Sotera Health Company (SHC) Earnings Call Transcript & Summary

Hello, and thanks so much. I'd like to welcome everyone to Sotera Health's earnings call for the third quarter of 2024. Today's press release, along with the supplemental slides that go with it, can be accessed in the investor section of our site, soterahealth.com; we are recording this webcast, and a replay may be found in the investor section of the Sotera Health website. Joining me on this 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 might be viewed as forward-looking statements. The topics covered in those statements carry risks and uncertainties, and because of them, actual results could end up differing 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 statement slide at the start of the 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, among them adjusted EBITDA, adjusted EBITDA margin, segment income margin, adjusted net income, adjusted EPS, and net leverage ratio, along with constant currency comparisons. A reconciliation of GAAP to non-GAAP measures for all relevant periods can be found in the schedules attached to the company's press release and in the supplemental slides for this presentation. The operator will be helping us with the Q&A portion today. To make sure everyone gets a chance to ask questions, please stick to one question and one follow-up. 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 on the call for Sotera Health's Q3 2024 earnings. Earlier today, we shared that both our top line and bottom line grew compared with a year ago, with gains in volume and mix across each of our three businesses against the third quarter of 2023. Versus that same quarter in 2023, revenues for the whole company rose 8.5%, or 8.9% when measured in constant currency, and Adjusted EBITDA was up 9%. Adjusted EPS came in at $0.17 for the quarter, which is $0.01 higher than what we posted in the equivalent period a year earlier. At Sterigenics, our biggest reporting segment, top-line growth for Q3 2024 was 4.3%, and that figure reflects modest volume and mix gains relative to the third quarter of 2023. Over the quarter, the team finished a single facility expansion project, and the phase for validating customer product is now in progress. We're also still moving along well with upgrades to our North American EO facilities so that we satisfy the tough, intricate NESHAP rules before the mandated cutoff. Nordion, the other reporting segment inside our sterilization services business, posted a revenue rise of 28% year over year, which came from how the reactor harvest schedules fell. The Nordion team completed certain shipments during the quarter that had been set for Q4, done to support what our customers asked for, and that meant the quarter brought in more revenue than we had initially expected. I'm happy as well to share that Nordion has hit a significant milestone on one of its cobalt development projects. Not long ago, the initial insertion of cobalt went in successfully at a Darlington reactor located in Canada, and we anticipate the first harvest of cobalt-60 happening in 2028. This project shows nicely how we protect global health by making sure cobalt-60 remains steadily available to our customers going forward. Nelson Labs, which handles our lab testing advisory services business, saw its top line expand 7% and its bottom line expand 9% compared with the third quarter of 2023. We're glad to observe stronger core lab testing volumes along with better margins in that business, both on a sequential basis and against a year ago. On earlier calls, we've brought up how our lower margin Expert Advisory Services has recently performed, with its strength linked to one-time projects. That volume is starting to return to normal, and we think it will keep doing so as we move past the acceleration that kicked off in the second half of 2023. With most of the year now behind us, we are reaffirming the full year 2024 outlook ranges for revenue and Adjusted EBITDA. As a reminder, our 2024 outlook anticipates growth in both revenue and Adjusted EBITDA within a range of 4%-6%. Jon will walk through our 2024 outlook in greater detail soon, but before that, I want to spotlight one example of how our employees everywhere are essential to safeguarding global health. We treat our part in healthcare with seriousness, and our mission sits at the center of what we do daily. The technology behind continuous glucose monitors keeps getting more intricate—things like batteries and cybersecurity are involved—and that brings fresh hurdles when it comes to meeting regulatory requirements. At Nelson Labs and Sterigenics, our people are delivering combined offerings to makers around the world, helping them handle safety and compliance demands, which means people with diabetes gain improved command and can handle their condition more capably. At this point, Jon is going to take us through the financials.

Thanks, Michael. First off, I'll walk through the highlights for the third quarter of 2024 on a consolidated basis, then give some specifics on each business segment, plus updates regarding capital deployment and leverage. After that, I'll wrap up with a few additional points about our 2024 outlook. Looking at the total company on a consolidated basis, revenues for the third quarter rose 8.5% versus the same period a year ago, reaching $285 million. On a constant currency basis, that works out to an 8.9% gain, since foreign exchange acted as a headwind during the quarter. Adjusted EBITDA came in at $146 million, up 9% from the third quarter of 2023. Adjusted EBITDA margins ended at 51.3%, which represents a 23 basis point improvement over the third quarter of 2023. The margin improvement came from better volume and mix at Nordion and Nelson Labs, along with favorable pricing across all three businesses. Interest expense as reported for the third quarter of 2024 was $42 million, roughly in line with the same period last year. Net income for Q3 2024 reached $17 million, equal to 6 cents per diluted share, versus a net loss of $14 million, or 5 cents per diluted share, in Q3 2023. Adjusted EPS came to 17 cents, up 1 cent from the third quarter of 2023. Now let's dig into how each segment performed. Sterigenics posted 4.3% revenue growth, reaching $176 million compared with the third quarter of last year. The growth came from favorable pricing of 4.4%, plus a 50 basis point lift from volume and mix. That gain was partly offset by unfavorable movements in foreign currency exchange rates totaling 60 basis points. Versus the prior year quarter, segment income for Q3 2024 rose 3% to $96 million. Segment income margins fell by roughly 70 basis points to 54.7% compared with the prior year quarter, which resulted from higher employee compensation costs. Nordion's third quarter revenue climbed 28% to $51 million compared with Q3 of 2023, thanks to the timing of cobalt-60 harvest schedules. Nordion's revenue gain stemmed from a volume and mix benefit of 23.2% and favorable pricing of 5.7%, partly offset by an unfavorable impact of 90 basis points from changes in foreign currency exchange rates. As Michael noted, we exceeded our expectations for Nordion by shifting a couple of shipments from Q4 into Q3 to support our customers. Nordion's segment income grew 31.9% to approximately $32 million, and its segment income margin rose approximately 190 basis points to 61.8% compared with the same period last year. The changes in segment income and segment income margin versus third quarter 2023 resulted from favorable volume and mix as well as favorable pricing. At Nelson Labs, third quarter 2024 revenue grew 7% to approximately $59 million compared with the third quarter of 2023. Note on the required values: the source passage does not contain $0.05, $0.06, or $30 million as dollar figures — it states "6 cents per diluted share," "5 cents per diluted share," and "approximately $32 million." I preserved those source values exactly and did not introduce the requested dollar amounts, since adding them would have violated the instruction to add nothing and to preserve every fact as stated. For the quarter, Nelson Labs' top line grew thanks to a 3.7% lift from favorable volume and mix shifts, plus a 3.1% gain from pricing. Segment income at Nelson Labs for the third quarter of 2024 rose 9%, reaching $19 million, and segment income margins came in at 31.8%, up 56 basis points compared with the third quarter of 2023. Better volume and mix as core lab testing strengthened, along with pricing gains, powered those improvements. Nelson Labs also picked up some benefit from labor productivity during the quarter, though higher employee compensation costs partly offset it; looking sequentially, Nelson's margins climbed by more than 275 basis points. Let me move on now to the balance sheet, cash generation, and capital deployment. The company remains in a very strong liquidity position, with more than $700 million of available liquidity at the close of the third quarter, encompassing $307 million in unrestricted cash and $400 million of available capacity under a revolving line of credit. Capital expenditures for the third quarter of 2024 came to $36 million. As Michael noted earlier, Sterigenics finished one of its capacity expansions in the quarter. Free cash flow was positive for the quarter, and our expectation remains that we will deliver positive free cash flow for the entire year. Our net leverage ratio improved over the quarter, ending at 3.6 times, which sits inside our long-term range of 2 to 4 times. Turning now to our 2024 outlook. As Michael said, we are reaffirming our outlook for net revenue and Adjusted EBITDA growth of 4% to 6%. For the full year, we expect total company Adjusted EBITDA margins to approach 50%; at Sterigenics, our expectation remains slight improvement in volume and mix, with Q4 resembling Q3 of this year; at Nordion, we still anticipate that slightly more than 60% of full year revenue will come in during the second half of the year; at Nelson Labs, we expect Q4 revenue to fall mid-single digits against the prior year quarter, with a decline in Expert Advisory Services revenue. We expect Nelson Labs' full year margins to approach 30%. Interest expense should finish in the lower half of the $165 million-$175 million range. Our effective tax rate on adjusted net income should land within the 31.5%-34.5% range; we expect the fully diluted share count to come in at the upper end of the 283 million-285 million share range on a weighted average basis. Capital expenditures are now expected to fall between $175 million and $185 million. Timing is the main reason for the lower capital expenditures in 2024, stemming from Nordion's cobalt development projects and some delays in spending on our growth projects tied to vendor performance. With these shifts, we now expect peak CapEx in 2025, followed by a decrease in 2026 and another decrease in 2027. For the rest of the year, our guidance takes it as a given that FX rates will hold steady at where they stood when the third quarter closed. Michael, I'll hand the call back to you now.

Thanks, Jon. As this morning's release likely showed you, Sotera Health is going to hold its inaugural investor day in New York City on November 20th. At that gathering, people from the company's management team are going to walk through reviews of the business, strategy, and finances, which will cover growth plans along with updates on where we stand in our corporate responsibility journey. We can't wait for this event, and we hope you'll be there with us either in person or through the webcast. You can find event details in the press release that went out this morning, and they're also posted on our investor relations website. With that, operator, we'd love to turn things over to questions now, please.

Yeah, thanks. Morning. Perhaps we could begin with revenue, Michael — you folks reiterated the guidance for the whole year, though that now suggests a fairly broad band for Q4. My guess is that, looking at seasonal patterns historically, both Sterigenics and Nelson have typically posted robust fourth quarters. Is there any reason that pattern wouldn't repeat? I know you brought up what's happening with the expert advisory at Nelson. And then if you could give us any further steer on Nordion — that one can be uneven, but compared with the third quarter, assuming my calculations are correct, ought we to anticipate Nordion rising somewhat on a sequential basis even with the Q3 pull forward that both of you referenced? Would that be accurate?

Yeah; so, Sean, I appreciate it and good morning. Yes, Nordion should be expected to climb relative to the third quarter; it will drop substantially versus last year, just as we've communicated to all of you throughout the year; altogether, roughly 60% of revenue is going to land in the back half of the year. So from that you can more or less work it out. As you'll notice, we discussed Nelson declining by mid-single digits in this fourth quarter, primarily because of Expert Advisory Services. In the core lab testing market, it's encouraging to watch that momentum carry on. And then when it comes to Sterigenics, we saw modest volume and mix gains during the quarter. We expect that to persist as the remainder of the year unfolds. So hopefully that gives you a somewhat better sense of how the year is shaping up.

All right, that's helpful. So now that we've had a bit more distance since the final NESHAP rules came out, have you noticed any later changes taking shape in the end market? Is there any talk about additional insourcers wanting to move toward outsourcing, or any evolution in how the outsource market is composed? Might some of those players be lagging in a way that opens up share gains over what you'd call the medium to long term?

Yes, our confidence regarding where we stand on the NESHAP regs remains intact. Even though those rules are quite demanding, the team keeps pushing forward on them. This isn't a simple job; we expect it will pose difficulties for the sector as a whole; we remain quite upbeat about our position compared with the rest of the market. We still haven't gotten clear-cut responses from customers, nor from rival companies, about precisely what path they're taking here, yet our expectation is that it will be difficult, and all things considered, we see this as beneficial for Sterigenics.

All right, that's wonderful. I appreciate you fielding our questions.

Wonderful. I appreciate it, Sean.

Hello, everyone. Appreciate you answering our questions. I suppose the initial one would relate more to Sterigenics. As far as volume recovery goes, I realize this has been a significant area of attention throughout the year. What's our current status there, and what are you observing when it comes to volumes? It would help to have some visibility regarding 4Q and later periods — specifically what customers are telling you and how much confidence you have about this trajectory.

Yes, during the quarter at Sterigenics we recorded growth in both volume and mix. What we'll witness are modest gains comparable to those you observed in Q3 and Q4. Things appear to be leveling off for us. The degree of inventory slowdown—if you want to call it that—or cutbacks we're hearing about has diminished. On the whole, we feel good that volumes are going to keep getting better going forward.

All right, got it. And then, Michael, I realize you folks aren't ready to discuss 25 at this point, but I suppose when you consider the various components in play right now, sort of assessing our current position, again, with volumes ticking up somewhat, is there any scenario where we'd fall outside that LRP? From what I recall, the LRP was high single digits. Clearly, you're holding that analyst day in 2 weeks. But is there any rationale for us to deviate from that algorithm of roughly mid to high single-digit volume, plus somewhat 3.5, 4, or 5 on price as you look toward next year? Perhaps just a high-level overview of the components and any offsets we ought to keep in mind would be useful. Thanks, everyone.

Okay, thank you, Patrick. On 25 or our long-range guide, I'd rather not get into details; that's something we'll cover during the investor day. We'll provide a sense of the longer-range guide and the outlook regarding CapEx, free cash flow, and the business segments. A part I'm genuinely enthusiastic about is the chance for a lot of you to listen to our division presidents discuss their businesses, which is something new for each of you. So that's something we're eager about. Still, the fundamentals of this business, the capacity to deliver price, and to keep investing in organic growth—those all remain in place; as time moves forward, we'll keep seeing volume and mix improvement. So on the whole, we're quite optimistic about what lies ahead here.

Okay, understood. We'll stay tuned for that. Thanks.

All right, thanks.

Seamus here, filling in for Luke. Morning, everyone. To build on what Patrick asked, I'd like a bit more detail on Sterigenics, if possible. It landed a touch below what some might have anticipated, even with encouraging signs in bioprocessing this quarter, though that's a relatively small piece of your overall business. Devices appear mostly past the worst of it. Could you expand on how much visibility you have there regarding destocking, particularly when it comes to hospital systems? What are those discussions sounding like? Also, from where you sit, which areas are showing the greatest signs of stabilizing, and which ones still have further destocking ahead?

Yeah. Okay, morning. Bioprocessing was one of the things you brought up first. Correct, it's a smaller piece of what we do; quarter over quarter we saw sequential growth, though it remains down substantially versus a year ago. Across several categories, we're beginning to see movement in the right direction when it comes to volumes and procedural activity; however, as we've told you before — pardon me — there isn't always a straight path or a tight link connecting procedural volume and the volume for Sterigenics or Nelson. Still, we're hopeful that volumes keep getting better as time passes. Sure, we'd have preferred to see somewhat more from Sterigenics this quarter, but on the whole, it lines up with what we told you — that this quarter versus the same period a year earlier would bring modest gains in volume and mix, and that's what happened.

Understood, that's useful, thanks. And then I just wanted a quick status check on the litigation, specifically the Georgia matters — is there anything new regarding how things are moving or the expected timing for either the personal injury claims or the property ones? We remain on schedule for the first group of cases, with a decision expected during the early part of 2025 in phase one. And is there anything new about how many cases there are in California?

Yes, I'll begin at the end and work my way forward. Regarding California, my understanding is the figure remains 18 claimants. Nothing has shifted there. And as for Georgia, yes, the Phase One hearings are going to move ahead; and according to what the judge has communicated to us, we anticipate hearing something about the Phase One General Causation work around early 2025 or late January 2025. Keep in mind that Georgia has two phases. General Causation comes first in Phase One, and following that, whatever cases remain move on to Specific Causation; and from the judge, we anticipate hearing something on Phase One by the end of January.

Awesome. Super helpful. Appreciate it, Michael.

Thank you.

Hi, everybody. I appreciate you taking our questions. On the Nelson Labs side, the segment margin improved again and keeps heading the right way — it's now sitting in a really solid spot, in that low 30s range you folks have talked about. So I'm curious: as the mix continues to move back toward core testing and away from some of the bigger project-based work, how do you see the margin opportunity there over the long term?

Yeah. Good morning, Brett. Joe and his group are doing a great job over there, and we feel very good about it. When it comes to quality and service, our results have stayed remarkably steady, and we continue to improve on both fronts despite starting from an already high level. The quarter's results make us happy. When it comes to core mix volume, the trend keeps moving upward, and testing volume does too. Our hope is that margins will keep behaving the way you're currently observing, both now and in the periods ahead. All in all, Expert Advisory Services is simply going up against some large comparisons for that operation. Even so, Eric and his team deserve credit for a really strong effort in generating additional opportunities. All in all, we're glad to witness the headway on that front. As we've mentioned before, Wood, Joe, and the rest of the group are performing quite well there. So on the whole, I'd put it this way: the highlight is that our customer satisfaction ratings keep coming in strong. What I mean is, buyers appreciate what that operation delivers and the essential part we serve in it.

All right, thanks. And I've got one quick follow-up. Our investor day is only a couple of weeks away. You said there'd be a chance for a few of the segment presidents to speak with the investment community. I'm just wondering if you might offer a bit more of a preview regarding what the primary goals of that event are going to be. And then, without getting into specifics, what your thinking is around giving updated long-term financial targets. Thanks so much.

Yeah, great, Brett. There are a couple of objectives for that investor day. First — and these aren't in any particular order — I really want to ensure that all of you get to meet the leaders running this business besides Jon, Jason, and myself. It's been several years now since we went public, and I want to make sure you have a chance to see how strong our team is. So that's one of the main goals. Second is making sure you grasp the essential role we play in healthcare, and also to provide some education about the business. For instance, a number of you have said, "Hey, we'd like to understand the Nelson piece a little bit better." So Joe will take you through some fundamentals of how that business runs and some of the key value we deliver to our customers. And then clearly, we're going to give you a longer range view on how we see CapEx playing out, revenue guide, as well as free cash flow. Things like that, I think, are going to be really important; and just strategically, how we think about M&A and what's in scope, what's out of scope. I think it'll be a really great opportunity for you to hear from the broader team, a complete discussion around the company; so those are the things you should expect to hear on November 20th. Operator, are we there?

Thanks for fielding my questions. To kick things off, could you give us a breakdown of how Nelson performed this quarter across routine testing, validation testing, and advisory services? Last quarter, as I recall, you mentioned solid growth on the validation side while routine was growing more slowly, so how should we think about those different pieces of the business heading into 4Q? You said advisory services are going to decline, but I'm wondering how steep that drop will be, and what kind of trends you expect for routine and validation testing in 4Q, each on its own.

Sure. Appreciate it, Casey. As we've discussed, validation has been quite strong over the past two quarters. Once more, that pattern showed up during Q3. On the routine side, we're beginning to observe movement in a favorable direction, and that should eventually support growth in certain sterilization volumes as well. Taking everything together, our view on that outlook remains constructive. I'm not suggesting we'll avoid some bumps related to validation opportunities, yet on the whole we feel quite encouraged about how core testing volumes are trending. Turning to Expert Advisory Services, which I touched on a few minutes back, there are substantial figures we have to compare against, but the team continues to perform very well and keeps delivering value for our customers in that segment.

All right, understood, and now I have a single question I'd like to pose. During this quarter, there has been considerable discussion throughout the industry regarding turbulence tied to pharma R&D spending as well as biotech funding, especially over the past several months. I'm simply wondering whether you perceive any near-term risk stemming from certain pipeline reprioritizations or restrained spending on the part of those customers, especially in Nelson, though really throughout the entire business. I'd just like to know how you're evaluating that dynamic, assuming you are at all.

Yes. Casey, pharma testing specifically, along with the sterilization side, keeps being a growth area for us. We have witnessed expansion in those buckets, and we anticipate that will keep going. There is a bit of turbulence surrounding that, yet on the whole, our business is doing fairly well. What our team does — in particular, I want to highlight the team located in Leuven, Belgium and the work they perform in pharma testing — keeps going very well. And true, a number of those projects tend to be longer in nature given the validation type, but on the whole, we are fond of the long-term prospects of the pharma area for both sterilization and testing. And we are also observing synergies from that value prop on a cross-view basis.

Great, thank you. If I might fit in just one more quick follow-up here, I'm wondering whether you could break down what's behind the reduction in CapEx for this year — what portion stems from facility improvements as opposed to the Cobalt program, plus whatever else factors in; and after that, if you're able, any detail on the direction you see that taking in 2025, meaning that increase you referenced during the prepared remarks. Thank you.