Montrose Environmental Group - Q4 2022

Transcript

Operator (participant)

Greetings, welcome to the Montrose Environmental Group Inc. Fourth Quarter 2022 Earnings Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rodny Nacier, Investor Relations. Thank you, Mr. Nacier. You may begin.

Rodny Nacier (Investor Relations)

Thank you. Welcome to our fourth quarter and full year 2022 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 two. I would like to remind everyone that today's call will include forward-looking statements that are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ in a material way due to known and unknown risks and uncertainties that should be considered in evaluating our operating performance and financial outlook.

We refer you to our recent SEC filings, including our latest annual report on Form 10-K, 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.

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

Vijay Manthripragada (President and CEO)

Thank you, Rodney, and welcome to all of you joining us today. I will provide you with business highlights and then hand it over to Allan for our financial review before we open it up to question-and-answer session. I will speak generally to the updated earnings presentation shared on our website. Before I begin, I would like to take a moment to acknowledge the plane crash in Little Rock, Arkansas, which took the lives of five of our colleagues last week. They were on their way to helping our clients, and this is one of those unthinkable events for which there are no words. Our prayers and thoughts go out to the families that lost their loved ones and to our CTEH colleagues who are mourning a deep, deep loss. I am proud of how the collective team has come together.

I am also amazed at the poise and grace with which our CTEH team is handling this sudden and unexpected shock. To all of our CTEH leaders and colleagues, thank you for your unwavering fortitude. To our clients and partners who jumped in to help and are joining us to remember those we lost, thank you. I also remain grateful for the efforts of our colleagues around the world, from Australia to North America to Europe. Their results and efforts have resulted in another incredible year for Montrose. I am really pleased with the execution across all levels of our business. As we have noted before, our business is best assessed on an annual basis, given demand for environmental services is not driven by specific or predictable quarterly patterns. This is how we manage our business and how we recommend you view our results as well.

Let me now go to our financial results. We were pleased to report another exceptional year in 2022, I'll highlight a few key themes. First, we achieved record organic revenue growth of 26% in our core business, representing approximately two-thirds of the growth in the blue bars on page five of the presentation. As a result, our average organic growth over the past three years has been approximately 18% compared to the 7%-9% at the time of our IPO in mid-2020. Historically, acquisitions represented more than half of our annual revenue growth, recently, organic revenue growth has been a greater contributor to our overall growth trajectory. Second, our organic revenue growth outperformance in core services helped mitigate the impact of the anticipated $125 million decline in CTEH COVID-19 related revenues from 2021 to 2022.

Given the incredible surge in CTEH revenue in 2021, we expected to be down in 2022. Revenues held steady on the back of strong organic growth outperformance in the rest of our businesses. 3. What is particularly encouraging for us is that our organic growth outperformance was broad-based and across segments. It is primarily driven by demand for our PFAS water treatment technology, greenhouse gas measurement and mitigation, and renewable energy services. 4. We were also thrilled to see customer revenue retention and cross-selling revenues increase to record levels. Customer revenue retention increased to 96% in 2022. As a reminder, the 4% isn't necessarily lost revenue, but more a function of project frequency. Our customer relationships remain as strong as ever.

In addition, cross-selling revenues, which are defined as revenues from clients using more than one Montrose service, nearly doubled to 35% of total revenues. In essence, our organic growth outperformance is less about customer acquisition and more about deepening existing customer relationships. Growth in these metrics reflects the success of our business development efforts and, as importantly, our integrated service offerings. Finally, and fifth, we are also happy with the strength of our balance sheet and continued strong cash generation. Our acquisitions were and continue to be funded through our operating cash flows. Our balance sheet remains effectively hedged against rising interest rates, and it provides us with ample flexibility to continue consolidating our industry and investing in environmental innovation.

As it relates to acquisitions, which remain a core part of our strategy, we believe our slower pace during 2022 was prudent as we focused on executing against our accelerating organic growth opportunities. So far in 2023, we have increased our cadence of M&A activity, and though small, we believe they are very additive to Montrose, and we are very pleased to have added the teams from Frontier Labs, Huco Consulting, and Environmental Alliance to our family. We expect more announcements in the near future, and as you can see to the quick start this year, we expect 2023 to be back to our historical cadence of strategic acquisitions. As Allan shares more about our 2023 outlook, I think it is important to highlight where we came from, which is what slides five and six are meant to depict.

Revenues and total operating segment Adjusted EBITDA from our core business have seen very strong and sequential growth each year since our IPO in 2020. During that same time, we invested in our corporate infrastructure to transition to public company life and to transition out of our emerging growth status more quickly than anticipated. Regarding 2022 expectations, our revenues came in consistent with expectations, primarily due to organic growth outperformance, as discussed earlier. Our operating segment EBITDA was a little lower than expectations for three primary reasons. First, as our water treatment and biogas services scale, their margin profile, though very attractive at run rate levels, is immature at this time as we invest to capture organic growth opportunities. Though I am oversimplifying, the revenue that replaced the CTEH COVID-19 revenues from 2021 was lower margin in the short term.

It grew faster than we expected, and importantly, it represents more consistency and higher margin opportunity in the long term. Our recent acquisitions in our consulting and engineering service lines have been lower, mid-teens margins, but very strategically additive. We purchased a few small testing businesses that were also lower margin. We expect margins for these businesses will increase as part of Montrose over the coming years. These acquisitions have also been very financially accretive. Finally, when we last spoke in November, CTEH had a near record October of 2022, we expected fourth quarter 2022 outperformance. The fourth quarter ended lower than we expected. The CTEH business is challenging to predict over months or quarters, as we have noted before.

CTEH remains core to the Montrose strategy and had a spectacular overall year, as you can see on slides five and six. This is more of a short-term phenomenon. Given all these factors, our 2023 outlook on pages five and six reflects our bullishness, particularly with our core services. We expect double-digit organic revenue growth in 2023 for our core business, which will offset the continued wind down of the CTEH COVID-19 services. Those services remain meaningful, particularly in early 2022. We also expect strong double-digit operating segment Adjusted EBITDA growth for our core services, which will offset a slight decline in CTEH. Finally, we expect to be back to a regular M&A cadence, and Allan will expand further on these trends. Overall, our long-term strategy remains unchanged.

We are confident in our ability to create shareholder value as we have been doing, given our ability to innovate and capitalize on strong demand for our environmental solutions. I will discuss broader regulatory and industry trends. We continue to see market drivers as government policy initiatives are catching up with public and private sector demand for better environmental stewardship. We remain well-positioned to capitalize on these tailwinds. Specifically, first on PFAS, the U.S. EPA continues to be focused on the issue of PFAS and added several more PFAS chemicals to the Toxics Release Inventory in January. The EPA also proposed rules regarding lower thresholds for chemicals of special concern. Both likely increase future demand for our consulting and testing services in particular. In addition, the U.S. EPA plans to publish final drinking water limits for PFAS by the fall of 2023.

Their recent memo also includes recommendations for at least quarterly testing of wastewater and technology-based treatment, both of which are expected to continue driving demand for Montrose's testing and treatment capabilities. With regards to methane emissions, late last year, the EPA released a supplemental proposal for the oil and natural gas sector to reduce methane emissions from facilities, among other emission reduction requirements. The proposal expands the scope of requirements and requires states to reduce methane emissions from hundreds of thousands of existing sources nationwide for the first time. In addition, the U.S. Bureau of Land Management published a proposal that requires operators of federal and tribal oil and gas leases to take steps to avoid the waste of methane. If adopted, we expect to see increased demand for our emissions measurement, monitoring, and assessment services.

Third, finally, regarding demand for our environmental consulting services, in January, the U.S. EPA announced availability of $100 million, which builds on previous investments from the American Rescue Plan to support projects that address various aspects of pollution, emissions, and climate matters in disadvantaged communities. In addition to the demand we have started to see from the American Rescue Plan, we have also seen increased demand from industrial clients partnering with communities as a result of these new efforts to monitor air quality in particular. This creates tailwinds for our consulting and testing services. In January, the U.S. EPA released a document on how to ensure cumulative environmental impacts are considered with permitting remediation, waste management, environmental emergency response, and other decisions. If implemented, we expect this proposal will help increase demand across our services.

In essence, with regulations, while many of these actions are in the early rulemaking phase, the macro demand drivers for environmental services remain on the rise. Though we are highlighting U.S. regulations as that is most of our business, the same general trends are true in Australia, Canada, and Europe, which we expect will collectively represent a greater % of our revenue in the coming years, given stellar growth opportunities. Next, I would like to discuss our performance by segment. Within our assessment, permitting, and response segment, excluding CTEH, we were pleased to see solid organic revenue growth in other services in the segment. In addition, we were able to add small but strategically and financially creative acquisitions to the segment. These trends are harder to see given the expected $125 million decline in CTEH COVID-19 revenues, which overshadow the segment.

We see a lot of future opportunity in building other services within this segment. Going forward, we expect to reduce CTEH variability through investments in the organic growth of their non-response services as well as acquisitions. The team is very strong, we remain long-term bullish on opportunities related to CTEH. Margins in the segment were primarily impacted by the shift in business mix and the lower margins of our recent acquisitions. Within the measurement and analysis segment, demand for our testing services remained very strong and drove solid organic growth. Given the regulatory momentum I just discussed, we remain upbeat about continued growth in this segment given our position as a market leader. Our margins remain in the high teens to 20% as expected.

Finally, within our remediation and reuse segment, our organic growth outperformance for the full year was primarily driven by demand for our PFAS water treatment and renewable energy services. As we've reiterated on prior calls, margins remain below what we consider normalized levels given our ongoing investments into this business. We were pleased to see sequential margin improvement in this segment during the fourth quarter, also as expected. In terms of our research and development and technology achievements, we were awarded and have filed for eight and 14 patents respectively. We are particularly excited about our progress with PFAS destruction and carbon dioxide capture. Given the early nature of these innovations, they may not succeed in the field, but they show promise, and they speak to our team's ability to identify and capture long-term environmental opportunities for our clients.

In addition, we are actively working on partnering with next-generation technologies for waste-to-energy and real-time air monitoring services, which we believe will contribute to our continued long-term value creation and growth. In summary, these results belong to the approximately 3,000 Montrose colleagues around the world. To those of you that are listening, congratulations on another solid year. To our investors, thank you for your continued support and for giving us the opportunity to create value for you, for our clients, and for our employees. As we look forward to 2023, we believe we are well-positioned to achieve our objectives given our strong track record. We remain as optimistic as ever in the future for Montrose Environmental. With that, let me hand it over to Allan. Thank you.

Allan Dicks (CFO)

Thank you, Vijay. We are pleased to have closed out another year with strong organic growth in our core business, benefiting from the in-demand nature of our unique environmental solutions, our expanding customer relationship, solid customer retention, and exceptional cross-selling success. We are also pleased with the resumption of our typical M&A cadence with the recent closing of our sixth acquisition since the beginning of 2022 and second so far in 2023. Successful execution of accretive M&A remains one of our key growth pillars, and we are encouraged by the robust pipeline of prospective acquisitions in 2023. Moving to our revenue performance on slide 12. We were happy to see continued strong organic growth across most of our service lines during the fourth quarter and full year 2022.

Full year revenues were $544.4 million, compared to $546.4 million in the prior year. Excluding the revenue impact of the planned exit from legacy wastewater treatment and biogas O&M contracts, revenue was up 1.2%. This top-line resilience was exceptional when considering the year-over-year decline in CTEH COVID-19 related revenues of $125 million. This COVID-19 headwind was almost entirely offset by our 26% organic growth in the remainder of the business, as well as the positive contributions from acquisitions. For the fourth quarter, total revenues were $139.5 million, compared to $143.8 million in the prior year quarter.

This decrease in revenues was driven by significantly lower CTEH revenues, partially offset by organic growth in our measurements and analysis segment and the remainder of our assessment permitting and response segment, as well as the positive contributions from acquisitions. Looking at our Consolidated Adjusted EBITDA performance on slide 13. Full year Consolidated Adjusted EBITDA was $66.2 million or 12.2% of revenue, compared to Consolidated Adjusted EBITDA of $73.2 million or 13.4% of revenue in the prior year. The year-over-year change in Consolidated Adjusted EBITDA dollars and as a percentage of revenue was driven by the significant decline in CTEH earnings and to a lesser extent, business mix and higher variable costs impacting travel, field and lab supplies, and other direct costs. We were pleased to see strong traction with our pricing initiatives instituted during the year.

Fourth quarter Consolidated Adjusted EBITDA grew 3% year-over-year to $17.8 million or 12.7% of revenue, compared to Consolidated Adjusted EBITDA of $17.3 million or 12% of revenue in the prior year. Return to year-over-year growth in this metric was driven primarily by a full quarter benefit of pricing taken early in the year and favorable business mix. Turning to our business segments on slide 14. In our assessment, permitting and response segment, full year revenue and operating segment Adjusted EBITDA decreased to $187.2 million and $37.5 million, respectively. The CTEH business is entirely in this segment and is reflected in the year-over-year decreases in both revenue and Adjusted EBITDA. Organic growth in the remainder of the segment, plus acquisitions provided a partial offset.

Operating segments Adjusted EBITDA as a percentage of revenue was 20%, which was lower than the prior year as a result of business mix and the acquisitions of Environmental Standards, Environmental Intelligence and Horizon, all of which operate at lower margins than our other businesses in this segment. In our measurement and analysis segment, revenue increased 12.5% to $172.4 million, primarily attributable to strong organic growth as well as acquisitions. Measurement and analysis Adjusted EBITDA as a percent of revenue decreased to 18.3% as a result of business mix and the impact of the cyber attack in June, which temporarily disrupted some of our lab's ability to operate.

In our remediation and reuse segment, revenues increased 40.7% year-over-year to $184.8 million, reflecting strong organic growth related to the increase in demand for our PFAS water treatment technology and biogas services, as well as revenues from acquisitions. The increase in segment Adjusted EBITDA as a % of revenue was a result of significantly higher revenues and business mix. Moving to our capital structure on slide 15. Full year cash flow from operating activities was $20.6 million, compared to cash flow from operating activities of $37.6 million in the prior year. Cash from operations includes the payment of acquisition-related contingent consideration of $19.5 million in the current year and $15.6 million in the prior year, respectively.

Excluding these acquisition-related payments, adjusted cash from operating activities was $40.1 million for the full year 2022, compared to $53.2 million for full year 2021. This year-over-year change was primarily due to lower earnings before non-cash items of $9 million and an increase in working capital of $16.5 million in the current year, compared to an increase in working capital of $10.1 million in the prior year. These strong operational cash flows reflect our ongoing focus on balancing the generation of cash with investments in technology, R&D, startup initiatives, and corporate infrastructure to ensure continued scalability.

Our liquidity position also remains strong with cash on hand as of December 31st, 2022, of $89.8 million and an additional $125 million of availability on our revolving credit facility. As we've highlighted over the past few quarters, the interest rate swap we put in place in January 2022, and the solid cash position we have on the balance sheet, have resulted in almost no exposure to rising interest rates at current borrowing levels. Our leverage ratio as of December 31st, 2022, which includes the impact of acquisition-related contingent earn-out obligations payable in cash, was at 1.3 times. Our Series A-2 preferred stock has no maturity date, and we have the option, but not an obligation, to redeem the preferred shares at any time for cash, subject to a make-whole payment if prepaid prior to April 2023.

We view this preferred equity instrument as favorable to the value creation potential in the business, given its flexible dynamics and the fixed nature of the dividend in a rising interest rate environment. If you include the $182 million balance of the Series A-2 equity in our market cap, our total equity capitalization stands at approximately $1.7 billion. Moving to our full year outlook on slide 17. Based on the solid traction in our core business through 2022 and into 2023, we are initiating a full year growth outlook for revenue to be in the range of $550 million-$600 million, and for Consolidated Adjusted EBITDA to be in the range of $68 million-$74 million. Our revenue forecast reflects our expectation for continued double-digit organic growth in 2023.

We expect CTEH to be within its estimated $75 million-$95 million run rate, which is approximately $20 million-$40 million lower year-on-year, primarily due to the expected cessation of COVID-19 related services in 2023. Within our consolidated adjusted EBITDA outlook, we expect to see margin expansion and mid-teens EBITDA growth in our core business operating segments adjusted EBITDA. At the midpoint, the $12 million year-over-year increase to $85 million is expected to more than offset the $4 million-$6 million reduction in adjusted EBITDA from CTEH, as detailed on slide six of the presentation. We expect corporate costs to remain at roughly 6% of revenue, which percentage is expected to drop with the completion of acquisitions during the year. Putting the pieces together results in higher expected consolidated adjusted EBITDA for the year.

I'd like to highlight that our revenue and Consolidated Adjusted EBITDA outlook does not include any benefit from future acquisitions that have not been completed. It's worth reflecting further upon the details of the moving pieces we shared earlier on slides five and six of the presentation. We acknowledge that the significant outperformance of CTEH as a result of COVID-19 services. This dynamic began in Q4 of 2020, surged in 2021, saw significant decline in 2022. Although still at elevated levels in 2022 and anticipated to cease in 2023, it has created significant noise around business performance, growth, and margins. We believe it is important to provide transparency around the performance of our core business, excluding CTEH.

Since 2020, our core business revenue has grown organically at a compounded annual growth rate of 18%, with an additional double-digit % organic growth expected in 2023, well above our pre-IPO levels. Inclusive of acquisitions, but excluding discontinued services, our core revenue is expected to be at a 29% compounded annual growth rate from 2020 through 2023. Above our expectations at the time of our IPO for annual growth of 20%-25%. Core business operating segments Adjusted EBITDA has grown at a 15% CAGR since 2020, with an additional mid-teen percentage growth expected in 2023.

Although core business operating segments Adjusted EBITDA margins declined from 2020 to 2022 as a result of investments in operating infrastructure, particularly in our water treatment and biogas businesses, business mix driven by lower margin acquisitions and higher investments in start-up activities, margins are expected to increase in 2023. In conclusion, our 2022 results demonstrate the resiliency and non-cyclicality of our core business, along with the ongoing need for our unique environmental solutions. Our focused execution to capitalize on end market and regulatory tailwinds drove another year of double-digit organic revenue growth across most of our business. We were pleased to execute accretive M&A transactions, invest in talented team members, and expand our innovative IP portfolio. Looking to 2023, we remain optimistic in our ability to create substantial value for all of our stakeholders as we capitalize on demand for our leading environmental solutions globally.

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.

Operator (participant)

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment please while we pull for questions. Our first question comes from Jim Ricchiuti with Needham & Company. Please go ahead.

Chris Grenga (Equity Research Analyst)

Hi, good morning. This is actually Chris Grenga on for Jim.

Vijay Manthripragada (President and CEO)

Hey, Chris, how are you?

Chris Grenga (Equity Research Analyst)

Sorry for your loss, and congrats on the quarter. Just perhaps, could you provide a bit more color on what you're seeing in terms of the greenhouse gas monitoring and renewables looking forward into 2023, in terms of how those two are gonna contribute to growth? I have one follow-up. Thank you.

Vijay Manthripragada (President and CEO)

Yeah. Chris, why don't I take that, then Allan, please jump in. The majority of our work on the greenhouse gas measurement is around our measurement analysis segment and our assessment permitting response segment, our advisory work, Chris. We are seeing a material uptick in demand for both of those services, with clients asking us to help them think about how to frame the measurements for broader reporting purposes and ESG reporting, also for compliance purposes. As we think about our outlook for the measurement analysis segment, some of our attractive margin growth opportunities and our disproportionate high margin growth opportunities will be coming from that sector, and we certainly expect that to sustain over the next several years.

You'll see us accelerate organically, at double digits as we have over the last couple of years. There are also acquisition opportunities in that space, that we'll continue to expand upon once those occur. Does that answer your question, Chris?

Chris Grenga (Equity Research Analyst)

Yes. Thank you very much. With cross-selling now at 35% of revenues, where I guess, where do you see that going longer term? What's the potential to continue to increase that? Thank you.

Vijay Manthripragada (President and CEO)

That's where most of our attention is on the business development side, Chris. We have historically talked about focusing on deepening our relationships with customers, and that can come in several forms. It can be additional services to a client at a client site. It can be the same service across multiple client sites. One of the challenges with the metric we're presenting, it's the cleanest one to allow for consistent measurement over time, is that it's more than one service. If we add a second or a third service, Chris, it doesn't count in that metric. We think over time, our organic growth opportunities can be sustained by continuing to capture more wallet share across our existing customers. It's less about customer acquisition for us and more about deepening relationships.

Chris Grenga (Equity Research Analyst)

Great.

Vijay Manthripragada (President and CEO)

That measurement, as Allan has mentioned before, could easily go north of 50%. There's no reason over the long-term horizon why all of our customers shouldn't be using more than one Montrose service.

Chris Grenga (Equity Research Analyst)

Great. Very helpful. Thank you very much.

Operator (participant)

Our next question.

Vijay Manthripragada (President and CEO)

Thanks, Chris.

Operator (participant)

... from Tim Mulrooney with William Blair. Please go ahead.

Tim Mulrooney (Equity Research Analyst, Partner, and Group Head of Global Services)

Good morning, Vijay and Allan.

Vijay Manthripragada (President and CEO)

Hey, Tim. How are you?

Chris Grenga (Equity Research Analyst)

Hey, Tim.

Tim Mulrooney (Equity Research Analyst, Partner, and Group Head of Global Services)

Doing okay. Thank you. The EBITDA margin guide kind of implies flattish margin expansion year-over-year. We were expecting some margin expansion in 2023 as you get leverage on some of those fixed corporate costs you layered in last year and maybe as the remediation business scales up. Can you talk about some of those things that are holding margin expansion back in 2023 to that, you know, flattish type range? Maybe you could elaborate a little bit on if your long-term margin target of 20% or your timeframe around that target has changed at all. That's my only question. Thank you.

Vijay Manthripragada (President and CEO)

Hey, Allan, do you want me to start with that, and then you can jump in? Yes. Yes, please. Thanks. Tim, thanks for the question. It's a great question, Tim, and let me perhaps start with... let me take your question in pieces and let me know if this addresses it. Forgive me, it's gonna be a little bit of a lengthy answer.

Tim Mulrooney (Equity Research Analyst, Partner, and Group Head of Global Services)

No worries.

Vijay Manthripragada (President and CEO)

Our long-term outlook around 20% has not changed. It's driven, as we've talked about, by two factors. One is operating EBITDA, and the second is corporate expenses as a percentage of revenue. To get to 20%, Tim, operating EBITDA margins would need to be in the 22%-25% range, and corporate would need to come down to 3%-4% of revenue. Corporate will absolutely get there, and you'll see that tick down this year. Bear with us as we prove that out, but that's very tightly managed, and we have visibility to that. On our operating EBITDA margin run rate, that will also get to our range. If we think about our measurement analysis segment being at 18%-20%, we've demonstrated over the years that that is and will continue.

Our water biogas business at maturity, getting to the mid-20s. CTEH, you can see their margin has increased, getting back to the mid-20s post-COVID. The advisory and remediation practices being in the teens to 20%. From a macro perspective, our outlook hasn't changed. If you think about the slides five and six, Tim, the blue bars, you can see that we are expecting some operating leverage in 2023. You're exactly right. The pace of that has been challenging for us to predict. The reason for that, Tim, is twofold. It's hard for us to predict the acquisition profiles. I'll explain what I mean by that in a second. We've also been surprised by the success of our R&D efforts, and I'll expand on that as well.

On acquisitions, Tim, I'll give you three examples of assets that throw us off in the short term but are very accretive in the long term. We purchased a company called AirKinetics, Inc. towards the back half of last year. It's an air testing business. It's very strategically additive, excellent customers, and it plugs right into our infrastructure. At the time of purchase, it was effectively 0 EBITDA. We obviously don't need their corporate infrastructure, and the variable contribution on those customers is 70%+. Very financially accretive. It's gonna take us a couple of quarters to kind of harvest that, but that throws us off in the short term. As another example, Environmental Intelligence. This is the business in the Western United States that is a rock star asset. They help utilities manage fire risk as an example.

That business runs in the mid-teens. It's a large part of our organic growth surge in that segment, excluding CTEH, very strategic to the broader Montrose portfolio. Because it runs at mid-teens, it throws off the short-term margin profile. There's additional assets in the pipeline, Tim, that we're seeing come to market. Very strong brands, excellent client bases, very synergistic to Montrose. These businesses have historically struggled with cost management, so labor, price increases and pricing in an inflationary environment. They just haven't done it well. If we bring them into the Montrose fold, not only do we continue to capture share and harvest the synergies on the top-line side, but we think we can lift their margins really nicely as well. That again, will take us several quarters to harvest.

As we think about all of that's part of the reason why we're having a hard time articulating exactly what the cadence of that margin accretion will be. On the R&D side, Tim, as our patents come to fruition and as clients ask us to capture some of these themes, like PFAS destruction and carbon capture, as we invest in that, obviously also temporarily depresses margins. Like with ECT2 and the water treatment technologies over several years, we think that's gonna be very additive. Does that answer your question, Tim?

Allan Dicks (CFO)

You want me to answer that?

Vijay Manthripragada (President and CEO)

Yeah.

Allan Dicks (CFO)

Vijay?

Vijay Manthripragada (President and CEO)

Yeah, please.

Allan Dicks (CFO)

Let me just add. Yeah, let me just add, Tim. We're seeing, you know, a lot of growth opportunities, more so than two, three years ago. Many of those require some upfront investment, like our European expansion, for example. Because we no longer add back startup losses, that obviously has a short-term impact on margins. We're also growing at elevated levels above what we had anticipated, and in a tight labor market and an inflationary environment and a desire to maintain quality, it's really tough to grow double digit organically and expand margins at the same time. When revenue slows, as it did in 2020, we demonstrated an ability to expand margins quickly.

We don't think it's prudent in the short term to focus on margin expansion given the wave of organic opportunities that we're seeing.

Tim Mulrooney (Equity Research Analyst, Partner, and Group Head of Global Services)

Allan, just following that point, if you plan to continue to grow double-digit organically, is it unlikely that we will see margin expansion in the coming years, and that 20% EBITDA margin target is indeed farther away than what we were thinking?

Allan Dicks (CFO)

It depends on a number of factors, right? Again, if you look at our guidance for 23, and I point you again to page six. If you look at our core business, so pulling out CTEH, and focusing on operating segment margins, there is about a 100 basis point improvement in 23 versus 22. You're seeing some margin expansion. But we're also calling at the midpoint for double-digit organic growth, which is above what we had expected, certainly, at IPO time. Getting to the high teens, 20% margin is still absolutely achievable. As Vijay said, the mix of acquisitions can throw that off temporarily, and outsized organic growth can throw that off temporarily. But the end goal doesn't change. It's absolutely achievable.

When we look at the mix of business we have and the margin profile of the businesses we have and the underlying market sizes, so we have a sense of where our portfolio should settle out, that 20% is absolutely achievable. Corporate costs, as Vijay mentioned, will come down with acquisitions. You'll see that come down in 2023. It's a little slow out of the gate than we had anticipated, but again, the growth is also faster than we had anticipated. End goal is still we believe achievable. Is it three years? Is it five years? Is it 7 years? It's just really hard to say because we're gonna continue to be very opportunistic in driving revenue growth and prioritizing revenue, quality revenue growth over that time frame.

Vijay Manthripragada (President and CEO)

Hey, Tim. Hey, just stepping back, because I think you're alluding to our articulation of kind of our expectations at IPO over that five-year horizon, right? When we went public in 2020, we were around $230 million in revenue. What we said is that, you know, you should expect us to grow at 20%-25% a year, 7%-9% organic, right? Would that be a fair way to say where we started?

Tim Mulrooney (Equity Research Analyst, Partner, and Group Head of Global Services)

Yes. That's exactly the.

Vijay Manthripragada (President and CEO)

Yeah.

Tim Mulrooney (Equity Research Analyst, Partner, and Group Head of Global Services)

Where you started.

Vijay Manthripragada (President and CEO)

Yeah. If you, if you kinda just do the math on that, and just forgive me, I'm doing it on the fly, right? Let's just take the top end of that. 25% growth over five years, right? That's about a triple. Starting at $230, you should be at around $700 million-$725 million of revenue. At 20% margins, it's about $140 million of EBITDA. I think what we're trying to say is we're gonna achieve both milestones and hit our earnings and EBITDA targets. There's no question about that. What we're also saying is that we're actually outpacing our expectations on revenue. The margin profile may be different year in and year out, but it should be very additive to our shareholders and sets us up beyond that five-year horizon.

It's not like our absolute earnings potential or cash potential is any different. It's just that we're outpacing the top-line expectations by virtue of some of the advantages we've built with our business model and with our technology. Does that make sense? We're anchoring on margin, but it's the absolute cash and absolute EBITDA that we're not all that hesitant about saying we're very confident in hitting.

Tim Mulrooney (Equity Research Analyst, Partner, and Group Head of Global Services)

Yeah, no, I think that's a good way of framing it for investors, anchoring on the dollars rather than maybe I'm a little too focused on the margins here. Regardless, appreciate all the color you both shared here, and, I'll get back in line. Thank you.

Vijay Manthripragada (President and CEO)

Thanks, Tim.

Operator (participant)

Again, if you have a question, please press star one on your telephone keypad. Our next question comes from Andrew Obin with Bank of America. Please go ahead.

David Ridley-Lane (Equity Research Analyst)

Good morning. This is David Ridley-Lane on for Andrew Obin.

Vijay Manthripragada (President and CEO)

Hey, David.

David Ridley-Lane (Equity Research Analyst)

Good morning. Looking at the 2023 revenue guidance excluding CTEH, what are the factors that would, you know, drive you towards that lower end of 10% or the upper end of 17%? You know, what's driving some of the factors driving that variability?

Vijay Manthripragada (President and CEO)

Yeah. Let me start with that, and Allan will certainly jump in. David, there's a couple of variables there. One is the phasing in and starting of our various water and biogas projects. As we've said before, we're seeing a lot of interest in both of those end markets, and demand has been really attractive. Exactly when the projects start and stop is a little tougher for us to predict. That's gonna be one variable that dictates where we fall on that macro trajectory of either low double digits or high double digits. The other variable that's gonna be one that we're gonna need to watch is the cadence at which our greenhouse gas measurement practice really picks up. That's another one as...

That's partially a function of some of the regulatory flux that occurred at the very end of last year, where the technology, the imaging technology that we've been practitioners of for years was recently deemed the best emissions reduction technology by the EPA. How quickly clients adopt that will partially also dictate our ability to capture share in that part of the market. Those variables are the ones, depending on the cadence, that'll dictate whether we're on the low end or high end of that. Regardless, even the low end is elevated compared to our historical levels. Does that make sense?

David Ridley-Lane (Equity Research Analyst)

Yeah. That makes perfect sense. Do the last two quarters of CTEH have meaningful levels of COVID-related revenue? I'm just trying to understand the bridge. You've been at about a $100 million run rate in the second half of 2022 to the $75 million-$95 million guidance.

Vijay Manthripragada (President and CEO)

Yeah. CTEH is.

Allan Dicks (CFO)

Yeah.

Vijay Manthripragada (President and CEO)

Allan, you wanna take that guy?

Allan Dicks (CFO)

Sure, yeah. They still meaningful for them in terms of overall Montrose has shrunk significantly certainly by Q4, and we expect that to go away completely as we get into 2023. Sequential declines about a third of their revenue in Q4, but those contracts are largely winding up, so we don't expect to see much more of it in the new year.

Vijay Manthripragada (President and CEO)

David, just to add on to that, the team has done an exceptional job pivoting away from that part of the business to the traditional environmental side. They had even with the $125 million drop, you can see their overall reduction was less than that, and that's because the core business for CTEH, their core response, and tox business, Really started to pick up nicely and certainly has done so so far in 2023. The team's just been on a very nice cadence already so far this year, independent of the COVID work.

David Ridley-Lane (Equity Research Analyst)

Got it. The $75 million-$95 million does include growth in sort of core CTEH and the aggregate numbers just not the exit, the ending of the COVID-related revenues. Is that the right way to think about it?

Vijay Manthripragada (President and CEO)

Yeah. I think the right way to think about it is their cadence is 75-95. It's a matter of they have a very talented team and an ability to flex up and down, but it's a matter of the mix of the work and where they're deployed. As COVID winds down, they reallocate those resources to their more traditional work.

David Ridley-Lane (Equity Research Analyst)

Thank you very much.

Vijay Manthripragada (President and CEO)

Thanks, David.

Operator (participant)

Our next question comes from Stephanie Yee with JPMorgan. Please go ahead.

Stephanie Yee (VP and Equity Research Analyst)

Hi, good morning.

Vijay Manthripragada (President and CEO)

Hey, Stephanie.

Stephanie Yee (VP and Equity Research Analyst)

Can you remind us of the synergies between Montrose and CTEH, its business outside of the COVID-related work?

Vijay Manthripragada (President and CEO)

Yeah. They are a really critical part of our overall story, Stephanie. Just at a macro level, as clients think about ways to deal with various environmental opportunities and challenges, one of those is dealing with various incidents that occur due to changes in our climate or aging infrastructure. The macro demand for their services, which is something our clients need, is independently very additive. In addition to that, because they are the advisors working with incident command when something happens, there is substantive testing work, monitoring work, advisory work in toxicology and public health impact work, and then downstream remediation work that occurs when something unfortunate happens, right? Whether it's a hurricane or a flood or a fire or a derailment.

As they're helping these communities and helping incident command, the Montrose services that flow downstream of that initial event make it very synergistic. When we talked about maybe two years ago, Stephanie, one of the early indications of how synergistic it was, we referenced the oil spill in California and how five different Montrose teams deployed alongside CTEH to support that client, doing natural resource damage assessments, monitoring, in addition to the response. That is certainly the case as well with some of the recent incidents that have occurred so far at the end of 2022 and early part of 2023.

Stephanie Yee (VP and Equity Research Analyst)

Okay. Okay. That makes sense. I was just asking because I guess we were hoping that we wouldn't be talking about, you know, the COVID-related revenues tied to CTEH in 2023. I know that was a lot to explain in 2022. It looks like there's still a little bit of that rolling off in 2023. Just wanted to be reminded of, you know, why the coming together of the two companies was a good deal in the first place. Thank you for that.

Vijay Manthripragada (President and CEO)

Yep. Again, the COVID services, you know, forgive us, we had a hard time predicting exactly when that was gonna start and stop. You know, going back to 2021, we thought it would slow down, and it didn't. It continued into 2022. It was certainly substantive in the early part of 2022, but it's really behind us now, Stephanie. As we look at the 2023 guidance, that's a non-factor.

Stephanie Yee (VP and Equity Research Analyst)

Okay.

Vijay Manthripragada (President and CEO)

with what we know so far.

Stephanie Yee (VP and Equity Research Analyst)

Okay. Just one other question. Can you talk about how maybe the economic environment, it seems, you know, it's ebbing and flowing a little bit of uncertainty, how that factors into your intention of increasing the pace of acquisitions in 2023, if at all?

Vijay Manthripragada (President and CEO)

It doesn't. It doesn't. In fact, what we were alluding to and following on Tim's question, Stephanie, what we're saying is that the macroeconomic challenges have impacted our acquisition targets more than they've impacted us. As Allan talked about in his comments, we've been fortunate with our pricing discipline to be able to take up prices so that the cost pressures, the inflation-related cost pressures have not really had an impact on us. And because of the diversification of our end markets, we're broadly insulated from any major economic shifts to the upside or downside. It's a very steady business. Some of the smaller companies that we're buying have certainly been battered.

We see that candidly as a really attractive opportunity, which throws off again the short-term profile, but we think it'll be very attractive long term. We're not all that worried about it. Our balance sheet is hedged against those increased rate environments and has been for a while. For us, it's really more a matter of making sure it's strategically additive and us being opportunistic.

Stephanie Yee (VP and Equity Research Analyst)

Okay, great.

Vijay Manthripragada (President and CEO)

Allan, is there anything else you would add?

Operator (participant)

No, I agree with all that, Vijay.

Stephanie Yee (VP and Equity Research Analyst)

Okay, great. Thank you.

Vijay Manthripragada (President and CEO)

Thanks, Stephanie. Thank you.

Operator (participant)

Once again, if you wish to ask a question, please press star one on your telephone keypad. Please hold. There are no further questions at this time. I would like to turn the floor back over to Vijay Manthripragada for closing comments. Please go ahead.

Vijay Manthripragada (President and CEO)

Thank you. Thank you all again for your time, for your interest, and for your support of Montrose. We're thrilled and excited about 2023, and I'm sure we'll be talking soon. Take care.

Operator (participant)

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.