Medline Inc. (MDLN) Earnings Call Transcript & Summary

Good afternoon, everyone. My name is [ Aaron Wright. ] I'm the lead health care services analyst at Morgan Stanley, and welcome to the 24th Annual Global Morgan Stanley Healthcare Conference. We're happy to have Medline with us today, a recent IPO in the space, CEO, Jim Boyle. Thank you so much for joining us as well as CFO, Mike Drazin. I appreciate the time today.

So we'll kick it off with a bigger picture question. There's a lot on people's minds, obviously. But we've always thought of Medline as this sort of critical solutions provider across the broader health care system. The supply chain sits underneath this like bigger health system and you do everything from the Medline brand to the services component. And some of that framing gets compressed into an organic growth number or an EBITDA number on a quarter-to-quarter basis every 90 days. And Medline has an extensive history of a private business, right, in a private company. And you're 3 months into being a public company. What has changed? What has preserved from your private company days? And what has changed or what has surprised you since December?

Yes. I would say, listen, we're a 60-year-old company, not much about what we've done has changed. When you have 60 years of consecutive growth and you have a playbook that works, changing it isn't the right thing to do. It's always evolving. So change is part of the business, but adding additional levers for growth, adding additional arrows in our quiver as it relates to value props to our customers is just a core tenet of who we are. But investing in the business in advance of demand will continue to be something we do, having a very relentless focus on our customer and listening to them to what their needs and challenges are so we can make sure we're meeting that expectation. Right product, right place, right time as it relates to our distribution service offering at the best value will continue to be a leading indicator and maximizing the value we deliver to our customers to our brand, and we'll continue to do that. So I think the biggest kind of change is our business isn't sequential, right? It's lumpy. And when we win new prime vendor business, it's different by quarter. How we grow as a lagging indicator margin to revenue is something I think the markets are going to have to learn. We'll capture revenue and take share. And then the kind of the margin will pick up in the following kind of pathway as it relates to the Medline brand penetration and conversion curve. I think it's going to take a little while for the public markets to understand the cadence of our business and how it flows through. But what we look at is a long-term sustainable growth, first and foremost, taking share, then maximizing the brand and delivering value over time. I think it's going to take a little bit of time for the public markets to know that. I will tell you it's easier to be in a private company than it is a public company because I have all of you asking 95 questions as opposed to the family asking a few questions. So I think it's more about getting familiar and consistent as it relates to what the right kind of macro factors to communicate to you all is to make sure you understand kind of the long-term health of the business.

Yes. Okay. Speaking of some of those macro factors, let's talk about the most recent quarter and the guide. So organic sales guidance was increased in the second quarter, but adjusted EBITDA guidance moved a little bit lower here. Can you walk us through the bridge from the original EBITDA guide to the new guide range? And how much of that is attributable to the Middle East inflation, the [indiscernible] fire operational investments as well as some of the quality remediation and retail softness as well.

Yes. So let's first start with the quarter. The quarter was really strong top line growth of about 11.6% on a reported basis. If you actually adjusted out the impact from the tariff refunds, customer repayments, we actually grew close to 13%. So really, really strong top line growth, really strong top line demand, growth across both of our segments and all of our channels. And so we're really proud of the great signings -- sales growth that we're seeing in our business. It reflects the strong market share gains that we're taking. From an earnings perspective, you're right, we did take down earnings by about $200 million in totality for the full year for our full year guidance. Our new guidance for EBITDA is $3.3 billion to $3.4 billion from $3.5 billion -- so $200 million at the midpoint of the range, really made up of a couple of internal factors and a couple of external factors. So on the external side of the house, the Middle East is impacting us, as you can imagine. We quantified that in totality for the year of about $70 million of impact. That $70 million of impact is primarily made up of the cost of raw materials and finished goods like things like polyethylene, polystyrene NBR that's used to manufacture and source certain products that we make. In addition to that, the cost of diesel is obviously up as well. Diesel fuel was at $3.89 heading into the -- before the conflict. Diesel fuel is now closer to $5.5, $6. And so you're seeing that impact our cost of our transportation as we ship about 80% of our products on our own trucks here in the U.S. The other external impact was a fire. We had a fire in our Tracy facility back in June, unplanned, obviously, and very devastating, lost 1 million square feet of space. The great thing about that is the team rose to the occasion and within 6 weeks, we're able to bring product back to our customers in the similar levels to what they were receiving previously. And so really proud of the work the team has done to really drive to a great outcome for our customers. The combination of those 2 are about 25% of that $200 million or $50 million. The remaining $150 million is primarily made up of what we'll call internal factors. And they're about equal with the third one being retail being slightly less. So we are continuing to invest in our business. On the operations side of the house, as you all know, we signed $2.4 billion of new customer signings last year. That signing was a record year for us, really, really strong signings in the year that led to us implementing a lot of that in 2026. And so what we're seeing is, in certain cases, we're having to make investments in operations to support those new signings, for instance, in a facility like Romulus, Michigan where we have pretty much the entire Detroit market that we've ultimately won through our signings, we're having to invest in people without automation at the current point in time to support that growth. As we put automation in those facilities and expand that facility as an example, you'll see those costs start to come down. But ultimately, right now, we're inefficient in our Romulus facility. That's the operational side of the house. We also are making investments in quality. We have decided and Jim has decided the right thing to do for us is to further lean in on quality and to focus on a global action plan to drive quality across the organization. It's not to say our quality is not good. Our quality is good. However, we want to continue to invest in driving growth, driving the improvements in our quality across the globe. And so we are taking action to invest in quality in that space as well. And then lastly, the third impact to us was of a retail business. On the retail business, that's about 2% of our sales. So a smaller piece of our overall business. The business is a little bit lumpy, as you can imagine, right, is from day to day, it can bounce around. It's not like our typical prime vendor business where it's a 5-year contract. And so we saw a loss product at 1 of our customers in that space that has impacted us. That's all Medline brand, so the margin was more impactful than than it would be if it was a prime vendor deal. But our objective is to go get that back over time here. Just in the near term, it's going to be a loss for us. So the combination of all that is about $250 million those 3 external factors overall.

Okay. And you characterize roughly half of the $340 million impact as transitory and half is permanent. I guess as we think about the launch pad for 2027, what do we think about as the right baseline? I think consensus is at $3.7 billion for 2027 EBITDA. Is that the right framework to think about as we kind of normalize for some of these impacts, whether it's permanent or temporary?

Yes, I think what we were trying to signal to the market was roughly half of the cost that we believe that we're incurring is sort of permanent will remain in our base, things like some of these ops costs, some of these quality costs are investments in people. So those will remain in our base. Obviously, the retail business is sort of a loss, we'll get to back over time, but that's in our base. Whereas we expect that over time the Middle East, will at some point, hopefully subside. But I would tell you that right now, as we sit here today, we expect the Middle East will continue, unfortunately, into 2027, will be a cost headwind for us into 2027. I think overall, we're not ready to guide for you yet what '27 will look like. We'll give you some better view of what that might look like in the future. But I think the best way for us to tell you this is our landing spot for 2026 is $3.35 billion, and we'll grow off of -- that's the midpoint of our range. We'll grow off of that. And the components of the 2027, just to make it simple, are sales volume, Medline brand conversion, Middle East should be a headwind for us, unfortunately, if costs remain. Tariffs, right now, tariffs don't change, will be a tailwind for us. And then quality and ops investments will continue to some extent as they're actually annualized into 2027 as well. But more to come in the future on that.

Okay. And you're annualizing some of the outsized business -- prime vendor wins from last year with you have $650 million in new customer signings through the first half of this year. Can you speak to the nature of a lot of those relationships? And how does the quality and composition of those -- of the pipeline? What does it look like now? And -- and how do you think about that playing forward in terms of those?

Yes. I talked about each market, we commit to $1 billion in new prime vendor singings. That's what we believe we can control and we have complete visibility to it. So that's what we get guided to every year. Last year, $2.4 billion in signings. We did that because we took advantage of market conditions. We took advantage of some competitors struggling in the marketplace or getting out of the business. We took advantage of how we handled the tariffs in terms of price increases. We delayed price increase until August 1, which is different than the competition bid, which opened up doors. Customers are looking for sustainable, resilient supply chain partners that can support them in times of crisis or need, 29 million square feet, $5 billion of inventory, completely different than what you might think our competitor set is. And customers are looking for folks that actually want to be in the business we're in. Those are all tailwinds that we're hitting last year that are still hitting where this year. Last year, we had the good fortune of signing some very, very large home run deals. This year, the [ 650 ] is made up single doubles and triples. We didn't -- there's not a giant deal in there. We're continuing to take share at the pace we expected to take it at. I feel optimistic about what's in front of us. And so I think the market looks very, very similar as it relates to what we believe we control, and we'll continue to take advantage of those market conditions that actually are favorable for us. So I just think we're sitting in a position with a different playbook to offer value to our customers as compared to the competition, and that's what customers are looking for. And then finally, they're looking for speed to value. They're concerned about what's happening with OBBA, concerned about cuts in Medicare, Medicaid, and we are the value player in the marketplace. And whenever inflation happens and the ability to actually kind of increase their margin profile, they look to us as a value player in the marketplace to actually drive significant savings to them.

Okay. I think that's a good segue into my next question, which is just on broader utilization trends. And what have you incorporated, I guess, into guidance from an underlying utilization trend standpoint in terms of volume that you're seeing from the acute side as well as kind of other markets. How do you can...

We haven't seen softness. So we talked about softness in our guidance because we're listening to our customers. But it's important to say this lot -- just had lunch with a large hospital CEO on Friday, our comment to me was you're continuing to see outsized growth, even though we're continuing -- we're starting to feel the pain of [indiscernible] care. I don't actually think you're going to see a slowness of patient volume, which you're going to see the increase of [indiscernible] care and folks that actually can't pay their bills because guess what, when you have insurance or not, you need access to health care, you're still going to go in the hospital and you still going to need access to care. As it relates to us, we're still selling those supplies. It actually burdens, unfortunately, the health care from a provider perspective. Second, when you think about folks that don't have access to insurance, what they do is they wait until they're sicker before they actually go to get care. So they have the cold, they have the flu. They don't go to the primary care doctor, they end up in the emergency [indiscernible] end up in the ICU. And for us, that's the higher acuity of product and then get higher utilization of supply. So in an odd way, it can actually be more supplies rather than less. So when I look at what's happening in health care, I'm less worried about -- because we don't measure patient volume, we measure flow of goods. And I can tell you that the first half of the year, we've had fantastic same-store sales. And so that's may be different than your end in the marketplace, but what I believe is happening is we're going to see an elevation in folks that don't have access to insurance that creates kind of negative income for the health care ecosystem.

So in reality, how do you think about your even sensitivity to hospital volumes are elected procedures. What did you see in prior macro cycles on that front?

Very similar. I mean, we're consistent as it relates to kind of growth from that perspective from same-store sales. I mean we're hitting in the right direction. I think there's some talk about potential softness in surgical volume. We haven't seen that our supply chain -- excuse me, our surgical business was up 9% through the first half of the year, and that's including custom trays that go into open hearts and [indiscernible]. So we have not seen softness.

Okay. Great. And so once the current macro and some of the idiot credit kind of dynamics play out and normalize, what would a typical Medline your book like from an organic growth, EBITDA growth in margin progression standpoint as we think about the long-term growth algo?

Yes. I mean, our long-term targets are very simply $1 billion of new customer signings every year, which we're on track to achieve this year. earnings -- organic sales growth at high single digits and earnings growth at or greater than sales. Those are the -- and then ultimately, the last 1 would be for that leverage leverage target will be less than 3x. The combination of those 4 things that we think will continue to drive over the long term in our business.

Okay. So switching gears to the Medline brand, you've discussed about $5 billion of Medline brand conversion opportunity within that existing prime vendor base. How should we think about the piece of that conversion?

Yes. So it's important to frame that out when we talk about the $5 billion in prime vendor, the definition of prime vendor, our definition of prime vendor is acute and acute affiliated. So specific to that channel, take the nonacute out of it. That's an $18 billion segment of our total sales, $5 billion of that within that existing $18 billion has a Medline brand equivalent that we can convert to for our customers. And when you think about the conversion curve of the brand, we sell about $1.8 billion of our brand through competitive distributors through own [indiscernible]. Our brand stands on its own. So when we sign a new prime vendor deal, about 10% of that business is already in our brand. So we signed a new prime enter deal of 90% is third-party products, 10% is in our brand. In the first year, we normally double the penetration rate going from 10% to 20%. That's a lot of the commodities thinking about [indiscernible] under pads, think about tongue depressors, things that are very easy from a clinical acuity perspective to convert, and then every year thereafter, we see a 3% to 4% penetration rate of our brand. That's intentional by design through many years of trials and tribulations. If you go too fast, you can create pain for the clinical team because they can only handle so much change at a given time. And if you go too slow, you don't deliver enough value for the CFO from a savings perspective. So 3% to 4% is what we do. We literally have a road map with every single customer. This quarter, we're going to do incontinence and surgical drapes and gallons this quarter, we're going to do DME and capital equipment. This quarter, we're going to do an [indiscernible]. So we have a very consistent road map to value and savings for our customers. So we never get to that what have you done for me lately. The maximum penetration rate is 60% of the total spend. So Medline brand, if you have $100 million medsurg customers, 60% of that can convert to our brand. If you take the entire book of business right now, we have about 35% of it in our brand, which is why we still have $5 billion in convertible opportunities. So that is a focus for our sales force. That is what our sales paid on. They are paid on the brand alone, and their job is to communicate the value to the customer to ultimately deliver incremental savings for them and accretive margin growth for us.

And as you expand your own brand into more categories, how do you evaluate some of those potential new categories and new opportunities when is an acquisition preferable rather relative to internal investment?

Yes. If you think about the history of the company, 90% of our growth has been internal and organic creative to you. We built it ourselves. So we buy or build. So we have a tremendous muscle to actually leverage our internal resources to build something, research, duplicate and improve upon it at a better value. We do that very, very well. That doesn't mean we don't buy things. We have bought things and we've integrated them very well, but we look for things that we think we can create incremental value and something that actually might be I'll give you an example. We tried to get into respiratory many years ago competing with Hudson RCI, that is a very broad-based set of SKUs. And it takes a while to actually get 100% of the SKU mix. We were about 60% to 70% of it, and it's hard to compete with the competition. We don't have the entire SKU that came up for sale. That was an example of better to buy it than it is to build it, folded that into our ecosystem. And all of a sudden, we had 100% of the line and we were actually able to produce their products in our factories at a lower cost. We've got some leverage and some synergies. So when I think about a go-forward basis, when I started at 1996, about 20% of what a hospital buys had a Medline brand equivalent today at 60%, a nursing home today, 80% of what we sell. 80% of what they buy has a Medline brand equip -- over the next several years, my aspiration is to get somewhere between 70% to 75% convertible opportunity because every year, we add new Medline brands to our category. A recent example is a forced air warming system. If you know much about itself in themselves a product called [indiscernible]. They were the only product on the market. It's an SMS material that you [indiscernible] and you increase the core temperature of the body in surgery. There was no competition we went out, actually created a product, competed with it. We just launched it. So now all of a sudden, we have a $400 million TAM that we didn't have access to yesterday. So every year, we're adding line extensions to the existing categories and we're looking for new categories to get into it to expand the brand. First, we normally look first, can we build it ourselves because I'd rather take the business for free. And if we can't, then we'll go out and see what the acquisition profile looks like.

Okay. Can you talk a little bit about the lab and diagnostic space now a $1 billion business, estimated, I think, $25 billion market, which is what you've quantified in the past. I think you mentioned about 30% of that can be converted to Medline brand. Is that still the case? Do you still see a significant opportunity there. Has your thoughts changed on that market? How do you think about your deeper push into that channel and competitive landscape as well?