The following discussion and analysis of our financial condition and results of our operations should be read in conjunction with the Unaudited Consolidated Financial Statements, including the notes, included in Part I, Item 1 of this Quarterly Report on Form 10-Q (this "Report"), and with our audited consolidated financial statements and the related notes thereto in our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2019 , as filed with theSEC onNovember 25, 2019 and as amended onDecember 4, 2019 (the "2019 Annual Report"). You should review the disclosures in Part I, Item 1A. "Risk Factors" in the 2019 Annual Report, as well as any cautionary language in this report, including the disclosures in Part II, Item 1A. "Risk Factors" 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 toEvoqua Water Technologies Corp. , together with its consolidated subsidiaries. Unless otherwise specified, all dollar amounts in this section are referred to in millions. Overview and Background We are a leading provider of mission critical water and wastewater treatment solutions, offering a broad portfolio of products, services and expertise to support industrial, municipal and recreational customers who value water. With over 200,000 installations worldwide, we hold leading positions in the industrial, commercial and municipal water treatment markets inNorth America . We offer a comprehensive portfolio of differentiated, proprietary technology solutions sold under a number of marketleading and wellestablished brands to our global customer base. 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. Our solutions are designed to ensure that our customers have the quantity and quality of water that meets their unique 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 deliver and maintain these mission critical solutions through the largest service network inNorth America , assuring our customers continuous uptime with 96 branches as ofMarch 31, 2020 . We have an extensive service and support network, and as a result, a certified Evoqua Service Technician is generally no more than a twohour drive from more than 90% of our North American customers' sites. Our vision "to be the world's first choice for water solutions" and our values of "integrity, customers, performance and sustainable" foster a corporate culture that is focused on establishing a workforce that is enabled, empowered and accountable, 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 1,100 granted or pending patents, which in aggregate are imperative 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 two reportable operating segments that each draw from the same reservoir of leading technologies, shared manufacturing infrastructure, common business processes and corporate philosophies. Our reportable operating segments consist of: (i) our Integrated Solutions and Services segment and (ii) our Applied Product Technologies segment. The key factors used to identify these reportable operating segments are the organization and alignment of our internal operations, the nature of the products and services and customer type. • Within the Integrated Solutions and Services segment, we primarily provide tailored solutions in collaboration with our customers backed by lifecycle services including ondemand water, outsourced water, recycle and reuse and emergency response service alternatives to improve operational reliability, performance and environmental compliance. 45
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• Within the Applied Product Technologies 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. EBITDA and Adjusted EBITDA are non-GAAP financial measures. For more information regarding EBITDA and Adjusted EBITDA, including a reconciliation to the most directly comparable GAAP financial measure, please see the section titled "How We Assess the Performance of Our Business". 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, nondiscretionary market that is growing in importance as access to clean water has become an international priority. Underpinning this growth are a number of global, longterm 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 widerange 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 endmarkets and underpenetrated regions, including by investing in our sales force and crossselling to existing customers. We believe that we are uniquely positioned to further penetrate our core markets, with over 200,000 installations across over 38,000 global customers. We maintain a customerintimate business model with strong brand value and provide solutionsfocused offerings capable of serving a customer's full lifecycle water treatment needs, both in current and new geographic regions. Our Service Model We selectively target high value projects with opportunities for recurring business through service, parts and other aftermarket opportunities over the lifecycle of the process or capital equipment. In particular, we have developed internetconnected monitoring technologies through the deployment of our WaterOne® service platform, which enables customers to outsource their water treatment systems and focus on their core business, offering customers system optimization, predictive and proactive service, and simplified billing and pricing. Our WaterOne® platform also enables us to transition our customers to 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 waterrelated 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 andTechnology Development We develop our technologies through inhouse research, development and engineering and targeted tuckin, vertical market and geographyexpanding, technology-enhancing acquisitions. We have a reservoir of recently launched technologies and a strong pipeline of new offerings designed to provide customers with innovative, valueenhancing solutions. Furthermore, sinceApril 2016 , we have successfully completed thirteen acquisitions and the acquisition of a 60% interest 46 -------------------------------------------------------------------------------- inFrontier Water Systems LLC ("Frontier"), each of which expands our vertical markets and geographic reach and enhance our technologies, strengthening our existing capabilities and adding new capabilities and cross selling opportunities in areas such as mobile wastewater treatment, soil and air treatment, regenerative media filtration, anodes, UV and ozone disinfection, aerobic and anaerobic biological treatment technologies and electrochemical and electrochlorination cells. We are able to rapidly scale new technologies using our leading direct and thirdparty 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 bestinclass 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. We have separately identified and are pursuing a number of discrete initiatives which, if successful, we expect could result in additional cost savings over the next two years. These initiatives include our supply chain improvement program to consolidate and manage global spending, our improved logistics and transportation management program, capturing benefits of our WaterOne® platform and further optimizing our engineering cost structure, our global shared services organization and our sales, inventory and operations planning. These improvements focus on creating value for customers through reduced lead times, improved quality and superior customer support, while also creating value for shareholders through enhanced earnings growth. Furthermore, as a result of significant investments we have made in our footprint and facilities, we believe we have capacity to support our planned growth without commensurate increase in fixed costs. Acquisitions and Divestitures We believe that capex-like, tuckin acquisitions present a key opportunity within our overall growth strategy, which we will continue to evaluate strategically. These strategic acquisitions are expected to enable us to accelerate our growth by extending our critical mass in existing markets, as well as expand in new geographies and new end market verticals. Our existing customer relationships, bestinclass channels to market and ability to rapidly commercialize technologies provide a strong platform to drive rapid growth in the businesses we acquire. To capitalize on these opportunities, we have built an experienced team dedicated to mergers and acquisitions that has, sinceApril 2016 , successfully completed thirteen acquisitions and the acquisition of a 60% interest in Frontier, each of which expands our vertical markets and geographic reach and enhance our technologies, with purchase prices ranging from approximately$2.6 million to approximately$283.7 million , and preacquisition revenues ranging from approximately$3.1 million to approximately$55.7 million . OnDecember 31, 2019 we completed the sale of the Memcor product line to DuPont de Nemours, Inc. (DuPont). The aggregate purchase price paid by DuPont was$110.0 million in cash, subject to certain adjustments. Following adjustments for cash and net working capital, gross proceeds paid by DuPont were$131.0 million . The Company recognized a$49.0 million net pre-tax benefit on the sale of the Memcor product line, net of$8.3 million of discretionary compensation payments to employees in connection with the transaction and$1.0 million in transaction costs incurred in the three months endedDecember 31, 2019 . As a result of net working capital adjustments, the Company recognized an additional$9.0 million net pre-tax benefit in the three months endedMarch 31, 2020 . The Company and DuPont have a history of collaboration, and following the sale, DuPont will continue to supply the Company with Memcor® products. Key Factors and Trends Affecting Our Business and Financial Statements Various trends and other factors affect or have affected our operating results, including:
Impact of the COVID-19 pandemic. As discussed further below, the COVID-19
pandemic did not have a material impact on our consolidated results of
operations in the three months ended
47 -------------------------------------------------------------------------------- to our personnel. We have also taken initial cost reduction actions to preserve liquidity and reallocated resources to maintain productivity levels. In general, we saw increased demand for services from customers in healthcare and pharmaceutical industries beginning in mid-to-late March as the impact of the pandemic broadened. However, we also began to see signs of uneven demand from customers in certain other industries during that period. We continue to evaluate the impact of the pandemic on our business, particularly how social distancing guidelines might affect our access to our customers' sites and how the economic downturn resulting from the pandemic might affect our customers' willingness to make capital expenditures and our ability to collect from our customers. Given the evolving nature of the unprecedented pandemic, the overall impact on our operations over the remainder of the fiscal year cannot be reasonably estimated at this time. For more information regarding factors and events that may impact our business, results of operations and financial condition from the effects of the COVID-19 pandemic, see "Item 1A. Risk Factors" of this Report. 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, 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, imposition of tariffs 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. For example, the current weakness in global oil markets has created, and we expect will continue to create, some weakness in demand from customers that we serve in the oil and gas industry. Additionally, the COVID-19 pandemic has increased economic uncertainty and has caused an economic slowdown that is likely to continue and may result in a sustained global recession. 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, restrictions on international trade, including tariffs imposed by theU.S. government and other governments, as well as supply chain disruptions caused by the COVID-19 pandemic, have increased and could further increase the cost of certain materials and have restricted and could further restrict availability of certain commodities, which may result in delays in our execution of projects. Although we have offset a portion of these cost increases through price increases, there can be no assurance that we will be able to continue to recuperate additional cost increases 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, regulatory approvals and significant weather events. In addition, our contracts for large capital water treatment projects, systems and solutions for industrial, commercial and municipal applications are generally fixedprice 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. 48 -------------------------------------------------------------------------------- Government policies. Decaying water systems inthe United States ("U.S.") will require critical drinking water and wastewater repairs, often led by municipal governments. Further, asU.S. states increase regulation on existing and emerging contaminants, we expect that our customers will increasingly require sustainable solutions to their waterrelated 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 withinNorth 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. 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. Activities related to operational investments include employee training and development, integrating acquired businesses, implementing enhanced information systems, research, development and engineering investments and other activities to 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 twentyyear 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 Unaudited Consolidated Financial Statements is theU.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 theU.S. dollar, primarily in the euro,U.K. sterling, Chinese renminbi, Canadian dollar, Australian dollar andSingapore dollar. To prepare our Unaudited Consolidated Financial Statements we must translate those assets, liabilities, revenues and expenses intoU.S. dollars at the applicable exchange rate. As a result, increases or decreases in the value of theU.S. dollar against these other currencies will affect the amount of these items recorded in our Unaudited Consolidated Financial Statements, even if their value has not changed in the functional currency. While we believe that 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 theU.S. , if we expand our foreign operations in the future, substantial increases or decreases in the value of theU.S. dollar relative to these other currencies could have a significant impact on our results of operations. 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 (which is a non-GAAP financial measure). 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: 49 --------------------------------------------------------------------------------
• 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 outsourced water alternatives, to a broad group of industrial customers in ourU.S. ,Canada andSingapore 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, enduser, 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 ("G&A expense") consist of fixed overhead personnel expenses associated with our corporate functions and 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 due to the legal, accounting, insurance, investor relations and other costs associated with being a public company. Sales and Marketing. Sales and marketing expenses ("S&M expense") consist primarily of advertising and marketing promotions of our products, services and solutions and related personnel expenses (including all Evoqua sales and application 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 ("R&D expense") 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 technological feasibility and the release of products and services for sale has been short and development costs qualifying for capitalization have been insignificant. R&D expense 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." 50 -------------------------------------------------------------------------------- Adjusted EBITDA Adjusted EBITDA, which is a non-GAAP financial measure, 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, transaction costs and other gains, losses and expenses. We present Adjusted EBITDA 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 and provides greater clarity to management and our investors regarding the operational impact of long term strategic decisions regarding capital structure, the tax jurisdictions in which we operate and capital investments. 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 operating segment to evaluate the operating performance of such segments. EBITDA and Adjusted EBITDA of the reportable operating segments do not include certain charges that are presented within corporate activities. These charges include certain restructuring and other business transformation charges that have been incurred to align and reposition the Company to the current reporting structure, acquisition related costs (including transaction costs, 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 nonrecurring items. In addition, Adjusted EBITDA may not be comparable to similarly titled measures used by other companies in our industry or across different industries. 51 --------------------------------------------------------------------------------
The following is a reconciliation of our Net income (loss) to Adjusted EBITDA (unaudited, amounts in millions):
Three Months Ended Six Months Ended March 31, March 31, 2020 2019 2020 2019 Net income (loss)$ 7.9 $ 1.6 $ 61.4 $ (14.7 ) Income tax expense (benefit) - (4.6 ) 2.6 (9.1 ) Interest expense 13.3 14.5 26.8 28.9 Operating profit 21.2 11.5 90.8 5.1 Depreciation and amortization 27.3 24.2 52.5 47.3 EBITDA 48.5 35.7 143.3 52.4 Restructuring and related business transformation costs (a) 6.2 8.3 7.9 14.0 Share-based compensation (b) 2.3 4.7 6.0 9.3 Transaction costs (c) 0.5 2.4 0.7 4.5 Other (gains) losses and expenses (d) (0.8 ) 5.6 (57.6 ) 14.9 Adjusted EBITDA$ 56.7 $ 56.7 $ 100.3 $ 95.1 (a) Restructuring and related business transformation costs Adjusted EBITDA is calculated prior to considering certain restructuring or business transformation events. These events may occur over extended periods of time, and in some cases it is reasonably possible that they could reoccur in future periods based on reorganizations of the business, cost reduction or productivity improvement needs, or in response to economic conditions. For the periods presented such events include the following: (i) Certain costs and expenses in connection with various restructuring initiatives, including severance costs, relocation costs,
recruiting
expenses, and third-party consultant costs to assist with these initiatives. This includes: (A) amounts related to the Company's restructuring initiatives to reduce the cost structure and rationalize location footprint following the sale of the Memcor product line; (B) amounts related to the Company's transition from a three-segment structure to a two-segment operating model designed to better serve the needs of customers worldwide; and (C) amounts related to various other initiatives implemented to restructure and reorganize our business with the appropriate management team and cost structure. 52
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Three Months Ended Six Months Ended March 31, March 31, 2020 2019 2020 2019 Post Memcor divestiture restructuring(1)$ 3.7 $ -$ 3.7 $ - Cost of product sales and services ("Cost of sales") 2.9 - 2.9 - S&M expense 0.1 - 0.1 - G&A expense 0.7 - 0.7 - Two-segment restructuring(2)$ 0.3 $ 5.1 $ 1.3 $ 7.0 Cost of sales 0.3 2.5 0.6 2.7 R&D expense - 0.1 - 0.1 S&M expense - 0.4 - 0.6 G&A expense 0.4 2.1 0.7 3.6 Other operating (income) expense (0.4 ) - - - Various other initiatives(3)$ 0.3 $ 0.2 $ 0.5 $ 0.7 Cost of sales 0.3 0.2 0.4 0.5 G&A expense - - 0.1 0.2 Total$ 4.3 $ 5.3 $ 5.5 $ 7.7 (1) all of which is reflected in restructuring charges in Note 13, "Restructuring and Related Charges" in Part I, Item 1 of this Quarterly Report on Form 10-Q (the "Restructuring Footnote") in the six months ended March 31, 2020 and 2019, respectively. (2) of which$1.2 million and$7.0 million is reflected in the Restructuring Footnote in the six months ended March 31, 2020 and 2019, respectively. (3) all of which is reflected in the Restructuring Footnote in the six months ended March 31, 2020 and 2019, respectively. (ii) legal settlement costs and intellectual property related fees associated with legacy matters prior to the AEA Acquisition, including fees and settlement costs related to product warranty litigation on Memcor products and certain discontinued products. This includes: Three Months Ended Six Months Ended March 31, March 31, 2020 2019 2020 2019 Cost of sales$ 0.1 $ -$ 0.2 $ 0.1 G&A expense 0.2 0.2 0.2 0.5 Total$ 0.3 $ 0.2 $ 0.4 $ 0.6
(iii) expenses associated with our information technology and functional
infrastructure transformation subsequent to the AEA
Acquisition,
including activities to optimize information technology
systems and
functional infrastructure processes. This includes: Three Months Ended Six Months Ended March 31, March 31, 2020 2019 2020 2019 Cost of sales $ - $ -$ 0.1 $ 0.1 G&A expense 0.4 2.3 0.7 5.0 Total$ 0.4 $ 2.3 $ 0.8 $ 5.1 53
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(iv) costs associated with theMarch 2020 secondary public offering of common stock held by certain shareholders of the Company, as well as costs incurred by us in connection with establishment of our public company compliance structure and processes, including
consultant
costs. This includes: Three Months Ended Six Months Ended March 31, March 31, 2020 2019 2020 2019 G&A expense$ 1.2 $ 0.5 $ 1.2 $ 0.6 Total$ 1.2 $ 0.5 $ 1.2 $ 0.6
(b) Share-based compensation
Adjusted EBITDA is calculated prior to considering noncash sharebased compensation expenses related to equity awards. See Note 16, "Share-Based Compensation" in Part I, Item 1 of this Quarterly Report on Form 10-Q for further detail. (c) Transaction related costs
Adjusted EBITDA is calculated prior to considering transaction, integration and restructuring costs associated with business combinations because these costs are unique to each transaction and represent costs that were incurred as a result of the transaction decision. Such costs may include, without limitation, consulting and legal costs associated with due diligence and closing a transaction, restructuring and integration costs such as severance, facility consolidation costs, product rationalization or inventory obsolescence charges, system integration or conversion costs, fair value changes associated with contingent consideration, and costs associated with any litigation matters that arise subsequent to our acquisition of a business for which the matter in question preceded the transaction, but was not known, not probable or unresolved at the date of acquisition. We believe that viewing earnings prior to considering these charges provides investors with useful additional perspective because the significant costs incurred in connection with business combinations result primarily from the need to eliminate duplicate assets, activities or employees - a natural result of acquiring or disposing a fully integrated set of activities. Integration and restructuring costs associated with a business combination may occur over several years. This includes: Three Months Ended Six Months Ended March 31, March 31, 2020 2019 2020 2019 Cost of sales$ (0.3 ) $ 1.1 $ (0.2 ) $ 1.3 G&A expense 0.5 1.3 0.9 3.2 Other operating (income) expense 0.3 - - - Total$ 0.5 $ 2.4 $ 0.7 $ 4.5
(d) Other (gains), losses and expenses
Adjusted EBITDA is calculated prior to considering certain other significant (gains), losses and expenses. Such significant items represent substantive and/or unusual items that are evaluated on an individual basis. Such evaluation considers both the quantitative and qualitative aspects of their nature and they may be highly variable and difficult to predict. Unusual items may represent items that are not part of our ongoing business, items that, either as a result of their nature or size, we would not expect to occur as part of our normal business on a regular basis, items that would be non-recurring, or items related to products we no longer sell. While not all-inclusive, examples of items that could be included as other (gains), losses and expenses would be amounts related to non-cash foreign currency exchange gains and losses on intercompany loans, significant warranty events, and certain disposals of businesses, products or facilities that do not qualify as discontinued operations under GAAP. For the periods presented such events include the following: (i) impact of foreign exchange gains and losses; 54 --------------------------------------------------------------------------------
(ii) foreign exchange impact related to headquarter allocations;
(iii) expenses on disposal related to maintaining nonoperational business locations, net of gain on sale; (iv) expenses incurred by the Company related to the remediation of manufacturing defects caused by a third- party vendor;
(v) charges incurred by the Company related to product rationalization
in its electro-chlorination business; (vi) net pre-tax benefit on the sale of the Memcor product line, which is net of$8.3 million of discretionary compensation payments to employees in connection with the transaction and$1.0 million in transaction costs incurred in the six months endedMarch 31, 2020 ; and (vii) expenses incurred by the Company related to the write-off of inventory associated with product rationalization and facility consolidation.
Other (gains), losses and expenses include the following for the periods
presented below:
Three Months Ended
Other Adjustments (i) (ii) (iii) (iv) (v) (vi) (vii) Total Cost of sales$ 0.3 $ - $ -$ (0.1 ) $ 0.2 $ 0.1 $ -$ 0.5 G&A expense 7.8 - - - - (0.8 ) - 7.0 Other operating (income) expense - - - - - (8.3 ) - (8.3 ) Total$ 8.1 $ - $ -$ (0.1 ) $ 0.2 $ (9.0 ) $ -$ (0.8 )
Three Months Ended
Other Adjustments (i) (ii) (iii) (iv) (v) (vi) (vii) Total Cost of sales$ (0.2 ) $ - $ -$ 0.3 $ (0.1 ) $ -$ 5.1 $ 5.1 G&A expense 0.5 - - - - - - 0.5 Total$ 0.3 $ - $ -$ 0.3 $ (0.1 ) $ -$ 5.1 $ 5.6
Six Months Ended
Other Adjustments (i) (ii) (iii) (iv) (v) (vi) (vii) Total Cost of sales$ (0.1 ) $ - $ -$ 0.1 $ 0.3 $ 0.2 $ -$ 0.5 G&A expense 1.6 0.1 - - - 0.1 - 1.8 Other operating (income) expense - - - (1.6 ) - (58.3 ) - (59.9 ) Total$ 1.5 $ 0.1 $ -$ (1.5 ) $ 0.3 $ (58.0 ) $ -$ (57.6 )
Six Months Ended
Other Adjustments (i) (ii) (iii) (iv) (v) (vi) (vii) Total Cost of sales $ - $ -$ 0.5 $ 1.3 $ 3.0 $ -$ 5.1 $ 9.9 G&A expense 5.0 - - - - - - 5.0 Total$ 5.0 $ -$ 0.5 $ 1.3 $ 3.0 $ -$ 5.1 $ 14.9 55
-------------------------------------------------------------------------------- Results of Operations The following tables summarize key components of our results of operations for the periods indicated: Three Months Ended March 31, Six Months Ended March 31, 2020 2019 2020 2019 (In millions, except per share amounts) % of Revenue % of Revenue % Variance % of Revenue % of Revenue % Variance Revenue$ 351.7 100.0 %$ 348.6 100.0 % 0.9 %$ 697.8 100.0 %$ 671.6 100.0 % 3.9 % Cost of product sales and services (240.5 ) (68.4 )% (253.0 ) (72.6 )%
(4.9 )% (480.9 ) (68.9 )% (487.3 ) (72.6 )% (1.3 )% Gross profit 111.2 31.6 % 95.6 27.4 %
16.3 % 216.9 31.1 % 184.3 27.4 % 17.7 % General and administrative expense (62.1 ) (17.7 )% (48.2 ) (13.8 )% 28.8 % (107.9 ) (15.5 )% (103.0 ) (15.3 )% 4.8 % Sales and marketing expense (34.0 ) (9.7 )% (35.4 ) (10.2 )% (4.0 )% (72.0 ) (10.3 )% (71.6 ) (10.7 )% 0.6 % Research and development expense (3.2 ) (0.9 )% (4.0 ) (1.1 )% (20.0 )% (6.9 ) (1.0 )% (8.1 ) (1.2 )% (14.8 )% Other operating income (expense), net 9.3 2.6 % 3.5 1.0 % 165.7 % 60.7 8.7 % 3.5 0.5 % 1,634.3 % Interest expense (13.3 ) (3.8 )% (14.5 ) (4.2 )% (8.3 )% (26.8 ) (3.8 )% (28.9 ) (4.3 )% (7.3 )% Income (loss) before income taxes 7.9 2.2 % (3.0 ) (0.9 )% 363.3 % 64.0 9.2 % (23.8 ) (3.5 )% 368.9 % Income tax benefit (expense) 0.0 - % 4.6 1.3 % 100.0 % (2.6 ) (0.4 )% 9.1 1.4 % (128.6 )% Net income (loss) 7.9 2.2 % 1.6 0.5 % 393.8 % 61.4 8.8 % (14.7 ) (2.2 )% 517.7 % Net income attributable to noncontrolling interest 0.1 - % 0.2 0.1 % (50.0 )% 0.4 0.1 % 0.6 0.1 % (33.3 )% Net income (loss) attributable to Evoqua Water Technologies Corp.$ 7.8 2.2 %$ 1.4 0.4 % 457.1 %$ 61.0 8.7 %$ (15.3 ) (2.3 )% 498.7 % Weighted average shares outstanding Basic 116.5 114.5 116.5 114.5 Diluted 120.9 118.7 121.4 114.5 Earnings (loss) per share Basic$ 0.07 $ 0.01 $ 0.52 $ (0.13 ) Diluted$ 0.06 $ 0.01 $ 0.50 $ (0.13 ) Other financial data: Adjusted EBITDA(1)$ 56.7 16.1 %$ 56.7 16.3 % - %$ 100.3 14.4 %$ 95.1 14.2 % 5.5 %
(1) For the definition of Adjusted EBITDA (a non-GAAP financial measure) 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." 56
-------------------------------------------------------------------------------- Consolidated Results Revenues-Revenues increased$3.1 million , or 0.9%, to$351.7 million in the three months endedMarch 31, 2020 from$348.6 million in the three months endedMarch 31, 2019 . Revenues increased$26.2 million , or 3.9%, to$697.8 million in the six months endedMarch 31, 2020 from$671.6 million in the six months endedMarch 31, 2019 . The following table provides the change in revenues from product sales and revenues from services, respectively: Three Months Ended March 31, Six Months Ended March 31, 2020 2019 % Variance 2020 2019 % Variance % of % of % of % of Revenue Revenue Revenue Revenue Revenue from product sales$ 206.0 58.6 %$ 206.8 59.3 % (0.4 )%$ 402.6 57.7 %$ 386.9 57.6 % 4.1 % Revenue from services 145.7 41.4 % 141.8 40.7 % 2.8 % 295.2 42.3 % 284.7 42.4 % 3.7 %$ 351.7 100.0 %$ 348.6 100.0 % 0.9 %$ 697.8 100.0 %$ 671.6 100.0 % 3.9 % Revenues from product sales decreased$0.8 million , or 0.4%, to$206.0 million in the three months endedMarch 31, 2020 from$206.8 million in the three months endedMarch 31, 2019 . The decrease was primarily driven by a decrease in aftermarket revenues of$8.3 million , primarily driven by the divestiture of the Memcor product line, partially offset by increased capital revenues of$7.4 million . Revenues from product sales increased$15.7 million , or 4.1%, to$402.6 million in the six months endedMarch 31, 2020 from$386.9 million in the six months endedMarch 31, 2019 . The increase was primarily driven by increased capital revenues of$22.7 million , of which$4.9 million was related to the acquisitions of ATG UV and Frontier, partially offset by a decrease in aftermarket revenues of$7.1 million , primarily driven by the divestiture of the Memcor product line. Revenues from services increased$3.9 million , or 2.8%, to$145.7 million in the three months endedMarch 31, 2020 from$141.8 million in the three months endedMarch 31, 2019 . This increase was driven by stronger organic service growth, which was augmented by price realization. Revenues from services increased$10.5 million , or 3.7%, to$295.2 million in the six months endedMarch 31, 2020 from$284.7 million in the six months endedMarch 31, 2019 . This increase was driven by stronger organic service growth, which was augmented by price realization. Cost of Sales and Gross Margin-Total gross margin increased to 31.6% in the three months endedMarch 31, 2020 from 27.4% in the three months endedMarch 31, 2019 . Total gross margin increased to 31.1% in the six months endedMarch 31, 2020 from 27.4% in the six months endedMarch 31, 2019 . The following table provides the change in cost of product sales and cost of services, respectively, along with related gross margins: Three Months Ended March 31, Six Months Ended March 31, 2020 2019 2020 2019 Gross Gross Gross Gross Margin % Margin % Margin % Margin %
Cost of product sales
$ (240.5 ) 31.6 %$ (253.0 ) 27.4 %$ (480.8 ) 31.1 %$ (487.3 ) 27.4 % Gross margin from product sales increased by 4.4% to 30.0% in the three months endedMarch 31, 2020 from 25.6% in the three months endedMarch 31, 2019 . The increase in gross margin was primarily driven by costs incurred in 57 -------------------------------------------------------------------------------- the prior year of$5.1 million , mainly due to product rationalization, that did not reoccur in the current year. The remaining change is related to change in product mix and price realization. Gross margin from product sales increased by 4.4% to 29.3% in the six months endedMarch 31, 2020 from 24.9% in the six months endedMarch 31, 2019 . The increase in gross margin was primarily driven by costs incurred in the prior year of$9.9 million , mainly due to product rationalization, that did not reoccur in the current year. The remaining change is related to change in product mix and price realization. Gross margin from services increased by approximately 3.8% to 33.9% in the three months endedMarch 31, 2020 from 30.1% in the three months endedMarch 31, 2019 . Gross margin from services also increased approximately 2.6% to 33.5% in the six months endedMarch 31, 2020 from 30.9% in the six months endedMarch 31, 2019 . These increases are mainly driven by price realization recognized in revenue as well as better leverage of fixed costs as revenue volumes increase. Operating Expenses-Operating expenses increased$11.7 million , or 13.4%, to$99.3 million in the three months endedMarch 31, 2020 from$87.6 million in the three months endedMarch 31, 2019 . The change in foreign currency translation, most of which is related to intercompany loans, resulted in a net increase in operating expenses of$7.0 million period over period. Other increases in operating expenses include$2.5 million associated with the acquisitions of ATG UV and Frontier, transaction costs related to the sale of the Memcor product line of$1.0 million and additional employee related expenses of$1.2 million . Operating expenses increased$4.1 million , or 2.2%, to$186.8 million in the six months endedMarch 31, 2020 from$182.7 million in the six months endedMarch 31, 2019 . This increase is mainly due to the following: • increased employee related expenses of$3.3 million ; • increased costs of$2.3 million related to the ATG UV and Frontier acquisitions, mainly due to amortization expense on purchased intangibles; • costs of$1.2 million incurred in connection with the secondary public offering of shares of common stock held by certain shareholders of the Company; and • transaction costs related to the sale of the Memcor product line of$1.0 million .
The above increases were partially offset by favorable change in foreign
currency translation on the intercompany loans of
A discussion of operating expenses by category is as follows: Research and Development Expense - Research and development expenses decreased$0.8 million during the three months endedMarch 31, 2020 as compared toMarch 31, 2019 , and decreased$1.2 million during the six months ended of the same periods due to the Company's continued efforts to reduce spending, offset partially by increased expenses due to the Frontier acquisition. Sales and Marketing Expense - Sales and marketing expenses had a decrease of$1.4 million during the three months endedMarch 31, 2020 due to a reduction in employee related expenses, and an increase of$0.4 million in the six months ended mainly due to the Frontier acquisition offset by the reduction in employee related expenses. General and Administrative Expense - General and administrative expenses increased$13.9 million , or 28.8%, to$62.1 million in the three months endedMarch 31, 2020 from$48.2 million in the three months endedMarch 31, 2019 . This increase in general and administrative expenses was primarily due to the unfavorable change in foreign currency translation on the intercompany loans, as described above, of$7.0 million . We also saw increased depreciation and amortization of$2.5 million , mainly related to the acquisitions of ATG UV and Frontier. These acquisitions resulted in further increases within general and administrative expenses of$0.5 million . Costs incurred related to the secondary public offering of shares of common stock held by certain shareholders of the Company were$1.2 million , and employee related expenses increased by$1.1 million . 58 -------------------------------------------------------------------------------- General and administrative expenses increased$4.9 million , or 4.8%, to$107.9 million in the six months endedMarch 31, 2020 from$103.0 million in the six months endedMarch 31, 2019 . The increase is due to: • depreciation and amortization of$2.7 million , mainly
related to the
ATG UV and Frontier acquisitions;
• increased employee related expenses of
• increased costs of$1.3 million related to the Frontier and ATG UV acquisitions; • costs incurred related to the secondary public offering of shares of common stock held by certain shareholder of the Company of$1.2 million ; and • transaction costs related to the sale of the Memcor product line of$1.0 million .
The above increases were partially offset by unfavorable change in foreign
currency translation on the intercompany loans of
Other operating income (expense)-Other operating income (expense) increased$5.8 million , to income of$9.3 million in the three months endedMarch 31, 2020 from income of$3.5 million in the three months endedMarch 31, 2019 . The current year amount is primarily related to the gain on sale of the Memcor product line, while the amount in the prior year was primarily due to release of an acquisition related contingency due to the passage of time. Other operating income (expense) increased$57.2 million to income of$60.7 million in the six months endedMarch 31, 2020 from income of$3.5 million in the six months endedMarch 31, 2019 . The increase is mainly due to the net pre-tax benefit on sale of the Memcor product line of$58.0 million , which is net of$8.3 million of discretionary compensation payments to employees in connection with the transaction and$1.0 million in transaction costs incurred in the first quarter of 2020. Interest Expense-Interest expense decreased$1.2 million , or 8.3%, to$13.3 million in the three months endedMarch 31, 2020 from$14.5 million in the three months endedMarch 31, 2019 . Interest expense decreased$2.1 million , or 7.3%, to$26.8 million in the six months endedMarch 31, 2020 from$28.9 million in the six months endedMarch 31, 2019 . The decrease in interest expense was primarily driven by a reduction in LIBOR year over year in addition to a$100 million pay down of debt in the three months endedMarch 31, 2019 , partially offset by a write-off of deferred financing fees related to the debt paydown and interest expense associated with additional equipment financings. Income tax benefit (expense)-An income tax benefit of$7 and an income tax benefit of$4.6 million were recorded for the three months endedMarch 31, 2020 and 2019, respectively. The decrease in tax benefit from the prior year was principally due to the significant income earned in the current year, primarily from the sale of the Memcor product line, as compared to a significant loss in the prior year. Income tax expense of$2.6 million and an income tax benefit of$9.1 million was recorded for the six months endedMarch 31, 2020 and 2019, respectively. The decrease in tax benefit from the prior year was principally due to the significant income earned in the current year, primarily from the sale of the Memcor product line, as compared to a significant loss in the prior year. Net Income-Net income increased by$6.3 million , or 393.8%, to$7.9 million for the three months endedMarch 31, 2020 , from a net income of$1.6 million in the three months endedMarch 31, 2019 . The main driver of this increase is the sale of the Memcor product line, which resulted in a net pre-tax benefit on sale of$9.0 million in the three months endedMarch 31, 2020 . In addition to the net benefit of the sale, we saw overall contributions of revenue volume and mix of$11.9 million . These increases were offset by$7.6 million of foreign currency loss, mainly due to intercompany loans, versus a prior year period foreign currency loss of$0.6 million , resulting in a net loss of$7 million . Additionally, income increases were offset by a$4.6 million net increase in income tax expense in the current year period based on the projected effective tax rate for the fiscal year. Net income increased by$76.1 million , or 517.7%, to net income of$61.4 million for the six months endedMarch 31, 2020 from a net loss of$14.7 million in the six months endedMarch 31, 2019 . The main driver of this increase is the sale of the Memcor product line, which resulted in a gain on sale of$67.3 million , less amounts paid for discretionary bonuses of$8.3 million and transaction costs of$1.0 million incurred in the six months endedMarch 31, 2020 . The resulting 59 -------------------------------------------------------------------------------- net pre-tax benefit was$58.0 million . In addition to the net benefit of the sale, we saw overall contributions of revenue volume and mix of$19.6 million . Adjusted EBITDA- Adjusted EBITDA is a non-GAAP financial measure. Adjusted EBITDA for the three months endedMarch 31, 2020 was$56.7 million , which is consistent with the three months endedMarch 31, 2019 . Adjusted EBITDA for the quarter as compared to the prior year period was driven by increased revenue volume, price realization, and favorable changes in mix, offset by the changes as compared to the prior year period in non-recurring expenses and benefits. Adjusted EBITDA increased$5.2 million , or 5.5%, to$100.3 million for the six months endedMarch 31, 2020 from$95.1 million for the six months endedMarch 31, 2019 . The increase in Adjusted EBITDA as compared to the prior year period was primarily driven by the increased revenue volume, augmented by price realization and the favorable change in mix driven by higher service volumes. Segment Results Three Months Ended March 31, Six Months Ended March 31, 2020 2019 % Variance 2020 2019 % Variance % of Revenue % of Revenue % of Revenue % of Revenue Revenues Integrated Solutions and Services$ 237.9 67.6 %$ 226.8 65.1 % 4.9 %$ 466.0 66.8 %$ 437.3 65.1 % 6.6 % Applied Product Technologies 113.8 32.4 % 121.8 34.9 % (6.6 )% 231.8 33.2 % 234.3 34.9 % (1.1 )% Total Consolidated 351.7 100.0 % 348.6 100.0 % 0.9 % 697.8 100.0 % 671.6 100.0 % 3.9 % Operating profit (loss) Integrated Solutions and Services 36.7 10.4 % 37.0 10.6 % (0.8 )% 69.8 10.0 % 64.9 9.7 % 7.6 % Applied Product Technologies 23.8 6.8 % 11.3 3.2 % 110.6 % 86.9 12.5 % 15.8 2.4 % 450.0 % Corporate (39.3 ) (11.2 )% (36.8 ) (10.6 )% 6.8 % (65.9 ) (9.4 )% (75.6 ) (11.3 )% (12.8 )% Total Consolidated 21.2 6.0 % 11.5 3.3 % 84.3 % 90.8 13.0 % 5.1 0.8 % 1,680.4 % EBITDA Integrated Solutions and Services 54.0 15.4 % 51.3 14.7 % 5.3 % 102.8 14.7 % 93.2 13.9 % 10.3 % Applied Product Technologies 27.3 7.8 % 15.8 4.5 % 72.8 % 94.0 13.5 % 24.6 3.7 % 282.1 % Corporate and unallocated costs (32.8 ) (9.3 )% (31.4 ) (9.0 )% 4.5 % (53.5 ) (7.7 )% (65.4 ) (9.7 )% (18.2 )% Total Consolidated$ 48.5 13.8 %$ 35.7 10.2 % 35.9 %$ 143.3 20.5 %$ 52.4 7.8 % 173.5 % 60
-------------------------------------------------------------------------------- Adjusted EBITDA is a non-GAAP financial measure. 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 Adjusted EBITDA to operating profit, its most directly comparable financial measure presented in accordance with GAAP: Three Months Ended March 31, Six Months Ended March 31, 2020 2019 2020 2019 Integrated Integrated Integrated Integrated Solutions and Applied Product Solutions
and Applied Product Solutions and Applied Product Solutions and Applied Product
Services Technologies Services Technologies Services Technologies Services Technologies
Operating Profit $ 36.7 $ 23.8 $ 37.0 $
11.3$ 69.8 $ 86.9 $ 64.9 $ 15.8 Depreciation and amortization 17.3 3.5 14.3 4.5 33.0 7.1 28.3 8.8 EBITDA $ 54.0 $ 27.3 $ 51.3 $ 15.8$ 102.8 $ 94.0 $ 93.2 $ 24.6
Restructuring and related business transformation costs (a) 0.1 3.3 0.1 0.2 0.1 4.0 0.4 0.5 Transaction costs (b) - - - - - (1.3 ) 0.5 0.7 Other losses (gains) and expenses (c) - (8.9 ) - 5.2 - (59.2 ) 0.2 9.3 Adjusted EBITDA (d) $ 54.1 $ 21.7 $ 51.4 $ 21.2$ 102.9 $ 37.5 $ 94.3 $ 35.1
(a) Represents costs and expenses in connection with restructuring initiatives
distinct to our Integrated Solutions and Services and Applied Product
Technologies segments in the three and six months ended
2019, respectively. Such expenses are primarily composed of severance and
relocation costs. (b) Represents costs associated with a change in the current estimate of
certain acquisitions achieving their earn-out targets, which resulted in a
(decrease) increase to the fair valued amount of the earn-out recorded
upon acquisition, in the three and six months ended
2019, respectively, distinct to our Integrated Solutions and Services and
Applied Product Technologies segments.
(c) Other losses, (gains) and expenses as discussed above in "How We Assess
the Performance of Our Business-Adjusted EBITDA" distinct to our
Integrated Solutions and Services ("ISS") and Applied Product Technologies
("APT") segments include the following: Three Months Ended March 31, Six Months Ended March 31, 2020 2019 2020 2019 (In millions) ISS APT ISS APT ISS APT ISS APT Net pre-tax benefit on sale of the Memcor product line $ -$ (9.0 ) $ - $ - $ -$ (58.0 ) $ - $ - Remediation of manufacturing defects - (0.1 ) - 0.3 - (1.5 ) - 1.3 Product rationalization in electro-chlorination business - 0.2 - (0.1 ) - 0.3 - 3.0 Expenses related to maintaining non-operational business locations - - - - - - 0.2 - Write-off of inventory - - - 5.1 - - - 5.1 Foreign exchange impact related to headquarter allocations - - - (0.1 ) - - - (0.1 ) Total $ -$ (8.9 ) $ -$ 5.2 $ -$ (59.2 ) $ 0.2 $ 9.3 61
--------------------------------------------------------------------------------
(d) For the definition of Adjusted EBITDA (a non-GAAP financial measure) 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."
Integrated Solutions and Services Revenues in the Integrated Solutions and Services segment increased$11.1 million , or 4.9%, to$237.9 million in the three months endedMarch 31, 2020 from$226.8 million in the three months endedMarch 31, 2019 . The increase in revenue was mainly driven by growth in capital revenue of$7.7 million in addition to increased service revenue of$2.8 million , exclusive of acquisitions, which continued to be augmented by price realization. Our recent investment in Frontier resulted in an additional increase of$1.1 million of revenue. These increases were offset by a slight decline in aftermarket revenue of$0.5 million . The segment saw stable but uneven demand as a result of the COVID-19 pandemic during the latter half of March. The segment saw increases in volume in healthcare related end markets, partly offset by declines in the refining and oil and gas end markets. Demand in the power, microelectronics, food & beverage and municipal end markets remained stable through the period. [[Image Removed: chart-55dfcf7ccb2723391e6.jpg]] Revenues in the Integrated Solutions and Services segment increased$28.7 million , or 6.6%, to$466.0 million in the six months endedMarch 31, 2020 from$437.3 million in the six months endedMarch 31, 2019 . The increase in revenue was driven by stronger capital growth of$18.6 million , exclusive of acquisitions, in addition to service growth of$9.6 million , which was augmented by price realization. Our recent investment in Frontier resulted in an additional increase of$2.3 million of revenue. These increases were offset by a reduction in aftermarket revenue of$1.8 million . [[Image Removed: chart-6eb6780d5e2353adb0c.jpg]] Operating profit in the Integrated Solutions and Services segment decreased$0.3 million , or 0.8%, to$36.7 million in the three months endedMarch 31, 2020 from$37.0 million in the three months endedMarch 31, 2019 . Segment profitability improved$6.5 million in the period driven by increased organic and acquisition related revenue volume, augmented by improved pricing, and favorable change in product mix driven by the higher service volumes. Negative 62 --------------------------------------------------------------------------------
drivers to profitability were increased employee related expenses of
[[Image Removed: chart-5cd246093b67d2f1d7b.jpg]] Operating profit in the Integrated Solutions and Services segment increased$4.9 million , or 7.6%, to$69.8 million in the six months endedMarch 31, 2020 from$64.9 million in the six months endedMarch 31, 2019 . Segment profitability improved$13.8 million in the period driven by increased organic and acquisition related revenue volume, augmented by improved pricing, and favorable change in product mix driven by the higher service volumes. Profitability in the current year was also favorably impacted by the non-recurrence of$0.5 million of charges related to the achievement of earn-out targets associated with the Pure Water acquisition, in addition to the non-recurrence of other charges noted in the prior year of approximately$0.5 million related to restructuring and inactive sites. Negative drivers to profitability were increased employee related expenses of$5.2 million and higher depreciation and amortization expense of$4.7 million . [[Image Removed: chart-5e8dbf074c3f5d2bbea.jpg]] EBITDA in the Integrated Solutions and Services segment increased$2.7 million , or 5.3%, to$54.0 million in the three months endedMarch 31, 2020 , compared to$51.3 million in the three months endedMarch 31, 2019 and increased$9.6 million , or 10.3%, to$102.8 million in the six months endedMarch 31, 2020 , compared to$93.2 million in the six months endedMarch 31, 2019 . Applied Product Technologies Revenues in the Applied Product Technologies segment decreased$8.0 million , or 6.6%, to$113.8 million in the three months endedMarch 31, 2020 from$121.8 million in the three months endedMarch 31, 2019 . The impact from the divestiture of the Memcor product line and the acquisition of ATG UV resulted in a net reduction in revenue of$8.1 million . Additionally, APT saw an unfavorable foreign currency translation impact of$1.4 million . These decreases were partially 63 -------------------------------------------------------------------------------- offset by organic revenue growth in both EMEA of$5.4 million , driven by volume in Aquatics & Electrochlorination product lines, and in theAmericas region of$1.8 million across multiple product lines, partially offset by a decline inAsia Pacific of$5.7 million , mainly due to COVID-19 related slow down and delays. [[Image Removed: chart-0768ded3b1f24531c48.jpg]] Revenues in the Applied Product Technologies segment decreased$2.5 million to$231.8 million in the six months endedMarch 31, 2020 from$234.3 million in the six months endedMarch 31, 2019 . The divestiture of the Memcor product line and the acquisition of ATG UV resulted in a net reduction in revenue of$4.1 million . Organic revenue grew in EMEA by$6.6 million driven by capital volume in Aquatics & Electrochlorination product lines and in theAmericas region by$0.3 million , partially offset by a decline inAsia Pacific of$3.2 million predominantly due to COVID-19 slow down and delays. These increases were partially offset by an unfavorable foreign currency translation impact of$2.1 million . [[Image Removed: chart-837ee378535f56be857.jpg]] Operating profit in the Applied Product Technologies segment increased$12.5 million , or 110.6%, to$23.8 million in the three months endedMarch 31, 2020 from$11.3 million in the three months endedMarch 31, 2019 . The increase is mainly due to the the additional funds received as a result of the net working capital settlement related to the net pre-tax benefit on sale of the Memcor product line of$9.0 million . Increased profit was also driven by volume and mix performance, augmented by improved pricing, of$6.4 million , in addition to lower depreciation of$1.0 million and$0.5 million of net benefit from the divestiture of the Memcor product line and the acquisition of ATG UV. These increases were offset by operational variances of$2.6 million , increased employee related expenses of$0.8 million , and$0.3 million of unfavorable foreign currency.
Further operating profit decreases were due to costs of
64 --------------------------------------------------------------------------------
• An increase in restructuring charges of$3.1 million primarily due to costs incurred following the sale of the Memcor product line; • An increase in costs related to charges incurred by the Company related to product rationalization in its electro-chlorination business of$0.3 million ; and
• Release of an acquisition related contingency due to the passage of
time in the prior year for
These increases were partially offset by: • Reduction in costs incurred by the Company related to the write-off of
inventory in the prior year of$5.1 million associated with product rationalization and facility consolidation; and • A reduction in costs incurred by the Company from a settlement with a third-party vendor associated with remediation of manufacturing defects caused by the vendor of$0.4 million . [[Image Removed: chart-790dd262110be71522f.jpg]] Operating profit in the Applied Product Technologies segment increased$71.1 million , or 450.0%, to$86.9 million in the six months endedMarch 31, 2020 from$15.8 million in the six months endedMarch 31, 2019 . The increase is mainly due to the net pre-tax benefit on sale of the Memcor product line of$58.0 million , which is net of$8.3 million of discretionary compensation payments to employees in connection with the transaction and$1.0 million in transaction costs incurred. Increased profit was also driven by volume and mix performance, augmented by improved pricing, of$8.1 million , in addition to a$1.1 million net benefit from the divestiture of the Memcor product line and the acquisition of ATG UV and lower depreciation of$1.7 million . Further increases were due to net reductions in nonrecurring costs of$6.3 million related to: • Reduction in costs incurred by the Company related to the write-off of
inventory in the prior year of
rationalization and facility consolidation;
• A reduction in costs incurred by the Company from a settlement with a
third-party vendor associated with remediation of manufacturing defects
caused by the vendor of
• Reductions in costs related to the achievement of earn-out targets
associated with certain acquisitions of
• Reductions in costs related to charges incurred by the Company related
to product rationalization in its electro-chlorination business of
million;
• Increases in restructuring charges of
costs incurred following the sale of the Memcor product line; and
• Release of an acquisition related contingency due to the passage of
time in the prior year for$2.8 million . 65
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Operating profit was reduced by operational variances of
[[Image Removed: chart-d6c11d3739eb5ce3965.jpg]] EBITDA in the Applied Product Technologies segment increased$11.5 million , or 72.8%, to$27.3 million in the three months endedMarch 31, 2020 , compared to$15.8 million in the three months endedMarch 31, 2019 . EBITDA in the Applied Product Technologies segment increased$69.4 million , or 282.1%, to$94.0 million in the six months endedMarch 31, 2020 , compared to$24.6 million in the six months endedMarch 31, 2019 . 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$125.0 million 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. As part of our ongoing efforts to improve our cash flow and related liquidity, we work with suppliers to optimize our terms and conditions, including some times extending payment terms. We also facilitate a voluntary supply chain finance program (the "program") to provide certain of our suppliers with the opportunity to sell receivables due from us to participating financial institutions at the sole discretion of both the suppliers and the financial institutions. A third party administers the program; our responsibility is limited to making payment on the terms originally negotiated with our supplier, regardless of whether the supplier sells its receivable to a financial institution. We do not enter into agreements with any of the participating financial institutions in connection with the program. The range of payment terms we negotiate with our suppliers is consistent, irrespective of whether a supplier participates in the program. TheMarch 31 year to date amounts settled through the program and paid to participating financial institutions were$15.7 million , and$0 million in fiscal 2020, and fiscal 2019, respectively. A downgrade in our credit rating or changes in the financial markets could limit the financial institutions' willingness to commit to participation in the program. We expect to continue to finance our liquidity requirements through internally generated funds, borrowings under our Revolving Credit Facility and equipment financing arrangements. We believe that our projected cash flows generated from operations, together with borrowings under our Revolving Credit Facility and other financing arrangements are sufficient to fund our principal debt payments, interest expense, our working capital needs and our expected capital 66 -------------------------------------------------------------------------------- expenditures for the next twelve months. Our capital expenditures for the six months endedMarch 31, 2020 and 2019 were$38.8 million and$40.7 million , respectively. However, our budgeted capital expenditures can vary from period to period based on the nature of capital intensive project awards. From time to time, we may enter into financing arrangements related to capital expenditures for equipment used to provide services to our customers. In addition, we may draw on our Revolving Credit Facility from time to time to fund or partially fund an acquisition. As ofMarch 31, 2020 , we had total indebtedness of$879.5 million , including$824.0 million of borrowings under the First Lien Term Loan Facility, no borrowings under our Revolving Credit Facility,$53.2 million in borrowings related to equipment financing,$0.7 million of notes payable related to certain equipment related contracts and$1.6 million related to a mortgage. We also had$12.0 million of letters of credit issued under our$125.0 million Revolving Credit Facility and an additional$49 thousand of letters of credit issued under a separate uncommitted facility as ofMarch 31, 2020 . 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. 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 ofMarch 31, 2020 andSeptember 30, 2019 , 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: 67
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