Sotera Health Company ($SHC)

Okay. Thank you. We're going to get started. We're going to start the afternoon session. And this afternoon, we're going to start with Sotera Health. Sotera Health is an end-to-end sterilization and lab testing services company that caters to the med-surg equipment manufacturers as well as other end markets. And with the company, I'm happy to have Jon Lyons, CFO; and Jason Peterson, Investor Relations. Jon, thanks for joining us.

Thanks a lot, Ryan. Good to be here.

I wanted to start with the leadership transition that you guys announced recently. Just wanted to get an update, any more details on the succession time line and any perspectives you could add just on Alton's background and experience that you're excited to have on board.

Great. Thanks. And before we get started, I do have to cover the legal side. So I may make some forward-looking statements today. Please refer to our SEC filings for a list of risks and uncertainties related to those. And now, I'll answer your question. So no, we're excited. I'm excited. I had a chance to talk to Alton a couple of times since he's been appointed. The Board ran an exhaustive search in coordination with Michael, really looking for the right person for the role. Just from a timing perspective, I think Michael was interested in taking a little bit of a turn. His view is that the role should be -- CEO role should be 2 terms, kind of 4 years, 4 years and then move on and he's nearly a decade -- about a decade in. And so we thought it was a time for transition for him. And I think it's a sign, too, of the position the company is in, and I think we can talk about that a little bit later from a positive perspective. But Alton is starting next week. We've got a deep med device experience with Hill-Rom, Baxter, most recently as CEO of Viant. We're excited about what he brings and what I understand is a very strong commercial orientation in my conversations with him, he impresses me -- one who's very complete. So might have a commercial orientation, but it is a complete kind of package from operation and commercial strategy. So we're really excited to get him on board and that transition starts next week.

And then just maybe wanted to put on the broader demand landscape. You guys talked -- first off, reported a very strong quarter in terms of volume as well as overall revenue growth. But I think you highlighted in March as the strongest volume month in years for Sterigenics. And then also mentioned April, those trends continue. So any color just on the market dynamics where you're seeing this demand really coming from or any other kind of color around types of customers or ways for us to appreciate.

Yes. No. Thanks, Ryan. Sterigenics, obviously, our biggest business, 2/3 of the company, really important to see that volume and mix growth in the business. And we look back on the quarter, it was very much in line with what we expected when we guided for the year and gave some specific guidance on the quarter. A little slow start to the year, January and February, which I think it's pretty well documented across the space. The weather had an impact on procedure volumes, it appears and certainly had an impact on our business. So we grew 6.1% on a constant currency basis, would have been nearly 8% with the weather impact. So we felt good about the start to the year. March was really strong, as you mentioned, probably a little bit of catch-up from January and February with some of the weather impact. But again, net-net, it still was a sizable headwind in the quarter. We got off to a good start in April. And as we sit here today, we're feeling good about the guide that we gave. So particularly as we ramp up in the second half, our guide for Q2 is similar in growth in Q1, coming off a tough comp in Q2 of last year. Then the second half, the comps ease a little bit from our downtime, our maintenance schedule that has a headwind or tailwind depending on what's going on. It's a headwind in the first half, it's a tailwind in the second half. And we're seeing just good fundamental demand from our customers across the med device space. We've seen good demand to date, and we have a good line of sight to what we're seeing going forward. And we also have our new x-ray facility coming online, which will provide a little bit of a tailwind, and there's been a lot of discussion about another customer, that's not big, but it's a pretty good transition for us in the EO space from an in-sourced to outsourced perspective that's going to start contributing to it.

And how do those trends continue from April into May?

Yes. I mean it's -- we're in the middle of May. Like I said, we feel good about the guidance that we've given in those conversations and the indicators about where the market is going and what kind of demand we're going to see for the balance of the year continue to be there. So I feel good about the quarter. I feel good about the year.

Excellent. You just mentioned the customer converting from in-sourcing to outsourcing that you're expecting to contribute later in the year. Any other -- any way you can help us size or just put into context the contribution that you expect from that customer?

Yes. And I know I brought it up, and it's something that's turned into kind of a much bigger talking point around the business and the industry than it is in size of -- than it is in a size of customers just because of the fact that's relative to the new regulation, it was an outsource versus -- an in-source versus an outsourced conversion. It's not like we have to build a facility for this customer. It's already an existing customer in different parts of the world, in different places. It's a meaningful impact to the business, but it's not like we're going to go build a facility for them or anything like that.

Got it. Okay. The other driver of growth pricing has certainly been an area of strength, 4.5% pricing growth in the first quarter. You've been guiding towards the high end of your historical range on pricing. Just maybe any -- any sort of outlook as to the sustainability of that pricing power you guys enjoyed?

Yes. No, I don't like to use the word pricing power. There's a customer on all -- the other end of all these discussions. And those are never easy discussions. I think we're recognized because we play an absolute critical role in healthcare with the highly regulated industry. What we do is not easy and it's not core to what many of our customers do. And so there's good value for the work that we do, and I think we're recognized for that work. That's been demonstrated over the years. I mean, the business has grown, Sotera Health has grown every year for 20 years. If you look at since we've been public, we've had good pricing improvement year-on-year. It's adjusted based on accelerating inflation, earlier in the decade, and we've seen that consistent performance, and there's no reason we anticipate that changing. We continue to deliver it quarter in, quarter out, and I don't expect that to change.

Maybe then moving on to the Nelson Labs segment. I think you've finally lapped some of the difficult comps after a record year in late 2024. Margins in the business, I think, are still suboptimal relative to your targets. Just what gives you the confidence that you'll be able to execute on that margin story in Nelson Labs? And just any sort of color on pipeline or you talked about validation projects and where there is a building pipeline. So any sort of visibility into that would be great.

All right. I think you had like 5 questions in there, Ryan. So I'm going to try to tackle them and just catch me if I got -- if I miss anything. I'll back everybody up a little bit. You mentioned 2024, yes, the Expert Advisory Services had a really strong record year in 2024. I mean it's like a $230 million business overall, and it was $34 million. That was really driven by some onetime remediation projects. And we saw that coming, I think, in the end of '24, we started messaging that we saw a little bit of a cliff headwind coming related to those remediation projects cycling off and the Expert Advisory business suffering accordingly. The business dropped from $34 million to about $10 million from '24 to '25 and had even a bit of a headwind coming into this year, as you mentioned, we're just lapping kind of the last comp on this Q1 of that headwind. So that's behind us. In the middle of facing that headwind, we also improved margins over 300 basis points last year, and we got the margin rate into our low to mid-30s target that we add. I think what you're referencing in Q1, Q1 margins were down year-over-year. It's the slowest month -- slowest quarter of the year, January and February, like in Sterigenics were really soft. The margins were pretty terrible, honestly, when I look at January, February, but that's really volume oriented. We've got -- it's a highly labor-intensive business. and scale. Volume matters a lot in the lab testing side. And we can't -- if you have a couple of slow months, you can't adjust your workforce that quickly. It becomes almost a fixed cost for you. It's kind of semi-fixed. And so as we came into March, volumes were back where they're supposed to be. The EBITDA margins were back where they're supposed to even on the high end of where I thought they might be. And so we're feeling good about the margin recovery in the business, the volume's there, the margin's there, and we saw that performance continuing. And as I look at the volumes for the rest of the year, there's a number of things that are coming through. Number one, you've got Sterigenics volumes. So when Sterigenics is processing, we're testing to support the lot release and validate that the sterilization was successful. So those accelerate. The validation pipeline, which we've said has been choppy depending on new regulations, R&D funding, things like that, new products, those sorts of things coming through. We've got good visibility into a validation pipeline of work coming in. And normally, Nelson is very short cycle. That can give us a little more visibility. So we've got the new regulations in with validation pipeline associated with that. We've got a couple of initiatives. We got our new clean room coming online in the second half. We just did an open house. We've got a good pipeline building for that as it comes online in Salt Lake City. So we're excited. We see good revenue growth and feel good about the guide that we've given there for the back half acceleration.

Great. On the strategic...

Did I get them all?

You did.

All right. Good.

And I wanted to go back to one of the points you made, sort of the cross-sell between Sterigenics and Nelson Labs, and that's been a big part of the investment thesis of Nelson Labs. I think you had previously maybe sized a synergy opportunity of $15 million. And I'm just curious how you progress to that goal? Or is that still a goal that's out there?

Yes. Thanks. Yes, we did put that goal out there 1.5 years ago. And so we're making good progress. It's never as fast as you want it to go. Our XBU customers, the customers that are doing business with -- doing business with both businesses generated about 70% of the revenue from the 2 businesses. So it's a really critical customer base. That group of customers grew 10% last year, which is faster than the total enterprise. So we're feeling good about the progress we're making there. But we still got plenty of work to do plenty of opportunity to accelerate that growth. And so we keep focused on it, but we're making the progress.

Okay Switching gears to capacity, always a topic of conversation. I think you've been citing capacity utilization of 80% or at least that's kind of the target. And now you're talking about adding to your capacity. So maybe just -- how do you feel today about your current capacity against that 80% target? Is there wiggle room or I shouldn't say wiggle room, but do you feel like you're nearing that target for -- by modality?

Yes. So as we look at it, capacity utilization really comes down to a modality geographic evaluation because that's what drives the business. Customers need the right modality in the right location with the right service level to support them. And depending on where you are in the globe, I would -- well, generally speaking, there's -- EO is tighter than gamma. We got a good amount of capacity available in gamma, and we have the ability to expand capacity in a lot of our sites to add to gamma. EO is where there's a considerable amount of tightness. And that is even variable, too, on large chamber versus small chambers. So think about a truckload of pallets versus a less than full truckload of pallets. The large ones are pretty tight across the U.S. and in different parts of the world and the smaller ones have more availability. So that's a piece where we really focus on optimizing our facility throughputs to create capacity where the customers need us. But the big story is we've got room to grow and deliver against what we've committed to, especially with the new facilities coming online that will help support that, too.

Okay. Maybe just to clarify. So the new facility you have coming online is more of the X-ray modality. And that will help -- how does that sort of help to loosen some of the...

It doesn't help loosen the EO, but it's in a good place where we know customers are going to need us with that capacity, and so it's going to help support our growth.

Got it. Okay. And just the time line for when that facility is expected to come online?

As it's coming on right now, it should start to contribute in the second half. And then we have a second greenfield that comes on late '27, early '28, that will start contributing in '28.

Okay. Regarding the EO litigation, you had a favorable update in terms of the dismissal of the 8th Georgia bellwether cases recently. How are you thinking about, I guess, the legal situation in Georgia? And then California is the next -- one of the next big sort of cases, which is more like early 2027, but anything investors should be paying attention to leading up to that?

Yes. No. I think a couple of things. First off, what we've always said is when science is front and center and fairly represented in the court room, to prove that these claims have no basis. And that's what happened in Georgia. Science was in the court room and it was demonstrated that there was no causality here between emissions from our facilities and the plaintiffs claims and those cases were dismissed. We're going to go through the appeal process. Obviously, that's a key thing. So we're not done there. But we are seeing -- I think when that is in forefront and not just us with other defendants, you're finding that we have a good posture. And California is coming, we're going through the pretrial motion and discovery and depositions and all those things. And we'll work to play that out. It appears so far that science is going to be front and center there. It remains to be seen exactly how that plays out, and we'll continue to monitor it and make sure we manage it effectively like we've been managing these cases very effectively for the last few years -- and January and April of '27.

And you mentioned you're already going through some of the pretrial motions. Can you remind me when is the Daubert hearing? Or when do you get a sense -- of science?

Yes. So that's happening over the coming months -- so weeks to months, I mean, this is imminently happening.

Helpful. I wanted to talk about the NESHAP rule change that is in the proposal phase right now, and I know there's -- it's in the commentary. How has that been impacting the industry, I guess, from a decisions like do we in-source or do we outsource versus in-source? Or do we build new facilities? Are you seeing that proposed rule where it potentially could be finalized? Is that already impacting industry on decisions like those that I mentioned?

Yes, it has impacted decisions. I mean you think about the customer referenced already, they decided to go from in-source to outsource. But the time lines and the implementation time lines has just created uncertainty, but also just deferred it. Deferred what were seemingly more imminent decisions that small players might make some small -- outsourced providers might make to go out of business or sell their facilities or make improvements. It just kicks the can a little bit down the road as the regulators have reflected in potentially adjusting the regulations and move the time lines out. So it's kind of just slowed things. Our dialogues with customers and other industry kind of slowed down from a much more heated level or heated pace than they were 1.5 years ago.

Okay. And you guys have made a lot of investment in your facilities to meet the new standards that are now being proposed to be rolled back. If you could please help us understand how does that still impact your competitive position in the market in terms of those investments.

We've made those investments. We're ready to comply with the standards that are finalized, whether they are the standards that were promulgated in 2024 or what's being contemplated now. One thing to clarify, the old rule was difficult. The 2024 rule was really, really difficult. When we say rolled back the 2024 rule, what we'll call the 2025 role, it's still way more difficult than the old rule. So these -- everybody is going to need additional improvements, additional capabilities in the facilities to make sure to comply even with that rule. And then who knows where the rule might be 2 years from now. So we're continuing our investments. We're going to be an industry -- we are an industry leader in this, and we're ready to be there and we'll be there for the long term to support our customers.

Okay. Your guidance, it implies some high single-digit growth in the back half of the year after, I guess, more mid-single-digit growth so far in the first quarter. Just you mentioned the new in-sourcing shifting to outsourcing customer, the X-ray capacity. Any other swing factors in terms of the visibility you have into the second half of the year.

Yes. I mean we're having great dialogue with our customers. They want to make sure we've got the capacity there when they need it. And so we've got some visibility from that. Things can always change, but we've got a good dialogue with customers what we expect, good pipeline of validations converting to normal sterilization. We got lower maintenance downtime in the second half than the first, which will turn to a tailwind and then we got those couple of things that you referenced. So there's a bunch of things adding up to shape up for a really good second half.

Great. I wanted to touch on your shareholder base. There's been some change over the past few months since the end of last year or you've seen some of the insider holders now fully sell their positions to the private equity sponsors. Maybe you could share with the audience, just how should investors think about your shareholder base now going forward now that your private equity sponsors have liquidated their position.

Yes. No, great. When I joined the company 3 years ago, 60% of the shares were held by the private equity owners or former private equity owners, and it was an overhang on the stock, and now that's gone. So when I look back and I look at what we've done over the last year, I'd tie it to when I started, I'm not claiming responsibility or pounding my own chest about what we've accomplished. But the private equity ownership is out, our leverage ratio is back into a spot where I think it's more palatable for a lot of the investment -- investor bases. We're almost -- we were at like 4x, now we're nearly 3x levered. We've taken interest expense. We're actually just closing on another repricing of our loan, in our term loan. In the last 9 months, we've taken out 100 basis points of interest costs out of the term loan. That's $14 million a year. Litigation had much more ambiguous kind of views around it. We've walked through how much clarity we have, still work to do, but things are much more clearing, I think, from my view, evidently manageable from where we are. And I think what that's doing is you're kind of pushing these things aside and everything that everybody loved about this business the strength we have supporting customers in highly regulated markets, the key customer relationships, critical to healthcare. We deliver price every year. We deliver growth every year for 20 years. People are now able to focus more on the fundamentals of this great business versus some of the challenges that we've had to deal with over the last few years. So I'm excited about where we are. I think it's a great opportunity to dig in and learn more about Sotera Health.

Maybe just one final one. Macro factors to the business. Anything that investors should think about in terms of geopolitical or energy costs?

Energy is a very small -- very small component. I came from glass melting industry. I thought about energy costs every day. I worry about supply. I don't worry about the cost because it's pretty much -- it's a very small base. And I don't worry about supply because I've done the diligence and know that we're in good shape from a supply perspective. So they're very small sales like into the Middle East, for example. So there's not a lot to worry about with respect to those kind of exposures right now.

Great. All right. Well wrap there. Thank you very much.