Solventum Corp Q1 FY2025 Earnings Call

Good afternoon. My name is Amy and I will be your conference call operator for today. I would like to welcome everyone to the Solventum First Quarter 2025 Earnings Call. As a reminder, this call is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. Thank you. I would now like to turn the program over to your host for today's conference, Amy Wakeham, Senior Vice President of Investor Relations and Finance Communications. Please proceed.

Thank you. Good afternoon and welcome to Solventum's first quarter fiscal year 2025 earnings call. Joining me on today's call are Chief Executive Officer, Bryan Hanson; and Chief Financial Officer, Wayde McMillan. A replay of today's earnings call will be available later today on the Investor Relations section of our corporate website. The earnings press release and presentation are both available there now. During today's call, our discussion and any comments we make will be made on a non-GAAP basis unless we have specifically called them out as GAAP. The non-GAAP information we discuss is not intended to be considered in isolation or as a substitute for the reported GAAP financial information. You are encouraged to review the supporting schedules in today's earnings press release to reconcile the non-GAAP measures with the GAAP reported numbers. Additionally, our discussion on today's call will include forward-looking statements, including but not limited to, expectations about our future financial and operating performance. We make these statements based on reasonable assumptions. However, our actual results could differ. Please review our SEC filings for a complete discussion of the risk factors that could cause our actual results to differ materially from any forward-looking statements made today. Following our prepared remarks, we'll hold a Q&A session. For the Q&A portion of today's call, please limit yourself to one question and one related follow-up. If you have additional questions, you're more than welcome to rejoin the queue. And with that, I'd like to now hand the call over to Bryan.

All right. Thank you, Amy and to all of our shareholders and everyone interested in our company story. Thank you for joining us today for our first quarter results. I’m going to get straight to the point. We are off to a strong start for 2025. As a result of this positive momentum, favorable foreign exchange, and decisive steps we've taken to mitigate the impact of known tariffs, we are raising our organic revenue guidance and confirming EPS for the year. Before we jump into the strong start for the year, let me just quickly address tariffs specifically and Wayde will provide more details in a minute. To be clear, tariffs will be a headwind for us this year, and without them, we would be raising our EPS guidance commensurate with the underlying momentum we're seeing in the business. That said, we've begun executing short-term mitigation measures based on what we know today and are actively developing, analyzing and implementing additional strategies. As a result, we expect to manage the current-year headwind within our existing full year EPS guidance. Given just the fluid nature of the situation, we will continue to closely monitor the evolving policy changes and assess what they mean for our organization. Relative to our continued momentum, progress here is further evidenced by our first quarter results, marking another positive quarter of volume growth. This makes it 4 consecutive quarters of positive growth and sequential improvement as we delivered 4.3% organic sales growth and adjusted earnings per share of $1.34, continuing to perform ahead of expectations. I think this is particularly impressive, given the company's historical performance. As I shared at our recent Investor Day, this business experienced 6 years of declining volume trends and 7 quarters. That’s nearly 2 years of negative volume growth before our spin. Stopping that decline and reversing the trend are direct results of the foundational enhancements we made across 3 primary areas: our mission and culture; our talent and capabilities; and our efforts to stabilize the business across commercial productivity, our innovation process and our strategic focus and alignment. I am impressed with the team's ability to execute these changes quickly, particularly given the distractions of the separation process. I want to extend my gratitude to our dedicated team members around the globe for another strong quarter and for their hard work overall, which is advancing our mission and driving us forward. This team continues to impress me as they make significant progress in executing the separation and advancing across all 3 phases of our transformation plan while delivering results that have already changed the trajectory of this business. Broadly speaking, this quarter has been one of the more eventful starts to a new year. We are actively navigating a shifting geopolitical landscape and rapidly evolving trade policies. While we are managing this turbulent environment aggressively, we are ensuring that our primary focus remains clear: delivering for our customers worldwide and investing in key areas that will support sustainable improvement in our growth. Just as I outlined at our Investor Day, we are fully committed to our growth and margin drivers to reposition this company for profitable growth and drive meaningful value for shareholders. Moving to our business segments, where progress and positive momentum continue, the MedSurg business had a very strong quarter. We continue to focus on the adoption of our recently launched V.A.C Peel and Place dressing in our negative pressure wound therapy business, one of our key growth drivers. This product simplifies procedures, reduces procedure time, and importantly, reduces the number of dressing changes per week, all meaningful advances for both patients and providers. The team has ramped capacity to meet strong demand, and our newly dedicated commercial team continues to drive momentum in this space. In MedSurg, the growth driver area of IV site management is also performing well, with our newly dedicated commercial team successfully converting key accounts during the quarter. Given our momentum in this area, we invested hundreds of millions of dollars for capacity expansion in the U.S., specifically in South Dakota, with strong support from the then Governor Kristi Noem. In our Dental Solutions business, we saw benefits in core restoratives, aesthetics, and recent product launches. Our differentiated brand recognition in Core Restoratives continues to resonate with customers and provides a solid foundation for growth. The recent launch of Filtek Easy Match and our refocused sales team supported solid growth in this area. The customer response to the Q4 launch of our first-to-market 3D printed Clarity Precision Grip Attachments remains very positive, enhancing our ability to offer a unique combination of dental and ortho solutions. Finally, our Clinpro Clear Fluoride Treatment launch continues to gain traction with strong demand in the quarter. The combination of these efforts has helped stabilize the segment even as overall market volumes remain challenged. In our HIS business, we focus on revenue cycle management, with our AI-driven autonomous coding technology streamlining the process to save customers time and money. Our HIS team is highly focused on leading the way in autonomous coding with innovative solutions, leveraging decades of trusted, high-quality, compliant coating. Lastly, our Purification & Filtration business saw another quarter of robust demand for our bioprocessing solutions, reinforcing confidence in the strength of the end markets. Our investment in additional capacity supported accelerated growth in the quarter. We expect to complete the P&F transaction by the end of 2025, and our team is diligently working for a smooth close and transition. At our recent Investor Day, I spoke extensively about our progress across the 3 phases of transformation. Our mission and values have been deployed globally and we are witnessing a deep understanding and connection from our team members. We've hired great talent across key transformation roles, and our separation efforts are on track. With our largest ERP cutover just starting, I want to thank our teams for their commitment. We are very aligned in executing our long-range plan focused on our 5 growth driver areas to expand our scale in attractive markets. Finally, once we close the divestiture of the P&F business, we anticipate executing tuck-in M&A. In summary, we're making steady progress on our transformation and are confident that the changes combined with our strategic plan will accelerate sustainable volume growth and ultimately deliver significant shareholder value. I'll now turn it over to Wayde to walk us through more detail on our first-quarter results and 2025 guidance.

Thanks and thank you to everyone at Solventum for the continued progress and strong start to fiscal year 2025. As you heard from Bryan, we're making meaningful progress on the 3-phase transformation plan as we complete our first full year as a public company. I'll focus my comments initially on a quick separation update before moving into our Q1 financial performance. Then we'll wrap up with our 2025 guidance update, including the impact of tariffs. Overall, the separation remains on track and we are executing against key milestones while delivering on our financial goals. To date, we have exited just over 30% of the more than 200 transition service agreements and we plan to exit all transition agreements over the next 2 years. In operations and supply chain, we continue to consolidate across manufacturing and distribution centers. We expect to significantly advance in our ERP milestones with 4 deployments planned this year, including our first major deployment in Q2. We want to thank our global team for their efforts in this large-scale separation. Now, turning to our Q1 results starting with sales. First quarter 2025 sales of $2.1 billion increased 4.3% on an organic basis compared to the prior year and increased 2.6% on a reported basis. During the quarter, foreign exchange was a 160 basis point headwind. Overall, we had stronger-than-expected volume performance driven by improved commercial execution as we align across the organization on our growth drivers. We also benefited from order timing related to customers buying ahead of upcoming ERP and distribution center moves. We expect this favorable timing benefit will be offset by year-end mostly in Q2 and Q3. The impact of SKU exits in the quarter was 30 basis points. Overall, our normalized Q1 organic sales growth estimate is closer to 2.5%. Pricing remains consistent, within our expected range and we are encouraged by the continued shift to positive volume growth across the businesses. Moving to segments, our largest segment, MedSurg, delivered $1.2 billion of sales, an increase of 6% on an organic basis. This growth was broad-based and led by the Infection Prevention and Surgical Solutions business which grew 8.2%. Our Dental Solutions segment delivered $328 million of revenue, an increase of 40 basis points on an organic basis, and we remain encouraged by the resilience of our dental portfolio. Our Health Information Systems segment contributed $329 million of revenue, an increase of 3.9% on an organic basis, benefiting from strong customer retention. The Purification & Filtration segment delivered $242 million of sales, an increase of 2.2% on an organic basis, led by bioprocessing filtration and industrial filtration. Gross margins were 55.6% in the quarter, slightly ahead of expectations and down 260 basis points compared to the prior year, reflecting increased costs related to our supply agreement with 3M. Our adjusted operating income was $407 million with a 19.7% operating margin, ahead of expectations. Our effective tax rate of 19.9% is just below the low end of our full year outlook. Overall, we delivered earnings per share of $1.34, ahead of expectations. We ended the quarter with $534 million in cash and equivalents and no outstanding borrowings on our revolving credit facility. We've made cumulative repayments of $400 million on our $1.5 billion prepayable term loans, with another $100 million paid off in March. For Q1, our free cash flow declined by $80 million, consistent with our expectations and reflecting planned payments and onetime separation costs. Now turning to our 2025 guidance update reflecting our strong Q1 performance to start the year. Our full year organic sales growth outlook is now a range of 1.5% to 2.5%, an increase of 50 basis points from our prior guidance. We anticipate a 50 basis point impact from SKU exits ramping throughout the year. The annual growth outlook, excluding this impact, is 2% to 3%. Regarding foreign exchange, we now estimate currency will have a neutral impact on sales growth for the year compared to the prior outlook of a 150 basis point headwind. For earnings per share, we maintain our initial guidance of $5.45 to $5.65, including estimated tariff headwinds impacting us during the second half of 2025. We estimate tariff headwinds of approximately $80 million to $100 million in 2025, translating to an EPS impact of $0.35 to $0.45. This will pressure our gross margin in the second half. We anticipate operating margins for the year will be at the low end of our planned range of 20% to 21%. Despite this, we expect to offset the impact of tariffs within our EPS guidance range. We are maintaining our free cash flow guidance of $450 million to $550 million. I want to reiterate our commitment to continued investment focused on long-term value creation while looking for margin expansion opportunities. In conclusion, we're building momentum, having delivered strong financial performance in Q1 as we execute on our separation plans. We’ll now hand it back to the operator for the Q&A portion of the call.

Your first question comes from the line of Patrick Wood with Morgan Stanley.

Beautiful. I'll leave the tariffs to everybody else because I can't survive talking about that topic anymore, so I'm going to go on the top line actually. How confident are you around that kind of 2.5% underlying? I say this because, obviously, the remaining core growth is at 4.6%. Obviously, we'll combine 4.3%, like a really, really strong quarter. Is this like a SKU level analysis or something like that? Because how confident are you that that's actually stocking from the customers and not just some of the commercial plans that you guys have been putting through and therefore is a little more durable than maybe you're suggesting?

Patrick, it's Wayde. We're confident. It's a number that's tough to predict beforehand because it's difficult to know how much customers are going to be buying in the timing of it. But after the fact, we've got good analytics. We work extensively with our distributor partners as well as our end customers to understand their order patterns. It is still an estimate. We specifically called it out closer to 2.5% due to some variability to it. But the 2.5% is a good number for us, and we think that’s the growth rate we achieved in the quarter. This is more than double the growth rate we had in 2024, so we’re very happy with the continued acceleration of the business across all 4 segments.

Yes. It's definitely faster than we thought. And then just as a quick follow-up, is it a fair assumption on our end to assume that the general price mix trends that you've seen in the previous quarter were consistent here? You hinted at that in the opening remarks but is it fair to assume that the entire delta is all volume?

Yes. We've been anticipating this for some time as we've got the business focused on volume growth which we think is the sustainable strategy. And so for pricing, again this quarter, we saw it in that normalized range for us, which is between plus or minus 1%. It’s not really the driver that we're focused on. It's all about volume growth for us from here.

Maybe just to start with thinking about the year ahead, to say it simplest, tariffs are a bigger headwind, you were very clear. But offsetting that is the business momentum and the lower FX. Can you help us at all think through the quarterly cadence as we adjust our models? Starting with the second quarter, last year, it was sort of flat sequentially but you have new products, you've got commercial momentum, etcetera. Help us a little bit directionally if you could.

I want to clarify, Rick, are you talking about growth by quarter, or what specifically are you referring to?

Can you report higher numbers in the second quarter, considering the positives against the negative impact of tariffs?

Tariffs don’t significantly impact us on the top line. The ordering ahead of the timing that we saw in the quarter was more associated with our ERP cutovers and plant distribution changes and SKU exits. That will come back in Q2, Q3, and maybe even Q4. Most of the impact will be in Q3.

Nice start to the year here, guys. I want to come back a little bit on Patrick's question in talking about that 2.5% underlying. Where are you executing? And were you seeing any additional buy ahead in April? Or did some of that draw down in April and early May?

The 2.5% compared to our expectations was above what we anticipated, and we are very pleased with that performance. It was the last time this company achieved that was in 2018, so we are very happy to see the performance in the quarter. The key driver is the benefits of enhancements to our commercial organization and the focus we now have. We need to keep that momentum going.

For Q2, we expect to see the majority of the order timing come back in Q3, but our expectations for Q2 are in line with those. We're currently in the throes of our ERP implementation.

I wanted to go into more detail here on the top line drivers, especially in MedSurg. As you look at it, both Infection Prevention and Advanced Wound Care are tracking ahead of your expectations. Can you unpack this a little bit for us?

The growth in the business is thanks to three key vectors: commercial execution improvements, existing brands in the marketplace, and new product launches. The urgency and focus on delivering what's committed is making a significant difference. The team is driving harder than before with several recognized and differentiated products that create opportunities for growth.

Congrats on a good quarter. I wanted to ask a little more on the tariffs in a way that you could help us think about the mitigation efforts, how you're offsetting $0.40 of earnings here.

The inventory turns for us are fast; we turn inventory in about 90 days, so we see the impact starting in Q3 and continuing into Q4. The estimated $80 million to $100 million in tariffs will be spread across these quarters. We're closely monitoring exemptions and working to optimize our inventory while evaluating selective pricing strategies.

It's Blake calling in for Vik. A clarification, the 10% you're assuming for Europe, sounds like you're not assuming that rate goes up after the 90-day pause. I want to confirm that.

We're assuming the 10% to and from the EU stays in place for the rest of the year. We're not making changes to that.

How should we consider the annualized tariff impact if we start by just annualizing what you’ve given for this year? Could it be higher or lower given mitigation?

It's really difficult to annualize right now. The tariffs are subject to change over time, and while we have mitigation strategies underway, it’s too soon to try to annualize the impact or evaluate 2026. Our goal is to manage the business and meet our metrics.

Maybe just a question on Dental for a moment here. Last quarter, you talked about you were taking share relative to the market growth, but this quarter, it looks slower. How do you think you performed relative to the market in Dental in the first quarter?

We performed pretty well. We are in resilient categories; even in challenging times, people will take care of dental issues due to pain or aesthetic concerns. Dental innovation launched recently is giving us a tailwind for the year, and we fully expect that to continue.

I'm curious if you could help us characterize how much of the tariff impact is tied up with the P&F business?

We're not breaking that out as we’re guiding for the whole company. We're expecting Q2 to be strong like Q1, planning for operating margins to be above 20%. The second half will see more pressure from tariffs.

Great. Thank you Amy and thank you everyone for listening and for your questions. We appreciate your interest in Solventum. If you do have any follow-up or need anything else, please don't hesitate to reach out to us directly. This concludes our first quarter fiscal year 2025 conference call.

Thank you. This concludes today's conference call. You may now disconnect.