Montrose Environmental Group, Inc. (NYSE:MEG) Q4 2023 Earnings Call Transcript
Montrose Environmental Group, Inc. (NYSE:MEG) Q4 2023 Earnings Call Transcript February 29, 2024
Montrose Environmental Group, Inc. misses on earnings expectations. Reported EPS is $-0.18 EPS, expectations were $0.1. Montrose Environmental Group, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, and welcome to Montrose Environmental Group Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Rodny Nacier from Investor Relations. Please go ahead.
Rodny Nacier: Thank you, operator. Welcome to our fourth quarter and full-year '23 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 our earnings presentation, which is available on the Investors section of our website. Our earnings release is also available on the website. Moving to Slide 2. We 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 SEC filings, including our annual report on Form 10-K for the fiscal year ended December 31, 2023, 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 a reconciliation thereof to their most directly comparable GAAP measure.
With that, I will now turn the call to Vijay beginning on Slide 4.
Vijay Manthripragada: Thank you Rodny, and welcome to all of you joining us today. I will provide you with business highlights. Allan will provide you with financial highlights and we will then open it up to Q&A. I will speak generally to the updated earnings presentation shared on our website. Before I begin, I would like to take a moment to thank our over 3100 dedicated colleagues around the globe. Their efforts drove another year of record revenue, adjusted EBITDA and cash flow by implementing best-in-class environmental solutions. I would also like to reemphasize 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 that is how we recommend you view our results as well.
In terms of our financial results and business highlights, 2023 was another stellar year for Montrose. Our performance was driven by the key themes we touched on last year. First, we were thrilled to produce record full-year revenue and consolidated adjusted EBITDA. Total revenue grew by 15% and adjusted EBITDA grew by 19%. Adjusted EBITDA margins increased as planned, and our cash flow was also at record levels. Second, our revenue predictability and consistency continue to increase. Our 95% revenue retention rate with customers in 2023 continues from last year. We also saw a consistent increase in cross-selling with over 50% of our 2023 revenues coming from clients utilizing two or more Montrose services, which was up substantially from last year.
Our integrated business model and our IP portfolio enabled cross-selling which further enhances our model. In effect, our flywheel is starting to spin really nicely. A large portion of the organic growth that we've seen over the last few years has been from cross-selling our services. So this level of integrated activity within our business gives us confidence to continue growing organically in 2024 and beyond. Third. We saw 24% organic revenue growth in our AP&R segment and 17% organic revenue growth in our M&A segment. Our strong organic growth in these segments was primarily due to higher demand for our advisory services and the positive performance in our lab and field services, particularly methane emissions and PFAS testing. Fourth, double-digit organic growth in our AP&R and M&A segments was partially offset by the expected revenue decline in our R&R segment.
This is due to our shift away from lower-margin work within our biogas services. Fifth, growth was also impacted by a shift in project timeline as our clients navigate proposed U.S. EPA PFAS regulations that the EPA originally proposed for Q4 2023 and now expects to finalize any day. With all that considered, for the full year, we produced total organic growth of 2%. I want to reiterate that our organic growth thesis has not changed despite the strategic shift in our R&R segment that caused a temporary slowdown in 2023. To put a finer point on our organic growth thesis, we have averaged 15% organic revenue growth per year for the last three years, and our 2024 outlook assumes low double-digit organic revenue growth. Our focus on higher margin work in 2023 manifested itself in our adjusted EBITDA results.
Our consolidated adjusted EBITDA margins increased 40 basis points despite the acquisition of Matrix. Matrix had full-year revenue of approximately 70 million at a 4.6% adjusted EBITDA margin prior to joining Montrose. We expect a continuation of adjusted EBITDA margin improvement in 2024. So, we not only expect to outperform our historical 7% to 9% organic growth cadence this year, but we expect to do it with higher margins. Fifth. We are witnessing growing activity in our end markets driven by 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, depending rules on climate disclosures and changes in air emission standards, we are experiencing significant regulatory tailwinds across all aspects of our business.
Sixth. Acquisitions remain core to our strategy. Our investments in M&A have been very additive to our ability to service customers through new technologies and geographic expansion. In addition to the strategic synergies, we are unlocking tremendous value from pricing and cross-selling opportunities. With larger deals, in particular, we are now starting to see cost synergies because we run on one platform and have robust support functions. With Matrix, which had margins of 4.6%, margins have already almost doubled in our hands on a run rate basis, and we expect continued margin accretion. Furthermore, through our larger scale and cross-selling capabilities, we believe we have grown the serviceable, addressable market for Matrix materially.
We closed five acquisitions in 2023, and so far this year we closed two. And our acquisition pipeline is more robust than we've seen in a while. I would also like to highlight that we are particularly proud of the success of our R&D efforts which aim to solve major environmental challenges and create new opportunities for our business. We submitted nine new and unique patent applications in 2023 which we believe will continue to differentiate our services and create value. For example, we expanded our PFAS treatment solutions to include unique foam fractionation and unique bioreactors to address the needs of our clients with waste water and landfill leachate challenges. We've also expanded our ability to more effectively remove metals from water like selenium at the request of our mining and industrial clients.
Furthermore, we're helping many of our clients and communities with air quality monitoring and greenhouse gas measurements using next generation sensors and proprietary software. The EPA is focused on GHG emissions and separately, the impact of air quality on disadvantaged communities have bolstered demand for our real time, quality assured and data-driven solutions. Our historical R&D investments are more than conceptual. They are already generating EBITDA and cash flow, and they are already helping us continue to generate strong shareholder value. Finally, our strong balance sheet and record cash flow generation for the year has enabled our investments in M&A and R&D. 2023 cash flow from operations of $56 million, which is more than double compared to the prior year, provided us ample flexibility to continue investing in attractive opportunities for Montrose.
Before I discuss our performance by segment, I would also like to discuss organic performance. When we purchased CTEH, it was almost exclusively a response business, making it more difficult to forecast quarter to quarter. What we saw in 2023 and what we are already seeing in 2024 is a really nice collaboration between the operating leaders of CTEH and the rest of Montrose, which is manifesting in the form of increased cross-sell. We are also seeing a nice increase in the consultative part of the CTEH business, and this means CTEH revenue is now proportionally less response and more typical of traditional environmental solutions. We exclude the emergency response related revenues from our organic calculation and have separately disclosed revenues from emergency response as requested by many of you, our shareholders.
I will now discuss our full-year performance by segment. Within our assessment, permitting and response segment, we were pleased to see strong organic revenue growth in our advisory services for the full year. We also saw positive contributions from our acquisitions. Our environmental emergency response business continued to perform above historical run rate levels, given several high profile response projects that continued from earlier in 2023. The increase in margins for this segment were driven by strong organic revenue growth and the increase in environmental emergency response revenue. We remain bullish on the outlook for our advisory services in 2024 and beyond, and in the long run, we expect this segment to continue to run at 20% to 25%.
EBITDA margins. Within our measurement and analysis segment, we also continued to experience strong organic revenue growth. We are especially pleased with the positive performance across our lab and field services, with particular strength in our air quality testing and greenhouse gas testing services. We continue to add to our geographic footprint with new locations to facilitate faster turnaround times for our clients. In addition, our software coupled with our sensor networks are creating new and differentiated opportunities for our business. In total, we remain upbeat about our prospects for continued performance in measurement and analysis for 2024. Annual margins in this segment were at and remained in our long term 18% to 22% expectation range.
Finally, within our remediation and reuse segment, revenue growth was primarily driven by our acquisition of Matrix, but was offset by reduced revenues from our ECT2 water and biogas practices. Margins during the year were lower, primarily given the impact of the Matrix acquisition, which was a 4.6% margin business prior to acquisition. Margins were also impacted by lower ECT2 revenues, which were due to delays in PFAS projects, given delays in the U.S. EPA's PFAS regulations and a planned shift in our biogas business towards higher margin services. The shifts in ECT2's biogas services and the improvements we are already making with Matrix are expected to enhance our margin profile in this segment in 2024. This segment should also be back to steady organic growth in 2024.
R&R segment is our least mature segment, and we expect margins to run operationally at 20% to 25% over the long term. Next, I will discuss recent regulatory updates and industry trends that support our long term growth outlook. The U.S. EPA remains focused on PFAS and recently added nine PFAS to the list of hazardous constituents under the Resource Conservation and Recovery Act. This rule will give the EPA the authority to regulate emerging contaminants such as PFAS at permitted waste facilities and pursue corrective actions in a wide variety of industries, creating substantive opportunities for Montrose. With regards to methane emissions, the EPA's new methane rule was finalized in December of 2023. This regulation aims to significantly reduce methane releases from flares, vents and leaks, along with requiring increased leak detection, all of which support incremental demand for our emissions measurement, monitoring and assessment solutions.
Our early investments in optical imaging technologies and our early investments in software and sensor networks continue to create strong tailwinds for our business given these regulations. Regarding demand for our environmental consulting services, the EPA continues to prioritize environmental justice in its rulemaking, permitting and enforcement activities. We anticipate this campaign will drive increased demand for our advisory and for our testing services. In summary, before I turn it over to Allan, I would like to again acknowledge the entire Montrose team for their hard work and dedication. I remain incredibly grateful for the immense value they bring to our clients which is reflected in these record 2023 results. Our upbeat outlook in terms of revenue growth and EBITDA margin expansion for 2024 is a function of the strength of our business and the differentiated nature of our business model, technologies and services.
Allan will touch on our 2024 guidance shortly, and we look forward to updating you on our progress throughout the year. With that, I will hand it over to Allan. Thank you.
Allan Dicks: Thanks Vijay. We are pleased with our strong performance in 2023, driven by strong execution, our track record of highly additive M&A activity and our expanding customer relationships, which drove another year of solid revenue retention and cross-selling success. Moving to our revenue performance on Slide 11. We were happy to see continued strong organic growth across most of our service lines during the fourth quarter and full-year 2023. Our fourth quarter revenues increased 18.8% to $165.7 million compared to the prior year quarter. Full-year revenues were up 14.7% versus the prior year to $624.2 million. The primary driver of revenue growth in both periods was the positive contributions from acquisitions including Matrix, strong double-digit organic growth in our AP&R and M&A segments and an increase in environmental emergency response revenues.
This was partially offset by our R&R segment where we experienced delays in project timelines as clients await clarity on PFAS regulations. We also executed a strategic shift in our biogas business to focus on higher margin, lower revenue services as Vijay discussed. Excluding revenue from discontinued businesses, revenue was up 20.2% to $162.8 million in the fourth quarter and was up 17.5% to $615.4 million for the full year. Looking at our consolidated adjusted EBITDA performance on Slide 12. Fourth quarter consolidated adjusted EBITDA was $17.5 million or 10.5% of revenue. This compares to consolidated adjusted EBITDA of 17.8 million or 12.7% of revenue in the prior year. Prior year Q4 EBITDA includes $2.2 million related to the discontinued specialty lab, which included a business interruption insurance gain following the cyberattack that impacted that lab earlier in 2022.
Excluding the discontinued specialty lab, Q4 2023 consolidated adjusted EBITDA increased 12.2%, driven by higher revenues. Roughly half of the lower Q4 consolidated adjusted EBITDA margin was due to the removal of the discontinued specialty lab, with the remainder primarily driven by seasonally low margins from Matrix acquired in June 2023, as well as unfavorable mix and significantly lower incentive comp expense in the prior year. Full year consolidated adjusted EBITDA was $78.6 million or 12.6% of revenue, an improvement compared to consolidated adjusted EBITDA of $66.2 million or 12.2% of revenue in the prior year. Prior year adjusted EBITDA included $2.1 million from the discontinued specialty lab. Moving to a review of diluted adjusted net income per share on Slide 13.
Adjusted EPS increased for the quarter and full year. For the year, we reported diluted adjusted net income per share of a $1.07, an increase of 24% compared to diluted adjusted net income per share of $0.86 in 2022. The increase was mainly driven by higher revenues and stronger adjusted EBITDA dollars. Please note, our diluted adjusted net income per share is calculated using adjusted net income attributable to stockholders divided by fully diluted shares. We believe diluted adjusted net income per share is the most helpful net income metric to Montrose and to common equity investors. Turning to our business segments on Slide 14. I'll focus my comments on the most recent quarter. In our assessment, permitting and response segment, fourth quarter revenue increased 10.9% year-over-year to $50.1 million.
The year-over-year increase was driven from primarily by organic growth, growth in revenues from environmental emergency responses and to a lesser extent, the positive contributions from acquisitions. AP&R's segment adjusted EBITDA increased 27.3% year-over-year to $9.2 million, or 18.3% of revenue, up from 15.9% in the prior year, reflecting the benefits of organic growth, favorable revenue mix and higher aggregate margins across our other businesses within this segment. In our measurement and analysis segment, revenue for the quarter increased 15.7% to $54 million, primarily attributable to double-digit organic growth and to a lesser extent, the benefits from acquisitions, partially offset by lower revenues from the discontinued specialty lab.
M&A segment adjusted EBITDA was flat year-over-year. Excluding the discontinued specialty lab, however, M&A segment adjusted EBITDA was $9.7 million, or 18.9% of revenue in the current year compared to $7.5 million or 17.6% in the prior year. The increase in adjusted EBITDA and adjusted EBITDA margin, excluding the discontinued specialty lab, was driven by organic revenue growth. In our remediation and reuse segment, fourth quarter revenues increased 29.3% to $61.6 million, primarily due to the acquisition of Matrix, 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 projects. The decrease in R&R segment adjusted EBITDA margin was due to lower water treatment revenues and the dilutive impact of Matrix.
Our margin optimization efforts are well on track at Matrix to achieve a double-digit adjusted EBITDA margin in that business by the end of 2024. Moving to a review of our cash flow and capital structure on Slide 17. Full year cash flow from operating activities was $56 million. This represented a conversion of adjusted EBITDA to operating cash flow of 71% for the year. Cash flow from operations, which increased roughly $35 million over the prior year, included the payment of acquisition related contingent consideration of $0.6 million in the current year and $19.5 million in the prior year, accounting for $18.9 million of the year-over-year increase in operating cash flow, with the remainder of the increase driven by lower working capital build and higher earnings before non-cash items.
For the year, we produced free cash flow, i.e., operating cash flow, this cash paid for CapEx, net of proceeds from asset sales of $27.4 million, representing approximately 70% of adjusted net income. In 2023, our cash capital expenditures of $29.6 million included $12.2 million to replace the plane we lost in a tragic accident earlier in the year. Ongoing maintenance CapEx is expected to continue to run at around 1% of revenues. Our net leverage ratio includes the impact of acquisition-related contingent earnout obligations payable in cash. We ended the year at a healthy ratio of 1.9 times and a strong available liquidity position of approximately $150 million. In January 2024, we voluntarily redeemed $60 million of the outstanding preferred stock.
The associated dividend savings are an estimated $5.4 million annually and represent a proactive step towards simplifying our capital structure. Following this redemption, the principal balance of the preferred stock outstanding was reduced to $122.2 million. As a reminder, our convertible and redeemable Series A2 preferred stock has no cash maturity date, but we have the option to redeem the preferred shares at any time for cash. In February, we upsized our credit facility to $400 million, adding $100 million to our available liquidity on the same terms as our pre-existing facility. $50 million of the increase was added to our term loan and the other $50 million increased our revolver capacity to $175 million. Overall, we believe our solid balance sheet, ample liquidity position and expectation of continued robust operating and free cash flow generation puts us in a good position to continue to drive additional value creation in our business in 2024 and beyond.
Moving to our full-year outlook on Slide 20. Based on the positive momentum in our business, we are introducing our outlook for full-year 2024 revenues to be in the range of $675 million to $725 million. We expect consolidated adjusted EBITDA to be in the range of $90 million to $95 million. Our revenue and consolidated adjusted EBITDA outlook for the full year represents double-digit revenue growth and margin expansion over the prior year. We anticipate strong organic growth in the low double digits given our current visibility into end market demand and cross-selling momentum. Our outlook also includes an expectation for environmental emergency response revenues to be in the range of $50 million to $70 million compared to $91 million in 2023.
Additionally, we anticipate the conversion of consolidated adjusted EBITDA into cash flow from operating activities will remain in excess of 50%, consistent with our long term annual target. As we think about the distribution of revenue and adjusted EBITDA in 2024, the addition of Matrix for the full year and the timing of environmental responses in the prior year will change the growth patterns of our revenue and margins as we move through the year. So we wanted to provide a bit more color on the topic as follows. We expect revenues to be up year-over-year in each quarter of 2024. We expect margins will be down in the first quarter and up in the second, third and fourth quarters, resulting in higher margins for the full year. For the first quarter, we anticipate revenues to be up mid-teens compared to Q1 2023.
While first quarter total revenues are up year-over-year, there will be a notable difference in revenue mix, mostly occurring within our AP&R and R&R segments. In our AP&R segment, we had a high margin emergency response megaproject in the prior year period, which is not expected to recur in Q1 2024. In our R&R segment, the primary factor is seasonally low margins from Matrix which was not in the comparable prior year period. Therefore, we expect first quarter consolidated adjusted EBITDA margin to be down year-over-year, but up 50 to 100 basis points sequentially compared to Q4 2023. In terms of seasonality, we anticipate revenue in the second, third and fourth quarters to follow similar seasonality as the prior year along with margins up year-over-year in all three quarters.
In summary, 2023 was another milestone year for Montrose with the strong momentum in demand, substantive regulatory tailwinds and strong cash flow generation, we believe we are well-positioned to realize another year of record performance in revenue, adjusted EBITDA, cash flow and diluted adjusted net income per share. 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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