Evoqua Water Technologies Corp.

Hello, and welcome to the Evoqua Water Technologies third quarter 2022 earnings conference call. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. After the speaker's 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 at any time you would like to withdraw your question, please press the pound key. 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. I would now like to turn the call over to Dan Braylor, Vice President of Investor Relations. Please go ahead.

Dan Braylor Thanks, everyone, for joining us for today's call to review our third quarter 2022 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'll open the call to questions. This conference call includes forward-looking statements, including our fourth quarter and full fiscal year 2022 expectations, long-term financial targets, statements relating to our demand outlook and markets, growth opportunities, our order pipeline, order conversion, cash generation, our acquisition strategy and pipeline, integration and future performance of our recent acquisitions, supply chain challenges, inflation, labor shortages, and general macroeconomic conditions. Actual results may differ materially from our expectations. For additional information on Avocla, 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 with respect to such non-GAAP financial measures is included in the appendix of the presentation slides for this call, which can be obtained at Avocla'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 Industrial Relations 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, and thank you for joining us. I appreciate your interest in Avoqua, and I'm pleased to provide insights into our results and outlook. We had a strong third quarter, and I'm pleased with the overall results. Market demand remains robust despite inflationary pressures and supply chain challenges. We're timely managing our lead times and any potential disruptions that may impact our order conversion timing. We continue to experience a robust pipeline, and this quarter's order growth was, again, very strong. Please turn to slide three. Overall organic revenue growth in the third quarter was approximately 9% year-over-year. We're particularly pleased to see broad-based diversification of organic growth across all regions, most product lines, as well as growth across aftermarket, capital, and service. As mentioned, demand remains solid and order growth is robust, with our book-to-bill ratio continuing to be greater than 1.0. Organic revenue growth on a trailing 12-month basis is above 10%, and we've made three acquisitions since January 1st. The team has done a great job of pushing price, and we remain price-cost positive for the quarter and the year-to-date. Adjusted EBITDA margin was down 40 basis points for the quarter, but expanded 30 basis points year-to-date. We are pleased to see APT's Q3 year-over-year adjusted EBITDA margin expand by 1.3%. ISS margin declined by 1.9% based on various items that Ben will discuss in later slides. We completed our second quarter with MarCorp and continue to be pleased with the progress. The integration is on track and we're working to complete our SAP system conversion by the end of Q2 in 2023. Our balance sheet and liquidity strengthened and we continue to focus on cash flow generation. Our operating cash flow and adjusted free cash flow on an LTM basis improved sequentially versus Q2. Our liquidity increased to $267 million, and our net leverage ratio improved to 2.9 times. Cash flow continues to be a priority to fund investments in organic growth, tuck-in acquisitions, and to further improve the balance sheet through debt reduction. Please turn to slide four. Water is an essential element for daily life, whether for human consumption, industrial production, or commercial purposes. Manufacturers are requiring more stringent levels of ultra-pure water while wastewater reuse has become vital in protecting diminishing water supplies and reducing the strain on municipalities. As water becomes more complex, Evoqua's essential treatment technologies make clean water more accessible. Because of this, the long-term market trends are very favorable, and we expect our business to remain resilient through normal market cycles. This slide highlights key financial metrics that we expect to be annually resilient over the long term. Organic sales growth, adjusted EBITDA margin, and cash generation. Each of these graphs highlight our resiliency through the FY20 and 21 COVID pandemic with growing and strong free cash flow in a demand-constrained market. This is due in part to our recurring revenue streams with service and aftermarket making up approximately 60% of our revenue. Digitally connected outsourced water, strong and growing in markets, and our industry-leading service are just a few drivers for organic growth in favorable and unfavorable market conditions. As stated previously, we remain price-cost positive on an absolute dollar basis. Intense inflationary costs have been dilutive to margins in FY22. For the quarter, inflationary costs impacted adjusted EBITDA margin by approximately 40 basis points, which improved from a 70 basis point impact in the second quarter. We continue with robust pricing processes, and we expect to remain price-cost positive in the fourth quarter. Despite these headwinds, we maintain our long-term target of 20% adjusted EBITDA margin. Our management team is focused on driving strong and consistent cash generation. Our strong base of stable, profitable, and recurring revenue provides an attractive foundation for cash generation. We have managed working capital well and see additional opportunities for improvement over time. We continue to target adjusted free cash flow conversion of over 100% or higher, and we've achieved that on an LTM basis for several years. Please turn to slide five. This chart represents our fourth quarter expected order activity by end market compared to the prior year's fourth quarter. As shown, we expect to see strong orders in the fourth quarter across most end markets, particularly life sciences, food and beverage, and life and general industries. Power and refining are improving from prior quarters outlook, with favorable market dynamics across both end markets. Expected fourth quarter orders in microelectronics are showing a decline from last year's fourth quarter due to very strong Q4 orders last year. We are well positioned in the microelectronics market, which has undergone a strong cyclical upturn that we expect to remain. Overall, we expect to see strong order demand across most of our end markets for the remainder of fiscal 2022. We do anticipate supply chain and labor challenges creating the potential for order conversion delays on behalf of our customers. At Evoqua, we're proud of our diverse team of employees executing on fulfilling this demand every day. As we continue to expand our company with skilled team members, we are pleased to be partnering with five HBCUs for talent recruitment in the fall and the spring. Please turn to slide six. Over past quarters, we've highlighted high priority end markets, including microelectronics, life sciences, renewable energy, and this quarter we highlight food and beverage. Food, particularly for wastewater treatment, has been a key end market for us since the ADI acquisition in 2017. We have been historically strong in beverage with processed water and are pleased to see gaining traction for wastewater treatment. With today's strict regulatory environment, manufacturing and processing requires high purity water for multiple applications, such as sanitizing equipment. High-strength organic contaminants have also driven the need for improved wastewater treatment, and our ADI product line has best-in-class anaerobic digestion for these applications. Our portfolio of wastewater technologies allow customers to treat the most difficult organic waste streams, while also helping them to achieve their carbon intensity goals by producing biogas, a source of renewable energy. Our core process water portfolio also plays a vital role in providing production process water and utility makeup water into these markets. Please turn to slide seven. We look at our environmental impact through our own footprint on the environment, but also through the products and services we provide to our customers. We're pleased to highlight two recent handprint lens, which are expected to positively impact our customers' water conservation while generating an attractive ROI. Bakersfield Renewable Fuels selected Evoqua to design, source, and assemble a wastewater system that combined granular activated carbon, ultrafiltration, and reverse osmosis technologies to treat up to 375 gallons of water per minute. The system was designed to allow for 75% recovery with an estimated annual savings of approximately 140 million gallons of water. We also helped the dairy processing plant, which experienced significant demand increases by replacing an aging wastewater system. Our anaerobic digester was selected to treat up to 2,100 cubic meters of wastewater per day. Through this treatment, we will produce an expected 5,000 cubic meters of biogas per day, which is approximately the average daily usage of 550 US homes. Please turn to slide eight.