Evoqua Water Technologies Corp. - FORM 10-Q - August 7, 2018

Attached files

file filename
EX-32.1 - EXHIBIT 32.1 - Evoqua Water Technologies Corp.cfosoxcertificationexhibit.htm
EX-31.2 - EXHIBIT 31.2 - Evoqua Water Technologies Corp.cfocertificationexhibt312.htm
EX-31.1 - EXHIBIT 31.1 - Evoqua Water Technologies Corp.ceocertifiationexhibit311.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
ý
 
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended
June 30, 2018
or
o
 
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 001-38272
 
EVOQUA WATER TECHNOLOGIES CORP.
(Exact name of registrant as specified in its charter)
 
Delaware
(State or other jurisdiction of
incorporation or organization)
 
46-4132761
(I.R.S. Employer Identification No.)

210 Sixth Avenue
Pittsburgh, Pennsylvania
(Address of principal executive offices)
 

15222
(Zip code)
(724) 772-0044
(Registrant's telephone number, including area code)
         Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý   No o
         Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý    No o
         Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer",


"accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer ý
(Do not check if a
smaller reporting company)
 
Smaller reporting company o 
Emerging growth company o
         If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
         Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No ý
         There were 113,890,779 shares of the registrant's common stock, par value $0.01 per share, outstanding as of July 31, 2018.




EVOQUA WATER TECHNOLOGIES CORP.
TABLE OF CONTENTS







CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward‑looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). You can generally identify forward‑looking statements by our use of forward‑looking terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “projection,” “seek,” “should,” “will” or “would” or the negative thereof or other variations thereon or comparable terminology. In particular, statements about the markets in which we operate, including growth of our various markets, and our expectations, beliefs, plans, strategies, objectives, prospects, assumptions, or future events or performance contained in this report are forward‑looking statements.
We have based these forward‑looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward‑looking statements are only predictions and involve known and unknown risks and uncertainties, many of which are beyond our control. These and other important factors, including those discussed in “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended September 30, 2017, as filed with the Securities and Exchange Commission (SEC) on December 4, 2017, and "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation" of this Quarterly Report (Report) may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward‑looking statements, or could affect our share price. Some of the factors that could cause actual results to differ materially from those expressed or implied by the forward‑looking statements include:
•
general global economic and business conditions;

•
our ability to compete successfully in our markets;

•
our ability to execute projects in a timely manner, consistent with our customers' demands;

•
our ability to accurately predict the timing of contract awards;

•
material and other cost inflation and our ability to mitigate the impact of inflation by increasing selling prices and improving productivity efficiencies;

•
our ability to continue to develop or acquire new products, services and solutions and adapt our business to meet the demands of our customers, comply with changes to government regulations and achieve market acceptance with acceptable margins;

•
our ability to implement our growth strategy, including acquisitions and our ability to identify suitable acquisition targets;

•
our ability to operate or integrate any acquired businesses, assets or product lines profitably or otherwise successfully implement our growth strategy;

1


•
delays in enactment or repeals of environmental laws and regulations;

•
the potential for us to become subject to claims relating to handling, storage, release or disposal of hazardous materials;

•
risks associated with product defects and unanticipated or improper use of our products;

•
the potential for us to incur liabilities to customers as a result of warranty claims of failure to meet performance guarantees;

•
our ability to meet our customers’ safety standards or the potential for adverse publicity affecting our reputation as a result of incidents such as workplace accidents, mechanical failures, spills, uncontrolled discharges, damage to customer or third‑party property or the transmission of contaminants or diseases;

•
litigation, regulatory or enforcement actions and reputational risk as a result of the nature of our business or our participation in large‑scale projects;

•
seasonality of sales and weather conditions;

•
risks related to government customers, including potential challenges to our government contracts or our eligibility to serve government customers;

•
the potential for our contracts with federal, state and local governments to be terminated or adversely modified prior to completion;

•
risks related to foreign, federal, state and local environmental, health and safety laws and regulations and the costs associated therewith;

•
risks associated with international sales and operations, including our operations in China;

•
our ability to adequately protect our intellectual property from third‑party infringement;

•
our increasing dependence on the continuous and reliable operation of our information technology systems;

•
risks related to our substantial indebtedness;

•
our need for a significant amount of cash, which depends on many factors beyond our control;

•
risks related to AEA Investors LP’s (along with certain of its affiliates, collectively, “AEA”) ownership interest in us; and

•
other risks and uncertainties, including those listed under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017, as filed with the SEC on December 4, 2017, and in other filings we may make from time to time with the SEC.

Given these risks and uncertainties, you are cautioned not to place undue reliance on such forward‑looking statements. The forward‑looking statements contained in this Report are not guarantees of future performance and our actual results of operations, financial condition and liquidity, and the development of the industry in which we operate, may differ materially from the forward‑looking statements contained in this Report. In addition, even if our results of operations, financial condition and liquidity, and events in the industry in which we operate, are consistent with the

2

forward‑looking statements contained in this Report, they may not be predictive of results or developments in future periods.
Any forward‑looking statement that we make in this Report speaks only as of the date of such statement. Except as required by law, we do not undertake any obligation to update or revise, or to publicly announce any update or revision to, any of the forward‑looking statements, whether as a result of new information, future events or otherwise, after the date of this Report.


3

Part I - Financial Information

Item 1. Condensed Consolidated Financial Statements

INDEX TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Evoqua Water Technologies Corp.
 
Unaudited Condensed Consolidated Financial Statements
 


4

Evoqua Water Technologies Corp.
Condensed Consolidated Balance Sheets
(In thousands)
 
 
 
(Unaudited)
 
September 30, 2017
 
June 30, 2018
ASSETS
 
 
 
Current assets
$
512,240

 
$
536,835

Cash and cash equivalents
59,254

 
57,307

Receivables, net
245,248

 
228,330

Inventories, net
120,047

 
140,467

Cost and earnings in excess of billings on uncompleted contracts
66,814

 
84,900

Prepaid and other current assets
20,046

 
24,888

Income tax receivable
831

 
943

Property, plant, and equipment, net
280,043

 
289,178

Goodwill
321,913

 
324,272

Intangible assets, net
333,746

 
319,276

Deferred income taxes
2,968

 
7,049

Other non‑current assets
22,399

 
22,611

Total assets
$
1,473,309

 
$
1,499,221

LIABILITIES AND EQUITY
 
 
 
Current liabilities
$
291,899

 
$
278,602

Accounts payable
114,932

 
140,434

Current portion of debt
11,325

 
9,708

Billings in excess of costs incurred
27,124

 
21,259

Product warranties
11,164

 
7,760

Accrued expenses and other liabilities
121,923

 
90,395

Income tax payable
5,431

 
9,046

Non‑current liabilities
964,835

 
857,403

Long‑term debt
878,524

 
780,430

Product warranties
6,110

 
3,545

Other non‑current liabilities
67,673

 
64,837

Deferred income taxes
12,528

 
8,591

Total liabilities
1,256,734

 
1,136,005

Commitments and Contingent Liabilities (Note 17)


 


Shareholders’ equity
 
 
 
Common stock, par value $0.01: authorized 1,000,000 shares; issued 105,359 shares, outstanding 104,949 shares at September 30, 2017; issued 114,771 shares, outstanding 113,811 shares at June 30, 2018
1,054

 
1,143

Treasury stock: 410 shares at September 30, 2017 and 960 shares at June 30, 2018
(2,607)

 
(2,837)

Additional paid‑in capital
388,986

 
529,992

Retained deficit
(170,006)

 
(160,421)

Accumulated other comprehensive loss, net of tax
(5,989)

 
(8,800)

Total Evoqua Water Technologies Corp. equity
211,438

 
359,077

Non‑controlling interest
5,137

 
4,139

Total shareholders’ equity
216,575

 
363,216

Total liabilities and shareholders’ equity
$
1,473,309

 
$
1,499,221

See accompanying notes to these Unaudited Condensed Consolidated Financial Statements

5

Evoqua Water Technologies Corp.
Unaudited Condensed Consolidated Statements of Operations
(In thousands except per share data)
 
Three Months Ended
June 30,
 
Nine Months Ended June 30,
 
2017
 
2018
 
2017
 
2018
Revenue from product sales and services
$
311,142

 
$
342,475

 
$
890,916

 
$
973,215

Cost of product sales and services
(210,715
)
 
(240,468
)
 
(614,088
)
 
(674,832
)
Gross profit
100,427

 
102,007

 
276,828

 
298,383

General and administrative expense
(31,136
)
 
(56,961
)
 
(120,534
)
 
(140,767
)
Sales and marketing expense
(36,946
)
 
(33,888
)
 
(108,729
)
 
(102,459
)
Research and development expense
(5,592
)
 
(3,682
)
 
(15,684)

 
(12,356)

Total operating expenses
(73,674
)
 
(94,531
)
 
(244,947
)
 
(255,582
)
Other operating (expense) income
(329
)
 
7,362

 
981

 
7,674

Interest expense
(12,466
)
 
(12,370
)
 
(39,117
)
 
(40,423
)
Income (loss) before income taxes
13,958

 
2,468

 
(6,255
)
 
10,052

Income tax (expense) benefit
(12,202
)
 
(1,433
)
 
(295
)
 
960

Net income (loss)
1,756

 
1,035

 
(6,550
)
 
11,012

Net income attributable to non‑controlling interest
253

 
242

 
2,348

 
1,427

Net income (loss) attributable to Evoqua Water Technologies Corp.
$
1,503

 
$
793

 
$
(8,898
)
 
$
9,585

 
 
 
 
 
 
 
 
Basic earnings (loss) per common share
$
0.01

 
$
0.01

 
$
(0.08
)
 
$
0.08

Diluted earnings (loss) per common share
$
0.01

 
$
0.01

 
$
(0.08
)
 
$
0.08

See accompanying notes to these Unaudited Condensed Consolidated Financial Statements


6

Evoqua Water Technologies Corp.
Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)
(In thousands)
 
Three Months Ended
June 30,
 
Nine Months Ended June 30,
 
2017
 
2018
 
2017
 
2018
Net income (loss)
$
1,756

 
$
1,035

 
$
(6,550
)
 
$
11,012

Other comprehensive (loss) income
 
 
 
 
 
 
 
Foreign currency translation adjustments
(3,027)

 
(2,018)

 
2,773

 
(2,811)

Less: Comprehensive income attributable to non‑controlling interest
(253
)
 
(242
)
 
(2,348
)
 
(1,427
)
Comprehensive (loss) income attributable to Evoqua Water Technologies Corp.
$
(1,524
)
 
$
(1,225
)
 
$
(6,125
)
 
$
6,774

See accompanying notes to these Unaudited Condensed Consolidated Financial Statements


7

Evoqua Water Technologies Corp.
Unaudited Condensed Consolidated Statements of Changes in Equity
(In thousands)
 
Common
Stock
Shares
 
Common
Stock
 
Treasury
Stock
Shares
 
Treasury
Stock
 
Additional
Paid‑in
Capital
 
Retained
Deficit
 
Accumulated
Other
Comprehensive
Loss
 
Non‑controlling
Interest
 
Total
Balance at September 30, 2016
104,495

 
$
1,045

 
245

 
$
(1,133
)
 
$
381,223

 
$
(172,169
)
 
$
(10,671
)
 
$
5,640

 
$
203,935

Equity based compensation expense
—

 
—

 
—

 
—

 
1,634

 
—

 
—

 
—

 
1,634

Issuance of common stock
864

 
9

 
—

 
—

 
5,512

 
—

 
—

 
—

 
5,521

Stock repurchases
—

 
—

 
124

 
(1,076
)
 
—

 
—

 
—

 
—

 
(1,076
)
Dividends paid to non‑controlling interest
—

 
—

 
—

 
—

 
—

 
—

 
 
 
(4,750
)
 
(4,750
)
Net (loss) income
—

 
—

 
—

 
—

 
—

 
(8,898
)
 
—

 
2,348

 
(6,550
)
Other comprehensive income
 
 
—

 
 
 
—

 
—

 
—

 
2,773

 
—

 
2,773

Balance at June 30, 2017
105,359

 
$
1,054

 
369

 
$
(2,209
)
 
$
388,369

 
$
(181,067
)
 
$
(7,898
)
 
$
3,238

 
$
201,487

Balance at September 30, 2017
105,359

 
$
1,054

 
410

 
$
(2,607
)
 
$
388,986

 
$
(170,006
)
 
$
(5,989
)
 
$
5,137

 
$
216,575

Equity based compensation expense
—

 
—

 
—

 
—

 
11,257

 
—

 
—

 
 
 
11,257

Shares of common stock issued in initial public offering, net of offering costs
8,333

 
83

 
—

 
—

 
137,522

 
—

 
—

 
 
 
137,605

Shares withheld related to net share settlement (including tax withholdings)
1,079

 
6

 
532

 
—

 
(7,773
)
 
 
 
 
 
 
 
(7,767
)
Stock repurchases
—

 
—

 
18

 
(230
)
 
—

 
—

 
—

 
 
 
(230
)
Dividends paid to non‑controlling interest
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(2,425
)
 
(2,425
)
Net income
—

 
—

 
—

 
—

 
—

 
9,585

 
—

 
1,427

 
11,012

Other comprehensive loss
—

 
—

 
—

 
—

 
—

 
—

 
(2,811
)
 
 
 
(2,811
)
Balance at June 30, 2018
114,771

 
$
1,143

 
960

 
$
(2,837
)
 
$
529,992

 
$
(160,421
)
 
$
(8,800
)
 
$
4,139

 
$
363,216

See accompanying notes to these Unaudited Condensed Consolidated Financial Statements


8

Evoqua Water Technologies Corp.
Unaudited Condensed Consolidated Statements of Changes in Cash Flows
(In thousands)
 
Nine Months Ended June 30,
 
2017
 
2018
Operating activities
 
 
 
Net (loss) income
$
(6,550
)
 
$
11,012

Reconciliation of net (loss) income to cash flows from operating activities:
 
 
 
Depreciation and amortization
55,813

 
61,924

Amortization of deferred financing costs (includes $2,075 and $2,994 write off of deferred financing fees)
5,970

 
4,926

Deferred income taxes
(107
)
 
(8,072
)
Share-based compensation
1,634

 
11,257

Loss (gain) on sale of property, plant and equipment
349

 
(6,507
)
Foreign currency (gains) losses on intracompany loans
(1,489
)
 
5,059

Changes in assets and liabilities
 
 
 
Accounts receivable
(6,454
)
 
14,509

Inventories
(7,964
)
 
(20,385
)
Cost and earnings in excess of billings on uncompleted contracts
(8,900
)
 
(18,519
)
Prepaids and other current assets
(9,139
)
 
(5,559
)
Accounts payable
(1,009
)
 
26,910

Accrued expenses and other liabilities
(10,678
)
 
(33,548
)
Billings in excess of costs incurred
249

 
(5,567
)
Income taxes
(1,181
)
 
3,471

Other non‑current assets and liabilities
5,248

 
(4,123
)
Net cash provided by operating activities
15,792

 
36,788

Investing activities
 
 
 
Purchase of property, plant and equipment
(40,475
)
 
(54,569
)
Purchase of intangibles
(4,175
)
 
(1,536
)
Proceeds from sale of property, plant and equipment
5,221

 
13,247

Proceeds from sale of business
—

 
430

Acquisitions, net of cash acquired of $0 and $28
(77,837
)
 
(10,235
)
Net cash used in investing activities
(117,266
)
 
(52,663
)
Financing activities
 
 
 
Issuance of debt
157,100

 
5,398

Capitalized deferred issuance costs related to refinancing
(4,198
)
 
(2,004
)
Borrowings under credit facility
113,000

 
46,812

Repayment of debt
(156,306
)
 
(154,752
)
Payment of earn-out related to previous acquisitions
—

 
(1,719
)
Repayment of capital lease obligation
(4,842
)
 
(5,990
)
Proceeds from issuance of common stock
5,521

 
137,605

Taxes paid related to net share settlements of share-based compensation awards
—

 
(7,767
)
Stock repurchases
(1,076
)
 
(230
)
Distribution to non‑controlling interest
(4,750
)
 
(2,425
)
Net cash provided by financing activities
104,449

 
14,928

Effect of exchange rate changes on cash
680

 
(1,000
)
Change in cash and cash equivalents
$
3,655

 
$
(1,947
)
Cash and cash equivalents
 
 
 
Beginning of period
50,362

 
59,254

End of period
$
54,017

 
$
57,307

See accompanying notes to these Unaudited Condensed Consolidated Financial Statements

9

Evoqua Water Technologies Corp.
Unaudited Supplemental Disclosure of Cash Flow Information
(In thousands)
 
Nine Months Ended June 30,
 
2017
 
2018
Supplemental disclosure of cash flow information
 
 
 
Cash paid for taxes
$
2,335

 
$
4,020

Cash paid for interest
$
31,546

 
$
31,179

Non‑cash investing and financing activities
 
 
 
Accrued earn-out related to acquisitions
$
4,871

 
$
1,395

Capital lease transactions
$
12,686

 
$
5,275

Cloud computing related intangible transaction
$
5,544

 
$
—

See accompanying notes to these Unaudited Condensed Consolidated Financial Statements

10

Evoqua Water Technologies Corp.
Notes to Unaudited Condensed Consolidated Financial Statements
September 30, 2017 and June 30, 2018
(In thousands)
1. Description of the Company and Basis of Presentation
Background
Evoqua Water Technologies Corp. (referred to herein as "the Company" or "EWT") was incorporated on October 7, 2013. On January 15, 2014, Evoqua Water Technologies Corp., acquired through its wholly owned entities, EWT Holdings II Corp. and EWT Holdings III Corp. (a/k/a Evoqua Water Technologies), all of the outstanding shares of Siemens Water Technologies, a group of legal entity businesses formerly owned by Siemens AG (Siemens). The stock purchase closed on January 15, 2014 and was effective January 16, 2014 (the Acquisition). The stock purchase price, net of cash received, was approximately $730,577. On November 6, 2017, the Company completed its initial public offering (IPO), pursuant to which an aggregate of 27,777 shares of common stock were sold, of which 8,333 were sold by the Company and 19,444 were sold by the selling stockholders, with a par value of $0.01 per share. After underwriting discounts and commissions, the Company received net proceeds from the IPO of approximately $137,605. The Company used a portion of these proceeds to repay $104,936 of indebtedness (including accrued and unpaid interest) under its senior secured First Lien Term Loan facility and the remainder for general corporate purposes. The Company did not receive any proceeds from the sale of shares by the selling stockholders. On November 7, 2017, the selling stockholders sold an additional 4,167 shares of common stock as a result of the exercise in full by the underwriters of an option to purchase additional shares. On March 19, 2018, the Company completed a secondary public offering, pursuant to which 17,500 shares of common stock were sold by certain selling stockholders. On March 21, 2018, the selling stockholders sold an additional 2,625 shares of common stock as a result of the exercise in full by the underwriters of an option to purchase additional shares. The Company did not receive any proceeds from the sale of shares by the selling stockholders.
The Business
EWT provides a wide range of product brands and advanced water and wastewater treatment systems and technologies, as well as mobile and emergency water supply solutions and service contract options through its segment branch network. Headquartered in Pittsburgh, Pennsylvania, EWT is a multi‑national corporation with operations in the United States, Canada, the United Kingdom, the Netherlands, Germany, Australia, China, and Singapore.
The Company is organizationally structured into three reportable segments for the purpose of making operational decisions and assessing financial performance: (i) Industrial, (ii) Municipal and (iii) Products.
Basis of Presentation
The accompanying Unaudited Condensed Consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). All intracompany transactions have been eliminated.
The unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such SEC rules. We believe that the disclosures made are adequate to make the information presented not misleading. We consistently applied the accounting policies described in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017, as filed with the SEC on December 4, 2017 (2017 Annual Report), in preparing these unaudited condensed consolidated financial statements, with the exception of accounting standard updates described in Note 2. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and the notes included in our 2017 Annual Report.

11


2. Summary of Significant Accounting Policies
Fiscal Year
The Company’s fiscal year ends on September 30.
Use of Estimates
The unaudited condensed consolidated financial statements have been prepared in conformity with U.S. GAAP and require management to make estimates and assumptions. These assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Estimates and assumptions are used for, but not limited to: (i) revenue recognition; (ii) allowance for doubtful accounts; (iii) inventory valuation, asset valuations, impairment, and recoverability assessments; (iv) depreciable lives of assets; (v) useful lives of intangible assets; (vi) income tax reserves and valuation allowances; and (vii) product warranty and litigation reserves. Estimates are revised as additional information becomes available. Actual results could differ from these estimates.
Cash and Cash Equivalents
Cash and cash equivalents are liquid investments with an original maturity of three or fewer months when purchased.
Accounts Receivable
Receivables are primarily comprised of uncollected amounts owed to us from transactions with customers and are presented net of allowances for doubtful accounts. Allowances are estimated based on historical write‑offs and the economic status of customers. The Company considers a receivable delinquent if it is unpaid after the term of the related invoice has expired. Write‑offs are recorded at the time all collection efforts have been exhausted.
Inventories
Inventories are stated at the lower of cost or market, where cost is generally determined on the basis of an average or first‑in, first‑out (FIFO) method. Production costs comprise direct material and labor and applicable manufacturing overheads, including depreciation charges. The Company regularly reviews inventory quantities on hand and writes off excess or obsolete inventory based on estimated forecasts of product demand and production requirements. Manufacturing operations recognize cost of product sales using standard costing rates with overhead absorption which generally approximates actual cost.
Property, Plant, and Equipment
Property, plant, and equipment is valued at cost less accumulated depreciation and impairment losses. If the costs of certain components of an item of property, plant, and equipment are significant in relation to the total cost of the item, they are accounted for and depreciated separately. Depreciation expense is recognized using the straight‑line method. Useful lives are reviewed annually and, if expectations differ from previous estimates, adjusted accordingly. Estimated useful lives for major classes of depreciable assets are as follows:
Asset Class
Estimated Useful Life
Machinery and equipment
3 to 20 years
Buildings and improvements
10 to 40 years
Leasehold improvements are depreciated over the shorter of their estimated useful life or the term of the lease. Costs related to maintenance and repairs that do not extend the assets’ useful life are expensed as incurred.

12

Goodwill and Other Intangible Assets
Goodwill represents purchase consideration paid in a business combination that exceeds the value assigned to the net assets of acquired businesses. Other intangible assets consist of customer‑related intangibles, proprietary technology, software, trademarks and other intangible assets. The Company amortizes intangible assets with definite useful lives on a straight‑line basis over their respective estimated economic lives which range from 1 to 26 years.
The Company reviews goodwill to determine potential impairment annually during the fourth quarter of our fiscal year, or more frequently if events and circumstances indicate that the asset might be impaired. Impairment testing for goodwill is performed at a reporting unit level. We have determined that we have four reporting units. Our quantitative impairment testing utilizes both a market (guideline public company) and income (discounted cash flows) method for determining fair value. In estimating the fair value of the reporting unit utilizing a discounted cash flow (“DCF”) valuation technique, we incorporate our judgment and estimates of future cash flows, future revenue and gross profit growth rates, terminal value amount, capital expenditures and applicable weighted‑average cost of capital used to discount these estimated cash flows. The estimates and projections used in the estimate of fair value are consistent with our current budget and long‑range plans, including anticipated change in market conditions, industry trend, growth rates and planned capital expenditures, among other considerations.
Impairment of Long‑Lived Assets
Long‑lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of the asset or asset group is measured by comparison of its carrying amount to undiscounted future net cash flows the asset or asset group is expected to generate. If the carrying amount of an asset or asset group is not recoverable, the Company recognizes an impairment loss based on the excess of the carrying amount of the asset or asset group over its respective fair value which is generally determined as the present value of estimated future cash flows or as the appraised value.
Debt Issuance Costs and Debt Discounts
Debt issuance costs are capitalized and amortized over the contractual term of the underlying debt using the straight line method which approximates the effective interest method. Debt discounts and lender arrangement fees deducted from the proceeds have been included as a component of the carrying value of debt and are being amortized to interest expense using the effective interest method.
Amortization of debt issuance costs and debt discounts/premiums included in interest expense were $1,875 and $478 for the three months ended June 30, 2017 and 2018, respectively and $4,376 and $1,932 for the nine months ended June 30, 2017 and 2018, respectively.
In October 2016, the Company wrote off $2,075 of deferred financing fees related to the extinguishment of debt and incurred another $481 of fees related to a tack-on financing the Company completed on October 28, 2016.
In November 2017, the Company wrote off $1,844 of deferred financing fees related to a $100,000 prepayment of debt, then subsequently wrote off another $1,150 of fees in December of 2017 due to refinancing its First Lien Term Loan. The Company incurred another $2,131 of fees as a result of the December refinancing.
Revenue Recognition
Sales of goods and services are recognized when persuasive evidence of an arrangement exists, the price is fixed or determinable, collectability is reasonably assured and delivery has occurred or services have been rendered.
For sales of aftermarket parts or products with a low level of customization and engineering time, the Company recognizes revenues at the time risks and rewards of ownership pass, which is generally when products are shipped or delivered to the customer as the Company has no obligation for installation. Sales of short‑term service arrangements are recognized as the services are performed, and sales of long‑term service arrangements are typically recognized on a straight‑line basis over the life of the agreement.

13

For certain arrangements where there is significant customization to the product, the Company recognizes revenue under the provisions of Accounting Standards Codification (ASC) 605-35, Revenue Recognition – Construction-Type and Production-Type Contracts. These products include large capital water treatment projects, systems and solutions for municipal and industrial applications. Revenues from construction-type contracts are generally recognized under the percentage-of-completion method, based on the input of costs incurred to date as a percentage of total estimated contract costs. The nature of the contracts is generally fixed price with milestone billings. Approximately $63,148 and $74,824 of revenues from construction-type contracts were recognized on the percentage-of-completion method during the three months ended June 30, 2017 and 2018, respectively and $168,030 and $204,731 for the nine months ended June 30, 2017 and 2018, respectively. Contract revenues and cost estimates are reviewed and revised quarterly at a minimum and the cumulative effect of such adjustments are recognized in current operations. The amount of such adjustments have not been material. Cost and earnings in excess of billings under construction‑type arrangements are recorded when contracts have net asset balances where contract costs plus recognized profits less recognized losses exceed progress billings. Billings in excess of costs incurred are recorded when contract progress billings exceed costs and recognized profit less recognized losses. Approximately $6,888 and $6,697 of revenues from construction-type contracts were recognized on a completed contract method, which is typically when the product is delivered and accepted by the customer, during the three months ended June 30, 2017 and 2018, respectively and $21,353 and $19,897 for the nine months ended June 30, 2017 and 2018, respectively. The completed contract method is principally used when the contract is short in duration and where results of operations would not vary materially from those resulting from the use of the percentage-of-completion method.
Product Warranties
Accruals for estimated expenses related to warranties are made at the time products are sold and are recorded as a component of Cost of product sales in the Unaudited Condensed Consolidated Statements of Operations. The estimated warranty obligation is based on product warranty terms offered to customers, ongoing product failure rates, material usage and service delivery costs expected to be incurred in correcting a product failure, as well as specific obligations for known failures and other currently available evidence. The Company assesses the adequacy of the recorded warranty liabilities on a regular basis and adjusts amounts as necessary.
Shipping and Handling Cost
Shipping and handling costs are included as a component of Cost of product sales.
Income Taxes
The Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that included the enactment date. Valuation allowances are provided against deferred tax assets when it is deemed more likely than not that some portion or all of the deferred tax asset will not be realized within a reasonable time period. We assess tax positions using a two‑step process. A tax position is recognized if it meets a more‑likely‑than‑not threshold, and is measured at the largest amount of benefit that is greater than 50.0% percent of being realized. Uncertain tax positions are reviewed each balance sheet date.
Sales Taxes
Upon collection of sales tax from revenue, the amount of sales tax is placed into an accrued liability account. This liability is then relieved when the payment is sent to the proper government jurisdiction.
Foreign Currency Translation and Transactions
The functional currency for the international subsidiaries is the local currency. Assets and liabilities are translated into U.S. Dollars using current rates of exchange, with the resulting translation adjustments recorded in other comprehensive income/loss within shareholders' equity. Revenues and expenses are translated at the weighted‑average

14

exchange rate for the period, with the resulting translation adjustments recorded in the Unaudited Condensed Consolidated Statements of Operations.
Foreign currency transaction (gains) losses which aggregated $(6,872) and $9,340 for the three months ended June 30, 2017 and 2018, respectively, and $(1,663) and $5,652 for the nine months ended June 30, 2017 and 2018, respectively, are primarily included in General and administrative expenses in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).
Research and Development Costs
Research and development costs are expensed as incurred. The Company recorded $5,592 and $3,682 of costs for the three months ended June 30, 2017 and 2018, respectively and $15,684 and $12,356 for the nine months ended June 30, 2017 and 2018, respectively.
Equity‑based Compensation
The Company measures the cost of awards of equity instruments to employees based on the grant‑date fair value of the award. Prior to the IPO, given the absence of a public trading market for our common stock, the fair value of the common stock underlying our share‑based awards was determined by our board, with input from management, in each case using the income and market valuation approach. Stock options are granted with exercise prices equal to or greater than the estimated fair market value on the date of grant as authorized by our compensation committee. The grant‑date fair value is determined using the Black‑Scholes model. The fair value, net of estimated forfeitures, is amortized as compensation cost on a straight‑line basis over the vesting period primarily as a component of General and administrative expenses. 
Earnings Per Share
Basic earnings per common share is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted earnings per common share is computed based on the weighted average number of shares of common stock, plus the effect of diluted common shares outstanding during the period using the treasury stock method. Diluted potential common shares include outstanding stock options.
Retirement Benefits
The Company applies ASC Topic 715, Compensation—Retirement Benefits, which requires the recognition in pension obligations and accumulated other comprehensive income of actuarial gains or losses, prior service costs or credits and transition assets or obligations that have previously been deferred. The determination of retirement benefit pension obligations and associated costs requires the use of actuarial computations to estimate participant plan benefits to which the employees will be entitled. The significant assumptions primarily relate to discount rates, expected long‑term rates of return on plan assets, rate of future compensation increases, mortality, years of service, and other factors. The Company develops each assumption using relevant experience in conjunction with market‑related data for each individual country in which such plans exist. All actuarial assumptions are reviewed annually with third‑party consultants and adjusted as necessary. For the recognition of net periodic postretirement cost, the calculation of the expected return on plan assets is generally derived by applying the expected long‑term rate of return on the market‑related value of plan assets. The fair value of plan assets is determined based on actual market prices or estimated fair value at the measurement date.
Treated Water Outsourcing
The following provides a summary of Treated Water Outsourcing (TWO), a joint venture between the Company and Nalco Water, an Ecolab company, in which the Company holds a 50% partnership interest as of September 30, 2017 and June 30, 2018, respectively. As the Company is obligated to absorb all risk of loss up to 100% of the joint venture partner's equity, TWO is fully consolidated within the Company's consolidated financial statements under ASC 810, Consolidation. The Company has not provided additional financial support to this entity which it is not contractually required to provide, and the Company does not have the ability to use the assets of TWO to settle obligations of the Company’s other subsidiaries.

15

 
September 30, 2017
 
June 30, 2018
Current assets (including cash of $1,907 and $2,297)
$
12,006

 
$
8,188

Property, plant and equipment
6,107

 
4,726

Goodwill
2,206

 
2,206

Other non-current assets
2,735

 
2,735

Total liabilities
(12,781
)
 
(9,500
)
 
 
 
 
 
Three Months Ended June 30,
 
2017
 
2018
Total revenues
$
3,570

 
$
3,020

Total operating expenses
(3,089
)
 
(2,535
)
Income from operations
$
481

 
$
485

 
 
 
 
 
Nine Months Ended June 30,
 
2017
 
2018
Total revenues
$
11,645

 
$
12,586

Total operating expenses
(8,857
)
 
(9,732
)
Income from operations
$
2,788

 
$
2,854

Recent Accounting Pronouncements
Accounting Pronouncements Not Yet Adopted
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU No. 2014-09 clarifies the principles for recognizing revenue when an entity either enters into a contract with customers to transfer goods or services or enters into a contract for the transfer of non-financial assets. ASU 2014-09 may be adopted using either of two acceptable methods: (1) retrospective adoption to each prior period presented with the option to elect certain practical expedients; or (2) adoption with the cumulative effect recognized at the date of initial application and providing certain disclosures. To assess at which time revenue should be recognized, an entity should use the following steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. The standard is effective for the Company for the quarter ending December 31, 2018. The Company has completed its first phase of adopting this standard, which was to identify the potential differences that will result from applying the new revenue recognition standard to the Company's contracts with its customers, and has begun the second step of reviewing its contracts to determine the impact of adopting the standard. The Company has completed its preliminary assessment of the impact of the new standard compared to the historical accounting policies on a representative sample of contracts.  The Company does not anticipate a material change to result from the adoption of the new standard related to its product sales.  The Company recognizes revenue for some of its contracts on a percentage-of-completion basis, which represented approximately 21% of its consolidated net sales for the nine months ended June 30, 2018.  The Company expects that for some of these contracts, the new guidance will instead require revenue to be recognized at a point in time.   The Company is continuing to assess the ultimate impact that the adoption of this standard will have on its consolidated financial statements and related disclosures.  In addition, the Company is evaluating the changes that will be required in its internal controls as a result of the adoption of this new standard.  The Company is planning to adopt the provisions of the ASU and its subsequent amendments using the modified retrospective transition method for existing transactions that will likely result in a cumulative effect adjustment as of October 1, 2018.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). ASU No. 2016-02 requires recognition of operating leases as lease assets and liabilities on the balance sheet, and disclosure of key information

16

about leasing arrangements. ASU No. 2016-02 will be effective retrospectively for the Company for the quarter ending December 31, 2019, with early adoption permitted. The Company is currently reviewing its leasing arrangements in order to evaluate the impact this standard will have on the Company's Consolidated financial statements and related disclosures.
In October 2016, the FASB issued ASU 2016-17, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. The purpose of this update is to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. The ASU requires the tax effects of all intra-entity sales of assets other than inventory to be recognized in the period in which the transaction occurs. The guidance will be effective for the Company for the quarter ending December 31, 2018 with early adoption permitted but only in the first interim period of a fiscal year. The changes are required to be applied by means of a cumulative-effect adjustment recorded in retained earnings as of the beginning of the fiscal year of adoption.  The Company is currently evaluating the potential impact of adoption on the Company’s Consolidated financial statements.
In February 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This ASU requires the disaggregation of the service cost component from other components of net periodic benefit cost, clarifies how to present the service cost component and other components of net benefit costs in the Statements of Consolidated Operations and allows only the service cost component of net benefit costs to be eligible for capitalization. This ASU is effective for the Company for the quarter ending December 31, 2018. Adoption will be applied on a retrospective basis for the presentation of all components of net periodic benefit costs and on a prospective basis for the capitalization of the service cost component of net periodic pension cost and net periodic postretirement benefit in assets. The Company does not expect the impact of adoption on the Company’s Consolidated financial statements to be material.
In May 2017, the FASB issued ASU 2017‑09, Scope of Modification Accounting, which amended Accounting Standards Code Topic 718. FASB issued ASU 2017‑09 to reduce the cost and complexity when applying Topic 718 and standardize the practice of applying Topic 718 to financial reporting. The ASU was not developed to fundamentally change the definition of a modification, but instead to provide guidance for what changes would qualify as a modification. ASU No. 2017‑09 will be effective for the Company for the quarter ending December 31, 2018. The Company is currently evaluating the potential impact of adoption on the Company’s Consolidated financial statements.
In May 2017, the FASB issued ASU 2017‑12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which expands and refines hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements and also make certain targeted improvements to simplify the application of hedge accounting guidance and ease the administrative burden of hedge documentation requirements and assessing hedge effectiveness. ASU No. 2017‑12 will be effective for the Company for the quarter ending December 31, 2018. The Company does not expect the impact of adoption on the Company’s Consolidated financial statements to be material.
In May 2017, the FASB issued ASU 2018‑02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows for a reclassification from Accumulated other comprehensive loss to Retained deficit for stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information to users of financial statements. ASU No. 2017‑09 will be effective for the Company for the quarter ending December 31, 2018. The Company does not expect the impact of adoption on the Company’s Consolidated financial statements to be material.
In June 2018, the FASB issued ASU 2018‑07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. ASU No. 2018‑07 will be effective for the Company for the quarter ending December 31, 2019. The Company does not expect the impact of adoption on the Company’s Consolidated financial statements to be material.
Accounting Pronouncements Recently Adopted
The Company adopted ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation – Stock Compensation as of October 1, 2017. The ASU includes provisions

17

intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. The adoption of this ASU did not have a significant impact on the Company's Consolidated financial statements.
The Company early adopted ASU 2016‑15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force) for the year beginning October 1, 2018. This new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The guidance is to be applied retrospectively to all periods presented, however there were no instances in prior periods that were impacted by the adoption of this ASU. This adoption did not have a material impact on the Company's Consolidated financial statements and for the quarter ending June 30, 2018, resulted in the reporting of an earn-out from a prior acquisition for $2,619 to be reported in the Financing section of the Unaudited Condensed Consolidated Statements of Changes in Cash Flows.
The Company early adopted ASU 2017‑04, Simplifying the Test for Goodwill Impairment, for the year beginning October 1, 2017. This ASU simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures goodwill impairment loss by comparing the implied value of a reporting unit’s goodwill with the carrying amount of that goodwill. The amendments in this ASU are effective for the Company for the quarter ending December 31, 2020. The adoption of this ASU did not have a material impact on the Company's Consolidated financial statements.
3. Acquisitions and Divestitures
Acquisitions support the Company's strategy of delivering a broad solutions portfolio with robust technology across multiple geographies and end markets. The following acquisitions were made during the nine months ended June 30, 2018.
The Company acquired Pure Water Solutions on January 31, 2018, a provider of high-purity water equipment and systems, service deionization and resin regeneration, with service operations in suburban Denver, CO and Santa Fe, NM for $4,699; $3,706 cash at closing with a maximum earn-out payment of $993 to be paid out twelve months after the closing. The fair value of earn-out payments at the date of acquisition was $461. Pure Water Solutions is part of the Industrial Segment, and extends the Company’s service network.
On March 9, 2018, the Company acquired Pacific Ozone Technology, Inc, a provider of advanced ozone disinfection systems, testing products and support services for $8,557; $6,557 cash at closing; with up to another $2,000 of earn-out payments to be paid out over three years after the closing. The fair value of earn-out payments at the date of acquisition was $934. Pacific Ozone, based in Benecia, CA, is part of the Products Segment and adds a new technology, ozone disinfection, to the portfolio and further enhances the Company's ability in the industrial water treatment and aquatics market.
Pro forma results for acquisitions completed during the nine months ended June 30, 2018 were determined to not be material.
The preliminary opening balance sheet for the acquisitions is summarized as follows.
 
Pure Water
 
Pacific Ozone
 
Total
Current assets
$
277

 
$
1,953

 
$
2,230

Property, plant and equipment
175

 
151

 
326

Goodwill
2,462

 
3,757

 
6,219

Intangible assets
1,488

 
2,678

 
4,166

Total assets acquired
4,402

 
8,539

 
12,941

Total liabilities assumed
(164
)
 
(916
)
 
(1,080
)
Net assets acquired
$
4,238

 
$
7,623

 
$
11,861


18

On April 9, 2018, the Company completed the sale of 100% of the corporate capital of Evoqua Water Technologies S.r.l., which includes the Company’s former operations in Italy, to Giotto Water S.r.l. (Giotto). The aggregate purchase price paid in cash by Giotto in the transaction was €350 ($430), subject to certain earn-out adjustments to be paid by Giotto in connection with the realization of specified tax benefits relating to previous years, and resulted in a nominal gain which is included in Other operating (expense) income of the Unaudited Condensed Consolidated Statements of Operations. The major classes of assets and liabilities included in this transaction were Accounts receivable of 344 euro, ($484), Cost and earnings in excess of billings on uncompleted contracts 225 euro, ($277), Prepaid and other current asset 283 euro, ($348), Goodwill 118 euro, ($145), Other non-current assets 180 euro, ($222), Accounts payable 33 euro, ($40), current Product warranty 516, ($625) and Accrued expenses and other liabilities 147 euro, ($181).
4. Fair Value Measurements
As of September 30, 2017 and June 30, 2018, the fair values of cash and cash equivalents, accounts receivable and accounts payable approximate carrying values due to the short maturity of these items.
The Company measures the fair value of pension plan assets and liabilities, deferred compensation plan assets and liabilities on a recurring basis pursuant to ASC Topic 820. ASC Topic 820 establishes a three‑tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:
Level 1: Quoted prices for identical instruments in active markets.
Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model‑derived valuations whose inputs are observable or whose significant value driver is observable.
Level 3: Unobservable inputs in which little or no market data is available, therefore requiring an entity to develop its own assumptions.
The following table presents the Company’s financial assets and liabilities at fair value. The fair values related to the pension plan assets are determined using net asset value (NAV) as a practical expedient, or by information categorized in the fair value hierarchy level based on the inputs used to determine fair value. The reported carrying amounts of deferred compensation plan assets and liabilities and debt approximate their fair values. The Company uses interest rates and other relevant information generated by market transactions involving similar instruments to fair value these assets and liabilities, therefore all are classified as Level 2 within the valuation hierarchy.

19

 
Net Asset Value
 
Quoted Market
Prices in Active
Markets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
As of September 30, 2017
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Pension plan
 
 
 
 
 
 
 
Cash
$
—

 
$
16,024

 
$
—

 
$
—

Government Securities
3,206

 
—

 
—

 
—

Liability Driven Investment
2,754

 
—

 
—

 
—

Guernsey Unit Trust
932

 
—

 
—

 
—

Global Absolute Return
2,139

 
—

 
—

 
—

Deferred compensation plan assets

 

 

 

Trust Assets
—

 
2,146

 
—

 
—

Insurance
—

 
—

 
17,396

 
—

Liabilities:

 

 

 

Pension plan
—

 
—

 
(34,803
)
 
—

Deferred compensation plan liabilities
—

 
—

 
(21,159
)
 
—

Long‑term debt
—

 
—

 
(912,471
)
 
—

 
 
 
 
 
 
 
 
As of June 30, 2018
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Pension plan
 
 
 
 
 
 
 
Cash
$
—

 
$
15,703

 
$
—

 
$
—

Government Securities
2,938

 
—

 
—

 
—

Liability Driven Investment
3,245

 
—

 
—

 
—

Guernsey Unit Trust
948

 
—

 
—

 
—

Global Absolute Return
2,058

 
—

 
—

 
—

Deferred compensation plan assets

 

 

 

Trust Assets
—

 
766

 
—

 
—

Insurance
—

 
—

 
18,029

 
—

Liabilities:

 

 

 

Pension plan
—

 
—

 
(34,162
)
 
—

Deferred compensation plan liabilities
—

 
—

 
(21,267
)
 
—

Long‑term debt
—

 
—

 
(798,662
)
 
—

The pension plan assets and liabilities and deferred compensation plan assets and liabilities are included in other non-current assets and other non-current liabilities at September 30, 2017 and June 30, 2018.
5. Accounts Receivable
Accounts receivable are summarized as follows:
 
September 30, 2017
 
June 30, 2018
Accounts receivable
$
248,742

 
$
232,513

Allowance for doubtful accounts
(3,494
)
 
(4,183
)
Receivables, net
$
245,248

 
$
228,330


20

6. Inventories
The major classes of Inventories, net are as follows:
 
September 30, 2017
 
June 30, 2018
Raw materials and supplies
$
64,113

 
$
75,000

Work in progress
16,425

 
22,762

Finished goods and products held for resale
44,402

 
51,400

Costs of unbilled projects
5,706

 
2,391

Reserves for excess and obsolete
(10,599
)
 
(11,086
)
Inventories, net
$
120,047

 
$
140,467

7. Property, Plant, and Equipment
Property, plant, and equipment consists of the following:
 
September 30, 2017
 
June 30, 2018
Machinery and equipment
$
338,056

 
$
358,603

Land and buildings
84,282

 
82,406

Construction in process
24,788

 
48,531

 
447,126

 
489,540

Less: accumulated depreciation
(167,083
)
 
(200,362
)
 
$
280,043

 
$
289,178

Depreciation expense was $13,259 and $14,530 for the three months ended June 30, 2017 and 2018, respectively. Maintenance and repair expense was $5,395 and $6,238 for the three months ended June 30, 2017 and 2018, respectively.
Depreciation expense was $38,645 and $42,518 for the nine months ended June 30, 2017 and 2018, respectively. Maintenance and repair expense was $15,905 and $17,620 for the nine months ended June 30, 2017 and 2018, respectively.
8. Goodwill
Changes in the carrying amount of goodwill are as follows:
 
Industrial
 
Municipal
 
Products
 
Total
Balance at September 30, 2017
$
128,190

 
$
9,865

 
$
183,858

 
$
321,913

Business combinations and divestitures
2,462

 
(145
)
 
3,757

 
6,074

Measurement period adjustment
(323
)
 
—

 
(314
)
 
(637
)
Foreign currency translation
(2,972
)
 
21

 
(127
)
 
(3,078
)
Balance at June 30, 2018
$
127,357

 
$
9,741

 
$
187,174

 
$
324,272

As of September 30, 2017 and June 30, 2018, $139,581 and $141,511, respectively, of goodwill is deductible for tax purposes.

21

The Neptune Benson reporting unit fair value excess was approximately 3.0% above the carrying value as of the date of valuation on July 1, 2017. The Company continues to monitor this reporting unit and noted no events that would cause a revaluation during the three months ending June 30, 2018.
All other reporting units significantly exceeded their carrying value and as such, no further analysis was performed.
9. Debt
Long‑term debt consists of the following:
 
September 30, 2017
 
June 30, 2018
First Lien Term Loan Facility, due December 20, 2024
$
896,574

 
$
790,600

Revolving Credit Facility
—

 
—

Equipment financing, due June 30, 2024 and June 28, 2025
6,930

 
9,615

Mortgage, due June 30, 2028
—

 
1,868

Notes Payable, due June 30, 2018 to July 31, 2023
3,287

 
2,310

Total debt
906,791

 
804,393

Less unamortized discount and lender fees
(16,942
)
 
(14,255
)
Total net debt
889,849

 
790,138

Less current portion
(11,325
)
 
(9,708
)
Total long‑term debt
$
878,524

 
$
780,430

Term Loan Facilities and Revolving Credit Facility
On January 15, 2014, EWT Holdings III Corp. (EWT III), an indirect wholly-owned subsidiary of the Company, entered into a First Lien Credit Agreement and Second Lien Credit Agreement (the Credit Agreements) among EWT III, EWT Holdings II Corp., the lenders party thereto and Credit Suisse AG as administrative agent and collateral agent. The First Lien Credit Agreement provided for a seven-year term loan facility, and the Second Lien Credit Agreement provided for an eight-year term loan facility. The term loan facilities originally consisted of the “First Lien Term Loan” and “Second Lien Term Loan” in aggregate principal amounts of $505,000 and $75,000, respectively.  The First Lien Credit Agreement also made available to the Company a $75,000 revolving credit facility (the Revolver), which provided for a letter of credit sub-facility up to $35,000. During the year ending September 30, 2017, certain subsidiaries of the Company entered into three amendments to the First Lien Credit Agreement, which provided for, among other things, the payoff and termination of the Second Lien Term Loan, upsizes to the First Lien Term Loan, and the upsize of the Revolver.  

On December 20, 2017, certain subsidiaries of the Company entered into Amendment No. 5 (the Fifth Amendment), among EWT III, as the borrower, certain other subsidiaries of the Company, and Credit Suisse AG, as administrative agent and collateral agent, relating to the First Lien Credit Agreement (as amended, amended and restated, extended, supplemented or otherwise modified from time to time prior to the effectiveness of the Fifth Amendment, the "Existing Credit Agreement"). Prior to the Fifth Amendment, approximately $796,574 was outstanding under the First Lien Term Loan (the Existing Term Loans).  Pursuant to the Fifth Amendment, among other things, the Existing Term Loans were refinanced with the proceeds of refinancing Term Loans. Borrowings under the First Lien Term Loan Facility (First Lien Term Loan) bear interest consisting of the Base Rate plus 2.0%, or LIBOR plus 3.0%. At June 30, 2018, the interest rate on borrowings was 5.30%, comprised of 2.30% LIBOR plus the 3.0% spread. The principal and interest under the First Lien Term Loan is payable in quarterly installments, with quarterly principal payments of $1,991, and the balance is due at maturity on December 20, 2024. 


22

Total deferred fees related to the First Lien Term Loan were $16,942 and $14,255, net of amortization, as of September 30, 2017 and June 30, 2018, respectively.  These fees were included as a contra liability to debt on the Condensed Consolidated Balance Sheets.

The Fifth Amendment, among other things, extended the maturity of the Existing Term Loan to December 20, 2024 from January 15, 2021, reduced the interest rate spreads on Term Loan borrowing to to 3.00% from 3.75%, and increased the revolving credit commitment and letter of credit sublimit to $125,000 and $45,000 from $95,000 and $35,000, respectively. 

The Fifth Amendment bifurcated the Revolver, with $87,500 of the $125,000 revolver capacity maturing on December 20, 2022 (the 2022 Borrowings), and the remaining $37,500 maturing on January 15, 2019 (the “2019 Borrowings”).  Borrowings under the Revolver bear interest at variable rates plus a margin ranging from 200 to 325 basis points, and 150 to 275 basis points for 2019 and 2022 Borrowings, respectively, dependent upon the Company’s leverage ratio and variable rate selected.  2022 Base Rate borrowings under the Revolver would have incurred interest at 6.75% as of June 30, 2018, calculated as the 175 basis point spread plus the Base Rate of 5.00%.  2019 Base Rate borrowings under the Revolver at September 30, 2017 and June 30, 2018 would have incurred interest at 6.5% and 7.25%, respectively, calculated as the 225 basis point spread plus the Base Rate of 4.25% at September 30, 2017 and 4.75% at June 30, 2018.

The Company had borrowing availability under the Revolver of $95,000 and $125,000 at September 30, 2017 and June 30, 2018, respectively, reduced for outstanding letter of credit guarantees. Such letter of credit guarantees are subject to a $45,000 sublimit within the Revolver, increased from $35,000 as part of the Fifth Amendment.  The Company’s outstanding letter of credit guarantees under this agreement aggregated approximately $6,706 and $13,157, at September 30, 2017, and June 30, 2018, respectively. The Company had no outstanding revolver borrowings as of September 30, 2017, and June 30, 2018, and unused amounts, defined as total revolver capacity less outstanding letters of credit and revolver borrowings, of $88,294 and $111,843, respectively. At September 30, 2017 and June 30, 2018, the Company had additional letters of credit of $10,568 and $87 issued under a separate arrangement, respectively.
  The First Lien Credit Agreement contains limitations on incremental borrowings, is subject to leverage ratios and allows for optional prepayments. Under certain circumstances beginning with fiscal 2015 results of operations, the Company may be required to remit excess cash flows as defined based upon exceeding certain leverage ratios. The Company did not exceed such ratios during fiscal 2017, does not anticipate exceeding such ratios during the fiscal year 2018, and therefore does not anticipate any additional repayments during the fiscal year 2018.
On June 26, 2018, the Company reached a contingent agreement under the First Lien Credit Agreement to increase the loan outstanding by $150,000 subject to successfully closing on the announced ProAct Services Corporation acquisition. The terms for this additional borrowing would be consistent with the current terms. In addition, the Company reached an agreement with certain Revolving Credit Lenders to amend their participation from 2019 Revolving Credit Commitments to 2022 Revolving Credit Commitments. On conclusion of these amendments, the entire Revolving Credit of $125,000 will have a maturity in 2022.
Equipment Financing
On June 30, 2017, the Company completed a Build Own Operate (BOO) financing for $7,100.  The Company incurred $50 of additional financing fees related to this transaction, which have been capitalized and are included as a contra liability on the balance sheet. This financing fully amortizes over the seven-year tenure and incurs interest at a rate of one-month LIBOR plus 300 basis points. This variable rate debt has been fixed at a rate of 5.08% per annum. Principal obligations are $254 per quarter. The Company had $6,930 and $6,085 principal outstanding under this facility at September 30, 2017 and June 30, 2018, respectively.

On June 28, 2018, the Company completed an equipment financing for $3,530 at a fixed interest rate of 6.24% over a 7-year term. This 7-year financing amortizes over a 10-year period, with monthly principal and interest payments of $39 and a balloon payment of $1,330 due at maturity. The Company had $3,530 principal outstanding under this facility at June 30, 2018.

23



Notes Payable
As of September 30, 2017 and June 30, 2018, the Company had notes payable in an aggregate outstanding amount of $3,287 and $2,310, respectively, with interest rates ranging from 6.26% to 7.39%, and due dates ranging from August 31, 2018 to July 31, 2023. These notes are related to certain equipment related contracts and are secured by the underlying equipment and assignment of the related contracts.
Mortgage
On June 29, 2018, the Company subsidiary MAGNETO special anodes B.V. entered into a 10-year mortgage agreement for 1,600 Euro ($1,868) to finance a facility in the Netherlands, subject to monthly principal payments of 7 Euro ($8) at a blended interest rate of 2.4% with maturity in June 2028. The Company had $1,868 principal outstanding under this facility at June 30, 2018.

Repayment Schedule
Aggregate maturities of all long‑term debt, including current portion of long‑term debt and excluding capital lease obligations as of June 30, 2018, are presented below:
Fiscal Year
 
Remainder of 2018
$
2,534

2019
9,854

2020
9,770

2021
9,816

2022
9,864

Thereafter
762,555

Total
$
804,393

10. Product Warranties
The Company accrues warranty obligations associated with certain products as revenue is recognized. Provisions for the warranty obligations are based upon historical experience of costs incurred for such obligations, adjusted for site‑specific risk factors, and, as necessary, for current conditions and factors. There are significant uncertainties and judgments involved in estimating warranty obligations, including changing product designs, differences in customer installation processes and future claims experience which may vary from historical claims experience.

24

A reconciliation of the activity related to the accrued warranty, including both the current and long‑term portions, is as follows:
 
Nine Months Ended June 30,
 
2017
 
2018
Balance at beginning of the period
$
23,309

 
$
17,274

Warranty provision for sales
4,108

 
2,697

Settlement of warranty claims
(9,701)

 
(8,221)

Foreign currency translation and other
(341)

 
(445)

Balance at end of the period
$
17,375

 
$
11,305

The decline in accrued warranty over the periods presented is attributable to improved product quality and better project execution, as well as the expiration of warranty periods for certain specific exposures related to discontinued products.
11. Restructuring and Related Charges
To better align its resources with its growth strategies and reduce the cost structure, the Company commits to restructuring plans as necessary. The Company initiated a Voluntary Separation Plan (VSP) during the year ended September 30, 2016, that continued throughout fiscal year 2017 and concluded during the six months ended March 31, 2018. The VSP plan includes severance payments to employees as a result of streamlining business operations for efficiency, elimination of redundancies, and reorganizing business processes. In addition, the Company has undertaken various other restructuring initiatives, including the wind down of the Company’s operations in Italy, restructuring of the Company’s operations in Australia, consolidation of functional support structures on a global basis, and consolidation of the Singaporean research and development center. The table below sets forth the amounts accrued for the restructuring components and related activity:
 
Nine Months Ended June 30,
 
2017
 
2018
Balance at beginning of the period
$
13,217

 
$
3,542

Restructuring charges related to VSP
19,199

 
312

Charges related to other initiatives
2,896

 
8,440

Write off charge and other non‑cash activity
(374)

 
(479)

Cash payments
(28,904)

 
(11,395)

Other adjustments
124

 
24

Balance at end of the period
$
6,158

 
$
444

The balances for accrued restructuring liabilities at September 30, 2017 and June 30, 2018 are recorded in Accrued expenses and other liabilities. The Company expects to incur another $1,200 of restructuring charges during the remaining of fiscal year 2018. Restructuring charges primarily represent severance charges and of the amounts incurred above, $9,664, $5,210, $6,843, and $378 were included in Cost of product sales and services, General and administration expense, Sales and marketing expense and Research and development expense, respectively, during the nine months ended June 30, 2017. During the nine months ended June 30, 2018, $3,086, $4,309, $750, and $607 were included in Cost of product sales and services, General and administration expense, Sales and marketing expense and Research and development expense, respectively. The Company continues to evaluate restructuring activities that may result in additional charges in the future.
12. Employee Benefit Plans
The Company maintains multiple employee benefit plans.
Certain of the Company’s employees in the UK were participants in a Siemens defined benefit plan established for employees of a UK-based operation acquired by Siemens in 2004. The plan was frozen with respect to future service credits for active employees, however the benefit formula recognized future compensation increases. The

25

Company agreed to establish a replacement defined benefit plan, with the assets of the Siemens scheme transferring to the new scheme on April 1, 2015.
The Company’s employees in Germany also participate in a defined benefit plan. Assets equaling the plan’s accumulated benefit obligation were transferred to a German defined benefit plan sponsored by the Company upon the acquisition of EWT from Siemens. The German entity also sponsors a defined benefit plan for a small group of employees located in France.
Pension expense for the German and UK plans were as follows:
 
Three Months Ended June 30,
 
2017
 
2018
Service cost
$
267

 
$
230

Interest cost
82

 
116

Expected return on plan assets
(40)

 
(30)

Amortization of actuarial losses
188

 
75

Pension expense for defined benefit plans
$
497

 
$
391

 
 
 
 
 
Nine Months Ended June 30,
 
2017
 
2018
Service cost
$
802

 
$
705

Interest cost
246

 
357

Expected return on plan assets
(121)

 
(93)

Amortization of actuarial losses
563

 
230

Pension expense for defined benefit plans
$
1,490

 
$
1,199

13. Income Taxes
The income tax provision for interim periods is comprised of tax on ordinary income (loss) provided at the most recent estimated annual effective tax rate, adjusted for the tax effect of discrete items. Management estimates the annual effective tax rate each quarter based on the forcasted annual pretax income or (loss) of its U.S. and non-U.S. operations. Items unrelated to current year ordinary income or (loss) are recognized entirely in the period identified as a discrete item of tax. Discrete items generally relate to changes in tax laws, adjustments to prior year’s actual liability determined upon filing tax returns, adjustments to previously recorded reserves for uncertain tax positions, initially recording or fully reversing valuation allowances, and excess stock compensation deductions.

Effects of the Tax Cuts and Jobs Act

New tax legislation, commonly referred to as the Tax Cuts and Jobs Act (Tax Act), was enacted on December 22, 2017. ASC 740, Accounting for Income Taxes, requires companies to recognize the effect of tax law changes in the period of enactment even though the effective date for most provisions is for tax years beginning after December 31, 2017, or in the case of certain other provisions, January 1, 2018. Though certain key aspects of the new law are effective January 1, 2018 and have an immediate accounting effect, other significant provisions are not yet effective or may not result in accounting effects for September 30 fiscal year companies until October 1, 2018.

The SEC issued Staff Accounting Bulletin No. 118 (SAB 118), which allows registrants to record provisional amounts during a one year “measurement period” similar to that used when accounting for business combinations. During the measurement period, impacts of the law are expected to be recorded at the time a reasonable estimate for all or a portion of the effects can be made, and provisional amounts can be recognized and adjusted as information becomes available, prepared or analyzed. SAB 118 applies to measuring the impact of tax laws affecting the period of

26

enactment, such as the change in tax rate to 21%, and does not extend to changes as part of the Tax Act that are not effective until after December 31, 2017, such as U.S. taxation of certain global intangible low-taxed income (GILTI).

The SAB summarizes a three-step process to be applied at each reporting period to account for and qualitatively disclose: (1) the effects of the change in tax law for which accounting is complete; (2) provisional amounts (or adjustments to provisional amounts) for the effects of the tax law where accounting is not complete, but that a reasonable estimate has been determined; and (3) that a reasonable estimate cannot yet be made and therefore taxes are reflected in accordance with law prior to the enactment of the Tax Cuts and Jobs Act.

Amounts recorded where accounting is complete in the nine months ended June 30, 2018 principally relate to the reduction in the U.S. corporate income tax rate to 21%, which resulted in the Company reporting an income tax benefit of $3,641 to remeasure deferred taxes liabilities associated with indefinitely lived intangible assets that will reverse at the new 21% rate. Absent this deferred tax liability, the Company is in a net deferred tax asset position that is offset by a full valuation allowance. Though the impact of the rate change has a net tax effect of zero, the accounting to determine the gross change in the deferred tax position and the offsetting valuation is not yet complete.

The new law includes a one-time mandatory repatriation transition tax on the net accumulated earnings and profits of a U.S. taxpayer’s foreign subsidiaries. The Company has performed a preliminary analysis, and as a result of an expected overall accumulated deficit, it is not likely that the Company will have a liability for the transition tax. Therefore, the accounting for this matter is provisional until the accumulated earnings and profits analysis is finalized in fiscal 2018.

The Tax Act introduces other new provisions that are effective January 1, 2018 and changes how certain provisions are calculated for fiscal years ending September 30, 2018. These provisions include additional limitations on certain meals and entertainment expenses, and the inclusion of commissions and performance based compensation in determining the excessive compensation limitation applicable to certain employees. We do not expect these new provisions to have a material impact to the Company’s tax expense.
Other significant provisions that are not yet effective but may impact income taxes in future years include: an exemption from U.S. tax on dividends of future foreign earnings, a limitation on the current deductibility of net interest expense in excess of 30% of adjusted taxable income, a limitation on the use of net operating losses generated after fiscal 2018 to 80% of taxable income, an incremental tax (base erosion anti-abuse tax or BEAT) on excessive amounts paid to foreign related parties, and an income inclusion for foreign earnings in excess of 10% of the foreign subsidiaries tangible assets (GILTI). The Company is still evaluating whether to make a policy election to treat the GILTI tax as a period expense or to provide U.S. deferred taxes on foreign temporary differences that are expected to generate GILTI income when they reverse in future years.

Annual Effective Tax Rate

The full year estimated annual effective tax rate, which excludes the impact of discrete items, was 0.1% and 22.8% as of the nine months ended June 30, 2017 and 2018, respectively, and is reconciled to the U.S. statutory rate as follows.

For the nine months ended June 30, 2017, the estimated annual effective tax rate of 0.1% was lower than the U.S federal statutory rate of 35.0% primarily due to higher forecasted earnings in the U.S. and certain non-U.S. jurisdictions that permitted the realization of net deferred tax assets which were previously impaired with a valuation allowance.

For the nine months ended June 30, 2018, the U.S. federal statutory rate of 24.5% is a blended rate based upon the number of days in fiscal 2018 that the company will be taxed at the former statutory rate of 35.0% and the number of days that it will be taxed at the new rate of 21.0%. The estimated annual effective tax rate of 22.8% differs from this blended U.S. federal statutory rate principally due to higher forecasted earnings in the U.S. and certain non-U.S. jurisdictions that permitted the realization of net deferred tax assets which were previously impaired with a valuation allowance. The reduction in the U.S. statutory rate has lessened the impact of foreign statutory tax rate differences as

27

a significant portion of the Company’s foreign income is in jurisdictions with a similar or slightly higher tax rate than 35.0%.

Prior and Current Period Tax Expense

For the three months ended June 30, 2017 the Company recognized income tax expense of $12,202, or 87.4%, on pretax income of $13,958. This rate was different from the U.S. statutory rate of 35.0% principally due to the income generated in the third quarter and the impact to year-to-date tax expense on a significantly smaller loss as compared to the loss at March 31, 2017. Discrete items for the quarter were not material.

For the three months ended June 30, 2018 the Company recognized income tax expense of $1,433, or 58.1%, on pretax income of $2,468. This 58.1% is higher than the U.S. statutory rate of 24.5%, principally due to lower forecasted earnings in the U.S. compared to prior quarters, and an increase in unbenefited foreign losses. Discrete items for the quarter were not material.

For the nine months ended June 30, 2017, income tax expense of $295 as a percentage of pretax losses of $6,255 were 4.7%.   This is slightly more than the estimated annual effective tax rate of 0.1% as a result of discrete period tax expense to record adjustments to the actual liability upon the filing of certain foreign income tax returns during the period.

For the nine months ended June 30, 2018, the Company recognized an income tax benefit of $960, which as a percentage of pretax income of $10,052 was 9.6%. This amount differs from the estimated annual effective tax rate of 22.8% as a result of a discrete tax benefit of $3,641 due to the remeasurement of U.S. deferred tax liabilities associated with indefinite lived intangible assets for the reduction in the U.S. statutory rate from 35.0% to 21.0%. Other discrete items were not material.
  
The Company projects to maintain a full valuation on U.S. federal and state net deferred tax assets (excluding the tax effects of deferred tax liabilities associated with indefinite lived intangibles) for the year ending September 30, 2018 as a result of pretax losses incurred since the Company’s inception in early 2014. Though the Company reported positive earnings for the first time in 2017 and is projecting earnings in 2018, management believes it is prudent to retain a valuation allowance until a more consistent pattern of actual earnings is established and net operating loss carryforwards begin to be utilized.

There are no amounts of unrecognized tax benefits recorded for the nine months ended June 30, 2017 and 2018. Management does not reasonably expect any significant changes to unrecognized tax benefits within next twelve months of the reporting date. U.S. federal, state and foreign tax returns remain open to examination for the years ended September 30, 2014 and forward.

14. Share-Based Compensation
    
In connection with the IPO, the Board adopted and the Company's stockholders approved the Evoqua Water Technologies Corp. 2017 Equity Incentive Plan (or the Equity Incentive Plan), under which equity awards may be made in the respect of 5,100 shares of common stock of the Company. Under the Equity Incentive Plan, awards may be granted in the form of options, restricted stock, restricted stock units, stock appreciation rights, dividend equivalent rights, share awards and performance-based awards (including performance share units and performance-based restricted stock).

Share-based compensation expense was $614 and $4,405 during the three months ended June 30, 2017 and 2018, respectively, and $1,634 and $11,257 during the nine months ended June 30, 2017 and 2018, respectively. The unrecognized compensation expense related to stock options and restricted stock units was $11,330 and $16,996, respectively at June 30, 2018, and is expected to be recognized over a weighted average period of 3.8 years and 1.3 years, respectively. $9 was received from the exercise of stock options during the three months ended June 30, 2018. The remaining stock options exercised during the three months ended June 30, 2018 were effected via a cashless net exercise.

28

        
Option awards vest ratably at 25% per year, and are exercisable at the time of vesting. The options granted have a ten-year contractual term.

    A summary of the stock option activity as of June 30, 2018 is presented below (amounts in thousands except per share amounts):
 
 
Options
 
Weighted Average Exercise Price/Share
 
Weighted Average Remaining Contractual Term
 
Aggregate Intrinsic Value
Outstanding at September 30, 2017
 
9,060

 
$
5.18

 
7.5 years
 
$
11,011

Granted
 
1,365

 
20.96

 
 
 


Exercised
 
(1,057
)
 
4.77

 
 
 


Forfeited
 
(112
)
 
8.29

 
 
 


Expired
 
—

 
—

 
 
 


Outstanding at June 30, 2018
 
9,256

 
7.52

 
7.9 years
 
$
20,503

Options exercisable at June 30, 2018
 
5,697

 
$
4.90

 
6.3 years
 
$
6,169


The total intrinsic value of options exercised (which is the amount by which the stock price exceeded the exercise price of the options on the date of exercise) during the nine months ended June 30, 2018 was $19,577.
    
A summary of the status of the Company's non-vested stock options as of and for the nine month period ended June 30, 2018 is presented below.

 
 
Shares
 
Weighted Average Grant Date Fair Value/Share
Nonvested at September 30, 2017
 
4,300

 
$
1.36

Granted
 
1,365

 
7.94

Vested
 
(1,995
)
 
1.16

Forfeited
 
(112
)
 
2.25

Nonvested at June 30, 2018
 
3,558

 
$
3.97


The total fair value of options vested during the nine months ended June 30, 2018, was $2,317.


Restricted Stock Units
In addition to the establishment of the Equity Incentive Plan, in connection with the IPO, the Company entered into restricted stock unit (“RSU”) agreements with each of the executive officers and certain other key members of management. Pursuant to the RSU agreements, recipients received, in the aggregate, 1,197 stock-settled RSUs, the aggregate value of which equals $25,000. The RSUs will vest and settle in full upon the second anniversary of the IPO (the “Vesting Date”).
The following is a summary of the RSU activity for the nine months ended June 30, 2018.

29

 
 
Shares
 
Weighted Average Grant Date Fair Value/Share
Outstanding at September 30, 2017
 
—

 
$
—

Granted
 
1,224

 
20.88

Forfeited
 
(7
)
 
20.88

Outstanding at June 30, 2018
 
1,217

 
$
20.88

15. Concentration of Credit Risk
The Company’s cash and cash equivalents and accounts receivable are potentially subject to concentration of credit risk. Cash and cash equivalents are placed with financial institutions that management believes are of high credit quality. Accounts receivable are derived from revenue earned from customers located in the U.S. and internationally and generally do not require collateral. The Company’s trade receivables do not represent a significant concentration of credit risk at September 30, 2017 and June 30, 2018 due to the wide variety of customers and markets into which products are sold and their dispersion across geographic areas. The Company does perform ongoing credit evaluations of its customers and maintains an allowance for potential credit losses on trade receivables. As of and for the three and nine months ended June 30, 2017 and 2018, no customer accounted for more than 10% of net sales or net accounts receivable.
The Company operates predominantly in eight countries worldwide and provides a wide range of proven product brands and advanced water and wastewater treatment technologies, mobile and emergency water supply solutions and service contract options through its Industrial, Municipal, and Products segments. The Company is a multi-national business but its sales and operations are primarily in the U.S. Sales to unaffiliated customers are based on the Company locations that maintain the customer relationship and transacts the external sale.
16. Related‑Party Transactions
Transactions with Investors
The Company paid an advisory fee of $1,000 per quarter to AEA Investors LP (AEA), the private equity firm and ultimate majority shareholder pursuant to a management agreement. Upon the IPO, the management agreement terminated and the Company stopped paying these fees to AEA and as a result, only paid $333 during the three and nine months ended June 30, 2018. In addition, the Company reimbursed AEA for normal and customary expenses incurred by AEA on behalf of the Company. The Company incurred expenses, excluding advisory fees, of $249 and $43 in the nine months ended June 30, 2017 and 2018, respectively. The amounts owed to AEA were $38 and $0 at September 30, 2017 and June 30, 2018, respectively, and were included in Accrued expenses and other liabilities.
AEA, through two of its affiliated funds, is one of the lenders in the First Lien Term Loan Facility and had a commitment of $16,218 and $14,301 at September 30, 2017 and June 30, 2018, respectively.
The Company also has a related party relationship with one of its customers, who is also a shareholder of the Company. The Company had sales to this customer of $1,255 and $376 during the three months ended June 30, 2017 and 2018, respectively, and $2,819 and $961 during the nine months ended June 30, 2017 and 2018, respectively, and was owed $2,354 and $720 from this customer at September 30, 2017 and June 30, 2018, respectively.

30

17. Commitments and Contingencies
Operating Leases
The Company occupies certain facilities and operates certain equipment and vehicles under non‑cancelable lease arrangements. Lease agreements may contain lease escalation clauses and purchase and renewal options. The Company recognizes scheduled lease escalation clauses over the course of the applicable lease term on a straight-line basis in the Consolidated Statements of Operations.
Total rent expense was $4,777 and $4,091 for the three months ended June 30, 2017 and 2018, respectively, and $13,608 and $13,843 for the nine months ended June 30, 2017 and 2018, respectively.
Future minimum aggregate rental payments under non-cancelable operating leases are as follows:
 
Operating
Leases
Fiscal Year
 
Remainder of 2018
$
2,985

2019
10,746

2020
9,368

2021
7,410

2022
4,998

Thereafter
10,948

Total
$
46,455

Capital Leases
The gross and net carrying values of the equipment under capital leases were $43,727 and $30,302, respectively, as of September 30, 2017 and were $50,005 and $30,077, respectively, as of June 30, 2018 and are recorded in Property, plant and equipment, net.
The following is a schedule showing the future minimum lease payments under capital leases by years and the present value of the minimum lease payments as of June 30, 2018.
 
Capital
Leases
Fiscal Year
 
Remainder of 2018
$
3,461

2019
10,492

2020
8,633

2021
5,563

2022
3,563

Thereafter
2,342

Total
34,054

Less amount representing interest (at rates ranging from 2.15% to 3.65%)
2,565

Present value of net minimum capital lease payments
31,489

Less current installments of obligations under capital leases
11,885

Obligations under capital leases, excluding current installments
$
19,604


31

The current installments of obligations under capital leases are included in Accrued expenses and other liabilities. Obligations under capital leases, excluding current installments, are included in Other non-current liabilities.
The Company is a lessor to multiple parties. The Company purchases equipment through internal funding or bank debt equal to the fair market value of the equipment. The equipment is then leased to customers for periods ranging from five to twenty years. As of June 30, 2018, future minimum lease payments receivable under operating leases are as follows:
 
Operating
Leases
Fiscal year
 
Remainder of 2018
$
1,372

2019
6,107

2020
7,257

2021
5,547

2022
5,395

Thereafter
63,356

Future minimum lease payments
$
89,034

Guarantees
From time to time, the Company is required to provide letters of credit, bank guarantees, or surety bonds in support of its commitments and as part of the terms and conditions on water treatment projects.  In addition, the Company is required to provide letters of credit or surety bonds to the Department of Environmental Protection or equivalent in some states in order to maintain its licenses to handle toxic substances at certain of its water treatment facilities.
These financial instruments typically expire after all Company commitments have been met, a period typically ranging from twelve months to ten years, or more in some circumstances.  The letters of credit, bank guarantees, or surety bonds are arranged through major banks or insurance companies. In the case of surety bonds, the Company generally indemnifies the issuer for all costs incurred if a claim is made against the bond. 
As of September 30, 2017 and June 30, 2018, the Company had letters of credit totaling $17,274 and $13,244, respectively, and surety bonds totaling $87,849 and $100,487, respectively, outstanding under the Company’s credit arrangements.  The longest maturity date of the letters of credit and surety bonds in effect as of June 30, 2018 was March 26, 2029. Additionally, as of September 30, 2017 and June 30, 2018, the Company had letters of credit totaling $901 and $867, respectively, and surety bonds totaling $12,970 and $5,545, respectively, outstanding under the Company’s prior arrangement with Siemens.
Litigation
From time to time, the Company is subject to various claims, charges and litigation matters that arise in the ordinary course of business. The Company believes these actions are a normal incident of the nature and kind of business in which the Company is engaged. While it is not feasible to predict the outcome of these matters with certainty, the Company does not believe that any asserted or unasserted legal claims or proceedings, individually or in the aggregate, will have a material adverse effect on its business, financial condition, results of operations or prospects.


32

18. Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consisted of the following:
 
September 30, 2017
 
June 30, 2018
Salaries, wages and other benefits
$
52,116

 
$
27,181

Severance payments
3,542

 
444

Taxes, other than income
9,244

 
10,113

Obligations under capital leases
9,777

 
11,885

Third party commissions
6,968

 
4,300

Insurance liabilities
4,915

 
4,293

Provisions for litigation
4,715

 
1,850

Earn-outs related to acquisitions
4,304

 
7,218

Other
26,342

 
23,111

 
$
121,923

 
$
90,395

The reduction in Accrued expenses and other liabilities is primarily due to timing of cash payments for various employee-related liabilities, along with the payment of accrued expenses related to the IPO during the nine months ended June 30, 2018.
19. Business Segments
The Company has three reportable segments – Industrial, Municipal and Products. Segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision maker, or decision making group, in deciding how to allocate resources to an individual segment and in assessing performance. The key factors used to identify these reportable segments are the organization and alignment of the Company’s internal operations, the nature of the products and services, and customer type. The business segments are described as follows:
Industrial combines equipment and services to improve operational reliability and environmental compliance for heavy and light industry, commercial and institutional markets. Their customers span industries including hydrocarbon refineries, chemical processing, power, food and beverage, life sciences, health services and microelectronics.
Municipal helps engineers and municipalities meet new demands for plant performance through leading equipment, solutions and services backed by trusted brands and over 100 plus years of applications experience. Their customers include waste water and drinking water collection and distribution systems, and utility operators. Their services include odor control services.
Products has distinct business operating units. Each has a unique standard product built on well-known brands and technologies that are sold globally through multiple sales and aftermarket channels. Additionally, Products also offers industrial, municipal and water recreational users with well-known brands that improve operational reliability and environmental compliance. Their customers include original equipment manufacturers, regional and global distributors, engineering, procurement and contracting customers, and end users in the municipal, industrial and commercial industries, including hotels, resorts, colleges, universities, waterparks, aquariums and zoos.
The Company evaluates its business segments’ operating results based on earnings before interest, taxes, depreciation and amortization, and certain other charges that are specific to the activities of the respective segments. Corporate activities include general corporate expenses, elimination of intersegment transactions, interest income and expense and certain other charges. Certain other charges include restructuring and other business transformation charges that have been undertaken to align and reposition the Company to the current reporting structure, acquisition related

33

costs (including transaction costs, certain integration costs and recognition of backlog intangible assets recorded in purchase accounting) and share-based compensation charges. 
Since certain administrative and other operating expenses and other items have not been allocated to business segments, the results in the below table are not necessarily a measure computed in accordance with generally accepted accounting principles and may not be comparable to other companies.

34

 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
2017
 
2018
 
2017
 
2018
Total sales
 
 
 
 
 
 
 
Industrial
$
155,904

 
$
184,133

 
$
464,414

 
$
536,351

Municipal
79,817

 
75,927

 
217,897

 
215,768

Products
93,257

 
104,013

 
258,181

 
280,496

Total sales
328,978

 
364,073

 
940,492

 
1,032,615

Intersegment sales

 

 
 
 
 
Industrial
1,206

 
1,810

 
3,553

 
7,575

Municipal
7,075

 
7,428

 
18,970

 
21,079

Products
9,555

 
12,360

 
27,053

 
30,746

Total intersegment sales
17,836

 
21,598

 
49,576

 
59,400

Sales to external customers

 

 
 
 
 
Industrial
154,698

 
182,323

 
460,861

 
528,776

Municipal
72,742

 
68,499

 
198,927

 
194,689

Products
83,702

 
91,653

 
231,128

 
249,750

Total sales
311,142

 
342,475

 
890,916

 
973,215

Earnings before interest, taxes, depreciation and amortization (EBITDA)
 
 

 
 
 
 
Industrial
34,758


35,805

 
102,133

 
117,646

Municipal
12,556


14,434

 
29,644

 
30,784

Products
21,196


23,989

 
53,070

 
57,635

Corporate
(23,794
)

(37,828
)
 
(96,172
)
 
(93,667
)
Total EBITDA
44,716

 
36,400

 
88,675

 
112,398

Depreciation and amortization

 

 
 
 
 
Industrial
9,191

 
11,390

 
27,632

 
32,244

Municipal
1,994

 
1,736

 
6,119

 
5,312

Products
2,084

 
3,269

 
8,722

 
9,345

Corporate
5,024

 
5,167

 
13,340

 
15,023

Total depreciation and amortization
18,293

 
21,562

 
55,813

 
61,924

Operating profit (loss)

 

 
 
 
 
Industrial
25,567


24,415

 
74,501

 
85,402

Municipal
10,562


12,698

 
23,525

 
25,472

Products
19,112


20,720

 
44,348

 
48,290

Corporate
(28,817
)

(42,995
)
 
(109,512
)
 
(108,689
)
Total operating profit
26,424

 
14,838

 
32,862

 
50,475

Interest expense
(12,466
)
 
(12,370
)
 
(39,117
)
 
(40,423
)
Income (loss) before income taxes
13,958

 
2,468

 
(6,255
)
 
10,052

Income tax (expense) benefit
(12,202
)
 
(1,433
)
 
(295
)
 
960

Net income (loss)
$
1,756

 
$
1,035

 
$
(6,550
)
 
$
11,012

Capital expenditures
 
 
 
 
 
 
 
Industrial
$
9,256

 
$
14,364

 
$
31,019

 
$
34,866

Products
1,658

 
2,817

 
4,239

 
5,138

Municipal
561

 
3,182

 
1,577

 
6,154

Corporate
1,772

 
2,536

 
3,640

 
8,411

Total capital expenditures
$
13,247

 
$
22,899

 
$
40,475

 
$
54,569


35

 
September 30,
2017
 
June 30,
2018
Assets
 
 
 
Industrial
$
461,471

 
$
492,875

Municipal
155,698

 
171,438

Products
513,941

 
538,430

Corporate
342,199

 
296,478

Total assets
$
1,473,309

 
$
1,499,221

Goodwill
 
 
 
Industrial
$
128,190

 
$
127,357

Municipal
9,865

 
9,741

Products
183,858

 
187,174

Total goodwill
$
321,913

 
$
324,272

20. Earnings Per Share
The following table sets forth the computation of basic and diluted income (loss) from continuing operations per common share (in thousands, except per share amounts):
 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
2017
 
2018
 
2017
 
2018
Numerator:
 
 
 
 
 
 
 
Numerator for basic and diluted income (loss) per common share—Net income (loss) attributable to Evoqua Water Technologies Corp.
$
1,503

 
$
793

 
$
(8,898
)
 
$
9,585

Denominator:
 
 
 
 
 
 
 
Denominator for basic net income (loss) per common share—weighted average shares
104,821

 
113,842

 
104,821

 
113,842

Effect of dilutive securities:
 
 
 
 
 
 
 
Share‑based compensation
3,164

 
5,205

 
—

 
6,094

Denominator for diluted net income (loss) per common share—adjusted weighted average shares
107,985

 
119,047

 
104,821

 
119,936

Basic income (loss) attributable to Evoqua Water Technologies Corp. per common share
$
0.01

 
$
0.01

 
$
(0.08
)
 
$
0.08

Diluted income (loss) attributable to Evoqua Water Technologies Corp. per common share
$
0.01

 
$
0.01

 
$
(0.08
)
 
$
0.08

Since the Company was in a net loss position for the nine months ended June 30, 2017, there was no difference between the number of shares used to calculate basic and diluted loss per share. Because of their anti-dilutive effect, 8,824 common share equivalents, comprised of employee stock options, have been excluded from the diluted EPS calculation for the nine months ended June 30, 2017.

36

21. Subsequent Events
The Company completed the acquisition of ProAct Services Corporation (ProAct) on July 26, 2018, through the Company's wholly owned subsidiary, EWT Holdings III Corp., for $133,772 paid in cash at closing. ProAct is a leading provider of on-site treatment services of contaminated water in all 50 states. ProAct will operate as a separate division within Evoqua’s Industrial Segment and will continue to be based in Ludington, Michigan with a nationwide service footprint and facilities in California, Florida, Michigan, Minnesota, New Jersey, Virginia and Texas.
In connection with the closing of the ProAct acquisition on July 26, 2018, EWT Holdings III Corp. entered into Amendment 6 to the First Lien Credit Agreement dated January 15, 2014 (as amended, amended and restated, extended, supplemented or otherwise modified from time to time prior to the effectiveness of Amendment 6, the Existing Credit Agreement). Pursuant to Amendment 6, among other things, EWT Holdings III Corp. borrowed an additional $150,000 in incremental term loans, and all of the revolving credit lenders whose revolving credit loans were scheduled to mature on January 15, 2019 agreed to convert 100% of these commitments into revolving credit loans that will mature on December 20, 2022. The other terms of the Existing Credit Agreement, including rates, remain generally the same.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of our operations should be read in conjunction with the condensed consolidated financial statements, including the notes, included in 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 ended September 30, 2017, as filed with the SEC on December 4, 2017 (the “2017 Annual Report”). You should review the disclosures under the heading “Item 1A. Risk Factors” in the 2017 Annual Report, as well as 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.,” “EWT Holdings I Corp.,” “we,” “us,” “our” and similar terms refer to Evoqua Water Technologies Corp., together with its consolidated subsidiaries. Unless otherwise specified, all dollar amounts in this section are referred to in thousands.
Overview and Background
We are a leading provider of mission critical water treatment solutions, offering services, systems and technologies to support our customers’ full water lifecycle needs. With over 200,000 installations worldwide, we hold leading positions in the industrial, commercial and municipal water treatment markets in North America. We offer a comprehensive portfolio of differentiated, proprietary technology solutions sold under a number of market‑leading and well‑established brands. We deliver and maintain these mission critical solutions through the largest service network in North America assuring our customers continuous uptime with 87 branches which are located no further than a two‑hour drive from more than 90% of our customers’ sites. We believe that the customer intimacy created through our service network is a significant competitive advantage.
Our solutions are designed to provide “worry‑free water” by ensuring that our customers have access to an uninterrupted quantity and level of quality of water that meets their unique product, process and recycle or reuse specifications. We enable our customers to achieve lower costs through greater uptime, throughput and efficiency in their operations and support their regulatory compliance and environmental sustainability. We have worked to protect water, the environment and our employees for over 100 years. As a result, we have earned a reputation for quality, safety and reliability and are sought out by our customers to solve the full range of their water treatment needs, and maintaining our reputation is critical to the success of our business and solution set.
Our vision “to be the world’s first choice in water solutions” and our values of “integrity, customers and performance” foster a corporate culture that is focused on employee enablement, empowerment and accountability, which creates a highly entrepreneurial and dynamic work environment. Our purpose is “Transforming water. Enriching life.” We draw from a long legacy of water treatment innovations and industry firsts, supported by more than 1,250

37

granted or pending patents, which in aggregate are important to our business. Our core technologies are primarily focused on removing impurities from water, rather than neutralizing them through the addition of chemicals, and we are able to achieve purification levels which are 1,000 times greater than typical drinking water.
Business Segments
Our business is organized by customer base and offerings into three reportable segments that each draw from the same reservoir of leading technologies, shared manufacturing infrastructure, common business processes and corporate philosophies. Our reportable segments consist of: (i) our Industrial Segment, (ii) our Municipal Segment and (iii) our Products Segment. The key factors used to identify these reportable segments are the organization and alignment of our internal operations, the nature of the products and services and customer type.
•
Within the Industrial Segment, we primarily provide tailored solutions in collaboration with our customers backed by life‑cycle services including on‑demand water, build own operate (“BOO”), recycle and reuse and emergency response service alternatives to improve operational reliability, performance and environmental compliance.
•
Within the Municipal Segment, we primarily deliver solutions, equipment and services to engineering firms, OEMs and municipalities to treat wastewater and purify drinking water, and to control odor and corrosion.
•
Within the Products Segment, we provide a highly differentiated and scalable range of products and technologies specified by global water treatment designers, OEMs, engineering firms and integrators.
We evaluate our business segments’ operating results based on income from operations and EBITDA or Adjusted EBITDA on a segment basis. Corporate activities include general corporate expenses, elimination of intersegment transactions, interest income and expense and certain other charges, which have not been allocated to business segments. As such, the segment results provided herein may not be comparable to other companies.
Organic Growth Drivers
Market Growth
We maintain a leading position among customers in growing industries that utilize water as a critical part of their operations or production processes, including pharmaceuticals and health sciences, microelectronics, food and beverage, hydrocarbon and chemical processing, power, general manufacturing, municipal drinking and wastewater, marine and aquatics. Water treatment is an essential, non‑discretionary market that is growing in importance as access to clean water has become an international priority. Underpinning this growth are a number of global, long‑term trends that have resulted in increasingly stringent effluent regulations, along with a growing demand for cleaner and sustainable waste streams for reuse. These trends include the growing global population, increasing levels of urbanization and continued global economic growth, and we have seen these trends manifest themselves within our various end markets creating multiple avenues of growth. For example, within the industrial market, water is an integral and meaningful component in the production of a wide‑range of goods spanning from consumer electronics to automobiles.
Our Existing Customer Base
We believe our strong brands, leading position in highly fragmented markets, scalable and global offerings, leading installed base and unique ability to provide complete treatment solutions will enable us to capture a larger share of our existing customers’ water treatment spend while expanding with existing and new customers into adjacent end‑markets and underpenetrated regions. To capitalize on these opportunities, we are investing in our sales force, marketing and technologies, and cross‑selling to existing customers. We are uniquely positioned to further penetrate our core markets, with over 200,000 installations across over 38,000 global customers. We maintain a customer‑intimate business model with strong brand value and provide solutions‑focused offerings capable of serving a customer’s full lifecycle water treatment needs, both in current and new geographic regions.

38

Our Service Model
We selectively target high value projects with opportunities for recurring business through our Water One® service, for parts and other aftermarket opportunities over the lifecycle of the process or capital equipment.  In particular, we have developed a pipeline of smart, internet-connected monitoring technologies through the deployment of our Water Assure® smart water platform that provides us with an increasing ability to handle our customers’ complete water needs through on-demand water management, predictive maintenance and service response planning.   Our Water Assure service also enables us to transition our customers to more accurate pricing models based on usage, which otherwise would not have been possible without technological advancement. Our technology solutions provide customers with increased stability and predictability in water‑related costs, while enabling us to optimize our service route network and on-demand offerings through predictive analytics, which we believe will result in market share gains, improved service levels, increased barriers to entry and reduced costs.

Product and Technology Development
We develop our technologies through in‑house research, development and engineering and targeted tuck‑in, technology‑enhancing and geography‑expanding acquisitions. We have a reservoir of recently launched technologies and a strong pipeline of new offerings designed to provide customers with innovative, value‑enhancing solutions. Furthermore, we have successfully completed ten technology‑enhancing and geography‑expanding acquisitions since April 2016 to add new capabilities and cross‑selling opportunities in areas such as electrochemical and electrochlorination cells, regenerative media filtration, anodes, UV disinfection and aerobic and anaerobic biological treatment technologies. We are able to rapidly scale new technologies using our leading direct and third‑party sales channels and our relationships with key influencers, including municipal representatives, engineering firms, designers and other system specifiers. We believe our continued investment in driving penetration of our recently launched technologies, robust pipeline of new capabilities and best‑in‑class channels to market will allow us to continue to address our customer needs across the water lifecycle.
Operational Excellence
We believe that continuous improvement of our operations, processes and organizational structure is a key driver of our earnings growth. Since fiscal 2014, we have realigned our organizational structure, achieved significant cost savings through operational efficiencies and revitalized our culture, which has energized our workforce and reduced employee turnover. We have identified and are pursuing a number of discrete initiatives which, if successful, we expect could result in additional cost savings over the next three years. These initiatives include our ePro and supply chain improvement programs to consolidate and manage global spending, our improved logistics and transportation management program, further optimizing our engineering cost structure, capturing benefits of our Water One remote system monitoring and data analytics offerings. We refer to these initiatives as “Value Creators” as these improvements focus on creating value for customers through reduced leadtimes, improved quality and superior customer support, while also creating value for stockholders through enhanced earnings growth. Furthermore, as a result of significant investments we have made in our footprint and facilities, we have capacity to support our planned growth without commensurate increase in fixed costs.
Acquisitions and Divestitures
See Note 3. Acquisitions and Divestitures and Note 21. Subsequent Events to the Unaudited Condensed Consolidated Financial Statements in Item 1 of this Report for a complete discussion of recent acquisitions.
Key Factors and Trends Affecting Our Business and Financial Statements
Various trends and other factors affect or have affected our operating results, including:
Overall economic trends. The overall economic environment and related changes in industrial, commercial and municipal spending impact our business. In general, positive conditions in the broader economy promote industrial,

39

commercial and municipal customer spending, while economic weakness results in a reduction of new industrial, commercial and municipal project activity. Macroeconomic factors that can affect customer spending patterns, and thereby our results of operations, include population growth, total water consumption, municipal budgets, employment rates, business conditions, the availability of credit or capital, interest rates, tax rates and regulatory changes. Since the businesses of our customers vary in cyclicality, periodic downturns in any specific sector typically have modest impacts on our overall business.
Changes in costs and availability. We have significant exposures to certain commodities, including steel, caustic, carbon, calcium nitrate and iridium, and volatility in the market price and availability of these commodity input materials has a direct impact on our costs and our business. For example, the U.S. government has recently proposed imposing greater restrictions on international trade, including tariffs and/or other trade restraints on certain steel and aluminum imports. These restrictions, particularly those related to China, could increase the cost of our products and restrict availability of certain commodities, which may result in delays in our execution of projects. There can be no assurance that we will be able to recuperate these higher costs from our customers through product price increases. 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. Further, additional potential acquisitions and international expansion will place increased demands on our operational, managerial, administrative and other resources. Managing our growth effectively will require us to continue to enhance our management systems, financial and management controls and information systems. We will also be required to hire, train and retain operational and sales personnel, which affects our operating margins.
Inflation and deflation trends. Our financial results can be expected to be directly impacted by substantial increases in costs due to commodity cost increases or general inflation which could lead to a reduction in our revenues as well as greater margin pressure as increased costs may not be able to be passed on to customers.
Fluctuation in quarterly results. Our quarterly results have historically varied depending upon a variety of factors, including funding, readiness of projects and regulatory approvals. In addition, our contracts for large capital water treatment projects, systems and solutions for industrial, commercial and municipal applications are generally fixed‑price contracts with milestone billings. As a result of these factors, our working capital requirements and demands on our distribution and delivery network may fluctuate during the year.
New products and technologies. Our ability to maintain our appeal to existing customers and attract new customers depends on our ability to originate, develop and offer a compelling array of products, services and solutions responsive to evolving customer innovations, preferences and specifications. We expect that increased use of water in industrial and commercial processes will drive increased customer demand in the future, and our ability to grow will depend in part on effectively responding to innovation in our customers’ processes and systems. Further, our ability to provide products that comply with evolving government regulations will also be a driver of the appeal of our products, services and solutions to industrial and commercial customers.
Government policies. Decaying water systems in the United States will require critical drinking water and wastewater repairs, often led by municipal governments. Further, as U.S. states increase regulation on existing and emerging contaminants, we expect that our customers will increasingly require sustainable solutions to their water‑related needs. In general, increased infrastructure investment and more stringent municipal, state and federal regulations promote increased spending on our products, services and solutions, while a slowdown in investment in public infrastructure or the elimination of key environmental regulations could result in lower industrial and municipal spending on water systems and products.
Availability of water. In general, we expect demand for our products and services to increase as the availability of clean water from public sources decreases. Secular trends that will drive demand for water across a multitude of industrial, commercial and municipal applications include global population growth, urbanization, industrialization and overall economic growth. In addition, the supply of clean water could be adversely impacted by factors including an aging water infrastructure within North America and increased levels of water stress from seasonal rainfall, inadequate water storage options or treatment technologies. Because water is a critical component and byproduct of many processes, including in manufacturing and product development, we expect that, as global consumption patterns evolve and water shortages persist, demand for our equipment and services will continue to increase.

40

Operational investment. Our historical operating results reflect the impact of our ongoing investments to support our growth. We have made significant investments in our business that we believe have laid the foundation for continued profitable growth. We believe that our strengthened sales force, mergers and acquisitions team, enhanced information systems, research, development and engineering investments and other factors enable us to support our operating model.
Our ability to source and distribute products effectively. Our revenues are affected by our ability to purchase our inputs in sufficient quantities at competitive prices. While we believe our suppliers have adequate capacity to meet our current and anticipated demand, our level of revenues could be adversely affected in the event of constraints in our supply chain, including the inability of our suppliers to produce sufficient quantities of raw materials in a manner that is able to match demand from our customers.
Contractual relationships with customers. Due to our large installed base and the nature of our contractual relationships with our customers, we have high visibility into a large portion of our revenue. The one‑ to twenty‑year terms of many of our service contracts and the regular delivery and replacement of many of our products help to insulate us from the negative impact of any economic decline.
Exchange rates. The reporting currency for our financial statements is the U.S. dollar. We operate in numerous countries around the world and therefore, certain of our assets, liabilities, revenues and expenses are denominated in functional currencies other than the U.S. dollar, primarily in the euro, U.K. sterling, Chinese renminbi, Canadian dollar, Australian dollar and Singapore dollar. To prepare our consolidated financial statements we must translate those assets, liabilities, revenues and expenses into U.S. dollars at the applicable exchange rate. As a result, increases or decreases in the value of the U.S. dollar against these other currencies will affect the amount of these items recorded in our consolidated financial statements, even if their value has not changed in the functional currency. While we believe we are not susceptible to any material impact on our results of operations caused by fluctuations in exchange rates because our operations are primarily conducted in the United States, if we expand our foreign operations in the future, substantial increases or decreases in the value of the U.S. dollar relative to these other currencies could have a significant impact on our results of operations.
Public company costs. As a result of our IPO, we now incur additional legal, accounting and other expenses that we did not previously incur, including costs associated with SEC reporting and corporate governance requirements. These requirements include compliance with the Sarbanes‑Oxley Act as well as other rules implemented by the SEC and the NYSE. Our financial statements following our IPO will reflect the impact of these expenses. In addition, the one‑time grant of stock‑settled restricted stock unit awards made in connection with the IPO to certain members of management will result in increased non‑cash share‑based compensation expense, which will be incremental to our ongoing share‑based compensation expense. This share‑based compensation expense is expected to be expensed beginning in the first fiscal quarter of fiscal 2018 and continuing over the following eight fiscal quarters.
Debt refinancings and Incremental Term Loan. On December 20, 2017, certain subsidiaries of the Company entered into Amendment No. 5 (the “Fifth Amendment”), among EWT III, as the borrower, certain other subsidiaries of the Company, and Credit Suisse AG, as administrative agent and collateral agent, relating to the First Lien Credit Agreement, dated January 15, 2014 (as amended, amended and restated, extended, supplemented or otherwise modified from time to time prior to the effectiveness of the Amendment, the “Existing Credit Agreement”). Proceeds of the Fifth Amendment were used to refinance $796,574 of Existing Term Loans.  Principal and interest under the Term Loans outstanding under the First Lien Credit Agreement are payable in quarterly installments, with quarterly principal reductions under the Fifth Amendment of $1,991, and the balance due at maturity on December 20, 2024.
On June 26, 2018 the Company reached a contingent agreement under the First Lien Credit Agreement to increase the loan outstanding by $150,000 subject to successfully closing on the announced ProAct Services Corporation acquisition. The terms for this additional borrowing would be consistent with the current terms. In addition, the Company reached an agreement with certain Revolving Credit Lenders to amend their participation from 2019 Revolving Credit Commitments to 2022 Revolving Credit Commitments. On conclusion of these amendments, the entire Revolving Credit of $125,000 will have a maturity in 2022.


41

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 business are revenue, gross profit, gross margin, operating expenses, net income (loss) and Adjusted EBITDA.
Revenue
Our sales are a function of sales volumes and selling prices, each of which is a function of the mix of product and service sales, and consist primarily of:
•
sales of tailored light industry technologies, heavy industry technologies and environmental products, services and solutions in collaboration with our industrial customers, backed by lifecycle services including emergency response services and build‑own‑operate alternatives, to a broad group of industrial customers in our U.S., Canada and Singapore markets;
•
sales of products, services and solutions to engineering firms and municipalities to purify drinking water and treat wastewater globally; and
•
sales of a wide variety of differentiated products and technologies, to an array of OEM, distributor, end‑user, engineering firm and integrator customers in all of our geographic markets and aftermarket channels.
Cost of Sales, Gross Profit and Gross Margin
Gross profit is determined by subtracting cost of product sales and cost of services from our product and services revenue. Gross margin measures gross profit as a percentage of our combined product and services revenue.
Cost of product sales consists of all manufacturing costs required to bring a product to a ready for sale condition, including direct and indirect materials, direct and indirect labor costs including benefits, freight, depreciation, information technology, rental and insurance, repair and maintenance, utilities, other manufacturing costs, warranties and third party commissions.
Cost of services primarily consists of the cost of personnel and travel for our field service, supply chain and technicians, depreciation of equipment and field service vehicles and freight costs.
Operating Expenses
Operating expenses consist primarily of general and administrative, sales and marketing and research and development expenses.
General and Administrative. General and administrative expenses consist of fixed overhead personnel expenses associated with our service organization (including district and branch managers, customer service, contract renewals and regeneration plant management). We expect our general and administrative expenses to increase due to the anticipated growth of our business and related infrastructure as well as legal, accounting, insurance, investor relations and other costs associated with becoming a public company.
Sales and Marketing. Sales and marketing expenses consist primarily of advertising and marketing promotions of our products, services and solutions and related personnel expenses (including all Evoqua sales and application engineer employees’ base compensation and incentives), as well as sponsorship costs, consulting and contractor expenses, travel, display expenses and related amortization. We expect our sales and marketing expenses to increase as we continue to actively promote our products, services and solutions.
Research and Development. Research and development expenses consist primarily of personnel expenses related to research and development, patents, sustaining engineering, consulting and contractor expenses, tooling and prototype materials and overhead costs allocated to such expenses. Substantially all of our research and development expenses are related to developing new products and services and improving our existing products and services. To date, research and development expenses have been expensed as incurred, because the period between achieving

42

technological feasibility and the release of products and services for sale has been short and development costs qualifying for capitalization have been insignificant.
Research and development expenses can fluctuate depending on our determination to invest in developing new products, services and solutions and enhancing our existing products, services and solutions versus adding these capabilities through a mergers and acquisitions strategy.
Net Income (Loss)
Net income (loss) is determined by subtracting operating expenses and interest expense from, and adding other operating income (expense), equity income from our partnership interest in Treated Water Outsourcing and income tax benefit (expense) to, gross profit. For more information on how we determine gross profit, see “Gross Profit.”
Adjusted EBITDA
Adjusted EBITDA is one of the primary metrics used by management to evaluate the financial performance of our 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, purchase accounting adjustment costs, non-cash share-based compensation, sponsor fees, transaction costs and other gains, losses and expenses. We present Adjusted EBITDA, which is not a recognized financial measure under GAAP, because we believe it is frequently used by analysts, investors and other interested parties to evaluate companies in our industry. Further, we believe it is helpful in highlighting trends in our operating results, because it excludes the results of decisions that are outside the control of management, while other measures can differ significantly depending on long‑term strategic decisions regarding capital structure, the tax jurisdictions in which we operate and capital investments. 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 EBITDA and Adjusted EBITDA of each reportable segment to evaluate the operating performance of such segments. EBITDA and Adjusted EBITDA of the reportable segments does 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, integration costs and recognition of backlog intangible assets recorded in purchase accounting) and share-based compensation charges.
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, Adjusted EBITDA may not be comparable to similarly titled measures used by other companies in our industry or across different industries.
The following is a reconciliation of our Net income (loss) to Adjusted EBITDA (unaudited, amounts in thousands):

43

 
 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
 
2017
 
2018
 
2017
 
2018
Net income (loss)
 
$
1,756

 
$
1,035

 
$
(6,550
)
 
$
11,012

Income tax expense (benefit)
 
12,202

 
1,433

 
295

 
(960)

Interest expense
 
12,466

 
12,370

 
39,117

 
40,423

Operating profit
 
26,424

 
14,838

 
32,862

 
50,475

Depreciation and amortization
 
18,293

 
21,561

 
55,813

 
61,924

EBITDA
 
44,717

 
36,399

 
88,675

 
112,399

Restructuring and related business transformation costs (a)
 
13,349

 
8,930

 
36,382

 
25,273

Purchase accounting adjustment costs (b)
 
—

 
—

 
229

 
—

Share-based compensation (c)
 
614

 
4,405

 
1,634

 
11,257

Sponsor fees (d)
 
1,042

 
—

 
3,042

 
333

Transaction costs (e)
 
1,899

 
4,655

 
5,659

 
6,014

Other (gains), losses and expenses (f)
 
(6,490
)
 
3,624

 
682

 
405

Adjusted EBITDA
 
$
55,131

 
$
58,013

 
$
136,303

 
$
155,681


(a)
Represents:
(i)
costs and expenses in connection with various restructuring initiatives since our acquisition, through our wholly-owned entities, EWT Holdings II Corp. and EWT Holdings III Corp., of all of the outstanding shares of Siemens Water Technologies, a group of legal entity businesses formerly owned by Siemens Aktiengesellschaft, on January 15, 2014 (the “AEA Acquisition”), including severance costs, relocation costs, recruiting expenses, write‑offs of inventory and fixed assets and third‑party consultant costs to assist with these initiatives (includes (A) $3.3 million and $19.2 million for the three and nine months ended June 30, 2017, respectively, and $0.0 million and $0.3 million for the three and nine months ended June 30, 2018, respectively, (all of which is reflected as a component of Restructuring charges in “Note 11. Restructuring and Related Charges” to our Unaudited condensed consolidated financial statements included in this Report) related to our voluntary separation plan pursuant to which approximately 220 employees accepted separation packages, and (B) $3.8 million and $6.5 million for the three and nine months ended June 30, 2017, respectively, (of which $0.4 million and $2.9 million for the three and nine months ended June 30, 2017, respectively, is reflected as a component of Restructuring charges in "Note 11. Restructuring and Related Charges" to our Unaudited condensed consolidated financial statements included in this Report), reflected as components of Cost of product sales and services ($1.7 million and $3.4 million for the three and nine month periods, respectively), Sales and marketing expense ($1.0 million and $1.0 million for the three and nine month periods, respectively), and General and administrative expense ($1.1 million and $2.0 million for the three and nine month periods, respectively); and $1.7 million and $7.1 million for the three and nine months ended June 30, 2018, respectively, reflected as components of Cost of product sales and services ($0.6 million and $2.2 million for the three and nine month periods, respectively), Research and development expense ($0.1 million and $0.6 million for the three and nine month periods, respectively), Sales and marketing expense ($0.0 million and $0.5 million for the three and nine month periods, respectively) and General and administrative expense ($1.0 million and $3.8 million for the three and nine month periods, respectively) (all of which is reflected as a component of Restructuring charges in “Note 11. Restructuring and Related Charges” to our Unaudited condensed consolidated financial statements included in this Report) related to various other initiatives implemented to restructure and reorganize our business with the appropriate management team and cost structure). Differences between amounts reflected as restructuring charges

44

in "Note 11. Restructuring and Related Charges" to our Unaudited condensed consolidated financial statements included in this Report and amounts reflected in this adjustment relate primarily to consulting costs and other charges related to implementing such initiatives that have primarily been recorded as components of Cost of product sales and services ($1.4 million), Sales and marketing expense ($1.0 million) and General and administrative expense ($1.0 million) in the three and nine months ended June 30, 2017;
(ii)
legal settlement costs and intellectual property related fees associated with legacy matters prior to the AEA Acquisition, including fees and settlement costs related to product warranty litigation on MEMCOR products and certain discontinued products ($1.0 million and $1.8 million for the three and nine months ended June 30, 2017, respectively, reflected as components of Cost of product sales and services ($0.1 million and $0.3 million for the three and nine month periods, respectively) and General and administrative expense ($0.9 million and $1.5 million for the three and nine month periods, respectively), and $1.0 million and $2.0 million for the three and nine months ended June 30, 2018, reflected as components of Cost of product sales and services ($0.7 million and $1.1 million for the three and nine month periods, respectively) and General and administrative expense ($0.3 million and $0.9 million for the three and nine month periods, respectively));
(iii)
expenses associated with our information technology and functional infrastructure transformation following the AEA Acquisition, including activities to optimize information technology systems and functional infrastructure processes ($1.0 million and $4.7 million for the three and nine months ended June 30, 2017, primarily reflected as components of Cost of product sales and services ($0.4 million and $2.1 million for the three and nine month periods, respectively), Sales and marketing expense ($0.1 million and $0.7 million for the three and nine month periods, respectively), Research and development expense ($0.0 million and $(0.1) million for the three and nine month periods, respectively) and General and administrative expense ($0.4 million and $1.9 million for the three and nine month periods, respectively), and $5.5 million and $10.2 million in the three and nine months ended June 30, 2018, primarily reflected as components of Cost of product sales and services ($1.0 million and $3.3 million for the three and nine month periods, respectively), Sales and marketing expense ($0.0 million for the three and nine months periods, respectively) and General and administrative expense ($4.1 million and $6.5 million for the three and nine month periods, respectively)); and
(iv)
costs incurred by us in connection with our IPO and secondary offering, including consultant costs and public company compliance costs ($4.3 million for both the three and nine months ended June 30, 2017, primarily reflected as components of Cost of product sales and services ($0.1 million for the three and nine month periods, respectively), Sales and marketing expense ($1.9 million for the three and nine month periods, respectively), and General and administrative expense ($2.3 million for the three and nine month periods, respectively) and $0.6 million and $5.6 million for the three and nine months ended June 30, 2018, respectively, all reflected as a component of General and administrative expense).
(b)
Represents adjustments for the effect of the purchase accounting step-up in the value of inventory to fair value recognized in Cost of product sales as a result of the acquisition of Magneto.
(c)
Represents non‑cash share‑based compensation expenses related to option awards. See “Note 14. Share-Based Compensation” to our Unaudited condensed consolidated financial statements included in this Report for further detail.
(d)
Represents management fees paid to AEA pursuant to the management agreement. Pursuant to the management agreement, AEA provided advisory and consulting services to us in connection with the AEA Acquisition, including investment banking, due diligence, financial advisory and valuation services. AEA also provided ongoing advisory and consulting services to us pursuant to the management agreement. In connection with the IPO, the management agreement was terminated. See “Note 16. Related-Party Transactions” to our Unaudited condensed consolidated financial statements included in this Report for further detail.

45

(e)
Represents expenses associated with acquisition and divestiture related activities and post‑acquisition integration costs and accounting, tax, consulting, legal and other fees and expenses associated with acquisition transactions ($1.9 million and $5.7 million in the three and nine months ended June 30, 2017, respectively, and $4.7 million and $6.0 million in the three and nine months ended June 30, 2018, respectively).
(f)
Represents:
(i)
impact of foreign exchange gains and losses ($(7.1) million gain and $(2.1) million gain in the three and nine months ended June 30, 2017, respectively, and $8.8 million loss and $5.2 million loss in the three and nine months ended June 30, 2018, respectively);
(ii)
foreign exchange impact related to headquarter allocations ($(0.1) million gain and $1.0 million loss for the three and nine months ended June 30, 2017, respectively, and $(0.3) million gain for the nine months ended June 30, 2018); and
(iii)
expenses related to maintaining non-operational business locations ($0.6 million and $1.8 million in the three and nine months ended June 30, 2017, respectively, and $0.5 million $1.2 million in the three and nine months ended June 30, 2018, respectively).
(iv)
expenses incurred by the Company related to the remediation of manufacturing defects caused by a third party vendor for which the Company is seeking restitution ($1.6 million for both the three and nine months ended June 30, 2018, respectively, all reflected as a component of Cost of product sales).
(v)
gain on the sale of assets related to the disposition of land at our Windsor, Australia location ($(7) million for both the three and nine months ended June 30, 2018, respectively, all reflected as a component of Other operating (expense) income).

Results of Operations
The following tables summarize key components of our results of operations for the periods indicated:

46


 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
2017
 
2018
 
 
 
2017
 
2018
 
 
 
 
 
% of Revenues
 
 
 
% of Revenues
 
% Variance
 
 
 
% of Revenues
 
 
 
% of Revenues
 
% Variance
 
(in thousands)
 
 
(in thousands)
 
Revenue from product sales and services
$
311,142

 
100.0%

 
$
342,475

 
100.0
 %
 
—
 %
 
$
890,916

 
100.0
 %
 
$
973,215

 
100.0
 %
 
—
 %
Cost of product sales and services
(210,715)

 
(67.7
)%
 
(240,468)

 
(70.2
)%
 
3.7
 %
 
(614,088)

 
(68.9
)%
 
(674,832)

 
(69.3
)%
 
0.6
 %
Gross profit
100,427

 
32.3
 %
 
102,007

 
29.8
 %
 
(7.7
)%
 
276,828

 
31.1
 %
 
298,383

 
30.7
 %
 
(1.3
)%
General and administrative expense
(31,136)

 
(10.0
)%
 
(56,961)

 
(16.6
)%
 
66.0
 %
 
(120,534)

 
(13.5
)%
 
(140,767)

 
(14.5
)%
 
7.4
 %
Sales and marketing expense
(36,946)

 
(11.9
)%
 
(33,888)

 
(9.9
)%
 
(16.8
)%
 
(108,729)

 
(12.2
)%
 
(102,459)

 
(10.5
)%
 
(13.9
)%
Research and development expense
(5,592)

 
(1.8
)%
 
(3,682)

 
(1.1
)%
 
(38.9
)%
 
(15,684)

 
(1.8
)%
 
(12,356)

 
(1.3
)%
 
(27.8
)%
Other operating (expense) income
(329)

 
(0.1
)%
 
7,362

 
2.1
 %
 
(2,200.0
)%
 
981

 
0.1
 %
 
7,674

 
0.8
 %
 
700.0
 %
Interest expense
(12,466)

 
(4.0
)%
 
(12,370)

 
(3.6
)%
 
(10.0
)%
 
(39,117)

 
(4.4
)%
 
(40,423)

 
(4.2
)%
 
(4.5
)%
Loss before income taxes
13,958

 
4.5
 %
 
2,468

 
0.7
 %
 


 
(6,255)

 
(0.7
)%
 
10,052

 
1.0
 %
 
 
Income tax (expense) benefit
(12,202)

 
(3.9
)%
 
(1,433)

 
(0.4
)%
 
(89.7
)%
 
(295)

 
—
 %
 
960

 
0.1
 %
 
—
 %
Net income (loss)
1,756

 
0.6
 %
 
1,035

 
0.3
 %
 
(50.0
)%
 
(6,550)

 
(0.7
)%
 
11,012

 
1.1
 %
 
(257.1
)%
Net income attributable to non‑controlling interest
253

 
0.1
 %
 
242

 
0.1
 %
 
—
 %
 
2,348

 
0.3
 %
 
1,427

 
0.1
 %
 
(66.7
)%
Net income (loss) attributable to Evoqua Water Technologies Corp.
$
1,503

 
0.5
 %
 
$
793

 
0.2
 %
 
(60.0
)%
 
$
(8,898
)
 
(1.0
)%
 
$
9,585

 
1.0
 %
 
(200.0
)%
 
 
 
 
 
 
Weighted average shares outstanding
 
 
 
Basic
104,821

 
 
 
113,842

 
 
 
 
 
104,821

 
 
 
113,842

 
 
 
 
Diluted
107,985

 
 
 
119,047

 
 
 
 
 
104,821

 
 
 
119,936

 
 
 
 
Earnings (loss) per share
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
$
0.01

 
 
 
$
0.01

 
 
 
 
 
$
(0.08
)
 
 
 
$
0.08

 
 
 
 
Diluted
$
0.01

 
 
 
$
0.01

 
 
 
 
 
$
(0.08
)
 
 
 
$
0.08

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other financial data:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted EBITDA(1)
$
55,131

 
17.7
 %
 
$
58,013

 
16.9
 %
 
(4.5
)%
 
$
136,303

 
15.3
 %
 
$
155,681

 
16.0
 %
 
4.6
 %

(1)
For the definition of Adjusted EBITDA and a reconciliation to net income (loss), its most directly comparable financial measure presented in accordance with GAAP, see “How We Assess the Performance of Our Business-Adjusted EBITDA.”

47

Consolidated Results
Revenues-Revenues increased $31,333, or 10.1%, to $342,475 in the three months ended June 30, 2018 from $311,142 in the three months ended June 30, 2017. Revenues increased $82,299, or 9.2%, to $973,215 in the nine months ended June 30, 2018 from $890,916 in the nine months ended June 30, 2017.
The following table provides the change in revenues from product sales and revenues from services, respectively:
 
Three Months Ended June 30,
 
 
 
Nine Months Ended June 30,
 
 
 
2017
 
2018
 
% Variance
 
2017
 
2018
 
% Variance
 
 
 
% of
Revenues
 
 
 
% of
Revenues
 
 
 
 
 
% of
Revenues
 
 
 
% of
Revenues
 
 
 
(in thousands)
 
(in thousands)
Revenue from product sales
$
168,252

 
54.1%
 
$
200,478

 
58.5%
 
19.2%
 
$
474,543

 
46.7%
 
$
550,202

 
42.6%
 
15.9%
Revenue from services
142,890

 
45.9%
 
141,997

 
41.5%
 
(0.6)%
 
416,373

 
53.3%
 
423,013

 
57.4%
 
1.6%
 
$
311,142

 
 
 
$
342,475

 
 
 
10.1%
 
$
890,916

 
 
 
$
973,215

 
 
 
9.2%
Revenues from product sales increased $32,226, or 19.2%, to $200,478 in the three months ended June 30, 2018 from $168,252 in the three months ended June 30, 2017. The increase in product revenues was primarily due to the growth in capital projects of $13,837 year-over-year in addition to revenue from the acquisitions of Noble, ADI, Olson, Pure Water and Pacific Ozone, which accounted for $12,842 of increased revenues. Aftermarket and other component product sales also had organic revenue growth of $3,319. The remaining increase of $2,228 was due to gains from foreign currency translation.
Revenues from product sales increased $75,659, or 15.9%, to $550,202 in the nine months ended June 30, 2018 from $474,543 in the nine months ended June 30, 2017. The increase in product revenues was primarily due to growth in capital projects which resulted in an increase of $31,743. The acquisitions of Noble, ADI, Olson, Pure Water and Pacific Ozone accounted for another $31,774 of the growth in revenues year-over-year. Aftermarket and other component product sales had organic growth of $3,772. The remaining increase of $8,370 was due to gains from foreign currency translation.
Revenues from services increased $893, or 0.6%, to $141,997 in the three months ended June 30, 2018 from $142,890 in the three months ended June 30, 2017. The main driver of this increase was $753 recognized from the Noble and Pure Water acquisitions in addition to the timing of the delivery of services as compared to the prior year.
Revenues from services increased $6,640, or 1.6%, to $423,013 in the nine months ended June 30, 2018 from $416,373 in the nine months ended June 30, 2017. The increase was driven mainly by timing of delivery of services in the current period as compared to the prior period. Another $1,842 was recognized from the Noble and Pure Water acquisitions.
Cost of Sales and Gross Margin-Total gross margin decreased to 29.8% in the three months ended June 30, 2018 from 32.3% in the three months ended June 30, 2017. Total gross margin decreased slightly to 30.7% in the nine months ended March 31, 2018 from 31.1% in the nine months ended June 30, 2018.
The following table provides the change in cost of product sales and cost of services, respectively, along with related gross margins:

48

 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
2017
 
2018
 
2017
 
2018
 
 
 
Gross
Margin %
 
 
 
Gross
Margin %
 
 
 
Gross
Margin %
 
 
 
Gross
Margin %
 
(in thousands)
 
(in thousands)
Cost of product sales
$
102,988

 
38.8%
 
$
131,241

 
34.5%
 
$
298,898

 
37.0%
 
$
359,547

 
34.7%
Cost of services
107,727

 
24.6%
 
109,227

 
23.1%
 
315,190

 
24.3%
 
315,285

 
25.5%
 
210,715

 
32.3%
 
$
240,468

 
29.8%
 
$
614,088

 
31.1%
 
$
674,832

 
30.7%
Cost of product sales increased by approximately $28,253 to $131,241 in the three months ended June 30, 2018 from $102,988 in the three months ended June 30, 2017. The increase in cost of product sales was primarily driven by the volume increases year-over-year related to organic capital project and aftermarket revenues, which accounted for $21,095 of the increase, as well as due to the acquisitions of Noble, ADI, Olson, Pure Water and Pacific Ozone, which accounted for $7,158 of the increase.
Cost of product sales increased $60,649 to $359,547, in the nine months ended June 30, 2018 from $298,898 in the nine months ended June 30, 2017. The increase in cost of product sales was primarily driven by the increased volume in capital projects and aftermarket revenues, which accounted for $42,803 of the increase, as well as the acquisitions of ADI, Olson, Pure Water and Pacific Ozone, which accounted for $17,846 of the increase year-over-year.
Cost of services increased by approximately $1,500 in the three months ended June 30, 2018 from $107,727 in the three months ended June 30, 2017. The increase in cost of services was mainly related to an overall increase in revenue volume.
Cost of services increased by $95 to $315,285 in the nine months ended June 30, 2018 from $315,190 in the nine months ended June 30, 2017. The increase in cost of services was mainly related to an overall increase in revenue volume.
Operating Expenses-Operating expenses increased $20,857, or 28.3%, to $94,531 in the three months ended June 30, 2018 from $73,674 in the three months ended June 30, 2017. Included in the three months ended June 30, 2017 amount was a gain from favorable foreign currency impacts of $7,100, whereas the amount included in the three months ended June 30, 2018 was a loss from unfavorable foreign currency impacts of $8,828. This change in foreign currency resulted in an increase in operating expenses of $15,928. Additionally, the Company incurred increased expenses of $4,209 associated with the acquisitions of Noble, ADI, Olson, Pure Water and Pacific Ozone. Another $2,619 increase was due to the acquisitions of Noble and ADI achieving all the required earn-out targets, which resulted in an increase to the fair valued amount of the earn-out recorded upon the acquisitions. These increases were offset by a reduction in research and development spending of $1,910 and a slight reductions in employment costs.
Operating expenses increased $10,635, or 4.3%, to $255,582 in the nine months ended June 30, 2018 from $244,947 in the nine months ended June 30, 2017. Included in the nine months ended June 30, 2017 amount was a gain from favorable foreign currency impacts of $1,489, whereas the amount included in the nine months ended June 30, 2018 was a loss from unfavorable foreign currency impacts of $5,059. This change in foreign currency resulted in an increase in operating expenses of $6,548. Another $9,281 increase was due to the acquisitions of Noble, ADI, Olson, Pure Water and Pacific Ozone. These increases in operating expenses were offset by a $5,194 reduction in restructuring expenses and employment costs driven by the cost improvement initiatives implemented in the current and prior year. A discussion of operating expenses by category is as follows:
Research and Development Expense - Research and development expenses decreased due to reduced spending and an increase of cost reimbursements received from outside parties over the same periods in the prior year.
Sales and Marketing Expense - Sales and marketing expenses had a decrease mainly due to a reduction in restructuring charges and lower employment costs.
General and Administrative Expense - General and administrative expenses increased $25,825, or 82.9%, to $56,961 in the three months ended June 30, 2018 from $31,136 in the three months ended June 30, 2017. This increase in general and administrative expenses was primarily due to unfavorable foreign currency impacts on the intracompany loans of $15,928, as describe above, in addition to increased employee related expenses of $3,555, primarily due to increased

49

share-based compensation expense. The Noble, ADI, Olson, Pure Water and Pacific Ozone acquisitions resulted in another $3,723 of increased costs, and another $2,619 was due to the earn-out adjustment mentioned above.
General and administrative expenses increased $20,233, or 16.8%, to $140,767 in the nine months ended June 30, 2018 from $120,534 in the nine months ended June 30, 2017. This increase in general and administrative expenses was primarily due to increased costs from the acquisitions of $8,295 and unfavorable foreign currency impacts on the intracompany loans of $7,254, as described above, as well as $2,619 attributable to the earn-out adjustment mentioned above. The remaining increase was due to increased employee related expenses and amortization expense.
Other operating (expense) income-Other operating (expense) income increased $7,691, or 2,337.7%, to income of $7,362 in the three months ended June 30, 2018 from expense of $329 in the three months ended June 30, 2017. In the three months ended June 30, 2018, the Company sold two parcels of land in their Australian location which resulted in a gain of $6,990. The sale of precious metals resulted in another $457 of gain, in addition to an insurance settlement of $100. There were no similar transactions in the three months ended June 30, 2017.
Other operating income increased $6,693, or 682.3%, to income of $7,674 in the nine months ended June 30, 2018 from income of $981 in the nine months ended June 30, 2017 for the same reasons as mentioned above.
Interest Expense-Interest expense remained flat with a very slight decrease of $96, or 0.8%, to $12,370 in the three months ended June 30, 2018 from $12,466 in the three months ended June 30, 2017. The decrease in interest expense was primarily due the reduction in the overall loan balance due to a $100,000 prepayment during the first quarter of the current fiscal year, coupled with the refinancing that occurred in December 2017, offset by the impact of increasing LIBOR rates. Interest expense increased $1,306, or 3.3%, to $40,423 in the nine months ended June 30, 2018 from $39,117 in the nine months ended June 30, 2017. The increase in interest expense was primarily due to the increase in charges associated with the $100,000 prepayment of the Term Loan in November 2017 coupled with the refinancing that occurred in December 2017.
Income tax (expense) benefit-An income tax expense of $12,202 and $1,433 was recorded for the three months ended June 30, 2017 and 2018, respectively. The decrease in tax expense is principally the result of lower earnings compared to the same quarter in the prior year. In each period, discrete items were not material.
An income tax expense (benefit) of $295 and ($960) was recorded for the nine months ended ended June 30, 2017 and 2018, respectively. This decrease is the result of a discrete tax benefit of $3,641 to remeasure U.S. deferred tax liabilities associated with indefinite lived intangible assets from 35.0% to 21.0%. Other than accounting for the reduced U.S. federal tax rate to 21.0%, there are currently no other U. S. tax reform effects reflected in operating results as either such amounts are not expected to be material, or certain other applicable provisions are not effective for fiscal year tax filers until October 1, 2018.
Net Income-Net income decreased by $721, or 41.1%, to $1,035 for the three months ended June 30, 2018 from $1,756 in the three months ended June 30, 2017. This was primarily driven by the increase in operating expenses, mainly the unfavorable change in foreign currency impacts as described above. Net income increased by $17,562, or 268.1%, to net earnings of $11,012 for the nine months ended June 30, 2018 from a net loss of $6,550 in the nine months ended June 30, 2017. This increase was primarily driven by increased sales and gross profit.
Adjusted EBITDA-Adjusted EBITDA increased $2,882, or 5.2%, to $58,013 for the three months ended June 30, 2018 from $55,131 for the three months ended June 30, 2017. Adjusted EBITDA increased $19,378, or 14.2%, to $155,681 for the nine months ended June 30, 2018 from $136,303 for the nine months ended June 30, 2017. Benefits derived from restructuring and operational efficiencies that were implemented in the current and prior fiscal year, as well as increased volume and accretive profitability associated with organic revenue growth and current and prior year acquisitions, provided for the increase in Adjusted EBITDA.

50

Segment Results
 
Three Months Ended June 30,
 
 
 
Nine Months Ended June 30,
 
 
 
2017
 
2018
 
% Variance
 
2017
 
2018
 
% Variance
 
(in thousands)
 
 
 
(in thousands)
 
 
Revenues

 
 
 

 
 
Industrial
$
154,698

 
$
182,323

 
17.9
 %
 
$
460,861

 
$
528,776

 
14.7
 %
Municipal
72,742

 
68,499

 
(5.8
)%
 
198,927

 
194,689

 
(2.1
)%
Products
83,702

 
91,653

 
9.5
 %
 
231,128

 
249,750

 
8.1
 %
Total Consolidated
$
311,142

 
$
342,475

 
10.1
 %
 
$
890,916

 
$
973,215

 
9.2
 %
Percentage of total consolidated revenues
 
 
 
 
 
 
 
 
 
 
Industrial
49.7
 %
 
53.2
 %
 
 
 
51.7
 %
 
54.3
 %
 
 
Municipal
23.4
 %
 
20.0
 %
 
 
 
22.4
 %
 
20.0
 %
 
 
Products
26.9
 %
 
26.8
 %
 
 
 
25.9
 %
 
25.7
 %
 
 
Total Consolidated
100
 %
 
100
 %
 
 
 
100
 %
 
100
 %
 
 
Operating Profit
 
 
 
 
 
 
 
 
 
 
 
Industrial
$
25,567

 
$
24,415

 
(4.5
)%
 
$
74,501

 
$
85,402

 
14.6
 %
Municipal
10,562

 
12,698

 
20.2
 %
 
23,525

 
25,472

 
8.3
 %
Products
19,112

 
20,720

 
8.4
 %
 
44,348

 
48,290

 
8.9
 %
Corporate
(28,817
)
 
(42,995
)
 
(49.2
)%
 
(109,512
)
 
(108,689
)
 
0.8
 %
Total Consolidated
$
26,424

 
$
14,838

 
(43.8
)%
 
$
32,862

 
$
50,475

 
53.6
 %
Operating profit as a percentage of total consolidated revenues
 
 
 
 
 
 
 
 
Industrial
8.2
%
 
7.1
%
 
 
 
23.9
%
 
24.9
%
 
 
Municipal
3.4
 %
 
3.7
 %
 
 
 
7.6
 %
 
7.4
 %
 
 
Products
6.1
 %
 
6.1
 %
 
 
 
14.3
 %
 
14.1
 %
 
 
Corporate
(9.3
)%
 
(12.6
)%
 
 
 
(35.2
)%
 
(31.7
)%
 
 
Total Consolidated
7.7
%
 
4.3
%
 
 
 
9.6
%
 
14.7
%
 
 
EBITDA
 
 
 
 
 
 
 
 
 
 
 
Industrial
$
34,758

 
$
35,805

 
3.0
 %
 
$
102,133

 
$
117,646

 
15.2
 %
Municipal
12,556

 
14,434

 
15.0
 %
 
29,644

 
30,784

 
3.8
 %
Products
21,196

 
23,989

 
13.2
 %
 
53,070

 
57,635

 
8.6
 %
Corporate and unallocated costs
(23,794
)
 
(37,828
)
 
59.0
 %
 
(96,172
)
 
(93,667
)
 
(2.6
)%
Total Consolidated
$
44,716

 
$
36,400

 
(18.6
)%
 
$
88,675

 
$
112,398

 
26.8
 %
EBITDA as a percentage of total consolidated revenues
 
 
 
 
 
 
 
 
Industrial
11.2
 %
 
10.5
 %
 
 
 
32.8
 %
 
34.4
 %
 
 
Municipal
4.0
 %
 
4.2
 %
 
 
 
9.5
 %
 
9.0
 %
 
 
Products
6.8
 %
 
7.0
 %
 
 
 
17.1
 %
 
16.8
 %
 
 
Corporate and unallocated costs
(7.6
)%
 
(11.0
)%
 
 
 
(30.9
)%
 
(27.4
)%
 
 
Total Consolidated
13.1
 %

10.6
 %
 
 
 
25.9
 %
 
32.8
 %
 
 

51

Adjusted EBITDA on a segment basis is defined as earnings before interest expense, income tax expense (benefit) and depreciation and amortization, adjusted for the impact of certain other items that have been reflected at the segment level. The following is a reconciliation of our segment operating profit to Adjusted EBITDA:
 
Three Months Ended June 30,
 
2017
 
2018
 
Industrial
Municipal
Products
 
Industrial
Municipal
Products
 
(in thousands)
Operating Profit
$
25,567

$
10,562

$
19,112

 
$
24,415

$
12,698

$
20,720

Depreciation and amortization
(9,191
)
(1,994
)
(2,084
)
 
(11,390
)
(1,736
)
(3,269
)
EBITDA
$
34,758

$
12,556

$
21,196

 
$
35,805

$
14,434

$
23,989

Restructuring and related business transformation costs (a)
—

—

—

 
—

820

293

Transaction costs (b)
—

—

—

 
2,612

—

—

Other (gains), losses and expenses (c)
—

—

—

 
—

(6,990
)
1,609

Adjusted EBITDA (2)
$
34,758

$
12,556

$
21,196

 
$
38,417

$
8,264

$
25,891

 
 
 
 
 
 
 
 
 
Nine Months Ended June 30,
 
2017
 
2018
 
Industrial
Municipal
Products
 
Industrial
Municipal
Products
 
(in thousands)
Operating Profit
$
74,501

$
23,525

$
44,348

 
$
85,402

$
25,472

$
48,290

Depreciation and amortization
(27,632
)
(6,119
)
(8,722
)
 
(32,244
)
(5,312
)
(9,345
)
EBITDA
$
102,133

$
29,644

$
53,070

 
$
117,646

$
30,784

$
57,635

Restructuring and related business transformation costs (a)
—

—

—

 
—

820

293

Transaction costs (b)
—

—

—

 
2,612

—

—

Other (gains), losses and expenses (c)
—

—

—

 
—

(6,990
)
1,609

Adjusted EBITDA (2)
$
102,133

$
29,644

$
53,070

 
$
120,258

$
24,614

$
59,537


_______________________
(a)
Represents costs and expenses in connection with restructuring initiatives distinct to our Municipal segment and Products segment, respectively, incurred in the three months ended June 30, 2018. Such expenses are primarily composed of severance and relocation costs.
(b)
Represents costs associated with the full achievement in the three months ended June 30, 2018 of earn-out targets established during the Noble and ADI acquisitions, distinct to our Industrial segment.
(c)
Represents:
(i)
gain on the sale of assets distinct to our Municipal segment related to the disposition of land at our Windsor, Australia location for the three months ended June 30, 2018; and
(ii)
expenses incurred by the Company in the three months ended June 30, 2018, distinct to our Products segment related to the remediation of manufacturing defects caused by a third party vendor for which the Company is seeking restitution.
Industrial
Revenues in the Industrial Segment increased $27,625, or 17.9%, to $182,323 in the three months ended June 30, 2018 from $154,698 in the three months ended June 30, 2017. The increase in revenue was driven by further capital penetration primarily in the power market and remediation projects of $17,163. Our acquisitions of ADI, Noble and Pure Water resulted in another increase of $11,111 of revenue. These increases were offset by a decline in service revenue of $649, primarily in the power, hydrocarbon processing and chemical processing.

52

Revenues in the Industrial Segment increased $67,915, or 14.7%, to $528,776 in the nine months ended June 30, 2018 from $460,861 in the nine months ended June 30, 2017. Further capital penetration, primarily in the power market and remediation projects, resulted in an increase of $31,665. Service revenue also increased $6,974 primarily in power, hydrocarbon processing and chemical processing. Another increase of $29,276 of revenue was attributable to our acquisitions of ADI, Noble and Pure Water.
Operating profit in the Industrial Segment decreased $1,152, or (4.5)%, to $24,415 in the three months ended June 30, 2018 from $25,567 in the three months ended June 30, 2017. The decrease in operating profit was mainly related to negative temporary absorption, productivity and inflation which impacted profit by $2,800 and $2,619 related to the full achievements of the earn-out targets established during the Noble and ADI acquisitions. Another increase of $2,199 related to higher depreciation and amortization driven by capital investment in service assets and the acquisitions mentioned above. Partially offsetting these decreases was $3,823 of profit driven by revenue volume, net of product mix, as well as price realization and $2,643 of increased profit from the ADI, Noble and Pure Water acquisitions.
Operating profit in the Industrial Segment increased $10,901, or 14.6%, to $85,402 in the nine months ended June 30, 2018 from $74,501 in the nine months ended June 30, 2017. The increase in operating profit was primarily related to $4,432 of benefits experienced as a result of lower costs driven by restructuring and cost improvement initiatives implemented in the current and prior fiscal year. The ADI, Noble and Pure Water acquisitions contributed $7,736 of an increase to operating profit while $4,407 of increased operating profit was generated from revenue volume, net of product mix, as well as price realization. These improvements were offset by higher depreciation and amortization of $4,612 driven by capital investment in service assets and the acquisitions mentioned above and the $2,619 related to the earn-out adjustment.
EBITDA in the Industrial Segment increased $1,047, or 3.0%, to $35,805 in the three months ended June 30, 2018, compared to $34,758 in the three months ended June 30, 2017. Adjusted EBITDA increased $3,659, or 10.5%, to $38,417 in the three months ended June 30, 2018, compared to $34,758 in the three months ended June 30, 2017. The increase in EBITDA resulted from the same factors which impacted operating profit, less the change in depreciation and amortization. Adjusted EBITDA in the Industrial Segment excludes the charge of $2,619 related to the full achievements of earn-out targets established during the Noble and ADI acquisitions that was discrete to the Industrial Segment. There were no comparable charges incurred in the same period of the prior year that would impact Adjusted EBITDA for the Industrial Segment.
EBITDA in the nine months ended June 30, 2018 increased $15,513, or 15.2%, to $117,646 as compared to $102,133 in the nine months ended June 30, 2017, respectively. Adjusted EBITDA increased $18,125 , or 17.7%, to $120,258 in the nine months ended June 30, 2018, as compared to $102,133 in the nine months ended June 30, 2017 for the same reasons mentioned above.
Municipal
Revenues in the Municipal Segment decreased $4,243, or 5.8%, to $68,499 in the three months ended June 30, 2018 from $72,742 in the three months ended June 30, 2017. Capital revenues decreased by $3,673 as the Company completed a large waste water retrofit project, aftermarket declined by $1,281 driven by timing of large orders in drinking water in 2017, and lower revenue of $41 from our Italian operations as this portion of our business was sold in April of 2018. These decreases were offset by growth in service revenue of $752.
Revenues in the Municipal Segment decreased $4,238, or 2.1%, to $194,689 in the nine months ended June 30, 2018 from $198,927 in the nine months ended June 30, 2017. Capital revenues decreased by $404 for the same reasons noted as the quarterly decrease in revenues and aftermarket declined by $5,263 driven by the timing of large orders in drinking water. These decreases were offset by increases in service revenue of $2,002. The remaining change in revenues of $573 is the result of the sale of our Italian operations.
Operating profit in the Municipal Segment increased $2,136, or 20.2%, to $12,698 in the three months ended June 30, 2018 from $10,562 in the three months ended June 30, 2017. The increase in operating profit was due to a gain on sale of land for $6,990, $1,124 from lower costs primarily related to employment expenses through the continued alignment of a more customer focused organization, lower depreciation and amortization of $258, and $56 from the sale of our Italian operations. Profitability improvements were partially offset by $6,292 related to product mix of capital and services revenues as compared to higher margin aftermarket, in addition to warranty timing and other operational variances as compared to the same period in the prior year.
Operating profit in the Municipal Segment increased by $1,947, or 8.3%, to $25,472 in the nine months ended June 30, 2018 from $23,525 in the nine months ended June 30, 2017. The increase in operating profit was primarily due the gain from

53

the land sale of $6,990, lower employment expenses and other operational efficiencies of $544, reduction in research and development spending of $992 and a reduction in depreciation expense of $807. These increases were partially offset by product mix from higher margin aftermarket revenues to lower margin capital and services revenues, plus other operational variances of $7,386.
EBITDA in the Municipal Segment increased $1,878, or 15.0%, to $14,434 in the three months ended June 30, 2018, compared to $12,556 in the three months ended June 30, 2017. Adjusted EBITDA decreased $4,292, or 34.2%, to $8,264 in the three months ended June 30, 2018, compared to $12,556 in the three months ended June 30, 2017. The increase in EBITDA resulted from the same factors which impacted operating profit, less the change in depreciation and amortization. Adjusted EBITDA in the Municipal Segment excludes the $6,990 gain on sale of land in Windsor, Australia, as well as a charge of $820 related to restructuring and realignment costs incurred during the three months ended June 30, 2018, that were discrete to the Municipal Segment. There were no comparable charges incurred in the same period of the prior year that would impact Adjusted EBITDA for the Municipal Segment.
EBITDA in the nine months ended June 30, 2018 increased $1,140, or 3.8%, to $30,784 as compared to $29,644 in the nine months ended June 30, 2017, respectively. Adjusted EBITDA decreased $5,030 , or 17.0%, to $24,614 in the nine months ended June 30, 2018, as compared to $29,644 in the nine months ended June 30, 2017 for the same reasons mentioned above.
Products
Revenues in the Products Segment increased $7,951, or 9.5%, to $91,653 in the three months ended June 30, 2018 from $83,702 in the three months ended June 30, 2017. Organic growth was $3,434 due to growth across the segment from project, aftermarket, and component sales. Revenue growth from the acquisitions of Olson and Pacific Ozone was $2,464, and growth from foreign currency translations was $2,484. Revenue from a business line divested in the prior year accounted for a decline of $431.
Revenues in the Products Segment increased $18,622, or 8.1%, to $249,750 in the nine months ended June 30, 2018 from $231,128 in the nine months ended June 30, 2017. Organic growth was $7,190 due to growth across the segment from project, aftermarket, and component sales. Revenue growth from the acquisitions of Olson and Pacific Ozone was $4,340, and growth from foreign currency translations was $8,331. Revenue from a business line divested in the prior year accounted for a decline of $1,239.
Operating profit in the Products Segment increased $1,608 or 8.4%, to $20,720 in the three months ended June 30, 2018 from $19,112 in the three months ended June 30, 2017. The volume and mix of revenues, along with operational efficiencies and impact of foreign currency, accounted for an increase of $1,925. Added to that was an increase from the acquisitions of Olson and Pacific Ozone was $868. These increases were offset by increased depreciation and amortization expense of $1,185, mainly from the increased amortization related to the acquisitions.
Operating profit in the Products Segment increased $3,942 or 8.9%, to $48,290 in the nine months ended June 30, 2018 from $44,348 in the nine months ended June 30, 2017. The volume and mix of revenues, along with operational efficiencies and impact of foreign currency, accounted for an increase of $4,108. The increase from the acquisitions of Olson and Pacific Ozone was $457. Another decrease was due to $623 of higher depreciation and amortization mainly from the increased amortization related to the acquisitions.
EBITDA in the Products Segment increased $2,793, or 13.2%, to $23,989 in the three months ended June 30, 2018, compared to $21,196 in the three months ended June 30, 2017. Adjusted EBITDA increased $4,695, or 22.2%, to $25,891 in the three months ended June 30, 2018, compared to $21,196 in the three months ended June 30, 2017. The increase in EBITDA resulted from the same factors which impacted operating profit, less the change in depreciation and amortization. Adjusted EBITDA in the Products Segment excludes $1,609 of costs associated with the remediation of a manufacturing defect caused by a third party vendor as well as a charge of $293 for restructuring and realignment costs incurred during the three months ended June 30, 2018, that were discrete to the Products Segment. There were no comparable charges incurred in the same period of the prior year that would impact Adjusted EBITDA for the Products Segment.
EBITDA in the nine months ended June 30, 2018 increased $4,565, or 8.6%, to $57,635 as compared to $53,070 in the nine months ended June 30, 2017, respectively. Adjusted EBITDA increased $6,467 , or 12.2%, to $59,537 in the nine months ended June 30, 2018, as compared to $53,070 in the nine months ended June 30, 2017 for the same reasons mentioned above.

54

Liquidity and Capital Resources
Liquidity describes the ability of a company to 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. We consider liquidity in terms of cash flows from operations and their sufficiency to fund our operating and investing activities.
Our principal sources of liquidity are our cash generated by operating activities and borrowings under our Revolving Credit Facility. Historically, we have financed our operations primarily from cash generated from operations and periodic borrowings under our $125,000 Revolving Credit Facility. 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.
We expect to continue to finance our liquidity requirements through internally generated funds and borrowings under our Revolving Credit Facility. We believe that our projected cash flows generated from operations, together with borrowings under our Revolving Credit Facility are sufficient to fund our principal debt payments, interest expense, our working capital needs and our expected capital expenditures for the next twelve months. Our capital expenditures for the nine months ended June 30, 2017 and 2018 were $40,475 and $54,569, respectively. However, our budgeted capital expenditures can vary from period to period based on the nature of capital intensive project awards. We may draw on our Revolving Credit Facility from time to time to fund or partially fund an acquisition.
As of June 30, 2018, we had total indebtedness of $804,393, including $790,600 of borrowings under the First Lien Term Loan Facility, no borrowings under our Revolving Credit Facility, $9,615 in borrowings related to equipment financing and $2,310 of notes payable related to certain equipment related contracts. We also had $13,157 of letters of credit issued under our $125,000 Revolving Credit Facility and an additional $87 of letters of credit issued under a separate uncommitted facility as of June 30, 2018.
Our senior secured credit facilities contain a number of covenants imposing certain restrictions on our business. These restrictions may affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. The restrictions these covenants place on our business operations, include limitations on our or our subsidiaries’ ability to:
•
incur or guarantee additional indebtedness;
•
make certain investments;
•
pay dividends or make distributions on our capital stock;
•
sell assets, including capital stock of restricted subsidiaries;
•
agree to payment restrictions affecting our restricted subsidiaries;
•
consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;
•
enter into transactions with our affiliates;
•
incur liens; or
•
designate any of our subsidiaries as unrestricted subsidiaries.
We are a holding company and do not conduct any business operations of our 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 our senior secured credit facilities, 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.

55

In addition, our Revolving Credit Facility, but not the First Lien Term Loan Facility, contains a financial covenant which requires us to comply with the maximum first lien net leverage ratio of 5.55 to 1.00 as of the last day of any quarter on which the aggregate amount of revolving loans and letters of credit outstanding under the Revolving Credit Facility (net of cash collateralized letters of credit and undrawn outstanding letters of credit in an amount of up to 50% of the Revolving Credit Facility) exceeds 25% of the total commitments thereunder.
As of September 30, 2017 and June 30, 2018, we were in compliance with the covenants contained in the senior secured credit facilities.
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.
Cash Flows
The following table summarizes the changes to our cash flows for the periods presented:
 
Nine Months Ended June 30,
 
2017
 
2018
Statement of Cash Flows Data
(in thousands)
Net cash provided by operating activities
$
15,792

 
$
36,788

Net cash used in investing activities
(117,266
)
 
(52,663
)
Net cash provided by financing activities
104,449

 
14,928

Effect of exchange rate changes on cash
680

 
(1,000
)
Change in cash and cash equivalents
$
3,655

 
$
(1,947
)
Operating Activities
Cash flows from operating activities can fluctuate significantly from period‑to‑period as working capital needs and the timing of payments for restructuring activities and other items impact reported cash flows.
Net cash provided by operating activities increased to a source of $36,788 in the nine months ended June 30, 2018 from a source of $15,792 in the nine months ended June 30, 2017.
•
Operating cash flows in the nine months ended June 30, 2018 reflect an increase in net earnings of $17,562 as compared to the nine months ended June 30, 2017 and decreased non‑cash charges of $6,417 primarily relating to a reduction in deferred taxes and the foreign currency impact on the intracompany loans, partially offset by increased share-based compensation expenses.
•
The aggregate of receivables, inventories, cost and earnings in excess of billings on uncompleted contracts, accounts payable and billings in excess of costs incurred on uncompleted contracts used $3,052 in operating cash flows in the nine months ended June 30, 2018 compared to a use of $24,078 in operating cash flows in the nine months ended June 30, 2017. The amount of cash flow generated from or used by the above mentioned accounts depends upon how effectively we manage our cash conversion cycle, which is a representation of the number of days that elapse from the date of purchase of raw materials and components to the collection of cash from customers. Our cash conversion cycle can be significantly impacted by the timing of collections and payments in a period. Further, as it relates to capital projects, fiscal 2017 represented a continued rebuilding of the pipeline of capital projects as compared to the period prior to the Acquisition, which represented a depletion of the pipeline of capital projects. This build‑up of capital project activity contributed to the variability of accounts receivable, inventories, excess billings on uncompleted contracts or billings in excess of costs incurred on uncompleted contracts from period to period.

56

•
The aggregate of prepaid expense and other current assets, income taxes and other non current assets and liabilities used $6,211 in operating cash flows in the nine months ended June 30, 2018 compared to a use of $5,072 in the nine months ended June 30, 2017. This is mainly due to timing of payments.
•
Accrued expenses and other liabilities used $33,548 in operating cash flows in the nine months ended June 30, 2018 compared to a use of $10,678 in the nine months ended June 30, 2017. The increased use of operational cash flow in both periods resulted primarily from timing of cash payments for various employee-related liabilities along with the payment of accrued expenses related to the IPO and other transactions.
Investing Activities
Net cash used in investing activities decreased $64,603 from $117,266 in the nine months ended June 30, 2017 to $52,663 in the nine months ended June 30, 2018. This increase was largely driven by the increased spending on property, plant and equipment during the nine months ended June 30, 2018, offset by the sale of land.
Financing Activities
Net cash used by financing activities decreased $89,521 from $104,449 in the nine months ended June 30, 2017 to $14,928 in the nine months ended June 30, 2018. This lower amount of cash provided by financing activities for the nine months ended June 30, 2018 was primarily due to the issuance of debt that occurred during the nine months ended of the prior year. This change was offset by $137,605 cash received upon the issuance of stock during the IPO, net of the $100,000 prepayment of debt made in November of 2017 and the payout of the earn-out related to the Noble acquisition of $1,719.
Seasonality
While we do not believe it to be significant, our business does exhibit seasonality resulting from our customers’ increasing demand for our products and services during the spring and summer months as compared to the fall and winter months. For example, our Municipal Segment experiences increased demand for our odor control product lines and services in the warmer months which, together with other factors, typically results in improved performance in the second half of our fiscal year. Inclement weather, such as hurricanes, droughts and floods, can also drive increased demand for our products and services. As a result, our results from operations may vary from period to period.

Off‑Balance Sheet Arrangements
As of September 30, 2017 and June 30, 2018, we had letters of credit totaling $17,274 and $13,244, respectively, and surety bonds totaling $87,849 and $100,487, respectively, outstanding under our credit arrangements. The longest maturity date of the letters of credit and surety bonds in effect as of June 30, 2018 was March 31, 2024. Additionally, as of September 30, 2017 and June 30, 2018, we had letters of credit totaling $901 and $867, respectively, and surety bonds totaling $12,970 and $5,545, respectively, outstanding under our prior arrangement with Siemens.
Contractual Obligations
We enter into long‑term obligations and commitments in the normal course of business, primarily debt obligations and non‑cancelable operating leases. As of June 30, 2018, our contractual cash obligations over the next several periods were as follows:

57

 
Total
Less than
1 year
1 to
3 years
3 to
5 years
More than
5 years
 
(in thousands)
Operating lease commitments(a)
$
46,455

$
11,087

$
17,729

$
9,128

$
8,511

Capital lease commitments(b)
34,054

11,452

15,564

6,018

1,020

Long‑term debt obligations
804,393

9,927

19,586

19,597

755,283

Interest payments on long‑term debt obligations
262,870

41,970

82,375

80,323

58,202

Natural gas commitments
3,343

3,343

—

—

—

Total
$
1,151,115

$
77,779

$
135,254

$
115,066

$
823,016

 
 
 
 
 
 

(a)
We occupy certain facilities and operate certain equipment and vehicles under non‑cancelable lease arrangements. Lease agreements may contain lease escalation clauses and purchase and renewal options. We recognize scheduled lease escalation clauses over the course of the applicable lease term on a straight‑line basis.
(b)
We lease certain equipment classified as capital leases. The leased equipment is depreciated on a straight line basis over the life of the lease and is included in depreciation expense.
Recent Developments
The Company completed the acquisition of ProAct Services Corporation (ProAct) on July 26, 2018, through the Company's wholly owned subsidiary, EWT Holdings III Corp., for $133,772 paid in cash at closing. ProAct is a leading provider of on-site treatment services of contaminated water in all 50 states. ProAct will operate as a separate division within Evoqua’s Industrial Segment and will continue to be based in Ludington, Michigan with a nationwide service footprint and facilities in California, Florida, Michigan, Minnesota, New Jersey, Virginia and Texas.
In connection with the closing of the ProAct acquisition on July 26, 2018, EWT Holdings III Corp. entered into Amendment 6 to the First Lien Credit Agreement dated January 15, 2014 (as amended, amended and restated, extended, supplemented or otherwise modified from time to time prior to the effectiveness of Amendment 6, the Existing Credit Agreement). Pursuant to Amendment 6, among other things, EWT Holdings III Corp. borrowed an additional $150,000 in incremental term loans, and all of the revolving credit lenders whose revolving credit loans were scheduled to mature on January 15, 2019 agreed to convert 100% of these commitments into revolving credit loans that will mature on December 20, 2022. The other terms of the Existing Credit Agreement, including rates, remain generally the same.
Critical Accounting Policies and Estimates
See Note 2. Summary of Significant Accounting Policies in the Unaudited Condensed Consolidated Financial Statements in Item 1 of this Report for a complete discussion of our significant accounting policies and recent accounting pronouncements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
 Interest Rate Risk
We have market risk exposure arising from changes in interest rates on our senior secured credit facilities, which bear interest at rates that are benchmarked against LIBOR. Based on our overall interest rate exposure to variable rate debt outstanding as of June 30, 2018, a 1% increase or decrease in interest rates would increase or decrease Income (loss) before income taxes by approximately $7.9 million.
Impact of Inflation

58

Our results of operations and financial condition are presented based on historical cost. It is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required and we cannot provide any assurance that our results of operations and financial condition will not be materially impacted by inflation in the future. The Company engages in activities to adjust pricing practices with customers to mitigate the inflationary cost impact incurred.
Foreign Currency Risk
We have global operations and therefore enter into transactions denominated in various foreign currencies. While we believe we are not susceptible to any material cash impact on our results of operations caused by fluctuations in exchange rates because our operations are primarily conducted in the United States, if we expand our foreign operations in the future, substantial increases or decreases in the value of the U.S. dollar relative to these other currencies could have a significant impact on our results of operations.
To mitigate cross-currency transaction risk, we analyze significant exposures where we have receipts or payments in a currency other than the functional currency of our operations, and from time to time we may strategically enter into short-term foreign currency forward contracts to lock in some or all of the cash flows associated with these transactions. We also are subject to currency translation risk associated with converting our foreign operations' financial statements into U.S. dollars. We use short-term foreign currency forward contracts and swaps to mitigate the impact of foreign exchange fluctuations on consolidated earnings. We use foreign currency derivative contracts in order to manage the effect of exchange fluctuations on forecasted sales, purchases, acquisitions, inventory, capital expenditures and certain intercompany transactions that are denominated in foreign currencies. We do not use derivative financial instruments for trading or speculative purposes.

Additionally, we are subject to foreign exchange translation risk due to changes in the value of foreign currencies in relation to our reporting currency, the U.S. Dollar. At this time the Company’s translation risk is primarily concentrated in the exchange rate between the U.S. Dollar and the Euro due to intercompany loans denominated in Euro used to facilitate the capital requirements of our non-U.S. subsidiaries.  As the U.S. Dollar strengthens against the Euro income will generally be negatively impacted, and as the U.S. Dollar weakens income will generally be positively impacted.  At this time these are s non-cash impacts.  We manage our worldwide cash requirements in accordance with availability in multiple jurisdictions and effectiveness with which those funds can be accessed. As a result, we may access cash from among international subsidiaries and the U.S. when it is cost effective to do so,. We continually review our domestic and foreign cash profile, expected future cash generation and investment opportunities and reassess whether there is a need repatriate funds held internationally to support our U.S. operations. Accordingly, we do not expect translation risk to have a material economic impact on our financial position and results of operations.


Item 4.    Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
            Our management has evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures, as defined in Rule 13(a)-15(e) of the Exchange Act, as of the end of the period covered by this Report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures as of the end of the period covered by this Report are effective at a reasonable assurance level in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent or detect all errors and all fraud.
 

59

While our disclosure controls and procedures are designed to provide reasonable assurance of their effectiveness, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarterly period ended June 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

60

Part II - Other Information

Item 1. Legal Proceedings
From time to time, we are subject to various claims, charges and litigation matters that arise in the ordinary course of business. We believe these actions are a normal incident of the nature and kind of business in which we are engaged. While it is not feasible to predict the outcome of these matters with certainty, we do not believe that any asserted or unasserted legal claims or proceedings, individually or in the aggregate, will have a material adverse effect on our business, financial condition, results of operations or prospects.

Item 1A. Risk Factors
There have been no material changes to the information concerning risk factors as stated in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017, as filed with the SEC on December 4, 2017.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
           In the three months ended June 30, 2018, we issued 20,788 shares of our common stock to certain employees upon the exercise of stock options granted pursuant to the Stock Option Plan, which amount gives effect to the net exercise by certain of such employees of a portion of their vested options to cover exercise price and applicable tax withholding obligations, and 23,124 Restricted Stock Units to our directors. In June 2018, we issued 21,164 shares of our common stock to an executive officer of the Company in satisfaction of an existing bonus award agreement. These issuances were deemed to be exempt from registration under the Securities Act in reliance upon Section 4(a)(2) of the Securities Act and/or Rule 701 promulgated thereunder. The securities were issued directly by the registrant and did not involve a public offering or general solicitation.

Item 3.    Defaults Upon Senior Securities

None.

Item 4.    Mine Safety Disclosures
None.

Item 5.    Other Information
None.

Item 6.    Exhibits
The following exhibits are filed or furnished as a part of this report:


61

Exhibit
No.
Exhibit Description
2.1

2.2

10.1

10.2

31.1*

31.2*

32.1*

*
Filed herewith.



62



SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
EVOQUA WATER TECHNOLOGIES CORP.
 
 
 
 
 
 
 
 
 
 
August 7, 2018
/s/ RONALD C. KEATING
 
By:
Ronald C. Keating
 
 
Chief Executive Officer (Principal Executive Officer)
 
 
 
 
 
 
 
 
 
 
August 7, 2018
/s/ BENEDICT J. STAS
 
By:
Benedict J. Stas
 
 
Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)
 
 
 







63

Evoqua Water Technologies Corp. Reports