Evoqua Water Technologies Corp. (AQUA) Q4 2018 Earnings Conference Call Transcript

Evoqua Water Technologies Corp. (AQUA)
Q4 2018 Earnings Conference Call
November 27, 2018, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning and welcome to the Evoqua Water Technologies fourth quarter and full year 2018 earnings conference call. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. After the speaker's opening remarks, there will be a question and answer period.

If you would like to ask a question during this time, simply press * and the number 1 on your telephone keypad. If you would like to withdraw your question, press the # key on your telephone keypad. 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 would now like to turn the call over to Dan Brailer, Vice President of Investor Relations. Please go ahead.

Dan Brailer -- Vice President of Investor Relations

Thank you, Laurie. Good morning, ladies and gentlemen. Thank you for joining us for Evoqua Water Technologies conference call to review our fourth quarter and full year 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 follow-up to accommodate as many questions as possible. This conference call includes forward-looking statements, including our current outlook for first quarter and full year Fiscal 2019, statements regarding our two segment realignment actions and expected restructuring charges and cost savings for Fiscal 2019 and beyond.

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 and the 10-K, which is expected to be filed on or before December 11th. We expect to file an 8-K shortly after the 10-K filing with three years of historical, quarterly, to segment results. This conference call 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 historical 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 30th. 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 -- President and Chief Executive Officer

Thank you, Dan. Good morning. We appreciate your interest in Evoqua and you joining us for today's call to review our fourth quarter and full-year results. As you know, we announced our preliminary results on October 30th and announced our company realignment to a two-segment business, effective as of October 1st. Today, we will provide more insight into the results, the two-segment rationale, and the current 2019 outlook. Please turn to slide three.

Our industrial segment had solid sales growth in the fourth quarter and full year. We've been working on a digital water strategy that is well under way. As part of that strategy and after the successful completion of our pilots, we launched our Water One initiative officially this past month. Our industrial and municipal businesses reported service revenue growth and we expect to see that growth continue into 2019.

Apart from our Aquatics product line, which I will discuss in a moment, our product segment had solid sales and EBITDA growth in the fourth quarter and for the full year. Free cash flow was strong in the quarter, primarily driven by working capital improvements and for the full year, our conversion rate was 80%, up from 17% in the prior year.

We were disappointed with our full year results and have taken actions to address our challenges and to strengthen our market-leading position. An ERP integration at Neptune-Benson, supply chain disruptions influenced by tariffs, and the delay of a large aquatics project primarily led to our fourth quarter challenges. These primary factors were concentrated in our product segments Aquatics product line, Neptune-Benson, and in our municipal segment, and will be addressed on the next slide.

Our market remains strong and improvement actions are well under way. The two-segment realignment to streamline and simplify our business is progressing and we expect to see benefits materialize by the third quarter of 2019. In 2019, we intend to focus our efforts primarily on profitable growth, operational excellence, cost management, and free cash flow generation.

Continued improvement in free cash flow is expected to come from working capital management, focusing M&A activity on CapEx-like tuck-in transactions, and managing gross capital expenditures to the highest return investments. To mitigate the risk of rising interest rates, we've entered into an interest rate hedge representing $600 million or approximately two-thirds of our credit facility.

Finally, we've incorporated a free cash flow metric into management's 2019 incentive compensation program. We enter our 2019 fiscal year with a clear focus on executing our plan, maintaining our high level of customer service and meeting shareholder expectations. Please turn to slide four.

We continue to benefit from a stable and recurring flow of revenue growth. As you can see on this chart, approximately 44% of our revenue is derived from services, which are stable and recurring with a 99% renewal rate on our annual service contracts. The chart shows quarterly revenues and adjusted EBITDA on a rolling 12-month basis. Over the last three years, we have consistently reported quarterly LTM revenue growth through Q4 of 2018.

Adjusted EBITDA has growth steadily for the last 11 quarters except for this last quarter's performance. With our action plans under way, we have confidence in our ability to extend our market-leading position and we expect to back to consistent LTM growth in the second half of 2019 with a stable, growing outlook for our fiscal year.

Please turn to slide five. We have highlighted the segment drivers for the fourth quarter performance by bridging our reported fourth quarter 2017 adjusted EBITDA of $71 million to our fourth quarter 2018 adjusted EBITDA of $61 million. The industrial segment reported an increase in adjusted EBTIDA and performed generally in line with our internal expectations. Our municipal segment adjusted EBTIDA was down approximately $2 million and was modestly below our internal expectations.

Our fourth quarter 2018 corporate costs were approximately $1.5 million versus the prior year given the higher incremental costs of operating as a public company. The product segment is comprised of five businesses, including aquatics and disinfection, which is one of our highest margin businesses. The aquatics and disinfection business represented approximately 48% of the product segment's 2018 full-year adjusted EBITDA compared to 63% in 2017.

The Aquatics product line within the aquatics and disinfection business is primarily comprised of Neptune-Benson. The fourth quarter challenges were isolated to the Neptune-Benson product line as we migrated the business onto the company's SAP system, dealt with supply chain disruptions influenced by tariffs and experienced a large project delay. In November, we completed the migration of the business onto our SAP system.

Regarding supply chain disruptions, Neptune-Benson sells a very high margin filtration system that has critical components sourced from China that partly created our challenge. We've taken mitigating actions, which should address this issue in the second half of 2019. Because of these challenges, the aquatics and disinfection businesses for 2018 fourth quarter adjusted EBITDA declined 62% versus the prior year and was down 26% for the full year versus 2017.

Excluding aquatics and disinfection, the product segment's adjusted EBITDA grew approximately 12% in the fourth quarter and approximately 39% for the full year. For the full year, we were pleased with the industrial segment's performance and the product segment excluding the aquatics product line. We understand the challenges facing the municipal segment and our organizational realignment is expected to streamline and simplify the overall business.

I would now like to turn the call over to Ben to review the fourth quarter and full year financial results.

Ben Stas -- Executive Vice President and Chief Financial Officer

Thank you, Ron. Please turn to slide six. For the fourth quarter, revenues grew by approximately 3%, driven by growth in the industrial segment, partly offset by declines in the municipal and product segments. Adjusted EBITDA was down 14% to $61 million, driven by previously discussed challenges in the aquatics product line and municipal segment. Adjusted EBITDA margin was down 330 basis points to 16.7% versus the prior year.

During the quarter, we estimate price cost was negative by less than $2 million. We will continue to improve pricing actions across the business to offset projected inflationary and tariff-driven cost increases. Please turn to slide seven.

For the full year, revenues grew by approximately 7% for the prior period, driven by the industrial and product segments. Pro forma growth contributed 4% and tuck-in acquisitions contributed approximately 3%. Adjusted EBITDA increased by $9 million or 4.4% over the prior year, but margins were adversely impacted by higher inflationary costs, capital mix, and underperformance in the high-margin aquatics product line. These margin pressures were partly offset by pricing benefits and cost reduction initiatives.

Please turn to slide eight -- fourth quarter revenues, where our industrial segment grew over 9% versus the prior year driven by demand in power, hydrocarbon, and chemical processing markets, capital revenues contributed approximately 40% of sales increase as we continue to see growth in industrial wastewater, recycle, and reuse opportunities. Adjusted EBITDA increase approximately 2%, while margins were impacted by mix and higher cost.

For the full year, industrial revenues increased over 13% with pro forma growth of approximately 7% over the prior year. Power market demand and remediation projects were the drivers. Excluding acquisitions, capital sales contributed to over 80% of full year sales growth. This entire capital mix impacted overall profitability compared with higher inflationary cost. Adjusted EBITDA grew almost 13% for the full year to $169 million while adjusted EBITDA margin was flat the last year at 23.2%.

Please turn to slide nine -- for the fourth quarter, municipal segment revenues were down approximately $2 million to $78 million, driven by lower capital sales and supply chain disruptions influenced by tariffs. Project-related revenues decreased approximately $4 million versus the prior year. Aftermarket sales were flat and service revenues grew by over $2 million. As a result, adjusted EBITDA was down approximately $2 million to $13 million and margins were down approximately 250 basis points to 16.4%.

For the full year, revenues were down approximately $6 million or 2% over the prior year, driven by $5 million of lower project sales, $5 million of lower aftermarket sales offset by price gains and service growth of over $4 million. Adjusted EBITDA declined almost $8 million over the prior year for a 13.7% margin. Drivers of the year over year decline in adjusted EBTIDA and margins were lower sales volume, mix, inflation impacts, and the previously discussed supply chain disruptions.

Please turn to slide 10. The product segment fourth quarter revenues decreased approximately $5 million in the quarter or 5% versus the previous year. The underperformance of our Aquatics product line had a significant impact on overall segment's performance. Adjusted EBTIDA for the fourth quarter declined by approximately $7 million to $16 million or 18.3% margin, compared to the prior year driven by the Aquatics product line.

For the full year, revenues grew by approximately $14 million or 4% compared to the prior year. The aquatics and disinfection business revenues were down approximately $20 million, partly offsetting $25 million or 19% growth from the remaining four businesses. Acquisitions and divestitures contributed approximately $4 million and foreign exchange contributed $5 million of growth.

Full year adjusted EBTIDA was down approximately $2 million to $76 million for a margin of 22.4%, driven by the aquatics and disinfection business, offsetting approximately 39% adjusted EBTIDA growth for the remaining product businesses. Please turn to slide 11. We are pleased with the fourth quarter's free cash flow generation of approximately $33 million.

We finished the year with free cash flow of approximately $50 million for an 80% conversion rate up from 17% in the prior year. Working capital improvement was the primary driver. In Q4, we added a $150 million tack-on to our first lean term loan to fund the acquisition of ProAct and for general corporate purposes. This tack-on increased overall leverage 0.4 terms to 4.1 times adjusted EBITDA.

Our capital allocation priorities are focused on reducing net debt, high returns investments, and tuck-in acquisitions. We also have secured a $600 million interest rate cap representing nearly two-thirds of our credit facility to migrate rising interest rates. Our current average cost of debt is approximately 5.2% as of September 30th.

Please turn to slide 12. We had a strong year of high returns investments in 2018, with CapEx totaling almost $81 million or 6% of sales. We invested approximately $47 million above maintenance CapEx including $14 million for a large outsourced water project and over $11 million for mobile service asset capabilities and capacity. Maintenance CapEx represents approximately 2.5% of sales. Networking capital improves sequentially from Q3 as a percentage of sales. The addition of ProAct increase overall working capital by approximately $7 million or 0.5% of sales.

I would now like to turn the call back over to Ron to review the two-segment structure and our 2019 outlook.

Ron Keating -- President and Chief Executive Officer

Thank you, Ben. Please turn to slide 13. As Ben reviewed, our business has historically been divided across three segments that initially allowed us to focus on our core markets. However, as we've grown and added several acquisitions, we realize the need to evolve our structure to optimize our ability to quickly serve customers and channel partners.

For example, our teams in the industrial segment began offering carbon solutions for emerging containments such as PFAS removal into the municipal market. Meanwhile, our municipal segment products such as CoMag and MEMCOR were being sold into the industrial market. Finally, the product segment was selling across industrial, municipal, and the recreational markets.

We heard from customers that multiple sales people all with Evoqua business cards were serving their needs but offering different pieces of the solution. We recognized that we could better serve the needs of our customers and more effectively deploy our solutions by addressing the siloes that existed between our products and services organizations.

As we turn to the future, we set forth a strategy that enables us to better leverage our broad portfolio and expertise that existed across our businesses. Fundamental to the success of that strategy is aligning our organization around customers and partners by organizing ourselves based on how they want their problem solved and how they seek value.

When we reflected and analyzed how this happens, it's in two distinct ways, through the solutions and services we deliver directly and through the suite of products and technologies we offer primarily through third-party challenges. As such, we've created two new segments. The first, integrated solutions and services, which will include the former industrial segment as well as the municipal services group that offers odor and corrosion control solutions to municipalities in North America.

The second -- apply product technologies which will include our former product segment as well as our municipal products provided through our wastewater technologies and advanced filtration businesses. We expect this structure to allow us to better serve our customers and partners by eliminating internal barriers.

Please turn to slide 14. Moving forward, the integrative solutions and services team is focused on servicing the North American market. We're moving from a pay by service model to embracing programs such as Water One, which take advantage of our portfolio, our service network, and our innovative digital solutions.

As previously discussed, through water one, we deploy complete solutions to enable and optimize customer performance through a pay by use model. We're also moving away from regional account selling to a more national account focus, allowing us to better leverage our national footprint and technical talent.

Meanwhile, the applied product technologies segment will move from individual product sales to offering customers a suite of technologies that best fit their needs. The applied product technologies team will sell through our integrated solutions and services segment and through our established third-party channels across the globe, allowing us to expand our reach and impact underserved markets.

We expect to incur one-time charges of $17 million to $22 million associated with our new two-segment structure over the course of the next two fiscal years. These charges should fall within two categories -- structure and integration cost of $10 million to $12 million and footprint product rationalization and other costs for $7 million to $10 million. Benefits associated with this structure should begin to materialize in the third quarter of 2019.

Please turn to slide 15. I look at 2019 as being the continuation of building our foundation. We've made significant progress improving the company since the days we were operated as a division of our former owner. As we systematically work through the necessary steps in positioning the company for the future, we will be focused primarily on three main priorities -- delivering profitable growth, expanding our margins through operational actions, and increasing our free cash flow.

Our first priority will be to focus on the execution and implementation of the new structure to drive profitable growth. Our go to market strategy will allow us to get closer to the customer, with an opportunity to more effectively offer a full range of solutions and services. Pricing actions and margin expansion initiatives will be key components to this priority. We're deploying our Water One digital platform that is utilizing on-demand pay by the gallon capabilities to better serve our customers and lower our operating costs.

We're taking several operational actions to drive margin expansion. We expect our two-segment realignment to streamline and simplify our supply chain, engineering, and back office operations to deliver solutions and services more effectively. As we've discussed earlier, our digital deployment will be an important part of our future and we believe we have the capabilities, the service network, and the customer base to drive installations broadly and to expand our market-leading position.

Third, we plan on free cash flow generation, plan to focus on free cash flow generation through working capital management and by prioritizing investments to the highest return growth opportunities. We've also altered our incentive compensation plans for the first time, now incorporating a free cash flow metric.

Please turn to slide 16. As you can see on this slide, we're outlining our key assumptions for establishing our full year 2018 outlook. We expect revenue growth for the full year to be between 3% and 7%. We anticipate inflationary cost and tariff challenges, however, we plan to continue taking price and cost reduction actions throughout fiscal year 2019.

Our two-segment organizational alignment is under way. We've already begun streamlining and simplifying the business and we expect to see benefits beginning to materialize in Q3. Free cash flow is an important metric for us. We are forecasting free cash flow to be greater than 80% of adjusted net income. We do not expect to be a US cash taxpayer in 2019 as we are forecasting the full-year tax expense to be between $12 million and $20 million. As of September 30th, 2018, we had approximately 114 million shares outstanding.

Please turn to slide 17. The capital and projects portion of our business by its nature can experience unexpected deferrals from time to time which may impact quarterly revenues and margins. While this variability may impact results in a quarter, we're confident that the business, as historically shown, will generate long-term incremental growth when viewed over a trailing 12-month basis. We have a seasonal cadence by which we expect to see revenues and adjusted EBITDA improve sequentially throughout the year.

Please turn to slide 18. As you've heard today, we're taking a number of actions to improve the business and to create long-term shareholder value. We believe no other company has the reach, scope, scale, or product range that Evoqua offers. We acknowledge the underperformance to our expectations has been our challenge and not the challenge of fulfilling customer demand.

We continue to deliver to our customers, satisfying their needs at the time that the services and solutions are requested, even though it may not meet the timing or the outlook we originally expected. As we had discussed, the Q4 challenges were primarily driven by the Aquatics product line and municipal segment.

We expect our municipal business to normalize as we progress through 2019. However, we expect to see Q1 challenges from mix, supply chain, and the Aquatics product line. Given these circumstances, we're providing first quarter guidance but intend to return to annual guidance going forward.

In the first half of the year, we will be working through the challenges that impacted our most recent quarter and 2018 performance. We expect to have the impact from the organizational realignment and the Neptune-Benson SAP integration behind us. We will focus on our core business. We anticipate mix impacting our business in the first half of 2019, as lower margin capital projects temporary soften our margins.

The market has been receptive to price increases and we should we gaining momentum as the year progresses. For the second half of the 2019, we expect to see improved service revenues beginning to take hold as well as early benefits from our Water One rollout. We also expect positive benefits from the realignment to begin, both in cost synergies as well as customer sales efficiency.

We're forecasting a normal seasonal pattern to occur with a stronger second half. Free cash flow is expected to improve with a conversion rate greater than 80% while continuing to invest in growth. We currently forecast first quarter total reported revenues to be in the range of $305 million to $320 million, representing growth of approximately 3% to 8%. Adjusted EBITDA is currently projected to be in the range of $34 million to $38 million, representing a decline of approximately 15% to 5% for the reasons previously mentioned.

We currently forecast full-year total reported revenues to be in the range of $1.38 billion to $1.44 billion, representing growth of approximately 3% to 7%. Adjusted EBTIDA is currently projected to be in the range of $220 million to $240 million, representing growth ranging from 2% to 11%.

Please turn to slide 19. Our focus and expectation to achieve four key metrics in the next three to five years remains steadfast. With the organizational changes we are undertaking and our confidence in the business, we expect to extend our market-leading position over this timeframe. We project to grow revenues organically 3% to 5% annually and to achieve a 20% adjusted EBITDA margin.

Our organizational realignment actions, the expected shift mix from capital to more profitable service and aftermarket and our operational execution will be important drivers to profitable growth. Free cash flow will be a significant focus as we balance investing and high return projects and strengthening the capital strategy. We target free cash flow to adjusted net income to be at least 100%.

Finally, we want to deliver and maintain a net leverage position in the range of 2.5 times of adjusted EBITDA to provide the capital strength and capacity to invest and growth the business.

We will now open your call to questions.

Questions and Answers:

Operator

At this time, I would like to remind everyone in order to ask a question, please press * then the number 1 on your telephone keypad. If your question has been answered and you wish to remove yourself from the queue, press the # key. In the interest of time, we do ask that you limit yourself to one question and one follow-up so everyone has a chance to ask their questions.

Your first question comes from the line of Michael Halloran of Baird.

Michael Halloran -- Robert W. Baird & Co. -- Analyst

Good morning, gentlemen. Let's start with a couple guidance questions here. First, on the growth assumed for 2019, could you give some color on how you get to that range? How much of that 3% to 7% up is pricing? How much is acquisition? What is your order book and backlog today saying and how does that frame where that 3% to 7% is?

Ben Stas -- Executive Vice President and Chief Financial Officer

So, we're looking at about -- at this point in time, we're being relatively conservative -- we're looking at 2% to 3% organic. The rest of that would come from price and acquisitions.

Ron Keating -- President and Chief Executive Officer

I would say, Mike, the order book is very good. We have a strong backlog as we go into the year. One of the things we're being cautious on is the timing at which we're projecting some of the business to flow through the quarter, just given some of the past history we've seen.

Michael Halloran -- Robert W. Baird & Co. -- Analyst

Then on the margin side, when you look at some of the cost push you have in the fourth quarter, obviously, they're lingering into the first quarter -- could you try to bucket out some of those costs for us and give us a sense for what those dollar numbers might look like that you're assuming for pressure and how much of this is transitory once you get past the first quarter of next year?

Ron Keating -- President and Chief Executive Officer

One of the things we've discussed in prior calls is when we anticipated getting the cost price mix balance out. We forecasted Q4 to be about $2 million worth of impact on the negative side. It was slightly less than that as we came through the quarter. With the continued challenges on tariffs coming into the last quarter of this calendar year, first quarter of our fiscal year, we're certainly being realistic around what kind of impact we could have as we go into the first half.

We're continuing with price actions. As you guys know, we're on contracts that are annual around a lot of our service applications. We also have some longer lead time projects we deliver to across some of the businesses. It's tougher to get price increases on those if we've already got the orders.

So, as we have progressed through the fiscal year, we'll see continued increases on the pricing that will yield the benefit and offset the material cost increases that we're seeing.

Michael Halloran -- Robert W. Baird & Co. -- Analyst

What about some of the other ones like the supply chain side? Are you including that on the pricing side and some of the aquatics issues?

Ron Keating -- President and Chief Executive Officer

That's being included in that. As we look in the first quarter of the fiscal year completing out the supply chain with the cost increases and just some of the challenges in negotiating component supply back and forth, where we're bringing product in from international locations, certainly China, and in some cases, even delivering projects into China. It's created some delayed negotiations for supply, both from products or components coming in and also products that we're shipping in.

Operator

Your next question comes from the line of Deane Dray of RBC Capital Markets.

Deane Dray -- RBC Capital Markets -- Managing Director

Thank you. Ron, I was hoping you could start with a perspective on the challenges you all have faced and how you've addressed them since going public. I think you've been real transparent on the call, kind of taking us through what are market conditions versus execution issues like the Neptune problems in the ERP.

Take us through where you have been surprised on market conditions and where have you had challenges on the execution. Include forecasting as well because I think that's been kind of a bumpy quarterly process for us. I think it's helpful how you show on an annual basis how smooth, but the quarterly challenges you might face. Start there, please.

Ron Keating -- President and Chief Executive Officer

Sure. Thanks, Deane. It's a good question. Obviously, we've had some challenges as we expect projects to go in certain quarters that they don't necessarily go. It's one reason we continue to show the annual guidance and we also show the LPM charts you see in here.

One of the things that we're doing as we go into 2019 is making sure we're balancing the forecast against the more consistent run rate business without creating the variability around what some of the quarterly larger project shipments do. We're trying to balance that coming into the first half of the year.

We know it's going to go through the fiscal year, but predicting the exact timing has been difficult. It's one reason as we talked about when we first became a public company, we were only giving annual guidance and not quarterly guidance. There can be variability from one quarter to the next against the projects. We've taken some hard lumps on that, as you guys know. We're trying to be very reasonable and realistic in what we're forecasting going forward and lessons learned around execution inside of those.

The other thing that has been a challenge for us this year has been the inflationary cost and the impact it's had on business that is contracted. So, the timing that you can raise your prices and see price realization come through versus the timing of the material cost challenges when it can be a lot more short cycle because we're buying from suppliers and then we're delivering on a long-term contract has been a little bit more difficult for us.

So, we've taken the right actions in being able to address that and addressing it very quickly, but it comes over time. We're taking the actions but those occur as the end of contract comes and we price against the new contract going forward. So, it's really building the timing around that. It's a public company versus what we dealt with as a private company.

Then as we're going forward, we've done 12 acquisitions over the last 18-24 months. We've integrated all of those with the exception of three very successfully. Then the Neptune-Benson one was a challenge for us. It was a larger acquisition, very profitable business. Their ERP system was a paper system that was challenged on the back end. So, changing that over to SAP created a challenge for us in the fourth quarter.

Deane Dray -- RBC Capital Markets -- Managing Director

That's real helpful. Then maybe some comments on the realignment. Intuitively, it makes a lot of sense and certainly, it flows better in terms of capital projects versus services and that alignment makes sense. Why wasn't this addressed before? You had the opportunity when you guys were private. Did that ever come up in terms of an opportunity or was it because Neptune came into the portfolio late and this is something that you came and thought of after that transaction?

Ron Keating -- President and Chief Executive Officer

That's a great question. We've been asked this question a couple of times by different groups. What we had to do -- we started our acquisition pipeline and executing on that in '16, continued that as we went public last year continued through this year. We've created critical mass around our portfolio that we can now align around technology verticals versus market verticals, where it was a little bit of a mess.

We've also seen the opportunities to pull these great technologies into other industries that they may not have been housed in in the municipal business and also industrial with these emerging contaminants in PFAS and PFOA that we were coming in with the right solutions on.

So, being able to do this and align it around the channels to market is cleaning up the organization very effectively and allowing us post acquisitions with critical mass inside of our full technologies to deploy these solutions more globally. We're excited about it. It's going to be fantastic benefit for us in the long run and ultimately, our customers asked us to do it.

That's one of the reasons we did it. They wanted us to make it more simple for them to do business and it's created a great benefit and we're seeing it in the pipeline of the order activities coming through. We're really pleased with what the outlook is.

Operator

Your next question comes from Nathan Johns of Stifel.

Adam Farley -- Stifel Financial Corp. -- Analyst

Hey, good morning. This is Adam Farley on for Nathan. Just following up on Water One -- could you give us a little update on the initial traction you guys are seeing? Is it better, worse, or the same than you guys expected.

Ron Keating -- President and Chief Executive Officer

Absolutely. That's a great question. We launched Water One as an official rollout last month and we were really pleased with the initial response we're getting. Today, we have more than 500 installations spread throughout the US. We had anticipated a 50% take rate. We're seeing around a 70% take rate right now. It's totally dependent on a customer's face in some of the regulatory requirements in the area. But where they have space, there's no regulatory challenges, then we're getting a 90%+ take rate. But we are pleased with the rollout and how it has progressed so far.

Adam Farley -- Stifel Financial Corp. -- Analyst

Great to hear. Shifting thoughts to products -- the launch has been delayed a couple of times. What's the current status of the project and what's your expectation for the shipment of the project? Thanks.

Ron Keating -- President and Chief Executive Officer

The large aquatics project -- it has been delayed and it's been delayed because of jobsite constraints. So, the challenges in getting the jobsite there and ready, as you can imagine, a project that's going to take the amount of water filtration products we're shipping to that area is a very large project. We are not the critical component in the timing of the project being available. We're one of the things that goes in toward the end when they're ready to start filtering water.

So, that's why we've basically taken it out of the first half of the year. We anticipate it will go throughout the year, but we're not putting a specific quarter end but we would expect the back half.

Operator

Your next question comes from Brian Lee of Goldman Sachs.

Brian Lee -- Goldman Sachs -- Analyst

Hey, guys. Good morning. First question I had was just on the guidance cadence here. It sounds like there's a little bit of a difference between the sales cadence and the EBITDA cadence. If you could just walk us through a little bit. It sounded like the impact in fiscal Q1 is going to be relatively minimal from some of the issues that impacted Q4, just looking at the guidance of year on year growth that's implied for the quarter versus what you're seeing for the full year. Is that right?

The second question would be on the EBITDA margin view for '19. It looked flat versus what you reported in '18 but starting off on a much lower base. So, a lot of the pickup is back-half weighted. If you could walk through some of the puts and takes that need to play out for the EBTIDA growth to accelerate in the back half, maybe what the biggest drivers are.

Ron Keating -- President and Chief Executive Officer

Brian, I'll start and then hand it off to Ben. On the first quarter earnings versus the sales guidance, it's really around mix and a continuation of what we discussed in the fourth quarter. It's the supply chain cost increases that were driving through offset by pricing. We anticipate a little bit more challenge on the tariff and the cost side in Q4 or Q1 of our fiscal year or the calendar year.

It's really tied much more to mix, we've got some larger capital projects going out in the first quarter of our fiscal year that have a slight impact, as I discussed in my opening remarks. I'll pass it to Ben for the back half of the comments.

Ben Stas -- Executive Vice President and Chief Financial Officer

We see the previous project investments that we've made with capital pulling through the services and aftermarket in the second half, so mix becomes a positive force in the second half, driven by services. Also, the contributions from Water One and digital conversions as well. Price realization coming through in the second half, mitigating the recent inflationary impacts we've had and the benefits of realignment we should see beginning in Q3 and starting to come through in the second half.

Brian Lee -- Goldman Sachs -- Analyst

Fair enough. That's helpful. My second question around the capital allocation priorities -- I know you guys have stuck to your knitting here, but just wondering if you have any thoughts around a buyback given what the stock has seen in terms of a pullback.

Ben Stas -- Executive Vice President and Chief Financial Officer

At this point in time, we're not contemplating a buy back, but we believe our first priority would be debt reduction, net debt reduction.

Ron Keating -- President and Chief Executive Officer

And growth capital. We want to continue to invest in growth capital as we're going forward.

Operator

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

Pavel Molchanov -- Raymond James -- Managing Director

Thanks for taking the question. Back to the earlier question about the uplift in EBITDA in the course of the year -- what credit are you ascribing in that to alleviation of tariff-related costs or are you assuming it's status quo forever?

Ron Keating -- President and Chief Executive Officer

Yeah, Pavel. What we're anticipating is that our pricing actions take route and start getting on the top side of that in the back half of the year. That's something we discussed, actually, in our prior calls around when we anticipated that to happen potentially in this first quarter. However, with continued tariff challenges and some of the supply chain disruptions we're seeing and longer lead times coming from some of our sub-suppliers, we have pushed that to later in the year that pricing will offset.

Pavel Molchanov -- Raymond James -- Managing Director

Okay. If and when tariffs subside, how would you adjust prices at that point? Would you essentially undo the price increases or would you keep them?

Ron Keating -- President and Chief Executive Officer

The answer is no. As we talked about, on the way up, there's a challenge in cost because what happens is we're on longer-term contracts we bid. On the way down, in a standard environment, we're able to get the price increases passed on to the value we're providing -- again, we're in a unique position supplying our customers with great products and services and we'll continue to hold that.

We think there's a long-term benefit to the business model and way we operate. Plus, a lot of the cost changes that we're making and efficiency opportunities around Water One and the digital connected solutions give us a great long-term upside around margin expansion.

Operator

Your next question comes from the line of Stephen Tusa of J.P. Morgan.

Stephen Tusa -- J.P. Morgan -- Managing Director

Good morning. Can you give some color on the amount of ad-backs to expect in 2019, restructuring and all that other stuff.

Ben Stas -- Executive Vice President and Chief Financial Officer

We've outlined that, Steve, on page 14 of the deck. The majority of that spend will happen -- the cash will roll out over two years, but the actual -- we'll accrue a lot of that expense or at least two-thirds to three-quarters of it this year.

Stephen Tusa -- J.P. Morgan -- Managing Director

That's really the only major add-back? I think there's stock comp as well, those EBTIDA ad-backs. What's the number? Is that basically it, the restructuring?

Ben Stas -- Executive Vice President and Chief Financial Officer

If you want stock comp --

Stephen Tusa -- J.P. Morgan -- Managing Director

A total number is fine, including all that stuff.

Ron Keating -- President and Chief Executive Officer

Right now, we're looking at about $22 million in stock comp.

Stephen Tusa -- J.P. Morgan -- Managing Director

$22 million in stock comp next year. What was the number this year?

Ben Stas -- Executive Vice President and Chief Financial Officer

About $16 million.

Stephen Tusa -- J.P. Morgan -- Managing Director

Why is that going up?

Ben Stas -- Executive Vice President and Chief Financial Officer

We will have some additional benefits for employees associated with further alignment, where they will have the opportunity to purchase shares at a discount. In addition to that, certain portions of the compensation will be aligned, particularly the ELT to stock compensation versus cash-based compensation.

Stephen Tusa -- J.P. Morgan -- Managing Director

Okay. $45 million in total ad-backs, in that range?

Ben Stas -- Executive Vice President and Chief Financial Officer

That would be the range.

Stephen Tusa -- J.P. Morgan -- Managing Director

Just on the flip side, you said no cash, taxes in 2019, so that means your adjusted free cash flow number does assume basically zero cash taxes as well, right? That runs through free cash flow?

Ben Stas -- Executive Vice President and Chief Financial Officer

US cash taxes.

Stephen Tusa -- J.P. Morgan -- Managing Director

Is that something you can have visibility on into 2020 and 2021? How sustainable is that?

Ben Stas -- Executive Vice President and Chief Financial Officer

We have a large amount of NOLs, at this point in time, over 100 million.

Stephen Tusa -- J.P. Morgan -- Managing Director

Okay. Got it. Is there any thought to when you won't be reporting adjusted numbers in the intermediate term? It's a pretty significant percentage of the actual adjusted numbers is the adjustments. Any kind of color on when you guys will go to a more normal way of reporting all this stuff.

Ben Stas -- Executive Vice President and Chief Financial Officer

So, Q4 '20 is when we expect the current restructuring roll off to be completed. In addition to that, depending on M&A and transactions and acquisitions, there will always be some we associate with long-term events, but the majority would be finished by Q4 '20.

Operator

Your next question comes from the line of Andrew Kaplowitz of Citi.

Andrew Kaplowitz -- Citigroup -- Managing Director

Good morning, guys. Ron, I wanted to start on your comments on the convention. I know you've said you've integrated most of your acquisitions well and you're going to do both for a while, but how do you avoid the kind of system integration issues you had in aquatics. Why do you think M&A is still proxy for R&D and CapEx? It does seem to have higher risk for you guys than those organic ways to spend your cash.

Ron Keating -- President and Chief Executive Officer

So, Andy, the one we've had a challenge with was strictly Neptune-Benson. The other ones have gone very well. In the system operation as well as the business operation information, when we're able to buy these sometimes around 5 post-synergy to 7 times. There's a real opportunity to leverage some growth by bringing that product into our product portfolio.

The challenge that we have with Neptune-Benson was more the system they had been operating on and converting into an SAP system, where it was basically a paper process ERP system that was very manual and very challenged as we cut it into SAP. Most of the other acquisitions that we've done -- we've integrated very quickly, taken them into the business. Neptune-Benson was a larger acquisition in a different vertical market than we've historically served.

So, building out our product portfolio in the industrial and product technology side, even with deploying into muni and recreational, is good opportunity because we already have the foundation there we can leverage. It really helps mitigate challenges from acquisitions as we go forward on that.

Andrew Kaplowitz -- Citigroup -- Managing Director

Maybe just a quick one for Ben -- Ben, the restructuring, you said it starts to kick in Q3. Why can't this happen, kick in faster? Is it more fixed capacity takeout? Aren't you consolidating some people? Why wouldn't you get the cost out starting quickly?

Ben Stas -- Executive Vice President and Chief Financial Officer

We certainly don't want to create disruption as we're doing this. We want to be thoughtful, planful, and have appropriate transitions in place as we do this. We made sure as we set expectations in Q3 that we had the time to do this the right way and we don't have any negative impacts associated with customers. We want customers to only see positive impacts as the result of this. We're going to be very thoughtful in terms of how we do this.

Operator

Your next question comes from the line of Andrew Buscaglia of Berenberg.

Andrew Buscaglia -- Berenberg Capital Markets -- Analyst

Just a quick one from me -- with the aquatics push out, what were the factors that influenced that. I'm trying to get my arms around something like that not occurring again elsewhere in your business.

Ron Keating -- President and Chief Executive Officer

The underlying factors on the aquatics push was the large project, the customer didn't have their jobsite ready. We've been anticipating this one to ship for quite some time. When a customer says, "I'm not ready to take those high-value components, then we have to delay." So, it's not something that was without our control.

On the supply chain challenges, there are some critical components that were coming out of China that we had extended lead times to be able to complete products to ship to other projects. What we're doing there is we're going through another supplier or a couple other supplier qualifications that come out of different geographies. So, we've got a balance on this.

Andrew Buscaglia -- Berenberg Capital Markets -- Analyst

And then on your -- 30% of your sales are related to municipal customers. With project-based work, are there any concerns with those types of customers around rising interest rates or in tariffs or any hesitation on their part that could lead to a similar situation?

Ron Keating -- President and Chief Executive Officer

We're not hearing that on municipal. Generally, the municipal projects are longer timeframe and we have milestones we are completing percent of completion against and then a delivery comes at the end. The other thing we're hearing from municipal is we're seeing the pipeline pick up quite a bit against some of the new contaminants that they're challenged with, very much like the common services we're providing to municipalities around PFAS and PFOA. Some of the issues there, we're seeing a pickup in the pipeline on the municipal side.

Operator

Your next question comes from the line of Joe Giordano of Cowen.

Joe Giordano -- Cowen and Company -- Analyst

You touched on R&D earlier. If we're going to be in a situation where M&A slows down, if I look at R&D in gross terms or percentage of sales, it's pretty low this year, is that a number that has to step up in the absence of more material M&A?

Ron Keating -- President and Chief Executive Officer

The R&D is really tied to the product sales. That's what you have to apply it against if you look at a percentage, where you think about our service sales and our integration solutions, what we do is we're technology agnostic, we design, source, and assemble for customers needs and then we service it on the backside. You would take that percentage against the product sales and it's a fairly reasonable percentage when you look at that amount of businesses supporting.

Joe Giordano -- Cowen and Company -- Analyst

When I think through the restructuring savings, can you talk me through the major buckets? What are the major buckets of that?

Ron Keating -- President and Chief Executive Officer

I think what you have on there is the structure and the integration of the businesses, where we have had historically 15 divisions and we're bringing that down around technology platforms into larger divisions with less overhead and less back office. That's where a lot of the opportunity comes from.

The other thing we're able to get out of that is we're able to get economies of scale, where we're creating centers of excellence in our manufacturing, sourcing, and supply chain opportunities across the two businesses.

Then as we look at the footprint of our service facilities where we've had a footprint for municipal, a footprint for light industry, a footprint for heavy industry, there's a real opportunity, then in some of the acquisitions with ProAct and others, we're able to go in and get critical mass. One of the things you guys will see if you're coming on our investor tour next week is we're going to see the Houston location that historically was four different locations in Houston. That's consolidated down to one. Those types of opportunities are tremendous potential for us against savings as we go forward with reorganization.

Joe Giordano -- Cowen and Company -- Analyst

When you think about the guidance today versus full-year guidance for last year, when you're going through your planning, how would you say the conservatism, if there was something you'd say, "Maybe 50-50 we get this," maybe last year you put in the number, this year you -- how would you rate the level of optimism, conservatism into back-half things you have to guess on a little bit more?

Ron Keating -- President and Chief Executive Officer

I would say you balanced it well in how you articulated it. I think as we came forward out of the gate as a public company and we had been rolling on very good opportunities as a private company and the growth that we've shown over the past three years as shown in the presentation, we have to make sure we are much more measured and thoughtful in what we're rolling forward into annual guidance.

Operator

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

Ron Keating -- President and Chief Executive Officer

Thank you all for participating again in the call today. As we discussed through the call, we feel we're uniquely positioned to be the solution provider of choice. I ultimately want to thank the employees inside of Evoqua for their tremendous efforts through 2018 and their dedication as we roll into a very successful 2019. We're proud of the legacy. We're very optimistic about the future and delivering sustainable results in the future and creating great shareholder value. Thank you very much for your time. We look forward to speaking to you again.

Operator

Thank you. That concludes today's Evoqua Water Technologies fourth quarter and full year 2018 earnings conference call. You may now disconnect your lines and have a wonderful day.

Duration: 62 minutes

Call participants:

Dan Brailer -- Vice President of Investor Relations

Ron Keating -- President and Chief Executive Officer

Ben Stas -- Executive Vice President and Chief Financial Officer

Michael Halloran -- Robert W. Baird & Co. -- Analyst

Deane Dray -- RBC Capital Markets -- Managing Director

Adam Farley -- Stifel Financial Corp. -- Analyst

Brian Lee -- Goldman Sachs -- Analyst

Pavel Molchanov -- Raymond James -- Managing Director

Stephen Tusa -- J.P. Morgan -- Managing Director

Andrew Kaplowitz -- Citigroup -- Managing Director

Andrew Buscaglia -- Berenberg Capital Markets -- Analyst

Joe Giordano -- Cowen and Company -- Analyst

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