Q2 2023 Sotera Health Co Earnings Call
Good morning, and welcome to the Superior Health second quarter 2023 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.
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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 Tusa Terra Health's second quarter 2023 results call you can find today's press release and accompanying supplemental slides on the investors section of our website at <unk> Dot com.
This webcast is being recorded and a replay will be available in the investors section of the Terra health website on the call with me today are chairman and Chief Executive Officer, and Michael Pietrus, 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 <unk> 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 net income adjusted EBITDA adjusted EPS net debt adjusted EBITDA margin segment income margin and net leverage ratio. In addition to constant currency comparisons a reconciliation of GAAP to non-GAAP measures for all relevant periods may be found in the <unk>.
Attached to the company's press release and in the supplemental slides for 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 in the Investor Relations team I will now turn the call over to so Terra health Chairman and CEO Michael features.
Good morning, everyone and thank you for joining Terra health second quarter 2023 earnings call I would like to take a moment to introduce our newly appointed Chief Financial Officer, John Lyons.
John comes to Us from Owens Corning, a 10 billion dollar global building construction materials leader, where he served in various executive roles.
Prior to Jon's time with Owens Corning. He served in several senior leadership positions at Cardinal Health after beginning his career in public accounting.
John brings a wealth of financial acumen.
I'd also like to take a moment to thank Michael Biehl for his contributions as the interim CFO for Sutera health Michael. Thank you for your commitment and support over the past year and lean the company's finance organization.
As previously communicated on June 30th the settlement funds of approximately $408 million related to the Illinois ethylene oxide claims were released from escrow and on July six the claims against stair genetics of the 879 claimants, who opted into the settlement were dismissed with prejudice.
Although we continue to believe these claims are without merit. We're pleased this settlement is finalized one month ahead of schedule. Thanks to the efforts of our legal team.
And with a 99.7% participation rate.
In a moment John will review, our second quarter 2023 results in more detail, but first I would like to review a few items from the quarter.
Total company revenues declined four 3% and adjusted EBITDA declined five 6% compared to the second quarter of 2022 driven primarily by the expected timing of New Orleans, Cobalt 60 harvest schedules.
We delivered adjusted EPS of 21 cents for the quarter, which is a 6% decrease from the same period last year.
<unk>, our largest reporting segment delivered five 6% topline growth for the second quarter of 2023.
Sir James continues to service our customers, even though the global economic outlook is challenging with lingering customer inventory and supply chain challenges and inflation.
Although Sarah James volumes are lighter than plan the share Jack's team has prudently managing costs, which has contributed to a 310 basis points segment income margin improvement compared to the first quarter of this year.
During the quarter the team completed two expansion projects and they continued to make progress on our E O facility enhancements in North America.
These industry, leading enhancements demonstrate our commitment to ensure best in class in Michigan trolls for our employees customers and decrease in which we operate.
Nordion, our other reporting segment within the sterilization services business experienced a 37% year over year revenue decline due to the timing of cobalt 60 harvest schedules we.
We have good visibility into the timing of the Orange revenue as it's tied to the harvest schedules from our cobalt 60 suppliers as previously conveyed and Orient 2023.
Revenue will be particularly lumpy as approximately 75% of the revenue is expected to occur in the second half of the year with approximately 50% of the year's revenue occurring in the fourth quarter.
Nordion does continuing to source a portion of its cobalt 60 supply from Russia at the start of the year. We stated that a total supply disruption from Russia could potentially result in a zero to 3% impact on total 2023 so terra health revenues at this juncture in the year, we are confident that there is.
Zero risk to Russian supply impacting total so terra helped full year 2023 revenues.
The cobalt 60 supply chain is a complex one and I'm proud of the continued efforts by our nursing team to ensure availability cobalt 60, he's used to sterilize approximately 30% of the world's single use medical devices is critical to the global health care community. This is a great example of how we play a critical role in safeguarding global Hell.
<unk>.
Nelson Labs, our lab testing and advisory services business experienced sequential growth and expanded margins of approximately 680 basis points or the first quarter of this year revenues in the second quarter of 2023 were $2, 8% below the prior year quarter, which had experienced record revenues.
However volumes continued to be challenging in our lab business in light of the softer than expected volumes and Nelson labs team is actively managing costs, while keeping focus on quality and customer satisfaction.
Due to the volume softness that stair Jackson Nelson labs that we expect to continue we are adjusting our full year 2023 outlook.
Full year adjusted EBITDA growth to be in the range of approximately 3% to 6%.
We are confident that we've taken into account weaker volumes and other market dynamics reflected in is it in this adjusted range. We will continue to concentrate on executing our strategy.
To best serve our customers around the globe.
Prior to John walking us through the financials in more detail I'd like to take a minute to underscore our mission safeguarding global health, which is at the heart of our work we performed government mandated sterilization validation testing for medical and pharmaceutical products used each and every day.
We supply cobalt 60 for radiation oncology professionals to help treat brain cancer. In addition, we provide critical technical and regulatory expertise to solve our customers' product development Australia needs.
Our indispensable service itself to protect millions of patients and health care providers around the world.
One such example of how we shape our global health is VR team at Nelson Labs, Europe , which performed extractable mutual studies for single use nasal spray using lifesaving rescue treatment of patients experiencing an opioid overdose.
The societal impact of this FDA approval is significant it's overdoses caused by the use of synthetic opioid drugs, including federal Unfortunately remain a major in chronic problem in our society.
Another example of our team's fulfilling our mission is highlighted through a video link located on the safeguarding global health Slide in our second quarter 2023 earnings presentation released this morning and available on our Investor Relations website I encourage you to watch the video to learn about how stair Janice and Nelson.
<unk> labs work in conjunction to ensure critical sterilization embattled validation testing are performed for the successful delivery of vaccines around the world.
Now John will walk us through the financials.
Thank you Michael I want to begin by saying how excited I am to join so Terra health, which hold such a unique position in the global healthcare supply chain.
I look forward to working with our talented team and also look forward to meeting many of you in the near future.
I'll begin by covering our second quarter 2023 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 conclude with some additional comments on our updated 2023 outlook.
On a consolidated total company basis second quarter revenues declined by 44, 3% as compared to the same period last year to $255 million.
This equates to a four 1% decline on a constant currency basis as foreign exchange headwinds are monitoring are moderating for the company.
As mentioned on our first quarter call. We expect continued moderation of foreign exchange headwinds and expect foreign currency to become a tailwind during the back half of the year.
Adjusted EBITDA declined by five 6% compared to the second quarter of 2000 $22 million to $128 million.
Adjusted EBITDA margins were 53%, representing a 73 basis point decline from second quarter 2022 levels. The decline in margins is driven by the lower volumes from Nordion and Nelson labs experienced versus Q2 2022.
Importantly, EBITDA margins were up sequentially in Q2 on the improvement in <unk> and Nelson that Michael referenced earlier as well as higher volumes from Nordea.
Adjusted EPS was <unk> 21.
A decrease of <unk> <unk> from second quarter of 2022, the result of lower EBITDA and higher interest expense versus the prior year.
Net income for Q2, 2023 was $24 million or <unk> <unk> per diluted share compared to net income of $30 million or <unk> 11 per diluted share in Q2 2022.
Our reported interest expense for the second quarter 2023 was $31 million, which is an increase of approximately $17 million versus the same period last year.
The increase is driven by higher rates on our variable rate debt as well as incremental interest on our $500 million term loan that closed in Q1 of this year.
Now, let's take a look at our segment performance.
For the quarter <unk> delivered five 6% revenue growth to $167 million as compared to the second quarter of last year.
Revenue growth drivers for Q2 2023 included favorable pricing of six 7% and favorable changes in foreign exchange rates of almost 1%, partially offset by unfavorable volume and mix of one 7%.
Compared to the prior year quarter segment income for Q2, 2023 increased seven 5% to $91 million and segment income margins increased by 100 basis points to 54, 9% driven by favorable pricing, partially offset by unfavorable volume and mix and inflation.
It's already on second quarter revenue declined by approximately 37% to $32 million.
Compared to Q2, 2022, which we expected based on the timing of cobalt 60 harvest schedules.
<unk> revenue decline was driven by unfavorable impact from buying a mix of nearly 39% and changes in foreign currency exchange rates of almost 4%.
We offset by a favorable impact from pricing of five 7%.
Segment income declined 47% to approximately $18 million and segment income margin decreased 380 basis points to 55, 6% compared to the same period last year.
Segment income in segment margin changes versus second quarter of 2022 were due to the unfavorable volume and mix offset by favorable pricing.
For Nelson Labs second quarter, 2023 revenue declined by two 8% to $57 million compared to the second quarter of 2022.
Revenue was impacted by unfavorable volume and mix of six 9%.
Partially offset by a three 6% benefit from pricing and favorable changes in foreign currency of almost 1%.
Nelson Labs second quarter 2023 segment income decreased by eight 6% to 19 million and segment income margins contracted by over 200 basis points to 33, 9% versus second quarter 2022.
This decline was due to unfavorable volume and mix as well as inflation, partially partially offset by favorable pricing.
When adjusting for the $408 million outflow cash provided by operating activities was a source of over $100 million for the first six months of 2023, which was in line with the same period last year.
As of June 32023, we had approximately $635 million of available liquidity, which includes $263 million in unrestricted cash and $372 million of available capacity on our revolving line of credit.
As expected our net leverage ratio at the end of Q2 2023 was four two times.
This was an increase from the year end 2022 level of three two times due to the new $500 million term loan issued in connection with the ethylene oxide settlement and the associated $408 million payment.
Our capital expenditures for the second quarter 2023 totaled $53 million.
Growth Capex and facility enhancements drove the increased investment versus Q2 of last year.
Now turning to guidance.
We are adjusting the full year 2023 outlook, we provided in February .
We now expect total revenues to be in the range of $1 35 billion to $1 <unk> 5 billion.
From our previous range of $105 5 billion to 1.19 billion, representing annual growth rate of approximately 3% to 5%.
From a quarterly shape perspective, as Michael mentioned, we anticipate that approximately half of <unk> full year revenue will occur in the fourth quarter.
For the full year, we expect adjusted EBITDA to be in the range of $520 million to $535 million from a range of $5 $30 million to $550 million, representing an annual growth rate of approximately 3% to 6%.
The tax rate is now expected to be in the range of 30% to 32% from our previous range of 30% to 33%.
Weighted average diluted shares remain in the 283 million to $285 million range.
Adjusted EPS remains in the range of <unk> 78 to 86 cents.
We now expect capital expenditures to be in the range of $200 million to $215 million at the upper end of the previous range of 185 million to $215 million driven primarily by increased capitalized interest from higher borrowing costs.
Lastly, we expect net leverage to finish the year at or below four times.
Now I'll turn the call back to Michael.
Thank you John .
At this point operator, let's open the call up for question and answer.
We will now begin the question and answer session to ask a question you May Press Star then one on your telephone keypad, if youre using a speakerphone. Please pick up your handset before pressing the keys.
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We ask that you please limit yourself to one question and one follow up if you have additional questions you may reenter the question queue.
At this time, we will pause momentarily to assemble our roster.
And the first question will be from Patrick Donnelly with Citi. Please go ahead.
Hi, you Brendan on for Patrick.
Thank you so much for all of the.
Clarity with the revised guidance actually wanted to ask on the settlement in Illinois with the three cleanup that decided to opt out.
Any idea what the timeline is moving forward.
Hi, Good morning, Brendan It's Michael No. We don't we are waiting on the courts to tell us the timelines and scheduling plans.
Great. Thank you and then second question is a follow up on how should we think of pricing in the second half of the year.
Given the reduced volumes.
Great. Thank you so much thank you.
And the next question will be from Sean Dodge from RBC capital. Please go ahead.
Yeah. Thanks, good morning.
And congratulations John .
Glad to have you here.
Michael.
The sequential improvement in <unk> margins can you just walk us through in a little bit more detail what drove that and then.
As we think about the expectation that volumes, there will be a little bit softer than maybe initially contemplated how much adjustment or maybe how much more adjustment can you make to that cost structure in the short term to try and right size for that.
Yeah, Good morning, Sean.
We will continue to be efficient as best we can in our operations as we look across all three businesses as the buying software.
We've had some challenges as you've probably seen and heard in other areas that inventory destocking and inventory levels in some of our customers, but we feel pretty good about the margin levels and consistent performance, we get out of <unk>, there isn't huge flexibility on that cost structure. There is some labor aspect within those operations, but they're not large operations. If you take a given facility.
Okay, Great and then on the Eo emissions.
The regulations there.
Any more updates or thoughts on the proposed rule there from the EPA in and what the final rule could look like and I guess have you been in communication with the EPA says the proposed rules were.
Elyse.
So we submitted comments and I think there was probably in total something like 40000 comments across the industry.
Our expectation is the EPA, they're working under consent orders should we expect them to have some type of adoption of our niche app by March of 2024, that's the current timeline that we're expecting to see final rules, we've had conversations with our regulators through different trade groups.
They are aware of the inputs from us as well as many others.
Okay, great. Thanks again.
Thank you Sean.
And the next question is from Dave Windley from Jefferies. Please go ahead.
Hi, Good morning, Thanks for taking my question, Michael We've we've talked in the past about.
Kind of the volumes that the industry the broader health care industry as seen on the med Tech side and.
Hospital volumes have been rebounding in returning to pre pandemic levels in many many facets around the world. We're seeing we're seeing that we do see inventory pressure at our customers. We see that as I mentioned last quarter, we're seeing that continue into this quarter, we will see that.
That doesn't mean, we're not seeing improvements in cardiac devices orthopedic. It's just when you look at it in totality, there's categories that are down, particularly when you look at <unk> you look at the surgical kits and areas like that where there was lots of inventory buildup because people are scrambling to get it.
During the Covid time period, so I don't want you to walk away thinking that we're seeing it across the board.
Significant customer growth and many many customers in the categories I just referenced as.
As far as price listen that's always a conversation we have with customers or somebody on the other end of that conversation, we feel confident about our ability to continue to get price because of the great share, which we bring in the criticality of our services.
But thats always a delicate conversation stirrer.
<unk> in the quarter continue to have a nice a nice quarter and outside of the volume and mix was just a little softer, but we factored it into our thinking going forward and we think as I mentioned just previously when asked the company in total will get three 5% to 5% price, depending on which business you're talking about it in our outlook right. Okay, Great and then maybe.
Relatedly, but but bigger picture on your guidance on your margin implication in the in the new guidance is.
Not a lot, but slightly higher in fact, then than where it was in the past so you're kind of taking cost out faster than than the revenue decline.
Could you talk a little bit more detail about the areas, where you're able to do that.
Without without further implicating or further compromising revenue.
Yes.
David We don't we're going to continue to do the right things around cost and make sure. There is a balance here taking care of our customers, but this is not a cost play this business in total as we've talked about many times is a high single digit organic grower, we feel confident in our ability to return to those levels. When we get through this abnormal time period, if you will with some of the Destocking.
<unk> bio processing challenges that are out there I mean bio processing using a huge segment for us, but it does impact us as well, particularly in the <unk> a little bit of Nelson.
Did in the quarter that you saw here in the first quarter was abnormally low but as we messaged in the past that is always our lowest quarter to year, but I don't want you to think this is a big machete bunch.
A bunch of cost out play that's not what this business is about we feel confident in our ability to continue to grow this business and high single digits and worked through this current cycle. We're in.
So I just wanted to be clear with that David will continue to drive efficiency, you know, Mike and Joe and particularly our working operating efficiencies and her team and as you may recall late last year, we built up.
Appropriately let some of those those head counts if you will trend down on a natural level, but I don't want you to think.
Getting super aggressive and just taken a bunch of cost out yeah got it that's very helpful. Thanks for the additional detail yeah, great. Thanks, David.
And the next question is from Luke Circuit from Barclays. Please go ahead.
Hey, good morning, Thanks, just a follow up on <unk> question. There. So on the on the volume side, you mentioned a little bit bio processing can you talk can you kind of break out where the weakness was.
Of med device versus the pharma non devices business that you guys have.
So I would just say look.
<unk> processing, we see that the <unk> business, mostly it's not a huge portion but it is good mix for the company.
You know that industry as you've seen with some of our customers have publicly gone fourth in the last weeks. They continue to struggle with volumes. So that I would tell you that's where we're seeing it.
We also have some food and cosmetics within Hysteriagenic side, that's been a little softer in the current cycle and then also med med Tech.
On the lab side, it's med device and some bio processing and some of the pharma side as well Biopharma in particular.
Okay.
Any quantification on how the bio processing volumes are down just just to frame. It and then I have a follow up on like your your outlook, yes, theyre down significant double digits.
Cool and then so you had excess of probably 30% or so.
Okay. That's helpful.
Can you just give us a sense of how the quarter paced out what's your exit rates, where anything that gives you that confidence where you can say, yes things are going to start getting better and step up.
Yes, there is.
The cyclicality in this business a little bit as you saw first quarter to second quarter. We when we look at the third quarter, Doug I'll take you Stare James If you look at the third quarter, we will see a slight improvement slight if you will versus second quarter and slight improvement again in the fourth quarter and then the Nelson side, obviously in the northern <unk>.
We gave prepared remarks on that 75% of the revenue beat in the second half with 50% of the total years revenue will be in the fourth quarter. So you can kind of figure how that it's a big hockey stick, which we knew all year long and the Nelson side Youre not going to see significant growth. When you look at it the back half of the year from the levels that we're at here in the second.
<unk> third quarter will be a little lighter than the fourth quarter. When you think about it that way that.
That's helpful. Thank you.
And the next question is from Casey Woodring from J P. Morgan. Please go ahead.
Great. Thank you for taking my questions and welcome John .
So yes, as a follow up to the Nelson point it looks like Nelson revenue came in inline with expectations. Today. So I'm just wondering if the new guide is contemplating a slower recovery and Nelson and the back half than maybe what you had originally thought.
Guiding the flat revenue here sequentially.
Or was the revised guidance here, mainly lower stair Jack volume and then just what are you hearing from customers and Nelson any sort of order trend commentary that you can get so far is through <unk>.
Yes.
Thank you I would say on the Nelsons, both Nelson <unk>.
Ben.
<unk> had been factored in the softness have been factored into the guide consist with the comments I just made a little bit ago, you will see third quarter, a little lighter than you see in second and Youll see fourth quarter more in line with kind of a second so you'll have a relatively flat. If you will second half of the year versus where we finished second quarter.
As far as what we're hearing from customers one of the things. We really are obsessed with is quality and service, making sure net promoter scores. We continue to see improvements in stability in that area, which we're proud of him.
Hit-or-miss, we've got some customers that have that meet some new product testing a high priority for them. So that does have an impact we know MTR has slowed down a little bit in Europe , which was having a big impact and then we've done a really nice job in our Biopharma area over the last couple of years and that's a little choppy here than we'd like but overall we're real.
Confident on where the Nelson business goes long term you also saw the step improvement in margins the second quarter that we told you to expect.
The first quarter is always the lowest and when you look at where those margin levels.
That's pretty consistent with what we see here near term, but the mid term, we expect it to get to mid to longer term, we expect it to be in the mid <unk> as we've told you in the past.
Yes.
Particularly important here given the rising interest rate environment, and then what should we be modeling for interest expense for the back half of the year. Thank you.
Yeah, Let me, let me unpack a few of those I think taken in turn I think your first question was around around Capex.
We've got about $100 million, we've spent through the first half of the year really all our programs are on track we're out in front I think of the EPA regulations, a little bit as we've been going on in our facility enhancement. So theres no real change on what we've been doing there were executing our plan and really driving that improvement across our network.
The biggest thing that changed is we have this rising rate environment is and some pretty extensive capex programs as we have an uptick in capitalized interest that's pushing us into the top end of the range.
Give you a flavor, it's a little north of $10 million in total capitalized interest for the company.
I'll take your last question failing remember the second one right off top of my head.
Around debt Paydown.
So I was just a question sorry.
We're evaluating a little bit of debt Paydown, we feel really good the team did a nice job, giving the term loan in place and improving our liquidity position. So we feel really good about the liquidity position that we have and we're considering debt paydown as we look at the back half of the year and over the next year, but no immediate plans just yet.
And then just lastly, as you think about interest expense, we do expect an uptick in interest expense in the second half we did about 60.
$60 million of interest expense in the first half.
We would expect about a 40% increase versus that number in the second half and it's really driven by a couple of factors most notably the increasing rate environment. We're in and we have some we have some hedges that.
Were advantageous that are rolling on a little more advantageous than the hedges that we have remaining.
And then we have the annual or the.
For a full six months of the term loan that came in at the beginning of February .
Thank you.
And the next question is from Matthew Mission from Keybanc. Please go ahead. Thank.
Hey, good morning.
You guys said you completed two expansion products in the quarter.
The softer volume environment impact your ability to kind of build those over the near term.
I'm, sorry, Matt I didn't hear that last part you trailed off.
I said that.
Does the softer demand environment impact your ability to kind of fill those that filled that extra capacity over the near term.
Over the near term no actually one of those is actually doing very very well. So I would say I would say not.
Okay, and then Michael I think Nelson labs, as there has been a recurring.
Negative theme for almost a couple of years now.
Just how much time do you personally plan to spend on Dallas and labs in the second half like digging in on that business.
And that business very frequently.
We just made sure he understand that one of the things we've talked about in the past.
That business has been a consistent performer pre pandemic. It was probably the mid thirties and margin rates, we got a big bolus of volume that came in in PP&E that was great mix that we really did a great job digesting. It took our margin rates up significantly higher than our expectations, we were able to execute against that.
But it's something that we all spend time on making sure that we're doing the best we can and take care of our customers in that segment.
Thank you.
And again, if you have a question. Please press Star then one.
The next question is from Michael Polack from Wolfe Research. Please go ahead.
Good morning. Thank you for taking the question another twist on the guidance update you know Michael to your credit earlier. This year, you were calling out potential destocking.
<unk> was again, a little light versus the street in line with Us as I. If you hadn't told me any adjustment to the full year I would have I think with a straight face been able to pencil out.
The back half as a prior well as it previously was so kind of getting back to your.
Old range and so you know look fanatically you seem to have anticipated.
Some of these challenges I'm just wondering what changed is it just the medical you had it numerically it was softer and that's that's the answer or you know and maybe bring in John here, John just curious if there's kind of a.
Change in guidance philosophy now.
Now that you're in the seat so any color on this front would be great.
Yes, somatic Lee with <unk>.
Time, when we talked last time Mike.
We saw we saw some concerns around the sources, but you don't know exactly where as we've talked about in the past, we don't know exactly where our customers' inventory levels are we've got thousands of customers on the <unk> side and how that's going to play out. It's a really mixed bag as I mentioned earlier in this call. We've got some categories are doing really really well and then there is some others that aren't in it.
The impact of that I think it's to your point to medically we've seen it in.
Numerically, we wanted to make sure we're being thoughtful as we give guide the rest of the year based on what we're seeing but we're still very bullish on this business overall and our ability to continue to deliver significant growth year in year out.
Right now we want to make sure we're being responsible and messaging to you John can give you a reaction.
Philosophy on guidance, but.
My initial reaction is that Michael and I are very much aligned on our approach to this we want to tell you what we see in a timely manner.
Why.
Look down the field and make sure we're telling you what we see in hitting the numbers that we put out there it's a very important to us.
And we will continue to work at it.
Helpful for the follow up just can you refresh us on just sterile <unk> capacity expansion projects how many.
Our in process and over the next say 18 months.
How many what do you expect to start going live in filling up.
Yes, so we've got four of them still in process and those will start rolling out one late this year and then a couple into next year and the following year.
Thank you so much.
<unk>.
And ladies and gentlemen, this concludes our question and answer session I would like to turn the conference back over to Michael Pietrus for any closing remarks.
Great. Thank you Chad. Thank you everybody for joining us this morning.
Appreciate your time and support ongoing and have a great day. Thank you bye bye.
Conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.
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