Solventum Corporation ($SOLV)

Travis Steed, Bank of America medical device analyst. Welcoming Solventum Corporation next up in Vegas. We have Garri Garrison, President of Health Information Systems; and Amy Wakeham, Senior Vice President, Investor Relations. Welcome. Thanks for joining us.

Maybe on health care IT to start, maybe just provide a high-level description of your HIS segment and kind of how it fits within the broader Solventum portfolio. Are there any synergies or imports to the software business alongside the traditional medtech supplies business?

So Health Information Systems is really a system that -- or a business that we really have 3 business pillars in. We have our revenue cycle management business, we have our performance management business, and then we have what's called Clinician Productivity Solutions, which is our speech and Ambient business. So it's more medical software. It's not device like what you see in a typical medtech. But if you think about those 3 pillars, really what this is focused on is it's really around making sure that hospitals can get paid appropriately. So we build all of the software that's utilized by about -- greater than 75% of the market uses our product in the U.S. So it's well penetrated, it's a highly profitable business, it's a very attractive business. And then when you think about performance management, performance management is really a pillar of businesses that really focus on what I call being able to get to the accurate payment. So if you think of RCM as being able to apply a code to a claim, the performance management system is actually what we call grouping of all of the information to be able to get to the right payment. And then in our third pillar is speech and Ambient, which is a physician tool to be able to get documentation placed into the electronic medical record sort of through speech to text. The Ambient does an audio capture of not only the physician, but the patient and any family members in the room, and then creates that visit into a document, into the EHR for the physician. So that's kind of how our business is structured.

That's a whole overview. Maybe if you look at Street estimates, they're calling for 4% growth in 2026, increasing to kind of 5% by '28. What are the kind of key puts and takes on accelerating growth in this business?

We are seeing accelerated growth. We've had the last couple of quarters have been really good. Where we're seeing a lot of that opportunity is in a couple of different spaces. Autonomous coating for one, the market is beginning to pick up autonomous coding. We're starting that transition toward adoption. The second area is the expansion of what we're seeing in the international markets. around computer-assisted coding. So what we're seeing outside the U.S. is a lot of different countries are reevaluating their payment systems, and they want to move to payment systems similar to what we have in the U.S. And so that's driving a lot of growth for us in the external market outside the U.S. right now. And then in the third space I would say that we're seeing significant growth is in that grouping applications. So a lot of people ask me, do you -- who's your competitors? We don't really look at the market that way. We look at the market more around coopetition, because if we design the payment system that's utilized by either a payer or a state agency, then we sell those grouping applications to our competitors. And so we're seeing pretty significant growth there in the U.S. and outside the U.S. right now, growing faster than what we've seen in the market for a while.

Given the business operates primarily within the mid-cycle revenue management, can you emphasize that proportion of the market and what kind of share Solventum has approximately?

So this market is about a $10 billion SAM. What we're seeing in this particular space is market share is not a tool we really use. What we look at is we look at the number of hospitals that use 1 or more of our products, and right now, that's greater than 75% of the U.S. markets using our product. Many of our customers may use 4 to 5 of our products in the revenue cycle space. So that's what we use to measure kind of how well we're doing and kind of what kind of growth we're seeing. The other thing that we do is we also see pretty significant growth as we expand our footprint in our client base. So we typically run contracts that are 3 years or 5 years in length, but we're seeing significant growth when we do those contract renewals of these customers adding additional modules. And so that's what's helping us achieve those growth rates.

What's the problem you're solving with your flagship RCM product and 360 Encompass? And where does it kind of sit within the software stack among the other EHR solutions?

So in the hospital setting, you have what we call clinical systems and you also have what we call financial systems. So our product actually integrates with both. The problem that we're solving for the customers is multifaceted. So we are trying to get the most accurate documentation from the physician through the use of our speech models. And then that feeds the data into the RCM product to where we can actually get the most compliant and most specified codes that describe the complexity of that patient. And then we do the rules applications to be able to make sure that we meet the compliance standards and the regulatory standards around whether you're filing an accurate and clean claim. And then we actually do quality analysis of the care that was provided. And then we actually drop that back into a client's billing system. So we take the actual information that's been documented into the electronic health record and bring that into our system so that our AI engines can read and interpret that. And then we actually do all the applications for payment and then drop that back into their billing system. So that's how it works.

Okay, helpful. How long does it typically take to onboard a customer and integrate a new customer? And what's the customer acquisition costs look like and the major steps in the implementation process?

Sure. So a couple of things. If a customer already has one of our platforms, let's say they have 360 Encompass, and they're just adding a module, that can typically be done in about 30 days. That doesn't take long. If it's a new platform that they're installing, you're typically talking somewhere between 4 to 6 months to do an implementation there. And the reason that it takes that long is that you're evaluating and actually integrating with all of the hospitals' clinical and financial systems. So we're bringing data feeds over from their electronic health record. If they have data feeds from a lab system, that is brought over. If they have a different OB system, then we bring that over into our actual platform. And if they have other components that they use, like a Philips system in radiology, then we integrate all of that into the actual database that we have. So it's similar to doing an ERP. It's a pretty big lift. The other thing that you have to do at the same time is also evaluate all of the security connections to make sure that you're protecting that data because it is PHI data. And so that's why you see a 4 to 6-month implementation period. The way that we structure that is we also do training and education. We do change management in the process, teaching the client how to use that product during the implementation. And then we also test the data coming out of that. So is it giving us the right output? Is everything transitioning the way it is supposed to be done? And so it's about making sure the customer has full usage before it goes live. We actually do our implementations in order to help our customers. We do them based on milestone billing. So once you reach a certain point, then you could bill for a portion of the implementation fees. But we do not start taking the license fees for the software until they're actually live. And then those are taken as 1/12 of which your annual license fee is. So on a monthly basis, you get a ratable revenue, is what you get.

And what's the typical contract cycles look like with hospital customers?

It's 3 to 5 years. Most of the majority of them are 5-year contracts. And so we have a very high renewal rate. It gives us a lot of opportunities to work with the customer about any additional modules that they need in order to achieve what their internal goals and objectives are. And so we take every opportunity there to actually expand our footprint with the customers when we do those renewals.

Okay. And then RCM is your largest business within health care -- HIS segment. Increasingly, competitors are leveraging AI to try to gain into this market. Maybe describe why your competitive position is durable and what the market is getting right or wrong about that opportunity?

So I appreciate that question because we're hearing a lot about AI. I think you guys are all a little nervous about AI. Let me give you my viewpoint. I've been around a long time. We've heard a lot of buzz words. AI has [ some meat ] to it, but AI is an enabler. It is not a product. You still need to know the problem you're solving. You need to be able to have the subject matter expertise to solve that problem. So you need to know and be able to determine is the output from the AI accurate or not. The AI systems today hallucinate and they're learning off of inaccurate data as well. So you have to have a large amount of data in order to be able to get really good output from the system. Why I think we've been able to tap into that, and I'll make one little statement -- I told Amy I had to say this. We've been able to invest in AI, and we've been investing very heavily but we've also been able to maintain our margins at the same time. Not many companies can say that. And so that's pretty critical, is to understand there is a cost to AI and you're seeing a lot of investment, but you're not seeing people talk about being able to maintain their margin or getting a return from their investment today. What we've done is we have been very, very focused on it. But our advantage is that we have the subject matter expertise of being in this space for over 40 years. We're the trusted leader in the market. Our customers trust our output. We focus on accuracy and compliance. And what's helping us with the AI models is we obviously can actually code faster, we can build automation faster, but we have the expertise to know when the output is right or wrong because we built over 1 million proprietary rules that have helped put guardrails up to give us those higher accuracy rates. And so I think that's why we see a lot of opportunity in the space and why we're seeing the market start to adopt things like autonomous coating much quicker than we anticipated.

And as you said, you're not sitting still in AI either. To maybe talk about integrating kind of third-party AI tools and LLMs and kind of what remains internal and proprietary and kind of where we're at in kind of 3 to 5 years?

Right. So a lot of people ask me, do we build ours internally or do we use external parties? We do both. So we build internally, but we also use a lot of the large language models or the small language models or agentic AI that we can get from other firms. What you see right now is some firms do well with certain case types, other LLMs by another firm may do better in a different specialty. So we use them all. So we look for what's going to give our customers the highest value. And if we can get that value from external versus something we build internally, we're certainly open to that. What we see with these models is they're ever-changing. We see them actually growing at a rapid pace, which tells us there's more to come in this space, of what we can do with them. But again, it goes back to what problem are you solving? I'm often asked, are we seeing a lot of the startups enter into our space? Absolutely. But what we're not seeing is market share move there. Because at this point, they're not able to scale. So they may start with what we call 1 or 2 service lines, something that's very easy. But a hospital has a significant number of service lines. Are they going to try to find 15 vendors who can do 2 service lines each? They'll be looking for somebody who can do a comprehensive move to manage all their service lines with high accuracy rates. And so with our move into this market in 2012, with what we call computer-assisted coding, we've been in that transition a long time, because we had to train the coding systems and the engines even when we're doing computer-assisted coding to get those high accuracy rates. So we've been marching down this path for some period of time. And so AI is giving us the opportunity to run faster, but it certainly isn't replacing all that subject matter expertise in the proprietary rules that we've had to build to get the accuracy rates that we do today.

I think some of us think it makes sense to include our RCM business and as part of ERP or EHR solution. Does that make logical sense or is that even realistic?

From a customer perspective today, they really look to us to be EHR agnostic. And the reason is, is that if you look at a system, you may have 1 large IDN that's 100% all of their systems are on 1 single EHR. The majority of them are not. So what you might find is that, on the inpatient side, they have one EHR, but in their physician clinics, they have second EHR. So what we've done is tried to stay agnostic to meet the market demands [Technical Difficulty].

And performance management and clinical productivity, what's the kind of the revenue split of that business? What are the key split of that business? What are the kind of the key products in that business? [Audio Gap]

Productivity Solutions is about 30% of our revenue. So let's talk about both of them individually. Performance management is... [Audio Gap] What we do, we have high renewal rates. So we continue to serve that group. Then when you think about the CPS business or our Clinician Productivity Solutions, this is where you see speech and Ambient. So your competition there would be Microsoft, I would say, Epic's an emerging competitor there. And then we're #2 in the market right now with speech. We're seeing a lot of, I would say, market churn in this space. With Ambient coming into the market, we're also seeing speech price erosion during the time. I don't know if we're at the threshold on price yet. I don't know whether we're going to see it go down. But in both of those 2 spaces, we've seen some price erosion, as we've seen a lot of consolidation of who's really playing in that space. We like this business. What this gives us is the opportunity to have a direct line to communicate with the physician around documentation as they're creating it. So that fits very well with our revenue cycle products, is be able to talk with the physician around what pieces of documentation are missing. Because ultimately, if that documentation is not there, you cannot charge for it. And so you can't make assumptions, that's where you hit fraud and abuse. So having that direct line, we've been inclined to keep that business. We still have a solid business there and we have a good margin there. And so we continue to look at it as a business that we intend to continue in our portfolio.

And then when you think about health care IT pricing in general, we've actually done some calls with hospital CEOs and CFOs, and it's a small portion of their overall budget. So is there ability to even increase price in some of these businesses?

So we look at a couple of different things when we're thinking about price, primarily 3 components. We look at the inflationary rates. We look at the cost of maintenance to our products. So for example, if CMS is making a lot of changes to the rules and regulations and we have to invest a lot of time to do that, then that can help drive price up because our cost to manage goes up. And then the third thing we use around our pricing is the value that we bring to our customers. So we do use value-based pricing. We do look at what is the return on investment that clients are going to be able to achieve. And then we also look at what new features and functionalities that we're building into the product does that drive price at a renewal. So those are the types of things that we look at. One of the things that I will tell you that does influence our ability as to whether we can take price is where are hospital margins today. So for example, during COVID when hospital margins were negative, it was very hard to get price. Obviously, that was the time hospitals were in crisis. That was not the time to try to spend getting priced. So it's something that we look hard at every year and we take that into account. But most of our growth is coming from new customers and expanding that footprint into existing customers, is what I would tell you.

Helpful. What do you think investors don't appreciate about RCM?

One word, the complexity. So in the market, a lot of people think that coding is easy. I can put in a word, I can put it in the search engine on my laptop, and I can put in a word and get a code right now. Unfortunately, there's a whole lot more to it than that. So a lot of people don't understand the complexity of how you actually get to the code. And then when you actually want to get to payment, you have significant amount of rules that you have to deal with. So you have to figure out on the front end, number one, was their prior approval with my payer that I'm going to get paid for this? Did I even get cleared to the procedure? Number two, am I in the right side of service? So is this -- should it have been done in the physician's office? Should it have been done in ambulatory surgery? Should it have been done in hospital outpatient? Is it an acute care admission? Then you have to get to, do I have the documentation right? Do I have the specificity? Did the physician give me all the information? Was there a lot more complex conditions this patient had that was influencing the care that we did for them? Then you have to get to the code. Then you have what's called the compliance rules. Then you have the regulatory rules, which is about think of it as tax law. That's the easiest way for me to explain to you about the regulatory environment that we have to live with. So if you have this code and that code, do you get to post both on the claim? If you have this code, does that mean this one over here gets demoted in the weight that it carries? There's an enormous amount of that. And then you add into it things like post-payment rules. So if I had an acute care admission, a hospital admission, that the patient visited the ER within 72 hours prior to that admission, it gets bundled. You don't get to bill for both. So it gets very, very complex very quickly. And so a lot of people look at it and go, there's a lot of start-ups, they can get to an AI-driven code very quickly, it's going to put your business at risk. I think a lot of people do not understand the complexity of how you get to what is an accurate code and how do you stay compliant and don't get yourself into trouble with fraud and abuse very quickly.

So you've had a few investor meetings already at the conferences. Is there anything else that we're not -- we haven't talked about that you think is important?

I would say one of the things I got quite a few questions about in the meetings was the opportunity in the international space. It is growing pretty rapidly. What I would tell you is that it's a [ different ] type of kind of a sale. In the U.S., we go straight to the hospital IDNs, the physician offices, the ambulatory centers. When you're actually going outside of the U.S., you're basically selling to a country. It's at the Ministry of Health level. It is not going to individual hospitals out of the gate. So you're doing market development as you're actually going into these countries. In the past, I would tell you it would take us 3 to 5 years to bring a new country up on a payment system. Now that they've become digital, we're seeing that move in a much more rapid pace, between 1 and 3 years. And so you still have market development to do because they're trying to make global decisions for their country around what objectives they want to meet, what payment system they want, are they going to use something on the shelf, do they want you to build one for them. And then once we actually go into the country and help them with those decisions, then it becomes the time for us to localize to that market. And you do have to localize. Even though health care is global, there are key differences. What we do in the U.S. may not work in another country. An example I used in one of the sessions is, in the U.S., if you go to the hospital and you have dehydration, we're going to give you some fluids in the ER. If you're really dry, we might keep you overnight observation and give you more fluids overnight and send you home tomorrow. We can't do that when you go into a country that has a very high heat index because medically those patients will go into acute renal failure, which could kill them very quickly. The majority of those are admissions when you get into countries that have that kind of heat. So you can't just take what you do in the U.S. and plop it into another country. You literally have to localize to the market. But that's what gives us the advantage is we know these types of things. We know how to do the evaluation of the data. We can build their payment systems or we can use something off the shelf and adjust. And then we go into the country, work with those ministries of health and then drive the market with the need for the RCM products and the group or applications that we take to market.

Thank you. Amy, I don't know if there's anything that you wanted to highlight post-Q1 before we close, but you're welcome to if you want, or we could close here.

I think the only thing I'd highlight is, I think if you listen to our conference call, you probably heard a lot of discussion, certainly, we started off the first quarter well and are excited about the rest of the year where we did highlight upcoming ERP changes that are going to impact Q2 and Q3. And so I just want to make sure that as you're thinking about our business, that you're taking that into account and that we highlighted expecting approximately $100 million of sales coming into Q2, out of Q3, and that that will reverse in Q3. And I know that's caused a little bit of consternation as we kind of work through that with investors. But I certainly felt that was important. But I think the most important message is the underlying business. We feel really good about we're seeing margin expansion. We're seeing accelerating growth. A lot of the changes we've done over the last couple of years, we're really seeing -- starting to see take hold. And everything that Garri is talking about when we think about the HIS business, that's a key component. And I think that's what's really exciting across all 3 of our business segments, is they're all really moving forward and accelerating at different paces and timing. But really excited about what's coming and look forward to the rest of the year.

Yes. The one advantage that I have, and I'd love to remind my peers is, A, I don't have tariffs; B, I don't have oil and gas that's influencing my business; C, I don't have supply chain. So I don't have a lot of the disruptions and the headwinds that they see. And so for us, it's a very stable business. And so we're able to predict pretty much what's happening, what's coming pretty quickly and have a lot more insight.

It's a great conversation. I learned a lot.

Thanks for having us, Travis.

Thanks.