Sotera Health Company (NASDAQ:SHC) Q4 2022 Earnings Call Transcript
Sotera Health Company (NASDAQ:SHC) Q4 2022 Earnings Call Transcript March 3, 2023
Operator: Good morning, and welcome to the Sotera Health Fourth Quarter 2022 Conference Call. Please note that this event is being recorded. I would now like to turn the conference over to Vice President and Treasurer, Jason Peterson. Please go ahead.
Jason Peterson: Good morning, and thank you. Welcome to Sotera Health's Fourth Quarter 2022 Results 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 Interim Chief Financial Officer, Michael Biehl. 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 statement slide at the beginning of this 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 and adjusted EPS, net debt, net leverage ratio and 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. The operator will be assisting with the Q&A portion of the call today. I'll now turn the call over to Sotera Health's Chairman and CEO, Michael Petras.
Michael Petras: Good morning, everyone, and welcome to Sotera Health's Fourth Quarter 2022 Earnings Call. This morning, we reported another quarter of year-over-year top and bottom line growth. We have achieved both top and bottom line growth in each quarter since becoming a public company in November of 2020, which speaks to the strength and resiliency of our business model. Consistent with my commentary during our third quarter earnings call, while we see improvement in certain areas of the broader macro environment, some headwinds still exist. Safeguarding Global Health remains our mission as we execute on delivering growth and profitability for our shareholders. Michael Biehl will provide more detail on the financial results in a moment.
But first, I want to highlight a few items from our fourth quarter and full year results. We reported total revenue growth of 4.3% and adjusted EBITDA growth of 4% compared to the fourth quarter of 2021. We delivered adjusted EPS of $0.25 for the quarter which is a $0.02 increase over the same period last year. For the full year, revenue grew by 7.8% and adjusted EBITDA grew by 5.2% compared to the prior year. I am proud that we've extended our streak of annual revenue growth, which we have achieved since 2005 when we started tracking it. Let me now shift to cover each of the business unit results. Sterigenics, our largest reporting segment, delivered 7.6% top line growth for the quarter. The segment saw solid demand across all modalities for the full year, Sterigenics delivered 9.6% revenue growth.
Consistent with our Sterigenics strategy, we are making significant investments in additional capacity across our global network. Currently, Sterigenics is progressing with 7 capacity expansions across all major geographies and modalities. We are also advancing our EO emission control enhancements across our North American facilities. These industry-leading enhancements underscore our ongoing commitment to ensure best-in-class operations for our employees, customers and the communities in which we operate. Nordion, our other reporting segment within the sterilization services business had a good year. At the beginning of 2022, we indicated that a total disruption of cobalt-60 supply from Russia could result in an up to 3% impact on total Sotera Health revenues.
I am pleased to say that the Nordion team has done an exceptional job navigating this geopolitical risk in 2022 and avoided the potential 3% revenue risk from Russian supplied cobalt-60. As we consistently message, Nordion's revenues are lumpy due to the timing of cobalt-60 harvest supply schedules. As expected for the quarter, Nordion's revenue declined by 7.1%, which was driven by the timing of cobalt-60 harvest schedules. However, when viewed on a longer-term basis, Nordion's revenue stream is very consistent. For the year, Nordion's revenues were up 9.3%. 2022 was a challenging year for Nelson Labs, our lab testing and advisory service business. Fourth quarter 2022 revenue grew by almost 3% compared with the same period in the prior year while revenues grew approximately 2% year-over-year or 4.4% on a constant currency basis.
I am pleased with the Nelson team as they navigate through labor and supply chain challenges in 2022. Overall, 2022 was a good year for Sotera Health considering the uncertainty driven by macroeconomic pressures in geopolitical events. As projected, we deployed the greatest amount of capital in the company's history the fund capacity expansions, cobalt development, EO, emission control enhancements in various operational excellence projects across each business. This level of investment speaks to the company's commitment to growth. Additionally, our balance sheet ended the year in a strong position with net leverage finishing at 3.2x, well within the long-term range of 2 to 4x. As communicated in the press release last week, Sotera Health closed on the issuance of a $500 million Term Loan B.
The proceeds of this incremental debt financing, along with cash on hand, will be used to fund the $408 million ethylene oxide litigation settlement in Cook County, Illinois, paying off the existing borrowings under our revolving credit facility to further enhance liquidity and for other general corporate purposes. We are pleased that this issuance received such very positive interest from the market and puts us in a strong liquidity position moving forward. Although this new borrowing will initially increase our net leverage ratio slightly above 4x, we expect net leverage to settle within our long-term target range of 2 to 4x by the end of 2023. As for the Illinois EO settlement, the plaintiff executive committee reports that the process is on track for participation rates to be determined by the late April or early May.
We are scheduled to fund an escrow account for the settlement on May 1 and subject to participation by substantially all the eligible claimants, we expect the settlement to be completed in the settled cases to be dismissed by late July or early August. I also want to take a moment to highlight the progress made on our ESG initiatives this past year. While I reflect on how far we've come in the past year, I am proud of our team's accomplishments. As part of our IPO, the Board established ESG oversight with our nominating and corporate governance committee. We established an internal cross-functional ESG committee, which reports into me and appointed 2 seasoned senior executives as co-chairs to help lead the identification, implementation of ESG initiatives consistent with our overall business strategy.
During 2022, we achieved numerous corporate responsibility accomplishments. I want to highlight a few of the specific activities. In the environment area, we established consistent environmental health and safety metrics across our global businesses. We launched a new global EHS policy added incremental EHS leadership and engaged a third-party software solution to assist in establishing baseline EHS metrics. In addition, we continue our investment in state-of-the-art emission controls at our EO facilities. With respect to human capital, culture in our communities, we completed our annual global employee engagement survey with 84% participation. We launched the Sotera Health Women's Network, leveraging the work done at Nelson Labs on women's leadership development and expanding its impact across the company.
Additionally, we developed a new career website and completed our Leading For Our Future leadership Development Program, which had the project team focused on ESG activities. In 2022, we also launched a new corporate responsibility website and published our first corporate responsibility report. In addition to the operational and financial performance, our ESG initiatives combined to make an impressive and very busy year for the team. We look forward to reporting on our ESG progress in future calls. As we look forward to 2023, we will continue to focus on our priorities. A few of these are investing for organic growth, which includes adding capacity, enhancing our infrastructure and investing in cobalt development programs. We will continue to invest in upgrades to our North American EO emission control systems.
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We remain committed to our focus on operational excellence, which involves improving customer service across our businesses. We will continue to be disciplined with capital while deleveraging our balance sheet during the course of the year. Today, we also provided our initial outlook for 2023. For the full year 2023, we expect total revenues in the range of $1.055 billion to $1.090 billion, which represents growth of approximately 5% to 9%. Adjusted EBITDA in the range of $530 million to $550 million, resulting in growth of approximately 5% to 9%. And adjusted EPS in the range of $0.78 to $0.86, representing a decline of 10% to 19%, which is driven by increased interest expense and expected increase in our adjusted net income tax rate. Now Michael Biehl will take us through the financials in more depth.
Michael Biehl: Thank you, Michael. I'll first cover the fourth quarter 2022 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'll conclude with some additional details around the 2023 outlook. On a consolidated total company basis, fourth quarter revenues grew by 4.3% as compared to the same period last year to $252 million. This equates to 7.2% growth on a constant currency basis. Adjusted EBITDA grew by 4% from the fourth quarter 2021 to $130 million. Adjusted EBITDA margins were 51.5%, representing a slight decline from fourth quarter 2021 levels. Our operating performance drove adjusted EPS of $0.25 an increase of $0.02 from the fourth quarter of 2021.
Fourth quarter 2022 had a net loss of $320 million or $1.14 per diluted share which includes a $408 million legal reserve recorded in the quarter compared to net income of $36 million or $0.13 per diluted share in the fourth quarter 2021. This legal reserve is related to the binding term sheet to settle the ethylene oxide claims in Cook County, Illinois. Our reported interest expense of $32 million is burdened by a mark-to-market loss on certain outstanding interest rate hedges for which we did not elect hedge accounting. We've removed the effect of that loss in our adjusted earnings per share. Excluding this loss, fourth quarter interest expense was approximately $25 million. Now let's take a closer look at our segment performances. In the fourth quarter, Sterigenics delivered another strong quarter with approximately 8% revenue growth to $162 million and 7% segment income growth to $89 million as compared to the fourth quarter of last year.
On a constant currency basis, Sterigenics grew revenues over 10% compared to the fourth quarter of last year. Revenue growth drivers for the fourth quarter included favorable pricing of 5.6% and favorable volume and mix of almost 5%, partially offset by unfavorable changes in foreign currency exchange rates of 2.6%. Compared to the fourth quarter of 2021, segment income margins contracted by 20 basis points to 55.1% driven by the timing of pricing actions versus realized inflation. Sequentially, margins did improve in each quarter of 2022. Nordion's fourth quarter revenue declined by approximately 7% to $34 million compared to the fourth quarter of 2021, which is driven by the timing of cobalt-60 supply schedules. Nordion segment income declined by more than 5% to $20 million compared to the same period last year.
On a constant currency basis, Nordion's fourth quarter revenue declined by 3% versus the same period last year. Nordion's revenue change versus fourth quarter 2021 was driven by volume decline of nearly 14%. Headwinds associated with changes in foreign currency exchange rates of over 4%, offset by favorable pricing 11%. Nordion's margins were 59.5%, a 130-basis-point improvement from fourth quarter 2021 margin levels, which is driven by pricing contributions, partially offset by mix. For Nelson Labs, the fourth quarter of 2022 revenue improved 2.7% to $56 million compared to the fourth quarter of 2021. Segment income of $20 million was less than 1% favorable versus fourth quarter 2021. On a constant currency basis, Nelson Labs grew revenues 5.3% compared to the fourth quarter of last year.
Revenue growth for the fourth quarter of 2022 was impacted by a 5.5% benefit from pricing, partially offset by headwinds associated with changes in foreign currency exchange rates of 2.6%. Fourth quarter 2022 margins for Nelson Labs contracted to 36.3% or approximately 90 basis points versus fourth quarter 2021 margin levels. This decline was driven by inflation increased staffing in anticipation of incremental volume, partially offset by pricing improvements. Even though there was a margin decline versus the same quarter last year, fourth quarter 2022 was the highest margin rate for the year as margin expanded 180 basis points compared to the third quarter. Prior to providing highlights related to capital deployment net leverage, I would like to touch base on cash generation.
Due to the critical nature of the services we offer and the strength of our business model, we generated $278 million of operating cash flow during 2022. This robust cash flow allows us to fund operating needs and invest for future growth. As of December 31, 2022, we had $396 million in cash, and over $475 million of available liquidity, and our net leverage fell to 3.2x of adjusted EBITDA. In November, we borrowed $200 million on our revolving line of credit to enhance liquidity in connection with litigation needs, which was held as cash on the balance sheet at year-end. This revolver borrowing was paid off during the first quarter of 2023 with cash on hand and proceeds from the recent $500 million Term Loan B financing, which we have borrowed primarily to fund the Illinois EO litigation settlement.
Our CapEx for fourth quarter and full year 2022 was $72 million to $182 million, respectively. Both CapEx and facility enhancements drove the increased investment levels for 2022. Inflationary impacts as well as some opportunistic spend earmarked for 2023, drove our investments above the $170 million upper end of our 2022 guidance range. Finally, I want to provide additional color around our 2023 outlook. I'll start with a quantitative summary and finish with our assumptions. For full year 2023, we expect total revenues will be in the range of $1.055 billion to $1.090 billion representing an annual growth rate of 5% to 9%. Adjusted EBITDA will be in the range of $530 million to $550 million, also representing an annual growth rate of 5% to 9%.
Effective tax rate applicable to adjusted net income in the range of 30% to 33%, so I want to provide some color on due to the increase compared to the prior year rate. As many of you may recall, 2017 U.S. tax reform provided for limitations on the deductibility of interest. U.S. tax reform provided for a change in 2022 whereby deductibility will be further limited. This, combined with higher interest expense due to increasing interest rates, along with the large carryforwards of nondeductible interest from prior years, has resulted in a larger valuation allowance and a higher effective tax rate for 2023. Adjusted EPS is expected to be in the range of $0.78 to $0.86, this represents a decline of 10% to 19%, which is primarily driven by increased interest expense as well as the increased tax rate.
Fully diluted share count in the range of 283 million to 285 million shares on a weighted average basis, capital expenditures to be in the range of $185 million to $215 million, representing continued elevated investments for growth as we continue to fund capacity expansions at both Sterigenics and Nelson Labs as well as invest in EO emission enhancements in North America and cobalt development projects at Nordion. With the closing of the $500 million Term Loan B, our leverage will increase slightly above our long-term stated target range of 2 to 4x. By year-end 2023, we expect to be back within this range. From a qualitative standpoint, our assumptions are as follows: we're anticipating labor market and inflationary pressures to continue into 2023, as well as some continued indirect impact from supply chain disruptions.
We expect that Russia will continue to face more sanctions as the war in Ukraine heads into its second year, but we believe Nordion will continue to be able to navigate the challenges. Authorities around the world understand the importance of cobalt-60 produced in Russia to the global health care system. Michael will touch on the risk associated with the disruption of cobalt-60 supply from Russia in a minute. As we look at the cadence of quarterly reporting, I'll comment briefly on each business unit. We expect our largest and most consistent business, Sterigenics, to have lower volumes and margins in the fourth quarter as typical and we'll realize increased volumes and margin expansion through the rest of the year. Keeping with the typical cadence, the phasing of Nordion's financial performance is driven in large part by harvest and shipment schedules for cobalt-60.
2023 will be particularly lumpy as almost all of the first half 2023 revenues and segment income will occur in the second quarter. While approximately 75% of Nordion revenues and 80% of segment income will be realized in the back half of the year. Returning to a pre-pandemic quarterly cadence. Nelson Labs expected to have lower margins in the first quarter of 2023 and are expected to expand margins through the year. We expect margins to climb back to normal run rate levels in the mid- to high 30s in the back half of the year. From a foreign currency standpoint, our guidance assumes that year-end 2022 rates remain relatively constant for the year. From a capital deployment standpoint, we continue to prioritize growth initiatives, deleveraging our balance sheet and long-term strategic acquisitions.
We do not assume any acquisitions in our guidance. I'll now turn the call back over to you, Michael.
Michael Petras: Thanks, Michael. Prior to transitioning to a question-and-answer session, I would like to address the topic of Nordion sourcing of cobalt-60 from Russia, which has been previously discussed. Nordion has always had an outreach program to ensure the governments and regulators around the globe understand the importance of cobalt-60 produced in Russia to the health care community as approximately 30% of the global medical devices are sterilized using gamma radiation. We continue to engage in regular dialogue with these officials and are carefully monitoring the geopolitical situation to protect the supply of cobalt-60. At the present time, we continue to receive supply of cobalt-60 from Russia and believe that we'll be able to continue to procure cobalt-60 from Russia.
Our 2023 guidance is based on our current understanding of previously announced sanctions by the United States, United Kingdom, Canada and the European Union. That said, there is no way to predict what certainty how sanctions against Russia will unfold in the short, mid or long term. If there was a full disruption of cobalt-60 supply from Russia, we would expect an impact of between 0% and 3% of total Sotera Health 2023 revenue. This is identical to the guidance originally provided in 2022 and for which we experienced no impact. Before transitioning into the Q&A session, I want to reemphasize that Sotera Health remains in a strong position for both growth on the top and bottom line in 2023. Overall, we feel very good about the company's current and future prospects.
At this point, Operator, let's open the call for Q&A.
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