All right. Good morning, everybody. Thanks for joining us. I'm Dave Windley with Jefferies Healthcare Equity Research. Welcome to our 2024 conference. Very much appreciate your interest and attendance, here in the conference, and, and very pleased to introduce, Sotera Health and the company's, Chief Executive Officer, Michael Petras. Thank you for being here.
Yeah. Good morning, David. Thank you.
Really appreciate.
Happy to be here.
You making the trip. So, you've had an exciting couple of years, to say the least. No boring moments. Let's, you know, let's start in the biggest segment. Let's just dig in and talk about Sterigenics and the biggest segment, your growth there. Well, first of all, as you've said many times, the overall business is very resilient to include Sterigenics. Volume, mix, price, you're usually getting very solid growth out of that. The growth algorithm, I think, includes volume and mix of something like 5%, but that's been a little low lately because of, you know, maybe slower device volumes for a period of time, but also some disconnects. So maybe you could talk about the landscape that you see, and then kind of the resolution of these, you know, lack of correlations that your business is seeing versus the underlying market, and how you see that navigating back to those attractive dynamics.
Yeah, great. Thanks, David. Thanks for having us here today as well. You know, I'll make some forward-looking statements here, so just, you know, feel free to go to the SEC filings to look at under our risk and uncertainties, and I'll also reference adjusted numbers, adjusted EBITDA, and that's a reconciliation you could find out there as well in the SEC. But David, back to the business side of things, you know, as you referenced, our largest business is Sterigenics. That's a business where we provide terminal sterilization for med device and pharma companies around the world. We have approximately 50 facilities. We have, you know, several thousand customers in that business.
Yeah, and when we do, we talk about a business here that gets across Sotera Health in total, we get about 3.5%-5% price, and Sterigenics is in the middle of that range. And then you have, as you referenced, volume and mix on top of that. And as David referenced, volumes have been a little bit more challenging in this business over the last several quarters because of destocking phenomenon. So you see procedural volume has been good, generally speaking, in healthcare, and the disconnect that David's referencing is the fact that a lot of our customers have had inventory challenges over the last several years, which we're now, to your point, though, we're seeing that stabilize. We mentioned in our last earnings call, and we're continuing to see that stabilize, and we're hopeful that as the year progresses, we'll continue to see rebounds in volume activities within the Sterigenics business and get to the more traditional levels as we get into 25.
That's great. Michael, can you talk about the visibility? So you're talking about initial signs of stabilization. How much forward visibility into that do you have, you know, customer inventory levels, things like that, that you have some, you know, actual data on or customer dialogue on?
Yeah. So it's more based on our interactions with our customers and the dialogue we have. You know, we don't have access to their inventory levels or where it sits in the chain between distribution, or health systems, or point of care. But, you know, in the interactions with our other customers, we're seeing that stabilization. We're starting to see the volumes recover, and, you know, that business doesn't have as good of visibility as our Nordion business, which has great visibility. But, you know, we do have some visibility, you know, weeks out, months out, a few months out.
Are minimum volume thresholds in contracts of any consequence for you? Like, are they a protection to your downside.
Yeah
Or are you really operating above-
Yeah
Minimum thresholds?
Yeah, really good question. No, so not all of our contracts in Sterigenics, but many of our contracts do have minimum thresholds and take or pay aspects to them, and that, that has helped in the last couple of years, just the last several quarters as volumes have been a little challenging. So we, we do see some of those still coming into play, David, in 2024, where folks are running below their optimized levels, but fewer and fewer of those, which is another area that gives us confidence around that take or pay.
Okay. And the—I think we've sized or you've sensitized the kind of 4% low-end growth versus 6% high-end growth is kind of dictated by the pace and strength of this recovery. Maybe, you know, correct me if I'm wrong on that or, or, or add color around, you know, where you see that trending at the moment.
Yeah. Yeah, we provided a guide of 4%-6% revenue growth for the year 2024 coming out of our last earnings call, and we said a lot of that's gonna be dependent upon how this volume recovery comes through. And it's really focused in the Nelson Labs and Sterigenics business, and we see that when we ship today, we feel pretty good about our ability to achieve that based on the volumes we project to increase slightly as the year progresses.
Okay. And I'm beating the dead horse here.
Yeah.
But on this volume recovery, is that, do you think of that as a broad statement, or is that very specific to things like surgical kits and life science, you know, bioprocessing, that have been really specific call-outs? Is it those things, or is it a broader thought process?
It's broad, but those are the larger categories that we've
Yeah.
Called out over the last several quarters, and that's where I, I feel we're starting to see stabilization around that, in the general hospital categories and a couple of additional categories that you referenced as well.
Is so coming back to price. So you talked about Sterigenics' price being in the middle of the 3.5-5 range, that, you know, I think you had periods where the business overall got more price during post-pandemic periods, but overall, your, your price taking and your businesses have, has been very consistent in that 3.5%-5% range. Is that Sterigenics price fairly consistent across modalities, or do you, are you able to get more or less price in gamma versus EO versus E-beam or whatever?
Yeah, as you referenced, 3.5-5 across the company. Sterigenics has been running a little higher than the typical middle of that range because of inflation and our ability to pass that on. We're seeing the inflation piece stabilizing. We think we'll be in a, you know, back to normalized levels within Sterigenics in 2024. There is some shift by modality. You know, ethylene oxide's probably run a little hotter than in the U.S. than it has in other geographies. But overall, we, you know, we have a pretty consistent formula on how we execute on our pricing around the world based on the market conditions.
Okay. Let's transition to the regulations and the changing kind of expectation levels around that. I mean, don't wanna wander through the entire history here, but the IRIS-
Be a long day if you did anyway.
Yeah, it sure would. The IRIS update triggers litigation activity. NESHAP regs are, you know, forever in development or production to become real. They now have become real. How much visibility do you think you, as an organization, had into where that was going to go, such that the investments that you've been making for some time essentially prepare you for the regs before they were even real?
Yeah. A couple things. There's a lot impacted within that, and I'll try not to go through five years of history here. But I would just tell you that the new regs are out finally from the EPA. They came out in April. With there's two years for compliance across the industry. You know, they're very challenging regs. We think the industry's gonna have a challenge overall in getting there. We feel confident about the progress that we've made against it and the work that we have left to do. So overall, we feel good about that. We do wanna make it clear, we don't fundamentally agree with the science and the level of, you know, of risk that they put into it.
We think they were way too aggressive and overreaching in how they used IRIS as the baseline for that, but put that aside. We're past that right now. We're moving forward with the regs and where we're at today. We know this industry, we know it very well. The regulators know we know this very well. We've communicated with them throughout this process, and worked with them, but at the end of the day, they made the rules and the regs, and we're abiding by them. We didn't know the final rule till it showed up, but you know, we obviously were engaged with them. They were asking for input because we're one of the largest sterilizers in the world. We feel good about it, and there's some things that we're gonna have to make additional enhancements beyond what we initially thought, but we think it's an immaterial amount of money when we look at it in the overall scheme of the investment we've been making since 2018, 2019 time period.
Okay, so.
And they're, and they're progressing well.
So.
Our teams, I actually just had a review last week with them in Illinois, and they're progressing really well.
Excellent. So relatively limited incremental investment versus the enhancements that you embarked on to begin with?
Yeah. Yeah, so we, we'll spend probably in total around $150 million for this program, somewhere in that neighborhood, and we've spent the vast majority of that through 2024. We'll have a tail on that in 2025. There's some additional requirements that came out with the rules that we didn't completely anticipate, but again, it's not a material amount of money and just some things we'll have to continue to refine our measurements and controls.
Okay. One of the things that we've been able to pull a little bit more data than we had at our disposal, you know, earlier in our coverage of your company, and see that the emissions, the EO emissions from these facilities, yours and others, have dropped pretty precipitously over years. And in the last past couple of years, your emissions are very low. I mean, sitting at kind of industry-low levels, which I'm sure you're proud of and not surprised by. We're also, those... Your volumes are going up. You... I should clarify. I'm talking emissions, but usage data is also relevant here. So you're using less EO, you're recapturing higher amounts of it so that you're emitting even less of it, but you're supporting higher volumes through your facilities. Talk about how you're able to kind of use EO more sparingly, evidently, to drive higher volume with less usage.
Great insights. We, we have continuously made investments in our EO facilities for many, many, many, many years, way before we got into this IRIS and proposed new changes to NESHAP. We've been making investments in our facilities around the world and continue to make improvements. So that, that's something we've been doing for years. We've accelerated that, obviously, with the proposed new regulations in the works for the last several years. The other thing that we've been doing, we've been working with our customers for the last several years on cycle redesigns, and telling them, "You don't need to use as much EO as you're using. We think you could still effectively have a safe product without microorganisms on it, and we can, we can work with you." So we've been working with customers on redesigning. So a combination of things you talked about, additional controls and improvements we continue to put in our facilities, as well as, you know, increasing volumes, but also then working with customers to reduce the amount of EO they use. So net-net.
Yeah.
We hope to reduce the amount of EO used overall.
Do you think that is a Sotera or Sterigenics specific initiative, or do you think that's, that your, say, your primary competitors in sterilization are also trying to do those cycle redesigns as well?
I would say, it's something that we've led with, and we've been very aggressive in that. I gotta tell you, just because we want to do it, doesn't mean it happens.
Right.
Our customers have to invest the resources to do this, and they have a lot of other competing priorities within their business as well. If it's cost out, if it's new product development, if it's change in manufacturing, they have engineering constraints as well. So just because we want to do it doesn't mean it happens. It takes time, and then you've gotta work through the regulatory bodies to get the final approvals. I would suspect our major competitors have... Our major competitor has probably done the same thing. I don't know that they've done it to the level we have, but I'm sure that they're evaluating the same thing, 'cause they're looking to reduce the amount of EO. I can't tell you broadly against the smaller regional players, if they've made the investments in facility improvements, nor the investments to reduce the amount of EO used in cycles.
Got it. Okay, let's transition to Nelson. It seems to my thinking that your growth in that business has been impacted by maybe two categories of issue. One is this regulatory delay in Europe, and the other is a relatively lower pursuit by your customers of new validation, new product validation opportunities. So, presuming you agree with that, let me dig into the first one. So-
Yeah, David, I would just say there's probably three factors.
Sure. Okay.
One is the med device regulation you talked about. Second one is, you know, a good portion of that business comes from small to medium-sized companies that are doing, you know, venture-backed financing and R&D for med device or pharma, so that is impacting. The third one is the whole restocking and routine lot release. Those are the three things I would say have impacted the volumes there the most over the last several quarters.
Okay. Okay, so on the regulatory, I believe the delay, the original timing was maybe March of 2023, or that was when the regulatory delay was announced or put in place for a 2-year delay. So at what point do you anticipate the customers then come back? Because the deadline is starting to get close and they need to take up these activities.
Yeah, so when you get a look at this, is figuring out the customers have a couple options here. They can continue to move forward down the path of re-qualifying their products to be compliant with the med device regulations, or they can develop new products, right, that, you know, can work on a similar path that helps them get to the deadline that they need to. So you're somewhere in between, depending on the customer, where they wanna be. You know, we'll start to see us lapping some of that volume in the Q2 of 2024. But overall, we're optimistic. Just if I step back and look at Nelson Labs, we're optimistic about the validation volumes and that coming back as we progress throughout the year. You know, the team is seeing that and feeling the impacts of that, you know, real time. It, Medical Device Regulation are not just broadly, you know, we're starting to see that market activity rebound.
Okay, and, and just to be clear on timing, you're saying that that's a second half benefit to the P&L?
Yeah, as we look at it. You know, that business has performed really well in the advisory services consulting side of the business, David, which we've talked about in the past. A little lower margin rate and from a mix perspective, and the big thing that was holding back was the volumes in routine and validation testing. And we expect that to continue to improve as the year progresses.
Okay. Okay, on the life sciences part of Nelson's business, which I think is around a third, is bioprocessing, I think it
Seems a little heavy, but okay.
So.
Yeah.
About a third, maybe a third of Nelson is life sciences, and within that is bioproduction, maybe the way to think about it?
Yeah.
How are those... You know, how is that trending? That obviously, bioprocessing has been broadly impacted.
Yeah.
.A way from you. Not a surprise that that's impacted. How do you see that stabilizing?
Yeah, I think over time you could see us increase our presence in bioprocessing across the whole company, Sotera Health. I mean, in particular with Nelson Labs, one of the big things is USP regulations that are just coming into play around the bioprocessing components, around extractable leachable testing. You know, we're a world leader in that area, and we had testing. You know, we provide a lot of testing in that area, and you know, we're seeing a lot of interest in that because of the new regulations coming in. So one thing that's good about the Nelson Lab business, when there's regulation and new regulation, and there's clarity around those regs, customers come to us for help in navigating through that. We see this playing out in extractable leachable with a lot of the bioprocessing componentry.
Got it. So part of where I was going with that is how much of that life sciences work that you do comes from the kind of smaller venture investment? You touched on that a minute ago. Venture-funded type companies that, you know, maybe have been a little bit more cautious about their availability of funding and how much, you know, funding has now improved a little bit year to date?
Yeah.
How much are you feeling a little uplift as a result?
Yeah, yeah, we feel that in the validation side. I would just be clear though, the majority of the Nelson Labs business is med device testing. We do about 900 different tests in that business. I would say, over two-thirds of that business approximately is med device testing. The rest, you know, on the pharma life sciences side. So we are seeing the improvement in that area that I just referenced, and you asked about, but don't underestimate the med device venture capital side, which will have a play, and that's where we'll experience that in the validation side of the business. And I feel we're really well positioned there.
Okay. So on the funding elements of that, be it, as you highlight, be it biotech or med device companies getting funded, you're feeling some benefit of the earlier improvement in funding this year?
Yes.
Okay. Okay. And then on the margins, this is a business where margin, kind of figuring out where the stable margin target is, has been a little bit of a moving target. What are your thoughts about, kind of incremental margin? I think you've kept staffing relatively high. You pointed at kind of customer service levels that you wanted to maintain or improve. How do you think about, incremental margin and improvement in the margin in that business as the revenue comes back?
Yeah. And just to give some context for the broader audience, you know, during the COVID periods, we got big boluses of volumes that came through because of some of the specialized testing we were doing, our margins exceeded 40%. That's a little too high for that business. Our business is more normalized around the mid-30s. As we talked about here today, the volumes have been a little softer in the core testing markets, and we've chosen to keep labor in place, you know, through the most part of 2022 and 2023, and our margins has settled back. We said that for 2024, we expect margins to approach 30% and then get to more normalized, our 35%, mid-30s range as we exit the year and progress into 2025. So as we look at this, the big cure for that is getting the right mix of volume and labor. It's a pretty labor-intensive business. Joe and the team have been kind of right-sizing it as coming out of 2023 and into 2024. Now we've got to make sure we don't lose that recipe as we look into 2024 and volumes start to recover. The most important part of that business is good quality and good service and turnaround times, and that's what Joe and the team are focused on there right now, to make sure we don't lose focus on that.
Got it. Let's zoom out of the segments a little bit. I'm kind of skipping over Nordion, but it's, as you said, the highest visibility, kind of most predictable. And we should emphasize incredible margins in that business. But I'm less concerned about what's going on there. So one of the things, moving to kind of corporate level, one of the things-
That's surprising for you to tell me you're less concerned about something.
Less concerned.
That's good.
How about that?
That's good.
Yeah. So refinancing debt improves your, I think, your interest burden by about, I think, $5 million or so.
For this year, yeah.
And so that's a moderate improvement to free cash flow. What other things is management focused on to improve the cash conversion for the company?
Yeah. So for us, it's about how do we generate more free cash flow? And the biggest drivers for us will be CapEx and working capital. I mean, obviously, you know, the team did a really nice job on the refinancing. We saw, you know, the debt markets at trading at spreads that we hadn't seen in a long time, and we felt it was the right thing to do before our debt became current. So the team did a really nice job executing on that, in the last couple of weeks. So that'll help us a little bit, but the big thing is CapEx, which we said will start to come down in 2025, and then again in 2026. We'll take these levels down, because right now we're at an elevated level. We're at over $200 million in 2023 and 2024. We'll see that coming back down. That would be a big one. Then Jon and the team are doing a lot of work on working capital. You know, just making sure AR, AP, and inventory levels. So, you know, we feel really good about our ability to continue to generate free cash flow in this business. This is a great cash flow business. Right now, we're just at elevated levels of CapEx, and we had interest rates a little higher, so those things kind of came together. But the fundamentals around cash flow here are there.
Yeah. Excellent. So coming back to the CapEx point, you said over $200 million last couple of years, step down 25, step down 26. I think Jon talks in terms of CapEx, maintenance CapEx, excuse me, in kind of a bare bones context, which is in the maybe $60 million range or something like that.
Yeah, plus or minus. I think Jon said $60 million, plus or minus $10 million.
Okay.
Yeah. It's.
But then you've also talked about, like, a target range that I think is more in like the 150-170 range, and so they're pretty, pretty wide, you know, or, or pretty big complement of growth CapEx still in that number-
Yeah
Implied. So maybe talk about what that goes to and how much, you know, are you turning the screws on the levels of growth CapEx beyond 2024 that you'll have? Could it go below the $150, is essentially the question.
Yeah, I wouldn't count on that for 2025.
Got it.
Nowhere near that. I would say when we look at it, there's some big, the big growth CapEx is really around Sterigenics and Nordion. In Nordion, we have cobalt development projects because, you know, that business, I just this week, we're sitting down with the team looking at 2034. You know, the supply and demand curves around cobalt development, for twenty-- all the way out through 2034. So the team's got a long-range perspective on it. So we will have continued cobalt development over the next few years. That is really strategically important to us. So we get cobalt in 2030, 2035, and beyond. And then on the Sterigenics CapEx, you know, we've got a couple programs that we're running out right now. We've got two greenfields we're in the process on, the third expansion's pretty meaningful that's wrapping up here in the next quarter. And then we'll have the two greenfields that'll roll out into 2025. But I would tell you, I don't see a greenfield out beyond these two for a period of time right now. We'll do some small tuck-in, you know, CapEx for growth within Sterigenics, but not huge numbers. But this business is always has a level of CapEx associated with it for growth.
Sure.
But it's a chamber here, chamber there, more cobalt-
Okay
Open up aeration capacity-
Okay
Things of that nature. The greenfields, we haven't done one since 2017 or 2018, and now we've got two in flight.
And so those are still requiring of CapEx, but as you just said, you wouldn't do those once every 5-7 years.
Yeah
Or something like that.
You're right.
So.
So why we feel confident in our ability to step it down is those will be stepping down, even though they're still continuing, and then, the EO enhancements that are running about four.