Good morning. Welcome to the virtual portion of the 27th Annual Needham & Company Growth Conference. Thanks for joining today. We're going to have a discussion with the management of Montrose Environmental Group. With us today is the CEO, Vijay Manthripragada , and Allan Dicks , CFO. Welcome, both of you. My name is Jim Ricchiuti , by the way, in the Equity Research Department at Needham & Company, covering industrial and environmental technology companies. Vijay and Allan, thanks for spending time with us today.
Why don't we begin, Vijay, with this just extremely unfortunate, tragic events that have taken place in Southern California. So earlier this week, the company put out a press release noting that your operations have not been affected as of three days ago. I know the situation is very fluid, hopefully improving out there. At least that's what the reports seem to suggest. But what can you say, any broader implications for your operations over the near term?
Thank you so much, Jim. It's wonderful to see all of you. Allan and I are thrilled to be here with you and happy New Year to all of you. Jim, regarding your question, that's right. Our business operations are absolutely not impacted, thank God, and I certainly hope that that continues and expect that will continue. Like the hurricanes at the end of 2024, we have many employees, as you know, Jim, in Southern California, including some of my direct reports who are for now safe but are in evacuation warning zones. O f course, many of our clients and friends have been and are continuing to be deeply impacted.
As we think about our kind of operations across the southern part of the state, a lot of our executive team, including Allan, are in the Irvine office, which is okay for now, but certainly within the risk zone. We just wanted to make sure we were there for our people, for our families, and our friends. We really appreciate you allowing us to do this virtually. Of course, we look forward to seeing you in person in the very near future. As it relates to opportunities, of course, the question that's likely coming next from you is related to our response business. It is a little too early to tell. The situation is still unfolding on the ground, and first responders are still there. Of course, we're thinking through that as well.
W e'll get more detail on that, I'm sure, in your upcoming earnings call.
Perfect.
Let's move to the broader discussion of the business. F air to say 2024 was a challenging year, at least in respect to how the stock performed. T hat's the question that we get from investors quite often. S ome of it started with the Supreme Court Loper Bright ruling in late June. T hen we had, obviously, the U.S. election, and we saw a further reaction. T he decline has been a bit surprising considering that the company reaffirmed your full-year revenue and Adjusted EBITDA guidance as recently as November, right, in the Q3 release. So I guess the question that I wanted to start off with the broader discussion is, what do you think investors may be missing about the Montrose story and the company's near and long-term prospects and potential?
It's a loaded question, Jim, but I appreciate you asking it. It is obviously one that's quite pertinent to this discussion. Look, I completely agree with you. As we look at our stock price performance in 2024, between the end of June and the end of July, starting with and around the Loper Bright decision from the Supreme Court, our stock price declined approximately 70% on the back of no business news, F or Allan and I and the team, it was doubly surprising because just a little earlier from that event, around Q2, we had increased guidance on the back of business momentum. W e've heard this directly from many investors, Jim, which is that there's general concern given that decision and other political developments that the U.S. EPA and the subsequent environmental priorities are going to get decimated.
T hat is perhaps the biggest disconnect as it relates to Montrose because there will certainly be many changes that we expect. It's a little too early to tell. In fact, today is Administrator Zeldin's confirmation hearing. But if you think about our client base, which is predominantly the private sector, right, so think your Fortune 500 companies.
I f you think about how U.S. state agencies have significant influence over how environmental regulations are promulgated in their geographies, if you think about the fact that 20% of our business is outside of the United States, right, Australia, Canada, Europe, and given most importantly that our work is anchored on clear rules that have been in place for decades that are bipartisan in nature and have both regulator and industry support, we actually, ironically, see more upside than downside over the next four years from that sequence or series of decisions. A s we think about both Loper Bright and the new Trump administration, just to put another data point in context, Jim, we went public. We grew through and went public at the end of the last Trump administration.
W e understand the dynamics quite well and are arguably more prepared for it now than we were the first time around. We're pretty optimistic. In fact, we're quite optimistic about the next four years. T hat's the biggest disconnect between what the market is perceiving as it relates to the broader environmental industry and Montrose's specific business, if that makes any sense or if that answers your question.
It does. Vijay, maybe just help someone in the audience who may not be as up to date on the ruling, the Supreme Court ruling, overturning the so-called Chevron deference. Talk to us again about, for those folks, maybe just help them in a quick summary of that. Y ou also, the follow-up to that is you've actually, as recently as the last call, suggested that you're also seeing some increase in advisory and consulting services as a result of that. G o ahead.
That's right. T esting services. T his is a deeply nuanced discussion, so please forgive me for grossly simplifying it, Jim, but in the 1980s, the U.S. Supreme Court ruled that when there's ambiguity in statutes or statutory language, that the courts should, and these words matter, defer to the federal agencies. T he reason is because the federal agencies have technical expertise. I t seemed, and in many ways is pragmatic. I f you think about, put the EPA aside, the way pharmaceuticals have developed and our genetic capabilities have developed or the internet and web and data, there's been a lot of technological transformation an t echnical expertise matters a lot. T he idea was defer to the agencies when the language was ambiguous.
Fast forward 40 years, and the concern is that agencies are overreaching or underreaching and going well beyond what the intent of their mandate was, t hat process of overreaching or underreaching was partially driven by the whipsawing based on political parties, and it was creating a fair amount of uncertainty for regulated entities like us and a lot of our clients, so in 2024, the U.S. Supreme Court ruled that the courts should respect, but not necessarily defer to agencies, and that puts a lot more attention on what the statutes are and what they were meant to do and exactly what they say. M ost important, I don't know if that summarizes it well, but that's kind of in a grossly simplistic way what it is.
The meaning for Montrose is really three things, which I don't know if we've done a good job, Allan and I, of communicating this and conveying this. The first is that there's going to be more certainty and stability with agency action. Chevron goes in both ways, Jim. You can't overreach, but you also can't dismantle or underreach. What the statutes say is what you shall do. A s political parties shift, you think Obama to Trump or Trump to Biden or Biden to Trump, there's going to be more, in theory, stability because what Congress intended is what the agencies shall do, which creates more predictability for us as a business and for our clients.
The second dynamic is that because of what's expected at the federal level, it's practically, or for all intents and purposes, shifted some of the power to the states and their agencies. As it relates to the environmental industry for us, that actually bodes quite well for Montrose given the nature of how our business and our operations are set up. T he third is that, and you alluded to this in the concluding part of your question, Jim, is that because of Chevron and because of the shift in policy and the way folks are or aren't interpreting statutes, there's going to be some near-term confusion. W e've seen this with the promulgation of various rules, right? Different courts may interpret what the language meant or is saying differently. T hat drives demand for our advisory services.
T he reason we have so much conviction is because our business is anchored on very clear language, right? We're not really dependent on ambiguous language or elements of agency diktats that are overreaching. This is pretty clear, right? We shouldn't drink lead. You probably shouldn't eat arsenic. I 'm being a little facetious, but there's a lot of long decades-long history of bipartisan consensus and industry alignment on a host of these issues. W e feel really good because we're anchored on kind of some fundamentals here. Our clients, we've talked to all of them, are staying the course. T hat was the decision was, and that's the impact to us.
T hat really leads into one of the follow-up questions, Vijay, is we're seven months from this ruling, and you've had a fair amount of time to collect information and the reaction from your clients. W hat exactly are you hearing? What have you heard? Has it changed at all? H ave things changed at all even as a result of the new political landscape?
P eople are waiting to see what the administration wants to do. But no, nothing has changed. T hat's why you've heard Allan and I say this. We said this months ago. We're continuing to say it. The dynamics are different, but because of the private sector, Jim, and our focus on the private sector, the emphasis may be different as U.S. energy production picks up, manufacturing activity picks up, as we onshore various activities that perhaps were not there before or pick them up in activity levels. All of that is going to drive demand for our services. And then as it relates to your question around Loper Bright, we've actually seen a visible increase in our advisory demand cycles.
I wanted to turn to an area of the business that remains in the news, and we had a company earlier this week at the conference talking about the implications around PFAS, and boy, it doesn't sound like things are changing there. What, first of all, help the audience understand what it is that Montrose does as it relates to the issue around PFAS because it really cuts across your business segments?
That's right. PFAS is a class of contaminants around which regulations have just started to get formalized, publicized, and promulgated at the federal level, right? In early 2024, a series of drinking water limits. The rules got promulgated. But before that, there was a host of testing-related requirements and assessment-related requirements and reporting-related requirements. For M ontrose, Jim, our business, as you know, has kind of three key pillars. We have advisory services, consulting work. We have testing services where we measure levels of environmental contaminants in air, water, soil. W e have treatment and engineering solutions where we extract that from the environment. PFAS, by virtue of what it is, cuts across all three of those business lines for us. It represents, Jim, in any given year, 10% to 15% of our revenue.
Again, if you think about what the statutes say, right, the EPA shall regulate contaminants that may impact public health. T here's very little doubt that that's fully within the EPA's scope. T he question comes down to what the limits should be, what should be included, and how they should be regulated. That's always the case with new rules. A lot of the work we're seeing now is our clients working with us to assess risk, measure, and really quantify what the magnitude of the remediation need is for them, and then engaging us on helping think through how best to treat in the most effective way and in the most economically efficient way. That's the phase that we're in.
T he dynamic that's shifted the most for us is that it is a much larger addressable market than any of us foresaw, especially with the new rules that got put out in April of 2024. So we thought of it as a $100 to 200 billion market here in the U.S. over a 10-year period. It's now thought to be a $200 to 300 billion market. But the compliance deadlines have pushed out to 2029 as opposed to 2027 or 2028. So as we think forward three to five years, we're feeling even better than we did before about the opportunity ahead of us. But it's kind of taken off at a little bit of a different trajectory than we anticipated two, three years ago.
Historically, Montrose has the bulk of the business been from commercial clients. This part of the business is also. We've seen a fair amount of announcements on the government side, including the announcement that you made recently on a win with DOD, as well as this clearly is an issue that goes beyond U.S. borders and international repercussions. You've just announced something in Australia. Maybe you could elaborate on some of these items.
A bout 20% of our business is outside of the United States, Jim, as you know. That is made up by revenues and earnings from a combination of Canada, Australia, and Northern Europe. In Australia and Northern Europe, our work is anchored on our patent portfolio, right? We have about 23 patents, many of which are anchored around next-generation ways of PFAS remediation and treatment. Our abilities have given us some incredible opportunities in both geographies. W e've seen really nice growth in Northern Europe on the back of some of their rules related to PFAS and the removal of PFAS from various water streams. In Australia, you alluded to this. We recently worked closely, and we announced this with Sydney Water, which is the largest, I believe, municipal water program in Australia.
We're working with them to extract PFAS from drinking water as they find it there. T hese are just small examples, but simple examples that demonstrate that, yes, this is well beyond a U.S. issue. The applicability of our technology is global. I t really comes down to how quickly our client base begins to act on treatment requirements. I t's not just a regulatory issue, Jim. We've seen over the years that there's a pretty large state or provincial emphasis here. A lot of our demand in 2022 and 2023 came from states, perhaps more so than the feds before they put out rules. We're seeing this in our other geographies as well. T he investor community and the legal community and the public are also very, very impactful here as our client base thinks through decisions and how best to implement them.
That also ties into, again, going back to the change in the political landscape. Talk to us, first of all, about, as it relates to Montrose's footprint, some of the key states that play a big part in some of this. T o the extent it's still much of the environmental activity is still going to end up being at the state and local level. This is a state and local issue for everyone.
It fundamentally comes down to drinking water, Jim, right, so Allan and I joke about this all the time. When it comes to drinking water or rain or air, t here's unanimity that we want it to be clean, and some of these issues are kind of global in nature, a lot of our demand over time has come from states like Washington or Alabama or Maine or Michigan, red, blue, purple, and there's many other states now that are actively involved with our clients on a host of remediation activities, some of which we can't necessarily fully disclose today, but this is a bipartisan issue.
E ven Administrator Zeldin, assuming he gets confirmed today or shortly, Jim, has been very forward-leaning on a host of these, right, as during his time in Congress voted for every major PFAS legislation that came through. So this is not something that we see as a partisan issue. Our clients certainly don't see it that way. We haven't seen any indications of any of that activity stopping or slowing down for that matter. Treatment activity is picking up quite nicely. W e expect that to continue to ramp over the next three to five years. But we've seen a substantive uptick on the assessment, advisory, and testing side, Jim.
That is both because of the federal mandates, but in heavy part because of the many, many states across the country that are actively monitoring and assessing what the risk profiles are, putting aside all the international opportunities we just talked about as well.
Just from the standpoint of economic activity, industrial production in the U.S. has kind of lagged for a while. There is this thinking that if we start to see some of these initiatives that come into play that the upcoming Congress is looking at doing the new administration, that there's going to be greater focus on industrial activity, domestic energy production, and exports. That also has implications, doesn't it, for your business?
Significant implications,. Any starting increase operationally or even slowdowns, any shift or change drives demand for our services, Jim. Most of our business is anchored on assessments, ongoing permit requirements, testing requirements, and compliance requirements tied to a host of contaminants or environmental rules that have been, again, in place for a long, long time that everyone kind of agrees on, and candidly, a lot of our industrial clients have already put the infrastructure in place to comply, so they don't necessarily want it unwound because that's a cost as well, we certainly have seen and expect that increase in energy production, increase in technology activity with a lot of our technology clients, and I say that a little generically. AI has gotten a ton of attention, but with that come data centers that have a lot of energy use, water needs.
All of that activity is a major net positive for Montrose, again, because we are predominantly private sector oriented.
On e of the issues investors have raised is just the level of acquisition activity at the company. You can comment, number one, on the decision to perhaps pause the M&A activity. I also wanted to ask you before we get some color on that, one of the things that the company's been demonstrating is success on cross-selling. I t's worth noting where the company was a couple of years ago in terms of cross-selling activity because this also is a result of some of the M&A that you've done and integrated and where it is today?
T hose are two distinct themes, Jim. P lease let me know if I'm not touching on them appropriately. A s it relates to cross-selling, that's less a function of M&A and more a function of our business strategy, right? W e have two anchors to how we've approached the environmental market, the first of which is that we have integrated in a unique way our consulting practice with our testing capability, with our engineering and treatment capabilities, which are anchored on a patent portfolio, right? So that combination of technology plus engineering plus consulting plus testing doesn't really exist in the same way in the market today. The reason that matters from a cross-selling perspective is the industry, by virtue of how it's grown up, is very fragmented.
O ur client base, the private sector, tends to deal with these issues in a very fragmented way, right? Lots of vendors, lots of consultants, lots of providers. By offering a more cohesive service, we've created value for them. T his is all. We've published data demonstrating all of this. B y virtue of that value creation, we've effectively created a really compelling flywheel whereby we can provide additional services. It streamlines and increases, arguably, the quality and efficiency of the services being provided to them, more value to them, which further enhances our ability to cross-sell.
Y ou've seen that manifest in the data we've published in terms of the number of clients using more than one service and how that's increased over time. C andidly, as we increase from two services to three services to four services, that doesn't show up in the data you're seeing. But that actually is more cross-selling on our part. This continued into 2024. W e're really excited to continue to share some stories. I'll give you one simple anecdote.
Please.
In the waste management industry, which we haven't historically talked about with you and we've really seen pop up as a more prominent player within our portfolio of late, there was an issue that came up early last year. T hat caused our consultants and our toxicologists to come on site and say, "Hey, let us help you think about what's happening here." We very quickly found out that they needed more testing. So our labs and our air testing teams got involved. Then we quickly found out that they needed water treatment support. So our ECT2 technology, our treatment technology business, got involved. A t this time, the entire Montrose portfolio is supporting that client across our consulting, testing, and treatment services, along with our remediation engineers. T hat's just yet another beautiful story.
H ad we not had the capabilities we had in-house, we would not have been able to, A, provide those services, nor would B, the client, have been able to benefit from a more coordinated offering the way they have. W e hope and look forward to their willingness to share that story more fully once the issue is resolved.
T o turn to some of the more recent developments as it relates to what you've communicated to investors. A llan, I'll let you pick up on this. Talk to us about the plans to deliver. Talk to us about the decision. Vijay, you may want to comment as well on the decision to pause M&A activity. So Allan, let me turn that over to you, and then we'll do a deeper dive into some of those questions.
W e've heard pretty clearly from investors that the acquisition activity and just the natural noise that that creates in the financials and in free cash flow is confusing, and the preferred instrument, which was used to finance the acquisition of CTEH
back in early 2020, is clearly an instrument investors generally would like to see taken out. It was initially $182 million principal value. We redeemed $60 million of that early in 2024 and have said we are going to pause acquisitions and prioritize the repayment of the balance of that $122 million outstanding preferred instrument. $60 million of that, you'll see us repay in early April, likely. That's when the holder can elect to convert into common stock. We're likely to take that out in cash instead, and the remaining $62, we expect will be repaid well before the end of the year.
Pro forma for that redemption, we expect leverage to be at around three times at the end of next year, absent any further acquisitions. So we will certainly demonstrate an ability, from what we expect, to be robust free cash flow in 2025 and ability to naturally delever. Y ou'll see that manifest in cash flows and leverage.
T he topic of cash flows, Allan, it's worth highlighting, a couple of the issues that led to some disappointing cash flows and to the extent that we'll see some resolution of that in the near term.
T o start off with, it's always more meaningful to measure cash flow on a full fiscal year. T he Q2, Q3 noise, if you will, there is certainly a lot of seasonality in that cash flow. There were, however, two distinct and unique issues that we grappled with in 2024. The first related to the acquisition of Matrix, which was a large acquisition for us up in Canada. As we integrated that business into our systems in 2024, the complexity of their invoicing was very different from the typical invoicing we have. W e underestimated client sensitivity to changes in invoice templates. So that led to a delay in getting invoices out. There's a lot of back and forth with clients. It has been a tremendous focus of ours. T hat issue is completely resolved.
Y ou'll see that behind us again on a full year basis. That'll be a non-issue. The second issue was a large project for a city in Southern California that was managing a naval base where one of their very large hangars full of asbestos burned down. It became a large response and, again, a number of different service lines pulled in, very large project. Our contract is with the city. The city is being reimbursed by the Navy. W e don't have a contractual relationship with the Navy. The city has said, "We acknowledge we owe you. There's no dispute with any of the invoices. We're on the hook for this. But we're a city. W e're dependent on the Navy paying us." So we are making progress there. There are no collection issues. The city has been very responsive.
The Navy wants a lot of detail, which we have been providing. So we're making progress there. But that was a large receivable that certainly threw our DSOs out of whack. Again, that's a temporary issue. Absent that issue, cash flows would have been really strong in 2024 and where we would have expected at 50% to 60% conversion. With this issue, it's probably 40% to 50%.
Y ou mentioned Matrix. Talk to us about it. It's been one of the larger acquisitions. But how satisfied, Vijay, are you with how that acquisition has performed? Allan, you can speak to the margin improvement that you've seen in that business.
I 'm happy. Allan, feel free to jump in. There's multiple merits to that partnership or that family joining the Montrose family, Jim. The first is strategically, it was a premier environmental pure play and a blue chip brand in Canada primarily in the Canadian province of Alberta. They'll call it Western Canada. That was very synergistic strategically and operationally with the Montrose engineering and treatment business. T he mission, the people, and the fit within our business was, on every measure, an A-plus fit profile. What made that transaction challenging as a public company is that even though they were a blue chip and even though they had a spectacular position in the market, their margins were suboptimal because they were an ESOP. T hey weren't running as efficiently as they could.
W hat we said is, "We're going to bring them into the Montrose fold. We're going to emphasize margin accretion. W e're not as worried about growth because we do see some long-term tailwinds in that business." What we've been thrilled to see is that and to give you a sense for their margin profile, Jim, if you recall, that business was around 4.5% EBITDA margin at the time of acquisition. That has more than tripled in our hands in the last 18 months. O n the back of pricing discipline, staff utilization discipline, overhead discipline, just putting our kind of blocking and tackling operational playbook to play. If you look at the multiple we paid, it's been cut by more than two-thirds. So the return profile for our common shareholders is exceptional, even notwithstanding the temporary cash flow issue that Allan talked about.
T his is, as a small company and in the public eye where folks tend to think quarter to quarter as opposed to years, you watch the sausage being made, right? You saw a blue chip business come into our fold, skew our margin profile, have integration issues. We talk about integration being core to how we do it. Every business is integrated into one system. We're very disciplined about that. But that creates sometimes temporary noise, right? You watched all of that unfold. But as I sit here today looking out at 2025, we've achieved every goal we set out to achieve, both in terms of margin accretion without compromising their revenue growth opportunity, staff retention. C andidly, the outlook for this year is as stronger than I expected.
S imilar to what happened here in the United States with the transition from President Biden to President Trump, we expect there will be a transition from Prime Minister Trudeau, who recently resigned, to we expect Prime Minister Poilievre, who is an Alberta native. Our business understands that dynamic very well. S imilar to what I just described to you here, we expect some tailwinds from that general transition for our Matrix business in Canada over the next couple of years. So kind of across the board, I couldn't be happier. It's been challenging, candidly, as a public company to explain all this to all of you. I f we were a private business, this would be considered a home run.
W e're running low on time. I want to get to two final questions. Number one, the M&A issue. When you say pause M&A, give us a sense. How open-ended is that? T he question on the 8K that was out. Go ahead, please.
T he pausing M&A, Allan's exactly right. We are very close to our investors. We're very grateful for the caliber and quality of our investor conversations. O ur thesis and our strategy has not changed, Jim. We have a lot of organic growth opportunity ahead of us. This market is made up of small companies, thousands of them. It's so highly fragmented there really is a consolidation opportunity here.
None of that is unchanged. Candidly, this is just good in many ways for us to just take a deep breath, given how fast we've grown, to just make sure that we're kind of well-positioned as we look at $1 billion, 2 billion to $5 billion in revenue opportunities. T his is just a pause that I would consider into kind of the latter part of this year. Depending on how all of the political dynamics and operations unfold, we expect we'll pick right back up in partnership with our investor community and our teams either later this year or early next.
The 8K that came out, what, last week? The decision.
The SARs?
Yes, please.
W e just look. We had some SARs that were creating a lot of noise on the P&L. We eliminated them. No additional equity was issued. It was simply to try, as Allan alluded to earlier, clean up the P&L in a way that makes sense. So the management team just gave it up. That's it. Nothing else there, and hopefully, that continues to clean up the financials and streamline the P&L and should show what the true underlying economics are.
Vijay, if there's one thing you want to leave with investors today, just given all the volatility in the stock and what you see in the business as we start in the early part of 2025, just if there's anything you want to take away for investors.
We would love to have you join this journey with us. Allan and I are about as optimistic as you can get about the future. We think it's been a pretty dislocated market for us. I f you want to hear why we have so much conviction, we'd love to engage with you. I f you hear that conviction over these conversations, we would welcome the partnership with you. We think this is a long-term trend over generations that is only going to transform the way the world works. We think we're an early mover in that space. W e're as excited as can be. W e'd love to continue to have these opportunities to share that enthusiasm with all of you, Jim.
I want to thank you both for joining us today, and especially under the circumstances of what's going on, what's gone on in the past week in Southern California. I wish your colleagues the best, and hopefully, your clients, everyone stays safe there and we see improvement. Thank you.
T hank you so much, Jim.
Thank you. Take care, all of you.