Solventum Corporation (SOLV) Earnings Call Transcript & Summary

All right. I'd like to welcome everyone back to the day 2 of the Sixth Annual KBCM Healthcare Forum. My name is Brett Fishbin, Senior MedTech analyst. And I'm pleased to be joined this morning by Solventum, who is represented today by Bryan Hanson, the CEO; Wayde McMillan, the CFO; and Amy Wakeham, SVP of Investor Relations. This will be a 100% Q&A session. Questions can be submitted below the video screen and time permitting, we'll relay to management, but I'll kick things off.

So Bryan, you've been CEO at Solventum now for over 2 years. It's been a super eventful period, thinking about the original separation from 3M. You defined a new mission, upgraded talent across the organization, started thinking about portfolio management as well as acquisitions. So I was just hoping we could kick things off with some high-level thoughts, just how you feel Solventum is in regards to standing the company up what some of the biggest accomplishments have been and then your key priorities for this year?

Yes. So first of all, thanks for having us, and looking forward to the conversation. I would say that you hit some of the things that we're proud of already. So I appreciate you listing those. But maybe if I could just take a step back and say, generally, and I know that my own team if they're listening, is sick of me saying this, but I'm very happy with the progress. I'm not satisfied with where we are, right? There's still things that we can improve. But there's no doubt that this team has done a lot in a very short period of time with a lot of things going on around them. And so maybe I'll just spend a minute or 2 on the 3, I'm just going to call them sections or phases that we put into place in the transformation and talk about some of the things that we've done well and some of the areas that I want to see us continue to improve. And I'd say in that Phase 1 that we've talked about a lot, you referenced it, was around mission, talent, culture and separation. And that was what we really concentrated on there. And I was very happy with the change in the mission, gets people fired up to be here because we actually get to have a MedTech mission now. We've got some really nice upgrades in talent to be able to stand up the organization. We move very rapidly on that. And then, of course, the culture that we put into place allows us to be able to be a little more nimble, a little more fast-acting and more accountable organization. And so I've been very happy with those changes that we've made and people have really leaned in, as indicated by our engagement survey, which was above benchmark even in a challenging transformation setting. So very happy about that. Separation, we're about halfway through, feeling good about the team that we brought on to separate. It hasn't been without challenges, but we've been able to manage the challenges, which says a lot about that team, particularly given the other projects that we've been running, but we still have another half to go. So we got to finish it this year. We're going to be mostly finished with the separation by the end of '26 coming into '27, a lot to do, but I have a lot of confidence in the team. So Phase 1 feels really good, but still a lot to do on the separation side. Phase 2 was around the strategic focus of the organization. We spent a lot of time looking at the markets, which markets we're going to invest in, which markets we weren't and then defining growth drivers inside of those and then completely restructuring the commercial organization to match those growth drivers and also change our innovation process to match those growth drivers. So a lot of great progress there, concentrating on growth drivers, specializing the sales organization, changing up the innovation process, and that's allowed us to triple basically the growth rate from '24 when we looked at the '25 growth rate. So very happy about the progress there. But we have more to do. Our LRP is 4% to 5%. That's our market growth. We feel very confident that we should be able to get there. And then once we do, try to exceed it. But that's what we still need to prove. More of the same in that Phase II, but we've got to get to our market growth and beyond at some point. And then in Phase III, we've done a lot there, too. The SKU rationalization program, we're more than halfway through. The P&F sale was a big, big moment for us, obviously, for a lot of reasons. And then the Acera acquisition just gives you a sense of where we're going to go from here. And I'd say we've got a lot more to do here as well. We've talked about transform of the portfolio -- transformation of the portfolio as being something we're going to continue to concentrate on, meaning that we will continue to look for assets to acquire in that small tuck-in type framework, and we'll continue to assess the strategic fit of the businesses that we currently have. So again, great progress in each of the 3 transformation phases, but a lot more to do in each of the 3 transformation phases.

All right. Perfect. And we're going to switch gears in a minute to the guidance and most recent quarter results. But also just to kick things off, it seemed like a really big priority, Bryan, for you was culture and upgrading the culture. So maybe just simply put, like what are some of the key elements that you've focused on and tried to implement that are different from when this company operated as part of a larger conglomerate?

First of all, I appreciate you asking the question because normally it goes right to the modeling questions. And this is probably one of the most important questions you will ask. And I would even broaden it. It's not just culture. It is that foundation in the business, its mission, talent culture. Those are the first 3 elements of the 5 that I focus on. So mission, talent culture, then it becomes strategy execution. Not to say they're unimportant, but they have to come after the foundation building. And that's what we've done. We spent a lot of time on the mission and the purpose of this organization. That means a lot, Brett, because people are working very hard. In a transformation, you are sprinting. It's a long-term sprint and people can get fatigued. And if you don't have a purpose around what you're doing, if you don't feel good about what you're accomplishing, you're probably not going to have the stamina to get through the transformation. So mission and purpose is number one. Talent is obvious. You just hire people that love to work in that environment. You got to have people that love to work in that environment. And on the culture side, it's unleashing the great people that you have with the purpose that they have. And that to me means that you have decentralized decision-making so that you have better speed, you can be more nimble and you're more accountable for those decisions. And that's what we put into place. And people are leaning in. They're enjoying it. They're really enjoying this new environment probably faster than I expected them to. So I would say it's more than culture. It's those 3 elements that have built this foundation that are absolutely required in a transformation.

All right. Perfect. And then just switching gears a little bit. I wanted to ask about last year before we talk about this year. You finished 2025 with above 3% organic growth, which was above the initial guidance of 1% to 2%. So maybe just simply put, like what went better than expected in 2025?

Yes. So a lot actually. And because there were some risk coming into 2025. We did a global commercial restructuring of the sales organization. There's always potential risks associated with that. We did a significant ERP cutover as a part of the separation. There's always risk and distraction associated with that. We did the P&F transaction, the whole divestiture and delinking and we've done the Acera acquisition. So a lot of things that could have derailed our focus but didn't. So I would say that, first and foremost, the ability for the organization to digest that amount of change in those many projects and still deliver was fantastic. And I expected more to go wrong. I was continue to knock on wood because I think we managed it well, but very impressive. But the big things in my view are that focus around the growth drivers that I said before that -- you don't know how fast an organization is going to move to that new strategic direction. We have seen a lot of movement very quickly led to the commercial restructuring and the focus on being able to drive those growth driver elements because of the specialization and the sales operations that we built around it and then the products that we've been launching in those areas. That's really what went better than expected, digesting all the change, all the projects while delivering on the new strategy and the new focus. That's what -- so it helped us deliver more than we expected in '25, and we'll continue to do that into '26.

Yes. So let's talk a little bit about 2026. Just starting with the revenue growth. The initial guidance was 2% to 3% or 3% to 4% adjusting for the 100 basis points of expected SKU reductions. So maybe just walk through at a high level, some of your key assumptions underlying that range. And I think a common question is what you see as the biggest swing factors driving potential upside or downside to that range?

Maybe on that one because it's more associated with the guide itself and top and bottom of it. Maybe, Wayde, I'll flip it over to you, if you don't mind answering that one.

Yes, sounds good. Happy to start that one. And as Bryan said, Brett, thanks for having us here today. So as we think about our 2026 guide, starting with that organic sales growth, we gave some color on our last earnings call to normalize our full year total company 2025 at about 3.5%. And that's factoring in the SKU headwind and then some of the improved Dental back orders that we saw that really boosted the Dental growth rate in the second half of 2025. So on a normalized basis, 3.5%. And so that's an important number for us as we looked at our guidance for 2026. We put that 3.5% at the midpoint, again, on an ex-SKU basis and said, all right, if we continue to see the acceleration we saw last year, as Bryan said, that was a significant improvement over the 1.2% we had in '24. So if we continue to see that kind of acceleration, we'll be at the midpoint of our guidance. If we can improve upon that and actually continue to accelerate more, that will put us at the higher end, closer to that 4% on an ex-SKU basis. And that's really built on some of the things that get us there are just what Bryan laid out, improved commercial enhancements. We've got innovation improving. And it also factors in some of the market forces. There are some market forces that could push us really to the higher or the low end. And then just a few other things we think about at the low end of that range is some of the separation activity that we have going on. We've got certainly a lot of ERP work to be completed here in 2026. and distribution center cutovers as well as all the TSA exits. And so we've got a lot of additional work on top of our day jobs to complete in the separation here in 2026. We certainly have to factor that into the guide. But having said that, as we said in our past earnings call, we're very excited about the momentum we're seeing, the strength in the sales growth rate already after just 1.5 years, 2 years of being spun and a separate public company, well on our way to that 4% to 5% market growth or long-range plan that Bryan just mentioned, and that's our first step and what we're targeting to get to.

Perfect. And maybe just digging in a little bit into some of the specific segments. I think on the earnings call, you guys did talk about the potential for improved growth in HIS compared to 2025. And I think you guys have probably been getting some more questions about AI and potential impact of AI companies on that business. So maybe just a little bit more about what gives you the confidence to kind of talk about the business that way for this year and how you're thinking about the overall competitive environment with some of the new entrants?

Yes. I mean -- so maybe just taking a quick step back, we expect because each of our businesses have growth drivers that each of our businesses will improve year-over-year. So that is -- in our view, it's kind of table stakes and an expectation that we're giving at each of our businesses. And that would be continue, right? I mean, again, every year that we have it, we're going to be looking for more the next year. HIS specifically, for us, AI is an opportunity. We look at this as an absolute opportunity because it's another tool in the tool belt, if you will, to be able to move an important initiative forward, which is autonomous coding. If you look at revenue cycle management, it is a category, is a growth driver. One of the major areas of growth inside of that over the next 5 years for us is going to be autonomous coding. And one of the big variables in allowing us to make autonomous coding work would be AI. Now we've been using and leveraging AI for 10 years in this space. And of course, the tools are getting better and better. We don't see AI, and I think this is important like a large language model. We don't see it as a competitor. We see it as a variable in the equation that we can use to solve the equation, right? It by itself doesn't solve the problem. It in concert with what you train it is what allows us to solve the problem. And we think that we're differentiated in the way that we can train just given our decades of experience in the space. We've been dealing with customers at scale. We have a huge data set. We have proprietary algorithms, and we have proprietary rules that we use to be able to train our AI, which sets us ahead of competitors that are trying to do the same thing.

All right. Perfect. And then switching to Dental. It's been a relatively sluggish market really since COVID. And I wanted to just ask like if you guys are starting to see any signs of end market recovery and just how you're thinking about like the growth dynamic this year for that segment?

Yes. I think it was indicative of the fourth quarter. You just look at all the dental companies that presented, it was clear that there's a little momentum in the market. I'd say it's kind of stabilizing to improving, which is great. And if you think about our LRP assumptions, which goes out to 2028, we had assumed in that LRP assumption that the market by then would get back to that 3% to 5%, which is pretty typical of that market in a normal environment. So it's nice to see that it is stabilizing, and we are seeing some improvement. That said, Brett, we're not waiting on that. Our innovation is what's driving our growth, and we're going to continue to double down in the innovation. They've done a great job in Dental. Pretty much all of our growth in '25 was because of new product innovation, and we expect that to continue with product launches into 2026. So we do expect the market to improve. We expected that from the very beginning with our LRP. It's glad to see it's beginning in to move that direction. But innovation is going to be the key for us to continue to drive performance here.

All right. Perfect. And then just turning to the operating margin guidance. Specifically, you guided 21% to 21.5% for the year. We viewed that as a really impressive and positive ramp, thinking about the full year impact of tariffs that are baked in. So wondering if you could just unpack a little bit some of the key levers that are supporting that type of margin expansion despite like the tariff headwind.

Yes, Wayde, I'll probably hand that one over to you.

Yes. Sounds good. I appreciate that comment, Brett. It is certainly a margin expansion story here for us, a multiyear margin expansion story for us, and we want to continue to expand margins every year, including 2026, which, as you call out, we are looking for about 70 basis points more headwind from tariffs, as we annualize tariffs, into 2026. We think it can be about another 70 basis points of headwind for us. So inside of that is our 50 to 100 basis points of margin expansion. So it's well over 1% even at the low end when you factor in the tariff headwinds. And so the main drivers for that are sales leverage. As we continue to accelerate sales and we drop through more to the bottom line. And then we've got 2 efficiency and effectiveness projects running. First, the programmatic savings, which is mainly targeted at our supply chain. And we gave a good amount of detail on this at our last Investor Day, our Head of Supply Chain, Paul Harrington, laid out a comprehensive plan for driving significant savings, mainly in gross margin in the supply chain. And then we're building upon that with a new program we launched at the end of last year called our transform for the future. And again, this program is focused not just on efficiencies, but also effectiveness. Think about areas around process and systems and structure. And the key here is to make sure that we can continue to invest for growth. We want to make sure that these programs drive efficiency. So it really fuels our investment for growth and drives operating margin expansion for us. So we put all that together, we do think we've got a nice margin expansion story. The transform for the future and the programmatic savings are multiyear projects that are designed to help us improve effectiveness and efficiencies over years to come here.

And then just one more on margins. The MedTech market and the market as a whole has been sluggish lately. I think part of it has to do with the conflict in the Middle East and rise in oil and commodity prices. So I was hoping you could just comment at a high level how you think about Solventum's exposure, maybe from just a revenue and margin perspective if this issue became very prolonged?

Yes. So maybe I'll start, Wayde, and if there's anything you want to add, please do. I'd say, first, we have relatively little infrastructure in the areas of the conflict, which is great. And at the same time, even though it's relatively little, there's still some of our people that are there. And of course, our first priority is to make sure that they're safe, and we're doing everything we can to keep them that way. And so far, mission accomplished. So that's the first thing. Secondly, because we have that little infrastructure, we don't really see a lot of revenue risk associated with this today and certainly feel comfortable with the guide that we gave in 2026 even with the conflict. But to your point, we're going to have to watch it over time because this will have an impact to oil prices already has. Question is how long does that remain? There's certainly for every organization, if you have oil prices that are sustainably higher, you're going to have logistics cost issues, you're going to have raw materials cost issues. But for 2026, we don't see it as being a big of an issue. If it would sustain potentially more in 2027, but it would take it a while to sustain at that pricing to have a significant impact for us.

All right. Perfect. Perfect. And then just maybe to wrap up the guidance questions with just a little bit about cadence and free cash flow. So first on cadence, I think one of the biggest just like areas of pushback from investors, you kind of look at the full year guidance and it looks good, but there's like some considerations for 1Q. It seems to be shaping up as like the lightest quarter for growth and also margins. So just kind of I want to hear about what gives you confidence in like the type of ramp that's implied by the guidance, assuming 1Q falls in line with what you expected coming out of the 4Q call?

Wayde, do you want to take that one?