All right, we'll get started here. I'm Jason Bednar. I cover med tech here at Piper. Next fireside chat is with Solventum, a long history in healthcare but very young public company, having recently spun out of 3M. Also, the newest addition to our coverage. So very happy to have with us today Solventum CEO Bryan Hanson and CFO Wayde McMillan. Thanks a lot for joining us today, guys.
Sure, thanks for having us.
Great. So we're going to dive right into Q&A. Just to start, maybe a question for each of you. You're both part of the story of Solventum. You aren't strangers by any means to the med tech community. You had really good seats at other high-quality med tech companies before coming to Solventum. So it just begs the question from a lot of investors who know you, why now? Why Solventum?
You want to go start?
Yeah, sure.
Okay
So for me, the previous role that I had was at Zimmer Biomet, as I think you know, and I love transformation. I love turnarounds, and when I came into Zimmer Biomet, I knew that I wanted to be there for that crazy time that you deal with when you're turning a business around. Once we got to the point where we went from 0% growth to pretty consistent upper end of mid-single, and I had the right team in place, I knew it was time for me to go on and do something different. The question was where and when. When 3M called, this is a 100-year iconic company that when they call, you pick up the phone and you have the conversation, and just, it felt so much like what we did at Covidien spinning out of Tyco.
It was very interesting right out of the gate, so what I did immediately was pick up the phone and call this guy who used to work with me at Covidien and said, "Hey, listen, man, I think we've got an opportunity here that could be a lot like what we did back in the day. Would you be interested in going as a team?" and as soon as he said yes, I said yes, and here we are. We've never looked back.
All right. Yeah, I think Bryan covered it well. Maybe just to add a couple of the things we thought about with this business. I mean, really great markets, which for us wasn't the case with the Tyco Healthcare Covidien spin. We had to do a lot of work and take a lot of risk to actually improve the market growth rates. And we are in some really great markets for very different businesses, but all in that mid-single digit range. And so that gives us a view that it's less risky transformation because we don't have to change the markets we're in. We have to improve how we're performing in the markets we're in. And as Bryan said, we had great chemistry working together. And when this guy, it's kind of like 3M calling Bryan when Bryan called me. Love the opportunity to work with Bryan again.
I came from Insulet, which was an amazing company. I really could have worked there the rest of my career. Serving a mission for people with diabetes is incredible. But we've also got an amazing mission here. We've got a lot of excited people across the company to have a standalone healthcare mission. It's a bit challenged as a healthcare business under an industrial conglomerate. And so we've got a lot of excitement in the business to capitalize on right now. We've got a lot of work to do. And so we're going to need that extra energy to do the separation. But we think we'll have something special when we're done.
Yeah, great start. So I think a lot of investors probably had some working knowledge of some of the businesses you have. Some may still be new to the story. Maybe bridge the gap for those that are still kind of coming up to speed. You've got four different business units. Help on how they all fit together because this isn't you'll look at some of the businesses, and some of it doesn't look like natural synergies or a natural fit. So help where that makes sense. And then maybe help us where maybe it doesn't make sense.
Yeah, I'll start with that again.
Yeah. So again, one of the things that was attractive about this particular opportunity was every business segment is in markets that are large and attractive from a growth profile standpoint. That's rare, at least in my background. That's rare. And so to see those, even though they're disparate, was an attractive element of deciding to come here. What we found, though, is there is some overlap. What 3M does extremely well and has done historically extremely well is to create intellectual property that's extremely powerful. If you think about that, it's a chemical manufacturer. They create compounds that's new to planet Earth. And as a result, they create unique technologies that are significantly differentiated. And they leverage that across their disparate segments. And so as a result, you see a lot of entanglements and a lot of that usage of the IP.
But that's a powerful reason why our brands are strong, very strong. So that's the connective tissue between all the businesses other than HIS, which doesn't use the same intellectual property. And then with HIS, the commonality would just be the call point. HIS is a software business for sure, mainly in revenue cycle management. But they call on the very same customers that our MedSurg business calls on. And they have deep penetration in those customers as well. So those would be the connective tissue pieces. But clearly, they're disparate businesses.
Yeah. And you made a comment to start that this is going to be a transformational type spin. I remember back from the investor day, you got up and said, portfolio transformation is going to be part of this story. Maybe talk about some of the investor feedback you've gotten since that time on that topic. And then for those in the room, what do you think Solventum looks like maybe two to three years from now?
I can't tell you that yet. I don't know how to tell you that now, but you'll probably get a better picture of that when we come into our February earnings call, fourth quarter earnings call, and we talk about our LRP, at least in certain areas, but what I would say is right away, again, looking at the different segments, you say, OK, not everything fits perfectly. Let's run the analysis. I don't want to make any snap decisions, so we've been running in parallel with phase one and phase two of phase three, which is portfolio transformation, and we've been analyzing the value of each of our businesses. Are the markets that we want to be committed to? Do they have fast growth markets? Are they markets that we can win in, and are they profitable?
Other considerations go into it, like capital intensity, those types of things. But the biggest things would be, is it an attractive growth market? Can we win in that market? And is it a profitable market? And so that's what we're going through. Once we land the plane on the markets that we're most attracted to, we will overinvest in those. And the other ones, we're going to manage differently. That could mean as simple as we're going to harvest those businesses to be able to fund the other ones up to and including potential divestiture if somebody sees more value in those businesses than we do. So that's where we are in the process.
If I really kind of give you a view without too much color on what I want to be in the future, it's a more streamlined, more focused organization that is really doubling down in their growth driver areas, which will be those very specific markets that we select.
OK. All right, well said. One other thing that resonated with me from the investor day, I can still see you up there talking, and you're saying, this is going to be a lot of hard work. I think that might have been the line, but from your ZB days, you were all about retiring risk, and Zimmer Biomet had a lot of other challenges as well when you entered, so where are we at, do you think? It's still early days, but where are we at in terms of addressing some of that hard work and retiring the risk at Solventum? I'll let you start, and Wayde, I'm sure you've got some opinions you can weigh in on as well.
Yeah, so maybe I'll start just with why we were saying that it's going to be a lot of hard work. I think any separation, by the way, because we've been through them before, are hard. There are just a lot of challenges that go into separation. What I probably didn't fully appreciate is what I was just talking about, is the interconnectivity between all the 3M businesses. I did not expect intellectual property in the way that we have it. I think of intellectual property typically as a patent and a drawer that you just transfer. This is literally know-how, bespoke equipment. It's a bespoke process, and the only way you can protect that intellectual property is to verticalize it, and so you see a lot of connective tissue as a result of that.
$3 billion of our revenue require those raw materials that are unique to 3M and have intellectual property. That's very unusual in a business. I did not fully appreciate that until we got in. And once, of course, we realized that, that's why we were being cautious out of the gate to say, listen, this is more complex than we expected. Now, the good news is we intentionally hired leadership team members that have been through separations before and were prepared for that kind of complexity. But that's the reason why we came out of the gate saying, OK, this is a little more complex than we've seen in the past.
Yeah, I think you covered it well, Bryan. I would just maybe add more around the separation work itself. As Bryan said, it's hard work. And it's work on top of your day-to-day job. So what's different than us from other companies who aren't in the middle of a separation is people have a day job. Here, you have a day job. And you have to work on the separation. And in a lot of cases, you have to work with your 3M counterparts. And that's because a lot of the systems and services that we use are still with 3M. And we've got transition service agreements and a process to move those systems and capabilities over to Solventum. On the services, which is mainly the ERP finance side of things, that'll happen over the next two to three years.
Manufacturing has a little longer period of time because you have to move manufacturing lines and manufacturing capability verified, validated inside of a regulated manufacturing process. So that's three to four years. So the main TSA work will happen over the next one to four years as we move all those services, manufacturing, distribution centers over. And then, as Bryan highlighted, we actually have a longer period of time for the IP and supply continuity project. We have 10-12 years there. So we have a good amount of time to work with 3M on moving that intellectual property over.
Yeah, OK, and I'm sure it's much more than this, so forgive me, but a lot of this hard work seems more kind of middle of the P&L related, maybe manufacturing, cost of goods, OpEx, not necessarily impacting revenue. So correct me if I'm wrong on that, but I guess the piece that I'm wondering about is, why wouldn't revenue growth be faster given how strong other parts of med tech are right now? You talked about kind of underperforming right now within some of the categories you play in. Why is your business not yet at that level?
Yeah, maybe because I'll get right into why it's not and what we're going to do about it, but maybe speak to some of the changes we did have as a result of separation with some of the regional structures, commercial structures that did create a little disruption, and then I'll go into the gap, though. Yeah.
Sounds good. That's a perfect bridge from all that separation work as we separate from 3M. And so as Bryan said, as part of that separation, we relied on 3M in a lot of the regional countries, a lot of the smaller countries out there, I think like 60 countries where we had different integrations with 3M that had to be separated at the spin. So a big part of that was us actually creating new entities and, in some cases, new distribution channels and new sales and commercial structures in those regions. And in a lot of cases, we've gone to distribution because we didn't have the economies of scale we used to have as 3M in some of these regions.
So we've got a lot of new people in a lot of countries outside the U.S. working through a different sales and operational channel out there, distribution channel out there. So there is a lot to do with revenue as part of the separation there as well.
OK.
I want to make sure that was clear. Mainly in the U.S., not so much. But outside the U.S., what Wayde just referenced is absolutely true and created some level of disruption, even on the revenue side. But that's not really the issue. If you look back before the separation, these businesses, although they're in attractive markets, have been underperforming pretty consistently. And I'd like to say it's one or two businesses. But it's pretty much every one of the businesses are underperforming their markets, which is part of the reason why we're here. You'll love that. You'll love seeing an underperforming business that's actually spending money in R&D that is underperforming an attractive market. That's a great place to start. So perfect scenario. Here's why I see it as the underperformance has been there.
Probably the most critical of which is, even though we're spending a very reasonable amount of money in R&D, we're not getting the vitality index one would expect of that spend, and that's frustrating. Typically, you would see vitality index in the teens to potentially even 20%. We're more in the single digits, low single- digits, even though we're spending 4%-5% of our overall revenue in R&D. So what are we going to do about it? Really, for me, the change in trajectory of the business has four elements to it, and this is not rocket science. There's no whiz-bang here. It's just basic blocking and tackling because we're already in attractive markets. The first is very easy and fast. You just hire really strong commercial leaders, and they drive a different cadence and culture of accountability in the organization. Operating mechanisms change.
Incentives change so that there's more risk but less cap, so that you're just changing the aggressiveness of the sales organization. That happens very fast. That's the fastest way to turn. The second is you change structure. So you go in and say, listen, I'm going to specialize in a specific area. Now I've got to hire those people. I'm going to expand a sales organization. Takes a little more time. But it's still pretty fast. You've got to hire people. You've got to develop them. You've got to train them. You've got to get them productive. But still relatively fast. The third would be product development. I've got gaps in the technology in those areas I want to focus. I've got to invent new technologies to create traction in those areas. That takes a little more time. But it's low risk.
If you're in attractive markets, you ideate, you develop, you commercialize, you get regulatory approval, you're ready to go. Very low risk, just takes time. And the fourth one is once we get our leverage ratio down, we're going to be looking to pepper in, tuck in acquisitions in those attractive markets that we're already in and drop them in the bag. Those are the four components of the turnaround. I think the really important message, though, is it's a low-risk turnaround. If you're trying to turn a business around that's in a slow-growth market, you've got to take bigger risk, as Wayde referenced with Covidien. You've got to make big decisions to be able to get into other markets. And that is a risky proposition. We don't have that. We also have a W-2 sales organization, which is fantastic. I did not have that in my previous life.
You had a 1099. In a 1099 sales organization, you're paying a percentage of every dollar you sell. So if I buy a company and I put it in the bag of a 1099 rep, I'm immediately paying a tax on that revenue. If I buy a company today and I have a base and bonus, base and bonus don't change for the rep. I just drop it right in. I get immediate leverage. So we're in attractive markets with a W-2 sales organization. That's a really nice thing to have.
I know it's hard to compare. No company or turnaround is like another. But you talked about the success you had at ZB taking that from little to no growth to mid-single digit, mid-single digit plus type growth. Are the actions you've taken here, do you think they're similar? Or what is similar?
What are you replicating here on that experience? Because I think you probably want to get to that mid-single digit target over time at Solventum.
So interestingly enough, although they're different, my phases of the transformation are the same. So I pretty much stole them. I'm laughing because Rachel, I see you sitting over there. She's my head of strategy before. She's like, I think I've seen these phases before. But it really is first and foremost around mission, talent, culture. That's the first phase. And we spent a lot of time on that. Whether it was at Zimmer Biomet or here, that is where we have spent an enormous amount of time. You've got to have a purpose in an organization. That's the mission. That's the reason why you wake up every day. And in health care, that's a great mission, as Wayde referenced. The second is you've got to hire great people. And then you've got to have a culture to maximize the benefit of those people that you've hired.
In other words, decentralized, fast decision-making, power that those people have to move. So that's what we've been working on. The second phase, just like at Zimmer Biomet, is a true five-year plan. What is the five-year plan going to be, which says that we are going to be very focused in the markets that we're going to spend time in? So we're going through that process today. We'll announce it at our LRP. What are the markets that we're going to concentrate on? We're going to do, again, all of our resources then focused in those areas, and we're going to double down, and the third phase, again, was portfolio transformation. As you saw at Zimmer Biomet, we made some moves, sold some businesses out, and acquired a bunch of smaller companies to be able to build in other areas, so it's a very similar phased approach.
I'd say what I like more here is that people really want it. I don't know that everybody wanted it as much because you kind of had the Hatfields and McCoys at Zimmer Biomet back then. Zimmer and Biomet were competitors. All of a sudden, they came together. They did not like each other very much, so it took a long time to get people to act as one. Here, people are already acting as one, and they really want the change. They want to get out from underneath the industrial conglomerate, and they want to move faster. They want to make decisions, and they want to become a health care company, so to me, this is easier because people are probably more excited out of the gate.
OK. All right. Easier but still a similar timeline that you put on it?
Yeah.
OK.
That was a good way to.
I'll try.
So on the tariff topic, I'm asking all my companies this. So again, we don't have necessarily the history here to work with of what happened under the last cycle of tariffs. But maybe help us out with what your current manufacturing exposure looks like, your sourcing exposure. I know that the response is probably going to be way too early to tell. We'll update you when we can update you. But so we can at least level set ourselves. Do you have manufacturing in Mexico? Do you source out of China at all? So just so we can have a sense of what impact this might be as we start to think about this. So you knew my answer. So you got.
I took your answer before you gave it. Yeah.
It's like eight miles right there. So what I would say is, first of all, to your point, I've been around long enough to be through a number of administrations. And not everybody does what they say. So it's hard to predict what's going to happen. But any time somebody's talking about tariffs of this size, you've got to pay attention. So we're clearly paying attention. The good news is we probably have a little less exposure maybe than others because of our regional setup in manufacturing. Just as an example, if I think about China, most of our China manufacturing is for China or for that region. So it doesn't really come back into the U.S. Mexico is a little more. Canada, a little more. So we'll just have to wait and see where this actually goes. Do we do the tariffs? Do we not?
What countries are impacted by those tariffs? It would be crazy for us not to be paying really close attention to this.
Yeah, but it sounds like maybe ability to flex a little bit, maybe manufacturing one location or another, to, I don't want to say circumvent, but to get around the tariffs.
That's harder to do. So if you did have a tariff in a specific country where you had a large amount of product coming in from that country to the U.S., to pivot in a regulated environment is pretty tough. So it would take time. And I don't know that the return on investment would be there. But certainly something that we'll pay attention to. But it wouldn't be a quick turnaround.
OK. All right. Maybe a more uplifting topic. Sorry, and a question for both of you. I think we're all getting comfortable with your styles here at Solventum. Not that they're necessarily entirely different from your last experiences, but I think the impressive piece out of the gate is that you're already establishing a pattern, at least to the financial community, raising guidance elements in each of your first two quarters of reporting. I guess, what should we make of that as we think forward? And Wayde, this may even be more of a question for you. Is that by design? Is that how investors should think about how you'll be framing outlooks as you give those outlooks?
Yeah, sure. I'll start that one. Maybe a bit of context would be, certainly with a separation, there's more risk or variability with the numbers. And so we are very happy to have two strong quarters in our first two quarters here where we were on track and didn't see a lot of disruption from the separation. So that adds just a little bit of additional variability as you think about setting guidance. The other thing is just to keep in mind, our first two quarters we had, actually for the year, we had thought about a SKU rationalization program that could create some headwind to the year. And we were very fortunate to have our wave one of our SKU rationalization get out over 5%, over 3,000 SKUs without having a major impact to revenue.
So by taking that out of our planned guidance for the year, that gave us the opportunity to raise. We also had a really strong Q2 in our Medical OEM business in MedSurg. And some of that was unexpected because it was a large backorder recovery. So those three things were really what fed into our thesis to be able to go from what was at the start of the year flat to down two, to now flat to up one. Moving from below flat to above flat was a big deal for us. And so we are seeing some fundamental strength in the volume of the business as well, starting to improve. And that's the signs that we're looking for. But it was really important for us out of the gate to have two quarters where we set appropriate expectations and then meet or beat them.
We want to build credibility with all of the shareholders and investors watching our business just right out of the gate, that we have good credibility built here. It's really important to us.
Okay. All right, and then I'll ask you. I'm glad we got Bryan as a buffer here. So '25 Street numbers are kind of all over the place. This is something that came up on the last call even. Without talking about specifics, do you think the Street is mismodeling anything right now? Or are there certain line items where you say that's really out of whack?
Yeah, it's interesting you brought that one up, Jason. Because we haven't guided to 2025 yet, most companies don't until they get to either close to or at their Q4 number. And understanding that we have probably significantly more moving parts than most companies do at this point in time. Because of that feedback, we built a lot of additional information and color into our prepared remarks and public commentary. And so I do think we've seen 2025 in particular come into not an unreasonable range. Actually, it's really tightened up recently. And even the long term, we're starting to see some improvement there, even before we can put out our long range plan. So we're very happy that you've launched coverage on us now. Thank you for joining. We actually just had another one over the last couple of days.
So we're starting to build a nice sell-side coverage base. And folks like you all that understand us very well can help communicate all of that additional information we're providing to people to help put all those pieces together so that we have, again, a fairly tight range to 25. And once we get our long range plan out, I think that'll help the future years as well.
Yeah, absolutely. I totally understand that. Last minute here. As we think forward to the next month or two, we don't have a history of Solventum pre-announcing in conjunction with a big institutional conference. I don't know if that's something that either of you feel comfortable saying, hey, sitting here today, we plan to pre-announce when we get to that conference or around that conference. Or no, we absolutely won't. Any comments on that?
I think we'll say the same thing, but why don't you go?
Yeah, sure. So we're not planning to at this point in time. We are very much focused. And as you all know from the investor day, that was very early in Bryan and my tenure with the business. And so we've been working really hard since then to build our 2025 and our long range plan. And all of our plan has been designed to launch that in 2025. Bryan's talked about earlier how we've had good success hiring people earlier than expected. So we've got the leaders in place. And that allowed us to pull that long range plan into our February Q4 call. So that'll really be the big point for us is when we give our 2025 guide, we'll give our long range plan. And I think it'll be a real seminal moment for this business.
All right. Something to look forward to for sure.
We are out of time, unfortunately. But Bryan, Wayde, thanks so much for joining us. Really appreciate it. And thank you to everyone in the room too.
Thank you.