Q3 2024 Solventum Corp Earnings Call and Business Update
Amy: Good afternoon. My name is Amy, and I will be your conference operator for today. At this time, I would like to welcome everyone to the Solventum 3rd Quarter 2024 Earnings Call. As a reminder, this conference is being recorded.
Amy: All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session.
Amy: If you would like to ask a question during this time, please press the star and the number one on your keypad. If you would like to withdraw your question, again, press star and the number one. Thank you.
Speaker Change: I would now like to turn the program over to your host for today's conference, Kevin Moran, Senior Vice President of Investor Relations. Please proceed.
Kevin Moran: Good afternoon and welcome. Today we will discuss Solventum's third quarter fiscal 2024 results along with an update to our 2024 outlook.
Kevin Moran: Just after market closed today, a press release was issued with our earnings results and updated outlook.
Kevin Moran: The press release and earnings presentation are available on the investor section of the Solventum website.
Kevin Moran: Joining me today are Bryan Hanson, our Chief Executive Officer, and Wayde McMillan, our Chief Financial Officer.
Kevin Moran: During the call, we will be making forward-looking statements that are subject to risks and uncertainties.
Kevin Moran: For a full description of these risks and uncertainties, please refer to our SEC filings and the forward-looking statement slide at the beginning of our presentation.
Kevin Moran: Please note that during our discussion, our comments will all be on a non-GAAP basis unless they are specifically called out as GAAP. GAAP to non-GAAP reconciliations for all relevant periods can be found in the schedules attached to our press release.
Speaker Change: For the Q&A portion of today's call, we kindly ask that you limit yourself to one question and one follow-up. And with that, I'll hand the call over to Bryan.
Bryan Hanson: All right, great. Thanks, Kevin, and thanks to everyone for joining us for the call today. Hard to believe, but we've already completed our second quarter as an independent company.
Bryan Hanson: and I'll tell you that I'm increasingly encouraged by the progress our team is making against our phased approach to transform this business.
Bryan Hanson: And just as a reminder, for those that might be new to the story, we look at transformation as Albentum in two ways. The first one is the turnaround of our business performance.
Bryan Hanson: and the second is just, you know, obviously standing Solventum up as an independent company. Both of these vectors provide a real opportunity to drive shareholder value.
Bryan Hanson: And in looking at the quarter, Q3 is yet another data point that speaks to the team's overall progress in this transformation and the success of our business continuity efforts.
Bryan Hanson: which we clearly see is being reflected in both the performance in the quarter and our ability to raise our full year guidance for the second consecutive quarter.
Bryan Hanson: We saw positive top-line growth in Q3 despite a challenging year-over-year comparison, and as a result, as I just referenced, we're raising our full-year organic growth rate to the upper half of our prior guidance of flat to 1%.
Bryan Hanson: and we're increasing our adjusted EPS and free cash flow guidance ranges as well.
Bryan Hanson: We saw operating margins improve sequentially, benefiting from some one-time items that helped offset the known incremental headwind from the 3M supply agreement markups.
Bryan Hanson: and following our discipline capital allocation strategy, we pay down 200 million of debt during the quarter. This should clearly show that we are committed to maintaining our investment-grade rating and prioritizing debt paydown.
Bryan Hanson: When thinking about our progress to date, I'm just incredibly proud of our teams for their continued and steady performance, especially as they continue to work through separation-related activities and challenges.
Bryan Hanson: And I want to make sure that I take a minute to say thank you, really, to all the Solvers that I know are listening out there today. It is your continued focus on working through the separation, maintaining business continuity, and most importantly, as we always talk about, delivering for our customers.
Bryan Hanson: It is greatly appreciated. It is a clear testament to your resolve to move our mission forward.
Bryan Hanson: Okay, moving from Q3, I'd also like to give an update on our phased approach to stabilizing and separating the business, repositioning us for profitable growth, and optimizing the portfolio.
Bryan Hanson: I'll start with phase one, and phase one really has just firmly taken hold as we've made significant progress on our mission, talent, culture, and structure, as well as separation activities, all of which are critical, and I would actually say foundational, for driving business growth.
Bryan Hanson: You know, it's hard to believe again, but it's been seven months since the spin, and our culture is rapidly taking shape. Our new leaders continue to gel as a team, learn and assess the business, and finalize our go-forward strategy.
Bryan Hanson: and the energy across the organization remains high. With tangible excitement as I travel around the world for our new mission at Solventum.
Bryan Hanson: We also continue to advance our planning for the Solventum Way Restructuring Project.
Bryan Hanson: This project is focused on creating a more flexible, more decentralized structure that ultimately will complement our culture shift. And it will focus on allowing us to create headroom to invest for growth while also concentrating on margins.
Bryan Hanson: As we finalize the plan, we're going to provide more context to the project and also obviously include some expected financial impacts.
Bryan Hanson: Given our progress to date, our current project cadence, we are on track to complete the largest majority of Phase I activities within our original 12-24 month timeline.
Bryan Hanson: Just overall, I'd say in this area, I'm really encouraged by our progress and I'm impressed with the team's ability to manage through the challenges and keep us on track.
Bryan Hanson: Okay, let's move to Phase 2. As we've referenced in the past, Phase 2 is focused on a long-range plan that will unlock the profitable growth potential of our business, just really ensuring we take full advantage of the attractive markets that we play in.
Bryan Hanson: And as a reminder, because we were able to accelerate talent acquisition in Phase 1, we've been able to compress the timeline in Phase 2, now enabling us to share both our long-range plan and our 2025 guidance during the fourth quarter earnings call that we have coming up in February.
Bryan Hanson: And as a reminder, some of the elements of the plan will be, first and foremost, our primary market and sub-market selection. Again, those markets and sub-markets where we will concentrate our efforts on a go-forward basis.
Bryan Hanson: And, as you would expect, the market selection in this process has bias towards those markets that are faster growth, markets where we have an ability to win, and markets that have relative profitability benefits versus our other markets.
Bryan Hanson: Inside of these markets we're also going to be selecting our growth driver initiatives and those will be intended to drive scale and share in these attractive areas.
[inaudible]
Bryan Hanson: And I would just say that we continue to make solid progress and we remain on track to finalize these decisions before the end of the year. And this is critical because final decisions here will facilitate the shifting of our commercial, R&D, and eventually M&A resources to these growth driver areas. And this disciplined focus will help us improve the vitality index and the overall innovation of our businesses, which is a key variable in accelerating our growth.
Bryan Hanson: Now that said, even before this shift occurs, we do have some recent product launches that are absolutely worth mentioning. Let's just start with MedSurge. In the quarter, we officially launched the VAC peel-in-place dressing that we've been talking about. This product gives us three advantages. The first is simplifying the procedure.
Bryan Hanson: The second is reducing procedure time, and the third is reducing the number of dressing changes per week. All of these combined give us the opportunity to reach a broader set of patients across multiple sites of care.
Bryan Hanson: And I would say out of the gate, the very positive early response we're getting for customers has us focus now on increasing capacity of this product in orienting our commercial structure to drive adoption.
Speaker Change: Okay, moving to our dental solutions business, we launched the ClinPro Clear Fluoride Treatment, which we believe, and I would tell you early customer response would indicate, it is a meaningful advancement in fluoride treatment technology.
Speaker Change: In our Health Information Systems business in collaboration with SIFT Healthcare, we recently introduced a new AI-driven payment integrity solution that we're calling the Solventum Revenue Integrity System.
Speaker Change: This focuses on improving our customers' reimbursement and leakage by predicting reimbursement pretty much at every step of the patient journey. And it's intended to not only reduce denials but potentially prevent them altogether, really helping our customers ensure that they get the timely and accurate payer reimbursement that they deserve.
Speaker Change: All right, and finally, in our purification and filtration business, we recently launched a new product in our Harvest RC family. And this latest edition is focused on improving our customers' manufacturing process.
Speaker Change: by streamlining time, by streamlining cost of producing, reducing risk during scaling, and boosting overall productivity with the clear goal of helping companies bring therapies to market more quickly and with less risk.
Speaker Change: These recent launches are encouraging, there's no question. Now they may take a little time.
Speaker Change: to deliver measurable results, but they are just the tip of the spear.
Speaker Change: when it comes to a refocused R&D effort that will begin in earnest during 2025, again, aligning with the selection of our growth driver areas.
Speaker Change: Okay, so let's move on to Phase 3, our Portfolio Optimization Phase. As I've shared previously, we have been actively assessing the value contribution and the strategic alignment of our markets and businesses.
Speaker Change: This work has been well underway since announcing our three-phase plan back at our investor day in March. We continue to make progress against this effort, and at the right time, we will discuss phase three in more detail.
Speaker Change: I think it's important to reiterate on these phases that all phases are not sequential, they are running concurrently. So parts may be in execution mode, parts may be in planning mode, but all are moving forward at one time.
Speaker Change: Okay, to close my section out, I'd just like to say that while we are clearly off to a solid start, it is not lost on us.
Speaker Change: That revenue growth remains below market. As we've said, this performance turnaround will take time, but rest assured, we are moving with urgency, while also being thoughtful and strategic about building and investing for the long term.
Speaker Change: We have an incredible opportunity ahead of us and by focusing on the right areas with the appropriate investments, we are setting the foundation for growth acceleration and ultimately significant value creation.
Speaker Change: Okay, with that, I'm going to turn it over to Wade.
Wade: Thanks, Bryan, and thanks to everyone at Solventum for the extra effort to separate from 3M and position us to report a strong second quarter as a public company.
Wade: As you heard from Bryan, we are tracking to our separation and execution plans across all three phases.
Wade: I'll focus on updates related to Phase 1 before getting into Q3 financial performance and then wrapping up with guidance.
Wade: We're continuing to advance our separation efforts. This includes our manufacturing strategy and site selection for our new manufacturing facilities as well as transitioning to our standalone distribution centers.
Wade: We have also made good progress to advance our product licenses and rebranding transitions.
Wade: We have changed our commercial distribution models in over 60 countries.
created structure and hired staff all ahead of schedule.
Wade: Shifting to IT, we have implemented new ERP systems in four countries and will continue to roll out globally over the next couple of years.
Wade: Overall, it's great to see these early successes and our team's resilience as we manage through this complex separation from 3M.
Turning now to our Q3 results.
Wade: Starting with sales, for the third quarter of 2024, sales of 2.1 billion increased 30 basis points compared to the prior year on an organic basis.
Wade: slightly ahead of expectations due to some order timing in the U.S.
Wade: During the quarter, foreign exchange was approximately neutral. Price was flat for the quarter as we've now normalized from 2023 actions and volume was slightly favorable.
Wade: From a year-over-year growth perspective, recall that Q3 had a tough comparison.
Moving to the segments.
Wade: Our largest segment, MedSurge, delivered 1.2 billion of sales, an increase of 1% on an organic basis.
Wade: Within infection prevention and surgical solutions, we saw continued adoption of our antimicrobial IV site management solutions with the growth of Tegaderm IV dressing.
Wade: Sales growth also benefited from continued positive trends in OEM products.
Wade: Performance in these areas was partially offset by negative pressure wound therapy.
Wade: Our dental segment delivered $313 million of revenue, a decrease of 3.9%.
Wade: This decline reflects challenging market conditions and the fact that this segment faced the toughest year-over-year comparison among all four segments.
Wade: Our Health Information Systems segment contributed $326 million of revenue, an increase of 1.5%, which benefited from growth of our Revenue Cycle Management Platform 360 and Compass.
Wade: Strength in revenue cycle management was partially offset by declines in performance management solutions and continued headwinds in clinician productivity solutions.
Wade: Finally, the purification and filtration segment delivered 238 million of sales, a decline of 0.3 percent, which was impacted by declines in drinking water filtration and dialysis membranes.
Wade: partially offset by better-than-expected strength in bioprocessing filtration and newly expanded capacity in industrial filtration.
Wade: Looking down the P&L, gross margins were 57.3% in the quarter, ahead of our expectations, and down 100 basis points versus prior year.
On a sequential basis, gross margins increased 180 basis points.
Wade: This included approximately 100 basis points of one-time benefits, which offset the impact of the 3M Supply Agreement markup.
Wade: We anticipate some of this one-time benefit will partially reverse in Q4.
As expected, operating expenses increased versus the prior year.
Wade: When excluding the impact of approximately 30 million of discrete items in Q2 2024, operating expenses in Q3 also increased sequentially.
Wade: As we have shared before, the added spend reflects public company stand-up costs and growth investments to support our business transformation.
Wade: We expect the magnitude of the increase in Q4 to be similar sequentially to what was seen in Q3 off the normalized Q2.
Wade: Moving down the P&L to non-operating items, our net interest expense benefited sequentially from a higher cash balance.
Wade: Lastly, our effective tax rate of 22.4% puts us on track for our full year expected tax rate of 18 to 19%.
Wade: All in, we delivered earnings per share of $1.64, ahead of our expectations.
Wade: Turning to the balance sheet, we ended the quarter with $772 million in cash and equivalents with no outstanding borrowings on our credit facility.
Wade: We generated $75 million of free cash flow in Q3, which includes making the first semi-annual interest payment.
Wade: We continue to expect debt pay down will remain the priority into fiscal 2026.
Wade: We maintain strong liquidity and financial position with continued free cash flow generation in addition to our unused $2 billion revolving credit facility.
Now, turning to our 2024 outlook.
Wade: We expect improved organic sales growth to be in the upper half of our full year guidance range of flat to up 1%.
Wade: This reflects our performance year to date and continued execution of our separation plans.
Wade: While we are not changing our full-year foreign currency impact expectation of approximately 50 basis points unfavorable,
Wade: Given recent rates, we do expect foreign currency to be a headwind in Q4.
Wade: For Earnings Per Share, we are raising our guidance to $6.50 to $6.65 on our improved sales outlook and stronger Q3 gross margins.
Wade: We are also raising our free cash flow guidance to a range of $750 to $850 million to reflect both continued strong cash flow generation and the expectation that capital expenditures will come in toward the lower end of the $400 to $500 million range we provided earlier this year.
Wade: In conclusion, we are off to a solid start as a new public company, delivering two consecutive quarters, a better than expected performance, which is encouraging given the complex and highly entangled separation.
Wade: We're delivering on our near-term financial commitments, executing on our separation activities, and focusing on turning around the business while raising the top and bottom line guidance for the year.
Wade: Looking ahead, we will continue to execute on our phased approach to transform our business, and we'll use our collective expertise in health, material, and data science to deliver our mission.
Wade: While we know this turnaround will take time and focused investment, we are encouraged by the meaningful progress and remain well positioned to execute our value creation plan.
Speaker Change: I'll now hand it back to the operator for the Q&A portion of the call.
Speaker Change: Thank you. At this time I would like to remind everyone in order to enter the queue to ask a question please press the star and the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.
Speaker Change: Your first question comes from the line of Travis Steed with Bank of America. Your line is now open.
Speaker Change: Everybody, thanks for the question. I wanted to ask first on the Q4 EPS guidance of 122 to 137.
Speaker Change: First, a little bit below the street, anything to call out there, but really the question is more about what that implies about 2025 EPS. If you annualize that at the midpoint, it's around 520.
Speaker Change: looking at the street numbers next year, the wide range, 530 to 580, and just trying to figure out should we be close to the lower end of that range, higher end of that range, just any color so we get models in the right place for 2025 would be helpful.
Hey Travis, it's Wade.
Speaker Change: So really what you're talking about is what's driving the decline here from Q3 to Q4. So a few things that we have to keep in mind is we had some timing benefits that we called out in gross margin which will benefit Q3
Speaker Change: and those were one-time in nature and they'll partially reverse here in Q4. So that's the biggest change and really the biggest impact to Q4. We had favorability, additional favorability in Q3 that will be a headwind for Q4.
Speaker Change: And then continued investment, you know, as we continue to invest in operations and ramp our operating expenses.
Speaker Change: As we said in our prepared remarks, it'll be a similar ramp from Q3 to Q4, as we saw from Q2 normalized to Q3. So both the standup cost of standing up the company as well as our growth investments.
Speaker Change: And then we called out as well, at this point in time, expecting FX to be a headwind.
Speaker Change: So those are things that are new to Q4 that have to be contemplated.
Speaker Change: in the Q4 earnings per share. But having said all that, we're also raising our EPS guidance for the full year, given the strength of Q3, even though some of it was one time in nature. And we're going to give some of that back in Q4 for the year, very happy to be raising our EPS guidance.
Speaker Change: And then you mentioned 2025 as well. We're not guiding to 2025 yet, certainly lots of moving pieces as we are in our first year here post-separation.
Speaker Change: We've got a lot going on to grow revenue, expand margins, and then the resulting EPS growth over time.
Speaker Change: I think you know I think it's really pretty well understood that 2025 will be pressured by the annualization of some costs post spin.
Speaker Change: As a reminder, we spun in Q2 of 2024, so we just have this natural annualization in Q1 of 2025.
Speaker Change: And that's going to show up in operating margin in a few areas. We've got the 3M supply markup that impacts COGS, so we'll annualize that in the
Speaker Change: first half of next year and then we've got our stand-up functional expenses which are ramping this year. We'll annualize those next year. We're making growth investments. Some we've made this year, some will be continue to be made next year.
Speaker Change: And then we also have the SKU rationalization program that we're contemplating wave two and how much of a headwind that could be in the extent of those wave two plans for next year.
Speaker Change: and then below the line we've got things to consider there as well. We've got the annualization of interest expense and then our normalizing tax.
Speaker Change: And so, we've certainly got a lot going on to annualize the businesses into next year. And then, as we talked about in prepared remarks, we also have our Solventum Way Restructuring Program, which could give us some tailwind into next year. That program's really designed to do both.
Speaker Change: fund our investments, as well as give us some additional margin enhancement. And we'll be putting all of that together into our calculus for 2025. And that will be when we report our Q4 earnings results, we'll give our 2025 guide.
Speaker Change: So, having said all that, once we move beyond those items in 2025, we've got a great platform here for which to grow earnings per share and expand margins over time.
Speaker Change: Great, thanks for that. The follow-up question I had was on how you're thinking about portfolio management and managing the dilution around that. I don't know if you're thinking through any updated thoughts on portfolio management would be helpful. Thanks a lot.
Speaker Change: Sure, you know, I could probably start that one just from a dilution standpoint, you know, we don't we haven't communicated anything in portfolio management yet So we really can't comment on any dilution at all or how the net impact of any portfolio moves will be
Speaker Change: So really no comment there, but I don't know, Bryan, if you just want to talk about our strategy in phase three around portfolio management.
The End
Speaker Change: Obviously, Travis, we wouldn't make those decisions if we didn't think it was good for shareholders. So we'll look at any dilution and offset that dilution. But just know that we're looking at our businesses from a strategic standpoint, and we're looking at the value contribution of those businesses, and eventually, at some point, when we have the right data in front of us.
Speaker Change: We'll begin to share if there's any changes that we're going to make but we would be thinking about the financial implications of any change And certainly we want to make sure it's good for shareholders
Next question, please.
Speaker Change: The next question comes from the line of Patrick Wood with Morgan Stanley. Your line is now open.
Speaker Change: Beautiful. Thank you for taking my questions. I guess the first one, I'm just curious, do you have any updated timeline on the TSAs and how we're thinking about those rolling off and how you're thinking about reinvestment as those begin to roll off?
Speaker Change: Hi Patrick, it's Wayde. Yeah, so I think the update on the TSAs is really that we're
Speaker Change: Seven months almost eight months in post spin here. We're making good progress as we mentioned
in our prepared remarks.
Speaker Change: But we're also right at the front end of this. If you look at the Investor Day presentation that we did back in March, we laid out the four main work streams, four main TSAs.
Speaker Change: And you'll see there that they're in the range of either two to three years, three to four years, or we've got the long supply continuity timeline.
Speaker Change: of up to 10 to 12 years. So here we sit in the first year. We don't have any updates on those timelines. I think once we start getting nearer to the two-year mark, three-year mark, four-year marks, that's when we'll be starting to roll off of.
these different TSAs, so.
Speaker Change: A lot of work going on within the business, a lot of folks doing just really yeoman's work of trying to separate the business while they do their day-to-day jobs, and as Bryan said in our prepared remarks, we really appreciate
Speaker Change: all the Solventum employees around the world taking care of the separation work while they're working through their day-to-day jobs.
Speaker Change: So a lot to update in the future, but at this point nothing done, but we had to prepare to march.
Speaker Change: No, of course, completely get that. And the follow-up's a little specific, but...
Speaker Change: But it's like something else, I don't know, foam or hydrocoils that are taking the traditional side. What's going on in that market?
Speaker Change: Yeah, hey Patrick. Thanks for the question. So I would tell you that there were a couple things going on with negative pressure wound therapy in the quarter. One that I think is important to note is we had a tough comp, a tough comp generally speaking in the quarter, but that in particular was one that was hit one of the hardest in med-surg. That was part of it and to answer your question specifically that they are separate.
So the Provena product line, which is our single-use.
Speaker Change: is, you know, it's a very exciting market, a sub-market of negative pressure wound therapy and that is growing pretty steadily. We're doing well with that product and we continue to see that kind of traction in Q3 and we expect it to happen beyond as well.
Speaker Change: The traditional negative pressure wound therapy is historically slower growth. We do feel like there's real opportunity to unlock growth in that market as well. The peel-in-place product that I referenced in the prepared remarks is one of the mechanisms to do that and the team's pretty excited about that launch.
Thank you for taking the questions. Yeah. Thanks, Patrick.
Speaker Change: Your next question comes from the line of Victor show breadth with Wells Fargo. Please go ahead.
Speaker Change: Your next question comes from the line of Vic Chopra with Wells Fargo. Please go ahead.
Speaker Change: Hey, good afternoon, and thanks for taking the question.
Speaker Change: Hey, good afternoon and thanks for taking the question. First one for me, I didn't hear an update on the secure rationalization project. Any update there would be great. And if you can also let us know when you expect to start seeing benefits from this program. And then I had a follow-up please.
Speaker Change: First one for me I didn't hear an update on the SKU rationalization project.
Speaker Change: Update there would be great and if you can also let us know when do you expect to start seeing benefits from this program and then I had a follow up please.
Speaker Change: Sure Hi, Vic its wood. So you may recall last quarter, we mentioned that we had with one that was launched this year and we're in the process of executing upon that and.
Speaker Change: That got a significant number of skus out over 3000 Skus that the team is working on.
Speaker Change: And that will have very little impact on top and bottom line. We're also working on wave two but we don't have any update yet teams are just working through that working through the modeling of it and Brian and I'll be reviewing that here as we get towards the end of the year and make a decision on what SKU rationalization will look like in <unk>.
Speaker Change: 25.
Speaker Change: Okay. Thank you.
Speaker Change: My follow up question was on the dental segment I know you called out tough comps.
Speaker Change: But you also called out market softness.
Speaker Change: Just wondering what your expectations of a recovery, but the dental market and how you're thinking about growth in 2025. Thank you.
Speaker Change: Yes, so maybe I'll take a crack at that one so I can't predict when we're going to see that softness turn but it is impacting our business, but probably the bigger impact for us again was comps in the dental business.
Speaker Change: We see softness in the market impacting our business, but given the portfolio that we have and just the procedures that we typically play in that are less elective in nature, we don't usually get as impacted as other players in the dental space. So it's a negative pressure on our business for sure, but not maybe as much as other players in dental I don't know that I want to speak.
Speaker Change: To win we're going to see that turnaround for us we're going to focus on what we can control and the team is pretty excited about the <unk> product launch that doesn't sound that amazing when you're talking about floor I treatment, but it's a pretty amazing innovation in that space and our customers are seeing it that way.
Speaker Change: The good news is we got a lot of demand as a result of it. The bad news is we don't have the capacity for it right now and so we're working hard to get capacity in place and support that demand.
Speaker Change: Thank you. The next question comes from the line of David Roman with Goldman Sachs. Your line is now open.
David Roman: Thank you and good afternoon everybody.
David Roman: Wait I was hoping you could maybe unpack a little bit of the drivers in the gross margin line and specifically <unk>.
Speaker Change: This is a line obviously, where there are a lot of moving parts and last quarter, you had some discrete headwinds around international and OEM mix. This quarter, you add some tailwind dynamics and I believe the full recognition of the <unk> supply agreement reflected in there. So as we think about a baseline normalized gross margin is.
Speaker Change: Is that 56 and change number are good.
Speaker Change: Starting point and how should we just think about the different moving parts around this line item, whether thats potential SKU rationalization business mix investments youre, making to expand their own supply chain independence et cetera.
Speaker Change: Hey, David Thanks, I'm glad you asked that question because there is a lot of moving pieces on this one.
Speaker Change: We took a little extra care to put some additional information in the prepared remarks, but it's always good to talk about it here in Q&A. So I'm glad you brought it up so just to summarize we had approximately 100 basis points of onetime benefits here in Q3 and that offset the impact of the <unk> supply agreement markup in the quarter.
Speaker Change: We do expect part of that tree and benefit to reduce to reverse in Q4, which results in a lower margin in Q4 as you mentioned and then.
Speaker Change: As you also mentioned recall that in Q2, we had some unfavorable higher international cost impacts in gross margin and that is some of what we saw reverse here in Q3.
Speaker Change: If you package all that together, we had some headwinds in Q2.
Speaker Change: That somewhat reversed in Q3, and then we get a benefit in Q3 that will also be a headwind in Q4. So I think one way to think about this day would be to take Q2, and Q3 and put them together and then using the assumption for the <unk> step up as.
Speaker Change: As well as some of the benefit here and I think what Youll do is come out below just below that 56% that you are talking about.
Speaker Change: Okay, that's fair.
Speaker Change: That's super helpful and I appreciate on the portfolio management side that that's a continuously evolving process, but maybe Brian you can help us think through like when you talk about kind of value to the organization. There is sort of like the one way to look at it which is just pure dilution from an EPS perspective, the other way to think about it is how it fits in strategically.
Speaker Change: Whether that's opportunities for cross divisional product development or commercialization, where you have the right to win like Hei ads is a great market, but it may not fit necessary with the med search business. So help us kind of think about the parameters that you're using to assess the portfolio management decisions.
Speaker Change: Yes.
Speaker Change: Adam pretty well, if you think about where we're going to invest I think that's the most important is you've got to know where youre going to invest didn't know where youre not going to invest and then you make decisions from there what youre going to do in those not invest areas, but the areas, we're going to concentrate on first and foremost is the fastest growth markets that we have we need to make sure that anything we're going to invest in gives us.
Speaker Change: Positive mix from a revenue growth standpoint, so that's number one number two is I talked about in prepared remarks, and you just referenced it is to make sure that we concentrated in areas, where we do believe we have a pathway to win we have to be in a market position that is favorable and where we believe we have the right to win in that space and the third is.
Speaker Change: Really important as well going back to mix, but from a margin perspective, we want to make sure that we have a good margin profile and the markets are businesses, where we are going to be investing as well if we're going to grow fast in those businesses and we don't have attractive margins and we're going to get negative mix that we don't want that in margin. So those are the primary areas and to your point, where do our businesses connect and work.
Speaker Change: In a one plus one potentially be a three is there value in that it doesn't have to be there, but that's a nice a nice add as well.
Speaker Change: Okay.
Speaker Change: Your next question.
The next question comes from the line of Rick Wise with Stifel. Your line is now open.
Speaker Change: Good afternoon everybody.
Speaker Change: Brian just reflecting on your opening comments about Europe.
Speaker Change: Increasing encouragement that the progress has been made maybe focusing.
Speaker Change: <unk> thought.
Speaker Change: Toward the med search business again.
Speaker Change: Help us better understand.
Speaker Change: The.
Speaker Change: The new sales and leadership team you brought in place are affecting the business.
<unk>.
Speaker Change: The new appealing place wound.
Speaker Change: Product.
Speaker Change: You are talking about.
Speaker Change: How is it going to how are some of these changes concretely going to affect the business as you reorient sales.
We think compensation.
Speaker Change: And just.
Speaker Change: Talk through that if you would and help us think about where you expect over the next year or two.
Speaker Change: What does that translate into in terms of.
Speaker Change: Our growth in these early days of silver income for the Med search base.
Speaker Change: Yes.
Speaker Change: Thanks, Rick and I think it's a good proxy actually for the entire business to be honest, because it's a similar game plan almost across all businesses and functions.
Speaker Change: It makes a big difference if you think about just misheard in particular, we've made some pretty significant changes and if you think about the deficiency in revenue growth versus market first thing you need to do is do a root cause analysis Y and my underperforming markets that are attractive today and when you do that root cause analysis you find.
Speaker Change: Those deficiencies lie.
Speaker Change: And they can be in three different areas, we're already in attractive markets and we know thats not one but it could be that you don't have the rigor in place from a commercial standpoint, that's pretty easy to fix so if we get the right talent in place we start to Dan as a result of that talent get better mechanisms to drive commercial rigor change our compensation structure, which we're doing in <unk>.
Speaker Change: 25 to be more performance based those are all things you can do right out of the gate by bringing the right people and you're getting that rigor in place and we are doing that I, just misheard, but across the board. The second is changing commercial structure.
Speaker Change: And again as you start to take your growth driver areas and you begin to isolate the areas, where we want to specialize our sales organization and our expanded we're going to be doing that as well as we come into 2025 and it takes a little bit longer because you got to isolate the areas you've got to hire the people and you've got to train the people you've got to get them to be productive, but that is definitely something that will be moving forward on the one.
Speaker Change: It takes a little bit longer that we'll have in med surge in the other businesses as well as just getting the innovation gas filled that will take us a little longer you've got 88. Once you know the gaps you have got it and develop the app to get regulatory approval and then you essentially launched but those are things that the new team will be focused on obviously, but I would just say I fully expect.
Speaker Change: Given the changes that we've made that we're going to see underlying business improvement in 2025 in med surge and that that will be across all of our businesses.
Speaker Change: I think we're going to benefit from exactly what you said the talent upgrades that we've made the focus theyre going to have on commercial rigor and the change in compensation plans that we have and also some of the new launches just like people in place we've got to get the capacity up in those areas, but we should benefit from knows I want to caution everybody, though from getting out over their skis because thats one variable obviously when we look at 2025.
Speaker Change: We do have some offsets to that we just talked about SKU rationalization, which put a little pressure on 2025, we've got some comps that we're going to have to deal with in pricing and backward recovery, but make no mistake I look at 2025 for med surge in our other businesses as the tip of the spear to begin to change the underlying business performance of this company and that will then as a.
Speaker Change: Results start to.
Speaker Change: To take us off that historical underperformance that we've had.
Speaker Change: That's great.
Speaker Change: Just to follow up.
Speaker Change: Sure.
And maybe I shouldnt be focusing on this.
Speaker Change: I'd be curious to hear your thoughts the ERP transit.
Speaker Change: Transition, it's encouraging that you've already implemented.
Speaker Change: In four countries.
Speaker Change: Where are we in that process and maybe talk to us about.
Speaker Change: What it means what you are expecting from those initial efforts.
Speaker Change: What how we think about that as a positive underpinning driver for 25 and beyond thank you.
Speaker Change: Yes, Rick its weighted I can take that one.
Speaker Change: You're highlighting one of the biggest areas of the separation and one of the areas thats getting the most attention.
Speaker Change: We've got some of the.
Speaker Change: The biggest project teams operating mechanisms, Brian and I are involved in down all through the organization.
Speaker Change: The ERP is are the backbone of our systems and so we're spending a lot of time here no question.
Speaker Change: We are encouraged to get four countries done, but as you can imagine we've been smaller countries to start with and that's by design because we want to make sure that we've got all of our.
Speaker Change: Teams focused on ERP and the implementation of them and all of the.
Speaker Change: Different phases of the program as we execute from planning to execution and then hyper care on the other end and I would say under the first for a couple of them went really well a couple of them, we had some bumps and challenges, but the team has really pulled together worked through.
Speaker Change: Worked hard with our customers to try to close any gaps that we had.
Speaker Change: And we're in a much better place.
Speaker Change: After these first four and now we're moving on and we're going to continue to move of course with the biggest one.
Speaker Change: Our U S implementation in North America, and so we've got a lot of planning and places a lot of work being done but as you're as you're highlighting this is an important one for us to be very focused on it.
Speaker Change: Maybe just dropped off of those comments too and we were very focused when we brought people in and certain functions, particularly in manufacturing and others that have been through this type of ERP consolidation in the past ERP cutover, and even directly involved and spins and I think that's really important because if you've lived it.
Speaker Change: And you've been burnt by you know where to look so the team I think is very capable of managing this doesn't mean, it's not without risk we were definitely going to see risks. We already have had some challenges and managed through them, but we have a great team there should be able to get this done get it done effectively.
Speaker Change: Thank you. Your next question comes from the line of Ryan Zimmerman with <unk>. Your line is now open.
Speaker Change: Good afternoon, Thanks for taking my question so.
Speaker Change: So I'll ask both questions upfront.
Speaker Change: Just if you could remind us I think you'd have about 11% of revenue in China.
Speaker Change: First is that the right way to think about your exposure there.
Speaker Change: Look we're two days into a new administration. There is a lot of discussion about tariffs and potentially the impact there just remind us kind of what.
Speaker Change: Your manufacturing and potentially over there and how youre thinking about those considerations. If you don't mind and then the second question.
Speaker Change: In the purification business.
Speaker Change: Given IV shortages that are going on right now is there any consideration about the impact to dialysis filtration or things of that nature that may use a lot of saline solution in the near term. Thanks for taking the question.
Speaker Change: Do you want <unk> I'll take the person yes sure.
Speaker Change: So let me just maybe correct on the China U.
Speaker Change: We have just a little over 5% of our business in China.
Speaker Change: It's not a not a significant as 11% that you referenced if I just think about the tariffs I think first and foremost we just need to see what actually happens here I think everybody is going to kind of wait and see what happens. The good news is though when I think about what we actually bring in from China, It's a relatively small number and as a.
Speaker Change: Of that just given what we know I really don't see tariffs as being a major impact to our business now anything can change, but based on what I see today I don't see it as a major impact to our business.
Speaker Change: Which is a good thing obviously.
Speaker Change: On the P&L, you're wanting to yeah sure I mean, we have not seen any falloff in demand for support of the dialysis business set a purification filtration that the teams have brought up to us and so at this point, we think that all of the different centers dialysis centers and all the companies in the value chain are working very hard to continue to.
Speaker Change: Service that and then we haven't seen any falloff.
Speaker Change: I mean as a matter of fact, we.
Speaker Change: We are always under capacity constraints here so so.
Speaker Change: We did add capacity to help out the demand.
Speaker Change: Okay. Thank you.
Okay.
Speaker Change: Yes.
Speaker Change: Thank you as we head into the last couple of questions I just want to remind you if you'd like to ask a question. Please press star and the number one on your telephone keypad now. The next question comes from the line of Jason Bednar with Piper Sandler Your line is now open.
Jason Bednar: Hey, good afternoon, thanks for taking the question guys.
Jason Bednar: Brian I wanted to start with a follow up on dental solutions.
Jason Bednar: You get a distributor with some internal cyber security issues that probably affected demand in the fourth quarter of last year. So you've got an easy comp here in the fourth quarter.
Jason Bednar: Obviously, the tougher comps, we just saw in <unk>.
Jason Bednar: Lapped here in the in the.
Speaker Change: Third quarter, but love to hear how you're thinking about pricing and volume dynamics in the dental market. Once we get past some of the noise with comps here in the second half of the year.
Speaker Change: Yes, you actually you are right on when you think about comps first of all Q3 was a tough comp Q4 is an easier comp in the dental space in particular because of what you just referenced.
Speaker Change: When I think about price volume I think that in the dental business very similar to our other businesses pricing is normalizing now and so I don't know that I think dramatically differently than what we've been saying all along that we need to see volumes increase because we've been defending way too much on pricing as a result of the inflationary period, which is ending.
Speaker Change: And pricing is now normalizing and Thats exactly what we saw in the quarter. So I don't see pricing as being the big lever for us in dental I see it like all of our other businesses, we have got to get the volume up.
Speaker Change: Okay, Great and maybe one quick follow up and then a separate question.
Speaker Change: But are you still comfortable Brian looking at pricing as being positive and dental or is it more neutral ish in dental going forward and then as a follow up.
Speaker Change: Separate question.
Speaker Change: Yes.
Speaker Change: Drafting off of some of the past portfolio management question at what point I think its something there is a lever metric at a 25% of assets are in yet and correct me if I'm wrong on that measure, but at past that level. If youre looking at a divestiture you'd have to get clearance from parent three.
Speaker Change: And again correct me, if I'm wrong on that I'm sure. There's some legalities in there, but what's the level you'd have to clear in order to get that clearance or asked another way are there smaller assets.
Speaker Change: If youre doing SKU rationalization or other assets you could sell off where you would not have to get such clearance. Thank you.
Speaker Change: Yes.
Speaker Change: So on the pricing can hold on that one we're not going to get specific pricing thoughts individual businesses, but may be weighted in the second you can just speak to your overall view of pricing, we think about it from a company standpoint, which you've talked about in the past.
Speaker Change: When I think about the considerations for portfolio moves for US you know normally you have the typical considerations on whether youre going to make the portfolio. We have additional considerations that you are talking about right now as a result of the fact that we're so close to the spin from <unk>.
Speaker Change: And there are multiple considerations that you've got to think of that as a result of that.
Speaker Change: In some of those we don't have complete control over some of them. We do some of them. We don't know what I would just say there is it the same way that we are assessing our businesses were also clearly understanding what those considerations are we're assessing them and then managing through them. We feel like we need to do that proactively so that that is not a barrier for us to do.
Speaker Change: Do transactions, if we want to I'm not committing that we are going to do transaction than just saying, we don't want that to be a barrier for us.
Speaker Change: Of course, there is to play there it's not just us the three and is going to be involved in that decision as well.
Speaker Change: So you want to maybe just talk in trying to.
Speaker Change: Pick up on the pricing comment that you had Jason good to hear you on the call.
Speaker Change: So just in summary, Q3, as we mentioned in the prepared remarks, we did.
Speaker Change: We've been communicating for some time now expecting normalization of pricing and it was neutral to our Q3 performance and so the.
Speaker Change: The good news is we're starting to see volume improve as revenue growth over the past year and first half of 2024 was more than all driven by price.
Speaker Change: Business has really been benefiting from price for some time and now we're starting to see volume turn and start to improve.
Speaker Change: Not to say, we're satisfied at all we're not satisfied with the results and the growth yet, but it is good to see the volumes start to improve.
Speaker Change: Versus the underperformance over the past few years, and that's where the business has been experiencing volume declines.
Speaker Change: Next question.
Speaker Change: Sure. The next question comes from the line of Chris <unk> with.
Speaker Change: Wolfe Research your line is now open.
Speaker Change: Yeah, Hi, guys. Thanks for taking my question two questions first in terms of health information systems, the organic growth rate was a little light relative to.
Speaker Change: Some of the past few quarters was there anything anomalous in the third quarter that we wouldn't expect it to recur going forward.
Speaker Change: Yes, thanks for the questions. So I would say if I just kind of break down the quarter.
Speaker Change: It's pretty steady in our revenue cycle management business.
Speaker Change: I feel really confident and comfortable in that business.
Speaker Change: The team has a good handle on it.
Speaker Change: Out of an annuity business that was steady we continue to see is I think you.
Speaker Change: You referenced in your prepared remarks, some challenges in kind of clinical productivity solutions.
Speaker Change: That's where our M modal business was acquired and I'll just be fully transparent. Each has never was really fully invested in internet fast paced market, if you're not investing aggressively you fall behind and we did and that's where we're going to continue to see some pressure.
Speaker Change: The team is working on a solution, but I really don't see that as a.
Speaker Change: Is there any kind of significant improvement in that particular part of the business in the short term.
Speaker Change: Where we did see maybe a bit of an anomaly was our performance management business was soft in the quarter I don't expect that to continue there was just some volumes in the quarter that impacted that business I do not expect that to continue.
Speaker Change: On the positive side as I referenced in revenue cycle management, one of the new product launches that we have around data integrity is pretty interesting. It is early days for sure get approved some things out but as you can imagine our customers are always worried about leakage when it comes to reimbursement and we're using this data integrity solution to be able to get there.
Speaker Change: The information they need and submit for reimbursement standpoint to ensure they get better reimbursement.
Speaker Change: Leakage.
Speaker Change: That's one thing that we're going to concentrate on trying to drive in the market, but generally speaking outside of the performance management anomaly in the quarter, which should not repeat next quarter. It was pretty standard.
Speaker Change: Okay, Great and then a question maybe for Wade in terms of foreign currency.
Speaker Change: Is the guidance based on the spot rate as of the end of the quarter and then if you could talk a little bit about the revenue cost mix geographically as we think about translation and the.
Speaker Change: And Andrew will talk of trying to model what that might be.
Speaker Change: Sure yes so.
Speaker Change: <unk> for us.
Speaker Change: We typically set the rates near the date when we're guiding so over the past week or so we factor that into our guidance discussions and planning and so we're not using in the quarter were using something closer to our earnings call date, which has seen quite a bit of volatility over the past few weeks I am sure Thats why you are asking the question and then.
Speaker Change: Just to summarize again, we had very little impact here in Q3, but based on the recent FX rates, we do expect a headwind both top and bottom line here in Q4.
Speaker Change: As far as our revenue and cost mixed geographically.
Speaker Change: I think it's pretty well understood that the <unk> businesses almost all on the U S. But the other businesses have good exposure outside the U S and so we're running.
Speaker Change: Manufacturing within the U S and outside as well so we don't have.
Speaker Change: We have details to provide at this point as far as that translation mix goes, but I think just generally the way to think about it would be.
Speaker Change: Given the diversification of our three product segments that are.
Good amount of our business outside of the U S as well as inside we're going to be subject to most FX moves like any other med device company and then from a manufacturing footprint standpoint, we also have a good amount of manufacturing all throughout Europe, a little less in China and Asia Pacific.
Speaker Change: Okay, great. Thanks for thanks again guys.
Speaker Change: Thank you.
Speaker Change: And our final question for today comes from the line of David Roman again with Goldman Sachs. Your line is now open.
Speaker Change: Okay.
David Roman: Thanks for letting me sneak another one in here.
Speaker Change: I wanted to come back Brian to comment you've made a couple of times around.
Speaker Change: Capacity.
Speaker Change: And your ability to meet to meet demand and how do we square that with kind of the ramp in capex year compared to what you originally provided at the analyst meeting and shall we expect some of the Capex that may not have occurred this year to flow into next year and I think you also.
Speaker Change: Retrofitting our headquarters.
Speaker Change: How do we kind of put all that together and what does that mean for your future Capex.
Speaker Change: So obviously I'll pass that over to Wei to talk about Capex, but maybe just to make sure that I'm clear Theres a couple of different vectors of capacity when I'm talking about it one would be in purification and filtration.
Speaker Change: We are investing capital there to drive capacity, we saw that in our industrial business and had a benefit in the quarter were doing the same when it comes to our membrane business and those are pretty significant investments that we've made on the membrane business. It will take a little bit of time for it to come to fruition over the next couple of quarters, when I talk outside of purification and filtration now when I think about capacity.
Speaker Change: With Peel in place should I think about capacity with Klim pro that's not really heavy capital intensity there.
Speaker Change: Demand planning.
Speaker Change: Did not have the right demand plan in place and the commercialization planning for that launch and we underestimated the demand and as a result, we just don't have the we don't have the capacity to fill it. So I don't think in those two areas significant cash spend or capital requirements. They are pretty low intensity capital businesses, we just didn't get the.
Demand right, but maybe where you talk about the total capex, yes. So we've guided to 400 $500 million since the start of our public company here in Q2, and we've just updated that this quarter to thinking to the low end of $400 million to $500 million, having said that David we know we're going to have to make investments for both the separation.
Speaker Change: As well as the organic growth of the business and as Brian said Theres a couple of areas. In addition to our new products, where we're capacity constrained and I think one of the advantages of the growth drivers strategy that will bring us a very focused.
Speaker Change: Growth.
Speaker Change: <unk> and <unk>.
Speaker Change: By doing that we can be very much planned for where we're making our capex.
Speaker Change: Expenditures and doing them in areas that we know we're going to be growing the business versus kind of a blanketed approach to growing the business and then youre always trying to catch up in the areas that youre growing in maybe over investing in others. So again, one of the byproduct advantages of our growth drivers strategy as Brian mentioned earlier shifting resources to get behind.
Speaker Change: The growth drivers are part of that is the capital expenditures and as Brian mentioned, one of the criteria for the growth drivers is thinking through the relative profitability and capital intensity in that.
Speaker Change: But having said that we know we're going to be investing in.
Speaker Change: In addition to supporting the faster growth of the business over time is also to separate the business and we're investing pretty heavily right now we talked earlier about Erp's. We also have pretty significant manufacturing line moves moving our distribution centers and logistics. So we've got a lot of work to do in Capex.
One of the things, we're going to have to spend on to separate the businesses.
Speaker Change: Great. Thanks, so much for taking the additional questions.
Speaker Change: Thank you, yes, thanks, David.
Speaker Change: Okay seeing no further questions I'll close the call by saying. Thank you so much for joining us and hope that everyone has a wonderful day.
Speaker Change: Thank you. This concludes today's conference call you may now disconnect.
Speaker Change: [music].
Speaker Change: Yeah.
Speaker Change: [music].