Onterris, Inc. (ONT) Earnings Call Transcript
November 17, 2022
Earnings Call Speaker Segments
Good afternoon. I'm Stephanie Yee. I'm the lead waste analyst at JPMorgan. And today, we're very pleased to have with us Montrose Environmental. With us today is CEO, Vijay Manthripragada; and CFO, Allan Dicks. Thank you so much for being here.
Thanks, Stephanie.
Vijay, can you help us understand what are the growth drivers for Montrose and maybe how they differ by segment? How much is regulatory-driven? How much is company-specific .
Yes, it's a great question. We're kind of in the fortunate spot of having a couple of growth drivers, Stephanie. The business is still heavily regulated,; or I should say, our clients are still heavily regulated, and that has historically served as an accelerator of our growth. The methane rule that came out from the administration on Friday in multiple formats is going to have a pretty material impact on our advisory and our testing business. The ongoing concerns around the forever chemicals, the PFAS chemicals, continue to cause our organic growth to be at highly elevated levels. That touches all 3 of our segments. Ongoing demand for negative carbon intensity energy has had a particular impact within our remediation and reuse segment. And then the core business has been at elevated organic growth levels. And so as we think about -- of what's driving the business, we're going to do somewhere between 20% to 25% maybe more organic growth this year, excluding our emergency response business. And those are the primary reasons for why that's occurring. Alan, is there anything else that you would add on that?
That's fine.
And can you touch on some of the regulatory legislation that you're keeping an eye on? Maybe you can talk about the Inflation Reduction Act, but any other kind of regulations that we should watch.
Sure, sure. So yes, the inflation Reduction Act had several components of it that had -- that have environment or climate change-related drivers. The regulation of facilities that admit certain amounts of methane and both the carrots and the sticks for those facilities to measure more frequently, upgrade equipment, cap legacy wells, all of those impact both our -- all 3 of our segments, in particular, our permitting and our testing business. There's also monies allocated in the IRA for the measurement of contaminants in air and water specifically for communities that are disadvantaged historically. And that falls very nicely into kind of our classic testing business. And it's been allocated within what they're now labeling the environmental justice part of the EPA doesn't have enforcement oversight, but it works closely with the rest of the agency and the localities to implement these various initiatives and rules. That is now -- that has been complemented by Friday's methane rule. And the methane rule effectively takes parts of our historical oil, gas, refining and now our natural gas industry and makes all of it regulated, whereas only a part of it was regulated before. And it increases the frequency at which you have to do methane emissions testing. So there are now approximately 2,000 midstream compressor stations, over 10,000 upstream compressor stations. There's over 300,000 wells that fall under the jurisdiction of this regulation, and then, of course, there's the refineries. The regulation also facilitates the adoption of next-generation technologies, which we've been heavily investing in. And it also names OGI Optical Gas Imaging as the best available technology, which is what Montrose has been doing for years. We're the largest provider of that service in North America. As you kind of put all that together, Stephanie and it's just a pretty significant amount of tailwind for that part of our business in particular.
Okay. Great. And it's nice to hear about the development with OGI because I know that is something that Montrose has been doing, but there just wasn't necessarily that regulatory push for increased adoption.
And then PFAS is a topic du jour, and that has -- that continues to be increasingly regulated. The thresholds are coming down. There's been proposals to name some of the compounds super fund compounds, and that has a host of implications, which create tailwinds for our business. The Department of Defense in the United States has recently limited the ability to burry or burn PFAS waste. And that is a driver for our regeneration within -- which is where we have intellectual property and capabilities. So kind of even within that realm, we're really excited about the opportunity set ahead. And that business has been growing triple digits this year. Obviously, we don't expect that to continue into perpetuity. That's again a function of some of that demand.
And how should we think about the operating leverage for Montrose? I know that you're investing in the remediation and reuse segment and maybe that's a large part of it. But as we think about high single digit or above organic revenue growth, how does that translate into operating leverage?
Yes. It's really different across the different segments. But what we found within our measurement and analysis segment, which is the most mature and the oldest of our 3 segments, as we've gotten national scale, the ability to optimize a lot of our operational processes, so I think invoicing or collections or quality assurance or report writing, we've been able to consolidate a lot of those services. And obviously, the cross utilization of labor is a lot more effective when you've got a larger customer base. So we expect that -- and that segment runs at what we would consider mature margins, so kind of high teens to low 20% EBITDA margins, which is best in class, if you look at other companies in the space. We expect that within the AP&R segment, which is very immature in terms of our national footprint. And then -- so that'll mature through both organic growth and acquisitions, a lot of acquisition opportunities on that side within our remediation reuse space, Particularly the biogas and the water treatment, that will be mostly organic. As you said, that's a different operating leverage. There, it's much more about front-running some of the infrastructure in anticipation of continued sizable growth over a 2-, 3-, 4-year horizon. So we expect across both the AP&R segment and remediation and reuse, we're going to start to see really nice operating leverage. And then if you look at the business mix from an operating perspective, the higher growth opportunities tend to run at higher margins. So we should get a natural lift from positive mix over time. And then corporate as a percentage of revenue, you'll start to see that systematically come down beginning next year.
Okay. And since you touched on acquisition opportunities within the assessment segment, I guess, can you highlight some of the, I guess, expertise or technology or areas that you're looking at for M&A opportunities? .
Why don't I use the -- our recent acquisitions as kind of proxies for the types of things we're looking at without giving away what we're looking at. Environmental Standards was the largest acquisition this year, and we tempered our acquisition cadence this year, Stephanie, given how organic surged, but Environmental Standards specializes in kind of traditional environmental consulting but more specifically serving as kind of an advanced auditor over the data streams and permitting inputs that come in from other consultants. And the reason that was highly additive to us is, as we think about some of the commitments being made by Boards and C-suites that are perhaps outside of the traditional regulatory regime or part of evolving regulations, the integrity of that data is really critical. And that's an example of expertise, right? So advanced chemistry auditing, data auditing capability in the environmental space, they're kind of a known brand. They often sit with decision-makers to determine which set of lab data is the most viable or which technology is producing the best results, and that facilitates the rest of Montrose's execution, particularly with emerging regulations. And they also have a national footprint and a very strong presence headquartered out of Valley Forge, Pennsylvania so the Northeast where we're trying to expand our geographic capability. Triad Environmental was a small bolt-on consulting firm out of Tennessee to complement kind of our rapidly growing southeastern U.S. presence, a more traditional environmental consulting company. IAG was a 4-person firm that specializes in SCADA systems. So, automating operations for our environmental technology implementations are very complementary to our biogas. And our water team it's a 4-person firm. So we call that an acquisition really hired 4 people. And then aero kinetics was a tiny air testing business that further consolidated our leadership in the Southwestern United States. And so we are already the leading provider of air testing services, but that market continues to grow really attractively. And California tends to be a little ahead of the curve on air regulations, which we think will further give us insights -- will give us further insights into where some of the technology and regulatory regimes are going to go specifically related to greenhouse gases and organic compounds. So those are the transactions. Did I forget anyone?
Okay. Great. Can you talk about Montrose's go-to-market strategy? So how do you win in the marketplace? It seems like you're growing above industry growth rates? I know we're looking at a lot of diverse smaller industry segments. So can you just talk about how you go to market, how are you able to win, who are you competing with?
Yes. So we don't -- because we're an integrated environmental company, we're like a Venn diagram, nobody competes exactly with us, but different parts of our business compete with different types of businesses. Our advisory business would compete with more traditional consulting businesses, right, like a ramble and Byron or exponent. Our testing business would compete with more traditional the TICC industry, so Eurofins, SGS, and our remediation reuse business compete with the more traditional either water companies for our water practice so that's sushi. Evoqua, engineering businesses like a Tetra Tech, AECOM Jacobs, their environmental piece. And then on the biogas side, that -- there's -- there have been a -- there has been a flurry of activity in terms of just sponsor-based or other financial partnerships with the utility company. So that world is still very nascent. But we don't have anyone competing exactly alongside us. In terms of our go-to-market strategy, it starts with our seller to our model. Our revenue is very sticky, and we kind of operate with MSA type agreements with our clients. And as we've demonstrated since years before going public, and we talked about this as part of the IPO. 95% of the revenue for any 1 year comes back the next. It's not like we lose the incremental 5 to 10. It's just that the scope of the work may change year in, year out. So in the short of a quality or safety labs, it's very sticky revenue. It's not contractually recurring, but it is very sticky. And so we continue to maintain that base. Our sales and business development teams are largely around cross-selling services across that existing base. So seller-doers execute, retain the revenue. We have some support to continue expanding services by segment. And then our effort is really more exposing existing clients to the other services that we provide. The concept of an integrated solution set doesn't exist in the market, so we're educating the market as we go.
And I guess, do you really -- do you compete on price or not really, it's really your service offering and expertise that.
It depends. yes. So if you're in a highly regulated industry, there's not a lot of room to innovate because the regulations dictate how you can do things. So in those instances, you have to be price competitive, but you can charge a premium if you have a quality advantage. Where we have intellectual property and technology and software advantages, we are more price makers than takers. And so our higher margins within our water business, for example, our higher margins with our greenhouse gas measurement business, those are examples of where we have advantages. And so there, we compete less on price and more on the fact that our solution is unique. Is there anything else you would add there, Alan? do you want to talk about pricing just in terms of the.
Yes. Yes. The pricing that we've taken this year, Stephanie, in response to anticipated labor inflation was successfully done. The additional inflation that we saw primarily in the second quarter around travel costs, which is a function of both higher rates as well as us having to move individuals around more with the tight labor supply and then other direct costs has resulted in a lot of key learnings for us, right? So we took -- we've taken multiple price increases this year. One is we've lost very few customers. So even in businesses where it's a little more commoditized, a little more competitive, the switching -- the risk of switching is high. And in some instances, for smaller customers, we took prices up 20%, 25%, and so almost low attrition. So that was a really key learning. And then the discipline that -- and the centralization of some of the pricing has given us another insight, right? This used to be a very decentralized function. Often our project managers. We're responsible for pricing. They were measured on project profitability. This exercise and the need to be a lot more disciplined around pricing has given us a lot more control, which will serve us well as we look out over the next several years.
And I know there is a slight mismatch right now between the cost inflation that you've taken on and then the price increases that you put forth. I guess how much of your revenues are those fixed price contracts or maybe it's harder to push price in real time versus the time of materials where you can kind of react more quickly?
Yes. The -- again, it's very different by business. The time and materials businesses, which tend to mostly be within our measurement and analysis and on the advisory side of the business and the emergency response business, so there, you're charging labor rates. The ability to increase prices pretty quickly is there. And so we've been able to react to the inflationary -- the inflation that we've seen. The longer-term contracts come in 2 forms. One is the larger project-based projects where you are -- you have a fixed price. But because these are large projects, we also fix our input costs with our vendors. And so the incremental exposure is really on our labor. So it's a very small component. So we don't have a lot of pricing risk on those projects, projects that run multiple quarters or, in very limited situations, multiple years. Those usually have annual cost escalators. So it's harder to take pricing up midyear. On a very, very limited basis, you're fixed for more than 1 year. There, we're going to have to wait until those projects to unwind. But again, we're talking fractions of a percentage of our total revenue.
What's been encouraging is that even in those types of scenarios, the team did approach clients to revisit what was a fixed price contract, and they took prices up, in some instances, there as well. So clients have been oddly supportive, candidly, just given our expectations. But in hindsight, it makes sense because they faced a lot of the same pressures and we're doing the same thing with their partners. And so it's been a very constructive dialogue. We've been really pleased with that so far. Also, Stephanie, we don't have a lot of huge multiyear clients. We tend to be primarily several weeks to several quarters of that high-volume cycle process. So we have very little exposure to that long-term construct.
Okay. Great. Let's talk a little bit about your PFAS-related businesses. It's seeing very strong growth. Can you -- I know you have a proprietary technology with regenerable resins. How much has that played a role in kind of the high-growth kind of.
It's almost exclusively because of it. It's a function of 2 variables. One is our integrated model is unique. And so the industrial clients working with us really like the fact that we have advisory experts that understand regulations, testing capabilities, so we can do things that would be atypical in the market and the teams that have technology that's best in class. Regeneration gives you a sustainable advantage. And so we have yet to take waste off-site contrasted with having to take waste off multiple times a week, if not every day. That also has a cost and liability reduction implication. The efficacy with which we remove short [chain] PFAS has mattered a lot to the clients we're working with DoDs, airports and private companies in particular, and that's the main reason they're working with us. If anything, the technology has been very compelling. They are used to working with huge multinationals. And so the question was is Montrose able to execute, which, as you can see from our results, we've delivered. But when we first started these projects, the incumbents were orders of magnitude bigger than we were. And so there was just a question as to whether we could actually implement the next generation of technology in some of the largest treatment systems being developed in the world as we speak.
And I think PFAS is now about 20% of our total company revenues. Do you anticipate maybe breaking that out for investors in the future? And also, do you think the rate of growth that you've experienced is sustainable over the next few years? .
You want to take the segment piece now, Alan?
Yes. We -- there are lots of ways to slice and dice the way we look at the business, right, by geography, by service line. By contaminant is a way. It's not the way we look at the business. But, again PFAS, although predominantly in the remediation space. There's a lot of testing revenue. And, to a lesser extent, there's advisory revenue as well. So we don't really look at it that way. There are lots and lots of different contaminants, PFAS just happens to be the largest -- even though it's a family of thousands of compounds. So no. We'll talk about what the water treatment business is doing. And again, most of that is PFAS but start breaking it out by contaminant, that's probably not likely.
Yes. And this is -- in the growth rate, Stephanie, candidly, we grew triple digits this year, and the team's burned out. So we need to temper that a little bit next year. We think that, that will -- we're going to try to plateau that to get all the systems and the quality controls and team morale kind of where we want it to be. We can see by virtue of the pilots what the next bottle list of activity will be. I'm certain we will slow it down through the first half of next year and then begin to kind of ramp back up back half of next year into 2024. And as a result, we will see a higher growth in other parts of our business, like the renewables and the greenhouse gas part in particular, and we're going to step up our M&A activity. So our -- we manage the business to, call it, 25% to 35% year in year out growth. And we did over 25 right, so far organic this year. So we pull back on M&A. Next year, we'll try to normalize the organic, so we can step up the M&A. Does that make sense?
Yes. Yes. And I know you talked about cross-selling or increased cross-selling traction that you gained. Has that occurred in the PFAS solutions areas or .
That's the reason. In fact, the several industrial clients and the multiple projects within those clients that are driving organic are all a function of cross-selling. It is proof positive of both the integrated business model and the business development and go-to-market approach.
And do you have any client concentrations within your PFAS customers?
We do. Yes. So they are similar to what COVID was last year, where we had hundreds of projects but a couple of large clients that had multiple projects, it's similar here where we have large clients with multiple projects under them. So we don't have any one project concentration risk. But there are some very large clients making up a majority of that surge this year.
Is there a particular industry that those clients are in?
The ones making PFAS.
In terms of -- you touched a little bit on this, the company's growth algorithm. So I think in terms of what you've published, you talked about 20% full revenue growth, 100 to 150 basis points of margin expansion in a typical year. Does that still hold true? It sounds like maybe it's stepping up higher? And also, how does that break out between organic versus M&A?
Yes, it's a great point. So we went public at 2 30-ish of revenue, and we're north of 5 50-ish this year, so plus/minus. So it gives you a sense that we kind of failed our 20% test. On an annualized basis, we have been at an elevated growth rate. And that's come a little bit of a surprise, right? Last year, we were surprised by the CTH business that surged. And this year, we've been surprised by the continued cadence of organic. And as a result, we outgrew our expected size and had to invest. As you know, Stephanie, we talked about. We lost our emerging growth status, internal audit, right? All the things that come with just being a faster filer. And those investments have been made. Now to Alan's point, we'll step back down next year, but the business is tracking really nicely. We are at elevated organic levels. And so I expect the balance compared to what we were, which was 7 to 9 organic 15-plus M&A. That has shifted a little bit more towards organic less towards M&A. Certainly, for the last 2 years, we'll try to normalize that back a little bit next year because the M&A opportunities are as voluminous as they've ever been, and at some point, the target discussions won't last, and they won't wait as long -- we don't want to forgo some of those because they're very strategically added.
Okay. Can we talk a little bit about Montrose's renewable energy biogas business, just -- what do you do there? And what do you see as kind of the growth rate and margins for that business over the next few years?
Yes. So it's -- we are we are focused on today dairy waste to biogas. Our portfolio of opportunities is expanding to other forms of equally negative carbon intensity energy. So we will be able to expand beyond dairy waste in the near future. We'll either acquire or partner with technologies to expand that footprint. The market demand cycle there seems to be incredibly strong, we have seen utility partners and natural, and energy company partners ask to participate in these types of projects as part of their commitment to have a portfolio of renewable energy. They tend to be a little tapped out on wind and solar, and so they're looking for other forms. And this is a proven area. If you could contrast the United States and Germany, for example, as one illustrative example, they have multiple thousands of running digesters, and we don't have anywhere close to that and we are multiples bigger than that as an economy and in terms of the number of farms that we have. So the opportunity is quite significant. It has gotten increasingly crowded. And so it's not just Montrose that's seeing this. You've seen this with both companies that have entered the public market or private companies that have gotten bought -- the largest being the recent $4-plus billion acquisition. by a big multinational entering the space. And so we're just -- we're excited. We're seeing a lot of demand cycle there, and it's just a question of how we execute on it. But our -- what we do is we design the facility, and then we work with the -- we don't own the capital. We don't take the capital risk for the energy. And we work with the farmer, the utility energy and the financial sponsor to implement.
And I guess in terms of target margins, would it be kind of in line with what you expect for the remediation reuse segment? Or how do you think about returns?
Yes. The biogas business should run in the high teens at scale absent intellectual property advantage. And we're looking at a number of opportunities to bring that into the Montrose fold. So that business has been in high single digits. As it started to scale rapidly. There's been a lot of fixed cost investment. As that starts to get to maturity, we think mid- to high teens, again, absent that IP.
So it's a lot like our PFAS business was 3, 4 years now. We're investing heavily in front running the opportunity set. We expect in a couple of years, it will be where PFAS is.
But the difference being on the PFAS side, we do have IP. And so those run rate margins are closer to 22%, 23%. So that difference is just in the IP.
Okay. Great. I think we're up on time. So let's just stop there. Thank you for being here. Appreciate the time.
Thank you, Stephanie, thank you.
Thank you.
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