Sotera Health Company (SHC) Earnings Call Transcript & Summary

Hello, everyone, and thanks for being with us today for Sotera Health's call covering the fourth quarter of 2021. It's a pleasure this morning to share results showing yet another period of double-digit increases in both revenue and adjusted EBITDA. That makes five quarters now that we've released figures since becoming a public company, and during each one since our November 2020 listing, we've posted double-digit growth on both the top and bottom lines. During our previous call, I reminded listeners that Sotera Health has achieved revenue gains annually ever since 2005, the point at which our tracking starts. Thanks to these favorable full-year 2021 results, that run has now officially been stretched by one more year, achieved against a solid 2020 comparison — a year in which we still grew even as the pandemic first struck. Scott will walk through more specifics shortly, but let me share a few fourth quarter performance highlights: total revenue rose 11% while adjusted EBITDA climbed 10% versus the same period in 2020, and adjusted EPS came in at $0.23, an increase of $0.14 from last year's fourth quarter. Sterigenics delivered yet another solid year, carrying positive momentum through the fourth quarter and continuing to operate close to peak utilization, with the team still running our facilities at optimal levels. Nordion closed out the year on a strong note, with full-year results well ahead of its historical growth trend. As anticipated and mentioned during our prior call, Nelson Labs is still dealing with the lingering effects of the pandemic. A mix of declining elevated PPE testing, the ongoing return to normal for core testing activity, and customer supply chain disruptions all weighed on the segment, producing a weak quarter. Lately, absenteeism tied to the pandemic and difficulties in the labor market have hurt the lab business too. The Nelson Labs team has responded decisively to these challenges. On the whole, Sotera Health posted a solid quarter and a robust 2021 on a consolidated basis; that outcome also shows up in how carefully we've managed our balance sheet, reaching net leverage of 3.5x — an improvement of three-quarters of a turn across the full year. That aligns with both our near-term and longer-term leverage targets. Beyond the financial figures we're sharing today, I'm eager to walk you through a handful of the many examples of how our mission — safeguarding global health — makes a real difference in the markets we serve and, ultimately, for patients. One instance involves testing artificial skin for critical burn patients, work carried out by Nelson Labs. Another involves sterilizing components used in robotic cardiac surgeries, done at Sterigenics facilities with Nordion's Cobalt-60. We're also thrilled about the recent introduction of the Nelson Labs Mark, a verification program that authenticates and confirms the legitimacy of Nelson Labs testing tied to the efficacy and safety of certain products on the market. The Nelson Labs Mark represents the result of many years spent on validation testing, and it's exciting for us to give both our customers and consumers a way to tell apart legitimate products from ones that might not have undergone sufficient testing. For us, 2021 proved to be a major year when it came to carrying out our strategic priorities, building on our financial results through ongoing work on organic growth efforts and strategic M&A. Beyond that, we keep pushing ahead with rolling out our ESG strategy, moving forward our communication around subjects that matter enormously to our overall mission, along with internal and external stakeholders. One part of this, among other things, is that our ESG program helps propel our efforts when it comes to diversity, equity, and inclusion. As an organization, we're always trying to sustain a culture that backs a strong team — one that's collaborative and diverse in both attributes and ideas. Also, during 2021, we introduced the Sotera Health Academy. That's a fresh digital thought leadership library built to serve our customers better by drawing on the knowledge and expertise of our expert advisors, and it also covers expertise tied to our newest acquisition, Regulatory Compliance Associates, or RCA. Through the Sotera Health Academy, our customers will be able to reach critical content so they can broaden what they know. Our customers, and plenty of others across the industry, depend on our expertise to guide them through a regulatory landscape that keeps getting more complex. All in all, I feel enormous pride in the whole Sotera Health team for turning in a record year in 2021, our first full year as a public company. Our Sotera Health team stayed focused on our mission, safeguarding global health while serving the needs of customers, healthcare workers, and patients. Looking ahead to 2022, we'll keep concentrating on our priorities, among them driving operational excellence throughout our businesses, investing for growth — for instance, by adding capacity and improving infrastructure — pursuing strategic M&A, and integrating acquisitions efficiently. Earlier today, we gave our guidance for 2022. For the full year 2022, our guidance calls for total revenues between $1 billion and $1.03 billion, which works out to growth of roughly 7%-11%. Adjusted EBITDA between $515 million and $535 million, again working out to growth of roughly 7%-11%. Adjusted EPS between $0.93 and $0.99, which works out to growth of 6%-13%; we're aiming for a higher level of investment in growth-oriented projects in 2022, reflecting a positive longer-term view of the demand environment for our products and services. We'll carry on with the capacity expansions that were active as we entered the year; on top of that, we plan to start two new sterilization greenfields, while we keep investing in the major Cobalt-60 supply development projects we previously announced. Scott will go through the outlook in greater detail, covering our qualitative assumptions about trends, as well as what we currently expect regarding the keys. Now I'll say a few words about what we anticipate in the broader markets where we operate and how those markets affect our businesses. As we enter 2022, the ongoing and shifting character of the pandemic, together with the secondary effects it has on the supply chain and the labor market, continues to be a significant consideration. Through the bulk of the prior year, our sense was that those effects reached us mostly in indirect ways, by generating difficulties for our customers. Lately, the strain has become more pronounced where labor is concerned, since we have seen elevated rates of absenteeism tied to the pandemic, plus disruptions in the labor market that take the shape of shortages of workers and rising wages. It's a point we've made repeatedly: our businesses are set up well to hand off inflationary and cost-related pressures so that our margin profile holds steady, and that has not changed. A year ago, we described the macro backdrop as unsettled, while staying watchful and, at the same time, mildly positive; this year, my description of the environment would be much the same. The durability of the markets we serve gives us encouragement, yet we stay careful given all the surprising twists this pandemic has delivered. At this point I'll hand things over to Scott, who will walk through the fourth quarter in greater depth and offer additional thoughts about our outlook.

Thank you, Michael. To start, I'll walk through the consolidated results for the fourth quarter, then share some perspective on each business segment, followed by updates on capital deployment and leverage. I'll wrap up with additional detail on what we expect for 2022. Looking at the total company on a consolidated basis for Q4, revenue rose 11.3% versus the same quarter a year ago, reaching $241 million. In constant currency terms, the increase was roughly 11.5%. Adjusted EBITDA was up 10% from Q4 of 2020, coming in at $125 million. Adjusted EBITDA margins came down 40 basis points relative to last year's fourth quarter, and that was entirely attributable to margin compression in the Nelson Labs segment. I'll say more about that shortly. Our solid operating results, together with a decline in interest expense exceeding $32 million, produced adjusted EPS of $0.23 per share, which is $0.14 higher than Q4 of 2020. As a reminder, the lower interest expense came about because we repriced our term loan and paid down debt as planned, in line with our capital deployment strategy. Now let's dig into how each segment performed; during Q4, Sterigenics posted revenue growth above 11% and segment income growth of nearly 13% compared with last year's fourth quarter. The revenue increase for Q4 came from organic volume and mix growth exceeding 8%, plus a pricing contribution of almost 4%. Inorganic contribution was zero for the quarter, and FX effects were negligible. Versus the fourth quarter of 2020, segment income margins widened by over 50 basis points, thanks to a higher utilization level than pricing. Sterigenics volumes are still close to peak utilization. We're continuing to invest meaningfully in Sterigenics capacity as well as the improvements at our North American EO facilities; turning to Nordion, Q4 revenue climbed 28% to $37 million versus Q4 of 2020. Nordion segment income rose 33% to $21 million compared with the same period a year earlier. Nordion's growth on both the top and bottom lines came from a 19% contribution out of volume and mix, almost 7% from pricing, and a favorable 2% FX impact. Nordion's margins increased by roughly 220 basis points, thanks to operating leverage on their higher sales and favorable pricing versus Q4 of last year. At Nelson Labs, Q4 revenue was up 2% to $54 million compared with the fourth quarter of 2020, while segment income fell approximately 13% to $20 million for that same year-over-year period. As Michael noted, Nelson Labs is the one business unit dealing with challenges tied to both direct and indirect effects of the pandemic. Like in the third quarter, Nelson Labs faced a 10% headwind from lower PPE testing, which was mostly offset by contributions from the BioScience Laboratories and RCA acquisitions. Favorable pricing also added a little over 3% to revenue, while non-PPE volumes were largely unchanged. For Nelson Labs, margins in the fourth quarter of 2021 fell roughly 620 basis points versus the same quarter a year earlier. The biggest factors were a reduced share of PPE testing and margin dilution stemming from the BioScience Laboratories and RCA acquisitions. Those two deals accounted for about 190 basis points of dilution to segment income margins during Q4. In our view, this acquisition-related effect is shorter term in nature while we scale those businesses up. Q4 was additionally impacted by the labor market growing more difficult, which was mentioned earlier. Let me now turn to some highlights on capital deployment and net leverage. CapEx totaled $102 million for 2021, reflecting a sizable step-up in spending during Q4. Our spending was, and continues to be, aimed at growth initiatives, facility enhancements, and Nordion cobalt supply projects. That responds to both present and expected growth in customer demand. At December 31, we held $107 million in cash and keep a strong liquidity position. Net leverage came down to 3.5x, which amounts to an improvement of roughly three-quarters of a turn for the year. As we said previously, our recent debt paydowns together with the January repricing of our term loan brought full-year interest expense down from over $215 million in 2020 to roughly $74 million in 2021. Lastly, I'd like to offer more detail on our 2022 outlook. I'll begin with the quantitative summary, then wrap up with our assumptions. For the full year 2022, our guidance is total revenues between $1 billion and $1.03 billion, which represents growth of about 7%-11%. Adjusted EBITDA between $515 million and $535 million, also representing growth of roughly 7%-11%. A tax rate applicable to adjusted net income of 29%-30%. Adjusted EPS between $0.93 and $0.99, representing growth of 6%-13%. A fully diluted share count between 280 million shares and 283 million shares on a weighted average basis. Before I get into capital expenditures, I wanted to add some color on our effective tax rate for 2022. Some of you might remember that the 2017 tax reform included limits on the deductibility of interest. That tax reform at the time set up a change for 2022 under which deductibility would be limited further. This tighter limit on deductibility, together with a large carry-forward of nondeductible interest from earlier periods, affects how we account for taxes and leads to a somewhat higher tax rate in 2022. Turning to CapEx. Our CapEx is projected between $140 million and $170 million for the year. That level is a material increase over our 2021 CapEx and an even bigger increase relative to our historical spending levels. In 2022, we're boosting investment in a number of capacity expansion projects; we intend to launch two new sterilization greenfields in 2022 that should come online by 2024. Beyond that, we anticipate increased spending to advance Nordion's long-term cobalt development efforts, while continuing to put money into more ordinary capacity expansions at the Sterigenics and Nelson Labs sites we already operate. Across every segment, in every major technology, and in every geography where the company operates, our capacity expansion portfolio includes investments. The higher spending we've outlined, especially the launch of the two new sterilization greenfields, shows how confident we are about long-term customer demand for what we provide. We've said many times before that investments of this kind only get made when demand justifies them. We also foresee greater spending tied to our initiative for facility enhancements throughout the U.S. EO network. And lastly, for 2022 we anticipate interest expense will match 2021. On the unhedged share of our variable rate debt, the rising interest rate environment ought to produce higher interest expense, which will partly cancel out savings from debt paydown and the 2021 repricing. Qualitatively speaking, here's what we're assuming: labor market and inflationary pressures should persist through the first half of 2022, along with some continuing direct or indirect effects from COVID-related supply chain disruptions; no particular geopolitical risk has been factored into our projections, though we remain focused on anticipating and managing risks of that kind as far as we're able. Turning to the cadence of quarterly reporting, I'll offer a brief comment on each business unit.

Sterigenics wrapped up 2021 carrying good momentum, and we anticipate that carrying over into 2022, with the biggest payoff from capacity additions made lately and pricing programs coming through during the back half of 2022. As always happens, how Nordion performs is shaped largely by the timing of harvests and shipments of Cobalt-60. Given how we expect deliveries to play out this year, we believe the split between the first and second halves will be fairly even. Nelson Labs should keep facing pressure during the first half of 2022 from the very same headwinds that have hit recent quarters. Given that, we anticipate segment revenues declining early in the year, with margins slipping further into the low 30% range for the start of 2022. Along with capturing gains from pricing and operational programs, we anticipate run rate segment income margins moving back toward more typical levels during the back half of the year. Both Nelson Labs and Sterigenics will see some delay between inflationary cost strain in the first half and the offsetting pricing gains in later quarters. On the FX side, our guidance presumes today's rates stay in place through the rest of the year. Today's rates would amount to roughly a 1% headwind to total company revenue for the year, and that headwind is baked into our guidance. On capital deployment, we keep prioritizing growth efforts and strategic acquisitions; we assume no acquisitions in our guidance. I realize that was a lot, and we're glad to take any questions in the Q&A. Like Michael, I'd like to thank our entire team for their individual and collaborative work, which keeps putting us in a strong spot for future growth. Michael, over to you.

Thanks, Scott. Prior to moving into Q&A, there's a subject I want to cover that lots of investors are thinking about. In our Nordion business, a portion of the Cobalt-60 we obtain comes from Russia, which we've already made public before. We're keeping an eye on the geopolitical circumstances right now and are doing what's necessary to safeguard our Cobalt-60 supply. As of today, none of our customers' orders have been impacted. Our 2022 guidance reflects what we currently know about sanctions that have already been announced, and at this point we don't anticipate those having any effect on supply from Russia. Nobody can say with certainty how these events will play out over the near term or the long term. Given the scenarios we've examined so far, should the situation become dramatically worse, we'd still expect an impact somewhere between 0%-3% of total Sotera Health 2022 revenue. So to wrap up before we head into the question and answer portion, Sotera Health remains well positioned for growth on both the top and bottom line in 2022. All in all, we feel very good about where the company stands now and where it's headed. With that, Norma, let's open the call up for questions and answers. Thank you.

Oh, excellent. Thanks, and good morning. I appreciate all the detail. Just one question regarding the guidance. The, you know, EPS growth range, clearly at the low end of that range sits below the sales growth range you gave us. Scott, I'd really like to understand, you know, which factors might potentially push EPS to that point, and conversely, which factors would get you to, sort of, the upper end and produce some leverage? I have one follow-up.

Sure. Thanks, Matt. You know, I believe if you examine the guide in terms of the change in adjusted EBITDA compared with the change in revenue, you can infer from that largely flat margins at the adjusted EBITDA level. A few other items we're considering among the other drivers of adjusted net income and adjusted EPS would involve a modest rise in depreciation expense, which reflects some of the investments we're making. As I said earlier, we're assuming relatively flat interest expense year-over-year, but we are assuming a modest rise in the tax rate applicable to adjusted net income, based really on the kind of pre-programmed shift in the corporate tax environment stemming from the 2017 tax reform.

All right. So essentially level, apart from the depreciation tax rate and interest expense, more or less. Is that the correct way to look at it?

Yes, that's a reasonable reading.

All right. If I may, Michael, one more question on that. Clearly, there have been plenty of inquiries regarding Russia and Ukraine. Others who have exposure seem to be conveying something that sounds like greater reassurance, or at minimum an initial stance that a major effect isn't anticipated. Could you give us any background — perhaps regarding what kinds of contracts and agreements you hold, or what kinds of sanctions are involved, and why at this stage you feel somewhat more confident than others who might be looking only at where that relationship sits on a surface level? Thanks.

Yes, Matt. Thanks, and good morning. Here's what I'd say: cobalt is something we purchase from a number of suppliers across the globe. Among those is Russia, and with them we hold a long-term supply agreement, just as we do with other utilities worldwide. Keep in mind that we acquire the material and then ship it to our Ottawa facility, where final processing takes place. Given current conditions and our conversations with the authorities, no sanctions currently apply to our materials, and we believe we'll keep moving product and delivering it to our customers. Naturally, this comes down to handling certain portions of our inventory, along with the inbound and subsequently the outbound shipments headed to our customers — those are what really count. As things stand right now, we aren't affecting our financials, nor do we foresee any effect on them from this. Also, during my prepared remarks, I laid out the worst-case scenarios as we currently see them, should the situation shift dramatically.

To clarify that worst case, what exactly would shift? Would it involve sanctions placed on the materials, or does that also take in certain logistical difficulties, say, in moving supplies out? What pushes you to that 0.3 or the upper end of that 0.3?

Any one of those could do it, correct? Matt, it's tough. This situation keeps changing, as you're aware. How the logistics routes are shifting, so to speak, or developing, plus whether sanctions land specifically on the materials or the segment, and the banking relationships too. A lot of factors play into this. Clearly, I lack strong visibility into all the sanctions and plans that others might be weighing; that's essentially the way we approached it. Should we prove unable to obtain the cobalt we require, that would represent the negative impact.

Understood.

And could.

Thanks so much.

Okay. Thanks, Matt.

Oh, go ahead. All right.

Nope. That's it. Thanks.

Thanks, and good morning. About the Sterigenics capacity additions — Michael, you mentioned a pair of new sterilization greenfield sites. Can you give us more detail? What locations are they in? Will ethylene oxide be used, or another technology? How much extra capacity will that add? Also, anything on permitting or the regulatory side — the lead times, and how hard it is to build one of these facilities from the ground up?

Sure, Sean. As is our usual practice when evaluating expansions, we've held discussions with customers, with regulators, and with members of the local communities. We won't provide details about the amount of capacity involved or which modality it uses, but across every major region and technology, we're putting money into our network. These greenfield sites should go live during the back half of 2024. The good news, which Scott mentioned, is that this matches our prior approach. There are considerable customer expectations and interest surrounding this, and in the end, once we start digging, it will lead to the commitments. Our outlook on this is quite positive. The key takeaway here is that our customers in these end markets keep finding worth in what we offer, and the need for it hasn't gone away. You can see that in how Sterigenics has done so far, and that pattern will hold true down the road too.

All right. Scott, I believe you described a few of the factors affecting net income for the year, coming from elevated interest and debt. When we consider EBITDA tied to these investments, is anything weighing on EBITDA while you develop this additional capacity prior to it generating revenue?

No. That definitely isn't the case regarding our 2022 guidance.

Okay. All right. Thank you.

Great. Thanks, Sean.

Hi. Patrick couldn't make it, so Jason is filling in for him. There are two things I want to ask about quickly. To start, in the outlook you mentioned certain assumptions baked in regarding supply chain, inflation, labor supply, and how quickly elective procedures bounce back. Could you talk about what you're observing on those fronts as far as trends across the year?

Sure. Regarding the recovery side, Jason, when it comes to device volumes, we keep witnessing steady growth as they come back. Clearly, late in the prior year, conditions weakened because elective procedures were halted and Omicron began spreading. Looking ahead to 2022, we anticipate a steady, step-by-step pickup, much like what we forecast a year ago, and that formed a portion of my remarks about what lies ahead. My apologies — Jason, what was that second thing you wanted to ask?

Turning to supply chain, plus perhaps inflation and labor availability.

Yes, yes. Regarding supply chain, as you know, we anticipated inflation within the business; we have strong confidence in our capacity to counter it through pricing and other operational enhancements in the business; we observe a difficult labor market, as noted in our remarks, evidently experiencing it more acutely in the United States compared to other markets globally; it appears in operations such as Sterigenics and Nelson, where we have noticed it. We expect some lingering effect from that inflation as we enter the first half of the year. Then, as we stated, during the second half of the year, we will begin to realize some pricing and productivity that can counter that inflationary pressure.

Understood, that's useful. So, only one additional item from me. As your leverage keeps coming down — and I believe by the close of the year you're approaching three times — what amount are you actually at ease with? What is your current thinking regarding M&A and growth that isn't organic, going forward?

Yes, like we said, our long-term target was net leverage of 2 to 4x; today we sit inside that band; we take a lot of pride in last year's achievement, bringing it to 3.5x. Our number one focus remains, and has consistently been, putting money back into the company for inorganic growth. That explains the bigger step-up in the pace of our capacity expansions. The funds are available, the customer demand exists. One further thing we didn't mention during our remarks here: we've just wrapped up our yearly customer satisfaction survey, and once more received very strong feedback throughout the businesses from our customers. So we're genuinely proud of what the teams deliver every single day. We view the end markets as quite robust, and we're going to put capital to work for inorganic growth. We'll be extremely deliberate and strategic about M&A, ensuring it aligns with strategy and produces the returns we'd anticipate. On the whole, there's really no significant shift in our capital deployment approach versus what we've described previously.

Excellent. That's quite useful. Thanks.

Excellent, thanks for fielding the questions. To start, folks, could you share a bit about how much line of sight you have on the litigation moving ahead in Willowbrook as anticipated in July, and also your views on. I'm aware there's a proposed rulemaking regarding NESHAP at some point before the year is out.

Yes, Matt, Michael here. I'll handle that one. Actually, I'll take this chance to touch on several items regarding the EO matter. To begin with your question, at present the trials are scheduled in Illinois for July of 2022, September of 2022 and November of 2022; so three trials are currently what we anticipate during the back half of the year, so to speak. We're eager to get those finished. Our teams are highly focused on our defense, and we feel good about our current position. In the end, the courts will make the determination. Regarding, as you're aware, broader developments, we keep advancing with our GFE enhancements. A number of you might have observed some of the activity late in the year and then more lately, early in the year. To start, we'll mention New Mexico. A court order was issued. The two parties, the attorney general and the company, each submitted proposals before a judge regarding how the facility should be monitored going forward. We were happy with how that turned out. The judge issued an order that matched what we expected, and we are proceeding with our GFE enhancements that we'll finish here in 2022 for the Santa Teresa facility; also another important item, you know, even though we've had a facility up and running in Georgia for a good while with improvements, which once again lead the world in many respects, we are also glad to see that acknowledged by the regulators, and we received a new environmental air permit in Atlanta, during the early portion of 2022. So we're quite encouraged by what we're doing in this area, and we're going to keep advancing with that strategy. Regarding NESHAP, which I think is what you mean, at present our understanding is at some point in the second half, likely late second half, we will see a new NESHAP proposed rule that'll be open for public comment; so that's the timing as it stands. We've said many times before to the team here, we'd prefer to have this finished sooner. We would have preferred to see it in 2018, 2019, 2020 or 2021. Currently, the government is projecting second half of 2022, and we're eager. Just give us the new rules, and we'll ensure we exceed the expectations there.

All right. Great; looking at this year, I saw that the guidance included a somewhat broader range for reported sales growth compared with what we had a year ago. I mean, it's not a huge difference. My thinking would be that, you know, in 2022, you've got somewhat more clarity than perhaps you had at the start of last year, or maybe that isn't the case. What is causing a bit of that broader range? Sort of what falls under the low end as opposed to the high end?

You know, Matt, what I remember is that regarding the first guidance we put out during the early portion of 2021, it matched this one when it came to how big the range was. We did make the range narrower once we reached the second half of the year, but I wouldn't, you know, I wouldn't interpret anything based on how big the range is. This is simply, I believe, a reflection of the various variable drivers affecting the business. Clearly, there's a great deal happening in the world at this moment, and we simply want to be certain that we're taking into account the full set of factors.

Alright. One final item regarding cobalt. Should any shifts occur, could you give us a broad picture of how a supply interruption would affect Nordion, and then how that would trickle down to Sterigenics?

What would happen is we'd be unable to obtain the cobalt we require out of Russia, correct? As you know, we've got a certain amount of cobalt anticipated in our operations this year originating from Russia that we would subsequently distribute to clients such as Sterigenics. What flows from that is Nordion wouldn't receive it, so they couldn't deliver it to those clients. Keep in mind that not every bit of cobalt we acquire during a particular year leaves during that same year. Processing takes time and there are matters of that sort before shipment, plus we have additional cobalt suppliers, which explains the range we provided — 0%-3% throughout the entire company. The consequence would be our capacity to deliver it to clients like Sterigenics or other clients depending on Nordion.