Sotera Health Company (SHC) Earnings Call Transcript & Summary

All right. Hello, everybody. Thanks for joining us today. My name is Casey Woodring from the Life Science Tools and Diagnostics team here at JPMorgan. I'm pleased to be joined here today by Sotera Health CEO, Michael Petras, is here to my left. There will be a Q&A portion following the company presentation. So with that, Michael.

Great. Thanks, Casey, and good afternoon, everybody. Thanks for joining us. We'll get through forward-looking statements. Some of the statements I'll make today may be considered forward-looking statements. Please refer to our SEC filings for a description of the risks and uncertainties that could cause our actual results to differ materially from projected or implied. The company assumes no obligation to update forward-looking statements. During the discussion today, we may talk about certain non-GAAP financial measures, including adjusted EBITDA. And you can refer to our SEC filings for a reconciliation of these measures as well. So what I'll do today is I'll give a brief overview of the company, talk a little bit about the financials as well. We did -- we have a couple of things that we pointed out this afternoon that you may or may not have seen in the public markets. We reconfirmed our revenue guidance that we gave at the end of the third quarter. And then we also just within the last hour, announced a settlement for the litigation in Illinois around ethylene oxide. So I'll touch upon both of those briefly. I will not get into a lot of details on the fourth quarter or 2023 projections. We will do that on February 28. So first, overall, overview for the company or driven by our mission of Safeguarding Global Health. Many you may or may not know that the words Sotera comes from the Greek goddess of safety. And that's really what the company stands for Safeguarding Global Health is really our mission. When you look at the company and what we do for some of you that aren't as familiar with the company, we've got 3 operating business units: Sterigenics, Nordion and Nelson Labs. In the sterilization services side, we have Sterigenics and Nordion. Sterigenics is the largest business entity that we have. And in this business is where we sterilize medical devices and pharma products. So customers make the products, the big med device pharma companies make the products, package them up and ship them out to point-of-care, before they get to the end use or the point-of-care, it goes through one of our sterilization facilities around the world, and we do terminal sterilization to make sure there's no microorganisms and the products are safe. One of the key ways you sterilize is with Cobalt, Cobalt-60. Nordion is the world leader in supplying Cobalt-60 to the sterilization market. They sell to not only Sterigenics but also the competitors to Sterigenics. This is the only one of our businesses of the 3 business that's a product business. The other 2 are service businesses. Getting to that point, I'll go to the third business that's Nelson Labs. Nelson Labs is our microbiological and analytical chemistry testing lab and advisory services business. This is a service business, similar customers that we have in the sterilization services. And this business, we test products to make sure they meet the regulatory requirements and they're safe. How we do all this is we have customer relationships, blue chip customer relationships. We do business with the top medical device and pharma companies in the world. We have a global network of facilities that is in close proximity to our customers. We have over 60 facilities around the world. We have deep expertise, regulatory and technical expertise. You don't just wake up tomorrow morning, so you want to get the Cobalt-60 business, the sterilization business. There's a lot of complexity, a lot of regulatory requirements, and this is what our team has a lot of breadth and depth in. We have leveraged for both organic and inorganic growth and the foundation of the company is really the value, strong values and accountability and really how we look at our people and what they can bring to the company around customer focus, operational excellence and how do we make the company better every day but operating with very high integrity. What does this all lead to? It leads to a phenomenal business that has had revenue growth every single year since 2005. We've got TTM through the third quarter. Our adjusted EBITDA margins are greater than 50%. That's 50 is in 5-0. So 50-plus percent adjusted EBITDA margins. We have a $33 billion TAM. This is a business that cash flows several hundreds of millions of dollars a year. And I can tell you, it's a very difficult business to replicate. You want exposure to healthcare. This is a great business because we're not tied to pay reimbursement. We don't sell the GPOs. We don't sell them to a hospital channel. It's a very unique business. So that's just a little bit of an overview. On this page here, you see all the different kinds of medical devices and pharma products that we come in constant contact with through our medical device sterilization business or in our testing, same thing with pharma products. Again, we're all the blue chip customers, now 40 of the top 50 med device companies enrolled, they are the top 10 global pharma companies enrolled, they're customers of ours. And we play a really critical role in supply chain. We're kind of behind the scenes, not a lot of people know about us and what we do, but we play a critical role in making sure these products are safe and getting to market. I mentioned briefly our TAM and SAM. We've got a $33 billion TAM that we play in. And of that $11 billion is a serviceable addressable market today. And you can see on the right-hand side how it's broken out, over $3 billion is terminal sterilization that Sterigenics and Nordion play in. And then you've got about $7 billion in testing. That's in the lab testing side for both pharma and med device. This is a really big market, lots of opportunities for growth organically, and that's why we're so confident about our ability to continue to grow on the top line year in and year out. Speaking of growth, I'll talk a little bit about the long-term growth and how we see this business playing out in high single-digit organic growth. First, I'll talk about volume and mix. So we're seeing mid- to high single-digit volume and mix across the businesses. If you look at Sterigenics, they in particular, in that business is mid-to-single -- mid- to high single-digit growth on volume and mix. Nordion is on the low to mid-single-digit growth in volume and mix. And then Nelson Labs is in the mid- to high single-digits in volume and mix. One of the characteristics about this business, it's really unique is we get about 3.5% to 5% price per year across all 3 of these businesses. That's right, 3.5% to 5% price. You may have seen in the previous chart I referenced, one of the benefits is critical -- mission-critical service we have, is the fact that this is a very small percent of the product cost for the customers. It's less than 5% of the cost. We get 3.5% to 5%. Typically, you've got Nelson in the lower end of that range, Sterigenics in the middle of that range and Nordion in the high-end of the range. When you add that all up, you have a business that grows organically high single-digits year in and year out. We -- if you look at our history here, we've been able to expand margins on a consistent basis. There's 3 opportunities that really help us drive that. It's the operating leverage within the business model and how it plays out. It's our operational excellence, all the work we're doing with [ Kaizens ] and other opportunities to really run more simplified operations. And then lastly, the price that I just referenced on the left side of the chart. So this delivers high single-digits. And as I mentioned just moments ago, also, we're talking about 50-plus percent adjusted EBITDA margins. Talking about the financials and a little overview on how the numbers come together and our long-term value creation. If you look at our revenue over the last several years, starting back in 2019, some of you may not be as familiar with the company. We went public in November of 2020. In 2019, we were $778 million of revenue. And through September 30, 2022, we're at $993. So you can see consistent revenue growth. Again, as I mentioned earlier, we have relationships and long-term contracts with the largest global medical device and pharma companies. Our top 25 customers, they have an average tenure of over 10 years with us, and they use multiple facilities of ours around the world because really what's important for them is to have access to our quality systems and the reliable service that we're able to give them and they're able to rely upon us anywhere in the world. 90-plus percent of our sterilization sales or $660 million plus is tied to multiyear contracts. So not only do we have 3.5% to 5% price a year, we also have multiyear contracts, typically 3 to 5 years in duration. And over $660 million of our approximately $1 billion in revenue is tied to multiyear contracts. On the adjusted EBITDA, the right-hand side of the chart, we have really differentiated service capabilities that allow us to continue to perform in these highly regulated industries. You see in 2019, we had 48% margin. And through September 30, we had 50.5% adjusted EBITDA margins. As I've mentioned earlier, we've got operating leverage, we get price that falls through in operational excellence, but the business continues to perform in margin expansion. I didn't touch upon it on the left-hand side of the chart, but on the price side, we have a pretty good model in being able to offset inflation with the way our contracts are built. Our business, when you reflect on the past year when you saw this rapid inflation, we really see inflation in a couple of key areas. One would be on wages like most companies had wages. The second one would be on our utility spend in some of our facilities. And then the third place would be on construction costs as we continue to expand capacity. Those are the 3 areas, but we feel very confident in our ability to offset that pricing. There might be a little bit of a timing delay between when contracts coming up for renewal and some of the realized inflation. But overall, we have a pretty strong solid record of being able to continue to deliver price year in, year out to offset inflation. On capital expenditures. I'll tell you a little bit about this business. If you look at our 3 businesses, all 3 businesses take capital to continue to invest for growth. Over 60% of our CapEx last year was directed towards growth investments. If you look at 2020, it was a little bit slower on investment because of the pandemic and some of the delays that were built within that, but if you look at 2022, we've got a pretty healthy record of $152 million of investment in CapEx, and that's really directed towards Cobalt development projects with the Nordion team in conjunction with utilities, also significant facility expansions within the Sterigenics business where we had 3 capacity expansions go live in 2022. We'll continue those investments in '23. We're making significant investments in our ethylene oxide emission controls, and Nelson Labs continues to perform very, very well in extractable and leachable space. We continue to make investments in that side of the business as well. On the right-hand side, you could see our net leverage reduction. Prior to going public in September of 2020, we had 7.2x leverage. We've worked our way down as we committed. We've communicated we would be the 2 to 4x net leverage area as a long-range target. Through September 30, we were at 9/30/2022. We were at 3.3%, I'm sorry, on September 30, 2022. So we're committed to that long-range target. One of the things I do want to address, I mentioned earlier today, we put out a press release. One of the things that we've been dealing with as a company is a litigation around ethylene oxide, particularly in Illinois. And we reached a global settlement today on resolving approximately 870 claims in Illinois. To date, we had one unfavorable verdict, and we had one favorable verdict. We chose as a company to reach a settlement on this, and it's a global settlement for all the cases, including the ones that we had a runaway verdict down of $360 million. In total, the company has agreed to pay $408 million to resolve all 870-plus claimants in Illinois. The settle agreements are going to have conditions that have to be met, including opting and consent of substantially all the claimants in Illinois. So the plaintiff firms have agreed to a 98.6% participation rate across all the complaints. The one thing I want to make sure it's very clear to everybody is all these facilities continue across the Sterigenics platform to operate in compliant in a safe and reliable manner. Okay. There's no mission of liability here. We felt it was the right thing to do to get this litigation behind us because we've been subject to bias media coverage in Chicago market for several years that was not helping the company. We would have been required to put up a $550 million bond to challenge 1 verdict in the Kamuda trial. It's a lot of money. We had the money to do that, but it's a lot of capital. And then lastly, the number of cases that were still left out there was a lot of capital for us to deploy. We just felt that this was the right decision for all stakeholders. So we could turn the page and continue to move it forward. So it's a $408 million settlement for all the cases in Illinois. It helps us avoid the ongoing defense and a pellet costs. We will take a charge to 2022 earnings. It will be going below the line. We do believe this is a tax-deductible action. And as I referenced just a moment ago on this chart, we will go ahead and take on some incremental debt in the first half of 2023 to help cover the costs associated with this. We do have smaller levels of litigation ongoing in Georgia and New Mexico, but these are not impacted by this. The majority of our cases, we're sitting in Illinois, and that's why we chose to settle this and get this behind us. Kind of wrapping up here about the company. This is a phenomenal company. When you look at -- I'm going to drain this slide a little longer than I typically do because some of you -- I don't recognize a lot of the faces in the room, and I want to make sure people understand how great this company is. It's got a strong financial profile. We've had revenue growth every single year since 2005, greater than 50-plus percent EBITDA margins. We have excellent visibility in the majority of this company. Significant barriers to entry. As I mentioned earlier, you can't just walk in, go down the street and say, "Hey, I'm going to buy a couple of containers, I'm going to get a couple of wagons and I'm going to start shipping Cobalt around the world, okay? That's not how this works. That is really a core competency of that business as well as all the regulatory requirements in the testing and sterilization side of the business across Nelson Labs and Sterigenics. So significant barriers to entry. We have a large and growing addressable market, a $33 billion TAM, strong industry dynamics where our customers rely on us and all the things we do in these essential and highly regulated industries, we're a trusted partner for the 65 facilities we have around the world. One of the other things I didn't talk a lot about is our expert advisory services. If you haven't had a chance, you ought to go out and look at Sotera Health Academy on the website, there's a lot of customer engagement in that area where they come to us to help them get through regulatory problems or challenges with different agencies. That's really a strength that helps lead to downstream testing or sterilization services for the company. We have strong operational excellence across the teams and helping expand margins. We've done many acquisitions, 2 transformational deals with Nelson Labs in '16, Nordion in '14, and we've done 9 bolt-on acquisitions. We see lots of opportunity for inorganic growth in addition to the high single-digit organic growth that I referenced earlier. And we have an experienced management team. So those are all the prepared remarks I have. Casey, I'm happy to take time and answer any questions.

Great. Thank you. That was a great overview.

Maybe I'll sit down. I had knee surgery, my body parts are all wearing out and realizing the warranty goes. So I'll take a minute to sit. Yes, Casey, go ahead.

Now we'll start the Q&A session. If anybody has a question please feel free to raise your hand, and we have a mic runner in the room to take your question. And then if anybody is listening on the webcast, please feel free to submit a question via the conference portal. So Michael, yes, just to get started here a few on the recent announcement. Can you just explain the settlement in a little more detail? Is this a final settlement? Or is it a proposal? Can you just walk us through what the next steps are for a full resolution and the time lines behind them?

Yes. We signed a binding term sheet of the plaintiff executive committee. So what -- there's 873 cases. And what we'll do is they now will go out, we're going to first go to the court today or tomorrow morning, probably more likely tomorrow morning based on the East Coast time or Central Time. And the courts will go stay on all the existing litigation in Illinois. Then the plaintiff's firm will appoint a claims administrator. And the claims administrate will take about 90 days to go ahead and evaluate all the cases in a sign of value to them for each of the plaintiffs. And then the plaintiffs have approximately 30 days after getting that value to opt-in or opt-out. And then once all those are accumulated, they come back to us for final 15 days to review that. We have to fund a settlement fund by May 1, which we're prepared to do to deliver the $408 million. They have a small building, as I referenced earlier, to opt out some of the plaintiffs, approximately 12%. So if it's -- it's about 98.6% of the plaintiffs have to opt in. If they don't, we can walk back from that.

Have you done any sort of analysis to see what percentage of plaintiffs would opt in or opt out? How confident are you that this is a final resolution? And is that 98.6% number achievable?

Yes. We feel pretty confident based on the representations from the plaintiff firms, representing the plaintiffs.

You mentioned that you can elect to not proceed with the settlement if any of the plaintiffs who opt out meet certain criteria. What are those -- what is that criteria? And is there any risk there?

Yes. We'll have a more detailed filing an 8-K tomorrow morning on this, but -- because it just happened after the deadlines tonight. But basically, there's a couple of paths that we could walk away if we felt and they would be if more than 12 people opt out. Also, we had some conditions certain kinds of cancers, close proximity to the facility that if someone was half a mile away and they chose to opt out we have an ability to walk away from this as well. In addition to that, if the claims administrator finds that 40 of the plaintiffs do not have legitimate claims that gives us an opportunity to reevaluate as well and then also if the courts do not approve the settlement. But again, we feel confident that this will get resolved based on the representations from the plaintiff firms.

I'll just pause here for any audience questions.

Michael, you just talked about New Mexico and Georgia, and you were comfortable with where they stood, but why would there not be more sort of similar even if lesser settlements in those states?

Yes. Each of these jurisdictions are a little bit different. I mean I look at Illinois, when you factor in the media coverage and the politicized nature of that, you factor in the Illinois court system and some of the requirements there about causation, expert defense that you're able to put on. It's a different standard, particularly in Georgia, is a very different standard. And then I would tell you another point around besides causation requirements to experts. The last thing I would also tell you in Georgia is there's a cap on punitive damages there as well. And it's just different jurisdictions. Many of us know the Illinois system is a little challenging. And we feel pretty good about where we're sitting in Georgia. There's about 300 cases approximately there. But again, there's some significant differences in that -- the standards required there.

Does this sentiment prevent future point is from bringing lawsuits against Sotera in Illinois? Or would this completely resolve the Willowbrook?

No. So there -- they could -- if somebody is newly diagnosed today, they could bring new claims, yes.

I have a follow-up question on that. Could you talk about the possibility or likelihood of future plaintiffs from other states besides Georgia and Illinois?

Yes. Again, one thing to keep in mind, all these facilities are operating in a safe and compliant manner, right? And we've got litigation in Georgia, very different kind of nature, as I just mentioned. We're going to continue to operate these facilities in a safe compliant manner. This is a broader industry. We're looking forward to the new requirements coming out in 2023. The government has informed us that we'll see new standards in 2023, so we're hopeful for that. And it will also help reinforce the compliance and the improvements that we've been putting in these facilities. I'm sorry, I don't know if you -- it's hard to see you back there with the light, but okay. I didn't know if you had another question, sorry.

Any other questions from the audience?

Yes, thanks. Just to help you get off the subject of litigation maybe. On your strategy, at the end of your introduction there, you mentioned, I think, some of the sort of regulatory services you have within your Nelson Labs. I think it was, you said, I guess, on things like quality, compliance, these sort of areas. Is that a focus of your strategy going forward to grow that? Or is that just a sort of peripheral service offering?

Yes. So thank you for the question. So we have our expert advisory services. We also made an acquisition of RCA, Regulatory Compliance Associates. This is an area that is very important to us. We've put the resources across the company together at Sterigenics and Nelson to go service that market, and we could help with many different facets of our services in helping customers get through regular requirements and also helping them with some of their facilities and some of their processes. So yes, this is an area that's been growing for us, and we see that continuing in the future.

Looks like we have another question from back there.

Two questions. One, can you just confirm that the first case, the $360 million, that is a part of the $400 million? And then the second question is how many lawyers did you solicit feedback from and how many cases do those layers represent?

So yes, to answer your first question is the Kamuda verdict of approximately $360 million is part of the $408 million settlement. And the second question you asked was about the plaintiffs. So there's a plaintiff executive committee or executive counsel that represents the vast majority. I think it's 85% to 90% approximately the case of the plaintiffs that we're representing in the negotiation because there were so many lawyers involved that they pick and put a committee together to represent the negotiation.

Got it. And does that assume that the full $360 million is paid, meaning that the residual plaintiffs get around $50,000 on average?

We're not getting into the details of what plaintiffs are getting -- what amount, that's something ultimately that will be agreed to by the plaintiff firms with their plaintiffs in the complaints, but I would assume that, that large verdict had an outsized number, if you will, relative to others. One thing I want to make sure it's clear, though, that everybody understands because of the fact we reach a settlement, I want to make sure we understand there's no evidence that these facilities cause cancer. There's no science that supports the belief that these facilities cause cancer. And that was very apparent in the trial of Ms. Fornek as well.

I guess just talking about the liquidity options that you talked about earlier, considering moving above the 2x to 4x leverage range, is there a maximum leverage ratio in your covenants? Or is there anything you've committed to that would prohibit additional debt capacity here?

Yes. We're not concerned about running into any of our debt covenants. We feel that we'll be slightly above the 4x longer-range target, the 2 to 4x longer-range target, but we're comfortable with and as you also saw this business operated in the high-7s before when we were a private company, 7.2 just prior to the IPO, but we don't anticipate going anywhere near that. It will be more in the 2 to 4x, slightly above that in the short term. We don't see an impact on covenants.

Got it. Maybe we can touch on the base business here, moving away from the litigation. So just the reiteration of your 2022 guide. Just kind of curious if anything has changed in terms of your assumptions for FX or inflation that you talked about last quarter?

No. As we mentioned on the call, we saw inflation kind of settling in, and I'd say that's pretty consistent where we sit today. We reconfirmed our guide of $995 million to $1.5 billion, and we'll give more details at the end of February.

Part of the 3Q guide down for the year was on Nelson Labs, you'd highlighted that you had not seen a recovery in demand for certain testing services there. Can you just elaborate on what Testing Services specifically saw a slower recovery in that quarter, how those have tracked in 4Q? And if there's anything to call out there in terms of underlying demand within Nelson?