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spk12: Hello and welcome to the Evoqua Water Technologies third quarter 2021 earnings conference call. At this time, all participants have been placed on a listen only mode and the floor will be open for your questions following the presentation. After the speaker's opening remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, please press the pound key on your telephone keypad. As a reminder, this conference call is being recorded, and your participation implies consent to our recording of this call. If you do not agree with these terms, please disconnect at this time. Thank you. I would now like to turn the call over to Dan Braylor, Vice President of Investor Relations. Please go ahead.
spk13: Thank you, Nicole. Thanks, everyone, for joining us for today's call to review our third quarter 2021 financial results. Participating on today's call are Ron Keating, President and Chief Executive Officer, and Ben Stass, Executive Vice President and Chief Financial Officer. After our prepared remarks, we will open the call to questions. This conference call includes forward-looking statements, including our expectations for the fourth quarter and the full year of fiscal 2021, statements relating to the impact of the COVID-19 pandemic, anticipated inflation, and macroeconomic conditions, demand outlook in our end markets, growth opportunities, our pipeline, our acquisition strategy, and the impact of the proposed infrastructure legislation. Actual results may differ materially from expectations. For additional information on Evoqua, please refer to the company's SEC filings, including the risk factors described therein. On this conference call, We'll also discuss certain non-GAAP financial measures. Information required by Regulation G of the Exchange Act with respect to such non-GAAP financial measures is included in the appendix of the presentation slides for this call, which can be obtained via EVOQUA's Investor Relations website. Unless otherwise specified, references on this call to full-year measures or to a year referred to our fiscal year, which ends on September 30th. Means to access this conference call via webcast were disclosed in the press release, which was posted on our corporate website. Replays of this conference call will be archived and available for the next 14 days. With that, I would now like to turn the call over to Ron. Ron? Thank you, Dan.
spk01: Please turn to slide three. We continue to be pleased with the company performance under challenging market dynamics brought about by the pandemic. Our priorities have remained focused on the health and safety of our employees, ensuring business continuity, and improving our balance sheet and the liquidity of the company. The column on the left provides highlights of some achievements since the start of the pandemic. We have grown revenues, increased EBITDA margins, enhanced liquidity, and improved our net leverage ratio. As the economy transitions to a reopening phase, we believe we are well positioned for profitable growth. Our priorities for cash will focus on driving organic growth delivering on our M&A strategy, and further enhancing our balance sheet consistent with our priorities prior to the pandemic. We're seeing solid demand for our products and solutions. However, visibility on timing remains somewhat challenged. We're experiencing the same macroeconomic challenges as many of our peers, attraction of skilled talent, inflationary pressures, and material availability. As we have discussed in the past and will continue to highlight, Evoqua has many organic growth drivers as we look to the future. Our organization has done an excellent job of managing through a difficult period, and while market dynamics continue to present a variety of challenges, our organization is getting stronger and more competitive. Please turn to slide four. We are happy to highlight our third quarter results and the performance of the overall business. Our book-to-bill ratio for the quarter was above 1.1, and our opportunity pipeline remained strong across our diverse set of end markets and geographic regions. Both segments reported organic revenue growth as service and aftermarket demand increased, and our pricing initiatives continue to remain ahead of rising costs. Price cost for the quarter was positive by close to $1 million, and we expect that trend to continue with positive price costs for the fourth quarter and the full year. We continue to watch the evolving status of COVID-19 and our following safety protocols published by global health authorities. We'll manage changes in the operating environment with as agility and resilience as we have throughout the pandemic, still focused on safety and continuity of business operations. We had another solid quarter in managing our short-term assets as networking capital to sales improved by 80 basis points quarter over quarter to 12.3%. a sequential improvement of 60 basis points. Our focus on strengthening our balance sheet and increasing cash flow continues, and solid results were recorded across most key metrics. Our operating cash flow and adjusted free cash flow improved on a year-to-date basis, liquidity increased to $385 million, and our net leverage ratio improved to 2.8 times. We expect to further enhance the balance sheet as we invest in organic growth opportunities and continue to pursue our acquisition strategy. Please turn to slide five. As shown in prior calls, this chart represents our expectation for Evoqua's order demand in our primary end markets. In addition to our fourth quarter outlook, we have added a recap of our expectations shown in prior webcasts since Q2 of 2020. We started presenting this outlook at the beginning of the pandemic to give investors an indication of the expected short-term demand trends when visibility was otherwise challenging. As commented earlier, we are seeing strong order demand, and this chart indicates eight of our 10 key end markets are expecting improved year-over-year fourth quarter order demand. I would note that we are seeing strong demand in chemical processing. However, it is shown as red because we booked our largest outsourced water contract for a chemical processing company in the prior year's fourth quarter. If we were to exclude that contract, the CPI dot would also be green. We'll be happy to address questions about specific end market drivers during the Q&A session. Please turn to slide six. Our business has been resilient during the pandemic and continues to benefit from stable and recurring revenue growth. As shown in previous earnings calls, this graph presents our revenue and adjusted EBITDA on a rolling 12-month basis from quarter to quarter since 2017. Our overall revenues have grown at a compound annual rate of almost 5%, with adjusted EBITDA growth over 8% during this time. The business continues to operate on a steady and profitable growth trajectory after adjusting for the divestiture of Memcor. We primarily pursue capital projects to ultimately drive stable, recurring, and profitable service and aftermarket growth. Currently, our service business comprises 42% of our trailing 12-month sales, while service and aftermarket combined make up approximately 60% of our business. As we have previously discussed, the nature of our business is subject to quarterly variability. However, we have good visibility into our revenues from products and services on an annualized basis. I would now like to turn the call over to Ben.
spk15: Thank you, Ron. Please turn to slide seven. For the third quarter, reported revenues were up 6.3 percent to approximately 370 million. Organic revenues grew 3.2 percent, with both segments contributing to revenue growth. Segment demand improved, pricing was positive, and we saw growth in a variety of end markets, including chemical processing, food, and health sciences, while aquatics declined. We also experienced growth across all major regions. Third quarter adjusted to increase 3.8% to 66.2 million for an overall margin of 17.9%. Price costs and product mix improved profitability. Increased service volume positively benefited margin expansion, but was offset by unfavorable operational variances, higher operating expenses from employee compensation and travel, and general inflation. Please turn to slide eight. Applied product technologies third quarter revenues were $130 million, up 9.2%. Organic revenues increased $5 million, or 4.2%, driven by favorable pricing and strong growth across multiple product lines. Foreign currency positively impacted revenues by approximately 5%. Adjusted EBITDA for the third quarter decreased 1.7% to approximately $28 million. Adjusted EBITDA margin decreased 250 basis points to 21.8%. Operational variances, including additional warranty reserves and production variances, impacted adjusted EBITDA margins, in addition to higher employee expenses. Price, cost, and product mix was favorably impacted profitability. Please turn to slide nine. APT is focused on driving organic growth through new product development and international market expansion. Each quarter this year, we're highlighting product innovations that are expanding our addressable market and providing customers with enhanced solutions across the globe. Last quarter, we highlighted our latest UV technology. This quarter, we launched Powertron with our ozone generation system, expanding on our Pacific ozone acquisition from 2018. On-site ozone generation has been used globally for decades as a highly effective treatment method for industrial water applications. This next generation solution offers enhancements to help companies improve operations and reduce the amount of energy required to achieve water quality targets. This more sustainable approach to treatment also has a smaller footprint. Our ozone offering provides customers with optimized performance for ease of operation so they can focus on their processes and trust their water quality. Please turn to slide 10. Our integrated solutions and services segments third quarter revenues were up 4.8% to approximately $240 million, and organic revenues grew 2.7% over the prior year. We were pleased to see broad market demand driving revenues and profitability. Service and aftermarket revenues increased as site access constraints have improved. Price cost for the quarter was positive, while capital sales were down versus last year. The capital decline was primarily related to timing of microelectronics projects in the prior year, which was somewhat offset by new projects across a variety of end markets. Our digital strategy continues to enhance our profitability through service efficiencies, pricing, and competitive takeaways, with digitally-enabled revenues growing at robust rates, adjusted even to increase 11.3% to $56 million due to higher volume, favorable price costs, and productivity improvements. Adjusting the margin for the quarter was 23.5%, up 140 basis points over the prior year. Please turn to slide 11. Last quarter, we highlighted our ISS backlog composition. The service backlog is comprised of outsourced water contracts, which includes our mobile fleet, service deionization, build and operate assets, as well as service contracts on customer-owned equipment, municipal services, and carbon services. Whether the customer chooses to use an Evoqua-owned asset or to purchase the asset, we focus on earning the customer service and aftermarket business over the long term. This slide outlines the average revenue conversion range for our outsourced water asset by category. We have updated the slide, which shows third quarter backlog growing sequentially by $33 million to $745 million. We saw strong growth in capital backlog, while service backlog declined slightly from Q2. We expect to see quarterly backlog variations due to timing and billings. Over 60% of ISS revenues are comprised from services, of which approximately one-half comes from outsourced water and one-half comes from service contracts on customer-owned equipment. Service revenues are growing, recurring, profitable, and we believe we're well-positioned for profitable growth. Our opportunity pipeline is very strong, and we're working with customers on both service and capital solutions. Please turn to slide 12. Capital spending, primarily for outsourced water orders, was approximately $18 million for the quarter. Third quarter net working capital was 12.3% of LTM sales, an improvement of 80 basis points over the prior year and a 60 basis points improvement sequentially. Over the long term, We anticipate working capital to sales could be in the mid-teens range, given some projects may have varying amounts of working capital requirements. Please turn to slide 13. Operating cash flow was $103 million year to date versus $101 million in the prior year. You can see over the past four years, we have significantly improved operating cash flow. Adjusted free cash flow continues to be well above our 100% conversion goal at 186% year to date. Our net leverage ratio finished at 2.8 times adjusted EBITDA, which was down almost a third of a turn from the prior year and down almost a full turn over the past 18 months. We continue to target leverage ratio in a 2.5 to 3 times range. Our weighted average cost of debt as of Q3 is approximately 2.7%, an improvement of approximately 100 basis points over the prior year. Sequentially, our weighted average cost of debt dropped by approximately 45 basis points, The year-over-year reduction is driven by a combination of reduced debt levels, lower rates, and a shift of debt to lower-cost facilities. I would now like to turn the call back over to Ron. Thanks, Ben.
spk01: Please turn to slide 14. Infrastructure plan negotiations in Washington have continued, and we outlined two important legislative proposals with highlights on clean water. On Thursday, July 30th, the White House and Senate published a summary on the bipartisan infrastructure deal. On August 1st, the final version of the bill was unveiled, and PFAS and emerging contaminants continue to receive strong bipartisan support. This is unfolding in real time, and we're staying close to it. The original $10 billion of spending proposed by the Biden administration in March remains intact as currently proposed. Additionally, the PFAS Action Act passed the House within the last two weeks with strong bipartisan and White House support. This bill would require the EPA to designate PFOA and PFOS as hazardous under CERCLA and to issue a drinking water regulation for those two chemicals within two years. The bill also gives the EPA five years to determine whether all PFAS should be designated as hazardous. We continue to closely monitor the legislative process and are encouraged by the strong bipartisan support for clean drinking water investments. Please turn to slide 15. We think about sustainability in two ways. First, our handprint, enabling our customers to become more sustainable through our solutions and service offerings. And second, our footprint, driving Avoqua to become more sustainable within our own internal operations. Recently, a chemical plant in the southern U.S. was facing increased water demand due to higher production. Rather than tap into the aquifer by digging a new well, the plant reached out to Avoqua for an innovative solution. The result was to reuse the plant's wastewater which was being discharged into an adjacent marsh. Initially, a large-scale, 100-gallon-per-minute reverse osmosis pilot was run to establish viability of the project, which was successful and continues to operate. The customer is now expanding the relationship with Evoqua by having us explore point source reuse of water within the plant, which will ensure that the water volumes in the marsh remain stable and the plant has the needed production resources. From a footprint perspective, we are beginning our journey of reducing our CO2 emissions from the use of fossil fuel. As a first step from FY19 to FY20, we reduced our generated emissions by 1,540 metric tons, the equivalent of removing more than 300 passenger vehicles off the road for one year. Also, we were very pleased to have been listed on the Clean 200 list in recognition of our sustainability initiatives and our ability to make ourselves and our customers more sustainable. Please turn to slide 16. As we summarize the quarter with key highlights, our pipeline is robust, our order book is growing, and our overall market demand is growing. Economies are reopening at varying rates due to the pandemic, and challenges exist fulfilling demand. The search for skilled talent, rising commodity prices, and labor inflation is prevalent. We continue to manage these challenges well, and our price-cost impact was positive for the quarter and is positive year to date. Our visibility to order conversion is improving, but it has not fully returned to normal levels. Our team continues to execute, and we experienced organic revenue growth in the quarter, highlighted by growth in service and aftermarket, as well as growth across all of our key geographical regions. We are pleased with the continued strengthening of our balance sheet, cash flow, networking capital, and liquidity. This strength enhances our strategic flexibility and enables us to continue investment in organic and inorganic growth opportunities, including bolt-on M&A. We are also at this time reaffirming our full-year outlook with revenue and adjusted EBITDA expected to be in the previously communicated range of $1.43 to $1.47 billion and $240 to $255 million, respectively. I will now open up the call for your questions.
spk12: As a reminder, if you would like to ask a question, you may do so by pressing star, then the number 1 on your telephone keypad. Again, that is star 1 to ask a question. Your first question is from Nathan Jones of Stiefel.
spk03: Good morning, everyone. Good morning, Nathan. Hi, Nathan. I'd like to start off with a question on the ISS capital backlog. I think the disclosure this quarter on that backlog plus the disclosure last quarter implies to me that the backlog, ISS capital backlog, was up about 40% quarter over quarter. Can you talk about what kinds of things you've been booking and how we should be thinking about those converting to revenue? Yeah.
spk15: Thanks, Nathan. If you look at our market outlook, we've sort of highlighted where we're seeing the strength in demand, but specifically we're seeing across many end markets, particularly microelectronics, that we are seeing strength in orders.
spk03: And how should we think about kind of a, I guess, an average backlog duration? How long does that stuff take to turn into revenue?
spk15: This backlog was varied. but there were some longer, larger projects with this backlog that'll take a bit more time, as much as one to two years.
spk01: And Nathan, as you look at slide 11, where we've called out mobile fleet, service deionization, build and operate, kind of operate and balance those into 40%, 40%, 20%, and you can do some math around the calculation on time.
spk03: Yeah, great, thanks. Follow-up question I wanted to ask was on the operational variances in the quarter. You guys called out some increased warranty costs and some production variances. Can you talk about what's driving that, if there's been countermeasures deployed to try and fix those things, and what the expectations, I guess, especially around warranty costs are going forward? Has it been fully reserved, or should we be expecting more?
spk15: Yeah. So the production variances were largely doing the product mix. Last year we had a lot of microelectronics orders running through the plant that had great absorption. There was also some general inflation in there on indirect materials that was also included. It's a little bit of labor inflation. But that pretty much offsets the leverage that you normally see on that upside within APT because of that mix. The warranty was approximately a million and a half, and we believe we're fully reserved. They were mostly due to supply issues, vendor warranty quality issues. We're certainly going to work with those vendors in terms of recovering that. But in an abundance of caution, we want to make sure we took care of our customers first and we built the appropriate reserves.
spk03: So the production variances weren't actually variances in your own production processes. They were other things that led to those variances.
spk15: Yeah, it's mostly absorption, but there was some general inflation included in that as well. And we're going to offset the inflation with price. We continue to expect to do that. But there's no major issues within our production operations itself. But you can get variances due to the type of products that are running across there. Some have better absorption. Some do not have quite as good of absorption. And last year, we had larger orders that went through the production associated with microelectronics.
spk03: Okay, that makes sense. That is very helpful. Thank you very much.
spk15: Yep.
spk12: Your next question is from Dean Dre of RBC Capital Markets.
spk16: Thank you. Good morning, everyone. Hey, Dean. Good morning. Good morning, Dean. Good morning. Lots of underlying positives to talk about here between price-cost or what I like to call your traffic light slide page five and everything turning green. But actually, Ron, I wanted to start with an update on the state of your outsourcing business. You see really nice with Nathan's question pointing out the growth and the backlog of What's the gating factor for you in building out this outsourcing business? Has it been temporary just being able to get on-site access? Is it the customers making that decision to flip from, you know, CapEx to OpEx? Just, you know, state of the outsourcing business today and, you know, what the outlook is over the next several quarters.
spk01: Sure. Thanks, Dean. Thanks for the questions and the comments. And first of all, I would agree with you. There's a lot of lot of positives here certainly as you look at slide five and we continue to highlight that actually as I commented in the in the opening remarks excluding one very large order and CPI last year we would have all but one dot that would be green right now so we feel pretty good about that gating factor on outsourced water because it continues to gain traction for us is it is a little bit of the above all of the above that you mentioned it is site access which is challenging and It improved over the past three to six months, but we're seeing some customers that are very concerned about it with the new variant coming out and customers that are actually requesting that we validate that our service techs and our team members are vaccinated before they can come on site. So we're all watching what's going to happen with the Delta variant a little cautiously. The other piece is customers actually pulling the trigger. We have some very nice projects that are in the pipeline that have been delayed, and customers are delaying decisions because of the availability of their materials to operate as effectively as they would like to be, as well as some of the inflationary challenges that they're concerned about they're dealing with right now they feel like may subside, you know, over the next, you know, 12 to 18 months. So it's still very positive. The pipeline is growing. Things look Very nice on the outsourced waterfront, but we do have a little bit of cautiousness from the marketplace overall as they're pulling the trigger on larger orders right now.
spk16: That's real helpful. And then second question for Ben. It's just kind of a nice problem or question to be asked. Is your free cash flow conversion is significantly higher year to date than what we had been modeling? You know, we were bracing for some of this impact of growth capex with the outsourcing business, and it really has not been that significant in terms of weighing on the conversion. So what does it say about fourth quarter conversion and the setup for next year from a free cash flow standpoint, please?
spk15: Yeah, so, you know, it'll depend on mix. As capital kicks in, that'll put more pressure on free cash flow conversions we head into next year. But we do expect to stay above our 100% goal, and we remain very confident in doing that. As we head into Q4, we also feel good about Q4 as well to stay within our expectations. We've done a lot in this area, particularly with our shared services, receivables collections, overall cash conversion cycle reduction across the organization. There could be some pressure on inventory as we continue to manage through some of these supply chain challenges and make sure that we have enough stock to weather any hiccups that we get from suppliers. But we feel very good about collections, and we also feel very good about our payable process as well to help offset the majority of that.
spk16: And just to clarify, are you carrying a higher buffer inventory at this time?
spk15: Yes, we are.
spk16: Yeah, that makes sense. We're seeing that everywhere, so I appreciate hearing that. Thank you. Thanks, Kim.
spk12: Your next question is from Mike Halloran of Bayard.
spk09: Hey, good morning, everyone. Hi, Mark. So kind of continuing on a couple of the questions we've already been asked, you know, first, you know, last quarter we would have talked about a fourth quarter implying the Really healthy exit rate in the next year. You know, there's some supply chain challenges and things like that happening. Didn't change guidance of the fourth quarter range. The implied range is awfully wide. So I guess the question is just the confidence that you're going to exit this year at a really high, good momentum kind of run rate. And any thoughts on that or an update on that?
spk01: Yeah, Mike, thanks for the question. You know, one thing we want to do on guidance, we continue to maintain, you know, being balanced in what we give as guidance. I think you've seen that from us for, you know, the last several quarters is just, you know, making sure that we are down the middle of the fairway, kind of taking the treetops out. Certainly with a lot of the, you know, some of the uncertainty, I would say, with the Delta variant coming out, but Again, as we highlight on slide five, what's happening in markets, what's happening with our order activity, our book-to-bill ratio to be north of 1.1 in Q3 really shows very strongly for what we expect to enter into FY22 with.
spk09: Yeah, so still a high degree of confidence in the momentum that you're going to take exiting the year, correct? Yes. Right. So then when you think about some of the supply chain challenges, Obviously, the price-cost piece has been very good so far. How are you thinking about the timing of those? Does price-cost stay positive through the fourth quarter, or are there some legs that start materializing? And then, as you're looking ahead to the supply chain side, any other kind of internal challenges through your networks, how do you think those flatten out, and when do you see normalization?
spk01: Yeah, so I think I actually made a couple of comments on that during the opening. We do see price-cost staying positive all the way through the end of the fiscal year. And then we think there will be some normalization as we start to see cost balance out coming into the FY22 timeframe and during that fiscal year as well. But we've got terrific momentum from the team. We're continuing to look at inflation across many areas, not just material costs, but across labor, freight, et cetera. There's a lot of challenges in the marketplace with inflationary impacts on the different services we provide, and we're having to make sure that we get the appropriate price for that as well.
spk11: Thanks, gentlemen.
spk10: Your next question is from Eaton Buckbinder of Citi.
spk14: Hi, good morning.
spk11: Good morning.
spk12: Good morning, Eitan.
spk14: Within the cash flow walk, the gross capex was about $34 million year-to-date. That's already ahead of the full year of 2020 and almost at 2019 levels, you know, with one quarter to go. So given customers may be hesitant to spend on capex, you know, their own for capital projects, have you seen the quoting pipeline for build, own, operate, and prove? And do you anticipate that it surpasses 2019 levels?
spk15: Yes, the build-own-operate pipeline. Again, how this works is customers choose whether they want to do capital or build-own-operate. Many times they choose that at the end. But the pipeline for these types of projects continues to be robust. So we'll see which way they choose. But historically, they've chosen more in the build-own-operate area. We're seeing more conversion to build-own-operates.
spk01: And one of the big opportunities, Aitan, is we – approach a customer with that as a first option. So it gives us a tremendous opportunity and a competitive advantage where we're going in and bidding on a project to be able to lead with outsourced water first.
spk14: That's helpful. Thank you. And then the midpoint of your guide implies about 17.1% adjusted EBITDA margin, which would represent a second straight quarter decline and trailing 12-month adjusted EBITDA margin. So have you seen Operational variances or price-cost headwinds accelerate, which could lead to Q4 adjusted EBITDA margin down year over year, or is it more conservatism and taking off the treetops?
spk01: I would just highlight what I mentioned earlier. We're being very balanced as we go forward. We didn't see a need to move guidance just based on a little bit of the uncertainty we're seeing with COVID, and we wanted to make sure we were down the middle of the fairway.
spk11: That sounds good. Thank you very much. Thanks.
spk12: Your next question is from Steve Tusa of JP Morgan.
spk05: Hi, good morning.
spk14: Good morning.
spk05: Good morning, Steve. Just on the – any early thoughts on 22, you know, and kind of sense of organic growth versus the kind of longer-term targets that you guys talk about?
spk01: Yeah, Steve, you know, we haven't given any guidance on 22 yet. We certainly – anticipate based on the strong order book and the, you know, the backlog that we've been building that we'll continue to be, you know, in line with our long-term targets that we've given.
spk05: Okay. I had to try. And then just on the infrastructure bill, and anything coming out there that you see – you know, that drives growth in the near term or maybe some people stepping back and delaying and kind of looking for better visibility on how this is all going to work? Just, you know, high-level questions there.
spk01: Look, overall, I think it is very positive for us that we're getting such bipartisan support around clean water. And I think that's the key as we go forward. So it speaks to fantastic secular trends for the industry as a whole for us and the solutions we provide. And the emphasis on emerging contaminants gives us a, you know, very positive outlook as to what's going to happen. That, you know, the EPA and the federal government are starting to, you know, really highlight this as something that needs to be addressed and will be addressed is very positive for the long-term outlook.
spk03: Right. Thanks. Appreciate it.
spk01: Thank you.
spk12: Our next question is from Andrew Buscaglia of Barenburg.
spk11: Good morning, guys. Good morning.
spk04: Good morning, Andrew. I was wondering if you'd comment on, you know, some services in the aftermarket. You know, I thought, you know, it's growing a bit, but, you know, it sounds like the Delta variant is kind of pushing that out due to site access issues. You know, are we setting up for a pretty robust year going forward or maybe quarter going forward if that lifts? And by that, I mean, can you talk about the nature of the spend birds? Is that the way to think of it? People are pushing off the services and maintenance of the stuff, and they're going to need a lot of that going forward, basically.
spk01: Yeah, Andrew, I think a little bit of what we've seen and we continue to experience is there's a bit of a bow wave that comes as people ramp back up their production, so there's opportunities for us that that will be expanding a little more greatly than they potentially have in the past as people open back up to full capacity and things start operating. But the other thing that I want to highlight through this is as we see capital projects come through, and we've discussed this in several other calls, for a dollar in capital that we sell, so if we go out and sell a $20 million capital system, typically between 18 months and 24 months later, you see about 22 and a half cents of service that flows from that capital sale. And so it's a little bit slower to get that services growth that is tied on to the capital projects that we highlight and we speak of. And there's a very nice benefit as you see that ISS backlog growing you know, that indicates we'll see the services that are, you know, stable and recurring revenue that will follow suit.
spk04: Got it. And maybe one on capital allocation, you know, any updated thoughts on M&A and then, you know, if M&A is not likely, what about focusing on, you know, continuing to pay down that debt
spk01: Well, I'll speak to the M&A piece, and we've got a very nice pipeline coming, and Ben can talk about paying down debt, because we're going to continue to do that. But on the M&A side, we have a robust pipeline of opportunities that we anticipate we'll be able to you know, continue to execute on our bolt-on strategy that we've highlighted in the past. And Ben, you want to talk about the debt payback? Yeah, sure.
spk15: M&A and organic growth are clearly priorities, especially in this environment. But we are focusing on reducing debt. We're currently at 2.8. You know, we've stated a goal of two and a half to three times. So we're within the range, but, you know, we've still got room to get to two and a half. So we're going to continue to focus on that reduction as well.
spk04: All right. Thanks, guys.
spk12: Your next question is from John Walsh of Credit, please.
spk11: Hi.
spk07: Good morning.
spk11: Good morning, John.
spk07: Good morning. I wonder if we could talk a little bit more about the pricing actions you're taking and just thinking about on the other side of this, if we get some deflation in these input costs, it's kind of hard to go back and look at history because of the way you've kind of transitioned the business model here. So how should we think about price stickiness and the ability to kind of naturally push through price with a 90% plus renewal rate?
spk01: Yeah. I mean, as you look at that, John, obviously, you know, we are, it's a little harder when you have longer term contracts to get the price immediately, but that also leads to a benefit on the backside when you have longer term contracts that of the price being much more stable and much more sticky. So, you know, we've had to go out with some surcharges just given the, you know, immediate nature on some of the inflationary pressures that we've seen. Surcharges, you know, go on and they typically will bleed off as we see deflationary moves. But as we go to annual contracts and we renew annual contracts from surcharges, we typically roll those more into the new contract pricing, which allows it to last longer than typically it would.
spk07: Great. Thanks for that. And then maybe just one more around capital allocation. Obviously, you've articulated your strategy of bolt-ons, but just curious what you're seeing or what your thoughts are on maybe larger industry consolidation. We've certainly seen a pickup in acquisition activity. We'd just love to get your thoughts there on potentially larger industry consolidation moves.
spk01: I think that there are certainly some potential industry moves that are out there. They are few and far between and much more difficult to action. And so our focus continues to be on the strategy we've articulated around a creative tuck-in or bolt-on acquisitions, and we'll continue to focus on that.
spk07: Great. Thanks for taking the questions.
spk01: Thank you.
spk12: Your next question is from Pavel Mokunov of Raymond James.
spk06: Thanks for taking the question. Two international things I wanted to ask about. First, on the supply side of the equation, after you sold the Memcor business in Australia a few years ago. Do you have any exposure to the Australian market at this point? And, of course, I'm asking in the context of the Sydney and Brisbane lockdowns.
spk01: We do have access to it. We still have a team on the ground that is providing systems and services as well as product technologies into that market. We still do other integrators. in Australia as well that deploy our products and technologies, Australia and New Zealand. But it's not a large portion of our business, Pavel. It's much smaller since we sold the Memcor business off.
spk06: Okay, understood. And then a few people asked about the U.S. infrastructure package and water treatment modernization. On the other side of the Atlantic, very similar conversation, also involving PFAS and places like northern Italy, Belgium, southern England. How do you assess that opportunity?
spk01: We think the opportunity, you know, certainly is there for integrators and service providers in those markets to deploy our technologies, our advanced technologies that we have in the APT portfolio. And a lot of that's around, you know, UV opportunities, different types of concentration up and you know, with RO and ion exchange systems. And where we can, you know, deploy some of our product technologies, we're very supportive of that. But we are not there as a system provider in those markets. We are simply providing technologies. Okay.
spk11: Thank you very much. Thank you.
spk12: Your next question is from Joe Giordano of Cowan.
spk11: Hey, guys. Morning. Morning, Joe. Hi, Joe.
spk02: Do you have a sense of the inflection in your business on revenue on the capital side, just given the backlog timing, the visibility you have there?
spk15: Joe, can you make inflection? Are you just talking about conversion of backlog to revenue?
spk02: You had the service business up in the aftermarket up and a quarter of capital down. I think that's been a couple quarters like that, just given the nature of the Do you have a sense of when that flips to positive for capital?
spk15: Yeah, if you look at the backlog chart for ISS, you saw that that ticked up, and we did point to the fact that general strength in orders within capital, including microelectronics. So, you know, some of those orders are longer in duration, so they're going to take some time to convert because they're larger microelectronics types of orders. But on average, it depends on the size of the order, but it can be three months to – you know, two years, depending on the size of the order.
spk01: But I think, Joe, as you see, it says capital averages nine to 12 months on that slide. And so, you know, that would give an indication inflection would occur within the next 12 months.
spk02: Fair enough. And then your comments on the networking capital that could be like mid-teens, is that like something that you see happening kind of now as a matter of course, or like what are the conditions that would need to be in place to move that higher to that level?
spk15: It depends on mix and it depends on end market where that capital occurs. Just as a reminder, a lot of the longer capital that was kind of negative in terms of CIE, BIE was in the municipal segment. We've reduced our exposure with the sale of Memphor. We feel good about staying in the lower end of that range, but it's possible that larger types of projects could come through that put pressure in the capital area on working capital short term. But again, it should correct itself relatively soon. We do think that the lower teens is where we should sit long-term.
spk11: Thanks.
spk10: Your final question is from Brian Lee of Goldman Sachs.
spk11: Hey, guys. Good morning. Thanks for squeezing me in. Hey, Brian. Good morning.
spk00: Maybe just on all the backlog and order strength in that context. Can you kind of give us an update on whether or not you're seeing increased activity around the PFAS pipeline? I think the last time you guys updated us, you were still talking about $100 million visibility on the pipeline for PFAS-related items. Just wondering if there was anything related to that specific in terms of the updates around backlog and order trends.
spk01: Yeah, so Brian, I would say that that's remaining fairly stable with what we see. A lot of what's going on in the federal government is causing, you know, people just, you know, or water districts to continue to address their immediate need, but not to advance the ball on really expanding it until they see what's going to happen with the EPA and with the federal government. So it's staying pretty steady. Our wind rate is staying very steady as well. And so we continue to see it be a piece of our business that has great promise but is not contributing greatly to the overall picture yet.
spk00: Okay, fair enough. And then maybe a second question for Ben. just kind of around the model and margin trends here. And speaking of inflections, I think this is the first time in fiscal 21 APT saw margins decline year-on-year, and then ISS went positive. So we kind of turned in a corner here in ISS where we should be expecting year-on-year margin trends to remain positive into Q4 and heading into fiscal 22, and then I wasn't clear on some of the residual impact of, you know, the warranties and operational factors. Is that going to weigh on APT in the near term where we continue to sort of see that negative on a year-on-year basis? Thanks, guys.
spk15: Sure. So for ISS, again, margin trends we're expecting to continue to be favorable as volumes improve and increase in the tough microelectronics comps. are in our rearview mirror. You know, this quarter, fourth quarter, we still have one more tough comp left. I just want to remind you of that. But then, you know, the comps get better as we head into next year. Service volume within ISS is certainly helping margins. And on the other hand, you know, we still got to keep our eye on inflation. And I want to remind you, price costs, even though we're positive, can put pressure on margins if you don't maintain your margins on the price. So just as a, you know, from a thought process, We can be positive and recover all our costs plus have additional price, but if that does not maintain the margin, that can be a little put some short-term pressure on margins. Within APT, the warranty, we believe, is fully reserved for. We don't expect additional issues as we head into the future. In an abundance of caution, we wanted to make sure we're aggressive with our customers so they don't feel any impact of these issues. We're certainly going to work with our suppliers to resolve these issues. So we don't see any hangover from that effect. And the other point within APT margins, they were also a little bit of a victim of tough comps because a lot of microelectronics in the prior year, large orders, that produced great absorption within the segment in the prior year. So they had some tough comps as well. So again, we don't see a lot of hangover effect from this APT margin challenge that we had this quarter on a quarter-over-quarter basis.
spk11: All right. I appreciate the call. Thanks, guys. Thanks. Thank you.
spk12: Thank you. That concludes our question and answer period. I would now like to turn the call back over to Ron Keating for his closing remarks.
spk01: So, first of all, I'd like to thank our dedicated team at Avoqua for continuing to deliver continuous operations and continuous support to our customers in somewhat challenging times, and certainly for providing the tremendously strong technology and sustainable solutions that we deliver to the market. Thank you all for participating in the earnings call today. We hope you'll be safe and we appreciate your interest in Evoqua.
spk12: Thank you. That concludes today's Evoqua Water Technologies third quarter 2021 earnings conference call. You may now disconnect your lines and thank you for your interest in Evoqua.
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