Good day. My name is Ellie, and I will be your conference operator for today. At this time, I would like to welcome everyone to the Solventum Second Quarter 2024 Earnings Call. As a reminder, this conference is being recorded. [Operator Instructions] 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.

Good afternoon and welcome. Today, we will discuss Solventum’s second quarter fiscal 2024 results, along with an update to our 2024 outlook. Just after market closed today, a press release was issued with our earnings results and updated outlook. The press release and earnings presentation are available on the Investors section of the Solventum website. Joining me today are Bryan Hanson, our Chief Executive Officer; and Wayde McMillan, our Chief Financial Officer. During the call, we will be making forward-looking statements that are subject to risks and uncertainties. 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 the presentation. Please note that during our discussion today, all our comments will 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. For the Q&A portion of the 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.

Alright. Great. Thanks, Kevin and thanks to everyone for joining us today. I’d tell you it’s exciting to be here for our first earnings call as a publicly traded company, and I want to start that call by saying that I’m encouraged by the progress that we have made and with the results of the quarter, which reflect our ability to come together as a new team and maintain business continuity in the midst of the separation. And we’re raising our full-year outlook as we continue to progress our plans to get this business to where we expect it to be. Simply said, we are moving with urgency, and we remain confident in our ability to create value. And for all the Solvers that I know are listening out there, I want to say thank you. It’s your hard work that has gotten us to this point. Make no mistake, this would not be happening, we would not be here without you. And for the call today, I’m going to provide a brief reminder of our Investor Day presentation, specifically around our situation analysis and reasons to believe in the value creation story, as well as a reminder of and update on our phased approach for the transformation and turnaround. And then I’ll pass it over to Wayde for a deeper dive on the quarter and our improved outlook for 2024, and of course, we’ll save time for Q&A and certainly look forward to that conversation. As some of you may be new to the story since our Investor Day in March, let me start by giving some background on Solventum, our team and again, why we’re confident in the value creation story. And I think the right place to start is the spin itself. We’ve talked about this before,…

I’ll start by echoing Bryan’s sentiment and thank everyone at Solventum for their hard work, getting us to where we are today. Our 3-phased approach is designed to create significant value over time. I’ll keep my remarks mostly focused on updates related to Phase 1 and separation activities before getting into Q2 performance and then wrapping up with guidance. To separate, we have significant efforts underway. We’re moving our manufacturing lines from 67 plants to 29 Solventum plants, 2 of which we’re building new at this time. We’re also separating our distribution and supply chain by changing from 122 to 73 distribution centers. Our rebranding efforts are significant across 90 countries. We have changed our commercial distribution models in over 60 countries. The IT work streams may be the most complex as we’re working to transition over 1,000 systems and stand up over 70 new platforms including our new SAP ERP system globally. In parallel to the separation work, we are already making progress on the turnaround, which is centered on improving revenue growth and expanding margins. It’s important to understand the historical baseline and I’ll provide some background for each metric as well. For revenue, we have historically underperformed our mid-single-digit markets with flat and declining volumes over the past 2 years. This was clearly reflected in 2023 and where price was more than all the revenue growth for the year. As we move out of a hyperinflationary period and price normalizes, we are intently focused on turning around the negative volume growth. Bryan covered the Solventum Way restructuring project, which touches every segment, function and region in the company. This effort is ongoing and will be an important part of our investment to reposition for growth and margin enhancement plan. Additionally, we remain focused on a comprehensive global…

[Operator Instructions] Our first question comes from Travis Steed from Bank of America. Your line is now open.

Hi, everybody. Congrats on your first earnings call. I guess, Wayde, I wanted to start with the guidance raise and really understand kind of all the moving parts there. I guess a lot of the EPS raise came from the tax, but it sounds like things are maybe been tracking ahead of plans and pushed the SKU rationalization to 2025. If anything, are you kind of more confident in kind of the outlook here quite kind of drove the guidance raise and how to think about Q3 and second half modeling for the different line items?

Hey, Travis, this is Bryan. Maybe I’ll start with some of your questions, particularly around just some of the confidence we have and what’s kind of pushing our guide. And then Wayde, I’ll pass if you, you get into more specifics there. So obviously, three components that Wayde talked about that are driving our guide and, really, our confidence. The first is just the business continuity is feeling pretty good right now, and we’re making great progress against our plan. That’s number one. Number two is Wayde referenced in his prepared remarks, it’s just the backorder recovery that we banked in Q2. And then the SKU clarity, and Wayde will talk more about that in a second, but we just have better clarity of the impact we’re going to see in 2024 versus 2025. That’s broad-based what we’re feeling right now, and that’s the reason for the guide change. I think importantly, though, just to maybe click down in the business continuity and progress against our plan. It doesn’t feel like a long time. It’s only been 4 months now, but those are pretty pivotal months in the separation. A lot can happen in those months. And for the most part, we delivered in pretty much every primary area during that time. And I think most importantly, business continuity. That’s where the biggest risk is. And every day that passes, Travis, we just feel better about reducing risk, retiring risk and then further executing on our turnaround strategy. I guess probably the simplest way to say it is a lot could have gone wrong and it didn’t, which is great. It doesn’t mean it’s going to be simple from here, but the momentum is positive, and that drives our confidence. But probably equally maybe even more important than that is we’re really moving fast in talent acquisition. And I think probably anybody would recognize that you don’t really want to put a strategy in if you don’t have the people in place that are accountable for the strategy. So the faster you can move to put people in place, particularly in L1 and L2 positions, it’s just critical to formulating the strategy, having ownership of the strategy and then eventually, that flawless execution of the strategy. So those are the things that we feel like are moving in the right direction, increasing our optimism. And hopefully, that’s reflected in our tone in the guide. So maybe with that way, we can give a little more color on the other components.

Yes, sounds good. Happy to pick up on sort of how we’re thinking about guidance here and SKU project. As Bryan said, we’re really pleased to be in a position where we can raise our full year guidance after just our first stand-alone quarter here as a public company. So let me talk about the new range. Really built off the back of what we called out in the quarter here, in Q2, revenue was totally ahead of our expectations because of the backorder reduction that we got, and that was from an improvement in service levels. So positive signs, as Bryan said, for business continuity. So the new range then contemplates normalizing the second half for that – for the price benefit that we’ve been seeing and it continues to wane into the second half as well as a tougher comp for that back order recovery. When you normalize for those two things from the first half, the high end assumes we see improvement in the business. And then near the low end assumes a more consistent performance. So we feel real comfortable with the range here that we have for the second half. It’s early days, but we are pleased with the business and its performance to date through the first half of the year, really, with the second half to go. And just keeping a focus on that number one priority for us is our growth driver strategy. A little color down the P&L. If we think about gross margins, we mentioned in the prepared remarks, a couple of things that drove costs higher in the quarter, both the international costs and some unfavorable mix in MedSurg, really, around the margin on those backorder recovery products. And so lots to consider, puts and takes. It could be…

Great. Thanks for all the color. I guess the next question I have is, thinking – or – kind of when can you guys start growing earnings again? I know 2025 is kind of a down year. But if you think about the plans that you have, is ‘26 a year where you potentially could grow earnings? And I don’t know if there’s any way, high level, to think about some of the things that you have to deal with in ‘25 and some of the headwinds you have in ‘25, like the SKU rationalization and kind of help us size some range of impact on that.

Wayde, if you want to provide a little more color on the – some of the pressure points in ‘25. Obviously, Wayde talked about it in his prepared remarks, ‘25 has got some unique annualization of expenses that are going to put pressure on us. And you’re right, ‘25 is going to be a tough year for EPS. But we absolutely would expect that to begin to recover in ‘26. We’d be extremely disappointed if we didn’t start to head in the right direction in ‘26. So Wayde, I don’t know if you want to provide anything more in ‘25. I thought you provided a lot in your prepared remarks, but…

Yes, I certainly can. I’ll have to say, we’re not guiding to ‘25 and ‘26 yet. There are certainly a lot of moving pieces as we’re in our first year post separation. We do have a lot going on to grow revenue and expand margins. And as Bryan said, resulting EPS growth over time. However, we do think it’s well understood that we’ll be pressured by the annualization of some of these costs post spin in 2025. So, just to list them, we have got the 3M supply markup that will annualize. We will be annualizing our stand-up functional expenses. And then below the line, we will be annualizing interest expense. And all of this is because we have got three quarters this year as a public company, and we will annualize our fourth quarter next year. And then I did mean to touch on the SKU project as well because this one is just great, great progress out of the gate, real nice start. We found that there was a lot of opportunity to take out a significant number of SKUs already in our first wave here. And the good news is they don’t impact revenue in a material way. There is a very small impact. We don’t expect them to impact margins or revenue in 2024. And the real benefit is it will help us simplify the supply chain. We will save a few million dollars on rebranding as well because we don’t have to rebrand these SKUs that had very low value to us. So, the team is continuing to work on the next wave, which we do anticipate will have more of an impact on 2025, but that work is still underway, and we don’t have an update there yet.

Great. Thanks a lot.

Our next question comes from Vik Chopra from Wells Fargo. Your line is now open.

Hey. Good afternoon and congrats on a nice quarter. A couple for me. So, by math, the revenue guidance raise as about $80 million to $150 million of dollar upside to 2024, maybe just help us understand what business segments are driving this? And then I had a follow-up, please.

Yes. Vik, happy to take that. We don’t break it down by segment. But what we can say is that the message that we put into the prepared remarks was the most important one. There is a good amount of risk as we separate the business and business continuity and we gained a lot of confidence. It would go from a long ways from having no quarters to having one quarter. As Bryan mentioned, it was a pivotal quarter for us. That’s where the confidence really grew. And so it’s really across the board that we are thinking that we are going to see some strength. Obviously, the backward recovery in MedSurg was a good size. I think Bryan called it banking it in the second quarter here, a good sized bump for us. And so with that, the business continuity and then also the SKU reduction program, we don’t think it’s going to have as much of an impact on ‘24. That would be just across the three segments with products, not including HIS.

Yes. I might just add to that, too. If you think about, really, four vectors, and I won’t go through all of these, but there are four vectors that you can accelerate growth with. And it’s no – there is no rocket science here. They are pretty basic. But for the things you got to do to drive it, one of the first things you can do, the fastest impact is just upgrading talent to drive better commercial rigor and just changing incentives to your – for your commercial organization to focus on growth. And those are the things we can do right now, right. We are bringing in great people. We have accelerated and promoted people that are very capable in the organization and brought people from the outside. That will have a dividend pretty quickly, because they will increase the rigor and accountability in the organization. So, that, we would expect to help us in the back half of ‘24 and certainly into ‘25.

Got it. Very helpful. And then just my follow-up question, can you just share some high-level feedback on your conversation with the activist and just provide an update as to how much of a stake they have actually amassed? Thank you.

As you would imagine, as a public company, we don’t talk about any individual investor. That said, as a public company and humble people, we absolutely listen to our shareholders and appreciate the feedback, but probably no more to say about that. Next question please, operator.

Our next question comes from David Roman from Goldman Sachs. Your line is now open.

Thank you and good afternoon everybody. I hope to get one in here on the financial side and then one follow-up on the strategic planning side. Maybe just starting on – with respect to the outlook for the balance of the year, I am trying to put together some of the moving parts as it relates to first half versus second half. And maybe, Wayde, you could help us bridge, a little bit, the commentary around the reiteration of the 21% to 23% operating margin. That’s roughly what you did here in the first half with some of the commentary around the 3M supply agreement, as well as the incremental investments and what that implies for sort of an exit rate for the year. And then, as I look at free cash flow year-to-date and the updated guidance, it implies a significant step-up in cash utilization here in the second half. Can you maybe help us understand some of the moving parts there as well?

Sure. So, just to cover a little bit more, David, to your question on first half, second half outlook, I think I have touched on revenue, a good amount there, just highlighting that we had a couple of items in the first half that won’t repeat in the second half pricing, waning and then the back of recovery, which is opportunistic and we don’t anticipate seeing that in the second half at this point. And so that’s what gets us our revenue growth rate, and it’s a zero to 1% for the year. And so you can do the math on that for the second half. I do just want to highlight from our prepared remarks that there is a comp – significant comp issue between Q3 and Q4, so that’s important for revenue. You mentioned bridging the – and the exit rate around operating margins. The way we are thinking about this is Q2 had some headwinds in gross margins and operating margins for us. Those are offset with the favorability in revenue. And so that’s what gives us confidence to hold the 21% to 23% for the year. We are not going to comment on an exit rate at this point. We are not giving the quarterly guidance. Obviously, we have just got one quarter under our belt. And we have got long ways to go. We are just not going to get to that level of detail. But what we can tell you is we had gained a lot of confidence in the quarter, and we learned a lot about the business post separation. So, it’s building confidence and that’s what allowed us to raise both the top and the bottom line here before we – just after our first quarter. You mentioned cash as well. I would say probably the biggest things that we are managing here post separation is just all of the timing of the intercompany work that we are doing as well as standing up our capital expenditure processes. And so we do think we will be using more cash in the second half of the year to settle out some of those as well as ramping up our capital expenditure use in the second half.

Got it. And then Bryan, I appreciate your comments on kind of being ready to share more with us on the fourth quarter call. But I think you have made comments in other forums about kind of the turnaround on the top line being roughly a 5-year period of time. Can you maybe update us on any thoughts with respect to that outlook and how that falls into the context of the phasing of the different parts of the Solventum turnaround that you referenced earlier?

Absolutely. And good to hear from you. So, I would say – I will repeat a little bit of what I said and then maybe add some additional color. I see this as an opportunity for us in our strategic plan to very clearly articulate what markets and some markets we are going to care about, right, we are going to double down in. And those will be our faster-growth markets, as you can imagine. We are working through that and I would expect to pick those by the end of 2024. Once we do that, that begins the shift of resources, commercially, R&D, M&A when we get to that point. And that begins to drive traction and focus in those areas. That just takes time, but maybe I can double-click on the revenue growth accelerators. I referenced that there were really four of those. And it just – again, there is no secret sauce here. If you have ever run a business and you turn one around, you drove revenue acceleration, these are the things you have to do. It’s just a question of doing them and how much time they take. And so I will just kind of start with the first as I referenced, getting great people in place that know how to drive rigor in a commercial organization is paramount, and it’s the fastest way to drive revenue growth. Second fastest way is commercial structure changes, either specialization or just increasing reach in those important spaces that we are going to concentrate on. Third, as you would expect, would be increasing the productivity of R&D. We have to do less of these iterative approaches in R&D and more impactful, more meaningful launches inside of the high-growth areas. And then probably in parallel with that would be…

That’s great. Appreciate it. Thank you.

Our next question comes from Vik Chopra from Wells Fargo. Your line is now open.

Hey. Just hopping back in queue for a couple of quick follow-ups. That $22 million of corporate and unallocated revenues, do you expect those to continue going forward? Should we be building those into our revenue projections?

Yes, I am glad you asked that one, Vik. An approximate number to the $22 million for the rest of the year, yes. So, in other words, that’s a good estimate for the next couple of quarters this year.

Okay. So, build out $22 million roughly for Q3 and Q4. Got it. And then I don’t think I heard an updated FX assumption for the year. Can you help us out with that? Thank you.

Oh, FX. So, we are – we just use the current FX rates at this point for the following – Kevin, do you actually have that?

Yes. So, right now, the last assumption we provided from a revenue perspective is 50 basis points of impact. We did not update that. So, it’s safe to assume that, that’s still our best guess.

And the way we do that, Vik, is we just take the current rates approximately right now and apply that. So, we are expecting 50 basis points for the full year.

Got it. Thank you very much.

Our next question comes from David Roman from Goldman Sachs. Your line is now open.

Thank you. Appreciate you are taking the additional questions here. Just maybe a few clarification items, maybe, Wayde, starting with the tax rate. I know you talked about some catch-up items that had occurred in the quarter. But I think as you look at the year-to-date tax rate and the updated guidance, it kind of puts the tax rate in that 20% to 21% range in the back half of the year. I guess is that a fair characterization of where that should land? And then secondly, you did make a passing reference to restructuring. Are you already at a point where you are ready to start rationalizing down costs? And is that – how is that impacting your outlook here?

Sure. I will pick up on tax rate and then, Bryan, if you want to talk about some of our strategies, so that’s probably the right way to take it.

Yes.

So, for tax rate, you have got it. Basically, we have had better than expected tax rate for the first half of the year. We had a pretty sizable year-to-date catch-up here in our first quarter post separation. And the second half is similar to what we expected for the full year when we gave our full year expectations. And this is one of the areas that has to settle out a little bit as we separate and our tax team is hard at work at it. So, that’s what we are comfortable with for a guide at this point. And then from a restructuring standpoint, Bryan?

Yes. Great question, David. Glad you asked it. The – so what I would tell you is our work is – we do feel like we are in the right position to start this project. And I think it might be – it might surprise you, actually, the primary reason for it. So, there is really two in my mind, but the one that comes to me is the most important is the restructuring is focused. We are calling it, again, Solventum Way. It’s focused on streamlining our structure so that we can complement the cultural shift that we are putting into place. We are going to change the culture of this company. We are going to look for speed. We are going to move faster. We are going to be autonomous. And we are going to drive accountability in the organization. You have to have the right structure to drive that culture shift. And I promise you, when we do it and we are doing it today, it will turn into growth. That drives growth in an organization. And as we know, growth drives the leverage in an organization in a really sustainable way. The second part of a program like that is what you would normally do in the business and Wayde and I have done it in the past, it’s to allow us the headroom to not only invest for growth, which we have to do, that’s a primary area of focus, but also drive margin expansion. So, we absolutely feel like that’s the right thing to do now for those reasons.

Bryan, I think you covered that really well. I will just add, I think part of the question was around timing and just maybe to reflect back on the Investor Day in March, where we laid out our four key actions for value creation and we talked about driving efficiencies to fuel the investment that Bryan just covered, and so no change in strategy, just sharing more about our efforts as we go here. Revenue growth remains the top metric for sure. But as Bryan said, driving efficiencies will help us first fund additional growth initiatives as well as we look to expand gross margins over time.

Alright. Got it. Thanks for the clarification.

Okay. It looks like there are no further questions. So, I will close it by just saying thank you so much for joining us on our first public call, and we look forward to engaging with many of you over the coming months. Thanks and have a great day.

Thanks so much.

Thank you everyone for attending today’s conference call. You may now disconnect. Have a wonderful day.