Sotera Health Company (SHC) Earnings Call Transcript & Summary

Okay. Good afternoon, everyone. I'm Rahul Sood, Managing Director in the Healthcare Investment Banking Group at Wells Fargo. On the stage, I'm joined by CEO of Sotera Health, Alton Shader, Alton? Welcome.

Thank you. It's good to be here.

Thank you for being here with us.

So for the investors who may be newer to the story, can you provide a brief overview of Sotera Health and explain why the services provided by your three different segments, Sterigenics, Nordion and Nelson Labs are so critical for your customers?

Yes, absolutely. Sotera Health's mission is safeguarding global health. And what we do is we advanced that mission through three business units in Sterigenics, Nelson Labs and Nordion. And our largest business unit is Sterigenics, and Sterigenics is a leading global provider of outsourced sterilization services to both the medical device and pharmaceutical markets. We offer all major sterilization modalities and technologies and we've got 49 facilities around the world. Now sterilization for those of you who aren't familiar, is the last government-mandated step that a med device, for example, needs to go through before it is available to be used by providers or for patients. The way the process works is for a medical device, a med tech OEM will manufacture the product, they'll package the product, and they'll box the product, they'll put it on a pallet and they'll deliver it to one of our 49 facilities. We will then sterilize that product, utilizing 1 of the technologies or modalities that it's been validated for. And once that sterilization process is complete, it's now ready for use. So that's Sterigenics. Moving to Nelson Labs. Nelson Labs is a leading provider of microbiology and analytic chemistry testing. And again, we serve both the medical device and pharmaceutical industries. And the goal for Nelson Labs is to ensure that their customers have safe, compliant and effective products. We offer over 900 tests, and we've got 12 labs globally to serve our customers. Our final business unit is Nordion, and Nordion is the leading provider of sealed store Cobalt 60 in the world and Cobalt 60 is essential for the use in gamma sterilization as well as targeted cancer treatments. We operate a Class 1-B nuclear facility, and we've got long-term contracts with nuclear reactors around the world to allow us to provide safe and effective and enough supply of Cobalt 60 to provide gamma sterilization around the world. Nordion also is a leader in transport technologies for Cobalt 60. This is not a typical product that you just put on the back of a truck. And it's really important because over 30% -- around 30% of single-use medical devices are sterilized with gamma radiation. So each of our three business units are absolutely essential to the health care supply chain. But Sotera Health is more than that. It's more compelling because of the complementary nature of these business units. For example, Sterigenics and Nelson Labs, they can offer an integrated offering for sterilization and lab services to a lab testing to our customers. And that just shows the value of the One Sotera approach to our customers. But overall, again, our goal is to advance our mission and ensure that our customers get safe, effective and compliant product to market, wonderful.

You recently joined Sotera. Why?

Yes. So I joined back at the end of May, and I've been working in health care for over 25 years. So I knew about Sotera, primarily through Sterigenics and as I was doing more research and speaking with Michael Petras, who's now -- the previous CEO for 10 years, he's now our Executive Chairman, to a lot more research on the company and realize just how essential and critical our offering is to the health care industry. And this was really inspiring. I also learned about, again, the complementary nature of our businesses. So Sterigenics and Nelson Labs, for example, there's a real opportunity, again, for us to be even more coordinated in our approach to our customers to offer differentiated solutions across these businesses. And that's a very exciting opportunity to me. We also have an incredibly strong financial makeup in our organization. There's not a lot of scaled businesses with EBITDA margins over 50%. And that becomes even more interesting based on the amount of cash generation that we're going to see over the course of the next year. And that has really positive implications for capital deployment. So I took that all into consideration and those are the main reasons I joined and couldn't be happier to be here.

Wonderful. You came from the customer side of the industry, what does that if I can call it, the outside-in perspective, tell you about what Sotera does, especially well for its customers today?

Yes, absolutely. So I came from a company called Viant Medical. I was the CEO there for about 7 years. It's a large contract manufacturer focused on the med tech industry. And I reflected heavily on my experience with Sterigenics when I was at Viant when I was thinking about this role. We -- one of the things we did at this company was we offered a variety of services across the manufacturing value chain, including final assembly of product and managing the sterilizer for our med device OEM customers. So we worked with Sterigenics a lot. And what I kept thinking back to was the really difficult time in our industry post COVID. COVID itself was very difficult. But coming out of COVID, you had the supply chain crisis. And I think back to my time and how much of my day was spent with suppliers who were not delivering for Viant at the time. I never had to worry about Sterigenics. I never had to pick up the phone and call Michael. In fact, I don't recall a meeting that I had during that time where somebody said that Sterigenics was the problem. I know that they were struggling as much as any other service provider during that time. But they continue to deliver for us, and we weren't their largest customer, but that showed the culture and the focus around the customer that Sotera has, and that's something that I feel very fortunate to be a part of.

Great. As you've been in the seat for a few months now, what are your observations thus far about Sotera. And any areas of focus for you?

Sure. So a couple of areas of focus. The first is I want to continue to build a great company here at Sotera Health for our customers and for all of our associates around the world. In addition, accelerating growth is a top priority for me. So we're a service business. And the first thing you need to do as a service business is take care of your current customers, and that is a real focus of mine to ensure that every interaction we have with our customers, we are delighting them. We are differentiating ourselves based on our service every single day so that when our customers have a choice to make, they lean towards us. We have thousands of customers today. And a good chunk of our growth in the future is going to come from our already established customer base. So having really crisp and high-quality operations, high-quality quality function is at the top of the list for me to ensure that we're delivering on, so that's one. Next is this integrated offering across Sterigenics and Nelson Labs. We have a real opportunity to provide differentiated solutions on the sterilization and laboratory testing side to our customers. And I believe that we can drive incremental growth if we do that right. So again, we've got a fantastic offering on -- across our three business units. We have a real focus on customer service today. I think we can turn that up even more, become even more focused on ensuring that every interaction is positive with our customers. And if we do that right, we've got an opportunity to really drive additional growth in the business.

Wonderful. Let's talk about Sterigenics for a little bit. So Sterigenics had a great second quarter with 7% constant currency growth. What are you seeing across your primary medical device and pharmaceutical end markets?

Yes. So we're very pleased with Sterigenics 7% constant currency growth in Q2. And overall, we see a stable demand environment in med device and pharma right now. The primary data point that we use when we're evaluating our demand, and we're putting our forecast and our guidance together, is what we hear directly from our customers. So what are we hearing from our commercial teams, what are we hearing from our operations teams and they understand how important it is for us to gauge what's happening with demand. So that's -- it's a big part of what we do. So overall, we are, again, seeing this stable environment, and we feel good about where we are in the market.

Great. There's been some commentary in the market around softness in the surgical procedure growth, are you seeing any headwinds in your -- that your customer base is seeing and coming over to you?

Sure. We're not seeing those headwinds right now. We see the same data that you're referring to. We recognize that there are a number of providers who had a reduction in procedures in Q2 of this year. But I'll note that a number of those providers also saw sequential growth Q1 to Q2. We also noted the relatively strong results from a number of large med techs. So again, we see a pretty constructive environment right now within Sterigenics, but again, I'll go back to the point I made in the previous question. We are constantly polling and working with our customers to see what they really need and what their demand is going to be in current quarter and the future. And overall, we see a pretty stable environment.

Great. On the regulatory front, there has been considerable discussion around the evolving niche app requirements. Can you please put the potential changes into perspective by comparing the current rule to the prior origins? When are these rules supposed to be finalized?

Yes. Good question. So I'll start with an important fact, and that is the rulemaking process is still ongoing. So we don't know when we're going to get a final rule, so that's one. Two is we have seen a -- when 2024 NESHAP regulations when those came out, we saw a lot of conversation around what that would mean for the industry. At that time, we made a number of investments to upgrade our emission controls within our EO facilities. So the short answer is whatever comes out of the final rule from NESHAP, our strategy is the same. So we've been investing -- invested around $200 million in these improvements. So whatever the final rule is, our strategy is the same. We're confident that we're going to be able to comply with those regulations.

Great. Can you walk us through the decision to expand the X-ray capacity in the U.S.? And what factors going to these type of decisions for you? Do you have some level of customer commitment before deciding to build something like this?

Yes, sure. So our x-ray facility in North Carolina is online now. We are expecting revenue in the second half of the year. And when we made the decision to invest in this facility, it was really to ensure that we had available capacity across all major modalities for our customers, so that's the main reason we did it. We generally have a pretty significant commitment from our customers before we start a greenfield project at really around 40% of the capacity spoken for at that time. We had a little less in this one because, again, it was a strategic move to have more X-ray capacity. And again, it's gone well. We're very happy with the pipeline and the funnel that we have and look forward to ramping that facility over the course of the next few years.

Great. Over the next several years, how do you expect sterilization modality mix to change, if at all?

Yes. We don't see a big shift in the modalities. So today, the primary modalities are EO as well as gamma. You see about 50% of med device volume going through about 30% of volume going through gamma sterilization. And again, we don't see a material change from that sort of a mix. I'll also state that because we're invested across all of those modalities, we're a bit indifferent on where the market moves. But I'll say that one of the things that we've got confidence in for gamma sterilization for example, we've got a lot of confidence in the short, midterm and long-term supply of Cobalt 60. So we don't see any sort of limitations on that very important modality.

For the audience's benefit, can you remind how embedded and sticky is the Sterigenics offering to its customers once they have decided to work with Sterigenics for sterilization.

Thank you. It's very sticky. So you don't see a lot of movement from one modality to another. You don't see a lot of movement in our space from one sterilization facility to another either. Generally, if you do -- one of a couple of things is happening. One, a supplier may just not be performing, right? So again, we're a service business, if you don't do what you're supposed to do, you don't hit your commitments with your customers, then they're going to look for another opportunity to move to a different supplier. That's one. Two, sometimes a customer will open a new manufacturing facility, right? And if they want to move -- if they're going to move that product from the facility they're in presently to a new geography, they're not going to use that same sterilizer because in general, you want to have your sterilization provider close to you, either close to the manufacturing facility or close to the ultimate distribution center, warehouse, wherever that's going because the transportation costs are significant in comparison to the sterilization costs. So overall, it's pretty sticky as long as you're delivering for your customers and performing good customer service.

Great. And lastly on Sterigenics. Can you provide an update on your greenfield projects?

Absolutely. So we talked about the X-ray project in North Carolina. Again, things are going well there. We are going to see revenue here in the second half of the year. We also have an additional greenfield project, which will come online in early 2028. We've got a nice pipeline in that business, and we're on track to get that online again in early 2028. I mean both of these investments reflect our confidence in the demand growth within this business. And we worked really closely with our customers before we went forward and put shovels into the ground here. So we've got a lot of confidence over the next few years that we will see high utilization in these sites.

Wonderful. Switching gears a little bit, Nelson. Nelson Labs had a pretty solid second quarter coming in at a little over 5% in constant currency growth. Can you talk about the different factors that contributed to the growth?