H2O Innovation Inc.

Hi. Good morning, everyone.

My name is Marc Blanchet. I'm the CFO of H2O Innovation.

This call will be held in English, but I will 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 Web site at h2oinnovation.com in the section Investors.

Frédéric Dugré, our President and CEO, is joining me today for the call, which duration is approximately 30 minutes. During this call, Frédéric will give an update on the business and present highlights of the second quarter ended December 31, 2021, and I will be presenting the financial results.

Please take a moment to read the forward-looking statement on Page 2 and the non-IFRS financial measurements on Page 3 of the presentation. I'll now hand over the call to Frédéric.

Thank you, Marc, and thank you to the analysts and the shareholders for joining the call today. We are really happy to present you these results for our second quarter ended December 31, 2021 as we are presenting sustained growth in revenues, improvement in our profitability and continuous business predictability, with a high percentage of recurrent revenues and diversified backlog.

For this second quarter, revenue stood at 42 million, representing an increase of 20% compared to the last year. We are particularly proud to show strong organic growth of 16.2% underpinned by new operation and maintenance projects, sustained activity of our WTS business pillar, growing traction for green specialty chemicals combined with the addition of new distribution to our network.

All of this is the result of investments made to expand our business development and commercial teams, development of new products and strong business execution even during this lasting pandemic, extreme volatility in the supply chain and unpredictability in freight and logistics. Despite all these business challenges, we grew our adjusted EBITDA to $3.8 million, representing an improvement of 6.7% compared to last year.

These results are aligned with our three-year strategic plan, which focused to grow the business organically at the rate of at least 10% per year, while pushing to improve the adjusted EBITDA above 11%. Our net earnings also improved markedly and stood at $800,000 for this second quarter.

The company is focused on renewing and expanding the scope of work on existing O&M projects combined with targeted and selective approach for the new WTS projects. As a result of this methodical approach, backlog remains strong at $126 million, up 12.7% compared to last year.

Our unique business model, relying on 87% of our current revenues by nature, is promoting strong customer retention throughout the different business lines and even creating multiple synergies and cross selling opportunities. We're also proud of our recent acquisitions completed in mid December 2021, allowing us to expand significantly our O&M business in the State of New York and expand margins at the business segment, which will [indiscernible] in the subsequent quarters.

At our last annual meeting of shareholders in early December, we also revealed our first ESG plan with six key initiatives that we intend to push in the coming years. Lastly, the award received by the Chamber of Commerce and Industry of Quebec for a successful strategy for business expansion outside of Quebec was the icing on the cake.

Let's move to the operation and maintenance business pillar presented at Page 5. First, the acquisition of JCO and Environmental Consultants in mid December allows us to position our O&M group in the State of New York, the fourth most populous state in USA.

Indeed, as you can see on this map, we are expanding significantly our footprint in the Northeast region, with slightly more than 200 industrial and municipal customers along the Hudson River. Because the Hudson River is the main source of drinking water for the City of New York and its surroundings, the municipalities and industries upstream are highly regulated and make use of membrane filtration systems regularly.

This is notably why the region was attractive to us and why it is also friendly to private O&M services. During the second quarter, we did further renewal of our single largest O&M project for the City of Gulfport, Mississippi.

After review, the city selected us and currently elected to extend our existing O&M contract till the end of February 2022. This delay should be sufficient to finalize the negotiation with the city and determine the scope of work for the new O&M contract.

Earlier this fall, we proudly renewed our O&M contract for the City of Long Beach, also in Mississippi, for the next four years. With this contract, a total of $12 million was added to our backlog.

On top of being able to adjust our pricing with annual CPI increases, we extended our scope of work and added five new employees. Moving to Page 6, let's have a look at the highlights of our Water Technologies and Services business.

Our business momentum remains positive for the second quarter. Indeed, we have been able to secure three new capital equipment projects for a total scope value of $4.1 million.

On top of that, one of our most important projects in the backlog has finally resumed, which had started delivering equipment by the end of this fiscal year for the largest water reuse projects dedicated to the City of San Diego. If things are going according to the latest schedule, this flagship project should positively impact our current fiscal year as well as the subsequent reporting periods.

Our diversified backlog derived of 34% of industrial-related projects and 66% of municipal projects stood at 41 million at the end of December 2021, an increase of almost 10% compared to last year. Our services team continued to grow and add new customers, notably in the ethanol sector where we have already strong references.

The retrofit of ultrafiltration modules on an existing membrane plant will allow us to propose a similar approach to multiple customers experiencing the same problem. They are looking actually for alternatives to reduce OpEx and increase performance.

This upgrade was made possible notably by our technical process and automation expertise. As you can see through these pictograms, our business activity for the WTS pillar remain really high, and our engineering and fabrication teams are extremely busy.

We're expecting the teams will remain busy for the multiple quarters driven by the robustness of our backlog. Let's look at Page 7 for the performance of our Specialty Products business.

The business pillar continues to provide really good results and contribute significantly toward profitability. Despite all the pressure on margins from the supply chain challenges and multiple constraints related to COVID, our EBAC increased by 91% while revenues remained stable compared to last year.

Our different business lines are working really hard to protect margins through product innovations, such as the PiPerLink developed by Piedmont and launch in November 2021 by continuously adjusting our pricing and by making investment into our plants. The investments made in Vista, California will enable us to not only refurbish the office space, but also gain warehousing and laboratory capabilities to support the growing demand for our green chemistry.

In parallel, we have doubled the square footage in Cheshire, UK in order to add warehousing capacity and in-source the manufacturing of specialty cleaners, which should enable us to better control the price, the quality and the lead time of the products made. We are expecting to begin production of the powder cleaners at the end of the third quarter.

During the second quarter, we continue to expand our distribution network with the addition of four new distributors covering the following territories; Indonesia, Singapore, Chile and Israel. These countries are strategic for us and have a high demand for specialty production components.

Lastly, our maple equipment business line was extremely busy to ramp up the inventory in order to fulfill the backlog of orders and get ready for the next maple season. We anticipate that the positive momentum in the maple market will remain in the coming years, as Quebec government will release quotas for new tasks allowing producers to increase their production.

Also, international demand and consumption for the golden syrup is expected to continue growing. Moving to Slide 8, we see the results of our constant effort to grow the business both organically and through acquisitions.

On an LTM basis, our revenues have grown by almost 13 million or 9%. On a five-year basis, our compound annual growth rate is almost 20%.

But our focus was not only to grow the business but also to focus on improving the profitability and the EBITDA margins. Despite the nominal decrease in our LTM EBITDA, the evolution of our EBITDA over the last five years was remarkable and has been growing at 40% on a CAGR basis.

Margins will normalize as the trend to our long-term targets with supply chain mitigation initiative and scaling of our SG&A as revenues continue to grow. Quarter-after-quarter, year-after-year, we are capturing business synergies between our different business lines, allowing us to improve our operational efficiencies, leverage our sales network and most importantly, retain our customers.

Talking about customer retention, we see on Slide 9 that we have been able to maintain a high level of recurrent revenues by nature. Going through the pandemic, we validated the robustness and resilience of our business model at multiple times.

The strategic decision to focus in growing recurring sales and customer retention has allowed us to significantly derisk the business and improve our gross margin and adjusted EBITDA. Thanks to the multiple synergies that we have between our various business line, our discipline in integrating the acquired companies and retaining our customers, we have improved significantly our financial performance and predictability.

I will now pass it on to Marc Blanchet, our CFO, who will review with you and discuss the financial performance of our company during the second quarter of fiscal year 2022.

Thank you, Fréd. So before I go over the financial results of the second quarter, I'd like to come back again on the last 12 months results.

I always say that H2O Innovation is a business that we have to look at on a LTM basis. In this quarter especially -- in this last 12 months especially, we made effort to grow organically.

This was one of the targets that we gave each other and we disclosed it for the three-year plan. So over LTM basis, just organic growth, we grew by 6.3% compared to 1.3% last year.

So we invested in growth initiatives in order to achieve the 10% organic growth as I said in the strategic plan. To achieve this objective, we hired sales resources and invested in SG&A to generate and support this growth.

The adjusted EBITDA remained relatively stable at 15.4 compared to 15.6 in the previous LTM. The adjusted EBITDA over revenue is slightly lower at 10% compared to 11% last year.

The reduction in percentage is explained by this investment in SG&A to generate growth and also a reduction of the gross profit margin, essentially due to COVID-19 pandemic. The fact that we can rely on three business pillar is the strength of H2O.

It allows us to be able to count on different source of revenue and thus reduce the risk of volatility on EBITDA. So if we go into Q2 results, Page 12, we reported revenues of 42 million compared to 35 million Q2 last year.

It's an increase of 20%. As Fréd mentioned earlier, assuming a constant USD exchange rate during this quarter, the consolidated revenue increase would have been 22.5 instead of 20 and the organic growth would have been 16%.

But quarter-over-quarter, we increased by 16% -- we grew by 16% organically. From the 7 million revenue increase, 3.2 is coming from the three acquisition closed over the last 12 months and the FX impact for this quarter is $800,000.

The gross profit margin ratio slightly decreased to 26.4 compared to 26.8 compared to Q2 last year. The percentage decrease was explained by reduced gross profit margin in WTS and O&M, partly offset by the improved gross profit margin in specialty products.

The adjusted EBITDA improved by 7% compared to Q2 last year and reached 3.8 million compared to 3.6 million last year. The adjusted EBITDA percentage decreased to 9% from 10.2% last year.

The percentage decrease is coming from the decrease in the gross profit margin and the increase in SG&A ratio. As explained in the last few quarters, we've decided to invest in SG&A to generate strong organic growth, which is giving results since this quarter, we generated 16% organic growth.

For the gross profit margin, this quarter it has been impacted by the current global consequences of the pandemic. The company does have an action plan to mitigate cost pressure, which will be presented in each of the business lines.

Finally, we're happy to report a net earnings of $800,000 which is a nice increase compared to $300,000 for Q2 last year. So now let's go over the results of O&M, Slide 13.

So despite an unfavorable FX impact, revenue of O&M increased by 12%. Revenue for Q2 stood at 19.7 compared to 17.6 last year, representing an increase of 2.1.

Of this increase, $700,000 is coming from our recent acquisition of JCO and EC and 2 million is coming from organic growth, which growth was partly offset by an unfavorable FX impact of $600,000. So the gross profit margin and percentage has decreased from 19.8% Q2 last year to 15.7% this quarter.

This is essentially due to an inefficiency related to increased illness related to COVID-19 with our workforce. We had many employees on sick leave and on preventive isolation due to COVID cases, especially during the December month, which caused a significant increase of overtime for the remaining employees.

Since the nature of our service requires a constant level of staffing, so we had to procure overtime cost and increase sick leave, which impacted the gross profit margin negatively. At the end of the first quarter, O&M backlog stood at 85.5 million compared to 74.9 million at same time last year.

It would have been 11.2 million higher or 15% higher, assuming a constant U.S. exchange rate between the two periods.

As we said in previous calls, backlog contains some contracts that are approaching to their renewal date, creating an important fluctuation on the O&M backlog. O&M long-term contracts have typical duration of three to five years and a different anniversary date for renewal.

Since we have a very high renewal rate, with more than 95% of O&M contract renewed since 2016, we believe that they're well positioned to replenish the backlog in the next 12 months. And as it was said earlier, we're under negotiation to renew our most important O&M contract with the City of Gulfport, Mississippi.

Last January, a resolution was adopted by the City Council to approve the extension of the city contract by one month until February 28. The city extended the contract for one month to allow time to finalize discussion for new service contract agreements.

It's also important to note that the contracts in Texas and in State of New York are usually evergreens. They're not included in the backlog.

So now let's move to Slide 14, Water Technologies and Services. So the WTS financial performance for Q2 was highlighted by 23% growth in revenue compared to Q2 last year.

Most of this increase is coming from the project side of our business, so the project activities, which generally brings lower gross profit margin compared to the service activities. Therefore, due to the business mix between the service and the project activities, the gross profit margin in percentage decrease to 18.8% compared to 22.4 last year.

The profitability of WTS was also affected by consequences of COVID, such as delay in equipment deliveries and increased costs of material. When it's possible, based on contract language and client relationship, these increased costs of material will be passed through the customer down the road when we negotiate extra [ph].

For the reason I just explained, WTS and EBAC stood at $0.5 million for Q2 compared to $800,000 last year. With the 4.1 million of new capital equipment projects awarded in November, the backlog of WTS stood at 40.7 compared to 37.1 last year.

As Fréd explained earlier, the backlog is well balanced between industrial and municipal projects. Now let's look at Specialty Products, Slide 15.

Specialty Products had a very strong second quarter. Revenue increased by 32% and EBAC increased by 91% compared to last year.

Revenue stood at 13.8 compared to 10.4 last year and EBAC stood at 4 million compared to 2.1 million in Q2 last year. The significant improvement of its financial performance is due to higher proportion of sales coming from specialty chemicals and GMP acquired in Q3 last year.

Even though Specialty Products showed a strong financial performance this quarter, this business pillar also faced significant challenges caused by COVID-19 pandemic. As explained in the previous call, Specialty Products is a business based on import and export of goods and had to deal with global supply chain matters and increased cost of material.

The gross profit margin was affected negatively, even though the Q2 profitability was improved compared to last year. We're taking proactive measures to mitigate the increase and to minimize the impact on the supply chain issues.

Financial position; so Page 16, the working capital, which is reconciliated in the appendix 28, increased by 3.3 million since January 30. The variation on working cap is mainly due to increase in inventory and account receivable.

I will give further explanation in the next slide on that. As for the other working cap items, I won't go over each of them since the variation compared to June 30 balance sheet is essentially explained by the growth or the FX impact.

So Page 17, I have that graph to help the investors to reconcile our financial position. As I said previously, the variation on working capital is mainly due to increase in accounts receivable and inventory.

So if we go to the first column, the first green one here is the account receivables. So there's 7.5 million increase in accounts receivable.

From that 7.5, 1.2 is coming from the acquisition of JCO and EC, which was acquired on December 15. So we have a full balance sheet without the revenues or barely any revenues.

As for the balance, the remaining, a third come from revenue growth, a third come from the seasonality of maple business, and a third come from delay in collection. Although we had some late payments, as of December 31, there is no significant account that was over 60 days late.

So this increase is explained by timing issue. And all the late payments have been paid as of today.

So if we go to the next column, the second biggest one in green is the inventory. So the inventory increased by, and I realize I didn't -- yes, we don't see that very well.

It’s inventory. I just noticed that on my printed version, we don't see the wording.

So the second one, 4.3 is inventory increase. So this increase is really due to our proactive measures to maintain a higher level of inventory and thus respond to the current supply chain issues, price increase.

So 3.3 million is explained by the increase of the Specialty Products inventory. The remaining is coming from the maple business line, which is currently building its inventory for the upcoming maple season.

Just want to highlight also the contingent consideration, which is I think the last column there. It increased by 2.7 million since June 30.

So part of it is explained by the acquisition of JCO and EC. And another part is the revaluation of the contingent consideration of GMP since their financial performance was higher than what was initially forecasted at year end.

So Slide 18, let's go to net debt. As you can see, we show the evolution here over the last five quarters.

On December 31, the net debt stood at 26 million compared to 0.5 million on June 30. This increase since June is mainly due to the financing of JCO and EC acquisitions on December 15 for which we paid 22.2 million from cash on hand.

The increase is also due to cash flow used in our operating activities coming from the increase in inventory and the higher receivable as I just explained. As announced on December 6, the increase of the revolving facility to 55 million provides greater flexibility to the corporation and to support our acquisition strategy described in our three-year plan.

So this concludes my remarks on the financial section. I will now turn the call over back to Frédéric for conclusion remarks.

Thank you, Marc. So let's move to Slide 19 for the conclusion and takeaways.

Well, overall, we are pleased with our financial and business performance for the second quarter. As mentioned by Marc earlier in the presentation, despite the challenges related to the COVID and the supply chain, our business remains strong and predictable with 87% of recurrent revenues by nature.

With approximately 50% of our consolidated revenues coming from the operation and maintenance contracts, we have less exposure to the volatility of the supply chain. Our multiple initiatives to grow the sales team, develop new products and expand our distribution networks are paying off, as we are presenting organic growth of 16% for this second quarter.

This is also in line with our objective to grow revenues at the double digit pace while continuously looking for initiatives to improve our adjusted EBITDA margin. Our balance sheet is strong, with very manageable leverage.

And the recent expansion of our credit revolver has allowed us to complete two O&M acquisitions in the State of New York. This new credit facility of 55 million will enable us to execute our three-year plan; invest in CapEx to grow and improve manufacturing as well as to complete other tuck-in acquisitions.

Talking about acquisitions, we're really happy of the contribution the three companies added in the last 12 months. Our constant focus to find ways and alternatives to mitigate inflation in our supply chain to properly integrate the acquired companies and maximize the synergies are allowing us to improve the profitability continuously.

Finally, the water sector and its investment thesis will remain very attractive for many years. This is driven by strong and sustainable fundamental drivers that the planet is currently facing.

The first one, the growing water scarcity with more drought events in highly populated areas, the tightening of more stringent regulations notably driven by emerging compounds, such as PFAS, microplastics and [indiscernible] that we find in water. The urgent need of investment to upgrade, refurbish and expand aging water and wastewater infrastructure.

And finally, the constant population growth, which will further push the adoption of water reuse and the installation of the centralized water in wastewater plants. All these drivers will continue to influence our industry and impact positively our business.

For this reason, as you can see at Page 20, we will take advantage of the World Water Day on March 22, 2022 to not only graduate officially to the TSX Exchange, but to also organize a Special Investor Day to create more awareness around the global water challenges in the solutions out there. More details will be announced in the coming weeks on that matter.

Thank you. And I will now turn it back to the operator for the Q&A session.

Hi. Good morning.

Maybe just to start, can you just talk a little bit about the two acquisitions completed in New York? Just remind us how are those two businesses being managed now that they're under H2O?

And is there a single point person from one of the businesses that oversees both operations? I'm just trying to get some insight as to how that operation is being managed?

Yes, so both companies acquired actually are integrated as part of our O&M business pillar under the leadership of one of our Vice President, who is already leading the entire group of operation and maintenance. Both of these businesses have been acquired also because they were -- the owners were looking for an exit, going for a transition.

So it was already planned right from the get-go that these businesses, there'll be people inside the organization that will step up within the organization to take regional leadership. And the idea will be progressively to integrate them with best practices that we have already with other projects that we run in the Northeast.

Again, if you look in the map that we put in the presentation, you will see that we had previously quite important projects as well in the Northeast area, already in Vermont, already in the New Hampshire area. So we're going to take what we have as a basis as to what we have now with these two companies in the State of New York.

But the great news now is that we have a large new customer base of 200 plus customers of industrial and municipal type of customers.

And as we think about the next 12 months with those two deals, is there any -- are there any near-term priorities as you've had these now, ownership of the freight [ph] a few months, any near-term priorities that you would like to focus on?

I think the priorities for these two acquisitions and the low hanging fruit as well is to maximize the synergies with, I will say, the WTS business because, as I said, this area in New York is very friendly to membrane system. We believe there are existing capital equipment improvements, capital equipment upgrades that we can bring to existing customers of these two groups.

So we have already projects that are under discussions with existing customers where we can bring a lot of value. So the priority for us is to really extract and capture these synergies and try to capture these low hanging fruits that we call.

The WTS says it’s a gold mine over there.

Gold mine of opportunities, indeed.

That's great. And then just -- Marc, thank you for the information and detail of working capital.

Would you be able to as we look through the next two quarters to the balance of the year, any indication on what working capital as a whole should look like for the company?

Yes. Well, the receivable -- you'll see working cap follow growth, obviously.

Receivables will come back to normal as it already is the case in the middle of the quarter. It was a timing issue.

And as for inventory, we start to build up, ramp up inventory a little bit over the last few quarters, especially Q1, Q2, especially due to the chemicals -- on the chemical side of our business and even Piedmont. So this is by design.

We're doing that to not miss on sales opportunities. We've also increased inventory at different customers or closer to our customers to avoid the delays into shipping.

So I don't expect to see -- I have to be frank with you. We're investing into inventories a little bit now, just so we don't -- we're able to capture the growth and preserve margin.

Okay.

So it's going to be rocking [ph] high and much more than that. But I think the investment has been done.

For now, it will be I think stabilized. And the rest will follow growth.

And again, it's by design. There's a couple of things behind it that drives this.

As I explained, there's new distributors also that we're adding. So we want to make sure that we have sufficient also supply.

As you probably realize, the supply chain issues with unpredictability for freight carriers to move materials around either incoming freights or outgoing freights make it a little bit more complicated. So this is why also having inventory in hand is allowing us to mitigate these challenges related to lead time and deliveries.

The whole world has changed. We went from having best practices of products and minimizing inventory and have just in time practices now, I will say, it's moved them from just in time to just enough.

But we feel confident. The business is going strong.

There was the seasonality from the maple, obviously, that will resolve in this third quarter. So that will be positive.

But we feel good where we are and this is why we are investing into our plants and manufacturing facilities in both California and notably in UK.

Hi. Good morning.

Thanks for taking my question. I'll start with the first one of all, congrats on the Gulfport contract that you won.

I was wondering if you can talk a little bit about it in terms of how large of an opportunity is it and as to the nature of your discussions with the municipality, obviously, to the extent that you can share or discuss? Thank you.

On WTS you’re talking about?

On Gulfport.

On Gulfport.

Yes. So this is actually the single largest O&M contract we have and one of our oldest as well in terms of relationship with the customer.

In terms of size, currently, it's a project that was mostly on the long-term basis with two components; street and drainage and operation and maintenance of assets. So it is quite significant.

And for years now, this contract would renew. So the city called for a public bid that we bid on.

It was a competitive bid. There were other bidders also.

Earlier, before Christmas, they selected the company H2O to continue negotiation and finalize the scope of work. So there are currently opportunities to even further expand the scope of work that we have.

This is why it's taking a little bit more time. But at this point, we feel confident that we're going to come to an agreement with them and be in a position I hope shortly to announce officially the renewal of this contract for multiple years.

Okay, great. Thank you.

Next question I have, Marc, you mentioned that there are several contracts coming up for renewal this year at least. I was wondering if you can share as to what percentage of your backlog that is, and would you have the opportunity to pass on CPI increases when you renegotiate those contracts?

So in terms of size, we haven't disclosed this and it's not as material as this year with Long Beach and Gulfport, okay. I can reassure you there.

And right now, what we feel is that we’ll sit down with municipalities for the CPI and everyone's expecting a higher CPI than is historically high. So what will be the strategy?

Do we -- will we want to have like long-term contract or maybe a shorter term with stronger adjustments and be able to sit down in two years or in a year. So that's what we're discussing.

So I don't want to disclose too much right now. I don't know who's on the call, if we got any competitors.

But we will work on that and try to pass those increase that we're facing and that everyone's facing right now on salary push, health insurance, COVID leave and overtime and all that. So we will sit down with our customers and take the best out of that.

And many of these contracts are already provisioned for CPI adjustment already embedded in the contract as we speak right now. So we're just going to apply the clause as we come to the yearly renewal.

Okay, great. And I'll just ask one follow up on that and then I'll jump back in the queue.

The CPI escalators, are those only for contracts that have a certain term or do you have those provisions in the evergreen ones as well?

So the provision itself is to the long-term contract. For the evergreen, it's managed differently, because the evergreen allows you also to regularly approach the customer and negotiate even on a monthly basis or a yearly basis new terms.

So again, as Marc explained, we want to be prudent because there's still competition out there. Yes, we want to adjust price as we move, but we want to be strategic also and we need to look at each of these customers differently depending on the scope that we need to perform.

I'll give you an example. On some MUD in the Houston area, Municipal Utility District, you may have a very mature MUD where you have already a number of houses there where they're not really growing.

So you'll be doing mostly maintaining of these assets. While if you look, for example, at a new MUD on their expansion where you know that in the coming years, there'll be maybe 200, 400 houses built over the next years, you may approach your pricing strategy differently and the service you will perform to a newer MUD than you will do for an old existing MUD already well established.

So this is why our strategy will be different and personalized to each of these evergreen contracts.

That's great. I'll jump back into the queue.

Thanks, again.

Thank you.

Thank you. Good morning.

Good morning, Frédéric.

Good morning, Frédéric.

The first question for me is on the O&M side. In the prepared remarks, you mentioned some COVID-related illnesses and overtime costs.

I think you mentioned mostly in December. So just wanted to confirm if those challenges have eased so far in Q3 and potentially have less of an impact in this quarter and the next few quarters?

Yes. So our strategy related to COVID since the beginning was really like Canadian, I would say.

So we're very prudent -- sorry, it's the first word I’d say. But we're very prudent and asking everyone to stay -- if you would be in contact, you stay in isolation for quite a high number of days, 14 days or 10 days depending.

And then the Omicron wave came in. So at a certain point in mid December, we were really struggling because we had so many people in isolation and the rest of the guys were doing crazy hours of overtime that could not be recharged to the customer.

So during the holidays, we readjusted that. And then CDC came up also with different guidance, the five days guidance, which we applied, but frankly it arrived quite late into the month and to the quarter.

January is different. Nevertheless, they're still cases, they're still absence and there's still some overtime.

It's being resolved. We don't see much more in February, but nevertheless we were struggling and had important costs especially in the old Houston area where crews are teaming up.

So that's where we got hit and it hit the margin.

Okay, perfect. And just on the margin profile of the whole business, 9% of EBITDA margin is in the quarter.

Obviously, some lag between price increases and your cost inflation. So just wondering if you can provide me a bit more color on the gradual aspect of your price adjustments and how that translates into your path going ahead of coming back to 10% gross margins and eventually reaching that 11% that's set out in the strategic plan?

So as Marc explained, there are these issues related to ours which I think will resolve by itself as we go through this Omicron wave. We already saw an improvement and seeing improvement as we speak.

And on the pricing, we are extremely diligent and proactive when it comes to Specialty Products to continuously adjust our price versus our cost, as cost fluctuates regularly. So far we have been -- we have been playing good defense on that front and collaborated with our distributors to adjust our pricing on a regular basis.

For the WTS on the equipment and projects, we have done already a few things to mitigate these volatility and price increases related to material first. For example, we have our contingency that we bid into our projects when we bid.

The validity also of our price on new projects that we did also has been shortened, allowing us to mitigate this escalation clause. When we can also -- we have in multiple projects change orders where we can to adjust this pricing and reflect the new reality.

So we're being very proactive on a couple of things to mitigate these pricings. And we're confident in our strategy that, yes, we're going to get there back to the 10% plus and 11% on our three-year plan.

Maybe if I can add, there's two elements in that three-year plan is also 10% growth. So we took proactive decisions to hire salesperson, and we've been talking about that since the third quarter last year.

And we can see the results also in the growth, there's temporary I think effect on the gross profit margin for this quarter for the reasons we framed, but that growth is starting to build up and this will even out at a certain point in time where we will be able to generate that double digit growth and preserving that double digit EBITDA, it's a matter of timing I think.

And then if I can just ask a quick follow up on that, on the group side. I know that the target was over 10% organic growth or around 10% organic growth by '24.

You've already reported 16% in the quarter there. So just maybe your thoughts on the sustainable aspect of your current growth profile and if there was anything in the quarter here that was a bit one-time in nature, just maybe your thoughts on near and mid-term growth as you think about that 10% that you're targeting?

Well, if you just look at our backlog, for example, right now, the backlog has been already growing significantly over the last 12 months. So within this backlog, you can more or less predict or expect what should be coming up in the next fiscal year, in the next 12 months as well.

So the 12% growth we added to our backlog will start to impact in the coming quarter as well, delivering new projects, delivering revenue recognition also from operation and maintenance contracts. So as we said also, we are currently looking for scope expansion into one of our important customer for Gulfport.

This will be another area where we think that will be impacted positively by growth. We are growing our distribution network with new distributors both for Piedmont, both for our specialty chemicals as well.

This is an area and we're starting to see significant, significant demand and traction for green chemistry. It's funny, because we add into our company for the last 12 years PWT and we have been doing the same chemistry, the SpectraGuard with the benefit of being the only one with chemicals out there without phosphate and made into a super concentrated formulation allowing us to reduce the freight of costs -- cost of freight.

And now finally, we're receiving solid, solid traction on our products because it's green and because the cost to move them around the world is way cheaper. So that's why we feel pretty good and confident that we'll be able to continue to see sustained growth into our revenues.

And we launched new products.

And there's new products also that will launch that are starting to get traction as well.

It's not only a bump of a quarter. It's a significant bump in one quarter.

We always have to look at it on a 12-month basis. But the objective is there and it's to be that 10% on a LTM basis and 11% EBITDA, and we're confident that this is doable.

Great. That's helpful.

Thank you very much.

Hi. Good morning.

Just wanted to start on the cost. I know you've cited several sort of drivers here.

But is it possible to estimate or quantify how much of the overall sort of change in SG&A is more permanent, then how much can be passed through to customers?

In SG&A?

Well, in overall cost as you said.

One is coming from, again, by design, because we added just in the last couple of 12 months, about four guys for sales only. So this is a little bit by design.

So there is an area where I think it's a matter of time before we’re starting to see revenue growth, and then we're going to see scalability happening and then a reduction in percentage of SG&A over revenues as we start to generate more and more sales moving forward. What can be passed to the customers, I will say at this point, very little.

I think the money is within our supply chain. And this is where we are making efforts to adjust our price accordingly.

Okay. So it sounds like it's just a question of timing for some of them to pass through.

I wanted to --

Again, as we said, if we want to be able to sustain this 10% growth for the coming years, we have no choice but to invest, right. And what we are starting to see at the second quarter is the results also of actions we took, I would say six months and nine months and 12 months ago, to start to increase our sales.

Just on the chemical side, we added one fellow, one salesman in Middle East, we added one salesman in India, and we added one salesman in Southeast Asia. And this is what we did over the last nine months.

So now we're starting to see the benefits of that. But again, we had to carry the cost burden of these new guys that joined the team.

So clearly about two years’ payback before he pays for himself and for all you pay for him until then.

Got it. That is very helpful.

I wanted to ask about the retrofit project in Iowa. I think in the press release, you highlighted that there are significant amounts of similar sort of facilities that need replacements or upgrades in the U.S.

in the next 5 to 10 years. Just wondering if you can expand on that and how are you positioning the company to capitalize on those projects?

Yes. So indeed, there is multiple ultrafiltration systems already out there.

We have been successful in changing, not only changing and replacing the membranes with an alternative membrane but the idea with this new membrane was to gain additional throughput, in a sense that the membrane that we replaced with was able to process more water. I'll try to simplify it, but process more water and the same volume.

And in this way allowed the customers to reduce their OpEx or improve their production. And also because of our expertise process-wise and because we have a team of engineers and a team of automation engineers, we have been able to change the parameters also of operation of the existing systems to improve the efficiency and reduce the OpEx for the customer.

So now there are multiple, like thousands of systems out there in stock [ph] more or less in a similar problem. So this is why progressively we want to approach the markets.

We have done the successful retrofit and now we're targeting other ones that our service team will tackle in the coming months. I've already tackled a few more.

So this is exciting. It's kind of a very technical niche approach.

But it's also a way to get into new customers, because if we're successful to retrofit and replace these membranes, well, most likely we're well positioned to bring the specialty chemicals, to bring other components, to bring on additional upgrades, proposed operation and maintenance. So it's kind of a door opener on existing infrastructure.

And on this project in Iowa, I think you're working with another company. Did you see any opportunities to maybe sign some strategic partnerships with some key players in that market?

Yes, there are a few, I would say, local companies out there that can help us on the service side. So this was a company that helped us to conduct the physical replacement and carry and move the membranes in the field.

So there are a few companies of similar nature out there that we could team up with, depending on where they are geographically.

Okay. But it's not a large strategic with a national footprint.

It's really more of a local or state-by-state approach?

Correct.

Okay. And just one last question about the Investor Day.

You had the recent update at the AGM in December. So if you can give us some thoughts on what to expect from the Investor Day, that will be helpful?

Well, the idea again, as I said, will be to bring more awareness around the water issues, generally speaking, so not only talk about H2O itself, but talk about -- because it's a World Water Day, talk about the general issues out there related to water scarcity, the new approach to water, try to break up taboos also about water reuse. Because I think it's part of our mission as well to create awareness about the technologies out there, even though there's tons of challenges related to water.

The good news is that there are technologies out there that can be used and applied to make a better planet. So this is what we're going to talk about, generally speaking, and try to have a keynote speaker up along these lines.

Okay, that’s great. Looking forward to that.

Thank you.

Good morning, gentlemen.

Good morning.

Maybe just I guess a two-part question on potential M&A here. In terms of maybe sourcing the prospects here internationally and also conducting due diligence work, I'm just trying to get a sense of how things are looking now versus, say, maybe 12 months ago with the level of travel restrictions globally that you're seeing across the geography.

And thankfully maybe just on also the seller's expectation aspect as well as, obviously, in recent months, things have really cooled down in some areas of the market. I'm just curious to see what you're seeing on your site there please?

Thank you.

Well, in terms of acquisitions, we still have definitely targets. There are targets out there of tuck-ins as we have said before, so this is what we want to go after.

As we said, there was two essentially areas that we're looking at. Operation and maintenance, we just did two.

We're looking also to complement and add more production components to our Specialty Products platform, let's put it this way. So these are the things that we'll be looking at and also additional technologies.

I don't think that in terms of game plan or strategy, we have seen change. You have to put some restriction in the traveling, allowing us to -- not allowing us to travel as we wanted to.

But through the relationships, through the contacts we have within the industries globally, I think we have been able to still strive and make moves and progress on different fronts on these acquisition targets. So we remain confident that in the next couple of months, we'll be in a position to come back to the market with great news on expansion and new acquisitions.

And I think in terms of sellers, most of what we see out there are same motivations. So we see business owners in general getting older, looking for exit strategy or we're looking for companies that are small size and looking for a platform to further grow their business, because they have some kind of limitation.

And if they join and come along with H2O, we can provide them instantaneously access to a large distribution network internationally, which by the way took us years to develop. So within a few months then they can expand their business very rapidly and efficiently.

So these are kind of things that we're looking at. And we're still confident that we'll be able to come up with great news in the coming months.

For sure. That's super helpful.

Thank you. And maybe just I guess a follow-up question on your previous comment on funding your growth strategy without diluting the shareholders.

I would assume that's predicated upon your ability to generate free cash flow. Obviously appreciate Marc's earlier comment on the puts and takes on working capital there.

Just trying to get a sense on how should we be thinking about I guess the free cash flow generation potential for the business over the long term, especially versus peers? Are there any I guess low hanging fruit that you have identified in terms of improving on your cash collection and DSO and those metrics there?

That's a good question, especially compared to the peers, because our peers are less maybe sometimes diversified than us. So if we look to O&M, as I explained, it's a question of timing.

So generally operation and maintenance we collect within 20 days after the invoice is issued. In this case, we have some 40 days-ish.

So that's kind of the result. That represents 50% of our revenues.

As I said, in terms of inventory, we will focus on trying to reduce the inventory level, but I think that the investment has been made. So how will we recollect that eventually is for us was a bit of a defense play or meant to preserve the gross profit margin coming from our products, so by it being able to supply ourselves more efficiently and even by bringing in-house some powder production, this is what we're doing in the UK right now.

So this also is part of the increase of the inventory that we see. We will be able to preserve more gross profit margin, generate more free cash flow.

So there's a bit of investment there in CapEx and inventory. But this is for a relatively short term return on investment.

So how to see free cash flow is maybe there's a bump here right now, but I think it should stabilize as it was maybe 12 months ago. That's what I expect to see.

I don't want to give too much details as I've never disclosed that. Obviously, I have a good crystal ball that I've tracked very efficiently and that's only what I can say right now.

We need to keep in mind that by nature, our business, generally speaking, is not very CapEx intensive. So to grow the business for us right now is, as Marc said, we are by decision, by design investing a little bit more into our inventory.

We're making also investments that were not done before in both to our chemical plants in California and UK. And as you know I imagine that the margins that we make on both of these business lines are extremely, extremely profitable.

So the return on investment expected on these investments that we're doing is quite good. There's always a mindset of timing of things in December.

When you take a picture on December 31 and looking at your receivables versus your payables, it's not perfect, but we're confident that within the next six months, by the end of our fiscal year June 30, things will go back to normal. And at this point in terms of dilution for acquisitions, our strategy is still the same.

We want to -- we're aggressive growing the company. But most importantly, we don't want it to go above the threshold, let's say, of 2.5x to 3x, that kind of ratio.

So this is what we feel comfortable at this point. But also the key is paying the right price when you make the acquisition on day one.

This is where you make your money and making an acquisition at the right price. So this is why we want to stay disciplined also in approaching our transactions, not overpaying companies that are really high in multiple, but take advantage of buying smaller companies at affordable price, not overleveraged and rapidly integrate them to create value.

Great. That's super helpful color there.

Maybe just one last quick housekeeping item for Marc. In terms of the CapEx, any I guess early projection for the year for that item?

Historically, CapEx has always been I’d say between 1% to 2%. So this year with the investment we're making in the UK and in California, it might be closer to the 2%-ish in terms of modernization.

So we want to remain disciplined and preserve that CapEx, unless there is an investment that would have a return, but we would explain then that there would be probably revenues coming with it and stuff. But in terms of CapEx really and reinvestment into our facility, or like the in-sourcing investment we're doing in the UK right now, will be maintained between that 1% to 2%.

Okay, it makes sense. That's it for me.

Thank you.

You're welcome.

Thank you very much for attending the call and we look forward to catch up with you and stay tuned for more details on the World Water Day where H2O is going to get listed on the TSX in Toronto. Thank you very much.

Have a great day. Bye-bye.

Bye-bye.