Sotera Health Company

Good morning and welcome to the Sotera Health second quarter 2024 conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw from the question queue, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Vice President and Treasurer, Jason Peterson. Please go ahead.

Good morning and thank you. Welcome to Sotero Health second quarter 2024 results call. You can find today's press release and accompanying supplemental slides on the investor section of our website at soterohealth.com. This webcast is being recorded and a replay will be available in the investor section of the Sotero Health website. On the call with me today are Chairman and Chief Executive Officer Michael Petras and Chief Financial Officer John 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 Sotero Health SEC filings in the forward-looking statement 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 net income, adjusted EBITDA, adjusted EPS, adjusted EBITDA margin, segment income margin, and net leverage ratio, in addition to constant currency comparisons. A reconciliation of certain non-GAAP measures to the most directly comparable GAAP financial 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 give everyone an opportunity to ask questions. As always, if you have any questions after the call, please feel free to reach out to me and the investor relations team. I'll now turn the call over to Sotero Health Chairman and CEO, Michael Petras.

Good morning, everyone, and thank you for joining Sotero Health's second quarter 2024 earnings call. Today, we announced both revenue and adjusted EBITDA growth compared to the second quarter of 2023, driven by volume growth in each of our three business segments. Compared to the second quarter of 2023, total company revenues increased 8.3% or 8.8% on a constant currency basis, and adjusted EBITDA increased 6.9%. We delivered adjusted EPS of 19 cents for the quarter, which is slightly down versus the second quarter of 2023, driven by higher interest expense. Sterigenics, our large reporting segment, grew the top line by 5.9% versus the same period in the prior year, delivering positive volume growth for the first time in several quarters. We continue to expect slight volume and mix growth in the second half of 2024 versus 2023. Nordean, our other reporting segment within the sterilization services business, increased revenues by 29% versus the second quarter of 2023. The timing of reactor harvest schedules resulted in the favorable volume and mix increase, which was the primary driver for the growth. Nelson Labs. Our lab testing advisory service business delivered its third consecutive quarter of top line growth as second quarter revenue increased 4% compared to the second quarter of 2023. We are pleased to see volume improvement within our core validation testing area while core routine lot release testing remains soft versus the second quarter of 2023. Our expert advisory services business continued its strong performance in the quarter. With the first half of the year completed, we are reaffirming our full year 2024 outlook. As a reminder, our 2024 outlook calls for both revenue and adjusted EBITDA growth in the range of 4% to 6% versus 2023. John will go through our 2024 outlook in more detail in a few minutes, but first, I'd like to highlight an example of how Cetera Health plays a crucial role in safeguarding global health. Our Nelson Labs business plays a critical role in testing medical devices to ensure the safety of these devices for use in patients. Recently, the team at Nelson Labs performed a lab testing on the Audis valve, which is the first ever expandable pediatric heart valve, and is highlighting the second quarter earnings presentation posted to the investor section of our website. Children with pulmonary valve disease experience valve replacement surgery at least five to six times throughout their young lives. This innovative heart valve can be implanted into pediatric patients and expands with the child's growth, which is expected to reduce the number of heart surgeries needed during their childhood. Nelson Labs worked with both the customer and the FDA to perform biocompatibility testing and evaluations to help ensure safe interaction between the medical device and body systems of the child for the duration of its intended use. These tests and evaluations were the last critical step for approval into a clinical trial. This is just another great example of how we play a critical role in safeguarding global health at Satara Health. Now, John will walk us through the financials.

Thank you, Michael. I will begin by covering the second quarter 2024 highlights on a consolidated basis and then provide some details on each of the business segments along with updates on capital deployment and leverage. I will then finish up with some additional details on our 2024 outlook. On a consolidated total company basis, second quarter revenues increased by 8.3% as compared to the same period last year to $277 million. This equates to an 8.8% increase on a constant currency basis as foreign exchange was a headwind in the quarter. Adjusted EBITDA increased by 6.9% compared to the second quarter of 2023 to $137 million. Adjusted EBITDA margins were 49.7%. representing a 68 basis point decline from second quarter of 2023, driven by a decline in Nelson Labs segment margins. Adjusted EPS was 19 cents for the second quarter of 2024, a decrease of one cent from the second quarter of 2023, driven by higher interest expense. Net income for Q2 of 2024 was $9 million, or three cents per diluted share, compared to net income of $24 million, or eight cents per diluted share in Q2 of 2023. The reduction in net income was driven by customary charges related to the recent successful refinancing of our debt structure. Our interest expense for the second quarter of 2024 was $40 million, an increase of almost $10 million versus the same period last year. The increase was driven by reduced interest income and a reduced benefit from favorable interest rate hedges that matured. Now let's take a closer look at the segment performances. For the quarter, Sterigenics delivered 5.9% revenue growth to $176 million as compared to the second quarter of last year. Revenue growth was driven by a pricing benefit of 4.9% as well as favorable volume and mix of 1.4%. These were partially offset by an unfavorable impact from foreign currency exchange rates of 40 basis points. Segment income increased 5.8% to $97 million. while segment income margins of 54.9% remained flat compared to Q2 of 2023. Segment income growth was driven by favorable pricing as well as volume and mix partially offset by inflation. Nordian second quarter revenue increased by 29% to $41 million compared to the same period in the prior year based on the timing of Cobalt 60 harvest schedules as we expected. Nordion's revenue increase was primarily driven by the favorable impact from volume and mix of 26.5%, as well as a 3.8% pricing benefit. The revenue increase was partially offset by negative changes in foreign currency exchange rates of 130 basis points. Nordion's segment income increased 31.7% to $23 million, while segment income margin increased 120 basis points to 56.8% compared to Q2 of 2023. Segment income and segment income margin improvement were driven by the favorable volume and mix as well as favorable pricing. For Nelson Labs, second quarter 2024 revenue increased by 4% to $59 million compared to the second quarter of 2023. The growth in revenue was driven by a pricing benefit of 3% as well as favorable volume and mix of 1.4%. These were partially offset by foreign currency headwinds of 40 basis points. Nelson Labs' second quarter 2024 segment income decreased by 11% to $17 million compared to the second quarter of 2023. This decline was driven by the impact of volume and mix, as well as higher labor costs, partially offset by favorable pricing. Segment income margins contracted by 489 basis points to 29% compared to the prior year quarter, but improved by 240 basis points sequentially. which is consistent with the expectation we laid out during our first quarter 2024 earnings call. I will now turn to the balance sheet, cash generation, and capital deployment. During the quarter, we closed on a $2.3 billion refinancing of our total debt structure. By completing this transaction, we have reduced 2024 expected interest expense by approximately $5 million and strengthened our company's balance sheet by extending maturities from 2026 to 2031. We were very pleased with the strong market reception for this financing, which we believe speaks to the strength of our businesses. doTERRA Health's liquidity position remains healthy. As of the end of Q2 of 2024, we had $646 million of available liquidity, which included $246 million of unrestricted cash and $400 million of available capacity on a revolving line of credit. Capital expenditures for the first half of the year totaled $77 million, as we continued to focus on completing our three stereogenics capacity expansions, the U.S. EO facility enhancements, as well as Nordion's cobalt development programs. Free cash flow was positive in the quarter, and as we've stated previously, we expect to generate positive free cash flow for the full year. We finished the quarter with a net leverage ratio of 3.8 times, which is within our long-term target range of two to four times. As Michael mentioned, we are reaffirming our 2024 outlook. To recap, for full year 2024, we expect total revenues and adjusted EBITDA to grow in the range of 4% to 6%. We expect total company adjusted EBITDA margins to sequentially improve throughout the year, with full year margins approaching 50%. In Sterigenics, we anticipate slight volume and mixed growth versus 2023 for the remainder of the year. For Nordion, we expect slightly more than 60% of full-year revenue to occur in the second half of the year with upper single-digit year-over-year revenue growth in the third quarter. For Nelson Labs, we expect second-half revenue to be similar to the first half. We also expect segment income margins to improve versus the second quarter of this year as we complete some large projects in expert advisory services. We continue to expect full-year margin rates to approach 30%. As we communicated after our debt refinancing, we expect interest expense between $165 million and $175 million. Our effective tax rate on our adjusted net income continues to be in the range of 31.5% to 34.5%. Adjusted EPS continues to be in the range of 67 cents to 75 cents. We expect a fully diluted share count in the range of 283 million to 285 million shares on a weighted average basis. We now expect capital expenditures to finish at the lower end of the $205 million to $225 million range. As previously communicated, we continue to expect CapEx to step down in 2025 and 2026, resulting in acceleration of free cash flow generation. This is a high priority for the company. Our guidance assumes foreign exchange rates at the end of the second quarter remain constant for the remainder of the year. As such, we expect FX to continue to be a headwind on a year-over-year basis. This headwind is expected to be more pronounced in the third quarter. Lastly, our guidance does not incorporate any M&A activity, and we still anticipate our net leverage ratio to improve during the year. I'll now turn the call back over to Michael.

Thank you, John. Overall, we're pleased with our performance in the second quarter, and we're looking forward to the second half of 2024. Prior to moving to Q&A, I would like to take a moment to say that we are very excited to welcome Christopher Simon, President and Chief Executive Officer of Hemianetics Corporation to Satara Health Board of Directors. Chris brings extensive commercial and strategic experience in the medical device industry, which we believe will serve us and our stakeholders well. At this point, operator, let's open the call for questions and answers.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from Dave Windley with Jefferies. Please go ahead.

Hi, thanks. Good morning. Thank you for taking my questions. Michael, you commented on and we noticed that volume growth seemed to return in serogenics. Sounds like you're expecting modest amounts of that to continue through the year. Perhaps you could elaborate on what you're seeing in the end markets and how that supports the continued volume growth. Thanks.

Good morning, David. Thanks for your question. Yeah, as you noted, you know, Sterigenics had nice volume improvement in the quarters, the first quarter and several quarters that they've had positive volume in mix. For the first half of the year, it came in flat, which was consistent with our expectations, and we see that slightly improving the second half of the year. And we're seeing, you know, as we had mentioned on our last call, we continue to see stabilization of inventory levels with our customer base. Although it's not a straight line with all customers in all categories overall, we're We continue to be encouraged, and it's in line with our expectations that we'll continue to see improvement in the volumes with Sterigenics. So we're happy with their performance in the quarter.

Thank you for that. Could you add on kind of the difference in observed trends between, say, general hospital market versus, you know, bio-life sciences market?

Yeah, I would generally say the general hospital, it continues to stabilize. Bioprocessing, although not a large category for us, as we've mentioned in the past, we did see sequential improvement with the exception of one big customer as an outlier that I think if you follow some of their comments, they're seeing a little bit slower recovery in the marketplace as well. But overall, we feel good about the expectations going forward in those categories.

Okay. And then my last question, you called out labor costs as an offset. I just wondered if you could give us a little more color on the inflation environment for an instability of your labor force. Thanks.

Yeah, in particular, we called out the Nelson side, and that's just merit increases, predominantly merit increases. John, anything else to add on that?

No, I think it's pretty stable. It's been great work to get the workforce in the right place, and

Joe and the team have done a nice job. As you saw, Nelson had another good quarter top-line growth. The mix isn't ideal yet, but we continue to see improvement there. The labor force is stabilizing. Turnover is stabilizing and actually down significantly. That promoter score has been strong, and employee survey results are good. So we're encouraged by what we're seeing on the Nelson side, and hopeful that continues. We're seeing validation volume continue to move forward, so that's great.

Great. That's all for me. Thank you.

Great. Thanks, David.

The next question comes from Brett Fishpin with KeyBank. Please go ahead.

Hey, guys. Thank you so much for taking the questions. Just wanted to follow up on Nelson Labs staying on topic here. You know, you mentioned the third consecutive quarter of growth, which was encouraging to see. So really just curious, like, what areas you're seeing the most upside from a volume perspective?

Yeah, Brett, thanks. As we've mentioned a couple times throughout these calls, the expert advisory services business continues to do well, having nice growth, although it's slowing down. As we mentioned to you, we expect that to slow as you go into the back half of the year on a year-over-year basis because they had some big growth towards the end of last year. Where we are seeing nice growth in activity is on the validation, the more complex testing activities. Routine testing has been a little sluggish, but we're optimistic that we'll see improvements as the year progresses there.

All right, thank you. And then just one follow-up, maybe taking a little bit of a step back. At least for us, it felt like 2Q was broadly ahead of expectations really across the board, but guidance was generally left intact. So just, you know, with that framing, maybe if you could just touch on some of the primary reasons why you left the full year outlook unchanged and whether there's a level of conservatism that's baked into the rest of the year. Thanks very much for taking the questions.

Yeah, Brad, I would just say the second quarter was in line with our expectations, and we're still hopeful that we'll see the gradual improvements in volumes in the back half of the year, which is reaffirming our guidance as well of that 4% to 6% top line growth. Okay, thank you.

The next question comes from Patrick Donnelly with Citi. Please go ahead.

Hey, guys. Thanks for taking the questions. Um, there's maybe one for you, John, just on the, on the margin side, you know, it sounds like the labor environment is, uh, is reasonable here in terms of a backdrop volumes showing the early signs of the recovery. Can you just talk about the margin ramp as we think about the second half and the different moving pieces in the businesses? Um, it feels like things are trying in the right direction. There's just want to talk through, uh, talk to the right way to think about it. Then, you know, maybe just the launching point for 25, just at a high level would be helpful.

Yeah, thanks for the question. Yeah, I mean, margins continue to be really healthy, you know, in the business in large part. The biggest thing is you heard us on the call today is the Nelson margins. Very happy the improvement that we're seeing sequentially, but the mix right now has those, you know, a little lower than we would target. Um, as we said, we see, we see that margin improving, um, in Nelson. We see kind of normal evolution of margin, uh, in the other businesses with, uh, with volume. Um, and we'd expect those margins to approach 50% on the full year basis for the entire company, which would be, you know, your, your launching point for next year.

Okay. That's helpful. Um, and then maybe staying just on, on kind of the financials, nice to see the leverage continue to come down, um, Can you just remind us where we're going to be at the end of this year? And then again, I guess with the CapEx shifting down, maybe just the magnitude, how much that comes down and what the cash flow could look like in the out years would be helpful. Thank you, guys.

Yeah, thanks, Patrick. I mean, you know, I guess I would say first, overall, on the leverage, you know, we continue to expect modest improvement versus prior year as we finish out this year. And as we sit here on the CapEx and overall on the balance sheet and leverage overall, we're very focused on driving free cash flow performance. We've got a pretty disciplined process. Michael and I operate here, and so we're pleased that we're able to push the CapEx number to the lower end of the range. We continue to expect positive free cash flow. for the year, and we expect that to accelerate as we come into the next couple of years as we drive CapEx, complete some of these programs, and drive CapEx lower.

Remember, Patrick, this is Michael, remember that the big outliers that are really driving the outsized CapEx right now is we're in an investment cycle on the stereogenics for some capacity expansions. We've got the NESHAP EO, General Facility Enhancements, and then we have this nor the end capex for cobalt development, which again, we haven't done something like that since around 2002 or 2003. So we're just at an elevated level, as we've mentioned in the past, 24 and 23. We see that stepping down in 25 and 26, as John just referenced.

That's helpful. Thank you, guys. The next question comes from Casey Woodring with J.P. Morgan. Please go ahead.

Great. Thank you guys for taking my questions. I guess maybe the first, can you just walk through Nordian performance in the quarter and what looks to be a bit of a pull forward there? I think you had previously expected 65% of segment revenue in the back half, now it's 60%. And then just curious on visibility for that second half growth rate, maybe if you could give us a sense of the split between 3Q and 4Q for Nordian performance.

Yeah, I would just say, this is Michael, I would say they came in relatively as expected. We do expect just a slightly greater than 60% of the total year revenue to come in the second half. One other point that we didn't call out, all the Russia cobalt we have in-house that we need for 2024, so we feel pretty good about the visibility as well on that side as well when we look at it, Casey. But overall, we feel good about where we sit with the Nordamp piece.

And Michael may have addressed it. I didn't catch your second part of your question.

Just the split between 3Q and 4Q in that back half, you know, 60% of the full year in Nordium.

Yeah, yeah. In Q3, we referenced that we expect upper single digits revenue growth in Q3 and, you know, the balance would be in Q4.

Got it. Okay. And then, you know, just on Sterigenics, curious on the destocking timing here. You know, do you expect that by the end of the year you'll fully work through the noise there and enter kind of a normalized market environment in 25? Or just kind of curious on how you're thinking about the forward outlook there.

Yeah, we would be hopeful that it's stabilized. We continue to see the inventory levels stabilizing and volumes in the end markets continue to perform. We think we'll be pretty well situated going into 25, Casey. Okay.

And maybe just last one quickly for me and then I'll hop back in the queue. Just now that you've had a little bit more time to digest the new litigation in California, just curious if you have any sort of sense of what a timeline to resolution will look like there. Thank you.

Yeah, Casey, no, I would just, there's nothing new really on the litigation front. I would only just tell you on California, the number of case count is consistent with where it was last time we spoke. We're working through case management activities, but we don't see anything in the near term as far as trial activity in California. Okay, thank you.

The next question comes from Luke Sergot with Barclays. Please go ahead.

This is Salem for Luke. Thanks for taking our questions. I know you just touched on the LA litigation. Any updates on Atlanta on relevant trial dates?

On the litigation front for Georgia, I would just say there's nothing maturely changing there. We expect the Phase 1 activity. Remember, it's going to go to two stages of causation, Phase 1 and Phase 2. We don't expect any of those to start before September of 2024, with rulings on that early into 2025. We've had a little bit of increase in the number of case counts there in Illinois, but there's nothing materially significant changes on litigation since our last update.

Got you. Thanks for that. And it might be early to be asking about this, but there are some increasing fears of a hard landing or recession. Could you just remind us how the various businesses kind of typically respond in that type of environment? And you previously mentioned Headwinds and Nelson coming from macro pressures on some SMID customers, for example. So thanks.

Yeah, thanks for the question. I would just say these businesses have performed every single year. As we've talked about since 2005, we've had revenue growth every single year, strong margins, strong cash flow generation. That doesn't mean we won't get impacted by broader macro, but we are really confident in our ability to weather through and the stability of the business model. is really a unique business, especially throughout health care. And remember, we did see on the Nelson side, we had a surge up in demand with COVID, and then coming down, we had the great resignation activities that kind of created some unstable environment there. But overall, that business is a strong performer, and we continue to expect that going forward. But we look at Zotero Health in total. This is a great business that will weather through many storms and continue to deliver growth and strong cash flow.

Was there a follow-up, Luke?

No follow-up.

Thank you. Thank you. The next question comes from Jason Bednar with Piper Sandler. Please go ahead.

Good morning, everyone. I wanted to start on the pricing side. I think you previously referenced last quarter an expectation of being at the lower end of your outlook, closer to something like 3.5%. Sorry if I missed it, but is that still the assumption today? And then would also just be, you know, Good to get your bigger picture perspective on the pricing outlook for your businesses. Inflationary pressures have receded meaningfully across the market. Maybe talk about your ability to continue to push through pricing well above inflation. We've seen a lot of players have their pricing kind of move back to where we were pre-pandemic, but your stock is still sitting in your historical range, which is still good to see.

Yeah, this is Michael. I would just say that our call out in the past, I believe, was around the Nordian business. Across the company, we get 3.5% to 5% price. Nelson's on the low end of that. Nordian's typically on the high end of that. I think what we called out earlier in the year is the timing because last year, Nordian outperformed. We expect it to be on the lower end of the range this year for Nordian. Overall, in the quarter, we're up 4% price in the total company. We expect the business continued to form in the traditional 3.5% to 5% for the remainder of the year.

Okay, that's helpful. Thanks. And then I wanted to follow up on Sterigenics and the margin comps there. They did a little bit tougher here in the back half of the year. You committed to seeing some improvement in Nelson in the second half, which I know you talked about. You have some projects that are coming off. That'll be good. But can you comment more directly on Sterigenics How much of that margin performance in that segment do you see being dependent upon top-line growth improving from what we saw here in the second quarter?

Yeah, thanks for the question. I think I said earlier on the call, the margins continue to be really healthy in stereogenics. Traditionally, we've seen the back half, you know, that margin, you know, has some good leverage to it. So, you know, we've seen the back half with stronger revenues and some stronger margins. You know, assuming we see some stronger revenues, we could see a little bit stronger margin. But, again, the margins today are really, really healthy.

Yeah, and I would just say the one point, the backdrop for the year-to-date numbers, just keep in mind our first quarter is typically the lowest quarter there where you have, you know, less margin leverage coming through. So that's typically what we've seen in this business. But overall, you know, we look at it. We called out Nelson Labs, but we look at the other two businesses. We have very strong, healthy margins and a great position in the marketplaces.

Thanks. And just to clarify, when you say stronger margins in the second half, is that sequentially versus the first half or stronger year over year?

First half.

Okay. Perfect. Thank you.

Great. Thank you.

The next question comes from Michael Pollark with Wolf Research. Please go ahead.

Hi. Good morning. Thank you for taking the questions. First one on sterigenics. I had in my notes that one of your capacity expansions, it was a brownfield, I believe, was going to start filling in the second quarter. I'm curious, did that start, did that happen as expected? And to what extent is that capacity expansion driving kind of the change in trend on volume and mix and stereogenics going from, you know, the last four quarters down 1% or 2%, now we're up 1% or 2%? I guess reframed, like new store versus same store kind of volume trends in stereogenics, how do you see them in light of, you know, your commitment to expanding capacity?

Yeah, Mike, thanks for the question. So that expansion has not impacted the second quarter. We actually are slightly delayed on that. We expect that to come up by the end of the year, normal construction-type delay. So we did not have any good guy from that in the second quarter.

Helpful. Thank you, Michael. And then the follow-up is on the routine testing volumes. And Nelson, it sounds like that's still weak. To what extent does the recovery in stereogenics foreshadow a recovery in the routine testing volume at Nelson?

We would hope that those two are linked in the strong correlation as the year progresses. Okay. Got it. Thank you. Okay. Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Michael Petras for any closing remarks.

Okay, good morning, and thank you, everybody, for your time today. As you can see, we had a solid second quarter as expected. We're confident in our outlook going forward, and the company is very well positioned. So I want to thank you all for your continued support and your questions and attention this morning, and have a great day. Thank you. Bye-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.