ATS Corp /ATS Q3 FY2024 Earnings Call

Welcome to the ATS Corporation Third Quarter Conference Call and Webcast. This call is being recorded on February 07, 2024 at 8:30 a.m. Eastern time. Following the presentation, we will conduct a question-and-answer session. I'll now turn the call over to David Galison, Head of Investor Relations at ATS.

Thank you, operator, and good morning, everyone. On the call today are Andrew Hider, Chief Executive Officer of ATS; and Ryan McLeod, Chief Financial Officer. Please note that our remarks today are accompanied by a slide deck, which can be viewed via our webcast and available at atsautomation.com. We caution that the statements made on the webcast and conference call may contain forward-looking information and our cautionary statement regarding such information, including the material factors that could cause actual results to differ materially from the statements and the material factors or assumptions applied in making the statements are detailed on Slide 2 of the slide deck. Now, it's my pleasure to turn the call over to Andrew.

Thank you, David. Good morning, everyone, and thank you for joining us. Today, we reported strong third quarter organic revenue growth, good contributions from recent acquisitions, and adjusted earnings in line with our expectations as we've built on the momentum achieved in the first half of the year. We completed the acquisition of Avidity, which further expands our life sciences products and services offerings and is complementary to our existing businesses. At the beginning of Q4, our PA Solutions Group completed the acquisition of ITACA, an Italian-based automation integrator with a focus on primary processing and pharmaceuticals. Avidity and ITACA are the most recent examples of how we use acquisitions to drive our strategy and evolve our portfolio. We are pleased to welcome both teams to ATS. Now I will update you on the business and our markets, and then Ryan will provide his financial report. Starting with our financial value drivers. Order bookings for the quarter were $668 million, supported by organic growth in life sciences and strong performance in food and beverage. The underlying trends driving demand for ATS solutions remain favorable. Q3 revenues were $752 million, up 16% from Q3 last year, including organic growth of 9%. Adjusted earnings from operations in Q3 were $101 million, up 17% versus Q3 last year. Moving to our outlook. Our backlog held strong at over $1.9 billion. By market, our life sciences backlog is up 10% compared to Q3 last year at a record $875 million supported by wins in key areas, including auto-injectors and contact lenses. We remain focused on opportunities to provide expanded or integrated solutions to our customers. For example, we secured a new order as a result of an innovative offering that includes BioDot's dispensing technology and SuperTrak Smart Conveyance technology, as part of a diagnostic cartridge assembly system. Our life sciences opportunity funnel remains strong, supported by market growth, including increased consumer demand for auto-injectors driven by GLP-1 drugs. In Transportation, backlog was $564 million, down 36% compared to Q3 last year, reflecting ongoing execution of large programs won in the last fiscal year along with expected variability in program awards in this market. We are working with one of our OEM customers to support their revised timing on a portion of their existing program. While the near-term market for electric vehicles remains dynamic, as OEMs look to lower platform costs and align capacity to end-market demand, the long-term fundamentals remain intact and support demand for our solutions. Our transportation funnel is strong and reflects diversified long-term opportunities to support our customers. With ATS' proven ability to partner with customers by providing flexible solutions, we are well positioned as the EV market continues to evolve. In Food and Beverage, Q3 bookings were strong as expected and our ending backlog was $207 million. Notably, we successfully secured our first IoT order for a tomato processing line. Our food and beverage businesses are focused on innovation and customer experience, including aftermarket service as we expand our offerings to our customers. In Energy, our funnel remains strong and is expected to provide opportunities for both refurbishment of existing nuclear reactors and investment in new reactors, providing sustainable clean energy. ATS has the experience, specialized skills and proven track record to support customers with their energy initiatives. In consumer products, our funnel is stable. However, customers are continuing to evaluate their investments in the current economic climate, which may impact the timing of some opportunities. On after-sales services, our consistent investment in this strategic area has included developing our digital solutions. As these solutions evolve, we are positioning ourselves to provide performance insights through our connected asset value chain, and support our shift towards providing higher-value services on both ATS and non-ATS equipment. During the quarter, we also secured a synergy win with Triad in our life sciences business to identify OEE improvement opportunities for a key customer. On our digital offerings across the automation value chain, our funnel is strong, and we remain focused on developing our capabilities, utilizing an integrated architecture to help our customers collect and analyze data in an efficient manner to drive performance. During the quarter, a global pharma customer awarded ATS a contract to build their IoT platform for data exchange with one of their major clients. On supply chain, lead times and material cost pressures continue to challenge some areas of the business, which our teams consistently work to offset through the use of our supply chain levers and ABM tools, while increasingly leveraging digital tools to drive insights and opportunities. ABM activity and engagement remains strong, and we measure and monitor our success to identify areas for ongoing improvement and deployment of our tools across the organization. During the quarter, we hosted our ABM Global Conference with a focus on ATS business model principles, processes, and tools to achieve impact on our value drivers. On M&A, we continue to expand our portfolio and our integration efforts with Avidity and ITACA are underway and progressing according to plan. Our M&A funnel remains active, healthy, and diversified across all target sizes. We remain disciplined in our approach and assessment of each target. On ESG, ATS' scientific products earned a silver medal as part of the EcoVadis sustainability program, an improvement from bronze last year. This award is a testament to the SP team's commitment to promoting sustainable practices and reducing our environmental impact. Additionally, Avidity recently launched the world's first water platform system with reusable cartridges that help customers reduce their environmental footprint. We consistently work to identify ways to demonstrate our commitment to ESG principles and priorities across the organization as well for our customers. On innovation, we remain focused on strategically investing capital to create solutions that drive returns for our customers. A few highlights for the quarter included the Comecer team developing a new software product for use by customers in the therapeutic radiopharma market, specifically to allow nuclear medicine departments to link dose preparation information directly to central hospital data systems. Our ATS Innovation Center continues to develop new solutions for auto-injector device assembly, allowing for threaded components to be connected together at very high speeds and accuracy. Comac announced the launch of a 3D scanning vision system that helps to automate and speed up the inspection and sorting of kegs prior to them being filled. To drive our efforts, ATS hosted its first-ever Global Innovation Summit in November, which included over 50 of ATS’s top innovators with the purpose of sharing technologies, innovation trends, and opportunities to accelerate technology development, including incorporating AI into our innovation approach and how we operate daily. In summary, our Q3 performance included strong revenue and earnings growth. Our opportunity funnel is well-diversified. Our strategic acquisitions are performing to plan, and we remain confident in our ability to continue our trajectory in creating shareholder value. We are pleased to see ATS recognized once again as one of Waterloo region's top employers. ATS was founded in the Waterloo, Ontario region over 45 years ago, and today, our team members continue to bring their best every day to serve our customers and grow our business. We remain guided by the ABM as our playbook, as we deliver on our shared purpose to create solutions that positively impact lives around the world. Now I will turn the call over to Ryan. Ryan, over to you.

Thank you, Andrew, and good morning, everyone. ATS delivered strong financial results this quarter with organic revenue growth, margin improvement, and we finished the quarter with a strong balance sheet. Starting with our operating results for the quarter. Order bookings were $668 million, down 31.8% compared to Q3 last year. As a reminder, Q3 last year included $300 million of orders from an EV customer, which we do not expect to repeat this quarter. Of note in Q3 this year, we drove year-over-year bookings growth in life sciences, including strong organic growth in addition to contributions from recently acquired companies, including Avidity. Our trailing 12-month book-to-bill ratio at the end of Q3 was 0.95 to 1. By market vertical, our trailing 12-month book-to-bill at the end of Q3 was at or greater than 1 in all markets with the exception of transportation. We have previously noted that as we continue to execute on our large programs in the EV market, we do expect to see longer periods between ordering cycles. On revenues, Q3 revenues were $752 million, up 16.2% over Q3 last year. Organic revenue growth was 9.1% in the quarter. Recently acquired companies added approximately 5% to revenue growth, and foreign exchange translation had a positive impact of 2.5% compared to Q3 last year. We finished Q3 with just over $1.9 billion of order backlog. Looking ahead, our revenue conversion for Q4 is estimated to be in the 36% to 39% range of order backlog. As a reminder, this assessment is updated every quarter based on revenue expectations from existing backlog and new orders booked and billed within the quarter. This conversion range also factors in the impact of approximately $200 million of transportation order backlog with one of our EV customers that has been delayed. Moving to earnings. Q3 adjusted earnings from operations were $101.2 million, up 17% from Q3 last year, primarily due to revenue growth. Adjusted earnings from operations margin was 13.5% in the quarter, up 13 basis points compared to last year, reflecting improved operating leverage. Our Q3 gross margin, excluding acquisition-related inventory fair value charges, was 28.5%, up 12 basis points from Q3 last year, reflecting higher volumes and acquisitions. Going forward, with an EV customer realigning its production schedule resulting in a delay of ATS’ execution on this contract in our backlog, we expect to see some near-term margin pressure in this part of our business. We are actively mitigating this utilization pressure by redeploying resources onto other programs, including in our life sciences business. Our expectation is for this program to restart in the first quarter of our fiscal 2025. On supply chain, material cost pressure is still present for some categories of spend, most notably for electrical and mechanical parts where lead times remain a challenge. Lead times have generally improved in other areas. As we previously noted, short-term inefficiencies caused by extended lead times in our supply chain impact our ability to drive margin expansion. Despite these ongoing challenges, our teams are well equipped to drive performance and mitigate these impacts for our customers. Moving to SG&A. Expenses were $6.9 million higher than Q3 last year and included $17.1 million of acquisition-related amortization and $900,000 of acquisition-related transaction costs, partially offset by an $11.7 million gain on the sale of two redundant facilities. Excluding these items, Q3's SG&A was $107.9 million, $14.7 million higher than last year, primarily due to increased employee costs, incremental SG&A expenses from acquisitions and foreign exchange translation impacts. Stock-based compensation expense for Q3 was $4.7 million. Excluding the mark-to-market impact related to changes in our share price, stock-based compensation expense was $5.3 million in Q3 compared to an expense of $4.3 million last year. On earnings per share, our EPS was $0.48 in Q3, up 50% over last year. Our adjusted EPS was up 16.1% to $0.65 in Q3, primarily reflecting growth in revenues. We've begun to implement our previously announced reorganization plan. In Q3, we incurred $16.2 million of costs with total expected costs of approximately $20 million. The majority of the remaining costs are expected to be incurred in the fourth quarter. We anticipate that these targeted cost reductions will allow us to invest further into accelerating growth in areas of the business to provide opportunity for higher returns in support of our strategic growth plans. Next, moving to the balance sheet. In Q3, cash flows generated by operating activities were $110.5 million, reflecting the timing of project progress and milestone billings and payments primarily on our large EV programs. Non-cash working capital as a percentage of revenue was 17.8% at the end of Q3, down from 18.4% at the end of Q2, again, primarily reflecting a reduction in working capital investments and our large EV programs. In the short-term, we continue to expect working capital to remain variable. Total year-to-date investments in CapEx and intangible assets were $62.5 million, which included $17.7 million in Q3. Our planned fiscal 2024 CapEx investment of $80 million to $100 million has flexibility and we expect to be in the lower end of this range for the year. On leverage, our net debt to adjusted EBITDA ratio was 2.3 to 1 as of the end of Q3 in line with our target leverage range of 2x to 3x net debt to adjusted EBITDA. In the quarter, we funded the acquisition of Avidity with cash on hand and by drawing on our credit facility. As integration efforts are early days, they are progressing as planned and we look forward to our continued work with the Avidity team along with ITACA. In summary, our quarterly performance once again highlighted the strength of our diversified and evolving portfolio and positions in strategic end markets. Going forward, we will continue applying measures to combat challenges, including those still lingering in our supply chain. Strong order backlog in our key markets once again provides good revenue visibility over the next several quarters. We remain confident in our team's ability to drive our strategy supported by the ABM, which will continue to unite our people across ATS as we remain focused on our employees, our customers, and long-term value creation for our shareholders. Now, we will open the call to questions from our analysts. Operator, could you please provide instructions? Thank you.

Your first question comes from Cherilyn Radbourne with TD Cowen. Please go ahead.

Good morning, everyone. Thank you for taking my questions. This is Pat Sullivan on the line on behalf of Cherilyn. I think last quarter you were able to give us a breakdown on auto-injector bookings. I'm wondering if you're able to comment on the level of auto-injector bookings this quarter. And then if you're able to provide a breakdown with respect to the competition of those bookings by customers, I guess, what is the level of competition you're seeing in that end market?

Yes. Good morning. We actually won a key award within the quarter. While it's an existing customer, it's a new production line for this customer, and we continue to see this as a real area of opportunity. To walk this a bit more specific and to give you some guidance on ATS' position, because it will help as we talk about competition and the competitive landscape. ATS invested in a technology with Symphoni, and it's our platform that allows us to build processes while in motion. Why that matters is when you look at output, it allows us to be up to almost 3x the output at roughly half the footprint. It’s a real key enabler, and it’s just one of the areas that we evaluate from how innovation allows us to differentiate and really offer high value for our customers as they continue maximizing their launch and impact. To give you some context on the market, multiple reports indicate this space is set for significant growth. We've always aimed to enable our customers to maximize their launch. With our solution set and global capability, we can be leaders in this area. So, I'm pleased with the progress and performance, and we view this market as one that will continue to evolve.

And Patrick, just the specifics. So this was a low single-digit percentage of our bookings in the quarter.

Okay. Thank you very much. And if I could ask one more, there've been a lot of recent announcements in the Canadian nuclear energy sector, including Capital Power and OPG assessing small modular reactors and the more recent refurbishment announcement at Pickering Nuclear Generating Station. Can you comment on what you're seeing in your funnel with respect to opportunities like this? Are there any opportunities for ATS concerning those two developments? And any idea about what kind of timeframes you'd be looking at from an RFP to actual execution perspective?

Yes. Absolutely. The headline market is favorable. To give you context, our trailing 12 months in this space is 1.16. We are seeing not only favorable end-market trends but also performing and executing to offer high value. Regarding SMRs, our funnel remains healthy. This is still early in its journey. ATS views itself as a high-value provider and we are staying close to the opportunities as they unfold. As far as the CANDU reactor and refurbishment programs, this is early. That said, it aligns well with what ATS offers for high value in this type of work. We're staying close as we’re in the early review stages, and we see this as something that will align with our capabilities and be of high contribution. There are favorable market dynamics on a global scale, and this is green energy that ATS supports.

Okay. Thank you very much.

Your next question comes from David Ocampo with Cormark Securities. Please go ahead.

Thanks. Good morning, everyone. On the $200 million of EV order backlog that got delayed. Curious if you guys see any risks if that portion gets pushed out further, and when that program does restart in fiscal Q1. Will that be at the normal run rate or lower than your initial projections of order deliveries and order execution?

Good morning, David. It's Ryan. Our expectation is this resumes in Q1 of fiscal 2025. Customers have the ability to change that dynamic, but that's not our expectation. In terms of run rate, at this point, we would expect it to resume as it had been originally planned and wouldn't see any ongoing impact. That’s our expectation.

Okay. Got it. And then the last one's just on the supply chain issues. This is something that's been hurting you guys for at least the last several quarters. Are you seeing any positive indicators relating to electrical components easing, and what are your expectations on the timing of margin improvement once the supply chain begins to normalize?

Yes. So again, David, it's Ryan. This is interesting. The suppliers are talking about improvements, and I would say we've seen some incremental improvements. But when we look at data around quoted lead times, particularly in electrical and mechanical components, we have not seen a material improvement. So that leads to the primary challenges, impacting our ability to reduce costs in the supply chain and offset some of those dynamics. In terms of when it shifts, this is close monitoring for us. It will take one to two quarters for it to work its way through our programs before we see benefits in margin.

And if I could just follow up on that, if you had to put a number on it, how much do you think supply chain has negatively impacted your gross margins? Because you have been in that 28% to 29% range for six or seven quarters?

It's not as much. We've been able to offset a lot through pricing and other areas. So it's not a headwind, but it's a barrier from us expanding margins. Our typical playbook is when we get an order, we do the design work and look for efficiencies in one of those areas, including supply chain. Extended lead times limit our ability to exercise all of those levers. So it’s not as much a headwind today or a negative impact on our margins, but it does limit our ability to expand margins during programs.

That makes sense. I'll hand the call over.

Your next question comes from Michael Doumet with Scotiabank. Please go ahead.

Hey. Good morning, guys. Wondering if you could just elaborate on the margin pressure as it relates to the delayed EV program. Is it strictly a result of operating de-leveraging due to the deferral? How do you manage potential lumpiness in transportation and the overall capacity of that business?

Yes. Good morning, Michael. The answer to your question is yes, it's primarily de-leveraging. To give you some context, we've been converting approximately 25% to 30% of our backlog, excluding orders booked and billed within the quarter. That provides you with a sense of the revenue challenge. With EV, it tends more towards the lower end of that range. In terms of what we're doing to mitigate, I talked about repurposing capacity where we can, including for some life science programs. We've scaled back on contractors. But we are maintaining our cost structure as our expectation is for this program to restart as we talked about in the first quarter of fiscal 2025. This will drive temporary inefficiencies and utilization challenges, which will negatively impact margins in the fourth quarter.

And Ryan, can you maybe just give us a sense of the magnitude of the margin pressure in Q4 based on the lower utilization?

If you think about our typical cost structure, it's roughly half labor and half materials. The materials don't have an impact, and we're dealing with labor inefficiencies. We can offset some of that, but there's going to be an impact.

Okay. That's helpful. And then just more broadly on life sciences, organic growth was still negative in the quarter, which is a bit of a surprise given some of the bookings you called out last quarter. What is the visibility on an acceleration in organic growth in that end market, and how much can GLP-1s move the needle going forward?

Yes. So we did have positive organic growth in life sciences revenues in the quarter. It was low single-digit, but there was positive revenue growth.

The significant growth area for our solution set is tied to U.S. obesity, with market growth expected to be real. Last year saw the second highest approval of new drugs in a decade. This progression bodes well for us. We're also engaged in various high-value areas, including auto-injectors and contact lenses.

Super helpful. Thank you, Andrew.

Your next question comes from Patrick Baumann with JPMorgan. Please go ahead.

Hi. Good morning. Thanks for queuing me in. Just wondering if you can give an update on the funnel for orders across EVs and food and beverage. How should we think about orders over the next year? The fourth quarter looks like the comp is a little easier. Do you think we could see some growth there?

Multiple questions on that. I'll walk through EV first. The funnel in the mid to long-term remains strong. Customers are facing various challenges, including technology and costs. We're focused on offering high value when they return to a measured pace. We have approximately ten customers in the EV space, indicating a solid opportunity for strategic investments. Regarding regulated food, this was a robust quarter, supported by technology and innovation.

Patrick, we don't typically provide forward-looking on our bookings. With large programs, variability can drive different discussions. We evaluate bookings over a longer timeline.

We focus on strategic end markets and have positioned ourselves well. While we don't give specific guidance, we have consistently aimed for performance driven by our playbook.

Okay, great. Makes a ton of sense. Thanks for bearing with me with that short-term question.

Thank you, Patrick.

Your next question comes from Michael Glen with Raymond James. Please go ahead.

Hey. Good morning. Over the past two days, we've seen strong indications from large players in the obesity drug market regarding capacity constraints. Can you help us connect this to your auto-injector product offering? Has the order funnel grown sequentially this quarter?

Certainly. The life sciences funnel is strong, and our backlog is also strong. The growth of our funnel continues to build. We view favorable conditions in this area and our capacity to support our customers effectively. Auto-injectors remain a critical focus for us, especially as demand increases, and we believe our innovation and capabilities place us well in this evolving market.

Okay. And regarding the market size projections you referenced earlier, what's your piece of the pie within those estimates?

The order timing is variable, and we strive to ensure successful customer launches through our longstanding partnership in this space. We have two decades of experience, enabling us to adapt to these evolving demands.

Okay. Thanks for taking the questions.

Your next question comes from Justin Keywood with Stifel. Please go ahead.

Good morning. We saw some de-leveraging in the quarter. The balance sheet is at 2.3x, which suggests reasonable capacity for further M&A. Can you provide an update on the pipeline, target verticals, and potential deal sizes you're exploring?

Good morning, Justin. Our M&A funnel remains healthy, comprising small, medium, and large targets in strategic products and technologies. We are patient and move quickly when we identify valuable offerings for our customers and shareholders.

Understood. And regarding GLP-1, we saw Novo announce an acquisition to shore up manufacturing capacity. Does ATS offer fill-finish, and does that take away the opportunity? Also, what’s the percentage of GLP-1 in your backlog?

We view the acquisition as positive for ATS, reaffirming our ability to support customers in overcoming product market constraints. Our IoT solution for a pharma customer exemplifies this collaboration. Ryan will elaborate on the backlog question.

Yes. It's low double digits as a percentage of our backlog.

So just to clarify, low single digits for bookings, but double digits for backlog?

Correct.

Hi. Good morning, gentlemen.

Good morning, Max.

Andrew, can you share the return on invested capital by vertical? Over the long term, should we assume that a preferable route would be to increase healthcare's share to potentially 80%?

Absolutely. We strategically allocate capital to align with high returns on invested capital. Our recent M&A strategy, including targeting digital and life sciences, reflects this. While some markets yield higher returns, we aim for strong returns across all verticals, particularly in life sciences.

To add on here, our transportation and EV business is primarily organic. Internal investments typically generate a higher return, putting these on a similar playing field with other verticals.

Okay. Do you have any directional updates on the pilot programs with other auto OEMs?

They are progressing to plan without delays, and we are approaching our customers' long-term investment perspectives in the market.

Your next question comes from Sabahat Khan with RBC Capital Markets. Please go ahead.

Great. Thanks and good morning. Just a clarification question about the $200 million of delayed backlog. Should we assume that if it hadn't happened, revenue would be $2 million higher for this next quarter, or is that impact going to be split between this and the following quarter?

Yes. Good morning, Saba. The $200 million backlog represents revenue executed over a period of time, usually 12 months. Our typical revenue conversion is in the range of 25 to 30%. In this case, it would trend towards the lower end.

Thank you. Regarding your understanding of nuclear, do you have capacities and capabilities for new builds to support it in five to 15 years? Curious where you see your role evolving?

We like our niche position and the value it imparts. We're expanding capabilities to support refurbishment, SMRs, and new builds. Leveraging innovation, we aim to support various stages of the nuclear lifecycle.

Great. Lastly, regarding the EV discussions with a major customer, are other OEMs that were doing test runs progressing?

The mid to long-term narrative hasn't changed much. Customers are measured with their investments but prioritize technology, innovation, and profitability while meeting market demand.

Great. Thanks very much for the color.

Mr. Hider, there are no other questions. Back to you for closing remarks.

Thank you, operator. We look forward to continuing to execute on our goal of creating value for our customers and shareholders. Thanks for joining us today. I look forward to speaking to you on our year-end call in May. Stay safe and goodbye for now.

This concludes today's conference. You may now disconnect.