Evoqua Water Technologies Corp. (NYSE:AQUA) Q4 2022 Earnings Call Transcript

Evoqua Water Technologies Corp. (NYSE:AQUA) Q4 2022 Earnings Call Transcript November 15, 2022

Evoqua Water Technologies Corp. beats earnings expectations. Reported EPS is $0.45, expectations were $0.32.

Operator: Hello and welcome to the 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 speakers’ opening remarks, there will be a question-and-answer period. 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 Brailer, Vice President of Investor Relations. Please go ahead.

Dan Brailer: 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 Stas, 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. 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 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 Investor Relations’ website. Replay of this conference call will be archived and available for the next 60 days.

With that, I would now like to turn the call over to Ron. Ron?

Ron Keating: Thank you, Dan and thank you for joining us. I appreciate your interest in Evoqua, 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 are 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 accretive 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 FY 2023. We are pleased to have achieved two important FY 2022 ESG goals relating to employee safety and water reuse.

Safety is the number one priority at Evoqua, and we reduced our recordable incident rate by 20% this year. When addressing water challenges, we plan 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 free cash conversion was well above our target of 100%. Net working 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 Mar Cor acquisition earlier this year. Please turn to Slide 4. Evoqua is 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 to Slide 5. 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 and onshoring manufacturing facilities. Overall, we expect to see increasing demand across most of our end markets in the first half of FY 2023 with potential slowing in the second half. We will discuss our outlook and underlying assumptions shortly. We’ll also be happy to address questions about specific end market drivers during the Q&A session. Please turn to Slide 6. Throughout the year, we highlight impactful handprint wins that showcase our contribution to helping our customers improve their sustainability objectives. In this quarter, we are 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 are improving reliability and energy efficiency. I would now like to turn the call over to Ben.

Ben Stas: Thank you, Ron. Please turn to Slide 7. 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 revenue 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 realization. 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%, actually the same as the prior year. We realized favorable price, higher organic volume and mix, which were offset by inflationary cost impacts. Please turn to Slide 9. Our Integrated Solutions & Services segment’s fourth quarter revenues were up 23.4% to approximately $347 million.

Organic contribution to revenue growth was 6.1% over the prior year, driven by price realization. Services and aftermarket revenues were strong, driven by Life Sciences, Food & Beverage and Light & 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. Mar Cor margins were also dilutive to segment margins. Full year 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 volumes 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 in FY 2021. 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 Mar Cor’s dilutive impacts. These margin headwinds were partly offset by favorable price realization and sales volume. 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, Evoqua’s backlog was at record levels at year-end.

Capital has seen strong growth with orders being driven by Food & Beverage, Microelectronics and power end markets. Our pipeline continues to be robust with opportunities across multiple end markets, and we expect to see book-to-bill rate to remain above 1.0 throughout fiscal 2023. Please turn to Slide 11. The Applied Product Technologies Segment’s fourth quarter revenues were up 9% 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, 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 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 contributed 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 translation. 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 operating 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 FY 2023. 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 the 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 release of an income tax valuation allowance as a 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 Mar Cor 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 timess net leverage to adjusted EBITDA range versus the previously stated target of 2.5 times to 3 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?

Ron Keating : Thanks, Ben. Please turn to Slide 13. This slide shows our performance in 2018 for three of four long-term financial targets, 3% 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 and 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.

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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 have provided 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 are committed to maintaining leverage within our targeted range as demonstrated by our steady reduction from 3.1 times following the Mar Cor 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 FY 2023, but economic uncertainty in the back half remains a question. For the full year of fiscal 2023, with current visibility, we expect revenue and adjusted EBITDA to be in the range of $1.81 billion to $1.89 billion and $310 million to $330 million, respectively. For the first quarter, relative to the midpoint of our FY 2023 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 are 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.

Q&A Session

Operator: Thank you. We’ll take our first question from Deane Dray from RBC Capital Markets.

Deane Dray: Thank you. Good morning everyone.

Ben Stas: Good morning, Deane.

Ron Keating: Good morning, Deane.

Deane Dray: 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?

Ben Stas: Deane, it was kind of as we expected. We’ve had some delays from customers 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 — we’re ready to take projects a little more quickly than we anticipated. So, we’re pretty pleased with the balance as we came through Q4.

Deane Dray: That’s good to hear. And Ron, on that theme, I’m always cautious. I was all teed up here for a discussion on fiscal ’23 guidance that looks a little conservative. You measured approach and so forth. But this guidance nicely brackets consensus, actually ahead of consensus. So — which we really like seeing. Maybe you can just clarify on the record backlog, does that gives you so much more earnings visibility than you might have entering a new fiscal year. So, talk about conversion expectations and kind of line of sight on that backlog.

Ron Keating: Yes. So 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 close 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. So, even giving the guidance where we did, Deane, we feel like, 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 we feel good going into the year that the order rates are continuing to flow fairly well.

Deane Dray: Great. If I could just squeeze one more question. And on digital revenues, really like seeing the growth there and the update. I think you’ve said before, you’d like to get it from kind of 20% of the mix today to closer to 40% over time. Is that still the goal? And what might the timeframe be to get there?

Ron Keating: Yeah. It is still the goal. We’re still driving forward on that and really referring to ISS’ 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.

Deane Dray: Great. Thank you.

Operator: Our next question comes from Nathan Jones from Stifel.

Nathan Jones: Good morning, everyone.

Ron Keating: Good morning, Nathan.

Ben Stas: Good morning, Nathan.