Montrose Environmental Group, Inc. (NYSE:MEG) Q3 2023 Earnings Call Transcript

Montrose Environmental Group, Inc. (NYSE:MEG) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Good morning and welcome to the Montrose Environmental Group, Inc. Third Quarter 2023 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would like now to turn the conference over to Rodny Nacier from Investor Relations. Please go ahead.

Rodny Nacier: Thank you. And welcome to our third quarter 2023 earnings call. Joining me on the call are Vijay Manthripragada, our President and Chief Executive Officer; and Allan Dicks, Chief Financial Officer. During our discussion today, we will be referring to the earnings presentation, which is available on the Investors section of our website. Our earnings release is also available on the website. Moving to slide two. I would like to remind everyone that today’s call will include forward-looking statements that are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ in a material way due to known and unknown risks and uncertainties that should be considered in evaluating our operating performance and financial outlook.

We refer you to our recent SEC filings, including our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, which identify the principal risks and uncertainties that could affect any forward-looking statements, as well as future performance. We assume no obligation to update any forward-looking statements. In addition, we will be discussing or providing certain non-GAAP financial measures today including consolidated adjusted EBITDA, adjusted net income, and adjusted net income per share. We provide these non-GAAP results for informational purposes and they should not be considered in isolation from the most directly comparable GAAP measures. Please see the Appendix to the earnings presentation or our earnings release for a discussion of why we believe these non-GAAP measures are useful to investors, certain limitations of using these measures, and reconciliations thereof their most directly comparable GAAP measure.

With that I would now like to turn the call over to Vijay beginning on slide four.

Vijay Manthripragada: Thank you, Rodny. And welcome to all of you joining us today. I will provide you with business highlights. Alan will provide you with financial highlights. And we will then open it up to Q&A. I will speak generally to the third quarter earnings presentation shared on our website. As we have noted each quarter, I would like to emphasize that our business is best assessed on an annual basis given demand for environmental solutions is typically not driven by quarterly patterns. We manage our business on an annual basis and it is how we recommend you view our results as well. Before we dive into the quarter’s performance, I would like to thank our approximately 3,500 colleagues around the world for whom I am very grateful.

Through their efforts, we were able to produce another quarter of record results and further our leading position in the environmental industry. As for our financial results, we had another quarter of exceptional performance due to reasons consistent with those discussed during the first-half of this year. First, we focused 2023 on delivering on our adjusted EBITDA targets and increasing our adjusted EBITDA margins. As you can see from our results, we are achieving both goals. Second, we continue to see strong organic growth in our business lines. And our long-term organic growth outlook remains as attractive as ever. Our objectives and strategy have not changed in this regard. During the third quarter of 2023, operating segment adjusted EBITDA and consolidated adjusted EBITDA margins were approximately 20% and 14% respectively, which represents an increase in margins versus the prior year for both.

The improvement in our adjusted EBITDA margins as a result of organic revenue growth in most of our business lines and our pivot away from lower margin revenue, particularly within our ECT2 biogas services. The third theme I will highlight is the strength in tailwinds from new and anticipated regulations, as well as our clients’ voluntary focus on environmental stewardship. From new regulations affecting PFAS disposal and tightened methane leak detection protocols, the pending rules on climate disclosures and changes in air emission standards, we are seeing regulatory tailwinds across our business. The fourth theme underscores the sustained advantages from our acquisitions. Our acquisitions are driving scale benefits, technology access, and widening our geographical reach, including the recent addition of Matrix in the Canadian market.

We have closed five acquisitions this year and our acquisition pipeline remains very attractive. Finally, our balance sheet and cash flow remains strong. Year-to-date adjusted cash flow from operations of $42.1 million increased 52%, compared to the prior year period, providing us with ample flexibility to continue investing in our business. Our balance sheet capacity remains very robust and our debt is hedged against rising interest rates insulating us from the current uncertain rate environment. I will next discuss our third quarter performance by segment. Within our Assessment, Permitting and Response segment, we were pleased to see continued strong organic revenue growth in our advisory services, which excludes CTEH. We also saw positive contributions from our acquisitions.

CTEH, our environmental response business performed above run rate level year-to-date given several high profile environmental response projects that continued from earlier this year. The increase in margins for this segment was driven by strong organic revenue growth in our advisory services and CTEH outperformance. We remain bullish on the outlook for our advisory services through the rest of 2023 and beyond. Within the Measurement and Analysis segment, strong organic revenue growth continues in this segment as well. We are especially pleased with the positive performance from our new data platform, methane and leak detection and measurement services, and PFAS lab serv. Given the building regulatory pipeline, we remain upbeat about continued performance in this segment.

Though quarterly margins remain elevated and are higher than the prior year, we expect annual margins to remain in the high-teens to 20% range. And finally, within our Remediation and Reuse segment, revenue growth in this segment was primarily due to our acquisition of Matrix partially offset by the expected moderation in our ECT2 technology services, which includes our water and biogas service. Margins during the quarter were lower, primarily given the impact of the Matrix acquisition and moderated revenues at ECT2, which saw triple-digit organic growth last year. Our previously communicated shift towards higher margin biogas services and the improvements we are making within Matrix will enhance our margin profile in this segment. Next, I will discuss recent regulatory updates and industry trends that support our long-term growth outlook.

The US EPA continues to focus on PFAS and in September finalized an important rule under the Toxic Substances Control Act. This rule requires reporting from companies in a wide variety of industries that have manufactured or imported the PFAS chemicals. With regards to methane emissions the US EPA and Bureau of Land Management have implemented new rules targeting methane emissions such flares events and leaks, supporting incremental demand for our measurement and assessment service. And finally, regarding demand for our environmental consulting services in October, the US EPA pledged significant funding to states to support projects aimed at advancing environmental justice. We anticipate these campaigns will drive increased demand for our advisory and our testing services.

These recent regulatory developments in addition to those we’ve highlighted over the past several quarters, demonstrate that macro tailwinds for our integrated environmental solutions remain very robust. Montrose remains very well positioned to benefit from the rapidly evolving environment industry and regulatory landscape. So, in summary, I remain incredibly grateful to the entire Montrose team. Our continued outperformance is attributable to the hard work and execution of our colleagues around the world. Given this continued momentum in our business, we are reiterating our full-year 2023 revenue and consolidated adjusted EBITDA guidance. We remain very optimistic about our outlook and our opportunity to create more shareholder value. With that I will hand it over to Allan.

Thank you.

Allan Dicks: Thanks, Vijay. We are very pleased to have delivered strong third quarter results. Our resilient performance throughout the year thus far, reflects the themes we’ve discussed since becoming a public company over three years ago as new environmental regulations and corporate mandates continue to drive demand for our unique environmental solutions. Our business remains strong and continues to grow given our successful execution of attractive M&A, ongoing cross selling successes, and expanding customer relationships. Moving to our revenue performance on slide eight. We saw organic growth across many of our service lines helped drive revenues to record levels in the third quarter. Our third quarter revenues increased 28.9% to $167.9 million compared to the prior year quarter.

Year-to-date revenues were up 13.2% versus the prior year period to $458.5 million. The primary driver of revenue growth in both periods was the positive contributions from acquisitions including Matrix, strong organic growth in our Assessment, Permitting and Response and Measurement and Analysis segments, and an increase in CTEH revenues. This was partially offset by lower revenues in a specialty lab that has been discontinued and the change in our Remediation and Reuse segment given the timing of projects and a strategic shift in our biogas business to focus on higher margin, lower revenue services. Growth in our year-to-date revenue was also impacted by our planned exit from legacy O&M contracts in 2022. Excluding revenue from discontinued businesses, revenue was up 32% to $165.9 million in the third quarter and was up 16.4% to $452.6 million year-to-date.

Looking at our consolidated adjusted EBITDA performance on Slide 9, third quarter consolidated adjusted EBITDA was a record $23.3 million or 13.9% of revenue. This compares to consolidated adjusted EBITDA of $17.1 million or 13.1% of revenue in the prior year quarter. The year-over-year improvement was driven by higher revenues and higher operating margins, driven in part by the benefit of pricing. Year-to-date, consolidated adjusted EBITDA was $61.1 million or 13.3% of revenue compared to consolidated adjusted EBITDA of $48.4 million or 12% of revenue in the prior year. With that said, I’ll reemphasize that Montrose’s performance needs to be assessed annually as quarterly results are not always indicative of annual performance. Turning to our business segments on slides 10 and 11.

As we previously highlighted, we remain primarily focused on meeting or exceeding our target for adjusted EBITDA dollars and operating cash flow generation with the longer-term goal of optimizing our margin profile. To that end we were pleased to see the impacts of shifts through our service portfolio, which helped contribute to the increase in operating segments, adjusted EBITDA margin to 19.5%. In our Assessment, Permitting and Response segment revenues increased 22.8% year-over-year to $57 million. The year-over-year increase was driven primarily by organic growth, growth in revenues from CTEH, and to a lesser extent, the positive contributions from acquisition. CETH is entirely in this segment so that business’ increase in environmental response revenues are fully captured here.

AP&R segment adjusted EBITDA increased 51.5% year-over-year to $14.9 million or 26.1% of revenue, up from 21.2% in the prior year quarter, reflecting the benefits of organic growth, favorable CTEH revenue mix, and higher aggregate margins across our other businesses within the segment. In our Measurement and Analysis segment revenue increased 15.3% to $50.5 million primarily attributable to double digit organic growth as well as the benefits from acquisitions completed subsequent to the end of the prior year quarter. M&A segment’s adjusted EBITDA increased 22% to $10.4 million or 20.5% of revenue, up from 19.4% in the prior year quarter, reflecting strong demand for our testing services and the benefits from our pricing action. In our Remediation and Reuse segment revenues increased 50.6% to $60.5 million, primarily due to the acquisition of Matrix and partially offset by the anticipated decline in revenues from certain large water treatment projects and the recent pivot in our biogas business to focus on higher margin, lower revenue project.

The decrease in R&R segment’s adjusted EBITDA as a percentage of revenue was due to lower water treatment revenues and the dilutive impact of Matrix, partially offset by the higher contribution margins within our biogas business. Our margin optimization efforts are well on track at Matrix and we expect to see low to mid-teens adjusted EBITDA margins by the end of 2024, up from low-single digits at the time of acquisition. Moving to our capital structure on slide 12. Year-to-date cash flow from operating activities was $41.5 million, which improved compared to cash provided by operating activities of $8.2 million in the prior year period. Cash flow from operations includes the payment of acquisition related contingent consideration of $0.6 million in the current year and $19.5 million in the prior year respectively.

Excluding these acquisition-related payments, cash from operating activities was $42.1 million in the first nine months of 2023 compared to cash from operating activities of $27.7 million in the first nine months of 2022, an increase of $14.4 million and representing an adjusted EBITDA to operating cash flow conversion of 69%. The year-over-year increase in operating cash flows was driven primarily by a lower working capital build and higher earnings before non-cash items compared to the prior year period. These strong operational cash flows reflect our ongoing focus on balancing the generation of cash with investments in technology, R&D and corporate infrastructure to ensure continued scalability. Our leverage ratio as of September 30, 2023, which includes the impact of acquisition related contingent earn-out obligations payable in cash was at a healthy 1.9 times.

Our current leverage ratio and inclusive of our fixed rate on $170 million of debt under our interest rate swaps, our weighted average interest rate under our credit facility was 4.4% as of September 30, 2023 with no exposure to rising interest rates at current borrowing levels. Our Series A-2 preferred stock has no maturity date and we have the option, but not the obligation to redeem the preferred shares at any time for cash. The holder has the option to convert up to $60 million to common equity in April of next year. We view this preferred equity instrument favorable to the value creation potential in the business given its flexible dynamics and the fixed nature of the dividend in a rising interest rate environment. If you include the $182 million of the Series A-2 equity in our market cap, our total equity capitalization stands at approximately $948 million.

Moving to our reiterated full-year outlook on Slide 14. Based on our strong performance so far in 2023 and the expectation for CTEH business to return to run rate levels during the fourth quarter, we reiterate our outlook for full-year 2023 revenues to be in the range of $590 million to $640 million, and for consolidated adjusted EBITDA to be in the range of $75 million to $81 million. Our revenue and consolidated adjusted EBITDA outlook for the full-year continues to represent double-digit growth and margin expansion over the prior year. As we begin to look ahead to next year, we anticipate strong organic growth in 2024 and we’ll provide a more fulsome outlook next quarter. In summary, demand for our environmental solutions remains robust and our reaffirmed outlook for 2023 represents our optimism in the positive trajectory of our business.

We remain as confident as ever in our ability to deliver shareholder value through our best-in-class suite of environmental solutions and to capitalize on end market and regulatory tailwinds. Thank you all for joining us today and for your continued interest in Montrose. We look forward to the opportunities we see ahead and updating you on our progress next quarter. Operator, we are ready to open the lines to questions.

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Q&A Session

Operator: Thank you very much. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Tim Mulrooney with William Blair. Please go ahead.

Tim Mulrooney: Vijay, Allan, good morning.

Vijay Manthripragada: Hey, Tim. How are you?

Allan Dicks: Good morning.

Tim Mulrooney: Doing all right. Thank you. Just a couple of questions. So, I know I completely agree with you that the business should be analyzed on an annual basis and that’s certainly how we think about it. But sometimes talking about the quarters can help folks understand what’s happening in the business. So, my question is just on the adjusted EBITDA margin, which was very strong and, you know, great to see in the third quarter implied guidance for the fourth quarter is showing that it would be down sequentially in year-over-year. I’m sure there’s a good reason for that. If you look at it on a second-half 2023 basis, you guys are right in line with doing what you said you were going to do. So, it’s not so much about, you know, are you hitting numbers you’re clearly hitting numbers. I’m just curious what’s causing that change in the margin profile from quarter-to-quarter or if there is a specific project or something like that.

Vijay Manthripragada: Yes, it’s a great, it’s a great point. And why don’t I start and Allan can jump in. So you’re exactly right. This is an annual business, and so the quarterly comparisons aren’t as meaningful. But if we step back — just to kind of answer your question explicitly — we’ve taken guidance up twice this year, Tim. And so we’re feeling really good about the business. And for — at the midpoint, yes, but for half the range we could very easily be flat to up quarter-on-quarter. So it’s not necessarily down. The one wildcard for us is the CTEH, which is unpredictable. And as you know from Q4 of last year, you know, that was the one variable that we had a tough time predicting. And so, that’s the only reason why we’re maintaining. And we still feel really bullish on kind of how this year has been panning out and what Q4 could potentially look like. Does that answer your question. Tim?

Allan Dicks: The other part of that on the margin question, Tim, is remember Matrix being a Canadian business is very seasonal. They are already a low margin business, Q4 is at or below their average. So that’s certainly going to be deteriorative to margin percentage in the fourth quarter.

Tim Mulrooney: Okay. Yes, that is helpful. And that does answer my question. A follow-up on that might be, you guys usually do call out how CTEH performed in the quarter, which is helpful for us for modeling purposes, especially as we model back towards normalization. How did CTEH performed in the quarter, third quarter of 2023. I know in the press release, you said it was up, but can you quantify that for us for modelling…

Vijay Manthripragada: Yes, yes. And all of this will be in the Q that gets filed later today, Tim. So, they remained elevated in the quarter. Their large response has now tailed off, but did have an impact on the third quarter. So they did $33.8 million in Q3 and that puts them at $103 million year-to-date.

Tim Mulrooney: Got it. But expected normalization…

Vijay Manthripragada: In Q4.

Tim Mulrooney: …in the fourth quarter and that $75 million to $95 million range is still relevant.

Vijay Manthripragada: Yes. Yes, when we say normalization, Tim, I mean we always talk about quarterly averages right so $6 million to $7 million of EBITDA, call it $24 million to 25 million of revenue a quarter, they are demobilizing in Q4. So they will be below their normalized levels if that makes sense. Still an incredible year and a homerun by any set of circumstances, but Q4 will be materially lighter we expect than the rest of the year has been so far.

Tim Mulrooney: Got it. Thanks very much. I hop back…