Sotera Health Company (SHC) Earnings Call Transcript & Summary

Hello, everyone, and thanks for joining. It's a pleasure to welcome you to the earnings call for Sotera Health covering the third quarter of 2023. Our press release from today, along with the supplemental slides that go with it, can be accessed in the investor section of soterahealth.com. Please be aware that this webcast is being recorded, and a replay will later be made available in the investor section of the Sotera Health website. Joining me on today's call are our Chairman and Chief Executive Officer, Michael Petras, as well as our Chief Financial Officer, Jon Lyons. Some of what we say during this call may qualify as forward-looking statements. The subjects covered in those statements carry risks and uncertainties, and because of that, actual results could end up differing 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 statement slide at the start of the presentation. No obligation is assumed by the company to update any such forward-looking statements. Also, please note that on today's discussion, the company will present both GAAP and non-GAAP financial measures, which include adjusted net income, Adjusted EBITDA, adjusted EPS, net debt, Adjusted EBITDA margin, segment income margin, and net leverage ratio, along with constant currency comparisons. You can find a reconciliation of GAAP to non-GAAP measures for all relevant periods in the schedules attached to the company's press release and in the supplemental slides of this presentation. The operator will be helping us with the Q&A portion of today's call. We ask that you keep to one question and one follow-up so that everyone has a chance to ask questions. As always, should you have any questions after the call, please don't hesitate to reach out to 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 on the call for Sotera Health's results for the third quarter of 2023. We announced this morning that both our top and bottom lines grew compared with a year earlier, along with an improvement in margin. As we've said before, headwinds in the macro environment remain — things like higher interest rates, inflation, and difficulties in customers' supply chains. Our team has performed well in countering those headwinds while we carry out our mission of safeguarding global health. Let me call out several points from what we achieved in the third quarter and in the first nine months of the year. Against the third quarter of 2022, revenues for the whole company rose 5.8%, and Adjusted EBITDA rose 7.3%; adjusted EPS for the quarter came in at $0.21, which is $0.02 lower than the equivalent period a year ago, because of greater interest expense. Sterigenics, the biggest of our reporting segments, achieved 6.7% growth in top-line revenue in the third quarter of 2023 compared with the third quarter of 2022, even with continuing customer inventory and supply chain difficulties and some softness in the market. Sterigenics has always been a business that grows steadily, and it still is. Since we became a public company, its revenue has risen by more than 30%, going from roughly $500 million in 2020 to $657 million across the last 12 months, while segment income has risen by $90 million over that same span. This steady growth at Sterigenics shows how well our team has done and how essential our business is, even while customers contend with major macroeconomic difficulties. Sterigenics is a robust operation that is central to delivering government-mandated sterilization services to more than 2,000 customers at 48 facilities in 13 countries. Over 90% of sterilization services revenue comes from customers who are on multiyear contracts; we matter a great deal to our customers as they commercialize their healthcare products and, in the end, in the part we play in getting safe products to patients. In the quarter, the team finished one more facility expansion project, and the phase for validating the customer's product is now under way. We're also still making solid progress on our EO facility enhancements in the United States. These enhancements, which lead the industry, show our dedication to ensuring 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, posted a 14% rise in revenue in the third quarter compared with a year earlier. As we've said before, Nordion's revenue is linked to the harvest schedules of our Cobalt-60 suppliers, which creates uneven revenue patterns from one quarter to the next. Our team has distinctive experience in managing the complicated Cobalt-60 supply chain, and the Nordion team is still on track to deliver a substantial share of its revenue for the full year in the fourth quarter, as planned and as previously communicated. Cobalt-60 sterilizes roughly 30% of single-use medical devices worldwide and is vital to the global healthcare community. That's one more strong illustration of the essential part we play in safeguarding global health. In our lab testing advisory service business, Nelson Labs, revenue was down 2.1% compared with the same quarter a year ago. Testing volumes remain soft, and there are three main reasons for that:... The first is the extended deadlines for complying with the European Union Medical Devices Regulations. The second is reduced funding for startups and smaller companies. And the third is routine Lot Release Testing, which is tied to sterilization volume. One positive note for Nelson Labs is how RCA has performed. RCA is essential in assisting customers as they remediate findings from FDA audits. But because RCA is a consulting business, its margins bring down those of Nelson Labs overall. Given that volumes have been softer than anticipated, the Nelson Labs team is managing costs aggressively while keeping its focus on quality. Our staffing levels have steadied, utilization and turnaround times have gotten better, and customer satisfaction scores remain strong. Now to the 2023 outlook. Because of volume softness at Sterigenics and Nelson Labs, we anticipate that 2023 revenue and Adjusted EBITDA will come in at the low end of the 2023 outlook range we gave on our second quarter earnings call. Next, I'd like to provide a short update on the ethylene oxide litigation in Georgia. In October, we said Sterigenics had signed a binding term sheet to settle 79 ethylene oxide claims brought against Sterigenics for $35 million, contingent on participation from all the plaintiffs. We anticipate closing this settlement by year-end. This settlement does not in any way amount to an admission of liability, nor does it mean emissions from our Atlanta facility ever presented any safety hazard to the surrounding community. The settlement resulted from circumstances specific to one of the cases that was set to go to trial in the State Court of Gwinnett County. We are still vigorously defending the roughly 240 remaining personal injury claims pending in the State Court of Cobb County, where we are hopeful the court will apply the rules of evidence correctly and give Sterigenics the chance to fully and fairly defend itself on the basis of valid science. The judge in Cobb County has already recognized how central science is to the EO cases by issuing a case management order that puts science and causation at the forefront of the 10 personal injury cases that will be decided first. Unlike the approach taken by judges in Cook County, Illinois, and Gwinnett County, Georgia, only cases in which the plaintiffs offer enough scientific proof to satisfy the judge that the plaintiffs' alleged exposure to EO from the Atlanta facility could have caused, and in fact did cause, the illnesses they allege will be permitted to go before a jury. We are confident that when the rules of evidence are properly applied, the science and related evidence regarding EO disproves claims that emissions from Sterigenics facilities can cause or do cause cancer, or the other harms alleged in the EO litigation. Almost twelve months back, in the Forni matter in Cook County, Illinois, a full defense verdict came back in Sterigenics' favor, which demonstrated this. You can find further specifics regarding the settlement along with the EO litigation in the 10-Q we filed today, plus, as usual, on the ethylene oxide sections of our investor relations site. Before I hand the call to Jon so he can take us through the financials in greater depth, I want to spend a moment emphasizing our mission: safeguarding global health, the core of what we do. We run tests on medical and pharmaceutical products that are used daily to confirm they are safe and satisfy regulatory requirements. Each year we sterilize millions of products, which benefits millions of patients. We provide Cobalt-60 to make gamma sterilization possible worldwide and for treating early-stage breast cancer; beyond that, we offer essential scientific and regulatory know-how to assist in resolving our customers' challenges. Our mission-critical services assist in protecting millions of patients and healthcare providers across the globe. One illustration of our teams carrying out our mission appears in a video link found in the Safeguarding Global Health slide within our third quarter 2023 earnings presentation, which came out this morning and is accessible on our investor relations website. I urge you to view this video so you can understand how Nordion serves a vital function in breast cancer treatment. At this point, Jon will take us through the financials.

Thanks, Michael. First, I'll walk through the Q3 2023 consolidated highlights, then share segment-level details, plus updates on capital deployment and leverage. Looking at the whole company on a consolidated basis, third quarter revenues rose 5.8% year over year to $263 million. On a constant currency basis, that's a 4.3% gain, since FX became a tailwind, which we had anticipated for the quarter. Adjusted EBITDA climbed 7.3% to $134 million versus the third quarter of 2022. Adjusted EBITDA margins came in at 51%, up more than 70 basis points against both Q3 2022 and Q2 2023. Adjusted EPS landed at $0.21, down $0.02 from the third quarter of 2022, due to higher interest expense year over year. For the third quarter of 2023, we reported a net loss of $14 million, which works out to $0.05 per diluted share. That figure includes the $35 million Georgia settlement. In the same quarter of 2022, we had net income of $25 million, or $0.09 per diluted share. Interest expense as reported for Q3 2023 came to $41 million, an increase of about $17 million compared with last year's third quarter. The main drivers of that increase were higher interest rates and the $500 million term loan we closed in the first quarter. Let's now take a closer look at segment performance. Sterigenics grew revenue 6.7% during the quarter, reaching $168 million, compared with the third quarter a year earlier. For the third quarter of 2023, our growth was supported by pricing that came in favorably at 6.3%, along with beneficial shifts in foreign currency exchange rates adding 2.2%. These gains were partially counterbalanced by volume and mix, which dragged results down by 1.8%. Looking at how the quarter compared with the same period a year earlier, segment income climbed 8.9% to reach $93 million. At the same time, segment income margins saw an improvement of about 110 basis points, landing at 55.3%. That margin expansion was driven by advantageous pricing, though it was partly offset by weaker volume and mix as well as inflation. Turning to Nordion, revenue for the third quarter increased 14.3%, totaling $40 million compared with the third quarter of 2022. The improvement in Nordion's top line was attributable to pricing that was favorable by 9.4% and volume and mix that contributed favorably at 6.9%, with these positives partly offset by a 2% unfavorable effect from movements in foreign currency exchange rates. Nordion delivered about $24 million in segment income, an increase of 18.5%, while segment income margin climbed over 210 basis points to reach 60% versus the prior-year period. The shifts in segment income and margin from the third quarter of 2022 reflected favorable pricing, volume, and mix, which were partially offset by inflation. Turning to Nelson Labs, third quarter 2023 revenue dropped 2.1% to roughly $55 million compared with the third quarter of 2022. That revenue performance was driven by an 8% decline in volume and mix, partly offset by a 4.1% benefit from pricing along with approximately 1.8% in favorable foreign exchange currency changes. For Nelson Labs in Q3 2023, segment income fell 11.2%, landing at $17 million, while segment income margins shrank roughly 320 basis points to 31.3%, compared with the third quarter of 2022. The drop stemmed from unfavorable volume and mix, plus inflation, though favorable pricing provided a partial offset. Now I'll move on to liquidity, net leverage, and capital deployment. Our liquidity position is solid. On September 30, 2023, we had roughly $645 million in available liquidity, made up of $245 million in unrestricted cash and $400 million of available capacity under our revolving line of credit. Across the third quarter, once you adjust for the $408 million Illinois settlement, we produced more than $145 million of operating cash. That really shows just how impressive this company's cash generation is. When we ended the third quarter, net leverage was at 4.2 x, compared with 3.2 x at the close of 2022 — mainly driven by the fresh $500 million term loan connected to the Illinois ethylene oxide settlement. In Q3 of 2023, capital expenditures totaled $52 million, and $150 million on a year-to-date basis. We've spent the last couple of years in a period of higher capex, driven by the U.S. EO facility upgrades, Sterigenics capacity additions, and the strategic cobalt development programs. In 2022, spending on the cobalt development and U.S. We put about $50 million into the EO facility enhancements programs, and by way of Q3 this year, we've laid out close to that same figure. To back the long-term expansion of gamma sterilization, our cobalt development programs are essential. Roughly two decades have passed since our previous major cobalt initiative. Another key point: these development programs currently underway won't begin producing revenue until late in the decade. Three capacity expansion projects remain in progress at Sterigenics. The first one's capital spending will be mostly wrapped up during this year. When it comes to the remaining two, both greenfields, the bulk of capital spending should be finished by the close of 2025. As we've noted previously, we anticipate that 2024 will bring yet another year of elevated investment. Looking at where things stand right now, we anticipate that spending on capital projects will drop considerably next year—specifically for the U.S. EO facility upgrades and the cobalt development initiatives in 2025, along with the growth-related investments at Sterigenics in 2026. Sotera Health is a wonderful organization, and we're committed to putting money into each of our three businesses so we can sustain and expand it over the long haul. Once we get past this period of heavy investment, we foresee a meaningful boost in how much of our robust operating cash flow turns into free cash flow—something that remains a top priority. At this point, I'd like to walk through what we're expecting for 2023. Given the continued weakness we're seeing in the market, our full-year 2023 results are now projected to land at the bottom of the guidance we gave earlier — total revenues between $1.035 billion and $1.055 billion, which reflects yearly growth of about 3%-5%. Adjusted EBITDA for the entire year should come in between $520 million and $535 million, translating to annual growth of roughly 3%-6%. As I mentioned earlier, about half of Nordion's yearly revenue is anticipated to arrive in Q4. Regarding Nordion, we anticipate that Adjusted EBITDA margins for the full year 2023 will be in line with those recorded for full-year 2022. Across the rest of the business, Q4 should look a lot like Q3 on both the top and bottom line. We're anticipating a tax rate somewhere in the 30%-32% range. Weighted average diluted shares should come in between $283 million and $285 million. For Adjusted EPS, the range we're expecting is $0.78-$0.86. Capital expenditures should land somewhere in the range of $200 million-$215 million. And finally, net leverage should end the year at or under 4x; with that, I'll hand the call back to Michael.

Thanks, Jon. Ahead of starting the Q&A, I want to take a moment to share our sympathies with the loved ones, friends, and coworkers of KeyBanc's Matt Mishan. Matt had covered our business beginning in 2020. Merely 1 week before he passed away, we had the good fortune to be with him in Boston. He will genuinely be missed. So at this point, let's begin the question-and-answer portion of the call.

Yes, thanks, and good morning. To begin, I'd like a brief point of clarification, Michael, regarding what you said about the Georgia cases that are still pending. So there are 240 left in that group; however, in those counties, you mentioned that the judge will mandate that claimants present some form of proof of exposure that led to their sickness. So is it accurate that this figure might be lowered, meaning the count that ultimately reaches trial could shrink? Or does that 240 represent the cases still remaining that have already gotten past that first barrier by submitting their evidence and are now headed to trial?

Morning, Sean; the way this operates is as follows: 240 cases exist. The judge selected 10 of them to move through what's called Phase I and Phase II. General causation is Phase I, while specific causation is Phase II. So, to answer you directly, yes, that total might decrease. If a condition advances, if it makes it through Phase I, it must clear that step. Whether it's Leukemia, Breast Cancer, or Lymphoma, it must pass Phase I. Consequently, any individual case must clear Phase I. Should it succeed there, it proceeds to Phase II. If it clears that review by the judge, it then goes before a trial jury, and the entire case is litigated. Therefore, a situation exists in which a claim gets eliminated during either of those initial 2 stages; suppose, for instance, it perhaps fails to get through Phase I and Phase II, which would mean no jury trial happens. So indeed, the quantity of cases might be cut down. Is that, is that understandable?

All right.

This is somewhat complicated. I want to be certain that I'm explaining it clearly enough for you.

No, no, that's great. That helps. Then, perhaps regarding the EO emissions regulations, could you provide any further updates? Have you been in touch with the EPA, and do you have any thoughts on what might change in the final rule? It seems that's now anticipated in Q1 of 2024.

No, we keep working with our regulators, as we always do, but we lack additional insight into precisely what the final rule will contain. Still, we remain highly confident in the improvements we've implemented, and for the NESHAP, we anticipate the timing to be in the first quarter, late first quarter.

Okay, great. Thanks again.

Thank you, Sean.

Hi everyone, and thanks for the questions. Michael, when we look ahead, some of these challenges clearly haven't gone away. Are you still feeling good — I should say, do you still have confidence — about this business delivering organic growth in the high single digits? A lot of companies have come forward and talked about 2024 as a year of comparatively slower growth, because of some of the pressures out there. Obviously, you folks have shifted to the lower end here. I'm just wondering whether we ought to view the near term somewhat differently, and whether your visibility into things gets better as we move through 2024.

Yes, Patrick, thanks. We believe we can keep expanding the business at a high single-digit pace. As you're aware, we encountered certain difficulties stemming from our clients, their supply chains, and issues with inventory. Yet if you consider the medium to long term, we anticipate this business will deliver organic growth in the high single digits.

All right, no, that's useful. Then regarding the margin profile, I'm guessing there aren't really any shifts when it comes to cost controls, considering the near-term headwinds; but could you just walk through the moving pieces on the margins? Clearly, pricing has been a favorable tailwind for you folks for quite a while. Is there any change to that algorithm as we move ahead, and just anything we ought to be considering in the near term regarding the margin moving pieces? Thanks.

Right, right. So clearly, the biggest thing we can pull on to push margin and grow it is volume. We do receive price. We've shown we can counter price, or inflation, thanks to the moves we make on pricing. But once more, everything traces back to the value we deliver alongside our customers. And, well, our customers hand over money for the service since it matters so much and is so essential to them. Yes, price has come in somewhat above what we'd guided toward. As you know, we've stated 3.5%-5%, you know, across the long range. It's landed a bit above that since inflation has landed a bit above that. We've been countering it, yet we anticipate that, you know, price will stay within that range going forward. We also anticipate volumes coming back to where they've sat historically, which will keep handing us terrific operating leverage. Still, the team's performing well handling all of that. You know, the Sterigenics facilities don't carry a ton of labor, yet Mike and the team have performed well handling things around that, and likewise with Joe on the Nelson side and working through the volume challenges there. You know, they've dealt with a lot given the COVID, the job crises that occurred, and then a few of the regulation changes. But on the whole, we feel good about what we're capable of, and our margin rates keep holding in there as we've demonstrated through our business model.

Good morning, this is Salomon, dialing in on behalf of Luke. Perhaps I could just build on what Sean asked a bit earlier regarding those unresolved cases. At this point, do we have any kind of schedule telling us when word might come as to whether certain of those matters are moving past Phase I or Phase II, or alternatively being halted? I'm simply wondering about a schedule on that front.