Good morning, everybody. Welcome to day two of the healthcare conference. Luke Sergott, I cover life sciences, tools, and diagnostics. Today with me, I have Michael Petras, CEO of Sotera Health. Thank you for making it down.
Good morning, Luke.
I guess we can get right into it. So let's talk about the demand trends and headwinds that you guys have been seeing, across the business. But let's start on the Sterigenics versus the primary business. You know, there's you guys service a lot of the industries, including bioprocessing. You have PPE for in, you know, the hospital supplies market, and mostly in the device arena. So just talk about the different headwinds from a volume perspective that you guys have been seeing and any type of visibility on the recovery there.
Yep. Good morning, Harry. Thanks, thanks for Barclays for hosting the conference and inviting us down today. You know, I'll make some forward-looking statements. Also, you know, you can refer to the SEC filings or our website as well for our risk and uncertainties, as well as any non-GAAP financial measurements. You can see those on our recent securities filings. So, thanks for having us. Regarding volumes on the Sterigenics side, as you know, many folks know, that's our largest business. It's just over 60% of our total business. We're seeing volumes have kinda stabilized. They're not getting significantly worse nor better. As we stated in our last earnings call, we think the year will be relatively flat, with the second half being slightly up on volumes. And we're seeing, you know, good procedural volume at the end markets.
But ultimately, I think there's still a lot of inventory in the channel that they've had to work out, across many, many of the medtech and pharma companies. You know, you referenced bioprocessing. Bioprocessing is not a huge volume area first, but it is one that we play in. And, you know, that in particular, as you've seen very clearly with some of the big processing folks, they've taken significant volumes down and have had inventory challenges over the last several quarters. But we don't see it getting a lot worse.
Yeah. Just give us a sense on something I learned from not covering devices, but just the how that channel works for you guys. I mean, you have the GPOs. You have the actual OEMs. Then you have the hospital inventories. Like, when do you see the destocking and part of that.
Yeah.
That value chain or supply chain?
Yeah. So, you know, our engagement is with the manufacturers themselves. We don't engage directly with the GPOs, nor the health systems. You know, from what I understand, not an expert on the entire supply chain, but the hospitals buy some products directly from mass distributors. And then they also buy some products from the medtech companies, physician preference items, for example. So they buy them directly from them. So there's some inventory at the hospital systems, but then there's inventory, largely more at the medtech companies as well as their distributors. That's usually where the inventory is. And where we get our orders from, though, ultimately, are from the medtech companies and the pharma companies.
Yeah, the OEM guys.
Yeah, so.
So right now, from the destocking that you guys have been seeing and, you know, the device volumes have been really strong the last few quarters. So is it safe to assume that the hospitals are essentially burning down their inventory and maybe getting some of that flush out from the channel of the distributors and GPOs and, like, to sell out from them? And then maybe there's a little bit more backlog from the OEMs, and then you guys will see it? Is that.
Yeah.
Kinda how it will work?
Yeah. Yeah. Right. But I would say most of the inventory, from our understanding, is really at the medtech companies directly and the distributors. There isn't huge amounts in hospitals. But hospitals, did you know, they do take inventory on. That's in consignment in some cases. But they also took on a lot of PPE and some of the more consumables during COVID. You know, I think one of the things that the, the medtech companies have been sorting through is during COVID, they weren't able to get all the, the componentry they wanted. All the times, they had multiple orders on multiple places, and they all came together over the last, you know, several quarters. So, you know, if you look at some of the public filings from the medtech companies, you, you see the, the leadership there talking about freeing up working capital in this area.
And it varies by company. Are you talking finished goods? You're talking raw materials? You're talking pharma? You're talking med device? It's not a real clear picture for anybody. But we get our orders from the OEMs, the medtech.
Yeah. That makes sense. And now, just wanna talk a little bit about capacity there from what you guys have from the device side. You continue to have to build out capacity and invest in CapEx. But, you know, as you're not seeing the big volume recovery that's hitting because, obviously, the destocking. But, you know, when things get back to normal, give us a sense of your utilization and, like, you know, how underserved that end market is or overserved. Just give us a sense of that landscape.
Yeah. Just, you know, proper context. On the Sterigenics side, you're not talking about a business that does 10% volume and then down 20%. We're talking about up a couple percent, down a couple percent. And, you know, last year was the first year since I've been here since 2016 that we saw a down year in volumes that I recall. You know, when we look at our capacity, we're pretty well situated right now, obviously, because volumes are a little bit lower. But we try to target 80% capacity utilization. When we work on the, you know, right now, we're in the midst of some capacity expansion programs. When we work on that with our customers, we try to get commitment above 40% of the volume before we start to move forward on the new capacity.
Okay. Okay. Talk a little bit about Nelson Labs. Again, you know, volume's kinda this is really kinda the ancillary too. I always spoke of associate this with, like, the ancillary to Steri, right? You do the actual sterilization in Sterigenics, and then you have Nelson Labs do the testing to say, "Yes, this thing was actually, you know, sterilized properly." So talk about the same headwinds hitting that segment as well, or still is there?
Yeah. There'd be three things that we've talked about, with Nelson Labs as far as where the volumes have been impacted. The first one would be the sterilization volumes, right, and some of the lot release volumes that we get from the sterilization companies that we ultimately do the final testing in lot release. The second one would be the European Medical Device Regulations that got deferred out a couple years. And then the third one would be small to medium-sized customers, which we have quite a few, you know, venture-backed funding where we do a lot of work for them. You know, but that business, you know, it's been you know, it's probably felt the most impact out of COVID over the last several years between shortages in testing volumes, as well as the labor because, you know, that business is more labor-intensive.
You know, they had a good fourth quarter. But one of the things that we wanted to make sure people understood in the fourth quarter, in particular in that business, you know, the volumes kinda were stable. They weren't terribly soft. But the real luxury was in our RCA business. That's the business where we're doing regulatory consulting and advisory. And that's where we're helping companies that get into challenges with FDA inspections and things of that nature. So it's a little lower-margin business.
Mm-hmm.
As we look into 2024, I'd say a couple things with, with Nelson in particular. One, like all three of our businesses, the first quarter is typically the softest.
Mm-hmm.
I would also tell you that, you know, the margin rates, you know, in the Nelson business, usually be relatively low in the first quarter, low for us. You know, we're a business that does 50% margin. So.
Yeah.
You know, it's lower for us than the other two businesses. And, you know, that's driven by, you know, labor utilization, things of that nature. But I would just think, you know, that business, we try to strive for a mid-30s.
Mm-hmm.
In margins. I don't think we'll ultimately get there in 2024, but, you know, that business, when, when the volumes come back and we do 900 tests in that business, we're, we're pretty critical for med device and pharma companies.
Okay. On the EU regulation, can you just give us the quick 101 what that is and what's changing there?
Yeah.
What are these? Do you view these as push-outs or as cancellations?
It could be a combination because what happens is there's the Medical Device Regulation. Those are new requirements that were being put on by the EU last year, earlier in the year. They've been going on for 2022 and 2021. And then what happened in 2023, early 2023, I can't remember exactly when it was in the first quarter, early second quarter, they deferred those out to 2026-2028, depending on the kind of class of device you are. And how that impacts me on the OEM side is they will evaluate, do they update their existing product.
Mm-hmm.
To meet the Medical Device Regulation, or do they go ahead and come out with a whole new product launch that's, you know, ultimately gonna replace it? Those are things that we're involved with customers. As they start to come out with these products, they come to us for testing. So over time, we'll see that volume commit.
All right. So it's more of a strategy on their part, and then you guys find out later. So that's why it could be a cancellation or.
Exactly. Right. Yep.
Got you. Then kind of, you know, a little, little distant here, but the, the you know, let's talk a little bit about pricing. You just mentioned margins, so it clicks pricing in my head.
Yep.
You guys continue to get decent pricing. I think that this is also partly due to how you guys run your capacity and the overall demand of the industry. So talk about your pricing strategy and how that's changed and then what we should think about as a normalized pricing environment for you.
Yeah, you know, over the last several years, our pricing's run a little higher than our long-term projections. Our long-term projections are 3.5%-5% across the company. Nelson's usually on the low end of that. Nordion's on the high end of that. In the last several years, all three businesses, you know, did very well, you know, some inflation-based and just contract renewals and some opportunities that we pursued. I would tell you, as we look at, you know, 2024, we'll be on the lower end of that range, because of the fact that Nordion, in particular, is gonna have a little softer year on price, still positive price, still well-performing. It's just the timing of contract renewals that happened last year that gave them a little bit more momentum in 2023 than they will in 2024.
On those contract renewals, is that more of just the pricing escalators weren't as big as they were in the past, or?
Yeah. Some of the contracts, they came. There were some large contracts. I think, if I'm not mistaken, Nordion had, like, 11% price last year, which is outsized.
Mm-hmm.
It was because of some large contracts that came from renewal last year where we had to some people up to the market levels.
Gotcha.
But it'll come back in the range of 3.5-5 across the companies we look beyond 2024.
And I think about your flat gross margin guide for the year. You typically end up guys, you guys typically get some type of expansion this year, not or not this year, but typically you get expansion. But this year, you're guiding to flat margins year-over-year. You know, is that just walk us through the dynamics. We just went through a little bit of the pricing's not, you know, not what you were getting last year. So volumes are coming back in the back half. Just walk us through the various dynamics.
Yeah, you know, the business in total does about 50%-50% adjusted EBITDA margins. Nordion's our largest margin business, over 60%. Nelson is our latest margins, as I mentioned. In a typical year, we'd like to be targeting around 35%, the mid-30s. And then, Sterigenics is in the low 50s. When we look at, we're really focused on margin dollars and how do we drive growth in margin dollars over time, which we will see again in 2024. There won't be as much margin expansion with some of the investments and things that we're doing across the company. You know, we get margin expansion from operating leverage as well as from, you know, price and mix help, you know, across any businesses. And I'd say just with the volumes, the way they are, we won't get as much operating leverage.
But again, we're really focused on margin dollars.
Mm-hmm.
Then we are margin rate.
Gotcha. And you were talking about just the investments. I mean, the when you guys IPO'd and we're talking about the margin opportunity, I mean, it's typical investment. "Oh, you're getting 50% EBITDA margins. How can we get higher?" so.
Yeah.
You always talked about improvement was likely gonna come on the Nelson side. Talk about some of the plans or investments that you need to make where you can improve that from the 30-35.
On the Nelson side.
Yeah.
Yeah.
I would say, you know, Nelson Labs business, in the past, during COVID, when volumes were at really high levels, you know, we were in the low 40s. That's, that's higher than that business. You know, we're talking about a lab here, Microbiology and Analytical Chemistry Lab, mid-30s.
Steri.
Yeah.
Yeah.
It's Steri.
Mid-30s is a pretty darn good business.
Yeah.
The Nelson team, again, I don't think we'll get there in 2024 with some of the volume challenges in that business. But, you know, it'll be a very solid business. And what drives, you know, volume and margins in that business is volume, operating leverage, you know, good productivity, and then price, overall.
Okay.
But, you know, we feel very good about where we are. Our, you know, our customer satisfaction scores across our businesses are very high. You know, we have strong relationships across the customer base.
Great. And then let's talk about the LRP, high single-digit top-line growth. Can you help us think about this, like, from a bottoms-up, and then we can do it from, you know, the pricing and volumes in the different businesses. But just overall market growth driving the three segments or how to think about that, and then we can go into the, you know.
Yeah. If you get 2%-4% market growth, you get 3.5%-5% price. You get some, you get some mix across that. You know, it starts to get you in that mid- to high single-digits organic growth.
Yeah. Well, and.
On top of that, we would put, you know, M&A.
Yeah. So, like, when you think about the Sterigenics, like, the key driver there is obviously device volumes, right? I mean, so how do you guys think about device volume? You know, what from an LRP perspective in that roll-up from the volume?
Yeah. Again, so take, you know, what in that business we do quite a bit in med device and pharma.
Mm-hmm.
So if you think of low to mid single-digits in, in volume and mix, and then you put price in price on top of that, you know, there that business does about 5% price per year, you know, or I'm sorry, about 4% price per year in that 3.5-5 I mentioned earlier. So if you get that 4, and then you get the volume and mix on top of it, you start to get into the mid to high single-digits in, in volume and mix.
Gotcha. It'll be the same thing. Okay. And then turn it back to, I guess, this guide from the 2024 guide on Nordion. Last year, you had a, like, huge 3Q for Nordion just from the way that the shipments or the harvests were scheduled. Anything outside of this year, like, any way to think about the revenue cadence for the Nordion business?
Yeah. So some of the folks that may not be as familiar with the business, this business, ships cobalt to their customers around the world. It's not a very transaction-intensive business. There's about 400-500 shipments a year. When we look at it, it really heavily predicated on when the nuclear utilities are able to pull the cobalt out of the nuclear reactors. Last year, 75% of the volume went in the second half of the year, which we signaled 75% of the total year was in the second half, 50% was in the fourth quarter. We, you know, we have good visibility in that business. It doesn't mean it won't move around, but it last year came through. When we look at 2024, the harvest schedule's a little bit more balanced. First half will be a little lighter than the second half.
Mm-hmm.
So it's more balanced. The first quarter's always the softest quarter for all three of our business. And this year in particular, with Nordion with the hardest schedule. I know lots of people have asked us, "Hey, how's this first quarter compared to last year?" 'Cause last year was really light for Nordion because of this.
Yeah.
I would just tell you, think about the first quarter and, if you take the last couple years, you know, 2022 and 2023, and you took an average of those, it'd be slightly less than the average if you think of it that way.
All right. That's helpful.
For first quarter.
Yeah. And then sticking with the Nordion business, I mean, you talk about where you're in the nuclear reactors. So, you've avoided the sanctions from the Russia side. You're starting to talk about getting, you know, contracts or supply from maybe some more Canadian reactors. Just give us a sense of the lay of the land, where the majority of the cobalt that you're getting is coming from, and then plans as you avoid, you know, some of the more geopolitical issues.
Yeah. So phenomenal business. Again, I'll kinda reiterate. What we do in this business is we supply cobalt-60 that's used for medical device and pharma sterilization. It's also used for brain cancer treatment. You know, the product that many of you are familiar with, Gamma Knife, the gamma in that product is coming from the folks over at Nordion. Phenomenal business. This product it's the only one of our three businesses that's a product business. So we get that cobalt out of nuclear reactors. We process it in a new usable form in our nuclear site license facility, and then we ship it to sterilizers or into the Gamma Knife application. We get cobalt from nuclear reactors all over the world. So Canada has been and continues to be one of our largest sources. We work with Ontario Power Generation. We work with Bruce Power.
We get cobalt from their nuclear reactors. Remember, these reactors' primary purpose in life is generating electricity. So we extract the cobalt in conjunction with the utility. We harvest it out of the nuclear reactor, and then we take it and process it. So we get cobalt from Canada, Russia, India, China, and Argentina. And, you know, we have these licensed vessels that are able to move this cobalt around the world. And then we take it, process it, and ship it off to customers ultimately. We don't hold much inventory of this product because it decays at 12% a year.
Mm-hmm.
Which is one of the beauties of this. You sell to your customer, and then it has replenishment opportunity every year.
From a geopolitical risk, like, as sanctions, like, what are you doing there to, you know, in case the cobalt from Russia gets sanctioned or something happens with China in that trade war or anything like that?
Yeah. So, you know, we work with the regulators, and the government bodies around the world to make sure they understand the importance of cobalt to the global healthcare system. We, you know, obviously, we monitor the geopolitical challenges. Most recently, it's been in Russia. The teams work with that. We make sure we're complying with all the rules. And, we continue to get cobalt, as we have. We state every year at the beginning of the year that there's a risk if we weren't able to get any cobalt this year from Russia, for example. I think this year we said 0%-3%.
Mm-hmm.
is what we said the total Sotera Health revenue risk would be if we weren't able to get cobalt from Russia. But we've been able to navigate that. And there's a lot of work that goes into it. Our teams do a phenomenal job working with the regulators in Europe and the U.K., Canada, U.S., Russia, making sure they understand the importance of what we do and making sure we get that cobalt. So we've been working at this for the last couple years. And, you know, there's a lot of complexity in that, what freight lines and ocean carriers and what insurance companies and what banks and how do you transact. So the teams done a really good job. We've actually gotten several inbounds from people asking us to help them, you know, take on that effort. And that's not our business.
We said, "Well, thank you." You know, we're doing it because we have to do it.
Yeah.
The global healthcare industry's relying on us. That's what's most important.
Sounds like a nightmare. Can we talk, and we were talking about the gamma and the, you know, X-ray technologies. Let's talk about the other alternatives to the ethylene oxide.
Mm-hmm.
We get asked this a lot. Our simple answer is that there's no other modality out there that can do it at the capacity that ethylene oxide does. So walk us like, how accurate is that statement? You know, and, and can you help, like, just give an anecdotal piece of, you know, how many hips and knees or cardiac devices can fit in an ETO chamber versus, like, an X-ray or gamma chamber?
Yeah. So according to the FDA, about 50% of medical devices or 20 billion devices a year are sterilized with ethylene oxide. Okay? So 20 billion devices a year. EO is not going away. Ethylene oxide is not going away. We, as a sterilizer, do not determine the modality for sterilization. It has to be determined by the manufacturer, the OEM, in conjunction with the FDA. And then they come to us and say, "Hey, we need something sterilized with EO, or we need something sterilized with gamma radiation." So, you know, when you look at ethylene oxide, it's a very effective sterilant. It's a dangerous material just like a lot of the other materials we deal with. You know, these are highly regulated industries. But you can have a 1-pallet chamber for ethylene oxide. You could have a 30-pallet chamber. You know, there's all kinds of sizes.
There's 1. There's 12. There's 14. There's 20-pallet chambers. So you get a lot of product in a chamber at a given time that you're able to sterilize. That's what makes it so efficient. And it's also a very effective sterilant. It, it really helps penetrate and make sure the product has no microorganisms. Remember, that's the reason we're doing the sterilization, is that when people are having surgical procedures, we wanna make sure if it's a pacemaker, if it's the PPE the doctor's wearing, we wanna make sure those products have no contaminants that harm the patient. That's ultimately what we're doing here.
How many devices could you fit on a pallet?
So you get cases of product on a given pallet. And then you could have a mixed lot, which is multiple different devices.
Yeah.
Or you could have one single pallet of one device. It really depends. You gotta be careful because the recipe for each product could be slightly different.
Yeah.
So you gotta be careful on what products you mix with. I don't know exactly how many products are in. It depends on how many in the master carton and how many master cartons are on a pallet.
Yeah.
But it's a lot.
It's a lot.
It's a lot.
You can't do.
We're talking 30 pallets, right?
Yeah. And you can't do that with the. Why can't you do it with the X-ray or the gamma? It's just not enough material?
because of the compatibility between the device and the type of sterilization.
Oh.
So some devices will not stand up to gamma radiation. Some won't stand up to ethylene oxide.
Okay.
It's dependent on the material composition.
All right. And then.
The density of the product.
And then we heard about a chlorine dioxide.
Mm-hmm.
At a packaging conference. I didn't. My guys did.
Mm-hmm.
So.
Wow. Hold on. I'm kinda impressed.
Oh, we're going deep. We go deep on that guy.
Yeah. We're going deep here. All right. Yeah. Go ahead.
So just talk about this as a potential threat. It, it seemed pretty promising, but, you know, it doesn't necessarily.
There's this, you know, our team invests in new technologies in exploration. Matter of fact, I'm going over to Europe in two weeks to go look at some of the work that we're doing over in this area. We'll continue to evaluate that. We don't see anything. Listen, if there was some solution out there for ethylene oxide replacement.
Mm-hmm.
It'd be out there in scale today. We've been talking about this area for several, many years. And there isn't really any viable alternative in that kind of scale.
Mm-hmm.
But, you know, over the next 20 years, maybe there will be. And, you know, we continue to invest in exploration of those topics as well.
Yeah. If you find one, you just bolt it right on.
If we find one, we'll make it. We'll either buy it or build it.
Yeah. All right. Last minute here. Let's talk about the recent state on the remaining litigation piece in Atlanta.
Mm-hmm.
You know, where are we with this? And is this gonna look a lot like should we think about this as the Illinois where there was a majority of the cases with a few of the dockets, or is this gonna be a little bit more spread out?
Illinois, it was a different animal versus what you get in Georgia. Georgia, the courts have decided instead of like what happened in Illinois was you basically brought a group of jurors in, and you had to teach them about securities law. You had to teach them about environmental law. You had to teach them about science and toxicology and everything else. In Georgia, the courts have decided they're gonna take 8 cases, and they're gonna go through phase one general causation around the science. The judge is gonna do this before the jury's brought in. And then if they get through general causation, could EO cause cancer?
Mm-hmm.
Then they're gonna go to specific causation and could this facility at this level potentially cause cancer? If, like, the eight cases, any of those get through that first and second phase, they'll go to trial, which won't happen till 2026.
Okay. That's helpful.
Yeah.
For sure.
Early is right now, the current view is early 2026.
Okay. Awesome. And what are the updates on those? Will we get updates on what the phasing of that?
Yeah. If more information, you know, relevant information comes out, we'll do it. But right now, you got a bunch of lawyers running up bills and.
Gotcha.
Running up all kinds of motions and things of that nature, we're working through.
Keep it sailing with what's in business.
All right. Great.
Thank you, man.
Thank you.
Great.
Thanks. Good to see you.
All right.
Thank you.
Likewise.