Sotera Health Company (SHC) Earnings Call Transcript & Summary

Hello, all, and thank you for joining Sotera Health's call about our 2022 first-quarter earnings. This morning it is genuinely a pleasure to report on another quarter that produced double-digit expansion in both revenue and profit compared with last year's equivalent period. Labor markets and supply chains have faced strain from the pandemic as well as from geopolitical conditions, and the broader macro situation continues to show greater upheaval than nearly anyone alive today has ever seen. Despite those circumstances, Sotera Health has continued to post growth without interruption in each quarter from the time we went public and across our entire history. Scott will walk you through the details in a moment, but I want to share a few key points about how we did in Q1. Our total revenue rose 12%, while adjusted EBITDA was up 10% versus the same period in 2021. Diluted EPS reached $0.11, which is $0.07 higher per share, and adjusted EPS landed at $0.22 — a 22% gain year over year. Sterigenics has begun the year well, with the business continuing to experience strong demand across every major sterilization modality. Sterigenics has also achieved significant strides in its ongoing capacity expansion initiatives and its EO facility upgrades. Nordion turned in a really solid quarter as well. Two things drove that: the timing of when Cobalt-60 shipments landed, and the fact that last year's comparable quarter was an easy one to beat. I want to give a huge amount of credit to the Nordion team — they've been steering through today's geopolitical landscape to keep Cobalt-60 flowing out of Russia, and that's no small feat given how many complications come up along the way. Back on our March call, I noted that if Cobalt-60 supply were disrupted, it could hit Sotera Health's 2022 revenue by somewhere between 0% and 3%. As of right now, neither our supply nor Sotera Health's revenue has taken any hit at all. Thanks to the shipments that have come in since we last reported, we're now putting the possible fallout from a Russian supply interruption at somewhere between zero and two percent of Sotera Health's total 2022 revenue. Once more, a big thank you to the Nordion crew for handling this situation so skillfully throughout the quarter. Sterigenics and Nordion are both doing well, but as we anticipated and told you about on our previous call, Nelson Labs has run into tougher conditions. The first quarter was a weak one for Nelson Labs, and it also happened to be the final quarter in which the company felt the heaviest effects of declining high volumes of pandemic-related testing. During our previous earnings call, we noted that Nelson Labs experienced an outsized hit in Q1 stemming from workforce difficulties, which included lower volumes tied to absenteeism driven by Omicron. It's encouraging that these headwinds at Nelson Labs are now trending favorably, and we anticipate a return to more typical levels during Q2. Absences caused by Omicron have dropped considerably, and Nelson Labs' leadership is handling headcount quite effectively even with a tight labor market. We continue to actively manage our balance sheet, ending with net leverage of 3.4x. That figure matches our objectives for both the short term and the longer term. Since 2022 has kicked off well and we're still only a few months in, we're restating the guidance we gave on our previous call: revenue and adjusted EBITDA growth of 7%-11%, plus adjusted EPS growth of 6%-13%. Scott will walk through every piece of that guidance shortly. I'd also like to point to a few recent illustrations of how we carry out our mission of safeguarding global health. As bioprocessing expands, Sterigenics is sterilizing single-use kits inside bioreactor collection bags that get used to produce cell therapies for fighting cancer. Turning to RCA, the expert advisory operation that joined us recently through acquisition, our work involves collaborating with clients on creating efficient setups, which allows gene therapy medications bound for clinical studies to be transported safely. Meanwhile, at Nelson Labs Europe, our team performs essential testing that verifies the safety of containers and delivery mechanisms used with more than 20 vaccines — covering COVID-19, tetanus, hepatitis B, and influenza — and that represents just a small sample of how we contribute to keeping healthcare dependable and safe day in and day out. Taking everything into account, I hold enormous pride in every member of the Sotera Health team for delivering yet another robust quarter and positioning the business for continued achievement throughout 2022. On this call, as always, everyone at Sotera Health remains committed to our purpose of protecting health worldwide, while taking care of customers, medical professionals, and patients, and looking out for one another in the process. Before handing the discussion over to Scott, I want to touch briefly on the larger markets in which we operate. I've mentioned this repeatedly in the past: we continue to observe both the direct and indirect effects of the pandemic, along with the geopolitical situation affecting the entire marketplace. Right now, disruptions to supply chains, difficulties in the labor market, and inflation are creating particularly severe pressure. Up to this point, we have succeeded in cushioning most of the direct blows, and we're encouraged by our ability to largely counterbalance inflationary headwinds by adjusting prices. Even with the challenging macroeconomic backdrop, demand in our end markets has held up well, and that makes us hopeful about the remainder of 2022. At this point, I'll turn things over to Scott, who will walk through Q1 and our unchanged 2022 guidance in more depth.

Appreciate it, Michael. To start, I'll walk through the consolidated highlights for the first quarter of 2022, then share some perspective on each business segment, plus updates regarding capital deployment and leverage. I'll wrap up by revisiting the specifics of our reaffirmed 2022 outlook. Looking at the total company on a consolidated basis, revenue for Q1 2022 rose 12% versus the same quarter a year earlier, reaching $237 million. Constant currency revenue was up roughly 13%. Adjusted EBITDA climbed 10% from Q1 2021, hitting $115 million. Adjusted EBITDA margins came in at 48.7%, a decline of 90 basis points relative to last year's first quarter. That decrease came entirely from margin compression in the Nelson Labs segment, since Sterigenics and Nordion each saw margins expand during the quarter. I'll go deeper on segment margins shortly. Solid operating performance produced adjusted EPS of $0.22 per share, roughly 22% above Q1 2021. Reported interest expense of $10 million reflects a benefit from a mark-to-market gain on certain outstanding interest rate hedges. That gain has been excluded from our adjusted EPS. Absent that gain, interest expense in Q1 would have come to roughly $17 million. Let's now examine how each segment performed. Sterigenics posted 14% revenue growth in Q1, reaching $149 million, with segment income up 16% to $79 million versus the prior-year first quarter. Growth drivers during Q1 were volume and mix contributing nearly 10%, plus pricing adding more than 5%. Inorganic activity contributed nothing this quarter, while FX created a 1% headwind. Segment income margins widened by over 90 basis points from Q1 2021 to 53.1%, thanks to operating leverage and pricing. We're happy with how Sterigenics is progressing on both its active expansion projects and the upgrades at our North American EO facilities. Turning to Nordion, Q1 revenue increased more than 31% to $34 million against Q1 2021. Nordion segment income rose about 37% to $19 million versus the same period a year ago. Volume and mix drove over 24% of Nordion's revenue growth, with pricing adding almost 7%. FX was essentially flat for the quarter. As Michael noted, Nordion's year-over-year comparison faces the impact of a relatively weak revenue quarter in Q1 2021. Nordion's margins widened by roughly 240 basis points to 55.6%, supported by operating leverage on higher sales and pricing. As for Nelson Labs, Q1 revenue fell approximately 3% to $53 million compared to the first quarter of 2021, while segment income dropped approximately 26% to $17 million. Declines of 11% from pandemic-related testing and more than 2% from Omicron-related absenteeism were largely offset by an 8% benefit from acquisitions and 4% from price. Other core testing volumes and FX each contributed a decline of about 1%. For Nelson Labs in Q1 2022, margins came in at 32%, which is a drop of 990 basis points from the same quarter a year earlier. I want to point out that this decrease matched what we had anticipated and mentioned during our previous earnings call. The margin contraction versus a year ago stemmed mainly from roughly 200 basis points tied to a reduced mix of PPE testing, more than 250 basis points due to acquisitions, and around 300 basis points from Omicron's effect on both employee absenteeism and testing volumes. We anticipate bouncing back from the Omicron portion in Q2, and we look for the dilution linked to acquisitions to improve as synergies build through the latter half of 2022. Let me now share a few points on capital deployment and net leverage. CapEx in Q1 totaled $36 million, aligning with the higher spending levels we've budgeted for 2022. At March 31, 2022, cash stood at $121 million, and our liquidity position remained solid. Net leverage came down to 3.4x. Now I'd like to go over our reaffirmed 2022 outlook. For the full year 2022, we anticipate total revenues between $1 billion and $1.03 billion, which reflects growth of about 7%-11%. Adjusted EBITDA between $515 million and $535 million, again reflecting growth of roughly 7%-11%. Adjusted EPS between $0.93 and $0.99, reflecting growth of 6%-13%. CapEx between $140 million and $170 million for the year. Our expansion program stays in line with what we said on the prior earnings call, covering seven capacity expansions at existing sites plus two greenfields for Sterigenics. The remaining parts of our earlier outlook are unchanged too. When considering the pattern of quarterly reporting, I want to remind everyone that although this business segment frequently sees variability and performance shifts from one period to another, Q2 of 2021 was an anomaly for Nordion. Nordion saw an especially heavy concentration of Cobalt-60 shipments in Q2 of 2021, and we don't expect that to repeat in any single quarter this year. We look for strong Sterigenics results and better Nelson Labs performance in the second quarter. Michael, back to you.

Thanks, Scott. Before we start the Q&A, I want to make a few remarks, since our next earnings call is going to happen after the first EO trials get underway. The initial trial is set to kick off in Illinois on July 18th and wrap up at some point in August. Our team is getting ready for trial in earnest, and while there's no way to know how a trial will turn out, we feel good about our defenses against these claims and about how safely we run our operations. We expect quite a few legal motions and court rulings in the months ahead, which might affect the trials and attract press coverage. Right now, we don't plan to comment on pretrial developments or give updates on the trials. Let me restate something we've said on many occasions: the company plans to fight these claims aggressively. Our company has a vital role in healthcare, and our people and facilities operate safely and in line with regulations. It's our employees' dedication to our company and our mission that has produced Sotera Health's steady, excellent results across so many years and leaves me so hopeful about what 2022 and the years after hold for us. Last, I want to take a moment to welcome a new addition to the Sotera Health team. Joe Vitale has come aboard as the company's Head of Investor Relations and is here with us on today's call. Joe is getting up to speed fast, and we can't wait for him to engage with the investment community and share the Sotera Health story. With that, I'd like to hand things to our operator, Joe, and begin the question-and-answer session.

Yeah, thanks, and good morning. Regarding Nelson Labs, you indicated revenue and EBITDA would be weighted toward the back half, once pandemic impacts fade and non-COVID-related work starts picking up speed. On that second point, could you bring us up to date? It sounds like that remains your view, but how much visibility do you actually have into activity throughout Nelson starting to normalize or accelerate as we move toward the back half of the year?

Good morning, Sean, this is Michael, and thanks for asking. At Nelson, the team there — visibility isn't at the same level as what you get at Sterigenics and Nordion, though we still have solid visibility with that team. Clearly, we rely on some testing volumes continuing to recover, but the team came in line with what we expected for the first quarter. We keep gaining visibility there, and we keep stabilizing the workforce. Things aren't entirely where we want them yet, but we're confident in our view of the second half, the second quarter, and further out.

All right, thank you. Michael, you brought up obtaining the Nordion supply out of Russia. There are definitely certain complications that have to be managed throughout that process. Could you share a bit more about what exactly those complications involve? You brought up the possible effect from a disruption or for disruption in 2022, but how should we view that when we look forward to 2023 and past that?

Yes. Sean, the first thing I want to state very plainly is that we follow every rule and regulation that exists regarding this particular matter. Cobalt has not been sanctioned by the U.S. government, the Canadian government, or the Russian government. We keep watching that situation. You know, we simply have to handle logistics around filling containers, placing them onto vessels, ensuring those vessels are able to depart ports, reach ports, be unloaded, and go through banking. You know, there are simply numerous details, as you're aware, when conducting business globally. That's what, you know, the team, as I said during my remarks, has performed very well at keeping on top of, speaking with regulators, tracking the, you know, the sanctions that exist and ensuring we remain in compliance with them. You know, regarding what we've provided as guidance here on 0%-2% of a potential impact if something were to affect our capacity to obtain cobalt. Right now, we've seen no effect on our supply. We've managed to obtain it. We're serving our customers. If you speak with our customers, they truly haven't observed anything because of the excellent work the team has done at Nordion. We've gotten cobalt as early as this, as recently as this week. We'll keep doing that. Regarding 2023, we aren't able to discuss Sotera Health or Nordion or any of the business units for 2023 right now.

Okay. Understood; that's helpful. Thanks again.

Yep, great.

Hello, and many thanks. Phil here, filling in for Amit. I appreciate you fielding this. As I attempt to break down the guidance, it seems Nelson Labs mostly matched the targets you'd outlined for Sterigenics. By any measure — whether compounded or compared with a year ago — it appears to have sped up. Nordion clearly delivered quite a robust quarter overall. Would you characterize the segment as having beaten what you anticipated entering 1Q as a whole?

Well, Phil, good morning. Michael speaking. In aggregate, I'd answer yes. As we've explained previously, certain parts can be uneven — Nordion sometimes comes in lumpy, since we operate according to harvest timetables set by our utilities. Like Scott mentioned, Q1 of the prior year was on the lighter side. Q2 of last year will be a bigger one, correct? So that unevenness exists to some degree. Broadly speaking, we landed a touch above what we'd expected, and we're pleased with how the business performed during Q1.

Right. Okay, that helps a lot. Thanks. So my follow-up, tied to that same logic, concerns the cautious stance for the rest of the year in not bumping up guidance once the quarter closed. I realize you give a reported top-line range. Is there an FX headwind working against you there? Or which other elements are you weighing that resulted in no increase following such a robust first quarter? Many thanks.

Yes. I'll have Scott speak to the FX shortly, but what I'd say is, look, that's 1 quarter done, 3 quarters remain ahead of us; we're upbeat regarding how 2022 is coming together, yet there are many moving pieces. Our customers are grappling with difficulties in getting materials and supply to flow. We're observing some fluctuation in that. Clearly plenty of moving pieces exist in the business, yet we feel good about our reconfirming or reaffirming, so to speak, our 2022 guidance, which is genuinely solid with meaningful growth across the year. It's simply early right now; 1 quarter sits behind us.

Right. And on the FX piece in particular — back when we put out guidance a couple of months back, we did say at that point that the guidance carried an assumption of roughly a 1% FX headwind for the year. And as I mentioned earlier, we did actually take a 1% headwind in our Q1 results, and our assumption remains that a headwind of that magnitude on FX persists across the rest of the year.

Okay, that helps a lot. Thanks a lot, guys.

Great, thank you, Phil.

Hi, everyone. Appreciate you taking the question. Scott, just a few quick clarifications here. Regarding the M&A contribution this quarter, particularly for Nelson, what portion came from BioScience versus what portion came from RCA? I'm just trying to figure out what will carry through the remainder of the model for the year.

We haven't provided a breakdown of the specific contribution by acquisition. For context, we picked up RCA — sorry, BioScience in March of last year, and here in Q1 you're still seeing roughly 2/3 of an incremental contribution from them. And as you likely remember, it was in November of last quarter when we bought RCA. You're getting. Honestly, you'll get a full quarter of incremental contribution from RCA, at minimum across the first three quarters of this year, and then a partial one in the fourth quarter.

Alright. Okay. So I suppose, regarding what you said about pricing at Nelson, do you folks hold a significant number of master service contracts? You've managed to extend it, I suppose, throughout each of the three businesses here. Could you discuss where things might be somewhat more uneven as opposed to simply being in a position to hand along higher costs?

What I'd say is that, as we've mentioned previously, all three of these businesses possess the ability to pass through pricing; the service we provide is extremely essential and represents only a modest share of what our customers' products and services cost overall. Let me just offer that as a broad statement. Looking at the three businesses, Nelson happens to be the one that, you know, depended more heavily in the near term on the method for achieving that price, given that it operates with a greater focus on individual transactions. The contractors involve master contracts featuring releases made against them over time, whereas Nordion Sterigenics tend to be longer in duration. I hope that addresses your question. That said, I believe it merely validates what you already suspected.

Yeah, it does. Thank you.

Yep. Yep, great.

Hello there. I appreciate you taking my questions. Nice work on yet another solid quarter. I was hoping perhaps you might elaborate somewhat regarding what's happening with Sterigenics. As you're aware, within the medical device portion of what we track, demand has come back more quickly than people had anticipated, perhaps. The underlying drivers for those companies are picking up speed a bit sooner. So I'm curious what that means for how Sterigenics performs across the coming 3 or 4 quarters, in your view. Some insight there would be great. I've got one more thing to ask.

Yes. Morning to you, Matt. What I'd say is that our mood is one of optimism. Clearly, Sterigenics delivered a really robust opening quarter, and we feel good about how the remaining months of the year will shape up. At the same time, I should mention that things differ quite a bit depending on which customer and which geography you look at. Take Asia — that's where I'll begin, and if you'll allow me, Matt, I'll sort of travel the globe from the standpoint of Sterigenics. When it comes to Asia, as you'd expect, COVID-related shutdowns are happening at facilities across those regions. That's created certain difficulties. Our focus is on making sure our customers are well taken care of. Over in Europe, demand has been quite solid and the region keeps delivering good results; meanwhile, in the U.S., results have been uneven. Some of our customers are performing very strongly, which you can pick up from their earnings reports. Others are experiencing a bit of pressure, which shows up in what they've announced too; we're keeping an eye on that. What's driving it is trouble with supply chains — obtaining components and, in certain cases, moving goods across borders. On top of that, there remains a modest labor effect. Naturally, many companies felt this in January because of the absenteeism we mentioned earlier in our comments. Broadly speaking, I'd say we're optimistic, though we're staying careful given how much things vary customer by customer. Another piece of context I can offer, drawn from areas where we enjoy strong visibility, concerns hospitals. Hospitals, you know, are sitting on substantial backlogs of surgical procedures, yet what's tripping them up at present is staffing. So many workers have exited the healthcare labor pool inside the provider network that it's proven difficult, especially when it comes to nursing care; that feeds through to demand from end users as well. All in all, we're feeling good regarding what lies ahead for Sterigenics, and likewise for Sotera Health as a whole in 2022. I believe you had another question, Matt. I hope the first one has been answered.

Yes, definitely. Thanks a lot. That was really useful. The second thing is perhaps if you might give a high-level view regarding how certain of the increasing input expenses that we are observing throughout our coverage universe — it has clearly been a major subject for the Q1 reporting season and the 2022 outlook. You know, wages, higher energy prices, freight, that sort of thing. I'm just curious whether you could offer us some insight into how each of your three main segments is impacted on a comparative basis, given those sorts of changing costs. Thanks.

Right. Like we mentioned during the previous call, we haven't gone deep into the specifics on this call so far, beyond pointing to the inflationary pressure we're experiencing. It centers on labor along with energy and utility spending. Those essentially make up the two categories. Regarding transportation expenses, if you look at all three of our businesses, transportation costs don't exist for us within Sterigenics and Nelson. At Nordion, where transportation costs do exist for us, they get passed through to our customers. As for energy costs, we're encountering them throughout our businesses, mainly on the Sterigenics side, since that business has a bigger facility footprint globally; then on the labor side, once again, we encounter it throughout the businesses, though I'd say it's primarily on the Sterigenics and Nelson side, since labor represents a higher percentage of their overall cost there. That's roughly our summary of where the inflation is showing up. You know, we don't have the material side. Transportation isn't something we have throughout the businesses. It's really concentrated only in energy, utility, and the labor component.

Thanks so much.

Great.

Hello everyone, and thanks for taking my questions. Scott, perhaps I could build on what was just discussed regarding the various elements affecting costs. Could you walk us through the margin levers as the year unfolds, and maybe address the pacing too? Clearly, there's a lot happening, including the margin pressure from Nelson, plus some items you just mentioned, like pricing. I'm just trying to understand the pluses and minuses here and how we ought to view them as we move further into the year.

All right. Taking each business unit separately: with Sterigenics, to start with, although seasonality doesn't have a huge effect on Sterigenics, Q1 is the single quarter that usually carries some pressure tied to seasonality. Because of the operating leverage in that business, that seasonal effect on the top line usually also carries through to what is really the year's lowest margin profile. Our expectation for Sterigenics is that as they keep ramping the top line sequentially over the course of the year, the margin profile should improve too, again simply because of the operating leverage in that business plus a certain amount of incremental pricing that keeps flowing into the P&L. Turning to Nelson Labs, clearly the normalization of the various factors that have weighed on their recent results has a significant effect on their story. As we said in our prepared comments in Q2, we anticipate sequential improvement for Nelson Labs, mainly from the normalization of the Omicron-related absenteeism, which we cited as roughly a 300 basis point impact in Q1. It's in the second half of the year, as Nelson sees some of their other revenue streams and margin drivers normalize, that you see a more meaningful return to the "normalized levels" from the first half of last year. Then for Nordion, as we've often referenced, Nordion is such a lumpy business, and such a high proportion of their cost structure is fixed, that really at the end of the day, the harvest schedule, which translates to top line performance, is just gonna significantly drive their margin profile from quarter to quarter. Again, the operating leverage can result in some movement back and forth in their margin profile. Compared with last year's margin profile, we expect Nordion to hold fairly steady.

All right, that's genuinely useful. Michael, perhaps regarding the litigation angle, it would be helpful to have a bit of context on that, as you did in the prepared remarks. How should we think about the timeline ahead there? Clearly, you mentioned somewhat the start dates and a possible resolution. Maybe at a broad level, walk us through the sorts of catalysts on that front that we ought to watch for.

Okay, so I think the best approach is to zero in on 2022 and handle it in smaller pieces, so to speak. As things stand for 2022, there are 3 trials on the calendar. The first is July 18th, like I said, followed by September 12th and November 7th — those make up the 3 dates for trials in Illinois during 2022. Keep in mind, those dates aren't ours to choose. The court determines them, which means they could shift, but our confidence is fairly high that this schedule will hold; we'd expect things to kick off on July 18th, with a ruling likely arriving somewhere between mid-August and late August. That's our best guess for how long we think any single trial will take, and then the following one comes immediately after, beginning September 12th. A comparable timeline — 4 to 6 weeks — before a jury delivers a ruling.

Great. Thank you, guys.