our expectations. The shortfall in our California HMO contract was primarily driven by missing HEDIS and CAHPS measures, particularly in HOS and Part D, as well as higher than expected industry cut points. We have already identified data and workflow opportunities within our Stars infrastructure and initiated actions across the enterprise to drive better and more consistent Stars performance. We've conducted more provider and member engagement initiatives to improve performance in survey measures, addressed data issues that impacted gap closure and Part D, and accelerated our progress in HEDIS gap closure to further strengthen our position in these metrics. These changes are in place and operationalized for the 2026 plan year cycle. In conclusion, we continue to demonstrate profitable growth and are addressing the challenges that impact our performance this year. We have taken decisive action in those areas, and our revised outlook reflects a prudent view of the cost pressures we're seeing today. At the same time, we continue to invest in capabilities and operational changes that are important to support our next phase of growth. Over the past couple of years, we have evolved our leadership roster, systems, and technology architecture to support greater scale. We are already seeing benefits from some of these changes that include greater visibility and control over inpatient utilization through our partnerships with providers to de-delegate institutional acute UM functions. We also continue to seek opportunities to assume more control over our pre-service utilization for outpatient and professional spend where appropriate. Additionally, our clinical model remains a core strength of our business and primary driver of our unit costs. The investments in claims processing, clinical operations, and Stars infrastructure build on that foundation. With that, I'll turn the call over to Jim to further discuss our financial results and outlook.

Thanks, John. I'll dive into our third quarter results for the quarter ended September 30, 2026. Health plan membership of 301,200 increased 31% year-over-year, supported by strong member addition and high retention. Our health plan membership generated revenue of approximately $1.4 billion in the quarter, representing approximately 37% growth year-over-year. Third quarter adjusted gross profit of $142 million represented an adjusted MLR of 89.5%, approximately 100 basis points above the implied midpoint of our third quarter guidance and an increase of approximately 200 basis points year-over-year. Approximately half of the year-over-year increase in MLR was driven by changes in Part D and MRA, and additional clinical investments, and that's consistent with the comments we made on the Q2 call. As John mentioned earlier, we also observed a notable increase in provider-led appeals and disputes in the quarter, along with elevated costs within our skilled nursing and catastrophic case categories. These components drove the remaining increase in MLR. Turning to operating expenses, adjusted SG&A was $120 million, an increase of 25% year-over-year. As a percentage of revenue, adjusted SG&A of 8.9% improved by 60 basis points year-over-year and outperformed the midpoint of our guidance range by approximately 90 basis points. We delivered this result even as we made incremental investments as previously mentioned in the Q2 call and John's commentary today. Additionally, included in the quarter was a benefit from an incentive compensation true-up our year-to-date targets. Taken together, third quarter adjusted EBITDA of $22 million produced an adjusted EBITDA margin of 1.6%. Moving on to cash flow and the balance sheet, we generated $158 million in operating cash flow during the first nine months of the year, and our liquidity profile remained strong. We concluded the quarter with $743 million in cash, cash equivalents, and short-term investments. Overall, our reserves remain well-positioned in both current and prior years, and we are confident our cash flow generation will continue to support our growth going forward. Lastly, our funded leverage ratio at the end of Q3 was 2.4 times our trailing 12-month EBITDA. Moving to our guidance for the fourth quarter, we expect health plan membership to be no less than 305,000 members, revenue of no less than $1.32 billion, adjusted gross profit of no less than $104 million, and adjusted EBITDA of no less than negative $28 million. For the full year 2026, we expect revenue of no less than $5.25 billion, adjusted gross profit of no less than $575 million, and adjusted EBITDA of no less than $100 million. A fourth quarter adjusted gross profit of at least $104 million implies an MLR of 92.1%. In our guidance, we have assumed the continuation of the elevated medical claim spend we experienced in Q3 with no contemplation of the stabilizing trends we observed in both September and October. Furthermore, while we're not including any benefits from the initiatives currently in progress, the costs of these initiatives are fully burdened in our guidance. Lastly, on Part D, our revised guidance continues to embed an assumption for increased cost relative to typical medical expense in Part D. Additionally, we are assuming a continuation of the higher costs experienced in the third quarter related to elevated appeals and dispute activity, along with increased costs in certain categories. In SG&A, we expect higher expenses during the fourth quarter, reflecting growth-related costs and marketing expenses related to AEP, consistent with our past experience. Our updated outlook reflects prudence and activism as we address the pressures we discussed today. As we see no factors typical of the fourth quarter, we expect the actions we have taken this quarter provide visibility, control, and support improved performance as we reposition ourselves for 2027. With that, let's open the call for questions.

Thank you. [Operator Instructions] Our first question comes from the line of Matthew Barden of KeyBanc. Your line is now open.

Hi, thanks for taking my question. I guess I want to unpack a little bit about those cost trends that you identified and discussed. John, in terms of the new claims processing system, I think it's called Facets, and the deployment of that system, I think you alluded to better identification or faster claims processing. Can you talk a little bit about that new system and how that has either contributed to you identifying these claims or was it just concurrent with you seeing higher claims? Can you unpack that a little bit? Thanks.

Yeah, Facets is an industry-leading claims adjudication application. We migrated off something that we thought was sub-scale. One of the benefits of this is we felt that we needed better auto-adjudication rates so we could pay our providers faster. We needed to make sure that we had the kind of state-of-the-art payment integrity programs to offset the aggressiveness from a lot of the larger providers. And anyone that's gone through one of these system conversions knows it's a messy process. I'm actually pretty happy with where we have ended up in terms of getting through most of this in July. And so we're three months past that now, and I feel very happy about where we are from a stability point of view. But really what happened is we saw volatility in our paid claims, and we started seeing that in July. And once we realized we had a lot more appeals and disputes coming through, we had to react on that. And I'm happy to say that the amount of appeals has dropped off significantly in August, September, and October. As Jim said, in spite of that kind of stabilization, we're still taking a very prudent approach toward the rest of the year. And I feel good about where we are in that regard. I feel good about where we are with our reserves. And that's the main, that's the main issue on Facets.

Just to make sure we understand, were the claims just happening to be running higher after you implemented Facets, or was it helping you identify higher trends?

It created volatility. And so when you go through one of these system conversions, what happened was we were just making sure that the configuration of the system was correct. And so you had some timing differences between when claims were coming through, and we saw a higher trend really kicking in July. And once we saw that, we made all the requisite changes and got all of that through in terms of getting paid claims stabilized. But that created the higher trend, and it really started in July. And we started seeing that, and the actual trend is starting to actually taper off a little bit in August, September, and October. But again, we're just being extra, extra careful, making sure that we're kind of assuming that trend continues in Q4, despite the fact that I think some of the trends are already starting to stabilize. Alright, got it. Thank you.

Our next question comes from the line of Kevin Fischbeck of Bank of America. Your line is now open.

Can you hear me? Hi, this is [ Watkin ] on for Kevin Fischbeck. Can you hear me now? Sorry about that. Yeah, so could I just get your initial thoughts on 2027 and positioning? Yeah, it's a good question.

We did a deep dive, as you might expect, on the assumptions that we made in the bids. We compared that to the trends that we anticipate and the mitigation efforts that we have in place for the balance of the year, which, just to underscore, we did not factor into the guidance. And the result of that is we made some changes with respect to certain networks. We made some changes with respect to how fast we grow certain products or not grow certain products. But overall, we feel good about where we are in 2027. We feel good about finding again that balance between growth and margin expansion. I think we've been pretty good at that over the years, and we'll get back to that same cadence. And you can imagine, we did a pretty thorough dive as to how much we should grow. And how we're positioned relative to competitors in PlanFinder. And again, I think we feel pretty good with solid profitable growth at that 20% level.

Got it. Thanks. And then just last one. So a lot of companies have taken action to diversify their membership across plans. Is that something you guys are looking to do? And do you have any targets on how big any one contract as a percentage of membership should be? Thank you guys.

Well, I think with respect to us, we have so much membership in the California HMO. That's something that we're looking at, obviously. And I'm not going to comment too much on the tactics associated with that, but more so focused on really getting to the root issues in Stars. And really what I think is going on is we still got 6 out of 7, you know, 4-star and above. We got three, you know, 4.5-star plans, just to remind everybody. But those are still being well-run, really, because we're smaller in those markets. We've gotten so big, that, you know, we just have to, you know, continue to invest in automation. We have to continue investing and really incentivizing our provider partners and our IPAs to work with us and focus on Stars more and better. But that's kind of where we're zeroing in on. It's like we might have some, you know, kind of cross-walk types of tactics. But we got to get to the root issues. We got to get to the root and fix it. Just to remind everybody, when we started the company, we bought a plan that was 3.5 stars. It dropped to 3. This was way before we had anything to do with it. We were able to get from 3 stars to 4.5 stars. And the way we did that was to underscore the fact that Stars is not a functional department. Stars is a cultural requirement, and we have so many new people here. We're growing so big with new people, new leadership. That's something that we're going to be underscoring yet again is this is something that everybody in the company has to focus on serving that senior. And we'll get this fixed. That I can promise you.

Thank you. One moment for our next question. Our next question comes from the line of John Stanzel of JPMorgan. Your line is now open.

Great. Thanks for taking the question. Just thinking about the reduction in guidance here in the back half, you know, appreciate that, generally speaking, your profit is a little bit more front half weighted. Can you spend a little bit of time thinking about, I appreciate the conservatism in the back half of the year, but what the jumping off point is when we think about kind of like a fully burdened medical profit and EBITDA number to grow off of in '27.

Yes, and John, I'll take this one, and then John Kao can fast-follow. But just in terms of developing our Q4 guidance, we did want to reflect the cost trends that the call and put ourselves in a position where we could deliver on the revised expectations, and obviously, you're seeing some prudence in that. So in our guide, we're assuming a couple things, and we're not assuming a couple things. So that's important to understand from the jumping off point. In our guide, we're assuming that we're continuing the higher appeals and disputes at what I would describe as a peak rate. So, putting some prudence in the appeals and disputes expectation. And as John Kao mentioned, that's already starting to come down. We also are assuming a continuation of the SNF length of stay issues that we've talked about, but also CAT cases kind of continuing. And as we actually exit Q3, we saw both of these things kind of moderate. What we are not assuming is any favorability from payment integrity or payment accuracy activities, so that's not any assumption. We're not assuming any returns from the clinical investments that we called out on Q2. So, in that, we're kind of making sure that we can deliver and not baking in any of the, what we think is going to be run rate benefits for 2027. And then finally, we just put an extra layer of conservatism on it. So the question, and maybe I'll push this over to John Kao, is that the right starting point for 2027? Yes, John, I would strongly advise not to use the Q4 MLR as an annualized.

starting point for '27. That would be, I think, a mistake. You know, we have a lot of initiatives going on. And again, just made a decision that this is a bit of a reset, and we're going to do the reset, let's just make sure we can, you know, convey confidence to the Street as to, you know, what we can achieve. And I think there's potential for upside. And, you know, we're going to be focusing on that. And that would be my suggestion for you without getting into '27 guidance. Thank you.

Got it. And then just thinking about kind of, as you do at '27 AEP, how are you thinking this? I know '26 was a year where you had kind of a higher mix of chronic and higher acuity enrollment. As you think about your 20% growth in 2027 as a baseline, your confidence there, do you think the mix will look more like '26 or more of a normal year where it's maybe less skewed to chronic and high acuity enrollment?

Yeah, that's a great question. Just to underscore one piece of detail. The margins associated with that C-SNP membership, even in year for this year, has been pretty good. That's a big deal. And so really, I think the points that we highlighted with respect to appeals, disputes, revenue cycle, aggressiveness of providers, a couple of outpatient kinds of costs were the drivers. The mix issue is not something that we think contributed to this. Having said that for '27, I think you're going to see a balanced, more balanced on HMO products. I think there's still some pockets that we think C-SNP makes sense for us. But yeah, I mean, that was the first thing I looked at is that, you know, it's part of this mix and it's actually performing quite well in year.

Does that answer, John, your question? Yep, very helpful. Thank you.

Thank you. We'll move it for our next question. Our next question comes from the line of Justin Lake of Wolfe Research. Your line is now open.

Thanks. Just following up there on the fourth quarter, one way to look at it is your third quarter MLR was up about 200 basis points year over year. Looks like the fourth quarter implied is up close to the 400 basis points year over year. Is there any way to parse out that extra 200 bps? Is that just, like you said, conservatism? Is there increased spending on initiatives that you've added for the fourth quarter that wasn't there in the third quarter? Anything more that you can give us there?

I think the one thing that we would say that was present in Q3 as well, in terms of a little bit extra burden that was in the baseline, was just part of the Part D, which has a little bit of an uptick in the MLR in the fourth quarter, that's just structural and kind of how the bids work out in the risk corridors, et cetera. We did have a little extra layer of investment in the clinical side. So that is, if you're doing it year over year, you have to kind of apply that same factor. Then you sequentially, you've got, I would call it a pretty full run rate of these costs that we described, the appeals and disputes, the CAT cases, and the SNF, kind of pushing into Q4. And what we're really doing is saying it's a bit one-sided, which is we are putting a full count for what we think the trend could be without any offsets that we've already been actioning and actually starting to see some results. Payment integrity is a perfect example of that. So we are being prudent on that, but that's, that's how the bill came about, Justin.

Yes, just to add to Jim's comments. Really the operative word from our point of view is prudence. You know, we really looked at the Q3 numbers, we saw uptick in those appeals and disputes. Those are in our world called adjustments with respect to claims payment. We've seen a positive trend with those coming back down starting in August, September, and October, stabilizing. We see ADK stabilizing. We have initiatives with respect to CAT case management, SNF length of stay management. All of the blocking and the tackling is implemented. But really, we just like, let's just be super prudent and not assume any of that's going to start being reflected until we actually get the paid claims in place.

Okay, and then kind of same question on SG&A. Looks like it's relatively flat, Q3 to Q4, typically up about $15 million, you know, which kind of makes sense given selling costs.

Okay, and then kind of same question on SG&A. Looks like it's relatively flat, 3Q to 4Q, typically up $12 million to $15 million, you know, which kind of makes sense just given selling costs during AEP.

What's going on 3Q to 4Q that's keeping SG&A flat despite that?

Yeah, but for a little bit of incentive comp that we mentioned on Q3 is tracking exactly as to what our expectations. We are 120 in Q3 and 132, I believe, in Q4. So it actually does pick up, Justin. We said we'd... How much was the incentive comp benefit in Q3? It would track according to plan, so maybe we'd be in the high 120s in Q3, I think was. And it's picking up to 132. So we really haven't made any material changes. In fact, we've been investing in the SG&A areas because we want to position ourselves for 2027. We called that out in Q2. There was going to be a little extra investment made in Q3 and Q4. because we want to position ourselves for 2027, we called that out in Q2. There was going to be a little extra investment made in Q3 and Q4. Got it. Thanks, guys. Thank you.

One moment for our next question. Our next question comes from Michael Ha of Barclays. Your line is now open.

Thank you. So I know you're pursuing Stars litigation now, so assuming no litigation results in restoring 4 stars in time for next October, is impacting payment year 2029 achievable? Are there any milestones from now until next October that would demonstrate that to us? Can you help us frame the gross Stars funding headwind for '28 and the portion that would remain after things like provider sharing and benefit cost actions, and if you would take benefit cuts potentially in '28?

Yes, so with respect to Dates of Service 2026, Payment 2029, obviously it's a bit early to comment on that, but I will give you some input that we feel good about our HEDIS gap closure initiatives. We feel good about our Part D data issues that got cleaned up. And just really as a reminder, even heading into plan preview two just a couple of months ago, I was feeling optimistic just because we had such a good CAHPS score. We really got a little bit blindsided with HOS (Health Outcomes Survey). And so that's still one area that is a little bit elusive for us, which really caused me to pause about '26 in aggregate. But a lot of the changes in operations I'm comfortable with. But, you know, give us a little bit more time, you know, and obviously I think CAHPS and HOS is going to be more and more important. I think our Part D is going to be strong this year in terms of dates of service. With respect to, I think, your third question, you got to remind me what the second one was, but yeah, I mean, I think we're going to look at this like we always do, finding the right balance between growth and margin. I will say that the kind of the confidence I have with our ex-California markets and our operationalization of those markets. I feel good about it. I think we have a handle on the issues. We have a handle on utilization, and we have so much growth in those areas that the embedded earnings are going to start to show. We're starting to steer the right way with us in those ex-California markets that will allow us to grow there. And I think there's still more room for us in California to still get decent growth. I don't think we need to slow down growth in California, maybe a little bit, particularly given where everybody else is. And so we'll make the right decisions with respect to benefit design.

pretty good at that. Michael, what was your second question again? second question. I guess just the gross Stars headwind after providers sharing benefits, cost actions, mitigation plans you have in place and it's just how you think about that.

Yeah, yeah, let us get back to you on that one, please, because the mitigation initiatives is pretty material. And I underscore two areas. One is embedded earnings. A lot of the investments that we made in obviously '26 and the C-SNPs I think is going to start paying off. It's going to help bridge some of that gap with respect to Stars. And then, and MRA, I think we are, as we have shared with you in the past, pretty conservative as it relates to risk adjustment. And I think that there's lots of opportunity for us. We took a very, I would just say, conservative approach philosophically to coding. We did not want to be dependent on that, but I think it's also fair to say we can do a better job and we're doing, just, I think what we're starting to dive into that, we determined there's a lot of opportunity for us on risk adjustment. And so we'll be in a position to share a lot of that with you when we give you kind of the full plan. We expect to do that after the Q4 call.

Got it. Thank you. And I wanted to clarify, I know you're still targeting 20% membership for next year, but I just want to clarify, your Star Rating decline in California, has it not affected early AEP sales at all or even broker feedback? And then for 2020? Yes. Okay.