Onterris, Inc. (ONT) Earnings Call Transcript
September 15, 2022
Earnings Call Speaker Segments
All right, everybody, we're going to get rolling here. Thanks so much for joining us, and welcome back to Laguna. It's nice to see everybody and be in-person this year as opposed to a virtual format. Before we get rolling, I do have a disclaimer that I need to read here. For important disclosures, please see the Morgan Stanley research disclosures website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. With that, it's my pleasure to host the Montrose Environmental Group. Front office, Vijay Manthripragada, President and CEO; and Allan Dicks, CFO. Gentlemen, welcome, and thanks so much for joining us.
Thanks for having us.
Thank you.
Great to see all of you.
Our pleasure.
So, let's dive in here. I wanted to start sort of high level, maybe level-setting the room and the audience streaming on the company. So maybe talk to us about the history of the company, how it came together, how it evolved and some of the core offerings by segment?
Yes. So, we were on the receiving end of dealing with environmental issues as either sponsors or financial providers that were owners of businesses that had liabilities. And what we realized going through that process was that we had multiple facilities in multiple states, that we're facing very similar issues that were subject to different sets of regs. And as a result, the issues were being managed at the local level, and were being -- and the services were being provided by different vendors. And so it was a potpourri of solutions for what was becoming increasingly a board level or C-suite level discussion, liability management concern. And this was back in the 20 -- early 2010s. And so, we looked around and we said, gosh, what's going on? And why is this? It's a $1.3 trillion industry. We said, who's the leader, right? If we wanted to kind of streamline this and work with 1 or 2 leaders, who is it? We asked around. There was none, right? Depending on who you ask, you got a different answer. We said who's really focused on environmental issues. We've got 100 different answers. And we said, well, this sounds like a wide open market opportunity, that's why Montrose started to be kind of an integrated environmental business focused on environmental issues. And that was 10 years ago, and here we are.
Fantastic.
That's the history in a nutshell.
So thinking about the business, are there any geographic or customer-specific opportunities or cases that you would call out where Montrose is either well aligned, well differentiated relative to peers and the opportunity itself?
Yes. We -- in terms of geography, we are primarily a U.S. company. So we're still relatively young as an operating business. We were incorporated in '12, got off the ground in '13. We went public in 2020, right in the midst of the pandemic. So we're still kind of a new business. In terms of our geography, we're still concentrated here in the U.S. Because of some of our technology, our IP and our solution set, we got pulled into Canada, Australia, and then recently into Northern Europe. Our customers are primarily industrials, right? So we consciously chose to pivot towards the private sector when we first started, recognizing that most of the other players providing services in this space were more government oriented. And so, those would be the kind of the 2 main answers to your question.
So as you think about this year and the opportunities before you and bouncing that against your top line guidance range, $520 million to $570 million, what do you see or what needs to occur to say, push you to the upper end of that range this year?
That's a great question. So we -- when we set our guidance at the end of last year, we were kind of thinking we would do -- we had 17% organic last year, excluding the response business. And including the response business, we were kind of 60% plus organic, but that doesn't -- that's an odd way to look at it. It's, call it, 17% core organic. And then this year, we've publicly said we expect our organic growth to be north of 20%, and we're well on track to meet or beat that. And so, when we looked at our guidance at the end of last year for this year, candidly, we've been a little surprised on the continued surge in organic growth, which is really a function of some of the regulations that have come our way, that have benefited us, the Inflation Reduction Act, on the methane side where we are one of the leaders. PFAS, our technology has really ramped up in a really compelling way on the water side. And then, we've also been a little bit surprised by the adoption around some of the renewables and the natural gas side. And so, what gets us to the upper end of that range, it's -- our organic growth acceleration certainly pushes us towards the upper end of that range. We are also an acquisitive business. We tend to buy companies mid to high single-digit multiples, matters we've talked about with you, and they're largely to kind of bolster our specific geographic footprint or go buy a technology to build scale in select markets. That -- the cadence of that can certainly get us very rapidly to that range, if not above the range. We don't guide including acquisitions, right? So that is one variable, because we can't predict exactly how M&A is going to roll out. We have purposely throttled back the M&A engine because our organic has surged. The rate-limiting factor both with M&A and with organic is our team's ability to absorb that growth. So, if you're organically growing at the rate we are hiring, training, onboarding, quality assurance, all that stuff, is really hard to do, especially on the biogas and water side. And so, it's the same folks, including Allan and I, that are intimately involved in all the deals. So that pulls our attention away from the deals. So how we push and pull those levers is what would either get us on the lower end or higher in that range. Does that makes sense?
Yes, absolutely. No, that's...
I think you got it.
Well, then there's a pricing element that was not fully baked. The surge in inflation was not fully contemplated when we set guidance toward the end of last year. So the pricing we've taken is another factor that might push us in the hiring.
Got it. Excellent point. There's a piece of the business I just want to drill down into really quickly, and that's CTH. Yes. In the first half of 2021, you raised the run rate up to -- I think it's $75 million to $95 million core run rate of the business. That was from a 60% to 80% range.
Yes.
What has been the driving force behind the core business? We've talked at length about -- above and beyond CTH or…?
CTH -- for those of you that may not be as familiar as our response business. And so if we think about, again, our integrated environmental model, we think of it like an organism or our own bodies. CTH is kind of the emergency room that you go to when you get hurt, right? So, the same thing with the environment. So, the reason for the increase in their core run rate revenue, even though it's, by definition, an event-driven business -- is a function of more incidents occurring, right? So climate change-related events, aging infrastructure that results in contamination, right, fires, floods, those events. If you look over a 10- to 15-year horizon, whatever the reasons may be -- and we've certainly had some investors push back on our use of the term climate change. The -- there's just a very clear kind of uptick in the frequency of those events. And so, they're just -- they're dealing with more stuff in advanced economies, especially here at home, either due to aging infrastructure or due to more floods, more fires. If you go west of the Mississippi, tends to be fires and droughts, you got [indiscernible] and then certainly hurricanes. Even -- and this year, despite having a slow hurricane season, there's just been a lot of events that we've been dealing with. So that business has more events. They have more services that they're providing. So, when we first acquired that business, at the same time, we went public. They didn't have a COVID response business. It's not core to what we do, right? They're just really good responders, but we never had a pandemic response concept there. It wasn't even in the discussion when we bought them. But because they're kind of trusted responders for all of the major U.S. companies, they got a call saying, hey, we're doing this pandemic thing, any chance you could help. They created a product in the summer of '20, and then Q4 of '20, they launched it, and it took off, right? So that business did over $200 million -- from 0 to $200-plus million, which speaks to kind of that innovative engine that they have. And so what that caused them to do is expand their software capabilities and expand their service offering, and that's spilled into every subsequent year since. And the software has become more ubiquitous, more advantageous. So more events, more software. And their model -- they don't hire and fire. They have about 300 to 400 people that are on call, fully certified trained, but not employees. So if something occurs like the pandemic, they can step up and get up to 600, 700 FTEs, and then come back down to 200, which is their run rate. And that got bolstered as well. So, if you put all of that together, that's what caused us to say their core is organically growing as well.
Got it. That's very helpful.
And it's been a bit confusing, Matt, because when you come off of a $225 million -- when your run rate of $75 million to $95 million and when we say you're going to be at $100 million, everyone thinks that that's coming off a cliff, but they're just -- that's the way that...
Yes, the variable model.
Absolutely.
I want to circle around to something you mentioned or alluded to earlier, and that's regulation -- environmental regulation. It's been a positive catalyst for demand for the company. If you sort of think back, say, 3 to 5 years and compare your view then to what it is now, sort of the slope of demand, is it greater? Is it equal to or less than -- how has that progressed relative to your expectations?
Yes. It's -- federal regulations have been greater than we expected. And then, in all of the markets in which we operate, states and localities continue to have a fair degree of influence. The Feds set the baseline and the states can interpret beyond that. So, we've been surprised by both the regulatory market -- So PFAS is a big driver of our organic last year. And this year, the recent naming of 2 compounds as potential Superfund circular compounds, the expansion of the number of compounds regulated, the testing thresholds, deemed toxicity human health have been lowered. The IRA with all the methane and greenhouse gas-related regulations have been expanded. The list just goes on and on and on. So, we've been surprised to the upside on that. We've also candidly been surprised by the influence that, obviously, all of you as investors and the private market participants, have had on companies, coupled with what looks like now increased SEC regulation. So, this is a topic terrain that never really -- that's quite as high in the private market space. So in addition to regulations, there's this whole broader investor shareholder pressure point that creates tailwinds for us as a service provider.
There's a specific piece of legislation. I want to focus on here for a minute, and that's the Inflation Reduction Act that was recently in the past, I think, right around your 2Q results. As you look at that, as you unpack that, what opportunity set is there embedded within Montrose?
Yes. So we are one of the largest air testing companies in North America, and we have been at the forefront of a lot of innovation around methane emissions measurement and advisory work. And so, the Inflation Reduction Act has a series of elements related to the frequency of methane testing, the investment of CapEx to mitigate aging equipment and leaks, potential penalties, right? And that word potential is important because there's a lot of nuance to it. If you emit above a certain threshold, the capping of legacy wells, pricing incentives based on how much greenhouse gas or methane, you emit. All of that is kind of what we do, right? That was our advisory work. That was our testing work. And so, to now have a regulation that effectively penalizes the larger businesses. If they don't do those things, it means a lot more demand for us, and we're already seeing.
Got it. Fantastic. That's great insight. I appreciate it. Maybe just take a moment here to pivot over to profitability and the cost structure of the company.
There we go. So obviously, as we all know, inflation has been running hotter than expected.
Maybe real quickly, what impact has that had on the company? Is there any one segment that's been affected? And how are you guys coping with it?
Yes. We -- so, it's -- in anticipation of higher than trend inflation going into the year, we took a series of pricing initiatives, very data-driven. We bifurcated our customer base, put them in a quadrant and understood where our opportunities lay. And so, as opposed to just taking a kind of a flat rate across the board -- which is what we had done historically. There's been a very decentralized process for us historically with a lot of autonomy out in the field. We centralized a lot of the decision-making and use data to be very surgical about how we took pricing. So, we had a lot of success early in the year in taking pricing. What surprised us as we got into the second quarter was the rate of inflation in travel costs, specifically, and in some of our other direct costs. So, we fully covered all of our labor increases, hadn't quite anticipated a 40-plus percent increase in some of these other direct costs. So, we have, and are currently putting in place another round of increases to address that, and have had a lot of success with what we've done today. Had very little customer churn, very little pushback. And so, it's been a great learning exercise for us. And the controls that we've put around the discipline, we put around pricing, is something that will benefit us going forward. So Q2 certainly saw a margin impact. The half of -- first half of Q3, we'll see some of that. But as we get into Q4, and this pricing fully kicks in, we should have fully recovered it. So what's been a -- not a surprise, but a pleasant experience is that customers understand, and we really haven't had a lot of pushback from a lot of customer churn as well.
Great. Now how about on the efficiency side, right? That's pricing and passing through some of the inflation impact. But naturally, I think many companies look internally and see can they get leaner, so to speak. Have you guys put in any initiatives in place or you highlight anything you've done thus far to help mitigate some of this?
We -- when you double in size, Matt, like every couple of years, and you see a path to continue doing that, it's always a balance with kind of reining in the forward leading nature of kind of driving growth. And so our -- what I would characterize as automation to us, is more oriented towards continuing that growth more profitably and less about driving incremental efficiency out of every labor hour. Right? So, have we taken steps, for example, with the implementation of more advanced mobile tools and software, something simple like a next-generation ERP or CRM? Yes, we've done all the basics. But where we've invested pretty heavily in technology has been because of our increased success with federal clients, right, next-generation cybersecurity capabilities. But we've also been very forward-leaning on software that we're one of the largest aggregators of environmental data, which we think is going to be very valuable. And so, can we use software for our clients and sensors where we have some unique technology advantages to capture information more accurately, more frequently in ways that may not necessarily be dictated by regulations, but some plan, the need to send humans out to do the work. That benefits our clients, it's efficiency and neuro nomenclature, but for us, it's a massive market opportunity as well. So that's where we've been really kind of spending more time and energy. The acquisition of sensible IoT in the middle of last year is a great example of that, right? That you could say it's efficiency, but for us, it's an untapped market need.
Got it. Great. I just want to -- I know we're getting close to our stops here, but I want to touch on M&A a bit because it's according to our strategy. It's key to this business. You've done a great job of rolling up a number of companies. Maybe just quickly, what can you maybe share about your current M&A pipeline? Are there solutions, customer geographies that you're looking at and interested?
Yes. We -- our growth in the water and biogas space has pulled us into new geographies. And so, Europe has really embraced some of our intellectual property on the water treatment side. If that really takes off the way we think it will, we'd rather not do that organically. And so, we'll probably bring in a complementary engineering team, water engineering team out of the European markets. So we're looking at that very actively. We're probably 1 to 2 years away from formally doing that. But that's an example of geographic expansion of skill set, M&A. We are likely not really going to acquire much in that space for now. All of our bolt-on activity is going to be on the testing side, where we're already one of the leaders, and on the consulting side. So, a lot of the advisory work is now evolving as the SDG and greenhouse gas has become more prominent vis-a-vis where they were -- other contaminants where they were years ago. And so, we're adding some capabilities in that realm. Our recent acquisition of Air Kinetics was an air testing business in Southern California. That was a geographic move. Similarly, Triad, a small environmental consulting firm was a geographic move out of the Southeast, effectively just building local presence and scale in markets that we see growing, and our customers largely introduce -- for our existing people. Does that answer your question?
That answers the question. Now that's fantastic insight, and we appreciate it. And we appreciate you joining us here this afternoon. Thanks so much, and thanks, everybody else for joining us. Appreciate it.
Thank you. Matt. Thanks guys. Thanks, everyone.
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