Avidity Science, LLC (ATS) Earnings Call Transcript & Summary

Good morning, and welcome to the ATS Corporation conference call and webcast. This call is being recorded on September 22, 2023 at 8:30 a.m. Eastern Time. [Operator Instructions]. I'll now turn the conference call over to David Galison, Head of Investor Relations at ATS. Please go ahead, Mr. Galison.

Thank you, operator, and good morning, everyone. On the call today are Andrew Hider, Chief Executive Officer of ATS; Ryan McLeod, Chief Financial Officer; and Cash Mahesh, Group Executive Life Sciences. Please note that our remarks today are accompanied by a slide deck, which can be viewed via our webcast and available at atsautomation.com. Now before I begin, I would like to draw your attention to the forward-looking statements. During the course of this presentation, we will make projections or other forward-looking statements regarding future events, future results or future financial performance of the corporation. Several assumptions were made in preparing these statements. These assumptions are based on our current knowledge as it exists today. I wish to emphasize that there are risks that actual events or results may differ materially from these statements. Also, we may refer to certain non-IFRS measures. Management believes that ATS shareholders and potential investors in ATS use these non-IFRS financial measures to assist in making investment decisions and measuring operational results. For the complete cautionary note regarding forward-looking statements, including the material factors that could cause actual results to differ materially from the statements and the material factors or assumptions applied in making such statements as well as regarding non-IFRS measures. Please refer to Slides 2 and 3 of the presentation. Now it's my pleasure to turn it over to Andrew.

Thank you, David. Good morning, everyone, and thank you for joining us on such short notice. Today, we're pleased to announce the acquisition of Avidity Science, a global provider of automated water purification equipment, services, consumables and software for the life sciences industry, including biomedical research. Avidity's automated solutions are proven to improve reliability across drug discovery and development. From an ATS perspective, those diverse offerings complement and expand our life sciences products and services and customer base and delivers profitable revenue, much of it reoccurring. This accretive transaction is aligned with our strategy to target acquisitions in attractive markets with differentiated technologies, strong competitive positions and solid growth potential. Avidity is a natural fit alongside BioDot and SP, providing complementary equipment, technologies and customer support to improve the reliability of scientific research. In addition to strong reoccurring revenue, Avidity's margin profile is accretive to ATS' current gross margin and adjusted EBITDA margins. From a financial perspective, the transaction offers commercial and cost synergy potential, year 1 earnings accretion and meets our return on invested capital targets. The total purchase price is USD 195 million. This implies a transaction multiple of 10.3x Avidity's projected calendar 2023 adjusted EBITDA after factoring in our estimated year 3 synergies under ATS' ownership. Over the next 3 years, we anticipate cost and commercial synergies of approximately $1.5 million, including supply chain optimization and operational efficiencies. We expect this to grow to $2.6 million by year 5. The transaction will be accretive to ATS' earnings and cash flow per share in our first year of ownership, and we expect to reach double-digit return on invested capital by our fifth year of ownership. We are financing the acquisition with existing cash and by drawing on our revolving credit facility, which will result in a pro forma leverage of 2.5x net debt-to-LTM adjusted EBITDA. The acquisition is expected to close in calendar Q4 2023, pending the completion of normal course regulatory clearances. In terms of strategic rationale, Avidity broadens our life sciences capabilities by expanding our suite of products that support our customers throughout the drug development life cycle from basic research and development to commercial production. It has demonstrated strong profitability and cash flow generation and is expected to be accretive to ATS' gross and adjusted EBITDA margins. During our due diligence process, we identified synergies that would allow us to realize additional financial upside from the acquisition. Founded in 1969 and based in Waterford, Wisconsin, Avidity designs and manufactures, critical water purification systems, components, and consumables used in critical environments in biomedical research and life sciences applications or strict variable controls and data integrity are crucial. It serves a diverse blue-chip customer base of pharma, biopharma companies and research institutions. Avidity has a highly skilled workforce of 380 employees with the majority based in the U.S., in addition to facilities in the U.K., Japan and China. Avidity systems support customers in both the biomedical research and life sciences water purification industries. Avidity's patented solutions play key roles across the preclinical drug discovery process by minimizing variables and enhancing the integrity of research results. Its offerings include advanced automated watering systems, integrated water purification and quality control systems as well as consumables, identification tools, software, and service and support. The company is expected to generate $84 million in revenue this calendar year. Consumables software and aftermarket services and support represent approximately 40% of revenue, adding to stability and profitability and cash generation to support further organic and inorganic growth in the life sciences industry. Growth in Avidity's industry is still propelled by growth in pharma drug development, increases in pharma and biotech R&D, increased automation to drive repeatability and accuracy results and an increasing need for data quality. We see these trends continuing. Additionally, there are multiple avenues to create synergies beyond leveraging Avidity's technologies and implementing the ATS business model. Across our existing range of products and services, particularly when combined with SP and BioDot, Avidity provides a broader suite of equipment and technologies, leading to cross-selling opportunities, and increased distribution with key channel partners. Some examples include integrating our digital solutions, like our industrial IoT illuminate to improve data analytics for customers and cost reduction through supply chain optimization. Thinking about our M&A playbook. This transaction satisfies each of our 4 acquisition criteria; industry; strategic value; operational fit; and financial returns. Avidity operates in a large and growing industry that is underpinned by strict industry and government regulatory requirements for highly reliable test results. It possesses several differentiated technologies, enable a strong position in niche applications while bolstering our existing lab automation offerings. Our assessment and cultivation process also showed there is a strong operational fit with Avidity's experienced and motivated leadership team. This sets us up well to apply the ABM playbook to further enhance operations and uncover additional synergies. This is a financially attractive acquisition with strong profitability, high reoccurring revenue, EPS and cash flow accretion in year 1 and an attractive return on invested capital by year 5. The acquisition of Avidity is another step in the ongoing evolution of ATS towards high-value end markets. These are highly regulated spaces where ATS can have substantial value to its customers through the application of automation technology. On a pro forma basis, our exposure to regulated industries which include life sciences, but also food and nuclear to be close to 70% of our revenue. Going forward, we will continue to explore opportunities to acquire assets in key targeted areas with our focus remaining on transactions that are strategic for ATS and provide a solid return on investment. In summary, we're excited about the addition of Avidity to the ATS family. Avidity operates in an industry with attractive fundamentals, grown ATS' Life Sciences offerings and grows our equipment range supporting our purpose to positively impact lives around the world. Avidity enjoys strong profitability and offers a compelling opportunity to grow our recurring revenue stream. This is an attractive transaction from a financial perspective that is accretive to our earnings and cash flow and generates a compelling return on our capital. With that, I will turn the call over to questions. Operator, over to you.

[Operator Instructions] Your first question comes from the line of Michael Doumet from Scotiabank.

Congratulations on the deal. My first question was on, I was hoping maybe that you can unpack some of the cost and commercial synergy opportunities. Where do you think you see those opportunities specific? And maybe just to provide us a rough split between the 2?

Yes. When we step back and look this business and through our diligence process really aligned, and we understood the leadership team and their focus on continuous improvement. And so when we look at businesses like this, the ABM playbook serves us well. And so as we step back and look at the synergies, it's supply chain management, it's operating efficiency as well as commercial synergies. And so as a whole, we're pleased with the addition. We're pleased with the opportunity and do seek to continue the ability to grow that. From a split standpoint, I would say it's 2/3 cost synergy, 1/3 sales synergy -- revenues synergy.

Perfect. And maybe just a follow-up, just -- if you can provide us a sense for the historical growth for Avidity in the last couple of years. I'm also curious to dig into that 40% recurring revenue piece from a consumables, SaaS, aftermarket, how that's trended over the last couple of years as well.

Yes, Michael. So revenue growth, it's been in the high single digit around just under 8% on an average cumulative average basis. And the second part of your question with respect to the recurring revenue piece of the business.

That's correct. Just wondering what the trend there is as well and potentially, if that can go higher.

Yes. So there is opportunity, but it's historically grown roughly in line with the rest of the business.

Congratulations.

Your next question comes from the line of Michael Glen from Raymond James.

So just in terms of some background, was Avidity a supplier to ATS prior to the deal? Or maybe can you speak to how you identified Avidity as a potential target for the business?

Michael. So no, it was not a supplier. And one of the areas when we added both Biodot and then SP really identified this space as being an attractive additional area that we wanted as part of ATS. And look, fundamentally, we very much like businesses that at a core, have strong recurring revenue, have very strong ties with customers, and this is well aligned with that. When you look at this space, -- it is about regulatory approvals. It's the need for data. It's about quality and integrity in the data and avidity really aligns well with that. And it was just a natural next step for the addition with SP and Biodot. So we're pleased with the progress. We identified this, call it, 6-plus months ago or around the 6-month mark and really work towards a successful outcome, which we're pleased to announce today.

Okay. So the -- so just to understand how it fits with SP and Biodot, this is an adjacent type piece that will sell alongside those pieces of equipment that the customers are looking for.

Michael, you're right. The way we're going to be operating this business, we believe in decentralized businesses. So we're going to be operating this as an independent business. But as we have created the Life Sciences group, these businesses between Biodot, SP and Avidity will be working together on commercial opportunities. We've had blue chip customers on our side, as you know, and Avidity has enjoyed great relationship with blue-chip customers. So we're going to be sitting together and working on the cross-selling opportunities between the businesses.

Okay. And can you just -- can you speak to the existing management for the business? Do they stay on under ATS ownership?

This is a big part of also the diligence in you're well aware that that's one of our key criteria when we look at any business, which is how we're going to operate. And what we can say is that we've been impressed with the leadership team and the team as a whole. And even more importantly, when we really dug in and learned their impact with customers, they have a very strong brand for the niche that they play in, and it's testament to the leadership team and their capability.

Your next question comes from the line of Justin Keywood from Stifel.

First, I was just hoping to clarify on the growth. I think I heard in the opening remarks that Avidity is expected to do $84 million in sales this year. And that would imply, by my math that the business would be growing about 2.5% versus what was mentioned as growing at high single digits. So just wondering if there's anything unusual for this year versus the historic growth rate?

Yes. So I was giving you the growth rate over the past 3 years and the current year growth rate is in the range that you identified. There is an opportunity to accelerate beyond that, but there's been some, frankly, delays in certain projects within the business. So we're comfortable in the business achieving the number that we laid out.

And Avidity has been a bit acquisitive. I see they've acquired 8 acquisitions in their history. Is there an opportunity to acquire more related businesses like the [ video ]?

So Justin, you're touching upon an area that we actually like and there is. And the opportunity is really the lab automation for drug discovery, and the continued focus on this area and what matters to these customers. And I mentioned this a little earlier is, these are areas where regulatory approvals are required strict. The need for data is growing and continues to increase and the quality and integrity around that data is a very important. And these are lifesaving or very strong solutions for the market, where it's oftentimes a drug that they're trying to ensure that, that really meets and continues to meet the qualifications. So there is, and we're going to continue to build out our funnel around this.

Understood. And just finally, I see that video provides some solutions into the agriculture area. If you can just describe what proportion of overall sales that is? And if there is an opportunity for other verticals within the water purification area?

Yes. Justin, so it's a very small part of their business, and I'll let Cash provide a bit of color on what it is.

Yes. Look, I mean, thing that avidity provides is high-quality water, and there are a lot of applications for that. As Ryan said, predominantly, a majority of the applications that they focus on is in the life sciences and biomedical research markets, but they happened to also still in the agriculture market very, very small.

[Operator Instructions] Your next question comes from the line of Cherilyn Radbourne from TD [ Cowen ].

In terms of the background to the acquisition, I wondered if you could just speak a little bit about why the Avidity team is looking to partner with ATS at this particular time in its business life cycle?

Cherilyn. So this business -- they -- natural evolution, this is an own business and they were looking for the next step. And 1 of the areas that, as you're well aware, we continue to cultivate. And I'll just say the team did an excellent job of working with the management, identifying the opportunity and working them around what the ABM could support as well as what we could learn from them. And this business has grown on their services. They've grown on their consumable space. And so we're very pleased with the progress. We do view this as a 2 way street of learning and our ability to work with them on how to improve their operations, but also then taking some of their services capability and bringing it across the total portfolio of ATS.

Great. That's helpful. And then I was also intrigued to read that they've got the facilities in China and Japan. Just wonder if you could speak to how big a part of the business that is and whether that could be additive to ATS' activities in that region?

So in terms of revenue contribution, Asia represents about 25% of their revenues. The majority of that is based in China. So those are important parts of the business, and I'll let Cash answer the balance.

And Cherilyn, the business in China, they have is in China for China. That's a great model, as you know. And that's something we may be learning from and seeing if we can do more broader ATS and ATS life sciences. Coming to Japan, they have mainly a distribution center. They do not manufacture in Japan, but it's a great market also. So from an ATS perspective, these 2 are markets that we have been looking at, and it would be a solid learning curve for us to learn from Avidity.

Your next question comes from the line of Sabahat Khan from RBC Capital Markets.

I guess, just looking at their offering, obviously, very life sciences based. But as you look at some of your other end markets, is there an opportunity to take some of these water purification capabilities elsewhere across your portfolio?

So as we step back, certainly, there's going to be areas that we do view that we can continue to build out and build our capability we would outline this in the synergy around cost and revenue. But we do view that there's additional opportunity. We need to get in. We need to work with the team. We need to align around their technology, their development and continue to support their growth. So first and foremost is really integrating and aligning to overachieving or achieving our targets and really helping the business continue to support its growth.

And then I guess just in terms of kind of the transaction, was this a competitive bidding process? Or was this a one-on-one deal for ATS.

So it started competitive. We were able to lock early on in the process, and that came from a lot of the work with meeting with their leadership team, meeting with the group identifying what we could do with the team together. And so we were able to lock that early on and then obviously go through our diligence and ensure that we have alignment to what the potential is.

Your next question comes from the line of Maxim Sytchev from National Financial.

Andrew, I was wondering if you don't mind maybe talking about sort of the competitive set in the markets that the company serves? Just sort of maybe any color there? Because I mean I think [indiscernible] sort of spinning off is what really the businesses. So I'm just get curious how sort of that competitive dynamic exists in the end markets that the company [indiscernible].

So Max to break this down, and I'm going to just walk kind of the numbers to start. It's, call it, 70 -- a little over 75% biomedical call it, a little less than 25% Life Sciences in their end market. And the biomedical space is more a niche space for them. They are a key player, and they are a key kind of piece of that. It's a very fragmented space, and they are a leader in their area that they support. And so we do view this as very aligned with how we think about strategic end markets where we can take a key position with the standpoint of technology from a standpoint of customer interaction and really niche capabilities that customers value. And so that has been the driver. Now certainly, they're in life sciences and they support areas around that, but the bigger piece is in the fragmented space of Biomedical. And they are a lead in that space.

Okay. Super helpful. And maybe just a quick question for Ryan, if I may. Just how should we think about kind of kind of working capital intensity sort of free cash flow conversion. Any color there? Like is it any different from kind of like -- how should we think about this?

Yes. So it's a little bit more working capital intensive given it's more a product like business. So it's in the low 20s typically. Low CapEx business very much like ATS in the 2-ish, 2% to 3% range.

Okay. Okay. And then maybe just last 1 in terms of sort of when you look at the facilities, the footprint, sort of all these things like, obviously, I understand you telegraph the synergy component, but any thoughts in terms of where things could be sort of optimized based on what you've sort of seen under food right now?

Yes. I mean so stepping back, look, this business, strong alignment to continuous improvement. We think we can support them and help them, and there's going to be more areas we identify throughout the process. as you know, and well aware Max. This is -- it's early days. We have a playbook that we've aligned around our ability to execute. We're going to drive that playbook, and we'll identify more and more areas for opportunity.

[Operator Instructions] we have a follow-up question coming from the line of Mr. Michael Glen from Raymond James.

The seller of the business I missed it, is it was a private equity or as a family company?

Private equity.

Is private equity. And then the $1 billion TAM that you outlined for that TAM, what's Avidity's market share right now within that TAM?

So Michael, as Andrew said, roughly 75% of the market they serve is biomedical research, and that is a -- that's about $300 million of that $1 billion. And then the larger one is the Life Sciences, where the market share is lower, as you know, and there are opportunities to grow, but that's a market where we -- Avidity mainly focuses on service and support.

Okay. And then the accretion that we're thinking about, if we're trying to measure that, would it be like a low single-digit type accretion that you're thinking or something more meaningful than that?

Low single digit in the first year.

Mr. Hider, there are no further questions. Back to you for closing comments.

Great. Thank you, everyone, for joining us. This is another proof point of the evolution of ATS and our focus on adding high value to our business. And we welcome Avidity and the team to the organization. Thank you for joining us. Stay safe, and goodbye for now.