Evoqua Water Technologies Corp (AQUA) 2018 Q2 法說會逐字稿

Good morning, and welcome to the Evoqua Water Technologies Second Quarter 2018 Earnings Conference Call. (Operator Instructions) 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 will now turn the conference over to Dan Brailer, Vice President of Investor Relations. Please go ahead.

Thank you, Crystal. Good morning, ladies and gentlemen. Thank you for joining us for Evoqua Water Technologies' conference call to review our second quarter 2018 financial results. Joining me 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. (Operator Instructions)

This conference call includes forward-looking statements, including our outlook for fiscal year 2018. Actual results may differ materially from expectations. For additional information on Evoqua, please refer to the company's SEC filings, including the risk factors described therein.

On this conference call, we'll also have a discussion of certain non-GAAP financial measures. Information required by Regulation G of the Exchange Act with respect to such non-GAAP financial measures is included in the presentation slides for this call, which can be obtained via Evoqua's website.

All non-GAAP financial results have been reconciled and included in the appendix section of the presentation slides. Unless otherwise specified, references on this call to full year measures or to a year refer to our fiscal year, which ends on September 30.

Means to access this conference call via webcast were disclosed in the press release, which was posted on our corporate website. Replays of this conference call will be archived and available for the next 7 days.

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

Thank you, Dan. Good morning. We are very pleased to report our second quarter 2018 results. To begin today's call, I want to provide some background on Evoqua's business and the markets we serve. Because we're a new public company, we'll provide more information on our business profile, our competitive differentiators and our market strategy through the fourth quarter. Following that, Ben will walk through our second quarter 2018 results.

Please turn to Slide 3. When we arrived at Evoqua in 2014, we found a business with tremendous potential, market-leading technologies, a great history of servicing customers' needs and a strong team of people. We defined our purpose: transforming water and enriching life, simple, focused and clear.

We're the leading provider of comprehensive water treatment solutions in North America. We provide systems, services and technologies to 38,000 customers with over 200,000 customer installations that's generating trailing 12 (sic) [12 months] revenues of $1.3 billion and $224 million in adjusted EBITDA, a 17.3% margin. Our business spans a diverse range of industries and includes the 20 largest U.S. companies in each of the pharmaceutical, food and beverage, hydrocarbon processing, chemical processing and power industries.

Please turn to Slide 4. In 2014, we initiated a series of changes by creating segments and divisions aligned by vertical markets or technologies. We focused our sales and marketing strategy on full-service solutions, deploying our technologies supported by ongoing service and mining our installed base. We invested heavily in our team, aligned our RD&E spend to the highest market priorities and established a systematic and targeted approach to M&A that augments our R&D and organic growth. As you can see, the business has responded well, delivering solid and improving year-over-year sales and profitability results.

Please turn to Slide 5. We're the #1 player in water treatment, which we believe is the most attractive and value-added segment of the water market. The global market is enormous at an estimated $600 billion, which we distilled down to our $85 billion addressable market, of which we further refined in our served market of $10 billion.

We supply water treatment systems by delivering technology and innovation supported by best-in-class service, primarily in North America. We're not a chemical company, nor are we focused on the transmission of water. We do not make meters, pumps or valves, but we do use them in our systems. And we have long-standing relationships with EPCs and design companies that provide a [spec-ed in] advantage for new capital projects or major renovations containing our solutions.

On the right-hand side of the slide, you can see we operate across a very diverse set of end markets that are attractive and growing. We're typically #1 or 2 in each of our target markets but still have less than 25% market share in each, providing significant room for growth. We're not dependent upon any key market or customer with no single vertical market accounting for more than 20% of our revenue and no single customer accounting for more than 2%.

Please turn to Slide 6. Our business is organized by customer base and offerings into 3 reportable segments that each draw from the same source of leading technologies, shared manufacturing investments and common business processes. On the left, you can see our Industrial segment that has a significant value proposition that includes optimizing industrial water usage, reducing operating costs, increasing operational reliability and supporting environment compliance and sustainability. Service is a major revenue driver across this segment, leveraging the largest service network in North America with broad application and process expertise. Our Industrial business provides technology-agnostic solutions with an emphasis on service and support to more than 25,000 customers.

The market we serve is approximately $6 billion in North America. We sell and service through our best-in-class direct channels that become an integral part of our customers' operations and their processes. We have a blue-chip customer portfolio serving a substantial majority of the Fortune 500 industrial companies. Our Industrial business is very sticky and very profitable, with EBITDA margins of 24%.

In the center, our Municipal business serves an estimated $4 billion market. This segment draws on more than 100 years of corporate history and technological leadership. We have focused this group primarily on the wastewater portion of the market, which has the highest growth potential, and we've seen EBITDA margins improve over 500 basis points over the past 5 -- 3 years. We sell through a leading third-party channel network, primarily in North America, and are focused on further penetrating our installed base for retrofit and rehab opportunities.

On the right, our Products business provides a highly differentiated and scalable range of products and technologies that become process standards and in many cases, displace traditional methods of treatment. This is our most global business and also very profitable with an EBITDA margin of approximately 24%.

Please turn to Slide 7. Last quarter, we provided a deep dive look into our Industrial segment. This quarter, we will review our Products segment, followed by the Municipal segment in the next quarter.

Our Products segment is our shortest cycle business and sells differentiated technologies to a diverse set of water treatment specifiers, integrators and end users globally. We also sell our portfolio of technologies and products either as discrete offerings or as components of broader solutions through our Industrial and Municipal segments. Our product offerings include filtration, disinfection, electrodeionization, electrochlorination, separation and anodes technologies. We are channel-agnostic in applying and selling our product technologies into the market.

Our filtration and disinfection offerings include our Defender line of products, which is the leading regenerative media filter in the commercial aquatics market. Our IONPURE electrodeionization solutions allow customers to achieve ultrahigh purity water without the use of chemicals in the treatment process. Microelectronics, pharmaceuticals and high purity industrial markets are primary applications for this technology.

Our electrochlorination products provide water treatment solutions for maritime, ballast water, downstream oil and gas and power markets. We also have extensive capabilities in anode technologies, cathodic protection and solid and liquid separation.

We have built a tremendous business enabled by leading technologies, 100-plus years of technical know-how and more than 1,250 patents, all supporting a large and growing installed base. We have significant and visible recurring revenues, and with more than 40% of our Products segment business coming from outside of North America, it is our most global segment.

Finally, as we will discuss shortly, we are supplementing our organic growth and capabilities through an active M&A strategy. As such, 6 of our last 10 acquisitions have been added to the Products segment.

Please turn to Slide 8. There are many opportunities across our 3 businesses for smart water applications utilizing Evoqua's water treatment solutions. Customers are driving the adoption of smart water technologies as part of their strategic goal to reduce water usage and cost. Digital water platforms help make more effective decisions, increase water system efficiency and drive new business models.

In addition to industrial markets, we see applications for smart water across the many vertical markets within our Products business. This schematic showcases the interconnectivity of our aquatics and disinfection divisions portfolio of products and analytical equipment. [A&D] is a leader in the filtration and disinfection of recreational water. This mechanical room schematic is for a typical commercial pool, illustrates the connectivity of our equipment using predictive analytics and remote monitoring to reduce operating costs and improve operational performance. This is another variation of our smart water applications to be deployed such as our Water One Assurance.

Please turn to Page 9. Evoqua's business is well positioned for long-term growth, and our service and support network is a significant competitive differentiator. It truly is the jewel in the crown. Our service network is 4x larger than our closest competitor, and we have a branch within a 2-hour radius of 90% of our customer base. Our core offerings are preventative maintenance, on-demand services, operating services and Water One Assurance.

Our business makes up approximately -- our service business makes up approximately 46% of our revenue. This business is very sticky, highly visible and generates attractive market -- margins. We have a 99% renewal rate in this business. And we are an integral part of our customers' processes that makes us the first call for all of their water needs.

Our focus on service and support creates a business model where approximately 80% of our upcoming year's revenue streams are highly visible at the beginning of each year. The service and aftermarket businesses are consistent and recurring due to our contract renewal rate and our large installed base.

Our business that is highly repeatable comes from small capital projects generated from our service relationships and from larger projects that are already in backlog at the beginning of each fiscal year. And our book-to-bill revenue is generated primarily from our Products business that is shorter cycle book and ship as well as large capital projects where we've specified.

As we continue to build our organizational capabilities organically and through M&A, customer engagement has increased, resulting in more pipeline opportunities that are favorably impacting our business.

Our capital projects are increasing in size, scale and complexity. At the same time, we've been actively pursuing an internal cross-selling strategy. We have had 3 or 4 recent projects that have provided an operational learning experience in which we have transitioned from utilizing outside vendors to internal supply chain partners.

Establishing these internal supply chain methods, combined with our cross-selling strategy, are increasing capital demand and will lower costs and improve profitability over time. The combination of increased capital demand and large projects have created short-term margin pressures but will also leave an attractive and profitable service and aftermarket tail.

Please turn to Page 10. Our future growth will come from both organic sales initiatives and through a systematic M&A process. Our industry is very fragmented, and while we are the industry leader, we still have only an approximate 12% market share. We utilize M&A to fill gaps in our product portfolio to penetrate desirable vertical market segments or to expand our geographic reach.

Our transactions have been accretive in year 1, and we're very pleased with the performance of our acquisitions. We believe tuck-in acquisitions are low risk by nature, and we expect to seamlessly integrate the businesses into our organization.

Overall, we're agnostic between M&A and R&D for new product development, and we believe there is a large pipeline of outstanding opportunities at attractive multiples. We expect to expand our service reach, enhance our technological capabilities and accelerate our sales and profitability growth rates through our disciplined M&A process.

As recently announced, we completed the acquisition of Pacific Ozone in March. We are very pleased to have Pacific as a part of the Evoqua family. Pacific Ozone is a manufacturer of high-end integrated ozone systems, targeting multiple industrial markets, including bottled water, beverage, food processing and industrial process water applications. The addition of Pacific filled a portfolio gap and brings with it over 5,000 installations in more than 30 countries. The Pacific leadership team will join the Evoqua team to help us build a larger and more global ozone disinfection business.

Please turn to Page 11. Here, you see a listing of our past 10 transactions since the acquisition program was put into place in 2016. Most of the deals have fulfilled portfolio gaps, allowing us to accelerate penetration into new and existing markets and to expand our suite of customer solution offerings.

As noted on this slide, the 2016 Neptune-Benson acquisition was a platform transaction that provided a leadership role in the aquatics market and a base to grow from in the broader products market. Following that acquisition, we acquired 4 tuck-in businesses: VAF, Delta, Olson and now Pacific, that support and expand our business in advanced filtration and disinfection. We have a strong pipeline of more than 100 qualified candidates, and we expect to announce more transactions in the coming quarters.

Please turn to Slide 12. We are very pleased with our second quarter results. Revenue growth for the quarter was up double digits, primarily driven by growth from our Industrial and Products segments and acquired companies. We were very pleased that all 3 segments reported double-digit year-over-year EBITDA growth for the quarter.

Our growth and profitability initiatives are in place, and we are making solid progress in each segment. We believe we are taking market share and delivering compelling solutions to our customers. We are pleased with the performance through the first half of the year, and we are very well positioned to see continued profitable growth organically and through M&A for the full year.

I would now like to turn the call over to Ben to walk through our financial results and to review our 2018 outlook.

Thank you, Ron. Please turn to Slide 13. For the second quarter, reported revenues were up over 11% to $334 million. Pro forma revenues, normalizing for acquisitions, were up almost 7%, driven by growth in the Industrial and Products segments, and acquisitions contributed more than 4%.

Capital project growth outpaced service revenues during the quarter, mostly in the Industrial and Municipal segments. As Ron mentioned, this has created some mix pressure but will provide a solid base for future growth in our highly profitable service and aftermarket business.

Second quarter adjusted EBITDA grew by approximately 31% versus the prior year to $58 million, 17.3% of sales, a 270 basis point expansion in EBITDA margins. We experienced inflationary cost pressures during the quarter and a productivity challenge due to weather and capital mix.

We also continued to invest for future growth to support our robust pipeline. Volume leverage and cost management contributed to margin expansion, offsetting inflation, growth investment and productivity challenges.

Please turn to Slide 14. For the second quarter, our Industrial segment had revenue growth of 13% year-over-year to $181 million, with pro forma revenues up approximately 6%. The major drivers of organic revenue growth resulted from capital for wastewater recycle and reuse applications in the power, HPI and CPI markets as well as general strength across most industrial end markets.

EBITDA grew approximately 18%, and margins expanded to 23% of sales, a 100 basis point improvement over the prior year. The EBITDA margin improvement was driven by volume leverage, cost initiatives and acquisition synergies, while partly offset by capital growth mix. Capital revenue growth is expected to lead to more profitable service and aftermarket sales over the medium to long term.

Our Water One Assurance pilot in Boston is nearing completion as we prepare for a national rollout to begin later this summer. During the quarter, we were awarded a long-term contract using our new Evoqua NexSys technology for a global biotechnology company. The Boston pilot has been very successful, and we expect that Water One Assurance will be a competitively differentiated, high-return service offering.

Please turn to Slide 15. For the second quarter, our Municipal segment revenues of $64 million were up approximately 1% over the prior year. Strong membrane sales were a driver in the quarter, partly offset by some delays in wastewater projects and backlog.

EBITDA grew over 14% to $10 million, 15.2% of sales, a 180 basis point expansion in EBITDA margins. Improvements were driven by membrane margins combined with benefits of lower warranty costs resulting from improved quality and project management. During the quarter, we were also pleased to be awarded a capital project with our BioMag technology that will replace obsolete equipment and increase our customers' plant capacity.

Please turn to Slide 16. Our Products segment grew 16% to $88 million, driven by double-digit year-over-year growth in most key product divisions. Pro forma revenues increased 14% versus the prior year. EBITDA of $23 million increased 36% to 26% of sales, an increase of 380 basis points.

Volume leverage, inclusive of mix, ongoing cost reduction initiatives and acquisitions synergies contributed to higher profitability. The acquisition of Pacific Ozone is expected to be accretive and is an excellent addition to Products segment portfolio. During the quarter, we were also pleased to be awarded a significant electrodeionization project for a large Asian microelectronics customer that requires ultrapure water in their critical component manufacturing processes.

Please turn to Slide 17. Free cash flow improved sequentially by $25 million and was $3 million better than the prior year. We expect free cash flow to continue to improve as we proceed through the year. And we remain focused on our targeted free cash flow conversion of 100% of adjusted net income for the fiscal year.

Our long-term leverage target is in the range of 2.5x. We have reduced leverage over the past 3 quarters, primarily due to increasing EBITDA and the debt paydown of approximately $100 million from the IPO proceeds in November.

Please turn to Slide 18. Capital spending in the quarter increased approximately $3 million to $16 million versus last year as we are investing in high-return customer-outsourced water projects. Our spending is in line with our targeted percentage of sales for both maintenance and high-return growth CapEx.

Working capital declined $3.5 million sequentially from Q1 to $194 million. Actions taken to improve working capital efficiency resulted in improvement in our cash conversion cycle. We expect working capital as a percentage of sales to remain in the mid-teens as we proceed through the year.

Please turn to Slide 19. We are pleased with our performance and our position for long-term profitable growth. As we look to the second half of the year, there are 3 factors that are noteworthy to our full year outlook.

First, we are experiencing a capital mix shift with larger capital installations from across segments and divisions that are favorably impacting our overall original revenue outlook. These capital installations will have solid upfront profitability and long service tails on a go-forward basis. But current installation margins are lower due to the timing in the projects. We are raising our full year revenue outlook to reflect increased customer penetration and demand for capital equipment and integrated solutions.

Second, we're experiencing higher inflationary cost and commodity pricing that in aggregate are putting short-term cost pressures on the business. We're actively engaged in accelerating pricing actions and productivity initiatives to offset the expected inflationary costs.

Third, a portion of our Products segment revenue that was previously anticipated to be shipped in the third quarter is now projected to be shipped in the fourth quarter. This is purely a timing matter that we occasionally experience in our business.

Our overall 2018 outlook on the business has not fundamentally changed. However, we are experiencing unanticipated cost increases, common throughout the industry, as well as mix and shipment timing impacts.

For the third quarter, we expected adjusted EBITDA to grow in the range of approximately 5% to 10% over the prior year. For the full year, we expect total reported revenues to be in the range of $1.34 billion to $1.37 billion, an increase of $10 million to the high end and the low ends of the original range and representing growth of approximately 7% to 10% over the prior year.

Adjusted EBITDA is now expected to be in the range of $235 million to $245 million, a $10 million reduction to the high end of the previous range. The 2 acquisitions completed so far this year, Pure Water and Pacific Ozone, while strategically important, are not material to our overall financial results and are included in our outlook.

Consistent with first quarter comments, our 2018 blended statutory tax rate is expected to be between 24% and 26%. We expect our 2018 annual effective tax rate to be approximately 13% to 16%, excluding discrete items. Consistent with our assumptions, we expect our end markets will remain healthy and stable and continue to support the realization of our outlook.

We will now open the call to your questions.

(Operator Instructions) And our first question comes from the line of Deane Dray with RBC Capital Markets.

Just like to start in the change in guidance here, and then very specifically, the first factor on the increase in the capital projects. And we always view these as a high-quality problem in that you're going to increase your installed base and get access to a revenue stream on the aftermarket. But just give us a sense of what the timing issue on these projects. Were they not in the budget? Did they get pulled forward? And were they not part of the guidance originally?

Yes, Deane. So to your point, we consider it a very high-quality problem. We actually like the fact that we've got good capital installs going out, but it does create a bit of a mix shift for us. So as you look at it, what happened there is a few larger projects going out that are having installation revenues that go upfront. And the installation revenue is typically a little lower margin than the service and aftermarket tail. But the great news is that we're seeing increase in revenue. We've raised the guidance there because we see a very strong pipeline for that. And we have a very good backlog that we'll continue to benefit from with the service and aftermarket tail that comes behind.

Got it. And then the other factor on the higher inflation costs, maybe just for Ben, can you walk us through the whole price-cost dynamic? And can you size for us have much price you got through in the quarter? And what was the material cost inflation?

So we haven't seen much price shift, Deane. Those actions are underway and will be coming as we head into the second half of the year. But we did get a little more cost than we expected. As we look forward to [Q,] it wasn't a huge amount in the quarter, but we saw it late in the quarter when the costs are coming through. As we head into Q3 and Q4, we're expecting to have in the range of $2 million to $3 million in Q3 of additional commodity costs. We'll start seeing the price in Q4 based on the actions. And for the year, we're expecting an additional $2 million of headwinds net for the second half of the year.

The net additional $2 million is reflected in the current guidance?

It is.

Correct.

And then just one last question, if I could. Could you discuss the factors in the other expense, corporate expense line?

Other corporate expense line?

Just the corporate expense, it looks like it was higher than what we were modeling for. Any particular factors you got?

Yes, we had some first follow-on expenses. We'll get you the details offline on that. I don't have them at my fingertips, but there are some other expenses in there related to the refi and the first follow-on, okay?

Your next question comes from the line of Nathan Jones with Stifel.

Just following up on some of the guidance change there. You did take the top end of the adjusted EBITDA guidance down by $10 million. It sounded like a couple low single digit maybe of that, explained by higher raw material costs before you get to offset that with price. What are the other factors that have gone into the reduction in the top end of the guidance there?

Yes, Nathan. It's mix. It's the capital mix that we're seeing now as a higher portion of the revenue than what we had originally planned. But again, that's speaking to the question that Deane had earlier. That's very good news for us longer term. It's one reason we raised the top -- the revenue guidance as well because we've got a strong pipeline coming through. We've got a strong backlog. And what that does for us is give us a tremendous follow-on in service and aftermarket coming behind.

Yes, absolutely. I get that. It is, I think Ben said, rich people problems or high-quality problems. Does it imply it though, I mean, if you have a heavier mix of capital projects, that should be accretive to the overall EBITDA if service revenue still at the same level? So is there any implication here that the service revenue in '18 may be a little lower than you originally thought?

No, I think again, it's just -- it's the timing on when the projects are going out and the timing in the second half and where we're seeing capital being installed and the service follow-on. So it really is the commodity move and then the mix move that's making a change. It's not the service side not growing as quickly. It's staying pretty steady.

Okay. And then with this -- the increased level of capital projects going out here, could you maybe give us some color on the timing of those new installations moving into an aftermarket and service revenue generation?

Yes. So basically, we've got about -- over the next 6 to 12 months, those will be installed, and we'll start turning service and revenue aftermarket dollars coming. And typically, you can think about any $1 of capital that goes in generates around $0.22 of service and aftermarket for us on an annual basis. So -- and it's a very long tail. So it's -- it really is a very positive outcome. We're pleased to be winning these projects, and we are confident we're taking share and providing more to our customers.

And those projects pretty much immediately start generating aftermarket and service revenue? There's not much of a lag to that?

Not much of a lag at all. I would say, service starts immediately, and then the aftermarket typically is around 6 months.

Our next question comes from the line of Brian Lee with Goldman Sachs.

I guess, first off, can you talk, Ben, about what's embedded in your 2018 outlook here for contribution margins? I know there's a couple of moving pieces here with respect to mix and the price-cost dynamics. And then, I guess, how we should think about that level for 2019? Are you anticipating that it normalizes to some of the targets you've laid out in the past?

So our long-term contribution margins are not going to change. We do have some short-term impacts that Ron described. And again, it's the 3 factors I've talked about. It's the capital mix shift, which is temporary. There's a timing impact due to some product shipments that were going to go in Q3 that we expect to get in Q4. Those are high-profit shipments, so that does create a little bit of a challenge. And it -- because it's really timing that will be recovered in Q4. And then the third factor is inflationary impacts mostly, which are commodity, but also some other type of inflationary impacts that again is a timing impact, price realization pressure will follow as we're executing on the price realization. So I don't know that it's [something] we should think about our incrementals differently at this point in time. It's just a temporary timing difference as price realization kicks in and as the mix normalizes to our traditional level.

Okay, fair enough. That's helpful. And then just on that pricing front, a number of your peers in this space have talked about implementing price increases or having already done so and maybe being on their second or third price increase of the past year. So for you guys, does the -- I know you said you're engaged in pricing actions as we speak, but nothing has actually been flowing through as of yet. Is that due to sort of the bulky nature of some of your capital projects and that having more of a lag effect and timing issue in terms of getting prices across? Or maybe can you speak to sort of why some of your peers may have been quicker to implement the pricing action? I know the products and the project activity is not apples-to-apples, but just wondering how we should parse out the differences between your model and others.

Yes. So if you think about that, Brian, the capital projects are a little longer cycle. So -- and they are the ones that we would have bid historically. So once -- new projects that are going out and that we're bidding now, we're getting the price increases on those. And then on our service contracts that are typically annual contracts, so as those have come to a renewal time, we're able to increase the prices on those, which will flow through in the next year. So it's a little longer cycle for those price increases to flow through on an annualized contract.

Okay, great. Last one and I'll (inaudible) sorry I was just going to ask -- and apologies if there's some background noise here. The delays in the muni wastewater projects, can you just speak to what impact it had on the quarter? Is that all back in 3Q? I'll pass it on.

Most of that will be back in Q4. It is purely timing in the wastewater division within the municipal area. But yes, that did have an impact in the quarter, and it's likely to have an impact in Q3 with a recovery in Q4. But it is timing as well.

Our next question comes from the line of Steve Tusa with JPMorgan.

Can you just maybe talk about the free cash flow ramp in the second half? You're still sticking with about 100% conversion or greater than that for the year. And I guess, what's the -- what does kind of third and fourth quarter look like?

So we're not going to give quarterly guidance, but we're sticking for 100% for the year. And the ramp will get us to that 100% for the year that we have in our current outlook.

Okay. So there's no kind of linearity and that you should -- seasonality or linearity in the second half on that number?

There is, and fourth quarter will be the strongest.

Okay. Okay, great. And then I guess, the third quarter kind of implied EBITDA is around $60 million at the midpoint. Is that the kind of the right ballpark, right ZIP code?

That's the right ZIP code, yes.

Our next question comes from the line of Andrew Kaplowitz with Citigroup.

It's Vlad Bystricky on for Andy. So just on working capital. So working capital, after ticking up year-over-year, it's been more stable over the past few quarters here. And I know you talked about around 15% for the rest of the year, I think. But can you give us some color maybe on how you're thinking about a target level of working capital going out beyond this year? And do you see potential opportunities to continue to take working capital down below the mid-teens levels?

Sure. I mean, we're targeting mid-teens right now. A lot of that depends on the mix of the business. Higher capital puts more stress on working capital because it's a longer cash conversion cycle as services and aftermarket kick in, it's a quicker cash conversion cycle. So as our mix changes, we should be able to do better. But we also have working capital initiatives in place to drive further improvement, particularly in DSO and DPO.

Okay, that's helpful. And then just maybe digging into the Products segment for a minute here. 14% pro forma growth on a tough comp seems like a pretty strong number there. So can you talk about -- I know there's some lumpiness in the business, but can you talk about the sort of the underlying growth rate in Products overall and your visibility, especially on some of your overseas markets there?

Yes. The Products business for us is a very strong growing business. We're very -- we're really pleased with what they've done. As we've articulated numerous times, we expect the Products business to be high single-digit growth and it's performing as such. In fact, it's exceeding that. It is a global business. So if you think about the first half of the year, our China business has grown by 35%, 30% in the most recent quarter. And we're really pleased with the outlook. We're providing more products into solutions there that are displacing traditional methods of treatment. And what that is doing is getting on as a platform and creating a very nice pull-through for us long term.

Our next question comes from the line of Pavel Molchanov with Raymond James.

First, on the M&A front, as I've been counting up all of the industry-wide buyouts in the field of water technology, I think I've gotten to something like 19 deals year-to-date. You guys have done 2 of those, of course. Is it fair to say that the competitive landscape on the buy side of these deals is becoming tougher and tougher, more and more competitive than it has in years past?

Pavel, it's interesting, and it really depends on the size of the acquisition target we're going after. Typically, the ones that we've done, as we articulated to you guys, are primarily tuck-ins. These are generally bilateral negotiations that we're doing with an owner or an entrepreneur that we are bringing their product portfolio into ours or we're acquiring them to get geographic or vertical market reach. So it really has not created difficulty for us on the competitive front as we're going after the acquisitions we've been targeting.

Okay, interesting. Municipal segment, down a little bit year-over-year on the top line, not EBITDA, this quarter. I think it was down also last quarter. Is that -- is it realistic to expect that the comp will turn positive before the end of the year? Or is it going to continue to be kind of a flat to down segment?

No, it will turn positive before the end of the year. Again, as Ben spoke to, there's some project timing. In some of the larger projects, we have a backlog. But we actually were up 1% this quarter over the prior year second quarter. And we anticipate -- as we actually articulated early on the -- in the business rollout, we are looking at low single-digit growth for municipal, and we're still on that same track.

Our next question comes from the line of Joe Giordano with Cowen.

As you go through with Water One Assurance, can you talk about like what the implications are on like capital -- working capital needs for you, if you're taking on the upfront costs and how that changes maybe free cash flow dynamics as you transition towards that kind of offering?

So the Water One Assurance program is really CapEx. That's really investment. In terms of the working capital, we're really talking about receivables that would be on the growth. But there's not going to be huge working capital impact on Water One Assurance. So again, the cash usage is really on CapEx.

What kind of magnitude on the CapEx then?

So we're going to invest $23 million over the next 3 years to roll out the program.

And that will cover like the full rollout that you were talking about? Like you're talking $200 million of installed base that you were trying to (inaudible) to?

Yes, what we're targeting in that, Joe, was 50%. And so that was -- that is what we have built into the model. Now what we've seen in Boston is we've seen a much higher take rate on our second pilot, which is a much larger pilot, as you know. We're proving out again a lot of the analytics through this rollout on the second pilot. And with that take rate ticking up, if we see that across the nation being the similar type take rate, then we would have to take the CapEx up. But right now for the 50% rollout, we would expect that $23 million covers it.

Great. And then just a question on the Industrial side, it looks like the margins on the acquired businesses seem to be substantially higher than the core business. Is -- any kind of color on that and how the future pipeline in Industrial looks relative to those kinds of numbers?

Well, you've got to remember, those acquired businesses also include some synergies, right, as well that's helping those margins. But yes, these are good businesses, and we're also seeing some cross-selling of those businesses. Some of those projects that we are winning, that Ron talked about earlier, from cross-divisional selling, is directly a result of the acquisitions, where we are now having a more comprehensive solution in the marketplace. So all of this leads to good news for the future. But again, the acquired businesses are nice businesses that have been accretive.

(Operator Instructions)

Okay. No further questions, Crystal?

You do have a question. It comes from the line of Nish Damodara with Baird.

Just a quick one, what kind of acquisition contribution are you expecting from Pacific Ozone this year?

It's relatively insignificant. It would hopefully have much more of an impact next year.

Thank you. That concludes our question-and-answer period. I would now like to turn the call back over to Mr. Ron Keating for his closing remarks.

Thank you, Crystal. Thank you all for participating in our earnings call today. As we've highlighted in the call, we feel we're very uniquely positioned to be the solutions provider of choice for the water industry. Our technologies, our channel and our extensive service footprint truly make us able to partner with customers.

You may have seen recently that Evoqua was named the Water Company of the Year by Global Water Intelligence and the Water Technology Company of the Year by Frost & Sullivan. We're really very pleased to receive these recognitions, again, speaking to the goals of our team and the members all around the globe of Evoqua, of exceeding our customers' expectations and making sure we're providing them with best-in-class solutions. We're very proud of the legacy we have and very optimistic about delivering sustainable results for the future. And I look forward to speaking with you all again. Thank you.

Thank you. That concludes today's Evoqua Water Technologies 2018 Second Quarter Earnings Conference Call. You may now disconnect your lines at this time and have a wonderful day.