CA - H2O Innovation Inc. (HEOFF) Q4 2023 Earnings Call Transcript

2023-09-27 16:22:08 ET

H2O Innovation Inc. (HEOFF)

Q4 2023 Earnings Conference Call

September 27, 2023, 10:00 AM ET

Company Participants

Marc Blanchet - Chief Financial Officer

Frederic Dugre - Co-Founder, President and CEO

Conference Call Participants

Michael Glen - Raymond James

Frederic Tremblay - Desjardins

Endri Leno - National Bank

Ben Jekic - PI Financial

Gabriel Leung - Beacon Securities

Presentation

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the H2O Innovation Fourth Quarter Fiscal Year 2020 Financial Results. [Foreign Language] At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session and 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, September 27, 2023 at 10 a.m. Eastern Time.

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

Marc Blanchet

Yes. Thank you, and good morning, everyone. 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, President and CEO, who is joining me today for the call, which duration is approximately 30 minutes to 45 minutes. During this call, Frederic will give an update on the business and present highlights of the Q4 and the fiscal year ended June 30, 2023. 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 over the call to Fred.

Frederic Dugre

Thank you, Marc, and to everyone for joining the call today. We wanted to start the presentation by providing some perspective on the evolution of the business over the last five years, which highlights the significant growth and margin expansion achieved by the corporation.

H2 Innovation over this timeframe has increased revenue by greater than 2 times and adjusted EBITDA by 3 times through a combination of organic growth and accretive acquisitions. Our recurring revenues for the fiscal year 2023 was 88%, providing increased predictability and visibility into future operations.

Notwithstanding the challenging fourth quarter for Maple, we look at our corporation through a full year lens and make business decisions for the long-term. We view the weakness in Maple as an aberration and all are more confident than ever in our fiscal year 2024 and 2025 outlook provided in our three-year plan.

This is underpinned by our current backlog, which has experienced additional growth since the end of our fiscal year 2023 and margin expansion visibility, which is supported by numerous active initiatives.

We have implemented price increase programs, CPI adjustments on O&M contracts and in-sourcing of some of our manufacturing products, while also experiencing expansion of embedded margins in our backlog for the new WTS and O&M projects.

It is worth highlighting as well that the strong cash flow generation in fiscal year 2023, which ended the year at almost $29 million and was $14.5 million in Q4 2023 alone, reducing our net debt to approximately $40 million. This contraction of the net debt is a significant value generator.

Today, with over 1,000 employees at H2 Innovation, all working hard towards a well-defined business plan with the right KPIs in place to motivate everyone to achieve our objectives, we remain very confident in the future.

Let’s have a look at the performance of each of our business pillar. Starting at page five with our largest revenue generator in business pillar, the operation and maintenance. In fourth quarter only, our O&M team was awarded three new and expanded seven operation and maintenance contracts.

In terms of renewal contracts, this included Hudson Valley in the State of New York, as well as the Northeastern side of the United States. Of these contracts is the City of Lincoln in New Hampshire and has been extended for an initial period of five years.

H2O Innovation was also awarded a new O&M contract with Rocky View County in Alberta for a period of two years with the option to renew for three additional years. The corporation has also secured two additional O&M contracts in the States of New York and Texas.

In course of fiscal year 2023, the operation and maintenance group also received two important recognition awards for the City of Canton in Georgia and the Town of Warren in Rhode Island. These awards testify to the level of compliance and quality of the work delivered to our customers. This is exactly why we retain our existing customers and why we keep winning new business.

We are showing extraordinary care for our customers and do not compromise on environmental compliance. On top of that, our business model promotes high customer retention and offer multiple sales synergies to create value for the customers.

By continuing building our North American platform, combining Water Treatment Equipment, Services, Specialty Products and Operation and Maintenance, we continue to monetize the platform with repeat and new business with both industrial and municipal customers.

Moving to page six. Let’s have a look at the highlights of our Water Technology and Services business pillar, the WTS. During the fourth quarter, we secured 14 new water treatment projects totaling almost $18 million comprised of eight industrial and six municipal contracts.

On April 6th, new water projects announced, which include 1.5 million gallons per day ceramic ultrafiltration system for the Fort Berthold Indian Reservation in North Dakota. This design will feature a high water recovery rate of over 97%.

Another project was for an electrical vehicle manufacturer that includes a treatment using multimedia filters, degasifier and RO system. The company also secured a contract for 1 million gallons per day treatment system with two seawater RO systems for a U.S. customer. The Fort projects include an 18 million gallons per day ultrafiltration system for the West End Water Treatment Plant in the City of Billings, Montana.

On June 28th, the company was awarded two First Nation projects in Northern Alberta in Canada. The first contract involved the drinking water rental system to provide water for the community of Garden River, sorry, while the full-scale drinking water projects is being completed.

The other project is for an emergency expansion of the John D’Or drinking water plant to accommodate the needs of the communities that have been unfortunately displayed by wildfires during the summer.

In addition, H2O secured a project for the turnkey deployable water treatment plant using granular activated carbon on one of the primary technology used to for PFAS removal in order to polish the drinking water and of an amusement park in the State of New York. This newly awarded project was derived from execution of cross-selling initiatives between business pillars as this is an existing customer of the operation and maintenance business line.

Furthermore, the City of Delaware, a long-term client requested an expansion to the existing ultrafiltration system, which was provided by H2O back in 2013. Two other undisclosed [ph] projects were also secured, including one of the mining clients that requested an extension of the current rental period for two of the mobile treatment systems.

Looking at the evolution of our backlog and its diversification between industrial and municipal customers, our decision to remain membrane agnostic and develop open source membrane platform was a winning strategy and an important differentiator as well. Also, our focus on water reuse and our growing reference list are positioning H2O on the leading edge of our industry in order to solve water scarcity issues.

Moving to page seven. Let’s have a look at the combined evolution of the WTS and operation and maintenance backlog, which have grown at a three-year CAGR of 24% and 13%, respectively.

At the end of the fourth quarter, WTS’ backlog stood at $58.7 million, representing an increase of 61% year-over-year. Not only is our backlog growing, but we are experiencing explosive growth in industrial projects diversified our customer base with many of our new contracts being repeat business from some of the largest corporations in the world.

Subsequent to the end of the quarter, we announced $28.7 million of new contracts for the WTS business line and continue to see the funnel of high margin opportunities. The addition of these new contract pushes the WTS backlog to a new high of $83 million.

This diversification should allow us to improve WTS margin profile in the coming quarters. We believe that the EBAC margin should also continue to improve as well into the revenue as the revenue recondition move into the larger industrial and municipal projects recently signed with prices reflecting the latest materials and wage increases.

At the end of the fourth quarter, the operation and maintenance backlog stood at $131 million, representing an increase of 4% year-over-year. Subsequent to quarter end, the company announced a new operation and maintenance contract and renewals, taking the backlog now to $167 million. We continue to add new contracts while extending existing contracts and adding new scope of work.

The company is laser-focused on implementing CPI adjustments to offset labor cost pressure. On a combined basis, our consolidated backlog has moved from $190 million at the end of June 30, 2023, to now to-date at $250 million, representing a 31.6% organic growth in the last three months. Again, this is giving us an excellent visibility for revenue recognition and margin improvements in the coming quarters.

Let’s look at page eight on the performance of our Specialty Products business pillar. The fourth quarter showed another impressive growth of our Specialty Products revenue. All our business lines are pushing for innovation and have been capable to attract new customers to our business.

The company has achieved a significant breakthrough in the Israeli desalination market through the scale -- to the sales, sorry, of a super-concentrated and dendrimer-based product synthesized in our facility in California. Furthermore, the team presented a compelling case study during the recent European Desalination Society Conference, show casing the successful implementation of the antiscalant has in the desal -- at the desalination plant in Israel.

In the past fiscal year, nine new mega desalination plant started using this green chemistry product in countries like Israel, Singapore, Algeria, Qatar and Argentina. This, in total, represents 2.2 million of cubic meter per day of seawater being treated.

With these new plants, a total of 3.3 million of cubic meter per day are treated now in larger scale seawater RO plant using this green chemistry, which represents a CO2 emission savings of 183 tons per year, because the antiscalant is phosphate-free and 11 times more concentrated than conventional products, it has the lowest carbon footprint in the industry and the lowest cost of freight and handling.

More and more, the clients are recognizing the benefits of our green chemistry and are realizing important savings on freight, warehousing, emissions and packaging. These differentiators are definitely driving new sales and attracting new customers looking for sustainable and eco-friendly products and solutions.

It is worth highlighting that Piedmont, one of H2O subsidiaries received two significant company purchase orders for two 600,000 cubic meter per day seawater reverse osmosis desalination plant.

The Maple business had a very challenging period on the heels of the worst Maple harvest over a decade and industry production 60% lower year-over-year. The company has taken 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 diversified our client base into other auxiliary markets where our expertise in sugar concentration and membrane filtration could be beneficial.

I will now pass it up to Marc, our CFO, who will review with you and discuss the financial performance of the company.

Marc Blanchet

Thank you, Fred. Before going over the results of the fourth quarter, I’d like to go over the results of the fiscal year compared to the previous fiscal year. We’re proud to report a second consecutive year with organic growth above 15%. In fiscal 2022, our organic growth was at 17.7%. This last fiscal year, it was at 20.1%, which allowed H2O to generate revenue of $253.3 million for fiscal year 2023, compared to $184.4 million for the previous year.

We invested in growth initiatives to achieve the 10% organic growth objective provided in the three-year strategic plan, such as hiring sales resource and investing in SG&A to generate and support this growth. Those investments have been successful since the target largely been exceeded.

This explains also the increase in SG&A compared to previous last 12 months. However, the ratio over revenue is lower and went from 18.1% and now stands at 17.5%, showing the scalability of our business model as revenue continues to grow.

Net loss stood at 1.3%, compared to a net earnings of 5.1% last year. Net earnings for fiscal 2022 were impacted by a deferred tax recovery of $4.6 million.

The adjusted EBITDA increased to $21.4 million, compared to $18.1 million in previous fiscal year. The adjusted EBITDA over revenue is lower at 8.4%, compared to 9.8% 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 -- Specialty Product business pillar and due to high inflation of material cost and pressure on salary, combined with the most difficult Maple harvest season in many years since as Fred explained.

The fact that we can rely on three business pillar is the strength of the -- of H2O Innovation. It allows to be able -- it allows us to be able to come on different sources of revenue and thus reduce the risk of volatility on EBITDA.

The last few years, we’ve been focusing a lot on growth to focus, sorry, the last few years, we have been focusing a lot on growth. The focus for fiscal 2024 will bring -- will be to bring back the EBITDA at above 10%. We have committed to a three-year plan and intend to deliver.

Now let’s look at slide 11. I would like to go over some of the financial highlights of Q4. The main highlight is the momentum maintained on revenue growth. We are reporting revenue of $65 million, compared to $52 million last year. This represents an increase of 24.8%. 16% is organic, 3% coming from acquisition related to the Leader Evaporate -- Evaporator acquired in June 30, 2022.

The adjusted EBITDA in dollar increased by 34% compared to Q4 last year, standing at $3.1 million, I am sorry, the adjusted EBITDA in dollar decreased by 34% at least, yeah, I wish too, standing at 3.1%, compared to 4.8%. It represents 4.8% of revenue, compared to 9.1% last year. The percentage decrease of adjusted EBITDA over revenue is due to the decrease of the gross profit margin in percentage. The gross profit margin was -- has decreased from 25.9% to 23.5% compared to last year due to high inflation of material cost pressure and salaries, business mix within the Specialty Products business pillar, combined with the most difficult Maple harvest season since many years.

The percentage of SG&A over sales increased compared to Q4 last year, investment in sales and business development are paying off since revenue are still growing faster than SG&A ratio. The highlights we’re the most proud of is the cash flow generated from our operating activity.

We generated $14.5 million, compared to $6.4 million of cash flow used during the same period last year. It’s a variation of $21 million and it’s mainly explained by the favorable change in working capital items.

In addition, we want to highlight the increase of our consolidated backlog. It’s up by 16% at the end of Q4, but increased by an additional 31% since June 30th, as explained by Fred a few minutes ago and with the press release this morning. It now stands at $250 million. Obviously, it provides good visibility on revenue for the upcoming quarters.

Okay. Now let’s look at slide 12. We present the P&L highlights for Q4. On that slide, I would like to bring your attention on the table on the right. I’m going to address the FX rate variation impact on revenue giving the opposite fluctuation on certain currency for the fourth quarter is a global positive impact of $6 -- $7.6 million or 4.1% on revenue on our main three currency USD, GBP British pound and euro. Exchange rates were favorable compared to Q4 last year.

Adjusted EBITDA for the fourth quarter stood at $4.8 million, which is a decrease of 4.3% compared to Q4 last year. The main reason is the decrease of the gross margin from -- as I explained in the previous slide, considering a sale [ph] profitability has been impacted by ongoing macroeconomic trends, supply chain, higher inflation, increase in wages and the tough Maple season.

2023 maple syrup, as we explained, got off a late start, temperature went up quickly and resulted in a 60% decrease in production compared to last year for our customers. So our customers are the producers and they are the one that suffered from that production loss. So as Fred explained, we -- just previously we rightsized a bit that business in order to adjust our fixed cost in order to -- for the upcoming revenues.

Slide 13, operation and maintenance. So let’s go over each business pillar. So for the O&M business pillar, revenue for 2023 stood up $117 million, compared to $87 million last year, representing an increase of $30 million or 34%. 15% organic growth generated from important scope expansion and new projects secured in previous quarters.

O&M EBAC reached 13.1%, compared to 10.5% last year, representing an increase of 2.6% or 24%, but represents a slight decrease in percentage over revenue. The gross profit margin in percentage decreased from 17% to 16%.

Hence to create a state an attractive environment for workforce and to create value for our customers by offering them a balance team, we decided to establish a minimum wages of US$15 per hour for all employees. This was implemented in Q1 2023.

We also increased salary in accordance with inflation. So since 65% of our employees are working for this business, deliver the O&M gross cost margin and EBAC are more sensitive to factors related to workforce.

In most of the O&M contract, we are entitled to increase the annual fee based on Customer Price Index, CPI. Therefore, such annual fee increase are being effective with our customers as each contract reaches its annual contractual adjustment date. We will then continue to achieve price realization and gain margin points in the upcoming quarter.

On June 30th, the O&M backlog stood at $130 million, compared to $126 million last year and following the press release of this morning, the backlog now stands at $167 million. And I want to bring your attention also on the contract in Texas and the State of New York. They’re usually evergreen and are not included in the backlog.

Now let’s look at WTS, slide 14. The revenue improved by 18%, which is coming -- all of it is coming from organic growth, mostly from service activities and also execute capital equipment projects.

WTS EBAC stood at 4.6%, compared to 3.5%, representing an increase of $700,000 or 17%. The increase in dollars is mainly due to improvement of gross profit margin, explained by improved project performance. However, the EBAC in percentage over revenue decreased slightly and is explained by higher SG&A -- selling -- higher SG&A. Those expenses were higher due to new hiring of sales resource, higher labor costs and commission, as well as travel, trade shows and conferences.

The WTS backlog stood at $58.8 million, compared to $36 million last year. It’s an increase of 61%. And again, following the press release of this morning, it now stands at $83 million. The significant increase of the backlog is due to our investment in sales resources. We’re also focusing on industrial project, which generally comes with better margin, which allow us to improve WTS gross profit margin.

Slide 15, revenue of Specialty Products stood at $85.5 million, compared to $54.4 million. It is an increase of $31 million or 57%, which is 35% organic growth coming from strong performance of all business lines, Leader Evaporator acquired last June generated 12.1% or 22%. Leader was the acquisition we did in June last year.

FX rate variation were nearly zero for this fiscal year. EBAC stood at $18.3 million, compared to $15.2 million, representing a $1 increase of 3.1%. The decrease in percentage is mainly explained by the deterioration of the gross profit margin. The gross profit margin stood at 39.8%, compared to 47.1%. The gross profit margin variation is explained two main reasons.

First, business mix within the business pillar, since most of the revenue are coming from Maple farming equipment following the acquisition. They’re usually at a lower average gross margin with a bigger impact during the fourth quarter since the Maple industry faced the worst harvest season in many years due to the weather conditions.

The second reason is the increase of raw material costs for manufacturing of our specialty chemicals. Price increase, procurement strategy and in-sourcing manufacturing has been implemented in recent quarters, which should impact favorably the margin.

The selling -- the SG&A expenses increased by $5.3 million. The main reason are the hiring of sales resource, pressure on salaries in connection with the inflation level, the resumption of travel combined with the acquisition of Leader. However, the SG&A expenses ratio over revenue decreased by 0.7%.

Since we are expecting a slower Maple season for fiscal -- not -- sorry, since we’re expecting slower Maple revenue for fiscal year -- for the next fiscal year, at the end of June, we rightsized the team in order to adjust fixed costs with anticipated revenue, which should improve the gross profit margin and EBAC percentage.

Slide 16, we’re very proud to present this financial position that has trended that is stronger. Accounts receivable increased by 3% since June 30, 2022. So it increased 3% over the year, while sales increased by 25% and the variation is mostly explained by FX variation. Therefore, demonstrates the improvement with data collection since accounts receivables remained relatively stable.

If we look at the inventory level, it increased by only 1% since last year. Again, FX explains most of this variation and we’ll remain vigilant in regards to the level of inventory to be maintained, but at the same time, properly aligned to support sales growth.

The payables increased by 5.3% or 22%, partly due also from foreign exchange and also higher compensation benefits payable and timing of payment to suppliers. Regarding the contingent consideration, the decrease is related to payments related to GCO and EC acquisition, which was made during Q3 and partial payment related to the GMP acquisition in Q1. The third and last payment of the GMP earn-out was settled and paid in August 2023, so last month.

Slide 17, cash flow. We want to highlight the fact that our operating activities generated $28.9 million for fiscal 2023, compared to a use of cash of $6.3 million for the same period last year. As explained in previous call, the fast organic growth of the previous quarter was on working capital, but we’re starting to improve the cash conversion cycle of this payment -- of these investments.

This year, we also invested $10 million of CapEx. Most of these investments are growth CapEx and are for equipment required to execute new O&M contracts or equipment we manufacture and leads to some of our customers.

The net debt. So on slide 18, you can see the evolution of the net debt. As of June 30, 2023, the net debt, which includes contingent consideration stood at $39.9 million, so just before the -- below $40 million, compared to $50 million last year. It’s an improvement of $10 million due to the cash cycle improvement.

This wrap up the presentation of the financial results. I’ll now hand the call back to Frederic.

Frederic Dugre

Thank you, Marc. In conclusion, on slide 19, I want to bring back our three-year growth plan slide that we presented back into our AGM in December last year. Looking at our sales pipeline, rich and diversified municipal and industrial opportunities, the strength of our distribution network for Specialty Products, recurring revenue is at 88%, a consolidated backlog of $190 million, which has, by the way, expanded to $250 million post year-end and the continuing market drivers for the water industry, we envision continuation of a strong organic growth with a focus on margin improvement in the coming years.

Consequently, we increased our revenue midpoint targets to $278 million and $315 million for fiscal year 2024 and fiscal year 2025, respectively. While growing revenues, we remain equally focused on improving our adjusted EBITDA margin above 11% by fiscal year 2025.

As previously mentioned, we have implemented price increase programs, CPI adjustments on operation and maintenance contracts and in-sourcing of manufactured products while also experiencing expansion of embedded margins in our backlog for the new WTS and operation and maintenance projects.

The water industry tailwinds have never been so strong. It is being compounded by restoring of manufacturing and government stimulus for new infrastructure. While the corporation is seeing a wave of new bookings from the proliferation of industrial activity in the U.S., we’re just now seeing U.S. infrastructure stimulus funds hitting the agency level for deployment in municipal projects. This represents the next wave of growth of our industry.

We’re very pleased with the level of growth in fiscal year 2023 and the value surface to shareholders through generating $29 million of operating cash flow, thereby reducing net debt to around $40 million level. Our growth prospects, margin expansion visibility and balance sheet strength positions the company for value creation into a foreseeable future.

Thanks, everyone, for joining the call today and we look forward to answer your questions. I will turn it back to the Operator for the Q&A.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question comes from Michael Glen from Raymond James. Please go ahead.

Michael Glen

Hey. Good morning. Fred, you talked about -- in the opening remarks, you talked about the win within the Israeli desalination market. Like I’m just trying to frame the size of your desalination business right now and like what is the underlying growth opportunity, like what’s the or the growth outlook for that business in particular, what you sell into desalination, like is that, for thinking of a three-year to five-year CAGR for that market, like, what does that look like?

Frederic Dugre

Well, first, what we’re selling to desalination market is mostly components and consumables. So what I mean component is the filter housing, it’s the coupling business. We’ll be selling also filter going inside the filter housing. We’ll selling specialty chemicals as well. So our addressable market is through these products that we’re selling. And you were referring to a CAGR of how much you said, Glen? Michael? Sorry.

Michael Glen

I’m just -- from your side, I’m just trying to -- you have a view on the industry overall and maybe your underlying business, like what kind of growth CAGR do you think we should be thinking about as we model your desalination business in future years?

Frederic Dugre

So the desalination business, even though it has been a little bit cyclical, has been growing tremendously over the last -- in the last five years. So for us to envision a 7% to 9% to 10% is definitely within reach. So that’s what we’re aiming at…

Marc Blanchet

Also considering the fact that we’re gaining our market shares.

Frederic Dugre

Considering the fact that -- in addition to the fact that we’re gaining market share in that market. So for us to beat this market is kind of accessible, because as Marc explained, we had the resources into areas that we’re not covering.

So that’s why we’re celebrating these wins. I mean being able now to address the South American market with dedicated personnel covering the regions, supporting our existing distributors and growing the distribution network is where we see the big upside.

Same thing in other regions. I highlighted the fact that in Israel, it’s a big desalination market. We didn’t have anything going in the last two years and now we have finally found a way to get going there with the chemicals.

So these -- the way we’re addressing the business development now through regions, through a team leading and supporting specifically regions and their local distributors is paying off and we are in a position to beat the current growth -- organic growth as expected in the market.

Michael Glen

What would be the size of your desalination, like, your desalination dedicated business right now would be about what kind of run rate in revenue?

Frederic Dugre

Well, we don’t provide the specific segment. I mean, it’s within the Specialty Products, but we don’t give this granularity of information. But it’s -- I can tell you that it’s a very fair portion of the Specialty Products. I mean, this is where most of our energy is going. Outside of the Specialty Products, there is a Maple and most of it is, I would say, desalination related Specialty Products.

Michael Glen

And for you as a company, if we’re thinking about what you would like to do with M&A, is there part -- is there logical add-ons to think about that you could acquire…

Frederic Dugre

Yeah.

Michael Glen

… with some M&A, like, some new products and things like that, that would help?

Frederic Dugre

Absolutely. So I think you’re on the money on this. I mean, what we’re trying to do here, we have more than 100 distributors. They are currently selling the products I just mentioned to you. If we’re able to acquire a company bringing Specialty Products, complementary Specialty Products, we can rapidly grow the small business into a business that becomes a more sizable through the acceleration we can give by pushing the product into our network. So that’s an example.

So, yes, we have been and we continue to be on the look for opportunities for Specialty Products. We believe also a very good way to grow the business effectively into the operation and maintenance to add acquisitions -- small acquisitions into specific regions to expand into specific geography. We have done it in the past. We’ve done it for Texas. We have done it for New York. This is a very effective way to grow the O&M through small acquisitions.

Michael Glen

Okay. And Marc, you kind of touched on the fleet investments that are being made. Can you just remind us what -- where you are with your fleet, are those units leased at this point in time, and like, what’s happening with that particular part of the business?

Marc Blanchet

Yeah. So we started to invest into that a bit more than a year ago. We now have eight units. We’ve got four under construction and we’ll continue to grow that. The objective is to get about 40 units within the next five years and right now they’re all leased, especially every time we haven’t started manufacturing and equipment until we’ve got a lease.

So we -- I mean, probably, the best would be to have a fleet standing in a yard and be ready to deploy it, but we’re not there yet. So right now we’re signing contracts, build them, lease them, and on and on, and until now, we haven’t had any contract that have been terminated.

Frederic Dugre

They say that you don’t have the fleet until you have assets available in the parking lot and right now everything we’re building is currently deployed in the field. So it’s kind of a good problem to have.

Michael Glen

And just some of the metrics that you can share like return on capital, payback period on these type of projects?

Marc Blanchet

It’s -- I am going to share that, but it’s good. Very good.

Frederic Dugre

Yeah. The idea…

Michael Glen

Okay.

Frederic Dugre

Yeah. The idea is, I mean, obviously, it’s very strategic, as you will understand, very competitive information that, we’re trying to deploy these assets to mining customers and they’re buying these assets because they have urgent needs for water and they have complicated water to process. So we value this, obviously, differently than when we sell it, when we sell the same technology to a municipal customer, right? So let’s assume that it’s quite a high margin and it will be a transformational move in the coming years for us as we continue to expect...

Marc Blanchet

It will participate in the improvement of our EBITDA percentage, obviously.

Frederic Dugre

That’s the annual.

Michael Glen

Okay. Okay. Thank you for taking the questions.

Marc Blanchet

Thank you, Michael.

Operator

Your next question comes from Frederic Tremblay from Desjardins. Please go ahead.

Frederic Tremblay

Thanks. Good morning.

Frederic Dugre

Good morning, Frederic.

Marc Blanchet

Good morning, Frederic.

Frederic Tremblay

Maybe we’ll start with Maple since it was called out the headwind in the quarter. Just, I mean, with Q1 being almost over now, can you maybe share some thoughts on your expectations for Maple in Q1 and maybe the second quarters relative to Q4? Are we expecting a gradual improvement or was the sort of the weakness isolated to Q4 from a demand and profitability perspective?

Frederic Dugre

So I think the Q1 is still impacted by the low season that the producer has. So I think the farmers in general still have a flower based on the bad season they have. Fortunately, there will be a point where they will have no choice but to invest and have new equipment or to replace them, because these equipments are getting old in the field.

So we still believe that this year will be a challenging year in a sense that it won’t be an extra year as we had in the past in previous years. However, we know that in Canada, in Quebec, more specifically, the Federation has announced another $7 million of new tax available. So the producers and the farmers will have the possibility to further expand their production in the coming quarters, coming years.

Now we’ve heard that many of them have started to apply for this possibilities to expand their quota to increase the number of tasks in their production. Some may invest this year, but most of them, we believe will be for the following year. So this year, I think, it will be a year where we’re expecting some flat year kind of compared to what it was before.

Our strategy to mitigate that, as Marc said, we have rightsized the business, we have done some price adjustments on our products, we are still in the process of turning around or integrating the company acquired last June, so Leader Evaporator.

So now we are a little bit more than a year into it and we’re still making good progress to gain efficiency into manufacturing and optimize what we have now. So for us, it will be to play more defense this year with that division and try to maximize profit through tight margin control on our products and manufacturing.

Frederic Tremblay

Okay. Thanks for that. That’s helpful. Maybe switching to inflation and pricing. You did mention that you’re starting to see stabilization on the horizon for inflation. At the same time, you’re still in the process of adjusting some prices and implementing CPI adjustments. In terms of rough timing, when should we expect to have fully caught up on the past inflation headwinds to the pricing strategies?

Frederic Dugre

Well, it can go up to -- for the operation and maintenance, it can go up to two years. I mean by the time you do the full cycle and revisit all your customers, I mean, some are evergreen, some are long-term contracts, you need to wait to anniversary date to engage into a conversation with your customers, some will accept to have an increase over a two-year period instead of having just a drastic increase. So it’s really hard, because it has to be customized through each customer.

The mistake will be to try to push too much a drafted price increase to your customers without paying attention and then becoming blindsided and then seeing the customers starting to engage a conversation with your competitors than losing the business.

So we have to be very thoughtful, very strategic the way we’re approaching it and this is where our team has this customer and unique customer relationship, and I will even call it, intendency with the customer to convey that message, but time is our best aligned to this. So I mean, sorry, I mean, I wish we could correct it over a quarter, but it will still be deployed and has started to be deployed, but it will take several more quarters.

On the other hand, we’re seeing the stabilization more into the cost of wages. So for us, now we feel that the worst is behind us in terms of drastic inflation into labor costs and we think that now our hands are around it, we see more stability, we still less than over and so on. So this is helping us in the overall operation itself, so.

Frederic Tremblay

Great. And then just a last one for me. Great to hear on cash flow generation from operations, especially in Q4. Any thoughts on what we should expect there in fiscal 2024? Is there still room to sort of improve or enhance working capital management, and just -- I guess, just sort of general views on cash generation for the year end? Thanks.

Marc Blanchet

Yeah. I mean, last year, I would say, an important KPI metric that we’ve implemented is cash conversion cycle for all business lines. So the money are done on a monthly basis, they even have like, I’d say, variable remuneration targets related to it. So we’re pushing hard to continue to improve it.

I mean the -- as much as 2022 was almost anomaly, we cut up on that following the sudden growth. Now we kept the base and it will go more towards normality, I would say, going forward, but also we’ll continue to push on improving those -- that KPI our cash conversion cycle.

Frederic Tremblay

Thanks. Thanks for taking the question.

Frederic Dugre

Sure. Thank you.

Operator

Your next question comes from Endri Leno from National Bank. Please go ahead.

Endri Leno

Hi. Good morning. Thanks for taking my questions. The first one for me, it’s actually a bit of a continuation of a question just asked on the cash in there. But from a different angle in that your cash balance is pretty significant in this quarter. So I just wanted to ask whether, number one, you have any minimum liquidity covenant from your lenders, and if not, what would be the best use of the cash that you have in the balance sheet?

Marc Blanchet

It’s -- our cash, let’s say, our allocation strategy -- capital action strategy right now will go towards the CapEx for increasing the fleet and also we have to say that we’re looking at M&A targets.

The three-year plan of last year and the previous one, we said, we would kind of take last fiscal year to integrate. I think we did a pretty good job at it and things are pretty well on its way. Next fiscal year and the following one and we’ll update the three-year plan in December, but it’s definitely to get back into M&A strategy would deleverage the company and so that the teams are ready also to integrate additional targets if we agree on certain ones.

Frederic Dugre

I mean having a strong balance sheet that is not leveraged at this point for us, is a good opportunity to continue and push our M&A strategy. As we said now, we think that things are coming back to normal. We believe that multiples for potential targets are coming back to some more common sense, let’s put it this way, and we think that we’re in a good position with the pipeline of opportunities we have for M&A to capture these ones.

Endri Leno

Okay. No. thank you. And Fred, you answered my next question on multiples and the environment there. But just a quick follow-up, perhaps, for Marc, and maybe you mentioned it, apologies if I missed it, but what are you aiming for CapEx for 2024?

Marc Blanchet

So, I mean, we’ll stick pretty much in line with the history. So we have about 1% to 2% of CapEx per year, okay? So half of it is growth CapEx, half of it is maintenance CapEx. So that’s in the normal course of business.

And as we announced last summer, we are investing into the fleet of assets, so trying to build a fleet, and I would say that, the amount of CapEx invested for that fleet will be plus or minus similar to this year, maybe a little bit more. It depends on how fast we can build them, but it’s, yeah, somewhere between $6 million to $8 million of investment for that fleet.

Endri Leno

Okay. Thank you. And one other question I want to ask and I know you just announced some new wins and congrats on that on the backlog. But with the economy slowing down a little bit. Are you seeing any changes to the bidding universe, I mean, especially when it comes to the WTS or is it just go, go?

Frederic Dugre

Not at all. It’s not really…

Marc Blanchet

Not really, but not...

Frederic Dugre

If anything, I mean, we have seen even acceleration. I think this acceleration is driven by restoring, but also water now being perceived as an operational risk for these industrial companies.

And I’ve been mentioning that is that, previously, companies were sourcing the water from most of it for the city, relying on the city to provide them. But now with challenges related to availability, scarcity, price of the water itself, they’re now looking for ways to source the water that they need for their processes on their own way.

So they are investing into their own water treatment facilities that actually what we’re building is mostly water reuse facility for industrial customers and this has great success and we haven’t seen a slowdown per se in that market.

And as I said, on top of that, the municipal stimulus money, notably in the United States hasn’t really impacted us yet, in a sense that now this money started to flow to agency level, started to flow to consolidate engineers, for example, to start the plantification, start to prepare the RFQ, RFP and they will go to tender in the coming months.

So we think that for us, there’s another wave of opportunity also behind it. The mining sector hasn’t really slowed down either with all the transition for the electrical and energy transition. So, I mean, we’re not short of opportunities clear on that market.

Endri Leno

No. That’s great to hear. Thank you. And last one for me and I’ll jump in the queue. But when you’re talking about further price increases outside of their CPI in the O&M. So I’m looking at more of the SP segment. What kind of price increases do you think you can push on over the next year, right? Like is there any more room to do there, and if you can quantify, at least even in broad terms, it would be very helpful? Thank you.

Frederic Dugre

So we have essentially two strategies on this. One, which is, yeah, straight price increase and we think that we can see areas in some countries that are, I would call it, I would call it, less competitively exposed than other ones. So we can see a price increase of, let’s say, 3% to 7%.

In other areas where it’s more sensitive to price, notably in the Middle East, because it’s a high visibility regions where the entire world wants to sell to the Middle East for components and products. So this is a more sensitive area where we’ll be more prudent in the way we’re approaching price increase between 2% to 5%.

The other strategy is for us to replace some products at lower margin by high value products margin and that’s why I was referring also to the benefit of our green chemistry. It has multiple benefits also outside of the green purpose and the green and phosphate-free and lower footprint in emission, but it has also the benefit of having better margin, because this product is made completely in-house, sensitize the polymer.

So again, this is giving us an excellent price point where if we’re able to replace the conventional product phosphate-based product with this green chemistry, not only we make the customer better and with a better product, but also we improved the margin profile. So it’s a different strategy, and again, we have to customize it depending on who we’re talking to.

Endri Leno

Okay. Sounds great. Thank you very much. I will jump in the queue.

Frederic Dugre

Thank you.

Operator

[Operator Instructions] Your next question comes from Ben Jekic from PI Financial. Please go ahead.

Ben Jekic

Hi. Good morning.

Frederic Dugre

Yeah. Hi.

Ben Jekic

I think the question has probably been answered, but I just wanted to ask one on the Maple business. So you said it’s going to -- so what we’ve seen in the 4Q will kind of extend through fiscal 2024. Do you disclose, especially for us kind of fresher to the story, what is the size of the Maple business within the segment within that?

Frederic Dugre

So we -- I mean, we didn’t disclose it as per se. But I mean, last year, we said, we doubled it with the acquisition of Leader, and this year, Leader did $12 million. So it gives you a bit of an idea and it was slower than expected. So if you make round numbers, you probably arrive around $25 million, $30 million of revenue.

Ben Jekic

Got you. Perfect. Thank you so much.

Frederic Dugre

Thank you, Ben.

Operator

Your next question comes from Gabriel Leung from Beacon Securities. Please go ahead.

Gabriel Leung

Good morning and thanks for taking my questions. I actually just had one follow-up, just around, I guess, the EBITDA margin aspirations for the current fiscal year at sort of 10.5% plus. Given where things sort of fell in fiscal Q4 and given what you’ve seen so far on the Maple side for the September quarter, maybe just talk to us again about how -- where do you think -- where are you prioritizing the margin expansion over the coming several quarters and at what point would you expect to see year-over-year improvement in the EBITDA margin percentage. Do you think it’ll be more of a back half thing at this point, given what you’re seeing?

Marc Blanchet

Yeah. So there’s two things. I think the first benefit will be coming from the price increase for Specialty Products, because it’s faster to deploy and it’s easier to see the benefit amid the price. The second half of the year or even the coming quarter, but I think the benefit of the backlog that now we’re just ramping up from WTS is carrying again projects at much better margins than the previous one we had in the backlog.

So we know that these new projects we’re going to execute and deliver will be at better margin. So this is just a fact. I mean, you look at the profile of the backlog we have, once we are going to -- once it’s going to hit the P&L, it will carry a better margin.

Then the long-term strategy, as I said, and this is the one where we have to be meticulous and strategic is the operation and maintenance, where we have to customize our approach to each of the O&M customer we have. So it is our main focus from the beginning of this fiscal year and it was the previous year as well. So this will remain and we’re engaged and we’re confident in executing that.

Gabriel Leung

Okay. Thanks for the feedback.

Frederic Dugre

Thank you, Gabe.

Operator

Your next question comes from Michael Glen from Raymond James. Please go ahead.

Michael Glen

Hey. Marc, can you just -- for the working capital and the outlook and the CapEx outlook next year, just give a dollar figure for total CapEx, including the fleet next year, what we should be thinking about, if you could maybe put it into dollar terms? And then maybe just wrap some info around working capital, should it -- should we continue to see an inflow on working capital next year or will there be an outflow? Thanks.

Marc Blanchet

So you got a tough one here. So in terms of CapEx, as I said, about 2% of the revenues are regular CapEx spending in addition to the fleet, which as I said, $6 million to $8 million. Then in terms of working cap, as I said also previously in the call, we should go back to normal -- more normality in terms of ratio. So like you to maybe look at what we did 2019, 2021, those are normal years. So in terms of working cap ratio, I think, it will look more we’ll see like that. Does it help

Michael Glen

Okay. Yeah. That should help. So on the -- when you’re talking about the 1% to 2%, it should probably kind of trend towards the higher end of that range then? Is that a fair statement?

Marc Blanchet

Yes. 2% makes sense, 1.8% to 2%. That’s in line with what we did historically in normal years.

Michael Glen

Okay. Okay. Thanks.

Marc Blanchet

Of sales, right? 2% of sales.

Michael Glen

Yeah.

Marc Blanchet

Yeah. Good.

Operator

Presenters, there are no further questions at this time. Please proceed with your closing remarks.

Frederic Dugre

Well, thank you very much for joining the call today and we look forward to catch up with you on Q1. Thank you for your trust and confidence. Thanks.

Marc Blanchet

Thank you. Bye-bye.

Operator

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

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H2O Innovation Inc. (HEOFF) Q4 2023 Earnings Call Transcript