Sotera Health Company (SHC) Earnings Call Transcript & Summary

All right. Great. Thanks, everybody, for joining us today. Welcome to the JPMorgan Healthcare Conference. My name is Casey Woodring from the Life Science Tools and Diagnostics team here at JPM. I'm pleased to be joined by Sotera Health today, CEO, Michael Petras. So I'll turn it over here in a second to Michael to get started with the presentation. Afterwards, we'll do the standard Q&A session. So with that, take it away.

Great. Thanks, Casey, and thanks to the JPMorgan team. Good morning, and welcome. Forward-looking statements here. If there's any numbers, reconciliations you need to see, you could go to our website as well as the SEC website to do any reconciliation for any of the measurements that we're talking about here today. Sotera Health, unbelievable company. Safeguarding global health is our mission. That's what we wake up and do every day across our company is safeguarding global health across our 3,000 employees around the world, our over 5,000 customers in 50 countries, providing end-to-end solutions for our customers, starting early on in the product development cycle all the way through distribution to the end customer in the products that we help sterilize and get to the market in a safe and compliant matter. When you look at our company, we've got deep embedded relationships with blue chip customers that many of you know of. Our relationships average over 10-plus years across our top 25 customers. We have a large and growing marketplace that we participate in. 70% of our contracts and revenue are tied to multiyear contracts. And on the foundation of all this is the commitment to our values and our culture across the organization. As I mentioned minutes ago here, you could see our role we play across health care and end-to-end supply chain starting in R&D, materials and packaging optimization; working through pre-FDA filings and clinical trials across our business units that we help support; product manufacturing; all the way through quality control and testing. And you see here on this chart, where each of the 3 businesses play in providing this end-to-end solution in safeguarding global health. Talking a little bit more depth about each of the 3 businesses, 3 unique businesses that are tied by 1 common mission of safeguarding global health. And if you look at the Sterigenics business, we have over 2,000 customers that are being fulfilled. Their needs are being fulfilled across our 48 facilities in 13 countries and 4 continents. You see on the chart here, the modalities that we serve across ethylene oxide, gamma sterilization and E-Beam. This business is the business where your customers drop the product off. We don't take ownership of the product. They drop it off. We sterilize it by the modality that they've gotten approved with the FDA. And we go ahead and sterilize it. They pick the product back up and they ultimately ship it to the end customers for point of care. Great business, 48 facilities across 13 countries fulfilling the needs of over 2,000 customers. We move to our next business, which is Nordion, also in the sterilization services business. One of the key modalities for sterilization is cobalt or gamma sterilization. Nordion is the world leader in providing Cobalt-60. This is the only 1 of our 3 businesses and it's a product business. The other 2 businesses are service businesses. And in this business, we get the cobalt from nuclear reactors around the world. We process it in the usable form. We ship it to sterilizers like Sterigenics and our competitors around the world. We have a one-of-a-kind facility. It's a nuclear site licensed 1B facility in Ottawa, Canada, where we fulfill over 400 orders a year across our customer base on a global basis. Great business. Again, the only 1 of our 3 businesses that's a product business. Our third business is Nelson Labs, which is another service business. And here, we provide microbiological and analytical lab testing in consulting services and advisory services for our customers here. We have about 3,000 customers. What really matters in this business, quality, reliability in service and timely service. We make sure the products meet the regulatory requirements are safe for patients across the 900-plus different tests that we do in this business. This business based in Salt Lake City, Utah. You see here the mix of the business. We have routine testing. It's about 47% of the business. We have validation testing that's approximately 41% of the business. And then we have an advisory service business that's 12%. We've talked about multiple times, our RCA business. As we talked about at our Investor Day in November, you could see this business has consistently brought growth. If you look over the last several years since we went public in November of 2020, we've got 8% compounded annual growth rates on the top line and the bottom line adjusted EBITDA with free cash flow growth of 10% over that same time period. Over $140 million of adjusted EBITDA growth since we went public in November of 2020. We look forward into '25 and beyond. The 4 key priorities across the company is our focus around excellence in servicing our customers with end-to-end solutions. It's bringing that full suite of capabilities across Nordion, Sterigenics and Nelson Labs to our customers across the entire health care supply chain. Second key priority is winning in growth markets. As we all know, MedTech and pharma, not everybody is winning. You've got to target a segment, the right markets that are winning. And that's where we're well positioned as we continue to move forward in servicing these higher-growth markets. Our third key priority is driving operational excellence to continue to focus on enhancing free cash flow. We're in an elevated period right now where we've had CapEx the last couple of years at the highest levels they've had in the history of the company. We see that coming down over time but really important for us to continue to drive operational excellence and getting the returns on the capital investments that we've put in place, which leads us to our fourth key priority, making sure we're good stewards of the capital and making sure that we have great processes in place for how we deploy the capital with the elevated CapEx that we're currently experiencing throughout the business. So this is all about how do we generate returns for our shareholders and broader stakeholders over time. We are well positioned for growth across the company, both organically and inorganically. If you look at the favorable health care trends, aging populations, demand for health care services that positions the company very, very well. We've got strong end markets that we partake in. As I mentioned here earlier, we're going to continue to focus on higher growth markets within the MedTech and pharma services area. And then one of the other key benefits and strengths of this company is the cross-business unit -- collaboration in cross-business unit selling. We have a great business with Nelson and Sterigenics, significant customer overlap, significant growth by customers that want to do business with us in both segments of our business units. And when we do that, we see much higher customer satisfaction scores. There's also opportunities for organic growth that we'll continue to look at. We're in an $18 billion marketplace, as I mentioned to you earlier. Today, our company is just over $1 billion in revenue, but we see opportunities for us to continue to grow this company over the long term. And we look at markets within our defined segments. You look at -- we talked about in November, and I'm reiterating here today, we talked about the growth of the company, 5% to 7% on a constant currency basis at the time. We look at the 3 business units. You've got Sterigenics, that will be in the mid-single digit to high single digits in this period. We're talking about over the next 3 years. Nelson Labs in the mid-single digits and Nordion in the low single digits -- Nordion low single digits to mid-single digits across that business unit. You see our -- within this 5% to 7%, we see -- we feel confident in our ability to generate at least 3% to 4% price across that, and you see the respective impact across each of the 3 business units. But this is a business that will continue to grow and it's grown every single year since 2004. We've grown every single year since we've gone public, and we see continued growth in the future. Talking about that 5% to 7% growth, that could translate to 5% to 8% growth in EBITDA over that same time period to time period, '25 to '27. In that time period, we look to expand margins on the lower end of that range of the 5% growth. We expect 50 basis points of margin enhancement over that time period. The higher end of the range is 7% revenue growth. We expect the ability to generate 150 basis points of margin expansion. So we're continuing to look for operating leverage across the company and not only growing top line growth, but also bottom line growth as well. As I mentioned, we talked about in the recent past when we found the company, the last couple of years, we've had an elevated level of CapEx spend. And that's really because of the fact that we've got a couple of significant activities going on in the company right now. One is our U.S. EO facility enhancements. The second one is the build-out of greenfields within the Sterigenics business. We haven't done a greenfield since probably about 2017. We're in the midst of doing 2 of them currently. And then the third big activity is the cobalt development work. We -- again, in the early 2000s was the last time we did a cobalt development program. This is to assure long-term supply of cobalt. So we're in the midst of 2 cobalt development projects, one with Darlington. Darlington is part of the Ontario Power Group, which is one of our largest and most reliable suppliers in Canada. The other partnership program that we're working with is Westinghouse around cobalt development. So we see -- over the time period between now and 2027, we see the CapEx spend coming down. So if you look at the chart, we did approximately $200 million on average of CapEx over the last couple of years. We see that coming down to approximately $100 million, $110 million by the time we get through 2027. Because of these programs, the facility enhancements will be going away as well as the cobalt development in 2 of the greenfields that we're in the process of rolling forward on. One of the greenfields that Sterigenics will be coming on in late '25. The other one will be coming in, in late '26, early '27. One thing I want to make sure people understand, we have a very disciplined capital allocation process within the company. All CapEx approvals above $500,000 require John, our CFO, and my own personal approval on that. We target a 20% IRR in each of these programs. And we also look at the paybacks in these programs on an ongoing basis. We also do a say-do analysis, as we call it. We do look backs with our leadership team as well as our Board, making sure we're delivering on what we committed when we put the program in place. All this should lead to free cash flow generation of $500 million to $600 million over that 3-year time period, which is a significant improvement from where we've been in the last couple of years. One of the topics I want to give a brief update on is litigation. As many of you know, the industry has been in a situation where there's been a significant amount of ethylene oxide litigation impacting all the players or many of the players in the marketplace. I'll walk you through each of the geographies. The first one being Cobb County, Georgia. We have about approximately 300 personal injury cases there. And there was a ruling in November 2024, what the process was with the courts. There's a 2-phase process. The first one is general causation and the second one is specific causation. And in the first phase, general causation, there were 8 pool cases. The judge has ruled that the plaintiffs' 2 experts were dismissed and they could not be experts any further in the cases. The third expert was able to stand through, and we have gone ahead and appealed that in the process. By the way, the other side has done the same thing. They're appealing that their 2 experts should be included as well. So we're in appellate process right now. We expect to hear something in the latter part of 2025. In Los Angeles, there's really not a significant change from when we last discussed in our quarterly call. We have 4 cases. We have 4 cases, about 29 claims. In Santa Teresa, no personal injury claims. We have the New Mexico Attorney General case, which is scheduled for trial in 2026. And then in Cook County, Illinois, we have approximately 100 cases. And these are all newly filed since the February 2023 settlement. We anticipate 3 trials in 2025, April, June and late 2025. The other point I would make is we have $110 million judgment that the courts have awarded to us on insurance defense costs. We're waiting for the appellate process. The insurers are appealing that. We're waiting for that ruling to come out. One thing I want to call out here is, listen, there's always -- people can bring these frivolous suits at any point in time, right? So there's risk of that occurring in any other jurisdictions. This is an industry-wide challenge, and our competitors are seeing that as both in-house and outsourced sterilizers are seeing that. We are very confident in our position. When the science is fully, fairly and appropriately presented, we are very confident in our ability to prevail in these cases. All right? This company operates in a compliant, safe manner within the regulatory requirements, and we will continue to move forward in that vein and work through these defense programs. So this company is very well positioned for success as we've talked about many times, the foundation, the values of the culture, the deep customer relationships, large and expanding markets, the deep expertise. We see this company growing 5% to 7% organically over the next 3 years and cumulative free cash flow of $500 million to $600 million during that time period. So with that, Casey, let's go ahead.

All right. Thank you. That was a great overview. I guess to kick off the Q&A session here, just to start, I wanted to hit on the preannouncement from this morning, the greater than 5% constant currency revenue growth rate for 2024. Curious on how 4Q trended relative to expectations? And if you could provide a breakdown of how each segment performed in the quarter? And any further color on how pricing and volume trended?

Yes. So I would just say, the quarter total came in, as we said this morning, at approximately $1.1 billion of revenue. It was consistent with what we expected. We'll give more details on this in February when we do our earnings call. But overall, things are moving in the direction we expected.

Okay. Now that you have sort of an early look on how 2024 finished up, I'm curious on any preliminary thoughts on the puts and takes in 2025. How pricing and volume, particularly in Sterigenics, is expected to progress in 2025 relative to how '24 finished up?

Yes. I would say in the first quarter earnings call -- in the fourth quarter earnings call in February, we'll give a more thorough outlook of 2025. But I would say overall, expectations are consistent with what we've seen. The one thing that's moved significantly, as everybody's been following post the elections and our last earnings call, has been currency. So it's something we'll have to continue to monitor as the year plays out and our go forward for 2025, the dollar's strength that everybody's seeing.

Got it. That's helpful.

But overall, we feel good about where volumes have been coming together and are around what we expected finishing out 2024.

Okay. Maybe taking a step back here, just you're coming off your first Analyst Day post IPO. Just what was the key message that you hoped investors took away from the event?

Yes. Our goals in doing an Investor Day, we went public in November 20, 2020, and ironically it was 4 years to the day that we had our Investor Day. A couple of things we're trying to accomplish at that. One, we wanted to make sure that people had a broad understanding of our capability across the broader health care supply chain. That was the first thing. Second thing, there were some business units, particularly in Nordion and Nelson, that we got feedback from investors that they wanted a better, deeper understanding around that business. So we made sure that we provided more clarity around that. We also wanted to make sure that we got our leadership team out there. You talk to Jon and you talk to Jason and myself all the time. We wanted to also make sure we got some of our other leaders out front and center that are leading the 3,100 employees across the company. And then lastly, we wanted to give the next 3-year outlook based on what we see today based on today's volumes. We wanted to do that. So we felt we accomplished what we were trying to do with that session.

Okay. At the event, you issued new 3-year financial targets, the 5% to 7% annual top line growth rate. That embeds 3% to 4% annual pricing benefit and then low single-digit kind of end-market growth rate. On the latter piece, can you walk through the volume and mix assumptions in the new targets and how those compare to your expectations prior?

Yes. I would say when you look at 5% to 7% growth, I'll go back to one of the charts that I discussed here earlier, you look at about 65% of our revenue comes from the Sterigenics business, right? We think they'll be mid-single digits to high single digits on revenue growth. They'll be in the higher end of that price range. At least 4% price, we think, comes out of that business which is consistently we've been able to achieve over the long run of that business historically. Nelson Labs, we see that business at mid-single digits. It will be on the lower end of the price range, which is pretty consistent with what we've seen in the past. And again, that business is about 20% of our total revenue. And then the last one is Nordion. This is the one that's probably changed from a price perspective. We see some of the pricing coming towards the lower end of the price range, and they've traditionally been on the higher end of that range. But we see this business continue as a low-single-digit, mid-single-digit business. So 3% to 4%, we feel on the Sterigenics side. We're hopeful that we could see even better than that on price over time.

Got it. Yes. And just as a follow-up, I think coming out of the Analyst Day, the underlying market growth rate, that low single-digit number compares to the prior messaging of volume and mix benefit of around mid- to high single digits over the long term. So just any color on the discrepancy there? Is that just...

Yes. We're just looking at the volumes have been -- the last couple of years, the volumes have been a little choppier. And based on what we see over the next couple of years and the levels that we're going, that we feel the next 3 years this is an appropriate level of guide.

Okay. So in addition to the top line target, your EBITDA margin expansion targets call for 3-year expansion of at least 50 basis points cumulative at the low end of the target and 150 basis points at the high end of the revenue target. You've talked before about how volume is the key driver here of margin expansion in your business. But are there any other levers you can pull on the operational side? I'm just curious on how you think about margin expansion moving forward.

Yes. The price, obviously, is a factor that comes in there of favorable mix. And I'd say the other one is just operating leverage, right? The volume comes through, we'll continue to -- if that marketplace continues to rebound and ends up having significant volume growth, we'll be well positioned to capitalize on that. So I think that's the biggest leverage you referenced, Casey. The other thing is the team continues to work on operational excellence activities as well and how to be more efficient in our current operations and get better utilization of our assets. So those will all be factoring.

Okay. Lastly, on the long-term targets. On your free cash flow target at the Analyst Day, you pointed to greater than $500 million cumulative from '25 to '27. Today, the slides, I think, were updated, it's $500 million to $600 million now. Maybe just walk through how conservative that prior estimate was. What's changed since the Analyst Day? Or if we're kind of splitting hairs between your [indiscernible].

Yes, I wouldn't say much has changed. We did some clarification coming out of the Investor Day. Some of the investors said, "Hey, help us understand if you're in the higher end of that range of revenue growth and EBITDA growth, what does that mean? So we came out with some investor conferences shortly after Investor Day and they just made sure there was clarification that the $500 million was at the lower end of the growth range, the $600 million's in the higher. So nothing really materially changed. We just wanted to be a little clearer in our messaging.

Okay. And a follow-up, I guess, to that, just how much visibility do you have into your CapEx targets related to the free cash flow targets you have? And what's your confidence in bringing the CapEx spend down over time?

So we've got pretty good visibility. That doesn't mean things won't shift from quarter-to-quarter slightly year-over-year. If we -- there's one CapEx program in particular that we're continuing to monitor and making sure that's an appropriate way to deploy capital. But overall, we feel pretty confident about where we are on the capital targets we laid out and our ability to get to approximately $100 million, $110 million in 2027. Yes, we've had good visibility. The big things that are driving it is the Sterigenics growth that we talked about, those 2 greenfields, the Nordion CapEx and cobalt development. And the third one is the facility enhancements in Sterigenics. We have some CapEx within Nelson Labs to continue to drive growth, but it's pretty minimal and good returns in that business.

Okay. Turning to some more business-specific topics. On Sterigenics, you talked throughout '24 about gradual volume improvement there as your customers worked through destocking. Should we continue to expect this gradual volume improvement in '25? And at what point this year would you expect volume to return to like more normalized levels as destocking hopefully abates?

Yes. I would -- we'll guide on 2025, as I mentioned, in late February. But overall, we expect a gradual improvement throughout the year on Sterigenics. We saw that. We would have expected and hoped for significantly more volume, but it didn't play out in 2024. But where we see '24 finishing and into '25, we're confident the volumes will continue to improve based on what we know today.

Got it. Yes, that makes sense. Can you give us an update on how destocking trends have progressed between different customer groups? Bioprocessing is one that has come up a lot this year. Just between MedTech, bioprocessing, the rest of your customers, how those fall kind of?

Yes. We're not a huge player in bioprocessing. I mentioned in the past it is an important segment for us, but it's a smaller segment and it's a good mix for us as a company. But overall, I see that's the one market that you've got a pretty consolidated 4 or 5 big players and you saw those inventories very publicly available in the destocking playout. I think that's stabilized, and we're starting to see some returns. Third quarter, we saw the growth over the second quarter. We would expect that to continue over time. Some of the other categories, quite honestly, we're not having a lot of discussion around inventory destocking these days. It's -- even in the third quarter, we mentioned that on our earnings call that that hasn't been a big topic. So I think it's stabilizing.

Okay. A key part of your Analyst Day in terms of Sterigenics was the work that you've done to get ahead of the NESHAP rules and what those rules mean both in terms of potential increased outsourced sterilization penetration and then potential competitive share gain for Sotera. Is there any way to frame what that opportunity looks like in terms of maybe how much the in-sourcing market could shift to outsourced? And then the competitive market dynamics there, how much share is up for grabs for Sotera? And any color around how the NESHAP rules have changed your market outlook?

Yes. I would just say the NESHAP rules are very challenging. As we've said all along, we feel we're well positioned to accelerate in that market, but they're not easy rules. And I think the broader marketplace is going to have a challenge. As we talked about at our Analyst Day, one competitor has recently filed bankruptcy, not exactly sure if that person ends up long term staying in the game or not, but that's one example of somebody that's very challenged by its ethylene oxide space and the regulatory requirements that are coming out. We're having lots of dialogue with customers about where they are today in their supply chain and trying to understand long term what that looks like for them. You could say we're having positive conversations, but we're not at a point where we're quantifying share gains from that. But we're going to be positioned to help our customers if there's a challenge for them with the current supplier or their own in-house operations. We feel good about where we're positioned on this. Not easy, but we feel really good about where we're at in this.

You have one of your greenfield Sterigenics facilities coming online in the back half of '25 and the other in '26, '27 time frame. How should we think about capacity utilization as these greenfields come online? And how will they factor into your margin cadence once they do come online?

Yes. I would say they're not significant operational cost in -- there's not a lot of big increases in the operations cost. So over time, you'll see the volumes continue to improve in those facilities. The second half of the year is where we'd expect that first greenfield you mentioned to take place. There will be a slower ramp as you start to go through validation process with the customers. So I wouldn't expect a big material impact in margins in 2025.

Got it. That's helpful. Along the same lines, the cobalt capacity expansion projects that you've detailed, can you just remind us of the time lines there and how material those will be business?

Yes. The team is doing a really good job on that, Riaz and the group. As you know, we've got a global supply base for Cobalt-60. Our largest base has historically been around the Canada operations. We've got 2 big suppliers there, Bruce Power and OPG. They're great suppliers and partners to us. So the one program we have going is with Darlington. That is within the OPG family of reactors. We expect the first harvest to be 2028 out of that facility. That program is moving along very, very well. The team is doing an outstanding job, both OPG and our team. So we expect that 2028. And then the other program that we're in development on is the Westinghouse program. And we expect that to be the latter part of the decade. Timing is still a little bit movement. But overall, that program is progressing well with the team at Westinghouse.

Got it. On the Trump administration...

I'm sorry. Remember the other big benefit. I'm sorry, Casey. Remember the other big benefit for some of you who aren't as familiar with the story is on Westinghouse. That helps us open up a U.S. reactor base, which today there are no U.S. reactors that can make Cobalt-60. So that's the 1 benefit of that program that we like as well.

Okay. Got it. No, just on the Trump administration and potential tariffs. I know that you have significant exposure in Canada, right, with Nordion. So how easy would it be to maneuver supply chains if tariffs were to go into effect? And maybe just give us an updated picture on your manufacturing exposure across the different regions?

Yes. As I mentioned, the only business of our 3 business that's a product business is the Nordion business. They do have a significant base in Canada. Obviously, it's too early to finalize exactly any potential impacts of that. A couple of things I'd tell you. One, there's no rules out there yet. No tariffs are in place. There's rumored to be. The other thing I would say in the past, cobalt has been excluded from those tariffs. Okay? I don't know that that's any indication for the future on how that will play out. The other point that I would make is, typically, it's the importer of record, which i.e., would be the customer in that case that brought the cobalt in that would be on the hook for the tariffs. So those are a couple of things I'd keep in mind as we look through. We're continuing to monitor the situation, and we'll see how it plays out probably with the tariffs between U.S., Canada and Mexico. We don't have a big presence in Mexico from a product perspective either.

Got it. Can you walk through your exposure to Russia and supply there on the cobalt side?

Yes. So on Russia, we get -- Russia is a supplier to us and approximately 20% a year, I believe, is what our public disclosures are on that we get from Russia. At any given year, it could be higher than that. The team has done a great job making sure we're compliant with all the rules and regs around some of the sanctions, but we've been able to get an ongoing supply for the last several years. And I'd really put a tribute to our team that's been able to execute on that across all the regulatory bodies in making sure we're compliant and making sure we're getting this key product for the health care system out in front of people so they all understand it. So overall, we'll continue to execute against that program we have in place.

Got it. Turning to Nelson, I wanted to touch on some of the noise out there around whether a divestiture of Nelson would be on the table for that business. Can you just remind us of the overlap between Nelson and the rest of Sotera, the strategic fit there and why it makes sense in your portfolio?