Sotera Health Company (SHC) Earnings Call Transcript & Summary

Good morning. I'm Dave Windley. I cover pharma services, cover a variety of health care areas. But appreciate you being here. Welcome to Jefferies Healthcare Conference for 2025 here in New York. It's a wonderful day on the walkover. I managed to only walk through 1 weed cloud on my way through. So I think I'm still sober. We're pleased to -- I don't think I've been in the lead-off spot on the first morning very often. So it's an early wake-up call but I appreciate your attention here this morning. So our first presenting company in this track is Sotera Health, SHC is the ticker. Michael Petras is the company's CEO, joining us. Jason Peterson, is also in the audience, IR. So really appreciate you being here and supporting the conference. I think Michael is going to give us a couple of lead-off comments here and we'll dig into questions. So Michael, I'll turn it over to you.

Yes. Good morning, Dave. Thanks for the time and inviting us out and looking forward to a full day of investor meetings. Before we start, there are some statements I'll make that will be considered forward-looking statements. Refer to our SEC filings on our website for more details. During the discussion, I'll talk about some non-GAAP financial measures, including adjusted EBITDA. So refer to our SEC filings for that as well. But overall, we came out of the last quarter with some -- feeling pretty positive about where the business sits today and what the outlook looks like for 2025. We reaffirm the guide that we have in place. And the team is doing a good job executing and taking care of customers. I had a chance last week to go out West and spend some time at Nelson Labs, which is doing really well and seeing some nice activity. And then I visited several of our Sterigenics facilities as well during the course of the week. So overall, 2025 shaping up to be a pretty good spot.

Excellent. So I just wanted to start off with -- we've known you, known the company since you came public, which has been coming up on, I guess, 4 years ago or so, if I remember correct, maybe almost 5, yes. So just kind of a big picture a little bit before and after type question. So this -- you've held and integrated this collection of businesses since before the IPO. The pandemic certainly caused kind of a spike and then a hangover after for a lot of different industries, including health care and including your own and the business appears to be stabilizing. Like you said, the first quarter was a good quarter. Last few quarters have been positive. So I guess, how would you compare the portfolio of businesses today to before COVID, same, different, more -- different mix, competitive position, things like that. What's the before and after assessment?

Yes. I'd say the company, we're very fortunate. We play the critical role in health care and we continue to grow every year. So that's been very consistent. Since 2005, we've grown every single year as a company. And the team has done an outstanding job dealing with a lot of challenges. I'd say the biggest thing, David, that we've seen change over time is the supply chain dynamics. And just the parts moving around, customers having a lot of dynamics within their own supply chains. When we step back and look at it, that's been a bigger challenge than we thought. The inventory correct -- buildup and then corrections, it came out of COVID. But we -- as you mentioned, we haven't been having those discussions with our customers around inventory takeout with -- outside of a couple that we do but that would be normal course pre-COVID as well. I'd say that was the biggest thing. And then the second thing would have been the labor dynamics, particularly a business like Nelson Labs that has a significant amount of labor content in the labs. We saw some dynamics there with the Great Resignation and everything else. But Joe and the team have got that in a much more stable spot or turnover is in a more stabilized place. Our service rates have recovered very well. So overall, I'd say we're in a pretty good spot relative but those are some of the big pieces that really impacted us during the course of COVID just shortly thereafter. From a mix of business perspective, I would say, particularly across Sterigenics and Nelson, the presence of pharma, we -- that was a strategic priority for us pre-COVID. And not that COVID did that to us but as we rolled out and started executing some of our strategies and priorities, we started to see a pickup on that side. So we're seeing penetration rates increasing from a mix perspective in the more pharma capabilities as well.

And I probably failed to put this point on it. But one of the bragging points of the business pre-COVID was how kind of consistent it was. You're spec-ed in, your necessary service for medical products and COVID, as it did for so many businesses caused more volatility than normal and your business maybe in particular, because it normally is so stable. Do you think we've gotten far enough past the supply chain dynamics and things like that, has that noise settled down enough that this business can settle into a pretty predictable pattern?

Yes. Let's kind of walk through that with each -- respective to each of the businesses. So I'd first start with the Nordion business, been a very consistent performer year in and year out all through COVID. And we still see the lumpiness from quarter-to-quarter. That's not really driven by COVID or supply chains. It's really driven by our utility suppliers when they harvest their cobalt. And it's -- because remember, what happens in that business is they have a nuclear reactor and its primary purpose is to generate electricity. So when they are shutting down for maintenance is when we're able to harvest the cobalt. So we're kind of at their direction of when we can harvest it. So you'll see the lumpiness here. But that business has been very consistent. It's been delivering year in and year out for us. On the Nelson Labs side, we saw the big COVID bump and then we saw a step back and then we saw the Great Resignation. That one's been a little choppier. And even now, I'd say, if you look at the small element within that business is the RCA business. We've talked about that before, that's our regulatory compliance business. And last year was a very strong year in that business because coming out of COVID, a lot of the FDA audits were postponed during COVID, then the audits really kicked up in 2023 and 2024. And we saw a really nice pickup in that business. We had a record year last year in that business. Now this year, we're seeing that business struggling because of the fact that the FDA has got so much going on. I actually was with the team last week and I was learning a lot more about some of the dynamics that play out on that side. But when you get -- the labor part is in a good spot. The service rates are in a good spot. The quality is in a good spot. So we're seeing that. We're not hearing a lot of noise around issues with supply chain as much on the Nelson side. And then we'll take the Sterigenics side. That business has usually had some consistent volume and mix growth. And post-COVID we saw those volumes flat to slightly down, which is atypical. We're seeing that normalize now. And as I mentioned earlier, we're not having as many conversations around concerns around inventory takeout with the customer base. And that's getting a more stable base. That business is roughly 2/3 of our total company. All 3 of them are very strong cash flow generators and that business, in particular, gets great leverage as volumes come through. So we're optimistic we'll continue to see that improve throughout the year.

Got it. Good place to step off into a little more detail into the businesses and talk about Sterigenics, you just mentioned the flat to down volumes kind of coming back. Can you talk and maybe bifurcate detail there around whether that's medtech, bioprocessing, both? What are some of the categories of volume that have improved?

Bioprocessing has improved. It's a small portion of our business but one that is easily recognized by the investment community of looking at that and there's a distinct set of customers there. We're seeing that volume start to pick up, which is a positive. It's not a huge number for us but we're seeing sequentially and year-over-year, nice growth. But we're seeing just overall general hospital supplies in several categories, more broadly across medtech, that's continues to increase. And then the pharma side, we've seen nice volume improvements as well on the Sterigenics side.

And then while we're -- going back to your point, while we're on this and going back to your point about one of the bigger macro things being supply chain changes, what are you seeing as it relates to Sterigenics and how companies maybe -- your clients may be changing their supply chain and while we're talking about it, are tariffs influencing that yet at all?

We haven't seen a big impact from that. Now if more people want to bring -- more customers want to bring products into the United States, that should benefit us because we've got a very strong network here in the U.S. We're not seeing a significant change in that environment. We've had a couple of customers talk to us. We've had some inbounds around some folks that are offshore that want to put more volumes in the U.S. but we haven't seen it materialize in any significance at this point. But we continue to monitor that. Overall, I'd say the volumes are positive in that business and we continue to track in that direction as well.

Okay. So on tariff, it sounds like not a change in terms of the routing of activity. Any concerns about clients needing to mitigate the tariff impact on their own businesses and coming to you around cooperation, so to speak, on price -- the price of your service?

No. That hasn't been part of the conversation.

Not at all. Okay.

Not that I'm aware of. We've got pretty much fixed contract with pricing built into them and that's really what we're living by day in and day out with our customers. We haven't seen material changes in that because of tariffs.

Got it. And to include, you wouldn't expect challenges or difficulty in achieving your target pricing. You talk about, I think, a [ 3.5% to 5% ] type range for your 3 businesses. You don't think that will have to be sacrificed going forward if tariffs become a reality or as they do [indiscernible].

No, we should -- listen, you used the word challenge. When we talk to customers about price, those are always difficult conversations. There isn't somebody sitting on the other end saying, hey, send me a price increase every year, right? So I just want to be respectful to our commercial teams that have to deal with this every day. I don't want to make it sound like it's really simple because it's not. We have a business that brings a critical service to health care. We got to make sure we don't outrun our value prop and we price accordingly for that. But we've been a consistent performer, as you referenced around price and we don't see that changing today or in the near term or in the midterm.

Okay. Going back to volumes on Sterigenics a little bit. As you kind of alluded, the part of the picture here, at least, has been clients managing working capital and taking down some inventory in the aftermath of supply chains having been so disrupted by COVID. So the dynamic seems to have been as we watch hospital volumes, surgical volumes, medtech reports, et cetera, that their activity levels have been pretty darn strong for a couple of years during the period when volumes for you have been, as you described, flat to down. Can you talk about that disconnect and the drivers of it?

Yes. I would say there's, even pre-COVID, there's been a correlation directionally between procedural volumes and the Sterigenics volume or the Nelson Labs volume. Now Nelson's got some other aspects of it, new products, biotech funding, regulation, things of those nature that also impact that business in a positive way. On the Sterigenics side, directionally, we've seen those 2 go the same direction. But we had not, as you just referenced, in the last several quarters. And I would say the best of our knowledge and we don't have great insights exactly where all the inventory sits within our customers and their supply chains but we've seen that really diminish as a concern. And we're seeing now directionally, as the markets continue to perform on procedure volumes, we're seeing directionally that alignment. But again, we're not going to have a 99 R-squared on this, right? But we are seeing it more closely tracked now.

Yes. And what about kind of competitive positioning and market share? How stable is the existing base? Do you see clients move their activity from yourselves to another sterilization supplier ever?

This is not a business that's put out for e-bid or e-auction day in and day out. There's a lot involved in this business with Sterigenics I'm referencing specifically here. I mean, all our business have similar characteristics. But in this one, in particular, it's part of the regulatory filings where they sterilize and the recipes. They had to go through a validation process. I will tell you, though, over the last couple of years, with all the EO dynamics in some of our facilities, having some of the challenges that we had with the regulators and some of the dynamics in communities, we lost a little share position over the last couple of years that -- but that is atypical in this business, right? Typically, you're pretty locked in with our customers. We still have very strong relationships with almost all those customers that involve particularly in the Illinois facility. But share is not something that moves in a dramatic fashion like I've seen in other industries.

Yes. And do you see from a -- you've, I think, generally described that from a capacity standpoint, you're probably adding capacity at a lag to demand, kind of validating that the demand is there and then break ground, then spend the CapEx is. Is that still true? And do your competitors do the same thing? Or have you seen some of them be willing to build ahead of the curve and try to make moves on market share?

We try to make sure we're disciplined in our capital -- we do make sure we're disciplined in our capital allocation and we try to have good visibility before we put the shovels in the ground. We want to make sure that this expansion -- greenfields are pretty expensive in this arena. But even just putting additional cobalt in or an additional chamber can be expensive. So we got to be careful on the capital side to make sure we see the appropriate returns there. So that's one of our key priorities is capital allocation. As far as our competitors, I can't tell you how they look at the demand profile. My suspicion is they lean in a little bit more and building ahead but you'd have to ask them that, I really don't know how they think about that.

Got it. Okay. So let's move into the regulatory environment but flip this question. NESHAP regs, the general environment has tightened a little bit. That would seem to be more onerous for smaller players with less scale to comply with those tightened regulations. What do you see in that regard? And is it right to think that we could see some smaller players exiting the business, share shifting because they can't keep up with the regs, talk about the landscape as these regulations take hold.

So the NESHAP regulation that takes place in April '26 is currently in place and you got to be conforming to that. That's a challenging standard. I think there's going to be several people that struggle to get there. We've spent a significant amount of money on that and we'll continue to spend on that and we'll do that throughout next year as well to make sure we're compliant. I think some of the smaller players will struggle. It's interesting. I was with a major medtech company, not last week, the week before and they said, we're pretty far -- they have -- they buy from us and they also do a little bit of in-sourcing. They said, we're pretty far along on this. And I asked a couple of key -- Mike was with me, who runs our Sterigenics business. We asked a couple of key questions. And...

They realized he wasn't as far along as he thought he was?

We realized. I'm not sure they did yet. I would just tell you, it's -- there's a couple of -- this is not an easy task and I think it's going to take a lot of time and effort and a lot of trial and error for some of these folks to figure out. We've been on this journey for quite some time. Now we have larger facilities that are older facilities. So they are probably more complicated. They probably will take more capital. But we feel really good about where we're sitting on that. That doesn't mean we have everything perfectly nailed at this point. But we're well positioned to comply with the requirements as we see them today. And I think it should create a positive momentum for the company. We're getting some inbounds that indicate that as well. Not huge numbers yet that are going to move the needle. But we're feeling pretty good about the dialogue and how we're seeing the landscape play out. This is not going to be an easy rule for most people to get to.

Right. Can we -- on this topic, can we lay out the kind of the market competitive structure yourselves and STERIS, are the 2 leaders, you're materially bigger than the next largest player. How much share do those -- do you have -- do you -- the top 2 have? And relative to this topic, how do you think about the migration of the rest of that pie?

We'd say in any given modality or geography between us and STERIS, we probably have 50% to 2/3 of the market combined, collectively, give or take, depending on what market you're in. And then there are some smaller players, regional players. We're not seeing big global international players to the scale of us or STERIS. When you look at regionally, if you took the U.S., particularly we're talking about this regulation, there are smaller guys that we've seen one file bankruptcy. We've seen a couple of smaller guys say they're going to shut down and move volumes. They're usually a long list of small customers that come with that. So we're involved in some of those discussions and trying to help take care of those customers. A lot of them have relationships with us already or did at one point. And over time, that may create more opportunities for us. We feel pretty good about how we're situated on that.

Okay. So maybe something you said and that answer makes me want to ask the question, are those -- are those clients -- is that business that you would want? The kind of small customers sounds like small volumes, can that be profitable business?

Yes, it could be profitable business as long as we have the capacity for it. People talk about EO capacity and it comes in different shapes and sizes. It depends what kind of chamber size you're talking about, right? Small, medium or large chamber sizes. So in -- our capacity is a little more constrained, some of the larger chamber side, high volume, some of the smaller to medium-sized chambers. We have a little bit more capacity and flexibility. But listen, at the end, a lot of those customers probably aren't with us because either; a, we didn't have the capacity or; b, they didn't like our pricing and create an opportunity for somebody else. So we're going to be very disciplined around that. And hopefully, we're an option for that customer to consider.

You're -- and we talked about this earlier but your pricing and pricing strategy, you've been pretty -- I'd say, very consistent and disciplined around this and taking a little bit of price every year. How do you think about balance of price versus volume? I mean, do you -- is there any willingness to sacrifice price to pick up significant amounts of volume as these regulations are evolving?

If I told you, yes, my sales team would cringe, based on the conversation I have with them every day. Yes. No, I would say our pricing in the Sterigenics business has been pretty consistent around 4% per year. Then with inflation, it went a little higher because we're able to pass that through. In areas where we have really tight capacity, U.S. EO, for example, we're running higher than that, right? And we'll continue to price accordingly to the market conditions. We also think there may be opportunity. We're having conversations with our customers about what we call NESHAP pricing. We're spending, call it, close to $200 million we'll spend on the NESHAP pricing or NESHAP improvements. And over time, we're going to be talking to our customers about, listen, we've got to get paid for some of that CapEx we're putting in place. And those are things that we're going to look at as opportunities to make sure we can continue to support the industry. But our business and our conversations internally are not structured around go get the volume, cut the price. I've been in industries like that where you had to do that for certain reasons to keep your capacity efficient and everything else, we don't have that dynamic here. We're going to be very disciplined around our pricing around this. We have a critical service we bring and we got to make sure we're getting paid for the value.

And then thinking about capacity in some of these operators that are perhaps going to struggle to comply and your relative capacity, as you just said, kind of operating at pretty good utilization and in some modalities pretty tight, are some of those facilities acquirable or does it just make more sense to build your own?

You're talking competitors?

Competitors, right, yes or even an OEM internal facility that you might carve out.

We will always entertain those conversations. We've had conversations with some of these OEMs about badge flipping and taking over the facility for them and running it and haven't been able to find an equation that works there for both sides. We've looked at some of these smaller folks. And the question becomes for us, is it worth the incremental cost to get that facility compliant in the effort? And we've looked at a few of them over the last several months and it's just not somewhere we'd want to deploy capital. Just too many challenges with those existing facilities. And we think we're better off suited running within our network and doing what we do really well. So we've passed on those to a great extent. We'll continue to look at them not only in the U.S. but around the world as well, though.

Okay/ Let's -- I'm using a lot of time on Sterigenics but it is your biggest business. Does the Trump nuclear executive order have any impact on your business?

No, not near term. I mean, it's -- nuclear is coming in with a lot of acceptance these days, which I can understand to some degree. We rely on nuclear reactors around the world, predominantly in Canada. But as you may know and recall, we've got a partnership with Westinghouse where we're looking at getting PWRs up and running to make cobalt, which has never been done before. And that's a combination of our technology and Westinghouse's. That program is moving along very well. And I think the more interest in nuclear can help get more acceptance around that, which could hopefully keep that program moving along as well as it does and may create more opportunities for more utilities to have interest in that. The flip side, though, that we want to think about is, the primary businesses of these utilities I mentioned earlier is to make electricity. So that's the primary purpose but there may be opportunities to make cobalt like we're seeing today.

I hear, there's demand for electricity lately.

There is. There is.

So moving to Nelson, you commented about staffing is in a better place. Service levels have, I think, stabilized and improved. NPS scores, I think you measure and have been on the rise. What's maybe -- not painful -- what's your primary strategic initiative there? Is it adding staff to be ready for more volume? Is it still more on the quality side? Is it new client capture? What's the primary driver there?

So a couple of things. First of all, business is in a good spot. They, really, their volumes are starting to pay up. That business, remember the underlying drivers of that business, routine processing, how to get sterilized, doing routine testing of that. New funding for new products is another driver of that, right? I would say regulation is a big one as well. When new regulations come in and there are several new regulations that are hitting that business in particular, which is a net positive where customers are coming to us saying we need help, if it's extractable, leachable testing for bioprocessing, if it's geotoxicity testing, if it's health care reprocessing regulations. I was out there last week reviewing with the team and all 3 of those regulations are starting to ramp up and those are net positives for that business. So -- what -- we -- as you mentioned, we're stable with the labor and the workforce quality has been good. What we want to make sure is we're continuing to be responsive to our customers on turnaround time. We're putting capital in to expand and refresh a clean room, basically build out a brand-new clean room, which hasn't been done in 5 years probably at least. And that's really to double down on sterility assurance, which is core of that business in the foundation. And we see that as a big thing for our customer base that leads to many other opportunities. So I'd say, overall, right now, it's continuing to grow. We made an acquisition in '17 in Leuven, Belgium, which has performed really, really well. That continues to perform. And I'm happy -- I did mention the RCA challenge with some of the -- the FDA cutbacks has impacted that. But Joe and the team are doing a really nice job. I'm really proud of what's going on in that business the last several years.

How much of Sterigenics funnel comes from Nelson?

Sterigenics funnel comes -- so let me kind of put it this way. We've got about 70% customer overlap. We've got -- about 40% of the of Nelson Labs is sterility assurance business. So there's a lot of flow that goes through. And then remember, we've got these embedded labs, which are really critical. They're either literally co-located with Sterigenics or like within very close proximity across the parking lot in cases. We see a lot of synergy from that in connectivity for our customer base. And quite honestly, we're not even as good as we need to be in that area. We're getting better but it's one of the areas I've told the team, part of the cross-BU activities, we got to get better here. As we did some of our customer satisfaction survey results, we're seeing really positive things. And I want to understand why, why, why is what I keep telling the team and how do we accelerate that?

Yes. So maybe asking in a different way, if we see an uptick. You mentioned building out this additional clean room for sterility assurance. Is an uptick in sterility assurance, a precursor to volume sterilize -- some more volume bulk sterilization in Sterigenics?

Yes. So you should see it coming from Sterigenics going into Nelson Labs for sterility assurance is how you should see it kind of on the routine on routine testing.

Okay. All right. Maybe capital allocation to finish. How are you thinking about that? What are priorities? And to the -- to what extent are you still -- have an appetite for acquisition?

Yes. So we will continue to look for acquisitions. They got to be on strategy, though, right? So when you look at the Sterigenics business, it's geographic expansion or tuck-ins of key modalities that we already play in. Nelson Labs, we'll continue to look for opportunities. So we've really stepped off and held off on doing any M&A on the Nelson side till we get our house in order the last couple of years. We'll continue to look for opportunities here, particularly around the pharma capabilities. And then in Nordion, if we can look at the opportunities to diversify our business. But our first priority is to continue to invest in organic growth. That's really important for us. And then over time, continue to look for opportunities to pay down debt if we have excess capital. But overall, our capital commitments that we put out for this year and the guidance, we still feel confident around that. We are expanding. We announced recently an X-ray facility in Sterigenics that will be opening up by the end of the year this year. That was one of the 2 greenfields that we had mentioned was still in process. There's one more behind that. But we're really driving that towards focus on where our customers need us and modalities and geographic expansion. So organic growth is one of our first priorities for capital allocation.

And the last question on -- overall and on this topic. You've also been focused on improving free cash flow. Part of that is CapEx moderating as you get out of some of these more intense spending periods. Can you remind us the path on that?

Yes. So first of all, if we get volumes, we get great operating leverage, which helps us get more EBITDA. When I look at 2025, margins will stay pretty consistent in Sterigenics and Nordion. I think we'll see some margin expansion in the company, primarily driven by Nelson Lab in 2025. We've kind of said, so it starts with EBITDA and getting margins going. But when we look at our CapEx, we see that coming down. By the time we get to '27, we'll be -- we'll have a lot of the cobalt development behind us. We'll have the 2 greenfields behind us on Sterigenics and we'll have the facility enhancements in NESHAP behind us. So when you put that all behind us, we feel like we're going to be around $110 million of CapEx is what we committed and over $500 million of free cash flow over this next 3-year period from when we did our Investor Day last year. So we still feel confident about CapEx around the $110 million range at 2027 and the free cash flow of '25, '26 and '27, $500 million plus is what we've committed.

Excellent. That lands the plane. Michael, thank you for your time and comments and I wish everybody a good conference. Thanks for being here.

Thanks, David.