Thanks, everyone for being here at RBC's 2024 Global Healthcare Conference. My name is Sean Dodge, and I'm the Healthcare IT, Healthcare Services analyst here at RBC. I'm pleased to be joined by our next presenting company, which is Sotera Health, and here on behalf of the company is Jon Lyons, who's their Chief Financial Officer, and then Jason Peterson, who runs their investor relations. So special thanks to both of you for joining us today. I want to start, Jon, just with your 2024 guidance and your execution toward that. So you all are targeting 4%-6% growth for both revenue and EBITDA. You made good progress on that on the revenue side in the quarter.
EBITDA missed just a little bit, but maybe just kind of walk us through some of the dynamics that you've talked about, some headwinds impacting you in parts of the business, maybe just kind of the dynamics around those.
Yep. Yeah. Thanks, Sean. And before we get started, I just have to cover off the f orward-looking statement. Some of the statements I make today may be considered forward-looking statements. Please refer to our SEC filings for a description of the risks and uncertainties that could cause our actual results to differ materially from those projected or implied. The company assumes no obligation to update forward-looking statements. During this discussion, we may talk about certain non-GAAP financial measures, including adjusted EBITDA, adjusted net income, adjusted EPS, and net leverage ratio. Please refer to our SEC filings for reconciliation of these measures. Now, we can have the conversation.
Sounds good.
All right, so I think you asked about our guidance for the year, 4%-6% revenue growth, and some of the challenges we've been facing as we kind of walk into that.
That's right.
You know, I mean, I think you do know, Sean, I mean, the, the business is actually really resilient. If you look over time, I think the business has grown every year since 2005. You know, we started facing some of these headwinds early last year and still put up another year of growth on the top line, which we're really proud of. And we expect, you know, to keep working through these headwinds this year and still deliver another year of growth, as the guidance implies. We'll lead that with our price performance, right? We have a . . . Well, you know, we've been. Our long-term guide is that we'll deliver 3.5%-5% price every year. You know, and we expect another good, solid year of price performance this year that'll help drive that revenue growth.
And the real variability, the real variable in there, in the 4%-6% is how much the volume growth index grows. And as you look over time, what we've been facing in Sterigenics has been really the destocking trend that I think is pretty well documented in the industry. You know, as we work through the year, we think we're in the later stages of that. Seeing some signs of improvement, you know, off of what's been a pretty, you know, more recently pretty stable, you know, not getting a lot better, not getting a lot worse environment.
And as we move into the second half, we expect to start comping positive and putting up some volume growth. And then on the Nelson side, there's been a few headwinds that we've talked about. Number one was the deferral of the MDR regulation in Europe. Number two was just as interest rates rose, we saw funding fall for, you know, startups and new ventures and smaller companies, where we do some good business, on, as they try to bring products to market.
And then the last thing is connected to the sterilization business. The beauty of the business is they're pretty connected relative to what Nelson does in sterility and what Sterigenics does. But, you know, when those volumes were a little bit lower in Sterigenics, it had a knock-on effect in Nelson. As we move through the balance of this year, you know, we do expect that core lab testing business to move up.
Okay. So on the inventory destocking headwinds, for you all, is this kind of broad-based, widespread, or are there pockets of customers or types of products or geographies where you're seeing this kind of being particularly challenging?
Yeah. Yeah, it's really interesting, and it's interesting that it changes almost month-to-month, quarter-to-quarter. But broadly speaking, the trends have been pretty consistent with what we've seen. You know, we've talked about in the past, labware, we've talked about, bioprocessing, and we've talked about general hospital, and really, a lot of that's like the kits, you know, big COVID hangover for hospital or the surgical kits, right? And, you know, we see that working through right now. You know, bioprocessing labware are still down year-over-year in a pretty meaningful way. But, you know, we are seeing some slight improvements sequentially, and we're seeing surgical kits actually comp positive, or the general hospital comp positive, which is a good sign in the most recent quarter.
Okay. In bioprocessing and labware, can you give us a sense of what proportion of what you sterilize those couple of categories make up?
Yeah, I mean, I'll just generally kind of speak about it. When we look at sterilization for Sterigenics, it's about two-thirds med device.
Okay.
You can imagine, I mean, we're, you know, more than 40 of the top 50 med device companies, more than, you know, we're nine of the top 10. We're with nine of the top 10 pharma companies. We've got a wide range of products and, you know, items from those different companies. And then, you start looking, we sterilize commercial products, agricultural products in the side of this. You know, and so we've got a wide impact on the industry. I would just say that, you know, on the bioprocessing side, it's a meaningful, important growth vector for us, but it's small on the smaller end of our volumes.
Okay. And you mentioned a couple of categories, like hospital kits already starting to comp positive. Maybe just walk us through how much visibility you have into client sterilization needs ahead of time, and then your guidance assumes this all kind of dissipates mid-year. Just what gives you conviction in that?
Our conviction's really driven by a couple of things. I would say, number one, we are seeing some decent trends. I said, well, you know, we're not there. I didn't—we know, we didn't call for the turnaround in the second quarter. But we are seeing some positive movement. I mean, we read the same things and talk to a lot of people like you all do, and the people in the room do, where we're looking at, you know, what are people saying publicly about what they expect?
and then we're talking to our customers and, you know, working to understand what kind of demands they need. But all that o r what they expect. But all that being said, you know, it's not like I have orders for August right now, right? We have some, we have some idea, and we have some expectations, but it is relatively short cycle.
Maybe turning to the Nelson side, you talked about the Expert Advisory Services part of the business really starting to kind of generate or gain some momentum. Maybe just give us a little bit of background on what you all do in that part of Nelson and what's driving some of this growth.
Yeah, sure. I mean, the business has been performing really well for us. You know, the majority of that business came from an acquisition we did back in 2021 of Regulatory Compliance Associates. And the idea there is really a connecting rod across the businesses, whereby they help customers get products to market, you know, regulatory filings and those sorts of things, which, you know, you can clearly see sterilization's a key part of that. So you can see how they can be at the front end of something that then connect in for lab testing or for sterilization service going forward. And also, I think where we've seen a pickup more recently is they help folks work through FDA issues, FDA audits.
And, you know, FDA audits dropped in COVID, like a lot of things, and they've come back, and so we've seen an increasing need from our customers to get help working through findings on audits. And that's really what's driven the business up recently.
In Nelson, you also talked about a little bit of headwind from the deferral of the European regulations. Maybe just talk about what's happening there, and then when that's expected to.
Yeah, so, I'm sure folks have some background on this, but, you know, med device companies, as part of the MDR, needed to revalidate existing products to ensure compliance. And we were providing a lot of support there. I think beginning of 2023, that regulation got postponed to later, 2027, like 2027, 2028. And, you know, we had a pipeline of activity that we were working that really fell off, started falling off, you know, kind of towards the end of Q2, and then in Q3 really came off. So we're gonna start comping against the easier comps, really, starting in Q3 as we cycle past that.
And then, maybe turning to the Nordion side of the business, so that's an area where you've got long-term, really good visibility, but it can be lumpy quarter to quarter.
Sure.
There's also some amount of Cobalt-60 that you do source from Russia. Maybe just talk about the business there and your exposure to the Russian sources over the course of this year.
Yeah. No, happy to talk about that. Yeah, we're really proud of the way that business executes and the harvest schedules are lumpy, as you mentioned, and you're really somewhat at the mercy of the utility schedule, right? The purpose of these public utilities is to produce electricity.
You know, cobalt's a nice side, side opportunity for those utilities to, to serve some public good, and to serve and for us to then help sterilize medical products. And so what we're really good at is managing that supply chain and managing the execution around that, that lumpiness, right? So you do 50% of your volume in one quarter, that takes an incredible amount of operational excellence for that team to kind of execute and get that done, and so we're really proud of the visibility we have and the way we're able to adjust our people, our resources to get that done.
You know, for Russia specifically, you know, we start out the year with up to 3% of a risk on the top line if we had a disruption in our Russian supply. You know, we disclose, on average, it's about 20% of our supply, and any given year, it can go up to 50%, and I don't see a big change in that going forward.
Okay. H ow should we think about, again, the long-term visibility you have into the harvest schedules? Maybe just, are there some years coming up where the Russian mix is going to be a little bit higher than it has been over the last couple of years, or?
Yeah, I, you know, I think our disclosure stands. We average on average, 20%. You know, and again, it can go up in any given year or a couple of years, but, you know, we just recently updated that disclosure, and I think it's good.
Okay. So maybe going back to Sterigenics, you talked about mix in the Sterigenics business being a little bit of a headwind the last few quarters. What does that mean when you talk about mix in Sterigenics? Is that geographies where things are being sterilized, is that the types of products that you're sterilizing?
Yeah, you know, overall, mix is a consideration in the business. You know, different products, different geographies can have some differences. The big story for us has been the volume. And so, you know, we talk about volume and mix, but the big part of the story is the volume that we already talked about.
Okay. Is the mix, I guess, more of a structural thing, or do you see that normalizing at some point?
Like I mentioned, Sean, I don't see it as a big structural issue. You know, we do good market, market segmentation and work to drive the mix as best we can, over time. That's a objective for the company, but more thinking about the growth and, you know, where are products gonna grow and who do we want to be overweight with. But it's not a big issue for us in margins or volumes right now.
Okay, and then in Sterigenics, you also did talk about inflation being a little bit of a pressure in Q1. Is that, is that primarily labor, or there are other cost inputs where you're seeing?
Yeah, I mean, so interestingly, right, our variable costs are largely, you know, in Sterigenics, you got labor, and you've got, you know, EO, for example, utility costs, those sorts of things. We had a few points of inflation. It certainly has fallen from where it was, you know, the last couple of years. So it's largely labor, a little bit of EO, and that, that's the big, those are the big moving pieces.
Okay. What has inflation been running at there recently?
Oh, I mean, I don't even know the number off the top of my head, but we were, you know, we were certainly running north of 5% in different areas. You know, and I think you look at our price performance over the last couple of years, our price in Sterigenics ran hotter, you know, I think over 6% the last couple of years. You know, and that was in response to the inflation environment that we were seeing. So we're really proud of the business. I think there was some skepticism going into that, you know, would this business be able to overcome the inflation? And we did.
Okay. On the Nelson side, like we were talking about, the advisory business there had been really strong. That's, as you pointed out, kind of more of a consulting type business, so it carries a little bit lower margins than the traditional lab work that you do there. You are guiding to an increasing or kind of a ramp in Nelson margins over the course of the year. So maybe just given the strength in the advisory part of the business, maybe what's driving this ramp in Nelson margins?
Yeah, yeah. No, good, good question, Sean. Thank you. You know, when we look at it, a couple of things. Yeah, it's been really strong, but the advisory business is inherently project-based, and so a little episodic. We have some projects winding down, so we've kind of got two moving pieces in here that'll help margins. One, we expect sequentially, the advisory services businesses will come down a little bit.
But at the same time, we expect the lab services business, the lab core testing side of the business to go up. And so those two things moving kind of in opposite directions will have a positive effect on margins.
And you talked before about the linkage between some of the sterilization work and the lab work, and so the expectation that lab volumes start to increase in the back half of the year would be tied to the destocking headwinds that we-
That, and we see some good positive signs in some of the funding environments, and just what we're hearing from customers around what's coming towards us from a validation perspective.
Okay. Well, if we think about sales cycles or just kind of visibility on the Nelson side of the business, how much kind of lead time or advanced visibility do you have into revenue there?
Similar to Sterigenics, it's also a pretty short cycle. So, you know, we'll give a quote, and it, you know, it could be months before something shows up at our dock door and gets ready for a testing program that could take days to weeks or months to actually drive revenue and get it done. So, again, that's pretty short cycle and, you know, we just work the same way, make sure we're close to our customers and understanding what the expectations they have, and that we have the service ready to provide. And the great thing about what the team's been doing there, you know, the customer satisfaction, the turnaround times, the service levels are really good in the business right now. And so we think we're well positioned for our customers when they're ready.
Okay. The final rule for the new NESHAP regulations were released not too long ago. You did have the proposed rule. The final rule looks like it's a little bit different than what was proposed. It sounds like most of the difference was around kind of the monitoring or the ongoing monitoring requirements. Maybe just give us a little bit of a high level on what those are and what that means for Sterigenics.
Yeah. I mean, the good thing and the bad thing. Well, maybe not the bad thing. The good thing is, we've been waiting for a rule for a while. We've been investing to make sure we are ready to comply with the rules when, you know, where we thought the rule was going. You know, and we're, so we're happy to finally have the rule, and, you know, we think we're in great shape to ultimately comply with it.
Like I said, we've been investing for a while. I think we started investing back in 2019. And so we've had a lot of learning going on over the last couple of years, figuring, you know, this was new, new, you know, new technology, you know, not necessarily new technology, new application of technology, and figuring out how to make it fit with every facility, which might have a different footprint, different composition of chambers, and those sorts of things.
You know, Michael and I did a review a couple of weeks ago with the team on the status of our work there, and, you know, we've come a long way. Even in the twelve months I've been here, I've seen the evolution of that, and so we think we're ready for the rules. There are a lot of different monitoring requirements, different rules inside that we're working to get clarification, make sure we're prepared. So, for example, on the permanent enclosure, PTE 204, it's required, like, the monitoring on the metric is a rolling three-hour average.
And so we have to go in our facilities, making sure we're like, okay, we're measuring it on a three-hour average, and that, you know, where are the blips and how they happen, and make sure we're already developing protocols that are helping us work towards being compliant in that, and then also clarifying all these different rules and how you comply.
And you talked about having already begun preparing for this back in 2019, knowing this was coming well in advance. How many facilities do you have that are subject to this? How many have been completed, and how many are left to do, as far as complying with the new, more stringent regulations?
Yeah, I think we have eight facilities, EO facilities in the U.S. We're making great progress. I'd say we see the light at the end of the tunnel. We'll get a large way through the balance of our operations. Not necessarily you go facility by facility and get 100%. You might, you know, some of the different aspects of the program going in at different times in different facilities. But we'll be largely through this year, and we'll finish up next year.
If we think about the, just the dollars tied to this, how much have you spent already, and how much is left to go?
Yeah, I mean, this year we're going to spend $40 million. That'll put us over $100 million on the program. I do expect that $40 million to step down a bit next year, but we still have a meaningful amount to go. I think it's really important too, as we look at the regulations that came in, you know, we don't see a material increase in what we expected to spend you know, from what our plans were. But again, it's a big number trending, you know, towards $150 million.
Right. So it's been a little bit of a challenge for Sterigenics, but I guess the long-term silver lining here could be the increasing kind of onerousness of operating these potentially makes outsourcing a lot more attractive. So maybe just what proportion of sterilization is outsourced right now, and how do you think maybe these more stringent requirements change that in the future?
One of the things we do really well is operate in highly regulated industries. You know, for EO, we are an industry leader, and we're going to be here for our customers, so they can count on us. You know, I do think you're going to see some things play out with the regulation, where some folks may decide to exit, some may, folks may decide to, you know, outsource more after, you know, insourcing some. You know, we do think the majority of sterilization services across modalities is outsourced today. I'm actually refining those numbers, but, you know, there's nothing that tells us it's going a different direction than outsourcing.
Okay. And so if we think about just CapEx more broadly, you've guided to $205 million-$225 million this year. We've talked about the spending on the facility enhancements. You've also been building some new capacity in the Sterigenics side. There's some investments you've made in Nordion in the new innovation or Cobalt-60 development.
Yep.
How should we think about capital expenditures trending over the next couple of years as some of these capacity investments and the enhancements wind down?
Yep. Yeah, no, good question. We have three big programs going on: the EO enhancements, the Cobalt development, and the growth projects. As I've said before, we expect those to start cycling down in 2025 and 2026, so we'd expect a sequential decline in CapEx. You know, we're working through and just starting up our strategic plan, so I'm not ready to give a precise target for where that'll end up. But rest assured, it's a high focus for us. We want to make sure that we're supporting the business and also mindful of our free cash flow generation because it's really important that we start generating some strong free cash flow coincident with our strong operating ability to generate strong operating cash flow.
Could you give us a sense of well, like a maintenance level for CapEx would be, either in terms of % of revenue or dollars?
Yeah. And that maintenance number has come up a bit over, people look back four or five years ago with the business. We have increased our level of maintenance. We're, I'd say, about $60 million of maintenance, and that can be ±$10 million in a given year. And when I talk about maintenance, it's your typical facility maintenance. You got to fix the roof, you have some equipment you need to repair, but also our replenishment of Cobalt in our gamma facilities is included in that.
Okay. And then just turning to the litigation for a moment, so you recently settled some cases in Georgia. Just maybe any update on the timelines there, when the remaining ones are expected to go to trial, and then how many cases remain in Georgia?
Yeah, yeah, there's about 260 cases remaining. We're pleased to get that settlement behind us. I think we got 79 cases done. So we're happy with that, and we think we have a good opportunity to put on our defense, you know, because we think the science behind our defense is really strong, and we think we have an opportunity, like in the Fornek case, we think we can win. And this next phase happens in Cobb County, starting later this year with Phase I on the first 8 cases. Once whatever survives Phase I, general causation goes to Phase II, specific causation. We'd expect a ruling on Phase I early 2025, the next phase to come, you know, later in 2025.
And then, you know, if anything survives to the third phase, a jury trial, we'd expect that in 2026.
Okay. And then there's also the situation in California. I think a lot of people naturally are going to look to what happened in Illinois and what happened in Georgia as a proxy or some way of trying to quantify California.
Right.
Maybe just kind of outline for us the similarities and kind of the dissimilarities between California and the others.
Yeah, I mean, given the recencies, I'm not, you know, I'll probably hold off on too many comments here, right? We've got a pretty, I think, extensive FAQ on our website, but I'd just say a couple of things. Number one, back to what I said earlier, we think the science in our defense is very strong, and we'll look forward to continue fighting on this because we don't think we caused the illnesses that have been alleged. The second thing I would call out, you know, on this is around the local regulator who has published and/or publicly showed or that the testing in the neighboring community is background levels of EO.
Okay.
So we think that's a good fact just to point to. But again, we have an active litigation going on, so that's going to be many, many facts and many things to discover. And the last thing I would just highlight is that this has been pushed to the complex docket in California, where you know, I think they're better equipped to handle the complexity of you know, the things that are involved in this type of litigation.
Is there any kind of initial timeline you can provide there?
I mean, there's no court management, or there's no order yet on case management, and it's stayed right now, pending that.
Okay. Maybe just in our last few seconds here, we'll talk about balance sheet leverage, so 3.8 x now.
Yep.
We talked about tapering CapEx, maybe just capital priorities and just, you know, where you feel comfortable with leverage kind of longer term.
Yeah, yeah. I definitely am targeting lower leverage. We think we have a great opportunity to de-lever naturally, as we expect this business to continue growing, just like we have year after year. Continuing to produce more EBITDA will help us de-lever, and it's just from a priorities perspective, organic growth in the business. I expect we'd contemplate some debt paydown, and then, you know, opportunistic M&A. We still think we have some opportunity there, and we'll continue to pursue things that we think are valuable for our shareholders.
Sounds good. Well, that's a good place to leave it. But, Jon, thanks again very much for being here.
Thanks, Sean. Thanks for having us.