Sotera Health Company (SHC) Earnings Call Transcript & Summary

Hello, everyone, and thanks for joining. I'd like to welcome you to the call covering Sotera Health's results for the first quarter of 2024. Our press release from today, along with the supplemental slides that go with it, can be accessed in the Investors area of our site, soterahealth.com. Please be aware that this webcast is being recorded, and a replay will be made accessible in the Investors portion of the Sotera Health website. Joining me on today's call are Michael Petras, our Chairman and Chief Executive Officer, and Jon Lyons, our Chief Financial Officer. Some of what we say during this call may count as forward-looking statements. The subjects covered in those statements carry risks and uncertainties that might lead actual results to differ materially from what is projected or implied. For a description of those risks and uncertainties, please see Sotera Health's SEC filings and the forward-looking statements slide at the start of this presentation. No obligation is assumed by the company to update any forward-looking statements of this kind. I'd also note that on today's discussion, the company will present both GAAP and non-GAAP financial measures, which include adjusted net income, adjusted EBITDA and 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. <<operator_script>>. If any questions come up after the call, as always, please 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 here on Sotera Health's call covering the first quarter of 2024. We reported growth on both the top and bottom lines this morning when measured against the first quarter of 2023, and all 3 of our business units contributed to that growth. Jon will walk you through our financial results in more detail shortly, but before that, I'd like to call out a handful of points from what we delivered in the first quarter. Total company revenues rose 12.5%, while adjusted EBITDA was up 13.7%, each compared with the first quarter of 2023. For the quarter, adjusted EPS came in at $0.13, which matches the same period a year ago. Sterigenics, which is our biggest reporting segment, delivered another quarter of revenue expansion, coming in at 4.1%. Demand remained a bit muted because buyers continued to navigate supply chain difficulties. Within our sterilization services business, the other reporting segment is Nordion, and its revenue rose 181% compared with the same period a year ago. You might recall that Nordion's first quarter of 2023 was unusually weak, and the substantial increase versus last year is driven in large measure by when our suppliers, which are major utilities, scheduled deliveries of Cobalt-60 harvests. Our lab testing advisory services business, Nelson Labs, achieved revenue growth of 10.8% compared with the prior year. At Nelson Labs, we've now posted two quarters in a row where revenue grew compared with the same period a year earlier, and the main driver was the ongoing strength of our expert advisory services business. When it comes to volumes in core lab testing, those were down versus a year ago, which largely reflected the extended deadlines under the European Union Medical Device Regulations — something we had anticipated. This morning, we're restating the outlook that we shared during our previous earnings call. To recap, our 2024 outlook anticipates growth in both revenue and adjusted EBITDA of 4% to 6% compared with 2023. What will mostly determine where we land inside our full year revenue range is how soon and how substantially the market recovers in both Sterigenics and Nelson Labs. Turning to recent ethylene oxide news: regarding the California lawsuits, we feel strongly that Sterigenics did not cause the illnesses being claimed. From what we currently understand, these newly filed suits essentially present the same questions as the EO cases that plaintiff firms and other jurisdictions brought before, only now they involve the burden facilities and the unique situations of each new plaintiff. Our expectation is that the evidence will show Sterigenics ran its facilities < > in a safe manner and met every applicable regulation. Our business carries out sterilization of essential medical supplies and instruments in a safe manner, and we have always met—and gone beyond—the rules that apply to what we release into the air. According to what the regional authority, South Coast Air Quality Management District, has said repeatedly, ethylene oxide concentrations in nearby neighborhoods sit at the same background readings detected in places that do not have a sterilization plant close by. Provided we could present a complete and equitable defense, we feel good about how the court will rule. We understand how hard it is when lawsuits involve cancer and other serious medical conditions, but in our judgment, cases concerning ethylene oxide will not have a meaningful impact on the business over the long run. A full set of FAQs has been posted, which you can find in the Ethylene Oxide area of our investor website, and we'll refresh it from time to time with relevant updates. Please keep in mind that litigation is actively underway, so we won't offer any further remarks past what I've just said and what appears in our FAQs and SEC filings. As a lot of you are aware, back in March, the EPA completed its revised national emission standards for hazardous air pollutants, usually called NESHAP. Even though meeting these revised requirements will prove extremely difficult for the sterilization sector, our substantial, forward-looking investments at our U.S. When it comes to ethylene oxide facilities and the EPA, we have permanent total closure technology available, plus other advanced emission controls, and those have put Sterigenics in a position to meet FDA requirements within the timeline the final rule establishes. We don't expect to spend any significant additional CapEx beyond the amounts already built into our plans in order to comply with the finalized regulations. Despite these challenges, we need to stay focused on our mission: Safeguarding Global Health. We play a part in keeping health care safe and in safeguarding millions of lives around the world. One illustration of that is the part Nordion plays in treating brain cancer, which our earnings deck mentions; we take our health care role seriously, and our team remains unwavering in its dedication to carrying out our mission each and every day; at this point Jon will walk us through the financials in greater detail.

I appreciate that, Michael. To start, I'll walk through the consolidated highlights for the first quarter of 2024, then go into some specifics for each business segment, plus updates regarding capital deployment and leverage. After that, I'll wrap up with further details about our outlook for 2024. Looking at the total company on a consolidated basis, revenues for the first quarter rose 12.5% year over year, reaching $248 million. On a constant currency basis, that works out to an 11.8% gain, since we saw a total company foreign currency tailwind of slightly less than 1%. Adjusted EBITDA came in at $112 million, up 13.7% from the first quarter of 2023. Adjusted EBITDA margins stood at 45.1%, which is a 50 basis point improvement over the first quarter of last year, and most of that is due to higher Nordion revenues against unusually light revenue in Q1 2023. Interest expense during the quarter was $42 million, compared with $29 million in Q1 of 2023. That rise in interest expense came from higher interest rates as well as having a full quarter of the $500 million term loan that was put in place during Q1 of 2023. Adjusted EPS came to $0.13 per share, flat versus the first quarter of 2023, since better operating results were offset by greater interest expense. On a GAAP basis, net income for the first quarter of 2024 was $6 million, or $0.02 per diluted share, versus net income of $3 million, or $0.01 per diluted share, in first quarter 2023; now let's look more closely at how our segments performed. During the first quarter, Sterigenics posted 4.1% revenue growth, reaching $166 million. The drivers of revenue growth for the quarter were favorable pricing of 4.9% and a favorable foreign currency impact of nearly 1%, partly offset by unfavorable volume and mix of 1.6%. Segment income rose 3.6% to $86 million, fueled by favorable pricing and shifts in foreign exchange rates, partly offset by unfavorable volume and mix along with inflation. Nordion's first quarter revenue climbed 181% to $24 million versus the same period last year, while segment income rose to $11 million. As a reminder, Nordion had an abnormally low first quarter in 2023. The increases in Nordion's revenue and segment income versus first quarter 2023 came from favorable volume and mix tied to the timing of reactor harvest schedules. Nelson Labs' first quarter 2024 revenue grew by 10.8% to $58 million, driven by favorable volume and mix along with pricing. Segment income rose by 8.8% to $15 million, also driven by favorable volume mix along with prices. Segment margin rates dipped slightly versus Q1 of 2023 because of a shift in mix, as we saw strong growth in expert advisory services. Now I'll give details on liquidity, net leverage and capital deployment. The company's liquidity position continues to remain strong. By the end of the first quarter of 2024, our liquidity stood at more than $660 million, comprising over $260 million in unrestricted cash along with $400 million available through our revolving credit facility. Operating cash flow for the quarter came in positive, though below typical levels, largely because of the Georgia settlement payment. First quarter 2024 capital expenditures reached $35 million. Our stated spending priorities, as communicated before, center on expanding capacity at Sterigenics, upgrading U.S. EO facilities, and advancing Nordion's cobalt development initiatives — all essential to the company's growth over the long term. Beyond the 3 Sterigenics expansion programs currently underway, we anticipate no significant additional capacity expansions at Sterigenics in the near term. Free cash flow for the quarter was slightly negative, reflecting the weaker operating cash flow performance I just referenced. For the full year, we do anticipate generating positive free cash flow. The quarter closed with net leverage of 3.8x, which sits inside our 2x to 4x target range. Per Michael's remarks, given the first quarter results and our view of the rest of this year, we are reaffirming the outlook shared in February 2024. To summarize, for all of 2024, we anticipate total revenues and adjusted EBITDA growing between 4% and 6%. As we said on our Q4 2023 earnings call, we expect to land at the lower end of our long-term stated price range of 3.5% to 5%. Adjusted EBITDA margin rates for full year 2024 are assumed to resemble last year's. During Q2, we expect year-over-year margin rates to dip modestly, driven by a decline in Nelson Labs' margin rates stemming from the mix change I noted earlier. Within the Nelson segment, we do expect income margin rates to strengthen sequentially as the year progresses, with full year margin rates nearing 30%. Looking at cadence, we anticipate slightly under 45% of total company adjusted EBITDA for the full year to be generated during the first half. At Sterigenics, we still foresee modest volume and mix recovery starting in the second half of 2024. For Nordion, we continue to expect a more balanced year than last year, with roughly 35% of revenues coming in the first half. Additionally, we now estimate Russian cobalt supply risk at between 0% and 1.5% of total company full year revenue. Regarding Nelson Labs, we expect volume and mix to remain roughly flat year over year for the rest of the year. Core testing volumes should improve as we lap some large projects in expert advisory services, which underpins our expectation for sequential margin improvement; we continue to expect interest expense between $170 million and $180 million; and effective tax rate, our adjusted net income in the range of 31.5% to 34.5%. Adjusted EPS is expected to be in the range of $0.67 to $0.75. On a weighted average, fully diluted, we're looking at somewhere between 283 million and 285 million shares. For capital expenditures, the range is $205 million to $225 million. As we've said before, CapEx should come down in '25 and '26, which will speed up how much free cash flow we generate. That matters a great deal to the company. No M&A is baked into our guidance, and we continue to expect net leverage to get better over the course of the year. At this point, I'll hand the call back to Michael.

Thanks, Jon. To close out what we had ready to say, I'd like to stress once more that Sotera Health is still in a strong spot to expand all through 2024. With 63 sites around the world, we give our clients outstanding support each and every day, and everyone here takes pride in the essential part this company serves within the health care community. With that, we're ready to take your questions.

Michael, perhaps regarding the broader picture here, could you discuss what you observe when it comes to volumes? I realize those volume-related challenges have persisted somewhat over the last several quarters. It appears that with Nelson Labs, perhaps there was a slight uptick. With Sterigenics, maybe it's still hanging around a bit. Could you simply describe what you're observing, plus the expectations and what you're picking up in real time as we move toward 2Q and 3Q?

Patrick, when we examine the business, it's largely in line with what we communicated during our previous call. We anticipate a modest gain as the year moves forward. We aren't witnessing deterioration at either Nelson or Sterigenics. Regarding Nelson, we highlighted that we keep performing strongly in the Expert Advisory Services segment. One of our units, RCA, keeps delivering excellent results, which carries a negative mix effect, and they're genuinely assisting a good number of customers facing difficulties with regulators; that's the reason they get engaged, and they're executing that really well; we're observing that Nelson's volumes have stabilized. And we anticipate that will get better eventually as certain RCA projects begin to decelerate owing to their nonrepeat character; that's among the items we pointed out during our prepared remarks. On the Sterigenics front, things have remained fairly steady with modest gains, and we'll keep tracking that. We're confident in our guidance for the remaining portion of the year and the outlook; yet it isn't deteriorating in any major way. Certain categories have improved on a sequential basis, bioprocessing, lab ware, those have gotten better quarter over quarter, yet they remain considerably lower than the prior year. General Hospital has been the kids area, we've noticed an uptick there as inventory has begun to level out and our customers' burnout rate — burndown rate, so to speak, is leveling out too. So on the whole, we feel good about where we set the guide for the remainder of the year, with modest gains as the year moves forward.

All right. That helps. And then perhaps regarding the litigation angle, clearly our California matter emerged, I believe, roughly a month back. Could you just discuss broadly what your thinking is on that? Merely attempting to establish some patterns around what to expect. I'm certain the schedule hasn't been served and, as we're all aware, such matters drag on; yet is there any method to simply structure this matter so we might consider it more clearly.

Indeed, Patrick, like we mentioned during the prepared remarks, we have FAQs available. A great deal of information exists as we attempt to address the inquiries being submitted. We're at a very early stage here. Two lawsuits have been submitted, roughly 18 claims altogether, comparable in character to those we've observed in other jurisdictions, except these particular ones concern Vernon; and I merely wanted to highlight certain comments we've provided indicating that regulators have tracked for the past several years the emission levels against their background levels, meaning those are equivalent to other regions lacking sterilization facilities nearby. We keep performing extremely well at that location. We serve an essential function. We sterilize, I believe it's more than 40 million products, 45 million products annually. That represents a truly essential function within health care, and we remain focused on it. Our attorneys will handle the litigation portion; however, that's the extent of our knowledge right now. We're at a very early point in that conversation. We're confident we can mount a defense, as demonstrated during our second trial in Illinois, and shall prevail.

Turning to the final NESHAP requirements — now that those rules are out, did anything shift meaningfully compared with the original proposal? And could you also update us on where things stand with the facility enhancements? How much time remains, and what amount is still left to spend before everything is done?

Yes. Sean, thanks for asking. Like we said this year, our expectation is to spend roughly $40 million on facility enhancements during this year. A tail will carry into 2025 and decline that year, though we ought to wrap up next year. I'm quite pleased with the work the team has put in here. Our leadership in this area has been plainly shown. You'll watch that unfold across the coming several months and the coming couple of years. These rules are extremely difficult. I don't want to downplay that. Big challenges lie ahead for the industry, but I feel quite good, and so does the team. In fact, Jon and I held a deep-dive with the team earlier this week regarding the progress we're making. At most U.S. facilities, either work is finished or a substantial portion is already underway. Sean, as I've mentioned on earlier calls, some of them — remember, we prefer to move quickly, yet for certain regulators this simply isn't a priority. They're delaying and dragging their feet on permits and similar items purely because it isn't the top priority within their jurisdictions. Still, we feel good about our position. The rules are difficult, I want to make that very clear, but we feel good about leading here. One item I've highlighted repeatedly to this group is permanent total closure method 204. We suspected that might end up being the rule, and it is indeed in the rule. We're fairly far along on that. Ongoing monitoring will bring challenges, and we'll need to work with regulators to understand precisely how the rules should be interpreted. Overall, this company will remain in this business, and we'll keep performing, taking care of our customers, and making sure we play a critical role in health care.

Sean, thanks. On SG&A, that line item climbed significantly, compared to both the same period last year and the prior quarter. Anything worth flagging specifically? And what's the right way to frame the SG&A run rate for the rest of the year?

Yeah, Sean, I suspect a few modeling items are better handled away from this call. Following all your figures is proving a bit difficult for me. Nothing here strikes us as worrisome. Standard merit increases are flowing through. Certain variable compensation is also coming in, though nothing major enough that I'd single it out to you.

Thanks. The first item concerns Nelson. Could you put a figure on how much RCA dilutes things? Also, does your longer-term goal of a mid-30% margin for that unit still hold? And perhaps, starting from the 30% you'll achieve in Nelson this year, how should we view the path of that margin?

Right. Casey, Michael here. We aren't going to provide specifics regarding RCA; it has weighed on mix, yet the margin rate for that business is getting better. Operating leverage keeps coming their way, and the top line for that business keeps expanding; we — like we mentioned this morning, we believe Nelson's margins, when you consider the mix profile for the remainder of the year, will be a bit lower, and they are getting close to 30%, so to speak; our view remains that over the long term this business sits in the mid-30s. Additionally, we'll see sequential growth as the year moves forward; that's another point. I want to be sure that's clear to you.

Understood. Then for my next question, could you help us gauge how much of a margin improvement we should expect at Sterigenics from the first half to the second half, based on the volume rebound you're assuming? Also, what pricing should we model for Sterigenics in the latter half? And would that serve as a solid starting point for pricing next year?

Yes. Thank you, Sean. As volume increases in this business, you'll see operating leverage flow through to the P&L. We keep obtaining price in that unit given how essential our services are and the strong value delivered to our customers. Companywide, we've stated price of 3.5% to 5% annually. For 2024, we indicated we'd land at the lower end of that range due to certain Nordion contract timing. We believe Sterigenics will be where it usually sits, in the middle of that range, and that's our expectation for 2024. Thank you, Casey.