Good morning. I'm Larry Eglinton, the Medical Body Panelist as well as Margaux. It's my pleasure to host this fireside chat management healthcare. With us, we have Jay Sagaro, the CFO and Carolyn Borders, Head of Investor Relations. We'll format it as a fireside chat.
If anyone has a question, please can. Jay and Carolyn, thanks for being here. Thanks for being a shareholder supporters of the Wells Fargo Healthcare Conference. Appreciate it.
Yes, absolutely. Larry, thank you for the invitation as always. And then to those in attendance, thanks for joining us today. We appreciate your interest in our company. So Larry, was reflecting on that yesterday and this is the third year that we've been at the conference since we became an independent company.
And I have to say, we are incredibly proud of the progress that we've made. From my standpoint, most notably, we substantially increased investment in R and D over the last several years and we have advanced products through the pipeline to the point where we're sitting on a series of launches that will take place in 2026 that will over time really transform our company. The second thing I would say is we've done an incredible job on margin, controllable margin. We really have focused on implementing a lean business system and that has allowed us to identify opportunities, execute and we're having audio issues here.
This one's okay?
Okay.
So the lean business system that we have in place has done really an unbelievable job in terms of allowing us to identify, categorize and attack margin opportunities. That's really the second area. And then third, listen, our entire company is wired around creating a world where healthcare has no limits. Having the right team in place and the right culture is a third area that we're incredibly excited about. Now having said all of that, it's not without some volatility.
And as you know and we'll no doubt discuss, our company is very exposed to tariffs. We had some very substantial guidance adjustments over the last couple of quarters. Our company is exposed to China, but I would say that beyond those factors, the controllables, everything is going extremely well. That's good to hear.
So perfect segue into my first question here. Jay, what's your view of the hospital capital equipment environment? How has it evolved through 2025? Have you seen it get better or worse or stable compared to last year?
We think the capital equipment market in particular in The U. S. Is buoyant. First of all, survey quarterly hospitals, our top 40 or so customers and we have an independent agency do that on our behalf. And what we see is continued momentum around hospital capital.
That showed up in our orders through the first half of the year in the last three or four quarters. And there's really a solid environment and a commitment to invest in critical technology. But in The U. S, I would say it's strong. I would say also though that the areas that we play in predominantly, principally imaging, the ultrasound business, imaging, these are areas where hospitals are to a large extent capacity constrained and also they're profitable areas for the hospital and they're crucial in terms of disease diagnosis.
And so you put all of those things together and as we look at our surveys, not only is the environment good, but the environment for some of our product categories, our critical product categories is also very robust. Now the other thing I would say is, we have seen a little bit of a turn in Europe as well. There's some increasing momentum in terms of hospital capital there. A couple of years ago and last year, it was a bit more stagnant, but we're now seeing that market open up and we're taking advantage of that, which I think is just great.
That's helpful. You didn't touch upon China. What's the latest there? And just remind us of your expectations for the second half versus the first half?
Yes. So during our earnings call, we a second quarter which came in a little bit better than our expectations in China. And so we had expected down a little bit more and it was only down very low single digits. I think from our standpoint and a lot of that came down to conversion of the backlog, better conversion than we anticipated when we put the forecast together. But as we looked at the market in totality, we saw that it is still taking time to move through tender process to completion.
So the notion of you have interest in equipment, you announce a tender, tender approval, that process through the sale, through the equipment installation has extended very substantially relative to previous. And so we're still seeing some of that. We took a bit of a cautious approach as we looked at second half guidance and lowered it, not dramatically, okay. Mind you, these are it's talking about small adjustments, but we did see a world where the second half would be worse than the first half versus our previous guidance. And so on balance, from our standpoint, we're always going to take conservative view when forecasting China.
And so we just we made that adjustment. Now I was really pleased thinking about the global environment, we raised the midpoint of the guidance by 50 basis points, which is roughly $100,000,000 and I think that was a great outcome for us, in the face of a slight adjustment in China.
That's helpful. Obviously, investors are very focused on order growth for your company. In the second quarter, order growth dipped to 3% from 10% in the first quarter. Why such a big change? And how do we think about order growth going forward?
Yes, it's interesting because generally the second quarter order growth was principally in line with our expectations, very much so. And as were each of the other dimensions of the P and L, but we don't guide to orders, so nobody had a sense of that. We had an incredibly strong first quarter, 10% orders growth. We also had a very strong fourth quarter of last year with 6% orders growth. My view on this is you can never overanalyze one quarter in isolation because there's false signals in that.
Things shift from one quarter to the other or naturally occur from a funnel conversion standpoint at a certain timeframe. So it's much better to look at things over a trailing multi quarter basis. And as we look at the trailing four quarters, trailing three quarters, trailing two quarters, we're talking about incredibly robust growth. Year to date, we're talking 7% order growth, which is something that sets us up well to achieve our midterm aspirations. And so I wouldn't over read into it.
And I think that we'll continue to watch orders going forward for us. This idea of surveys, strong momentum in key markets, all of those things play into a fairly robust environment as I said in my opening comments. So we feel good about that.
Jay, maybe I'll just add that we do encourage investors not only to look at orders growth because sometimes that is lumpy, but also to look at backlog which was at a record $21,300,000,000 at the end of last quarter and also book to bill which was healthy at 1.07 times.
Thank you. That's helpful. So in light of your comments, Jay, about China being a little bit worse in the second half versus the first half, what's giving you the confidence and what are the drivers of the acceleration of the organic growth embedded in the guidance? You expect Q3 to be a little better, I think than Q2 and Q4 to be even better?
Absolutely. So and what this really comes down to, we talk a lot about book to bill as Carolyn mentioned. It's book turning to bill starting in Q3 and Q4. You start to see that like some of that order strength from the fourth quarter starts to convert to sales in Q3, in Q4, even in Q1 of next year. And so really that robust backlog allows us to start paying off some of the sales growth that we would like to see as we move into the future here.
So from a third quarter standpoint, I think we guided 2% to 3%. At this point in the quarter, if you think about our business in the third quarter, about half of our business is flow and that relates to our PDX business or our service business. The other half is capital related. So at this point in the quarter, more than 90% of the capital is what we called secured, meaning a backlog with a delivery date in the quarter. And then there will be some incremental sales that take place from a sell and install standpoint, which is orders that occur and are delivered in the quarter.
But we have very good line of sight to the third quarter and increasingly good line of sight to the fourth quarter as we put together these projections.
That's helpful. Talk about margins please, Jay. In Q2, gross margin was down about 180 basis points year over year. Obviously, the tariff impact increases through the year for you, for every company. How should we think about the gross margin?
And maybe you could touch upon operating margin as well.
Sure. We're very pleased with the margin progress of the company. I think it's one of the bright spots, as I mentioned earlier. And a lot of this comes down to the business system that we have in place. It's incredibly rigorous based on lean principles and it really enforces a hierarchy of how you manage strategy implementation and then how you identify opportunities for margin improvement.
It's clearly been one of our bright spots. Now interestingly in the second quarter of the year, we had a couple of things collide to impact gross margin. First, we had the tariff impact which for the second quarter was really the first quarter that we had a meaningful tariff impact. And then the second thing that happened is because of the cadence of our R and D pipeline and when products were moving through to feasibility, we actually had some of our R and D costs, which and some that we even anticipated in R and D flip to gross profit to cost of goods. And so that depressed gross margin in the third in the second quarter of the year.
It will be a little bit of a drag in terms of these items, but R and D was down as you noted, despite the fact that overall program spend will continue to be robust. So I think the mix between those two lines is something that we'll have to watch carefully for the rest of the year. What I will tell you is, if you adjust for tariff impact, you're still talking thirty, forty basis points of EBIT margin expansion for the year, which is right where we want to be. We're happy with that progress this year. We'll have more next year.
And interestingly, as we look at next year's margin expansion, what I'm excited about is our commitment of holding tariff impact flat, because what's happened right now is we have about $265,000,000 worth of tariff impact in our numbers this year. Through intense efforts by our operating teams, we're able to hold that number flat next year despite the fact that we have like FIFO inventory impacts impacting next year and we didn't really have a big impact in the first quarter, we're able to hold that flat. It's a huge achievement, but what it will allow us to do is it will allow us to hopefully have tariffs become neutral and then even start to become a tailwind in future years as we look to drive margin expansion.
Just so I understood your comments correctly, for next year, you're saying the tariff impact flat year over year, 26 versus 25. And that next year, you said you have 30 basis points of underlying margin improvement this year embedded in the guidance. You think you can do better than that next year?
Well, here's what I will say and I'll stop short of September, so we never like to give guidance for next year. But if you think about our aspiration, what we've said is we want to be 17% to high teens to 20% plus by 2028, okay. In order to do that, we need to accelerate some margin improvement. Obviously, this year was a huge challenge principally because of tariffs. And so as we get on that cycle, you will start to see some nice margin expansion in the coming years. Okay. So that's helpful.
Super helpful. Thank you. Jay, maybe talk about some of the growth drivers
We're very excited about Flurcano. Think from our standpoint, this is a game changer for cardiac imaging. It really is. And I think what we're seeing is real interest by our customers. Everybody who has it has been very compelled by the image quality and the improvements that they're seeing as a result of implementing with Flurcado.
We always knew this would be a highly orchestrated launch. It's not as simple as launching a drug that you ship. There are so many different facets to this. It starts with getting CMS reimbursement, which we did. Quickly it moves on.
You have to have commercial carrier reimbursement, which is another hurdle. Then you also have to have a radio pharmaceutical network in place that allows you to deliver product consistently to your customers. Right now, we have a target of getting to 25 by year end. We're at about 18 radio pharmacies that support the volumes that we need to deliver. Once we get to 25, it will be like 90% coverage.
But then with respect to centers, it's not as simple as going to a center saying, here you go. It's more complex, meaning go to the center, explain how workflow is going to change as a result of this new product, how workflow can support enhanced outcomes for patients. And so that entire process is a complex one, but I'm so proud of the team and what they're doing in terms of the education, the tracking, the progress. So we feel very good about what we're expecting to do this year and we're incredibly excited about the long term potential. I know you have some robust numbers out there, listen we're chasing them.
We said 500,000,000 plus by 2028 and we really want to make the plus as big as possible.
That's helpful. Good to hear. And then Photon County CT, talk about your confidence in being able to file this year or launch next year and how you're thinking about the ramp?
This is interesting because oftentimes when you increase R and D spending substantially, it's hard to spend the money effectively. What I mean by that is like you're hiring whole new teams and you're hiring new capabilities, competencies and oftentimes what happens is you have pipelines that drift despite the increase in spending. That's a real challenge. I've seen that with lots of different companies in the past. What I think I'm most proud of and I said this at the outset, we've increased our R and D spending and all of the timelines for the most part, there's little movements here and there, all the timelines are intact.
As it relates to photon counting, we're going to file in the second half of the year as we said, and then be ready to launch in 'twenty six, incredibly excited about what this brings to bear and how this positions us. I'm limited in terms of the comments that I can make, given we don't have an approved product yet, but I can tell you that our team is really excited about what we're going to do and getting in the race here. This is an area that generally the photon counting segment is still small, but it's an area that we don't play in today. Whole body PET, it's a market that we don't play in today. We're A, if not the leader in imaging and ultrasound and yet there are markets that we don't participate in at this point.
And so getting photon counting out is really significant. Getting whole body pet out really significant, not to mention all the refresh that we're doing from the rest of the product line because we have a whole host of those products. And what we find is when you do launch new products oftentimes it triggers investment cycles. But these new markets I think are really compelling from our standpoint. Everybody in the room, we have a big conference, the RSNA is the most notable show for radiology and that occurs later in November.
I'm so excited for what we're going to share there. Obviously, you're all invited to join us.
Sounds good. Someone from our team will definitely be there. And Jay, digital, you said at your Investor Day that digital revenue including AI was $1,200,000,000 in 2023 and you expect that to grow by 50% to $1,800,000,000 by 2028. What are the drivers? Are you on track?
And are you going to like maybe disclose more on the earnings calls about the progress here? Because if I think about it, I'm not sure I've heard like on the recent earnings calls, any updates there?
I do think there is an opportunity as we think about disclosure, some incremental information in terms of this I think might be beneficial for investors. So, we'll take that up and discuss that. We're making great progress here. First of all, we're at I think it's $1,200,000,000 as of last year, which is a very robust amount. And it's things like AIR Recon DL, which is an artificial intelligence enhancement for MRIs, which allows scans to take place much faster with higher image quality.
That's a huge improvement. When you think about radiology departments that are constrained today, having something like AIR Recon DL is a game changer. And so of course, we're winning MR sales as a result of that and then we're adding on the sale of that particular product. So that's just one small example. We have now Sonic DL, our whole ultrasound portfolio has really interesting technology embedded.
In some instances, it's an add on. So when we sell Vscan Air, we have innovation package options, which incorporate into that product our CaptionHealth technology. That's a deal we did several years ago. And really what CaptionHealth is about is AI to help guide ultrasounds, allowing trained sonographers to do it faster or untrained sonographers to get images, which is something that really wasn't possible before this. So that innovation package is available software as a service.
So these are the kinds of investments that we're making across the entire portfolio to support the growth of this. We feel very good about it. It's an important investment for us because not only is it a line item that we can kind of pull out and tell you about, it also gives us the opportunity to differentiate ourselves versus competitive offerings.
That's helpful. Jace, I wanted to switch gears, talk about your long term outlook.
You have an LRP out there. It calls for mid single digit CAGR for twenty six to twenty eight.
How are you feeling about that because China was expected to contribute 150 to 200 basis points by basically the normalization of growth there. So, how are you feeling about the LRP at this point?
What I would say is, it's almost like if you think about this year, right, maybe the second half is a little bit softer, but we raised the guidance for the full year. Why is that? Well, what that comes down to is execution on the commercial side, execution on the R and D side amidst an interesting backdrop. And so I am incredibly pleased. We did the Sutter deal earlier this year.
We have more deals like that in the works. We've announced some others. What those deals represent is putting forth the full capability of our company, service, world class products, world class service, a commercial organization that is outstanding. You wrap all of those things together and we're winning with our customers. And so on balance, I feel really good about our mid term aspirations.
And it comes down to those three dimensions, world class products driven in large part by the refresh that we're doing, so much of that. By the way, I think last week we announced Vivid Pioneer, which is cardiac ultrasound. It's our next generation product. Image quality, AI incorporated into the workflow, extremely portable, great probes. There was tremendous excitement around this new product.
Now we've been quietly investing in this for the last couple of years and Phil unveiled it recently at a conference in Madrid. For us, that's one of the many reasons that we're very excited about the mid term growth prospects and our ability to achieve this mid term mid single digit sales growth. It's going to be on the back of new products that allows us to do this.
I wanted to come back to China for a minute, just one follow-up question. You gave some helpful commentary about how you're thinking about the year. My question is, but I forgot to ask when we're on that topic. Is there anything that you can say, anything in the public domain about how things are progressing in China in terms of the tender process, the environment, any new information out there we should be aware of?
No real new information. I think it's kind of progressing as we expect, as we in line with what we said, but you can't overread two weeks, because the last time we talked about this was a few weeks ago. You can't overread progress during those kinds of timeframes. But yeah, I would say things are generally okay in China and we're just watching very cautiously. And as we think about when we give guidance and things of that nature, always take a conservative view on China given some of the volatility there.
But like I said, so happy that we were able to achieve a higher level of sales growth for this year. And let's see what happens if China starts to recover above our expectations that becomes an incremental tailwind. Right, but obviously the guidance this year is 3%.
And so people listening to your response on the LRP, think would be at least maybe would be wondering, can you still hit the mid single digit CAGR if China doesn't recover? Do you have kind of other tailwinds like the Sutter deal that could help you overcome that if China doesn't recover?
So from my view, there is so much good momentum that we're comfortable with mid single digit sales growth over the mid term despite a volatile under a range of China scenarios, let's put it that way.
Okay.
Now the interesting thing is that all of that comes down to momentum that we're seeing in core markets, new product supplements and continued work in terms of service and commercial excellence.
If I think about next year specifically, take the 3% from this year, you have both on accounting coming, you have Vorcado ramping. What are some of the tailwinds and headwinds that we should be considering next year without obviously giving specific guidance?
Yes, thank you. I always appreciate my post Labor Day twenty twenty six question I appreciate that. So stopping short of giving guidance, I think for us as we approach next year, you start to benefit from the new product cycles. That's really the biggest thing that will contribute to orders growth and then to some extent sales growth. You'll have the Flurcato ramp because remember if we're going to get to $500,000,000 plus by 2028, you have to start to have bigger numbers in 2026.
Those numbers start to be significant in the context of even a $20,000,000,000 company. So that's another one. And then you have some of the big deals that start to play through next year and future years. So I think we've done a good job really insulating the mid term with the large deals that we're talking to today and that we've executed on plus these new products.
Okay. Jay, there is as you know with the One Big Beautiful bill, there are significant Medicaid cuts, investors are concerned about the impact on hospital capital equipment spending. What's your view?
We have so the hospital capital environment in The U. S. Has been solid. We haven't seen an impact from hesitancy by our customers.
We've talked to our customers about this and we haven't seen major concerns yet. Now when we do our survey in the upcoming quarter, we're going to be sure to embed some questions around some of these aspects because I think they're really important to have a fine tuned understanding of. But so far, we've seen no impact. And frankly, there are aspects of the bill that supportive of a robust capital environment. And so we don't know like one way or the other, what the impact will ultimately be.
We'll survey our customers, we'll look at this very carefully. But as of now, we've seen no change to what has been robust buying behavior.
That's helpful. Jay, before capital allocation, I wanted to ask a tax question. We've seen it come down from 24% only like two years ago. This year, think you're guiding to 20% to 21%. I think the first half was even lower. Is there more room for improvement?
We want to continue to improve the tax rate. Asked and you told me last year that I had the highest tax rate in all of MedTech, our company It's really motivated. And we were already we had already circled that on the P and L as an opportunity for us. Were 24%, 24 was really high, then we were 22%, now we're 20% to 21%. What I have to say is, we have an incredibly talented tax organization and a tremendous tax leader.
And so I and that team so much of that team has been in place for a long time. And so but the interesting thing is when you spin off from another company, the objectives of the company may change as it relates to certain aspects of the P and L. In the case of tax, we weren't previously optimizing the tax rate of GE Healthcare. We were optimizing the tax rate of GE with the support of GE Healthcare. So now we move to an independent company.
And make no mistake, it was a lot of work that was undertaken by the team to do a strategic assessment and understand what the attributes and opportunities are, But we've been hard at work at that and we've been able to drive a very meaningful impact because at the end of the day, is a real impact to the P and L and cash. And I expect us to drive more of that in the future.
That's helpful. So capital allocation, just remind us of your M and A criteria including size, accretion, dilution and return on invested capital please?
Sure. For us, M and
A is an important growth driver. But what I would say is, we really like targets where there is an incredible strategic logic, because when we find that, we find that there is a limited buyer universe and you can tend to get attractive or reasonable deals done. And so the best example that I can think of this and we have actually several of them, but we purchased MIM a couple of years ago. And MIM software is for Theranostics. It's basically radiation oncology workflow.
And the interesting thing about MIM is when we were selling our product offering against competitors, they were sometimes selecting the competitor product because they like their radiation oncology workflow better or if they were buying our product, they were essentially buying MIM as well. So it's no wonder when you did this NIM deal, was a few $100,000,000, the synergies were fabulous. And so we were able to drive a very robust return. That deal is tracking ahead of its deal model on I think every P and L Jim mentioned including orders, very robust orders growth and it just made so much strategic sense for us. We did a deal called Intelligent Ultrasound, smaller deal, same concept, automation of the maternal fetal exam.
Well, guess what, there's only a couple of buyers of that. Caption Health, another example of a deal really where we were the logical if not only potential buyer. And so great transactions for us. Strategic, we need to have a really tight fit. Now once we have that, we like revenue growth.
We want to see accelerating revenue growth. We want to see accretion in the very near term, not necessarily year one, there may be deals that you do in year one that are year one dilutive. And then we want to see a high single plus ROI by year five. Those are the financial criteria that we have. By the way, we're also focused on tilting our business more to recurring revenue.
So that's another aspect that we consider. We have a rich pipeline of deals in place. And what I would say is we don't have a size governor, but there is much more smaller deals in the pipeline. Are far more deals less than 10% of market cap because they're just more available targets, they're less risky, they represent great opportunities for us and in many instances, it's a product technology or capability that we can plug directly into a gap that exists. So as I think about M and A, you can expect us to see those kinds of things thematically.
The NMP acquisition, which is something our Japanese distributor for our PDX business. Well, it's a tremendous deal and now it gives us a platform to expand in Japan that we didn't really have before, direct control over critical attributes. So, very excited about the pipeline. We brought in a new leader in this area from Edwards Lifesciences, Finn Haley. We spent a lot of time on this.
And I think what we transact, you never know because at the end of the day, we really have very rigorous criteria. We've passed on dozens, if not more than 100 deals since I've been there, because the economics aren't right. So I think we'll get to the right spot with this, but definitely excited about the pipeline.
That's helpful. Before we end, we've got a couple of minutes left. I actually wanted to ask about one business that doesn't get a lot of attention, PCS. That was one of your softer businesses in the first half of the year. You have a new leader there, someone investors know from her prior company. What is the strategy there?
Is that an area where we could see some tuck in M and A?
No, it's interesting because at the start of the session, said we're proud of a few things. One is culture and team. And then during the presentation today, I referenced we have a new tax leader, we have a new business development leader, we hired Jeanette Bancas, who is a star business leader. And so thrilled that we have somebody with her capability and competency at our company. And listen, PCS has underperformed.
There have been some supply chain issues, couple of comp issues. At the end of the day, we want that business to do a lot better and it can. That business will benefit from a whole host of launches that will take place next year and Jeanette is focused incredibly on those successful launches, accelerating revenue growth, but also accelerating margin improvement. So you'll see both of those. Now to your point, there are a whole host of tuck in acquisitions in this area, because the reality is, it's $3,000,000,000 business, which is not huge for us, but it sits in a critical spot in hospitals.
So the real estate that we occupy lends itself to some nice tuck ins around it and we're evaluating lots of different opportunities in this space. But I think the thing that you can count on is a real focus of that team on accelerating sales growth as a result of innovation and supply chain and also accelerating margin improvement back to that whole business system. This team has embraced it completely.
And importantly, in that product portfolio, you will see us moving from more standalone hardware type focus of R and D efforts to more of connected platforms, more smart AI, which is something that will we believe make it more palatable to the customer to want to embed those devices and refresh the portfolio.
That's helpful. Thank you. Jay, we're almost out of time. Thank you very much for being here, both you and Carolyn and the rest of the team in the audience. I wanted to give you the opportunity to make some closing remarks here.
Well, no, listen, thank you again for your support over the years. We really appreciate it and you picked up coverage early and really brought some insights to the entire investor community. So thanks for that. From our standpoint, really pleased with the execution. 2026 has a whole host of exciting product launches that benefit that year, but even more 2027, 2028, 2029 and beyond.
So, so excited about what we've been able to deliver on thus far and really set ourselves up for this successful midterm. Thank you. Thank you.