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Edited Transcript of HEO.V earnings conference call or presentation 13-Nov-19 3:00pm GMT

Q1 2020 H2O Innovation Inc Earnings Call

QUEBEC Dec 5, 2019 (Thomson StreetEvents) -- Edited Transcript of H2O Innovation Inc earnings conference call or presentation Wednesday, November 13, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Frédéric Dugré

H2O Innovation Inc. - Co-Founder, President, CEO & Director

* Marc Blanchet

H2O Innovation Inc. - CFO

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Conference Call Participants

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* Daniel Rosenberg

Haywood Securities Inc., Research Division - Analyst of Technology

* Gabriel Leung

Beacon Securities Limited, Research Division - Research Analyst of Technology

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. And thank you for standing by. Welcome to the H2O Innovation conference call announcing its first quarter 2020 financial results. (foreign language) (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 that could cause actual results to differ materially from those anticipated. I would now -- I would like to remind everyone that this conference call is being recorded today, November 13, 2019, at 10:00 a.m. Eastern time.

I will now turn the conference over to your host, Messrs. Frédéric Dugré and Marc Blanchet. Please go ahead, gentleman.

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Marc Blanchet, H2O Innovation Inc. - CFO [2]

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Thank you. Good morning, everyone. My name is Marc Blanchet, 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. Frédéric Dugré, 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 first quarter 2020, and I will be presenting the financial results of this quarter. Please take a moment to read the forward-looking statement on Page 2 and the non-IFRS measurements on Page 3 of the presentation. Frédéric?

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Frédéric Dugré, H2O Innovation Inc. - Co-Founder, President, CEO & Director [3]

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Thank you, Marc, and thank you for joining the call today. As you can see on Slide #4, our business has tremendously evolved over the last 12 months. Indeed, the acquisition of Hays completed in December 2018 allow us to establish ourselves rapidly in Texas with strong and sustained O&M activity. Since then, we have been able to integrate successfully the company, retained our customers, our employees and capture sale synergies with existing customers of Utility Partners. Lately, in order to accelerate the growth of our Specialty Products business pillar, we announced earlier in November the acquisition of Genesys International, a manufacturer of specialty chemicals for membrane applications. The transaction is transformational for us in many ways.

Not only it will enable us to grow our product offering, but it will also allow us to grow significantly our distribution and manufacturing platform. I will further talk about the synergies and the rationale of Genesys acquisition at the end of the call.

Moving to Slide #5, we can see that our business mix has not only influenced our adjusted EBITDA improvement but also the level of recurring revenues. For this first quarter of 2020, looking at the last 12-month basis, we continue to observe an organic growth, mostly fueled by the growth of our second and third business pillar. The strategy to grow first the Specialty Products and the O&M business pillar has a direct and positive impact on our adjusted EBITDA. Such strategy allow us to increase our recurrent revenues to 80% and thus contributed to improve our predictability and customer retention.

On Slide #6, we can see that consolidated revenues have increased by 20.1% year-over-year from an LTM perspective. Over the same period, the adjusted EBITDA increased by 58%. This significant improvement is notably due to the acquisition of Hays South in Texas through a successful integration to the sales synergies captured early after the acquisition and to the organic growth of Specialty Products, particularly for the Piedmont product launch.

I will now let Marc review the financial performance for the company for the first quarter ended September 30, 2019.

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Marc Blanchet, H2O Innovation Inc. - CFO [4]

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Thanks, Frédéric. So before we go over to consolidated financial statements, we will present the results of each of our 3 business pillar. Please go to Slide 8, first business pillar, Projects & Aftermarket. Revenue for this first quarter, for that pillar, stood at $8.2 million, which is a decrease compared to $10.3 million of last year. This variation is due to the timing of Project contracts. As explained in the call of September, we expect to recognize a similar level of Project than last fiscal year, but most of the revenues will be recognized in the second half of this fiscal year.

As for the gross profit margin, it stood at $1.7 million or 20.3% compared to $2 million or 19.9% for the same quarter last year, representing a decrease of $300,000 but an improvement in terms of percentage over revenues.

This decrease in revenue impacted the Projects' EBAC negatively. Project EBAC stood at $600,000 or 7.9% during this quarter of 2020 compared to $1.1 million or 10% last year. It's a decrease of $0.5 million and a decrease in percentage. This decrease in percentage is impacted by the decrease in revenue and the addition of the salesman and process engineer to support the growth of wastewater activity.

The project backlog stood at $40.2 million as of September 30 compared to $50.5 million last year, representing a decrease of 20%. As we said many times, the focus of this business pillar is to improve the gross profit margin prior to focusing on growing of volume of revenues.

The project backlog is well balanced with diversification between water and wastewater as well as between industrial and municipal, which reduces the risk related to focusing on one single market.

Second business pillar, Page 9, Specialty Products. Revenue from the Specialty Products stood at $5.2 million during this first quarter compared to $4.2 million last year. It's an increase of $1 million or 23.4% compared to last year. This increase in revenue for this business pillar is supported by significant orders delivered during this quarter for our Piedmont business line. Sales coming from the maple business line also contributed to this increase. Maple producers have recovered from the bad season 2 years ago and are reinvesting again in new equipment, while they are preparing for the upcoming maple season. The gross profit margin stood at $2.2 million or 42.7% compared to $1.9 million last year or 44.9%. It's representing an increase of $300,000, but a decrease in percentage. This variation is mainly due to the business mix within this business pillar. If you remember this business pillar has 3 business lines, so PWT, which is chemical; Piedmont, which are Specialty Products for the desalination industry; and Maple Equipment. So this year's first quarter had a lower level of revenue coming from PWT, which generally comes with higher gross profit margin. Specialty Product EBAC stood at $1 million or 18.3% compared to $600,000 or 15.4% last year. It's representing an increase of $400,000 or 47.1%. The increase is due to the higher level of revenue and a good control on our operating and selling expenses.

Third business pillar, Operation & Maintenance, Slide 10. For first quarter of 2020, our O&M recurring revenue have increased to $14.8 million compared to $9.1 million -- sorry, $9.9 million. It's representing a 50% growth. Over that $4.9 million of revenue increase, $5.1 million comes from the acquisition of Hays, which was completed in December 1 last year. So this revenue increase compensates the loss of approximately $300,000 due to 2 contracts that customer decided to take back in-house. So the gross profit margin stood at $2.8 million or 19.1%compared to $1.6 million or 15.9% for the same quarter last year. It's representing an increase of $1.2 million or 79.8% of increase compared to last year. This variation is mainly due to the 2 project last year that were in a start-up phase during the first quarter. So when projects are in start-up phase, it has a lower gross profit margin and therefore impacted negatively the gross profit margin of last year. The EBAC stood at $1.9 million or 12.5% for this quarter compared to $0.8 million or $800,000 last year or 8%. It's representing an increase of $1.1 million or 136% increase. This variation is essentially due to the addition of new revenues coming from Hays and the improvement of the gross profit margin.

As for the backlog, on September 30, the backlog stood at $113 million. It's representing a 26.5% increase compared to last year. This increase is boosted by the renewal and the addition of multiple O&M contracts that will be executed over the next few years. It's important to note that Hays O&M contracts are not included in the backlog since most of the Hays contracts are with municipal utility districts and are usually evergreen contracts, therefore cannot be included in our backlog. So this significant backlog, combined with a high recurring revenue coming from Hays, are providing us an excellent visibility on revenue for the upcoming quarters.

Please go to Slide #11, Financial Highlights. So now let's look at the consolidated basis numbers. So reported for this first quarter revenues of $28.2 million, it's an increase of 15.8% compared to the same quarter of previous fiscal year. As explained earlier, this increase is mainly coming from the acquisition of Hays as well as the organic growth from Specialty Products business pillar. Hays contributed to $5.1 million of that growth since the acquisition was closed on December 1. The gross profit margin ratio increased to 23.8% compared to 22.6% last year. This increase of the gross profit margin in percentage is explained by the increase of the gross profit and percentage coming from Projects & Aftermarket and O&M business pillars and also by the adoption of a new accounting rule, IFRS 16, which resulted in a decrease of the cost expenses by $100,000 for the first quarter.

For those who are less familiar with this new accounting rule, IFRS 16, what it does essentially on an accounting perspective, it considers leases the same way assets are considered. On P&L, rent expenses has been replaced by amortization expenses and interest accretion. And on the balance sheet, there are 2 new sections, right of use of assets and lease liabilities.

SG&A Expenses, Slide 12. On the SG&A expenses, so our expenses in dollar increased this quarter compared to the same quarter of previous fiscal year. This increase is due to the acquisition of Hays, which was done, as I've said earlier, on December 1 and contributed to $100,000 of increase. We've also hired administrative -- made some hiring in the administrative team to support the growth. We've had, this first quarter, nonrecurring professional fees due to new accounting standards of IFRS 15. So we had the audit of IFRS 15 and the work was done on the first quarter, therefore, expenses were there, those are nonrecurring expenses. And there was also some professional fees related to the change in segment information. So a lot of work was done related to that and additional nonrecurring professional fees were accounted then. The adoption of IFRS 16 also resulted in a decrease in the admin expenses by $30,000.

In percentage, the SG&A over revenue are pretty stable at 17.9% compared to 18% last year.

Now let's go to Slide 13, Adjusted EBITDA. So the adjusted EBITDA increased by $300,000 to reach $1.6 million during this Q1 2020 compared to $1.3 million last year. Our adjusted EBITDA in percentage increased to 5.8% compared to 5.2% for the same quarter of previous fiscal year. This increase in adjusted EBITDA is driven by the increase in revenue, the increase of the gross profit margin offset by an increase in SG&A.

Also, the adoption of IFRS 16 in the first quarter contributed to reduce by $300,000 the operating lease expense for the quarter. Excluding this adjustment of IFRS 16, the adjusted EBITDA would have been 4.6% of revenue. Therefore, the impact of IFRS 16 is nearly 1% of the adjusted EBITDA.

In previous calls, I expressed the objective of the management to reach an adjusted EBITDA of 6% to 7% of revenues. Now once we consider the impact of IFRS 16, the adjusted EBITDA objective of the management for this fiscal year should be reevaluated between 7% to 8%.

Now let's go to the Financial Position, Slide 14. Working capital decreased by $1.2 million. It was a $12.8 million -- it was $12.8 million on June 30, which is a decrease to -- from -- sorry, last year, it was at $12.8 million and now it is -- not last year, sorry. June 30, it was at $12.8 million and it has decreased to $11.6 million on September 30. This decrease is mainly impacted by, again, IFRS 16, which added on September 30 $1.2 million in the current portion of lease liability. Therefore, without the impact of IFRS 16, the working capital would have been similar to June 30.

So if we look at receivables, they decreased by $800,000 to $18.6 million from September 30 compared to $19.4 million on June 30. This decrease is mostly attributable to timing between invoicing and collection. Inventory increased by $200,000 to reach $7 million on September 30 from $6.7 million on June 30. This increase is due to sales increase to support the growing demand on Specialty Product business pillar, especially in the maple business line, which inventory often need to be on hand and available.

The payable increased by $2 million to $14.3 million compared to $12.3 million June 30. This increase is mainly due to timing of project for the first quarter. Contract assets increased by $1.9 million to $7.8 million from $5.9 million on June 30. This variation is generated by difference between project advancement and project invoicing schedule from one project to another.

Slide 15, the Net Debt. This has decreased by $1.6 million to reach $8.2 million on September 30 from $9.8 million on June 30. This decrease is mainly due to long-term debt reinforcement schedule and while cash increased by $600,000. The adoption of IFRS 16 also contributed to reduce the net debt by $0.5 million since obligations under finance lease has been reclassified to the lease liability on the balance sheet.

I also want to highlight the significant decrease of the net debt since Q1 last year. This decrease is coming from the fact that last December we changed bank -- while we change bank, we negotiate our credit facility, which was combined with an extra financing raise at the same time of the Hays acquisition. Another important factor explaining this decrease over the last year is the fact that we generated cash flow from our operating activities for an amount of $7.3 million over the last 12 months.

If we go to Page 16 now, looking at our cash flow, we're very proud to report that our operating activities generated $2.2 million in cash for Q1 compared to $700,000 for the same quarter last year. This variation of cash flow from operating activities reflects the healthier management of the corporation's working capital items.

This concludes my remark on the financial section, and I'll now hand over the call back to Frédéric for conclusion remarks.

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Frédéric Dugré, H2O Innovation Inc. - Co-Founder, President, CEO & Director [5]

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Good. Thank you, Marc. As mentioned earlier, the acquisition of Genesys is transformational in many ways for us.

At Slide #17, we see that our vision behind the merger of the PWT and Genesys is to increase, is to create a major supplier of specialty chemicals for membrane applications with one of the largest distribution network and global manufacturing capabilities. The first rationale to support this acquisition is to build a strong combined portfolio of products by combining the strengths of both the phosphonate and the dendrimer chemistries. This extended and diversified product portfolio and offering should enable us to cover a large range of application related to membrane, water treatment and thus capture more sales.

Second, the combination of Genesys and PWT sales distribution network will allow us to build one of the largest distribution platform for specialty chemicals. Indeed, once integrated, we will have more than 100 distributors active in more than 70 countries.

Finally, since PWT is already manufacturing its products in California, while Genesys is blending theirs in the U.K., we believe the merger of the companies will allow us to optimize our manufacturing strategies in order to reduce freight costs for our customers and reduce delivery time as well. Such manufacturing capabilities should also allow us to avoid certain commercial tariffs imposed by governments. Our intention is to leverage both manufacturing sites in their respective geographies.

Finally, as mentioned earlier, our growth trajectory continues as shown on Slide #18. Following a strong fiscal year 2019 with an adjusted EBITDA of $7.2 million, we are starting our fiscal year 2020 on a strong basis with the acquisition of Genesys. On a pro forma basis with Genesys, our revenues will be at $128 million and/or adjusted EBITDA at $10.3 million, representing a growth of 8.8% on a consolidated revenue basis and 43% increase on our adjusted EBITDA relative to our 2019 fiscal year.

The merger on a pro forma basis, again, should also increase by $10 million the revenues of our Specialty Products group. This result also will increase our recurring revenues by nature to almost 78%. Genesys group of companies was an acquisition target for almost a decade now. Today, we feel honored to work with Genesys employees, distributors and customers to create a unique specialty chemical group with strong expertise in membrane filtration, innovative and diversified portfolio of products manufactured globally and one of the largest distribution network around the globe.

Moving on to Slide #19, the Key Highlights. Last fiscal year, growth was accelerated by the acquisition of Hays in December 2018 in order to expand our operation and maintenance presence in Texas. Rapidly after the acquisition, we have been able to keep our customers, retain and motivate new employees and realize the first sales synergies. This contributed to the 15.8% growth of our revenues in the first quarter.

Also, for the first quarter of fiscal year 2020, the adjusted EBITDA reached $1.6 million. Our combined backlog reached $153 million as of September 2019, supported by a diversified of industrial and municipal projects and by the renewal of multiple O&M contracts. For the first quarter, our balance sheet also improved significantly by the cash generated from the operations, as Marc explained, $2.2 million, allowing us to continue to reduce our net debt, now standing at $8.2 million.

Finally, it's worth to recall that our business model is unique as it brings predictability through our 80% of recurring sales. It also allows us to capture many sales synergies among the 3 business pillars in order to provide added value for our customers, thanks to our loyal, innovative and dedicated team of people who make it work every day. And also thank you to our shareholders who have made the acquisition of Genesys possible.

This now complete the management presentation. I will now turn it back to the operator for the Q&A period. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Daniel Rosenberg with Haywood Securities.

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Daniel Rosenberg, Haywood Securities Inc., Research Division - Analyst of Technology [2]

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I just wanted to follow up on your adjusted EBITDA expectations. I think I missed the number, but what did you mention were your expectations for next year on the EBITDA margin?

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Marc Blanchet, H2O Innovation Inc. - CFO [3]

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So the EBITDA margin expectation for next year, considering IFRS 16, is between 7% to 8%.

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Daniel Rosenberg, Haywood Securities Inc., Research Division - Analyst of Technology [4]

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Okay. And you also mentioned that project and maintenance growth is going to be heavy towards the back end and it was a little later this quarter. I was wondering, have your expectations on growth for the year changed in that late or you're still comfortable where you are?

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Marc Blanchet, H2O Innovation Inc. - CFO [5]

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No, still comfortable where -- similar to what we presented in September.

I don't know if you remember, but I expressed the fact that this year the project schedule, as we see it right now, we -- the projection of revenues will be mostly recognized in the second part of the year. Therefore, we expected to see the first 2 quarters a bit slower and most of the revenues for Projects will be recognized in the second half. Nevertheless, we expect to see the project at the same level. For the last 2 years, as we expressed many times, the objective is to secure project with higher gross profit margins. So the focus is on quality of revenue instead of growing the business. We believe that strategy will derisk the business and be less volatile on the project revenue. Therefore, the strategy stays the same. But again, in terms of execution of project, we said revenues will be mostly converted or realized in second half.

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Daniel Rosenberg, Haywood Securities Inc., Research Division - Analyst of Technology [6]

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Okay. And could you provide any color in terms of the Sustainable Water partnership and maybe how the backlog looks in terms of industrial projects versus municipal-type work?

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Frédéric Dugré, H2O Innovation Inc. - Co-Founder, President, CEO & Director [7]

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Yes. We still have a few products under design and under construction. As we explained earlier, we commissioned one. The one that is already under operation now is for Virginia WaterHub, a large industrial customer in Virginia. In the first quarter, we are on our way and almost at commissioning phase now for 2 other industrial projects in the East Coast of the United States as well to initial customers. And we still have other ones now under engineering phase and design that will also impact the current fiscal year 2020.

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Marc Blanchet, H2O Innovation Inc. - CFO [8]

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As for maybe backlog, if I can answer that question, the how is it diversified. I refer you to the Page 9 of the MD&A, it's very similar. We've reached, I would say, that comfort level. That's why we are not presenting it, didn't present it in this, but it's similar to what it was in September. And you got the split between industrial and municipal, wastewater and water on Page 9 of the MD&A.

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Operator [9]

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Your next question comes from Gabriel Leung from Beacon Securities.

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Gabriel Leung, Beacon Securities Limited, Research Division - Research Analyst of Technology [10]

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A couple of things. First, on the O&M side of the business, I noticed that revenues were down sequentially from Q4, and I'm just curious if that was just reflecting those 2 contracts that decided not to renew or just decided to take the operations back in-house.

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Frédéric Dugré, H2O Innovation Inc. - Co-Founder, President, CEO & Director [11]

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Exactly. You're spot on. So these 2 projects brought in-house again by the customers. We had no options for us on this side, impacted the first quarter compared to the same quarter last year.

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Gabriel Leung, Beacon Securities Limited, Research Division - Research Analyst of Technology [12]

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Sorry, I mean on a sequential basis.

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Frédéric Dugré, H2O Innovation Inc. - Co-Founder, President, CEO & Director [13]

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Sorry, repeat that again?

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Gabriel Leung, Beacon Securities Limited, Research Division - Research Analyst of Technology [14]

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I was talking about the sequential growth. Because I think last quarter your O&M business was about $15.9 million, you're $14.8 million this quarter. So just wondering if there is anything else aside from those 2 contracts?

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Frédéric Dugré, H2O Innovation Inc. - Co-Founder, President, CEO & Director [15]

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Yes. So one of the contract actually was terminated or finished in the course of the fourth quarter and now we feel the full impact of this termination in this first quarter.

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Gabriel Leung, Beacon Securities Limited, Research Division - Research Analyst of Technology [16]

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Understood. All right. Got you. Now in terms of new deal flow in O&M, you guys also had a very big renewal quarter. But in terms of new business, new bookings, I know you guys have talked about working on some larger opportunities. Just curious where things are at in terms of the large OEM deal pipeline?

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Frédéric Dugré, H2O Innovation Inc. - Co-Founder, President, CEO & Director [17]

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Yes. We have a couple of -- not couple, but we have a very healthy sales pipeline of O&M projects that we're bidding on. Our sales team is quite active. And again, I mean, it's a matter of time. I mean, sometimes, we bid on projects but the -- as much as this business is sticky, the sales cycles are quite long because it involves political decision sometimes to turn into the private sector their operations. So it's coming, but it's a matter of time. Otherwise, organically, we keep pushing our existing projects and our existing project managers to increase their scope of work by adding more scope of work. So this is a nice growth opportunity that we're feeling. And Hays itself continues to add growth to their existing revenue base as well. So new projects, existing scope of work increase. Hays continue to grow itself. So this is how we envision this year, current fiscal year.

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Gabriel Leung, Beacon Securities Limited, Research Division - Research Analyst of Technology [18]

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Got you. And in terms of the opportunities that you're getting involved in, it sounds like most of these are, do we take it to -- do we sort of privatize the stuff or take it out? Are you finding -- are these competitive opportunities? Or is it really just deciding whether or not they're going to outsource, I guess, the operations?

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Frédéric Dugré, H2O Innovation Inc. - Co-Founder, President, CEO & Director [19]

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We do both actually. So there are bids actually publicly known that we participate on and there's other one that we work directly with customers and municipal customers to propose to privatize their service. The other aspect of our growth also that we're filling and started to field back last fiscal year is the operation and maintenance opportunities coming from the project group. If you remember, I expanded earlier that Sustainable Water, one of our partner, has provided us now 2 opportunities that we're commissioning and other ones that we're working on. But as we commission these projects, we're also capturing the operation and maintenance of them. And this is one of the growth avenue also that we're seeing for the operation and maintenance, is to capture this portion of the growth coming from projects commissioned by the first business pillar.

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Gabriel Leung, Beacon Securities Limited, Research Division - Research Analyst of Technology [20]

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Got you. And then one last question for Marc. Sorry, just a point of clarification on the EBITDA margin targets of 7% to 8%. Were you referring to fiscal '20 as these being targets?

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Marc Blanchet, H2O Innovation Inc. - CFO [21]

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Yes, that's correct.

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Gabriel Leung, Beacon Securities Limited, Research Division - Research Analyst of Technology [22]

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And does that 7% to 8% target factor the pending Genesys transaction? Or is this the sort of core H2O...

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Marc Blanchet, H2O Innovation Inc. - CFO [23]

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Oh, it was before.

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Gabriel Leung, Beacon Securities Limited, Research Division - Research Analyst of Technology [24]

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Before, okay, got you. Okay. Before the acquisition. Okay, got you.

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Marc Blanchet, H2O Innovation Inc. - CFO [25]

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If you want to modelize the impact of the pending transaction, I'll refer you to the pro forma that were attached in the prospectus.

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Operator [26]

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We have no further questions at this time. I turn the call back over to the presenters.

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Frédéric Dugré, H2O Innovation Inc. - Co-Founder, President, CEO & Director [27]

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Okay. Thank you very much, and thank you for attending the call, and I look forward to catch up with you on the next quarter of the results in February. Thank you. Have a good day.

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Operator [28]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.