Sotera Health Company (SHC) Earnings Call Transcript & Summary

Hello, and thanks so much. I'd like to welcome everyone to the call covering Sotera Health's results for the second quarter of 2022. Our press release from today, along with the supplemental slides that go with it, are available in the Investors area of our site, soterahealth.com. This webcast is being taped, and a replay can be accessed in the Investor Relations portion of the Sotera Health website; joining me on today's call are Michael Petras, our Chairman and Chief Executive Officer, and Michael Biehl, our Interim Chief Financial Officer. Some of what the company says during this call might be viewed as forward-looking statements. The subjects covered by those statements carry risks and uncertainties that may lead actual results to differ materially from what is projected or implied. For a description of those risks and uncertainties, please see Sotera Health's SEC filings and the forward-looking statement slide at the start of our presentation. The company undertakes no obligation to update any forward-looking statements of this kind. Please be aware that on today's call, the company will present financial measures under both GAAP and non-GAAP, among them adjusted EBITDA, adjusted EPS and net leverage ratio. Reconciliations of non-GAAP measures to GAAP measures for all relevant periods can be found in the schedules accompanying the company's press release and in our supplemental slides. The operator will be helping us with the Q&A portion of today's call. <<operator_script>> I'll now hand the call over to Sotera Health Chairman and CEO, Michael Petras.

Hello, everyone, and thanks for being with us on Sotera Health's call for the second quarter of 2022. I'm delighted that we will be reporting yet another period of growth on both the top and bottom lines compared with a year ago, particularly given that we're measuring against an extraordinarily strong quarter a year earlier. As a matter of fact, Q2 of 2022 stands as the strongest quarter for revenue and earnings in the history of our reporting. I'm particularly proud of how our team has performed amid persistent economic and geopolitical uncertainty, which includes elevated inflation, swings in currency, labor shortages and continuing difficulties in the supply chain. Even with those conditions, Sotera Health continues to deliver expansion and strong financial performance, while also taking care of our clients and remaining committed to our mission, Safeguarding Global Health. I want to welcome Michael Biehl, our interim CFO, to this call. Shortly, he will take you through the financials in more depth. But first, let me highlight several items from what we reported for the second quarter. Relative to the same period in 2021, our total revenue increased 5.8%, and adjusted EBITDA was up 1.2%; on a constant currency basis, revenue climbed approximately 9%. Keep in mind that the second quarter of last year enjoyed high demand for COVID-related testing at Nelson Labs along with significant Cobalt-60 product shipments at Nordion. Adjusted EPS came in at $0.27 for the second quarter, which is $0.01 higher than the same period a year ago. During the first half of 2022, Sotera Health achieved total revenue growth of 8.5% and adjusted EBITDA growth of 4.8% against the first half of 2021. Measured on a constant currency basis, revenues for the first half of 2022 increased by approximately 11%. Taking everything into account, I'm pleased with how we performed financially during the first six months, considering the difficulties I just described; shortly we'll discuss what we're expecting for the remainder of 2022 along with the updated guidance for Sotera Health's entire year; however, at this moment I want to walk through what happened at each of our three businesses in greater detail. Our largest reporting segment, Sterigenics, continues delivering robust 2022 results, as that business experiences healthy demand across every significant sterilization modality while running at elevated capacity utilization levels. The team remains dedicated to fighting inflationary headwinds and getting the most out of operational efficiencies. Sterigenics is working hand in hand with the Sotera Health Expert Advisory Services group to develop streamlined procedures that meet what our customers require and what regulators demand, while at the same time getting the most out of capacity at our Sterigenics sites and, ultimately, delivering stronger service to our customers. On that note, I'm happy to share that our standing as a thought leader on EO efficiency keeps getting acknowledged across the industry. Not long ago, at a major industry gathering, recognition went to our Expert Advisory Services team for the EO cycle optimization effort carried out alongside a sizable global customer. That effort achieved a significant drop in EO consumption and cycle times, all without sacrificing sterility assurance levels — one more great example of how our teams are pursuing the Sotera Health mission. Sterigenics keeps making meaningful progress on our capacity expansion programs and facility enhancements. Back in May 2022, we shared news that our Sterigenics Indiana site had officially opened its new E-beam line. Additional installed capacity should come online later in 2022 and across the following 24 months, since we commissioned 7 capacity expansion projects within 2 greenfield investments. As we've said before, we keep putting money into industry-leading emission control upgrades at our EO processing facilities; our commitment stands to preserve best-in-class operations for customers, employees, and the communities where we operate. Nordion, the other reporting segment inside our sterilization business, also posted a very strong quarter, helped by the timing of Cobalt-60 product shipments. During Q2 2022, our top line exceeded what Nordion generated in the same period of 2021 — a quarter that had already gotten a lift from unusually robust shipments of cobalt. As we've said before, the timing of work at nuclear reactor sites is what dictates Nordion's sales, which means revenue doesn't arrive evenly across quarters. That uneven rhythm continues to be visible in our reported figures, from the standout results we just posted for the second quarter to the outlook we hold for the back half of 2022. This quarter, the Nordion group performed at a very high level, moving a substantial volume of cobalt-60 even as it contended with a highly difficult geopolitical landscape and a global supply chain that grows more varied by the day. Keep in mind that this operation sources Cobalt-60 from around the world, then turns that material into a completed product at our Auto Canada site, after which it delivers those goods to customers worldwide while meeting strict regulatory requirements. I'd like to point out that as of today, no sanctions prevent Nordion from obtaining Cobalt-60 out of Russia. Everything we do complies fully with all applicable rules. As of this point in the year, our estimate of the risk that Russian supply could be disrupted now stands at 1% or less of Sotera Health's total revenues for 2022. Our third reporting segment, Nelson Labs, also posted a solid second quarter, bouncing back from certain operational challenges present in the first quarter of 2022. To put a finer point on it, Q2 2022 brought in more money than any other quarter in Nelson Labs' entire history. The folks at Nelson Labs keep strengthening their leading spot in testing and advisory work for the medical device and pharma sectors, assisting clients in bringing their offerings to market in a safe, compliant way. During the quarter, demand held steady and output rose considerably, with Nelson Labs recovering from the staffing shortages caused by Omicron absences that had dragged on things earlier in the year. As you might remember, Nelson Labs got a big lift from pandemic testing, which hit close to its high point in early 2021 and since then has settled back to normal. Even with that persistent pressure, the Nelson Lab team keeps increasing sales in other segments of the operation, such as additional high-value testing categories. As I mentioned during my opening remarks, we are happy with the strong beginning to 2022 that all 3 of our businesses have produced. Conditions in the broader economy have been difficult, yet we anticipate keeping up solid momentum through the latter portion of 2022. Having enjoyed a strong year, we're now tightening the full-year guidance we've set for 2022, factoring in the currency challenges we're facing along with other broad economic pressures that will probably continue through this year; we feel good about the price increases we've put in place to counter inflation, though, as we've mentioned, a delay is possible based on when customer contracts come up for renewal. As for the guidance itself, we expect net revenue for the full year to rise 7% to 10%, and adjusted EBITDA for the full year should increase 7% to 9%. Each of those aligns with the growth targets we've set for the long term. Our capital expenditures guidance for 2022, between $140 million and $170 million, remains unchanged in our view. Before handing things to Michael Biehl, I'd like to point to a few recent illustrations of how we fulfill our mission of safeguarding global health. At Nelson Labs, we're partnering with a customer to launch a new gene therapy drug capable of cutting dosing protocols for severe hemophilia patients from more than 100 doses each year down to 1 dose each year, dramatically enhancing quality of life for numerous patients. Solutions like this one touch many patients' lives directly and make us extremely proud to help deliver innovative health care products. At Nelson Lab, we're actively evaluating how well surface Disinfectix works against the monkey pox virus. That's one more illustration of our teams collaborating with clients to tackle possible worldwide health threats as they happen. At Sterigenics, we're partnering closely with a customer to develop a sterilization method for innovative heart valve catheters, offering a less invasive treatment option compared with open heart surgery. At Nordion, we're bringing an extra production cell online to concentrate on Cobalt-60 recovery, which lets Nordion make full use of particular products nearing end-of-life in different applications. This investment cuts waste and therefore delivers a beneficial environmental outcome. We're proud to offer these illustrations of how our Sotera Health teams strive to make sure health care gets delivered consistently, reliably and safely each day. Last, I'd like to say a few words about the organizational change we made recently. I want to officially welcome Michael Biehl, our Interim CFO, who has come aboard the leadership team at Sotera Health and will head the finance organization as we carry out our nationwide search for a permanent CFO. Michael offers us substantial public company leadership experience and financial know-how, and we're glad to have Michael with us. Now Michael Biehl will walk us through the financials in greater detail.

Thanks, Michael — and I’m glad to have the opportunity to help the company through this period. First, I’ll take you through the second quarter 2022 highlights for the consolidated business, then give specifics on each segment, along with updates on capital deployment and leverage. After that, I’ll close with a few additional details about our revised 2022 outlook. As Michael mentioned, the second quarter of 2022 was exceptionally strong for us — our largest quarter ever for both revenue and adjusted EBITDA. It’s worth repeating that we are comparing these results with what had been Sotera Health’s best quarter on record, which makes our Q2 2022 top line performance even more remarkable. Looking at the entire company on a consolidated basis, revenue increased 6% compared with the same quarter a year ago, reaching $267 million. Adjusted EBITDA rose 1% over Q2 2021, reaching $136 million. Adjusted EBITDA margins were 51.1%, down 240 basis points from second quarter 2021 levels, but still reflecting solid capacity utilization and throughput. The year-over-year decline in adjusted EBITDA margin was mainly due to the timing of pricing actions relative to realized inflation at Sterigenics, a less favorable product mix at Nordion, and an unfavorable though improving margin profile at Nelson Labs. Keep in mind that Nelson Labs had benefited from high-margin pandemic-related testing volumes through the second quarter of 2021, before those volumes began to normalize. Notably, Nelson Labs did improve margins incrementally by 400 basis points compared with first quarter of 2022 margin levels, and I’ll discuss that further shortly. Our solid operating performance generated adjusted earnings per share of $0.27, up $0.01 from second quarter of 2021, which had been our highest adjusted EPS period prior to this quarter. Diluted EPS for the second quarter came to $0.11, a decrease of $0.04 versus second quarter last year. A major factor behind that decrease was an impairment charge of $9.6 million tied to a joint venture connected to our 2020 Iotron acquisition. Because of a shift in business strategy, that joint venture will not move forward, and the joint venture partner will keep using existing Sterigenics facilities for their processing needs. That impairment reduced diluted earnings per share by roughly $0.03 this quarter. Our reported interest expense of $14 million reflects the benefit of a mark-to-market gain and certain outstanding interest rate hedges for which we did not collect hedge accounting. We’ve stripped the effect of that gain out of our adjusted EPS. Without this gain, second quarter interest expense would have come to approximately $17 million. Now let’s dig deeper into how our segments performed. In Q2, Sterigenics posted 9% revenue growth to $158 million and 7% segment income growth to $85 million compared with Q2 of last year. Drivers of Q2 revenue growth included favorable pricing of 6% and favorable volume and mix of 5%, partly offset by unfavorable foreign currency headwinds of 2.5%. If we use the second quarter of 2021 as our reference point, segment income margins contracted by 90 basis points, coming in at 53.9%. A pair of factors drove that: foreign currency headwinds, along with the timing of contractual pricing moves in relation to realized inflation. Looking sequentially, margins did improve compared with the first quarter of 2022. Michael mentioned earlier that we feel good about the active capacity expansion projects Sterigenics has in flight. That group is also focused on driving better operating efficiencies so we can get full leverage from capacity that is already running at heavy utilization. Now turning to Nordion: Q2 revenue increased 3% to about $51 million compared with Q2 2021. Each of those quarters represented record highs for the business. Nordion segment income declined 4% to $30 million versus the prior-year period. Again, both quarters stand at elevated levels compared with any other quarter. The revenue gain at Nordion was driven primarily by 6% pricing, partially offset by 3% of foreign currency headwinds in the quarter. As Michael pointed out, Nordion shipments don't follow a linear pattern quarter to quarter. Despite the robust revenue in the first half, our full year 2022 revenue expectations remain unchanged. Nordion's margins were 59.4%, down 410 basis points from the peak margin levels seen in second quarter 2021. Product mix was less favorable than in second quarter 2021, and foreign currency headwinds contributed to the gap. Even with that, we're pleased on the whole with Nordion's strong margin profile. At Nelson Labs, second quarter 2022 revenue increased 1.3% to $58 million versus the second quarter of 2021. Segment income of $21 million was 12% unfavorable compared with the second quarter of 2021. Keep in mind that second quarter revenue was up $5 million, or 9%, from first quarter 2022 as Nelson Labs bounced back from a low point in labor utilization. Revenue growth for second quarter 2022 received a favorable boost of 6% from recent acquisitions and 5% from pricing. Those gains were partially offset by a 5% decline in pandemic-related testing volumes versus 2021, plus foreign currency headwinds of 2.6%. For Q2 2022, Nelson Labs margins narrowed to 36%, about 500 basis points below Q2 2021 margin levels; that decline is mainly attributable to less favorable mix in Q2 2022 resulting from a reduction in pandemic-related, high-margin testing, plus dilution from acquisitions. Nelson Labs did record a 400 basis point improvement in margins from first quarter 2022. As expected, the 300 basis point headwind in first quarter 2022 from mobile crown-related capacity constraints dissipated in the second quarter. On top of that, high-value testing services, excluding those tied to the pandemic, made up the remainder of the improvement. While we expect pandemic-related testing is now behind us, the Nelson Lab team continues to pursue margin improvement opportunities through acquisition synergies, greater labor utilization and delivery of high-value services. Now I'd like to share some highlights on capital deployment and net leverage, which came in at $1 billion-$1.022 billion. During the second quarter of 2022, capital expenditures totaled $36 million, which matches the elevated spending trajectory we previously outlined for the entire year. The reason investment is rising relates to growth CapEx as well as upgrades to our facilities, and across 2022 we anticipate deploying somewhere between $140 million and $170 million, keeping our plans firmly on course. As of June 30, 2022, we held $140 million in cash, and our liquidity remains strong enough to fund the projects ahead. Net leverage for the quarter equals 3.4x adjusted EBITDA, aligning with the 2022 guidance we provided and with our longer-term leverage targets. I'd now like to take you through the updated outlook covering all of 2022. We've tightened total revenues to a band from $1 billion to $1.22 billion, representing year-over-year growth of approximately 7% to 10%. Our adjusted EBITDA has likewise been narrowed, to between $515 million and $525 million, or about 7% to 9% growth on an annual basis. From our perspective, this revised range properly incorporates the foreign currency and macroeconomic headwinds we expect to remain through 2022. It further captures reduced product shipments anticipated from Nordion during the back half, after that business delivered a robust first-half performance. Nevertheless, we still expect to produce strong results even against a challenging backdrop. The adjusted earnings per share range now stands at $0.93 to $0.97, echoing the tighter adjusted EBITDA flow-through. Every other element of the guidance we issued previously remains as it was. Michael, I'll now turn the call back over to you.

Thanks, Michael. Ahead of taking your questions, I'd like to give a quick status report on the EO litigation. Details of that litigation aren't something we can discuss, though I can say the initial trial in Illinois has been shifted to August 12 from its July '18 start date. On top of that, Sterigenics has been seeking insurance coverage related to the EO tort litigation. An order came down yesterday from a federal court in the insurance coverage suit, finding that the defendant insurer has a duty to defend Sterigenics, and that could let us recoup a portion of our defense costs from the Illinois EO litigation. Let me restate something we've said repeatedly: the company plans to defend itself vigorously against these claims. Ours is a vital role in health care, and our people and facilities run safely and in compliance, reflecting our employees' dedication to the company and our mission, which has produced Sotera Health's steady, outstanding results across so many years and leaves you highly optimistic about our outlook for 2022 and beyond. With that, Howard, let's begin the question-and-answer portion.

This is Lizy calling in for Patrick, Donnelly, and Jason. Could you discuss how the back half of the year will be paced, especially Q3 and Q4, and how the two should be weighed against each other when it comes to revenues and earnings?

As we've said, we're looking at $1 billion to $1.2 billion in revenue and EBITDA of $515 million to $525 million. We feel good about what's ahead in the second half of the year. Sterigenics keeps delivering solid growth as we move forward. Like we said in our prepared remarks, Nordion — as we've told you previously — is one where we generally anticipate the first half and second half to be roughly equal in size. As we pointed out during the call, a portion of the shipments landed in the second quarter. That means the second half is going to be somewhat lighter than the first half; however, our expectations for the full year remain the same, and we still expect to see volume growth improvement versus the prior year for Nelson in the second half of this year compared with the second half of last year.

Then one other thing, only regarding pricing. Through the back half of this year, plus as we move into the next one, do you anticipate that you'll keep obtaining price? And how would you describe your view on it?

Yes. We've said on many occasions that across the whole company, we produce roughly 3.5% to 5% in price annually. Usually, Nelson Labs sits at the lower end of that span. Nordion sits at the higher end of that span. What I'd say to you is that in the second quarter, and likewise on a year-to-date basis, all 3 businesses went beyond that level of performance, and we keep seeing that play out over the course of the year. As we also mentioned in our remarks, there is simply some timing involved, especially with regard to a few of the bigger long-term contracts. It's merely a matter of when those actually occur, depending on contract renewal periods, yet we remain confident in our capacity to keep pushing price so as to counter inflation pressures.

I'm just curious about — so with the guidance revised down, what portion comes from supply chain and what portion from FX? Could you just go into the puts and takes there, why you chose to bring that down to touch?

This is Michael Biehl; and approximately, the $8 million drop in sales is entirely FX. The EBITDA cut of $10 million at the upper end range, about slightly under half is inflation and slightly under half is tied to FX, and the remainder is volume and product mix.

Understood. That helps. Next, I simply hoped to get clarity regarding Nelson Labs when it comes to margin expansion — COVID-related pressures ease during the latter half of 2022. I also wanted — I just wanted that confirmed; plus, about labor utilization which you mentioned, could you expand on what you've observed there? It appears you've managed to handle this difficult labor environment quite well; I'm curious what assumptions are built into the guidance concerning that trend?

Yeah. Appreciate it, Casey; speaking is Michael Petras. Regarding your initial inquiry about certain COVID and pandemic items, we noted a sizable volume of PPE testing arrived during '21. When we look at Q2, our second quarter, it declined substantially versus the same quarter a year earlier, and we anticipate the picture will stay roughly steady in terms of those testing volumes across the remainder of the year. Right? So it has dropped considerably from where it stood in '21, yet right now we view it at a more typical level. Concerning Nelson — like we said on our prior call, we anticipated margins would keep recovering within that business; and the team has executed well on that front. You brought up utilization. We keep performing well at steadying that workforce. When we examined the close of last year, turnover was high throughout the market, an extremely difficult labor environment, as everyone is aware; after that Omicron struck at the start — the opening of Q1. . Thus we have managed to steady our turnover there, and in addition our training along with our productivity has begun to trail behind that. Yet above all, our customer feedback, the Net Promoter Score and turnaround time metrics are heading the right way; so we're quite proud of what the team is accomplishing there. Consequently we're optimistic about us continuing to see growth across the latter half of '21 in the back half of 2022.

Phil here, covering for Amit. I'd like to continue from where those previous questions ended. About Nelson — from what we heard, you're anticipating higher volumes versus the same period last year across the half, along with ongoing gains from pricing; and beyond that, it seems you foresee a steady state for testing. That 5% drag in 2Q is something I'm aware of. Since testing decelerated during the latter portion of '21, could you walk us through and put numbers to what you're expecting — specifically, as a percentage, how much of a COVID testing headwind should we anticipate in the back half of the year?

Phil, we're not going to break things down to that granular a level for the back half of the year. That said, the momentum in that business just keeps growing, in our view. We feel good about the activity and the volumes, though we're also aware that there are wider macroeconomic factors out there that we're watching closely. Given how soft the second half of '21 was, we'd anticipate a rebound in the second half of '22, even with the macro picture possibly somewhat uneven. Through the first six months of the year, PPE testing represented roughly an 8% headwind on a year-to-date basis compared with a year earlier. That should give you a rough idea of the scale. However, Q2 came in at roughly 5%, and we expect that figure to represent a more typical pace from here on.

Alright, that's useful information. Now when we consider the mix across segments, I just want to ask about Sterigenics — is there anything worth flagging or notable for the back half, whether from a comparison perspective or something you think will break from the pattern? Or does it stay steady, with high single-digit to low double-digit year-over-year expansion across all those main components, like we've been seeing?

Yeah, I'd say that's a reasonably fair characterization. I'd add one thing: they posted a strong third quarter a year ago, correct? So they'll be up against that as they come into it; yet on the whole, the team is feeling quite confident about their position and what they're hearing from customers. I mean, they are — I don't want to overlook the macroeconomic difficulties we mentioned in our remarks. Customers continue to face shortages on components and in getting products manufactured, and there remain some labor-related issues among our customer base; still, taken as a whole, the Sterigenics team sees a solid growth opportunity during the latter half of the year.

That's useful too. Could I squeeze in — only one additional? It seemed as though the whole top line guidance cut was tied to — yet when we consider how things went during the first half of the year, would you say the business beat what you expected and made up for a portion of those macro difficulties, separate from the top line reduction for the full year that we're looking at today?

Yes. Broadly speaking, I'd agree. I also acknowledge that I did bring up Nordion having a bit of volume shift out of the second half and into the second quarter. So you need to factor that out somewhat; still, I'd say Sterigenics and Nelson keep doing well, and so does Nordion. Nordion, as we've talked about before, they have — that's where our business excels, since we're handling fairly intricate worldwide supply chains. And the team has performed remarkably in carrying that out and looking after our customers.

Over the past few months, I've noticed some increased attention, I think, on one of your locations in Southern California—Vernon, if I'm not mistaken, is what that town is called. My understanding is that it's an EO site of yours. And I'm just curious, Michael, whether you could share your thoughts on the situation there?

Sure. Let me start by saying—thanks, Mike, for raising it, and it's good to hear your voice. To begin with, some context: at our L.A. facilities, we sterilize more than 40 million medical devices. As you're probably aware, and as a lot of people know, we're awaiting the EPA's release of new rules and regs, and that has proven difficult. Those rules have been something we've been expecting for a number of years, and we are eager for them to finally arrive. In L.A., our facility has drawn some notice from members of the local community as well as from the regulators. We are in compliance with the applicable rules and regs at that site. And on the schedule for upgrades to our facility, we've come to an agreement with them. As I've said on a number of these calls, we have a bold plan for EO facility enhancements at every one of our U.S. facilities, the L.A. facilities included. What we did was put that in writing through an agreement with California's regulators so that we keep advancing that plan. So we must keep operating in line with the rules and regs, something our team is very used to. But that facility continues to play a role in serving the worldwide health care market.

Thanks for that explanation, Michael. The next thing I wanted to ask about is the EPA's rulemaking. I saw a memo — I believe it was yesterday, or perhaps earlier in the week — suggesting they're nearing the proposed rule sometime later this year. Is that what you expect? Or do you have anything else to share about the timeline for when this at last gets moving, after all the years of delay?

Yes. I appreciate you bringing up those years of delay. New rules are something we've been awaiting, and we're eager for them to arrive. We have strong confidence that the upgrades we're implementing will represent industry-leading controls, which we hope the EPA will embrace. We're out in front with certain practices we believe should be taken up throughout the industry, and hopefully that's the path things take. If that doesn't happen, we'll still operate in a manner that's even safer and more compliant than what's mandated. Based on what we've seen as of now — yesterday, that is, and the communication you mentioned — they indicated they're in the process of submitting a new plan, which would be routed to OMB. Our hope is that sometime during the second quarter or third quarter of 2023, the rule will be finalized — it's known as NESHAP. We believe there's a possibility it will be released for public comments at some point late this year, though enforcement likely won't begin until the second or third quarter of '23. But Mike, I want to be certain we're clear on this: that isn't our own forecast. It's simply what we're hearing from them. We've been given many dates previously. We're hoping they'll actually move even more quickly.

To start, I want to ask a bit more about the insurance — that short insurance you mentioned. Does that come specifically from the Willowbrook litigation? Or does it apply to Broadway in your case?