Sotera Health Company (SHC) — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Sotera provides sterilization services, cobalt-60 (Co-60) products, laboratory testing and advisory services through Sterigenics, Nordion and Nelson Labs.
Key financial results
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Revenue | $255.3m | $266.6m | $475.9m | $503.4m |
| Gross profit | $139.6m | $150.4m | $251.1m | $279.3m |
| Operating income | $63.2m | $71.5m | $96.6m | $125.0m |
| Net income | $23.5m | $30.4m | $26.4m | $61.1m |
| Adjusted EBITDA (non-GAAP) | $128.5m | $136.1m | $227.0m | $251.5m |
- Q2 revenue fell 4.3%; six-month revenue fell 5.5%. Service revenue rose 2.0% in Q2 and 3.0% year to date, while product revenue declined 35.2% and 53.3%, respectively.
- Q2 gross margin was approximately 54.7%, versus 56.4% a year earlier; operating margin was approximately 24.8%, versus 26.8%. For the first half, gross margin was approximately 52.8%, versus 55.5%, and operating margin was approximately 20.3%, versus 24.8%.
- Q2 net income declined 22.7%; first-half net income declined 56.8%. Higher borrowing costs were a major factor: Q2 net interest expense rose 118.8% to $30.7m; first-half expense rose 143.8% to $59.6m.
- First-half operating cash flow was negative $302.7m, versus positive $108.3m in 2022, primarily reflecting the $408.0m Illinois settlement payment. Capital expenditures were $98.1m, up from $71.6m.
- At June 30, cash and cash equivalents, including restricted cash, totaled $270.5m. Debt carrying value was approximately $2.227bn, including $2.222bn long-term debt. The revolving facility had no borrowings and $372.1m available after letters of credit. The company reported compliance with debt covenants.
Material changes and segment performance
- Sterigenics: Q2 revenue rose 5.6% to $166.6m and segment income rose 7.5% to $91.5m, mainly from pricing. First-half revenue increased 6.3% to $326.6m.
- Nordion: Q2 revenue fell 36.7% to $32.0m; first-half revenue fell 52.0% to $40.5m. Management attributed the declines primarily to expected Co-60 harvest timing and unfavorable volume and mix.
- Nelson Labs: Q2 revenue fell 2.8% to $56.7m; first-half revenue fell 2.6% to $108.8m. Lower volume and unfavorable mix outweighed pricing benefits.
- The $408.0m Illinois EO settlement was funded with a new $500.0m Term Loan B, alongside repayment of $200.0m drawn on the revolving facility. Term Loan B carries a variable rate; its Q2 weighted-average rate was 8.82%. Existing term-loan weighted-average rates were also substantially higher than in 2022.
Outlook, risks and contingencies
- Management expects Nordion Co-60 harvest schedules to improve in the second half of 2023 and does not expect a material Co-60 supply or revenue impact for the remainder of 2023 from Russian reactor supply disruptions. These are expectations, not guarantees.
- Management expects cash, operating cash flow and available credit to cover working capital, debt service, planned capital spending and anticipated litigation costs for at least the next 12 months. Capital investment is focused on capacity, facilities and Co-60 supply-chain strength.
- The Willowbrook, Illinois settlement covered 879 claimants; their claims were dismissed with prejudice after settlement funds were released. Three claimants did not opt in, and new Willowbrook cases were filed in June. Litigation continues in Georgia and New Mexico; the company says potential losses cannot be reasonably estimated and could materially affect results, liquidity or financial condition.
- Insurance limits for environmental litigation had been fully used by June 30, 2023. Recovery of additional historical insurance proceeds is uncertain; future EO claims are excluded from coverage.
- The U.S. EPA proposed stricter EO requirements in April 2023. Final rules were expected by the first half of 2024; compliance could require additional capital and operating costs, and some proposed requirements could be difficult or unachievable at existing facilities.
- A Queensbury, New York scrubber failure led to nine intermittent EO releases over approximately 48 hours in May. The facility resumed operations after remedial measures; the company expects a DEC fine, with the amount undetermined.
- A shareholder securities class action and related books-and-records demands are pending. Separately, a Dutch criminal-proceeding resolution requires court approval and a €990,000 charitable contribution.
Most important facts for investors to verify
- Whether Co-60 harvest timing improves as forecast and how Nordion revenue and margins develop in the second half.
- Cash generation after the one-time settlement outflow, capital-spending requirements and liquidity available after letters of credit.
- Debt interest rates, hedge coverage, refinancing needs and the effect of elevated interest expense on earnings and cash flow.
- Developments in remaining EO claims, insurance recoveries, proposed EPA rules and the Queensbury enforcement matter.
- Underlying performance alongside non-GAAP Adjusted EBITDA, including the recurring or continuing costs excluded from that measure.