Medline Inc. ($MDLN)

Okay. Good morning, everybody. Very pleased to have the management team from Medline here, Jim Boyle, Chief Executive Officer; and Mike Drazin, Chief Financial Officer. I want to keep this as interactive as possible. Should there be any questions, obviously, feel free to raise your hand, and we'll get a mic over to you for the benefit of [ you ] go participating via webcast.

Last talk about Medline and kind of your journey here. into the public markets. But I wanted just to start with -- is very [ topical ]. We're getting a lot of questions on is just quality remediation, the warning letter that you just received. Maybe just sort of frame for investors what's going on? How do we contextualize this? Why isn't this a bigger problem? How does this not metastasize, et cetera?

Yes. Thank you for asking, and thank you all for being here. Quality of Medline is paramount, right? The patient safety is the most important thing that we focus on each and every day. And the most recent warning letter was from our [ ReadyCare ] Walking facility, which is where we make CHG wipes, which is a [ presurgical ] antiseptic. This goes back to October. We actually informed the FDA that we found some things we were not happy with. We actually closed the factory down. So the warning letter was not a surprise as anticipated. And part of our job is to make sure that we inspect ourselves as arduously at the FDA would to make sure that we're delivering the right product at the right place at the right time with the right quality metrics. And so just from a recall perspective, overall, last year, we had 29. We've had 15 this year. We make 190 [ different ] products. I'd love to tell you that we could never have a recall or never have a quality issue, but unfortunately, that's just not the case. It does come up and how you respond to it, I think, is what matters. So first and foremost, how do we mitigate the burden to the customer to offer something that actually allows them to continue to operate in a proficient fashion. Specific to this recall, we actually worked with [ Sage ] to bring in inventory to actually supplement the inventory for our customers, the distributor, we have the ability to do that. I'll give another recall example. We recalled some surgical [ tapes ] in gallons earlier in the year. One of our factories that we have done business with was not meeting the expectations through one of the inspections we did. So we chose to cut them off. The beautiful thing about having redundancy across your -- [ category ], we were able to shift that volume to other -- [ meet ] the demands of the customer from a fulfillment and throughput perspective. So from a quality perspective, we take it very seriously. We have over 2,700 people of quality across the globe, and we invest hundreds of millions of dollars in the organization. We're investing in $10 million in the plant we're talking about in [ Waukegan ] that's currently subject to the warning letter, and we're working very closely with the FDA to make sure we're not only meeting but exceeding their expectations.

And I think sometimes there's perhaps a misunderstanding of what the recall actually means and how it materializes. I get a lot of questions, which is, [ the ] FDA made them do this. Maybe just remind people like how a recall originates, what the process is and just broadly the interaction with the agency through that?

Yes. Every recall we've had has been voluntary, meaning we did it to ourselves. And part of that is a rigor in inspecting yourself. So we have a responsibility as an organization as a manufacturer to make sure that you're inspecting yourself as if the FDA was doing it. So the FDA is not dictating that we recall, we report to the FDA that we are recalling and then we work with the FDA on the remediation efforts as it relates to what the cause of the recall was. So the partnership with the FDA is more about remediation and actually getting to the [ RAD ] outcome than it is actually delivering the recall.

And that kind of 29 recall is 15 recalls, are the one -- how quickly does it take to sort of reach your definition of resolution on any of these matters?

It depends on the product category. In the surgical [ drapes ] and gallons, we literally displaced it almost immediately, right? We discontinued manufacturing with one of our suppliers. Moved it to another supplier, we're able to fulfill customers' demand. So that was almost a nonimpact to the market. In terms of the [ ReadyCare ] [ Waka ], we actually shut the factory down and we are not producing, we will not produce again until we actually meet the expectations we've set for ourselves in conjunction with the FDA, which could be later sometimes this year. So it really depends on the complexity of the recall.

And then maybe just to round out this conversation, just how should we think about the financial impact or financial risk associated with the shutdown of the [ Walking ] implant and just quality remediation in general. It's not going to be material to our numbers. Every recall we've had this year has been small and it won't be material to [ over ] numbers, and we're still confident in our guidance.

Okay. Excellent. Maybe we can just segue over to the business. I mean you started the year at 8% to 9% organic revenue growth guidance. You raised that here after the first quarter. Maybe just give some background as you came into the year, the initiation of guidance, what you were seeing in end markets and in your business and then what you saw exiting the first quarter that gave you confidence to increase the outlook for the year?

Yes. We were really pleased with our results in the first quarter. We -- organic growth of about 10% overall growth of about 11%. That's not adjusted for days. So if you adjusted for days, our actual growth is closer to 13%. So really pleased with the demand across all of our businesses. The acute care channel grew at close to 12%, [ nonacute ] close to 7% and international grew close to 10%. So really, really pleased with the overall results that the sales. Demand levels remain strong. And so we see -- we saw the opportunity to increase our guidance for the full year. So our new guidance as we set at the beginning of the first quarter. At the end of the first quarter is organic sales guidance of 8.5% to 9.5%.

And it would seem like you are diverging a little bit from what your -- some of the end market trends that you've talked about. One of the things I believe that's reflected in your guidance is the risk around some deterioration in utilization, hospital purchasing as we go through the balance of the year. So in that context, in your increased outlook obviously implies greater share capture. So maybe just help us think through what's happening in the end market and what's driving that divergence in your -- widening divergence in your performance?

Yes, we're seeing -- in the first quarter, we did not see softness, and we don't measure patient volume. We measure flow of supplies. And I can tell you, the flow of supplies from Medline was as good as normal. And candidly, the outsized growth in the first quarter was tied to sales growth outpacing what we predicted and some acceleration of the [ prime ] inner implementations going into the quarter. So it's both share gains and same-store sales growing better than we actually anticipated. So when you think about the reason we don't measure patient environments, we don't have visibility to that we have visibility to the flow of goods. And our business tends to benefit on both sides of the equation. So if patient volume goes up, that means more procedures that means more supplies used. But when patient volume goes down, specifically around uninsured, so you think about what's happening with the Affordable [ Care Act ] and what's happening with the [ OBBA ] cuts of Medicare -- Medicaid. When uninsured patients don't have insurance or consumers, they don't go to the doctor or the flu. They don't go to the doctor for a cold. They wait until they have pneumonia, they end up in the emergency room and they end up in the ICU. So for us, that's a much higher utilization from [ a ] -- from [ really ] a cost of care. So we're seeing a lift in the number of supplies based on the incident of care as compared to a doctor's visit. So we're covering up the diminished patient volume by the utilization of what the procedure that they went into the facility for was. So our flow of goods in the first quarter was as good or better than it was last year which is why we saw it. So we are baking into our numbers, David, just listening to our customers that they are anticipating some potential softness from a volume perspective in the back half of the year. That's what's baked into our numbers. If that doesn't happen or benefit from the same thing we benefited from in the first quarter, there's some favorability in the back half of the year.

And just to be clear, the first quarter, did you see that acuity benefit? Or is it really just same-store sales growth execution? The acuity dynamic that you laid out, that's a theoretical impact.

Well, you saw acute care sales grew 12%, so we did see an acceleration. So it's a higher [ acuity ] and so you saw some acceleration in the [ Q ].

All right. Great. Maybe it's a good opportunity to go into a little bit more detail on some of the individual business drivers, and we'll start with Supply Chain Solutions. You talked about $2.4 billion of prime vendor contracts sold last year above the $1 billion average run rate that you expect and what you're contemplating for 2026. Maybe just help us understand a little bit more like what drove that outsized growth? And then remind us kind of on the conversion of that contract to revenue?

Yes. So we commit to $1 billion every single year because that's what we know and believe we can control. We know what's coming up for renewal with our customers. We know what relationships we have, and we know where we are in the sales cycle. So that's the $1 billion is what really we can control any given year that we can actually account for, if you will. And then we take advantage of market conditions that are currently in play that are favorable to our business model. If you remember last year, we did not raise prices initially when the tariffs hit. We do not react in times [ chaos ] and act when we don't actually have an idea of what's going on. So we chose to wait to raise prices. And first and foremost, what could we do internally to mitigate as much as possible. We educated our customers on what was happening, why was it happening and what are we doing about it in advance of doing anything. And we waited until August 1 to push any price increases through, which is different than our competition did. And opens doors that historically have [ make ]. Some of our outsized wins last year were tied to that. Second, customers are all looking for speed to value. We are the value player in the marketplace, what's happening with cuts and reimbursement has opened doors that historically have been closed that customer yesterday that was willing to look now is looking for the value player in the marketplace and created some outsized wins last year. Third, consolidation in health care is not slowing down, it's picking up. The integrated delivery networks in these large health care systems merging is becoming more robust and really larger from a geographical footprint perspective, Medline is the only supply chain solution provider that serves every single point of care. Any [ were ] a caregiver, a patient or a consumer needs access to patient, Medline as a supply chain solution, a product formulary clinical engagement platform and a sales force dedicated to that individual care setting, and we have the ability to merge them all and serve really an integrated delivery network with a consistent solution across their entire network, and we are the only ones who can do it. That's also been a tailwind. And so those things are still relevant today, right? We still have financial crisis, now we have the Middle East. Tariffs are still in play. There's concern around resilience with some of our competitors. Customers want resilient, sustainable long-term supply chain partners. And candidly, I think we might be the only people that want to be in the business we're in right now. We continue to invest in the business and customers see that and they want to be with the player that's going to be around for the long haul, not for the short term.

That's very helpful perspective. And maybe as we kind of think about the Medline brands, side of the business, there's sort of two pieces to it, right? There's the prime vendor contract winning and then converting distributor product to Medline -- Medline product. But there's also an opportunity, I think, within each of the three segments to drive higher penetration of Medline brands, especially in lab and diagnostic and also in the other two in [ MedSurg ] and frontline care also. But maybe we could start on the conversion opportunity and then maybe go into a little bit more [ segment ]?

Yes. When we [ sign ] a new prime enter business, it's important to really products, so it's 90% distributed products. 10% of the business is already in our brand. We're distributing about $1.2 billion of our brand through competitive distributors. Our brand stands on its own. In that first year, we normally see our Medline brand penetration double to get to 20%. So we see a lift. And normally, that's surgical custom procedure trays. Just for context, what is that? That's a bundle of goods picked non-sterile put into a bundle in sequence that actually increases really the turnover rate in the operating room and [ a ] the cost and actually keeps them from having to open 100 packages. They opened one. And it's a bundle of goods already built for like a total hip, an open heart, a [ lacolite ] and then we also pick up a lot of the commodity items in the first year. So think your [ tone ] pressures your comes, your exam gloves, your under path. Those are easy for the clinical team to accept in a positive manner. And then from year 2 on, we see anywhere between a 3% to 4% penetration rate lift, and that's an intentional pace of change that we've built in to many years of trials and tribulation right? When you go too fast, it's hard for the clinical team to accept that change because too much change is hard for [ them ]. Believe it or not, when the box changes from red to blue, they freak out. If you don't actually tell them the boxes changes from red to blue even if it's the same item in the box. We also learned, if you go too slow, you don't deliver enough incremental value and savings for the CFO. So that pace of change is built through many years of really evidence-based conversion to deliver value to the customer on a consistent basis. We have every quarter mapped out in our 5-year agreements with our customers saying, this quarter, we're going to do under [ pads ] in an example this quarter, we're going to do advanced wound care and DME. And so there's a predictable road map to conversion to [ the ] customer that they can map out and we never get to that would have even for me lately because we're always driving intrinsic value for our customers each and every day. When you think about the segments, [ lapping ] diagnostics is something we're very excited about. It's a $25 billion market. We just got into it in years ago at the request of our customers. They saw a lack of competition in the marketplace. We do $1 billion in that space, and it's growing pretty nicely. The first quarter, we saw 1% growth, but that was diminished by a slow flu season. The actual base business was growing in the teens, and we're going to see that recover in the back half of the year because of all the -- [ prediagnostic ] space we signed last year will go live this year. Surgical Solutions was a very robust growth driver last year. We saw a lift in custom procedure trays and conversions from competitive accounts, moving over to us, very similar to the prime vendor model customers were moving to us for the custom procedure trades because they want resilient sustainable partners in that operating room to make sure that they can execute cases every single day. And then we did see a nice lift in frontline [ carry ]. When you think about Frontline [ Care ], I think about your daily use goods, literally everything from exam gloves to go to urology to advanced wound care. It's a very, very robust subset that plays across every single care setting. Your surgical solutions lives mainly in your hospitals, in your surgery centers, the frontline care lives across the entire [ continuum ]

And how does it work? If you have a prime vendor contract that maybe you [ sit ] making us up 5 years -- 5 years ago or something like that. And there are categories that you didn't participate in then. How do you go access those accounts. So if you -- as you think about closing that $1 billion to $25 billion, again, trying to use the pictures in the IPO slides to figure out which products you might be going after. But as you start to launch some of those products, what's the mechanism to go back and add to existing prime vendor contracts? And does that create opportunity for growth beyond that incremental [1initial]1 penetration you talked about?

Well, the entire brand is on the contract. So when we signed a prime [ lender ] deal, we built in, let's say, escalators from a conversion curve to allow them to buy down the cost of distribution. So when you think about today, when I started in 1996, 20% of what a hospital buys from a medical surgical budget had an equal Medline [ alternative ]. Today is 60%. Next 5 years, my aspiration to get somewhere around 75% because every single year, to your point, we're adding new categories to the line. And so when you think about the way this thing is built is our reps are incented to present every opportunity to the customer every single day. And then we [ parse ] that out, saying, this quarter, we're going to do this in this. So as the new categories are added on, that gets added to their bag and then get to the sales cycle. As they're doing their quarterly business reviews. They're saying, "Hey, Mr. Customer, we just added [ forced ] air warning, which is a new product category for Medline that competes with Berhoger. If you don't know what that is, it's a blanket that forces hit error to increase your core temper before surgery and during surgery. And so -- it isn't around -- it's really the brand itself. And if the brand expands, our job is to actually present every opportunity to customer every single time.

And a question that I always get on Medline conversion is -- what is the sort of interplay between distributing for your customers then become your competitors? Correct. Just talk to us a little bit about that relationship and how you find the right equilibrium there? Because one why would take the Bar hugger example? Why would they ever is [ three ] if you're just going to start making your own product. But at the same time, it seems like their ultimate end customer wants you to view the distributors. So just help us think about all the different moving parts there.

I think the best way someone's asked me is, why would it in or go through when they know you're going to cannibalize their business, right? That's basically what you're asking. Here's the most important thing to remember. The customer is making every decision. Medline is making no decision. And so most of our manufacturing competitors are not distributors. They have to access the distribution channel to get access to the customer. The customer is choosing their prime vendor. And when they choose Medline, there is no optionality for third-party manufacturers to get into that channel without accessing their prime vendor or their distribution channel. So the customer, when they choose Medline, that is the avenue for the competitive brands to go into our channel. I would tell you, the competitive brands would say, Medline as a distributor is a fantastic partner to keep more inventory on hand so we don't have back orders. They actually serve our customers better. They actually pay their bills on time. And we also offer them some nontraditional services like backhaul functions and some other things that our competitive distributors don't because we own our fleet of trucks. They would also tell you that Medline is very transparent and very honest and says, "Hey, we're going to go to market and compete with you and made the best company wins, right? If you win, we're going to distribute your product, if we win, we're going to distribute our product. But ultimately, the customer is making the decision, both who their distribution partner is and what product they're buying. And so the real answer is the customer is making the decision and dictating what avenue they have to access in order to access them as a distribution partner.

And ultimately, that $1.2 billion that's being distributed to others is the vision to bring that. Is that a target for a prime vendor relationship?

Yes. So when you think about different ways to actually engage a customer, right? When you get the opportunity to sell your brand, then all of a sudden, you have the opportunity to discuss the customer, but the overall value prop is. And so a backdoor entry would be say, hey, we're going to sell our brand first, get an opportunity to actually sell a widget. And then as we get a better relationship with that customer, we can sell the entire value prop. I would also tell you because we sell in every class of trade, we may be the prime [ miner ] in the physician office space and not in the acute care space. That is another way to enter into the acute care market to actually pick up the business and vice versa, right? We may own the acute care distribution channel. We don't own the surgery center or a [ physician ] office. It's a way to capture that market share as well.

And maybe as you kind of wrap this all together, as we think about your end markets growing, call it, the 3% to 4% range, obviously, for this year, contemplating growth double that you've been generating that pretty consistently. As you kind of reach higher levels of penetration, the 60% example you gave about comparable midline brands, how do you keep going at a rate that is so significantly above the markets you serve.

Well, I mean, you have to think about our business, we still have a long way to go. We serve $175 billion TAM in the U.S. and we sell $28.4 million. So there's -- I was raised until you have 100% of the business, you don't have it all, right? And so we're going to go after every [ single ] dollar that we can. And then when you look at the acute care part market, we have about 45% share. It's growing 12%. So we're doing pretty good in that. And you look at traditional post-acute, which is like skilled nursing facilities, nursing homes and home health and hospice. We have about 35% of that business, which means we still have a tremendous amount of growth in surgery centers, we have roughly 1/3 of that business. And as an office, we do point $5 billion and $9 billion market that we just got into 10 years ago growing nicely. So I don't see a limit in our potential for growth across the business segment. And then you look at -- think about the brand, our 10-year cohort average penetration rate is about 42%, some at 60% fully maximized some in the 30s, more like your academic medical centers who give limited choice or actually don't force the conversion curve. So I just see -- I mean there's a $75 billion TAM in our brand alone, and we did about $12.5 billion in our brand last year. So there's a tremendous amount of opportunity in front of us.

Okay. I want to go to margins, but open up to see if there are any questions from people in the audience. Okay. We'll keep going. Before I actually get to margins, maybe we just kind of was kind of a good transition, I guess, talk a little bit about the guidance. I mean, I think people understand the strategy to run the business annually. As you experience on your first -- on the reaction of first quarter earnings, the privilege now being public is that there's tremendous focus on the quarters. So help us think about like how you manage that interplay between how you run the business and then meeting short-term expectations.

Yes. So you're right, David. We think about the business in years, not days or quarters. And so we've always run this business for the long term. We'll continue to run the business for the long term. We invest for the long term, and we invest for the top line growth first. And so our objective is to provide annual guidance to all of you so you understand where we're headed for the year. As we report our quarterly results, we'll tell you what that means to the overall full year guidance. And we need to continue to educate and manage how we're thinking about the quarters because the quarters don't have a linear run to them, right? So the first quarter is always our lowest quarter. Why? Because days matter in our business. There's 61 days in the first quarter or 66 days in the fourth quarter. So our fourth quarter is always the largest quarter. There's also some seasonality to our business. For instance, like the flu respiratory virus season, as Jim mentioned earlier, we saw a weak or low severity respiratory business in the first quarter relative to last year. You saw that show up in our lab and diagnostics business. And then lastly, I would say that the bond patterns and demand levels of our customers always tend to spike in the fourth quarter as well. And so there's variability from quarter-to-quarter. We'll do our best to educate you on what that means for the overall year and help you understand how we think about the full year guidance overall.

And as I look at your guidance for this year, the $3.5 billion to $3.6 billion of adjusted EBITDA, and I look at where consensus numbers ended up getting kind of weighted after your Q1 results. It does put an [ onus ] on the back half of the year. So maybe just help us think about the cadence of EBITDA and profitability. So there's a couple of things playing out in the first half of the year versus the second half of the year. That's important to understand. One is I called out the tariff impact is pretty burdensome in the first half, and it will be favorable in the second half. Why? Well, we're still taking impact to our P&L from the tariff rate, which is at the old [ AEP ] rates, as of February 28 or March 1, we went to a 10%, which is favorable to what we were paying previously. And so that will show up in our sales in the second half of the year. So tariff favorability will be a net positive for us in the back half of the year. Offsetting that, though, will be a couple of things. One will be the Middle East. And so we've talked about the Middle East. Let me just frame it for everybody, right? The Middle East inflationary pressures on our business will show up in the second half because they're sitting in inventory right now. And that really relates to two things. One, our fuel costs. So we buy diesel fuel every day to run our trucks and trailers. We have 2,000 trucks and trailers that we operate. In addition, we pay a fuel surcharge for our inbound container costs. Now that inbound container costs won't show up until the second half of the year because of our contractual obligations. But that's the smaller impact to our business from the Middle East. The bigger impact are raw materials and finished goods that we're sourcing today to [ manufacture ] our own products order of finished goods over sourcing to sell to our customers. And so those are [ nitrolicanvlopes ]. Those are plastics that we're acquiring to make the [ resins ] are acquiring to make plastics or the plastics we're acquiring the are finished goods. We have seen a spike in costs in the last couple of months from those that are now in our sitting in our inventory and will become impactful to our P&L in the second half of the year. We have not made a plan yet to raise prices. That's a question we always get. We are continuing to run the play we always run, which is to try to invest and mitigate the costs first, driving our normal playbook that we've run historically. And if we think -- if we see costs continue to rise and cost continue to persist for a long period of time, we'll evaluate the idea of issuing a price increase, much like we did last year with the tariff price increase in August 1. So that's how we operate and mitigate the Middle East impact as much as possible. And then the second piece of this is then we talked about this in the first quarter earnings. We have made intentional investments in our business to support the growth. Now some of the first quarter year-over-year OpEx expense -- OpEx increase, sorry, was driven by just investments in the second quarter, third quarter, fourth quarter of last year. So that's that quarterly variability that I talked about. But we also were intentional in making a few investments in our operations to support both our existing customers and new customer growth. As we talked about, we signed $2.4 billion of new customer signings last year as we bring those customers on and go live, we've had to make some investments in operations in a couple of key regions. For instance, in Michigan, where we brought in a number of prime vendor customers last year. We had a smaller warehouse that did not have automation. And so we've had to add additional labor resources to support that ongoing customer implementation and maintain our service levels. And as we expand that facility and we add automation, that will drive that cost down over time.

Okay. So as we -- I think you also said that tariff savings would help help offset some of those incremental costs. So if we think about that as a plus 1, minus 1, I don't know if that's the right way to think about it. You still end up with like well over 50% it's like 60% of implied adjusted EBITDA in the back half of this year. I think it should be a little bit better than Q1, just to do scale revenue? Like is that a fair representation?

Yes, that's a fair representation. I won't give you the number for the second quarter, but we do expect some modest sequential as I mentioned on the first quarter call, modest sequential improvement from Q1 to Q2 and then the second half will be much stronger.

And then as you think longer term about margins, I think you've talked about growing adjusted EBITDA dollars, at least in line with revenue. And maybe just pick apart some of the building blocks that get you there? I mean, I had thought when I looked at 2027, obviously, things are evolving, but we kind of said we thought that, well, you have a lower quarter -- lower tariff run rate exit in the fourth quarter of '26. You'll have -- should have some leverage on year 2 of being a public company and then maybe there's some underlying margin improvement in each of the segments, but help kind of recognize all of that.

Yes. So I think it's too early to call '27. But you're right. That's what we said when we went on the roadshow was, we believe '26 will be a year in which there'll be a burden from the tariffs. We'll see tariffs normalize into the base business by the second half of the year. And so going into 2027, we expect to deliver earnings growth at or greater than sales. That was our commitment. That's our long-term commitment. And we'll evaluate what that means as we think about the Middle East here in the next couple of quarters and how that plays out into '27. But that is our commitment, long-term earnings growth at [ eaten ] sales. How we get there, the building blocks for better very simply volume growth we grow top line at this very healthy rate, high single digits, you'll see volume growth and margin dollar growth from that. You'll see us continue to drive Medline brand conversion as we drive Medline brand conversion. You see that improvement going from 5% EBITDA margin to 22-plus percent. EBITDA margin. It's our investment -- sorry, it's our manufacturing and our sourcing initiatives that we drive savings every single day. We have these 450 product managers. We have a global sourcing organization, a broad manufacturing footprint those teams jobs are to reduce the cost of goods in the products that we operate that we sell or manufacture and focus on driving those costs down to customers. And then lastly, operating average, as you mentioned. So as we continue to grow the business, we'll leverage our scale and drive operating leverage in the business that will drive margin dollar growth added greater than sales over time.

And can you get margin expansion in each of the segments? I think like in Supply Chain Solutions, you were on this like roughly 50 basis points a year of improvement. Obviously, I know one quarter doesn't make the trend for a year, but can you see underlying margin expansion by business?

Margin percent expansion, I think, is not really sort of something we want to talk about or to highlight, but I think it's more margin dollar growth. And so Supply Chain Solutions, as your point, yes, we did 5.5% EBITDA margin last year in 2025. The first quarter was sort of 4.8%, which is lower than the 5%, obviously. That's not representative of what we expect the full year to look like. We expect to get back into the -- but we don't think about CS [ sidechain ] solutions. We're in a Medline brand on a margin percent expansion. It's more about the dollar growth. And our commitment again is longer term growing at greater than sales.

The other thing I would say is Supply Chain Solutions was overburdened with something I think we did a bad explaining. So the first year, we signed [ PrimeLiner ]. We give a first year conversion rebate. It's a 1-year hit, and it hits supply chain solutions. So supply chain solutions being hit with a pretty big input and especially in the first quarter of this rebate that we're paying to customers tied up. So that's -- that will normalize. That's a 1-year deal that healed itself.

And I think you also had this dynamic of incremental investments to support customer onboarding without the revenue. And I assume most of that was -- most of all of that was elevated to supply chain solutions, which all to depress the margin there.

That's correct. The operations investments when you think about that new prime vendor customer that we bring on board, it's 90% supply chain. So it gets elevated to that more than the...

Onboarding all the labor. So we onboard labor days in advance of revenue utilization, right? We have to train them to pick package ship before we actually award the customer. Recently, we've been onboarding in 5 to 6 months because what we've seen is competitors leave the business much faster. So instead of giving a 90-day these a 120-day conversion ramp, they're giving them 30 days, and we want to be really in advance of that. So there is a cost of labor. I mean you think about the third and fourth quarter, hitting the first quarter with a higher spend as relative to last year, and that will [ hill ] itself over time.

And as you execute that margin expansion, you obviously generate free cash flow, I think relative to other sponsor-backed IPOs really underlevered even today. And then you obviously pretty quickly without actually paying down any debt, but maybe you'll choose to do that. But help us think through your capital allocation framework and how you're prioritizing use of cash, especially as you continue to strengthen the financial position.

We generated free cash flow every year. And so -- our first priority is to invest in the business. That's really how we thought about this for the long term. As I mentioned earlier, [ our ] investors. So investing in our sales force, investing in our operations to support the new customers, our existing customers, investing in new product development. We spend about $500 million a year on capital to support both our distribution network. We're adding two new DCs in Texas and California. We're adding automation every year to our business, both auto [ store ]. Now we've made an investment in [ Symbotic ] on the bulk automation side. We add new trucks and trailers every day. We think about the manufacturing footprint, we're expanding our Mexico manufacturing footprint, which we believe will go live here in the next couple of months that the year plus expansion that we've been doing in our Mexico facility for our kitting business. we'll add new production lines as well throughout our network. And we invest in technology. So that $500 million of CapEx every year is sort of a good view for us. In addition to that, we have intentionally invested in win capital. Working capital for us will always be usage as long as we're growing the business, which we expect to grow for the long term. Why? Because we carry more in tour than our competition, 80-plus days on hand has been intentional that drives service -- the best service rates, service levels or fill rates in the industry and it allows us to step in when our competition have problems. And so really focused on that, and we'll continue to focus on working capital being a usage. So after the free cash flow, we have close to $1.3 billion last year before the one-timers. We will -- you'll see us lean in a little bit more on M&A, right? As we talked about and Jim talks about a lot, like M&A for us is an opportunity to drive strategic growth in our business. We'll be disciplined. We'll focus on products, focus on channels, we'll focus on service offerings. You'll see us lean in on M&A. If we don't have any M&A to do or less M&A to do. Over time, we would consider delevering in the business. Now to your point about leveraging, we're at 3.1x we do long term want to be investment grade. And you saw us just in the last couple of weeks, we [ dabbled ] in the investment market. We issued $2 billion of investment-grade secured bonds. And so as we see sponsor sell down, lower or ownership on the Board. And we further see deleveraging, you'll see us step into the investment-grade markets.

And then any parameters you can help us think about from an M&A standpoint. What types of acquisitions are you looking for? Are there different channels of care of interest, geographic expansion? I know you did a small dental deal in Canada. And I think that was sort of kind of let experiment with the market, so we can learn as a participant. Maybe let out for folks.

Yes. First and foremost, we look for additional opportunities to expand the brand. 90% of our growth historically has been through internal creativity, not through M&A, 10% it's been a nice to have, not a need to have. That being said, I think there's going to be some opportunities to M&A from a product perspective that comes to market in the next 18 to 24 months because what we're seeing is a lot of our manufacturing competitors up into the Class III and Class IV devices. -- in the Class 1 and 2 don't fit within their strategy. So they're going to sell some noncore assets and we'll be there ready to pick those up. So we're -- of $2.2 billion in cash on hand. So we have plenty of dry powder to do that. and we think there's an opportunity. We did that last year with Ecolab's [ Microtech ] Surgical Solutions business, and we also bought [ Convatec's ] skin care line and they sit perfectly within what we do, and they did not perfectly within what they do. you mentioned [ Sinclair ]. Sinclair was an opportunity for us to have a petri dish to test the dental market to see if it's something we're interested to do in the U.S. I can tell you -- we're outperforming the deal model. It is very interesting. I don't want to be what the current distributors are in the dental market. I want to be what we are in the med-surg market, in the digital market, meaning a manufacturer that distributes it delivers value through their brand. We're on the path to be 30% Medline brand convertible opportunity within dental already , which I'm very proud of our divisions for doing that. So then it looks like the wash rents repeat from a model perspective and just a different channel, similar to what we did in lab. Diagnostics. So I am opportunistic. We'll know the answer to that by the end of this year. So we're looking at different channels. We're getting into animal health. We did that just through internal muscle. Is there an opportunity to do some M&A, maybe internationally. I think there's an opportunity for us to create some acceleration in growth in the international markets from a brand perspective. Remember, that is not a distribution business that is a brand business alone because the printer model live outside of that. And then some of the service offerings. A couple of years ago, we bought a company called [ Pref ] Connect that helps caregivers manage the preference cards for surgical procedures, which today are, on average, 75% accurate because they're manual and nobody updates it. This ties in with Epic and [ Cerner ] has visibility and what's actually used in the procedure. It goes all the way back to our [indiscernible]. So we're always building the right most robust custom tray to meet the needs of the surgeon every time they walk in. So we will continue to look at those things. We're pretty excited about what's ahead of us. And my guess is we'll probably be more opportunistic than we have in the past that relates to M&A.

Excellent. Maybe I'll turn it back to you to close this out here. Any -- you've obviously been at different [ ester ] conferences you met with a number of people here. How do you want people to kind of walk away from this conference and key takeaways for those in the room and on the webcast.

People keep asking if we're going to change who we are now that we're a public company, and the answer is no. With 59 years of consecutive growth, what we've done actually works, and we know it works, which is why we're not giving quarterly guidance. We're giving annual guidance because we know what we can do. And our business to Mike's point, isn't sequential. You can't take 3.5 to 3.6 and divide it by 4. That's not how the business works. And so my ask would be it takes some time to learn the sequential nature of our business, the seasonality of our business, and you'll understand portraying the numbers the way we do. I mean simply put, I mean, our job is to make health care run better to deliver improved clinical financial and operational outcome, and we're going to continue to do that in an outsized fashion as compared to the market.

Excellent. Well, I very much appreciate your participation. Look forward to the next update, I guess, in July or August.

Thank you, everyone.