Sotera Health Company (SHC) Earnings Call Transcript & Summary

Hello, everyone, and thanks for joining us. This is the call covering Sotera Health's results for the first quarter of 2023, and we're glad to have you here. Our press release from today, along with the supplemental slides that go with it, can be accessed in the Investors portion of our site, soterahealth.com. A recording is being made of this webcast, and once it's done, a replay will be posted in the Investors section of the Sotera Health website. Joining me on the line are Michael Petras, our Chairman and Chief Executive Officer, and Michael Biehl, who is serving as Interim Chief Financial Officer. Some of what we say during this call may fall into the category of forward-looking statements. The topics covered in those statements carry risks and uncertainties, and because of them, actual results might differ materially from what has been projected or implied. For a description of those risks and uncertainties, please see Sotera Health's SEC filings as well as the forward-looking statements slide located at the start of this presentation. No obligation is assumed by the company to update any forward-looking statements of this kind. Be aware that in today's discussion, the company will present financial measures under both GAAP and non-GAAP, which include adjusted net income, adjusted EBITDA, adjusted EPS, net debt, adjusted EBITDA margin and net leverage ratio, along with comparisons on a constant currency basis. You can locate a reconciliation of GAAP to non-GAAP measures for all relevant periods in the schedules that accompany the company's press release and in the supplemental slides for this presentation. Assisting with the Q&A portion of today's call will be the operator. To make sure everyone gets a chance to ask questions, we ask that you keep yourself to one question plus one follow-up. As usual, should you have any questions after the call, don't hesitate to contact me and the Investor Relations team. At this point, I'll hand the call over to Sotera Health Chairman and CEO, Michael Petras.

Hello, everyone, and thanks for being with us on Sotera Health's call for the first quarter of 2023. As we discussed on our fourth quarter 2022 earnings call, revenues and adjusted EBITDA for the first quarter of 2023 came in lower than the prior year. That was caused by the expected timing of Nordion's cobalt-60 supply harvest schedules along with reduced volumes at Nelson Labs and Sterigenics. Those softer volumes are normal for the year's first quarter, even though Sterigenics volumes did rise compared with the first quarter of 2022. In a moment, Michael Biehl will walk you through our financial results in greater detail, but first, let me call out a few points from our first quarter results. Total company revenues fell 6.8%, while adjusted EBITDA dropped 14.6%, both measured against the first quarter of 2022. Adjusted EPS for the quarter came to $0.13, down $0.09 from the same period a year ago. At Sterigenics, our largest reporting segment, top line growth reached 7% for the quarter, with the business units seeing gains across every major modality during what is usually a lighter quarter for that segment. The Sterigenics team keeps navigating inflation headwinds as well as some supply chain challenges affecting customers. We remain engaged in investing in additional capacity, with 6 active expansion projects at Sterigenics, and we are also advancing our EO facility enhancements in North America. These enhancements, which lead the industry, reflect our steadfast dedication to guaranteeing best-in-class emission controls for our employees, our customers, and the communities where we operate. Nordion, our other reporting segment within the sterilization services business, saw an expected 75% year-over-year revenue decline stemming from the timing of cobalt-60 harvest delivery schedules. As we have said repeatedly, Nordion's revenue timing is linked to harvest schedules from our cobalt-60 suppliers, which are large utilities. Because we have solid visibility into those harvest schedules, we remain confident in our 2023 revenue forecast, despite the fact that Nordion's revenue timing will be particularly uneven this year, with roughly 75% of the revenue expected in the back half of the year. As many of you are aware, Nordion obtains part of its cobalt-60 supply from Russia. We said previously that a complete disruption of supply from Russia might lead to a 0% to 3% impact on total 2023 Sotera Health revenues. Now that the quarter is behind us, we estimate the potential Russian cobalt-60 supply disruption risk at a 0% to 2.5% impact on total Sotera Health revenues. More importantly still, keeping the supply of cobalt-60 uninterrupted matters greatly to the global health care community, since cobalt-60 sterilizes approximately 30% of the world's single-use medical devices. I take pride in how our Nordion team keeps working on this. It is a strong illustration of how we carry out our mission of safeguarding global health. Nelson Labs, our lab testing and advisory service business, saw lower volumes in the first quarter, with revenue down 2.3% from the prior year. For Nelson Labs, the opening three months of the year tend to be on the weaker side, and on top of that, we haven't yet gotten back to where we were before the pandemic in a few categories of testing. Still, we're heartened by some order trends we've seen lately, and from an operations standpoint, we're ready to get back to the volumes we saw before the pandemic. Just like we told everyone on the previous earnings call, Sotera Health completed a $500 million Term Loan B issuance in the first quarter. Our net leverage ratio came in at 3.4x for the first quarter of 2023. Given our position once the first quarter wrapped up, we're at ease restating the guidance we gave on that prior earnings call. To jog your memory, our 2023 guidance anticipates revenue and adjusted EBITDA each climbing between 5% and 9% compared with 2022. Michael Biehl is going to walk everyone through the specifics of that guidance shortly. Even though inflation, labor and customer supply chains remain troublesome, those pressures appear to be settling down somewhat. Delivering growth and profitability for our shareholders stays a firm commitment across our teams. I want to underscore the mission we hold — safeguarding global health — since that sits at the core of what everyone here does. Broad human health and well-being needs are what our products and services address. From supplying vital scientific know-how and regulatory consulting that resolves our customers' hardest sterility problems, to stopping infection across a wide array of medical and pharmaceutical offerings, to confirming how accurately our product performs, we contribute to keeping health care safe and we shield the lives of millions globally. Michael Biehl will now walk us through the financials in greater depth.

Thanks, Michael. First off, I'll walk through what stood out in Q1 2023 across the whole company, then provide details on each of our business segments, along with news on how we're putting capital to work and where leverage stands. I'll finish with a handful of other points regarding what we expect for 2023. Turning to the consolidated picture for the entire company: revenue during the first quarter reached $221 million, down 6.8% compared with the prior-year period. Because we absorbed a foreign currency headwind of 1.5% at the total company level, the decline amounts to 5.3% when measured on a constant currency basis. We think those challenges are starting to let up, and at this point we're anticipating that foreign currency will become a positive factor during the second half of the year. On an adjusted basis, EBITDA reached $98 million, which represents a 14.6% decline relative to the first quarter of 2022. When it comes to adjusted EBITDA margins, they were 44.6%, marking a 410 basis point decrease versus the levels seen in the first quarter of 2022. The anticipated Nordion cobalt-60 supply harvest schedules account for the bulk of that. Thanks to how we operated, adjusted earnings per share landed at $0.13, a figure that's $0.09 below what we saw in the first quarter of 2022. For Q1 2023, we posted net income of $3 million, which works out to $0.01 per diluted share. In the same period a year earlier, Q1 2022, net income came in at $31 million, or $0.11 per diluted share. Interest expense as reported for the quarter totaled $29 million. Turning to our segments, let's dig into the details. Sterigenics delivered yet another solid quarter: revenue rose 7% to $160 million, while segment income climbed more than 4% to $83 million, both compared with last year's first quarter. When you strip out currency effects, Sterigenics revenue was up over 8% from Q1 of last year. Looking at what fueled our revenue increase in Q1, we saw roughly 6% benefit from pricing and 2% from favorable volume mix, though foreign currency movements worked against us by about 1%. Segment income margins came in at 51.8%, which represents a 135 basis point contraction relative to Q1 of 2022. That decline reflects the usual seasonal pattern of lower first quarter volumes compared with later in the year, plus the effect of inflation, with favorable pricing providing some offset. At Nordion, revenue for the quarter dropped around 75% to $9 million versus the same quarter in 2022 — a result we anticipated, stemming from how cobalt-60 harvest supply schedules fell. Nordion's segment income also decreased, landing at $2 million compared with the prior-year period. When looking at Nordion's top line and segment profit compared to the first quarter of 2022, the shift came mostly from lower volumes and product mix, which accounted for close to 71%, plus roughly 4% in unfavorable currency movement. Over at Nelson Labs, revenue for the first quarter of 2023 came in at $52 million, down 2.3%, while segment income fell more than 17% to $14 million versus the same period in 2022. As we've noted before, the opening quarter tends to be the weakest one of the year for Nelson Labs. If you strip out currency effects, Nelson Labs' revenue was down about 1% from the prior year's first quarter. In the first quarter of 2023, our reduced revenue took a hit from more than 5% in volume decline and mix, plus 1% in foreign currency-related headwinds. An approximate 4% pricing benefit partly made up for those pressures. Nelson Labs' first quarter 2023 margins narrowed to 27.1%, a drop of roughly 490 basis points compared with the first quarter of 2022. The decrease stemmed from the effect of the usual softer first quarter volume compared with the rest of the year, partly offset by beneficial pricing. I'd like to point out that at Nelson Labs we are keeping our staffing levels unchanged as we anticipate volumes will rise across the year. Moving on, I want to walk you through some key points on how we're generating cash, putting capital to work, and where net leverage stands. During the quarter, our operating cash flow came in at roughly $34 million. As of March 31, 2023, we held $648 million in cash and cash equivalents, and our available liquidity was above $1 billion. Michael mentioned this earlier, but in Q1 we completed a $500 million Term Loan B. By using cash from the balance sheet plus part of the proceeds from that new term loan, we paid off the $200 million we had drawn under our revolving credit facility; then on May 1, we placed $408 million into escrow related to the Illinois ethylene oxide litigation settlement. Although the new borrowing and paying for the $408 million cash settlement will initially drive our net leverage ratio past 4x during the second quarter of 2023, we expect that by year-end, net leverage will land within the 2 to 4x range we've set as our long-term target. Until the settlement is finalized and the money goes out to the settling plaintiffs, the $408 million held in escrow will show up as restricted cash on the company's balance sheet in the second quarter of 2023. Additionally, in the first quarter, the company completed an amendment to its first lien credit agreement, bringing in $76.3 million in new revolving loan commitments and raising our total available capacity to $423.8 million. Looking at things on a pro forma basis once the first quarter wrapped up, and once we'd put $408 million into the settlement escrow, we're sitting at roughly $600 million in liquidity. That leaves us well positioned moving ahead. On top of that, we were able to boost the letter of credit capacity under our revolving credit facility, adding $165 million for a new total of $351 million. When it came to capital expenditures, the first quarter of 2023 totaled $45 million. The heavier investment during that quarter was driven by Growth CapEx along with facility enhancements. As Michael pointed out, considering the position we were in at the end of the first quarter and our expectations for the remainder of the year, we feel good about reaffirming the outlook we provided back in February 2023. Just to sum up what we're looking at for the whole of 2023: total revenues should come in somewhere between $1.055 billion and $1.090 billion. That works out to growth of 5% to 9% on an annual basis. On adjusted EBITDA, we're expecting a figure in the $530 million to $550 million range, and that also translates into a 5% to 9% yearly growth rate. As for adjusted net income, the effective tax rate we anticipate should land somewhere between 30% and 33%. Back on our fourth quarter earnings call, I walked through the reasons the tax rate is up compared with the year before — mainly it's the result of higher interest expense, plus the limits on interest expense deductibility that came out of 2017 U.S. tax reform. We anticipate adjusted EPS to come in between $0.78 and $0.86. That amounts to a drop of 10% to 19%, driven chiefly by greater interest expense and the higher tax rate versus the full year 2022. We project capital expenditures to fall between $185 million and $215 million, which reflects ongoing elevated investment for growth as we keep funding capacity expansions at both Sterigenics and Nelson Labs, plus putting money into EO facility enhancements in North America and cobalt development projects at Nordion. The remaining pieces of the outlook we issued earlier are unchanged as well. Now, on the cadence for our quarterly reporting: I'll walk through a few points for each business unit, and for Nordion, I'll briefly address the uneven pattern we still expect throughout the year. For the full year, approximately 75% of Nordion's revenue and 80% of its segment income will be recorded in the back half. As Michael noted earlier, the potential impact on Sotera Health's 2023 total revenues from a full cutoff of cobalt-60 sourced from Russia is now estimated at 0% to 2.5%, given that the first quarter saw no supply interruptions. Over at Sterigenics and Nelson Labs, our expectation is that volumes will climb and margins will widen as we move through the year. I'll hand the call back to you now, Michael.

Thank you, Michael. Ahead of moving into the Q&A portion, I'd like to address ethylene oxide regulations and litigation. As a lot of you are aware, the EPA has put out its proposal for tighter EO rules; with those proposals now on the table, there's a window during which industry players and members of the public can send in comments for the EPA to weigh as it finalizes the proposed regulations. Even though these proposals create hurdles that would force every industry participant to alter how they operate, we've put substantial time, effort and capital into our EO facilities, and we feel confident about our leadership position here. Turning to the Illinois EO settlement, the plaintiff Executive Committee has reported that things continue on schedule, with participation rates to be presented in May. Under the terms of the settlement agreement, on May 1, Sterigenics placed the agreed upon settlement amount of $408 million into escrow. Assuming participation by substantially all the eligible claimants, we anticipate this settlement will be completed and the settled cases dismissed in late summer. As I finish up my remarks, I want to stress once more that Sotera Health continues to be strongly positioned for growth through 2023. The first quarter was atypical because of the expected cadence of cobalt-60 supply harvest schedules. On the whole, we feel very good about where the company stands now and where it's headed. With that, operator Joe, I'd like to open the call up for question and answers.

Hello, and good morning. Lizzie here, filling in for Patrick. During the fourth-quarter call, I believe you brought up Nelson Labs getting back to margins in the high 30% range during the second half of the year. Your comments on order trends came across as fairly positive. Could you expand a bit on what you're observing in that area? Thank you. I also have a follow-up question.

Morning, Lizzie. Michael speaking. That's right — we anticipate Nelson Labs margin rates landing near the figures you just referenced, in the mid- to high 30s, and we look for volumes to keep rising as the year goes on.

Fantastic. Thank you. And regarding Sterigenics, I believe you said pricing was roughly 6% for the quarter. Should we view that as the pattern for the full year too, plus your general thoughts on inflation? Thanks. That's all from me.

Yes. Thank you. Throughout the entire company, as we've said, our expectation is 3.5% to 5% in price annually. Sterigenics sits roughly at the midpoint of that band. Nelson falls toward the bottom of it, while Nordion lands toward the top. During the past several quarters, we've been somewhat above those bands, given the inflation offset. My sense is that over time it will settle into the more normal bands we've observed. However, the past couple of quarters came in somewhat elevated as a result of the inflation offsets.

Thanks.

Morning, and thanks for taking my question. I've got two. Starting with the guidance, I appreciate you reaffirming the full year. Has anything shifted within the segments compared with what you originally planned? My hunch is nothing has, but I'm curious whether, for instance, Nelson might be somewhat softer than you previously expected while Sterigenics is somewhat stronger. Anything along those lines? Or do all three segments now sit where they did when you first issued the outlook?

Yes, Mike. Michael here. I'd say they match what we provided in February at the time of the initial outlook. It's fairly consistent.

Thanks. To follow up about Illinois, I suppose, have you observed the participation rates? Or when exactly do you anticipate seeing them? And will the public see them at some point during this month through a filing or some other channel?

No. So that — Mike, those are only being shown right now to the claimants, so that's just going out; they will have a stretch of time across the coming weeks and months, during which they'll be looking at that, and we don't currently even have visibility into it. We are in ongoing discussions with the plaintiff counsel to ensure things are on track. As we said on the call here today, we did fund the escrow, the May 1 escrow of $408 million because we feel comfortable on how things are progressing. But we won't have visibility just until late summer, as I've mentioned in the past as well.

Okay. Thank you.

Thank you.

Yes. Thanks. Good morning. Michael, the EPA proposal has now come out — could you bring us up to date on where you stand with upgrading your scrubbing capabilities? How many facilities have been completed, and how many remain? Also, do the enhancements you've been implementing suffice to satisfy what the EPA has set out under these tighter standards?

Yes, our improvements are moving along quite well. As we've said previously, we've been implementing three main improvements: central discharge, double scrub, and permanent total and closure negative pressure 204. We feel quite confident about the investments we've made and the progress achieved. Certain items in the proposal must be tackled by the entire industry. A public comment period is coming up over the next several weeks and months, and we will submit our comments on that. Some items will need modification as a result. That could call for some extra capital. What I mean is, certain elements in there might prove unachievable for the whole industry. My belief is that, in the end, that isn't what the EPA intends. Once they engage and grasp, from the industry's perspective, how these facilities run, they will make the right adjustments. These are draft proposals; even so, we feel very, very good about the leadership position of the investments we've made and the direction we're heading on that.

All right, sounds good. Then regarding the guidance, Michael Biehl, you mentioned some of this during the prepared remarks, but that sharp EBITDA increase over the rest of the year — is the thinking that it'll come fairly evenly from every segment? Or does it mainly hinge on Nelson bouncing back and Nordion running on a steadier cadence? Is there anything else you can tell us about what's driving that, and what visibility you have right now into the back half of the year?

Yes. This is Michael Biehl. As we said, since Nordion is lumpy, we believe 75% of revenues and 80% of EBITDA will land in the second half. That remains on track with what we told you initially. So there's really no deviation from our original statement. And truly, for Sterigenics and Nelson, the first quarter tends to be softer, as history shows, and we expect that to keep building through the rest of the year on a fairly even basis.

All right, excellent. Thanks once more.

Good morning, and thank you. I appreciate that you're discussing the recovery in Nelson, and you anticipate volumes returning, but is there anything you could highlight that would provide us a bit more clarity on that? Was there anything — did any push outs occur during the quarter? Could you speak about any of your backlog — are you accumulating additional backlog? Anything at all just to give us some reassurance that volumes will in fact come back?

Yes, whenever we examine some of our order trends within our backlog, especially in the validation area, we're observing somewhat more strength than what we saw previously. So we — that ties to some of the prepared remarks regarding pre-pandemic levels. As you might remember, we've discussed validation not having completely recovered from pandemic levels; that specifically, some of the items where we're seeing a bit of optimism as it progresses going forward. So the team keeps executing on it. As I've said before, what I'm most proud of is the turnaround time, the competitiveness that we've enhanced, along with the customer SAT scores and the Net Promoter Scores that we keep getting strong results on. So the team is performing quite well as we expect the ramp to arrive. And another item that we've discussed previously is simply the labor situation, and we feel pretty well positioned on labor as we move through the year as well.

All right. Now, as a second question, are you able to share the recapture rates for the Atlanta sites as well as the rest of your EO sterilization at Sterigenics?

Could you clarify what recapture rate refers to in your question?

So the assumption is that these new regulations will land at roughly 99.5% recapture, right? Is your operation running higher than that?

Correct. What I believe you're referring to, I suspect, is emissions from the process itself. I don't want to get overly technical, but there's …