Sotera Health Company (SHC) Earnings Call Transcript & Summary

Hello, and thank you for joining us. I'd like to welcome everyone to the call covering Sotera Health's results for the second 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. A recording of this webcast is underway, and a replay will be made accessible through the Investors section of the Sotera Health website. Joining me on today's call are our Chairman and Chief Executive Officer, Michael Petras, and our Chief Financial Officer, Jon Lyons. Some of what we say during this call may fall into the category of forward-looking statements. The subjects covered by these statements carry risks and uncertainties that might lead actual results to 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 at the start of the presentation. No obligation is assumed by the company to update any of these forward-looking statements. I'd also note that on today's call, the company will present both GAAP and non-GAAP financial measures, which include adjusted net income, adjusted EBITDA, adjusted EPS, adjusted EBITDA margin, segment income margin, and net leverage ratio, along with constant currency comparisons. Reconciliations of certain non-GAAP measures to the most directly comparable GAAP financial measures for all relevant periods can be located in the schedules included in the company's press release and in the supplemental slides for this presentation. The operator will be helping us with the Q&A portion of today's call. To give everyone a chance to ask questions, please keep to one question and one follow-up. As usual, should you have any questions following 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 covering the second quarter of 2024. We reported today that revenue and adjusted EBITDA both rose relative to Q2 of 2023, fueled by greater volumes across all three of our business segments. Against the second quarter of 2023, revenues for the whole company were up 8.3%, which comes to 8.8% when measured on a constant currency basis, while adjusted EBITDA rose 6.9%. Adjusted EPS for the quarter came in at $0.19, a touch lower than the second quarter of 2023 because of increased interest expense. At Sterigenics, our biggest reporting segment, the top line climbed 5.9% compared with the same period a year earlier, marking positive volume growth for the first time in several quarters; for the second half of 2024 versus 2023, we still anticipate modest growth in both volume and mix. Nordion, the other reporting segment inside our sterilization services business, saw revenues rise 29% against the second quarter of 2023. Favorable volume and mix gains stemmed from the timing of reactor harvest schedules, and that was the main factor behind the growth. Nelson Labs, which handles lab testing and advisory services, posted its third quarter in a row of top line growth, with second quarter revenue up 4% from the second quarter of 2023. It's encouraging to see volumes improve in our core validation testing area, even as core routine lot release testing stays soft compared with the second quarter of 2023. Our expert advisory services business kept up its strong showing during the quarter; now that the first half of the year is behind us, we are reaffirming our full year 2024 outlook. As a reminder, that 2024 outlook anticipates revenue and adjusted EBITDA growth of 4% to 6% against 2023. Jon will walk through our 2024 outlook in greater detail shortly, but first I want to spotlight one example of how Sotera Health is essential to protecting global health. Our Nelson Labs business is vital when it comes to testing medical devices so that they are safe for patients to use. Not long ago, the Nelson Labs team carried out lab testing on the Autus Valve, the first expandable pediatric heart valve ever made, which is featured in the second quarter earnings presentation available in the Investors section of our website. Kids who have pulmonary valve disease undergo valve replacement surgery at least 5 to 6 times over the course of their young lives. This novel heart valve can be implanted in pediatric patients and grows along with the child, and that is expected to cut down on how many heart surgeries are needed while they're growing up. Nelson Labs collaborated with the customer as well as the FDA on biocompatibility testing and evaluations to help confirm safe interaction between the device and the child's body systems for as long as its intended use lasts. Those tests and evaluations represented the final critical step toward approval into a clinical trial. Once again, this illustrates just how essential our part is in protecting health around the world here at Sotera Health. At this point, Jon is going to take us through the financial results.

Thanks, Michael. I'll start with the consolidated highlights for the second quarter of 2024, then walk through details for each business segment, plus updates on capital deployment and leverage. After that, I'll wrap up with a few more specifics on our 2024 outlook. Looking at the total company on a consolidated basis, second quarter revenues rose 8.3% versus the same period a year ago, reaching $277 million. On a constant currency basis, that works out to an 8.8% gain, since foreign exchange acted as a headwind during the quarter. Adjusted EBITDA grew 6.9% from the second quarter of 2023, hitting $137 million. Our adjusted EBITDA margin was 49.7%, representing a decline of 68 basis points versus the second quarter of 2023, driven by lower margin in the Nelson Labs segment. For the second quarter of 2024, adjusted EPS reached $0.19, a decrease of $0.01 compared with the second quarter of 2023, reflecting increased interest expense. Net income in Q2 of 2024 totaled $9 million, equal to $0.03 per diluted share, compared with $24 million, or $0.08 per diluted share, in Q2 of 2023. The reduction in net income resulted from customary charges associated with the recent successful refinancing of our debt structure. In Q2 of 2024, interest expense reached $40 million, which is nearly $10 million higher than what we saw in the same quarter a year ago. The drivers behind that rise were a decline in interest income along with a reduced advantage from interest rate hedges that were favorable and had reached maturity. Turning now to a deeper review of segment results. During the quarter, Sterigenics achieved revenue growth of 5.9%, reaching $176 million compared with the prior year's second quarter. This revenue increase was composed of a 4.9% gain from pricing as well as a 1.4% positive contribution from volume and mix; these gains were partially counterbalanced by a 40 basis point negative effect from foreign currency exchange rates. Segment income improved by 5.8%, totaling $97 million, and segment income margins stood at 54.9%, unchanged relative to the second quarter of 2023. Higher earnings for the segment were driven by beneficial pricing along with volume and mix, though inflation partially counteracted those gains. For Nordion, second quarter revenue increased 29% to $41 million compared with the equivalent quarter last year, reflecting the timing of Cobalt-60 harvest schedules, which matched our expectations. The rise in Nordion's revenue primarily reflected a favorable volume and mix contribution of 26.5% together with a pricing advantage of 3.8%. Partially offsetting that revenue gain were unfavorable movements in foreign currency exchange rates totaling 130 basis points. Nordion's segment income climbed 31.7% to $23 million, and segment income margin improved by 120 basis points to 56.8%, compared with Q2 of 2023. Better segment income and margin were driven by beneficial volume and mix, along with advantageous pricing. At Nelson Labs, revenue for the second quarter of 2024 increased 4%, reaching $59 million, compared with the same quarter in 2023. That top-line improvement consisted of a 3% benefit from pricing and a 1.4% lift from favorable volume and mix. Partially countering those gains was 40 basis points of pressure from foreign currency. Turning to Nelson Labs' second quarter 2024 segment income, it declined 11% to $17 million relative to the second quarter of 2023. The drop stemmed from the effects of volume and mix as well as increased labor costs, with favorable pricing providing a partial offset. On segment income margins, we saw a year-over-year decline of 489 basis points, landing at 29%. However, compared with the previous quarter, that figure improved by 240 basis points, which is consistent with what we told you to expect on our first quarter 2024 earnings call. Turning now to the balance sheet, along with cash generation and capital deployment: during the quarter, we completed a refinancing of our entire debt structure totaling $2.3 billion. As a result of getting this transaction done, our anticipated interest expense for 2024 has been reduced by approximately $5 million, and the company's balance sheet has been made stronger by pushing out maturities from 2026 to 2031. The strong reception this financing received in the market has left us quite pleased, and we see it as a reflection of the strength of our businesses. Sotera Health continues to be in a healthy liquidity position. At the close of 2024's second quarter, our liquidity stood at $646 million. That figure comprised $246 million in unrestricted cash plus $400 million we could draw from our revolving credit line. During the year's first six months, capital expenditures came to $77 million, reflecting our ongoing emphasis on finishing the three capacity expansions at Sterigenics, upgrades to the US EO facility, and Nordion's Cobalt development initiatives. This quarter delivered positive free cash flow, and consistent with what we've said before, we anticipate positive free cash flow across the entire year. At the close of the quarter, our net leverage ratio stood at 3.8 times, putting us inside the 2 times to 4 times range we target over the long term. Michael noted earlier that we are reaffirming our 2024 outlook, and to summarize: for the full year 2024, we anticipate growth of 4% to 6% in both total revenues and adjusted EBITDA. Throughout the year, we look for total company adjusted EBITDA margins to improve sequentially, with full year margins nearing 50%. For the rest of the year in Sterigenics, we expect a modest increase in volume and mix compared with 2023. Turning to Nordion, we anticipate that just over 60% of the full year's revenue will come in during the second half, and that the third quarter will see revenue rise by a high single digit percentage compared with a year earlier. At Nelson Labs, we're looking for second half revenue roughly in line with what we saw in the first half. In addition, we anticipate segment income margins will be better than they were in this year's second quarter, thanks to wrapping up a number of sizable expert advisory services projects; for the full year, our expectation of margin rates nearing 30% is unchanged. Consistent with what we said following our debt refinancing, interest expense should fall somewhere between $165 million and $175 million. On adjusted net income, we still anticipate an effective tax rate in the range of 31.5% to 34.5%. Adjusted EPS is still expected to land between $0.67 and $0.75. Looking at weighted average figures, we're looking at roughly $283 million to $285 million fully diluted shares. For capital expenditures, the projection has shifted toward the bottom of the $205 million to $225 million band. We've noted previously that CapEx ought to decline through 2025 and 2026, which should speed up free cash flow generation. That's something the company cares about deeply. Our guidance assumes foreign exchange rates stay where they closed the second quarter for the remainder of the year. Given this, FX should continue to be a headwind on a year-over-year basis. That headwind should be more pronounced during the third quarter. Finally, no M&A activity is factored into our guidance, and we continue to expect our net leverage ratio to improve over the course of the year. At this point, I'll hand the call back to Michael.

Thanks, Jon. On the whole, the second quarter turned out well for us, and we're eager about what the back half of 2024 holds. Before we get to Q&A, I want to pause and share how thrilled we are to have Christopher Simon — President and Chief Executive Officer of Haemonetics Corporation — joining the Sotera Health board of directors. Chris carries deep commercial and strategic know-how from the medical device sector, and we're confident that will benefit both us and our stakeholders. With that, operator, please go ahead and open the line for questions and answers.

Hello, and good morning. I appreciate you fielding my questions. Michael, you made a remark, and we also observed, that Sterigenics appeared to see a comeback in volume growth. It sounds like you anticipate a modest portion of that persisting across the year, and maybe you could say more about what you're observing in the end markets and how that backs the ongoing volume growth. Thanks.

Yes, good morning, David, and thanks for asking. As you pointed out, Sterigenics enjoyed solid volume gains during the quarters — the first quarter and multiple quarters in which they recorded positive volume and mix. Across the first half of the year, it landed flat, which matched what we had expected, and we anticipate that ticking up somewhat in the second half of the year. And what we're seeing — as we said on our previous call — is that inventory levels keep stabilizing among our customer base, even though it isn't a straight line across every customer in every category. On the whole, we remain encouraged, and it aligns with our expectations that we will keep witnessing volume improvement at Sterigenics. So their performance this quarter pleases us.

Thanks for that. Could you also speak to how the trends have differed between, let's say, the general hospital market and the bio lifesciences market?

Sure. Broadly speaking, things keep settling down in general hospital. When it comes to bioprocessing, it isn't a big category for us, as we've said before, but we saw improvement on a sequential basis, apart from one major customer that stood out as an exception — and based on some of what they've said, they're experiencing somewhat slower recovery in the market too. Still, on the whole, we're feeling positive about what lies ahead for those categories.

All right. Then for my final question, you mentioned labor cost as something that offset results. I was just curious whether you might provide a bit more detail regarding the inflationary conditions and how stable your workforce is. Thanks.

Yes; specifically, we highlighted the Nelson part, and that is simply merit raises, mostly merit raises. Jon, anything to add?

No. I'd say things are holding up well; the team has done an excellent job getting staffing where it needs to be, and...

Yes. Jon, the team has performed well. As you observed, Nelson delivered another strong quarter in terms of top line growth. The mix isn't where we want it yet, but we keep seeing gains on that front. The labor force is settling down, turnover is settling down and in fact down considerably. Net promoter score has been solid and employee survey results are favorable. So we're encouraged by what we're seeing on the Nelson side and hopeful that continues. We're seeing validation volume keep moving ahead. So that's great.

That covers everything I had. Appreciate it.

Sounds good. Thank you, David.

Hi there, everyone. I really appreciate you giving us the chance to ask our questions. I'd like to continue where we left off regarding Nelson Labs, keeping with that same subject. You brought up that this marked the 3rd straight quarter with expansion, and that was good to hear; so I'm genuinely wondering which parts are delivering the strongest gains when it comes to volume.

Yes, Brett. Thanks. Like we've said a few times during these calls, our expert advisory services segment keeps performing strongly, posting solid expansion, even though that's decelerating, and as we told you, we anticipate a slowdown once you reach the latter half of the year measured against the prior year, since they enjoyed substantial gains near the close of last year. The place where we're experiencing solid gains in activity would be validation, the more intricate testing. Standard testing has been somewhat weak, though we remain hopeful that things will improve later in the year.

Okay. Thanks. One more question — perhaps zooming out a bit. From where we sit, it seemed like the second quarter came in above what people were expecting on pretty much every line, yet the outlook was mostly kept as it was. With that in mind, could you maybe walk through some of the main factors behind why the full-year guidance stayed the same, and is there some degree of conservatism built into what's left of the year? Thanks so much for taking the questions.

Yes, Brett. I'd simply put it this way — the second quarter matched what we had anticipated, and we remain optimistic about seeing volumes improve gradually during the back half of the year, which also supports our reaffirmed guidance of 4% to 6% top line growth.

All right, thank you.

Hey there, everyone. Appreciate you letting us ask a few things. This one's probably directed at Jon, and it's about margins. From what we can tell, the labor situation looks fairly steady as a backdrop, and volumes are beginning to show some tentative recovery signals. Could you walk us through how margin expansion should play out as we look at the back half, along with the various components across the segments? It seems like the trajectory is favorable. So I'd like to hear how we ought to frame that, and then maybe a starting reference point for '25, even if it's just big picture, would be useful.

Yeah, I appreciate that. Margins, honestly, remain quite strong across the company for the most part. The main item, which you heard from us during today's call, is what's happening with Nelson margins. We're quite pleased with the sequential gain we're seeing, though at present the mix keeps those somewhat below our intended level. Like we mentioned, we anticipate that Nelson margin getting better. In the remaining businesses, we foresee a typical margin trajectory alongside volume, and on a full year basis for the whole company, we would look for those margins to get close to 50%, and that figure would serve as your starting point for the coming year.

All right, that's useful. And then perhaps remaining only on the financial side, it's good to watch the leverage keep declining. Could you remind us again where we'll stand when this year wraps up? And then, with CapEx moving lower, perhaps just the size of that reduction, by how much it drops, and how cash flow might shape up in later years would be useful. Thanks, guys.

Yes. Thank you, Patrick. What I'd say is, first, on leverage in general, our expectation remains modest enhancement compared with the previous year as we close out this one. And as we're sitting here regarding CapEx and, more broadly, the balance sheet and leverage as a whole, driving free cash flow results is a major focus for us. The approach Michael and I use here is quite disciplined, so we're glad we can move the CapEx figure toward the range's bottom end. Our expectation for the year continues to be positive free cash flow, and we anticipate that speeding up as we enter the coming couple of years while we push CapEx, wrap up some of these programs, and bring CapEx down further.

Patrick, it's Michael here. Keep in mind that the significant outliers are truly what's pushing the unusually large CapEx at the moment, since we're in a period of investment at Sterigenics for certain capacity expansions. There's the NESHAP, EO, and overall facility improvements, plus we have the Nordion CapEx related to Cobalt development — and again, we haven't undertaken anything along those lines since roughly 2002 or '03. So as we've said, we're simply at an elevated level during '24 and '23; we expect that to step down in '25 and '26, as Jon just mentioned.

That's useful. Thanks, everyone.

Excellent. I appreciate you both for fielding my questions. So, perhaps to start, could you take us through how Nordion did during the quarter and explain what appeared to be some amount of pull forward? My understanding is that earlier you were looking for 65% of segment revenue to land in the back half, and now that figure is 60%. Also, I'm just wondering about the visibility into that growth rate for the second half, and perhaps you could provide some sense of how 3Q and 4Q break down for Nordion.

Yeah, so I'd simply put it this way — Michael here. In my view, they landed pretty much in line with what we anticipated. Our expectation is that just a bit more than 60% of the full-year revenue will arrive in the second half. Another thing we didn't mention, all the Russian cobalt that's on hand with us that we require for 2024, so on that front too we feel fairly confident regarding the visibility when we examine it, Casey. All in all, though, we feel positive about our position with the Nordion component.

Michael might have already covered that, and I missed the latter portion of what you asked.

I just wanted to ask about how that splits between the third quarter and the fourth quarter in that second half. You said 60% of the full year comes in Nordion.