Conference Transcript - MDLN 2026-06-09

Speaker 2

Okay. Good morning, everybody. Very pleased to have the manager team from Medline here, Jim Boyle, Chief Executive Officer, and Mike Drazen, Chief Financial Officer. I want to keep this as interactive as possible. Should there be any questions, obviously, feel free to raise your hand. We'll get a mic over to you for the benefit of people participating via webcast. Lots to talk about Medline and kind of your journey here into the public markets, but I wanted just to start with something that's very topical we're getting a lot of questions on is just quality remediation, the warning letter that you just received, maybe just sort of frame for investors. What's going on? How do we contextualize this? Why isn't this a bigger problem? How does this not metastasize, et cetera?

James M. Boyle, CEO

Yeah, thank you for asking. And thank you all for being here. Quality of Medline is paramount, right? Patient safety is the most important thing that we focus on each and every day. And the most recent warning letter was from our ReadyCare Waukegan facility, which is where we make CHG wipes, which is a pre-surgical antiseptic. This goes back to October. We actually informed the FDA that we found some things we were not happy with. We actually closed the factory down, so the warning letter was not a surprise. It was anticipated. And part of our job is to make sure that we inspect ourselves as arduously as the FDA would to make sure that we're delivering the right product at the right place at the right time with the right quality metrics. And so just from a recall perspective overall, last year we had 29. We've had 15 this year. We make 190,000 different products. I'd love to tell you that we could never have a recall or never have a quality issue, but unfortunately, that's just not the case. It does come up, and how you respond to it, I think, is what matters. So first and foremost, how do we mitigate the burden to the customer to offer something that actually allows them to continue to operate in a proficient fashion? Specific to this recall, we actually worked with Sage to bring an inventory to actually supplement the inventory for our customers. As a distributor, we have the ability to do that. I'll give you another recall example. We recalled some surgical drapes and gowns earlier in the year. One of our factories that we had done business with was not meeting the expectations through one of the inspections we did. So we chose to cut them off. The beautiful thing about having redundancy across your network, meaning multiple suppliers to supply the same product category, we were able to shift that volume to other manufacturers to still meet the demands of the customer from a fulfillment and a throughput perspective. So from a quality perspective, we take it very seriously. we have over 2,700 people of quality across the globe. We invest hundreds of millions of dollars in the organization. We're investing in 10 million in the plant we're talking about in Waukegan that's currently subject to the warning letter, and we're working very closely with the FDA to make sure we're not only meeting but exceeding their expectations. And I think

Speaker 2

sometimes there's perhaps a misunderstanding of what recall actually means and how it materializes. I get a lot of questions, which is, oh, the FDA made them do this. Maybe just remind people, like, how a recall originates, what the process is, and just broadly the interaction with the agency through that.

James M. Boyle, CEO

Yeah, every recall we've had has been voluntary, meaning we did it to ourselves. And part of that is a rigor in inspecting yourself. We have a responsibility as an organization, as a manufacturer, to make sure that you're inspecting yourself as if the FDA was doing it. So the FDA is not dictating that we recall. We report to the FDA that we are recalling, and then we work with the FDA on the remediation efforts as it relates to what the cause of the recall was. So the partnership with the FDA is more about remediation and actually getting to the outcome than it is actually delivering the recall.

Speaker 2

And that kind of 29 recalls, 15 recalls, how quickly does it take to sort of reach your definition of resolution on any of these matters?

James M. Boyle, CEO

It depends on the product category. In the surgical drapes and gowns, we literally displaced it almost immediately, right? We discontinued manufacturing with one of our suppliers, moved it to another supplier, and we were able to fulfill customers' demands. So that was almost a non-impact to the market. In terms of the ReadyCare Waukegan, we actually shut the factory down, and we are not producing. We will not produce again until we actually meet the expectations we've set for ourselves in conjunction with the FDA, which could be later sometime this year. So it really depends on the complexity of the recall.

Speaker 2

And then maybe just to round out this conversation, just how should we think about the financial impact or financial risk associated with the shutdown of the Waukegan plant and just quality remediation in general?

James M. Boyle, CEO

It's not going to be material to our numbers. Every recall we've had this year has been small, and it won't be material to our numbers, and we're still confident in our guidance. Okay, excellent.

Speaker 2

Maybe we can just segue over to the business. You started the year at 8% to 9% organic revenue growth guidance. You raised that here after the first quarter. Maybe just give some background as you came into the year, the initiation of guidance, what you were seeing in end markets and in your business, and then what you saw exiting the first quarter that gave you confidence to increase the outlook for the year.

Michael B. Drazin, CFO

Yeah, we were really pleased with our results in the first quarter. Organic growth of about 10%, oral growth of about 11%. That's not adjusted for days. So if you adjusted for days, our actual growth is closer to 13%. So really pleased with the demand across all of our businesses. The acute care channel grew at close to 12%. Non-acute grew close to 7%. And international grew close to 10%. So really, really pleased with the overall results at the sales. Demand levels remain strong. And so we saw the opportunity to increase our guidance for the full year. So our new guidance as we set at the beginning of the first quarter, at the end of the first quarter is organic sales guidance of 8.5% to 9.5%.

Speaker 2

And it would seem like you are diverging a little bit from some of the end market trends that you've talked about. One of the things I believe that's reflected in your guidance is the risk around some deterioration in utilization and hospital purchasing as we go through the balance of the year. So in that context, your increased outlook obviously implies greater share capture. So maybe just help us think through what's happening in the end markets and what's driving that divergence in your – that widening divergence in your performance.

James M. Boyle, CEO

Yeah, we're seeing – in the first quarter, we did not see softness. And we don't measure patient volume. We measure flow of supplies. And I can tell you the flow of supplies for Moundline was as good as normal. and candidly, the outsized growth in the first quarter was tied to same-store sales growth outpacing what we predicted and some acceleration of the prime-ventor implementations going into the quarter. So it's both share gains and same-store sales growing better than we actually anticipated. So when you think about the reason we don't measure patient volume is we don't have visibility to that. We have visibility to the flow of goods. And our business tends to benefit on both sides of the equation. So if patient volume goes up, that means more procedures, that means more supplies used. But when patient volume goes down, specifically around uninsured, so you think about what's happening with the Affordable Care Act, what's happening with the OBBA, cuts of Medicare, Medicaid, when uninsured patients don't have insurance or consumers, they don't go to the doctor for the flu. They don't go to the doctor for a cold. They wait until they have pneumonia. They end up in the emergency room, and they end up in the ICU. So for us, that's a much higher utilization from a procedure, from really a cost of care. So we're seeing a lift in the number of supplies based on the incident of care as compared to a doctor's visit. So we're covering up the diminished patient volume by the utilization of what the procedure that they went into the facility for was. So our flow of goods in the first quarter was as good or better than it was last year, which is why we saw it. So we are baking into our numbers, just listening to our customers, that they are anticipating some potential softness from a volume perspective in the back half of the year. That's what's baked into our numbers. If that doesn't happen or we benefit from the same thing we benefited from in the first quarter, there's some favorability in the back half of the year.

Speaker 2

And just to be clear, the first quarter, did you see that acuity benefit or it was really just same-store sales growth execution? The acuity dynamic that you laid out, that's a theoretical impact.

James M. Boyle, CEO

Well, you saw acute care sales grow 12%, so we did see an acceleration. So there's a higher acuity, so you saw some acceleration in acute care.

Speaker 2

All right, great. Maybe it's a good opportunity to go into a little bit more detail on some of the individual business drivers. Maybe we'll start with supply chain solutions. You talked about $2.4 billion of prime vendor contracts sold last year above the billion-dollar average run rate that you expect and what you're contemplating for 2026. Maybe just help us understand a little bit more what drove that outsized growth and then remind us kind of on the conversion of contract to revenue.

James M. Boyle, CEO

Yeah, so we commit to a billion dollars every single year because that's what we know and believe we can control. We know what's coming up for renewal with our customers. We know what relationships we have, and we know where we are in the sell cycle. So the billion dollars is what we believe we can control any given year that we can actually account for, if you will. And then we take advantage of market conditions that are currently in play that are favorable to our business model. If you remember last year, we did not raise prices initially when the tariffs hit. we do not react in times of crisis or chaos and act when we don't actually have an idea of what's going on. So we chose to wait to raise prices. And first and foremost, what could we do internally to mitigate as much as possible? We educated our customers on what was happening, why was it happening, and what were we doing about it in advance of doing anything. And we waited until August 1st to push any price increases, which is different than our competition did, and opened some doors that historically have been closed. Some of our outsized wins last year were tied to that. Second, customers are all looking for speed to value. We are the value player in the marketplace. What's happening with cuts and reimbursement has opened doors that historically have been closed. That customer yesterday that wasn't willing to look now is looking for the value player in the marketplace and created some outsized wins last year. Third, consolidation in healthcare is not slowing down. It's picking up. The integrated delivery networks in these large healthcare systems merging is becoming more robust and really larger from a geographical footprint perspective. Medline is the only supply chain solution provider that serves every single point of care. Anywhere a caregiver, a patient, or a consumer needs access to patient. Medline is a supply chain solution, a product formulary, a clinical engagement platform, and a sales force dedicated to that individual care setting. And we have the ability to merge them all and serve really an integrated delivery network with a consistent solution across their entire network. And we are the only ones who can do it. That's also been a tailwind. And so those things are still relevant today, right? We still have financial crisis. Now we have the Middle East. Tariffs are still in play. There's concern around resilience with some of our competitors. Customers want resilient, sustainable, long-term supply chain partners. And candidly, I think we might be the only people that want to be in the business we're in right now. We continue to invest in the business, and customers see that, and they want to be with the player that's going to be around for the long haul, not for the short term. Very helpful perspective. And

Speaker 2

And maybe as we kind of think about the Medline Brands side of the business, there's sort of two pieces to it, right? There's the prime vendor, contract winning, and then converting distributed product to Medline product. But then there's also an opportunity, I think, within each of the three segments to drive higher penetration of Medline Brands, especially in lab and diagnostics, but also in the other two in med surgeon frontline care also. But maybe we could start on the conversion. opportunity and then maybe go into a little bit more detail on each of the individual

James M. Boyle, CEO

sub-segments yeah when we sign a new prime vendor business it's important to realize that day one it's 90 third-party products so it's 90 distributed products 10 of the business is already in our brand we're distributing about 1.2 billion of our brand through competitive distributors our brand stands on its own in that first year we normally see our medline brand penetration double to get to 20 so we see a lift and normally that's surgical custom procedure trays just for context what is that that's a bundle of goods picked uh non-sterile put into a bundle in sequence that actually increases really the turnover rate in the operating room and actually decreases the cost and actually keeps them from having to open 100 packages they open one and it's a bundle of goods already built for like a total hip an open heart a lap coli tray and then we also pick up a lot of the commodity items in the first year so think about your tongue depressors your combs your exam gloves your underpads those are easy for the clinical team to accept in a positive manner And then from year two on, we see anywhere between a 3% to 4% penetration rate lift, and that's an intentional pace of change that we've built and learned through many years of trials and tribulation. When you go too fast, it's hard for the clinical team to accept that change because too much change is hard for them to receive. Believe it or not, when the box changes from red to blue, they freak out if you don't actually tell them the box has changed from red to blue, even if it's the same item in the box. We also learned if you go too slow, you don't deliver enough incremental value in savings for the CFO. So that pace of change is built through many years of really evidence-based conversion to deliver value to the customer on a consistent basis. We have every quarter mapped out in our five-year agreements with our customers saying, this quarter we're going to do underpads and exam gloves. This quarter we're going to do advanced wound care and DME. And so there's a predictable roadmap to conversions and value for the customer that they can map out, and we never get to that what have you done for me lately because we're always driving intrinsic value for our customers each and every day. When you think about the segments, lab and diagnostics is something we're very excited about. It's a $25 billion market we just got into 10 years ago at the request of our customers. They saw a lack of competition in the marketplace. We do a billion dollars in that space, and it's growing pretty nicely. The first quarter, we saw 1% growth, but that was diminished by a slow flu season. The actual base business was growing in the teens, and we're going to see that recover in the back half of the year because of all the prime vendor signings in the lab and diagnostics space we signed last year that will go live this year. Surgical Solutions was a very robust growth driver last year. We saw a lift in custom procedure trays in conversions from competitive accounts moving over to us. Very similar to the prime vendor model, customers were moving to us for the custom procedure trays because they wanted resilient, sustainable partners in that operating room to make sure that they can actually do cases every single day. And then we did see a nice lift in frontline care. When you think about frontline care, think about your daily use goods, literally everything from exam gloves to gauze to urology to advanced wound care. It's a very, very robust subset that plays across every single care setting. Your surgical solutions lives mainly in your hospitals and your surgery centers, but frontline care lives across the entire continuum of care.

Speaker 2

And how does it work, you know, if you have a prime vendor contract that maybe you signed, I'm making this up five years ago or something like that, and there are categories that you didn't participate in then, how do you go access those accounts? So if you, as you think about closing that $1 billion to $25 billion, again, trying to use the pictures in the IPO slides to figure out which products you might be going after, after but as you start to launch some of those products what's the mechanism to go back and add to existing prime vendor contracts and does that create opportunity for growth beyond that incremental that initial penetration that you talked about well the entire brand is on the

James M. Boyle, CEO

contract so so when we sign a prime vendor deal we build in um we'll say escalators from a conversion curve to allow them to buy down the cost of distribution so when you think about today when i started in 1996 20 of what a hospital buys from a medical surgical budget had an equal Medline brand alternative. Today it's 60%. In the next five years my aspiration is to get somewhere around 75% because every single year to your point, we're adding new categories to the line. And so when you think about the way this thing is built is our reps are incented to present every opportunity to the customer every single day and then they parse that out saying this quarter we're going to do this and this. So as the new categories are added on, that gets added to their bag and that gets added to their sales cycle as they're doing their quarterly business reviews. They're saying, hey, Mr. Customer, We just added forced air warming, which is a new product category for Medline that competes with Bearhugger. If you don't know what that is, it's a blanket that forces hot air to increase your core temperature before surgery and during surgery. And so it isn't around, it's really the brand itself. And as the brand expands, our job is to actually present every opportunity to the customer every single time.

Speaker 2

And a question that I always get on Medline conversion is, what is the sort of interplay between distributing for your customers then become your competitors? Just talk to us a little bit about that relationship and how you find the right equilibrium there. Because I was like, well, why would, take the bear hugger example, why would they ever distribute through you if you're just going to start making your own product? But at the same time, it seems like their ultimate end customer wants you to be the distributor so just just help us think about all the the different moving parts

James M. Boyle, CEO

there i think the best way someone's asked me that is why would why would a vendor go through you when they know you're going to cannibalize their business right that's basically what you're asking me here's the most important thing to remember the customer is making every decision medline is making no decision and so most of our manufacturing competitors are not distributors they have to access the distribution channel to get access to the customer the customer is choosing their prime vendor. And when they choose Medline, there is no optionality for third-party manufacturers to get into that channel without accessing their prime vendor or their distribution channel. So the customer, when they choose Medline, that is the avenue for the competitive brands to go into our channel. I would tell you, the competitive brands would say Medline as a distributor is a fantastic partner. They keep more inventory on hand so we don't have back orders. They actually serve our customers better. They actually pay their bills on time. And we also offer them some non-traditional services like backhaul functions and some other things that our competitive distributors don't because we own our fleet of trucks. They would also tell you that Medline is very transparent and very honest and says, hey, we're going to go to market and compete with you and may the best company wins, right? If you win, we're going to distribute your product. If we win, we're going to distribute our product. But ultimately, the customer is making the decision both who their distribution partner is and what product they're buying. And so the real answer is the customer is making the decision and dictating what avenue they have to access in order to access them as a distribution partner.

Speaker 2

And ultimately, that $1.2 billion that's being distributed to others, is the vision to bring that, is that a target for a prime vendor relationship?

James M. Boyle, CEO

Yes, so when you think about different ways to actually engage a customer, right, when you get the opportunity to sell your brand, then all of a sudden you have the opportunity to discuss the customer what the overall value prop is. And so, you know, a backdoor entry would be to say, hey, we're going to sell our brand first, get an opportunity to actually sell a widget, and then as we get a better relationship with that customer, we can sell the entire value prop. I would also tell you, because we sell in every class of trade, we may be the prime minister in the physician office space and not in the acute care space. That is another way to enter into the acute care market to actually pick up the business and vice versa, right? We may own the acute care distribution channel and we don't own the surgery center or the physician office. It's a way to capture that market share as well.

Speaker 2

And maybe as you kind of wrap this all together, as we think about kind of your end markets grow and call it the 3% to 4% range, obviously for this year contemplating growth more than double that you've been generating that pretty consistently. As you kind of reach higher levels of penetration, you know, the 60% example you give about comparable Medline brands, how do you keep going at a rate that is so significantly above the end markets you serve? Well, I mean, you have to think about our business. We still

James M. Boyle, CEO

have a long way to go. We serve $175 billion TAM in the U.S. and we sell $28.4 billion. So there's, I was raised until you have 100% of the business you don't have at all, right? And so we're going to go after every single dollar that we can. And when you look at the acute care market, we have about 45% share. It's growing 12%, so we're doing pretty good in that. And you look at traditional post-acute, which is like skilled nursing facilities, nursing homes, and home health and hospice, we have about 35% of that business, which means we still have a tremendous amount of growth. In surgery centers, we have roughly a third of that business. In physician office, we do $1.5 billion in a $9 billion market that we just got into 10 years ago growing nice. So I don't see a limit in our potential for growth across the business segment. And then when you think about the brand, our 10-year cohort average penetration rate is about 42%. Some at 60% fully maximized, and some in the 30s, more like your academic medical centers who give limited choice, or actually don't force the conversion curve. So I just see, I mean, there's a $75 billion TAM in our brand alone, And we did $12.5 billion in our brand last year. So there's a tremendous amount of opportunity in front of us.

Speaker 2

I want to go to margins, but it's open up to see if there are any questions from people in the audience. We'll keep going. Before I actually get to margins, maybe we just kind of – it was kind of a good transition, I guess. Talk just about the guidance. I mean, I think people understand the strategy to run the business annually. as you experience in the reaction of first quarter earnings. The privilege now of being public is that there's tremendous focus on the quarters. So help us think about how you manage that interplay between how you run the business and then kind of meeting short-term expectations.

Michael B. Drazin, CFO

Yeah, so you're right, David. We think about the business in years, not days or quarters. And so we've always run this business for the long term. We'll continue to run the business for the long term. We invest for the long term and we invest for its top-line growth first. And so, you know, our objective is to provide annual guidance to all of you so you understand where we're headed for the year. As we report our quarterly results, we'll tell you what that means to the overall full-year guidance. And we need to continue to educate and manage how we're thinking about the quarters because the quarters don't have a linear run to them, right? So the first quarter is always our lowest quarter. Why? Because days matter in our business. There's 61 days in the first quarter. There's 66 days in the fourth quarter. So our fourth quarter is always the largest quarter. there's also some seasonality to our business for instance like the flu respiratory virus season as jim mentioned earlier we saw we saw a weak or low severity respiratory business in the first quarter relative to last year you saw that show up in our lab and diagnostics business and then lastly i would say that the buying patterns and demand levels of our customers always tends to spike in the fourth quarter as well and so there's variability from quarter to quarter we'll do our best to educate you on what that means for the overall year and help you understand how we think

Speaker 2

about the full year guidance overall and as I look at your guidance for this year the 3.5 to 3.6 billion dollars of adjusted EBITDA and I you know look at where consensus numbers ended up getting kind of weighted after your Q1 results it does put an onus on the back half of the year so maybe just help us think about the cadence of EBITDA and profitability. So there's a couple

Michael B. Drazin, CFO

things playing out in the first half of the year versus the second half of the year that's important to understand. One is, as we called out, the tariff impact is pretty burdensome in the first half and it'll be favorable in the second half. Why? Well, we're still taking impact to our P&L from the tariff rate, which is at the old IEPA rates. As of February 28th or March 1st, we went to a 10% rate, which is favorable to what we were paying previously. And so that'll show up in our sales in the second half of the year. So tariff favorability will be a net positive for us in the back half of the year offsetting that though will be a couple of things one will be the middle east and so we've talked about the middle east let me just frame it for everybody right the middle east inflationary pressures on our business will show up in the second half because they're sitting in inventory right now and that really relates to two things one are fuel costs so we buy diesel fuel every day to run our trucks and trailers we have 2 000 trucks and trailers that we operate in addition we pay a fuel surcharge for our inbound container costs now that inbound container costs won't show up until second half of the year because of our contractual obligations but that's the smaller impact to our business from the middle east the bigger impact are raw materials and finished goods that we're sourcing today to manufacture our own products or to finish goods that we're sourcing to sell to our customers and so those are nitrile exam gloves those are plastics that we're acquiring to make the resins we're acquiring to make plastics or the plastics we're acquiring that are finished goods we have seen a spike in costs in the last couple months from those that are now sitting in our inventory and will become impactful to our P&L in the second half of the year. We have not made a plan yet to raise prices. That's a question we always get. We are continuing to run the play we always run, which is to try to best to mitigate the cost first, driving our normal playbook that we've run historically. And if we see costs continue to rise and costs continue to persist for a long period of time, we'll evaluate the idea of issuing a price increase, much like we did last year with the tariff price increase on august 1st so that's how we operate and mitigate the middle east impact as much as possible and then the second piece of this is then we talked about this in the first quarter earnings we have made intentional investments in our business to support the growth now some of the first quarter year over year uh opex expense opex increase sorry was driven by just investments in second quarter third quarter fourth quarter of last year so that's that quarterly variability that i talked about but we also were intentional when making a few investments in our operations to support both our existing customers and new customer growth. As we talked about, we signed $2.4 billion of new customer signings last year. As we bring those customers on and go live, we've had to make some investments in operations in a couple of key regions. For instance, in Michigan, where we brought in a number of prime vendor customers last year, we had a smaller warehouse that did not have automation, and so we've had to add additional labor resources to support that ongoing customer implementation. maintain our service levels and as we expand that facility and we add

Speaker 2

automation that'll drive that cost down over time okay so as you it is as we I think you also said that tariff savings would help comp help offset yeah some of those incremental costs so we think about that as a plus one minus one I don't know if that's the right way to think about you're still end up with like well over 50% it's like 60% of implied adjusted EBITDA in the back half half of this year is is q2 i think should be a little bit better than q1 just as you scale revenue like is that is that a fair representation yeah that's a fair representation i won't give

Michael B. Drazin, CFO

you the number for second quarter but we do expect some modest sequential as i mentioned on the first quarter call modest sequential improvement from q1 to q2 and then the second half will be um will be

Speaker 2

much stronger and then as you think longer term about margins i think you've talked about growing adjusted EBITDA dollars at least in line with revenue. Maybe just pick apart some of the building blocks that get you there. I mean, I had thought when I looked at 2027, obviously things are evolving, but we kind of had said, we thought that, well, you have a lower quarter, lower tariff run rate exit in the fourth quarter of 26. You'll have, should have some leverage on year two of being a public company, and then maybe there's some underlying margin improvement in each of the segments. But help me kind of reconcile that.

Michael B. Drazin, CFO

Yeah, so it's too early to call it 27, but you're right. That's what we said when we went through the roadshow was we believe 26 will be a year in which there will be a burden from the tariffs. We'll see tariffs normalize into the base business by the second half of the year. And so going into 2027, we expect to deliver earnings growth at or greater than sales. That was our commitment. That's our long-term commitment. And we'll evaluate what that means as we think about the Middle East here in the next couple of quarters and how that plays out into 27. But that is our commitment, long-term earnings growth at a greater than sales. How we get there, the building blocks of that are very simply volume growth. If we grow top line at a very healthy rate, high single digits, you'll see volume growth and margin dollar growth from that. You'll see us continue to drive Medline brand conversion as we drive Medline brand conversion. You see that improve the margins going from 5% EBITDA margin to 22 plus percent EBITDA margin. It's our investment, sorry, it's our manufacturing and our sourcing initiatives that we drive savings every single day. We have these 450 product managers. We have a global sourcing organization, a broad manufacturing footprint. Those teams' jobs are to reduce the cost of goods in the products that we operate, that we sell or manufacture, and focus on driving those costs down to our customers. And then lastly, operating leverage, as you mentioned. So as we continue to grow the business, we'll leverage our scale and drive operating leverage in the business that will drive margin dollar growth added or greater than sales over time.

Speaker 2

And can you get margin expansion in each of the segments? I think, like, in supply chain solutions, you were on this, like, roughly 50 basis points a year of improvement. Obviously, I know one quarter doesn't make the trend for a year, but can you see underlying margin expansion by business?

Michael B. Drazin, CFO

Margin percent expansion, I think, is not really sort of something we want to talk about or to highlight, but I think it's more margin dollar growth. And so supply chain solutions is your point. Yeah, we did 5.5 percent EBITDA margin last year in 2024. The first quarter was sort of 4.8%, which is lower than the five, obviously. That's not representative of what we expect the full year to look like. We expect to get back into the fives. But we don't think about SCS, supply chain solutions, or even Medline Brand on a margin percent expansion. It's more about the dollar growth. And our commitment, again, is longer term, growing at or greater than sales.

James M. Boyle, CEO

One of the other things I would say is supply chain solutions was overburdened with something I think we did a badge up explaining. So the first year we signed a prime vendor, we give a first-year conversion rebate. That's a one-year hit, and it hits supply chain solutions. So supply chain solutions are being hit with a pretty big input, especially in the first quarter of this rebate that we're paying the customers tied out. So that will normalize. That's a one-year deal that heals itself in the next year.

Speaker 2

And I think you all set this dynamic of incremental investments to support customer onboarding without the revenue. And I assume most of that, not all of that, was allocated to supply chain solutions,

Michael B. Drazin, CFO

which also depressed the margin there. That's correct. The operations investments, when you think about that new prime vendor customer that we bring on board, it's 90% supply chain, so it gets allocated to that more than it does to us.

James M. Boyle, CEO

We're onboarding all the labor. So we onboard labor 90 days in advance of revenue utilization, right? We have to train them to pick back and ship before we actually onboard the customer. Recently, we've been onboarding them five to six months because what we've seen is competitors leave the business much faster. So instead of giving them 90-day, 90- to 120-day conversion ramp, they're giving them 30 days, and we want to be ready in advance of that. So there's a cost of labor. I mean, think about the third and fourth quarter hitting the first quarter, which is a higher spend relative to the last year. That will appeal itself over time.

Speaker 2

And as you execute that margin expansion, you obviously generate free cash flow. I think relative to other sponsor-backed IPOs, you're pretty under-levered even today. And then you obviously de-lever pretty quickly without actually paying down any debt. But maybe you'll choose to do that. But help us think through your capital allocation framework and how you're prioritizing use of cash, especially as you continue to strengthen the financial position.

Michael B. Drazin, CFO

Yeah, you're right. We generate a ton of free cash flow every year, and so our first priority is to invest in the business. That's really how we've thought about this for the long term. As I mentioned earlier, we're long-term investors, so investing in our sales force, investing in our operations to support the new customers or existing customers, investing in new product development. We spend about $500 million a year on capital to support both our distribution network. We're adding two new DCs in Texas and California. We're adding automation every year to our business, both in the auto store, and now we've made an investment in Symbotic on the bulk automation side. We add new trucks and trailers every day. We think about the manufacturing footprint. We're expanding our Mexico manufacturing footprint, which we believe will go live here in the next couple of months, that three-year-plus expansion that we've been doing in our Mexico facility for our kitting business. We'll add new production lines as well throughout our network, and we invest in technology. So that $500 million at CapEx every year is sort of a good view for us. In addition to that, we have intentionally invested in working capital. Working capital for us will always be a usage as long as we're growing the business, which we expect to grow for the long term. Why? Because we carry more inventory than our competition, 80-plus days on hand. It's been intentional. That drives the best service rates, service levels of fill rates in the industry, and it allows us to step in when our competition has problems. And so really focused on that, and we'll continue to focus on working capital being a usage. So after the free cash flow, we have close to $1.3 billion last year before the one-timers, you'll see us lean in a little bit more on M&A, right? As we talked about and Jim talks about a lot, like M&A for us is an opportunity to drive strategic growth in our business. We'll be disciplined. We'll focus on products. We'll focus on channels. We'll focus on service offerings. You'll see us lean in on M&A. If we don't have any M&A to do or less M&A to do, over time, we would consider delevering in the business. Now, to your point about deleveraging, we're at 3.1 times. We do long-term want to be investment-grade, and you saw us just in the last couple of weeks, we dabbled in the investment-grade market. We issued $2 billion of investment-grade secured bonds. And so as we see sponsors sell down, lower ownership on the board, and we further see deleveraging, you'll see us step into the investment-grade markets.

Speaker 2

And then any parameters you can help us think about from an M&A standpoint? What types of acquisitions are you looking for? Are there different channels of care of interest, geographic expansion? I know you did a small dental deal in Canada, and I think that was sort of kind of let's experiment with the market, see what we can learn as a participant. Maybe lay that out for folks.

James M. Boyle, CEO

Yeah, first and foremost, we look for additional opportunities to expand the brand. 90% of our growth historically has been through internal creativity, not through M&A. 10% has been through M&A, so it's been a nice to have, not a need to have. That being said, I think there's going to be some opportunities to emanate from a product perspective that comes to market in the next 18 to 24 months. Because what we're seeing is a lot of our manufacturing competitors move up into the Class 3 and Class 4 devices. And the Class 1 and 2 don't fit within their strategy. So they're going to sell some non-core assets, and we'll be there ready to pick those up. So we have $2.2 billion in cash on hand. So we have plenty of dry powder to do that. And we think there's an opportunity. We did that last year with EcoLab's Microtech Surgical Solutions business. And we also bought Comitech's skin care line. and they fit perfectly within what we do, and they did not fit perfectly within what they do. You mentioned Sinclair. Sinclair was an opportunity for us to have a petri dish to test the dental market to see if it's something we're interested to do in the U.S. I can tell you we're outperforming the deal model. It is very interesting. I don't want to be what the current distributors are in the dental market. I want to be what we are in the med surge market in the dental market, meaning a manufacturer that distributes, that delivers value to their brand. We're on the path to be at 30% Medline brand and convertible opportunity within dental already, which I'm very proud of our divisions for doing that. So then it looks like wash, rinse, repeat from the model perspective in just a different channel, similar to what we did in lab and diagnostics. So I am opportunistic. We'll know the answer to that by the end of this year. So we're looking at different channels. We're getting into animal health. We did that just through internal muscle. Is there an opportunity to do some M&A maybe? Internationally, I think there's an opportunity for us to create some acceleration and growth in the international markets from a brand perspective. Remember, that is not a distribution business. That is a brand business alone because the prime vendor model doesn't live outside of that. And then some of the service offerings. A couple years ago, we bought a company called PrefConnect that helps caregivers manage the preference cards for surgical procedures, which today are on average 75% accurate because they're manual and nobody updates it. This ties in with Epic and Cerner, has visibility into what's actually used in the procedure. It goes all the way back to our kitting manufacturer, so we're always building the right, most robust custom tray to meet the needs of the surgeon every time they walk in. And so we will continue to look at those things. We're pretty excited about what's ahead of us. And my guess is we'll probably be more opportunistic than we have in the past, as I realized, to M&A.

Speaker 2

Maybe I'll turn it back to you to close us out here. You've obviously been at different investor conferences. You've met with a number of people here. How do you want people to kind of walk away from this conference and keep key takeaways for those in the room and on the webcast?

James M. Boyle, CEO

People keep asking if we're going to change who we are now that we're a public company, and the answer is no. With 59 years of consecutive growth, what we've done actually works, and we know it works, which is why we're not giving quarterly guidance. We're giving annual guidance because we know what we can do. And our business, to Mike's point, isn't sequential. You can't take 3.5 to 3.6 and divide it by four. That's not how the business works. And so my ask would be, you know, take some time to learn the sequential nature of our business, the seasonality of our business, and you'll understand why we're portraying the numbers the way we do. I mean, simply put, I mean, our job is to make health care run better, to deliver improved clinical, financial, and operational outcomes, and we're going to continue to do that in an outsized fashion as compared to the market.

Speaker 2

Excellent. Well, I very much appreciate your participation. I look forward to the next update, I guess, in July or August. Awesome. Thank you very much.