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spk01: Hello and welcome to Evoqua Water Technologies fourth quarter and full year 2022 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 star two 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.
spk07: Thank you, Operator. Thanks, everyone, for joining us for today's call to review our fourth quarter and full year 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 will open the call to questions. We ask that you please keep to one question and a follow-up to accommodate as many questions as possible. This conference call includes forward-looking statements, including first quarter and full fiscal year 2023 expectations, long-term financial targets, and statements relating to demand outlook, growth opportunities, our book-to-bill ratio, our net leverage ratio, capital expenditures, our acquisition strategy, regulatory actions, material and labor availability, inflation, and general macroeconomic conditions. Actual results may differ materially from our expectations. For additional information on Evoqua, please refer to the company's SEC filings, including the risk factors described therein.
spk01: Hello and welcome to Evoqua Water Technologies fourth quarter and full year 2022 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 star two 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.
spk07: Thank you, Operator. Thanks, everyone, for joining us for today's call to review our fourth quarter and full year 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 will open the call to questions. We ask that you please keep to one question and a follow-up to accommodate as many questions as possible. This conference call includes forward-looking statements, including first quarter and full fiscal year 2023 expectations, long-term financial targets, and statements relating to demand outlook, growth opportunities, our book-to-bill ratio, our net leverage ratio, capital expenditures, our acquisition strategy, regulatory actions, mature and labor availability, inflation, and general macroeconomic conditions. Actual results may differ materially from our 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 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 Evoqua's Investor Relations website. Unless otherwise specified, references on this call to full-year measures or to a year refer 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 investor relations website. replays of this conference call will be archived and available for the next 60 days. With that, I'd like to turn the call over to Ron. Ron?
spk02: Thank you, Dan, and thank you for joining us. I appreciate your interest in ABOCA, and I'm happy to provide the insight into our results and outlook. Please turn to slide three. I'm very pleased with our fourth quarter and full year 2022 results. In the fourth quarter, both segments reported strong organic revenue growth with broad-based demand across aftermarket, service, and capital, and across most regions and product lines. Our book-to-bill ratio was again above 1.0 for the quarter, and for the second consecutive fiscal year, our full-year book-to-bill was approximately 1.1. Backlog reached record levels and our pipeline is strong as demand for clean and available water increases across our customer base and end markets. while we're actively helping our customers solve complex water treatment challenges while reducing their environmental impact with recycle and reuse solutions. Adjusted EBITDA grew double digits in the fourth quarter and over 18% for the full year. Price cost was positive and accreted to margins in the quarter despite challenges that impacted the full year. Material availability, inflationary pressures, and skilled labor access continue to provide challenges, but our team is effectively navigating the constraints. We have also driven price and operating efficiency across the organization, which will continue to be a priority in FY23. We are pleased to have achieved two important FY22 ESG goals relating to employee safety and water reuse. Safety is the number one priority at Avoqua, and we reduced our recordable incident rate by 20% this year. When addressing water challenges, we planned to lead by example and set and achieved our goal of reusing more than 55% of our water draw across our top 10 facilities. Cash flow for the year was strong, and we continue to drive improvements to our balance sheet. Adjusted pre-cash conversion was well above our target of 100%, Networking capital improved to 14% of sales, liquidity increased sequentially, and our net leverage ratio improved to 2.6 times from 3.1 times following the Markor acquisition earlier this year. Please turn to slide four. Evoque was a performance-driven water technology company focused on delivering customer solutions while driving strong and resilient financial results. As you can see, we have generated strong results across these six key metrics over the past several years. Our results demonstrate the strength of our business model and focused execution. We are proud of the progress we have made, and we remain confident on the execution of our strategy in the coming years. Please turn the slide back. This chart represents our first quarter expected order rate by end market relative to the prior year's first quarter. We expect to see order growth in the first quarter across most end markets, including life sciences, power, food and beverage, and light and general industries. Strong prior-year orders in microelectronics are driving a slight decline in the year-over-year order outlook, but our revenue should still be strong given our current backlog. We still expect to see continued growth in microelectronics, supported by government and private investments in onshore manufacturing facilities. Overall, we expect to see increasing demand across most of our end markets in the first half of FY23, with potential slowing in the second half. We will discuss our outlook and underlying assumptions shortly. We will also be happy to address questions about specific end market drivers during the Q&A session. Please turn to slide six. Throughout the year, we highlight impactful handprint lens that showcase our contribution to helping our customers improve their sustainability objectives. In this quarter, we're pleased to announce technology implementations with two of the world's largest companies, a chemical processing company located in the Gulf Coast of Texas and a global consumer products company. The chemical processing company engaged Evoqua to replace a brine recovery system and provide an outsourced water service contract for the next 10 years. The consumer products company is installing our reverse osmosis system for brine recovery as they make strides toward their water recycling goal to reuse more water than consumed at manufacturing sites around the globe. In addition to helping our customers solve their water challenges, we're improving reliability and energy efficiency. I would now like to turn the call over to Beth.
spk11: Thank you, Ron. Please turn to slide seven. For the fourth quarter, reported revenues were up 18.5% to approximately $505 million. Organic contribution of revenue growth was 8.7%, driven by price realization and volume growth. We saw revenues increases in aftermarket, services, and capital, as well as broad-based growth across most regions and product lines versus the prior year. Fourth quarter adjusted EBITDA increased 13.8% to $93.2 million for an overall margin of 18.5%. a decrease of 70 basis points versus the prior year, driven primarily by inflationary impacts, higher service labor costs, and lower productivity from training and onboarding of new service tax. As mentioned, price cost was positive and slightly accretive to margins in the quarter. Please turn to slide 8. For the full year, reported revenues were up 18.6% to approximately $1.7 billion, driven by higher volume and favorable price realizations. Organic contribution of revenue growth was over 10%, primarily driven by increases in aftermarket services and capital, as well as growth across all regions and most product lines versus the prior year. Full year adjusted EBITDA increased 18.7% to approximately $298 million for an overall margin of 17.1%, essentially the same as the prior year. We realized favorable price, higher organic volume, and mixed, which were offset by inflationary cost impacts. Please turn to slide nine. Our integrated solutions and services segments' fourth quarter revenues were up 23.4 percent to approximately $347 million. Organic contribution to revenue growth was 6.1 percent over the prior year, driven by price realization. Services and aftermarket revenues were strong, driven by life sciences, food and beverage, and light and general industries. Fourth quarter adjusted EBITDA increased 10% to approximately $78 million due to favorable price realization and higher sales volume from acquisitions. Adjusted EBITDA margin for the quarter was 22.4% down 270 basis points from the prior year. Productivity impacts outpaced price and cost benefits. Marker margins were also diluted to segment margins. revenues grew 23.4% to approximately $1.18 billion, with adjusted EBITDA up 18% to $259 million. The increase in revenues was driven by positive price realization and higher sales volume across services, capital, and aftermarket. Digitally connected sales grew double digits this quarter and overall have increased approximately $100 million since 2018. As of the end of the year, 2022, digitally-enabled revenues were $263 million up from $230 million at FY21. For the full year, adjusted EBITDA margins declined 90 basis points over the prior year, driven by material, fuel, freight inflation, and labor costs and MarCorp's dilutive impacts. These margins' headwinds were partly offset by favorable price realization and sales volumes. Please turn to slide 10. We continue to see strong year-over-year growth in ISS backlog, which was up 152 million or 20% over the prior year quarter, with growth coming from both capital and service orders. As Ron mentioned earlier, EVOCA's backlog was at record levels at year end. Capital has seen strong growth, with orders being driven by food and beverage, microelectronics, and power in markets. Our pipeline continues to be robust with opportunities across multiple markets, and we expect to see the bill rate remain above 1.0 throughout fiscal 2023. Please turn to slide 11. The applied product technology segment's fourth quarter revenues were up 9 percent to $157.6 million. Price realization and strong volume contributed to revenue growth in Asia Pacific and the Americas. while EMEA reported a slight decline. Organic contribution to revenue growth was 13.7% over the prior year, driven by price realization and volume across all product lines. Revenue was unfavorably impacted by $6.9 million in the period related to foreign currency translation. Fourth quarter adjusted EBITDA increased approximately 14% to $37.7 million. Adjusted EBITDA margins grew 100 basis points over the prior year, with an increase in profitability driven by price realization and higher sales volumes. These benefits were partly offset by increased inflationary impacts. Full-year revenues grew 9.5% to $552 million, with adjusted EBITDA up 13.2% to $119.7 million, while margins improved 70 basis points versus the prior year. The increase in revenue was driven by price realization and the higher volumes across all regions, particularly in North America and Asia Pacific. Organic contribution to revenue growth was 12.1% over the prior year, driven by price realization and volume across all product lines. Revenue was unfavorably impacted by $12.9 million in the year related to foreign currency translations. The increase in adjusted EBITDA was driven by price realization, higher sales volume, and favorable mix. These benefits were partly offset by increased inflationary costs. Please turn to slide 12. Capital spending, largely related to outsourced water orders for build-on-operate facilities and mobile fleet assets, was approximately $23.3 million for the quarter, or approximately 4.6% of revenues. We continue to expect CapEx net of financing as a percentage of sales to be in the 5% range in FY23. Fourth quarter net working capital was 14% of LTM sales, an improvement of 200 basis points over the third quarter of this year. I would like to thank our Evoqua team for continuing to drive improvements in working capital. As previously mentioned, over the long term, we anticipate net working capital to sales could be in their low-teens range, given some projects may have varying amounts of working capital requirements. For the full year, operating cash flow improved to $181.4 million versus $178.7 million in the prior year. Adjusted free cash flow as a percentage of adjusted net income continues to be well above our 100% conversion goal at 121% for the year. Net income for the fourth quarter included a non-cash benefit of $17.3 million associated with the reliefs of an income tax valuation allowance as the result of increased profitability. Please refer to slide 19 in the appendix for additional details. Our net leverage ratio finished at 2.6 times of adjusted EBITDA, well within our targeted range. We are very pleased to have improved our leverage profile as expected after the acquisition of MARCOR in the second quarter of fiscal 2022. Maintaining a strong and flexible balance sheet remains a key priority particularly given challenging macroeconomic market dynamics. And we are now targeting a two times to three times net leverage to adjust the EBITDA range versus the previously stated target of 2.5 to three times. Interest expense increases have been moderated by maintaining approximately 67% of our total debt at fixed rates. Our weighted average cost of debt increased by 110 basis points to 4.1%, from 3% in the prior year period. This increase compares favorably to Federal Reserve actions that increased target rates by 300 basis points to 3.25% from 0.25% as of September 30, 2022 and September 30, 2021, respectively. For the full year, the weighted average cost of debt rose 40 basis points to 3.39% in 2022 from 2.99% in 2021. I would now like to turn the call back over to Ron. Ron?
spk02: Thanks, Ben. Please turn to slide 13. This slide shows our performance since 2018 for three of four long-term financial targets. Three to 5% organic revenue growth, 20% adjusted EBITDA margin, and adjusted free cash flow conversion over 100%. We have multiple drivers supporting the resiliency of our business model in uncertain market conditions, be it COVID lockdown, supply chain constraints, or high inflation. This is due in part to our stable and recurring revenue streams, with service and aftermarket making up approximately 60% of our total revenue. Please turn to slide 14. Heading into our new fiscal year, we see many opportunities but also uncertainties on the horizon. We regularly work to align our outlook across the favorable tailwinds while managing for the market unknowns. As we have demonstrated, our business model is resilient and we are focused on stable, recurring, and profitable revenues. Our large concentration of business in North America provides a level of stability in uncertain times. We still see growth opportunities from deeper penetration into target markets and through geographic expansion as we sell our technologies globally. We have a record backlog with order growth across most end markets and a strong and growing pipeline. While customers are driven by ROI when making capital and operating decisions, regulation is also driving investments in water at the federal, state, and local levels. One example of noted interest is the PFAS market. The near-term impact is not expected to drive material revenue growth, but we expect PFAS remediation to provide long-term growth for many years to come. A slowing global economy is expected to improve labor and material availability and to moderate inflationary pressures throughout the year. We expect continued demand in North America in the first half of our fiscal year as we deliver against our backlog. An economic slowdown could occur in the second half of our fiscal year, but we will adjust accordingly. We're providing key assumptions for our full-year outlook on slide 18 in the appendix. Please turn to slide 15. We had an excellent quarter, and we're very pleased with the full-year performance. We delivered outstanding results across most key metrics of the business. We're encouraged by the strong, broad-based global organic growth coming across both segments, and our pipeline remains robust as demand is solid across most of our end markets. Our price actions continue to be a priority and are expected to contribute to growth during the coming year. Supply chain constraints and inflationary pressures will remain a challenge, but I have great confidence in our team's ability to navigate these and to successfully serve our customers. Our balance sheet remains healthy following three acquisitions in the year and the completion of the Frontier Equity purchase. We're committed to maintaining leverage within our targeted range as demonstrated by our steady reduction from 3.1 times following the Marquardt acquisition to 2.6 times as we close the year. We will continue to focus on tuck-in M&A as an extension of our organic growth strategy. Digital enablement continues to be an important driver of service efficiencies. Our connected outsourced water solutions continue to grow and we will continue to invest in this capability. As previously stated, we have a strong backlog as we enter FY23, but economic uncertainty in the back half remains a question. For the full year of fiscal 23, with current visibilities, we expect revenue and adjusted EBITDA to be in the range of $1.81 to $1.89 billion and $310 to $330 million respectively. For the first quarter, relative to the midpoint of our FY23 outlook, We expect revenues and EBITDA to be aligned with traditional quarterly seasonality. We've provided a summary of quarterly revenues and adjusted EBITDA from 2018 to 2022 on slide 20 in the appendix. In closing, we're pleased with our performance, especially when considering the inflationary impacts of the past year. We have high expectations as we look to the future. The world is facing significant challenges related to clean and available water, and more companies are investing in water reuse and recycling initiatives. We are confident in the investments we have made in our people, our technologies, our footprint, and our operating capabilities. We feel that Evoqua is uniquely positioned to address the market needs and to drive long-term shareholder value. I will now open the call to questions.
spk01: Thank you. At this time, if you'd like to ask a question, please press the star and 1 on your touch-tone phone. You may remove yourself from the queue at any time by pressing star 2. Once again, it is star and 1 to ask a question. We'll take our first question from Dean Dre from RBC Capital Markets.
spk10: Thank you. Good morning, everyone. Good morning, Dean. Good morning, Dean. Hey, congrats on a strong finish to the year. In last quarter in the commentary, there was some signaling that there might have been some delayed customer deliveries this quarter that could have impacted results. How did that actually play out? Was that a factor at all?
spk02: You know, Dean, it was kind of as we expected. We've had some delays from customers, you know, throughout the year. This was not more than normal in the fourth quarter, but we're always cautious around that. Where we had some customers that were delayed, we had others that were willing to take or ready to take projects a little more quickly than we anticipated. So we're pretty pleased with the balance as we came through Q4.
spk10: Good to hear. And, Ron, on that theme of always cautious, I was all teed up here for a discussion on fiscal 23 guidance that looks a little conservative, you know, your measured approach and so forth. But this guidance nicely brackets consensus, actually ahead of consensus, which we really like seeing. Maybe you can just clarify that. on the record backlog. That gives you so much more earnings visibility than you might have, you know, entering a new fiscal year. So talk about conversion expectations and kind of line of sight on that backlog.
spk02: Yeah. So, you know, as we highlight the backlog, it's coming across all end markets, which is very positive for us. We're pleased with the incoming order rate that continues to be very strong as well as we closed out Q4. The visibility that we have is a little better because the backlog and what our customers are doing is starting to normalize a little more than it was earlier in the year with other supply chain constraints that we've been managing through. Giving the guidance where we did, Dean, we feel like, you know, we're still being very balanced in the outlook as we look forward. We're pleased with the backlog. We're pleased with the position we're in. And, you know, we feel good going into the year that the order rates are continuing to flow fairly well.
spk10: Great. And if I can just squeak one more question in on digital revenues, really like seeing the growth there and the updates. I think you've said before you'd like to get it from kind of 20% of a mix today to closer to 40% over time. Is that still the goal? And what might the timeframe be to get there?
spk02: It is still the goal. We're still driving forward on that. And really referring to ISS's revenue, it's north of 20% with the growth that we've seen. We think we can continue to drive that to north of 40% of the ISS revenue. I think what you're looking at, Dean, is probably three to five years that we will get there, but it certainly is within the planning horizon.
spk10: Great. Thank you.
spk01: Our next question comes from Nathan Jones from CFO.
spk05: Good morning, everyone. Good morning, Nathan. Good morning, Nathan. I'll follow up on the guidance, I guess. I'd say at the midpoint... The guidance kind of employs margins up about 20 basis points and then an incremental margin of about 20%. Given some of the positives that you listed on the guidance slide in here, you know, with positive mix, with price-cost expected to be positive throughout the year, I thought maybe we could get a little bit better than a 20% incremental margin. Can you talk about, you know, what are the offsets to that and what could end up driving that above a 20% incremental?
spk02: Yeah, so Nathan, I'll start and let Ben pick up on it. But again, to the last comment I make, we still feel like we're balanced in our guidance going forward, just given some of the uncertainties that we see. The good thing about our pricing is our pricing is very sticky. So once we get it driven into the market, it continues to stay. If we see a pullback on inflationary challenges that we've been facing and it doesn't continue to run, I think there's some opportunity there. But we've been pretty measured in what we've given as an outlook. Ben, you have comments?
spk11: Yeah, sure. Nathan, I think one of the things we've got to stay measured on is fuel and freight, particularly with diesel. At this point in time, short term, we're keeping our eye on that. The materials were in really good shape in that side. You probably noted from the call that we were margin accretive on the price cost versus materials. So it's really about managing fuel freight and improving our productivity. As expected, we onboarded a lot of service techs, so we expect the productivity to improve as we go through 23. So those are a little bit of the puts and takes overall in terms of staying measured on margin.
spk05: So it sounds like despite bracketing consensus, this is still a pretty balanced guidance that you've put out here and pretty confident in it. My follow-up question is around Marcor. I think the Marcor revenue came in, it looks to be pretty substantially above what we'd expected. I know you guys are excited about the opportunities for that. So maybe you could talk a little bit more about the opportunities to leverage Marcor to grow the outsourced water business. Have you begun to see any results from that opportunity, or is that still on the come? And, you know, where do you think you can take that business?
spk02: Yeah, we are starting to see results from that, Nathan. The opportunity to connect a lot of the Markhor solutions that are in the field and that we're putting in the field, we'll start to see that being realized this year in FY23. What we saw in growth really centered around life sciences fits. very nicely with our core business. So we saw outpaced growth in the core businesses that we've had in life sciences because of now the expanded offering we have carrying Markle around. So we're able to do more for the customer base that we highlighted when we did the acquisition around a hospital system and a healthcare system with us being a full service provider now. So we're positive about what the next two to three years are gonna deliver with Markle.
spk05: Is there some kind of growth target that you could share on that?
spk02: You know, we were pretty thoughtful in the way that we did the analysis. We think we'll see double-digit growth, you know, come in the life sciences area just based on our base business that is continuing to expand combined with Markhor.
spk05: Great. Thanks very much for taking my questions.
spk01: Our next question comes from Brian Blair from Oppenheimer.
spk04: Thank you. Good morning, everyone. Good morning, Brian. Good morning, Brian. Staying on MarCorp for a minute, perhaps offer a little more on, you know, integration and how synergies are pacing relative to expectations. Growth seems to be great. Margin, you know, perhaps a little more dilutive than anticipated at this point. At least the optics say that. Just curious what you can offer there and whether we should anticipate that, you know, MARCOR gets to a level where it's margin accretive to ISS during your fiscal 23.
spk11: Yeah, great question. So I want to be clear. MARCOR is right now accretive to Avogadro, but still dilutive to ISS. The synergies are coming through as expected, and also the sales synergies are coming through as expected as well. 23 is probably a long putt to be accretive to ISS, but certainly within reach in 2024. But we will see improvement as we go through the year and the synergies take hold. Remember, a lot of those synergies are footprint related, so they take a little bit longer to get done, and we want to be very planful as we consolidate rooftops.
spk04: Understood. That all makes sense. And you noted in terms of regulatory tailwinds, there's some continued near-term uncertainty on PFAS regulation and how much of a catalyst that can be during fiscal 23, but perhaps looking to 24 and 25, that becomes much more material. Your team's been pretty consistent in framing that. I'm just curious whether the primary consideration remains the stringency of MCL or relative MCL versus MCLG in terms of what will be proposed, or if there are other factors that we should keep in mind?
spk02: No, I think as we're looking forward, we continue to be consistent with where it's been framed in the past. We still have a pipeline around $100 million. We're winning about 30% of those projects. The MCLs are set to be released at the end of this calendar year, so the first quarter of our fiscal 23, we're expecting that to happen. And at that point, then actually the municipalities and the water systems know exactly what they have to treat to, so you know where the goal line is. And that's when I think we'll start seeing a lot of the engineering work, a lot of the work that will start, you know, flowing down with funds flow that's coming, you know, from the government down to the different water districts We'll be latter half of 23, and as you said, into 24 and 25.
spk04: Appreciate the call, guys. Thanks.
spk02: Thank you.
spk01: Our next question comes from Mike Calloran from Beard.
spk09: Hey, good morning, everyone. Hi, Mike. So the CapEx 5% of sales plus minus, I'm guessing the high level is just a reflection of your confidence in leveraging a balance sheet to drive customer growth through some of the product offerings, correct? Agreed. Okay. Just make sure. And then the second one, any areas where you're seeing any cracks in the portfolio? I know Ryan talked about pretty healthy orders across the board. Just wondering if there's any pockets we have leading indicators that are showing some concerns, anything on the project side? Because obviously the commentary has been really positive, which is good.
spk02: Yeah, Mike, I would say that, you know, as we show slide five, you can obviously see the incoming order rate and the order expectation continues to be very strong. We do see some of our, you know, end markets slowing down the acceptance of capital. It doesn't mean they're not canceling anything. It's still in the pipeline, still in the works, but they're slowing down some of the POs being cut, I think being cautious. We continue as, you know, you kind of think about a canary in the coal mine. We watch light in general industry would be the first one that we think we would see slowing, but we're still seeing, you know, very favorable order activity there. And as we highlighted on slide five, we expect to see that in the first quarter of 23 as well.
spk09: Thanks for that. Last one quick, just any comments on the pipeline, actionability on the M&A side and your willingness to move at this point?
spk02: As far as the M&A pipeline?
spk09: Correct.
spk02: Yeah. I mean, we continue to work with tuck-in acquisitions. We were able to close out three last year as well as close out the acquisition of Frontiers Equity to get full ownership of that. We have a number of small tuck-in acquisitions in the pipeline, and we feel like they're going to be actionable in 23 as much as they have in the past year.
spk09: Great. Really appreciate it, everyone. Thank you.
spk02: Thanks, Mike.
spk01: Our next question comes from Andy Kukulitz from Citigroup. Good morning, everyone.
spk00: Good morning, Andy. Good morning, Andy. Ron or Ben, just maybe talk a little bit more about Q4 in terms of that adjusted EBITDA margin. I think it was down 70 base points, a little worse actually than Q3. I know you talked about price costs being margin accretive, but weaker productivity. I think you talked about pressure in your margin. Is labor productivity stable, getting worse, better? And how do you factor that in looking at that 23 guide? Yeah.
spk11: Great question. So it's ISS. That was where we saw the margin pressure. And a lot of the margin pressure came from productivity, particularly in the service tech area. We did a lot of onboarding of new service techs in the quarter and in the last two quarters to gear up to support that strong service backlog. So we do expect the productivity to improve overall within ISS in the coming quarters. But part of this is temporary. as you're continuing to onboard these service techs, get them up to speed. And I think one of the things, the strong digital growth in revenue will help us as we go into the future once we get through some of this onboarding period. And also in our factories, we had a lot of new labor ads in the factories gearing up for that strong backlog. And as we're onboarding them as well, there is some period of lower productivity. But that's predominantly what drove the challenges for ISS.
spk00: And that's helpful. And then maybe just, can you give us a little more color? I know there's always a level of EBITDA adjustments that you take. They're a little higher in Q4. Would you say this is the high watermark then for those adjustments? And, you know, how do you factor those or think about those into 23?
spk11: Yeah, a lot of the adjustments were the the cash non-cash exposure on fx on intercompany loans but we should see 2023 relatively similar to 2022 there's not anything that's an outlier maybe a little higher as we do some rooftop consolidations some of the adjustments you probably noted was in the area of restructuring as we've ramped up marco and so we still have marco work to do in that area but 2023 should be relatively in line with 22.
spk00: Helpful. Thanks a lot.
spk01: Our next question comes from Joseph Giordano from Cohen.
spk06: Good morning. This is Michael on for Joe.
spk11: Hi, Michael. Hi, Michael.
spk06: I just wanted to touch briefly, again, I know this was mentioned earlier on the call, but with revenue growth expectations for next year, You know, it seems a little higher than most were expecting. So, kind of pairing this back, how much of this would be, like, classified as new type business? And, you know, how does that work in terms of segmentation? Does ISS grow a little faster due to the backlog? And does, you know, APT decelerate at all?
spk11: You should see a relatively balanced growth next year. You know, both segments have very strong backlogs. You know, a lot of it depends on what happens in the macro as the year develops. ISS is sitting, if you notice, on page 10. You see that capital backlog has increased, and it's ramped up over the – and we'll have a little higher mix of capital. That will convert over a shorter period of time if you just look at the conversion rates on that chart. So ISS is well-positioned in that standpoint. And APT is seeing an all-time record backlog as well. Both segments have great opportunities as we head into the future.
spk06: Thanks. That's helpful. And one more follow-up, if I may. On the drinking water side, it appears it's kind of the second quarter of consecutive neutral outlook. What are some expectations for next year, and what are some drivers for that business as well?
spk02: I mean, if you think about municipal drinking water, that A lot of the investment that's going to come there is going to be around PFAS. It's also going to be around some of the treatment systems that are flowing down from the government funds that are coming. We expect that those will be coming in the latter half of 23 into 24 and 25 as the funds flow.
spk06: Great. Thank you.
spk01: Our next question comes from Brian Lee from Goldman Sachs.
spk03: Hey, guys. Good morning. Thanks for taking the questions.
spk06: Hey, Brian.
spk03: Hey, Brian. Hey. Maybe just kind of zooming out a bit on the margin question here. I know it sounds like, Ben, Ron, you're embedding some conservatism, as per the usual, into the guidance. But this would be kind of the third straight year where you're hanging around the 17% plus or minus threshold. EBITDA margin range. You obviously have talked about a longer-term target to get to 20% or so. Can you give us a sense of what you need to see, not necessarily in 2023, but just moving forward for that trend line to start putting you back on track to that long-term target, whether it's you know, supply chain price mix, just trying to get a sense of, you know, when we might start to see some of that inflection towards longer-term targets?
spk02: Yeah, Brian, it's a great question. And, you know, as we know, the last couple of years have not been overly normal years. We've been dealing with COVID and then runaway inflation. I think we've, you know, focused very heavily on being disciplined and offsetting our cost increases, our price. Now it's time for us to get the spread. So this year we're being pretty balanced in it, looking forward, not knowing what kind of, you know, economic pullback may occur. And really what's going to happen has been highlighted earlier with a lot of the, you know, diesel fuel, a lot of freight challenges that we've dealt with. But what I would say is our price is very sticky. As we roll price increases, it's not something that is going to go up and then be pulled back. We'll roll it forward. we see a little bit of an abatement in inflation. We'll start to see the spread happen. And we think that that's going to occur certainly over time. We've become very disciplined in our pricing actions and the way that we go forward and the way that we quote jobs now. And I think we will start to see in the latter half of this year, assuming things start to abate on the inflationary side and into 24 and 25, I think you'll see us getting back on track to achieving that 20% EBITDA margin we're focused on.
spk03: Okay, that's great. Appreciate the call there. And then just talking about the back half, since you did call out the potential for slowing, again, I know you're trying to embed some conservatism given the uncertainty that exists in the economic environment. Where do you potentially see that arising? It sounds like it'd be on the capital spending front, but are there specific end markets or geos where You know, you're thinking the slowdown could arise. And then just kind of the implications for Mix. I mean, it almost dovetails with the comments you just made about margins maybe towards the latter half starting to get back on track. Maybe that's a comment on Mix as well. But just any thoughts there on the second half commentary?
spk02: Yeah, I think it really, you know, you go back to our page five that we point out, you can see the diversification of our end markets. You know, and a lot of these end markets are fairly resilient to different types of recessions. I mean, obviously, life sciences is going to continue to be robust. Microelectronics looks like it's going to continue to be robust, certainly with, you know, the CHIPS Act and some of the on-shoring or near-shoring that's occurring right now. The one that we really watch is like general industry, you know, which is on the upper right-hand side of the page. That's a fairly good market for us. That's one that we think if we do see a slowing, we will see it come there first, and it will come in capital projects. We think that the benefit of us having approximately 60% of our full revenue, the sticky, steady, recurring service and aftermarket, everyone's going to continue to run their water systems. They just may not be investing as strongly in capacity expansion or new capital. And light in general would be where we'll see it first.
spk03: Okay. Thanks a lot, guys.
spk01: The next question comes from Patrick Bauman from J.P. Morgan.
spk08: Hi. Good morning. Thanks for taking my questions. Just wondering if you could – Give us some more color on the magnitude of pricing increases you're seeing in terms of revenue contribution, both in the fourth quarter and kind of where it landed for 2022, and then kind of what are the expectations for price into your fiscal 23. And then just kind of along those lines, can you talk about the process by which you're pushing price in the services business in particular and whether you've seen any attrition as a result of pushing price, you know, as those contracts, you know, come up for renewal?
spk11: Sure. So this quarter we saw about an 85-15 split price to volume. Next year we're expecting to see price to volume be in that 60-40 range. We've highlighted that in the appendix for you on our assumptions, so more volume. And we are not seeing much attrition at all. The price has been very sticky and stable, and we continue to push it. I think the good news is we're seeing that price to become accretive to margin in Q4, which is one of the areas that we wanted to really push for. So the key for us now is in margin expansion, as Ron mentioned earlier, is just getting our labor productivity improvement as we onboard the service techs and our plant employees. So we feel good about being able to work that margin expansion. But overall, we do expect to see a little more volume next year as we liquidate that very strong backlog and continue to focus on driving revenue through backlog.
spk02: And on our pricing on our service contracts, our service contracts are annual contracts. There's no single month that they all start and stop, so it's a rolling 12 months. We've been able to roll price increases into those. We have not seen a tremendous amount of attrition from it. In fact, we've stayed very strong. I would say over time, and we've grown in our service business, as you can see on our backlog chart, throughout COVID, Evoco really re-rated with our customer base that they knew that we were there to serve them, to take care of them, and we set a standard that the customer expects to see and to achieve, and they're willing to compensate us for it.
spk11: Hey, Brian, let's make sure I correct that. We're going to be 60% volume, 40% price next year, okay?
spk08: Sorry, Ben. The 2022, where did that land for the full year? I think you said 85-15 price volume for the fourth quarter. 85-15 for the year was 39 volume, 61 price.
spk11: Next year, we're expecting 60% volume, 40% price.
spk08: That's clear. Thank you. And then one quick follow-up, clean-up, I guess. I thought MarCore was like, I think, $180 million annualized revenue business is the way you were describing it when you acquired it. So I just wanted to kind of be clear. Was the entire $49 million of acquired revenue in the quarter from MarCore? And then... How is that business growing organically since you acquired it? And, you know, what do you expect it to grow, you know, looking into 2023 organically?
spk02: Yeah, so it was not all from Marcor. We also acquired Smith Engineering and then Epicor as well. So we closed. Epicor is very small. But as we look forward in the year and what we saw growth coming from Marcor is what I highlighted earlier. It's really coming from our traditional life sciences business and MarCorp's been steady. We anticipated it would be steady and we would get a lot of synergies coming from the efficiency side that we highlight as we called out 27 branches, 25 are in the same location as our service branches that we already have in CORE and VOCLA. And so where we've seen the growth has really been on our base business life sciences with us being able to do more with that customer base.
spk08: Understood. Thanks so much for the extra color and congrats on the strong results.
spk02: Thank you very much.
spk01: 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.
spk02: Thank you for joining us today and thank you for your interest in Avopa. I absolutely want to recognize the team that we have that executed tremendously throughout 2022. and will continue to execute throughout FY23. We were most proud of the impact that we had on our safety scores. As I said in the opening remarks, safety is the number one priority at Evoqua, and our team, through a very strong focus, was able to improve that metric significantly, as well as our ESG goals as we're driving with water recycle reuse inside of our own facilities as we're allowing other customers to do that. So we wish you all a good week, and thank you again for joining us. We'll speak to you again next quarter.
spk01: Thank you. This concludes today's Evoqua Water Technologies fourth quarter and full year 2022 earnings conference call. You may now disconnect your lines, and thank you for your interest in Evoqua.
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