EVOA WATEPAR The following discussion and analysis of our financial condition and results of our operations should be read in conjunction with the Unaudited Consolidated Financial Statements, including the notes, included in Part I, Item 1 of this Quarterly Report on Form 10-Q (this "Report"), and with our audited consolidated financial statements and the related notes thereto in our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2022 , as filed with theSEC onNovember 16, 2022 (the "2022 Annual Report"). You should review the disclosures in Part I, Item 1A, "Risk Factors" in the 2022 Annual Report, Part II, Item 1A, "Risk Factors" in this Report, and any cautionary language in this Report, for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Unless otherwise indicated or the context otherwise requires, all references to "the Company," "Evoqua," "Evoqua Water Technologies Corp. ," "we," "us," "our" and similar terms refer toEvoqua Water Technologies Corp. , together with its consolidated subsidiaries. Unless otherwise specified, all dollar amounts in this section are referred to in millions. Overview We are a leading provider of mission-critical water and wastewater treatment solutions, offering a broad portfolio of products, services, and expertise to support customers across various end markets. We are headquartered inPittsburgh, Pennsylvania , with locations across nine countries. We have a comprehensive portfolio of differentiated, proprietary technologies offered under marketleading and wellestablished brands. Our core technologies are primarily focused on removing impurities from water, rather than neutralizing them through the addition of chemicals. Our solutions are designed to provide our customers with the quantity and quality of water necessary to meet their unique specifications. We enable our customers to achieve lower costs through greater uptime, throughput and efficiency in their operations while supporting their regulatory compliance and environmental requirements. We deliver and maintain these mission critical solutions through our extensive North American service network, and we sell our products and technologies internationally through direct and indirect sales channels. We have worked to protect water, the environment, and our employees for more than 100 years. As a result, we have earned a reputation for quality, safety, and reliability around the world. Our employees are united by a common purpose: Transforming Water. Enriching Life.® Our vision "to be the world's first choice for water solutions" and our values of "integrity, customers, sustainable, and performance" foster a culture that is focused on establishing a workforce that is enabled, empowered, and accountable, creating a highly dynamic work environment.
We serve our customers through the following two reportable segments:
•Integrated Solutions and Services segment, which provides application-specific solutions and full lifecycle services for critical water and wastewater applications across numerous end markets, including outsourced water service contracts, capital systems, and related recurring aftermarket services, parts and consumables, and emergency services to enable recycle and reuse, improve operational reliability and performance, and promote environmental compliance; and •Applied Product Technologies segment, which provides highly differentiated and scalable water and wastewater products and technologies as stand-alone offerings or components in integrated solutions to a diverse set of system integrators and end-users globally.
Our segments draw from the same reservoir of leading technologies, shared manufacturing infrastructure, common business processes, and corporate philosophies. The key factors used to identify these reportable operating segments are the organization and alignment of our internal operations, the nature of the products and services and customer type.
Proposed Merger with Xylem Inc.
OnJanuary 22, 2023 , the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Xylem Inc., anIndiana corporation ("Xylem"), andFore Merger Sub, Inc. , aDelaware corporation and a direct, wholly 36 --------------------------------------------------------------------------------
owned subsidiary of Xylem ("Merger Sub"), pursuant to which Merger Sub will merge with and into the Company, with the Company continuing as the surviving corporation and as a direct, wholly owned subsidiary of Xylem (the "Merger").
At the effective time of the Merger (the "Effective Time") and upon consummation of the Merger, subject to the terms and conditions set forth in the Merger Agreement, each share of the common stock, par value$0.01 per share, of the Company issued and outstanding immediately prior to the Effective Time (other than treasury shares held by the Company and shares of the Company's common stock owned, directly or indirectly, by Xylem or Merger Sub) will be converted into and become exchangeable for 0.48 shares of common stock, par value$0.01 per share, of Xylem (the "Xylem Shares") to be issued by Xylem as consideration for the Merger. Cash will be issued in lieu of fractional shares. Upon the closing of the Merger, legacy Company stockholders will own approximately 25% and legacy Xylem shareholders will own approximately 75% of the combined company. The consummation of the Merger is subject to the satisfaction or waiver of certain customary mutual conditions, including (a) the receipt of the required approvals from the Company's stockholders and Xylem's shareholders, (b) receipt of required regulatory approvals under antitrust and foreign investment laws in applicable jurisdictions, including the expiration or termination of the waiting period under the Hart-Scott-Rodino Act (collectively, "Regulatory Clearances"), (c) the absence of any temporary or permanent order, injunction, law or other legal restraint prohibiting or making illegal the consummation of the Merger, (d) the Xylem Shares issuable to the stockholders of the Company in connection with the Merger having been approved for listing on theNew York Stock Exchange , subject to official notice of issuance, and (e) Xylem's registration statement on Form S-4 having been declared effective under the Securities Act of 1933. The obligation of each party to consummate the Merger is also conditioned upon (a) the accuracy of the representations and warranties of the other party as of the date of the Merger Agreement and as of the closing (subject to customary materiality qualifiers) and (b) compliance by the other party in all material respects with its respective pre-closing obligations under the Merger Agreement. The Merger Agreement contains certain termination rights that may be exercised by either the Company or Xylem. In certain of those cases, we may be required to pay Xylem a termination fee of$225.0 million .
In connection with the Merger, we recognized costs of
For further information on the Merger Agreement, refer to the Merger Agreement, a copy of which was filed as Exhibit 2.1 to our Current Report on Form 8-K filed with theSEC onJanuary 23, 2023 .
Other Recent Developments, Key Factors and Trends Affecting Our Business and Financial Statements
Our 2022 Annual Report includes a discussion of various key factors and trends that we believe have affected or may affect our operating results. The following discussion highlights recent developments, as well as significant changes in these key factors and trends. Macroeconomic conditions. Material, freight, and labor inflation resulted in increased costs in the first quarter of fiscal 2023, and we expect this trend will continue throughout fiscal 2023. Although we have offset a portion of these increased costs through price increases and operational efficiencies to date, our margin percentage has been negatively impacted. There can be no assurance that we will be able to offset all or any portion of these increased costs in future periods. If we are unable to manage commodity fluctuations through pricing actions, cost savings projects, and sourcing decisions as well as through consistent productivity improvements, it may adversely impact our gross profit and gross margin in future periods. Additionally, supply chain disruptions and labor shortages have restricted and could further restrict availability of certain commodities and materials, which may result in delays in our execution of projects in fiscal 2023 and negatively impact revenues. We have increased inventory levels to meet current order demand. Tight labor markets have resulted in longer times to fill open positions and labor inflation. Continued delays in filling open positions, particularly among our service technician population, could impact our ability to provide timely service to our customers. Although these factors did not have a material adverse effect on our results of operations for the three months endedDecember 31, 2022 , if sustained, they could have a material adverse effect on our results of operations going forward. In an effort to combat inflation, central banks began raising interest rates in the latter half of fiscal 2022, and interest rates are expected to continue to increase throughout the remainder of fiscal 2023. We do not believe that our exposure 37 -------------------------------------------------------------------------------- to rising interest rates in the near term will have a material impact on our business, financial condition, results of operations, or prospects, but if sustained over longer periods, this could have a material adverse effect on our results of operations. We plan to continue to evaluate aspects of our spending, including capital expenditures, discretionary spending, and strategic investments in the remainder of fiscal 2023. Impact of the COVID-19. We continue to monitor the global spread of COVID-19 and its potential impact on our operations, particularly our supply chain, and the macroeconomic factors that could affect end market demand. In connection with the recent lifting of lockdowns and quarantine rules inChina , we are monitoring our operating protocols to manage exposure risks and maintain productivity. We incurred additional incremental costs relating to safety measures implemented inChina , but those costs did not have a material adverse effect on our operations or financial results for the tthree months endedDecember 31, 2022 . However, if we or our suppliers are unsuccessful in mitigating any material adverse impacts of future COVID-19 outbreaks, it could impact our sales into affected regions and our ability to source materials from those regions.Russia -Ukraine war. We have no operations inRussia orUkraine , and our sales into these regions are minimal. However, the conflict inUkraine has exacerbated the material inflation and availability challenges described above, particularly with respect to the impact it has had on energy and fuel prices and the price of steel and other precious metals that we procure in our supply chain. Although these factors did not have a material adverse effect on our results of operations for the three months endedDecember 31, 2022 , we expect the inflationary impact on energy, fuel and steel prices to continue throughout the remainder of fiscal 2023. If these factors are sustained, or if the duration of the conflict is extended or the conflict spreads into a larger geographic portion ofEurope , our results of operations in future periods could be materially and adversely impacted. Acquisitions and divestitures. During the three months endedDecember 31, 2022 , we paid cash of$38 thousand as a result of net working capital adjustments related to the acquisition ofEpicor, Inc. that we completed in fiscal 2022. In addition, during the three months endedDecember 31, 2022 , we received cash of$1.8 million as a result of net working capital adjustments related to the acquisition of the Mar Cor Business that we completed in fiscal 2022.
How We Assess the Performance of Our Business
In assessing the performance of our business, we consider a variety of performance and financial measures. The key indicators of the financial condition and operating performance of our consolidated business are revenue, gross profit, gross margin, and net income (loss). Management utilizes these financial measures prepared in accordance with accounting principles generally accepted inthe United States ("GAAP") when reviewing the Company's performance and making financial, operational, and strategic decisions, and believes they are useful metrics for investors that help with performance comparability period over period. In addition, we consider certain non-GAAP financial measures such as EBITDA and adjusted EBITDA, as described more fully below. We evaluate our business segments' operating results based on revenue, income from operations ("operating profit"), and adjusted EBITDA on a segment basis. We believe these financial measures are helpful in understanding and evaluating the segments' core operating results and facilitates comparison of our performance on a consistent basis period over period.
Revenue
Our revenue is a function of sales volumes and selling prices. We report revenue
by segment and by source which includes revenue from product sales (capital and
aftermarket) and revenue from service. Revenue is used by management to evaluate
the performance of our business. Revenue growth is primarily related to organic
and inorganic factors. Organic revenue growth, as a component of revenue growth,
is defined as period over period revenue growth without (i) the impact from
acquisitions and divestitures during the first 12 months following the closing
of the acquisition or divestiture, which we refer to as inorganic impact, and
(ii) the impact of foreign currency translation. Divestitures include sales of
insignificant portions of our business that did not meet the criteria for
classification as a discontinued operation. We disregard the effect of foreign
currency translation from organic revenue growth because foreign currency
translation is not under management's control, is subject to volatility and can
obscure underlying business trends. The effect of acquisitions and divestitures
during the first 12 months following the closing of the acquisition or
divestiture are disregarded because they can obscure underlying business trends
and make comparisons of long-term performance difficult between the Company and
its peers due to the varying nature, size, and number of transactions from
period to period.
38
--------------------------------------------------------------------------------EBITDA and Adjusted EBITDA
EBITDA, which is a non-GAAP financial measure, is defined as net income (loss) before interest expense, income tax benefit (expense), and depreciation and amortization. Adjusted EBITDA, which is a non-GAAP financial measure, is one of the primary metrics used by management to evaluate the strength and financial performance of our core business. Adjusted EBITDA is defined as net income (loss) before interest expense, income tax benefit (expense), and depreciation and amortization, adjusted for the impact of certain other items, including restructuring and related business transformation costs, share-based compensation, transaction costs, and other gains, losses, and expenses that we believe do not directly reflect our underlying business operations. We present adjusted EBITDA because we believe it is frequently used by analysts, investors, and other interested parties to evaluate and compare operating performance and value companies within our industry. Further, we believe it is helpful in highlighting trends in our operating results and provides greater clarity and comparability period over period to management and our investors regarding the operational impact of long-term strategic decisions regarding capital structure, the tax jurisdictions in which we operate, and capital investments. In addition, adjusted EBITDA highlights true business performance by removing the impact of certain items that management believes do not directly reflect our underlying operations and provides investors with greater visibility into the ongoing drivers of our business performance.
Management uses adjusted EBITDA to supplement GAAP measures of performance as follows:
•to assist investors and analysts in comparing our operating performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance;
•in our management incentive compensation, which is based in part on components of adjusted EBITDA;
•in certain calculations under our senior secured credit facilities, which use components of adjusted EBITDA;
•to evaluate the effectiveness of our business strategies;
•to make budgeting decisions; and
•to compare our performance against that of other peer companies using similar measures.
In addition to the above, our chief operating decision maker uses adjusted
EBITDA of each reportable operating segment as a supplement to segment operating
profit and segment revenue to evaluate the operating performance of such
segments. Adjusted EBITDA on a segment basis is defined as earnings before
depreciation and amortization, adjusted for the impact of certain other items
that have been reflected at the segment level. Adjusted EBITDA of the reportable
operating segments do not include certain charges that are presented within
corporate activities. These charges include certain restructuring and other
business transformation charges that have been incurred to align and reposition
the Company to the current reporting structure, acquisition related costs
(including transaction costs and integration costs) and share-based compensation
charges.
EBITDA and adjusted EBITDA should not be considered substitutes for, or superior
to, financial measures prepared in accordance with GAAP. The financial results
prepared in accordance with GAAP and the reconciliations from these results
should be carefully evaluated. See "Non-GAAP Reconciliations" in this Item 2 for
a reconciliation of EBITDA and adjusted EBITDA to net income. You are encouraged
to evaluate each adjustment and the reasons we consider it appropriate for
supplemental analysis. In addition, in evaluating adjusted EBITDA, you should be
aware that in the future, we may incur expenses similar to the adjustments in
the presentation of adjusted EBITDA. Our presentation of adjusted EBITDA should
not be construed as an inference that our future results will be unaffected by
unusual or non-recurring items. In addition, other companies in our industry or
across different industries may calculate adjusted EBITDA differently.
39
--------------------------------------------------------------------------------Results of Operations
The following table summarizes key components of our results of operations for the periods indicated:
Three Months Ended December 31,
2022 2021
(In millions, except per share amounts) % of Revenue % of Revenue % Variance
Revenue from product sales and services $ 435.8 100.0 % $ 366.3 100.0 % 19.0 %
Gross profit $ 130.3 29.9 % $ 110.5 30.2 % 17.9 %
Total operating expenses $ (108.2) (24.8) % $ (97.7) (26.7) % 10.7 %
Other operating income, net $ 1.2 0.3 % $ 1.5 0.4 % (20.0) %
Interest expense $ (10.1) (2.3) % $ (6.6) (1.8) % 53.0 %
Income before income taxes $ 13.2 3.0 % $ 7.7 2.1 % 71.4 %
Income tax expense $ (3.9) (0.9) % $ (1.6) (0.4) % 143.8 %
Net income $ 9.3 2.1 % $ 6.1 1.7 % 52.5 %
Net income attributable to noncontrolling interest $ - - % $ 0.1 - % (100.0) %
Net income attributable to Evoqua Water
Technologies Corp. $ 9.3 2.1 % $ 6.0 1.6 % 55.0 %
Weighted average shares outstanding Basic 121.8 120.6 Diluted 125.3 124.9 Earnings per share Basic$ 0.08 $ 0.05 Diluted$ 0.07 $ 0.05 Other financial data: Adjusted EBITDA(1)$ 72.7 16.7 %$ 54.3 14.8 % 33.9 %
(1)Adjusted EBITDA is a non-GAAP financial measure. For a reconciliation to net income (loss), its most directly comparable financial measure presented in accordance with GAAP, see "Non-GAAP Reconciliations" in Item 2 of this Report.
Consolidated Results for the Three Months Ended
Revenue-Revenue increased$69.5 million , or 19.0%, to$435.8 million in the three months endedDecember 31, 2022 , from$366.3 million in the three months endedDecember 31, 2021 . Revenue from product sales increased$47.8 million , or 22.5%, to$260.4 million in the three months endedDecember 31, 2022 , from$212.6 million in the three months endedDecember 31, 2021 . Revenue from services increased$21.7 million , or 14.1%, to$175.4 million in the three months endedDecember 31, 2022 , from$153.7 million in the three months endedDecember 31, 2021 .
The following tables provide the change in revenue by offering and by the
components that contributed to revenue growth during the three months ended
Three Months Ended December 31,
2022 2021
% of % of
(In millions) Revenue Revenue $ Variance % Variance
Revenue from product sales: $ 260.4 59.8 % $ 212.6 58.0 % $ 47.8 22.5 %
Capital 165.7 38.0 % 151.0 41.2 % 14.7 9.7 %
Aftermarket 94.7 21.8 % 61.6 16.8 % 33.1 53.7 %
Revenue from services 175.4 40.2 % 153.7 42.0 % 21.7 14.1 %
$ 435.8 100.0 % $ 366.3 100.0 % $ 69.5 19.0 %
40
--------------------------------------------------------------------------------
(In millions) $ Change % Change
Three months ended
n/a
Organic 33.3 9.1 %
Inorganic 42.9 11.7 %
Foreign currency translation (6.7) (1.8) %
Three months ended
19.0 %
The increase in organic revenue was driven by favorable price realization and increased volume for products and services across most product lines and all regions. The increase in organic revenue volume was driven primarily by the Applied Product Technologies reportable segment.
Revenue in future periods could be negatively impacted by commodity and material availability constraints caused by global supply chain disruptions, skilled labor shortages, and the timing of projects.
Cost of sales and gross margin-Total gross margin decreased slightly to 29.9% in the three months endedDecember 31, 2022 , from 30.2% in the three months endedDecember 31, 2021 .
The following table provides the change in cost of product sales and cost of services, respectively, along with related gross margins:
Three Months Ended December 31,
2022 2021
Gross Gross
(In millions) Margin Margin
Cost of product sales $ (185.0) 29.0 % $ (153.8) 27.7 %
Cost of services (120.5) 31.3 % (102.0) 33.6 %
$ (305.5) 29.9 % $ (255.8) 30.2 %
Gross margin from product sales increased by 130 basis points ("bps") to 29.0%
in the three months ended December 31, 2022 , from 27.7% in the three months
ended December 31, 2021 . This increase was driven by favorable volume within the
Applied Product Technologies reportable segment, mix, and positive price
realization, which was partially offset by labor, material, and freight
inflation.
Gross margin from services decreased by 230 bps to 31.3% in the three months
ended December 31, 2022 , from 33.6% in the three months ended December 31, 2021 .
This decrease was driven by material and labor inflation and productivity
variances, partially offset by favorable price realization.
We expect continued pressure on gross margin in future periods due to material,
freight and labor inflation. Although we expect to continue to partially offset
those increasing costs with positive price realization, there can be no
assurance that we will be able to do so.
Operating expenses-Operating expenses increased $10.5 million , or 10.7%, to
$108.2 million in the three months ended December 31, 2022 , from $97.7 million
in the three months ended December 31, 2021 . Operating expenses are comprised of
the following:
Three Months Ended December 31,
2022 2021
(In millions) % of Revenue % of Revenue % Variance
General and administrative expense $ (64.0) (14.7) % $ (57.8) (15.8) % 10.7 %
Sales and marketing expense (40.4) (9.3) % (36.4) (9.9) % 11.0 %
Research and development expense (3.8) (0.9) % (3.5) (1.0) % 8.6 %
Total operating expenses $ (108.2) (24.8) % $ (97.7) (26.7) % 10.7 %
41-------------------------------------------------------------------------------- The increase period over period in operating expenses was primarily due to an increase in external legal fees and employee related expenses, as well as increased operating and amortization expense due to the acquisitions of the Mar Cor Business and Smith Engineering that were not present in the prior period. In addition, there was increased discretionary spending as compared to the prior period. The above increases were partially offset by foreign currency translation gains in the current period, compared to foreign currency translation losses in the prior period, most of which is related to intercompany loans.
Fluctuations in foreign currency translation and inflation could impact operating expenses in future periods.
Other operating income, net-Other operating income, net, decreased$0.3 million to$1.2 million in the three months endedDecember 31, 2022 , from$1.5 million in the three months endedDecember 31, 2021 . This decrease was driven by a reduction in income from precious metal sales, mainly from scrapped anodes inChina compared to the prior period, which was partially offset by an increase in gains on the disposal of fixed assets compared to the prior period. Interest expense-Interest expense increased$3.5 million , or 53.0%, to$10.1 million in the three months endedDecember 31, 2022 , from$6.6 million in the three months endedDecember 31, 2021 . The increase in interest expense was primarily driven by higher outstanding debt, primarily attributable to the borrowing of$160.0 million to fund the Mar Cor Business acquisition in January of 2022, as well as an increase in LIBOR year over year. Income tax expense-Income tax expense increased to$3.9 million in the three months endedDecember 31, 2022 , as compared to income tax expense of$1.6 million in the three months endedDecember 31, 2021 . The increase in tax expense was primarily due to higher projected annual effective tax rates as well as higher projectedU.S. income, which is no longer offset by maintaining a valuation allowance againstU.S. deferred tax assets.
Net income-Net income increased
Adjusted EBITDA-Adjusted EBITDA is a non-GAAP financial measure. Adjusted EBITDA for the three months endedDecember 31, 2022 increased by$18.4 million , or 33.9%, to$72.7 million , as compared to$54.3 million for the three months endedDecember 31, 2021 , primarily driven by favorable price realization, mix, and sales volume, which was partially offset by inflationary costs. See "Non-GAAP Reconciliations" in Item 2 of this Report for a reconciliation of adjusted EBITDA. Segment Results Three Months Ended December 31, 2022 2021 (In millions) % of Total % of Total % Variance Revenue Integrated Solutions and Services$ 305.4 70.1 %$ 245.1 66.9 % 24.6 % Applied Product Technologies 130.4 29.9 % 121.2 33.1 % 7.6 % Total Consolidated$ 435.8 100.0 %$ 366.3 100.0 % 19.0 % Operating profit (loss) Integrated Solutions and Services $ 42.7 183.3 %$ 35.3 246.9 % 21.0 % Applied Product Technologies 21.0 90.1 % 17.8 124.5 % 18.0 % Corporate (40.4) (173.4) % (38.8) (271.3) % 4.1 % Total Consolidated $ 23.3 100.0 %$ 14.3 100.0 % 62.9 % Adjusted EBITDA(1) Integrated Solutions and Services $ 69.0 94.9 %$ 53.5 98.5 % 29.0 % Applied Product Technologies 24.5 33.7 % 21.9 40.3 % 11.9 % Corporate (20.8) (28.6) % (21.1) (38.9) % (1.4) % Total Consolidated $ 72.7 100.0 %$ 54.3 100.0 % 33.9 % (1)Adjusted EBITDA is a non-GAAP financial measure. For a reconciliation to segment operating profit (loss), its most directly comparable financial measure presented in accordance with GAAP, see "Non-GAAP Reconciliations" in Item 2 of this Report. 42 --------------------------------------------------------------------------------
Integrated Solutions and Services
Revenue in the Integrated Solutions and Services segment increased
The following tables provide the change in revenue by offering and by the components that contributed to revenue growth during the three months endedDecember 31, 2022 and 2021 for the Integrated Solutions and Services segment: Three Months Ended December 31, 2022 2021 % of % of (In millions) Revenue Revenue $ Variance % Variance Revenue from product sales:$ 135.1 44.2 %$ 96.4 39.3 %$ 38.7 40.1 % Capital 77.6 25.4 % 67.1 27.4 % 10.5 15.6 % Aftermarket 57.5 18.8 % 29.3 12.0 % 28.2 96.2 % Revenue from services 170.3 55.8 % 148.7 60.7 % 21.6 14.5 %$ 305.4 100.0 %$ 245.1 100.0 %$ 60.3 24.6 % (In millions) $ Change % Change
Three months ended
n/a
Organic 18.5 7.5 %
Inorganic 42.9 17.5 %
Foreign currency translation (1.1) (0.4) %
Three months ended
24.6 %
The increase in organic revenue was primarily driven by favorable price realization related to service and aftermarket revenue across most end markets, with light and general industry and life sciences contributing the highest growth.
Operating profit in the Integrated Solutions and Services segment increased$7.4 million , or 21.0%, to$42.7 million in the three months endedDecember 31, 2022 , from$35.3 million in the three months endedDecember 31, 2021 . [[Image Removed: aqua-20221231_g1.jpg]] Operating profit was favorably impacted by price realization and the acquisition of the Mar Cor Business. These increases were partially offset by operational variances, including material, labor, and freight inflation and availability, and productivity variances. Adjusted EBITDA is a non-GAAP financial measure. Adjusted EBITDA in the Integrated Solutions and Services segment increased$15.5 million , or 29.0%, to$69.0 million in the three months endedDecember 31, 2022 , compared to$53.5 million in the three months endedDecember 31, 2021 . The increase was driven by the same factors that impacted 43 --------------------------------------------------------------------------------
operating profit, other than the change in depreciation and amortization, and also excludes restructuring and other non-recurring activity. See "Non-GAAP Reconciliations" in Item 2 of this Report for a reconciliation of adjusted EBITDA.
Applied Product Technologies
Revenue in the Applied Product Technologies segment increased$9.2 million , or 7.6%, to$130.4 million in the three months endedDecember 31, 2022 , from$121.2 million in the three months endedDecember 31, 2021 .
The following tables provide the change in revenue by offering and by the
components that contributed to revenue growth during the three months ended
Three Months Ended December 31,
2022 2021
% of % of
(In millions) Revenue Revenue $ Variance % Variance
Revenue from product sales: $ 125.3 96.1 % $ 116.2 95.9 % $ 9.1 7.8 %
Capital 88.1 67.6 % 83.9 69.2 % 4.2 5.0 %
Aftermarket 37.2 28.5 % 32.3 26.7 % 4.9 15.2 %
Revenue from services 5.1 3.9 % 5.0 4.1 % 0.1 2.0 %
$ 130.4 100.0 % $ 121.2 100.0 % $ 9.2 7.6 %
(In millions) $ Change % Change
Three months ended
n/a
Organic 14.8 12.2 %
Inorganic - - %
Foreign currency translation (5.6) (4.6) %
Three months ended
7.6 %
The increase in organic revenue was driven by strong sales volume and price
realization across all regions and most end markets. The strongest growth came
in the
Operating profit in the Applied Product Technologies segment increased
[[Image Removed: aqua-20221231_g2.jpg]]
44
--------------------------------------------------------------------------------
The increase in operating profit was primarily due to favorable sales volume,
mix, and price realization across all regions and most product lines. This
growth was partially offset by unfavorable operational variances, including
material, labor, and freight inflation and availability, and plant productivity
variances.
Adjusted EBITDA is a non-GAAP financial measure. Adjusted EBITDA in the Applied
Product Technologies segment increased $2.6 million , or 11.9%, to $24.5 million
in the three months ended December 31, 2022 , compared to $21.9 million in the
three months ended December 31, 2021 . The increase was driven by the same
factors that impacted operating profit, other than the change in depreciation
and amortization, and also excludes restructuring and other non-recurring
activity. See "Non-GAAP Reconciliations" in Item 2 of this Report for a
reconciliation of adjusted EBITDA.
Corporate
Operating loss in Corporate increased$1.6 million , or 4.1%, to$40.4 million in the three months endedDecember 31, 2022 , from$38.8 million in the three months endedDecember 31, 2021 . The increase was primarily due to higher costs associated with legal matters, as well as increased employment expenses, including share-based compensation in the current period compared to the prior period. These were partially offset by foreign currency translation gains in the current period, compared to foreign currency translation losses in the prior period, most of which is related to intercompany loans.
Non-GAAP Reconciliations
The following is a reconciliation of our Net income to EBITDA and adjusted
EBITDA. See "How We Assess the Performance of Our Business" in this Item 2 for
discussion on management's definition and use of this non-GAAP financial
measure.
Three Months Ended
December 31,
(In millions) 2022 2021 % Variance
Net income $ 9.3 $ 6.1 52.5 %
Income tax expense 3.9 1.6 143.8 %
Interest expense 10.1 6.6 53.0 %
Operating profit $ 23.3 $ 14.3 62.9 %
Depreciation and amortization 33.2 28.6 16.1 %
EBITDA $ 56.5 $ 42.9 31.7 %
Restructuring and related business transformation costs(a) 1.7
1.4 21.4 %
Share-based compensation(b) 6.3 5.3 18.9 %
Transaction costs(c) 3.3 0.9 266.7 %
Other losses (gains) and expenses(d) 4.9 3.8 28.9 %
Adjusted EBITDA $ 72.7 $ 54.3 33.9 %
(a)Restructuring and related business transformation costs
Adjusted EBITDA is calculated prior to considering certain restructuring or
business transformation events. These events may occur over extended periods of
time, and in some cases it is reasonably possible that they could reoccur in
future periods based on reorganizations of the business, cost reduction or
productivity improvement needs, or in response to economic conditions. For the
periods presented such events include the following:
(i)Certain costs and expenses in connection with various restructuring
initiatives, including severance and other employee-related costs, relocation
and facility consolidation costs, and third-party consultant costs to assist
with these initiatives. This includes:
45
--------------------------------------------------------------------------------
(A)amounts related to the Company's restructuring initiatives to reduce the cost
structure and rationalize location footprint following the sale of the Memcor
product line;
(B)amounts related to the Company's transition from a three-segment structure to
a two-segment operating model designed to better serve the needs of customers
worldwide; and
(C)amounts related to various other initiatives implemented to restructure and reorganize our business with the appropriate management team and cost structure.
(ii)Legal settlement costs and intellectual property related fees including fees and settlement costs associated with legacy matters, related to product warranty litigation on MEMCOR® products and certain discontinued products. Memcor ® is a trademark ofRohm & Haas Electronic Materials Singapore Pte. Ltd.
(iii)Expenses associated with our information technology and functional infrastructure transformation, including activities to optimize information technology systems and functional infrastructure processes.
(b)Share-based compensation
Adjusted EBITDA is calculated prior to considering sharebased compensation expenses related to equity awards. See Note 17, "Share-Based Compensation," in Part I, Item 1 of this Report for further detail.
(c)Transaction costs
Adjusted EBITDA is calculated prior to considering transaction, integration and restructuring costs associated with business combinations because these costs are unique to each transaction and represent costs that were incurred as a result of the transaction decision. Integration and restructuring costs associated with a business combination may occur over several years and include, but are not limited to, consulting fees, legal fees, certain employee-related costs, facility consolidation and product rationalization costs, and fair value changes associated with contingent consideration.
(d)Other losses (gains) and expenses
Adjusted EBITDA is calculated prior to considering certain other significant losses (gains) and expenses. For the periods presented such events include the following:
(i)impact of foreign exchange gains and losses; and
(ii)legal fees and settlement costs incurred in excess of amounts covered by the
Company's insurance related to securities litigation and
46
--------------------------------------------------------------------------------
We do not present net income on a segment basis because we do not allocate
interest expense or income tax benefit (expense) to our segments, making
operating profit the most comparable GAAP metric. The following is a
reconciliation of our segment EBITDA and segment adjusted EBITDA to operating
profit, their most directly comparable financial measure presented in accordance
with GAAP:
Three Months Ended December 31,
2022 2021 $ Variance % Variance
Integrated Integrated Integrated Integrated
Solutions and Applied Product Solutions and Applied Product Solutions and Applied Product Solutions and Applied Product
(In millions) Services Technologies Services Technologies Services Technologies Services Technologies
Operating profit $ 42.7 $ 21.0 $ 35.3 $ 17.8 $ 7.4 $ 3.2 21 % 18 %
Depreciation and amortization 22.5 3.4 17.8 3.5 4.7 (0.1) 26 % (3) %
EBITDA $ 65.2 $ 24.4 $ 53.1 $ 21.3 $ 12.1 $ 3.1 23 % 15 %
Restructuring and related
business transformation costs
(a) 1.5 0.1 0.5 0.6 1.0 (0.5) 200 % (83) %
Transaction costs (b) 2.3 - (0.1) - 2.4 - (2400) % n/a
Adjusted EBITDA $ 69.0 $ 24.5 $ 53.5 $ 21.9 $ 15.5 $ 2.6 29 % 12 %
(a)Represents costs and expenses in connection with restructuring initiatives in
the three months ended December 31, 2022 and 2021, respectively. Such expenses
are primarily composed of severance, relocation, and facility consolidation
costs.
(b)Represents primarily costs associated with a change in the current estimate
of certain acquisitions achieving their earn-out targets, as well as certain
costs associated with the integration of recent acquisitions.
Immaterial rounding differences may be present in the tables above.
Liquidity and Capital Resources
Liquidity describes the ability of a company to borrow or generate sufficient
cash flows to meet the cash requirements of its business operations, including
working capital needs, debt service, acquisitions, other commitments and
contractual obligations. Our principal sources of liquidity are cash generated
by our operating activities, borrowings under the 2021 Revolving Credit
Facility, and financing arrangements related to capital expenditures for
equipment used to provide services to our customers. Historically, we have
financed our operations primarily from these sources. Our primary cash needs are
for day to day operations, to pay interest and principal on our indebtedness, to
fund working capital requirements, and to make capital expenditures.
Our ability to fund our capital needs depends on our ongoing ability to generate
cash from operations and access bank financing and the capital markets. In
support of international operations, portions of our cash balances are held in
various currencies and may be subject to foreign currency translation and other
costs associated with repatriation, if necessary. Neither moderate increases in
net working capital nor macroeconomic conditions have materially impacted our
liquidity to date. In addition, we do not believe that our exposure to rising
interest rates will have a material impact on our business, financial condition,
results of operations, or prospects, and we plan to continue to evaluate aspects
of our spending, including capital expenditures, discretionary spending, and
strategic investments in fiscal 2023. We believe we are currently
well-positioned to manage our business and have the ability and sufficient
capacity to meet our cash requirements by using available cash, internally
generated funds, and borrowing under the 2021 Revolving Credit Facility.
As part of our ongoing efforts to improve our cash flow and related liquidity,
we work with suppliers to optimize our terms and conditions, including
occasionally extending payment terms. We also facilitate a voluntary supply
chain finance program (the "program") to provide certain of our suppliers with
the opportunity to sell receivables due from us to participating financial
institutions at the sole discretion of both the suppliers and the financial
institutions. A third party administers the program; our responsibility is
limited to making payments on the terms originally negotiated with our supplier,
regardless of whether the supplier sells its receivable to a financial
institution. We do not enter into
47
--------------------------------------------------------------------------------
agreements with any of the participating financial institutions in connection
with the program. The range of payment terms we negotiate with our suppliers is
consistent, irrespective of whether a supplier participates in the program. The
amounts settled through the program and paid to participating financial
institutions were $22.9 million and $20.3 million in the three months ended
December 31, 2022 and 2021, respectively. A downgrade in our credit rating or
changes in the financial markets could limit the financial institutions'
willingness to commit to participation in the program.
We expect to continue to finance our liquidity requirements through internally
generated funds and borrowings under the 2021 Revolving Credit Facility. We
believe that our projected cash flows generated from operations, together with
borrowings under the 2021 Revolving Credit Facility, and other financing
arrangements are sufficient to fund our short-term and long-term principal debt
payments, interest expense, working capital needs, and expected capital
expenditures. Our capital expenditures for the three months ended December 31,
2022 and 2021 were $22.7 million and $15.5 million , respectively. However, our
budgeted capital expenditures can vary from period to period based on the nature
of capital intensive project awards. Our focus on customer outsourced water
projects will continue to be a driver of capital expenditures. From time to
time, we may enter into financing arrangements related to capital expenditures
for equipment used to provide services to our customers. During the three months
ended December 31, 2022 and 2021, we entered into equipment financing
arrangements totaling $9.7 million and $5.9 million , respectively. In addition,
we may draw on the 2021 Revolving Credit Facility from time to time to fund or
partially fund an acquisition.
As of December 31, 2022 , we had total indebtedness of $881.2 million , including
$467.9 million of term loan borrowings under the 2021 Credit Agreement, $136.5
million outstanding under the 2021 Revolving Credit Facility, $150.3 million
outstanding under the Securitization Facility, which includes $0.3 million of
accrued interest, and $126.5 million in borrowings related to equipment
financing. We also had $8.8 million of letters of credit issued under our 2021
Revolving Credit Facility as of December 31, 2022 .
As of December 31, 2022 and September 30, 2022 , we were in compliance with the
covenants contained in the 2021 Credit Agreement, including the 2021 Revolving
Credit Facility.
2021 Credit Agreement
On April 1, 2021 , EWT Holdings III Corp. ("EWT III"), a subsidiary of the
Company, entered into a Credit Agreement (the "2021 Credit Agreement") among EWT
III, as borrower, EWT Holdings II Corp. ("EWT II"), as parent guarantor, the
lenders from time to time party thereto, JPMorgan Chase Bank, N.A ., as
administrative agent and collateral agent, and ING Capital, LLC , as
sustainability coordinator. The 2021 Credit Agreement provides for a
multi-currency senior secured revolving credit facility in an aggregate
principal amount not to exceed the U.S. dollar equivalent of $350.0 million (the
"2021 Revolving Credit Facility") and a discounted senior secured term loan (the
"2021 Term Loan") in the amount of $475.0 million (together with the 2021
Revolving Credit Facility, the "Senior Facilities"). The 2021 Credit Agreement
also provides for a letter of credit sub-facility not to exceed $60.0 million .
The 2021 Credit Agreement contains customary representations, warranties,
affirmative covenants, and negative covenants, including, among other things, a
springing maximum first lien leverage ratio of 5.55 to 1.00. The Company did not
exceed this ratio during the three months ended December 31, 2022 , does not
anticipate exceeding this ratio during the year ending September 30, 2023 , and
therefore does not anticipate any additional repayments during the year ending
September 30, 2023 .
Receivables Securitization Program
OnApril 1, 2021 ,Evoqua Finance LLC ("Evoqua Finance"), an indirect wholly-owned subsidiary of the Company, entered into an accounts receivable securitization program (the "Receivables Securitization Program") consisting of, among other agreements, (i) a Receivables Financing Agreement (the "Receivables Financing Agreement") among Evoqua Finance, as the borrower, the lenders from time to time party thereto (the "Receivables Financing Lenders"),PNC Bank, National Association ("PNC Bank "), as administrative agent,EWT LLC , as initial servicer, andPNC Capital Markets LLC ("PNC Markets"), as structuring agent, pursuant to which the lenders have made available to Evoqua Finance a receivables finance facility (the "Securitization Facility") in an amount up to$150.0 million and (ii) a Sale and Contribution Agreement (the "Sale Agreement") among Evoqua Finance, as purchaser,EWT LLC , as initial servicer and as an originator, andNeptune Benson, Inc. , an indirectly wholly-owned subsidiary of the Company, as an originator (together withEWT LLC , the "Originators"). 48 -------------------------------------------------------------------------------- The Receivables Securitization Program contains certain customary representations, warranties, affirmative covenants, and negative covenants, subject to certain cure periods in some cases, including the eligibility of the Receivables being sold by the Originators and securing the loans made by the Receivables Financing Lenders, as well as customary reserve requirements, events of default, termination events, and servicer defaults. The Company was in compliance with all covenants during the three months endedDecember 31, 2022 , does not anticipate becoming noncompliant during the year endingSeptember 30, 2023 , and therefore, subject to collateral availability, does not anticipate any additional repayments during the year endingSeptember 30, 2023 .Evoqua Water Technologies Corp. is a holding company and does not conduct any business operations of its own. As a result, our ability to pay cash dividends on our common stock, if any, is dependent upon cash dividends and distributions and other transfers from our operating subsidiaries. Under the terms of the 2021 Credit Agreement, our operating subsidiaries are currently limited in their ability to pay cash dividends to us, and we expect these limitations to continue in the future under the terms of any future credit agreement or any future debt or preferred equity securities of ours or of our subsidiaries. Our indebtedness could adversely affect our ability to raise additional capital, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk, and prevent us from meeting our obligations.
Contractual Obligations
We presented our contractual obligations in Part II, Item 7, "Liquidity and Capital Resources" in our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2022 , as filed with theSEC onNovember 16, 2022 . There were no significant changes in our contractual obligations during the three months endedDecember 31, 2022 .
© Edgar Online, source
