Sotera Health Company ($SHC)

Good morning, everybody. I'm Dave Windley with Jefferies Healthcare Equity Research. I appreciate your interest and attendance in Jefferies 2026 Global Healthcare Equity Conference. Also very pleased and appreciative of Sotera Health's attendance and participation. Michael Petras, the company's CEO, outgoing CEO, has joined us.

Michael, thanks for being here. I know I was going to start there. So you did make a leadership change announcement. Tell us about what makes now the right time? Why are you comfortable in handing the reins over and what brought you -- what brought the company into this decision?

Yes. So great, David, thanks for having us here. Before I start, obviously, we're making forward-looking statements. We further our SEC, the filings or descriptions and details, reconciliation of some of the adjusted EBITDA and some of the other numbers in terms of we may have if you could refer to our filings. But again, thanks for having us here today. As David mentioned on our last earnings call, we mentioned a transition. I would be moving over to the Executive Chairman job and will be taking over as the CEO. [Audio Gap] stopping anytime soon.

Got it. So most people in your position would have savored the opportunity to divorce yourselves of having to deal with guys like me. So Alton, sorry about that. . On -- from a strategy standpoint, you touched on this a little bit, Michael, on those last comments, but are you seeing -- foreseeing any changes or alterations in the strategic -- focused strategic outlook for the company with the change in leadership? Or is it pretty much all systems same and go?

Yes. I mean, listen, we've got a strategy. We go through a strategic planning process every year. It actually is starting now. is going to have a chance to spend -- he's been spending time with the team already, but he's going to spend time concentrated effort around the 3-year strat plan, and this all comes together then for a Board discussion we'll have with our Board every August. Listen, we have a pretty solid strategy. That doesn't mean you can't get better, it can't be accelerated. And we expect to bring value add to it and figure out a way to just enhance that over time. But we don't see wholesale changes in the strategy from where we sit today.

In terms of recent performance, moving to the business, in Sterigenics and I think, Nelson January and February, you described as being a little lighter with some acceleration in March. Perhaps talk about the progression of activity and momentum in the business as we move into the middle of the year.

Yes. So we're sitting here, coming off the last earnings call, we said that the guidance we gave around was around Nordion. We'd said about 40% to 45% of the revenue would happen in the first half. We said that in the second quarter that Nelson would have slight growth over prior year. And we said Sterigenics would have similar growth on a constant currency basis to what they had in the first quarter and I can tell you, a lot of investors asking me the question today, there's a lot of noise around med tech and health care. I can tell you today, we're very confident in what we communicated just several weeks ago in the quarter and the total year outlook. So we're seeing continued progress in the business. And particularly with Nelson, some of the things going on in the validation testing area that we signaled on our last call that we're seeing momentum on. So I would just tell you, overall, reaffirming where we were several weeks back, what we're seeing for the second quarter and the total year. We're in a pretty darn good spot.

Okay. Fantastic. .

And is not going to screw that up. We've already had that conversation multiple times, right?

Here are the keys, don't wreck the car. The first quarter, there was some call out on weather-related activity in the industry. Again, you had, I think, talked about January and February being a little slower. So relative to your comments that you just made about med device, should we think about the issues being like the weather impact being customers having difficulty getting volumes to you? Or is it more at the kind of their pull-through demand level that procedures didn't happen, therefore, the system didn't need their product? .

Yes, it was a combination of both. I mean it started with the customer end market. The procedure volumes were a little softer in January and February because of the weather. You heard that from many providers out there, which then flow downstream into some of our customers being able to get product to us as well. We see that coming -- we'll recover that volume over time, most of it, we think. But overall, we're not seeing that kind of noise, if you will, in the second quarter.

Okay. On the flip side, are you seeing kind of alluded to this, but are you seeing that volume come back to you in the second quarter? Or is that something you expect to be stretched over longer time period?

Stretched over multiple times, particularly the Sterigenics business is where we felt most of that impact. And as I just stated, we see consistent with what we talked about several weeks ago with the revenue guide in constant currency basis being consistent with what we saw in the first quarter.

Yes. Focusing on Sterigenics and thinking about that end market, I mean, you've already referenced the noise a couple of times. Apart from seasonality, how do you think about the longer-term -- medium- to longer-term outlook for commercial activity with your sterilization clients? .

Yes. So if we kind of step back and look at our 3 businesses, we got Nordion, the cobalt business. We got Sterigenics, our largest division, which is sterilization. We have Nelson Labs, which is our testing and analytical chemistry. I'd say we have the least visibility on the Nelson side, we have the most visibility on Nordion. I mean you're working with nuclear utilities and you know when the cobalt is going to be harvested and you've got to plan for that delivery to our customers. And then Sterigenics has some visibility several weeks and quarters out and when we -- one of the things that we talked about in the last earnings call, I mean, people want to know, just like last year, people said, "Hey, we're not sure you're going to be able to deliver a back-end loaded plan." Well, we did it last year, and we're telling you we're going to do it again this year. and some things that we gave some sound bites too, to make sure that investors understood there's a couple of factors that are going into our confidence. One, we're having conversations with our customers and some of the demands that they have on truckloads and things that they need in the back half of the year based on what they're seeing has been pretty consistent with us. We've got an facility, which will have a small contribution in the second half that will start to contribute. We've got one customer that had large in-house ethylene oxide sterilization. They decided to outsource that. We'll start to see a little bit of the impact from that late in the year. And then the fourth thing is we had several days out in the first half of the year for maintenance improvements and facility enhancements that will be less of a drag in the second half of the year. So those are the 4 things that I would tell you that should give you some confidence around what we're seeing in Sterigenics for the rest of the year.

Interesting. So on the -- that's helpful. Good list. The customers that are pointing to that second half, I guess a couple of questions, follow-up on that. One is, is it your sense that any of that is -- will pivot or toggle on the underlying -- like lower volumes, do their volumes come back in terms of surgical volumes at the end market? Would that move those customers off of that inflection in the second half? Second part of that question would be to what extent do you have firm order on that or kind of take-or-pay type protection on that volume.

So if some may were to fall off dramatically, yes, we'd feel that impact, right? Customers aren't going to just bigly ship us product without their end demand, but we don't see that happening. We feel pretty comfortable on what we've signaled. And the answer to your other part of your question about take-or-pay, there are -- there's a significant portion of customer base within Sterigenics that does have take or pay. We haven't disclosed exactly what that number is, but that does give us some confidence as well as we move throughout the year. I mean, listen, we provide a critical service. Our customers need our capacity to be able to provide the safety that's needed to patients in their care. And we provide that safety net for them.

In a more general sense, you mentioned your x-ray facility, you're investing, I think, still bringing on a second greenfield. You are working in kind of the Nordion business with expanded partners that you could harvest Cobalt from. How do you think about the longer-term landscape of, I'll call it, modality mix in sterilization? Is there a change or not a change?

There will be changes. I would just tell you, overall, the common theme to what you just described, the investments we're making is growth. Business has grown 20 consecutive years, and we see that growth continuing in the future, and that's what we're planning for. As far as modality across all 3 businesses, right, the testing, the sterilization as well as the cobalt supply. As far as the modality shifts, you'll see some shifts over time, but we don't see dramatic shifts. And we're making sure that we're a full provider across all modalities to our customer base and making sure we're able to hit their needs. At the same time we're making small R&D investments around some new evolving technologies that are less mature, but more niche-oriented, but we're also going to make sure that we have those options over the years to come for our customers as well.

In Nordion, I want to kind of understand the supply/demand equilibrium and how your investments with, I think, the Westinghouse reactors would relatively affect that? Like is demand far outstripping Supply currently?

Yes. So demand is not outstripping supply currently. So thanks for that question because there's a lot of misinformation out there. We're in a pretty darn good spot for the last several quarters where we've been able to supply all the demand for cobalt and we anticipate being able to do that for the rest of the year. Now let me step back a little bit and address a couple of words you threw in there and what we're doing. So we've got -- when we look at supply chain planning and capacity planning, remember what happens in this business. we rely on nuclear utilities that primary purpose in life is to generate electricity, okay? And in that, what they do is they also make Cobalt for us. And we pull the cobalt out at the point of when they're doing refurbishments or maintenance of their facilities. That's when we pull it Cobalt. We've got a global base of supply. So Canada is our largest base and our most tenured supply base. We buy it from Russia, we buy it from India, China, Argentina. And when we look at the time horizon on that business, we're making decisions 7, 10 years out based on what we know reactor life cycles are when the utilities are going to be taking them out. So we know that one of the utilities, OPG in Canada, one of our largest, most stable suppliers, great partner to us. they've got a reactor called Pickering that's going to go out of commission here in the short term. And we have now worked with them to develop Darlington, which is a reactor that will now start to make cobalt, okay? That was part of the strategy. And then the second one that you referenced is Westinghouse. Westinghouse gets us opportunity longer term. So today, there's a limited number of utility reactors that can make cobalt around the world. And Westinghouse gives us access to a new platform using our technology in conjunction with Westinghouse to go to utilities to make cobalt and PWR reactors, pressurized water reactors. That would be a new reactor platform, an existing reactor platform that has not made cobalt before. And again, we started to ramp that up. We haven't got any production out of it today. It will be closer to 2030 when we get it. But we've -- again, we're sitting here at '26, we've been planning for this for several years, and the intent there is to make sure we have supply long term to meet the growing demand for cobalt in the sterilization because about 30% to 40% of sterilization within Sterigenics business is cobalt related, which is so critical coming out of Nordion. Sorry, David, I said a lot like that, but hopefully, that's helpful.

I think this is an interesting topic. I'm going to pause on it for a second. So can you give us a sense of like how many Westinghouse reactors are out there operating and installed and how does it compare to the current base that you're fishing in?

Yes. So today, let's just say there's less than 30 reactors around the world that are making cobalt. And the Westinghouse has a much larger installed base of hundreds of reactors. Now it's not just simple like here's a battery, go plug it and this reactor is going to start making cobalt. It's a pretty long development cycle. We've got the technology proven out with Westinghouse. Now we go to utility and the utility has to go for a license amendment request with the U.S. Nuclear Regulatory Commission. And they're basically saying, "Hey, I've got a safety protocol in my reactors that makes generate electricity. Today, we want to now insert cobalt in here to start making a byproduct here, all right? So this isn't something that once it's proven out, you just go plug it in all over. We will control the ramp of that. It's got to be something that works for us, Westinghouse and the utility. So right now, we literally have 1 utility that we're working with that has 1 reactor to start with that's going for a license amendment request. And that over time, as we see demand we will engage additional utilities and reactors.

Got it. So it gives you a long target list.

Exactly.

Does that also in the long run in so much as it really hasn't, and you assured me of this early on, but like the Russia Ukraine conflict hasn't proven to be anything that really clipped your supply. But to the extent that not only does Westinghouse give you opportunity for additional supply, is there also a risk protection, risk mitigation element to that opened avenue?

Yes. Obviously, you're geopolitical landscape, we play in, we buy cobalt from Russia, India, China, Argentina, Canada. That's something that we always think about when we look at diversification of our supply base, when I first joined the company in '16, it was pretty much Canada and a little Russia. Today, we've got other bases that we looked at to diversify the company. We'll continue to do that. This happens to be 1 opportunity to do that. we've done a phenomenal job. I give credit to the Nordion team and the work that they've done to work through and make sure we're compliant with all the rules and regs on this critical isotope.

Yes. Let's move on to Nelson. We did some back of the envelope math and think we arrived -- actually arrived at a different number and Jason corrected me. So I think this is a good 1 that your core lab business in Nelson was about a mid-single-digit grower in '25. In '26, you're looking for, I think, somewhere in the 2.5% to 3% neighborhood growth. Is that -- is there a decel in there? And what are the various factors influencing that outlook?

Yes. So let's step back. What really drives that business is routine sterilization volume, new product spend, venture capital spend and new regulation. Those are the things that really drive that business. And Nelson is able to work through and help customers get products and make sure they're safe and meet the regulatory requirements. So when you step back and look at we see this business slight growth here in the upcoming quarter, the quarter we're in today, second quarter, and then we see growth throughout the rest of the year, so we can get to low single-digit numbers that you're referencing. Overall, we feel pretty darn good about where we're at because of some of these tests are more short term in nature, just routine lot release and then there's more complex testing and validation tests that are based on new regulatory changes or things of that nature that the customer needs to help with. I was telling one of the investors this morning, I had a call not too short time ago, a customer called and said, "Hey, we got an FDA issue here. we need you, we need Nelson labs to help get our products to market. That's what we're great at. We're really good at helping solve those problems and those are the kind of things that customers come to us for. And when we look at the long range of that and be able to connect that with the sterility plans in sterilization, it's really value added that we create for our customers. So overall, we feel pretty good about where we've guided you for the second quarter as well as the rest of the year.

On that point, I'm going to have on that 1 for a second. So this problem solving, responding to FDA inquiry, FDA issues. Is there a cyclicality to that? For example, I'm wondering, and I don't have as much perspective on the devices on the pharma side. But FDA has obviously gone through a period of some disruption, change in leadership. Is that something that potentially stimulates more scrutiny, more issues, more need for those solutions?

Yes. Let me answer that in multiple aspects. So within that business, we have a consultant business we've talked about in the past, RCA, which has had peaks and troughs all within the last year, right, the best year in the history, the lowest year in the history of that segment within Nelson Labs. That's really driven by FDA activity and some issues that customers maybe have -- what I was alluding to just a moment ago was more where we could help customers with this problem, which could then lead to ongoing business for us after that when they see our ability to help solve that. So that's a key part. And then the other thing I would tell you is just when new regulation comes out, right, when you have this new med device or you have this existing med device and new regulations, additional safety measures the FDA wants around that device, that's where we really excel in helping make sure these customers of ours are complying with those new regulations. So the FDA involvement, David, is across multiple fronts. When they elevate their audits and things of nature, we see elevated, yes, and it could come back down, which is what we saw with RCA but then there's just more -- just when they put in additional regulations that require compliance, that creates an opportunity for us.

Got it. While we're on this also, the like the Expert Advisory Services RCA was an acquisition. You made a couple of other acquisitions since coming public. Maybe challenges in the demand environment might have quieted that activity down. But going back to the top and change in leadership, M&A has not been as active. Is that something that resumes, something that ramps back up?

Yes. So I'd say when we look at M&A, it's also part of where you are in your capital structure and everything and the timing wasn't right for us to do some M&A. We didn't see the opportunities that lined up with capital situation and the market opportunity at that point in time. We will continue to look for M&A as our cash flow becomes more available. We'll look at -- obviously, Sterigenics has lots of opportunities around that and opportunities to continue to accelerate growth in that business. But those are trade-offs we'll make versus buy ongoing and making sure we're good stewards of capital.

And 1 more. Coming back to Nelson, I forgot this one. But there's a complementary you touched on it a little bit between Nelson's capabilities and things that can then roll into regular sterilization volume with Sterigenics and you have your cross-sell initiatives that you've ramped up. Can you give us a sense of like how much of Nelson's business is tied to Sterigenics and maybe vice versa, how much of Sterigenics growth can be -- is caught by Nelson?

Yes, I'll just give you a couple of high-level figures. I would tell you about 40% of Nelson's business is generally wrapped around sterility assurance. I would tell you about 20% of the revenue, approximately 20% of the revenue is tied to embed lab right within Sterigenics facility. So there's a strong correlation, we think there's real opportunity. We've showed it in our customer satisfaction scores, which, by the way, we just recently reviewed our scores for 2025. We had phenomenal numbers again. And the cross BU customers continue to be delighted. I think that's really 1 of the opportunities I think bring a lot of insights to in his experience on the commercial line and working with a lot of the same customers. We see opportunities that continue accelerate the cross-BU opportunity and the value prop. There are several things that we're working out the team right now of how to increase our penetration with key customers around some of the services jointly we could offer between Sterigenics and Nelson, guys that are doing sterilization, but not doing as much testing with us and then vice versa.

Okay. Coming back to balance sheet, you mentioned capital structure. You're on track to achieve your LRP targets for free cash flow over the 3-year period, I think, $500 million or $500 million to $600 million and improving your profile there. How do you think about deployment of capital as it becomes more available?

Yes. Thanks for calling that out. Yes. We committed at our November '24 Investor Day for the time period '25, '26, '27, we would do $500 million to $600 million in free cash flow. I'm telling you we're still very confident in our ability to deliver against that. When we look at capital allocation, the #1 priority would be organic growth. The second would be M&A and its strategic M&A that fits along our strategy. And then the third one -- third and fourth would be, do we do buybacks or do we go ahead and pay down debt. Our net leverage ratio is around 3.2x. We're trying to get it down below 3x. So as we start to free up that capital and start to look at where we would deploy it against those other 2 priorities after we get to the first 2, that's still something we'll work through depending on and where we sit today. One of the things that we looked at, quite honestly is, David, and I think we talked about this briefly last time, the PE folks owned about 31 million shares, about 12% of our stock coming out of our earnings call and 1 thing we seriously considered as the Board was do we go ahead and by the remaining -- some of the remaining tail shares that were left. Well, fortunately, the demand was so strong, we didn't have to get in the middle of that. So all those shares were bought out by the public markets, which was great. We kept our powder, which is super. One of the other things we've done since earnings that maybe you didn't notice, we also reduced our debt by 25 bps. We're down the SOFR plus 225. So that's down about 100 bps from where it was last year. When you look at our interest expense between a low pay down we did as well as refinancing, we've got about $14 million of interest expense. So we're just constantly working against that, how do we get to more free cash flow in the business, and we see that accelerating as CapEx comes down as well.

Thanks for that. And for clarity, the interest expense under the $14 million is the decline -- that's the savings number?

Yes, between the rate coming down as well as a slight payback last year. So coming out of last year, it was about $11 million. We told you run rate. And then with this latest 25 bps, it's about another $3 million, so it's a total $14 million now. Think about it that way.

On the -- moving to the litigation here quickly before we end. There was a recent announcement out of California on a summary judgment. Is there an opportunity for the company to appeal? Or what are generally speaking, next steps? .

Yes. David, this litigation takes many twists and turns throughout the process. The trials are set for January and April 2027. We've got a strategy we were working. We submitted a motion for summary judgment as you referenced, we lost that. We understood where it was in the timing of this process that the probability of getting that victory at that stage was low, but there were couple of things we wanted to make sure we got on the record as part of our strategy. And we're most hopeful as this judge continues to focus on science. And if he does that, we feel pretty darn good about the prospects of us winning in those trials. But listen, it's a state court, there's risk in that, and we're going to continue to evaluate that as a Board as we look through this. But overall, we're going to be well prepared for the trials in January and April.

Got it. And while we're on it, you've had some progress in Georgia. The Phase I, Phase II process is generally, I think, fallen in your favor. Can you give a similar update there?

Yes, so would you even basically, the experts, the quoted experts on the planning side weren't able to show causation, which is pretty darn critical in these cases. And the courts found on our side on that, which is what we've always said that if you put science front and center, we're going to prevail, and that's what's happened thus far. The plaintiffs are going to appeal. That process is taking a little longer than most people would think it should take. I think we'll have the outcome of those appeals Phase I and Phase II, and we'll get into much detail with that is sometime spring, summer of 2027. But again, if science is front and center, we feel very good because there is no causation proof that ethylene oxide, these low levels are causing the cancer that's being alleged here.

So this process through the courts, the legal progress is the word I meant to use, progress through the courts, is encouraging. The case counts in these various regions seem to continue to kind of grow. Is there an event or a time lapse that would put a cap on that? Like what would prevent the case counts from...

Yes. I won't get too much into detail, but there's a thing called statute limitations that come into play and then there's folks -- I can't speak for plant firms on how they think about these things, but there are some actions that they take that can have an impact on why you see case counts going up at any given time. But at the end of the day, if it's junk science, and that gets proven out in the court as junk science. I don't care what the case count is. We'll all these. At the end of the day, there's no causation here, and we're going to keep fighting it, but we've got to get the courts to see it the same way. And so far in Georgia, they are.

Got it. I think that brings us to the end [Audio Gap].