AdaptHealth Corp. Q3 FY2023 Earnings Call

Good day, everyone, and welcome to today's AdaptHealth Third Quarter 2023 Earnings Release Call. At this time, all participants are in a listen-only mode. Later you will have an opportunity to ask questions during the question-and-answer session. It is now my pleasure to turn today's call over to Richard Barasch, Chairman and Interim CEO. Please go ahead.

Good morning, everyone. Thank you for joining us today to discuss AdaptHealth's third quarter performance. Before we begin, I want to remind everyone that statements made during this conference call and in the press release may include forward-looking statements according to the Private Securities Litigation Reform Act. These statements may concern financial results for 2023 and beyond. Actual results could differ significantly from those projected due to various risk factors and uncertainties discussed in the company's SEC filings. AdaptHealth Corp. does not have an obligation to update the information provided during this call to reflect subsequent events. Additionally, we will be mentioning certain financial measures, such as EBITDA, adjusted EBITDA, and free cash flow, which are non-GAAP financial measures. Today's call is being recorded, and a replay will be available later today. We are pleased with our third-quarter results. Fueled by our Sleep business, we achieved a 6.3% growth compared to last year, resulting in record revenues for the quarter. We also generated cash flow from operations of $98.8 million and free cash flow of $21.7 million. Adjusted EBITDA did not meet our expectations due to unexpected delays in implementing the Humana contract. Jason and I will provide more details on this, but these results do not lessen our optimism that the contract will ultimately be profitable for AdaptHealth, nor do they dampen our enthusiasm for expanding our enterprise sales. Without this contract, we would have met our expectations for revenue, adjusted EBITDA, margins, and cash flow this quarter. Our sleep product line continues to excel, showing a 17% increase compared to last year. New PAP starts aligned with our expectations, and our PAP resupply business reached record order volumes. A key metric to note is that our resupply census has grown by 12% over the past year, totaling over 1.5 million patients. Our focus on electronic ordering has helped reduce friction and improve the patient experience. Establishing strong relationships with our patients is a vital aspect of our strategy to be more than just a supplier of devices and supplies. Continuing the positive momentum from the first half of the year, we increased our respiratory net revenue by over 8% year-on-year, driven by a larger patient census and stabilization in the duration patients remain on oxygen and vents. Our diabetes segment remains a work in progress, as we've discussed previously. While third-quarter results were a bit softer than anticipated, we are encouraged by the steps we are taking to improve this essential product line. To revive growth, we are directing our sales efforts toward the expanding government business, particularly in regions where diabetes is common. The government market for CGMs and pumps is large and growing, and we are adjusting our strategy to focus primarily on acquiring and retaining these patients. Government-sponsored payers now account for 79% of our CGM census, an increase of 200 basis points since last quarter. We are rapidly hiring dedicated diabetes representatives in high-prevalence areas, leveraging the entire AdaptHealth sales team's scale and capabilities. Our goal is to double the number of diabetes sales reps over the next few months. Additionally, we are exploring profitable strategies to engage in the growing pharmacy sales channel, allowing us to reclaim some market share lost as more commercial payers transition to that channel. Moreover, we are starting to implement a strategy that utilizes data generated from CGMs to enhance the patient experience while providing valuable information to their providers and payers. This will bolster our value proposition across our stakeholders. Despite our early challenges with the Humana implementation, our optimism about the contract's value remains intact. We have built a strong relationship with Humana and are working to ensure a smooth transition process for their members, who will benefit from improved service for their HME needs. However, we underestimated the patient transition's size and complexity, leading to longer than expected onboarding and a reduction in our anticipated CAP revenues from Humana. Nonetheless, we are confident that this agreement will deliver positive results for AdaptHealth. Since going public in 2019, we have achieved revenue and adjusted EBITDA growth annually, recently improving our cash flow and strengthening our balance sheet. We acknowledge responsibility for issues, some self-inflicted, that have affected investor confidence, including setbacks in our CEO search. The top priority for our Board is to appoint the right candidate for the CEO role as soon as possible. We are in discussions with highly qualified candidates, aiming to fill the position by year-end. In the meantime, our focus remains on key initiatives and goals set by our Board and management team. Increasing cash flow from operations and free cash flow remains a top priority. We are concentrating on better collections, improved inventory management, and more efficient capital spending, which have all positively impacted our cash flow results. Recently, we used some of our free cash for stock buybacks while also addressing our balance sheet. In 2023, we paid down our revolver and reduced our leverage from 3.66x to 3.51x. We have a favorable debt structure regarding rates and maturities but aim to reduce our leverage to below 3x by the end of next year. Regarding our business, our immediate focus is on strengthening our diabetes line to return to a sustainable growth rate, expediting the Humana business transition, and expanding our enterprise sales efforts. We will continue to lower operational costs through automation and improved processes while implementing our strategy to enhance our relevance in the healthcare ecosystem. Lastly, we want to address the impact of affected GLP-1s on our sleep and diabetes product lines. Importantly, we are not seeing any current effects on our sleep product line. Our total sleep census, including new starts and ongoing PAP resupply patients, continues to grow at a pace that suggests ongoing revenue growth. Furthermore, recent analyses indicate that the perceived impact of GLP-1s on PAP utilization may have been exaggerated in earlier assessments. For instance, a study revealed that only 3% of GLP-1 users with obstructive sleep apnea have discontinued their PAP therapy. Additionally, findings show a decline in adherence to GLP therapy over time. Many, including ourselves, believe that the sleep total addressable market may actually expand due to heightened awareness and increased diagnosis of OSA resulting from GLP-1 publicity. Our assumption remains that GLP-1 drugs are likely to significantly affect obesity over time, potentially reducing the current sleep TAM. The extent and timing of this impact are subject to much speculation, but we are prepared to respond proactively to any potential challenges. If there is a reduction in the sleep TAM, we believe we can counter it by consistently increasing market share, lowering costs through automation and improved processes, and focusing on patient retention. We have made progress in these areas over the past few years, and the discussion around GLP-1s will further drive our efforts. There is growing consensus that increased GLP-1 usage may also accelerate the growth of CGM usage. We think that diabetes patients on GLP-1s are likely to be proactive about their health and will be more inclined to monitor their A1C levels through CGM. Additionally, we believe that improved insurance coverage for CGMs, particularly in the government sector, will serve as a strong tailwind for us. AdaptHealth is central to efforts aimed at improving health outcomes for individuals with chronic conditions such as obesity, diabetes, sleep apnea, and COPD. We have a unique position, connecting providers, patients, and payers. Currently, we engage with over 1.5 million individuals with sleep apnea, approximately 170,000 diabetics, and 300,000 people with chronic respiratory illnesses. We regularly interact with these patients to help them adhere to their therapies by supplying and resupplying necessary equipment while coaching them on optimal usage. Enhanced adherence alone will yield better outcomes and lower downstream costs. We are just beginning to discover how to compliantly harness the data we collect to further improve our patients' health, particularly those with comorbidities. An early example of this is a recent survey of 10,000 individuals who set up on PAPs last month. Of those who responded, 7% reported taking GLP-1s, indicating this usage can coexist with CPAP therapy. Furthermore, 20% of this group has diabetes, yet only 15% of those diabetics are utilizing CGMs to monitor their health outcomes. If we apply these findings to our entire population, we can identify numerous opportunities to better serve patients with comorbidities.

Thank you, Richard, and thanks to all for joining our call today. Let me begin by reviewing our third quarter results. We achieved record revenue of $804.0 million, an increase of 6.3% over the third quarter of 2022. Other than the Humana details that Richard described, this quarter met our expectations for top line growth and adjusted EBITDA, and cash flow exceeded our expectations. Our total sleep revenue of $315.4 million increased 17% against a year ago, driven by PAP equipment setups and increasing resupply. Our new PAP equipment starts were consistent with our expectations in the third quarter. Our PAP resupply business achieved record order volumes, our resupply census now totals over 1.5 million patients, and our electronic ordering utilization broke company records. Respiratory revenue of $151.1 million increased 8% over the third quarter of 2022. As we continue to revamp our diabetes product category, CGM census was up 4.3% year-over-year, resulting in flat CGM revenue. As expected, pump and pump supply revenue was down $9 million year-over-year as our tube-based pump volumes remain under pressure from tubeless pumps. We expect this pressure to continue into the fourth quarter. As Richard said, we are bolstering our sales force and focusing on growth in the government sector. Outsized growth in our sleep product category largely offset a shortfall in diabetes and a modest increase in operating expenses. So overall, except for the unexpected losses on the Humana start-up, our top line and bottom line results were in line with our expectations for the quarter. The primary reason for the shortfall on the Humana contract was a delay in patient transitions and corresponding capitation deductions, resulting in a $10 million top and bottom line miss against our expectations. It will take longer than originally expected to transition to all patients, but we believe that we will indeed get substantially transitioned by early next year. As we continue transitioning patients, we expect sequential improvement in both our top and bottom lines. Our adjusted EBITDA was $161.2 million in the quarter, resulting in an adjusted EBITDA margin of 20.0%, down from 21.6% in the second quarter, primarily related to the patient transition backlog. Cash flow from operations in the third quarter was $98.8 million. CapEx was $77.1 million or 9.6% of revenue, resulting in free cash flow of $21.7 million. For the first three quarters of 2023, we generated $76.6 million of free cash flow, which was more than 2.5 times the first three quarters of 2022. We reiterate our full-year free cash flow goal of between 3% and 4% of revenue. For the third quarter of 2023, DSOs of 42.1 days were down over a day against 2022. And for the first three quarters of 2023, DSOs were 42.5 days, down from 44.8 days for the first three quarters of 2022. We continue to realize the benefits of our refining of revenue cycle process and investments we have made in our technology and workflow. Our net leverage ratio at the end of the quarter was 3.51x, down slightly from the second quarter. During the third quarter, we made principal payments of $10 million. And after the end of the quarter, we repurchased approximately 2.5 million shares in the open market for a total cost of $19.4 million. As part of our third quarter results, we recorded a $511 million impairment to goodwill as we discussed in our earnings release this morning. This non-cash pretax charge was triggered by our stock price as of September 30th. Turning to guidance. We are revising our prior outlook as follows. We are narrowing our expected revenue range to $3.160 billion to $3.185 billion. We are updating our expected adjusted EBITDA range to $630 million to $650 million. And we are maintaining our expectations for total CapEx representing 10% to 12% of revenue, which should yield free cash flow of 3% to 4% of revenue. To close our comments today, we believe we're well positioned heading into the final weeks of the year. We are turning around diabetes, we are focused on transitioning patients as part of our new relationship with Humana, and we are optimistic about our business overall.

And we will open the call for questions.

Good morning. You've got Taji on for Brian. Thank you for taking my question. So going back to the Humana contract, I really appreciate the color on the updated implementation timeline. But as we think about the profitability ramp, maybe you could provide some detail around your expectations around that and maybe outline the levers that will drive profitability at an accelerated rate?

Thank you for the question. We're delayed. We're talking about that. But we think once the transition occurs, we're going to head more to a situation where the profitability of the contract is more consistent. We are ramping up our efforts to transition this quarter. It's likely going to take us through the beginning, perhaps next quarter, but we feel very good that once that happens, we will resume the contract as we had originally planned it.

And Taji, this is Jason. I would say that at a unit economic or a patient level from this stage forward profitability as a percent will ramp very rapidly. The reason for that is, a capitation deduction on, let's say, an oxygen patient, the allowables, the fee schedules for that patient are around $120 a month. So for a full quarter, you've got $360. You've got thousands and thousands of patients on that oxygen allowable from competitors that still need to be transitioned. So as each and every one is transitioned, that entire amount comes back as CAP revenue for us, and it drops 100% to our bottom line. So we do expect a good ramp from this stage forward as we continue to stay focused on transitioning patients.

Appreciate the detail there. Just another follow-up. As I think about your guidance, looking at the midpoint, it implies a margin step-up in Q4. Just curious, the different puts and takes that are going to help you get that margin accretion in Q4?

Yes, sure, Taji. So firstly, we do historically enjoy a step-up in patient demand, particularly in our resupply categories. As insurance plan changeovers that occur in January as well as deductible resets, patients are hoping to get in front of that and stock up the resupply they need to carry them through the end of the year and into the New Year. So we are expecting, in our resupply lines, specifically sleep and diabetes, to be up over $20 million sequentially in Q4 from Q3. We expect that to flow at our typical purchase margin, call it about 40% of that, stepping down. So that's the first sequential step-up in profitability in Q4. The second, Humana, as we said, kind of patient-by-patient. As we are transitioning patients, we do expect a material step-up in CAP payments and that bottom line that we spoke about as we've made key investments just over the last several weeks in additional resources and capability to ensure smooth patient transition.

Great. Appreciate the time.

Good morning, everybody. Thanks for taking my questions. I've got two parts. And maybe, Jason, if I could just start with you. Just curious to frame the guide down on revenues. How much of it was diabetes versus the Humana contract delay? And then the same impact on EBITDA?

Yes, sure, Matt. So the first part of that question is the vast majority as we look towards Q4 is Humana-related. Diabetes, we did expect out of CGMs a little bit more in the third quarter, so we fell a bit short of that. So certainly, we're rolling a touch of that into Q4. But again, the vast majority of this was Humana-related, just rolling the timing. And you've got the compounding effect going into the fourth quarter.

Got it. I appreciate that. And then second question, part one. Can we zoom in a little bit more on the diabetes franchise? And I appreciate some of the color you gave us on the pump and CGM franchises. But just what are you seeing in terms of new patient starts and attrition? Is there anything that stands out?

Okay. This is Richard. First off, we're not seeing any attrition and any effect in diabetes relative to any perception of GLP-1 utilization. The issue that we have been dealing with is the shift in channels more than any attrition. What our strategy is to work in the pharmacy channel with payers, but the key to that will be to add value in the way that we generate data for the utilization of the payers. We believe that both manufacturers and payers will care about this and will help us to improve our margins in the pharmacy channel.

Yes, Matt, I'd add a little color. Certainly, at the top and bottom line financials on a unit economics of a pharmacy patient is typically less than the traditional medical benefit or DME channel. But as Richard said, we see tremendous value in aggregating patients and covered lives within diabetes, In Richard's prepared remarks, he spoke about the first steps that we've taken this quarter in actively monitoring CGM data produced from devices of our patients. We have deployed certified diabetes coaches with that data, engaging with patients. Initially, we really focused on sensor and overall utilization. And so what are the reasons that a patient was set up last month, and you'd expect a new sensor to be applied in the first 10 to 14 days, depending on the manufacturer. But a month later, we're not seeing the data communicated on that CGM. And so we're working hand-in-hand with those patients, and we're learning a lot about patients that are on initial setup that might not be in compliance. So compare this to the capability we already have with over 350 sleep coaches in our business that all day, every day are monitoring data produced from equipment and these devices to help patients along their journey with resupply. We intend to do more there, additionally monitoring A1C levels, hypoglycemia levels, just the rich level of information that's produced from these CGMs. We don't think that needs to be a medical benefit channel strategy or a pharmacy channel strategy. We think it's an all-encompassing diabetes strategy.

Got it. Thank you and apologies again for the chunky questions. Thanks so much.

Hey, good morning guys. So I apologize for another question on Humana. Maybe I'm just being dense here.

Sure, Pito. That's a great question. First, if you've been the DME provider for several years, you definitely won't want to change. However, the current contract mechanism means that the competitors in these 33 states and the District of Columbia are not authorized. They are out of network and cannot bill fee-for-service for these patients. The rental process, though, is where things get more complex. Transitioning a patient is trickier than we expected. We thought we would find better or more complete documentation from competitors, but that hasn't been the case. This situation means we need to collaborate closely with the patient and their provider to gather necessary information, like tracking down oxygen saturation testing to support therapy and referrals. Without delving into too many details, that's an example of what is needed to transition those patients. We've also invested in additional resources and capabilities recently, and we're already seeing an increase in our patient transitions week over week.

Okay, fair enough. And then shifting to diabetes, it's going to be sort of multipart, so I apologize again. What percent of revenues in diabetes are CGM versus pumps at this point? What's the breakout between commercial and Medicare sort of within the segments?

Sure, Pito. Yes, that's a complicated question. I'd say firstly, the delineation between pump and pump supplies versus our CGM business. We've been on record saying that pump and pump supplies was about $160 million of revenue last year and that we believe it will be about $120 million of revenue this year. That's the $30 million to $40 million compression we've been talking about, just that headwind created by the med tech and the tubeless based pump on the market. The rest of the business is CGM business. As Richard said in his prepared remarks, government payers made up now 79% of that census. So that's up another two full points sequentially from the second quarter. I mentioned that CGM census was up 4.3% in the third quarter and resulted in about flat revenue. And so what you're seeing there is continued but less reimbursement pressure created by a movement of traditional government payers and the medical benefit channel versus commercial. So as we're taking care of fewer commercial patients in exchange for taking care of more government patients, we will continue to see a reimbursement headwind. But for this quarter, our volume was enough to offset that pressure.

Okay. So from a market share, again, only focusing on Medicare, ignore sort of commercial MA for a second. Do you think you're gaining or is losing share within the Medicare CGM market?

Sure. We are gaining patients certainly. I think it's tough to delineate are we gaining share or not from that. But certainly, we're gaining patients. We are very aggressively recruiting new sales reps for really selling CGM and other diabetes products. We're really selling CGM in just key markets, key geographies. We spend a lot of time thinking through the data over the last two quarters about where we want to go strong in adding sales reps. So we do expect that government business growth to resume in the fourth quarter.

Yes, thanks for the questions. Jason, I'm just curious if you've reaped all the benefits from the system upgrades and restructuring from the last couple of years. If you can give us an update there?

Sure, Richard. I can confirm that over the past year, we have met our earnings and cost reduction targets of $25 million for 2023 and an annualized $40 million. We completed the necessary reductions in early September, and those savings will begin to materialize. Regarding our ongoing cost reduction efforts through technology, we are confident that there is still more potential. As we mentioned in the last three months, we intend to reinforce our cost management commitment for 2024, which will be a result of our technology investments and the significant integration work we've been focused on throughout the year.

Okay. That's helpful. And then with respect to the strategy on expanding enterprise sales. Can you just go maybe more in detail on that strategy and potentially sizing the opportunities there?

Yes, this is Richard. The traditional sales approach for Adapt has involved individual sales generated through referrals from providers, leading to prescriptions and their fulfillment. This results in millions of individual transactions. In contrast, our enterprise sales approach, such as our collaboration with Humana, consolidates patients in one location. We're encountering some challenges with Humana, but these will provide valuable insights, and I want to emphasize that our partnership with Humana is strong as we work through these issues. By working with large payers or hospital systems to aggregate various categories like continuous glucose monitors, positive airway pressure devices, and respiratory supplies, we can create savings for the system and reduce friction by establishing parameters that don't rely on individual prescriptions from separate providers. We believe the market opportunity is significant, with every payer and health system being a potential customer. We're already building a pipeline within a short timeframe that we're excited about, and we expect to see positive outcomes in this area in 2024.

Good morning. Thanks so much for taking the questions. I guess a couple, I guess different follow-ups, if I may, I guess coming back to diabetes. So I guess this quarter sounds like slightly lower than expected down 8% year-over-year in the quarter. And previously, you talked about kind of flat for the year, do you still expect it? Or is it more kind of down slightly for the year?

Hi Joanna, thank you for your question. This is Jason. Firstly, regarding pump and pump supply revenue, we anticipate a year-over-year decline of about $9 million to $10 million in the fourth quarter. Looking ahead to 2024 for pump and pump supplies, we need to consider the insulation by pump manufacturers, but five products are continuing to gain market share, and we plan to keep growing our distribution of OB5s through our pharmacy channel. Medtronic and Tandem are also introducing upgrades to their existing products. Overall, we expect that pump and pump supplies will pose another challenge in 2024 compared to 2023, but it should be less severe, perhaps about half the impact. Regarding continuous glucose monitors (CGMs), we've seen approximately 3% growth year-over-year so far, which falls short of our expectations. We were flat in Q3 and are anticipating a similar outcome in Q4, possibly with a slight increase. However, we expect the significant investment in our Salesforce to start producing results as we enter 2024. While it's too early to provide specific growth projections for CGMs, we are optimistic that our investment will lead to a return to growth for CGMs in 2024. That's the information we can share today.

Okay. That's helpful. And I guess, sleep, obviously, much better, but I see tough comps for next year. So I guess, how should we think about the sleep business into next year when it comes to growth?

Yes, absolutely, Joanna. I would say that as you think about the full year, the first half, in particular, we'll have a tougher comp, particularly on PAP equipment, as we had record setup levels in the first quarter as well as the second quarter of 2023. Due to that 13-month, the reimbursement cycle, those patients will come off of the rental reimbursement. However, they will come into our resupply reimbursement, and we're continuing to grow that double-digit year-over-year. So we certainly expect sequential growth in our census as we go from here until through 2024.

And if I may, on the sleep business, so I guess you talk about some surveys you've done on the GLP-1 use by CPAP patients. And you did say something to the effect of potentially could at some point, I guess is the utilization of these drugs increases meaningfully could impact that business. But any thoughts in terms of how you think it might change your long-term growth outlook for that business versus how you were thinking about this previously?

I believe I was trying to convey that there is a lot of speculation from various sources, including Bank of America, regarding the 3% statistic, which we consider very promising for our business growth prospects. However, the pace of adoption of GLP-1s remains uncertain. We recognize that if there are fewer individuals who are obese, there may be a marginal decrease in the number of people using PAP therapy. Even if that turns out to be true, we need to take proactive steps to mitigate any potential reduction in our total addressable market. We have the resources to do this, as we are the largest provider of sleep equipment, giving us a solid foundation. We can continue to invest in technology to lower our costs. We have increased our market share every year for the past several years, and although the investments we made in 2022 were challenging, they are now beginning to pay off.

Okay. Thanks. Just a technical on diabetes. I think you said pumps were down $9 million and CGM revenue was flat. But I'm seeing a $13.4 million year-over-year revenue decline. So I'm curious where the additional $4.5 million came from?

Yes, sure. Just a little bit of supply. So these are like traditional, like BGMs, test strips, wipes, things like that. That's continuing as expected to be just a smaller part of the business. No, the former. We're just expecting the 17% growth that we achieved in this quarter, right? I mean I don't expect we're putting up 17% growth in Q1 into next year on already very high comps. That's all we're saying, Eric. Yes. Good question, Eric. A couple of things to offer. Firstly, utilization is in line with expectations so far. So that means in the 1.2 million patients or more we classified that as. And the number of them utilizing equipment, and then kind of the size and shape of that equipment by category is largely in line with what we modeled with the data that was shared as part of the award, and within our expectations. I would tell you that the number of patients is higher than anticipated. I mean, I know Humana reported, I think, last week, they're showing huge growth over 2022. So we've got some of that coming on as well, so just more patients than anticipated overall which frankly is a very good thing. It didn't help us from a timing perspective as it just creates more and more patients that we need to push through with the capacity we've got on transition. But overall, that's a very good thing as we expect to continue to grow with Humana.

And at this time, I'm currently showing no questions in the queue. I'll go ahead and turn the call back over to today's presenters for any closing remarks.

Hi, this is Richard. Thanks. First of all, thanks to everyone for their very good questions that helped us articulate what we think are the very positive things that are going on in AdaptHealth. We look forward to more interaction and thank you for your time this morning.

This does conclude today's program. Thank you for your participation. You may now disconnect.