AdaptHealth Corp. ($AHCO)

[Audio Gap] AdaptHealth, they are one of the largest or maybe the largest provider of medical equipment, I guess, in the U.S. and Jason is here with us. We're going to go right into Q&A. before we start, I guess, Luke is in the audience, too. He's hiding. But in case anybody wants to say hi to Luke, he is right there.

So maybe -- yes, maybe we'll go just right into Q&A and start with first quarter. You guys came in a little bit below on EBITDA line, right? You call out a couple of items. So maybe remind us the elements, I guess, that created the shortfall, right? But also as we think about Q2, right, maybe the timeline of kind of recovery, some of these cost items that kind of were weighing on Q1 EBITDA.

Sure. Sure. I'd be happy to. So it's good to see you again, Joanna. Thanks for having us back at BofA. Yes. So first quarter for AdaptHealth was frankly, extraordinary in a lot of different ways. All 4 business segments grew organically. That's the first time that's happened, I think, since we broke into 4 different business segments. And so the underlying core business of sleep and respiratory, as Joanna mentioned, we're the largest durable medical equipment provider in the country. Both Sleep and Respiratory grew organically year-over-year between 3% and 4%. So we were happy to see that in the core business. Our diabetes business grew organically for the first time in some time, a little over 2% as we put out more CGMs, a lot more pumps. Pumps are having a pretty good run for the last couple of quarters. So that was good news. Wellness at home, which encompasses the true bent metal as we affectionately refer to it, beds, wheelchairs, walkers, that type of DME that's in service of patients with Sleep and Respiratory conditions primarily. That business line grew as well organically year-over-year. We did have several dispositions in the prior year. So reported, that segment was down, but ex those dispositions, that business was up as well. So the core in total was up a little over 4% organically year-over-year. The big news was that we have started a very, very large capitated agreement with a large West Coast-based hospital system and IDN. We're now covering over 12 million members in a capitated arrangement. So for those not familiar with capitated arrangements, they are at-risk contracts. We get paid a per member per month fee for managing an entire membership of a particular plan. And then we manage the utilization, which in DME happens to be extraordinarily steady and stable. As you can imagine, folks that need DME, that curve doesn't bend so quickly. You either need home oxygen or you don't, and those trends don't change too rapidly. So we take that risk. And so total organic growth was over 9% for the first quarter. So that was kind of the headline of what happened with revenue. Now with that did come additional carrying costs for that capitated arrangement above and beyond what we thought we would do for the first quarter. We thought we'd come in around $128 million of adjusted EBITDA. We came in at $121 million. And so we beat revenue by about $20 million. So that added certainly to the top and the bottom line. But at the end of the day, we were about $12 million over in labor for the first quarter. Now most of that was variable in nature, about $8 million. And so those were dollars spent for sign-on bonuses, incentive pay, overtime and contract labor as we were bringing on hundreds and hundreds of thousands of patients, all within about a 5- to 6-week time frame. So the amount of work and effort that went into that was challenging to predict, I guess, is how I would frame that. But we were very pleased that with all that additional variable pay, we were able to secure the revenue earlier than what we had originally anticipated. The rest of that $12 million was higher salary expense, more W-2 employees than we had predicted. That is essentially more staff. Over time, we will work to rightsize that staffing model with the new contract. So again, the headline, I think, for the year and for Q1 is that we are now fully transitioned for this capitated arrangement. What was partial revenue in the first quarter will now start flowing for the second quarter and throughout the rest of the year, which is why we show such a significant step-up in profitability as we work through the rest of 2026.

Right. And you gave the Q2 guidance where you talk about 19% EBITDA margin, right? So that also implies a step-up. So it sounds like some of it is normalization or just having more of the revenue flow through on top of the labor costs that you already have in place.

That's right. I mean our revenue ex patient equipment depreciation flows through about 60% gross margin. And so the effect in Q2 is that we step up revenue from $820 million to $850 million. And so that $30 million of incremental revenue is essentially all capitated business. It's expected to flow through right around 60%. So that sequentially adds a little under $20 million. As usual, throughout our history, collections are tougher in the first quarter. They step up pretty significantly into the second quarter and throughout the course of the year. That's the impact of patient deductible resets as well as those deductibles start capping out, the patient pay portion becomes lower and the patient dollar is a little harder to collect than the insurance dollar. So that means collection performance improves. So that should add about $10 million in the second quarter. And then finally, a lot of that variable labor has already run out that won't repeat and supporting the onboarding of the capitated arrangement. So you're seeing about a $40 million step-up in profitability, and those are the 3 bridge points to get there.

Right. This is very helpful. And on this capitated program -- contract, sorry, very exciting, right? I mean it sounds like you guys were talking about previously that those should be kind of running at an above-average margin versus like the consolidated.

That's correct. We expect -- yes, we expect at least 20%, so essentially the enterprise margin.

But just kind of walk us through the ramp-up. It sounds like kind of a lot of investments have been done and now you're, kind of, just capturing that sort of any time line or any kind of ramp-up to get to that margin?

Sure. So for perspective, the ramp-up in the infrastructure really started in earnest around September of last year. And so for perspective, we de novoed 35 brand-new locations. from September up until, call it, mid-February. We hired well over 1,200 employees all within that time frame. Some of them came from the incumbent DME provider as employees were displaced through the loss of that contract, we were able to convert many of those employees as well as new employees that we recruited on the open marketplace. Over 300 vehicles were procured, vehicles and sites were outfitted, hundreds and hundreds of thousands of active patients were converted onto our systems and our platforms, and we were able to acquire a little over $80 million worth of active patient equipment from the incumbent provider. So all of these things happened on the course of end of September through, call it, mid-February and then a little bit more into early March as the final phase of the contract started. So all that carrying cost was there pre-revenue or without the revenue to support it. So although we carried significantly more costs than we originally anticipated upfront, now that the revenues started, those margins start locking in quite rapidly. And so that's why we expect to see that step up over the course of 2026.

And would you say, as you exit '26, you're going to be at that margin target margin for that particular contract?

Yes. Yes, we would expect that.

Okay. Perfect. And I guess you do now have 2 large contracts, right? So the obvious question is like...

For now, we are working on that.

Exactly. So maybe walk us through that. Like should we expect another large one or there's more like the smaller ones, kind of how we should think about that step up.

Sure. Yes. Yes. So I would characterize the capitated pipeline or the opportunity is basically small, medium, large. The Humana capitated agreement that covers 33 different states in the District of Columbia that we started over 3 years ago now, that at the time was the largest transition of capitated business in the history of the industry. It was a very large contract. It was over 1 million covered lives. And certainly, with Humana membership growing in '26, we benefit from that as well as those plans have more membership and we take care of more of those patients. But that was a very large agreement. Prior to securing the Humana contract, I couldn't tell you that anyone inside of AdaptHealth thought that it would be possible to win the Kaiser agreement. Once we did, and we were able to now convert all of these patients successfully, the amount of inbound interest for this type of payment structure is elevated. We've now proven for the second time that we can transition huge populations of patients from incumbent providers onto the AdaptHealth platform. And in doing that, we become the single service provider for that plan. We provide the daily, weekly, monthly metrics around patient satisfaction, contact center measures, of referral provider satisfaction and operational metrics such as emergency orders arriving in that patient's driveway within 4 hours of discharge of that hospital. And so being a single operator as opposed to traditionally hundreds of DME operators in each state across the country, that's a huge benefit for insurance plans. Certainly, we're happy to offer some reimbursement compression in exchange for a tremendous amount of volume that economically makes a lot of sense for us. So that's an added benefit to the program. We are actively pricing small and arguably medium-sized contracts. We do have a dedicated team that's focused on this. They price them, they pitch them. Ultimately, they integrate them and then pass them off to operations for continuing that book of business. And Suzanne did allude to getting pretty close on a new opportunity in the last earnings call. And so with a little luck, we might have something to talk about by the next call.

So I guess a couple of follow-ups here. So first, this Kaiser versus Humana experience, right? With Humana, I guess it was a much bigger contract, right? Because initially, there was some disruption there.

Actually, it was much smaller.

Smaller initially.

The -- yes. So this is a tale of 2 different contracts. I think maybe what you're getting at is in the start-up of Humana, we incurred significant penalty payments from Humana. So we did open some de novo locations to support that Humana contract but it was 5 or 6, not 35 like we've done now with Kaiser. The other difference was that we were taking business literally from hundreds of DME operators, some of them just mom-and-pop single or 2-site location entities. And the communication of AdaptHealth to those members from Humana to those members, educating the referring providers that if you're a Humana Medicare Advantage plan on HMO, AdaptHealth is the only place that you can refer membership to for DME products. That was a considerable amount of disruption to handle all at the same time. And effectively, day 1, we got paid the per member per month. However, if a patient was serviced on home oxygen by a different provider at roughly $120 a month, that single patient would deduct from our payment. And so that took essentially 3 quarters to work through the system until the point that we were fully integrated, which was 2 years ago in early '24. The difference with Kaiser is that it was all coming from an incumbent -- a single incumbent provider. And so there was a very respectful and professional relationship built between us and that competitor that was established to essentially lift and shift those patients and transition them smoothly to AdaptHealth. And so there were no penalties incurred. That concept didn't even exist in the second opportunity. The difference was that we de novoed 35 sites, essentially all in geographies that prior to Kaiser, we didn't have footprint in. And so the opportunity that's in front of us now is as that contract is now fully transitioned, and we're starting to rightsize the staffing model to handle the volumes and to handle that relationship. The next thing we're doing is bringing in new sales force into these parts of Northern Southern California, Oregon, Washington, essentially everywhere Kaiser has a hospital footprint. And now those sales folks are selling into referring providers outside of the Kaiser network because we've got all that fixed cost essentially paid for, and now we can go find additional opportunity to bring in at a much higher flow-through of every new dollar of revenue.

And I guess on Humana a follow-up because you alluded to this idea of Humana is going to grow their membership much faster this year. Does that require more investments on your end?

It does not -- it does not. Well, I said that quickly. No fixed costs or additional infrastructure investments. Certainly, it will require a little more CapEx investment because the bigger membership means that the flow-through will be additional patients that are utilizing. So there'll be some CapEx that will come with that. But again, that contract also operates at or better the enterprise margins.

It's already there. Okay. And then on this capitated revenue exposure, I think you said, I guess, 9% in Q1 but obviously, there was partial Kaiser in there. So how should we think about the exit rate, like magnitude of things?

Yes. So as you said, about 9% of enterprise revenue is capitated in the first quarter. We expect to be exiting the year closer to 15%. Now much of that will come through the ramp as we fully transition and that revenue will start flowing in Q2 and beyond. That's a big part of it as well as we are working on pipeline.

And I guess coming back to, I guess, the core business outside of capitation but the sleep business is doing pretty well.

It's doing great.

Yes. So I guess walk us through the drivers there in terms of like what's driving that? And kind of you guys also alluded to this idea of like there's still a lot of undiagnosed patients out there and it sounds like that's improving. So kind of walk us through, does that change your view of this business and kind of growth algorithm for that particular service line because of this.

Well, I'd say that it doesn't change our view of the growth algorithm. I mean both Sleep and Respiratory, which represents almost 70% of the business, we expect that to grow in the 3% to 4% range over time. Respiratory, a little lighter than that, sleep a little heavier than that. That's our general growth outlook for the businesses. Now GLP-1s, certainly, there were a lot of concerns, I guess it was maybe 2 years ago, we were sitting here talking about this or even 3. Certainly, the top of the funnel, and we don't have data to show this, but we expect -- certainly, there are patients that they're on a GLP-1 either for diabetes or for weight loss. That's helped them with their OSA condition. Maybe their AHI has come down to a level that they're comfortable not sleeping with a CPAP. And so certainly, there must be some compression at the top of the funnel. However, the cross current is essentially coming from devices, wearables, watches, rings, other indicators that suggest a patient might have a sleep, might have sleep apnea. They are more detectors than they're not actually diagnosing. But that is creating a tremendous amount of volume in not just in sleep centers, but also at-home sleep testing, which is exploding. And so those cross currents are resulting in double-digit referral growth year-over-year. I've been in this business now 6 years. I've not ever seen that kind of referral growth. That doesn't mean you convert all of them ultimately as patients for a whole host of different reasons. But the top of the funnel, the demand for sleep, and we think just the environment and the awareness of sleep health is going to be here for many years to come. For perspective, there's slightly fewer than 7 million Americans that are on a CPAP. They sleep with a CPAP today. 25% of them are on our census. So we're by far the largest operator in the space. Moderate to severe sleep apnea, there's approximately 33 million Americans with moderate to severe sleep apnea. Mild sleep apnea, I mean, there's 80 million Americans. And many of those patients would also benefit from CPAPs or mouth guards or other products to treat OSA. So in terms of that top of the funnel, we're very confident. There's good growth ahead for sleep. Respiratory is also underdiagnosed, not nearly to the extent of sleep but there's millions of Americans, the American Lung Association believes, that have underdiagnosed or undiagnosed COPD, and so our sales force is also selling into those call points to help diagnose patients faster. When that happens, you're able to treat them with nebulizers and nebulizer medications. Ultimately, COPD only progresses. There is no cure. So that patient at some point will need oxygen, either portable, stationary or both. And at some point, the lungs will no longer ventilate, so the patient will need ventilation. We provide that entire product catalog to patients. And so many of our respiratory patients are on service more than a decade. And that business is continuing to slowly compound. We refer to that as a little bit of our bread and butter in the business. It's a great business, and we expect it's going to continue to compound over time.

So before we talk about the respiratory, but the sleep, so you said faster than 3% to 4%, would you say much faster, like close to high single digits or...

It depends on the quarter or the year.

But say like a longer term, would you...

[indiscernible] in that area.

Because also when you said your, I guess, referral growth was double digits, but also in the oxygen starts, that number was up a lot in this quarter, right? I mean I...

Well, that was capitated, but yes, yes. I mean if you take out the capitated and if you look at our segment revenue year-over-year ex CAP, both Sleep and Respiratory were up between 3% and 4%. We do expect that to continue for the foreseeable future.

And I guess for that business, there's some reimbursement changes that sounds like may be favorable for respiratory. Is there something that also could explain why maybe you're seeing more of a tailwind there?

Well, more of a tailwind there. Potentially, reimbursement change that would be a tailwind. The SOAR Act, S-O-A-R is still moving through Congress. There is a fair amount of support for that business, essentially reestablishing the rates that were in place during the COVID pandemic. Those rates were installed temporarily to incentivize particularly rural providers, which we provide a lot of rural respiratory service with increased reimbursement to make sure that the supply chain was healthy and patient access was not disrupted. So there is opportunity there. We'll see. We don't count any of that until or unless it's announced. I'd say there was also a national coverage determination, an NCD announced several months ago around ventilation. This one is interesting because Medicare is essentially requiring same or similar levels of monitoring of that equipment and the patient utilization as what's already required within our sleep health. We monitor the machines to understand is the patient utilizing or not that's required for Medicare billing claims. I'd say on the respiratory side, many years ago, we established an advanced respiratory team that are licensed respiratory therapists. They have been actively monitoring patients on our vents for years. And so the introduction of this NCD within the industry has created a tremendous amount of uproar because most DMEs don't have that infrastructure or that capability to conduct what's required by Medicare. For us, it's a shoulder shrug. We've been doing it for a long time. And so we are seeing elevated referral volume for ventilation. We do believe that this is some of the reason for that. But overall, the respiratory regulatory and reimbursement environment is very steady to arguably trending positive.

And I guess the last piece, right, diabetes. So there was a lot of disruption. It sounds like growth is still there, right? But like the margins are quite low. So kind of how are you guys thinking about strategically this business? Like do you expect margins to get better? Or should we think about sort of low single digits for that business?

Well, I'd say strategically, as we think through Diabetes, if we were making a decision today to invest a new dollar into that business, I don't know that we'd do that today because over time, particularly since Suzanne Foster arrived from Danaher 2 years ago, we thought through and reassessed how much volume does that product category drive to Sleep and Respiratory. I mean the answer is de minimis. Through the underwriting years ago, it was believed that, look, many patients with diabetes also have sleep apnea and vice versa. And so there was a belief of a cross-sell opportunity. That never panned out. There's operational reasons why attempting a cross-sell is complicated and arguably more risky than what it's actually worth. And which is why we say that if we were making the decision today, I don't know that we'd be moving into the product category. That said, it's the business we're in. It is only about a 3% EBITDA margin in the first quarter. It's becoming such a small piece of the pie. We have a de minimis amount of diabetes capitated revenue, not with Humana, not with Kaiser, with some smaller California plans. And so it's not critical in terms of selling new capitated opportunity. And again, it does not drive ancillary patient volume into the core, which is Sleep and Respiratory, over 70% of our revenue. And so for that reason, we intend to run it as best we can. It's still cash flows, but that's where we stand with Diabetes.

And since you mentioned capital deployment, so maybe we should talk about that.

Sure.

Right? You have target 2.5, right, net leverage ratio rate. And I guess you did some refinancing earlier last year, I guess, or maybe this year, was it some things you were changing up. So maybe talk about sort of your priorities in terms of leverage, M&A, investments.

Well, Joanna, I mean, arguably, the best bank out there led us through that refinancing. So we're grateful a couple of folks here in the room today. So thank you for that. That was an opportunistic deal. We have -- I mean, our next tranche of notes come due in August of 2028. They are our lowest cost bonds. They're at 6%, but we're raising money right now at 5%, basically 5% even. Once we hit our leverage target of 2.5 and potentially lower, that there's some potential improvement there as well. And so that alone, we intend to take out those '28 in August once the prepayment penalty goes away, and that move alone should save us about $3.5 million a year of interest. So that was a no-regrets move. With that, we did modestly upsize the revolver. The reason for that was we drew $100 million to acquire the patient equipment assets of this third-party DME in support of Kaiser. And so we're still carrying that revolver as of the end of the first quarter. For the year, we expect $200 million of free cash flow, slightly less than what we've produced in the last 2 years. A lot of that is the capital requirements and standing up Kaiser. In terms of allocating, Suzanne and I have targeted somewhere between 1 point to 2 points of M&A of revenue and arguably about the same amount of capital, $35 million to $70 million or so of M&A. We'll see if we get all that done in a year or not, but we work a pipeline. We've been extremely disciplined. Just as many DMEs that we look at these days, we actually walk away from more deals in diligence than we end up closing because of compliance concerns or they might be making business decisions that were -- just aren't going to work for AdaptHealth. But there is still opportunity. It is still worth running that pipeline, and we intend to do some deals. After M&A and certainly after supporting organic growth, I mean, we'll continue to delever and deploy more cash towards the balance sheet.

We only have 2 minutes. There are 2 topics I want to hit but you mentioned something I want to also touch base on in terms of the compliance issues at the smaller DMEs because we're hearing a lot focus in D.C. around fraud and abuse...

Well, there's a new moratorium in place.

Right, exactly. So kind of what does it mean to you guys? Does it open up kind of more markets to you to grow even maybe you don't have to buy, but just take over...

Well, patients. Our view is that the regulatory environment, which can include the Medicare competitive bidding program as well as the current moratorium that's in place for essentially new PTANs or new Medicare billing numbers within DME. For us, I mean, we've got 670 locations all over the country. And so our footprint is essentially everywhere already. So a moratorium doesn't hurt us. It might hurt others in a different way. But bigger picture, there are several vectors. [Audio Gap] The first is the regulatory environment is making it harder for smaller players. [Audio Gap]

I want to hit on that topic, AI, right, very hot topic. And I guess you guys been historic focused on technology and kind of streamlining. So maybe give us a quick overview where you stand there and also in terms of like how much more there is to, I guess, utilize this technology.

Well, I'd say with -- now with 12,000 employees on staff, that's a lot of manual work and labor that's happening in our business. There's another roughly a little over 4,000 employees or FTEs that are offshore as well. By definition, they're kind of picking things up and putting things down, copying on one screen and pasting on the other. So the opportunity set in front of us is large. I don't know that I'm ready to quantify it just yet. But we are making tremendous progress in certain areas of our business, one being the revenue cycle. We have deployed bots and other AI that is reducing the amount of offshore labor. You'll see that in our filings that those number of headcounts are continuing to come down. We expect that will continue in '26 and beyond. The second area is a combination of the myAPP, which is our patient app, now over 400,000 patients registered. Those numbers are going -- growing at a very, very rapid clip. And within the myAPP, it gives the patient choice and potential to resupply and order on their own without talking to an AdaptHealth employee or they can talk with our AI chatbots or call the phone numbers that have conversational AI bots that are -- again, they're doing so many things like scheduling patient setups, like reordering supplies, even paying their bills, that historically, humans were 100% part of that ecosystem. And so we're making great progress. We'll continue to report that, and we think there's a bright future with AI and technology here at AdaptHealth.

All right. I think that's all the time we have. Or is it...

I think we're going backwards.

Yes, we're going backwards. So that means we're done.

Thanks for having us.

Thank you so much. Thanks, everyone.