AdaptHealth Corp. Q2 FY2021 Earnings Call

I'd like to welcome everyone to AdaptHealth Corp.'s earnings conference call for the quarter ended June 30, 2021. Everyone should have received a copy of our earnings release earlier this morning. If not, I'd like to highlight that the earnings release, as well as a supplemental slide presentation regarding Q2 2021 results, is posted on our Investor Relations page. In a moment, we'll have some prepared comments from Steve Griggs, CEO; Josh Parnes, President; and Jason Clemens, Chief Financial Officer. We will then open the call for questions. Before we start, I'd like to remind everyone that statements included in this conference call and in our earnings release may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These statements include, but are not limited to, comments regarding our financial results for 2020 and beyond. Actual results could differ materially from those projected in forward-looking statements because of a number of risk factors and uncertainties, which are discussed in our annual and quarterly SEC filings. AdaptHealth Corp. shall have no obligation to update the information provided on this call to reflect subsequent events. Additionally, on this morning's call, we will reference certain financial measures, such as EBITDA and adjusted EBITDA, and adjusted EBITDA less patient equipment CapEx, which are non-GAAP financial measures. This morning's call is being recorded, and a replay of the call will be available later today.

Thank you, Chris, and thanks to everyone for joining our call. This week marks the first six months for the combination of AdaptHealth and AeroCare. Our original thesis has been confirmed. We are in a business with secular tailwinds since more and more healthcare is being delivered and monitored in the home, and we have proven that we can grow both through acquisitions and organically. Accordingly, by combining our companies, we envisioned we would improve patient access, patient experience, and clinical outcomes. With this vision in mind, we continue to execute on our strategy of organic growth, improving operations, and closing accretive acquisitions. We do this by leveraging technology and workflow to improve our operations and have already achieved significant direct and indirect cost savings via purchasing volumes. In addition, six months into the combination, we've seen great progress toward our synergy plan, including consolidating 88 locations and implementing our digital logistics and RCM platforms. Our synergies activities are substantially complete. We remain confident in our previously communicated synergy target of $50 million annually and $30 million in 2021. On the sales front, we made strong progress reorganizing and focusing our combined 615 person sales force. As part of this reorganization, we have taken the best training, tools, and practices and applied them across the entire business. We believe through our sales efforts and the re-supply engine, we will maintain an organic growth rate of 8% to 10% over an ever-increasing base. Most importantly, by combining our operational teams and leaders at all levels across the country, we believe that we will be more powerful than the sum of our parts in pursuing our mission to empower our patients to live their best lives out of the hospital and in the home. The success of our combined team is evidenced in reaching our highest-reported revenue and adjusted EBITDA margin for this quarter. So far in 2021, we have accelerated our acquisition pace. When we acquire a company, we not only evaluate the near-term and longer-term cash flow characteristics of the target, but equally or more importantly, how it will fit into the ongoing organic growth profile of the company. An example of this is our Q2 acquisition of Spiro Healthcare in New England. Prior to the acquisition, neither AeroCare nor Adapt had significant operations in this geography. As a result, we expect to grow significantly in this region. In addition, we completed three more acquisitions in the second quarter, one being the acquisition of Healthy Living Medical Supply based in Michigan. We are very excited as we continue to expand our diabetes presence with this acquisition. Already in the third quarter, we have closed six more acquisitions, each one meeting our criteria for earnings and strengthening our strategic presence in existing regions. The second quarter started with broad COVID-19 vaccine access across the country and the reopening of our economy. The reopening was evident in the referral patterns of our hospital and health system partners as elective procedures came back and pent-up sleep study demand was met. However, the emergence of the delta variant of COVID-19 has raised concern in our economy's overall recovery. We demonstrated our ability to respond since the beginning of the COVID-19 pandemic, and we are confident in our ability to continue to respond as necessary. In addition, we generated $9 million of revenue in the second quarter from B2B sales, supporting our hospital and health system partners and providing much-needed oxygen and ventilation equipment. Although we do not expect this revenue to be recurring, it continues to demonstrate the commitment of our workforce in serving the needs of our partners and patients. In summary, we are very proud that the past six months has validated the future that we envision for our patients, referral sources, employees, and shareholders.

Thanks, Steve. My remarks will focus on the key aspects of our strategic road map, including operational technologies, chronic disease management, and how these capabilities help enhance our overall business. I'll also comment on our diabetes integration and growth progress. But first, I'd like to discuss the operational impacts of the Respironics recall announced by Philips on June 14, 2021, that is affecting the entire sleep health industry. Philips Respironics has been a great partner of ours for years, and we're committed to working through these challenges together. For our business, there are two operational areas: the first is patients currently on billable census with products on recall, and the second is the supply chain for the new devices that could potentially impact our ability to meet new start demand. We have several levers available to mitigate the potential shortage, including inventory management, asset recovery, and alternative suppliers. There was no financial impact to Q2, but we believe the potential impact to the second half of 2021 could be up to $30 million of net revenue. We expect much of the shortfall in setups would be delayed until 2022 and likely recaptured, and we'll have a better perspective on this by the time we report next quarter. Turning to the key aspects of our strategic road map. We're very pleased with our continued adoption of our e-prescribe technology. For example, in our diabetes product line, approximately 40% of new orders are currently flowing through this technology and more importantly, our cycle times are down significantly. This reduction in cycle time drove improved patient and provider satisfaction. We have advanced one of our key technology synergies between Adapt and AeroCare. Our proprietary real-time end-to-end logistics delivery platform enables mobile-friendly order tracking and communication with our patients. This technology is the backbone of our CRM system used by our sales reps and has been rolled out across the vast majority of the organization. Continuing with our strategic road map, our long-term goal as a leading home care provider is to continue evolving our service model to more efficiently help patients manage chronic illness in the comfort of their own homes. Several programs are underway focused on our sleep, COPD, and diabetes patients, including technology-enabled coaching and chronic disease management to drive a better disease outcome over time. For one example, we have enrolled several thousand patients in our COPD disease management program, which develops individualized plans of care and provides patient clinical data reporting to physicians. This technology has already proven significant reductions in hospital readmission statistics. Additionally, this program simplifies workflow and drives efficiencies for our several hundred clinicians who serve patients in their homes. Improving patient experience and outcomes is a core principle at AdaptHealth. Accordingly, we will continue to invest in both talent and technology to further improve outcomes and reduce the overall cost of care. With these investments in technology and chronic disease management, we are accelerating growth in all of our product categories, most dramatically in diabetes, our fastest-growing product category. Coupled with our e-prescribe platform and proprietary intake technology, we believe we are growing in line with the overall end market. We have combined our national diabetes sales force with our hard-earned expertise in HME re-supply operations to accelerate organic growth in each of the six businesses we've purchased since last July. We continue to be extremely excited about the future opportunities within this product category.

Thanks, Josh. Good morning, and thanks for joining our call. For the second quarter ending June 2021, AdaptHealth reported net revenue of $617 million, an increase of 166% from the second quarter of 2020. As detailed and defined in our Q2 2021 earnings supplement, AdaptHealth's organic growth for the quarter was 10.1%, supporting our long-range organic growth estimate of 8% to 10%. This growth was again led by new starts in our diabetes product line and continued strengthening in our sleep business, following the lull of new starts impacted by the pandemic in mid-2020 as a frame of reference, pro forma net revenue for the quarter was $632 million, driven primarily by Spiro Health Services and Healthy Living. Beginning in Q1 2021, our pro forma net revenue disclosure in our Form 10-Q includes all acquisitions completed in the period as opposed to just material acquisitions, which were previously disclosed. We intend to maintain this increased level of disclosure going forward. Turning to profitability. Our adjusted EBITDA was $148 million for the quarter, resulting in an adjusted EBITDA margin of 23.9%, up from 21.6% in the first quarter. We benefited from a full quarter of AeroCare that historically delivered higher margins than the standalone AdaptHealth business. Additionally, our synergy program continues to roll along and is absolutely on track, contributing to higher margins for the quarter. On the regulatory and governmental front, there have been a series of positive announcements across our industry. First was the extension of the public health emergency announced on July 20th. The extension will provide continued reimbursement benefit for the next 90 days when the extension will be reevaluated. Our updated guidance includes the current PHE extension, but it does not include any future extensions. Additionally, CMS announced relaxed standards for CGM qualification, removing the four per day test trip requirement. Some commercial carriers have already followed suit, mirroring the CMS policy. Finally, and very importantly, CMS published a proposed rule calling for relaxed qualification standards for oxygen, including possible elimination of the chronic stable state requirement and possible elimination of the CMN or certificate of medical necessity. The industry has supported this change for many years, and we're pleased with the proposed changes. We think it's unlikely for these guideline changes to result in a material increase to revenue in 2021. But as we get more data behind us, we will certainly evaluate these announcements as part of our 2022 financial planning cycle that just kicked off. Turning to the balance sheet. We prepaid half of the outstanding principal on our 12% interest promissory note. We expect to pay down the remaining principal between now and September 30th. We had $175 million outstanding on the revolver at the end of the quarter. We're pleased to take this next step forward in simplifying our capital structure and refinancing expensive debt. We are also focused on driving increased conversion of adjusted EBITDA to cash flow from operations. Speaking of that metric, we generated $147.6 million of cash flow from operations for the first half of 2021. This included $15.9 million of cash outflow associated with CARES Act recoupment during the second quarter, representing about one-third of the 2020 advanced payment that will be returned to CMS. Overall, we are very pleased with the amount of cash our business is generating and remain in range of our previously discussed expectation of converting approximately two-thirds of adjusted EBITDA to cash flow from operations. I'd like to turn to our updated guidance for 2021. As announced this morning, we are increasing our 2021 full year guidance for net revenue, adjusted EBITDA, and adjusted EBITDA less patient equipment CapEx. We are guiding to net revenue of $2.38 billion to $2.48 billion, adjusted EBITDA of $555 million to $580 million, and adjusted EBITDA less patient equipment CapEx of $360 million to $375 million. This increase includes $90 million to $100 million of in-year revenue for the additional acquisitions announced today. As a reminder, our previous guidance included in-year revenue for Spiro Health Services. We also included in our estimate a potential Philips Respironics device shortage of up to $30 million of revenue. This situation is fluid, but we are confident we'll have enough clarity to assess any possible impact to 2022 by the time we report next quarter. As a reminder, our guidance does not include any contribution from acquisitions that have not yet closed. I have one more important topic to discuss. We continue our progress transforming our back-office operations, including the installation of new technology and capabilities. Our ERP met our Phase 1 go-live on June 1st, and all other transformation streams remain on track.

Thank you, Jason. Before we turn to questions, I'd like to thank our 9,068 employees across our 678 locations for their contributions to a successful second quarter. Also, we appreciated their continued commitment, passion, and excellence toward advancing our strategy of organic growth, improving operations, and accretive acquisitions. Thank you, and now let's open up for questions.

Hey, Good morning, guys. Congrats on a very solid quarter. I guess, I'll start off with a question, let's address the elephant in the room. I guess, for Jason, a lot of people have been asking us about your organic growth metrics. Any clarity or any other color you can share with us? And maybe some visibility into what Q1 and Q2 would have looked like using a more traditional organic growth metric, just to address that point that a lot of investors have been focused on?

Sure, Brian. Good morning. First, I want to highlight the ongoing and enhanced disclosure we are providing in our 10-Qs, which you might have caught in my prepared remarks. Regarding Q1, before any reports that have circulated recently, we changed how we disclose acquired revenue. We now include all acquired revenue for the quarter instead of just material acquisitions. This is a change aimed at improving visibility and transparency. You will see this in our upcoming 10-Q filing following this call and in the future. Additionally, we have added more disclosure, which can be found in our Q2 supplement posted on the AdaptHealth website early this morning under the Investor Relations page. On Page 7, we present a continuous bridge of organic growth, starting with reported net revenue growth, which is $617 million this quarter compared to $232 million from the previous year. The next step is pro forma net revenue, also included in our Q, showing $632 million for Q2 against $572 million last year. In defining organic growth for the company, we've made two adjustments. First, we exclude B2B revenue from our analytics because it is not recurring revenue. We are proud of this revenue, as Steve mentioned in the prepared remarks, but we do not consider it in our future contributions. Second, we differentiate between the formal definition of pro forma revenue and the acquisitions made by AeroCare from January 2020 up until our acquisition of AeroCare. Since AeroCare was very active in acquisitions, we have excluded those to avoid a misleading representation of growth. This complete bridge is included on Page 7 of our supplement. In terms of traditional organic growth, you might be referring to same-store growth. I'll pass that to Steve to explain why we do not use that metric to run our business.

Yes. Thanks, Jason, and Brian, too, for the question. So first, I just want to be clear and reiterate our belief that our business will grow 8% to 10%. We expect existing businesses, including the acquisitions, to grow 8% to 10%. So our managers out in the field are incentivized to grow their revenue level, not what they had three or 12 months ago. So if a regional leader has a $100 million revenue base and we acquire $20 million in revenue in the region, we're looking at incentivizing them to grow $120 million in revenue. And so whatever that point is, we look out 12 months and say that should grow 8% to 10% or whatever level we have in store for them. So when you talk about same-store growth, we just don't manage that way, and we don't account for it that way. I'll give you an example in the State of Texas. You know, Adapt had business in Texas in 2019 and in 2020, they acquired a very good business in Healthline. Almost immediately, the integration process started combining locations from legacy Adapt into Healthline and back and forth. And then they're doing a few other smaller acquisitions, and all those got combined into the existing operations. Then, in February, AeroCare was purchased. We had a very large presence in Texas, almost equal to the Adapt. And as we indicated, with AeroCare and Adapt combining offices, Texas was no exception. Multiple offices were merged together. So our Texas regional leader doesn't try to manage growth for a particular location in a particular time. She manages the entire region. And now the merged region is significant for her, and her goal for her and her salesmen is to grow the combined region 8% to 10%, and while at the same time, making it more efficient. So that process right there makes it extremely difficult, I would argue almost impossible, to calculate same-store growth because there's no more same stores. They've all been merged in together. And so that's why we look at what we are at today, and we want to grow that business. Does that make sense?

Yes. No, that's great. I really appreciate that and thank you for all that color. And I guess, my next question since I have you, Steve, I think at the beginning of the year, when we were looking at your long-term growth targets, one of the things you guys mentioned was trying to buy $100 million to $150 million worth of revenue a year. You're already at $300 million this year. So clearly, you've demonstrated your ability to acquire, your intent to maintain a robust pace of M&A. So should we be thinking that there's more in the pipeline? And how are you thinking about the integration of these deals and just the ability to bring them in and continue growing these assets that you're acquiring?

Yes. Currently, our pipeline is quite extensive, which surprises me a bit given the number of quality assets that AeroCare wanted to have previously, as did Adapt. I believe our acquisition activity will remain strong for the rest of this year and into 2022. How do we combine these acquisitions? Well, the initial acquisition work for AeroCare is mostly completed, so that team can focus on other acquisitions. When we begin to combine and integrate them, this is primarily managed by local and regional managers. For example, if a team in Texas is handling a specific acquisition and they complete it, another team in Tennessee will be responsible for integrating a different acquisition into their operations. As long as we don't overload any operational team with numerous acquisitions at once, which we avoid, we should be able to manage this process quite efficiently.

Gotcha. My last question for Josh is about your prepared remarks where you mentioned that you believe there is potential for growth in the diabetes market alongside the market itself. I noticed that Dexcom has projected around 20% volume growth over five years. However, your long-term guidance for the diabetes business suggests growth in the range of 10% to 12%. Are you being conservative in your outlook for diabetes? Is the 20% volume growth a reasonable near-term expectation?

Thank you, Brian. Our diabetes business is a smaller part of our overall operations. Even if we achieve higher organic growth there, it will contribute to an overall growth rate of around 8% to 10%. We've been in the diabetes market for about a year and have seen positive developments. From the start, we've been focusing on e-prescribing and applying lessons learned from the HME side of our business. Improvements in re-supply, e-prescribing, and efficiencies in intake technology are providing our prescribing partners and physicians with a more effective experience. This also enhances efficiency under the medical benefit, streamlining the documentation process. Consequently, we have been able to grow alongside the market, where companies like Dexcom indicate over 20% growth. We believe we can match that growth. Our long-term objective is to gain market share. However, we're still relatively new to this segment and continue to learn, but our initial progress has been encouraging.

I would add that we have six excellent businesses that we're managing now as an integrated platform. We acquired the first one just last July, so we've only been in this business for a little over a year. As mentioned in previous calls, as we gather more data and if our trends continue to show that we are indeed exceeding 10% to 12%, we will update our perspective when discussing guidance for 2022, which we will do in about 90 days.

Hey, good morning, guys. Thanks for taking my questions. Two quick ones here to start off with. Looking at the revenue guidance from December when you guys acquired AeroCare, you had $2.05 billion, $2.2 billion of revenues and then compare that to the new guidance of $2.38 million versus $2.48 million. You said in the press release that you have acquired $300 million of annualized revenues, which obviously didn't all close in the first quarter. Just how much revenue have you guys acquired since that announcement? Just trying to sort of bridge organic growth rate versus acquired growth from the December guidance to today's guidance.

Hey, Pito. This is Jason. I'll be glad to take that. So, we had three separate raises since the AeroCare announcement. In terms of revenue, if you recall, Q4 2020, we raised $130 million to $150 million of revenue. That was for the five deals we acquired from December 30 through that earnings call. The next raise was from the last call. We talked about Spiro, and there are some dollars in there for the CMS oxygen fee schedule rate increases that went into effect April 1. That was a $40 million raise. And then today, in my prepared remarks, I talked about raising $90 million to $100 million for acquisitions. So, I think if you take that all together, you're looking at $260 million to $290 million ballpark for acquisition raises. That's in year. So, to the point of we've acquired over $300 million of annualized, that's where that's coming from. The one item I will call out is the Philips impact, right, that's netted in there. But otherwise, those are the acquisition numbers.

Okay. Which is a nice sort of bridge to the next question about guidance. You raised the mid-point of the guidance by $22.5 million, beat the quarter by $17.4 million, which implies the back half of the year should go by about $5 million. But you've closed a number of deals since last quarter's guidance. So, can you just help me bridge the deal close versus the Philips recall? If I take a 30% margin on $15 million, that's a $5 million EBITDA impact or so. Is that the right way of thinking about that? Basically, I'm trying to understand what would have happened to guidance if you hadn't done any acquisitions this year?

Sure. I'll address the second part of your question first. Regarding the acquisition portfolio, it aligns well with the overall business. You can see the ongoing adjusted EBITDA margin we are achieving reflects what we're acquiring. The figures we are raising for acquisitions align closely with our core business. As for Philips, it's a bit less clear. We mentioned a potential revenue impact of up to $30 million for the second half, but I don't believe it's zero, nor do I think it will reach $30 million; it will likely fall somewhere in between. We haven't disclosed and won't discuss our gross margins for that segment. However, if you assume that 50% of that revenue translates to profit, then from $30 million, $15 million would drop down, or from $15 million, $7.5 million would drop down, and so on. This is why you're noticing the changes in the margin profile. Overall, we remain confident that the margin profile will be as we've indicated.

All right. Perfect. And then, last super quick question here, the exciting topic of DSOs. DSOs dropped very nicely in 2Q versus 1Q. Obviously, 1Q you had the question of AeroCare in there. Just curious where this exit sort of this year? There has obviously been a big question on cash flow conversion following a short report. So, I just wanted to address both the DSOs as well as our cash flow conversion. Thank you so much guys.

Certainly, Pito. Regarding DSOs, you can expect them to remain in the mid-40 to upper-40 range. We are quite comfortable and confident in that area. Although there's been some variability from quarter to quarter, you should anticipate DSOs to stay within the mid-40s to high-40s. As for cash flow conversion, we introduced the expectation back in Q3 of 2020 that we would convert about two-thirds of every dollar of adjusted EBITDA into cash flow from operations. When considering free cash flow, we project patient equipment capital expenditures to be around 8% to 9% of total revenue, and non-patient equipment CapEx to be about 1%. This will assist you in calculating our approach to free cash flow now and in the future. As mentioned in our prepared remarks, we are aligned with that expectation. We noted previously that Q1 might be a bit uneven due to transaction costs and Q1's unique characteristics. However, during the first half of the year, we are on track with our goal of converting two-thirds of every dollar of adjusted EBITDA into cash flow from operations. This focus is central to our company, and we're very proud of it.

Hi. Good morning, everyone. Thanks for taking my questions. I've got a couple for Jason. The first one is a bit of a repeat of the prior question, but I want to make sure I'm thinking about the new guidance correctly. So, you added sort of roughly $100 million, and this is sort of relative, I guess, to the last guidance raise, but you added about roughly $100 million in M&A. You raised at the mid-point by about $130 million, and that's despite the $30 million headwind from Respironics. Is that sort of the right way to think about it? So, the underlying business looks like it contributed a reasonable amount of the guidance range raise. Is that right?

Matt, that's the right way to think of it. I'd point out for you on the bottom of the range, we brought it up $165 million. And so, what you're seeing there is as we get later into the year, we are tightening the range. We're bringing it all up. The bottom is coming up significantly more than the top. Despite headwinds that we are expecting in Philips, we feel great about the raise.

Okay. I appreciate that. And then, Jason, another one for you. How should we think about the second-half cadence? I mean, there's a lot of moving parts with potentially seasonality, Delta virus, the deals you've completed, obviously, the Respironics recall, which may sort of disproportionately impact the third or the fourth quarter. Is there any way you can help us to think about a reasonable range for the third quarter, again, given all these moving parts?

Sure, Matt. I want to refer back to the shape and seasonality discussion we had last quarter, as well as the Q1 pro forma revenue number of $564 million that I mentioned. If you consider the $482 million we reported, keep in mind that it doesn't include a month of AeroCare, which will affect your calculations. Using the $564 million and adding it to our overall guidance, you can expect total company revenue for Q1 to fall in the 22% to 23% range of our annual revenue. Historically, we anticipate about a 1% increase in Q2, with an additional 1% to 1.5% in Q3, and the remaining share in Q4, where approximately 26% to 27% of our annual revenue will be generated. Specifically regarding diabetes, the growth rate is steeper, starting at around 18% in Q1 and finishing the year closer to 27% or 28%. Overall, this is the outlook you can expect for the business.

Really helpful. And then if I could sneak one last one for Josh. You touched on all the progress being made on the cost side of AeroCare. Any update on how you're progressing on sort of the revenue synergy opportunities for AeroCare? But I guess also for Solara as well. Any update there would be helpful. Really appreciate it. Thanks.

Sure. I will address the revenue synergy from Solara as well. Many of the revenue synergies I mentioned earlier are derived from our experience in re-supply with several acquisitions, especially the six related to diabetes over the past year. This has been a significant driver, and we believe it will continue to spur organic growth in that product category. Regarding AeroCare, we are observing two main things. Firstly, we are realizing cost synergies that are enhancing our margins. Secondly, we see the AeroCare organic growth engine effectively merging with our AdaptHealth sales efforts, which is boosting organic growth for both organizations. As you know, sales synergies generally take longer than cost synergies, but we feel that they are beginning to gain momentum about six months into the integration and should positively impact our late 2021 and 2022 figures.

Hey, good morning, guys. Thanks for taking my questions. Just, I guess, to reiterate a bit on the guide. Can you flesh out what does your guidance really assume in terms of any COVID impact for the back half of the year? I guess, especially with the resurgence of the Delta variant, how are you thinking about that progressing through with oxygen and ventilator volumes?

Hey, Courtney. Good morning. This is Jason. It is included, right? It's netted. You've got some positive factors as well as some challenges that are reflected in the revenue increase we've mentioned. A significant portion of the revenue comes from acquisitions and the Philips figures we've discussed earlier. Regarding the positive aspects, we included the public health emergency extension funding in our guidance, which will be available for another 90 days before being re-evaluated. On the downside, there are some allocations in this for COVID resurgence risks, which you can relate to the Philips situation. For the remainder of the year, these amounts won't be substantial due to the compounding effect of our business. If there is a COVID impact in Q3, it will likely be minimal since we may miss out on servicing some patients in Q4, which could become a bit more significant. We've considered all of this in our projections. Again, it's similar to the Philips calculations we provided, but I wouldn't classify the COVID impact as a major figure.

Okay. Yeah. That's really helpful. And then, I guess, one quick one on organic growth. I guess, you guys mentioned that in diabetes, you feel like you're growing in line with the market. I don't know if I misheard this comment, but I thought you said that specifically relating to diabetes. So, I guess, could you comment on other segments? Like how you think the organic growth is tracking for Adapt compared to the market?

Sure. First, when we discuss traditional durable medical equipment, we sometimes refer to it as bent metal, which aligns with our overall market expectations. We expect growth in that area to be around 2% to 4%, consistent with statistics from CMS regarding the aging population and elective surgeries. The home supplies segment remains very stable, continuing with an organic growth rate of about 2% to 3%, which is in line with our projections. In the respiratory segment, we experienced a slight increase in the first quarter, primarily due to COVID-related impacts from late November through mid to late February. However, those numbers have returned to normal levels, and we anticipate mid-single-digit growth moving forward. The sleep segment is slightly below expectations, projected at 7% to 9%. While it is a bit light, new starts have definitely picked up, and we are still addressing the effects of the COVID impact from mid-2020 that I mentioned earlier. In diabetes, we estimate that the net impact of market growth in this line is about 10% to 12%, as noted by Josh. Currently, we are observing data for this quarter that indicates market growth significantly exceeding that expectation. As we collect more data, we plan to update these figures accordingly.

Thanks. Good morning. I have quite a few, actually. They're all around the Philips recall. Jason, first, it sounds like you've put in a range of estimates for the impact somewhere between zero and $30 million. On the low-end of your guidance increase, did you use the low-end of the Philips impact or the high-end of the Philips impact? I'm just trying to get a sense of how that played into the range.

Yeah. It's the higher, Eric. So, $30 million on the bottom of the range. And I think we've got about $10 million on the top. I don't think it's zero. I mean, we've said up to $30 million. But if you unpack the acquisition raise as well as the Philips raise, it's $30 million of risk on the bottom and $10 million of risk on the top.

Great. And then, is it possible to get a sense of how that played out between 3Q and 4Q?

Sure, it's very back weighted. So, theoretically, if there are fewer patients to service or if there is an issue with product availability for patients, that will impact your rental revenue in Q3. However, there wouldn't be an effect on re-supply revenue for that quarter. Moving into Q4, you may still see a potential impact on rental revenue, but the patients you would have brought on in Q3 will not be there to re-supply. This means that re-supply starts to compound in Q4. In short, it's very back weighted.

Yeah. And then that leads to my question on mix, which is, I guess, our assumption is that the primary impact would be on equipment as long as we had good patient adherence, compliance, and not a lot of drop-offs on any new patient concerns out there. I'm curious what you can tell us about what you're seeing on re-supply right now. And what kind of calls you're getting to your centers or with your reps? Are you sensing patient concern, or not so much?

This is Steve. I'll take that. Surprisingly, with any patient that says they've stopped using their equipment, we stop billing no matter what that is, of course. And it's been surprisingly low, a few hundred patients really, that have said they've stopped using their Respironics machine. So, I think that after the initial panic, the referral sources in the health systems have contacted these patients and calmed them down and said, here's some mitigation techniques that you can do to relieve some of the risk on the Respironics unit. And then, hopefully, you'll get a new unit relatively soon. So, it's been very little. And then on the re-supply side, it's been also very little where you just haven't had that many patients. It's again in the hundreds that have said that they're not going to order their re-supply, because they're not using their machine anymore. So, the first number is on the active rentals where we're getting rental revenue. And that peels off, as you know, after 10 to 13 months when it becomes a purchased unit. And then on the re-supply as those patients after that time period, and again, so very little.

I understand you don't want to disclose specific margins, but our initial assumption was that equipment has low margins while re-supply has high margins. Is that a reasonable perspective?

Yes.

Yeah. And then, payer discussions. With this kind of a supply chain situation and at least in other distribution type channels, you typically see changes in payer behavior or changes in market prices. I know this is different because a lot of it is controlled under preset contracting. But what kind of discussions are you having with payers right now? And are you seeing any changes or potential changes in the pricing dynamics in the market given the situation at hand?

Well, not yet, but we are having discussions with them. So, Medicare, CMS will announce their inflation indicator here relatively soon, that will adjust our Medicare prices. And I think that's going to lead to a lot more discussion, but we're in discussion with them, but very little movement. I mean, you have some isolated things. And we've seen a Medicaid plan or to make a positive adjustment to the rates. But it's pretty insignificant to date. But we are in discussions with them and talking with them. So, not much to report yet.

Okay. Last couple of ones. Sorry for all of this, but I thought this was a bigger topic. So, we've heard ResMed has been giving higher allocations to large established providers in the marketplace. We've heard numbers of 20%, 25%. You may not want to quote a number, but have you been able to gain incremental allocations above historical purchasing patterns from other players in the market, whether or not it's ResMed?

Well, first to ResMed, they've made it very clear, and we've agreed with this that they are taking their customers' historic purchases, and that's where they base it. And then they take what they're able to produce to the historical demand and that creates a percentage. That percentage was less than historical for July, and it's going to be less than historical for August. And then that percentage is applied to all providers regardless of size. So, Adapt, Apria, Lincare, Rotec, whoever is getting the same percentage as the smallest player in the market. As far as other suppliers, there are some that are trying to come in there, but they have such low market share. We had a few equipment manufacturers that thought they might rev it back up, but they've declined. So, right now, you're obviously seeing on new patients, the shortage from Philips and then historic shortage from ResMed that we hope at least they'll be able to get back to their normal demand by the end of the quarter and then hopefully increase that in the fourth quarter. So that's what we're hoping. But there's a national global-wide shortage of components. Intel announced that the chip shortage is real, and it's going to last for an extended period of time. So, that's in all products, not just PAP equipment.

Have you considered collaborating with some Chinese manufacturers that have EUAs?

Yes. Yes. We're in early, early, early discussions.

Okay. And then, last one, I promise. Unused product in the channel, product in the number of sites that you have, you've done a lot of M&A. You've probably acquired companies that had some inventory. What have you been able to find whether it's under the patient's bed or in their closet or in one of your facilities? Have you been able to find more supply than perhaps you thought you had or maybe some safety inventory? I'm just curious what kind of a safety net do you have at this point considering this could go on for a while?

We're optimistic that our inventory will support us in the third quarter and possibly extend into the fourth quarter. The extent to which this inventory is effective relies on what ResMed can provide. I don't anticipate any new equipment from Respironics this year, so I believe this inventory will carry us through. However, I expect demand to decrease somewhat as health systems reevaluate whether to admit patients into sleep labs and acquire equipment they might not be able to obtain. This could pose challenges on the demand side. As we progress and gather more insights, we'll have clearer information. The FDA has issued a more favorable statement on managing this crisis, encouraging individuals to consult their doctors about using their machines, contrasting with Philips Respironics' previous guidance to stop using the machine entirely. Nevertheless, the FDA has not yet approved the actions Philips wishes to pursue regarding remuneration. I am hopeful that we will receive clarity on this within the next 30 to 60 days, which will provide us with better direction on the duration of this situation.

Thanks, Josh. Could you elaborate a bit more on the COPD program you mentioned and the potential it holds?

Sure. Yeah. So, happy to take that. So, on the COPD program, essentially what we're doing is we're enrolling our high-end respiratory event patients in a particular part of the country on a program that really helps clinicians monitor kind of real-time outcomes, gathers that data, puts it into kind of a technology that allows us to share that data with both the clinician and the health system. And really what essentially we're doing is we're tracking not just is the patient adherent to the actual therapy of the ventilator, but how they're doing kind of on a longer-term basis and how that relates to their plan of care. So, that's really kind of just early innings, let's say, of how we're thinking about chronic disease management across multiple different product categories that we believe should have real good runway on that, particularly sleep and diabetes. So, already on sleep, we're managing and coaching patients on adherence. Our goal is to do that over a longer period of time with those patients. As well as on the diabetes side, really we're working on some things with coaching on CGMs and working on how do we get that patient essentially not just adherent to the device, but really how do we get data around us being able to manage how well they're doing on their diabetes therapy, and how we can be helpful to all the stakeholders within that, which is physicians, insurance companies, obviously, the customers and the patients. But really, we sit at the intersection of being able to gather that data, but also impact that patient by leveraging the existing relationship where we have with that patient and that trusted relationship and also being able to be cost-effective at doing that at the same time without a really large investment in infrastructure to be able to do that. So, it's early innings on that, but I'd say, it's something that I'm going to be focused on, and I'm going to be pushing to drive that over the next couple of quarters.

Thank you and thanks to everybody for participating in your questions and your interest. We really appreciate it. And again, thanks to all of our incredible employees throughout our organization that are helping us with our continued mission to better serve our patients and improve outcomes. So, thanks a lot. Everybody, have a great day. Thank you.