Evoqua Water Technologies Corp (AQUA) 2022 Q3 法說會逐字稿

Hello, and welcome to the Evoqua Water Technology Third Quarter 2022 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.

I would now like to turn the call over to Dan Brailer, vice president of investor relations. Please go ahead.

Thanks, everyone for joining us for today's call to review our third quarter 2022 financial results. Participating on today's call are Ron Keating, president and chief executive officer and Ben Stas, executive vice president and chief financial officer. After our prepared remarks, we'll open the call of questions.

This conference call includes forward-looking statements, including our fourth quarter and full fiscal year 2022 expectations, long term financial targets, statements relating to our demand outlook and markets, growth opportunities, our order pipeline, order conversion, cash generation, our acquisition strategy and pipeline, integration and future performance of our acquisitions, supply chain challenges, inflation, labor shortages and general macroeconomic conditions. Actual results need different materially from our expectations. For additional information on Evoqua, please refer it to the company FCC filings, including the risk factors described therein.

On this conference call, we'll also discuss certain non-GAAP financial measures. Information with respect to such non-GAAP financial measures is included in the appendix of the presentation slides for this call, which can be obtained at Evoqua's Investor Relations website. Unless otherwise specified, references on this call to full year measures or to a year refer to our fiscal year, which ends on September 30. Means to access this conference call via webcast were disclosed in the press release, which was posted on our Investor Relations website. Replays of this conference call will be archived and available for the next 14 days.

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

Thank you, Dan, and thank you for joining us. I appreciate your interest in Evoqua, and I'm pleased to provide insights into our results and outlook. We had a strong third quarter, and I'm pleased with the overall results. Market demand remains robust despite inflationary pressures and supply chain challenges. We are currently managing our lead times and any potential disruptions that may impact our order conversion time. We continue to experience a robust pipeline, and this quarter's order growth was again very strong.

Please turn to Slide 3. Overall, organic revenue growth in the third quarter was approximately 9% year-over-year. We are particularly pleased to see broad-based diversification of organic growth across all regions, most product lines as well as growth across aftermarket capital and service. As mentioned, demand remains solid and order growth is robust with our book-to-bill ratio continuing to be greater than 1.0. Organic revenue growth on a trailing 12-month basis is above 10%, and we've made 3 acquisitions since January 1st. The team has done a great job of pushing price, and we remain cost-to-cost positive for the quarter and year-to-date.

Adjusted EBITDA margin was down 40 basis points for the quarter, but expanded 30 basis points year-to-date. We were pleased to see APT's Q3 year-over-year adjusted EBITDA margin expand by 1.3%. IFS margin declined by 1.9% based on various items that Ben will discuss in later slides. We completed our second quarter with Mar Cor and continue to be pleased with the progress. The integration is on track, and we are working to complete our SAP system conversion by the end of Q2 in 2023.

Our balance sheet and liquidity strengthened, and we continue to focus on cash flow generation. Our operating cash flow and adjusted free cash flow on an LTM basis improved sequentially versus Q2. Our liquidity increased to $267 million, and our net leverage ratio improved to 2.9x. Cash flow continues to be a priority to fund investments in organic growth, tuck-in acquisitions and to further improve the balance sheet through debt reduction.

Please turn to Slide 4. Water is an essential element for daily life, whether for human consumption, industrial production or commercial purposes. Manufacturers are requiring more stringent levels of ultrapure water while wastewater reuse has become vial in protecting diminishing water supplies and reducing the strain on municipalities. As water becomes more complex, Evoqua's essential treatment technologies make clean water more accessible. Because of this, the long-term market trends are very favorable, and we expect our business to remain resilient through normal market cycles.

This slide highlights key financial metrics that we expect to be annually resilient over the long term. Organic sales growth, adjusted EBITDA margin and cash generation. Each of these graphs highlight our resiliency through the FY '20 and '21 COVID pandemic with growing and strong free cash flow in a demand-constrained market. This is due in part to our recurring revenue streams with service and aftermarket, making up approximately 60% of our revenue. Digitally connected outsourced water, strong and growing end markets, and our industry-leading service are just a few drivers for organic growth in favorable and unfavorable market conditions. As stated previously, we remain price cost positive on an absolute dollar basis. Intense inflationary costs have been dilutive to margins in FY '22.

For the quarter, inflationary costs impacted adjusted EBITDA margin by approximately 40 basis points which improved from a 70-basis point impact in the second quarter. We continue with robust pricing processes, and we expect to remain price cost positive in the fourth quarter. Despite these headwinds, we maintain our long-term target of 20% adjusted EBITDA margin. Our management team is focused on driving strong and consistent cash generation. Our strong base of stable, profitable and recurring revenue provides an attractive foundation for cash generation. We have managed working capital well and see additional opportunities for improvement over time.

We continue to target adjusted free cash flow conversion of over 100% or higher and we've achieved that on an LTM basis for several years. Please turn to Slide 5. This chart represents our fourth quarter expected order activity by end market compared to the prior year's fourth quarter. As shown, we expect to see strong orders in the fourth quarter across most end markets, particularly life sciences, food and beverage and like general industries. Power and refining are improving from prior quarter's outlook with favorable market dynamics across both end markets.

Expected fourth quarter orders in microelectronics are showing a decline from last year's fourth quarter due to very strong Q4 orders last year. We are well positioned in the microelectronics market, which has undergone a strong cyclical upturn that we expect to remain. Overall, we expect to see strong order demand across most of our end markets for the remainder of fiscal 2022. We do anticipate supply chain and labor challenges, creating the potential for order conversion delays on behalf of our customers.

At Evoqua, we're proud of our diverse team of employees executing on fulfilling this demand every day. As we continue to expand our company with skilled team members, we are pleased to be partnering with 5 HBCUs for talent recruitment in the fall and the spring. Please turn to Slide 6. Over past quarters, we've highlighted high priority end markets, including microelectronics, life sciences, renewable energy. In this quarter, we highlight food and beverage. Food, particularly for wastewater treatment has been a key end market for us since the ADI acquisition in 2017.

We have been historically strong in beverage with process water and are pleased to see gaining traction for voice water treatment. With today's strict regulatory environment, manufacturing and processing requires high-purity water for multiple applications, such as sanitizing equipment. High-strength organic contaminants have also driven the need for improved wastewater treatment, and our ADI product line has best-in-class anaerobic digestion for these applications. Our portfolio of voice water technologies allow customers to treat the most difficult organic waste streams while also helping them to achieve their carbon intensity goals by producing biogas, a source of renewable energy.

Our core process water portfolio also plays a vital role in providing production process water and utility makeup water into these markets.

Please turn to Slide 7. We look at our environmental impact through our own footprint on the environment, but also through the products and services we provide to our customers. We're pleased to highlight 2 recent handprint wins, which are expected to positively impact our customers' water conservation while generating an attractive ROI. Bakersfield Renewable Fuels selected Evoqua to design source and assemble a wastewater system that combine granular-activated carbon, ultrafiltration and reverse osmosis technologies to treat up to 375 gallons of water per minute. The system was designed to allow for 75% recovery with an estimated annual savings of approximately 140 million gallons of oil. We also have helped the dairy processing plant, which experienced significant demand increases by replacing an aging wastewater system.

Our anaerobic digester was selected to treat up to 2,100 cubic meters of wastewater per day. Through this treatment, we will produce an expected 5,000 cubic meters of biogas per day, which is approximately the average daily usage of 550 US homes. Please turn to Slide 8. While we continue to invest in long-term organic growth, we see momentum in our programmatic tuck-in M&A process as well. We have now closed 3 acquisitions since January 1st, and we welcome our new colleagues from Smith Engineering in Evoqua.

Smith Engineering strengthens our service capabilities across key vertical markets, including life sciences, data centers, food and beverage and microelectronics. Evoqua was an opportunity to vertically integrate a key supplier of specialty resins for the power market. These acquisitions support our assets segment. As I mentioned previously, the integration of the Mar Cor business continues to be on track, and we reiterate our expectation for it to achieve 25% adjusted EBITDA margins in the next 12 to 18 months.

I would now like to turn the call over to Ben.

Thank you, Ron. Please turn to Slide 9. For the third quarter, reported revenues were up approximately 19% to $439 million. Organic revenues grew approximately 9% driven by broad-based price realization and volume growth. We saw organic revenues to increase in aftermarket capital and service categories as well as growth across all regions and most product lines versus the prior year. Third quarter adjusted EBITDA increased 16.3% over the prior year to $77 million for an overall margin of 17.5%. Strong volume, favorable price and mix were primary drivers of improved profitability.

As Ron mentioned earlier, inflationary impacts drove a year-over-year margin decline of approximately 40 basis points for the quarter. Please turn to Slide 10. Our Integrated Solutions and Services segment, third quarter revenues were up approximately 24% to $297 million. Organic revenues grew more than 7% driven by price realization and volume. Service and aftermarket revenues were strong across most end markets. Organic capital sales were down slightly due to strong prior year sales in chemical processing, but largely offset by strength in microelectronics and life sciences. The opportunity pipeline for capital projects and outsourced water is strong and growing. Our digital strategy continues to be an important strategic driver for long-term growth and profitability. For the quarter and year-to-date, digitally enabled revenues were up 11%.

Adjusted EBITDA increased 13.9% to $64.1 million due to higher volume, favorable price and the consolidation of Mar Cor operations. Adjusted EBITDA margin for the quarter was 21.6%, down 190 basis points from the prior year. Approximately, 90 basis points of the decline was the result of prior year onetime benefits from COVID subsidies and favorable settlements of insurance claims as well as a return to more normalized travel costs. Approximately, 60 basis points of the margin decline was from the dilutive impact of inflation. However, as we discussed, we had favorable price cost benefits on adjusted EBITDA dollars.

Please turn to Slide 11. We continue to see strong year-over-year growth in ISS backlog. Third quarter backlog was up $81 million or 19% over the prior year and up 10% versus Q2 of this year. We saw strong year-over-year sequential growth in capital primarily driven by microelectronics and food and beverage. Our ISS pipeline continues to be robust with opportunities across multiple markets. We expect to see our book-to-bill ratio remain above 1 in Q4. As Ron mentioned, we're closely monitoring our pipeline and order book as supply chain visibility creates the potential for shipment delays in Q4.

Please turn to Slide 12. Applied Product Technologies third quarter revenues were approximately $142 million, up more than 9%. Organic revenues increased $16.6 million or 12.8%, driven by strong volume growth and price realization as well as growth across all regions and most product lines. Adjusted EBITDA for the third quarter increased 15.5% to approximately $33 million. Adjusted EBITDA margins increased 130 basis points to 23.1%, driven by volume, favorable mix, but partly offset by inflationary impacts. Over the last several years, we've undertaken significant footprint consolidation actions in APT, going from 16 manufacturing centers in 2018 to 10 locations. This consolidation has provided for better fixed cost absorption, which has driven improved margin performance from higher organic revenue growth.

Please turn to Slide 13. One of APT's long-term organic revenue growth initiatives is to develop new and innovative technologies that expands our product portfolio and pursue market share gains in core markets. We are pleased to highlight 2 newly opened APT global manufacturing facilities in the United Kingdom and Singapore. The UK facility will serve as a global center of excellence in developing leading-edge ATV UV disinfection solutions and the manufacture of our Wallace and Tiernan product lines. Our Singapore port facility will manufacture Insure, a leading product in the microelectronics market and is expected to support Evoqua's growth and market development plans for the Asia Pacific market.

Please turn to Slide 14. Capital spending primarily for outsourced water orders was approximately $22 million for the quarter or approximately 5% of revenues. Third quarter net working capital was 16% of LTM sales. This includes net working capital acquired in the Mar Cor acquisition, which was $48 million as of the businesses opening balance sheet. Net working capital also increased to support strong organic order rates supported by higher inventory levels. As we've indicated in the past, 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.

Please turn to Slide 15. Year-to-date operating cash flow was approximately $87 million in Q3 versus $103 million in the prior year. Adjusted free cash flow as a percentage of adjusted net income was 104% on a year-to-date basis. We were pleased to see our adjusted cash flow conversion return to over 100% as we continue to support strong organic growth and capital expenditure investments, primarily for outsourced water orders. Our reported net leverage ratio finished at 2.9x and is now within our targeted range of 2.5 to 3x.

Maintaining a strong and flexible balance sheet remains a key priority for Evoqua Water. Our weighted average cost of debt for the third quarter was approximately 3.3%, up approximately 60 basis points over the prior year. Approximately, 65% of our $975 million in total debt has a fixed rate or is fixed through an interest rate swap, which is in place into 2026.

I would now like to turn the call back over to Ron. Ron?

Thank you, Ben. Please turn to Slide 16. We had a strong quarter with outstanding results across most key financial metrics. Market demand remains strong, and we're pleased delivering broad-based organic growth across both segments, all regions and most product lines. Our pipeline remains robust and backlog continues to grow to record levels. We are managing through a dynamic market with rising costs and supply chain uncertainties.

We are pleased with the positive price cost in Q3, and we are working to maintain that for the year, but margin expansion remains challenging. Outsourced water continues to make excellent progress and is contributing to the ISS segment's recurring revenue model. Digitally connected sales were up again double digits. Heading into the final quarter of our fiscal year, we are focused on sales and operational execution to convert our strong backlog. Price realization is expected to be positive despite higher inflationary costs and overall labor and material availability.

We continue to closely monitor the timing of customer purchase orders and shipments as supply chain uncertainties could create challenges. Closing on our prepared remarks, we are maintaining our previously provided outlook for the fiscal year.

I will now open the call to questions.

(Operator Instructions) And we'll take our first question from Deane Dray with RBC Capital Markets.

I think I should start with the impressive free cash flow in the quarter. And I appreciate the details you've given on working capital to sales. Even at 16%, you're in the top tier of the sector. But take us through the kind of net impact on Mar Cor. You gave the working capital from Mar Cor.

Is markedly higher than Evoqua was. We have some work to do there and some opportunity. Most of that will occur after we implement them on SAP. Both their payables and their receivables, they collect slower than we do, and they pay faster. So these are opportunities for us. Inventory, they do have a robust level of inventory on hand. And with the benefit of the business integration into shared services, we feel like we can unlock quite a bit of that at working capital. I think in the last call, we talked about as a percentage of sales, they're in the mid-20s, and we would like to bring them down to our mid-teens level. Overall, in Evoqua, if you look at our working capital and our DSO and DPO, very consistent with the prior quarter, we did see 2 days more of inventory, and you'll note that when you review our results. And that inventory, it was put in place to support very strong order rates as well as safety stock in this current period of time.

Yes, that makes sense. We're seeing additional buffer inventory. In fact, 2 days is really timely compared to what we've seen some of your competitors carrying. Second question and follow-up for Ron. The digital revenue is up 11%. What's interesting is that you're not talking about it. You're not talking about being impacted by chip supplies because these products and services do require semiconductors. So where does that stand? And what growth rate are you expecting from the digital businesses going forward?

Thanks, Deane. Actually, we have not been overly impacted by chip supply on our own connected systems that we're putting in. We have been impacted by chip supply on the APT side, where we're supplying products into our customers on a global basis. But that's – we're managing that. It's actually we're seeing a trend that it's stabilizing a little more, and we're able to at least have good lead times, good price expectations, where things are going to be and we're able to build that into the product line.

We're pleased with the digital - with the Connected Solutions a digital water growth. And I anticipate that will continue to grow at double digits. The opportunities there, as you know, we invested a lot of money in deploying connected systems. And even though we have deployed the connected systems until a customer signed up for water by the gallon, we weren't charging against that or billing them in that way, we're billing them by event. So that's where you're seeing and you'll see continued ongoing growth of digital and connected water because we already have the systems in place. We're converting customers to that. And we anticipate that will bode well as the tailwinds of the market are very positive.

And just to clarify, how much of the total revenue mix would you characterize as digitally enabled today? And where do you expect it in a couple of years?

Yes. Deane, we're somewhere in the neighborhood of 20% that we are connected around our full revenue that we have on site 24/7 with connectivity. We have said that we feel like over time, that could get up to 40%.

We'll take the next question from Nathan Jones with Stifel.

I want to talk a little bit more about the ISS margins and some of the pressures that you're seeing there. I would think that fuel labor on the service side and potentially some contract terms that are maybe more fixed in nature on that side of the business or the reset more slowly, that maybe are a little more difficult to pass pricing through. Could you give us a little bit more color on where you stand on those kinds of issues? If you've changed the contract tons over the last few years to enable pricing to get through more easily there.

Yes. Nathan, I'll speak to the contract terms to let Ben talk to the details on what we've seen. We have been able to pass on price escalators in the contracts. We have the ability to go out with surcharges inside of the contracts, and we've negotiated a much shorter time period into what different indexes enable us to do as far as the contracts go. And then even on our quote lead times now, we have somewhere between a 10-day validity on a quote and 30-day validity on quote, just depending on what the raw material is going into the process are. So we've taken the right actions around being able to move price certainly on the ISS side as far as commodity moves and labor and material costs and fuel costs. Ben, do you want to talk about the percentage?

Yes. Highlighted on the call earlier, we had some 1x that the majority of the reason for the ISS margin decline. There was about 60 basis points of inflationary related. And that does include labor inflation as well as some productivity impacts associated with onboarding new service tax to fill positions. And in that period of time, you have 2 techs going to one job as they are becoming trained. So there's a little bit of pressure there. But that should abate once these techs are up.

And the last thing is just continuing fuel cost increases. But a lot of that we're able to pass on as a part of the way of our contracts work. So it's dollar neutral to dollar positive. However, it does put pressure on EBITDA margin percentage. And so, for ISS, we had about 60 basis points of headwinds associated with price cost on margin, even though the price costs were dollar or plus dollars were positive and favorable. So those are the key things, Nathan.

Yes. I had another question on chips and margin opportunity. The chipset finally got passed through Congress, which enables probably a fairly significant microelectronics capacity to go into the US where you guys can get some very large projects. Can you talk about the opportunities here? I know you have relationships with some, if not all of the folks that are likely to put in some large capacity. Just any context if you can give us about how big these opportunities could be for Evoqua and what the time frame for realizing revenue out then might be?

Yes. Nathan, we see this as very positive. We think the opportunities are from and this again continues with the strong tailwinds that we have in the marketplace. The one thing we pointed out on Slide 5 is our Q4 expected orders coming in and microelectronics that shows red. That is simply due to prior year very strong Q4 orders. So that order activity versus order activity, we see a long-term opportunity for this for us being very strong. The onshoring has helped quite a lot. This chipset is going to help quite a lot. And companies are getting benefit for investing in the proper technologies. And in a lot of cases where these microelectronics fabs are, they are water-star regions or water challenged regions, even it's not the United States. So it's a huge benefit for the Evoqua. Fits us very well on the wastewater side as well as the processed water side. So we're positive on it.

We'll take our next question from Andrew Buscaglia with Berenberg.

Just a clarification on the Mar Cor contribution. It came in a little bit below expectation. It was around $40 million, $41 million, down sequentially. What's going on there? And then going forward, do we - is the low $40 million where you'd expect that deal to come in?

No. We just had a little bit of supply chain disruption in the quarter associated with the concentrates business that should rebound this quarter. But we expect that to be in that mid-40s range in terms of sales on an ongoing basis. A lot going on there, including an SAP implementation, the integration of the business, but the demand looks very stable and certainly strong in this concentrate area as well as our other key product lines.

And Andrew, one piece that you'll see in that Mar Cor growth that's coming in will also show in as organic growth because we're aligned on those customers. We're selling to a more-broad customer base through ISS, and that's going to be reported as organic growth because it's growth in our revenue going into those key accounts that Mar Cor was servicing.

Okay. And then just looking at the guidance, you held guidance that makes sense just given what's going on in the world. But your guidance would imply organic growth would probably go negative in one segment. I would think I had asked given the comp. Is that the way to think about that? And is that really just tough comp kind of obviously looking like that's going to decline?

Last year was a very strong Q4, if you look. ISS had some very, very robust sales in Q4 of the prior year. And that was sort of the opening up of COVID as well. But we'll see how it all shakes out. That's why we put a range out there and still wide to reflect various possibilities. But as I highlighted in the script, there is a chance for customer delays. We do have very strong comps, and we wanted to take - headed into the potential uncertain economic conditions, we want to take that a balanced approach.

I think that's the key. As we've talked about, our backlogs are terrific, Order activity is fantastic. Even as I highlighted on the end market corps where we see order conversions delays, it's really on the half of our customers being ready to accept the products that we're delivering, not necessarily on our behalf, being able to deliver a lot of times, we're waiting for them to say go. And so, we were balanced in the fourth quarter with that.

We will take our next question from Saree Boroditsky with Jefferies.

The EPA issued a health advisory that basically said there is no safe level of PFAS. How do you expect this to influence the upcoming Limit proposal and ultimately, the revenue opportunity for you guys?

We see this continuing to be a positive just as we've highlighted and what the EPA still has to do is just come out and put what the regulatory requirements are going to be and define that specifically so that we'll see the local water districts and state municipalities starting to adopt it. But Saree, it's a little like we've highlighted in the past. We have the pipeline that's north of $100 million. We went in about 1/3 of the projects that are let is the projects we really choose to go after. And we think the opportunity is going to be very strong as we go forward. But I think it is something that's going to be more like a dimmer switch turning on rather than a light switch on and off, and I think it will start ramping up, and it will continue to ramp and it's going to be here as a market tailwind for quite some time.

And then staying a little deeper into your order outlook to more positive for power, what are you seeing in this market and can this growth continue?

Yes. We continue to see opportunities around power and power distribution. Some of the go-power plants are continuing to operate. So they're treating their wastewater. They're treating the water coming off of the stacks. And then as far as the ones that have shut down, we have very positive outlook of what we do around dewatering of the ash ponds. And it speaks to the value prop that Evoqua brings with all of our technologies being able to be mobilized. So we've built mobile applications for each technology where we can treat very tough emerging contaminants as well as contaminates that have been in the market for a while, and power is a great place to apply those products and those assets.

We'll take our next question from Bryan Blair with Oppenheimer.

Circling back to Mar Cor for a second. You've noted integration is on track. The key points that you're pacing towards a 25% margin target over the next 12 to 18 months. You're very positive in that sense. You did cite SAP implementation. You discussed that for a while. Are there any other callouts in terms of heavy lifting for the time being in terms of integration? And are you willing to speak to synergies realized to date?

I'll talk about some of the key drivers. Ben can talk about synergies. But really, the key drivers we've got SAP implementation, we've got - we've aligned all the back office on our benefits, all the plans that are there, medical, et cetera. The opportunities that are coming ahead of us are really around facilities and facility consolidations. If you'll recall, when we did the acquisition, we highlighted 27 service locations in Mar Cor, 25 of those are in a market area that we also have an ISS branch. So whether we move into the Mar Cor facility, they move into ours where we find a combined facility that fits for both of - for both businesses to be in because we need more space. That's really what the heavy lifting going forward is. And we're making great progress on that. We feel pretty pleased with what's happening. And again, being able to reiterate the 25% EBITDA is certainly right within the center of the bell curve.

Yes, Bryan, margins are strong and they are growing, but the best is yet to come as we get into the consolidations and more heavy lifting. Those have been mapped out. We're in the process of improving and running those through our internal processes to gain approval. But so far, the early synergies are starting to come through, but we still really haven't seen the lion's share of the synergies and that will come when we finish the SAP implementation, and we get to the footprint consolidation. And also, I just want to remind you also on working capital post SAP implementation, there's a healthy opportunity to really sizably reduce their working capital as a percentage of sales.

Understood. That makes sense. And you quickly highlighted the deals closed in July. I realize they're smaller, but can you speak to expected financial contribution from Smith and Epicor? And I'm curious if economic uncertainty has impacted your M&A pipeline, if at all, for the kind of strategic tuck-ins that drive your trend?

Yes. I'll speak to both of them. We're thrilled to have the Smith and Epicor teams as a part of Evoqua now. Epicor is one that we've done business with quite some time – for quite some time with resin processing for the special power markets that we go offer. So that is really more of a vertical integration play. We already have the sales and the opportunity that we were executing on and it was a vertical integration that it will support us with EBITDA, but not necessarily a lot of top line growth.

But then Smith gives us a great potential for top line growth in very key markets, as I highlighted in the script, life sciences, data centers, microelectronics. But it's bigger in the Minneapolis areas where they're located. So we now have a very large footprint in that market between Mar Cor and Smith that we've tied together. And it fits with the strategy we talked about around geographic penetration that we highlighted and we wanted to go after once we were able to close on the Mar Cor transaction, which is very heavily focused on the Minneapolis market. Smith became a great opportunity for us as well. The pipeline for M&A, tuck-in M&A, still very robust. And I think we'll see that continue, just as we highlighted on Slide 8 in the deck.

We'll go next to Joe Giordano with Cowen.

You mentioned book-to-bill and 4Q price that's expected to be above 1. You also mentioned some stuff about shipping delays. I just want to kind of circle back to that. Is that book-to-bill more because orders are accelerating or more because shipments are delayed? Do you have maybe any color on some sort of like average daily order metric that you would look at for fourth quarter relative to third quarter or something like that?

Yes. Joe, I would say the book-to-bill is not a – it's orders coming in at a very high, very positive rate. It's not as a result of us not being able to ship. If you look at ISS specifically for the quarter, they had revenue growth, organic revenue growth of 7.3%. APT had organic revenue growth of almost 13%. So between those 2, we're really pleased with the growth that we're delivering and having a book-to-bill ratio that continues well above 1 means that we're building backlog. And it's really the tailwinds in the market and just the strategy being executed on by the team.

Maybe one just high-level thing and maybe additional comment, but we've just been reading a lot more lately about what's going on in areas like Lake Mead and Salt Lake City and those areas seem for a better word screwed. I'm just curious if you're hearing more incremental action plans like from leaders in those areas about whether it's president or businesses there need to do things fundamentally different. And like is it something that you guys are looking at involved with? And any commentary there?

Yes, that's a great question. It's a very difficult situation that the western half of the United States is around the droughts that have been continued there. And that's something we've paid attention to for quite some time. And we do see businesses operating differently. I mean they are so focused on wastewater capture, recycle reuse, making sure that if they are expanding capacity, they're doing it by being more efficient with their water chain rather than go more broadly. So we're pleased with our impact that we can have on that situation. And frankly, we're partnering with our industrial customers in those market areas every single day to be more efficient with what they do. It's one of the things that we like to highlight on our sustainability and what Evoqua does as a company is the handprint opportunity that we have to preserve a very precious natural resource of water is what we're focused on, and industrial customers are aligning with us to make sure they're investing in that.

We'll take our next question from Andrew Kaplowitz with Citigroup.

I know you mentioned labor availability and hiring costs impacting ISS. Is that issue for you, would you say stable within your service business? Is it getting better or worse than you mentioned fuel costs, should those costs be starting to come down now? Any more color on sort of the cost in that service business would be helpful.

Yes. I’ll highlight and talk about the service business specifically. It has stabilized. We certainly went through a period of having to make sure that we were addressing wage compression in certain market areas with what's happening just in labor rates in the overall market and certainly in skilled labor markets. But it has stabilized now, Andy. And I feel like we are in a good place. Some of the turnover that happened right at the end of October that seem to be pretty strong across the industry, has stabilized, and we've been able to fill positions and fill it more quickly and actually fill them with very skilled team members with some good experience behind them. So I think that we're in a pretty good spot as far as labor goes. Ben can talk about fuel and challenges there.

I think fuel is still uncertain. Certainly, we saw higher fuel costs at the beginning of the quarter than it started having some abatement towards the end of the quarter. I think some of the outlooks suggest maybe more stability for Q4, but a big question mark for what happens next year at this point in time. But most of our fuel costs, we are able to push to our customers. We have a fuel surcharge in place. So we passed that through. However, the higher it goes, it also puts pressure on margins because of the fact that you're pushing it through as a surcharge and not necessarily at your traditional margins. So that does give a bit of a margin drag for ISS.

Helpful, guys. And then I know it's a small part of your business, but you highlighted municipal drinking water is due for Q4. Maybe you could talk about that market. And then just leave commentary in and around municipal waste order. Obviously, that's much bigger. Stand-alone government seem relatively flush with cash, and then you've got eventual IAJ contribution. So what do those businesses look like moving forward?

Yes. I'll talk about municipal drinking water, first of all, we should be stable. It is a smaller portion of our business, as you can see, where it's represented on Page 5. But we are continuing to work with municipal systems around retrofit and rehab. Their upgrades to their systems and what they're doing. And so that fits the municipal drinking water side as well as municipal wastewater. I would tell you across wastewater, it is green.

It will continue to be green. We see for the foreseeable future, certainly with what's being addressed on the infrastructure spending bill as well as what's happening, we're trying to recycle and reuse water. So they're trying to make sure the wastewater plants are operating efficiently. They're up to capacity. And so, very good retrofit and rehab there. Book-to-bill ratio there as well of 1 should continue to go that way, and we anticipate the infrastructure bill, actually, a lot of the projects are being designed and engineered now. We would expect to see orders from that come early '23 with revenue starting towards the latter half of '23.

We'll take our next question from Pavel Molchanov with Raymond James.

As you build capacity or expand capacity, I should say, outside of North America, I recall last fiscal year, international was maybe 12% of revenue. Do you have a part for how big you want the international footprint to be or maybe a prediction for what that slice of the pie will be this year or next year?

Yes. So, I think if you look at our international revenue, it's closer to 20%. Now, some of that is reported in North America because it's North America selling into some of the international operations. But we like where it is. We like 20% is a pretty good number. We want to continue to grow overall at Oakland, but we think that the international markets are going to grow at a much faster pace for us, meaning the emerging markets. And we've seen that. I mean a little bit of a challenge, it was experienced certainly through the COVID lockdowns, but our team in China has continued to operate very efficiently. Our team in Singapore, we're branching more deeply into India. So there's some good opportunities for us as we grow. And then our team in Europe has done an excellent job continuing to deliver in some tough market environments. So we were happy to be able to open the 2 new facilities we highlighted in the deck, and it's really a continuation of our build-out on centers of excellence that are going to serve the various markets that we participate in.

In that context, are you looking at non-North American M&A opportunities as part of your consolidation road map?

We do. We continue to look at those around product portfolio extensions more than service level extensions. And as evident of that, would be the ATG acquisition that we just did back in '19 where we consolidated that into - that was out of the UK. It was out of a facility called Wigan. We just moved it to a much larger facility because that business has grown tremendously. So a lot of our historic acquisitions in the product space have been internationally based acquisitions, and we continue to focus on those as we go forward as well. We're really looking more around technologies there.

And we’ll go next to Andy Kaplowitz who is – I’m sorry. We'll go next to John Walsh with Crédit Suisse.

And Ben, I like your Sinatra quote earlier in the Q&A. I got to be nice because I was going to ask a not nice question. I guess maybe that's not the right way to frame it. But I wanted to go back to the guidance. I understand that the year-over-year bridges you're kind of talking about, but I'm kind of confused by the quarter-over-quarter Q3 into Q4. It looks like it's kind of below your normal seasonal sale and kind of margin lift that you get. I was just wondering if you could kind of unpack that a little more what's happening on the quarter-to-quarter walk.

Yes, sure. I think if you look at history, which suggests we have upside, and that's why we have the top end of the range. But then you look at the current circumstances that we face, the potential for a recession, macro uncertainty, supply chain challenges, potential for customer delays. That's really why we left the guidance the way we did because there are the potential for those uncertainties. Q4, as you can see, is traditionally our strongest quarter. So if certain delays were to occur, things that are outside of our control, we wanted to make sure we are measured and accounted for that. Again, I just feel like in this environment, it's important to stay balanced.

Okay. That's fair. And then you got the PFAS question earlier as it relates to the United States. But just curious as we're starting to hear more and more coming out of Europe, whether it be Belgium, Germany. There's a lot more activity now. Would there be any kind of difference in technology that you would maybe offer into those markets? Or maybe it's more of a channel thing? You just have to have the right channel in those markets, but we'd love to hear how you think about that opportunity as PFAS broadens.

Yes. I'll actually tag that on to the prior question around international opportunities for acquisitions, which I talked about product technologies. One of the areas that we're very focused on is disrupt in field on PFAS. So there's a lot of different types of technologies that are throughout Europe that they're working on on-site destruction of PFAS, and there are a lot of trials that are happening. That's very interesting to us. So we're engaged in those. We're paying attention to what is there and what is available. And that's the technology evolution that we would hope to see in PFAs not just capture it, concentrate it, landfill it or incinerate it, it is destruct on site. So you're not actually having to move the PFAS out of the location it is.

We’ll go next to Brian Lee with Goldman Sachs.

Maybe sort of a follow-on to the prior question here. Just as you think about year-end and we try to sort of true up the model. Ben, the nice margin expansion in APT is the highest we've seen since fiscal '21. Are we expecting further improvement in the 4Q? And any thoughts into ’23? Is this sort of kind of the new normal on the APT side? And then, I guess, secondly, on the second question here. You guys have talked about customer availability. I think you just talked about customer delays and potentially wanting to be prudent around that as well as you think about the forward outlook. Have you seen any shifts either for the better or for the worse around customer availability and how that's been impacting your capital sales, either dependent or visibility?

Yes, I'll talk to you about the customer availability and leave Ben to cover the others. What we - it's been very spot and it totally depends on the end market. It is not availability with us being able to get on site, which it historically has been through the COVID shutdown, and we dealt with a lot of challenge around that. But the availability difficulties that we faced throughout this fiscal year has been primarily measured by has been whether or not they're ready to take our product or our application or they turn on their system for our service to occur. So that's where we see the challenges.

I mean, as we've highlighted, our backlog is tremendous. Order activity is great. We're managing supply chain. Our team has done a remarkable job managing supply chain. And so now what we're balanced again is against the supply chain of our customers when they're getting their site ready or they're ready to turn on their production line. And that's created the delays. It kind of varies by end market, what we're seeing, but I think it's worth the larger installations versus the smaller that tend to have more delays and a big challenge for us.

On the margin side, APT has done an excellent job of their structural cost that we talked a little bit about earlier as well as portfolio. And these benefits that we expect will stick and a lot of hard work has been done in that area. On the downside, they still face price cost headwinds like they'll be positive on the dollar amount, but the pressure associated with inflationary impacts and also supply chain disruptions impacting productivity in the business, they have our manufacturing facilities under APT, the majority of them. So they continue to face situations where our park does not show up, an item does not show up, a person who's out sick with COVID and have to battle through those types of challenges as well. But yes, very, very proud of the margins that they've been able to deliver. And again, that's been the majority of their structure and their portfolio decisions.

And at this time, I will now turn the call back over to Ron Keating for any closing remarks.

Thank you. Thank you again for your interest in Evoqua. We greatly appreciate the time that you've given us today. I would like to just close with a sincere thank you to all of our team members around the globe have been incredibly impressed with the way that they've operated, the way they've delivered, and we continue to focus on meeting customer demand every day and really staying true to our costs and the purpose of what Evoqua does, which is transforming water and (inaudible). So thank you for your time. We look forward to speaking with you again next quarter.

Thank you. And that concludes today's Evoqua Water Technologies Third Quarter 2022 Earnings Conference Call. You may now disconnect your lines, and thank you for your interest in Evoqua.