AdaptHealth Corp. (AHCO) Earnings Call Transcript & Summary

[Audio Gap] of durable metal equipment and supplies into the home. Presenting today, we have Steve Griggs, CEO; as well as Jason Clemens, CFO. Anton Hie from Investor Relations is in the office -- in the audience as well. So I think we're just going to jump right into Q&A.

I guess one of the hot topics for you guys that's actually refreshing that I'm not going to start off with a labor question. We might get there, but I won't start off with it. It's more just about the supply shortages, the recall. So can you just talk a little bit about where you are and how you're seeing that impact the business.

Specific to Philips?

Well, start with Philips but then more broadly even about supply chain and...

Okay. Well, Philips announced in June of last year that they are -- voluntary recall on their PAP products, and they wouldn't be able to deliver any new PAPs to us. So that's been continuous, and they represent a little over 50% of the market that was taken out. So ResMed, the other half of the marketplace really hasn't been able to get the chips to be able to fulfill any more than they historically could. So that's then put pressure on everybody to deal with it. So the industry-wide, maybe 60% of the demand, is getting filled. Fortunately for Adapt, we were heavy ResMed shop. So we're higher than demand. Fortunately, we've talked to other providers. Fortunately, we've reworked our systems for asset recovery to get more machines back in there. So we're probably doing much better than the average of the industry, but still, every month, we increase our backlog of patients that are needed. Now ResMed just announced that they're going to do the AirSense 11 without the modem capabilities, meaning they don't have a chip. They'll need a chip. So they're going to be able to produce those in addition to the CPAPs with the chips. So it's really a chip shortage, and we got the chips. And the industry needs about 100,000 chips a month, which really isn't that much if you think about it. So maybe with the slowdown, there'll be more chips coming in there. And then Respironics does come back to the market, which is -- now looks like it's going to be sometime in '23. They'll come back. Philips is a big company. They shift some chips towards us, which they promised to do. So we see it resolving itself a little bit this year but certainly into '23. And then when you talk about the other stuff, the other supply chains, we've been fairly fortunate on products. We've had a handful of products here we've had troubles with but nothing too, too significant. Heated tubing, for example, tanks for portability had been problems. So we've been able to adjust that for, but then the cost of those have certainly gone up. The supply chain, the distribution, the freight part of them, the surcharge of them have all gone up considerably, and that's why Jason increased our CapEx percentage. That was all cost-related, 1 point, 1.5 points.

Okay. That's helpful. I guess maybe just help us understand the chip dynamic because it sounds like also, when you're looking for alternative suppliers, they also didn't really have chips either. So like what benefit does that -- is having that capability have there? Does that create any cost for you down the line to lock in a product that doesn't have that?

Yes, it's definitely going to be more expensive. That's going back to the technology or not even technology but processes that we had 7 years ago where you go out there, you can get the card and you download it and they download it in your software, then you get that information to the physician. So on those type of patients, we've lost the ability for real-time access to what's going on with those patients, but you can't get that data. So there's tons of patients that need machines right now that really don't need that downloading capability. For instance, what we call a re-PAP, they've had their PAP for 5 years and now they're eligible for a new machine. Well, they really don't need that downloading capabilities. They like it because it kind of -- there's a lot of stuff that ResMed and Respironics do for those patients in getting them real-time information. That information will show up on their machine, but it's not going to be as fun, for lack of a better word, for that patient to be able to utilize and get that information. So you have those. We have some insurers that don't require compliance, so it will be easy. But the ones that do require initial and ongoing compliance, that's going to put more labor to us, which is not -- it's a big deal but it's not overcome-able, I'll say. But for the doctors, that's really where they get frustrated because it's a different workflow for them. It makes it a little frustrated for them to deal with the patient.

And so how do you think about this shortage kind of resolving on the recall, like when do you think that things will get back to normal?

Sometime in '23, it will start the process to where we can start eating into that backlog. But it's going to take a good year to get through that backlog. So for us, we're significantly under our historical demands. And then so then we'll get to our historical levels in '23. Then I'll get to our historical levels plus the growth rate that you naturally would have had for 1.5 years. So that's an extra 12-plus percent that you have on there. And then you'll get into the backlog. So we're going to have -- if we have product available, we're going to be setting up record numbers of PAPs for 12-plus months. And when all that happens in all the resupply in the mass, the tubings that they need every 3 months on those patients will start accumulating too. So once all that starts to happen, it's going to be pretty exciting times for us.

Kevin, I'd add to that, that the return to normalcy versus calling the bottom, I mean we -- PAP rentals, traditionally 10%, 11% of our total revenue. It's down to about 8% today, so $58 million in Q1. More than likely, Q2 is a couple of million off of that as well just because there's less PAPs. But as we get into Q3 of this year, we have a much easier comp. And the way the rental cycle works, it's a 13-month cycle. So patients that were set up Q2 of 2021 will start rolling off late Q2 and early Q3 of 2022. Well, due to the PAP shortages last year, Q3 and 4 were very light set of quarters. And so there's less attrition coming in the third and fourth quarter this year. So if we're able to maintain our level of PAP setups that we're maintaining today and even grow it a touch as we think we can, it seems that the bottom of the PAP rental shortage in terms of our financials were just about there.

Okay. Great. And so then maybe moving off a little bit, I guess the organic growth -- it's assumed at the quarter that the organic growth would show some nice sequential improvement. When you think about that long-term growth trajectory that you guys have talked about, is that also kind of a 2023 kind of -- can you get there in 2023? Or does that -- to your point about the anniversarying and when things start to come through, do we have to kind of wait a bit longer to get there?

No. Once those PAPs come back, that growth rate will accelerate. So we did 3.7% organic growth rate. Well, our largest part of our business is CPAP and PAP-related products. Well, that was a negative for the quarter, and that should be a positive 7% or 8%. So if you do that differential math quickly, you can start seeing well, anything close to reasonable times, they're going to be that 7% to 8%. So that 7% to 8% will come back, and then we should get a PAP even more than that for the -- as we work into the backlog. So you got this pent-up need that we have out there.

I mean more than likely, we're at that 8% average organic growth rate in 2024. And if there's PAPs in Q1, even Q2 of next year, coming from either additional chips and ResMed production or Philips coming back online, I mean we're much more likely to see a double-digit organic growth rate of 22 -- I'm sorry, '23 over '22.

Excellent. And then as far as the diabetes opportunity, I mean that business continues to grow very well, beat our estimates by a decent chunk in the quarter. What's driving that? And are there any kind of tough comps we'd be thinking about as far as year-over-year growth based on kind of -- or is this actually a pretty good number for the year?

And so diabetes is the driver of our organic growth rate with the other part of our business, the PAPs with the shortage there. Well, diabetes is such a health care problem. I mean that it's no question, the biggest problem that we have because when you have diabetes, anything else you get, it's compounded. So those patients are problems for the providers, the health systems, insurance companies, everywhere. So I think everybody is starting to see the benefit of CGM, continuous glucose monitoring, on those patients and the effects of that. And so I think they're going to keep pushing that until these patients to make sure they get their insulin and sugars under control that that's going to be going on for a considerable period of time. So we suspect that those growth rates are going to be pretty strong for certainly the foreseeable future. Now at some point in time, you get to how much you're going to go into type 2 diabetics and how much they're going to allow us to go farther, and I think that will be the decider where that growth rate slows down 2 to 3 years from now.

And what about the whole kind of [ warehouse covered ] dynamic, the shift from the medical into the pharmacy? Is that -- where are we on that shift? And how do you think about the impact?

Well, according to Dexcom and Abbott, they feel like it's going to be ended this year. They were the big pushers of that because it's -- when you order something via the pharmacy benefit, there's no utilization review. So for them to put out new CGM units, that was great. But I think what we're all seeing in Dexcom, I think, and Abbott will admit that patients coming in there probably weren't the most desirable patients to come in there. And so therefore, the reorders on those, for the sensors and stuff like that, that need to be replaced on a monthly and quarterly basis aren't the same as they were when they're in the DME benefit where you've made sure that you had that proper patient moving in. So I suspect the pharmacy shift will top out this year, and that's factored into all of our numbers. So we lose a little bit here and there to the pharmacy, but in the DME benefit side, we're very, very comfortable with that high teens growth rate right now.

Great. And then I guess how are you thinking about margins? We talked about getting back to that normal long-term growth rate next year potentially and then all of that. What about the margins? Will the margins be back to normal next year? Or the supply cost have gotten...

Yes. No. We expect they will return to normalcy. I mean, 23% to 25% is what we've talked about in terms of adjusted EBITDA margins over the next couple of years. I mean if we think back on '21, Q2 and Q3 was 23.9%, and then came off certainly in Q4. As the rental dropped in Q1 this year, we were just -- we were at 19.5%. I think that's a bottom. I mean again, that's that rental census coming down, and there's no gross margin cost with that rental unit because it's down in the CapEx line. And so it's essentially $1 revenue drops to $1 of EBITDA margin. And so as that starts pulling back, we think we'll get the natural step up we get in quarters 1 through 4 of the course of any year. But with the PAPs coming online, it will pull through. So this year, we're estimating 21.9% adjusted EBITDA margin. We're confident we'll hit that. If I had to guess here today, I'd tell you we're a point higher than that in 2023.

Yes. I mean just the return to that 7% to 8% and maybe even double-digit growth rate, mathematically, the margins have to go up because our incremental margins on that growth are somewhat significantly higher than the margins in the business. So if you just do that math, they'd have to -- it will drive that -- those margins back to where they are and beyond as long as that growth rate stays up.

Historically, we've kind of thought about the business as being volume-driven from a revenue growth perspective. But with inflation, there's been a lot more focus on what's the pricing power of the businesses. So like how do you think about your pricing power? Is that pricing going to be a bigger part of the story? And how long does it take for pricing to kind of catch up to the inflationary environment?

I mean I've got some views on that.

Yes. Go for it.

The soft goods and our COGS, cost of supplies lines, is there inflation of freight forwarding costs? Yes, but you're talking about cotton products, plastics, just -- they're softer goods. The inflation in that part of the business is much less than the raw materials that go into our equipment, like aluminum and steel. I mean like it's just the surcharge activity on that side of the business is much heavier. Now we've accounted for that with an extra point of revenue in our CapEx guide for this year. We guided 9% to 11%. We hit 10.9% for Q1. It will bounce around a bit, but I would suspect that's going to land right around 10% to 11% for the full year. So some of that, we think, will peel off maybe as we exit this year just due to freight. We think freight will start normalizing. Surcharge activity, it's hard to tell. I mean once that inflation and that surcharge is baked in, it's hard to grind your suppliers down on those costs, but we do have alternatives. And so I think it's -- in the course of normal annual contract negotiations, things like that, we'll be able to get some of that out again, but it's really showing itself in the CapEx lines.

And I guess what about just supply costs generally? Because I think you guys talked about longer-term contracts and things like that. So like how do you feel about -- is there any risk, I think, on the cost side or anything kind of resetting? Is there any [ risk ] or anything like that, that you think about?

Outside of -- I mean regular product upgrades and things like that, you'll pay a little bit more for a new product than you did in the last model, but that's pretty standard. I mean that's -- I mean the business has always run that way. Fuel, that's a challenge in Q1, probably Q2 and beyond that we weren't projecting, but we did not adjust guidance for. So I don't know -- Steve, I don't know if there's any other big working concerns.

No. I mean fortunately, a lot of our products are small and expensive. Where you get killed is big products that are cheap because in your freight and how much it takes up for that container is -- so a hospital bed is horrible right now because it's so big. It takes up all the space. And so those items, we think that they're going to come down. We're supplying them right now as service to our patients and our partners, and the margins have come down significantly on those for the time being. But fortunately, it's such a small part of our business. The main part are the PAPs and the ventilators that are this small. Fortunately, that's a $5,000 machine like that. The amount of freight allocated to that is significantly less on a percentage basis. So we think we've managed through it fairly well. We don't see any big changes in there. I think we still have some more cost increases that are going to come through, but I think we've realized and experienced the bulk of them and adapted to them fairly well.

The company generates some pretty good cash flows. Q1 was a little bit weak. I don't know if you want to talk a little bit of the seasonality there and then from there, what you're thinking for the year and how we should think about capital deployment.

Sure. So first on cash flows, I mean cash flows from ops was pretty healthy at $66 million. Q1 and Q3 are heavy weighted on interest payments. So just a lot of interest, dollars going out the door due to our bonds and kind of the timing of that. So that was a little bit of an impact. DSOs were great. I mean we held at 47 days, consistent with Q4, which is pretty unusual. I mean just the deductibles reset and everything that happened in Q1 in health care, we were thrilled with the cash inflow. As part of the Oracle install, we are tightening up AP, and we're purposely paying faster on certain suppliers I mean just to capitalize on prompt pay discounts and avoiding late fee penalties and just maintaining good relations with suppliers. So some of that activity will continue in Q2, and then certainly on bonuses, payroll, things like that, that I think anyone in provider health care is pretty used to for Q1. So all in all, if you want to hit expectations, for the year, we've continued to stay 5% to 6% of revenue. And we still have [ to carry ] dollars going out the door. This is an unusual year. So that would be about $125 million to $150 million. We stand here today probably lower end of that, but that range feels comfortable. And then as we exit this year and get into next year, we think it will be a normal cash year. We originally talked about a 6% to 7% of revenue. We've raised that to 6% to 8%, maybe 7% to 8%. So we'll talk about free cash, and likely, we'll be guiding free cash as we get into the later half of this year. In terms of capital deployment, we did just announce an authorization on our $200 million share buyback program. So that program will start. We and the Board thought it was prudent that the -- frankly the trading levels, the stock has been performing at. It's starting to feel that if you put $1 for M&A, which we've talked about at 6x or less trailing EBITDA, we get synergy out of that and we do better than that. But the trading levels we've seen in the last -- even in the last couple of weeks, it's almost a push. I mean $1 M&A versus $1 of share buyback, they're both good investments in our view. So that program has started, and we'll give updates on that as the quarters roll by. Leverage has come down a touch since last quarter. That will continue as we grow our EBITDA and sustain our cash flow. But I think M&A certainly is still our first capital deployment choice for good, disciplined deals that are available and a little bit of share buyback. And overall, we're feeling pretty good from a liquidity perspective.

When you think about that reacceleration that you expect on the CPAP side, does that come for the front-end loaded CapEx? Could that potentially be a drag on that cash flow into next year or is that this year?

It would be, but our view is it would come with so much pent-up rental revenue and resupply revenue that will come with it. As a percent of revenue, I don't know if it's going to move that much, maybe 0.5 point. But the -- just that residual value of having the patient on sensors and resupplying them, I mean we talked yesterday in our earnings release about rental revenue soft due to lack of PAPs. But I mean resupply continues to grow despite having less sensors than we would have in -- if it weren't for the PAP shortages. And so it's just that compounding effect of having patients with sensors and continuing to sell those consumables into that patient base, which is really where the cash flow -- that's really where the cash flow engine is and that flywheel within the business. So CapEx might be hit a touch, but I think investors, certainly management, would be okay with that.

Yes. And those PAPs aren't going to come back in all one big bolus. They're going to come back and grow over a period of time. And so yes, we'll put more in CapEx, but the value of that patient is fantastic for us. So you might see a blip in a quarter, but it's not going to be anything significant.

And when you think about that first dollar of free cash flow, it could be M&A, where within your business lines are you focused on this?

Well, the diabetes business is still very attractive, but there's still very few assets out there that fit our criteria and fit our need. On the HME side, there's just a lot more assets. So we have geographically -- one of the big things that we wanted to do for years is make sure we've got geographic coverage into almost every state because getting into -- the barriers to entry to opening up a business within a state are tremendous. So the only state we're missing is Montana. If we found an acquisition there, we go and open up in Montana. But once you're in that state and you have the Medicare number, you have the Medicaid number, you got Blue Cross Blue Shield contract, you got the other local contracts, well, then you can do stuff within that state. But that takes a lot of time, and so that barrier to entry is a great protection for our franchises that we have out there, franchises being a generic word, out there but -- so we've spent that money. So there isn't that need for geographics for acquisitions. So now, acquisitions are all either very, very strategic or very opportunistic and as they become available. We just closed a transaction, I think, in 5 or 6 locations in the Northeast. Well -- and it fit perfectly into what we're doing in the Northeast. But that business could have been in the Southwest, could have been in the Southeast and would fit probably equally as perfectly. So -- because now we just got coverage everywhere. So anything we do fits into our plan and our processes and our logistics there in those states. So any acquisition that fits again our criteria will be very, very opportunistic and accretive for us.

And I guess COVID impacted a lot of things. The oxygen or the respiratory side is probably the most impacted. So where are we in that? And how are you thinking about what you've been doing versus what the right run rate should be there?

Yes. And so you're going to have a period of slowing down of oxygen as people come off COVID and that stuff because we had that increase. And so I think oxygen is going to be relatively flat and then it will start peaking back again. So right now, it's low growth. So it's in the low single digits, get to the middle single digits. I think we're still predicting 4% or 5% for the year. We're comfortable with that. And so CMS learned something valuable during the pandemic that the documentation, the requirements that they're requiring the doctors to do in order for them to order oxygen was too punitive. And so now they've loosened those, and loosening just made it more reasonable for physicians to order oxygen. So I suspect given that, we're getting rid of the CMN requirement that will go away first and next year. And so they'll just be -- the doctor will be able to use more clinical judgment on who needs the oxygen, will able to do more on short-term oxygen patients that they weren't able to do before. So I suspect the demand and the use of oxygen will grow relative to prepandemic levels pretty significantly that will offset some of that pandemic loss.

That's a good point about some of the waivers or expansion that's happened during COVID. Can you talk a little bit about how the company has benefited from public health emergency, sequestration, things like that? So like what's kind of in the number this year in the guidance that we should think about potentially as like a headwind for next year.

We raised about $3 million to $4 million top and bottom line in Q2 that we had not accounted for. It was a little bit a touch higher than that in Q1 since sequestration was 2 points rather than 1. So all in, we're probably looking at about an $8 million or $9 million headwind as we stand here today. Certainly, if the PHE gets extended for 1 or 2 additional quarters this year, that would be another $3 million to $4 million. So as we stand here today, $8 million to $9 million could be as high as pushing mid-teens of revenue and cash that will come in this year that we won't have next year.

But next year, there will be another CPI increase there. So the rate change for all this stuff where we got, stuff for the pandemic, rent relief and sequester, all that stuff, it tends to be netting out on a CMS level with the CPI increases. And the CPI increase next year is going to be pretty significant just like it was this year.

I was going to say this year, you got a pretty nice rate. So I think it's something similar for next year.

Probably. I mean the way it counts is it runs CPI-U -- CMS from CPI-U through June of the prior year. So we're almost there. I mean I think we saw the numbers even yesterday today. So last year through June, CPI-U was a touch under 6 points. We ended up getting a 5.1% increase. So we're not going to guess what that is. But if CPI-U is 6%, 7% or in that ballpark, I think it's reasonable to expect that we'd have a similar increase. Certainly, we'll guide to that once we get to the end of the year. That's the right way to think about it.

Yes. And we were talking about this before, Steve, before it came on, but the public health emergency actually, I find that when we talk to the DME companies, they're actually much better at forecasting when public health emergency ends than I am but -- so I would love to hear your perspectives on kind of what -- do we get another extension or for now...

Yes.

For how long?

Well, I think it's going through the year. I think there's political pressure to not extend it. And I think if they're not going to extend it, then they won't extend it and we'll know that in 7 days because you got to get 60 days' notice. And then once they extend it, I just don't think politically they're going to not extend it in 3 weeks before the election. Plus COVID's still here, and how we're dealing with it and the needs from it and some of the repercussions on the whole health system as a whole is still there. So to me, it would be premature to do it for a variety of reasons. So I suspect it's going to be extended.

Yes. Can you talk a little bit -- I guess the Community Surgical deal, can you talk a little bit about that business? VA is kind of -- I guess is that a growth opportunity for you guys going forward? How do you think about that business?

Well, yes, so they have a VA business. And so VA, generally speaking, is for small businesses. And so there are some exceptions to where a large business can be bet in those. And for those, I think that it will be a growth opportunity for us. But it's going to be pretty selective and pretty small. So I would put that as a high thing. I don't think that's a make-or-break force at all.

And then maybe just the last question because you might be in this question less often now that Apria is being bought. When we think about like the -- your long-term organic growth rate, it's always been higher than kind of that mid-single digits that I used to always guide to. So how do you reconcile that? Like what's the driver? Why is your growth presently higher?

Well, we're a sales organization. And that's been from day 1. We go out there and sell. And we believe and it's built in our culture, it's built in every person in there, the addressable need is up here, what's being delivered is down here. There's more people with COPD that are getting oxygen. There's more people with sleep apnea that are getting the CPAPs. There's more people that have problems ventilating their oxygen that need ventilation that are getting it. There's more people that need CGMs and diabetes treatment that are getting it today. So that addressable need is significantly higher. And our people are trained and motivated to get the patients, show the quality and what that -- what our treatment has done for that patient and to be able to show that doctor how they should be not waiting for the -- for this far into the cycle to be identifying those patients and identify those patients earlier, better for the patients, better for the system, better for their employer and better for the insurers. So that's how we live and breathe every day, and it just pays dividends for us.

All right. Great. That's all we have time for. Thank you.

Thank you.

Thanks, Kevin.