Ladies and gentlemen, greetings and welcome to the Montrose Environmental Group, Inc. Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. . As a reminder, this conference is being recorded. I will now turn the conference over to your host, Mr. Rodny Nacier, Investor Relations. Please go ahead, sir.

Thank you. Welcome to our second quarter 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 2. 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 annual report on Form 10-K for the fiscal year ended December 31, 2021, 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 the reconciliation thereof to their most directly comparable GAAP measure. With that, I would now like to turn the call over to Vijay, beginning on slide 4.

Thank you, Rodney. And welcome to all of you joining us today. I will provide a few business highlights, then hand it over to Allan Dicks for our financial review. We will then open it up to Q&A. I will speak generally to pages 4 through 8 of the presentation shared on our website. Regarding the second quarter of 2022, I am proud of the stellar execution of all of our team members who have helped us produce another solid quarter. We successfully navigated the turbulent macroeconomic environment, and we successfully responded to a cyberattack in June that temporarily disrupted our operations for a few weeks. Despite these challenges, we produced a strong broad-based revenue growth and more than offset the previously communicated and expected normalization of CTEH COVID-19 related revenues. In addition to record second quarter revenue and continued organic revenue growth outperformance excluding CTEH, our solid year-to-date operating cash flow, excluding contingent payments, was a stellar $16.6 million, which allows us to continue investing in our business. The Montrose team's dedication to providing excellent service to our clients continues to drive our success and define Montrose as one of the leading environmental solutions providers. To our team members joining us for the call, thank you. It is important to reiterate that demand for our environmental services does not follow fiscal quarter patterns and is best evaluated on an annual basis. In the context of our continued business performance, there are several key themes I would like to highlight from the second quarter. First, there was outperformance in organic revenue growth in most of our service lines. Our PFAS water solutions and our negative carbon intensity energy or biogas teams were a big contributor to this organic growth surged through the first half of the year. Second, the deceleration…

Thank you, Vijay. We are pleased to have delivered solid second quarter results, which reflect the resiliency of our business and the in-demand nature of our environmental solutions. Since our IPO two years ago, the need for environmental remediation and monitoring, particularly for PFAS, has gained significant momentum across the globe. We believe that our core business remains strong and continues to grow, benefiting from our expanding relationships with notable customers, continued success with our cross-selling initiatives and successful execution of accretive M&A. Moving to our revenue performance on slide 9. We continue to drive strong organic growth in our business. Our second quarter revenues increased 2.7% to $139.9 million compared to the prior-year quarter. Year-to-date, revenues were up 1.7% versus the prior-year period to $274.6 million. The primary driver of revenue growth in both periods was organic growth in our Measurement and Analysis and Remediation and Reuse segments as well as the positive contributions from acquisitions. This was partially offset by significantly lower COVID-19-related services provided by CTEH and our planned exit from legacy O&M contracts. Looking at our consolidated adjusted EBITDA performance on slide 10. As Vijay mentioned, we are no longer adding back start-up losses to consolidated adjusted EBITDA. The significant opportunities ahead to grow our business through innovation will make start-up initiatives, a more recurring expense in our business. So we believe this change to our methodology is appropriate. With that said, second quarter consolidated adjusted EBITDA was $15.6 million or 11.2% of revenue, inclusive of $0.9 million of start-up losses in the second quarter of 2022. This compares to consolidated adjusted EBITDA of $19.8 million or 14.6% of revenue, inclusive of $1.1 million of start-up losses in the prior-year quarter. Year-to-date, consolidated adjusted EBITDA was $31.3 million or 11.4% of revenue, inclusive of $1.7 million…

. Our first question comes from the line of Tim Mulrooney from William Blair.

Sorry, I joined a little late. So, I apologize if you already discussed this, Vijay, but I was hoping you could just briefly comment on how the IRA might impact your OGI business. It sounds like the proposed legislation includes a hefty penalty for excess methane emissions.

Yeah, Tim, we talked about it briefly. But let me shed a little bit more light. We think it's actually quite beneficial, Tim, and it's beyond just our OGI business. As we think about the support for better measurement for the replacement of equipment for the quantification of what's coming out because there's going to be penalties. It looks like above a 25,000 metric ton threshold. We anticipate the significant opportunities for our advisory business, for our leak detection and repair business. OGI is part of that, Tim. As you know, it's kind of a next-generation mechanism to measure and quantify. And then there's also some program management work that we think we can benefit from because there's verbiage in there to support the closure of old wells that are on non-federal land. So as we kind of look across the overall assessment permitting, measurement analysis and remediation reuse service lines for us, Tim, we think all three are likely to see tailwinds as a result of the act.

One more for me. Pivoting to margins, specifically, your R&R business, EBITDA margins there, if I'm reading the slides correctly, it looks like they were down about 150 basis points year-over-year. Allan, I heard you give quite a few reasons for why that is, including lower margins in your PFAS treatment business. As PFAS continues to grow as a percentage of the mix, how do you expect that to impact the overall profitability of that segment over the next couple of years?

Tim, why don't I take a macro look at it? And then, Allan, if you want to address the specific question. Tim, the main theme is – this is why the quarters are really choppy. A lot of it has to do with how these projects starts and ends ebb and flow and how some of these time lines shift. As we kind of look at a 2021 versus a 2022 outlook, you'll see us put forth some really attractive margin accretion in that macro segment over the course of this year. Quarter in, quarter out, there's going to be a little bit of noise. That's just a function of how these projects ebb and flow. So, I just want you to keep that in mind when you're comparing specific quarters. it may look like there's a trend that's going to be extrapolated over the course of the year. I really don't think that's the case here. But why don't I let Allan expand on that further?

Yes, you're exactly right. These large projects that span several quarters, Tim, don't necessarily have a consistent margin. It depends on the underlying deliverable. There's pretty complex revenue recognition associated with them. So over the course of the full project, we are generating very healthy margins and continue to believe that particular business and that segment will deliver low 20% margins at scale. But, Vijay, it's like quarter-to-quarter project timing and the nature of the project deliveries in that quarter can have an impact on margins. That segment also includes our soil remediation business. Those projects can also typically span a couple of quarters. And there, we've seen some headwind from variable costs for the pricing that we have been able to take earlier in the year, has somewhat been eroded by the rapid increase in travel and the tight labor market, which is also forcing more travel on us. And because of the nature and the length of those projects, it takes a couple of quarters to rereact to those cost increases. So you'll see us start to offset those higher costs in the next quarter or two.

It sounds like 14.8% is not the steady state or go-forward expectation. It's just timing lumpiness. It's something you guys have given in the past.

If you look at the first half of the year, Tim, as a contrast to that, margins are up 300 basis points, right? So it's kind of – we struggle with this because we try to say it every time. You've got to look at the year. You can't look at any individual quarter because there's a lot of noise in the way the numbers flow out.

Probably a few more times I might eventually get it.

Our next question comes from the line of Andrew Obin from Bank of America.

Sabrina Abrams on for Andrew Obin. Back on the EBITDA margins, can you talk about sort of the initiatives you're taking to sort of mitigate the higher variable costs and labor shortages? I understand like you talked about how EBITDA is lumpy and kind of has to do with the full project and what is booked when. But can you talk more about how you're thinking about the margin ramp in the second half?

Why don't I take a swing at that, Sabrina. Allan, please jump in. I think in Q2, Sabrina, there's a couple of themes to keep in mind. One is that the cyberattack that we faced in June impacted our Q2, primarily June, the most. There's a little bit of spillover into July, and it primarily impacted our Enthalpy lab network. And so, we expect and certainly anticipate that we're going to recoup that over the course of the next couple of quarters, but there's some noise in the system. It's about $1 million of impact in Q2. So that's one variable to keep in mind as you kind of look at the macro trend profile quarter on quarter. From a pricing perspective, there's two dynamics at play. We, as you know, have thousands upon thousands of projects that are short term in nature. For those projects, we're able to react very quickly on pricing. It's the longer-term multi-quarter projects that primarily are more remediation, water treatment, biogas oriented, where it takes us a little bit more time to respond. We have a lot of conviction that we can respond in pricing and customers have been very receptive to it. They are facing the same environment we're facing. And the team, candidly, at the beginning of the year did a really nice job taking up prices. We talked about how our labor costs have gone up and our prices have commensurately gone up to offset those, which is why our margin expectations remain unchanged. We were a little bit caught off guard with the escalation of costs like travel, and so we're just responding to those, and we'll get those right sized over the next couple of quarters.

Just a follow-up. Thinking about geographic expansion, can you talk a little bit about what your priorities here are and whether the potential for macro slowdown in Europe impacts your near-term priorities?

In terms of geographic expansion, it's primarily North America. So we are continuing to, as you saw with the TriAD acquisition, adding select capabilities in attractive geographies, where we're effectively building scale and an ability to execute across the broader landscape, both here in the US and in Canada. Our European efforts, Sabrina, are a function of our technology and our intellectual property getting pulled across the Atlantic. And so there, because we have unique ways to remove PFAS from water, which are really compelling and are increasingly proving out, that's why we're there. We're going to be very careful with how we expand there, but we're really bullish on the long-term opportunity with what we see. And whether that's in the form of partnerships or our execution on the ground, that is still to be determined, but that's not something we set out to do. It's something that we were opportunistic with if that makes sense.

. Our next question is from the line of Jim Ricchiuti from Needham Company. Please go ahead.

Looking at the growth in the Remediation and Reuse segment, and I'm wondering if there's any way you could help us understand the contribution that you're seeing to that growth rate from PFAS and biogas. Is there a way to give us a little bit more color on the extent to which they're driving the growth in that area?

It's most of it, Jim. So if you kind of look at the year, the quarter-on-quarter numbers that we posted, almost all of it is a function of the success we're having on the water and the biogas side. Just to put a little bit more – again, if you look at the quarterly organic or even the first half year organic, it's incredibly strong. And this goes back to my narrative around, please don't look at this just on a quarterly basis, look over the course of the year. We certainly do anticipate that organic growth this year will be well in excess of 20% year-on-year. And that is being driven primarily by our water and our biogas practices and then, to a lesser extent, some of the benefits we're seeing on the greenhouse gas side. This is all information we've provided kind of in the public context, Jim. So, I'll just repeat it to help put some more framework around this. As we look at PFAS, it sits across all three segments. It's across our advisory, our testing and our remediation practices. And it represented less than 10% of Montrose's revenue last year, obviously, growing materially from 2020. This year, we think it starts to approach 20%. So that gives you a sense of order of magnitude for how much of an influence it's having.

So if we think about the contribution first half or even in Q2, the PFAS was a bigger contributor to that growth rate, although you're seeing pretty good growth, it sounds like, from a biogas practice as well.

Yes. In order of impact, it's the PFAS water treatment, then biogas, then the greenhouse gas work.

Vijay, you alluded to some larger US government projects. And I wonder if you could talk a little bit more about that because we normally think of Montrose's business as very much commercial focused, the bulk of the revenue is coming from there. And so, is there anything that's changed and that's potentially going to add some incremental growth that's coming from that area?

It has, Jim, and it's certainly in our favor. It's the US Department of Defense, just to be a little bit more explicit about what that is. If you go back to where our technology tends to have relative advantages, both cost and efficacy, Jim, we've talked about this before, it's why industry leans in our favor. It's when you have more complex water and you have more contamination. So there's concerns around – as you know, it's a family of molecules, the short chain and the long chain, a fair degree of uncertainty around how to remove it, let alone how to measure it. The DoD, because of the drills they run, right, the Air Force, for example, on Army and Air Force and other bases, Navy bases, often has similar highly complex issues with contamination within the groundwater, surface water or even some instances, potable water. And so as a result, we're seeing our technology increasingly get adopted by government agencies for the same reasons we see our technology getting adopted by the private sector. It's actually very similar, Jim, to what happened in Australia and in Northern Europe where you had a really tough water treatment situation, the government pulled us in and the private sector noticed and adopted it, which is a little different here at home where it really was started with the private sector and then now seems to be adopted by the government. Short of a real opportunistic set of circumstances, we don't really play as much in the municipal space. But, certainly, where you have complex problems for the US Department of Defense, our technology as expected is resonating, and we're starting to see some nice potential multiyear works come our way.

Last question just relates to some of the cost pressures and pricing actions, which appear that you're going to see more of a benefit of the pricing over the next couple of quarters. But I'm kind of curious just in terms of outright labor shortages, where are you seeing it in your business lines more acutely? And how much of a concern is that?

We're seeing it primarily in our hourly and entry-level staff in what we would consider our Measurement and Analysis segment services, Jim. So a lot of our field teams that go on site to collect samples conduct tests are entry-level biologists and chemists. So, it is a concern. That's where we're seeing it primarily. We are obviously focused, first and foremost, on making sure we serve our clients. And with that, our team is doing really well. But offsetting select departures or material increases in costs, either with pricing or efficiency, is kind of where our next focus is. So it's something we're acutely aware of. It's candidly something we anticipated. And so, on the labor side, our team has done a really nice job responding to that. What we didn't anticipate is the magnitude of the increase in non-labor-related costs, like travel. And those are direct costs that we face as these projects roll out, which is why we have conviction that we can get those incorporated into our broader pricing scheme over the next couple of quarters.

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. I would now like to turn the conference over to Mr. Vijay Manthripragada for closing comments.

Thank you all again for the time. If there's any further questions, we're happy to address them one on one. We really appreciate all of your support. Wish you all the best and take care, and we'll talk to you next quarter. Operator Thank you, sir. The conference of Montrose Environmental Group, Inc. has now concluded. Thank you for your participation. You may now disconnect your lines.