Sotera Health Company ($SHC)

All right. I'd like to welcome everyone to the Sixth Annual KeyBanc Healthcare Forum. My name is Brett Fishbin, Senior MedTech analyst, and I'm pleased to be joined today by Sotera Health, who's represented by Jon Lyons, the CFO. I'll start us off with questions, but it will be a 100% Q&A session and questions can be submitted directly to me by typing in the box below the video screen. And if we have time, I can relay them to Jon. So Jon, just to kick things off, starting at a high level, it's been a bit over 5 years since the original IPO, and it's been an eventful journey for the company so far. So I was hoping we could maybe just take a step back and just get your high-level thoughts on where the company sits today relative to a few years ago for investors who may be revisiting or new to the story.

Thanks, Brett, and thanks for having us again here. It's always great to be with you and your investors. that you serve. Before we get started, I do have to remind everybody, I will likely make some forward-looking statements. Please take a look at our SEC filings for details on those and the like. Just to get into it, it's been an interesting journey, right, since the IPO back in 2020. I think the short answer really, this is the same great business that we IPO-ed. Certainly, we've been through a few things. There have been some complications in the industry. But everything we said about the company remains intact. We're a global industry leader operating in highly regulated markets. We've got a growing market with an $18 billion SAM. We've got a global footprint with 62 facilities around the world that puts us in the right spot for our customers to support their needs with our end-to-end solutions in sterilization and lab services. We think we're well positioned for above-market growth moving forward. And the financial profile continues to be incredible. We just hit in 2025, our 20th consecutive year of revenue growth every year in, year out through a couple of different challenging cycles. We continue to have over 50% EBITDA margins. The free cash flow performance is accelerating, and we're disciplined allocators of capital. And so we think there's a lot to love about this business, and we're excited to talk about it.

Awesome. So let's talk a little bit about 4Q and 2026. You guys recently hosted the 4Q '25 earnings call and really concluded last year on a solid note, 5.2% organic revenue for the year, 40 basis points of op margin expansion and a really healthy step-up in earnings per share. So I was hoping we could first look at last year and unpack the results a little bit. And I was hoping you could also just maybe touch on any dynamics or moving pieces that trended better or worse as compared to originally contemplated coming into the year.

Yes. When you start a year, right, the year always plays out a little different than you'd expect. But if you look at where we started the year, we had a 4% to 6% organic revenue guide, and we came in at 5.2%. So large part, some puts and takes, right? The expert advisory business wasn't as good as we thought it would be. It turned into a pretty significant, more of a headwind than we had thought. But we did have some upsides that covered that, particularly on the Sterigenics side, where our continued volume performance improved a little quicker than we expected. But overall, it was a good year. It was the first year of our 3-year plan that we laid out, and we're on track for all the goals that we set in that plan. You mentioned the 5% revenue growth. We had nearly 8% constant currency EBITDA growth. We actually grew margins 118 basis points for the year, and that was headlined by more than 300 basis points of margin improvement in Nelson. Sterigenics grew nearly 8% on the top line, nearly 9% on the bottom line. Nelson Labs saw growth in core lab testing, which we were pleased with, right? It's higher margin in the business and helped support that expansion. Nordion had another great year with upper single-digit growth in revenue and EBITDA. But we're not -- we're looking at the total picture here, right? So interest expense improved by $9 million year-over-year. The tax rate was significantly lower. And all that performance led to us a $0.16 improvement in adjusted EPS in '25. So we're really proud of what we accomplished in '25, and we feel great about the fact that we're on track for the objectives that we laid out at our November '24 Investor Day.

And then just looking ahead, you recently gave 2026 guidance and included constant currency organic growth of 5% to 6.5%. So maybe just remind investors how you're thinking about this year, if there's any puts and takes compared to 2025? And then how you think about some of the bigger key variables that could drive results 6.5%, 7% versus 5%?

Yes. Yes. So Sterigenics, we've called for another year of mid- to high single-digit revenue growth on a constant currency basis. And we're looking for another solid year in demand in med device and pharma. On Nordion, we're in the low to mid-single digits for the full year. We've got a little more weighting to the first half than we had in the last couple of years. So 40% to 45% of Nordion revenue, we expect to occur in the first half, with Q2 being a little heavier than Q1. Nelson, we're expecting to grow in the low single digits for '26. And I'd just call out on the pricing side, we expect another good year of pricing performance. We've called for about the midpoint of our 3% to 4% long-term guide. And so we're feeling good about the trajectory we have on the pricing and continued demonstration of the strength and value of the services we provide. And going into every year, the biggest variable, Brett, as usual, is going to be what our volumes ultimately going to be.

So maybe on that note, you talked about a couple of moving pieces early in the year, but maybe just like higher level, how you're viewing the overall demand environment in your 2 large segments, med device and also thinking about some of the other categories and just overall level of visibility into that volume backdrop as we move into the year?

Yes. So as I mentioned, in Sterigenics, we're looking for another solid year in the med device and pharma side. We exited '25 with good momentum. We're having really good dialogues with our customers. We're in a great spot relative to where we're positioned to support the industry. And we feel like we're going to have a good year of growth there, supporting that mid- to high single digits. Nelson Labs, a part of the business is really, really closely connected with Sterigenics and that core routine sterilization-related testing that we do, we expect continued growth in that. We expect the consulting business will no longer be a headwind, which is an important step for the business. The one thing I'd call out is the validation testing. That's related to new regulations and new product development and so it can be a little choppy, and I'd expect that to be a little choppy. As we look at how the year plays out, that will be one of the things we continue to watch.

All right. Helpful. And also just thinking about the earnings call, investors are always paying attention to cadence, and you had a couple of comments about the first quarter related to weather and the government shutdown. So maybe curious if you could just touch on the cadence again. And if you've started to see things normalize at this point after some of those big events earlier in the year?

Yes. Good call. One point of clarification. We definitely said shutdown and a lot of investors have thought we meant government shutdown and for obvious reasons, I understand why they would think that. When we say shutdown, we're actually referring to our maintenance downtime. So we have -- we shut down our facilities for, I'll call it, 3 reasons, just normal maintenance. The EO facilities are getting shut down for the improvements in our emissions controls. And then we shut down for cobalt loading in the gamma sites. So that's what we refer to. Certainly, when we came into the year, it was a little slow start to the year. Weather had a definite impact on us. And then we also -- as we mentioned, that maintenance downtime is higher than it was in the first quarter of last year, which is a year-over-year headwind for us, leading us to the mid-single-digits outlook for Sterigenics in Q1. On that facility maintenance point, though, we'll see that headwind in Q1 and Q2, and that headwind should turn into a tailwind in the second half. The year did -- as I mentioned, the year did start off a little bit slow, but we definitely have seen it start to pick up, but nothing that would change the outlook that we laid out for Q1.

All right. Perfect. Super, super helpful. And I think that makes a lot more sense. And then turning to the EBITDA guidance. 5.5% to 7% constant currency was the starting point, very squarely in line with your Investor Day targets. So just kind of a 2-part question. First, outside of volume leverage and price, is there anything else that you think is impacting the margin setup for this year? And then just thinking more recently, obviously, a lot going on in the world, and we've seen fluctuation in some commodity and oil prices. I'm just curious if that has an impact on your business and how you think about that?

Yes. So a lot there, Brett. First, I would say, we laid out a target of improving 50 to 150 basis points of margin over our long-range plan from November '24, which was the '25 to '27 period. We did 118 basis points last year. I think when you go to the midpoint of our guide, you get something like 23 basis points improvement implied, which puts us nearly to the top end of our range of EBITDA margin in year 2. You hit on it, pricing. Pricing can actually be margin dilutive. When you have over 50% pricing, you have to more than double inflation in dollar terms to have margin accretive pricing. That's not necessarily something that's very intuitive to people all the time. So I'd like to just point out like why isn't your margin expanding faster? It's like, well, I've got to more than double my pricing, my inflation with pricing. We get great operating leverage that supports it. Those are the big moving pieces. The energy costs, certainly, we have energy costs. We have exposure to natural gas. We have exposure to electricity. Those are very small factors of production when you look at our facilities. And then we have long-range contracts for EO that's got an annual pricing reset in it. So from a short-term risk, we're pretty insulated at this stage. A lot of our energy deregulated markets, our energy and gas contracts are fixed for the most part. So I'm not losing any sleep over energy costs, certainly, but I obviously think about the geopolitical impact of the business more than I think about that. But even then we've got a pretty small revenue base, small, very immaterial revenue amount that goes into the Middle East. and the demand for the health care products are continuing to be strong. So we feel good about where we're headed on the margin front, and we don't have a material exposure from energy.

All right. Awesome. And just to conclude the 2026 guidance conversation, the last piece is free cash flow. And I think there's a couple sources of elevated CapEx this year. So I was hoping you could just remind investors why that's going to be higher in 2026 than how you look at it long term? And then also like how you think about normalized CapEx for the business like next 3 to 5 years?

Yes. When you step back from it, I mean, what we're really focused on is free cash flow generation. And obviously, CapEx is a big component of that. Back at our Investor Day, we set a 3-year target of $500 million to $600 million of free cash flow. And that goal, we did $200 million plus last year. We're well on track to achieve that goal. And our assumptions on CapEx are really unchanged relative to what went into that objective. Our CapEx was $138 million in 2025. We came in quite a bit lower than our initial guidance, which I think the midpoint was around $200 million for 2025. And it's really timing, predominantly. Two things of timing. One, the second one of our greenfields, we delayed a little bit. Michael and I run a very disciplined capital allocation process, and we wanted to make sure we were very confident as we continue with that program that we were going to get the returns that we expected to get out of it. We got in a position where we felt comfortable to move forward. And so we've moved forward, but that kind of shifted a big chunk of 2025 spending into '26. The other thing with the 2-year delay that we received in the NESHAP regulations, we were able to go back and have a little bit better negotiation with suppliers, some suppliers that were kind of holding us hostage a little bit. And that allowed us to save a little bit of money on the NESHAP-related spending program, but also shifted a good bit of CapEx from '25 to '26. As we look forward, assuming we hit the plans we have for '26, CapEx in '27 is going to drop significantly. We'll be largely complete with our NESHAP-related spending. There might be a little bit of immaterial amount that trickles into '27 from a timing of payables perspective. We'll have a significant amount of the spending on the growth investments that will step down and even the cobalt development steps down a bit from '26 to '27. So we're in great shape. CapEx is going to drop. Cash flow, free cash flow continues to accelerate, and we're going to achieve that goal. We fully expect to achieve the goal we laid out at the Investor Day for free cash flow.

Awesome. And then I'm going to shift the conversation a little bit to the individual business segments, and we can go in order starting with the largest, which is Sterigenics. You touched on this a little bit about some of the improvement you saw in the back half of last year. It was a nice year for the business overall is a 7%, 8% organic growth coming off of 2 years closer to mid-single digits. So maybe just a little bit more on kind of like what you saw improve in the back half of last year that drove some of the step-up in growth. And we already talked a little bit about '26. So maybe just your thoughts on once we get past some of the 1Q items, if you think we can kind of get back into a similar cadence in the back half of '26?

Yes. No, Brett, I mean when we look at -- we're really pleased with the business performance in '25. And it really -- the volume performance, we started seeing it, and I think we started talking about it in the second half of '24. Obviously, you didn't see the volume performance come through really still starting in Q2 of '25. But we've seen, as I mentioned earlier, really solid demand in med device and our pharma customers. We've seen our XBU customers overall for the business grow at a faster clip. So we're pleased about our efforts there. We're continue -- we're a critical part of the supply chain, and we continue to expect that good solid demand from those customers. And we got some noise, as I said, in the first half, first on the -- not in the first half, but the first quarter relative to the weather and the downtime, and we fully expect to accelerate particularly in the second half relative to that downtime abatement. We've got new customers coming on. We've got the -- including the Haw River X-ray facility that will start coming online and start contributing.

I want to also ask, there were some dynamics, I feel like over the past couple of years with stocking, and it wasn't a huge topic as we got to the second part of last year. But I think like some people maybe think was there some level of pull forward of demand ahead of tariffs or like anything like that. So just curious like if you think the whole stocking topic, especially in med device has normalized at this point? And if you think that's like a big factor for the cadence this year?

Yes. I mean in our view, it's normalized. This is where -- when I say second half of '24, we saw it kind of normalizing then. This business always -- with 2,000 customers, there's always something going on with some customers. So we're dealing with somebody building inventory or taking inventory out. I would say the industry is stable. We don't see a big -- and by the way, this is not a pull-forward business. It's not like a distribution channel where you can give a quarter end incentive and you're trying to push some volume out the door. Our customers are delivering us a couple of days. We don't have big warehouses to bring product in, to hold product and wait for them to pick it up. I mean it's in and out in a handful of days with our customers. And so this is just not one of those industries where you can stuff the channel or you can accelerate volumes to any degree. I mean we got limited capacity, limited warehouse space. So it just doesn't work like that.

That makes sense. And then I think it's a good segue to my next question or 2 on capacity because it's -- you bring up a good point about limited capacity in the industry, and you guys have been kind of on the forefront of bringing more capacity to the table for customers. And I think like maybe in '24, you were talking about 8 different projects that were either completed or underway. So maybe just thinking about that overall, like how you think about the capacity additions and how that positions you for growth over the long term?

Yes. So Brett, it was -- there was several projects that we've completed over the last few years, and they vary, right? We're kind of at the tail end of this with 2 projects left. There's 2 greenfields left. But these come in different shapes and sizes. One expansion might be adding a cobalt, adding incremental cobalt to an existing facility or adding a chamber to existing facility. We've had some of that over the last few years when we think about expansion projects. We could add a new irradiator to an existing facility. And we've had those adds over the years that have been contributing actually positive to the business. All the investments we've made, we've seen pretty good returns on those over the last few years. As I mentioned, there's 2 greenfields left. We've target a 20% IRR. Expansion facility, you can imagine, is going to have a higher IRR than a greenfield, right, where you've got to put a lot more infrastructure in place upfront. So these 2 greenfields will return a little lower than the 20%, but still good returns, still above cost of capital. We feel good we've got the X-ray facility that will come online later this year. And then the second greenfield will come online late '27, early '28. So we're kind of at the end of this -- as I mentioned on the CapEx outlook, we're at the end of this kind of growth investment cycle for Sterigenics.

And I have to ask, I feel like you've answered this question a couple of times, but maybe just any more thoughts. I think it was notable that one of the 2 most recent projects was focused on X-ray, just given -- I think it's been a modality that Sotera in the past hasn't focused on as much. So maybe we can just kind of revisit the decision to start investing in that modality. And if you have maybe like a directional view long term of like where that could potentially go in terms of like mix or future projects?

Yes. No, great. X-ray has obviously become a little bit more prevalent in the industry. I would remind you, we are the global leader in cobalt. So I think it kind of makes sense that we -- cobalt is a great modality. The great thing is it's always available. It's always on. You don't have to worry about electricity. You don't have to worry about the cost of electricity. The cobalt is ready to sterilize products when you need it. X-ray can be a little bit more -- I mean, it's machine generated, right? So it can be a little bit different on the reliability, but still a reliable source of sterilization. We do have an X-ray -- existing X-ray in our network, but it was small, and the Board made a strategic decision to make sure that we had X-ray available for our customers who might want it. We actually debated a few years ago, should it be 2 or should it be 1? And the Board decided ultimately to go with one that's coming online here. And so we're excited to bring it online. We're excited to have that option for our customers. It's co-located with a gamma site. So we can kind of be the best of both worlds for our customer depending on what they desire. It's something we'll continue to evaluate more, but we have no plans currently in place for any incremental arrays, but we could over time.

Got it. All right. So we'll monitor that looking ahead, you're not going to get too much into the strategy long term. So maybe shifting gears a little bit on this topic. We had some news last week with the EPA announcing some proposed amendments to the 2024 NESHAP final rule. So we're going back into a period of change after we thought we had some clarity like after a long time. So maybe just -- I understand it's very early, but just maybe like any initial thoughts on some of the changes and your initial impressions on that announcement?

Yes. So it is very early, and it's actually changing. I got a message today, right, the comment period, the regulation was -- or the proposed regulation was posted. The comment period has started that ends May 1. We'll be hearing on April 1. So that was hot off the press this morning. We knew it was coming, obviously, from what was, I think, published on Friday. we're going to continue doing the work that we've been doing on our programs. We've got a leading program in place. We're going to be there to support whatever regulations might be final and required. A couple of things I'd call out. One, you also have a state-by-state consideration. Two, you also could get -- it could change over time no matter where they end. Lastly, I'd call out that even with the revised -- the updated regulation, it's still significantly more stringent than it was before the '24 regulation came into place. So even if they roll it back some like they've proposed, it's still considerably more stringent than it had been before. I think one thing that makes sure people caught in there was they're also revisiting the 2026 is risk assessment. We believe that there are certainly some issues with that assessment. And I think there's better understanding of the science and the methodologies that might be used. So they're inviting input on that. We think that's an important development depending on how it goes because it's something that is referenced significantly by plaintiffs attorneys inside our litigation. So if that is rectified, it should be helpful for us as we move forward dealing with the litigation issues.

Was that in reference to the IRS assessment like that took place already like kind of years back? Or is that something that...

Yes. They're revisiting -- they're inviting input on revisiting the output of the 2016 assessment.

2016, okay. Got it. Got it. Perfect. All right. So let's -- we have 15 minutes or so. So let's shift gears again to like Nordion. And I think like one thing that stood out to me as I was just looking at the last few years and our model going ahead is growth in Nordion has been stronger the past couple of years, I think averaging like 9% the last 2 years. And I wanted to just ask about that because it's a little bit different than like how you talk about the LRP and like call it, like normalized growth for Nordion. So what kind of drove that like high single-digit, almost double-digit growth in Nordion in the past 2 years? Was it like timing and just like 2 years in a row or like anything else?

Yes. I would say, over the last few years, there's been a couple of things going on with Nordion. One is we were coming off some old contracts and the industry was in a different position. And so there was some significant pricing resets in those contracts, which supported obviously the revenue growth. The other thing that was going on is cobalt was actually in a tight supply several years ago. And I think there was some pent-up demand for Cobalt-60 that came through over the last couple of years. We expect that moving forward, we're going to normalize to the guide that we had provided of the low to mid-single digits revenue growth.

All right. Got it. Got it. And then just thinking about also like the outlook. I think if we put together the 2025 results and the 2026 guidance, you're kind of in that mid-single-digit plus range. I'm just wondering kind of with that starting point in mind, thinking about '27, like is it reasonable or possible to think that you can end up above the original '25 to '27 LRP, just looking at the 3 years as a whole?

Yes. Brett, I understand the math you're doing. I'm excited about the performance they put up last year. I feel good about the guide that we've given for this year. 14 months into the LRP, I'm not ready to call a victory and raise the number just yet. But we feel really good about the business, great about their performance last year. We feel really good about the team and how they're managing a very complex supply chain, and we'll continue to deliver for our customers there.

Totally fair enough. And another point that came up on Nordion, I think, during this most recent earnings call was some of the milestones around obtaining new operating leases from the Canadian Nuclear Safety Commission. And I think Michael mentioned on the call that like this new contract or agreement was the longest ever granted. So I was hoping you could just like unpack that a little bit and what this means practically for the continuity of Cobalt-60 supply over the long term? And then just to throw in like a part 2, if that changes at all like how you approach contracts with customers given that like longevity of supply locked in?

Yes. I would say a few things here, right? We operate our one-of-a-kind Class 1B nuclear license facility in Ottawa, Canada. We got a 25-year license renewal, which is the longest of its kind. I think what that means is a couple of things. One, it's the recognition of our team we have a phenomenal team up there that operates in this highly regulated, highly complex industry. And the willingness of the regulator to issue that kind of license, I think, is a reflection of the business itself and the people who run it more than it's a testament about anything else. That said, it does alleviate one thing, right? We fully expect to get that license renewed. If it was a 10-year, we'd fully expect to get it renewed the following 10 years. So I don't think it has a dramatic impact. I just think it's more of a measure of kind of our leadership in the industry and what kind of operation that we truly have up there that they're willing to grant a 25-year license.

All right. Makes sense. And let's conclude the segment conversation with Nelson Labs, an area of the business where you've seen some headwinds over the past couple of years. And I think you mentioned at kind of the top of this call that you think the expert advisory services is no longer a material headwind. And so maybe just as you sit here today, like what are kind of those signs of stabilization and improvement, specifically in the expert advisory part of that business?

I mean just specifically in the expert advisory part of the business, it's effectively reset. It had its best year in its history last year. The expert advisory business was -- or I'm sorry, '24, still last year is still '24 to me, I guess. But in 2024, $34 million of revenue in the Expert Advisory Services business. It then followed up with about its worst year in its history, which was driven by the fact that we had these big remediation projects that were ending and they haven't been replaced, and we don't have line of sight to seeing replacement. We're effectively restabilizing at a pretty low base. When you look at the history of that business, it might be the worst year in its history, but it's in a range of what looks like a base of that business. So we don't expect it to be a headwind any longer. It is a headwind in Q1 as we do lap a pretty elevated Q1 of last year. But I think important in the business, if you look back at the overall, we saw really nice growth in our core lab testing business last year. particularly in the piece connected to Sterigenics and the sterilization-related testing. We also saw some good developments in some of the regulations on the validation side. But the validation side, as I mentioned earlier, is still a little choppy, but we're really pleased to see that good solid base of the sterilization and the XBU connection with Sterigenics. And then we'll maximize the opportunity when it's there on validation testing related to new regulations and new product development.

All right. Perfect. And maybe just one more follow-up on the segment, and then we'll conclude on the balance sheet and maybe one on litigation in our last couple of minutes. But you've talked more about the XBU strategy that came up a lot on the Investor Day and has been discussed in depth. through last year. So I think the number was like 9% overall growth from that customer cohort. So maybe just like a little bit more about what's driving like the better performance when you have customers or doing business in both segments and kind of how you drive that excess growth compared to the rest of the business?

Yes. Great. So just stepping back, 70% of our revenue in Sterigenics and Nelson comes from shared customers. And over 50% of the Nelson Labs testing is routine sterilization-related testing. Again, that's closely connected to Sterigenics. If you pull it apart, we've got 12 facilities in Nelson Labs, 9 of them are either co-located or in close proximity to Sterigenics facilities. So we're able to provide more effective solutions to our customer base when they're using both sides, we can be a little bit more streamlined opportunity for them. We've seen higher customer satisfaction rates when we're seeing both. But we're in the early innings of really maximizing the opportunity. We have opportunity for better attachment both ways. sterilization that we do that then is tested either in-house or by somebody else and further penetrating that for Nelson or validation testing that we do for Nelson and further penetrating that back into the routine sterilization activity. So we see a good opportunity to continue to move this in the right direction and increase that number, but it's a very important focus for us.

Awesome. Well, I think this has been a really good discussion on the growth and margin expansion and some of the segment drivers. I think we have a couple of minutes left. So maybe just concluding, kind of bringing it together. We talked a little bit about free cash flow, but net leverage has continued to creep lower pretty close to your target range of 2 to 3x. So maybe just in the last minute or so, you could touch on just any potential changes we could see in capital allocation once you are comfortably within that target leverage range? And then just if you had any other thoughts you wanted to leave investors with as we sign off here.

Yes. Great. Thanks, Brett. And again, thanks for having us here. Glad to kick off the conference with you. We're really pleased. We've improved net leverage nearly a third in just about 2 years, which just demonstrates the ability for this business, the growth rate of this business to actually grow into some of the elevated leverage that we had. And nothing is really changing from a capital allocation perspective. Clearly, as we move into this range, and we expect another year where we'll improve from the 3.2x. It gives us more flexibility to pursue on the strategic end, but it doesn't change the discipline that we operate from a capital perspective. So from a balance sheet perspective, continue to focus on maintaining a strong balance sheet. We're going to prioritize organic growth. And then we're going to be opportunistic about debt paydown, M&A and even consider some buybacks over time. So we feel good about the flexibility we have, the balance sheet strength and the trajectory that we have. When I think about just leaving the group with a couple of messages, it's a little bit of what I said earlier to be a little bit redundant. We've got good momentum in the business. We just mentioned we got a strengthened balance sheet. We're on track for the commitments that we made at our Investor Day. And we're confident in our ability to drive growth, to generate strong free cash flow and ultimately to drive shareholder value, right? That's what the people on this call care about, and that's what we're focused on doing. And we remain focused on our priorities that we laid out at Investor Day. Number one is excellence in serving our customers with end-to-end solutions. Number two is winning in growth markets. Number three is driving operational excellence to enhance free cash flow; and number four, disciplined capital allocation. We're very focused on those things, and we're looking forward to having a great '26 and generating shareholder value for this group.

All right. Jon, with that, thank you so much for joining us for today's session. Thanks to everyone in the audience for listening. Have a great rest of the conference.

Thanks for having us, Brett.