I think we're ready to go.
Ready to go?
Go. Excuse me. Good morning, everybody. My name is Luke Sergott. I cover Life Sciences Tools and Diagnostics at Barclays. If you're not in Miami and don't lose your voice, how are you gonna prove you were there? With me, I have Michael Petras, CEO of Sotera Health. Thanks again for making it down, you know, packed house on a Thursday. We're wrapping up the conference, and you guys are bringing it home for us. I guess we could start, if you wanna give a couple, you know, high-level thoughts or, you know, something prepared there, and then we could dig in some questions if you'd like.
Yeah, great. Thanks, Luke, for having us. Appreciate your support and the whole Barclays group overall. Happy to be here. You know, before we begin, some of the statements I'm gonna make are need to 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'll talk about certain non-GAAP terms, including Adjusted EBITDA, adjusted net income, Adjusted EPS, and net leverage. Please refer to our SEC filings. Overall, you know, happy to be here, happy to get a chance to get out and talk to some investors and give an update on the company.
Yeah. Let's start there and go over kind of the high-level takeaways from how you guys ended the year. It wasn't without any headwinds, but you still managed to beat your guide, put up some really good, you know, still really strong growth despite the medical device industry being a little softer than some were expecting from a recovery standpoint. Walk through the puts and takes as you ended the year and then how that launches you off into the beginning of this year.
Yeah, we, you know, the thing that's great about the business, we continue and consistently grow. We've grown every single year since 2005, even through all these economic cycles. Last year was well, a year with a lot of dynamics, but overall, we finished off pretty well. You know, Sterigenics continues to perform through all the different cycles. You know, they had a very good performance, ending 2022. You look at the Nelson business, our Lab business, that business, it was a crazy year. You know, coming off the pandemic, the first quarter had a lot of labor challenges that more stabilized in the second half of the year. Volumes aren't exactly where we'd like them to see in that business nor Sterigenics, but improving.
Then, the Nordion side, you know, that business in particular, you know, the curve ball that got thrown at them last year was the Russia supply. You know, they buy Cobalt from Russia and, you know, the geopolitical landscape had a significant turn in February, March, as many of us know. I would tell you they did a fantastic job navigating through that. Overall, we're happy about that, and we feel good rolling into 2023.
All right. Let's talk about some of the labor shortage. You guys called that out on the call as well, and that's kind of baked into your the cadence of your guidance. Is that across both of Nelson and Sterigenics, or is that just primarily hitting Nelson right now?
Yeah. We had the challenges with labor, if I kinda walk you through it. Nordion business has done a pretty good job, the labor market have pretty stabilized. It's not a really large team there.
Mm-hmm.
A couple global sites. On the Nelson side, in Sterigenics, we saw labor challenges, as most industries did, with increases in wage rates and shortages of labor. We started seeing that in late fourth quarter 2021. As it went through 2022, and obviously the beginning of 2022, there was a big COVID challenge with the relapse there. We felt it a little bit more in January, as the year progressed, February, March, April of last year, you know, the labor markets were pretty tight in the U.S. There was a lot of people not engaged in employment, that got better as the year went on. I'd say overall, we're in a pretty good spot on wages and labor around Europe has had a little bit of delayed reaction around the labor side. You know, we're seeing wage increases. They're more of them statutory-driven.
Mm-hmm.
Overall, the labor piece has stabilized pretty well. I mean, we actually just had reviews again yesterday overall on the labor side.
On the wage inflation, how many more levers do you guys have from a pricing perspective to offset that?
Yeah. Most of the wage increases, you know, we've seen, we planned for, and we're able to go ahead and offset that price, you know, based on how our contracts are set up. There'd be some lag in how that happens, but if you look at the overall business across the company, we've had 50%, just over 50%+ Adjusted EBITDA margins. We're not having significant expansion in margin rates, but we're holding our own, pretty well because of our ability to use price to offset inflation. Remember, the places we see inflation in our business is really threefold. We get a little bit in direct materials with Cobalt and EO, but it's mostly on utility and labor spend.
Mm-hmm.
We've planned for that as best as we can at this point.
It's a little more stable, yeah. sticking on the margin side, you guys have baked into the guide, really conservatively assuming Nordion weakness due to the, you know, Russia supply. The margin there is going to be impacted in the, a t least in the near term. Talk about the dynamics throughout the year and how you guys are modeling and thinking about the actual ramp cadence?
Yeah. All three businesses will be in a good spot, as far as margin rates in 2023. Nordion, what you're referencing in particular, the way Nordion works is, you get Cobalt out of nuclear reactors. Those reactors, what they do day to day is they generate electricity. When they shut down for maintenance or refurbishment, that's when we are able to harvest the Cobalt out of there. That schedule is really dictated by the utility. The way it's set up for 2023, which we have really good visibility on, approximately 75% of the revenue in Nordion will be in the second half of this year.
Mm-hmm.
Okay? A very small portion of revenue will occur in the first quarter.
Mm-hmm.
Overall, the margin rates will be fine throughout the course. You know, when it's all said and done across the business in Nordion, we'll be fine. It's just the timing of when the revenue will be off this year.
Yeah. You guys were talking about, diversifying outside of getting it from Russia. I guess the timeframe on how you guys are planning for that?
Yeah. That's a longer-range project. That's part of our CapEx increases over this year, last year a little bit, and then in the future years. We are working with utilities, you know, to go ahead and expand our Cobalt supply. I'd say a couple things that we've discussed publicly is the involvement with the Canadian. You know, we do a lot of work with OPG, Ontario Power Group, and we're looking to put Cobalt into their Darlington reactors. That's a big project that we're working actively with them. That'll take several years before it comes out, you know, with the development effort. And then you have to put Cobalt in. I kinda say put the bread in the oven and then the, y ou know, I'm not very technical.
We put the bread in the oven, then after a period of time, you pull the bread out and it's Cobalt-60. All right. That takes 18 months to three years. First you gotta get the development, actually, that's gonna be several years. After that, you put the Cobalt in, 59, it comes out Cobalt-60. That'll take at least 18 months to three years. I would tell you we're several years out. The second big area we're doing Cobalt development is in a partnership with Westinghouse.
Okay.
We're working with Westinghouse, to get engaged with several U.S. utilities. I think you ought to be thinking, you know, the late twenties and the early 30s.
Okay.
That's kinda the timeline.
All right. I got you. You're not very technical. We can talk about Nelson Labs a little bit. You mentioned earlier that the volumes aren't back to where you want them to be. I mean, this is the QC testing on the back of the sterilization before they go out, right? Centralizing all of that, how much of those volumes that you would like to improve are coming from Sterigenics versus being outsourced to you guys?
Yeah. I would tell you that about 40% of that business is sterility assurance, lot release, kind of routine testing. That, you know, that business is done okay. The volumes aren't great. It comes from Sterigenics, but also other sterilizers as well. We're, you know, about the other half of that business is more on validation, more complex testing, and that's tied to R&D, new product development. Overall, that business is done pretty well. We have pockets that are stronger than others. You know, we do a lot of work in extractable leachables, analytical chemistry that does very well for us.
I would say that the, the volumes and the new product testing stuff with what we saw wasn't as strong as we had hoped for in 2022, coming out of COVID, some of the supply chain engineering challenges. Overall, that business, you know, we continue to see variation. We do about 800 tests in that business, all pharma and med device related testing.
Are there any particular areas that are soft than others? Like, so like when we're talking about, like, indications from either pharma or across the medical device indication.
Yeah. I'd say the medical device has been a bit choppy in that business. Last year, we referenced a couple times during our calls that there's a couple areas that we do testing that our customers are waiting on FDA to give clarification on exactly what they want as far as requirements, which will impact the protocols we put in place. We saw some of those delays in 2022, but that started to normalize as we got to the back half of the year.
This is a validation?
Yes. Exactly.
Kind of walk through some of those tests on the. Is it like 'cause I'm thinking about medical device, it either works or it doesn't?
Yes. Let me give you an example. One of the things that we do that not a lot of people recognize is scopes.
Yeah.
Scopes for endoscopies, colonoscopies. We're the guy that helps put the instructions for you. Think about it, if you're a scope manufacturer, those scopes are gonna be used at the point of care.
Yeah.
You know, surgery center, outside the center. We are the folks that put the instructions for use together with the FDA in conjunction with the customer, that when a practitioner in a health system uses that scope, then they go to reuse it, there's steps and protocols that they have to follow to make sure it's clean.
Okay.
That's the work that we do to be an independent lab to validate that those scopes are clean and that, okay, there's no microorganisms of that nature. Something like that, I'm gonna make it up. I don't know exactly the particulars, but in the past, you had to do seven steps. We're the ones to do the independent testing to make sure. The FDA was saying, "Hey, we want you to do 20 tests.
Yeah.
20 steps. Then there was some discussion back and forth with industry, and they settled on 12. I'm just using this as an example.
Yeah.
That was some of the issue. You know, the customers didn't wanna be sending testing in for 20 steps. They only need to do 12, and they didn't wanna do 12 and then turn around and have to come back and do eight more. That was some of the stuff that last year caused some challenges, but we got, s ome of those regs got clarified now, so we're starting to see that volume in the latter half of 2022 start to materialize. That's an example.
You guys end up materializing it. It's gonna catch up when we're thinking about the ramp here in 23 for Nelson. Is it gonna look like the rest of the business will be back half-weighted, or we should expect?
I don't think any of the businesses will be as heavily weighted as we saw with what we're projecting with Nordion.
Yeah.
You know, Well, this year, Nordion's going to have a very low first quarter. You know, 75% of their revenue in the second half of the year. The other two businesses traditionally have a lower first quarter.
Mm-hmm.
We'll see that, but then the rest of the year will kind of balance out. I don't think you should expect it, you know, to go from here to here.
Yes
S ignificantly, but it'll be a steady increase as the year progresses.
Perfect. On your margin guide, you guys are assuming an 80 basis points contraction there. Walk us through the different dynamics and bucket out the different puts and takes you see.
When we look at it, you know, the business will still be 50%+ Adjusted EBITDA margins. We look at it, there's some timing of inflation, you know, that comes in and rolls out throughout the year in our ability to offset the contracts. It's not that we're not gonna get it's the timing of it, right? We may be experiencing inflation in an area, and that customer's contract might not be renewed till next year, something of that nature. There's some timing on that. We also have some mix that'll impact it, and then also some investments that we're making in the business as well, and some of the costs to help us with some of our strategic growth. Those are the things that'll drive it.
Overall, you know, margins will be very strong in the company.
Okay. Let's turn it over a little bit to the litigation side. You guys settled the cases. Give us an update there, on the opt-in rates. You guys also have the opportunity there to back out of the settlement at a certain point that's still an opt-in, so kind of walk us through the, if you can, the dynamics going on.
Let me give context for some folks that might not be as close to it. We had litigation in Illinois. We announced that in January 9th or so that we have reached an agreement on a settlement for approximately 870 cases. It'll be $408 million in total. It's kinda broken into two buckets. There's four plaintiffs, the trial plaintiffs, if you will. Some of the larger cases, they get an outsized portion of that settlement amount, and then the remaining 866 + cases will come together. The four have signed up, and they're all committed. Those are the larger portion of the settlement. The remaining 866 or so, what's happening right now is the plaintiff firms are going out to their clients, and they're helping them divide up the money.
Mm-hmm.
We should see something, guessing, I'm getting confused on dates, probably late April, May, we should start to see some more visibility of the participation rates. The plaintiff firms have committed 98.6% of the plaintiffs will sign up. That's their goal.
Mm-hmm.
What they've committed in the contract to us, that means 12 plaintiffs can opt out. There's some conditions around opting out that we put in place that out of the 12 opt-outs, they cannot be a certain criteria that we've laid out.
Okay.
If they are, we have the ability to walk from the deal. If they can't deliver the 98.6, we have the ability to walk from the deal. I don't think we're gonna have issues with that either. There'll be some things we'll have to walk through, but I think overall, we should be able to wrap this up in the August time period.
Yeah. I guess, like, what would happen as per you guys to walk from the deal 'cause it seems like a pretty decent outcome for everybody?
Well, first I'd say decent outcome, I'm really disappointed we gotta pay any money at all.
Yeah, I know.
There's no science causation here. Okay?
Yeah.
I wanna be clear. This is a scar for me that's gonna be there a long time. 'Cause paying anybody $400 million
That's a lot of money.
Yeah. It's a lot of money. We have built in flexibility that if they don't get the participation rate at 98.6%, that gives us flexibility to decide our optionality if we go forward with the deal or not.
Yeah. All right. outside of
We anticipate them delivering the dollar.
Yeah.
They signed up for it.
Yeah.
They know their client base.
Yeah, I mean, opting out money.
It's their business.
Yeah. All right. Let's talk a little bit about the upcoming Atlanta side of the cases. Higher burden of proof over there. Talk about what that means and the data that's needed to support their claims against you guys and what you guys have already produced.
Recognize how Illinois played out, a very different standard on expert testimony and what's allowed into evidence. It's a much lower threshold, and also the causation's a much lower threshold in Illinois than there was in Georgia, and there is in Georgia. Also, you know, Georgia has got a cap on punitive damages, which I think is a really important thing. It's a cap of $250,000.
Mm-hmm.
Ironically, was being challenged in the Supreme Court of Georgia, which yesterday, the state court, ruled that the cap that's being applied to place, it's constitutional. That's another good outcome. I would just tell you that in Illinois, it was a free-for-all. The way the judge ran the case, in our opinion, and you could read our motions for post-trial relief, we had a lot of issues. It was pretty much people getting in there talking about things they weren't experts on. They were putting in information that wasn't relevant to the case. There's a whole different approach. You know, they did discovery depositions and then pretty much threw everything into that first trial. In Georgia, it's gonna be a very different approach. There's a higher standard of scientific experts in what they're allowed to present. In addition to that, the Georgia courts are going through a process in Cobb County, where they first have to prove general causation.
Right.
Which means they have to prove that it is potential that a facility emitting this low amount of EtO could potentially cause cancer. If the case gets through that, then the second case is they get into a specific causation. Mrs. Jones, breast cancer, 22 years, this amount of exposure. You know, that's the next piece. If they get through two hurdles, general causation and specific causation, then there's a trial. The first two steps have to go through in front of a court before, and a judge, before they go to an actual trial in front of a jury. Where in Illinois, this poor jury of 12 people had to take all this information and try to sort through all these different people talking as if they were experts, throwing a bunch of information. George is taking a very different approach. I think that's probably what you're referencing, the causation side.
Yeah. Because on those two phases, if only one of those breaks, then.
The case is out.
Do all cases get kicked out?
What's happened is they've taken 10 cases to work through. It's kinda ones that'll be, I don't know, I wouldn't call them bellwether, but they're kinda guide cases that they wanna work through first.
Mm.
That's the first 10 cases.
Kinda like the Kamuda case.
Yeah. They'll work through those and see if they get through the first two phases of general and specific causation.
Okay. Could you give us the layout and timing there from what we should expect?
There's one case that's taking a different path. That, that plays out in 2023. Then all the other ones that I referenced, we have one case in one county and 300+ cases in the other county. The causation pieces of 300+ cases, and that'll take place in 2024.
Okay. We have some time.
Yeah.
Okay. The, any update on your strategy on the, settling all those like you did with Illinois, or we're just gonna wait till see how they play out?
Yeah. We're gonna see how it play. You know, listen, we've proven out clearly, you saw with the second trial and when the science is put out there in the facts.
Yeah
There's no case. It was ruled in our favor 12 to zero.
Yeah.
We feel pretty confident that the facts stand, that these are safe facilities, that this amount of EtO at this low level does not cause cancer. You know, we felt the need, it was a business decision, of course, in Illinois.
Yeah
Because of the unbiased media coverage.
Yep.
The other thing was really unique about Illinois is we had a runaway verdict on the first case, and Illinois also requires a bond of 150% of the verdict. We lost that first case, $363 million. We had to put a bond up for $540 million to have the right to go to appeal court, which is just absolutely ludicrous. Okay? We had to put $540 million up to go tell the courts that they were wrong. If you read our motion of post-trial relief, you'll see all the issues there.
Yeah.
When we just stepped back and looked at it from a business decision, the right thing was to try to end the situation in Illinois.
Yeah. It was, it was becoming burdensome. All right. Let's talk a little bit about, in the last couple minutes here, the, your LRP and, you know, maintaining that high single digits. Talk about the share gains versus pricing and your internal volume growth with existing customers. Walk us through the different dynamics on the thesis.
Yeah. If you look at the business, we see the company grow high single digits organically. If you go through the geography, you've got 3.5%-5% price, and then the rest is made up of volume and mix. If you take the Sterigenics business, they'll be right in the middle of that pricing bucket, around 4%. Last year, they ran a little hotter. They were closer to 6% price because of the inflation that they were offsetting. If you look at Sterigenics, it should be about 4% price, and then the rest, volume and mix, to make you high single digits. You take Nelson Labs.
Nelson Labs will be about 3.5% or on the lower end of that price, about 3.5%-4%, and then their volume and mix will get in the mid to high single digits. Then on the Nordion, we kind of look at the math on Nordion. Nordion will be low volumes, you know, low volume and mix, 0%-2%, and they'll be on the higher end of that range, about 5% on price. That if you put that all together, and you get a business that's 3.5%-5% on price, and then the balance made up to get your high single digits organic growth and volume and mix.
Yeah. The, the other pitch here is on the, you know, your, your margin structure is very, very healthy, but you always look at where you get the margin expansion coming from Nordion. Talk about how that has played out versus your initial when you guys did the IPO, and you're talking about expansion from there?
You know, all the businesses are performing. We obviously, as I referenced earlier, we had the Nelson. You know, that business, you know, has continued to steadily increase. We had the big step-up in margins back in late 20 and into 21 because of the COVID bump and some of the testing we had in PPD, which was very high mix. That got us into the low 40s. It's settled down, which is a more normalized range in the mid-30s to high 30s. All three businesses, you got Nordion, 50%+, you get Sterigenics 50%+ , and, you know, we get great operating leverages on the businesses.
Again, I think the bigger point is this just talks about the stickiness of our relationships with our customers, the importance of this mission-critical service. You know, the margins are great and everything, but it's the volume, it's the millions of lives that we save every day with the critical services we offer. I think that's the more important thing than just the margin rates. This is an unbelievable business that, you know, safeguards global health. That's what's really important.
Fair enough. Fair enough. Lastly, speaking of safeguarding global health, the NESHAP regulations.
The, the, the-
The NESHAP.
NESHAP.
NESHAP, thank you. Wrong accent on the wrong allowable. Any update there? I mean, these things have been supposed to be coming, like, since 2020. I mean, do you guys have any visibility into what's going on?
Nope. We, you know, we keep hearing from the regulators it's coming any month now. We'll wait and see. It's kinda interesting to me that the EPA is running around to all these communities telling them EO is more dangerous than we thought. We've been looking at this since 2018, we'll get back to you with some new rules.
Ooh.
Okay. We want the new rules. We've been wanting the new rules since 2018, 2019, 2020. You know, I'm not in the business of predicting when regulations come out of the EPA, but we feel very comfortable about the improvements we're putting in our facilities. You know, they might change some things and put some additional regulations that we don't anticipate, but I feel very confident that we're gonna be at the top end of the industry in our ability to perform and meet those requirements that come out.
Yeah.
We're waiting on that regulation. It's disappointing we haven't seen anything yet. They're running around telling communities to be worried. They don't give them any solutions.
What do you think the capture rate's gonna settle down to be? The capture rates are like around, 'cause it's at 99 right now?
Yeah. It all depends. It varies by state. It depends if you're talking about process emissions or fugitive emissions. I think ultimately they're gonna have to put some type of solution in that's got negative pressure as part of it. How far they go along that continuum will be determined. We're prepared as if they think about a facility and put the whole thing under a bubble, we're prepared for that.
Fair enough, man. All right. Thank you.
All right. Thank you.
Thank you.
Good to see you.