Evoqua Water Technologies Corp (AQUA) Q4 2021 Earnings Call Transcript

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Evoqua Water Technologies Corp (AQUA)
Q4 2021 Earnings Call
Nov 19, 2021, 4:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Hello, and welcome to the Evoqua Water Technologies Fourth Quarter and Fiscal Year 2021 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded and your participation implies consent on 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, Brittany. Thanks, everyone, for joining us for today's call to review our fourth quarter and full year 2021 financial results. Participating on today's call are Ron Keating, President and Chief Executive Officer; Ben Stas, Executive Vice President and Chief Financial Officer; and Snehal Desai, Executive Vice President and Chief Growth and Sustainability Officer. After our prepared remarks, we will open the call to questions.

This conference call includes forward-looking statements, including first quarter and full fiscal 2022 expectations and statements relating to demand outlook in our end markets, growth opportunities, our order pipeline, our acquisition strategy and pipeline, PFOS and infrastructure-related legislation, supply chain challenges, inflation, general macroeconomic conditions, our goals relating to our own greenhouse gas emissions and water reuse and statements related to the ongoing impact of the COVID-19 pandemic. Actual results may differ materially from expectations. For additional information on Evoqua, please refer to the company's SEC filings, including the risk factors described therein.

On this conference call, we'll also discuss certain non-GAAP financial measures. Information with respect to such non-GAAP financial measures is included in the appendix of the presentation, which can be obtained at Evoqua's Investor Relations website.

Unless otherwise specified, references on this call to full year measures or to a year refer to our fiscal year, which ends on September 30. Means to access this conference call via webcast were disclosed in the press release, which was posted on our Investor Relations website. Replays of this conference call will be archived and available for the next 14 days.

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

Ron C. Keating -- President and Chief Executive Officer

Thank you, Dan, and thank you all for joining us. I appreciate your interest in Evoqua, and I'm happy to give our overall highlights. As Dan mentioned, I'm joined by Ben Stas, our CFO, who regularly participates on these calls. And today, I'm also pleased to have Snehal Desai, our Chief Growth and Sustainability Officer, join me. Snehal will discuss some highlights on the PFOS landscape and our progress on sustainability. With that, we'll get started.

Please turn to Slide 3. We closed a very solid year with a strong fourth quarter performance. Market demand continues to be robust as customers are increasingly turning to Evoqua solutions to solve their most complex water challenges. On today's call, you'll hear how we're investing in technology, product innovation and sustainability initiatives. We'll also talk about the upcoming year and why we're pleased with our position, the long-term growth opportunities and our expectations to create significant shareholder value.

In Q4, we had a very strong broad-based organic revenue growth across both segments, and our book-to-bill ratio was north of one. Price/cost was positive for the quarter despite ongoing inflationary pressures on materials and freight. Supply chain constraints are impacting visibility and availability. But to-date, we have successfully navigated through a very dynamic period. I would like to thank our supply chain teams for an outstanding performance.

Our working capital performance and cash flow showed additional improvement as did our overall balance sheet strength. Our net leverage ratio came in at 2.5 times, which is at the low end of our targeted range. Our M&A pipeline is quite active, and we expect to supplement our organic growth initiatives over the coming year.

Please turn to Slide 4. I wanted to take a moment and highlight these six key financial metrics that reflect the progress the team has made over the past four years as a public company. As a customer-centric, innovation-driven company, we are focused on profitable growth and a strong balance sheet, allowing us to better serve our end markets. We've seen excellent improvement across our results even through the pandemic, and we're continuing to invest to serve our strong and growing market more effectively. We are well-positioned to tackle complex water challenges while delivering sustainable solutions that our customers value as evidenced by our growing backlog.

Please turn to Slide 5. This chart represents Evoqua's first quarter order expectations by end market relative to the prior year's first quarter. We continue to see growth across most of our end markets. Three end markets, chemical processing, municipal drinking water and refining marine showed neutral to slight declines in expected demand due to challenging prior year comps. Overall, we expect market demand to remain quite strong throughout the 2022 fiscal year. We'll be happy to address questions about specific end market drivers during the Q&A section.

Please turn to Slide 6. During our calls this year, we plan to select an end market and provide insight into the solutions we provide and why it is important. Macro electronics is one of our core vertical markets and is an attractive end market with growing demand across many geographies. We support multiple applications in microelectronics that utilize ultrapure process water and increasingly, wastewater treatment and printed circuit board and chip manufacturing. Sustainability continues to take a prominent role for the semiconductor companies. And as they look to use, reclaim and recycle water, they are partnering more closely with Evoqua.

We provide multiple offerings to the semiconductor manufacturers as well as the upstream suppliers through both ISS and APT. ISS focuses on selling integrated process and wastewater solutions, while APT sells products, components and technologies for printed circuit board ultrapure process water requirements. Our Ionpure brand is a leading-edge technology for the industry. And in a few minutes, Ben will provide insight into new innovations with the announcement of Ionpure Ultra.

Please turn to Slide 7. This represents our quarterly revenue and adjusted EBITDA on a rolling 12-month basis since 2017, highlighting the resiliency of our business. Our overall revenues have grown at a compounded annual rate of 5%, with adjusted EBITDA growth over 8% during this time. Currently, our service business comprises 41% of our trailing 12-month revenues, while service and aftermarket combined make up approximately 60% of our business.

Please turn to Slide 8. Evoqua celebrates the passage of the Infrastructure Investment and Jobs Act and the $55 billion in funding that it makes available for clean water. This legislation is historic in size, marking the single largest investment in water infrastructure that the federal government has ever made. This funding will be used for modernizing water infrastructure, replacing lead service lines and in addressing emerging contaminants, namely PFAS, in our water system. In addition, the final bill requires the EPA to set maximum contaminant levels for PFOA and PFOS in drinking water within two years of enactment.

I would now like to turn the call over to Snehal to discuss the PFAS road map and Evoqua progress related to sustainability.

Snehal A. Desai -- Executive Vice President, Chief Growth Officer

Thanks, Ron. Please turn to Slide 9. The U.S. EPA recently announced its PFAS strategic road map, which presents the Biden administration's all of agency plan for regulating and progressing PFAS related actions over the next three years. This road map includes some important time lines around planned regulations, namely the establishment of a national primary drinking water regulation for PFOA and PFOS and the designation of certain PFAS as CERCLA hazardous substances by 2023. The full road map is available on the EPA's website.

As Ron previously noted, the infrastructure bill requires the EPA to regulate PFOA and PFOS and drinking water within two years. This requirement matches and further solidifies the time lines included in this recently announced road map.

Please turn to Slide 10. In lieu of a federal regulation for PFOS, a patchwork of state-based standards is formed nationwide. As you can see on the right-hand side of this slide, these standards and regulations very widely state-to-state based on numerous variables, including the number of regulated PFOS chemicals as well as the enforceable concentration level. Despite the federal regulation pending for an expected effective date of 2023, many states continue to develop state-based regulations. For example, following this federal EPA's announcement of their PFOS strategic road map, Washington State Department of Ecology announced their decision to list PFOS compounds as hazardous substances under the state cleanup law, The Model Toxics Control Act. This follows the Washington Department of Health August 2021 proposed rule to set state action levels for five PFAS compounds in drinking water.

Evoqua's emerging contaminant program continues to support our core sustainability value by helping our customers with their sustainability goals related to clean water. In addition, Evoca continues to invest in treatability assessment and technology pilot testing for our customers, which I will discuss in more detail.

Please turn to Slide 11. We are pleased to announce environmental footprint goals on climate action and water reuse. In an effort to reduce our greenhouse gas emissions, we plan to set science-based targets by 2023. This is an important step on our journey toward reaching our goal of net zero greenhouse gas emissions by 2050. We will set science-based reduction targets in line with the Paris Agreement's 1.5-degree C pathway to prevent the worst effects of climate change.

As a water technology company that plays a key role in helping our customers build sustainable water systems, we're also committed to driving water reuse internally. By 2035, we aim to reuse more water than we withdraw from source. To do this, we will create water management plans for our facilities to increase efficiency in their water usage and implement additional water recycling and reuse initiatives. Water is our business, so we will use many of our own solutions and expertise in our effort to achieve this goal.

In line with our commitment to sustainability, we have also implemented a few changes to our compensation structure to further integrate sustainability into our strategy. Our fiscal year 2022 annual incentive program will include safety performance and water reuse targets, each weighted at 5% in order to align our incentives with our sustainability objectives.

Evoqua is committed to driving a technology driven, customer-centric culture, along with a broad portfolio of sustainable water treatment products and solutions. We're investing in our commercial organizations and leveraging business development strategies across customer vertical markets to drive profitable revenue growth. Digital optimization of these solutions will be a central component of this strategy.

In October, we opened our sustainability and innovation hub in Pittsburgh that will help us accelerate our ability to develop innovative and sustainable water treatment technologies. We have the capability to perform pilot testing, training and demonstrations of real-world applications in collaboration with strategic partners. We are very pleased to have this state-of-the-art facility now open.

Please turn to Slide 12. Our business model is to transform water and enrich life each and every day. We have highlighted two customer handprint wins featuring APT and ISS solutions. In Singapore, we're providing APT component technology for an aquaculture farm to filter and disinfect raw seawater to improve water conditions and support fish health. APT is providing the equipment, remote monitoring and preventative maintenance over the life of the contract. The customer avoids additional capex cost for the solution, and this allows them to focus on their core business. Our water purification system will help the customers fish farm produce an expected 350 tons of sea bass and red snapper annually.

For the second win, Evoqua has significant experience in wastewater technologies, and we are responding to a broad and growing number of treatment system opportunities. Renewable natural gas demand is growing, and we believe we are positioned to respond with our ADI anaerobic digestion technology. Evoqua's technical expertise and core competencies were key components in delivering the solution that allowed the customer to reach their requirement of minimum liquid discharge. This facility will generate an attractive ROI for the customer, saving them approximately $1 million annually.

I would like to turn it over to Ben.

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Thank you, Snehal. Please turn to Slide 13. For the fourth quarter, reported revenues were up 11% to approximately $426 million. Organic revenues grew 9.5%, with both segments contributing to growth. Service capital and aftermarket revenues grew, supported by pricing initiatives across all offerings. We also saw all regions growing revenues versus the prior year.

Fourth quarter adjusted EBITDA increased 8.3% to $81.9 million for an overall margin of 19.2%. Price/cost and product mix improved profitability. Price/cost was favorable for the quarter by approximately $2 million. Increased service volume benefited margin expansion, but was offset by higher material costs, freight and operational variances and higher operating expenses from labor inflation and travel.

Please turn to Slide 14. For the full year, reported revenues were up 2.4% to $1.46 billion. Organic revenues were up 1.6%, driven by higher capital sales in the APAC and EMEA regions, higher service volume and favorable price realization. Capital revenues were lower primarily due to the timing of prior year projects in the microelectronics end market and sales in the Americas due to customer site access challenges. Foreign exchange contributed 1.3% to revenue growth. Full year adjusted EBITDA increased 4.7% to $250.9 million. Favorable price/cost and cost reductions contributed to the increase, while partly offset by higher labor inflation and travel.

Please turn to Slide 15. Our Integrated Solutions and Services segment, fourth quarter revenues were up 12.8% to approximately $281 million. Organic revenues grew 11.5% over the prior year. Favorable price realization and higher volumes across capital, service and aftermarket drove the improvement over the prior year.

Our digital strategy continues to make solid progress. Revenues were up approximately 15% in the quarter and for the full year. Adjusted EBITDA increased 16.9% to $71 million due to higher volume, favorable price/cost mix and productivity improvement. Adjusted EBITDA margin for the quarter was 25%, up 80 basis points from the prior year.

Please turn to Slide 16. We continue to see strong year-over-year growth in ISS backlog. Overall backlog was up $107 million or 17% over FY '20, with a significant percentage of that growth coming from both capital and outsourced water orders across multiple markets, including microelectronics, power, marine and pharma. Our pipeline continues to be robust with both service and capital projects. We expect to see our book-to-bill ratio remain above one throughout fiscal 2022. We did an outstanding job of increasing backlog in light of booking our largest ever order in the fourth quarter of FY '20.

In late September, we placed a presentation on our Investor Relations website entitled Deep Dive into Outsourced Water and Digital Enablement Transformation. I encourage you to take a look at this instructional presentation that will help you understand important drivers to ISS backlog.

Please turn to Slide 17. Applied Product Technologies fourth quarter revenues were $145 million, up 7.6%. Organic revenues increased $7.8 million or 5.8%, driven by favorable pricing and mix. Revenues grew across all regions. Foreign currency positively impacted revenues approximately 1.8%.

Adjusted EBITDA for the quarter increased 1.2% to approximately $33 million. Adjusted EBITDA margin decreased 140 basis points to 22.9%. Operational variances resulting from supply chain challenges, including warranty reserves and production variances, impacted adjusted EBITDA margins in addition to higher labor inflation. Price/cost and strong revenue volume favorably impacted profitability.

Please turn to Slide 18. One of APT's long-term organic growth initiative is to develop new offerings that further our portfolio of sustainable products and to pursue market share gains in core markets. Each quarter, we have been featuring a new APT product innovation, and we are pleased to highlight the VNX Ultra. The VNX Ultra builds on our well-established Ionpure product line to deliver a more efficient solution to supply ultrapure water. Specifically targeted for the growing microelectronics market, the VNX Ultra reduces complexity by achieving a higher quality water in a single pass versus a traditional double pass process. The module reduces the need for mixed media ion exchange resin, simplifying operations while ensuring over 99.9% removal of constituents such as Boron, which reduces semiconductor yields.

Please turn to Slide 19. Capital spending, primarily for outsourced water orders was approximately $21 million for the quarter and $75 million for the full year or approximately 5.1% of revenues. Fourth quarter net working capital was 10.3% of LTM sales, an improvement of 220 basis points over the prior year and a 200 basis points sequential improvement from Q3.

Since 2019, we have improved net working capital to LTM sales by approximately 600 basis points. I would like to thank our Evoqua team for the outstanding performance in managing working capital.

Over the long term, we anticipate net working capital to sales could now be in the low-teens versus the previous mid-teens expectation, given some projects may have varying amounts of working capital requirements.

Please turn to Slide 20. Operating cash flow was $179 million FY '21 versus $177 million in the prior year. We continue to maintain a strong focus on cash generation. Adjusted free cash flow as a percentage of adjusted net income continues to be well above our 100% conversion goal at 181% for FY '21. This is the third consecutive year of cash flow conversion above 100% and the fourth consecutive year of increasing annual operating cash flows.

We have significantly strengthened our balance sheet throughout the pandemic. We now have $449 million of liquidity, an improvement of $144 million over the prior year. Our net leverage ratio finished at 2.5 times adjusted EBITDA. We have reduced net leverage by 1.3 turns and have reduced our net debt by approximately $260 million over the past 2 fiscal years. We are now at the low-end of our targeted leverage range of 2.5 times to 3.0 times. As Ron mentioned, we have an active M&A pipeline and the financial strength and flexibility to fund organic and inorganic growth strategies. Our weighted average cost of debt for the fourth quarter is approximately 2.7%, an improvement of approximately 70 basis points over the prior year. The year-over-year reduction is driven by a combination of reduced debt levels, lower rates and a shift of debt to lower cost facilities. We've reduced our annual cash interest expense to $26.5 million in FY '21, a reduction of $12 million from the prior year and a reduction of $26 million from FY '19.

Please turn to Slide 21. Two key long-term financial targets are 3% to 5% organic revenues growth as well as 20% adjusted EBITDA margin. This graph shows our performance since 2018 for both metrics. As you can see, our annual organic revenues and adjusted EBITDA margin have grown throughout the pandemic. We have a business model that has proven its resilience in a very turbulent period, and we believe we have significant opportunities for long-term growth. We have highlighted some of the revenue growth opportunities as well as levers we expect will help us achieve our adjusted EBITDA margin target.

We have high expectations as we look to the future. The world is facing acute challenges related to clean and available water. These problems are expected to intensify as climate change will undoubtedly compel the water industry to accelerate innovation and create additional treatment capacity. The investments we have made in our people, technology, footprint and operating capabilities have positioned Evoqua to help make the world a more green, healthier and safer place to live.

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

Ron C. Keating -- President and Chief Executive Officer

Thank you, Ben. Please turn to Slide 22. As we look to our new fiscal year, we are working to align our outlook across many favorable tailwinds while managing the market uncertainties. As previously mentioned, we expect to see continued broad-based demand and building momentum across the majority of our end markets.

Our ESG journey is accelerating, which is in part driving our pipeline of capital and outsourced water opportunities. Regulatory changes at the federal, state and local level, and the recent passage of the infrastructure build should also provide a favorable backdrop. Supply chain disruptions and labor availability are expected to limit visibility for the year and may cause some order conversion timing delays. Increased material and freight inflation pressures are expected to remain. We have provided key assumptions for our full year outlook on Slide 26 in the appendix.

Please turn to Slide 23. In closing, we are very pleased with the performance of the business in the quarter and for the full year. Our pipeline remains robust as demand is strong across most of our end markets. Supply chain constraints and inflationary pressures remain as we look to the New Year and beyond. We have navigated these choppy waters to date, and we have become a stronger and more resilient organization as we respond to and manage these challenges.

The management team is focused on driving profitable growth, and our balance sheet has never been stronger. We're investing in inorganic revenue drivers, margin expansion initiatives and also expect to execute on identified accretive acquisition opportunities.

For the full year, we are giving balanced expectations for revenue and adjusted EBITDA to be in the range of $1.50 billion to $1.58 billion and $255 million to $275 million, respectively. For the first quarter, we expect revenues and adjusted EBITDA to be aligned with traditionally seasonal experiences over the past 2 years. We have provided a summary of quarterly revenues and adjusted EBITDA from 2018 to 2021 on Slide 27 in the appendix.

I will now open the call for questions.

Questions and Answers:

Operator

[Operator Instructions] And we will take our first question from Deane Dray with RBC Capital Markets.

Deane Dray -- RBC Capital Markets -- Analyst

Thank you. Good morning, everyone, and nice, strong finish to the year.

Ron C. Keating -- President and Chief Executive Officer

Good morning. Thanks, Deane.

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Thanks, Deane.

Deane Dray -- RBC Capital Markets -- Analyst

Since we have Sne on the line today as well, first question on PFAS. And I appreciate coming in the past couple of years, we've seen all kinds of opportunity for Evoqua to address your customer PFAS issues. You've always kept commentary quite measured. And so now with the passage of the infrastructure bill, with money earmarked specifically for PFAS, how do you see this translating into your sales line? Will it be a state-by-state basis? Will -- what might the timing be? Are there projects that still need to be scoped? Because it really -- this is all now coming together nicely. You're already positioned here. You said you have enough capacity, but now there's funding. So how does this translate into a P&L opportunity? Thanks.

Snehal A. Desai -- Executive Vice President, Chief Growth Officer

Thanks for the question, Deane. And actually, as I was stating inside the commentary, it's been very positive to see that the new infrastructure bill actually called out specifically funding for PFAS. But we've seen state-by-state progress going on over the last couple of years. And given the two-year time line that the EPA has for setting these limits, I think that really where we're getting to right now as we continue to see some work at the state level. But frankly, they're going to be still waiting to see what those limits are.

So where there are an acute challenges, we continue to see opportunity in our pipeline. And actually, this signal now that money will start to flow. We'll start to give everybody the encouragement to start their engineering work and really start to focus on deployment. But we're still looking at minimum two years out, obviously, with those MCLs, but more of the action in the three- to five-year period.

Deane Dray -- RBC Capital Markets -- Analyst

Great. And then just as a follow-up, Sne, are there any technology gaps? Right now, from our perspective, you have all the core technologies to address remediation of PFAS, but it's an active area, a lot of innovation. Do you have all the right technologies? And then I've got a follow-up for Ben. Just on free cash flow, just outstanding year at 100 -- over 180% conversion. Any commentary about 2022 guidance on a free cash flow basis, especially on the work you've done in working capital sales?

Snehal A. Desai -- Executive Vice President, Chief Growth Officer

Yes. Let me start that off there. And just to your question on how do we sit with solutions. We are -- and continue to be well-positioned with the solutions set here, both with our assortment and carbon technologies. But frankly, all of the solutions that we are seeing deployed in the market.

I think the other thing to point out is, number one, with the moving landscape, we've had more customers talk to us about mobile solutions, solutions that can actually be transitioned as the limits change. So that's actually emerging. And then just as I pointed out in the commentary, the opening of our sustainability innovation hub allows us to continue to keep a finger on the pulse of some new and emerging technologies. Because as you can imagine, with our suite of solutions and our proximity to customers, many of these new types of treatment technology companies are coming our way. So we're working and checking those out as well.

So I think we're well-positioned as we are today, but we are more than capable to expand our solution set as they come forward. So I think we're in good shape.

Ron C. Keating -- President and Chief Executive Officer

And Deane, this is Ron. Just one comment to that, as Sne highlighted, we've invested heavily in our mobile fleet over the last couple of years. So being able to respond and react very quickly to individual application challenges that customers are having, we can do. And then as MCLs are set over the next two years and the treatment standard is well known, we can then define the permanent solution to going.

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

And on case, Deane, we feel very strong about being able to stay into the 100%-plus range on conversion. We've lowered our working capital expectations from mid to low teens as a result of the work we've done. So we feel good about being able to potentially exceed that 100% goal in 2022. I think the thing we have to keep our eye on is inflationary pressures and how that impacts inventory. In addition to various types of supply chain constraints in which we'll be holding some safety stock. But expect another strong year in free cash flow conversion in 2022.

Deane Dray -- RBC Capital Markets -- Analyst

Appreciate all the color. Thank you.

Operator

And we will take our next question from Nathan Jones with Stifel.

Nathan Jones -- Stifel -- Analyst

Good morning, everyone.

Ron C. Keating -- President and Chief Executive Officer

Good morning, Nathan.

Nathan Jones -- Stifel -- Analyst

I just wanted to start off on some of the commentary around APT that you had in this slide. Talking about operational variances, supply chain challenges, project variances that hurt APT margins. And I think we can see that in the decline we've seen in the incremental margins here over the last couple of quarters. So just hoping that you can talk a little bit more about what's going on there, what the strategies are to get around it. And it looks like from the incrementals in 2022 that you're kind of assuming that did some of those challenges are going to persist at least for part of the year.

Ron C. Keating -- President and Chief Executive Officer

Yes. So Nathan, I'll start, and then I'll give it to Ben for a little more color. On the APT side, if you'll remember, that's our most global business. So in that, we're dealing with supply chain challenges around shipping, around logistics, just being able to move the materials as efficiently as we've highlighted, labor and freight challenges and constraints that we dealt with.

The team has done an outstanding job of being able to manage through, making sure they have the right inventory at the right locations, and they're able to meet customer demand. So we're continuing to meet our customer demand, make sure that we are satisfying the needs of the market. They're just -- as you do that in the kind of environment we're dealing with now, there's a little bit of cost pressure that we're dealing with. But the margins in APT, as you know, over the past couple of years have really improved significantly, and we anticipate that to get back on track inside of '22.

But Ben, do you have comments?

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Yes. And no question about it. We are experiencing some transitory supply chain challenges, particularly with some of our suppliers and alternative suppliers that the team has been effectively dealing with. It's -- this segment is hyper-focused on quality and making sure that we are always have pristine quality to our customers. And as our -- some of our suppliers have been reopening, we have experienced some challenges in those areas. Again, we expect it to be transitory, and we've put a lot of programs in place to review and inspect on supplier quality to make sure that we transition out of these challenges quickly and efficiently.

Nathan Jones -- Stifel -- Analyst

And as they as are embedded in the guidance, it's for at least a few quarters here?

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Yes.

Ron C. Keating -- President and Chief Executive Officer

Yes. We may be able build on that and do better. But at this point in time, we have factored in that into the guide.

Nathan Jones -- Stifel -- Analyst

Understood and the responsible way to go about it. I wanted to talk about strategic pricing a little bit. You guys have been talking about strategic value-based pricing as a lever to improve margins. Maybe you can just talk a little bit about what progress that you've made on that initiative. Your price/cost positive in 2021? And should we expect to see value pricing start to have a positive impact on the margin profile once we get through all of this noise from COVID induced supply chain challenges.

Ron C. Keating -- President and Chief Executive Officer

Yes. Nathan thanks for the question on that. We've made great progress on this. In fact, we have put a lot of effort, a lot of initiatives around the pricing and price realization, getting the market-based pricing versus cost plus. And it's proving out very well.

I would say that if we weren't experiencing a little bit of the hyperinflation that we're dealing with around not only component cost of labor and freight inflation, we would see that falling through already. But we're trying to be very balanced in the guidance that we're giving for fiscal '22. I do absolutely believe that we're making great progress on this. We've got the right programs in place and the right investment and the tools for the team to be able to execute on this as a long-term strategy for margin enhancement going forward.

Nathan Jones -- Stifel -- Analyst

Great. Thanks for taking my questions.

Ron C. Keating -- President and Chief Executive Officer

Thank you.

Operator

And we will take our next question from Mike Halloran with Baird.

Mike Halloran -- Baird -- Analyst

Good morning, everyone.

Ron C. Keating -- President and Chief Executive Officer

Good morning, Mike.

Mike Halloran -- Baird -- Analyst

So first question, just I think kind of a follow-up to Deane's comment on the free cash flow side. Obviously, strong free cash flow toward the 2.5 times leverage, which is at the low-end of your target range. Any thoughts to a change in the philosophy and capital deployment? Or how are you thinking about what the M&A opportunity set looks like out there today and how actionable?

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

I don't think we're going to change our priorities. They'll remain the same, but we're probably going to -- we will potentially accelerate the growth element of that priority, both organic as well as inorganic. And we have, obviously, a great opportunity pipeline on both fronts. And so the cash deployment will be very much focused on the growth sides we had in the 2022.

Ron C. Keating -- President and Chief Executive Officer

Yes, Mike, we're going to continue to focus on the M&A pipeline that we have around tuck-ins that make the most sense. Service tuck-ins, product line, portfolio expansion, where we have gaps, and we've got a robust pipeline that we expect to utilize some of the capital deployment.

Mike Halloran -- Baird -- Analyst

And then at a high level, we've talked for a while here about the jump-off point into next year with some of the model conversion that's happening with how the backlog is translating a leading to repeat of the service revenue. Just taking a step back, do you still feel the same about we're at that inflection point? And if you think about it a little bit on a longer horizon, how do you see this cadencing playing out to get some level of normalization? Or maybe a better way to put it is, can you just put how this backlog conversion is -- put the backlog conversion concepts into context and kind of lay out how that looks as we start in New Year here.

Snehal A. Desai -- Executive Vice President, Chief Growth Officer

Yes. So as I mentioned on the call, we have a teach -- and available on our website. It really highlights a lot of that for investors. So encourage you might take a look at that. But you're still going to see -- as we book these large, outsourced water orders that, that backlog will convert over time. That will improve our cash flow. That will improve our mix and our profitability. And we'll continue to see more of a conversion into the outsourced water model over time. So -- but it's not going to be a rapid conversion. It's going to -- our sales mix will convert over a longer period of time.

Ron C. Keating -- President and Chief Executive Officer

And Mike, on the outflows on Page 16, as we've highlighted where the revenue conversion timing, we still see that model holding.

Mike Halloran -- Baird -- Analyst

Great. Well, thanks. I have seen the presentations. It's a good deck. Appreciate it.

Ron C. Keating -- President and Chief Executive Officer

Right. Thank you.

Operator

And we will take our next question from Bryan Blair with Oppenheimer.

Bryan Blair -- Oppenheimer -- Analyst

Thanks. Good morning, everyone.

Ron C. Keating -- President and Chief Executive Officer

Good morning.

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Good morning, Bryan.

Bryan Blair -- Oppenheimer -- Analyst

So to follow-up on Mike's question, I guess to ask a little more directly. What's factored in or contemplated in your guide in terms of the net impacts of your increasing service base from prior installations versus the somewhat muted economics of year one of new wins in outsourced water. Understanding that the latter factors into the former and in future economics?

Ron C. Keating -- President and Chief Executive Officer

Yes, we factored in what you see on Page 16, that trajectory and assume that trajectory would continue. And again, we provided more detail in the teach-in. And -- but basically, we've looked at the past -- looked at the trajectory puts slight accelerations in there to outsource water and factor that into our guidance.

Bryan Blair -- Oppenheimer -- Analyst

Okay. Understood. And then maybe offer a little more color on order progression into fiscal '22 and the key considerations for the year. We obviously of your end market slides and you provided some good commentary, all of which was appreciated. Just wondering how your team is thinking about the end markets and applications where you're most confident in continued strength throughout the year versus some watch areas as fiscal '22 progresses?

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Yes. So Brian, again, that is what we highlight on Page 5. And generally, what we do is we highlight 1 quarter out. But you can look in the appendix we've got the history that it shows by end market for what's happened. What we would anticipate is the markets that I highlighted in my comments around chemical processing, municipal drinking refining marine turning to green as we go through the year, our expectation is we're going to have nice growth across all of the end markets, the one that still is a question to us and continues to be a bit of a challenged market as the large-scale aquatics business. That's water parks, that's theme parts, etc. So the investment in that still in a COVID environment has been a little slower than we would see historically, but we do anticipate that normalizes over time.

Bryan Blair -- Oppenheimer -- Analyst

Okay. Appreciate all the color.

Operator

And we will take our next question from Andy Kaplowitz with Citigroup. Your line is now open.

Andy Kaplowitz -- Citigroup -- Analyst

Hey, good morning, guys.

Ron C. Keating -- President and Chief Executive Officer

Hey, Andy.

Andy Kaplowitz -- Citigroup -- Analyst

So Ron or Ben, you mentioned to expect normal seasonality in Q1, which I guess I'm a little surprised by, as most industrial companies are expecting some supply chain easing over the course of the year. So is implicit in that assumption of normal Q1 seasonality you're expecting to see supply chain challenges last basically the entire year. And as we sit here today, are you seeing supply chain challenges still get worse for you? Or have they started to level off at this point?

Ron C. Keating -- President and Chief Executive Officer

Yes. We've kind of seen them level off, Andy. That's why we're forecasting and giving kind of the normal ratios that we've historically seen. They've leveled off. We've been able to manage it, as I highlighted, even on the chart around us really managing the uncertainties in the market around labor, around component supply, also around freight. And we factored most of that into -- we certainly factored it all into the guidance, but we've also factored it into the pricing actions that we've taken in the market. So we feel like we're in a good position as this year goes, even with the challenged supply chain markets to be able to deliver against our normal curve.

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

And so the way to think about it is the upper end of our guide assumes we're conservative in our supply chain assumptions. If things are better, I think the upper end of the guide becomes more realistic, but we also did not want to put our heads in the sand with regards to the challenges that we see out there and the uncertainty. And so we tried to factor that into the midpoint of our guidance.

Andy Kaplowitz -- Citigroup -- Analyst

Very helpful, guys. And then I know you've given us sort of the end market bubbles. But maybe if we could just look -- if you look at your capital backlog growth, it really accelerated in the second half of the year. I think you talked last quarter about seeing a big uptick in microelectronic orders. So did that continue? Is that a big reason for Q4 backlog growth? Or are you really just seeing it across the board now, customers starting to feel better about getting through the pandemic industrial companies are pretty strong and their outlook for '22? I mean, what are you seeing?

Ron C. Keating -- President and Chief Executive Officer

Yes. So we did see, as we highlighted in the last call, good response for microelectronics. But what we're seeing is much more across the board at this point. And we're seeing some robust capital demand coming in across that ISS slide, as you can see on there in the growth. And it's pretty well split across the end markets that are showing as green.

Andy Kaplowitz -- Citigroup -- Analyst

Appreciate it, guys.

Ron C. Keating -- President and Chief Executive Officer

Thank you.

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Thanks, Andy.

Operator

And we will take our next question from Andrew Buscaglia with Berenberg.

Andrew Buscaglia -- Berenberg -- Analyst

Hey, good morning, guys.

Ron C. Keating -- President and Chief Executive Officer

Good morning.

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Good morning, Andrew.

Andrew Buscaglia -- Berenberg -- Analyst

I was wondering, ISS, you're going to see -- presumably, that business is going to get a little bit more service-intensive as that backlog converts. I'm wondering how much with labor being a challenge, broadly how much that affects you? Is this something you need to get ahead of and hire ahead of this anticipation of, I guess, being -- having to service more customers more intensively over the next couple of years?

Ron C. Keating -- President and Chief Executive Officer

Yes, Andrew, there's a few things that we're doing. We are kind of constantly watching the labor pool, watching our service tech pool and making sure that we have a good pipeline of team members and talent coming through. But we're also changing our business model, as we've highlighted. We're investing much more in digital solutions and being able to be on site 24x7 with customers without actually having to be there. So when we're able to deploy or we deploy our service techs and our service team, they're are going in to fix exactly what needs to be repaired or needs to be adjusted. And so in doing that, we're gaining great efficiencies out of that labor pool and out of our service tech.

We're going to continue to invest in that and continue to drive that. And that's one of the things we talk about on that teach-in is how much is going to digital and what the opportunities look like. So it's a little bit of a change in the model as well as it is making sure that we are constantly keeping a good pipeline of service teams and members and service techs coming through.

Andrew Buscaglia -- Berenberg -- Analyst

Okay. And can you help us out on free cash flow a bit? I mean, you're obviously very strong in 2021. You're mind going through with the puts and takes. I kind of mentioned that would repeat again in 2022. Are there anything -- is there anything going away that will be a net headwind or anything to think about the puts and takes into next year?

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Yes. I think we've focused a lot of areas, particularly shared services in a much more efficient cash conversion cycle. So those things will stick, and we will continue to get benefits from all the work in that area.

On the headwind side, again, higher inflation cost, supply chain availability, puts pressure on inventory. The other key area is mix that is a bit of an uncertainty. As capital business comes in, we've been doing a really good job on getting cash upfront on capital projects. But some projects have different levels of working capital requirement. And so that puts a potential for some unknowns with regards to the types of mix they're going to come in capital. But overall, we still feel very good about free cash flow in 2022, but we've got to keep our eye on inflationary pressures that could impact free cash flow.

Andrew Buscaglia -- Berenberg -- Analyst

All right. Thank you.

Operator

And we will take our next question from John Walsh with Credit Suisse. Your line is now open.

John Walsh -- Credit Suisse -- Analyst

Hi. Good morning.

Ron C. Keating -- President and Chief Executive Officer

Good morning, John.

John Walsh -- Credit Suisse -- Analyst

I just wanted to circle back to Andy's question around supply chain. So I think the six to 12 months, you highlighted that's, I'll say a little bit more cautious. Maybe you'd use the term conservative. But I just want to make sure that, that's macro-driven and that there isn't something specific to your business or water markets as it relates to labor availability or a certain type of component or material that we might be missing?

Ron C. Keating -- President and Chief Executive Officer

John, that is purely macro-driven. I mean, we're just looking at the overall labor markets. We're looking at the component supply around different geographies and frankly, just freight inflation. So we're being very balanced in the guidance we're giving around macro challenges.

John Walsh -- Credit Suisse -- Analyst

Great. And then maybe just a question for Ben here. So you obviously talked about that Q1 seasonality, but is there any finer point you'd like to give or provide just thinking about H1 versus H2 or anything as we should think about orders ramping through the years or costs or anything just as we're doing our model to highlight?

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Yes. So on Page 27 of the webcast in the appendix, we did provide our historic quarterly seasonality. I think for FY '22, '21 at this point feels about right and use that as a model for -- as you think about 2022. That's subject to change. The business has quarterly variability, as we've discussed in the past, but cutting wood and axe, I think that works out OK.

I think the second half, who knows at this point in time when supply chain could be better, could it be worse. We'll get to that -- when we get to that. But for now, I would use that as a model.

John Walsh -- Credit Suisse -- Analyst

Great. Appreciate it. Thank you for taking the questions.

Ron C. Keating -- President and Chief Executive Officer

Thanks, John.

Operator

And we will take our next question from Saree Boroditsky with Jefferies. Your line is now open.

Saree Boroditsky -- Jefferies -- Analyst

Thanks for fitting me in. So you talked about the potential for order conversions to be pushed out as part of your guidance. Is this being pushed from 1Q to 2Q? Or do you think that revenues actually get pushed out into 2023? And is this a supply chain issue? Or you're actually seeing customers delaying deliveries?

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Yes. So Saree, I think it really is talking to the quarterly variability that we see inside of our typical fiscal year. And that's one thing we highlight is we have variability in quarters, but on an annual basis, it generally becomes fairly steady, fairly repeatable, and we can absolutely be pretty confident in what we're giving around annuals. And that's one reason we don't give quarterly guidance. We give quarterly color.

The other thing I would say is, as you've seen the backlog in ISS shift and grow in the capital side, that is when you sometimes have variability. And it's not whether or not we're able to get the components and deliver, it's whether a customer site is ready for us to be on and to be able to install the capital system. So we're -- again, we're being balanced in the guidance we're giving and talking about what could happen with order conversion.

Saree Boroditsky -- Jefferies -- Analyst

Thanks for that color. And then just one follow-up, talk a little bit about the end market hours orders that you -- hours municipal drinking water. Can you just provide any color on what you saw in that market today? And what's driving the lower outlook for orders?

Ron C. Keating -- President and Chief Executive Officer

Yes. So again, on this slide, it is our Q1 order activity against Q1 of '21. So Q1 of '22 against Q1 of '21. And talking about the municipal drinking water bubble specifically, we had a very large prior year order come in Q1 of '21, that we don't see that same size single order coming Q1 of '22. Although the market is robust and looks strong as the year goes on, certainly, with the passing of the infrastructure bill, this is specifically talking quarter 1 '22 over quarter 1 '21.

Saree Boroditsky -- Jefferies -- Analyst

Okay. Perfect. So you're saying it's more company-specific and that kind of a comment on any end market outlook?

Ron C. Keating -- President and Chief Executive Officer

Yes, correct.

Saree Boroditsky -- Jefferies -- Analyst

Perfect. Thanks for taking my questions.

Operator

And we will take our next question from Steve Tusa with JPMorgan.

Steve Tusa -- JPMorgan -- Analyst

Hey, guys. Good morning.

Ron C. Keating -- President and Chief Executive Officer

Hey, Steve. Good morning.

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Hi, Steve.

Steve Tusa -- JPMorgan -- Analyst

Can you just talk about the opportunities you guys see in power and then muni wastewater going forward? What's going on there?

Ron C. Keating -- President and Chief Executive Officer

Sure. So a lot of the change in power, we continue to see investment that's being made as companies are moving to alternative energies. They're moving to different types of power generation and moving away from coal-fired power plants. Our opportunity there is on recycle reuse. I mean, ultimately, it is doing what Evoqua does around sustainability. It's taking water that has contaminants in it, cleaning it up, putting it back into the environment and making sure that we are enabling the power companies to close sites effectively and efficiently around that. So as the conversion happens from coal into natural gas into renewables, that a lot of the coal-fired power plants are being taken off line, and we help solve that.

On municipal wastewater, there's going to be investment that's going to come and we're seeing it already around plant specific action where they're bringing it back up to the designed capacity and back up to the design specification. So we've got a very nice pipeline of opportunities executing with plant direct applications around retrofit and rehab. And that really speaks to the history of Evoqua with more than 100 years that we've been servicing municipal wastewater plants.

Steve Tusa -- JPMorgan -- Analyst

Got it. Okay. Thanks a lot. Appreciate it.

Ron C. Keating -- President and Chief Executive Officer

Thanks.

Operator

And we will take our next question from Brian Lee with Goldman Sachs.

Grace -- Goldman Sachs -- Analyst

Hi, guys. Thanks for taking the question. This is Grace [Phonetic] on for Brian. I guess, first one, question on your revenue guidance. So your revenue guidance range for 2022, it's a bit wider than what you have given in prior annual targets, just a little bit. What is the implied organic versus inorganic growth? And is it all simply supply chain uncertainties? Or are there any other nuances to the guide heading into the year than in the years past? Is it price? Is it makes -- just any sense there? Thanks. And I have a follow-up.

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Sure. So the guide implies uncertainty around inflation. And as inflation occurs, we feel confident we'll stay positive on price cost. But as you price the cost, that has the potential to create higher revenue, but you're not necessarily going to get the EBITDA fall through. You'll get some, but not at your traditional margins. So that's what that's -- what's implied in there in terms of the wider guide on revenue. But at the same time, there's -- if commodity costs has stabilized and there's a potential for the other direction. So that's how we thought about that revenue guide. Okay.

Grace -- Goldman Sachs -- Analyst

Okay. Got it. And what's the implied organic growth there?

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

We have not put an implied organic growth out there at this point in time. Again, when you think about organic growth, part of that is how do you think about price as a part of organic growth, and we don't differentiate between price and volume in our guide.

Ron C. Keating -- President and Chief Executive Officer

And I would say the other thing is as we look at our M&A pipeline, and we've highlighted this in the past, doing tuck-in acquisitions around service locations, either we're going to put in capital expenditure and build a site and develop or we're going to find something that we acquire and tuck-in. They're very small. So we call that organic like inorganic growth because it's either deploy capital, install a facility or find someone that you can bring in as a tuck-in opportunity.

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Long-term, we expect to stay true to our goals of 3% to 5% organic growth.

Grace -- Goldman Sachs -- Analyst

Okay. Understood. I guess one more question for me. I appreciate all the PFAS color on the call and realize this is not near-term. But can you guys give us a sense for what you are hearing from your customers and any more activities or engagement? And then also, maybe any updates on the $100 million PFAS water contaminant pipeline you have referenced in the past as you head into 2022.

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Sure. Yes, I can follow-up on that. So first of all, we see the opportunity in the market, similar to how we talked about it in the past in the near-term. The pipeline still continues to be quite robust in that range. And then as the limits are starting to unfold, that will start to give our customers much more confidence around engaging engineering studies and doing the work that they do. I mean, the revenues don't -- the orders don't flow until the engineering work is done. And of course, the revenues don't flow and full after that. So we kind of still see it playing out over the next three to five years. But this new passage of the bill really starts movements in a more positive direction. But remember, it's the money and the limits together that are going to set the stage for exactly the timing and the type of solutions that our customers are deploying.

Ron C. Keating -- President and Chief Executive Officer

And our -- on the pipeline that we have, our pipelines continue to be robust with the specific state led efforts that Sne actually highlighted on one of his slides. And -- but we do anticipate that, that will increase as time goes on, certainly, with the passing of the bill and the focus that's being placed on PFAS.

Grace -- Goldman Sachs -- Analyst

Great. Thanks for the color. I'll pass it on. Thanks.

Ron C. Keating -- President and Chief Executive Officer

Thank you.

Operator

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

Ron C. Keating -- President and Chief Executive Officer

Thank you very much for joining us today, and thank you for your interest in Evoqua. I want to again highlight the appreciation we have for our team managing through the supply chain challenges and making sure that we are continuing to deliver new innovations and new solutions to the marketplace. I look forward to speaking with you all again next quarter. So have a great day. Thanks.

Operator

[Operator Closing Remarks]

Duration: 58 minutes

Call participants:

Dan Brailer -- Vice President of Investor Relations

Ron C. Keating -- President and Chief Executive Officer

Snehal A. Desai -- Executive Vice President, Chief Growth Officer

Benedict J. Stas -- Executive Vice President, Chief Financial Officer and Treasurer

Deane Dray -- RBC Capital Markets -- Analyst

Nathan Jones -- Stifel -- Analyst

Mike Halloran -- Baird -- Analyst

Bryan Blair -- Oppenheimer -- Analyst

Andy Kaplowitz -- Citigroup -- Analyst

Andrew Buscaglia -- Berenberg -- Analyst

John Walsh -- Credit Suisse -- Analyst

Saree Boroditsky -- Jefferies -- Analyst

Steve Tusa -- JPMorgan -- Analyst

Grace -- Goldman Sachs -- Analyst

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