Sotera Health Company (SHC) Earnings Call Transcript & Summary

Thanks. Morning, everyone, and I appreciate you being with us for Sotera Health's Q2 2021 earnings call. It's a real pleasure today to share that we've posted yet another quarter with double-digit increases in both revenue and adjusted EBITDA; these results extend the robust gains from Q1 and complete a strong first six months of 2021. What we achieved operationally and financially underscores that Sotera Health occupies an essential role within the health care value chain. Crucially, our team keeps carrying out our mission of safeguarding global health, even as we contend with the difficulties and shifting conditions brought by the pandemic. Scott will provide greater detail shortly regarding how each segment performed and our capital structure, but first, some second quarter highlights: total revenue rose 18%, adjusted EBITDA climbed roughly 18% versus Q2 of 2020, and adjusted EPS came in at $0.26, representing a $0.12 gain from the same quarter a year ago. It's worth remembering that although the pandemic definitely affected our top line during last year, each of our 3 businesses still achieved growth in Q2 of 2020. Thus, whereas plenty of companies are posting gains against a rather soft prior-year comparison, our double-digit improvement comes against a quarter in which every one of our businesses generated the steady positive revenue expansion that has defined this company for many years; this robust outcome reflects our ongoing commitment to strategic priorities, among them pursuing operational excellence throughout every business; directing capital toward growth efforts like capacity additions and infrastructure improvements; strategic M&A and smooth integration of acquisitions, such as Iotron and BioScience Laboratories; and continuing to deleverage toward our targeted levels. Multiple times earlier in 2021, we said our 2021 outlook presumes volumes will normalize progressively across the year. Broadly speaking, 2021 is unfolding as we expected, though there are certain subtleties in how the recovery has affected each business. Those subtleties show up in the second quarter results for each business. Sterigenics posted a solid quarter, with volumes continuing to rebound toward pre-pandemic levels. Indeed, Sterigenics volumes and utilization in Q2 came close to the pre-pandemic peak achieved during 2019. So relative to our initial 2021 outlook, Sterigenics has accelerated somewhat more quickly than anticipated. Nelson Labs keeps conducting essential testing of personal protective equipment, yet that category, as we expected and previously discussed, has turned into a year-over-year headwind, given the strong volume in Q2 of last year when pandemic-related testing first peaked. As anticipated, recovery in other non-PPE testing categories has been sufficient to counterbalance the drop in PPE-related testing. On the whole, I'd say that getting non-PPE testing volumes back to normal—covering testing tied to new product development too—will happen at a somewhat slower rate for Nelson Labs than the quicker rebound we're seeing at Sterigenics. It doesn't shock us that services tied to a far bigger activity cycle are recovering more gradually. Where Nordion is concerned, the second quarter posed a tough year-over-year comparison because shipments were unusually concentrated in Q2 of 2020. Even so, the team posted double-digit growth in that quarter. I feel proud of everyone at Sotera Health for the robust first-half financial results, and for how they keep concentrating on serving customers, health care workers and patients while keeping the workplace safe. Thanks to a strong first-half showing, along with added momentum as we head into the rest of the year, we're raising our 2021 outlook for both the top and bottom lines. In a moment, Scott will walk you through the specifics of our full-year 2021 financial outlook. Turning to capital deployment: we remain disciplined there. Our priorities for deploying capital haven't changed—we put growth investments first, then further deleveraging, then strategic M&A. Our net debt leverage ratio got better again in Q2. Now let me call out a few of the main capital deployment growth investments across each of our 3 business segments. At Nordion, we've talked for a while about its investment in 3 long-term Cobalt-60 supply projects. As we've said, these efforts are longer term by nature and will broaden our supplier base. We keep moving these development projects forward. At Nelson Labs, our focus stays on growing capacity and capabilities so we can serve customer needs. One strong illustration is our extractable and leachables testing area, where we've put money into equipment as well as technical staff to handle the major demand growth we've seen there. Earlier in the year, we shared progress on building out our European microbiological center of excellence located in Germany. I can now report that this new lab went live in the second quarter, quickly qualifying customers so operations could ramp up. I want to congratulate the Nelson Labs team on reaching this important milestone. We're happy that integration of BioScience Laboratories, which Nelson Labs bought in March, has gone smoothly. With BioScience Labs now inside the Nelson Labs business, revenue growth is already running above BioScience's pre-acquisition baseline. Finally, we made considerable headway during the quarter on the Sterigenics capacity expansions and on the Sterigenics EO facility enhancements. Stepping back from our specific results, I'll briefly note what we're observing in the broader markets where we operate. As I said earlier, the overall market recovery is unfolding in a way that's fairly consistent with the assumptions we set earlier in the year. In contrast to the prior quarter, during the second quarter we observed a relatively widespread rebound throughout both the Americas and EMEA. This strikes us as a positive development. That said, I believe keeping a note of caution is warranted. It's no secret that the virus remains present and that new variants carry risks. We'll keep watching what our customers and the market are doing. Beyond that, we and our customers have run into certain difficulties that remind us just how unpredictable the macro environment currently is. To illustrate, several of our customers have faced shipment delays stemming from various problems, whether that's a lack of labor or raw materials, or perhaps transportation services not being available. Shifting away from the financial results. There are 2 initiatives I'd like to highlight that we've sped up as part of operating as a newly public company. The first involves building a formal ESG program, one that takes a holistic approach to determining what matters most to us and to our stakeholders and what will do the greatest good for the environment, our employees and the communities where we do business. Within our emphasis on diversity, equity and inclusion, we've established a Diversity, Equity and Inclusion, or DE&I Council. This council is made up of employees drawn from across the globe and from various levels within the organization. It reports directly to me and holds clear actual goals aimed at expanding the company's diversity, equity and inclusion work. I sat down with the council not long ago to go over our progress, and though it's still early days, I'm eager to tell you a little more about these efforts during upcoming calls. Before handing things to Scott to walk through the second quarter and outlook in greater depth, let me pause once more to stress how much pride I take in the whole Sotera Health team. The way our team stays focused on carrying out our strategy, serving customers with excellence and concentrating on delivering results is largely why we're in a position to update our outlook today. I'll hand the call to Scott now.

Thank you, Michael. To start, I'll walk through the consolidated results for the second quarter, then go deeper into each business segment, and also share updates on how we're deploying capital and where leverage stands. I'll wrap up by giving you more specifics about our revised 2021 outlook. Looking at the consolidated picture, Sotera Health posted revenue growth of roughly 18% in Q2 versus the same quarter a year ago, reaching $252 million. When you strip out currency effects, revenue was up around 14%. Adjusted EBITDA likewise rose about 18% from Q2 of 2020, hitting $135 million. Compared with the second quarter of last year, adjusted EBITDA margins narrowed by 30 basis points; the main reasons were an unfavorable mix in both the Nelson Labs and Nordion businesses, plus the company absorbing an extra $4 million in administrative costs, mostly tied to ramping up public company expenses. Our solid operating results, together with a $36 million drop in interest expense, produced adjusted EPS of $0.26 per share, which is $0.12 higher than Q2 of 2020. Now let's turn to how each segment performed. At Sterigenics, Q2 brought 20.6% revenue growth and 22.4% segment income growth compared with the same quarter last year. The drivers behind second quarter revenue growth were organic volume and mix growth above 8%, a pricing contribution of roughly 4%, and about 6% from buying Iotron. Versus the second quarter of 2020, segment income margins at Sterigenics widened by 80 basis points in Q2 of 2021, thanks to better utilization and pricing. As Michael noted, we're happy to report that Sterigenics volumes this quarter have nearly matched the peak level set back in 2019. We keep investing meaningfully in Sterigenics. We remain on schedule to finish 6 Sterigenics expansions during this year, and work continues on upgrades to our North America EO facility. Switching to Nordion: Q2 revenue climbed 16.6% from Q2 of 2020, coming in at $49 million. Nordion segment income increased 13.7% to $31 million versus the prior-year period. The growth in Nordion's revenue and profit came from a 9.5% favorable FX impact and an 8% pricing gain, partially offset by somewhat softer volumes. We had expected volumes to be below the prior year because of the shipment concentration in last year's Q2 that Michael referenced earlier. Nordion's margins dropped roughly 160 basis points, mostly because of unfavorable mix. I'd point out that despite that year-over-year margin rate decrease, Nordion segment income margins exceed 63% this quarter. As is typical for businesses with a mostly fixed cost structure, Nordion's margins are usually greater when top line performance is stronger, thanks to favorable operating leverage. That's exactly what happened this quarter, just as it did during the second quarter of last year. Looking ahead to later quarters, when revenue growth is less strong, you should anticipate that margins will come back down, and that will pull the average for the entire year back to where it stood a year ago. Taken as a whole, Nordion did better this quarter than our initial forecast, since certain sales we had thought would land in the back half of the year actually came through in Q2. Consequently, we now expect Nordion's revenue in the latter six months to come in below what the first six months produced, though the total for the year should still exceed the figure we anticipated around this point in 2020. Turning to Nelson Labs, revenue for Q2 rose 13.9% versus the comparable period in 2020, reaching $58 million, while segment income climbed 8.3% to $24 million. Michael already described some of the subtleties around how the pandemic rebound is affecting testing volumes at Nelson Labs. During Q2, what we observed was that PPE-related testing shifted from being a favorable factor in recent periods to a 5% headwind on a year-over-year basis. Meanwhile, testing outside of PPE generated sufficient organic volume gains to make up for that drop; among these non-PPE testing services, it was Nelson's best quarter since the pandemic started, with volume and mix rising 6%. For 4 straight quarters now, Nelson's non-PPE testing services have posted sequential improvements in volume growth. Beyond that, BioScience Labs added incremental growth on top of the baseline they had before the acquisition, contributing more than 7% to segment revenue. Pricing that was favorable added roughly 4% as well. Margins for Q2 of 2021 shrank 210 basis points relative to the same quarter last year, because weaker demand for PPE testing, which carries higher margins, created an unfavorable mix of testing services in the quarter. Now I'll go over a few points on capital deployment and leverage. Our CapEx spending is on track with the guidance we gave for the full year, with $24 million spent during the second quarter, which brings the first half total to $45 million. As a reminder, we still expect capital expenditure of $100 million to $110 million for full year 2021. Our spending remains aimed at near- and longer-term growth initiatives, EO facility enhancements and Nordion cobalt supply projects. At June 30, cash stood at $156 million, which is $54 million higher than the December 31 level. We managed to generate that cash even after putting roughly $15 million toward the BioScience Labs acquisition, $12 million for the Nelson Labs Fairfield minority owner buyout in Q1 and about $8 million to purchase the minority partner stakes at our 2 facilities in China. With cash plus revolver availability totaling $435 million, the company is still in a solid liquidity position to cover our operational needs and investments; our revolving credit facility remains undrawn. Our net leverage ratio keeps getting better, standing at 3.8x as of June 30 versus 4.3x on December 31, 2020. We've made outstanding progress toward our deleveraging commitment, having already reached the top end of the long-term leverage target we set of between 2x and 4x. By combining term loan repricing with paying down debt, our interest expense for Q2 2021 fell $36 million compared with the second quarter of 2020. Across the first half of 2021, interest expense is down more than $71 million; given the significant cash we have built and after covering other capital deployment priorities, we will redeem in full our $100 million first lien notes in the third quarter of 2021; those notes rank right now as the costliest debt within our capital structure, and redeeming them will spare the company an additional $7 million in yearly interest expense. As Michael said, we're quite happy to be able to raise our full-year outlook above the initial outlook ranges given on our March 9 call. For full year 2021, total revenues are now projected at $920 million to $940 million, which represents growth of roughly 12% to 15% versus 2020; adjusted EBITDA for full year 2021 is projected at $475 million to $490 million, which represents growth of roughly 13% to 17% versus 2020; and adjusted EPS is projected at $0.87 to $0.91. Qualitatively, here is what we assume. Demand for our products and services should keep improving through year-end, just as it already has in the first half of 2021. As I noted earlier, Nordion's outperformance in the first half of the year means both its second half revenue and margins should come in below the first half of the year. Given that momentum exiting the first half of the year, Sterigenics should keep delivering solid top line growth and margin performance in the second half of the year. Meanwhile, Nelson Labs will keep feeling the interplay of how quickly non-PPE testing ramps back up relative to the decrease in PPE-related testing. On foreign currency, our guidance remains based on exchange rates in effect when we provide guidance updates. On capital deployment, we will keep prioritizing growth initiatives, debt repayment and strategic acquisitions that we identified throughout the remainder of the year. Before I hand the call back to Michael to wrap things up, I wanted to echo what he said earlier about how proud we are of the entire team. Our team's hard work shows in our Q2 and first half results and has helped position us for a solid 2021. Michael, back to you.

Thank you, Scott. Prior to wrapping up, I'd like to address some recent news concerning the Sterigenics Santa Teresa sterilization facility. As a lot of you know, a court order came down on June 29 that bans uncontrolled emissions from that facility and required Sterigenics to collaborate with the New Mexico Attorney General regarding the monitoring protocol. Although Sterigenics disputes the claims regarding the Santa Teresa facility, the company has implemented measures to guarantee, track, and document adherence to the order. No agreement on monitoring has been finalized yet between Sterigenics and the Attorney General, and a hearing with the judge has been requested so the court can establish a suitable monitoring protocol. That said, we see no reason to think the result of that process will interfere in any way with the facility's mission of sterilizing 2.5 million essential and frequently life-saving medical devices every single day. I'd also like to remind everyone that we regularly publish updates in the Special Notices section of our Investor Relations site regarding matters that could matter to investors, including updates about ethylene oxide and how those might impact Sterigenics facilities. As mentioned in our latest posting on the website, we were happy that Sterigenics recently obtained an environmental permit from the New Mexico Environmental Department, paving the way for the next step in Sterigenics' rollout of additional emission control enhancements at the Santa Teresa facility; that permit is a solid illustration of Sterigenics' productive relationship with regulators in the state. Returning to our performance. On the whole, we're quite pleased with our operating results and financial results so far this year, particularly given the ongoing challenges created by the global pandemic. Thank you once more to the Sotera Health team for their excellent execution this quarter and for positioning us well for a strong second half of the year. At this point, operator, we'd like to open the call up for questions and answers.

Congratulations on a truly robust, powerful quarter. Two questions, if I may. Could you perhaps spend a moment discussing the kinds of demand patterns you're observing? That's — I believe a competitor of yours earlier this week mentioned growing demand from several of your end markets in devices and sterilization; and then I had one thing to ask afterward.

Matt, Michael here. Sure, regarding demand, clearly, we're monitoring the COVID situation and how it affects elective surgeries. And as things stand for us, volumes have remained fairly steady. We're cautiously optimistic as the year moves forward. We're not assuming a catastrophic scenario; we believe we'll keep seeing growth in the second half of the year.

All right. Then regarding profitability, I value the detail about the mixed forces in the latter half of this year involving Nelson and the rest of the operations. Could you discuss how much of a factor Sterigenics' margins were in this quarter, or what direction Sterigenics' margins moved in the second half?

Let me take that one first, and Scott may chime in afterward. Clearly, our margins grew compared with the same period a year ago. For Sterigenics, I believe that was roughly 80 basis points. Given the way the operating model works, when you push volume through those sites that carry fixed costs, you achieve solid operating leverage. Therefore, when volumes recover relative to Q3 and Q4 of next year, we would anticipate seeing gains along with an increase in margin rates.

Yeah, let me hop in here and say I completely share Michael's view on Sterigenics — that ongoing strength in the core operating model is still there. So for the back half of the year, we'd anticipate the same positive pattern continuing that we're showing here in Q2, with the 80 basis points of margin expansion Sterigenics posted in Q2. Another point I'd stress: clearly, in this first year as a public company, we're taking on these new costs — new administrative expenses tied to being public. We noted earlier $4 million of cost headwind in Q2 by itself, and $8 million year to date; so that headwind in Q2 worked out to roughly 170 basis points of margin headwind that we overcame as a whole company; and so when you factor that in and look at the margin performance that's still strong for Sterigenics and across all 3 businesses, that really — it ought to provide some reassurance about how healthy the underlying margin profile is for the core business.

Let me fit in one final question here. You stand out somewhat in how certain contracts are built around things like wage growth or rising input costs; since that's turning into a broader worry throughout the economy, could you discuss — if you were to witness that, or if some wage pressure is already showing up at your plants and facilities — how it would enter into your — how should we think about its effect on your margins down the road?

Sure. Matt, it's Michael here. I'd say some inflation is showing up, mostly when it comes to labor. Given that we're a service business, it would land on the labor side, and the main concentration is within the U.S. We believe we can offset whatever inflation arises through how we set price in our agreements with customers. All told, it's a figure we can handle, yet one effect is plainly visible throughout the economy in the United States, as you know well, among other companies too, and simply that overall labor balance.

Thomas Kelliher here, filling in for Sean. Nice work on a strong quarter. To begin with, you mentioned before that each business unit had a strategic planning window running through July, and I believe pharma — particularly the Nelson Labs side — was a main point of focus. Now that it's August, what came out of those meetings? Any notable shifts in strategic direction or anything along those lines?

Yes. Thomas, I appreciate the question. Clearly, I won't dive into many forward-looking specifics. But to tie it back to that planning cycle, yes, as we've said before, we run an operating system throughout Sotera Health, and a 3-year strategic planning is one of its key elements. We just finished that up. Next week we'll actually hold a strategic planning session with the Board and walk them through that 3-year plan. That said, I'd say we're very optimistic about our position as a company and about delivering on our mission of safeguarding global health. And yes, pharma remains part of that strategy going forward, just as it has been until now.

All right. So you have several new capacity expansions that are set to come online within roughly the next 12 months. And according to you, all of them remain on schedule. Nothing significant in the way of delays or speedups or anything like that. So how should we frame the contribution we'll see from that added capacity in 2025, or perhaps in 2026?

Right. What I'd say is this: we do have 6 expansions lined up to go live during this year. In our prepared comments we also mentioned how proud we are that the Nelson team, through one expansion project — the Wiesbaden center of excellence — has now opened in Germany. So that's a positive. We won't break things out facility by facility, but we do see the necessity of adding more capacity so we can meet what our customers require. And as we've said before to many of our investors, we take that process seriously when it comes to evaluating capacity, and we make certain we've lined up some anchor customers, so to speak, prior to breaking ground or moving ahead with an expansion.

Perhaps I could ask one more thing regarding the guidance. Scott, could you walk us through the speed of recovery you anticipate for the back half, once more considering elective procedures, say, the ambiguity from a few of those conflicting signals we've received from certain ortho companies? And then, at a high level, is there any approach to consider 3Q against 4Q regarding how that pacing works?

Certainly. Well — regarding how quickly recovery happens, looking back at the guidance we initially provided in March, we had envisioned a steady volume normalization across the year. Thus, as Michael mentioned a few minutes back, essentially the year has unfolded pretty much the way we expected. Among the main shifts we've already discussed during this call is that Sterigenics has gained from what was likely a somewhat quicker ramp-up in its segment than we initially envisioned when setting our guidance. Consequently, I doubt that significantly alters what we envision for the year's latter half. We continue to perceive the chance that there will be an extension of what occurred in Q2, when we reached our peak level. And we anticipate ongoing strong year-over-year expansion, on both the top line and bottom line, for the business. We aren't observing any sort of obstacle regarding effects from the new variant so far in terms of how elective procedures might influence our volume. Something to keep in mind is that during last year's Q2, even amid the most severe pandemic shutdown efforts, our company achieved strong revenue growth. And Sterigenics even managed in Q2 of the prior year to deliver 4% revenue growth on a constant currency basis. So the reality that our business has remained so strong from a revenue-generating perspective, even through the pandemic's toughest stretches, provides us some reassurance that we can see a path to solid results for the year's second half.

That's useful. And then Michael, perhaps regarding the legal proceedings. You mentioned New Mexico a bit. From your team's view, is there anything to infer from that preliminary decision about how this might ultimately turn out? Clearly, it was positive to sidestep the most severe possibility of a complete shutdown, which you referenced. Maybe just share your conclusions regarding what took place. And then perhaps a brief update on the schedule for the remaining litigation, what we ought to watch for during the coming few quarters.

Yes. So regarding the final portion of your question about the litigation, you mean more generally at the other locations, especially Illinois?

Yes. That's right, yes.

Let me address that, since it's the first thing that comes to mind; regarding the litigation — the trial dates are — the initial 3 trial dates are now scheduled. July of 2020 — that's for Illinois, July of 2022, September 2022, and November of 2022; so those are the Illinois trial dates; those are the first 3 cases. So those are on the calendar. And with luck, they'll adhere to that schedule; they might shift, based on the pandemic and other factors. When it comes to New Mexico, we keep running the facility. We keep making improvements there, just as we have for the past several years. One thing I mentioned in my remarks that I believe is truly important for people to understand: the regulators in that state, New Mexico, their department, actually issued us a permit on June 11 for the upgrades we're making at the facility. We've been coordinating with them for quite a while now; so we'll keep advancing that process; we need to complete the construction permit, that's the following step, and we're right in the middle of that at this moment. On the court matter and uncontrolled emissions, the AG has a position on it. We have a position on it. And I think the key distinction is the practicality of some of the measures being suggested compared to what we currently do in operating the site. So we simply need a third party to step in and have that conversation. I don't know precisely — that motion was only filed in the courts within the last couple of weeks; so I'm not certain exactly when the judge will want to hold a hearing on this. It might be days, it might be weeks, it might be months; we will keep operating the facility safely, as we always have, and deliver the essential service of 2.5 million devices a day that we sterilize at that facility, which is vital to health care.

First off, regarding Nelson. I believe you mentioned that testing was either recovering or progressing more slowly. My guess is that work on devices and pharmaceuticals isn't shifting all that much. So what exactly is lagging right now?

Matt, Michael here. What I'd say is that certain activity tied to new product development is simply picking back up at a somewhat slower rate. When it comes to routine testing, a great deal of release testing there is holding up pretty well. As we noted in our remarks, we keep putting capital toward extractable and leachable work, and analytical chemistry is performing very strongly. However, in a few of those other spaces within new product development — perhaps the validation area — things might be moving a bit slower, and that's something we need to monitor. Still, as Scott said in his comments, we take real pride in the fact that our volumes grew faster than PPE testing. That represented a headwind during the quarter, exactly as all of us anticipated.

All right. And then — this is a hard one to pose, but could you go through a few of the distinctions separating your Sterigenics operation from AST, your nearest competitor, and assist in closing the distance between your figures and the ones they report? I mean, it simply appears — it simply appeared as though during this particular quarter, the separation was wider.

When you say that, which part of their operation compared with ours are you referring to?

Regarding the organic growth.

Ah, organic growth. In my view, that comes down to timing plus how much capacity is on hand. Like we've mentioned, our approach to deploying capital is quite disciplined, and we make certain we're putting our capacity to use. That capacity carries a high cost; we simply lack spare capacity sitting idle that could support substantial volume increases. Throughout this journey toward going public, we've consistently said we aren't the type of company that will report volume growth of 20%, 25%, or 15%. We don't possess that level of surplus or available capacity at any particular moment; what we do have is a business we're highly confident can keep expanding at a high single-digit rate, and we'll keep delivering results for our customers.

at this stage, with those new plants, what capacity are you operating at?

I'd put us around 80 — slightly in the low 80s, I'd say.

As Michael said before, that means we're basically returning to the maximum usage rates we normally had before the pandemic. So clearly, that's quite elevated for us in regard to our standard operating level. Plus, we've got those new capacity projects set to launch later this year and after that too, which gives us somewhat more room.