Evoqua Water Technologies Corp.
Q2 2018 Earnings Call Transcript

Published: 8 May 2018

[Operator:]

Good morning and welcome to the Evoqua Water Technologies second quarter 2018 earnings conference call. [Operator Instructions] As a reminder, this conference call is being recorded and your participation implies consent to our recording of this call. If you do not agree with these terms, please disconnect at this time. Thank you. I will now turn the conference over to Dan Brailer, Vice President of Investor Relations. Please go ahead.

[Dan Brailer:]

Thank you, Crystal. Good morning, ladies and gentlemen. Thank you for joining us for Evoqua Water Technologies conference call to review our second quarter 2018 financial results. Joining me on today’s call are Ron Keating, President and Chief Executive Officer and Ben Stas, Executive Vice President and Chief Financial Officer. After our prepared remarks, we will open the call to questions. We ask that you keep to one question and a follow up to accommodate as many questions as possible. This conference call includes forward-looking statements, including our outlook for fiscal year 2018. Actual results may differ materially from expectations. For additional information on Evoqua, please refer to the company’s SEC filings, including the risk factors described therein. On this conference call, we will also have a discussion of certain non-GAAP financial measures. Information required by Regulation G of the Exchange Act with respect to such non-GAAP financial measures is included in the presentation slides for this call which can be obtained via Evoqua’s website. All non-GAAP financial results have been reconciled and included in the appendix section of the presentation slides. Unless otherwise specified, references on this call to full year measures or to a year refer to our fiscal year, which ends on September 30. Means to access this conference call via webcast were disclosed in the press release, which was posted on our corporate website. Replays of this conference call will be archived and available for the next seven days. With that, I would now like to turn the call over to Ron.

[Ron Keating:]

Thank you, Dan. Good morning. We're very pleased to report our second quarter 2018 results. To begin today’s call, I want to provide some background on Evoqua’s business and the markets we serve. Because we're a new public company, we will provide more information on our business profile, our competitive differentiators and our market strategy through the fourth quarter. Following that, Ben will walk through our second quarter of 2018 results. Please turn to slide 3. When we arrived at Evoqua in 2014, we found a business with tremendous potential, market leading technologies, a great history of servicing customers’ needs and a strong team of people. We defined our purpose, transforming water and enriching life, simple, focused and clear. We're the leading provider of comprehensive water treatment solutions in North America. We provide systems, services and technologies to 38000 customers with over 200,000 customer installations that generating trailing 12 revenues of 1.3 billion and 224 million in adjusted EBITDA, a 17.3% margin. Our business spans a diverse range of industries and includes the 20 largest US companies in each of the pharmaceutical, food and beverage, hydrocarbon processing, chemical processing and power industries. Please turn to slide 4. In 2014, we initiated a series of changes by creating segments and divisions, aligned by vertical markets or technologies. We focused our sales and marketing strategy on all service solutions, deploying our technologies, supported by ongoing service and mining our installed base. We invested heavily in our team, aligned our RD&E spent at the highest market priorities and established a systematic and targeted approach to M&A that augments our R&D and organic growth. As you can see, the businesses responded well, delivering solid and improving year-over-year sales and profitability results. Please turn to slide 5. We’re the number one player in water treatment, which we believe is the most attractive and value added segment of the water market. The global market is enormous at an estimated 600 billion, which we distilled down to our $85 billion addressable market, of which we further refine and our served market of 10 billion. We supply water treatment systems by delivering technology and innovation, supported by best-in-class service, primarily in North America. We're not a chemical company nor we focus on the transmission of water. We do not make meters, pumps or valves, but we do use them in our systems and we have long-standing relationships with EPCs and design companies that provide the spec and advantage for new capital projects or major innovations containing our solutions. On the right hand side of the slide, you can see we operate across a very diverse set of end markets that are attractive and growing. We're typically number one or two in each of our target markets, but still have less than 25% market share in each, providing significant room for growth. We're not dependent upon any key market or customer with no single vertical market accounting for more than 20% of our revenue and no single customer accounting for more than 2%. Please turn to slide 6. Our business is organized by customer base and offerings in the three reportable segments that each draw from the same source of leading technologies, shared manufacturing investments and common business processes. On the left, you can see our industrial segment that has a significant value proposition that includes optimizing industrial water usage, reducing operating cost, increasing operational reliability and supporting environmental compliance and sustainability. Service is a major revenue driver across this segment, leveraging the largest service network in North America with broad application and process expertise. Our industrial business provides technology agnostic solutions with an emphasis on service and support to more than 25,000 customers. The market we serve is approximately $6 billion in North America. We sell and service through our best-in-class direct channels that become an integral part of our customer’s operations and their processes. We have a bluechip customer portfolio, serving a substantial majority of the Fortune 500 industrial companies. Our industrial business is very sticky and very profitable with EBITDA margins of 24%. In the center, our municipal business serves an estimated $4 billion market. This segment draws on more than 100 years of corporate history and technological leadership. We have focused this group primarily on the wastewater portion of the market, which has the highest growth potential and we've seen EBITDA margins improve over 500 basis points over the past three years. We sell through a leading third party channel network, primarily in North America and are focused on further penetrating our installed base for retrofit and rehab opportunities. On the right, our products business provides a highly differentiated and scalable range of products and technologies that become process standards and in many cases displace traditional methods of treatment. This is our most global business and also very profitable with an EBITDA margin of approximately 24%. Please turn to slide 7. Last quarter, we provided a deep dive look into our industrial segment. This quarter, we will review our products segment followed by the municipal segment in the next quarter. Our Products segment is our shortest cycle business and sells differentiated technologies to a diverse set of water treatment specifiers, integrators and end users globally. We also sell our portfolio technologies and products either as discrete offerings or as components of broader solutions through our industrial and municipal segments. Our product offerings include filtration, disinfection, electrodeionization and electrochlorination, separation and anodes technologies. We're channel agnostic in applying and selling our product technologies into the market. Our filtration and disinfection offerings include our defender line of products which is the leading regenerative media filter in the commercial aquatics market. Our IONPURE electrodeionization solutions allow customers to achieve ultrahigh purity water without the use of chemicals in the treatment process. Microelectronics, pharmaceuticals and high purity industrial markets are primary applications for this technology. Our electrochlorination products provide water treatment solutions for the maritime, ballast water, downstream oil and gas and power markets. We also have extensive capabilities in anode technologies, cathodic protection and solid and liquid separation. We have built a tremendous business enabled by leading technologies, 100 plus years of technical knowhow and more than 1250 patents, all supporting a large and growing installed base. We have significant and visible recurring revenues and with more than 40% of our products segment business coming from outside of North America, it is our most global segment. Finally, as we will discuss shortly, we are supplementing our organic growth and capabilities through an active M&A strategy. As such, six of our last ten acquisitions have been added to the products segment. Please turn to slide 8. There are many opportunities across our three businesses for smart water application, utilizing Evoqua’s water treatment solutions. Customers are driving the adoption of smart water technologies as part of their strategic goal to reduce water usage and cost. Digital water platforms help make more effective decisions, increase water system efficiency and drive new business models. In addition to industrial markets, we see applications for smart water across the many vertical markets within our products business. This schematic showcases the interconnectivity of our aquatics and disinfection division’s portfolio of products and analytical equipment. A&D is a leader in the filtration and disinfection of recreational water. This mechanical rule schematic is for a typical commercial pool illustrates the connectivity of our equipment, using predictive analytics and remote monitoring to reduce operating costs and improve operational performance. This is another variation of our smart water applications to be deployed such as our Water One Assurance. Please turn to page 9. Evoqua’s business is well positioned for long term growth and our service and support network is a significant competitive differentiator. It truly is the jewel in the crown. Our service network is four times larger than our closest competitor and we have a branch within a two hour radius of 90% of our customer base. Our core offerings are preventive maintenance, on demand services, operating services and Water One Assurance. Our business makes up approximately – our service business makes up approximately 46% of our revenue. This business is very sticky, highly visible and generates attractive margins. We have a 99% renewal rate in this business and we are an integral part of our customer’s processes that makes us the first call for all of their water needs. Our focus on service and support creates a business model where approximately 80% of our upcoming year's revenue streams are highly visible at the beginning of each year. The service and our aftermarket businesses are consistent and recurring due to our contract renewal rate and our large installed base. Our business that is highly repeatable comes from small capital projects generated from our service relationships and from larger projects that are already in backlog at the beginning of each fiscal year. And our book to bill revenue is generated primarily from our products business that is shorter cycle book and ship as well as large capital projects where we are specified. As we continue to build our organizational capabilities organically and through M&A, customer engagement has increased, resulting in more pipeline opportunities that are favorably impacting our business. Our capital projects are increasing in size, scale and complexity. At the same time, we've been actively pursuing an internal cross-selling strategy. We have had three or four recent projects that have provided an operational learning experience in which we have transitioned from utilizing outside vendors to internal supply chain partners. Establishing these internal supply chain methods combined with our cross selling strategy are increasing capital demand and will lower costs and improve profitability over time. The combination of increased capital demand and large projects have created short term margin pressures, but will also leave an attractive and profitable service and aftermarket tail. Please turn to page 10. Our future growth will come from both organic sales initiatives and through systematic M&A process. Our industry is very fragmented and while we are the industry leader, we still have only an approximate 12% market share. We utilize M&A to fill gaps in our product portfolio, to penetrate desirable vertical market segments or to expand our geographic reach. Our transactions have been accretive in year one and we're very pleased with the performance of our acquisitions. We believe tuck-in acquisitions are low risk by nature and we expect to seamlessly integrate the businesses into our organization. Overall, we're agnostic between M&A and R&D for new product development and we believe there is a larger pipeline of outstanding opportunities at attractive multiples. We expect to expand our service reach, enhance our technological capabilities and accelerate our sales and profitability growth rates through our disciplined M&A process. As recently announced, we completed the acquisition of Pacific Ozone in March. We are very pleased to have Pacific as a part of the Evoqua family. Pacific Ozone is a manufacturer of high end integrated ozone systems, targeting multiple industrial markets, including bottled water, beverage, food processing and industrial process water applications. The addition of Pacific filled the portfolio gap and brings with it over 5000 installations in more than 30 countries. The Pacific leadership team will join the Evoqua team to help us build a larger and more global ozone disinfection business. Please turn to page 11. Here you see a listing of our past ten transactions since the acquisition program was put into place in 2016. Most of the deals have fulfilled the portfolio gaps, allowing us to accelerate penetration into new and existing markets and to expand our suite of customer solution offerings. As noted on this slide, the 2016 Neptune Benson acquisition was a platform transaction that provided a leadership role in the aquatics market and a base to grow from in the broader products market. Following that acquisition, we acquired four tuck-in businesses, VAF, Delta, Olson and now Pacific that support and expand our business in advanced filtration and disinfection. We have a strong pipeline of more than 100 qualified candidates and we expect to announce more transactions in the coming quarters. Please turn to slide 12. We're very pleased with our second quarter results. Revenue growth for the quarter was up double digits, primarily driven by growth from our industrial and products segments and acquired companies. We were very pleased that all three segments reported double-digit year-over-year EBITDA growth for the quarter. Our growth and profitability initiatives are in place and we're making solid progress in each segment. We believe we're taking market share and delivering compelling solutions to our customers. We are pleased with the performance through the first half of the year and we are very well positioned to see continued profitable growth organically and through M&A for the full year. I would now like to turn the call over Ben to walk through our financial results and to review our 2018 outlook.

[Ben Stas:]

Thank you, Ron. Please turn to slide 13. For the second quarter, reported revenues were up over 11% to 334 million, pro forma revenues normalizing for acquisitions were up almost 7%, driven by growth in the industrial and products segment and acquisitions contributed more than 4%. Capital project growth outpaced service revenues during the quarter, mostly in the industrial and municipal segments. As Ron mentioned, this has created some mixed pressure, but will provide a solid base for future growth in our highly profitable service and aftermarket businesses. Second quarter adjusted EBITDA grew by approximately 31% versus the prior year to 58 million, 17.3% of sales, a 270 basis point expansion in EBITDA margins. We experienced inflationary cost pressures during the quarter and a productivity challenge due to weather and capital mix. We also continued to invest for future growth to support our robust pipeline. Volume leverage and cost management contributed to margin expansion, offsetting inflation, growth investments and productivity challenges. Please turn to slide 14. For the second quarter, our industrial segment had revenue growth of 13% year-over-year to 181 million with pro forma revenues up approximately 6%. The major drivers of organic revenue growth resulted from capital for waste water recycle reused applications in the power, HPI and CPI markets as well as general strength across most industrial end markets. EBITDA grew approximately 18% and margins expanded to 23% of sales, a 100 basis point improvement over the prior year. The EBITDA margin improvement was driven by volume leverage, cost initiatives and acquisition synergies, while partly offset by capital growth mix. Capital revenue growth is expected to lead to more profitable service and aftermarket sales over the medium to long term. Our Water One Assurance pilot in Boston is nearing completion as we prepare for a national rollout beginning later this summer. During the quarter, we were awarded a long term contract using our new Evoqua NexSys technology for a global biotechnology company. The Boston pilot has been very successful and we expect that Water One Assurance will be a competitively differentiated high return service offering. Please turn to slide 15. For the second quarter, our municipal segment revenues of 64 million were up approximately 1% over the prior year. Strong membrane sales were a driver in the quarter, partly offset by some delays in waste water projects and backlog. EBITDA grew over 14% to 10 million, 15.2% of sales, a 180 basis point expansion in EBITDA margins. The improvements were driven by membrane margins combined with benefits of lower warranty costs, resulting from improved quality and project management. During the quarter, we were also pleased to be awarded a capital project with our BioMag technology that will replace obsolete equipment and increased our customers’ plant capacity. Please turn to slide 16. Our product segment grew 16% to 88 million, driven by double digit year-over-year growth in most key product divisions. Pro forma revenues increased 14% versus the prior year. EBITDA of 23 million increased 36% to 26% of sales, an increase of 380 basis points. Volume leverage, inclusive of mix, ongoing cost reduction initiatives and acquisitions synergies, contributed to higher profitability. The acquisition of Pacific Ozone is expected to be accretive and is an excellent addition to products segment portfolio. During the quarter, we were also pleased to be awarded a significant Electrodeionization project for our large Asian microelectronics customer that requires ultra-pure pure water in their critical component manufacturing processes. Please turn to slide 17. Free cash flow improved sequentially by 25 million and was 3 million better than the prior year. We expect free cash flow to continue to improve as we proceed through the year and we remain focused on our targeted free cash flow conversion of 100% of adjusted net income for the fiscal year. Our long term leverage target is in the range of 2.5 times. We have reduced leverage over the past three quarters, primarily due to increasing EBITDA and the debt pay down of approximately 100 million from the IPO proceeds in November. Please turn to slide 18. Capital spending in the quarter increased approximately 3 million to 16 million versus last year, as we are investing in high return customer outsourced water projects. Our spending is in line with our targeted percentage of sales, for both maintenance and high return growth CapEx. Working capital declined 3.5 million sequentially from Q1 to 194 million. Actions taken to improve working capital efficiency resulted in improvement in our cash inversion cycle. We expect working capital, as a percentage of sales, to remain in the mid-teens as we proceed through the year. Please turn to slide 19. We are pleased with our performance and our position for long term profitable growth. As we look to the second half of the year, there are three factors that are noteworthy to our full year outlook. First, we are experiencing a capital mix shift with larger capital installations from across segments and divisions that are favorably impacting our overall original revenue outlook. These capital installations will have solid upfront profitability and long service tails on a go forward basis, but current installation margins are lower, due to the timing in the projects. We're raising our full year revenue outlook to reflect increased customer penetration and demand for capital equipment and integrated solutions. Second, we are experiencing higher inflationary costs and commodity pricing that in aggregate are putting short term cost pressure on the business. We are actively engaged in accelerating pricing actions and productivity initiatives to offset the expected inflationary cost. Third, a portion of our products segment revenue that was previously anticipated to be shipped in the third quarter is now projected to be shipped in the fourth quarter. This is purely a timing matter that we occasionally experience in our business. Our overall 2018 outlook on the business has not fundamentally changed, however, we are experiencing unanticipated cost increases, common throughout the industry as well as mix and shipment timing impacts. For the third quarter, we expect adjusted EBITDA to grow in the range of approximately 5% to 10% over the prior year. For the full year, we expect total reported revenues to be in the range of 1.34 billion to 1.37 billion, an increase of 10 million to the high end and the low ends of the original range and representing growth of approximately 7% to 10% over the prior year. Adjusted EBITDA is now expected to be in the range of 235 million to 245 million, a 10 million reduction to the high end of the previous range. The two acquisitions completed so far this year, Pure Water and Pacific Ozone, while strategically important or not material to our overall financial results and are included in our outlook. Consistent with the first quarter comments, our 2018 blended statutory tax rate is expected to be between 24% and 26%. We expect our 2018 annual effective tax rate to be approximately 13% to 16%, excluding discrete items. Consistent with our assumptions, we expect our end markets will remain healthy and stable and continue to support the realization of our outlook. We will now open the call to your questions.

[Operator:]

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

[Deane Dray:]

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

[Ron Keating:]

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

[Deane Dray:]

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

[Ben Stas:]

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

[Deane Dray:]

And that additional 2 million is reflected in the current guidance?

[Ben Stas:]

It is.

[Deane Dray:]

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

[Ben Stas:]

The other corporate expense line?

[Deane Dray:]

Just the corporate expense, it looks like it was higher than what we were modeling for, any particular factors you would call out?

[Ben Stas:]

Yeah. We had some first follow-on expenses. We will get you the details offline on that. I don't have them at my fingertips, but there were some other expenses in there related to the refi and the first follow-on.

[Operator:]

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

[Nathan Jones:]

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

[Ron Keating:]

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

[Nathan Jones:]

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

[Ron Keating:]

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

[Nathan Jones:]

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

[Ron Keating:]

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

[Nathan Jones:]

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

[Ron Keating:]

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

[Operator:]

Our next question comes from Brian Lee with Goldman Sachs.

[Brian Lee:]

I guess first off, can you talk Ben about what’s embedded in your 2018 outlook here for contribution margin and then the couple of moving pieces here with respect to mix and the price cost dynamics? And then I guess how would you think about that level for 2019, are you anticipating that it’s still the liability to targets that you laid out in the past?

[Ben Stas:]

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

[Brian Lee:]

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

[Ron Keating:]

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

[Brian Lee:]

The delays in the muni waste water projects, can you just speak to what impact it had on the quarter, is that all back in 3Q? I will pass it on. Thank you.

[Ben Stas:]

Most of that will be back in Q4. It is purely timing in the waste water division within your municipal area, but yeah, that did have an impact in the quarter as likely it has an impact in Q3 with a recovery in Q4, but it is timing as well.

[Operator:]

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

[Steve Tusa:]

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

[Ben Stas:]

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

[Steve Tusa:]

So there is no kind of linearity in that, you should, seasonality, linearity in the second half on that number.

[Ben Stas:]

There is and fourth quarter will be the strongest.

[Steve Tusa:]

And then I guess the third quarter kind of implied EBITDA is around 60 million at the midpoint, is that kind of the right ballpark?

[Ben Stas:]

That's right zip code. Yes.

[Operator:]

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

[Unidentified Analyst:]

It’s [indiscernible] on for Andy. So just on working capital, so working capital after taking up year-over-year, it's been more stable over the past few quarters there and I know you talked about around 15% for the rest of the year, I think, but can you give us some color maybe on how you're thinking about a target level of working capital going out beyond this year and do you see potential opportunities to continue to keep working capital down below the mid-teens level.

[Ben Stas:]

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

[Unidentified Analyst:]

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

[Ron Keating:]

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

[Operator:]

Our next question comes from the line of [indiscernible] with Raymond James.

[Unidentified Analyst:]

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

[Ron Keating:]

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

[Unidentified Analyst:]

Interesting. Municipal segment, down a little bit year over year on the top line, not EBITDA. This quarter, I think it was also down. Last quarter, is it realistic to expect that the comp will turn positive before the end of the year or is it going to continue to be kind of a flat to down segment?

[Ron Keating:]

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

[Operator:]

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

[Joe Giordano:]

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

[Ben Stas:]

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

[Joe Giordano:]

What kind of magnitude on the CapEx Ben?

[Ben Stas:]

So we’re going to invest 23 million over the next three years to rollout the Program.

[Joe Giordano:]

And that will cove like the full rollout that you were talking about, like talking 200 million of installed base that you’re trying to.

[Ron Keating:]

Yeah. What we’re targeting in that, Joe was 50%. So that is what we have built into the model. Now, what we’re seeing in Boston is we’re seeing a much higher take rate on our second pilot, which is a much larger pilot as you know. We’re proving out again a lot of the analytics through this rollout on the second pilot and with that take rate picking up, we see that across the nation being the similar type take rate, then we would have to take the CapEx up. But right now, with the 50% rollout, we would expect a 23 million coverage.

[Joe Giordano:]

Great. And then just a question on the industrial side, it looked like the margins of the acquired businesses seem to be substantially higher than the core business, can you just give any kind of color on that and how the future pipeline is, I feel, looks relative to those kind of numbers?

[Ben Stas:]

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

[Operator:]

[Operator Instructions] It comes from the line of Nish Damodara with Baird.

[Nish Damodara:]

Just a quick one, what kind of acquisition contribution you’re expecting from Pacific Ozone?

[Ben Stas:]

It’s relatively insignificant. It will get much more of an impact next year.

[Operator:]

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

[Ron Keating:]

Thank you, Crystal. Thank you all for participating in our earnings call today. As we highlighted in the call, we feel we're very uniquely positioned to be the solutions provider of choice for the water industry. Our technologies are channeled, and our extensive service footprint truly makes us able to partner with customers. You may have seen recently that a Evoqua was named the Water Company of the Year by both the water intelligence and the water technology company of the year by Frost & Sullivan, we’re really very pleased to receive these recognitions, again speaking to the goals of our team as members all around the globe of Evoqua of exceeding our customers’ expectations and making sure we're providing them with best in class solutions. We’re very proud of the legacy we have and very optimistic about delivering sustainable results for the future and I look forward to speaking with you all again. Thank you.

[Operator:]

Thank you. That concludes today’s Evoqua Water Technologies 2018 second quarter earnings conference call. You may now disconnect your lines at this time and have a wonderful day.