H2O Innovation Inc. (OTCQX:HEOFF) Q2 2023 Earnings Conference Call February 14, 2023 10:00 AM ET
Company Participants
Marc Blanchet – Chief Financial Officer
Frederic Dugre – Co-Founder, President and Chief Executive Officer
Conference Call Participants
Michael Glen – Raymond James
Endri Leno – National Bank
Naji Baydoun – IA Capital Markets
Gabriel Leung – Beacon Securities
Yuri Lynk – Canaccord Genuity
Operator
Good morning, ladies and gentlemen, and welcome to the H2O Innovation Q2 FY 2023 Financial Results Conference Call. At this time, all participants lines are in a listen-only mode. [Operator Instructions] Note that this call is being recorded on Tuesday, February 14, 2023.
And I would now like to turn the conference over to Frederic Dugre and Marc Blanchet. Please go ahead.
Marc Blanchet
Yes. Thank you very much. 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. Frederic Dugre, President and CEO of H2O is joining me today for the call, which duration is approximately 30 minutes.
During this call, Fred will be giving an update on the business and present highlights of the second quarter ended December 31, 2022. I will be presenting the financial results right after Fred’s presentation. Please take a moment to read the forward-looking statements on page two and the non-IFRS measurements on page three of the presentation.
I’ll now hand over the call to Fred.
Frederic Dugre
Thank you, Marc and thank you for joining the call today on this Valentine’s Day. Well, we couldn’t be prouder of our results and performance for the second quarter of our fiscal year 2023, particularly considering the current economic backdrop in high inflation and bottlenecks on the overall supply chain.
At H2O Innovation growth is present in every business line and in every aspect of our business. This is evidenced by record high revenues of $63.9 million, supported by 27% organic growth and leading to a 70% increase of our adjusted EBITDA. Cash flow from operations was also robust at $6.6 million in the quarter, a significant improvement from the previous quarters, and also in line with our strategic objectives to convert EBITDA to free cash flow. Our team is executing its business plan and exceeding its objectives.
H2O has built a North American platform to address a massive and growing market and continues to monetize the platform with repeat and new business with — from both industrial and municipal customers. With 90% of recurrent revenues by nature, our business model is resilient and more predictable financially. Combined with a consolidated backlog of $206 million, which has increased 63% year-over-year, strong market drivers and high recurrent revenues, we feel confident that our pace of growth will continue in the coming quarters.
While maintaining our growth trajectory, we remain committed to improve our EBITDA margin above 10% as for our three-year plan. For this second quarter, we posted an adjusted EBITDA of $6.5 million, up 70% from Q2 in previous fiscal year. With such results, we’re showing that we’re growing our EBITDA faster than our revenues, which also demonstrate the scalability of our business. Moreover, the measures we took to mitigate both price increase in raw material and inflation in wages are starting to reflect positively on our gross profit margins, as well as on our EBITDA margin.
Indeed, on an LTM basis, our revenues have increased 200 — have increased to $224 million, representing almost a 45% increase from previous 12 months. On a five-year basis, our compound annual growth rates stand at 17.4%, including acquisition and organic growth.
The adjusted EBITDA on the LTM basis reached $21.7 million, an increase of 40.7% compared to the previous 12-month. What is remarkable is that over the last five years, the adjusted EBITDA has increased by 31.7% on a CAGR basis, showing our dedication to scale up the business and grow the bottom line faster than our revenues.
Moving to slide number five. Let’s review the business activity for each of our business pillar, starting with the operation and maintenance. Our O&M team continues to deliver. Not only we have been able to secure new O&M projects, but we have been able to renew multiple existing O&M contracts. During the second quarter, we renewed four O&M contracts in the state of Texas, New Hampshire, New York, and one in the province of Alberta. As per the press release issued last week, this renewal in Alberta consists of operation and maintenance of 11 water treatment plant, but also two wastewater treatment systems, including 28 sewage lift station — sorry — for the Kananaskis provincial part. This is a second five-year mandate awarded to the company from this customer.
At the end of the second quarter, we have been awarded a three-year contract for the water utility located in Texas. This expansion in Texas should enable us to make better use of our existing resources in Texas, thus leverage also more a back office cost structure. The combination of contract renewals and new contract has enabled us to push the O&M backlog to $150 million, representing an increase of 75% year-over-year.
It’s important to recall that our O&M backlog doesn’t include evergreen contracts located in the state of Texas and New York, which represent about 30% of the overall revenues coming from the operation and maintenance. All these efforts are reflected into the financial performance of the O&M group. On an LTM basis, the O&M revenue stood at $106 million compared to $87.5 million, representing an increase of 21.7%.
The acquisition of JCO and EC completed in December, 2021 combined to the acquisitions — to the addition of 16 new O&M contracts and 14 renewals in the last 12 months contributed to post this important growth. Over the same period, the EBAC has moved from $10.5 million to $12.6 million, showing an increase of 20%. In the coming quarters, we will continue working on the renewing our O&M projects and capture CPI adjustments to improve our gross profit margin and EBAC margins.
Moving to page number six. Let’s have a look at the highlights of our Water Technology and Services business pillar. The WTS team remains extremely busy working on an impressive number of projects. In the second quarter alone, we commissioned three projects including an important water reuse plan for the City of Morro Bay in California. We also delivered five new projects. Among those, we deliver two mobile ultra-filtration units for a mining customer in Northern Ontario. These units, as shown on a picture on the left, are necessary to manage the level of water contained in leaching pound on the site in order to avoid any overflow in the environment of the contaminated water.
On top of executing our backlog, our WTS team was successful in securing seven new water treatment projects totaling $17.6 million. Now, three of them are for municipal applications, and four other are dedicated to industrial applications. This diversification is in line with our strategy to focus on industrial customers to further grow the business, allowing us to capture more recurrent revenues originating from the aftermarket service and consumable sales. These new bookings pushed by the WTS backlog to — pushed WTS backlog to a new high of $56.1 million at the end of Q2, representing a 38% increase compared to Q2 in previous fiscal year.
With such backlog, we’re expecting revenues to continue to grow in the coming fiscal year. These new projects added to our backlog are realized with price reflecting the latest material and wage increases. For these reasons, we’re confident seeing an improvement in our margin in the coming quarters.
As you can see through the pictogram, our existing activity for the WTS pillar remain high, and our engineering and fabrication teams are extremely busy. We are expecting the teams to remain busy for multiple quarters, driven by the robust backlog that we have. In the coming quarters, we should observe an increase into revenue recognition as the projects will move from the engineering phase to the fabrication phase, where usually most of the revenues are being recognized.
On an LTM basis, WTS revenues reach almost $46 million, representing an 8.2% increase compared to the last fiscal year. Pressure on margins remain our number one challenge for this business pillar due to the fixed price contracts that we have. Over the same period, the EBAC has increased proportionally by also 8.3%.
Let’s look at page seven on the performance of our specialty business pillar. The second quarter showed an impressive growth of specialty products revenues of 73%, where 48% was generated by the organic growth. The remaining portion of the growth originated from the acquisition of Leader Evaporator completed on June 30th, 2022. The organic growth is clearly driven by the high demand we’re experiencing from our specialty products, the strength of our large distribution network, and the growing interest of the end user for green chemistry and eco-friendly water treatment solutions.
As further chart on the right-hand side, our LTM specialty products revenues reach almost $72 million at the end of Sep — December, sorry, 2022. This represented an increase of 31.6% compared to our previous fiscal year. LTM EBAC stood at $18.1 million, up $4.6 million, or the equivalent of 34% compared to the previous fiscal year.
In October, we were able to validate the interest of our distributors solidified by business relationship, and introduced new products to a hundred distributors from 75 different countries during our Distributor Summit hosted in Bilbao, Spain. This three-day event was a unique opportunity to validate our growth opportunities and market drivers in various geographies. The general outcome is that the desalination market will remain strong with modest growth, while the water reuse market will accelerate significantly across the globe in the coming years.
We’re also proud to announce that our Pipa business line secured its largest coupling order for 1 million cubic meter per day, a new project in Saudi Arabia. This project will further expand our reference list of projects in the Middle East and may allow us to introduce complimentary specialty products to the same customer.
During the second quarter, with delivered our new PiPerLink product to 150,000 cubic meter per day seawater desalination plant in Morocco. This product is still at its instancy and we hope that this new installation will generate more commercial traction for this revolutionary product within the global desalination industry.
Our Maple division is now entering the peak of the maple season, which usually takes place between January to March, which also correspond to our third quarter. During this period, most of the maple farming equipment are delivered to our customers, creating an increase into our revenues and a reduction into our inventory of finished goods. In parallel, the integration of Leader Evaporators continues to progress well and many cost synergies opportunities are being identified and should impact positively the company in the coming quarters.
We’re also excited about the delivery of our first HyperMash system into a microbrewery in California. As shown on the picture on the bottom left, our expertise and sugar concentration acquired through the years will now help the brewery industry to increase their production yield by reducing their waste of raw material and their evaporation time translating into energy and water savings. As mentioned in our three-year plan, this represents one of the key strategic initiative to transform our maple farming equipment business into an agri food and irrigation business launch.
I will now pass it on to Marc, our CFO, who will review and discuss the financial performance of our company during the second quarter.
Marc Blanchet
Thank you, Fred. So, now let’s move on slide nine. Before going over the result of the second quarter, I would like to go over the result of the last 12 months compared to the previous 12 months.
I always say that we must look at our results on a LTM basis to capture the long-term evolution of the business. Our effort made over the last 12 months to focus on increasing organic growth allowed us to increase our LTM organic revenue growth from 6.6% to 26.3%. Our revenue on LTM basis reached $224 million compared to $155 million for the previous period.
We invested in growth initiative to achieve the 10% organic revenue growth objective provided in a three-year strategic plan. To achieve this objective, we hired sales resource and invested in SG&A to generate and support this growth. Those investment have been successful since the target have been largely exceeded. This explained the increase in SG&A compared to previous LTM. However, the ratio over revenue is lowered from 18.1 to 17.4, showing the scalability of our business models as revenues continue to grow.
Net earnings reached $4.4 million compared to $3.2 million, an increase of $1.2 million. The adjusted EBITDA increased to $21.7 million compared to $15.4 million in a previous 12-month period. The adjusted EBITDA over revenue is lower at 9.7% compared to 10% the previous period. The reduction in percentage is explained by the investment in SG&A to generate growth and the reduction of the gross profit margin due to the business mix. The fact that we can rely on three business pillars is the strength of H2O Innovation. It allows us to be able to count on different source of revenue and thus reduce the risk of volatility of the EBITDA.
On slide 10, I’d like to go over the revenue — to go over the results and especially the highlights of Q2. The main highlight is the significant revenue growth. We are reporting revenue of $63.8 million compared to $42 million in Q2, 2022. This represents an increase of $21.8 million or 52%. 27% is coming from organic growth and 20% from acquisition of — related to JCO and EC, both acquired in December 15th, 2021 and Leader Evaporator acquired on June 30th, 2022.
The adjusted EBITDA also improved by 70% and represents 10.1% of the revenue compared to Q2 last year. Adjusted EBITDA reached 6.4% this second quarter compared to 3.7% last year, which was 9% of the revenue. The percentage of SG&A over sales has decreased compared to Q2 last year. Investment made in sales and business development are paying off since revenue are still growing faster than SG&A ratio.
As for gross profit margin, it has increased reaching 26.6% compared to 26.4% last year, despite high inflation of material cost and pressure on salaries, which demonstrates effective price realization. The second quarter, we realized $6.6 million of cash flow from operating activities. The fast organic growth of the previous quarter pulled on working capital, but we’re starting to improve the conversion cycle of these investments.
In addition, we want to highlight the importance — the important increase of our consolidated backlog. It’s up by almost 63%, and it provides us with good visibility on revenue for the upcoming quarters.
Now, page 11, we’ve presented some P&L highlights of Q2. On that slide, I’d like to bring your attention on the table on the right. I want to address the fixed rate variation impact on the revenue given the opposite fluctuation of certain currencies. So, we’re doing business. We’re in Canadian dollar and reporting in Canadian dollar, but we have a lot of revenue in USD, and some revenue in British bound and in euro. So, for this second quarter, all these effects has an impact — a positive impact of $2.3 million or 5.4% in revenue. The USD exchange rate was favorable, but partly offset by the pound and the euro. On this quarter, each hundred point base of USD/CAD variation had an impact of $450,000 on the revenue, but only 25,000 on the EBITDA, and the pound had an impact of 33,000 on revenue and only 8,000 on the EBITDA.
Now I’ll go over the financial results by each business line. So that starts with operation and maintenance on slide 12. So, for the O&M business pillar, revenue for Q2 stood at $28.9 million compared to $19.7 million last year, representing an increase of $9.2 million or 47%. 14% of this growth is organic, and is generated from important scope expansion and new projects secured in the previous quarters. 24% is coming from the acquisition of EC and JCO, which were required Q2, 2022.
Operation and maintenance EBAC reached $3.1 million compared to $2.1 million for the same quarter last year, representing an increase of $1 million or 49% and represents a slight increase in percentage over revenue. Even though the EBAC percentage slightly increased, our gross profit margin in percentage remains stable. Hence, to create a safe and attractive environment for workforce and to create value for a customer by offering them a talented team, we decided to establish a minimum wage of $15 an hour for all employees, which was done during Q1, 2023. Since over 70% of our employees are working from this business pillar, the operation and maintenance growth profit margin and EBAC are more sensitive to factor related to workforce.
In most of the O&M contracts, we’re entitled to increase the annual fee based on consumer price index on CPI. Therefore, such annual fee increases our being effective with our customer as each contract reaches its annual contractual adjustment date. We will then continue to achieve price realization in the upcoming quarter quarters, so not only in Q3, but as we move forward in time, we continue to address that issue and increase prices.
At the end of the quarter, the operation maintenance backlogs stood at $150 million compared to $85.5 million last year. This is an increase of 75%. I would also like to bring to your attention that contracts in Texas and in the states of New York are evergreen contract and are not included in the backlog.
So, now let’s move to WTS, Water Technology and Services on slide 13. So WTS revenue improved by 29%, which is all organic from service activities and capital equipment project. WTS EBAC stood at $1 million compared to $0.5 million last year, which is an increase of $0.5 million or 110%. The increase is mainly due to the improvement of the gross profit margin explained by higher percentage of revenue coming from service activities combined with price adjustment clause based on inflation that we were able to negotiate with some of our contracts — some of our projects.
Selling and general — so SG&A, selling and general expenses were higher primarily due to new hiring of sales resources, higher labor costs and commissions, as well as resumption of travel and our participation to trade show and conferences. The WTS backlog stood at $56 million compared to $40 million last year, which is an increase of 38%. As Fred explained earlier, the backlog is well balanced between industrial and municipal project and provide excellent visibility on revenue for the upcoming quarters, keeping the focus on industrial project, which are characterized by better gross profit margin.
So now let’s move to specialty products, page 14. Specialty products have had a very strong performance from all business line of for this quarter. So, revenue stood at $23.9 million compared to $13.8 million. It’s an increase of $10 million or 73%, and 48.3% of this is organic, so it’s 48% organic growth. The acquisition growth is coming from Leader Evaporator represent 25.8% or $3.6 million. The FX rate variation had a net negative impact of only $100,000, mainly coming from the British pound and the euro.
The EBAC stood that $5.8 million compared to $3.9 million, representing a dollar increase of $1.8 million, but a decrease in percentage mainly explained by the deterioration of the gross profit margin. The gross profit margins stood that $41.8 million compared to $46.4 million. This decrease is mainly due to business mix within the business pillar and the increase of cost of raw material. When we compare to last year, revenue coming from maple business line were higher and have average gross profit margin lower than the specialty chemicals. That’s the main variance of — one of the main variants of the — when we talk about business mix.
Price increase and procurement strategy have been implemented in the recent quarters, which should impact favorably the margin in the upcoming quarters. The SG&A increased by $1.7 million. The main reason are the hiring of sales resource, pressure on salaries in connection with the inflation, the resumption of travel combined with acquisition of Leader. However, the SG&A ratio over revenue remains stable.
Let’s move to page 15, slide 15. So financial position. We will look at certain information there. Certain working cap items. So, first the account receivable, they increase by 18.5% since June 30, which is in connection with the revenue growth. And 5.8% of this increase is due to FX variation. If we look at the inventory level, it increased by 21% since June. Foreign exchange explains 3.5% of this variation.
Inventory increased to respond to the continuing high consumer demand as shown in the — by our revenue growth. We’re still maintaining high level inventory combined with the seasonality trend of the maple business line for the upcoming season. As Fred explained just a few minutes ago, this inventory is made of product that will be delivered to customers in the Q3 and Q4 based on order in hand. For this reason, we should see a decrease into the maple inventory in the next two quarters as we will get into the high season of the maple syrup production.
Accounts payable increased by $1.6 million or 7%, mainly due to the FX rate impact of $1.9 million and timing of payment to suppliers. Regarding its content and consideration, the decrease is related to the partial payment related to GMP acquisition that occurred during Q1.
Page 16 cash flow. On the page 16, I want to highlight the fact that cash flow from operating activities generated $6.6 million for the second quarter of fiscal year compared to a use of $3.3 million last year. As I highlighted earlier, the fast organic growth from the previous quarter pulled on the working cap, but we’re starting to improve the conversion cycle of these investment. This last quarter we also invested $3.1 million of CapEx. Most of these investment are equipment required to execute new operation maintenance contracts. Therefore, they are what we call growth CapEx.
On slide 17, the net debt. As you can see the evolution of the net debt — we show here the evolution of the net debt since second quarter of 2022. So, as of December 31st, 2022, the net debt, which includes contingent consideration, stood up $53.5 million compared to $50.3 million on June 30, representing a $3.2 million increase due to cash flow — sorry — it’s a decrease due to cash flow used in investing and financing activities. So, sorry, representing a 3.33 due to cash flow used in investing and financing activities. So essentially address payment and CapEx for the new O&M contract.
This wrap up the presentation of the financial result. I’ll now hand the call back to Fred for conclusion remarks.
Frederic Dugre
Thank you, Marc. Well, in conclusion on slide 17, I want to bring back our three-year growth plan slide that we presented at our annual general meeting of shoulders in December. Looking out at the sales pipeline, rich in diversifying municipal and industrial opportunities, at the strength of our distribution network for specialty products, our recurring revenues now accounting for about 90% of our turnover, our consolidated backlog of $206 million, and the compelling market drivers of the water industry, we envision continuation of strong organic growth with a focus on margin improvement in the coming three years. For these reasons, we are tightening our revenue targets for the coming years.
As previously announced at the AGM, we’re increasing our revenue mid-point targets to $234 million for this current fiscal year, $260 million and 215 — $315 million, sorry, for 2023, 2024, and 2025, respectively. While growing revenues, we remain equally focused in improving our adjusted EBITDA margin above 11% in the coming three years. Our roadmap still calls for margin improvements and optimization of our cash flow conversion. Multiple initiatives are pursued in order to mitigate the impact of high inflation in raw material and wages.
Moving to slide 18. The drivers of the water industries are now undeniable, population growth, aging infrastructure, more stringent regulatory measures, water scarcity, aging workforce, and company’s objectives to become more water positive. These factors contribute to grow our sales and will certainly generate a lot of opportunities for our business lines moving forward.
Even stakeholders outside the water industries are shifting their mindset towards water. Sound and responsible water management is becoming a mean to mitigate risk in manufacturing, to meet sustainable goals, thus becoming more ESG-oriented. For example, in the second quarter, we announced that our entire $65 million credit facility and revolver that we have at National Bank has now been officially recognized as a blue loan according to the IFC and World Bank standards. Let’s recall that this is the first of its time for the National Bank, but also I’m sure for many other Canadian banks.
Finally, with 108 M&A transactions completed in 2021 and 2022, we can conclude that the water sectors remained very active and also attractive for investors. Indeed, the average transaction size was around $530 million with an average revenue multiple of 2.9 times and an EBITDA multiple of 15 times. Even larger transactions, such as the latest one announced by Xylem acquiring Evoqua is proposing a transaction valuation greater than 20 times EBITDA.
We have confidence in our strategy as we have the right resources and access to multiple opportunities to maintain our growth momentum, while also minimizing our risk and improving our profitability. Our business model is very unique with high recurrent revenues representing an important financial differentiators, but also a strategic focus to maximize customer retention and long-term value creation.
Thank you. I’ll now turning back to the operator for the Q&A session.
Question-and-Answer Session
Operator
Thank you, sir. [Operator Instructions]
And your first question will be from Michael Glen at Raymond James. Please go ahead.
Michael Glen
Hey. Good morning. Fred, can you just maybe dig into a bit what’s going on with the desalination market in the Middle East? Like you’re having some very good performance there. Like where does your distribution sit in that part of the world? Can it grow more from current levels? And what’s sort of the growth outlook there for projects?
Frederic Dugre
Well, as I said in a call, the specialty products group, which combine the Piedmont product line, but also our specialty chemical line, is working now more effectively together. So what used to be a couple of years ago different business lines and working like more and more into silos are now working more effectively together on giving regions. So, not only we have increased the number of distribution points and agents and representation, but they work more effectively between the component business and the chemical business. So that’s one strategic aspect of it. So, this is creating more sales, more tractions, more visibility on the customers and more sales synergies.
Now the other aspect, if you look at the market itself, we have experienced excellent growth and we think that this growth will continue because the desalination market is still calling for massive infrastructure investment into that sector. Now, what I will say is new to us and what we have learned from the feedback we collected from our last marketing event with this is that we will see now an acceleration into water reuse for this region of the world, for the middle East.
So, far the water reuse was mostly in Southeast Asia and Australia and United States, obviously, but not yet. We have seen significant projects for water reuse in the Middle East, which we think will generate, what I will call, the second wave of massive investment into infrastructure in that area of the world. And this is where I think we’re very well-positioned to capture this coming growth, because of the experience we have in water we use in North America, but also because we have the right distribution network and the right products.
Michael Glen
And can you give an — like, the facility expansion that you did over in the U.K.? Does that tie in a — like how does that — has that still ramping production? I’m just trying to tie in how that expansion is adding — is helping add to your organic growth.
Frederic Dugre
Yeah. Tremendously. So, the expansion, at first was also to add capabilities to make powders. So, before we were making our cleaners, so we have two categories of specialty chemicals. We have essentially the antiscalants, and we have a family of cleaners that we use to clean the membranes periodically. So, the cleaners are in two format. Either they’re liquid or they’re in powder form. We were before outsourcing the production of this powder through third-party blender. We decided to expand and integrate that vertically to have a better control on the cost structure, to reduce the lean time and leverage this overall capacity to be able to produce more and better control our cost.
This was launched last — at the end of last fiscal year, and now we’re ramping up the production and we’re getting tremendous traction because obviously the powder format is easier to export. It reduce freight cost. It’s more green. It’s easier to manipulate and to store and so on. So, overall, as an ESG team, it’s a very attractive products for our customers.
Michael Glen
And is there a way for the quarter or on a trailing 12 basis to say like what percent of your revenue would be from desalination specifically?
Frederic Dugre
We don’t extract this specifically because many — same products will go to different applications, so it might go to desalination, to water reuse. It’s hard to know because sometimes we’re a little bit blind because the distributors won’t necessarily tell us where this is going, where is the final delivery of the final of the product. But we can see and we appreciate overall increase in ourselves, which is you also in line with the growth that we’re observing into the desalination market.
The beauty of a products, I would say is that it serves the OpEx expenses. So, not only it’s for construction of new plants, but all the chemicals are used for existing plants, right? So, the more we have our chemical installed and used the more, we should see recurrent revenues also down the road.
Michael Glen
Okay. Thanks for taking my questions.
Frederic Dugre
Thank you, Michael.
Operator
And next question will be from Endri Leno at National Bank. Please go ahead.
Endri Leno
Okay. Good morning. Thanks for taking my question and congrats on the great quarter. I have a few questions. But the first one, I wanted to ask — I mean, I’ll continue a little bit in terms of when it comes to the production and the facility in the U.K. Can you talk about the production capacity there, Fred? I mean, do you have room to expand production, or would you need to invest more to meet all the demand that you expect to see?
Frederic Dugre
Well, we still have room to expand. Right now, just to give you an example, we’re working on one shift production. So, we could further expand this into — by increasing the capacity with additional work shifts. So, this is one.
We’re still on the look to evaluate the possibility of making some of our chemicals that we make in California to make it as well in U.K. So, this will be a second investment. But we’re not talking about millions and millions of dollars of CapEx investments. So, if anything, it will be in the range of half a million to a million to increase capacity. Nothing used, but something that we believe could enable us to have a better control on margins, reduce freight, reduce some taxation depending on where the productive is made because there’s a lot that goes into the country of origin where the product is made. So, we’re trying to optimize this for the benefit of our customers, but also for the benefit of our margins.
Endri Leno
Okay. That’s great to hear. Thank you. The next question I wanted to ask is that I was looking at your headcount between Q1 and Q2. And it looked like it increased by about 4%. I just wanted to ask there, are you in a good place from a headcount perspective? Was that in response to the projects that you’ve won? Or is it just kind of more kind of forward hiring so that you can drive and you can win more projects?
Frederic Dugre
Well, we’re trying to not hire too much in advance. I would say most of the hire was coming from contractional addition, that we add at the end of December. If you remember, we announced this new contract that we got in Texas. That was — that happened — the startup officially happened in mid-December. Operation maintenance contract. I mean, so, this in itself created a little bump into the headcount. But yeah, so far, I mean, we’re good as we speak. I mean, we’re trying to balance this and in a proper way between our capacity to produce and manufacturer based on the backlog and again, the O&M growth that we’re experiencing.
Endri Leno
Okay. All right. Great. Next question I have is that, I mean, you spoke when you’re talking about WTS and you know how that segments the contracts and there are well bottled between municipal and industrial. So, the question I would ask is that there’s been an increased focus in North American manufacturing. Are you seeing an increase in industrial RFPs, especially in WTS, but perhaps even in SP and are you able to bid higher, or is it still pretty competitive out there?
Frederic Dugre
Well, definitely, I mean, the overall manufacturing initial activity has significantly increased for us. Also, we’re still into a competitive environment. I mean, don’t take me wrong. I mean, we still need to be successful. But overall, I would say that when we build an industrial opportunities, we are usually a smaller amount of people because it’s usually under invitation. So instead of, let’s say being, four on five bidders that you may see on municipal area, well, you may ended up by being two or three in industrial sector. And usually industrial customers will also know — take into account more the value engineering and the value proposition that you will have, where you can show either energy savings, a smaller footprint, allowing them to reduce into construction costs. So, all these advantages, or “easier” to promote to an additional customers than it is usually to a municipal customers, allowing us to better, to capture in a better margins.
Endri Leno
Okay. Okay. Great. Thank you. And last one for me, and I’ll pass over the line. It says, I just wanted to clarify on the three-year growth plan, do those revenue targets include assumptions for new acquisition, or is it only organic?
Frederic Dugre
Organic only?
Marc Blanchet
The upper bracket. So, it’s a bracket, so the bracket includes acquisition. The lower part of the bracket is organic, the upper part is acquisition. It includes some acquisition into a tuck-in format again.
Endri Leno
Okay. Great. Thank you, guys. Appreciate it. Good quarter again. Congrats.
Frederic Dugre
Thank you.
Operator
Thank you. [Operator Instructions]
And your next question will be from Naji Baydoun at IA Capital Markets. Please go ahead.
Naji Baydoun
Hi, good morning. I just wanted to go back to Texas. You’ve had some great success in the state there. I’m wondering if you could just give us a bit more color on the — sort of the market and what’s the potential growth outlook for — specifically for O&M?
Frederic Dugre
Well, I mean, it’s a nice project that we got from an utility owners. The utility market in Texas is growing quite fast. So, we see a lot of infusion of money to utility companies buying assets, refurbishing assets that are not necessarily in best conditions, but they’re investing money to these assets to upgrade them. And because of their nature of their business model, which is essentially owning the assets, we are providing them the support to operate these assets properly and efficiently.
So, this is a market that we have seen and enjoy growth over the last couple of quarters. We are still foreseeing this as a revenue growth for us in the coming quarters as we continue to grow relationship with these utility owners. The mud business in itself is good, steady, will still be opportunistic there and there to keep growing what we have. But I would say our focus now within the mud business is really to optimize what we have in terms of sales revenue generation, but also margins within there. We think that there are multiple operational efficiencies that we’re — we can capture and this is our focus right now.
Naji Baydoun
Okay. That’s great color. Thank you. And just on JCO and EC, it’s been a bit over a year now. I’m wondering if you can just maybe give us an update on cross-selling that’s happening there. Any other sort of integration initiatives that you think you should be — or that you’ll be focusing on for this year? Or do you think the business plan is — has already been executed?
Frederic Dugre
So, in terms of synergies, I will say that JCO and EC, this group in the state of New York, they were the first to materialize sales synergies with the WTS group. They have been embracing that concept very rapidly early on in the acquisition story, generating leasing of equipment, capital equipment, upgraded our customers and a couple of expansion there. So, this works very nicely and we have small successes that we’re now promoting internally. And this is nicely snowballing, if I can say it this way, with other customers in the area.
In terms of integration, there’s still a lot of optimization of efficiency we can capture. You need to keep in mind that when we’re doing these tuck-ins and acquisition tuck-ins, they’re still small companies and they’re becoming part of the bigger group in H2O. So, there’s a lot of investment that needs to be done from a back office perspective, from standardization of benefits, from standardization of best practices. And this is what we’re currently going through, but also helping them, I mean, to provide a better and more consistent service across the board, which we’re now expending and making sure that we renewed.
So, our focus, as I said to Texas, is now to optimize what we have currently work from the basis of customer we have, try to promote as much as we can cross-selling opportunities, which we’re doing and yeah, expanding from where we are and optimize through operational excellence to improve margins. That’s our focus.
Naji Baydoun
That’s great color. Just a couple quick questions. If we look at the margin improvement roadmap that you provided. Would you say — what’s kind of the remaining levers that you’ve yet to really push on? Like where’s the most of the upside going to come from going forward?
Frederic Dugre
So, as Marc said, we’re going to capture CPI adjustments in O&M, because we had no choice, but to give increases raise wages, increases to our employees at first, but as we come to anniversary date of our contracts, we are pushing for CPI adjustments. So, this is one.
Operational efficiency, as I said in Houston, in the state of New York, following the acquisitions there, is definitely a priority. We have still pushed to a number of distributors, a number of customers, price increases for chemicals, which will continue to reflect in the coming quarters. And that’s it. So, essentially, we have a pretty good roadmap on how we’re going to improve margins on price and on execution of O&M.
Naji Baydoun
That’s great. Thank you. Just one final quick question on the net debt position seems to be relatively stable here in the last few quarters. Obviously, sort of plan to get that number down, and any specific deleveraging targets saved through the end of fiscal 2023?
Marc Blanchet
Yes. Nothing disclosed, but I mean, I haven’t provided any guidance, but how can I help you with that one. I mean, we’re — as I said in the call, we’ll continue to convert the working capital into cash. That’s really the main focus as you, I mean, if you look at the last 12 months, working cap has increased significantly. It was a bit of a defense, but also turned out to be a good offense strategy, allowed us to grow significantly. So, working cap, we want to bring them in line with revenue. I think they were a bit upset. So, if you do that cash conversion to bring it back in line with historical, I think we should be able to — it will help you a bit.
And then there’s been some CapEx for new operation maintenance contracts. So, this is a bit of a more of a question mark depending of what will we win, if we win jobs that requires a lot of CapEx, maybe that has a bit of a fluctuation in terms of the — in the net debt. But it will also generate eventually EBITDA. So, it’s not — yeah, so, I don’t want to provide more guidance. It’s tough for me to say, just play with your model. And Naji, I’m sorry.
Naji Baydoun
No, no. That’s understandable. That that helps. Thank you very much for these details and congrats on a great quarter.
Frederic Dugre
Yeah.
Operator
The next question will be from Michael Glen at Raymond James. Please go ahead.
Michael Glen
Hey, guys. Can you provide an update — I think you’ve been over time seeking a finance partner to help with some of your industrial market penetration, someone to take on and help you help finance some of that work. Can you give an update as to where that stands? And is there anything on the horizon to get something across the line there?
Marc Blanchet
Nothing really in the short term horizon. Yeah. We’re in conversation with many different financial partners to help or in this whole customers to grow their own business.
Frederic Dugre
There’s a lot of indeed — a lot of funds that are like infrastructure funds that are interested in investing and trying to deploy capital into infrastructure. And indeed, some of them has approached us, but we’ve never answered to that at this point.
Michael Glen
Okay. And is there specifically something that’s holding you back from, like what are some of the big items there that you’d like to see for you to proceed with something along those lines, because it seems like it would be something that would help with your organic growth.
Marc Blanchet
Well, if there’s anything would be more for some of the equipment that we lease to some of our customers. It happens that for — let’s say, in the mining sector, we do have assets that we lease to industrial customers for a period of time. So, this may apply to that end of the sector. If there’s like a third-party, a financial partner interested in financing these assets, these mobile assets. But yeah, I mean, we’re not going to look for dilution specifically, or inequity financing or that — for this.
Michael Glen
Okay. And then, Fred, you highlighted that the large industry merger in the presentation, like when you think of your business where it’s positioned, how does a merger of that magnitude — how does that impact H2O’s business?
Frederic Dugre
Well, in the overall picture in terms of us being in the water space, I think it’s great to see the convictions and the confidence that Xylem has towards Evoqua and buying this company at good valuation. So, it means that certainly they’re not looking it for the next quarter, only in the next two years, but they’re definitely looking at it to grow this platform. And Xylem has been on the look to buy Evoqua for a number of years. They already presented a bid several years ago. So, it’s a consistent, and it shows the vision they have to grow the business. And I guess it was a similar intention also of [indiscernible] with when they came up with this monster transaction.
Now, for us on a daily basis, I don’t think it’s going to change a lot for us. Our business model is pretty unique. I mean, good example is that Xylem and Evoqua are not into operation and maintenance. They’re not really into chemicals, specialty chemicals. If anything, I mean, we could do more business together than compete each other. They’re suppliers of us. So, yeah — so we’re supplying to them, they’re supplying to us on different parts and components and equipment. So, I don’t foresee that as a threat at all.
Michael Glen
Okay. Thanks for the follow ups.
Operator
Thank you. Next question will be from Gabriel Leung at the Beacon Securities. Please go ahead.
Gabriel Leung
Hey, good morning and thanks for taking my questions. A couple follow-ups.
Frederic Dugre
Good morning.
Gabriel Leung
Good morning. Just a couple follow-ups. First, so I apologize if I missed this, but did you quantify the size, the coupling order and the specialty that that helped with the outperformance, first off. And secondly, would you expect some, I guess, downward variability in the specialty revenues in the current quarter? Or do you think that might be offset by the strength of the maple business?
Frederic Dugre
So, can you repeat it? It was not clear. If we quantify — like, the first part of the question, Gabe, if we quantified what?
Gabriel Leung
Sorry. The coupling order, that helped drive the …
Frederic Dugre
The coupling order. Okay. No, we did not because obviously we — it was a contract that was negotiation — negotiated one to one with a customer. The industry is a small world, so everyone knows where this — these couplings are going and what — which plant. So, we haven’t disclosed the price and the magnitude of this specific orders. But let’s say that it is the single largest coupling orders that we ever add for a project of this magnitude.
The second part, again, can you remind me then the second part, if we will — it was…
Gabriel Leung
Yeah. No, I’m just curious. Just given that — just given the — given the contribution from that order in fiscal Q2, would you expect the potential downward variability to the specialty revenues in fiscal Q3? Or do you think that’s going to be — that that might be offset by the strength of the maple business?
Frederic Dugre
No. The strength of the maple business will definitely impact the Q3 as plan as it is — as per the seasonality of this business. This large coupling orders will be more delivered in magnitude between the fourth quarter and the first quarter of the following year, according to the schedule that we have with the customer.
Gabriel Leung
Gotcha. No, that’s helpful. And secondly, maybe a follow up to that. Can you talk a little bit about the — I guess the pipeline and some of the opportunities you’re seeing within the no lease specifically as it relates to specialty business both in terms of coupling efforts, the chemicals? What you see being the potential impact for H2O over the next several years?
Frederic Dugre
Well, for us, in the next several years, we still have a very positive outlook for that particular business, for the specialty products, both the chemicals and the component business. So, this is why we have decided to further expand into product innovation, expanding our sales people as well. If you remember a year ago, we added sales people covering this geography in Dubai, in Saudi, in Southeast Asia as well. So, we believe fundamentally into that market, and it’s not going to be only for one or two or several quarters, but it will be more on a long-term basis.
The new component, as I explained earlier, is now the fact that we should see now ramp up towards water reuse in the coming years for — in the Middle East area, which wasn’t there several years ago. So, this could create additional opportunities for us, for new products, for expansion in sales and so on.
Gabriel Leung
Gotcha. Maybe one last question. Clearly, the company’s been extremely successful with evidence by the growth and the growth in revenues and bookings. I’m curious, given the increased scale of your business, given all the industry M&A, have you actually seen your close rates or success rates on deals increase in the last while? I’m just curious to see what the experience has been.
Frederic Dugre
When you say deals, M&A deals or–?
Gabriel Leung
No, just — I mean any deals that required RFP, I’m just curious to see if you’re — if the close rates of success rates have improved just given the increased scale of your business and just given all the M&A that’s happened within the industry itself.
Frederic Dugre
So, yes, in multiple ways. I would say yes, because we have been growing the references. So, the name of our company got recognition now on several plants. So, this is important. Receiving the trust and the endorsement of large customers in the Middle East, for example, is very important. So, having been able last year and be able to renew the single largest supply — the single — the supply for the single largest desalination plant in [indiscernible] is an important milestone, and that brings a lot of eyes and interest and endorsement from the industry. So, this helps us to secure more project.
The other factor also is that it seems that we have switched gears a lot in terms of interest to green chemistry and eco-friendly solutions, which we have for several years. So, we have been making this green antiscalant without phosphate for a great number of years. But now with this ESG trend, with the cost of freight that has completely exploded, our customers are now paying more attention and they’re looking for solutions to mitigate that. And this is where the SpectraGuard that we make, which is a super concentrated formulation at 11 time is reducing significantly the cost of freight, the cost of warehousing and all that. And this is a new criteria that now customers are looking at now. So, this is enabling us to further close new sales and new opportunities and more bookings.
So, all these differentiators add up to our ability to generate more sales. And it’s not different — as I said, it’s not different for WTS either. So, it’s a combination of innovation, differentiators, general recognition, endorsement from large customers and good execution on our end across the board, 23 years in making, by the way.
Gabriel Leung
For sure. No, that’s great. Thanks for all the feedback and congrats on the progress.
Frederic Dugre
Thank you.
Operator
Next question will be from Liam [indiscernible]. Please go ahead.
Unidentified Analyst
Hi. Good morning. Congrats for the great results. I just had a question on the O&M and specialty product pricing. For the O&M segment, would you be able to provide maybe an update on the proportion of contracts that remain to be adjusted for inflation?
Marc Blanchet
I’ll jump in. So, first, it’s about 50% of the revenues that are part of the backlog and have renewal dates on an annual basis. Some others are evergreen contracts and are — don’t have like a one-off big adjustments. It’s a continuous discussion. So, it’s tough to come up to say, hey, we’ve only reached, I don’t know, 25% or 40% and more is coming.
Also the fact that there is inflation — well, we saw the numbers again this morning, so that discussion that occurred maybe three months ago will occur again in nine months with certain customers where we increased last year. And I want to say we’re chasing our tail, but it’s a continuous effort that will need to be addressed. So, even though I would disclose you a percentage, I don’t think it will provide a good guidance. So, we don’t disclose the number. And I can tell you that our teams are doing continuous efforts in order to improve those adjustments related to inflation on a month-to-month basis.
Unidentified Analyst
Great. Thanks. And for the specialty products, if we see pressures in raw materials abate further, how would you say your pricing strategy is going to be affected?
Frederic Dugre
Well, we need to look at it in third business line. So, let’s start with the chemical. So, there’s essentially two sides for the chemical business, the one that are phosphate based and the one that are not phosphate based. Phosphate increased more significantly than the raw material we use to make the non-phosphate base. So, the exposure and the price increases wasn’t the same. So, because we have this differentiator of product that is green without phosphate, we haven’t suffered the same price escalation or price increases into a raw material than most of the other companies out there. We have still pushed price increases to our customers and we still continue to do it. But let’s say that our portfolio of products was more resilient than other one. They also — our strategy to in-source the fabrication of the powder was also another defensive strategy that allow us to somehow product and preserve the margin, which we still try to push forward and expanding or moving forward.
On the coupling side, let’s say, on the other components, fiberglass products that we have, the couplings, it’s more still related, let’s say, in the side of the coupling. In this case, we’re fluctuating and we’re having price adjustments regularly to reflect that into our protective margins. And the fiberglass is about the same. So, we’re following more easily this and adjusting constantly, because we have fixed price contract. So, when we bid on couplings, when we bid on filter housing, it’s specific price for specific projects. So, there’s more like accuracy between the projects we do and the margins we protect.
Unidentified Analyst
Great. Thanks again and congrats again on a good results.
Frederic Dugre
Thank you, Liam.
Operator
Next question is from Yuri Lynk at Canaccord Genuity. Please go ahead.
Yuri Lynk
Good morning, guys.
Frederic Dugre
Good morning, Yuri.
Yuri Lynk
Good morning. I jumped on a little late, so I don’t know if this was covered. But was the revenue associated with the large coupling order, was that recognized in the quarter or it’s going to be recognized in Q3 and Q4?
Frederic Dugre
No, it’s not recognized. It’s booking that we got and it will impact mostly Q4 and the following Q — next fiscal year, Q1.
Yuri Lynk
Okay. Q4, Q1. Okay. And then, just switching gears to M&A. I mean the multiples that you flagged in your deck kind of 15 to 20 times on a recent industry M&A. I mean, is that what you guys are seeing? I mean that’s kind of a little bit in excess of where you’re trading. So, is M&A tougher for you guys now? Or you’re seeing something different in the market?
Frederic Dugre
Well, the factor related to size that also calls for this multiple valuation, I would say. Obviously, we’re starting to look and we have looked in the past of larger transactions. And this is where we got a lot of competitors from the private equity scene and other strategic buyers to push upwards this multiple to 13, 14, 15, very rapidly and we have tried that in the past.
However, if we’re trying to stay disciplined and looking for smaller transactions, what we call as tuck-ins, I would say transactions of revenue size — coming of revenue size between, let’s say, anything between $5 million to $20 million, this is where we could see more multiple below, let’s say, the 10 times that we can have access to. So, there’s a matter of timing. There’s a matter of size. So, this is why for us the tuck-in strategy has been good because it allow us to bring opportunities at lower multiples.
Yuri Lynk
That’s fair. And are you comfortable doing tuck-in acquisitions with the balance sheet where it is now?
Frederic Dugre
Well, as we said, I mean, we’re not in a hurry. Right now our priority is really to push to maximize cash conversion from our EBITDA, integrate properly the company to maximize efficiency of the operational excellence, deleverage. All these actions will create sufficient cash that will be applied to the balance sheet to deleverage it. And yeah, position us again to reload and do these tuck-ins moving forward.
Yuri Lynk
That’s fair. Last one for me, maybe for Marc. The — you had a $2.8 million FX gain that was backed out of the cash flow. How did that impact the income statement? Where is that on the income statement?
Marc Blanchet
It’s a conversion. So, it’s a non-cash — well, is it — which one are you referring to? Is it the one in the cash flow or it’s the one I talked about? So, the one I talked about is the translation from the different currency into Canadian dollars.
Yuri Lynk
Okay. So, it’s not in EBITDA?
Marc Blanchet
No. As I said, you might have missed that part, but I did raise it. So, for the impact of the effect for this quarter and you can see that on slide 11. So, the — there’s an impact of $2.3 million. On the EBITDA, each 100 points has an impact of $450,000 on the revenue and 25K on the EBITDA. So, the impact on the EBITDA is — it’s minimal, because most of it is naturally hedged. I mean, we’re quite naturally hedged. So, most of our expenses are in USD, even though the revenues would be in USD and the revenues out of the U.K. also have some expenses over there. The variances may be from — most of them are due to the fact that most of the admin costs are in Canadian dollars. Don’t know if it helps to understand. And it’s mostly a conversion. So, when we convert for — on a consolidated purpose, the U.S. financial statements or the financial statements of the U.S. subsidiary, then you have those impact there. And it’s cash effect.
Yuri Lynk
Okay. I leave it there. Thanks.
Marc Blanchet
Okay.
Operator
Thank you. And at this time, we have no other questions registered. Please proceed with your closing remarks.
End of Q&A
Frederic Dugre
Well, thank you very much for attending the call and we’ll look forward to catch up with you on Q3 in mid-May. Thank you very much. Have a great day. Bye-bye.
Operator
Thank you. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time we do ask you to please disconnect your lines.
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