CA - H2O Innovation Inc. (HEOFF) Q1 2024 Earnings Call Transcript

2023-11-14 14:29:09 ET

H2O Innovation Inc. (HEOFF)

Q1 2024 Earnings Call Transcript

November 14, 2023 10:00 AM ET

Company Participants

Marc Blanchet - Chief Financial Officer

Frederic Dugre - Co-Founder, President and CEO

Conference Call Participants

Presentation

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the H2O Innovation Q1 Fiscal Year 2024 Financial Results Conference Call. [Foreign Language] At this time, all participants are in a listen-only mode. Following the presentation, we'll conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. [Operator Instructions] [Foreign Language]

Before turning the meeting over to management, please be advised that this conference call will contain statements that could be forward-looking and subject to a number of risks and uncertainties and could cause actual results to differ materially from those anticipated. I would like to remind everyone that this conference call is being recorded today, November 14, 2023 at 10 a.m. Eastern Time.

I'd now like to turn the conference over to your host for today, Mr. Frederic Dugre and Marc Blanchet. Please go ahead, gentlemen.

Marc Blanchet

Thank you very much. My name is Marc Blanchet, I’m the CFO of H2O Innovation. This call will be held in English, but I’ll just say a brief word in French to our French audience. [Foreign Language]

Before we begin, I invite you to download a copy of today’s presentation, which can be found on our website at h2oinnovation.com in the section Investors. Frederic Dugre, CEO of H2O is joining me today for the call, which duration is approximately 30 minutes. During this call, Frederic will give an update on the business and present highlights of the Q1 2024 ended September 30, 2023. And I will be presenting the financial results.

Please take a moment to read the forward-looking statement on page two and the non-IFRS financial measurement on page three of the presentation.

I’ll now hand [Technical Difficulty] Fred.

Frederic Dugre

Thank you, Marc, and thank you for joining the call today. Well, we are starting our new fiscal year 2024 with more modest growth of 5.7% in our first quarter compared to the same period of last fiscal year. The tempered growth revenue is mostly explained by the timing of revenue recognition associated to the deliveries of important customer orders of specialty chemicals and components. Despite this slower start, we're happy to report improvement in the gross profit margin. Indeed, following the implementation of multiple measures to improve our gross profit margin, we're now observing a positive trend in our operating profit. This is the result of our commercial teams striving to protect margin erosion, combined with our manufacturing, engineering, operating, and procurement teams working relentlessly to find ways to reduce our costs.

The significant CapEx investments made in the previous fiscal year such as development of a mobile fleet of water and wastewater treatment systems, a CapEx extrusion line and the in-house blending of the specialty power cleaner in our UK facility should continue to fuel margin expansion in the coming years. For these reasons, despite the modest revenue growth in the first quarter, we remain confident in our revenue growth target for fiscal year 2024. Our high recurrent revenue business model combined with an impressive 37.2% growth in our consolidated backlog now that's stand at $249 million gives us an excellent visibility to grow the corporation in the coming quarters and reach our targets presented in our three-year plan. Marc will cover the financial performance with greater details in the coming slides.

Moving to page five, with our largest revenue generator business pillar, the operation and maintenance. During the first quarter the O&M team secured eight new contracts where most of them are for industrial customers. In parallel as we continue to focus on customer retention, we successfully renewed 11 contracts and extended scope of work in seven existing O&M projects. These new awards, combined to the scope expansion and the renewal of O&M legacy contracts pushed the backlog to a record high of $166 million. These numbers testify to the quality of the work performed by our team and to the care provided to our numerous customers.

Talking of customer care, I want to underline the extraordinary work realized by our crews from four different locations in the Southeast United States that provided assistance to our customers and team in Live Oak, Florida, after the devastating hurricane Idalia at the end of August. In Q1, we finally merged and completed the integration of [Technical Difficulty] previously acquired in fiscal year 2022, both in the states of New York. This consolidation under the H2O Innovation brand will enable us to promote a more comprehensive solution offering to all customers. This final merger also provides uniform and equitable employment benefits to all workers in the state of New York and is also in line with the rest of H2O Innovation’s employees benefits.

Moving to page six, let's have a look at the highlights of a water technologies and services business pillar. During the first quarter we secured 12 new water, wastewater, and water reuse projects for a total of $29 million. These new projects contribute to keep a good balance between industrial and municipal projects in our backlog. These additions push the WTF backlog to a record high also of $84 million. Combined to our growing service in aftermarket business line originating from our growing installed customer base, it provides us excellent visibility in the revenue and EBAC growth in the coming quarters as the charge is showing up.

Lastly, launch and the development of our mobile water treatment fleet is going full steam. Mining customers continue to show interest in such product and business solution offering. During the summer only, we secured new leasing contracts totaling $3.4 million, bringing our actual constructed fleet in full usage and fully deployed in field. At the end of September 2023, we had two more flex box units under constructions which had been delivered at the end of October to another mining customer. Our objective to grow our fleet to 40 units within the next five years remain the same.

Now let's have a look at the evolution of our combined backlog over the last 12 quarters presented at page seven. With the addition of $29 million bookings from the WTS business pillar in Q1, combined to the renewal, scope extension and new O&M contracts, our combined backlog now reached $250 million at the end of Q1. This represents a 32% increase from June 30th, 2023. This record high backlog not only gives us strong visibility in the expected revenue growth in the coming quarters, but it also continues us to build our North American platform, combining water treatment equipment, servicing, specialty products, and O&M, which promote customer retention, thus, recurrent revenues. By doing so, we continue to monetize our platform where we repeat and new business with both individual and municipal customers.

Let's look at page eight on the performance of our specialty products business pillar. During the first quarter of 2024, our specialty chemical manufacturing facility in Vista in California obtained its ISO 9001:2015 certification. This quality management certification for all our manufacturing activity in California should enable us to pursue our growth among our existing customers and also seduce new customers for which such quality certification is one of the qualification requirements. In parallel, our UK based specialty chemical manufacturing facility continue to ramp up its powder production with growing demand for international customers. By insourcing the making of our powder-based products, we have a better control on the quality of the end products, its lead time production, and also enjoy an improved profit margin.

Meanwhile, Piedmont, the specialty component product line continued to pursue international opportunities, mostly for new desalination plants. During the same period, we secured multiple cartridge elements for current orders from filter housings previously installed into large dissemination plants. Our maple farming equipment teams continue to work on the integration of leader evaporator acquired slightly more than a year ago. The priority remained to improve the profitability of this business line. For this reason, we continue to rationalize our combined product line, while maximizing our customer offering and optimizing our cost and profit structure. It is worth to recall that following a poor maple season in spring 2023, the company took measures to optimize the cost structure and diversify into new business verticals.

Through our strategic objective of transforming the maple division into an agri-food division, we intend to lower the seasonality impact, and diversify our plant base into other auxiliary markets where our expertise in sugar concentration and member infiltration could be beneficial.

I will now pass it on to Marc Blanchet, CFO, who will review and discuss with you the financial performance of the company during this first quarter of fiscal year 2024.

Marc Blanchet

Thanks Fred. Let's move over to Slide 10. Before we go over the results of the first quarter, I'd like to go over the results of the last 12 months compared to the previous 12 months. As I said in previous calls, I'd like to present the result looking at a 12-month to capture the long-term evolution of our results.

Our revenue on a LTM basis reached $256.5 million compared to $202.1 million for the previous 12 months. We invested in growth initiatives to achieve the 10% organic growth objective provided in the three-year plan, such as hiring sales resources and investing in SG&A to generate and support this growth. Those investments have been successful, and the target has been exceeded since we generated organic growth revenue of $14.2 million. This is also explaining the increase in SG&A compared to the previous LTM. However, the ratio over revenue is slightly higher at $17.8 million compared to $17.5 million last year.

The net loss reached $1.7 million compared to the net earning of $4.5 million, a decrease of $6.2 million compared to last year. As a reminder, last year's net earning was positively impacted by a deferred tax recovery of $4.6 million. The adjusted EBITDA increased to $21 million compared to $19.1 in the previous 12 months. The adjusted EBITDA over revenue is lower at 8.2% compared to 9.4% last year. The reduction in percentage is explained by a reduction of the gross profit margin due to the business mix within the specialty business pillar and due to high inflation of material cost and pressure on salaries. In addition, during fiscal year 2023, the maple industry faced one of the worst harvest season in five years in Canada and in the US due to unseasonable weather conditions. The fact that we can rely on three business pillars is the strength of H2O. It allows to be able to count on different sources of revenue and thus reduce the risk of volatility and EBITDA.

Let's move to Slide 11. I'd like to go over some of the financial highlights of Q1. The main highlight is the improvement of the gross profit margin. The gross profit margin has increased from $24.1 million to $25.5 million compared to last year due to the improvement of the gross profit margin in WTS and the business mix within the specialty product business pillar. I'll give more details on that in the next few slides. The revenue growth was slower than the quarter due to the timing of revenue recognition related to project and timing of specialty components deliveries. We are reporting revenues of $59.3 million compared to $56.1 million last year. This represents an increase of 5.7%, which 2.1% is organic growth, and the rest is coming from favorable exchange rate impact.

The adjusted EDITDA in dollar decreased by 9% compared to Q1 last year, standing at $4.5 million compared to $5 million last year. It represents 7.6% over revenue compared to 8.8% over revenue last year. The percentage decrease of adjusted EBITDA over revenue is mostly explained by reduction of sales volume and the specialty of -- the sales volumes are in the specialty product business pillar. The percentage of SG&A over sales increased compared to Q1 last year because of the pressure on salaries and investment in additional resources, but also caused by soft revenue growth this quarter. Last year we invested in our sales force and in business development throughout the year. This is why we must look at the variation on LTM basically.

Cash flow used by operating activities is similar to last year. We used $2.5 million compared to $2.5 million last year. The highlight we're the most proud of is the increase of our consolidated backlog. It's up by 37% compared to Q1 last year, but it increased by an additional 31.7% since June 30. It now stands at $250 million. Obviously, it provides good visibility on revenue for the upcoming quarters. This is the result on the investments we did into our sales force.

Let's go now to Slide 12, where we present some of the P&L highlight of Q1. On that slide, I'd like to bring your attention on the table on the right where we address the fixed rate variation impact on revenue given the fluctuation of certain currency. For the first quarter, it's a global positive impact of $2 million or 3.5% on revenues because of USD, the British pound and the euro exchange rate were favorable. I'll now go over the financial results of each of the business slides -- each of the business [pillars] (ph) and we'll start with O&M at Slide 13.

Revenue for O&M during Q1 2024 stood at $29.2 million compared to $27.7 million last year representing an increase of $1.4 million or 5.2%. 2.4% is organic growth generated from scope expansion and new projects secured in the year. A process of realigning customer portfolio was initiated to focus on most profitable clients and clients that can generate opportunities. This is reflected in the organic growth this quarter. O&M's EBAC reached $2.6 million compared to $3 million last year, representing a decrease of $400,000 or 24% and a decrease in percentage over revenue. The gross profit margin in percentage remain stable at 14%. The O&M EBAC decreased in percentage and in dollars due to higher selling and general expenses explained by higher employee compensation costs and investment in new operational [indiscernible]

In most of the O&M contract, we are entitled to increase the annual fee based on customer price index, also called CPI. Therefore, such annual fee increased are being effective with our customers as each contract reaches its annual contractual adjustment date. We will then continue to achieve price realization and expand margin point in the upcoming quarters. In September 30, the O&M backlog stood at $165.7 million compared to $135.4 last year, which is a significant increase of 22.4%. I would like to bring your attention that the contracts -- that our contracts in Texas and in the states of New York are usually evergreen and are less included in the backlog.

Let's move to Slide 14 and look at the WTS revenue. They improved by 41%, which is coming mainly from organic growth in the service activity. The expansion of the service activity, which tends to be recurring in nature, and are generated at higher gross profit margin. It's in line with the corporation's three-year strategic plan, which is to focus on those type of revenues. This strategy has been successful since WTS gross profit margins stood at 24.6% for Q1 2024 compared to 18.9% last year. WTS EBAC stood at $1.7 million compared to $0.5 million last year. We've seen an increase of $1.2 million. The increase in dollars and in percentage over revenue is mainly due to the improvement of the gross profit margin, explained by a higher proportion of income from service activities. Also, selling and general expenses increased by $300,000, driven by the hiring of additional sales resource. But the selling and general expenses in percentage over revenue decreased from $14.2 million to $12.3 million. The WTS backlogs stood at $84.1 million compared to $46.6 million last year, which is an increase of 80%. The significant increase of the backlog is due to our investment in sales resource. We're also focusing on industrial projects, which generally comes with better gross profit margin and allows us to improve the WTS gross profit margin overall. The 42% -- sorry, 42% of those projects were industrial at the end of this quarter compared to 32% last year.

Let's move to Slide 15. Revenue for specialty products stood at $16 million compared to $18.4 last year, a decrease of $2.4 million or 13%. Timing and deliveries combined with lower maple business line revenue due to the 2023 bad harvest season led to a decrease in organic growth of $3.3 million, partly compensated by favorable exchange rate of $900,000. The gross profit margin stood at $7.5 million or 47% for Q1 compared with $7.7 million or 41.7% last year. The price increase, procurement strategy, and insourcing manufacturing have been implemented in the recent quarters, which affected favorably the margin in this quarter. And also the business mix within the business pillar with higher proportion of revenue coming from specialty chemical group explains the increase of the gross margin in percentage. EBAC stood at $3.9 million compared to $4.6 million, representing a decrease of $700,000. This decrease in percentage is mainly explained by the decrease in sales volume and the increase in selling and general expenses, the hiring of sales resource and the pressure on salaries due to the inflation level are the main factor behind those variations.

Let's move to Slide 16, the financial position for selected information. So the working capital increased by $43.9 – sorry. The working capital increased from $43.9 million to $45.9 million. Account receivable increased by 17.6% since June 30, while sales increased by 5.7%. The variation is mainly explained by significant invoicing in WTS business pillar and a foreign exchange rate impact of $600,000. Contract assets decreased by $1.9 million, which is explained by the invoicing of WTS. If we look at the inventory level, it increased by 21% since June 30. The increase is mostly due to the upcoming large component deliveries for the maple business line currently building its inventory for the upcoming maple season. And fixed variation also contributed to $200,000. We remain vigilant in regards with the level inventory to be maintained, but at the same time properly aligned to support the sales growth. Accounts payable increased by $900,000 or 2%, mostly due to a fixed rate impact. And regarding to the contingent consideration, the decrease is related to the [Technical Difficulty] GMP acquisition, which was settled and paid in August.

If we look at the cash flow on Slide 17, cash flow from operating activities used $2.5 million for Q1, same as Q1 2023. As explained in previous calls, the fast organic growth over the previous quarter pulled on the working cap, but we're starting to improve the cash conversion cycle of these investments. This quarter we also invested $3.4 million of CapEx. Most of these investments are growth CapEx for equipment required to execute new O&M contracts or equipment we manufactured and leased to some of our customers.

Slide 18, the net debt. As of September 30, 2023, the net debt stood at $47.9 million compared to $39.9 million on June 30, representing an increase of $8 million, increase that is due to unfavourable change in working cap items and investment in CapEx to support the growth and operations.

This wraps up the presentation of the financial result. I will now hand over the -- the call over back to Frederic.

Frederic Dugre

Thank you Marc. As a conclusion slide, slide number 19, I want to take a few minutes to talk about the arrangement agreement with Ember alongside with CDPQ, Investment Quebec [Technical Difficulty] As per the press release on October 3rd, 2023, the arrangement agreement proposed a purchase price of $4.25 a share, representing a 68% premium to the closing price of H2O shares on October 2nd. This prize represents also a premium to the research analyst consensus and is also above the range of the formal valuation and fairness opinions as well. Also, the proposed transaction is an all cash deal with no financing conditions.

At the end of October, we receive an interim order from the Superior Court of Quebec. On November 2nd, we ended the go shop period with no other superior proposal. The other important next step will take place on November 28th during the special meeting of shareholders where the vote on the transaction will take place. Following the vote, we are expecting the transaction to close before year end, subject to customary closing conditions being met. To vote, the shareholders can go at www.h2ovote.com which is a micro website that we created along with the help of Kingsdale the soliciting agent and follow the instructions there.

That concludes the call today. I will turn it back to the operator for the Q&A session. Thank you.

Operator

Thank you. [Operator Instructions] And there are no questions at this time. I will turn the call back over to Frederic Dugre for closing remarks.

Frederic Dugre

Well, thank you. As a closing comment, well, I just want to thank all our shareholders, the retail institutional brokers, IAs, portfolio managers, analysts, friends and family and employees for their contribution and continuous support and trust during all these years. You definitely contributed to our growth, the execution of our business plan, and to the tremendous value creation. You made our vision come to reality and allow us to meet our aspirations as entrepreneurs. Thank you very much. I wish you a great day.

Operator

Ladies and gentlemen, this concludes your conference call for today. We thank you for joining and you may now disconnect you lines. Thank you.

Question-and-Answer Session

End of Q&A

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