Sotera Health Company: FY2020 Form 10-K Summary
Business Context and Reporting Period
Sotera Health is a global provider of outsourced sterilization, cobalt-60 products and irradiator systems, microbiological and analytical laboratory testing, and advisory services for medical device, pharmaceutical, food, agricultural and other customers. Its reportable segments are Sterigenics, Nordion and Nelson Labs. The filing covers the fiscal year ended December 31, 2020, and was filed March 9, 2021.
The company completed its initial public offering in November 2020, selling 53.59 million shares at $23.00 per share and listing on Nasdaq under the symbol SHC. Sotera Health is an emerging growth company and may be considered a controlled company because Warburg Pincus and GTCR collectively owned approximately 70.1% of outstanding shares as of February 24, 2021.
Key Financial Metrics
| Metric | 2020 | 2019 | Change |
|---|---|---|---|
| Net revenues | $818.2 million | $778.3 million | 5.1% increase |
| Gross profit | $443.6 million | $395.4 million | 12.2% increase |
| Gross margin | 54.2% | 50.8% | Improved |
| Operating income | $206.0 million | $183.6 million | 12.2% increase |
| Operating margin | 25.2% | 23.6% | Improved 1.6 percentage points |
| Net loss attributable to Sotera Health | $38.6 million | $20.9 million | Loss increased |
| Adjusted Net Income | $99.1 million | $100.4 million | 1.3% decrease |
| Adjusted EBITDA | $419.9 million | $379.9 million | 10.5% increase |
| Operating cash flow | $120.6 million | $149.0 million | Decrease of $28.5 million |
| Capital expenditures | $53.5 million | $57.3 million | Decrease of $3.8 million |
Service revenue increased 6.0% to $713.5 million, while product revenue declined 0.6% to $104.6 million. Sterigenics revenue rose 5.7% to $498.8 million, Nordion revenue declined 1.2% to $114.7 million, and Nelson Labs revenue increased 7.4% to $204.6 million. COVID-19-related PPE testing contributed approximately $16.3 million of service revenue growth.
Net interest expense increased 36.5% to $215.3 million. The company also recorded a $44.3 million loss on extinguishment of debt. Cash interest paid was $211.3 million, compared with $151.0 million in 2019. The filing reports $331.9 million of operating cash flow before interest payments.
Liquidity, Debt and Capital Resources
- Cash and cash equivalents were $102.4 million at December 31, 2020, compared with $62.9 million at December 31, 2019.
- Total debt principal was approximately $1.864 billion, consisting primarily of a $1.763 billion term loan due 2026 and $100.0 million of first-lien notes due 2026.
- The company redeemed all $770.0 million of second-lien notes and repaid $341.0 million of term-loan principal using IPO proceeds. These actions generated a $44.3 million extinguishment loss, including a $15.4 million redemption premium and write-offs of debt issuance and discount costs.
- The revolving credit facility was increased to $347.5 million. It had no borrowings at year-end, $63.9 million of outstanding letters of credit and approximately $283.6 million of remaining availability.
- Debt service payments represented approximately 68% of operating cash flow before interest payments.
- Working capital was $174.4 million, compared with $128.4 million in 2019. Total assets were $2.761 billion and total equity was $454.6 million at year-end.
Material Changes Versus the Prior Comparable Period
- Revenue grew 5.1%, supported by Sterigenics pricing, organic volume growth, COVID-19 PPE testing demand and the Iotron acquisition.
- Operating income and margins improved despite higher litigation, public-company and COVID-19-related costs.
- Net loss worsened primarily because of materially higher interest expense and debt extinguishment costs.
- Operating cash flow declined because cash interest payments increased by approximately $60.3 million.
- The company acquired Iotron Industries Canada for approximately $105.2 million on July 31, 2020, adding E-beam processing capabilities and a 60%-owned Alberta joint venture.
- Willowbrook, Illinois operations were permanently closed and the facility was being decommissioned. Atlanta operations resumed in 2020 after emissions-control enhancements and court intervention.
- The balance sheet improved substantially after the IPO and debt repayment: total liabilities declined from $3.222 billion to $2.307 billion, while equity improved from a $641.1 million deficit to $454.6 million of equity.
Guidance, Outlook, Commentary and Unusual Items
Management expects continued organic growth through capacity expansion, increased utilization, additional Co-60 supply, broader laboratory capabilities and selective acquisitions. The company does not provide a conventional revenue or earnings forecast in the filing.
Management expects 2021 capital expenditures to exceed $100 million, including more than $15 million for environmental facility enhancements and approximately $21 million for cobalt development projects. Capital spending is expected to remain elevated for several years.
In January 2021, the term-loan repricing reduced the LIBOR spread and floor, producing an expected effective interest-rate reduction of 2.25% and estimated annual cash interest savings of approximately $40 million based on year-end debt. The filing states that 2021 savings will be partially offset by cash and non-cash repricing charges.
COVID-19 reduced elective procedures, some sterilization volumes, certain laboratory testing demand and medical-use Co-60 deliveries, while increasing demand for PPE testing. Management states that the pandemic’s duration and future effects remain uncertain.
Material unusual or non-core items included $36.7 million of professional services related to EO facility litigation, $2.6 million of Willowbrook closure costs, $44.3 million of debt extinguishment costs, $10.99 million of share-based compensation, $2.7 million of COVID-19 expenses and $2.5 million of business optimization expenses.
Principal Risks and Contingencies
- Extensive litigation alleges personal injury, property devaluation and other harm from purported ethylene oxide emissions at Willowbrook, Atlanta and Santa Teresa. The company denies the allegations and has not recorded a contingency reserve because losses cannot reasonably be estimated.
- The $10 million per-occurrence environmental liability insurance limit related to Willowbrook litigation was fully utilized by June 30, 2020. The company states that additional coverage for those claims is unlikely to be available.
- Potential outcomes include damages, settlements, injunctions, regulatory penalties, facility restrictions, reputational harm and additional litigation. The filing does not provide a clear estimate of potential exposure.
- The company relies on a limited number of suppliers, including a single U.S. EO supplier and three nuclear reactor operators for a substantial portion of Co-60 supply. Approximately 20% of current Co-60 supply is generated by Russian reactors, creating sanctions and geopolitical risk.
- Operations are subject to extensive environmental, nuclear, health, safety, transportation and FDA regulation. Changes to EO emissions rules or loss of required permits could increase costs or restrict operations.
- High leverage, variable interest rates, LIBOR transition risk, restrictive debt covenants and substantial contractual commitments could constrain liquidity and financial flexibility.
- The company had approximately $1.670 billion of long-term supply and service commitments, including primarily Co-60 commitments, and $124.9 million of estimated EO purchase commitments at December 31, 2020.
- Defined benefit and post-retirement plans were underfunded, with a combined reported post-retirement obligation of approximately $48.2 million and estimated future pension funding requirements of approximately $2.8 million annually for the next five years, subject to actuarial changes.
Important Facts for Investors to Verify
- Reconcile GAAP net loss with management’s Adjusted Net Income and Adjusted EBITDA, particularly the treatment of litigation, debt, amortization, share compensation and other recurring adjustments.
- Monitor the volume, legal status and insurance coverage of EO-related litigation and any changes to potential damages or required facility modifications.
- Verify progress against the company’s projected 2021 capital expenditures, environmental investments and cobalt development projects.
- Assess free cash flow after interest, capital expenditures, litigation costs and mandatory debt amortization rather than relying solely on Adjusted EBITDA.
- Track debt refinancing, interest-rate exposure, LIBOR replacement provisions and compliance with debt covenants.
- Evaluate the availability and geographic diversification of EO and Co-60 supply, including exposure to Russian counterparties and sanctions.
- Assess whether COVID-19-related PPE testing demand and deferred medical procedures create sustainable or temporary revenue effects.
- Review the company’s controlled-company governance structure, sponsor ownership, registration rights and potential future share sales.