Sotera Health Company (NASDAQ:SHC) Q4 2023 Earnings Call Transcript

Sotera Health Company (NASDAQ:SHC) Q4 2023 Earnings Call Transcript March 3, 2024

Sotera Health Company isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning and welcome to the Sotera Health Fourth Quarter and Full Year 2023 Conference Call. All participants will be in a listen-only mode. [Operator Instructions] after today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Vice President and Treasurer, Mr. Jason Peterson. Please go ahead.

Jason Peterson: Thank you. Good morning and welcome to today’s call. You can find today’s press release and accompanying supplemental slides on the Investors section of our website at soterahealth.com. This webcast is being recorded, and a replay will be available in the Investors section of the Sotera Health website. On the call with me today are Chairman and Chief Executive Officer, Michael Petras; and Chief Financial Officer, Jon Lyons. During the call, some of our comments may be considered forward-looking statements. The matters addressed in these statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please refer to Sotera Health’s SEC filings and the forward-looking statements slide at the beginning of the presentation for a description of these risks and uncertainties.

The company assumes no obligation to update any such forward-looking statements. Please note that during the discussion today, the company will present both GAAP and non-GAAP financial measures, including adjusted EBITDA, adjusted net income, tax rate applicable to adjusted net income, adjusted EPS, adjusted EBITDA margin, segment income margin, net debt and net leverage ratio as well as constant currency comparisons. A reconciliation of GAAP to non-GAAP measures for all relevant periods may be found in the schedules attached to the company’s press release and in the supplemental slides to this presentation. The operator will be assisting with the Q&A portion of the call today. Please limit yourself to one question and one follow-up so that we can try and give everyone an opportunity to ask questions.

As always, if you have any questions post call, please feel free to reach out to me and the Investor Relations team. I will now turn the call over to Sotera Health’s Chairman and CEO, Michael Petras.

Michael Petras: Good morning, everyone and welcome to today’s call. This morning, we reported both top and bottom line growth for the quarter and the full year, while delivering 50%-plus adjusted EBITDA margins. 2023 presented many challenges, including macroeconomic and customer supply chain pressures, a shifting regulatory landscape and a lumpy Cobalt-60 harvest schedule at Nordion. Throughout the year, the Sotera Health team demonstrated resiliency, adaptability and unwavering commitment to the company’s core values in the face of these challenges. In addition to the growth we delivered, we were successful in achieving a number of operational goals. At Sterigenics, we completed four capacity expansions and made significant progress on our US EO facility enhancements.

The Nordion team secured Cobalt-60 supply and successfully delivered 50% of its full year revenue in the fourth quarter. The team also made good progress on the long-term Cobalt-60 development programs. Nelson Labs achieved significant growth in its technical advisory services areas throughout the year. RCA, a business we acquired in 2021, continues to deliver strong revenue growth, as RCA supports customers in their interactions with regulatory agencies such as the FDA. We also resolved a substantial amount of ethylene oxide litigation in 2023 with the Illinois settlement of 880 claimants as well as the recent settlement of approximately 25% of the personal injury claims in Georgia. We finished 2023 in a strong liquidity position with approximately $700 million in liquidity, which is an increase of over $200 million from the end of 2022.

Jon will provide more detail on our financial results in a moment, but first, I want to highlight a few items from our fourth quarter and full year 2023 results. We reported total revenue growth of 23.3% and adjusted EBITDA growth of 28.7% compared to the fourth quarter of 2022. For the full year 2023, revenue grew by 4.5% and adjusted EBITDA grew by 4.3% compared to 2022. 2023 marks another year, in which we continue our streak of annual revenue growth, which we’ve achieved every single year since 2005. With respect to the business units, Sterigenics delivered 6.5% top line growth for both the quarter and the full year. As we’ve discussed previously, Sterigenics, our largest reporting segment, has delivered consistent growth throughout its history.

Serving its customer base through a comprehensive global network of 48 facilities, this segment has delivered a compound annual growth rate of 10% on its top line and 11% on its bottom line since becoming a public company. These growth rates speak to the durability of the business model as Sterigenics provide critical, often government-mandated services, which represents a fraction of the overall product cost for our customers. Nordion, our other business within the Sterilization Services segment, delivered 134.2% revenue growth for the quarter. This performance was expected and was driven by the timing of Cobalt-60 harvest schedules. As we’ve consistently messaged, Nordion’s revenue is tied to the harvest schedule of our Cobalt-60 suppliers, which results in irregular revenue patterns on a quarter-to-quarter basis.

The team has unique expertise in navigating the complex Cobalt-60 supply chain. And as I’ve stated earlier, the Nordion team did a fantastic job delivering 50% of its full year revenues in the fourth quarter. On a full year basis, Nordion revenues were up 4.4%. Revenue in Nelson Labs, our Lab Testing and Advisory Services business grew 4.3% in the quarter versus the fourth quarter of 2022. Full year 2023 revenue was down approximately 1% versus the prior year. Nelson Labs continues to face the same headwinds we referenced on our third quarter 2023 call, including the extension of compliance deadlines for European Union medical device regulations; the decline in funding for start-ups and smaller companies; and lastly, softened demand for routine lot-release testing tied to a slowdown in Sterilization volumes.

Overall, 2023 was a good year for Sotera Health considering the uncertainty driven by macroeconomic pressures, customer inventory destocking and geopolitical events. I also want to take a moment to highlight the progress we made on our corporate responsibility initiatives. I am proud of our team’s accomplishments since the IPO in 2020. As part of our IPO, the Board established ESG oversight within our Nominating and Corporate Governance Committee. We also established an Internal Cross-Functional Committee, which reports into me, and we appointed two seasoned Senior Executives as Co-Chairs to lead the identification and implementation of initiatives consistent with our overall business strategy. During 2023, we’ve built on the initiatives begun in 2021 and 2022.

Some of the highlights for our accomplishments include: In the environmental area, we have been working with a third-party software solution to establish in a first-time published baseline environmental metrics. As previously mentioned, we continue our investment in industry-leading, state-of-the-art emission controls in our EO facilities. We also published our first environmental management statement in our 2023 corporate responsibility report. With respect to human capital, culture and communities, we published our formal Human Rights statement and disclosed initial human capital data. We completed a global employee engagement survey with 83% participation rate. Our Sotera Health Women’s Network held an interactive session for our leaders with our Board Director, Ann Klee.

We are proud to announce that in 2023, women represented more than 40% of our global leadership promotions. On the governance side, we welcome Karen Flynn to our Board. Karen brings Board independence to 91% and she adds valuable commercial experience in the pharma services space, which is an important aspect of our long-term strategy. We also launched a formal enterprise risk management process with results that led us to prioritize six initial areas. These six areas are highlighted in our 2023 corporate responsibility report. And finally, our team completed outreach to institutions holding 60% of the company’s public stock float in 2023, and we held meetings on ESG topics with institutions holding approximately 40% of the public float. We greatly value these discussions and share the feedback regularly with our Board of Directors, including this past week.

We look forward to continuing to share our corporate responsibility accomplishments in the future. Earlier today, we provided our initial 2024 outlook. For the full year 2024, we expect to deliver another year of top and bottom line growth with total revenues and adjusted EBITDA growth expected to be in the range of 4% to 6% when compared to 2023. The variability within our full year revenue range will be largely driven by the timing and magnitude of the market recovery in both Sterigenics and Nelson Labs. Now, Jon will take us through the financials in more depth.

Jon Lyons: Thank you, Michael. I will first cover fourth quarter and full year 2023 results, including updates on capital deployment and leverage. I will then conclude with additional details on the 2024 outlook. On a consolidated total company basis, fourth quarter revenues grew by 23.3% or 21.9% on a constant currency basis to $310 million. The fourth quarter volume growth was abnormally high with 50% of Nordion’s full year revenues landing in the period, as Michael previously mentioned. Fourth quarter adjusted EBITDA grew by 28.7% to $167 million, and adjusted EBITDA margins expanded by almost 225 basis points to 53.7%. Our reported interest expense for the quarter was $43 million. Reported net income for the fourth quarter of 2023 was $39 million or $0.14 per diluted share.

Adjusted EPS was $0.26 for the quarter, an increase of $0.01. Now let’s take a look at our segment performance for the fourth quarter. In the fourth quarter, Sterigenics delivered 6.5% revenue growth to $172 million. Revenue growth drivers for the quarter included favorable pricing of 5.8% and favorable changes in foreign currency exchange rates of 1.7%, partially offset by slightly unfavorable volume and mix of approximately 1%. Segment income grew 6.4% to $95 million, driven by favorable pricing and changes in foreign currency exchange rates, partially offset by higher costs and unfavorable volume and mix. Nordion’s fourth quarter revenue increased by approximately 134% to $80 million, driven by favorable volume and mix of over 100% and pricing of over 30% as Nordion generated 50% of its full year revenue in the quarter as expected.

Segment income increased by more than 160% to $53 million, and segment income margins expanded by 720 basis points to 66.8%. Nelson Labs returned to growth in the fourth quarter as 2023 revenue improved 4.3% to $58 million compared to the same quarter last year. Revenue growth was driven by favorable pricing of 3.6% and a foreign currency tailwind of 1.2%, partially offset by unfavorable volume and mix of 0.5%. Segment income decreased 7.8% to $19 million and segment income margin declined by 420 basis points to 32.1%, which was driven by unfavorable volume and mix, coupled with some inflationary pressure, partially offset by favorable pricing. For the full year, we delivered $1.05 billion in revenue, up 4.5% or 4.2% on a constant currency basis.

We grew adjusted EBITDA 4.3% to $528 million, resulting in an adjusted EBITDA margin of over 50%. Reported interest expense for the full year was approximately $143 million. Reported net income for 2023 was $51 million or $0.18 per diluted share. Adjusted EPS for the year was $0.81 per weighted average diluted share, a decrease of $0.15 primarily driven by higher interest expense and a higher tax rate. I will now turn to liquidity, net leverage and capital deployment. The company continues to be in a strong liquidity position. As of year-end, we had approximately $700 million of available liquidity, which included $296 million of unrestricted cash and $400 million of available capacity under our revolving line of credit. For 2023, after adjusting for the $408 million Illinois settlement, we generated $260 million of operating cash, which is in line with prior years and demonstrates the cash-generating strength of our business.

Our net leverage ratio finished the year at 3.8 times within our target range of 2 to 4 times. As you may recall, our net leverage ratio increased to 4.2 times in the second quarter of 2023 after the financing of our $500 million term loan and subsequent $408 million Illinois settlement payment. Since Q2 of 2023, our net leverage ratio has improved nearly 0.5 turn, which demonstrates our ability to de-lever through growth. CapEx for the year finished at $215 million. As Michael mentioned, Sterigenics completed four capacity expansions during the year and made significant progress on the EO facility enhancements. We currently have three growth projects in process, two of which are greenfields. Nordion’s Cobalt-60 development programs are progressing well.

As I mentioned during our Q3 call, these are once-in-a-generation long-term projects that won’t yield incremental cobalt until later in the decade. For Nelson Labs, we continue to invest in expanding our pharma capabilities and in our lab information management system that we are deploying across the business segment. Now, I would like to discuss our 2024 outlook. For the full year, we expect total revenues and adjusted EBITDA to grow in the range of 4% to 6%, with adjusted EBITDA margins similar to 2023 levels. We expect another year of solid price performance with 2024 being at the lower end of our long-term stated range of 3.5% to 5% due to the moderation in inflation and timing of long-term contract renewals at Nordion. From a revenue cadence perspective, Q1 typically is the lightest quarter of the year for the company, and we expect that to be the case again in 2024.

In Sterigenics, we are assuming relatively flat volumes in the first half with slight recovery beginning in the second half of 2024. Versus 2023, Nordion revenues will be more balanced between the first half and second half with the first quarter again being the lightest quarter of the year but stronger than 2023. For Nelson Labs, revenues for the first half of the year will be slightly lower than the back half with the first quarter being historically the lightest quarter of the year. In the past couple of years, we have provided visibility to the revenue risk associated with Russian cobalt supply. As of today, there is an approximate risk of between 0% and 3% of total company 2024 revenue. At this point, I would like to direct you to Slide 18 of the earnings presentation that is posted to our Investor website under Events and Presentations, which outlines a change we are making to the calculation of adjusted net income.

By way of background, during Q2 of 2023, we closed on a $500 million term loan to fund the $408 million Illinois EO settlement. Consistent with our treatment of EO litigation-related costs, we excluded the interest costs related to $408 million of this loan to calculate adjusted net income. Beginning in 2024, we will no longer make this adjustment. We have presented the impact this change would have had in 2023, so you have the right basis for comparison going forward. As you will see on the slide, adjusted net income is reduced from $230.1 million to $202.3 million. The effective tax rate applicable to adjusted net income increased from 31.4% to 33.8%, and adjusted EPS changes from $0.81 to $0.71 per weighted average diluted share. These are the appropriate basis for comparison for our tax rate and EPS guidance.

For 2024, we expect interest expense between $170 million and $180 million. We are projecting an effective tax rate applicable to 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. We expect a fully diluted share count in the range of 283 million to 285 million shares on a weighted average basis. From a capital deployment standpoint, we will continue to prioritize organic growth and deleveraging as well as opportunistic M&A. And we expect capital expenditures in the range of $205 million to $225 million in 2024. As previously communicated, we expect 2024 to be at an elevated level before we start to see a decline in CapEx spending in 2025 when we will start to see free cash flow generation accelerate.

Finally, our guidance does not assume any M&A, and we anticipate net leverage to improve in 2024. I will now turn the call back over to Michael for closing remarks.

Michael Petras: Thank you, Jon. As we look forward to 2024, we will continue to focus on our priorities. A few of these priorities include, expanding our global network through disciplined investment in Cobalt-60 development and additional capacity. We’ll continue to invest in upgrades to our US EO emission control systems. We will further enhance our one company capabilities through cross-functional business unit initiatives, all while delivering top and bottom line growth with strong cash flow generation. I want to reemphasize the strength and durability of our business model. In 2024, we expect another good year of performance in spite of uncertain demand recovery. The fundamentals of the criticality of our services remain intact with our customers.

We have long-term relationships with the top medical device and pharma companies of the world that are supported by multiyear contracts. We will continue to execute for our customers and when market volumes improve, Sotera Health will benefit from that recovery. Our focus day in and day out is on our mission of safeguarding global health. This company plays a critical role in healthcare, and we are in a strong position for growth once again in 2024. At this point, operator, let’s open up the call for Q&A.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question will come from Sean Dodge with RBC Capital. Please go ahead.

Sean Dodge: Yeah. Thanks. Good morning. I just want to start on Sterigenics. Michael, you said the guidance assumes volume recovery in the second half of the year. Can you give us a sense of the proportions of Sterigenics revenue you’re expecting first half to second half? I guess, historically, second half have always been bigger in terms of revenue. Is 2024 going to be a lot more pronounced? And then maybe if you could just talk about the visibility you have into that? Is it just expecting a market recovery or there’s something else you’re seeing now that indicates that?

Michael Petras: Yeah, good morning, Sean. Yes, it will be similar to what we’ve seen in the past, where the second half is typically a little bit better than first half. I don’t think it’s going to be dramatic, but as we said, relatively flat volumes in the first half for Sterigenics and improving in the second half. It’s really trying to predict, as I stated in my comments, around the recovery in the market volumes. We still see some destocking occurring in the channels, but we can tell you, overall, we’re not seeing it get worse. It’s very stable, both on the Sterigenics side as well as the Nelson side. It’s not getting worse. We just — the question is when the recovery will start to come back? And we just want to give you visibility on how we are thinking about it as the year plays out.

Sean Dodge: Okay, great. And then on Nelson, maybe just any updates on the margin outlook there? Aside from just more volumes coming through, are there some cost actions you can take or lever as you can start to pull to drive some improvement in margins in the Nelson business?

Michael Petras: Yeah. As we’ve mentioned in the past, Sean, we got our position early in ‘23 where we’re probably over-resourced based on the volumes. And we did that with an eye towards better service and making sure that the volumes came back. We had the people in place to really take care of that business. I would tell you that we’ll see improvements as the year progresses. We’re going to — we will get turnover in that business. We’ll work that down. We’re not going to be backfilling as many jobs until we see the volumes recover. But our goal here is to get to the mid-30s as we’ve mentioned. It will take us some time to get there, but that’s ultimately where our aspirations are over time.

Sean Dodge: Okay —

Michael Petras: It’s a fine line there, Sean. We want to make sure we’re there to service the customers. That’s the biggest thing when that volume comes. Okay. Thank you.

Operator: The next question will come from Dave Windley with Jefferies. Please go ahead.

Dave Windley: Hi. Good morning. Thanks for taking my question. Michael, I wanted to start on a little bit more strategic question. On these long-term cobalt supply initiatives that you are working on, when and if those are successful, I know there’s some development work around new reactors and things like that, what’s the impact of that, I guess? You have a kind of a fairly stable and predictable growth rate, a certain amount of MedTech users’ notification for Sterilization. Would you expect that to lower your input costs? Would you compete on price for more market share? Does it allow you to supply or to serve volume that you’re not serving today? I guess, I’m wondering, we really haven’t discussed this, I don’t think in much length, because it’s far away, but what’s the lever for you when you get more Cobalt-60 supply?

Michael Petras: Yeah. David, thanks for the question. So just for some folks that aren’t as familiar, our cobalt development programs are really focused around working with OPG, Ontario Power Group, which is one of our longest-term suppliers, getting more capacity there as well as the program we’re working with Westinghouse. Our goal with these programs is to be able to keep up with the market growth over time. So there’ll be a portion of it that replaces existing reactors that will go out of service for maintenance work, if you will, or just being retired. But then more importantly, it’s also to bring out some additional capacity for longer-term flexibility in our global supply chain. So we think ultimately, David, it’s needed to keep up with the market growth over the long run.

Dave Windley: Okay. Okay. And then maybe on Sterigenics and following-up on Sean’s question. The volume and the destocking that you’re seeing, do you have — it sounds like you emphasized it’s not getting any worse, that’s good news. Do you have visibility into your customers? How much more destocking they need to do, any quantification of that to give you comfort that the volume kind of the correlation of your order patterns, the underlying MedTech order patterns might start to tighten up a little bit in the second half?

Michael Petras: Yeah, David, it’s pretty complicated the supply chain with your customers who have inventory, their distribution channels as well as the health systems. We are not seeing it to get worse, as I stated. One example would be, I met late in the year — actually, I’m sorry, it was the beginning of this year with one major MedTech customer CEO, and he said, “Listen, I took out $500 million of inventory in the back half of the year focused on working capital,” right. So we saw that, and we are seeing it across multiple customers. I think many of you who follow the MedTech space see that as well and bioprocessing space as well, where people are taking it out and trying to get back to pre-COVID levels or slightly below.