AQUA Evoqua Water Technologies Corp. - 10-K

Item 1A. Risk Factors

The following risks and uncertainties could materially adversely affect our business, financial condition, results of operations or prospects. Although the risks are organized by headings and each risk is described separately, many of the risks are interrelated. While we believe we have identified and discussed below the key risk factors affecting our business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect our business, financial condition, results of operations or prospects in the future. Any one or more of such factors could directly or indirectly cause our actual results of operations and financial condition to vary materially from past or anticipated future results of operations and financial condition.

Business and Operational Risks

Inflation has increased our operating costs, and we expect to continue to experience inflationary conditions.

During fiscal 2022, the cost of certain commodities and materials used in our operations, including resins, metals, and electronic components, and the cost of labor, energy, fuel, transportation, and other resources necessary to operate our business, increased significantly. We expect to continue experiencing inflationary conditions in fiscal 2023. Volatility

in the market price and availability of raw materials and other inputs directly impacts the cost of operating our business. We have taken actions to mitigate the impact of these cost increases through price increases, cost savings projects, and sourcing decisions. Although we were able to offset increased material costs through our pricing initiatives during fiscal 2022, inflationary pressures have limited, and are expected to continue to limit, our ability to achieve margin expansion. Failure to offset cost increases adversely impacts our gross profit, gross margin, and operating profit. Although price increases did not materially decrease demand in fiscal 2022, continued price increases to offset these costs could cause our customers to defer procurement of our products, solutions, and services or to buy from lower priced competitors, which could have an adverse impact on our revenues. In addition, many of our contracts are long‑term in nature, and our failure to accurately project operating costs or negotiate or enforce price escalation provisions in our long‑term contracts could have an adverse impact on our business, financial condition, and results of operations.

We rely on a large network of third party suppliers and transportation providers. Constraints on the availability of materials and transportation have impacted and may continue to impact our ability to execute projects on time and within budget.

Our products and solutions typically incorporate a wide variety of third party products, component parts, and materials. During fiscal 2022, we experienced significant increases in lead times for certain of these inputs due to availability constraints, and we expect these supply chain challenges to continue in fiscal 2023. We also rely upon various means of transportation through third parties, including shipments by air, sea, rail, and truck, to deliver products from our suppliers to our facilities and from our facilities to our customers, as well as for direct shipments from our suppliers to our customers. Factors beyond our control, many of which have been caused or exacerbated by the COVID-19 pandemic, including labor shortages and capacity constraints, container shortages, port congestion, disruptions to the national and international transportation infrastructure, fuel shortages, and transportation cost increases (such as increases in fuel costs or port fees), have impacted and could further impact our ability to execute projects or ship products to our customers on time and within budget, which could harm our reputation and have a material adverse effect on our business, financial condition, and results of operations. Generally, we have been able to pass on a portion of shipping and related costs to our customers, but there can be no assurance that we will be able to do so into the future. Failure to do so may adversely impact our gross profit and gross margin.

Deteriorating economic conditions and the potential for an economic recession may have a material adverse impact on our business and financial condition.

Economic conditions in the United States and globally have recently been deteriorating, and financial markets have experienced significant volatility. Central banks have raised interest rates to slow inflationary conditions. If these market conditions persist, we may see diminished liquidity and credit availability, inability to access capital markets, and the bankruptcy, failure, collapse, or sale of various entities, including certain of our customers and suppliers. Although we cannot predict the impacts these conditions may have on us, they could materially and adversely affect our business and financial condition. For example, the demand for our products may decline due to the deteriorating economic conditions which could negatively impact revenues, margins, and profitability of our business, the tightening of credit or lack of credit availability to our customers could adversely affect our ability to collect our receivables, and our ability to access the capital markets may be restricted. The impact of deteriorating economic conditions and a global recession may also have the effect of heightening many of the other risks and uncertainties described in this “Risk Factors” section.

The COVID-19 pandemic has adversely affected, and may continue to adversely affect, our business, financial condition, results of operations and prospects.

The COVID-19 pandemic, the resulting global economic slowdown, and the reopening of global economies that has followed have created a number of macroeconomic challenges that have impacted our business, including volatility and uncertainty in business planning, disruptions in global supply chains, material, freight and labor inflation, shortages of and delays in obtaining certain materials and component parts, and labor shortages. The COVID-19 pandemic has also heightened risks associated with our operations. Our service technicians enter high-risk areas such as hospitals and testing laboratories, putting them at greater risk of exposure to the virus. An outbreak among our service technician population or an outbreak among employees at any of our manufacturing facilities, which may require us to suspend or reduce operations at that facility, could have a material adverse effect on our business, financial condition, results of

operations and prospects. Additionally, a large number of our employees continue to work remotely, resulting in increased cyber-security risk.

New variants of COVID-19 and other future public health crises and pandemics may affect our operating and financial results in a manner that is not presently known to us or not presently considered to be a significant risk to our operations. The impact of the COVID-19 pandemic and other future public health crises and pandemics may also have the effect of heightening many of the other risks and uncertainties described in this “Risk Factors” section.

Our financial results depend on successful project execution and may be adversely affected by cost overruns, failure to meet customer schedules, failure of our subcontractors to fulfill their obligations to us, or other execution issues.

A portion of our revenue is derived from large projects that are technically complex and may occur over multiple years. These projects are subject to a number of significant risks, including project delays, cost overruns, changes in scope, unanticipated site conditions, design and engineering issues, incorrect cost assumptions, increases in the cost of materials and labor, health and safety hazards, third party performance issues, weather issues and changes in laws or permitting requirements. If we are unable to manage these risks, we may incur higher costs, liquidated damages, and other liabilities to our customers, which may decrease our profitability and harm our reputation. Many of these projects require us to contract with engineering, procurement, and construction firms (“EPCs”) and other subcontractors. If an EPC or other subcontractor that we have contracted fails to fulfill its contractual obligations to us, we could face significant delays, cost overruns, and liabilities. Our continued growth will depend in part on executing a greater volume of large projects, which will require us to expand and retain our project management and execution personnel and resources.

We may incur liabilities to customers as a result of warranty claims or failure to meet performance guarantees, which could reduce our profitability.

Our customers typically require product warranties as to the proper operation and conformance to specifications of the products we manufacture or install, and performance guarantees as to any effluent water produced by our equipment and services. Failure of our products to operate properly or to meet specifications of our customers or our failure to meet our performance guarantees may increase costs by requiring additional engineering resources and services, replacement of parts and equipment and frequent replacement of consumables or monetary reimbursement to a customer or could otherwise result in liability to our customers. We have in the past received warranty claims, and we expect to continue to receive them in the future. There are significant uncertainties and judgments involved in estimating warranty and performance guarantee obligations, including changing product designs, differences in customer installation processes and failure to identify or disclaim certain variables in a customer’s influent. To the extent that we incur substantial warranty or performance guarantee claims in any period, our reputation, earnings, and ability to obtain future business could be materially adversely affected.

Our inability to meet our own and our customers’ safety standards could have a material adverse effect on our sales and profitability.

Maintaining a strong and reliable reputation for safety is critical to our business. Many of our customers actively monitor and review our company‑wide safety record. Risks arising from unsafe products or unsafe performance by our employees include, among other things, personal injury or death caused by our products or occurring in our facilities, the destruction of customer or third‑party property during the execution of a service arrangement or due to the malfunction of our products, delays in or suspension of service or the failure to timely deliver our products. Workplace accidents or near-accidents, product-related accidents, or the failure to follow our own or our customers’ safety policies could damage our reputation or our customers’ perception of our safety record, which could have a material adverse impact on demand for our products and services, result in additional costs to our business or the loss of customers, result in litigation against us or increase government or regulatory oversight over us.

Failure to effectively treat emerging contaminants could result in material liabilities.

A number of emerging contaminants might be found in water that we treat, including PFAS, PFOA, selenium, micro-plastics, hazardous chemicals, or pathogens that may cause a number of illnesses, including cholera, typhoid fever, cancer, giardiasis, cryptosporidiosis, amoebiasis and free-living amoebic infections. Such contaminants or pathogens may be found in the environment, and, as a result, there is a risk that they could be present in water treated using our systems or products. In applications where treated water enters the human body, illness and death may result if contaminants or pathogens are not eliminated during the treatment process. In particular, contamination could result from failing to properly treat reusable products before they are distributed to our customers, or from actions taken by our customers or other third parties using our products, which could result in material liability. The potential impact of contamination of water treated using our products, services or solutions is difficult to predict and could lead to an increased risk of exposure to product liability claims, increased scrutiny by federal and state regulatory agencies and negative publicity. Additionally, regulatory bodies such as the EPA may issue new and onerous testing and permitting requirements relating to the treatment and destruction of certain contaminants such as PFAS and PFOA. If we are unable to comply with any such requirements or our products are unable to comply with any such requirements, we may incur fines and penalties and our ability to offer services relating to the treatment of these contaminants may be restricted, which could adversely impact our revenues.

Our future growth is dependent upon our ability to continue to develop or acquire new products, services and solutions that allow us to compete successfully in our markets.

We offer our products, services, and solutions in highly competitive markets. Our future growth depends upon our ability to (i) identify customer preferences and emerging trends in our target end markets, (ii) develop and maintain a wide range of competitive and appropriately priced products, services and solutions, (iii) enhance and differentiate our products from those of our competitors, (iv) develop and drive commercial acceptance of new products quickly and cost‑effectively, (v) keep our products, services, and solutions cost‑competitive, even when faced with rising commodity costs, (vi) attract, develop and retain individuals with the requisite technical expertise and understanding of customers’ needs to develop and sell new technologies and products, and (vii) execute projects in a cost-effective manner according to the schedules required by our customers.

Our growth strategy includes growth through acquisitions, and we may not be able to identify suitable acquisition targets.

Acquisitions have historically been a significant part of our growth strategy, and we expect to continue to grow through acquisitions in the future. We may not be able to identify suitable candidates, negotiate appropriate or favorable acquisition terms, obtain financing that may be needed to consummate such transactions or complete proposed acquisitions. There is significant competition for acquisition and expansion opportunities in our businesses.

Acquisitions require significant time and attention from management and other key personnel, which may result in attention being diverted from the operation of our existing business. Other risks associated with our acquisition strategy include ineffective integration of an acquisition, as further described below, inaccurately estimating a target’s financial condition or risk profile, failure to achieve planned synergies, litigation relating to an acquisition, failure to receive required regulatory approvals or such approvals being delayed or restrictively conditional, potentially insufficient internal controls over financial activities or financial reporting at an acquired entity that could impact our existing business on a combined basis, and an adverse impact on our existing business resulting from an acquired business that historically had a higher risk tolerance or whose personnel fail to comply with our existing policies.

We may have difficulty operating or integrating any acquired businesses, assets, or product lines profitably, or in successfully implementing our growth strategy.

The anticipated benefits from any acquisition may not be achieved unless the operations of the acquired business assets or product lines are successfully integrated in an efficient, effective, and timely manner. The integration of an acquisition generally requires substantial attention from management and operating personnel to prevent the acquisition from disrupting any existing operations or affecting our customers’ opinions and perceptions of our services, products, or

customer support. Risks associated with integration of an acquisition include failure of an acquired business to perform to our expectations, our failure to integrate an acquired business appropriately and on a timely basis, our failure to realize anticipated synergies and cost savings, our failure to preserve the customer relationships and retain key employees of an acquired business and difficulties, inefficiencies or cost overruns in integrating and assimilating the organizational cultures, operations, technologies, data, services and products of an acquired business with ours.

The process of integrating acquired businesses, assets and product lines could cause the interruption of, or delays in, the operation of our existing business, which could have a material adverse effect on our business, financial condition, results of operations or prospects. Acquisitions also place a burden on our information, financial and operating systems and our employees and management. If we are unable to manage our growth effectively, we may spend time and resources on such acquisitions that do not ultimately increase our profitability or that cause loss of, or harm to, relationships with employees and customers.

We may not achieve some or all of the expected benefits of our restructuring actions.

We have taken a number of restructuring actions in recent years in an effort to better serve the needs of our customers worldwide, achieve cost savings and operational efficiencies, and position ourselves for improved long-term growth and profitability. Achieving the expected cost savings and efficiencies will be subject to significant economic, competitive, and other uncertainties, some of which are beyond our control, and we may not be able to obtain the cost savings and benefits that we anticipate at the outset or that we currently anticipate in connection with these restructuring actions. Our assumptions may not be accurate, and we may not be able to operate in accordance with our plans, which may cause us to incur additional restructuring charges. These types of initiatives could yield unintended consequences such as distraction of our management and employees, business disruption and unforeseen costs, attrition beyond any planned reduction in workforce, inability to attract or retain key personnel and reduced employee productivity, which could materially adversely affect our business, financial condition, and results of operations. The successful implementation and execution of our restructuring actions are critical to achieving our expected cost savings as well as effectively competing in the marketplace and positioning us for future growth. If our restructuring actions are not executed successfully, it could have a material adverse effect on our business, financial condition, results of operations, and prospects.

Delays in enactment or repeals of environmental laws and regulations may make our products, services, and solutions unnecessary or less economically beneficial to our customers, adversely affecting demand for our products, services, and solutions.

Certain of our products, services and solutions assist various industries and municipalities in meeting stringent environmental and safety requirements enacted for the purpose of making water cleaner and safer. Our future growth is dependent in part on the impact and timing of potential new water laws and regulations, as well as potential changes to existing laws and regulations. If stricter laws or regulations are delayed or are not enacted, or repealed or amended to be less strict, or enacted with prolonged phase‑in periods, or not enforced, demand for our products and services may be reduced. We are currently unable to predict whether changes to statutes and rules will affect demand for our products and services. To the extent that such changes have a negative impact on us, including as a result of related uncertainty, these changes may materially and adversely impact our business, financial condition, results of operations or prospects.

If we become subject to claims relating to handling, storage, release, or disposal of hazardous materials, we could incur significant costs and experience delays in our business due to our efforts to comply.

Our business activities, including our manufacturing processes and waste recycling and treatment processes, currently involve the use, treatment, storage, transfer, handling and/or disposal of hazardous materials, chemicals, and wastes. These activities create a risk of significant environmental liabilities and reputational damage. Under applicable environmental laws and regulations, including RCRA and CERCLA, we could be strictly, jointly, and severally liable for releases of regulated substances by us at our current or former properties or the properties of others or by other businesses that previously owned or used our current or former properties. We could also be liable or incur reputational damage if we merely generate hazardous materials or wastes, or arrange for their transportation, disposal, or treatment, or we transport such materials, and they are subsequently released or cause harm. Our business activities also create a risk

of contamination or injury to our employees, customers or third parties, from the use, treatment, storage, transfer, handling and/or disposal of these materials, and these activities could result in accidental contamination or injury to the general public, as end‑users of our industrial and municipal customers’ products and services.

In the event that our business activities result in environmental liabilities, such as those described above, we could incur significant costs or reputational damage in connection with the investigation and remediation of environmental contamination, and we could be liable for any resulting damages including natural resource damages. Such liabilities could exceed our available liquidity or any applicable insurance coverage we may have. Additionally, we are subject to, on an ongoing basis, federal, state, and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations may become significant and could have a material adverse effect on our business, financial condition, results of operations or prospects.

Failure to retain our existing senior management, skilled technical, engineering, sales and other key personnel or the inability to attract and retain new qualified personnel could materially and adversely impact our ability to operate or grow our business.

Our success depends to a significant extent on our ability to attract and retain talent, specifically in senior management and skilled technical, engineering, sales, project management, and other key roles. Macroeconomic conditions, specifically labor shortages, increased competition for employees, and wage inflation, could have a material impact on our ability to attract and retain talent, our turnover rate, and the cost of operating our business. If we are unable to attract and retain sufficient talent, minimize employee turnover, or manage wage inflation, it could have a material adverse effect on our business, financial condition, results of operations, or prospects.

Wastewater operations may result in contamination or pose other significant risks that could cause us to incur significant costs.

Wastewater treatment involves various unique risks. If our treatment systems fail or do not operate properly, or if there is a spill, untreated or partially treated wastewater could discharge onto property or into nearby streams, rivers, and groundwater, causing various damages and injuries, including environmental damage. These risks are most acute during periods of substantial rainfall or flooding, which are the main causes of sewer overflow and system failure. Liabilities resulting from such damages and injuries could materially adversely affect our business, financial condition, results of operations or prospects.

Weather conditions, climate change, and legislation or regulations addressing climate change may adversely impact our business, financial condition, results of operations and prospects.

The physical impacts of climate change are highly uncertain and vary depending on geographical location, but could include changing temperatures, droughts, water shortages, wildfires, changes in weather and rainfall patterns, changes in sea levels, and changing storm patterns and intensities. These impacts present several potential challenges to water and wastewater service providers, such as potential degradation of water quality and changes in demand for water services, particularly during periods of increased precipitation, flooding, or water shortages. Inclement weather and extreme weather events may have varying impacts on our business. Certain events may disrupt the operations of our customers, creating customer shutdowns that prevent or defer our performance of services or sale of equipment, while other events may drive increased demand for our products and services, particularly emergency response services, which may create volatility in our financial results. Additionally, these events may disrupt our own operations and the operations of our suppliers, including the operation of manufacturing plants, the transportation of raw materials from our suppliers, and the transportation of products to our customers, any of which may increase our costs, reduce our productivity and adversely affect our business, financial condition, results of operations and prospects.

Additionally, concern over climate change may result in new or increased legal and regulatory requirements to reduce or mitigate the effects of climate change, including limitations on greenhouse gas emissions, which could increase our costs or require additional investments in our facilities and equipment, and require us to make significant new disclosures regarding the climate-related impacts of our business. New legislation and regulatory requirements may also impact our

customers and suppliers, which could affect demand for our products or our ability to source key materials. In addition, our customers and suppliers may impose their own requirements with respect to climate change and greenhouse gas emissions that may require us to incur additional costs to comply with such requirements. Any failure to comply with those requirements may also affect demand for our products or our ability to source key materials. From time to time, we establish strategies and expectations related to climate change and other environmental matters. Our ability to achieve any such strategies or expectations is subject to numerous factors and conditions, many of which are outside of our control. Examples of such factors include, but are not limited to, evolving legal, regulatory, and other standards, processes, and assumptions, the pace of scientific and technological developments, increased costs, the availability of requisite financing, and changes in carbon markets. Failures or delays (whether actual or perceived) in achieving our strategies or expectations related to climate change and other environmental matters could adversely affect our business, operations, and reputation, and increase risk of litigation.

Our business may be materially adversely affected by risks associated with international sales and operations.

Our international sales and operations are subject, in varying degrees, to risks inherent to doing business outside the U.S. These risks include tariffs and other trade restrictions, import and export requirements, foreign taxation policies, limitations on our ability to repatriate funds, unanticipated regulatory changes, geopolitical risks, political instability, currency fluctuations, varying levels of protection of intellectual property, difficulty enforcing agreements, disruptions in global supply chains, labor disruptions, and potential violations of anti-corruption laws.

Our international sales and operations are denominated in various foreign currencies, and we are subject to currency translation risk associated with converting the financial statements reflecting our international operations into U.S. dollars. The U.S. dollar strengthened as compared to many foreign currencies, including the Euro, during fiscal 2022, which adversely affected reported revenues of our international subsidiaries. Continued fluctuation in foreign currency exchange rates could result in continued adverse effects on our revenues.

We currently have operations and source and manufacture certain of our materials and products for global distribution from third‑party suppliers and manufacturers in the People’s Republic of China. Operating in China exposes us to political, legal, and economic risks. Our ability to operate in China may be adversely affected by geopolitical conflicts involving China and changes in U.S. and Chinese relations, laws and regulations, such as those related to, among other things, taxation, import and export tariffs, environmental regulations, energy use, land use rights, intellectual property, currency controls, network security, employee benefits and other matters, and we may not obtain or retain the requisite legal permits to continue to operate in China, or we may become subject to costs or operational limitations imposed in connection with obtaining and complying with such permits. We may also experience difficulty in managing relations with our employees, distributors, suppliers, or customers, with whom disagreements or conflicts of interest could materially adversely affect our operations or our ability to source and manufacture certain of our materials and products in China.

We have no operations in Russia or Ukraine, and our sales into these regions are minimal. However, the conflict in Ukraine has exacerbated material inflation and availability challenges, particularly with respect to the impact it has had on energy and fuel prices and the price of steel and other precious metals that we procure in our supply chain. If the inflationary impact on energy, fuel and steel prices continues throughout fiscal 2023 and these factors are sustained, or if the duration of the conflict is extended or the conflict spreads into a larger geographic portion of Europe, our results of operations in future periods could be materially and adversely impacted.

If we do not adequately protect our intellectual property, or if third parties infringe our intellectual property rights or claim that we are infringing their intellectual property rights, we may suffer competitive injury, expend significant resources enforcing our rights or defending against such claims, or be prevented from selling products or services.

We own numerous patents, trademarks, service marks, copyrights, trade secrets and other intellectual property and hold licenses to intellectual property owned by others, which in aggregate are important to our business. The intellectual property rights that we have and may obtain, however, may not provide our products and services with a significant competitive advantage because our rights may not be sufficiently broad or may be challenged or invalidated. Our failure to obtain or maintain intellectual property rights that convey competitive advantage, adequately protect our intellectual

property, or detect or prevent circumvention or unauthorized use of such property and the cost of enforcing our intellectual property rights could materially adversely impact our business, financial condition, results of operations or prospects. Any dispute or litigation regarding intellectual property could be costly and time consuming due to the complexity and the uncertainty of intellectual property litigation. Our intellectual property portfolio may not be useful in asserting a counterclaim, or negotiating a license, in response to a claim of infringement or misappropriation. We may incur significant costs and diversion of management attention and resources as a result of such claims of infringement or misappropriation, and we or our suppliers or subcontractors could lose rights to significant or disruptive technologies, be unable to license technology, provide or sell products or services, or be required to pay substantial damages or license fees with respect to the infringed rights or be required to redesign, rework, reprogram, or replace our or our customers’ products, subcomponents, software, or systems, or recast our valuable brands at substantial cost, any of which could materially adversely impact our competitive position, financial condition and results of operations even if we successfully defend against such claims of infringement or misappropriation.

Our industry is highly fragmented and localized.

We operate in markets that are characterized by customer demand that is often broad in scope but localized in delivery. We compete with companies that may be better positioned to capitalize on highly localized relationships and knowledge that are difficult for us to replicate. Our potential customers may prefer local suppliers, in some cases because of existing relationships and in other cases because of local legal restrictions or incentives that favor local businesses. Smaller regional suppliers may also have lower cost structures. As a result, efforts to expand or support our service network may not improve our ability to penetrate new local markets or expand our footprint in existing markets.

Our contracts with federal, state, and local governments involve unique risks and may be terminated or adversely modified prior to completion, which could adversely affect our business.

We derive, and expect to continue to derive in the future, a portion of our revenue from government customers, including municipalities. Sales to governments and related entities present unique risks, including potential disruption due to appropriation and spending patterns, delays in the adoption of new technologies due to political, fiscal or bureaucratic processes, delays in approving budgets, long purchase and payment cycles, competitive bidding requirements, qualification requirements, extensive specification development and price negotiations, milestone requirements and the potential unenforceability of limitations on liability or other contractual provisions. Government contracts may contain provisions not typically found in commercial contracts, including provisions permitting the government to terminate for convenience, reduce scope and potential future revenue, modify certain terms and conditions of existing contracts, suspend performance, impose fines or penalties, subject us to criminal prosecution or debarment, subject awarded contracts to protests or challenges by competitors, or claim rights in technologies developed by us. Exercise of any of these rights could cause us to recognize lower revenue or margin than anticipated under our government contracts. Additionally, because our water treatment projects and solutions for municipal customers often include fixed‑price contracts with milestone billings and liquidated damages for our delay, our performance under such contracts involves risks such as not receiving payments, not receiving payments in a timely manner or incurring significant damages if certain milestones are not met or not met on schedule. As a result, we could experience a material adverse effect on our business, financial condition, results of operations or prospects.

We rely, in part, on third‑party sales representatives to assist in selling our products, services and solutions, and the failure of these representatives to perform as expected could reduce our future sales.

Sales of our products, services, and solutions to some of our customers are accomplished, in part, through the efforts of third‑party sales representatives. We are unable to predict the extent to which these third‑party sales representatives will be successful in marketing and selling our products. Moreover, many of these third‑party sales representatives also market and sell competing products and may more aggressively pursue sales of our competitors’ products. Our third‑party sales representatives may terminate their relationships with us at any time on short or no notice. Our future performance may also depend, in part, on our ability to attract, incentivize and retain additional third‑party sales representatives that will be able to market and support our products effectively, especially in markets in which we have not previously sold our products. If we cannot retain our current third‑party sales representatives or recruit additional or

replacement third‑party sales representatives or if these sales representatives are not effective, it could have a material adverse effect on our business, financial condition, results of operations or prospects.

Product defects and unanticipated or improper use of our products could adversely affect our business, reputation, and financial statements.

Manufacturing or design defects in our products or unanticipated or improper use of our products by our customers could create product safety, regulatory or other risks, including personal injury, death, or property damage. These events could lead to recalls or safety alerts relating to our products, result in the removal of a product from the market or result in product liability claims being brought against us. Recalls, removals, and product liability claims can result in significant costs, as well as negative publicity and damage to our reputation that could reduce demand for our products and have a material adverse effect on our business, financial condition, results of operations or prospects.

Further, it is generally our responsibility to service the equipment we provide our customers throughout the duration of our contract with such customers, and our customers may be required to maintain insurance covering loss, damage or injury caused by our equipment. However, we are not able to monitor our customers’ use or maintenance of their water systems or their compliance with our contracts or usage instructions. Customers’ failure to properly use, maintain or safeguard their equipment or customers’ noncompliance with insurance requirements may reflect poorly on us as the provider of such equipment and, as a result, damage our reputation.

Our operations are subject to various hazards that may cause personal injury or property damage and increase our operating costs, and which may exceed the coverage of our insurance or for which we are not insured.

There are inherent risks to our operations. We are exposed to risks posed by severe weather and other natural disasters, such as hurricanes and earthquakes. In addition to natural risks, hazards (such as fire, explosion, collapse, or machinery failure) are inherent risks in our operations which may occur as a result of inadequate internal processes, technological flaws, human error, or certain events beyond our control. We also utilize approximately 940 vehicles in connection with our offsite services and distribution operations and, from time to time, these drivers are involved in accidents which may cause injuries, spills, or uncontrolled discharges and in which goods carried by these drivers may be lost or damaged. The hazards described above can cause significant personal injury or loss of life, severe damage to or destruction of property, plants, and equipment, including customer or third‑party property, contamination of, or damage to, the environment and suspension of operations. The occurrence of any of these events may subject us to investigations, require us to perform remediation, or result in us being named as a defendant in lawsuits asserting claims for substantial damages, environmental cleanup costs, personal injury, natural resource damages and fines or penalties. As a result, we may from time to time become exposed to significant liabilities for which we may not have adequate insurance coverage. We may also become exposed to certain claims that are excluded from our insurance coverage, such as claims of fraud or for punitive damages. Although we have liability insurance, we cannot be certain that this insurance coverage will continue to be available to us at a reasonable cost or will be adequate to cover any product liability claims. In addition, such events may affect the availability of personnel, proper functioning of our information technology infrastructure and availability of third parties on whom we rely, any of which consequences could have a material adverse effect on our business, financial condition, results of operations or prospects.

Financial and Credit-Related Risks

Our financial results may fluctuate from period to period and can be difficult to predict.

Our financial results may be impacted by large projects, which often have lower margins and greater risk from both a timing and execution standpoint than standard product sales. The timing of these project awards is often unpredictable and outside of our control. If we fail to accurately estimate our operating costs to complete these projects or if we fail to execute these projects efficiently and timely, our margins on these projects could be further eroded. The timing of these project awards is often unpredictable and can change based upon customer requirements due to a number of factors affecting the project that are outside of our control, such as funding, readiness of the project and regulatory approvals. If any of these large projects get delayed or canceled, our results during the periods in which these projects were scheduled to occur could be adversely affected and the delay or failure could have a material adverse effect on our business,

financial condition, results of operations or prospects. In addition, our contracts for large capital water treatment projects, systems and solutions for municipal and industrial applications are generally fixed‑price contracts with milestone billings. Additionally, competitive‑bid processes impose significant uncertainty with respect to our prospects for success, and our failure to properly predict our win rate could reduce our margins. Accordingly, our financial results for any given period may fluctuate and can be difficult to predict.

Our substantial indebtedness could adversely affect our financial condition and limit our ability to raise additional capital to fund our operations.

We have a significant amount of indebtedness. As of September 30, 2022, we had total indebtedness of $890.7 million, including $469.1 million of borrowings under our term loan facility, $151.3 million borrowings under our revolving credit facility, $150.2 million of borrowings related to our Securitization Facility (as defined below) which includes $0.2 million of accrued interest, $120.2 million in borrowings related to equipment financings. We also had $9.3 million of letters of credit issued under our $350.0 million revolving credit facility. We cannot provide any assurance that our business will generate sufficient cash flow from operations in amounts sufficient to enable us to fund our debt service obligations and other liquidity needs. Our inability to generate sufficient cash flow to satisfy our debt obligations could materially adversely affect our business, financial condition, results of operations, or prospects.

Our high level of indebtedness could, among other things, limit our ability to obtain additional financing in the future, reduce the amount of cash available for working capital, capital expenditures and other business needs, increase our vulnerability to adverse changes in the economy, expose us to greater interest rate risk, restrict us from making strategic acquisitions, force us to make non-strategic divestitures, place us at a disadvantage compared to less leveraged competitors, and increase our costs of borrowing. Any one of these impacts could have a material effect on our business, financial condition, results of operations, prospects, and our ability to satisfy our obligations in respect of our outstanding debt.

Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.

Borrowings under our senior secured credit facilities are at variable rates of interest and expose us to interest rate risk. Interest rates have increased meaningfully during fiscal 2022 and are projected to continue rising in the future. As interest rates rise, our debt service obligations on the variable rate indebtedness will increase even though the amount borrowed may remain the same, and our net income and cash flows will correspondingly decrease. Assuming no prepayments of the term loan facility (which had $469.1 million outstanding as of September 30, 2022) and that our revolving credit facility was fully drawn, each 0.125% change in interest rates would result in an approximate change of $1.0 million in annual interest expense on the indebtedness under our senior secured credit facilities. We entered into an interest rate swap during the third quarter of fiscal 2020 to mitigate risks associated with variable rate debt. The interest rate swap became effective June 30, 2020, has a term of five years to hedge the variability of interest payments on the first $500.0 million of the Company’s senior secured debt and fixes the floating LIBOR rate at 0.61%.

The covenants in our senior secured credit facilities impose restrictions that may limit our operating and financial flexibility.

Our senior secured credit facilities contain a number of significant restrictions and covenants that limit our ability, among other things, to incur additional indebtedness, pay dividends on or repurchase our outstanding capital stock, prepay certain indebtedness, create certain liens, divest certain assets, make certain investments, and enter into new lines of business. In addition, our senior secured credit facilities contain a financial covenant requiring us to comply with a 5.55 to 1.00 first lien net leverage ratio test. This financial covenant is solely for the benefit of the lenders under our revolving credit facility and is tested as of the last day of a quarter on which the aggregate amount of revolving loans and letters of credit outstanding under the revolving credit facility (net of cash collateralized letters of credit and undrawn outstanding letters of credit in an amount of up to 50% of the revolving credit facility) exceeds 12.5% of the total commitments thereunder. These covenants could materially adversely affect our ability to finance our future operations or capital needs. Furthermore, they may restrict our ability to expand and pursue our business strategies and otherwise conduct our business. These restrictions also limit our ability to obtain future financings to withstand a future downturn

in our business or the economy in general. In addition, complying with these covenants may also cause us to take actions that may make it more difficult for us to successfully execute our business strategy and compete against companies that are not subject to such restrictions.

Seasonality of sales and weather conditions may adversely affect, or cause volatility in, our financial results.

We experience seasonal demand in a number of our end markets, as demand for infrastructure and municipal products and projects generally follows warm weather trends. Seasonal effects may vary from year to year and are impacted by weather patterns, particularly by temperatures, heavy flooding, and droughts. Our operating results and financial condition could be materially and adversely affected by severe weather, natural disasters, or other environmental factors. Repercussions of these catastrophic events may include shutting down operations, a need to obtain additional equipment or supplies on an emergency basis, evacuation of or injury to personnel, damage to equipment or property, loss of productivity and harm to our reputation, any of which may result in a decrease in our revenue or decreased profitability.

We may incur impairment charges for our goodwill and other indefinite‑lived intangible assets which would negatively impact our operating results.

We have a significant amount of goodwill and purchased intangible assets on our balance sheet. As of September 30, 2022, the net carrying value of our goodwill and other indefinite‑lived intangible assets totaled approximately $507.8 million. The carrying value of goodwill represents the fair value of an acquired business in excess of identifiable assets and liabilities as of the acquisition date. The carrying value of indefinite‑lived intangible assets represents the federal hazardous waste treatment management permits obtained for locations operated by the Company. We do not amortize goodwill and indefinite‑lived intangible assets that we expect to contribute indefinitely to our cash flows, but instead we evaluate these assets for impairment at least annually, or more frequently if changes in circumstances indicate that a potential impairment could exist. Significant negative industry or economic trends, disruptions to our business, inability to effectively integrate acquired businesses, unexpected significant changes, or planned changes in use of the assets, divestitures and market capitalization declines may impair our goodwill and other indefinite‑lived intangible assets. Any charges relating to such impairments could materially adversely affect our financial condition and results of operations.

Our ability to use our net operating loss carryforwards may be limited.

As of September 30, 2022, we had approximately $235.2 million of U.S. federal and state net operating loss carryforwards (“NOLs”). Our federal NOLs begin to expire in 2035, while certain state NOLs begin to expire in 2023. Utilization of these NOLs depends on many factors, including our future income, which cannot be assured. As of September 30, 2022, we no longer maintain a valuation allowance against these NOLs.

We may be unable to bid on or enter into significant long‑term agreements if we are not able to obtain letters of credit, bank guarantees or surety bonds, and our liquidity may be adversely affected by bonding requirements.

A portion of our business, including our water treatment projects and solutions, requires us to provide letters of credit, bank guarantees or surety bonds in support of our commitments and as part of the terms and conditions on water treatment projects. In addition, we are required to provide letters of credit or surety bonds to the department of environmental protection or equivalent in some states in order to maintain our licenses to handle hazardous waste at certain of our regeneration facilities. We have in the past been, and may in the future be, required to provide bid bonds or performance bonds to secure our performance on certain projects or, in some cases, as a pre‑requisite to submit a bid on a potential project. Our inability to obtain adequate bonding or letters of credit to meet bid requirements or enter into significant long‑term agreements could have a material adverse effect on our business, financial condition, results of operations or prospects.

Information Technology and Cybersecurity Risks

We are increasingly dependent on the continuous and reliable operation of our information technology systems, including third party systems and solutions, and a disruption of these systems could materially and adversely affect our business.

We rely on our information technology systems in connection with various aspects of the operation of our business, including customer relationship management, customer service, purchasing, inventory management, project management, human resource management, billing, and accounting. We also rely on digitally connected systems for monitoring and operation of certain of our water treatment installations. Many of these systems are provided and operated by third parties, including cloud-based service providers. Our business and many of the products, services, and solutions that we offer depend on the integrity of these information technology systems, including our remote monitoring and data analytics features and our automated control solutions. These systems are inherently susceptible to a number of threats, including, but not limited to, viruses, ransomware, malware, malicious codes, hacking, phishing, denial of service actions, human error, network failures, electronic loss of data, and other electronic security breaches. Although we have experienced attempts by unauthorized external parties to access our networks and systems and the third party networks and systems upon which we rely, these attempts have not resulted in any material breaches, disruptions, or loss of information to date. A successful material cyber-attack may result in the loss or compromise of customer, financial or operational data, theft of intellectual property, disruption of billing, collections or normal field service activities, disruption of data analytics and electronic monitoring and control of operational systems, loss of revenue, ransomware payments, remediation costs related to lost, stolen, or compromised data, repairs to infrastructure, physical systems or data processing systems, increased cybersecurity protection costs, or violation of U.S. and international privacy laws, which may result in litigation. Any of these occurrences could harm our reputation or have a material adverse effect on our business, financial condition, results of operation and prospects.

We have adopted measures to mitigate potential risks associated with information technology disruptions and cybersecurity threats; however, there is no assurance that these measures will prevent cyber-attacks or security breaches. We also have a concentration of operations on certain sites, such as production and shared services centers, where business interruptions could cause material damage and costs. Although we continue to assess these risks, implement controls and perform business continuity and disaster recovery planning, we cannot be sure that interruptions with material adverse effects will not occur.

Our Water One® services are provided using remote monitoring technology that is connected to the “Internet of Things” (IoT), which is inherently susceptible to cyber-attacks and outages. A successful attack may result in inappropriate access to our or our customers’ information or systems or cause our products to function improperly. We have experienced outages due to disruptions in service by cellular providers. Although these outages have not had a material impact on our business to date, if outages occur with greater frequency or for extended durations, it could materially adversely affect our ability to monitor our assets, which could harm our reputation or result in a material loss of revenue, failure to fulfill contractual obligations and additional costs to repair damages.

If we experience a significant data security breach or fail to detect and appropriately respond to a significant data security breach, our business and reputation could suffer.

The nature of our business involves the receipt and storage of information about our customers, suppliers, employees, operations and financial performance. Further, we rely on various information technology systems to capture, process, store, and report data in connection with the products, services, and solutions that we provide to our customers, such as our Water One® services. We have procedures in place to detect and respond to data security incidents. However, because the techniques used to obtain unauthorized access, disable, or degrade service, or sabotage systems change frequently and may be difficult to detect for long periods of time, we may be unable to anticipate these techniques or implement adequate preventive measures. In addition, hardware, software, or applications we develop or procure from third parties may contain defects in design or manufacture or other problems that could unexpectedly and materially compromise information security. We outsource administration of certain functions to vendors that could be targets of cyber attacks. Any significant theft, loss and/or fraudulent use of customer, employee, or proprietary data as a result of a cyber attack targeting us or one of our third-party service providers could subject us to significant litigation, liability, and

costs, as well as materially adversely impact our reputation with customers and regulators, among others. Unauthorized external parties have attempted, and may continue to attempt, to gain access to our systems or facilities and to our proprietary business information. If our efforts to protect the security of information about our customers, suppliers and employees are unsuccessful, a significant data security breach may result in costly government enforcement actions, private litigation and negative publicity resulting in reputation or brand damage with customers, and our business, financial condition, results of operations or prospects could materially and adversely suffer. While we maintain insurance coverage that is designed to address certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses or all types of claims that may arise in the event we experience a cybersecurity incident, data breach or disruption, unauthorized access, or failure of systems.

We are subject to laws, rules, and regulations in the United States (such as the California Consumer Protection Act (“CCPA”)), and other countries relating to the collection, use and security of employee and other data. Our ability to execute transactions and to possess and use personal information and data in conducting our business subjects us to legislative and regulatory burdens that may require us to notify regulators and customers, employees, and other individuals of a data security breach, including in the European Union under the EU General Data Protection Regulation, or the GDPR. Evolving compliance and operational requirements under the GDPR, the CCPA, and the privacy laws of other jurisdictions in which we operate impose significant costs that are likely to increase over time.

Legal and Regulatory Risks

The cost of complying with complex governmental regulations applicable to our business, sanctions resulting from non‑compliance or reduced demand resulting from certain changes in regulations could increase our operating costs and reduce our profit.

Our operations and certain of our products are subject to various licensing, permitting, approval, and reporting requirements imposed by federal, state, local, and foreign laws. Our operations and certain of our products are subject to inspection and regulation by various governmental agencies, including the U.S. Environmental Protection Agency, the U.S. Food and Drug Administration (FDA), the Occupational Safety and Health Administration, and equivalent state and local agencies, as well as their counterparts in various states and foreign countries. A major risk inherent in our operations is the need to obtain and renew permits from federal, state, and local authorities. Delays in obtaining permits, the failure to obtain a permit or a renewal permit for a project, challenges to our permits by local communities, citizen groups, landowners, or others opposed to their issuance, or the issuance of a permit with unreasonable conditions or costs could limit our ability to effectively provide our services. We are also required to secure and maintain licenses required by several states which can take a significant amount of time and result in our inability or delays in our ability to bid on and execute certain projects. If we fail to secure or maintain any such licenses or if states place burdensome restrictions or limitations on our ability to obtain or maintain such licenses, we may not be able to operate in such states and our business, financial condition, results of operations or prospects may be materially adversely affected as a result.

Our newly acquired Mar Cor product line provides FDA 510(k) cleared water purification systems to the dialysis industry. Government regulation applies to nearly all aspects of testing, manufacturing, safety, labeling, storing, recordkeeping, reporting, promoting, distributing, and importing or exporting of these products. Modifications to existing products or the marketing of new uses for existing products also may require regulatory approvals, approval supplements or clearances. If we are unable to obtain any required approvals, approval supplements or clearances for any modification to a previously cleared or approved product, we may be required to cease manufacturing and sale, or recall or restrict the use of such modified product, pay fines, or take other action until such time as appropriate clearance or approval is obtained. Ongoing reporting regulations require that we report to appropriate governmental authorities in the United States and/or other countries when our products cause or contribute to a death or serious injury or malfunction in a way that would be reasonably likely to contribute to a death or serious injury if the malfunction were to recur. Governmental authorities can require product recalls or impose restrictions for product design, manufacturing, labeling, clearance, or other issues. For the same reasons, we may voluntarily elect to recall or restrict the use of a product. Any recall or restriction could divert managerial and financial resources and might harm our reputation among our customers and other healthcare professionals who use or recommend our products and services.

Our business may be further impacted by changes in federal, state, and local requirements that set forth air and wastewater discharge parameters, constrain water availability and set quality and treatment standards. Our failure or inability to comply with the stringent standards set forth by regulating entities or to provide cost‑effective and compliant design and construction solutions could result in fines or other penalties, and could have a material adverse effect on our business, financial condition, results of operations or prospects.

Foreign, federal, state, and local environmental, health and safety laws and regulations impose substantial compliance requirements on our operations. Our operating costs could be significantly increased in order to comply with new or stricter regulatory standards imposed by foreign, federal, and state environmental agencies.

Our operations, products and services are governed by various foreign, federal, state and local environmental protection and health and safety laws and regulations, including, without limitation, the federal Safe Drinking Water Act, the Clean Water Act, the Clean Air Act, the Resource Conservation and Recovery Act, the Occupational Safety and Health Act, the Toxic Substances Control Act, the Federal Insecticide, Fungicide, and Rodenticide Act in the U.S., the Restriction of Hazardous Substances (RoHS) Directive, and the Registration, Evaluation and Authorization of Chemicals (REACH) Directive in Europe, and similar foreign, federal, state and local laws and regulations and permits issued under these laws by the foreign, federal, state and local environmental and health and safety regulatory agencies. These laws and regulations establish, among other things, criteria and standards for drinking water and for discharges into the waters of the U.S. and its states, for the proper management of hazardous and non‑hazardous solid waste and for protection of public and worker health and safety. Pursuant to these laws, we are required to obtain various environmental permits from environmental regulatory agencies for our operations. We cannot provide any assurance that our operations, products, or services will be at all times in total compliance with these laws, regulations and permits or that we will be able to obtain or renew all required permits. If we violate or fail to comply with these laws, regulations or permits, we could be fined or otherwise sanctioned by regulators and be subject to lawsuits, civil or criminal, seeking enforcement and/or injunctive relief. We may also be subject to civil claims by citizens groups seeking to enforce environmental laws. In the event of an accident or if we otherwise fail to comply with applicable regulations, we could lose our permits or approvals and/or be held liable for damages and monetary penalties.

Environmental laws and regulations are complex and change frequently. These laws, and the enforcement thereof, have tended to become more stringent over time. It is possible that new standards could be imposed, either stricter or more lenient, that could result in the obsolescence of our products or lead to an interruption or suspension of our operations and have a material adverse effect on the productivity and profitability of a particular manufacturing facility, service, or product or on us as a whole.

Failure to comply with applicable anti‑corruption and trade laws, regulations, and policies, including the U.S. Foreign Corrupt Practices Act, could result in fines and criminal penalties, causing a material adverse effect on our business, financial condition, results of operations or prospects.

Due to our global operations, we are subject to regulation under a wide variety of U.S. federal and state and non‑U.S. laws, regulations and policies related to anti‑corruption and trade, including those related to export and import compliance, anti‑trust and money laundering. The U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act of 2010 and similar anti‑bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to government officials or other persons for the purpose of obtaining or retaining business. We operate in parts of the world that are recognized as high-risk regions for corruption. Our operations in these regions include sales to government and non-government customers and may include the use of third-party intermediaries. In certain circumstances, strict compliance with anti-bribery and trade laws, regulations and policies may conflict with local customs and practices in these regions.

The International Traffic in Arms Regulations generally require export licenses from the U.S. Department of State for goods, technical data and services sent outside the U.S. that have military or strategic applications. The Export Administration Regulations regulate the export of certain “dual use” goods, software, and technologies, and in some cases require export licenses from the U.S. Department of Commerce. Office of Foreign Asset Control regulations implement various sanctions programs that include prohibitions of restrictions on dealings with certain sanctioned countries, governments, entities, and individuals. Our policies mandate compliance with these trade laws, regulations,

and policies, and we have established procedures designed to assist us and our personnel in compliance with applicable U.S. and international laws and regulations. However, we cannot provide any assurance that our internal control policies and procedures will always protect us from improper conduct of our employees or business partners.

In the event that we believe or have reason to believe that our employees or agents have or may have violated applicable laws, including anti‑corruption and trade laws, regulations, and policies, we may be required to investigate or engage outside counsel to investigate the relevant facts and circumstances, which can be expensive and require significant time and attention from senior management. Any such violation could result in substantial fines, sanctions, civil and/or criminal penalties, imprisonment, disgorgement of profits, debarment from government contracts and curtailment of operations in certain jurisdictions, and might materially adversely affect our business, financial condition, results of operations or prospects. In addition, actual or alleged violations could damage our reputation and diminish our ability to do business. Furthermore, detecting, investigating, and resolving actual or alleged violations is expensive and can consume significant time and attention of our senior management.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of our operations should be read in conjunction with Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from such forward-looking statements. Factors that could cause or contribute to those differences include, but are not limited to, those identified below and those discussed in the section titled “Cautionary Note Regarding Forward-Looking Statements” and in Part I, Item 1A, “Risk Factors” in this Annual Report. Unless otherwise indicated or the context otherwise requires, all references to the “Company,” “Evoqua,” “Evoqua Water Technologies Corp.,” “we,” “us,” “our,” and similar terms refer to Evoqua Water Technologies Corp., together with its consolidated subsidiaries. Unless otherwise specified, all dollar amounts in this section are referred to in millions. Our fiscal year ends on September 30 of each year and references in this section to a year refer to our fiscal year. As such, references to: 2022 relates to the fiscal year ended September 30, 2022, 2021 relates to the fiscal year ended September 30, 2021, and 2020 relates to the fiscal year ended September 30, 2020.

Overview and Background

We are a leading provider of mission-critical water and wastewater treatment solutions, offering a broad portfolio of products, services, and expertise to support customers across various end markets. We are headquartered in Pittsburgh, Pennsylvania, with locations across nine countries. We have a comprehensive portfolio of differentiated, proprietary technologies offered under market‑leading and well‑established brands. Our core technologies are primarily focused on removing impurities from water, rather than neutralizing them through the addition of chemicals.

Our solutions are designed to provide our customers with the quantity and quality of water necessary to meet their unique specifications. We enable our customers to achieve lower costs through greater uptime, throughput and efficiency in their operations while supporting their regulatory compliance and environmental requirements. We deliver and maintain these mission critical solutions through our extensive North American service network, providing our customers continuous uptime with 119 service branches as of September 30, 2022. In addition, we sell our products and technologies internationally through direct and indirect sales channels. We have worked to protect water, the environment, and our employees for more than 100 years. As a result, we have earned a reputation for quality, safety, and reliability around the world. Our employees are united by a common purpose: Transforming water. Enriching life.®

Our vision “to be the world’s first choice for water solutions” and our values of “integrity, customers, sustainable, and performance” foster a culture that is focused on establishing a workforce that is enabled, empowered, and accountable, creating a highly dynamic work environment.

We serve our customers through the following two reportable segments:

• Integrated Solutions and Services segment, which provides application-specific solutions and full lifecycle services for critical water and wastewater applications across numerous end markets, including outsourced water service contracts, capital systems and related recurring aftermarket services, parts and consumables, and emergency services to enable recycle and reuse, improve operational reliability and performance, and promote environmental compliance; and

• Applied Product Technologies segment, which provides highly differentiated and scalable water and wastewater products and technologies as stand-alone offerings or components in integrated solutions to a diverse set of system integrators and end-users globally.

Our segments draw from the same reservoir of leading technologies, shared manufacturing infrastructure, common business processes, and corporate philosophies. The key factors used to identify these reportable operating segments are the organization and alignment of our internal operations, the nature of the products and services and customer type.

For the years ended September 30, 2022 and 2021, our segments accounted for the following percentage of our revenue:

Integrated Solutions and Services segment

Applied Product Technologies segment

Recent Developments, Key Factors, and Trends Affecting Our Business and Financial Statements

The following recent developments have affected our business and operating results during the year ended September 30, 2022:

Macroeconomic conditions. Material, freight, and labor inflation resulted in increased costs in fiscal 2022, and we expect this trend will continue into fiscal 2023. Although we have offset a portion of these increased costs through price increases and operational efficiencies to date, our margin percentage has been negatively impacted. There can be no assurance that we will be able to continue to offset all or any portion of these increased costs. If we are unable to manage commodity fluctuations through pricing actions, cost savings projects, and sourcing decisions as well as through consistent productivity improvements, it may adversely impact our gross profit and gross margin in future periods. Additionally, supply chain disruptions and labor shortages have restricted and could further restrict availability of certain commodities and materials, which may result in delays in our execution of projects in fiscal 2023 and negatively impact revenues. Tight labor markets have resulted in longer times to fill open positions and labor inflation. Continued delays in filling open positions, particularly among our service technician population, could impact our ability to provide timely service to our customers. Although these factors did not have a material adverse effect on our results of operations for the year ended September 30, 2022, if sustained, they could have a material adverse effect on our results of operations going forward.

In an effort to combat inflation, central banks began raising interest rates in the latter half of fiscal 2022, and interest rates are expected to continue to increase in fiscal 2023. We do not believe that our exposure to rising interest rates in the near term will have a material impact on our business, financial condition, results of operations, or prospects, but if sustained over longer periods, this could have a material adverse effect on our results of operations. We plan to continue to evaluate aspects of our spending, including capital expenditures, discretionary spending, and strategic investments in fiscal 2023.

Impact of the COVID-19 pandemic . We continue to monitor the ongoing effects of the COVID-19 pandemic, particularly as shutdowns and restrictions in parts of China have continued in response to the spread of COVID-19 variants. These shutdowns and restrictions did not have a material adverse effect on our operations or financial results for the year ended September 30, 2022. However, if the duration of these shutdowns and restrictions extends, or if similar shutdowns and restrictions are imposed in other regions, it could impact our sales into those regions and our ability to source materials from those regions.

Russia-Ukraine war. We have no operations in Russia or Ukraine, and our sales into these regions are minimal. However, the conflict in Ukraine has exacerbated the material inflation and availability challenges described above, particularly with respect to the impact it has had on energy and fuel prices and the price of steel and other precious metals that we procure in our supply chain. Although these factors did not have a material adverse effect on our results of operations for the year ended September 30, 2022, we expect the inflationary impact on energy, fuel and steel prices to continue throughout fiscal 2023. If these factors are sustained, or if the duration of the conflict is extended or the conflict spreads into a larger geographic portion of Europe, our results of operations in future periods could be materially and adversely impacted.

Acquisitions and divestitures . On January 3, 2022, we acquired the Mar Cor Business for approximately $195.0 million paid in cash at closing, following adjustments. We utilized cash on hand and borrowed an additional $160.0 million

under our 2021 Revolving Credit Facility (a multi-currency senior secured revolving credit facility in an aggregate principal amount not to exceed the U.S. dollar equivalent of $350.0 million) to fund the acquisition. The purchase price included a $12.3 million earn out, which is being held in escrow and will be paid, pro rata, to the sellers if the Mar Cor Business meets certain sales performance goals (the “Earn Out”). Any portion of the Earn Out not paid to the sellers during the first year following closing of the transaction will be returned to us. The Mar Cor Business is a leading manufacturer and servicer of medical water, commercial and industrial solutions in North America. Headquartered in Plymouth, Minnesota, the Mar Cor Business offers significant technical expertise in designing, building, and servicing high-purity water treatment systems. The addition of this business expands our service footprint in North America, furthering our reach into the healthcare vertical market. During the year ended September 30, 2022, we incurred approximately $4.9 million in acquisition costs, which are included in General and administrative expense on the Consolidated Statements of Operations. Additionally, we expect to incur between $18.0 million to $20.0 million in one-time integration costs within the next 18 to 24 months. The Mar Cor Business is included within the Integrated Solutions and Services segment.

On January 31, 2022, we completed the divestiture of certain resin regeneration assets in Germany (the “Germany Regen Business”) for approximately $0.4 million in cash at closing, resulting in a gain of $0.2 million recognized on the sale. The Germany Regen Business was a part of the Applied Product Technologies segment.

On April 1, 2022, we acquired the remaining 32% equity interest in Frontier Water Systems, LLC (“Frontier”) for an aggregate purchase price of approximately $10.4 million, making Frontier a wholly-owned subsidiary of the Company. This followed our initial acquisition of a 60% equity interest in Frontier in October 2019 and our acquisition of an additional 8% equity interest in Frontier in April 2021. San Diego-based Frontier is a leading supplier of engineered equipment packages for high-rate treatment of selenium, nitrate, and metals in water and wastewater. The business adds to Evoqua’s portfolio of advanced wastewater treatment technologies and is part of our Integrated Solutions and Services segment.

Also on April 1, 2022, we acquired the remaining 50% partnership interest in Treated Water Outsourcing, a joint venture between the Company and Nalco Water, an Ecolab company (“Nalco”), from Nalco for an aggregate purchase price of approximately $1.1 million.

On July 1, 2022, we completed the acquisition of Smith Engineering, Inc. (“Smith Engineering”) for approximately $18.9 million cash paid at closing. Smith Engineering is a leader in the design, manufacturing, and service of custom high purity water treatment equipment serving the biotech/pharmaceutical, data center, food and beverage, healthcare, medical device, and microelectronics markets. With over 1,200 customers in North America, Smith Engineering offers a variety of water treatment products and services, including filtration, UV, reverse osmosis, and deionization. Smith Engineering is part of our Integrated Solutions and Services segment.

On July 15, 2022, we completed the acquisition of Epicor, Inc. (“Epicor”) for $4.3 million cash paid at closing. Epicor has supplied specialty resins for power steam system treatment for fifty years. The resins provide a cost-effective and efficient method for creating and maintaining a continual supply of ultra-pure water for power plants. Epicor is part of our Integrated Solutions and Services segment.

How We Assess the Performance of Our Business

In assessing the performance of our business, we consider a variety of performance and financial measures. The key indicators of the financial condition and operating performance of our consolidated business are revenue, gross profit, gross margin, and net income (loss). Management utilizes these financial measures prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) when reviewing the Company’s performance and making financial, operational, and strategic decisions, and believes they are useful metrics for investors that help with performance comparability period over period. In addition, we consider certain non-GAAP financial measures such as adjusted EBITDA, as described more fully below. We evaluate our business segments’ operating results based on revenue, income from operations (“operating profit”) and adjusted EBITDA on a segment basis. We believe these financial measures are helpful in understanding and evaluating the segments’ core operating results and facilitates comparison of our performance on a consistent basis period over period.

Revenue

Our revenue is a function of sales volumes and selling prices. We report revenue by segment and by source which includes revenue from product sales (capital and aftermarket) and revenue from service. Revenue is used by management to evaluate the performance of our business. Revenue growth is primarily related to organic and inorganic factors. Organic revenue growth, as a component of revenue growth, is defined as period over period revenue growth excluding (i) the impact from acquisitions and divestitures during the first 12 months following the closing of the acquisition or divestiture, which we refer to as inorganic impact, and (ii) the impact of foreign currency translation. Divestitures include sales of insignificant portions of our business that did not meet the criteria for classification as a discontinued operation. We exclude the effect of foreign currency translation from organic revenue growth because foreign currency translation is not under management’s control, is subject to volatility and can obscure underlying business trends. We exclude the effect of acquisitions and divestitures during the first 12 months following the closing of the acquisition or divestiture because they can obscure underlying business trends and make comparisons of long-term performance difficult between the Company and its peers due to the varying nature, size, and number of transactions from period to period.

EBITDA and Adjusted EBITDA

EBITDA, which is a non-GAAP financial measure, is defined as earnings before interest, taxes, depreciation and amortization expense. Adjusted EBITDA, which is a non-GAAP financial measure, is one of the primary metrics used by management to evaluate the strength and financial performance of our core business. Adjusted EBITDA is defined as net income (loss) before interest expense, income tax benefit (expense) and depreciation and amortization, adjusted for the impact of certain other items, including restructuring and related business transformation costs, share-based compensation, transaction costs, and other gains, losses, and expenses that we believe do not directly reflect our underlying business operations. We present adjusted EBITDA because we believe it is frequently used by analysts, investors, and other interested parties to evaluate and compare operating performance and value companies within our industry. Further, we believe it is helpful in highlighting trends in our operating results and provides greater clarity and comparability period over period to management and our investors regarding the operational impact of long-term strategic decisions regarding capital structure, the tax jurisdictions in which we operate, and capital investments. In addition, adjusted EBITDA highlights true business performance by removing the impact of certain items that management believes do not directly reflect our underlying operations and provides investors with greater visibility into the ongoing drivers of our business performance.

Management uses adjusted EBITDA to supplement GAAP measures of performance as follows:

• to assist investors and analysts in comparing our operating performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance;

• in our management incentive compensation, which is based in part on components of adjusted EBITDA;

• in certain calculations under our senior secured credit facilities, which use components of adjusted EBITDA;

• to evaluate the effectiveness of our business strategies;

• to make budgeting decisions; and

• to compare our performance against that of other peer companies using similar measures.

In addition to the above, our chief operating decision maker uses adjusted EBITDA of each reportable operating segment as a supplement to segment income from operations and segment revenue to evaluate the operating performance of such segments. Adjusted EBITDA on a segment basis is defined as earnings before depreciation and amortization, adjusted for the impact of certain other items that have been reflected at the segment level. Adjusted EBITDA of the reportable operating segments do not include certain charges that are presented within corporate activities. These charges include certain restructuring and other business transformation charges that have been incurred to align and reposition the Company to the current reporting structure, acquisition related costs (including transaction costs and integration costs) and share-based compensation charges.

EBITDA and Adjusted EBITDA should not be considered substitutes for, or superior to, financial measures prepared in accordance with GAAP. The financial results prepared in accordance with GAAP and the reconciliations from these results should be carefully evaluated. See “Non-GAAP Reconciliations” in this Item 7 for a reconciliation of EBITDA and adjusted EBITDA to net income. You are encouraged to evaluate each adjustment and the reasons we consider it appropriate for supplemental analysis. In addition, in evaluating adjusted EBITDA, you should be aware that in the future, we may incur expenses similar to the adjustments in the presentation of adjusted EBITDA. Our presentation of adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. In addition, other companies in our industry or across different industries may calculate adjusted EBITDA differently.

Basis of Presentation

The discussion that follows includes a comparison of our results of operations and liquidity and capital resources for the fiscal years ended September 30, 2022 and 2021. For a discussion of changes from the fiscal year ended September 30, 2021 to the fiscal year ended September 30, 2020, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operation in Part II, Item 7 of our Annual Report on Form 10-K for the year ended September 30, 2021 (filed November 17, 2021).

Results of Operations

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

Year Ended September 30,

Variance

(In millions, except per share amounts)

% of Revenue

% of Revenue

Revenue from product sales and services

Gross profit

Total operating expenses

Other operating income, net

Interest expense

Income before income taxes

Income tax benefit (expense)

Net income

Net income attributable to non‑controlling interest

Net income attributable to Evoqua Water Technologies Corp.

Weighted average shares outstanding

Basic

Diluted

Earnings per share

Basic

Diluted

Other financial data:

Adjusted EBITDA (1)

(1) Adjusted EBITDA is a non-GAAP financial measure. For the definition of Adjusted EBITDA and a reconciliation to net income (loss), its most directly comparable financial measure presented in accordance with GAAP, see “Non-GAAP Reconciliations” in this Item 7.

Years Ended September 30, 2022 and September 30, 2021

Consolidated Results

Revenue -Revenue increased $272.7 million, or 18.6%, to $1,737.1 million in the year ended September 30, 2022, from $1,464.4 million in the prior year. Revenue from product sales increased $191.5 million, or 22.2%, to $1,052.5 million in the year ended September 30, 2022, from $861.0 million in the prior year. Revenue from services increased $81.2 million, or 13.5%, to $684.6 million in the year ended September 30, 2022, from $603.4 million in the prior year.

The following tables provide the change in revenue by offering and the components that contributed to revenue growth during the years ended September 30, 2022 and 2021:

Year Ended September 30,

$ Variance

% Variance

(In millions)

Revenue

Revenue

Revenue from product sales:

Capital

Aftermarket

Revenue from services

(In millions)

$ Change

% Change

Year ended September 30, 2021 total revenue

Organic

Inorganic

Foreign currency translation

Year ended September 30, 2022 total revenue

Revenue growth due to organic revenue related primarily to improved price realization and higher volume for products and services across most product lines and all regions. The North America and Asia Pacific regions contributed to strong organic revenue growth in service, capital, and aftermarket across most end markets.

Revenue in future periods could be negatively impacted by commodity and material availability constraints caused by global supply chain disruptions, skilled labor shortages, and the timing of projects based on potential deferrals of orders due to rising interest rates or recessionary conditions.

Cost of Sales and Gross Margin -Total gross margin decreased to 30.9% in the year ended September 30, 2022, from 31.2% in the prior year. The following table provides the change in cost of product sales and cost of services, respectively, along with related gross margins:

Year Ended September 30,

Gross

Margin %

Gross

Margin %

Cost of product sales

Cost of services

Gross margin from product sales increased by 20 bps to 29.6% in the year ended September 30, 2022, from 29.4% in the prior year. The increase in gross margin was primarily driven by favorable price realization and product mix. These factors were partially offset by labor, material and freight inflation.

Gross margin from services decreased by 110 bps to 32.7% in the year ended September 30, 2022, from 33.8% in the prior year. This decrease was driven by increased labor costs and resource constraints.

We expect continued pressure on gross margin in future periods due to material, freight and labor inflation. Although we expect to continue to partially offset those increasing costs with positive price realization, there can be no assurance that we will be able to do so.

Operating Expenses -Operating expenses increased $74.3 million, or 20.5%, to $437.3 million in year ended September 30, 2022 from $363.0 million in the prior year. Operating expenses are comprised of the following:

Year Ended September 30,

(In millions)

% of Revenue

% of Revenue

% Variance

General and administrative expense

Sales and marketing expense

Research and development expense

Total operating expenses

The increase period over period in operating expenses was primarily due to higher employee related costs associated with acquisitions, share-based compensation, and wage inflation. Additionally, non-cash foreign currency translation losses of $18.7 million in the current year, compared to foreign currency translation gains of $0.9 million in the prior year, mostly related to intercompany loans contributed to this increase. In addition, there were increased consulting, marketing and travel expenses, and increased amortization expense due to acquisitions in the current period compared to the prior period. The above increases were partially offset by a decrease in external legal fees compared to the prior period, as well as a benefit in the current period related to changes in the estimate of the Mar Cor Business achieving the earn-out target.

Fluctuations in foreign currency translation and inflation could impact operating expenses in future periods.

Other Operating Income, Net -Other operating income, net, increased $0.3 million, to $5.3 million in the year ended September 30, 2022, from $5.0 million in the prior year. This increase was driven by income from precious metal sales, mainly from scrapped anodes in China, as well as gains on the disposal of fixed assets compared to the prior period. Additionally, we received a refund from the Chinese government in the current period of certain taxes paid, which partially offset COVID-19 pandemic subsidies received from the Canadian government in the prior period, which did not reoccur in the current period.

Interest Expense -Interest expense decreased $2.8 million, or 7.5%, to $34.7 million in the year ended September 30, 2022, from $37.5 million in the prior year. The decrease in interest expense was primarily driven by a $100.0 million debt prepayment in conjunction with the April 2021 refinancing of our senior credit facility. As a result of the April 2021 refinancing, an additional $3.1 million of fees and a write off of $1.3 million of deferred financing fees were incurred in the prior period. This decrease was partially offset by a charge to interest expense of $2.1 million from a fair value increase in the purchase right liability to acquire the remaining equity interest of Frontier in the current period, as well as an increase in interest expense associated with higher outstanding debt that had a higher interest rate spread and LIBOR year over year.

Fluctuations in interest rates could impact interest expense in future periods.

Income Tax Expense -Income tax benefit was $3.0 million for the year ended September 30, 2022, compared to expense of $10.1 million in the prior year. The decrease in tax expense was primarily attributable to a reversal of the U.S.

valuation allowance, a benefit of $17.3 million, which was partially offset by an increase in foreign tax expense due to improved profitability in certain countries.

Net Income -Net income increased by $20.6 million, or 39.8%, to net income of $72.3 million for the year ended September 30, 2022, from $51.7 million in the prior year, as a result of the variances noted above.

Adjusted EBITDA -Adjusted EBITDA is a non-GAAP financial measure. Adjusted EBITDA increased $46.8 million, or 18.7%, to $297.7 million for the year ended September 30, 2022, from $250.9 million for the prior year, primarily driven by sales volume and related gross profit. See “Non-GAAP Reconciliations” in this Item 7 for a reconciliation of adjusted EBITDA to net income.

Segment Results

Year Ended September 30,

(In millions)

% of Total

% of Total

% Variance

Revenue

Integrated Solutions and Services

Applied Product Technologies

Total Consolidated

Operating profit (loss)

Integrated Solutions and Services

Applied Product Technologies

Corporate

Total Consolidated

Adjusted EBITDA (1)

Integrated Solutions and Services

Applied Product Technologies

Corporate

Total Consolidated

(1) Adjusted EBITDA is a non-GAAP financial measure. For a reconciliation of segment adjusted EBITDA to segment operating profit (loss), its most directly comparable financial measure presented in accordance with GAAP, see “Non-GAAP Reconciliations” in this, Item 7.

Integrated Solutions and Services

Revenue in the Integrated Solutions and Services segment increased $224.6 million, or 23.4%, to $1,184.5 million in the year ended September 30, 2022, from $959.9 million in the year ended September 30, 2021. The following tables provide the change in revenue by offering and the components that contributed to revenue growth during the years ended September 30, 2022 and 2021 for the Integrated Solutions and Services segment:

Year Ended September 30,

$ Variance

% Variance

(In millions)

Revenue

Revenue

Revenue from product sales:

Capital

Aftermarket

Revenue from services

(In millions)

$ Change

% Change

Year ended September 30, 2021 total revenue

Organic

Inorganic

Foreign currency translation

Year ended September 30, 2022 total revenue

Revenue growth due to organic revenue related to positive price realization and higher sales volume across service, capital and aftermarket in a variety of end markets. Service revenue was the largest contributor to organic revenue growth, with the largest growth coming from price realization, primarily in the light and general industry, chemical processing and mining, and life sciences end markets.

Operating profit in the Integrated Solutions and Services segment increased $18.3 million, or 12.4%, to $165.6 million in the year ended September 30, 2022, from $147.3 million in the year ended September 30, 2021.

Operating profit growth was driven by favorable price realization and sales volume. These increases were partially offset by operational variances, including material, fuel, and freight inflation, and labor inflation. Also, COVID-19 pandemic

subsidies received from the Canadian government in the prior year did not reoccur in the current year. Employee related expenses increased due to inflation and sales incentive compensation.

Adjusted EBITDA is a non-GAAP financial measure. Adjusted EBITDA in the Integrated Solutions and Services segment increased $39.7 million, or 18.1%, to $259.0 million in the year ended September 30, 2022, compared to $219.3 million in the year ended September 30, 2021. The increase was driven by the same factors that impacted operating profit, other than the change in depreciation and amortization, and also excludes restructuring and other non-recurring activity. See “Non-GAAP Reconciliations” in this Item 7 for a reconciliation of segment adjusted EBITDA to segment operating profit.

Applied Product Technologies

Revenue in the Applied Product Technologies segment increased $48.1 million, or 9.5%, to $552.6 million in the year ended September 30, 2022, from $504.5 million in the year ended September 30, 2021. The following tables provide the change in revenue by offering and the components that contributed to revenue growth during the years ended September 30, 2022 and 2021 for the Applied Product Technologies segment:

Year Ended September 30,

$ Variance

% Variance

(In millions)

Revenue

Revenue

Revenue from product sales:

Capital

Aftermarket

Revenue from services

(In millions)

$ Change

% Change

Year ended September 30, 2021 total revenue

Organic

Inorganic

Foreign currency translation

Year ended September 30, 2022 total revenue

Revenue growth due to organic revenue related to improved price realization and higher volume, across all regions, particularly in the North America and Asia Pacific regions. Unfavorable foreign currency translation primarily affected the Europe, Middle East, and Africa region.

Operating profit in the Applied Product Technologies segment increased $20.2 million, or 24.4%, to $103.1 million in the year ended September 30, 2022, from $82.9 million in the year ended September 30, 2021.

The increase in operating profit was driven by price realization, higher sales volumes, and favorable mix across all regions and multiple product lines. These benefits were partially offset by unfavorable operational variances, including increased costs associated with logistics, labor, and material inflation and availability. Employee related expenses increased due to inflation and sales incentive compensation.

Adjusted EBITDA is a non-GAAP financial measure. Adjusted EBITDA in the Applied Product Technologies segment increased $14.0 million, or 13.2%, to $119.7 million in the year ended September 30, 2022, compared to $105.7 million in the year ended September 30, 2021. The increase was driven by the same factors that impacted operating profit, other than the change in depreciation and amortization, and also excludes restructuring and other non-recurring activity. See “Non-GAAP Reconciliations” in this Item 7 for a reconciliation of segment adjusted EBITDA to segment operating profit.

Corporate

Operating loss in Corporate increased $33.8 million, or 25.8%, to $164.7 million in the year ended September 30, 2022, from $130.9 million in the year ended September 30, 2021. The increase was primarily due to foreign currency translation losses in the current period, compared to foreign currency translation gains in the prior period, most of which is related to intercompany loans. Additionally, there were increased employment expenses, including share-based compensation. These were partially offset by lower costs associated with legal matters in the current year.

Non-GAAP Reconciliations

The following is a reconciliation of our Net income to EBITDA and adjusted EBITDA. See “How We Assess the Performance of Our Business” in this Item 7 for discussion on management’s definition and use of this non-GAAP financial measure.

Year Ended September 30,

(In millions)

% Variance

Net income

Income tax (benefit) expense

Interest expense

Operating profit

Depreciation and amortization

EBITDA

Restructuring and related business transformation costs (a)

Purchase accounting adjustment costs (b)

Share-based compensation (c)

Transaction costs (d)

Other losses (gains) and expenses (e)

Adjusted EBITDA

(a) Restructuring and related business transformation costs

Adjusted EBITDA is calculated prior to considering certain restructuring or business transformation events. These events may occur over extended periods of time and in some cases, it is reasonably possible that events of a similar nature could reoccur in future periods based on reorganizations of the business, cost reduction or productivity improvement needs, or in response to economic conditions. For the periods presented such events include the following:

(i) Certain costs and expenses in connection with various restructuring initiatives, including severance and other employee-related costs, relocation and facility consolidation costs, and third-party consultant costs to assist with these initiatives. This includes:

(A) amounts related to the Company’s restructuring initiatives to reduce the cost structure and rationalize location footprint following the sale of the Memcor product line;

(B) amounts related to the Company’s transition from a three-segment structure to a two-segment operating model designed to better serve the needs of customers worldwide; and

(C) amounts related to various other initiatives implemented to restructure and reorganize our business with the appropriate management team and cost structure.

(ii) Legal settlement costs and intellectual property related fees, including fees and settlement costs associated with legacy matters related to product warranty litigation on MEMCOR® products and certain discontinued products.

(iii) Expenses associated with our information technology and functional infrastructure transformation, including activities to optimize information technology systems and functional infrastructure processes.

(iv) Costs associated with the secondary public offering of common stock held by certain shareholders of the Company, as well as costs incurred by us in connection with establishment of our public company compliance structure and processes, including consultant costs.

(b) Purchase accounting adjustment costs

Adjusted EBITDA is calculated prior to considering adjustments for the effect of the purchase accounting step-up in the value of inventory to fair value recognized in cost of goods sold as a result of the acquisition of the Mar Cor Business. See Note 4, “Acquisitions,” in Part II, Item 8 of this Report for further detail.

(c) Share-based compensation

Adjusted EBITDA is calculated prior to considering share‑based compensation expenses related to equity awards. See Note 18, “Share-Based Compensation” in Part II, Item 8 of this Annual Report for further detail.

(d) Transaction related costs

Adjusted EBITDA is calculated prior to considering transaction, integration and restructuring costs associated with business combinations because these costs are unique to each transaction and represent costs that were incurred as a result of the transaction decision. Integration and restructuring costs associated with a business combination may occur over several years and include, but are not limited to, consulting fees, legal fees, certain employee-related costs, facility consolidation and product rationalization costs, and fair value changes associated with contingent consideration.

(e) Other losses, (gains) and expenses

Adjusted EBITDA is calculated prior to considering certain other significant losses, (gains), and expenses. For the periods presented such events include the following:

(i) impact of foreign exchange gains and losses;

(ii) charges incurred by the Company related to product rationalization in its electrochlorination business;

(iii) amounts related to the sale of the Memcor product line;

(iv) expenses incurred by the Company as a result of the COVID-19 pandemic, including additional charges for personal protective equipment, increased costs for facility sanitization and one-time payments to certain employees;

(v) legal fees incurred in excess of amounts covered by the Company’s insurance related to securities litigation and SEC investigation matters; and

(vi) loss on divestiture of the Lange Product Line.

We do not present net income on a segment basis because we do not allocate interest expense or income tax benefit (expense) to our segments, making operating profit the most comparable GAAP metric. The following is a reconciliation of our segment EBITDA and segment adjusted EBITDA to segment operating profit, their most directly comparable financial measure presented in accordance with GAAP:

Year Ended September 30,

$ Variance

% Variance

Integrated Solutions and Services

Applied Product Technologies

Integrated Solutions and Services

Applied Product Technologies

Integrated Solutions and Services

Applied Product Technologies

Integrated Solutions and Services

Applied Product Technologies

Operating profit

Depreciation and amortization

EBITDA

Restructuring and related business transformation costs (a)

Purchase accounting adjustment costs (b)

Transaction costs (c)

Other (gains) losses and expenses (d)

Segment adjusted EBITDA

(a) Represents costs and expenses in connection with restructuring initiatives. Such expenses are primarily composed of severance, relocation, and facility consolidation costs.

(b) Represents adjustments for the effect of the purchase accounting step-up in the value of inventory to fair value recognized in cost of goods sold as a result of the acquisition of the Mar Cor Business, as well as other transaction related costs for acquisitions made in the current period.

(c) Represents costs associated with a change in the current estimate of certain acquisitions achieving their earn-out targets as well as other costs associated with acquisitions completed during the period.

(d) Other losses, (gains) and expenses as discussed above, distinct to our Integrated Solutions and Services and Applied Product Technologies segments include the following:

(i) trailing costs from the sale of the Memcor product line;

(ii) charges incurred by the Company related to product rationalization in its electro-chlorination business; and

(iii) loss on divestiture of the Lange product line.

Liquidity and Capital Resources

Liquidity describes the ability of a company to borrow or generate sufficient cash flows to meet the cash requirements of its business operations, including working capital needs, debt service, acquisitions, other commitments, and contractual obligations. Our principal sources of liquidity are cash generated by our operating activities, borrowings under the 2021 Revolving Credit Facility and financing arrangements related to capital expenditures for equipment used to provide services to our customers. Historically, we have financed our operations primarily from these sources. Our primary cash needs are for day-to-day operations, to pay interest and principal on our indebtedness, to fund working capital requirements and to make capital expenditures.

Our ability to fund our capital needs depends on our ongoing ability to generate cash from operations and access bank financing and the capital markets. In support of international operations, portions of our cash balances are held in various currencies and may be subject to foreign currency translation and other costs associated with repatriation, if necessary. Neither moderate increases in net working capital nor macroeconomic conditions have materially impacted our liquidity to date. In addition, we do not believe that our exposure to rising interest rates will have a material impact on our business, financial condition, results of operations, or prospects, and we plan to continue to evaluate aspects of our spending, including capital expenditures, discretionary spending, and strategic investments in fiscal 2023. We believe we are currently well-positioned to manage our business and have the ability and sufficient capacity to meet our cash requirements by using available cash, internally generated funds, and borrowing under the 2021 Revolving Credit Facility.

As part of our ongoing efforts to improve our cash flow and related liquidity, we work with suppliers to optimize our terms and conditions, including occasionally extending payment terms. We also facilitate a voluntary supply chain finance program (the “program”) to provide certain of our suppliers with the opportunity to sell receivables due from us to participating financial institutions at the sole discretion of both the suppliers and the financial institutions. A third party administers the program; our responsibility is limited to making payments on the terms originally negotiated with our supplier, regardless of whether the supplier sells its receivable to a financial institution. We do not enter into agreements with any of the participating financial institutions in connection with the program. The range of payment terms we negotiate with our suppliers is consistent, irrespective of whether a supplier participates in the program. The amounts settled through the program and paid to participating financial institutions were $92.9 million and $42.0 million in the year ended September 30, 2022 and 2021, respectively. A downgrade in our credit rating or changes in the financial markets could limit the financial institutions’ willingness to commit to participating in the program.

We expect to continue to finance our liquidity requirements through internally generated funds and borrowings under the 2021 Revolving Credit Facility. We believe that our projected cash flows generated from operations, together with borrowings under the 2021 Revolving Credit Facility and other financing arrangements are sufficient to fund our short-term and long-term principal debt payments, interest expense, working capital needs, and expected capital expenditures. Our capital expenditures for the year ended September 30, 2022 and 2021 were $82.0 million and $75.3 million, respectively. However, our budgeted capital expenditures can vary from period to period based on the nature of capital intensive project awards. Our focus on customer outsourced water projects will continue to be a driver of capital expenditures. From time to time, we may enter into financing arrangements related to capital expenditures for equipment used to provide services to our customers. During the years ended September 30, 2022 and 2021, we entered into equipment financing arrangements totaling $36.4 million and $37.5 million, respectively. In addition, we may draw on the 2021 Revolving Credit Facility from time to time to fund or partially fund an acquisition.

As of September 30, 2022, we had total indebtedness of $890.7 million, including $469.1 million of term loan borrowings under the 2021 Credit Agreement, $151.3 million outstanding under the 2021 Revolving Credit Facility, $150.2 million outstanding under the Securitization Facility which includes $0.2 million of accrued interest and $120.2 million in borrowings related to equipment financing. We also had $9.3 million of letters of credit issued under our 2021 Revolving Credit Facility as of September 30, 2022.

As of September 30, 2022 and September 30, 2021, we were in compliance with the covenants contained in the 2021 Credit Agreement, including the 2021 Revolving Credit Facility.

2021 Credit Agreement

On April 1, 2021, EWT III entered into a Credit Agreement (the “2021 Credit Agreement”) among EWT III, as borrower, EWT II, as parent guarantor, the lenders from time to time party thereto, JPMorgan Chase Bank, N.A., as administrative agent and collateral agent, and ING Capital, LLC, as sustainability coordinator. The 2021 Credit Agreement provides for a multi-currency senior secured revolving credit facility in an aggregate principal amount not to exceed the U.S. dollar equivalent of $350.0 million (the “2021 Revolving Credit Facility”) and a discounted senior secured term loan (the “2021 Term Loan”) in the amount of $475.0 million (together with the 2021 Revolving Credit Facility, the “Senior Facilities”). The 2021 Credit Agreement also provides for a letter of credit sub-facility not to exceed $60.0 million.

The 2021 Credit Agreement contains customary representations, warranties, affirmative covenants, and negative covenants, including, among other things, a springing maximum first lien leverage ratio of 5.55 to 1.00. The Company did not exceed this ratio during the year ended September 30, 2022, does not anticipate exceeding this ratio during the year ending September 30, 2023, and therefore does not anticipate any additional repayments during the year ending September 30, 2023.

Receivables Securitization Program

On April 1, 2021, Evoqua Finance LLC (“Evoqua Finance”), an indirect wholly-owned subsidiary of the Company, entered into an accounts receivable securitization program (the “Receivables Securitization Program”) consisting of, among other agreements, (i) a Receivables Financing Agreement (the “Receivables Financing Agreement”) among Evoqua Finance, as the borrower, the lenders from time to time party thereto (the “Receivables Financing Lenders”), PNC Bank, National Association (“PNC Bank”), as administrative agent, EWT LLC, as initial servicer, and PNC Capital Markets LLC (“PNC Markets”), as structuring agent, pursuant to which the lenders have made available to Evoqua Finance a receivables finance facility (the “Securitization Facility”) in an amount up to $150.0 million and (ii) a Sale and Contribution Agreement (the “Sale Agreement”) among Evoqua Finance, as purchaser, EWT LLC, as initial servicer and as an originator, and Neptune Benson, Inc., an indirectly wholly-owned subsidiary of the Company, as an originator (together with EWT LLC, the “Originators”). Under the Receivables Securitization Program, the Originators, pursuant to the Sale Agreement, are required to sell substantially all of their domestic trade receivables and certain related rights to payment and obligations of the Originators with respect to such receivables (the “Receivables”) to Evoqua Finance, which, in turn, will obtain loans secured by the Receivables from the Receivables Financing Lenders pursuant to the Receivables Financing Agreement. The Receivables underlying any borrowings will continue to be included in Accounts receivable, net, in the Consolidated Balance Sheets of the Company.

The Receivables Securitization Program contains certain customary representations, warranties, affirmative covenants, and negative covenants, subject to certain cure periods in some cases, including the eligibility of the Receivables being sold by the Originators and securing the loans made by the Receivables Financing Lenders, as well as customary reserve requirements, events of default, termination events, and servicer defaults. The Company was in compliance with all covenants during the year ended September 30, 2022, does not anticipate becoming noncompliant during fiscal 2023, and therefore, subject to collateral availability, does not anticipate any additional repayments during fiscal 2023.

Contractual Obligations

We enter into long‑term obligations and commitments in the normal course of business, primarily debt obligations and non‑cancelable operating leases. As of September 30, 2022, our contractual cash obligations over the next several periods were as follows:

(In millions)

Total

Less than

1 year

3 years

5 years

More than

5 years

Long‑term debt obligations (a)

Interest payments on long‑term debt obligations

Operating lease commitments (b)

Finance lease commitments (c)

Total

(a) The amounts shown in this table do not include any net reductions for deferred financing fees. The amounts for current and long-term debt shown on the Consolidated Balance Sheets are net of deferred financing fees.

(b) We occupy certain facilities and operate certain equipment and vehicles under non‑cancelable lease arrangements. Lease agreements may contain lease escalation clauses and purchase and renewal options. We recognize scheduled lease escalation clauses over the course of the applicable lease term on a straight‑line basis.

(c) We lease certain equipment classified as finance leases. The leased equipment is depreciated on a straight line basis over the life of the lease and is included in depreciation expense.

Evoqua Water Technologies Corp. is a holding company and does not conduct any business operations of its own. As a result, our ability to pay cash dividends on our common stock, if any, is dependent upon cash dividends and distributions and other transfers from our operating subsidiaries. Under the terms of the 2021 Credit Agreement, our operating subsidiaries are currently limited in their ability to pay cash dividends to us, and we expect these limitations to continue in the future under the terms of any future credit agreement or any future debt or preferred equity securities of ours or of our subsidiaries.

Our indebtedness could adversely affect our ability to raise additional capital, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk and prevent us from meeting our obligations. See Part I, Item 1A, “Risk Factors-Our substantial indebtedness could adversely affect our financial condition and limit our ability to raise additional capital to fund our operations.”

Cash Flows

The following table summarizes the changes to our cash flows for the periods presented:

Year Ended September 30,

(In millions)

Statement of Cash Flows Data

Net cash provided by operating activities

Net cash (used in) provided by investing activities

Net cash provided by (used in) financing activities

Effect of exchange rate changes on cash

Change in cash and cash equivalents

Operating Activities

Cash flows from operating activities can fluctuate significantly from period‑to‑period as working capital needs and the timing of payments for restructuring activities and other items impact reported cash flows.

Net cash provided by operating activities increased to $181.4 million in the year ended September 30, 2022 from $178.7 million in the year ended September 30, 2021.

• Operating cash flows in the year ended September 30, 2022 reflect an increase in net income of $20.7 million from the year ended September 30, 2021.

• The add back of non‑cash charges increased operating cash flows by $153.4 million for the year ended September 30, 2022 as compared to an increase to operating cash flows of $130.5 million for the year ended September 30, 2021, resulting in an increase of $22.9 million. This increase was primarily related to the add back of foreign currency losses in the current period, compared to the deduction of foreign currency gains in the prior period, as well as an increase in depreciation and amortization and share-based compensation expenses in the current period. This was partially offset by a reversal of the U.S. valuation allowance in the current period, which resulted in a decrease in add backs associated with deferred income taxes compared to the prior period. Non-cash changes also include amortization of deferred financing fees, gains and losses on sale of businesses, and gains and losses on sale of property, plant, and equipment.

• The aggregate of receivables, inventories, contract assets, accounts payable and contract billings used $32.6 million in operating cash flows in the year ended September 30, 2022 compared to the providing of $17.4 million in the prior year.

The amount of cash flow generated from or used by the above mentioned accounts depends upon how effectively we manage our cash conversion cycle, which is a representation of the number of days that elapse from the date of purchase of raw materials and components to the collection of cash from customers. Our cash conversion cycle can be significantly impacted by the timing of collections and payments in a period.

• The aggregate of the remaining assets and liabilities used $14.2 million in operating cash flows in the year ended September 30, 2022 compared to the use of $18.8 million in operating cash flows in the prior year, resulting in an increase to cash flows of $4.6 million. This is mainly due to timing of cash receipts on long-term receivables.

• Cash income taxes provided $2.4 million for the year end September 30, 2022, as compared to the use of $2.1 million during the prior year.

Investing Activities

Net cash used in investing activities was $310.7 million in the year ended September 30, 2022, as compared to net cash used in investing activities of $97.2 million in the year ended September 30, 2021, resulting in a net decrease to cash flow of $213.5 million as compared to the prior year period. This decrease was largely driven by cash outflow associated with the acquisitions of the Mar Cor Business, Smith Engineering, and Epicor, as well as the acquisitions of the remaining interest of Frontier and TWO in the current period as compared to the Ultrapure and WCSI acquisitions that occurred in the prior period. This decrease was also driven by higher cash outflow associated with purchase of capital assets compared to the prior period. Other activity related to purchases of intangible assets, proceeds from the sale of businesses, and proceeds from the sale of property, plant and equipment remained relatively consistent with the prior period.

Financing Activities

Net cash provided by financing activities increased $255.8 million to $125.5 million in the year ended September 30, 2022 from net cash used in financing activities of $130.3 million in the year ended September 30, 2021. The increase was primarily due to the debt refinancing activities that occurred in the prior period, as well as an increased issuance of debt compared to the prior period. This increase was partially offset by an increase of taxes paid related to net share settlements of share-based compensation awards compared to the prior period. Lastly, cash received from the issuance of common stock in connection with the exercise of stock options declined compared to the prior period.

Seasonality

For more information regarding how seasonality may impact our business, results of operations and financial condition, see Part I, Item 1A. “Risk Factors-Seasonality of sales and weather conditions may adversely affect, or cause volatility in, our financial results.”

Seasonal trends historically displayed by our business could be impacted by macroeconomic conditions, including supply chain disruption or recessionary conditions , and past performance should not be considered indicative of future results.

Off‑Balance Sheet Arrangements

We had the following outstanding under our credit arrangements at September 30, 2022 and September 30, 2021:

(In millions)

September 30,

September 30,

Letters of credit

Surety bonds

The longest maturity date of the letters of credit and surety bonds in effect as of September 30, 2022 was March 20, 2030.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions about future events that affect amounts reported in our Consolidated Financial Statements and related notes, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements. Management evaluates its accounting policies, estimates and judgments on an on‑going basis. Management bases its estimates and judgments on historical experience, current trends and various other factors that are believed to be relevant at the time Consolidated Financial Statements are prepared. Actual results may differ from these estimates under different assumptions and conditions.

Management evaluated the development and selection of its critical accounting policies and estimates and believes that the following involve a higher degree of judgment, complexity or uncertainty and are most significant to reporting our results of operations and financial position, and are therefore discussed as critical. The following critical accounting policies reflect the significant estimates and judgments used in the preparation of our Consolidated Financial Statements. More information on all of our significant accounting policies can be found in Note 2, “Summary of Significant Accounting Policies ” in Part II, Item 8 of this Annual Report.

Acquisitions and Purchase Price Allocation

We evaluate the inputs, processes and outputs of each asset acquired to determine if the transaction meets the definition of a business in accordance with Accounting Standards Codification (“ASC”) 805, Business Combinations (“ASC 805”). Acquisitions that do not meet the definition of a business are accounted for as an asset acquisition. In asset acquisitions, we allocate the purchase price as well as other costs of acquisition, such as transaction costs, to tangible and identifiable intangible assets or liabilities based on the basis of relative fair values. No goodwill is recognized in an asset acquisition.

We record acquisitions that meet the definition of a business using the acquisition method of accounting in accordance with ASC 805, which requires that the assets acquired and liabilities assumed, including contingent consideration, be recorded at their respective fair values at the acquisition date. The excess of the purchase price over the estimated fair values of the net tangible and intangible assets acquired is recorded as goodwill. The application of the acquisition method of accounting requires management to make significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed, in order to properly allocate purchase price consideration. These assumptions and estimates include a market participant’s use of the asset and the appropriate discount rates for a market participant. Our estimates are based on historical experience, information obtained from members of management of the acquired companies and with the assistance of independent third-party appraisal firms. Significant assumptions and estimates include quoted market prices, carrying values, and expected future cash flows, which includes consideration of future growth rates and margins, attrition rates, future changes in technology and brand awareness, loyalty, and the appropriate weighted-average cost of capital and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and unanticipated events and circumstances may occur which could affect the accuracy or validity of estimates used in purchase accounting. The purchase price allocation recorded in a business combination may change during the measurement period, which is a period not to exceed one year from the date of acquisition, as additional information about conditions existing at the acquisition date becomes available.

We record contingent consideration arrangements at fair value on a recurring basis as earn-outs related to acquisitions. The fair value of earn-outs related to acquisitions is based on significant unobservable inputs including the achievement of certain performance metrics. Significant changes in these inputs would result in corresponding increases or decreases in the fair value of the earn-out each period until the related contingency has been resolved. Changes in the fair value of the contingent consideration obligations can result from adjustments in the probability of achieving future development steps, sales targets and profitability and are recorded in General and administrative expenses in the Consolidated Statements of Operations.

Goodwill Impairment Review

We review goodwill to determine potential impairment annually during the fourth quarter of our fiscal year, or more frequently if events and circumstances indicate that the asset might be impaired. Impairment testing for goodwill is performed at a reporting unit level. A reporting unit is defined as an operating segment or one level below the operating segment. We have determined that we have three reporting units.

The fair values of reporting units are determined using a combination of two methods, one utilizing market revenue and earnings multiples derived from stocks of companies that are engaged in the same or similar lines of business and that are actively traded on a free and open market applied to the corresponding measure of our reporting unit’s financial performance (the market approach - guideline public company (“GPC”) method), and the other derived from discounted cash flow models with estimated cash flows based on internal forecasts of revenue and expenses over a specified period plus a terminal value (the income approach discounted cash flows (“DCF”) method). In estimating the fair value of the reporting unit utilizing a DCF valuation technique, we incorporate our judgment and estimates of future cash flows,

future revenue and gross profit growth rates, terminal value amount, capital expenditures and applicable weighted‑average cost of capital used to discount these estimated cash flows. The estimates and projections used in the estimate of fair value are consistent with our current budget and long‑range plans, including anticipated change in market conditions, industry trends, growth rates and planned capital expenditures, among other considerations.

We believe these two approaches are appropriate valuation techniques and we generally weight the two resulting values equally as an estimate of a reporting unit's fair value for the purposes of our impairment testing. However, we may weigh one value more heavily than the other when conditions merit doing so. If market conditions change compared to those used in our market approach, or if actual future results of operations fall below the projections used in the DCF method, our goodwill could become impaired in the future. As a result of our goodwill impairment assessment, we have concluded that none of our goodwill was impaired as of September 30, 2022, and we do not believe the risk of impairment is significant at this time.

Impairment of Long‑Lived Assets

Long‑lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Conditions that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate that could affect the value of an asset based on indicators of reduced profits or losses generated by the asset or asset group, a product recall, or an adverse action by a regulator, such as a successful challenge of patent rights.

When necessary, we record charges for impairments of long-lived assets for the amount by which the fair value is less than the carrying value of the asset or asset group. Fair value of long-lived assets is determined using an appraised value (obtained with the assistance of independent third-party appraisal firms) or using an income approach, specifically the discounted cash flow method. Starting with a forecast of the expected future net cash flows associated with an asset or group of assets, we then apply an asset-specific discount rate to arrive at a net present value amount. There were no material impairments of long-lived assets recorded in the current year.

We amortize long-lived assets with finite lives over their estimated useful lives on a straight‑line basis. This amortization methodology best matches the pattern of economic benefit that is expected from definite‑lived assets.

Revenue Recognition

For sales of aftermarket parts or products with a low level of customization and engineering time, the Company recognizes revenue at the time risks and rewards of ownership pass, which is generally when products are shipped or delivered to the customer as the Company has no obligation for installation. The Company considers shipping and handling services to be fulfillment activities and as such they do not represent separate performance obligations for revenue recognition. Sales of short‑term service arrangements are recognized as the services are performed, and sales of long‑term service arrangements are typically recognized on a straight‑line basis over the life of the agreement.

For certain arrangements where there is significant customization to the product and for long-term construction-type sales contracts, revenue may be recognized over time as performance is completed. In these instances, revenue is recognized using a measure of progress that applies an input method based on costs incurred in relation to total estimated costs at completion (the percentage-of-completion method). These arrangements include large water treatment projects, systems, and solutions for municipal and industrial applications. The nature of the contracts is generally fixed price with milestone billings. In order for revenue to be recognized over a period of time, the product must have no alternative use and the Company must have an enforceable right to payment for the performance completed to date, including a normal profit margin, in the event of termination for convenience. If these two criteria are not met, revenue from these contracts will not be recognized until construction is complete. Contract costs include all direct materials, labor, subcontractors costs and indirect costs related to contract performance. We believe this is the most accurate measure of contract performance because it directly measures the value of the goods and services transferred to the customer.

The percentage-of-completion method of revenue recognition requires us to prepare estimates of cost to complete for contracts in progress. Due to the nature of the work performed on many of our performance obligations, the estimates of total revenue and cost at completion is complex, subject to many variables and may require significant judgment. In making such estimates, judgments are required to evaluate contingencies such as weather, potential variances in schedule and the cost of materials, labor cost and productivity, the impact of change orders, liability claims, contract disputes and achievement of contractual performance standards. As a significant change in one or more of these estimates could affect the profitability of our contracts, we routinely review and update our significant contract estimates through a disciplined project review process in which management reviews the progress and execution of our performance obligations and estimates at completion. Contract revenue and cost estimates are reviewed and revised monthly and the cumulative effect of such adjustments are recognized in current operations. Such changes in contract estimates can result in the recognition of revenue in a current period for performance obligations which were satisfied or partially satisfied in a prior period. Changes in contract estimates may also result in the reversal of previously recognized revenue if the current estimate differs from the previous estimate. The amount of such adjustments has not been material.

For contracts with multiple performance obligations, we allocate the transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. In cases where we do not provide the distinct good or service on a standalone basis, the primary method used to estimate standalone selling price is the expected cost plus a margin approach, under which we forecast our expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service. Our contracts are sometimes modified for changes in contract specifications and requirements. Judgment is required to determine if such modifications result in goods or services that are distinct from the existing contract. For customized products and long-term construction type contracts, most contract modifications are for goods and services that are not distinct due to the significant integration provided in the context of the contract and are accounted for as if they were part of the original contract on a cumulative catch-up basis. We account for contract modifications prospectively when it results in the promise to deliver additional goods and services that are distinct and the increase in price of the contract is for the same amount as the stand-alone selling price of the additional goods or services included in the modification.

Our contracts sometimes contain variable consideration in the form of incentive fees, performance bonuses, award fees, liquidated damages, or penalties. Other contract provisions also give rise to variable consideration such as claims and unpriced change orders that may either increase or decrease the transaction price. We estimate the amount of variable consideration at the most likely amount we expect to be entitled. Variable consideration is included in the transaction price when it is probable that a significant reversal of cumulative revenue recognized will not occur or when the uncertainty associated with the variable consideration is resolved. Our estimates of variable consideration and determination of whether to include such amounts in the transaction price are based largely on our assessment of legal enforceability, anticipated performance, and any other information (historical, current, or forecasted) that is reasonably available to us. Variable consideration associated with claims and unapproved change orders is included in the transaction price only to the extent of costs incurred.

Product Warranties

Accruals for estimated expenses related to warranties are made at the time products are sold and are recorded as a component of cost of product sales in the Consolidated Statements of Operations in our Consolidated Financial Statements included elsewhere in this Annual Report. The estimated warranty obligation is based on product warranty terms offered to customers, ongoing product failure rates, material usage and service delivery costs expected to be incurred in correcting a product failure, as well as specific obligations for known failures and other currently available evidence. We assess the adequacy of the recorded warranty liabilities on a regular basis and adjust amounts as necessary.

Deferred Taxes, Valuation Allowances, and Tax Contingencies

Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been recognized in our Consolidated Financial Statements or tax returns. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We record a valuation allowance to reduce certain deferred tax

assets to amounts that are more-likely-than-not to be realized within a reasonable period of time. The factors used to assess the likelihood of realization include our forecast of future taxable income exclusive of reversing temporary differences and carryforwards, future reversals of existing taxable temporary differences and available tax planning strategies that could be implemented to realize the net deferred tax assets.

We consider both positive and negative evidence when evaluating the need for a valuation allowance on our deferred tax assets in accordance with ASC 740, Income Taxes . Available evidence includes historical financial information supplemented by currently available information about future years. Generally, historical financial information is more objectively verifiable than projections of future income and is therefore given more weight in our assessment. We consider cumulative losses in the most recent twelve quarters to be significant negative evidence that is difficult to overcome in considering whether a valuation allowance is required. Conversely, we consider a cumulative income position over the most recent twelve quarters, to be significant positive evidence that a valuation allowance may not be required.

Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. Income tax positions that previously failed to meet the more-likely-than-not threshold are recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold are derecognized in the first subsequent financial reporting period in which that threshold is no longer met. Uncertain tax positions are reviewed each balance sheet date. We recognize potential interest and penalties related to unrecognized tax benefits in income tax expense.

Recent Accounting Pronouncements

See Note 2, “Summary of Significant Accounting Policies ” in Item 8, included in this Annual Report for a complete discussion of recently adopted accounting pronouncements and recently issued accounting pronouncements not yet adopted.