Target Hospitality Corp

NASDAQ:TH

Earnings Call Transcript 2023-Q1

[Operator]

Good morning, and welcome to the Target Hospitality First Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Mark Schuck, Senior Vice President of Investor Relations. Please go ahead.

[Mark Schuck, Senior Vice President-Investor Relations]

Thank you. Good morning everyone and welcome to Target Hospitality’s first quarter 2023 earnings call. The press release we issued this morning outlining our first quarter results can be found in the Investors section of our website. In addition, a replay of this call will be archived on our website for a limited time.

Please note the cautionary language regarding forward-looking statements contained in this press release. This same language applies to statements made on today’s conference call. This call will contain time-sensitive information as well as forward-looking statements, which are only accurate as of today, May 9, 2023. Target Hospitality expressly disclaims any obligation to update or amend the information contained in this conference call to reflect events or circumstances that may arise after today’s date, except as required by applicable law. For a complete list of risks and uncertainties that may affect future performance, please refer to Target Hospitality’s periodic filings with the SEC.

We will discuss non-GAAP financial measures on today’s call. Please refer to the tables in our earnings release posted in the Investors section of our website to find a reconciliation of non-GAAP financial measures referenced in today’s call and their corresponding GAAP measures.

Leading the call today will be Brad Archer, President and Chief Executive Officer; followed by Eric T. Kalamaras, Executive Vice President and Chief Financial Officer. After their prepared remarks we’ll open the call for questions.

I’ll now turn the call over to our Chief Executive Officer, Brad Archer.

[Brad Archer, President and Chief Executive Officer]

Thanks, Mark. Good morning everyone, and thank you for joining us on the call today. Our strong first quarter performance reflects the positive business momentum we have sustained over the past year, which has supported many strategic achievements. We have meaningfully diversified the business and revenue mix with over 70% of revenue now derived from committed contracts backed by the United States government.

These high graded contracts have provided enhanced revenue and cash flow visibility, supporting over $339 million of discretionary cash flow over the last 12 months, representing an impressive discretionary cash flow yield to revenue of approximately 60% over that time. These accomplishments have solidified Target’s balance sheet with over $350 million of cumulative debt reduction since 2020, and an 80% improvement in Target’s net leverage ratio over the past year. We have significantly transformed Target’s operating platform while continuing to serve our existing world-class customers in simultaneously positioning the business to quickly respond to strategic growth opportunities.

In our HFS-South segment, we have remained focused on providing premium full service hospitality solutions to our world-class customers, many of whom have been customers for over a decade. As a result, Target continues to benefit from consecutive quarterly increases in customer demand, resulting in a 15% year-over-year increase in utilization with consistent customer renewal rates over 90%, which we have enjoyed for over seven years.

This continued strong demand and positive customer outlooks supported the acquisition of select community assets in the first quarter to appropriate align our network capacity with an existing customer’s growing labor allocation requirements. In addition, the strategic location of these assets enhances Target’s regional presence and provides opportunities to further expand our premier customer base.

We are pleased with our current HFS utilization and its ability to meet our strong customer demand while benefiting from the more fully optimized network we have created over the past year. Regarding our Government segment, our purpose-built portfolio of assets continue to serve the critical humanitarian aid mission that they were designed to support while exceeding the expectation of our partners in the U.S. government since our first community was established in 2014. Further, the U.S. government has continued to state its urgent need for additional humanitarian housing capacity, particularly with the impending removal of Title 42, which has anticipated to result in a substantial increase of individuals crossing the U.S. Southwest border.

In preparation for this meaningful increase in demand and to ensure uninterrupted access to existing humanitarian housing solutions, including Target’s expanded humanitarian community, the U.S. government has indicated it intends to exercise the existing contract six month option. This decision will allow for seamless continuity of the service offering at the expanded humanitarian community and serve as a bridge prior to long-term contract specification being finalized.

As previously discussed, our non-profit partner was awarded indefinite delivery, indefinite quantity contract related to the extension of our humanitarian community in Pecos [ph]. As a reminder, this award consists consisting of a base five-year term with an additional five-year option establishes the contracting vehicle required by the U.S. government to appropriately fund multi-year contract awards.

The IDIQ award to our non-profit partner is one of the final steps in the government’s contract award process, prior to working through definitive agreements. We remain highly pleased with the ongoing discussions with the U.S. government and our non-profit partner, and we anticipate working through additional contract specifications over the coming months with likely culmination in the fall of this year. We look forward to solidifying the longevity of this community and the critical humanitarian mission it was purpose-built to support.

In summary, we have achieved our strategic objectives to materially strengthen Target’s financial position while simultaneously diversifying our customer base and continuing to accelerate value creation for our shareholders.

I’ll now turn the call over to Eric to discuss our first quarter financial results, 2023 outlook and capital allocation initiatives in more detail.

[Eric T. Kalamaras]

Thank you, Brad. In the first quarter, we experienced continued strong demand fundamentals and positive momentum in customer activity, which further solidified our strong financial position. First quarter 2023, total revenue was $148 million, and adjusted EBITDA was approximately $91 million.

Our Government segment produced quarterly revenue of approximately $110 million compared to $47 million in the same period last year. A significant increase was attributable to the expanded humanitarian community. As a reminder, Target’s Government segment, including the expanded humanitarian community centers around annual minimum revenue commitments. Additionally, the expanded humanitarian community includes variable services revenue that aligns with monthly changes to community population.

This contract structure provides ideal flexibility for our customers as their occupancy requirements fluctuate over time, while providing meaningful minimum revenue commitments that create significant revenue and cash flow visibility for Target. We have found the structure is the optimal outcome for all parties creating a sustainable basis for contract longevity while maximizing operational flexibility.

Our HFS segment delivered first quarter revenue of $36 million compared to $32 million in the same period last year. This increase was driven by sustained momentum and customer demand for Target’s premium service offerings. Recurring corporate expenses for the quarter were approximately $9 million, and we anticipate recurring corporate expenses will remain around $9 million to $10 million per quarter for the remainder of the year.

Total capital spending for the quarter was approximately $32 million, but the majority related to select HFS-South asset acquisition focused on increasing capacity to appropriately match growing customer demand. We expect a more moderate pace of capital spending through the remainder of the year, excluding potential acquisitions.

We ended the quarter with $42 million of cash and over $167 million of liquidity with zero borrowings under the company’s $125 million revolving credit facility and in that leverage ratio of 0.5 times. As we previously announced on March 15, we partially redeemed $125 million of the 9.5% senior secured notes, which we view as a high risk free cash return. As relates to the outstanding senior notes, we continue to evaluate a range of possible liability management initiatives focused on further strengthening our financial position while balancing the expanding pipeline of strategic growth opportunities. This approach is centered on maximizing financial flexibility, enabling us to quickly react to value enhancing growth opportunities as they rise.

Turning to our financial outlook and capital allocation initiatives. Target’s enhanced end market portfolio and contract structure has supported increase to minimum revenue commitments and provided greater visibility on long-term revenue and cash flow. We believe the government’s decision to issue an IDIQ contract award to our non-profit partner solidifies the sustainability of this purpose-built facility by establishing the necessary mechanism to fund specific multi-year contract awards.

Further, the government’s desire to exercise the existing contract’s six month option supports the importance of this community as the government prepares for a significant increase in demand for humanitarian housing following the lifting of Title 42. We continue to work closely with our non-profit partner and anticipate additional contracts specifics related to Target’s critical hospitality solutions to be finalized later this year.

Further, in response to the government’s stated urgent and compelling need for additional humanitarian housing solutions, we recently acquired a strategic humanitarian asset, which we believe will allow Target to react quickly in support of the government’s demand for these humanitarian solutions.

Coupled with our ongoing business development efforts that have created the strongest project pipeline the company has seen in several years, the company is reiterating its preliminary 2023 financial outlook, which includes minimum revenue of $525 million, maximum revenue of $710 million, the minimum adjusted EBITDA of $365 million. Excluding acquisitions 2023, capital spending should approach more normal levels between $20 million and $30 million per year, predominantly focused on organic growth capital.

The range of preliminary 2023 revenue reflects the possible contribution of variable service revenue associated with the expanded humanitarian community, along with other potential second half weighted revenue catalyst. As it relates to Target’s strategic initiatives, Target is pursuing an expanding pipeline of growth opportunities and partnerships. These opportunities are designed to jointly leverage Target’s operating expertise with contracting vehicles that will create a number of solutions across various U.S. government agencies for projects that support national defense, energy transition and other humanitarian projects for the U.S. government.

As previously stated, Target is prepared to allocate over $500 million in net growth capital to these high return opportunities over the next several years. We are pleased with the progress of discussions for many of these projects and partnerships we have achieved tangible milestones regarding some of these large scale projects. We look forward to providing additional updates in the coming quarters as the opportunities fully progress.

With that, I will turn the call back over to Brad for his closing comments.

[Brad Archer, President and Chief Executive Officer]

Thanks, Eric. Our strong first quarter results reflect our ability to sustain momentum and continue achieving our strategic objectives. Over the past several years, we have exponentially grown the business, prudently managed our balance sheet, and significantly enhanced our financial flexibility. These accomplished have exceeded our expectations. We are excited about the operating platform we have created and are focused on pursuing an expanding pipeline of growth opportunities while continuing to accelerate value creation for our shareholders.

I appreciate everyone joining us on the call today, and thank you again for your interest in Target hospitality.

[Operator]

[Operator Instructions] The first question comes from Scott Schneeberger from Oppenheimer. Please go ahead.

[Unidentified Analyst]

Hey, good morning. It’s Daniel on for Scott. Thanks for taking our questions here. Could you guys, please elaborate on the on the May 5 update related to the work statement, please?

[Brad Archer, President and Chief Executive Officer]

Sure. Good morning, Daniel, it’s Brad. Look, what we talk about there is a performance work statement. What that is, it comes out before the task order, but it’s describing what’s going to be in this task order. It sets out the requirements what we will submit to the government into our partner. And reading this performance work statement, it’s very material aligned to what we’re already providing, so we’re happy to see that. So look at some point here over the next few months, this task order will come out. We will submit to that and then an award will be made. So this is just really the next step that we’ve been waiting on to get that out there, and get a long term agreement.

[Unidentified Analyst]

Got it. Thank you. Sounds good. And with Title 42 removal has been any conversations about removing the warm status of the Pecos facility?

[Brad Archer, President and Chief Executive Officer]

Yes, so specifically on PCC, we’ve been in talks with them. There’s been some calls about moving back into hot status. Nothing yet has been given to us on that, other than the calls and conversations coming in asking us, how quickly we could ramp that up in anticipation of Title 42 going away and the need for those beds to be filled. Furthermore, just across the board, I know there’s probably going to be this question on Title 42 just the amount of conversations we’re having with different agencies then or about PCC, they’re staggering. There’s been lots of them over the past few weeks asking what we can do for them. So active conversations going on across the board through different agencies as well as for the PCC.

[Unidentified Analyst]

Got it, thank you. And regarding the strategic asset purchase you made in the quarter related to the Government segment, can you please elaborate that on a little bit and help us think about the financial implications and when we may get an update on that?

And the second part of the question is the CapEx spend of $31 million in the quarter in the HFS-South segment. If you could please help us think about, how we should view that going forward as well.

[Eric T. Kalamaras]

Sure. Good morning. It’s Eric. So regarding the Government asset, I think as, there has been a consistent need and desire for additional influx capacity and space that’s been well stated by the government. And we keep hearing that same theme. What we chose to do was acquire a strategic asset, that asset was priorly any use for similar sort of capacity and really to try to offer the government a more immediate solution on other influx opportunities. Because we know that, additional influx sites are something that they’re trying to evaluate as part of being an extension of the permanent portfolio. So, I want to give them lots of different options, lots of different geographic opportunities, et cetera. So that was the purpose of that.

But at this point in time, look, that that very well can be part of the IDIQ and effectively the performance work statement, right? So in addition to what we have today. So, I’m not saying that will be the case, but it certainly could be. That was one of the reasons why we wanted to strategically acquire that. So as it relates to a cash flow contribution, what I would say is, nothing to report on that yet, although, we’re hopeful that at some point here in the near future, we have something specifically we can – that we can say.

Specifically to your question regarding the Permian transaction, we had talked for some time that we felt like we were becoming a little bit net short in our capacity. So we wanted to take the opportunity to go ahead and increase and expand the market share that we have in the Permian Basin and did so, with an asset that we’ve been looking at for a while. And so we feel like that was a nice addition to the portfolio. It comes to current cash flow. It’s not a super large transaction as you can see, but it’s an important one, and one that continues to give us additional breadth, additional customers and defend that market share.

So, I wouldn’t from modeling perspective, it’s a such size that I wouldn’t ascribe and do much with it in terms of your modifications in EBITDA, because we are still integrating that asset and we have some expense and from that. But look, I think it’s a nice growth opportunity for us and we’ll continue to create those tuck-ins as we see fit in the future.

[Brad Archer, President and Chief Executive Officer]

Yep. Let me just add one thing on the strategic facility acquisition. Eric talks about, when we first did this, it was more to continue to expand the ICFs, kind of what’s evolved out of this is a lot of other conversations with multiple agencies from CPP to others in the government. So, once you acquire this, we do a design, we go out and we lay this out in front of different agencies with Title 42 up on us going away. Lots of increased awareness about this facility multiple discussions being had throughout different agencies. So while we talk ICF, I wouldn’t be surprised that this ends up maybe even something else at this point.

So, but to Eric’s point, to have it ready for us to be able to respond quickly, that’s how you’d need to be set and ready on these large types of projects to help the government, especially in times like this. So we think this will help us do that.

[Unidentified Analyst]

Got it. Thank you so much.

[Operator]

The next question comes from Greg Gibas from Northland Securities. Please go ahead.

[Greg Gibas, Northland Securities]

Great. Good morning, Brad and Eric. Thanks for taking the questions. Congrats on the strong results in Q1. Wanted to just ask your, do you – I guess maybe the breakout between variable and fixed revenue on the humanitarian side in the quarter, and I guess just wondering if anything’s changed with respect to your variable revenue expectations for the full year? I think it was previously $50 million as kind of a baseline assumption. Just trying to get a sense of whether anything’s changed.

[Eric T. Kalamaras]

Yes, sure. So, there is not a large variable component for the quarter. Certainly what we look, we would always, we would like to see that at higher, right? It was what we would consider to be at the minimum levels on that. But I want to refrain from giving specific numbers on that Greg. I think the important point is that, we expected a, this is kind of the seasonal slowdown, right? We got that, that was actually very much in line. I think the thing that, that we have to wait for now is, with Title 42, so many, people are being held at the border that I think, it’s the question as to how quickly we move into hot status and then to what extent.

So because of that, and because we allocated approximately $50 million of variable revenue through the year, and because of the surge that we see during the warm summer months and into the early fall time period, we just don’t know what the extent of that’s going to be. And for that reason, we’ve chosen not to change anything as it relates to our revenue outlook. Now we frankly, I just think it’s too early. We were expecting somewhere in the neighborhood of only 10% of the variable revenue contribution to be the first roughly in the first call it, quarter and a half anyway. And so we’ve – my point is, we’ve eaten very little into that and there’s a lot of upside opportunities still left through the year.

[Brad Archer, President and Chief Executive Officer]

The thought on the business hasn’t changed.

[Eric T. Kalamaras]

Hasn’t changed one bit. No. And look in the concept between when we set up the contract, join with our nonprofit partner and at the request of the government was, for this minimum revenue component, right? And that was to keep this, the facility ready and waiting for when the surge happens. And those are, look that’s the definition of the influx capacity. And so we are ready and waiting for that. And when that revenue comes and hits, it can be meaningful. So for that reason, has the timing shifted perhaps to a little more back half weighted? Would’ve expected maybe a little bit more by now, but frankly not alarmed by that at all.

[Greg Gibas, Northland Securities]

Great. Really appreciate the color, helps a lot in kind of how you’re thinking about it. And, yes I do realize that variable is a small compete – component compared to the fix. I was going to ask on kind of getting back to that hot status from warm, but I think you kind of already addressed that in discussions there. Regarding, I guess the another step forward towards finalizing that multi-year contract, you mentioned being one of the final steps before completion. Could you maybe discuss what the remaining steps, we need to see are before we get that multi contract extension finalized?

[Brad Archer, President and Chief Executive Officer]

Yes, look it goes from the PWFS [ph] to the performance work statement to actually putting in our numbers on an initial task order, right? The government will issue this task order. We will put our RFQ in for that, if you will our bid and then an award what we would think, towards the latter part of the third quarter.

[Eric T. Kalamaras]

Yes. I think the one thing Greg and – that I would add in addition to Brad’s comments is we, when you take a step back and you think about the performance of work statement, what that is further defining, any scope modifications, right? To which, and this is important to which there weren’t any. And so I – that’s an important point, right? Because that, I think that allows that fit, that dovetails really nicely with the facility today. There’s – there as we see it, there’s nothing that needs incremental that needs to be done today, which I think it helps speed this process along fairly…

[Brad Archer, President and Chief Executive Officer]

Yes it’s designed the same warm hot status, the number of that is backwards…

[Eric T. Kalamaras]

So it’s really a function of getting, working through the task order process. And look, I think, so you want to logically say, okay, well why does it – why does it need to be, few months, three more months down the road? And part of it, part of the reason is because as I mentioned earlier, the government wants to continue to look at their influx sites. And so expanding those sites is not, it’s not a bad thing.

[Brad Archer, President and Chief Executive Officer]

They could come back one more of these, not just one.

[Eric T. Kalamaras]

Yes. And I think that’s the important, that’s the point decision just about PCC; this is about the overall influx site demand. Okay. And over and above PCC. And so there’s more to it go, there’s more going on than just our specific asset today. And to Brad’s point, they very well come back and say, it’s not one, it’s two or three.

[Greg Gibas, Northland Securities]

Got it. That’s helpful. If I could follow up too on that your comments relating to that recent strategic asset acquisition seems to make a lot of sense just given what you’re hearing from the government still being that short capacity and there being a lot of demand there. But you kind of said, don’t expect anything, in terms of contributions to financials this year, kind of guessing that, are you in discussions right now with the government in terms of how to use that? And just trying to think about, if we’re not expecting to see something near term, when you would think about timing of that facility beginning to be used?

[Brad Archer, President and Chief Executive Officer]

Yes, I’ll touch on just conversations. Yes, I mentioned this earlier. We are in having multiple discussions with different agencies, on this facility. Lots of activity there in a high level interest is kind of where I’ll leave it. And that interest is just kind of picked up even more so with May 11th, right around the corner in Title 42 going away. So while we don’t have anything in the numbers, the hope is at some point, this is just not a real estate acquisition. It actually becomes accretive to us at some point. That’s the goal, right?

[Eric T. Kalamaras]

Yes. And Greg, I would say, if I misspoke and said, don’t expect anything this year that wasn’t necessarily my intention, you may or may not. I think the point is we, look, we have the asset ready and available, so I’m – what I’m saying is, put anything now, right? But that doesn’t mean to Brad’s point, it doesn’t mean something can’t happen. As we work through this performance of work process, it doesn’t mean something can’t happen with that asset as part of that process.

[Greg Gibas, Northland Securities]

Okay, perfect. Thanks for clarifying and appreciate the color guys.

[Operator]

[Operator Instructions] The next question comes from Alec Scheibelhoffer from Stifel. Please go ahead.

[Alec Scheibelhoffer, Stifel]

Hi, good morning everyone. Thanks for taking my question. So just to get a start here, just based on earnings, and [indiscernible] from pressure pump is that we’ve been hearing, it appears activity in the Permian is likely about flat at current levels for the balance of 2023. Would you say that’s in line with your view and can you talk about demand in the Permian and expectations for activity over the next few quarters?

[Eric T. Kalamaras]

Sure. So, look as we have, as we said, probably for the past few quarters, we came off some pretty good growth and then we’ve seen that start to level. Well, I do think from a gross profit perspective, I would say that it’s probably steady as she goes. I think we probably, continue to see some, some very slight improvement that continues to articulate. This past quarter, as I mentioned, we did have some integration expenses from the asset purchase, so that did have an impact to bring down margin a little bit and an increasing cost.

But beyond that, look I think that business is a fantastic business. It continues to generate a significant amount of cash for us. As the marketplace there look, as there’s additional consolidation, as they continue, other producers and integrated companies continue to maintain their capital spending. They too are expecting, fairly low to single mid digit growth as well. So, I think if – tends to follow along with that, but I think that’s just fine for that business. It actually works out really, really well for us. I think in many ways, we prefer that, that type of an environment right now while we’re continue to allocate capital on the government side as well and we can really do both at the same time here. So Brad, what’d you say anything else?

[Brad Archer, President and Chief Executive Officer]

I think, well, we’re as excited as that business as always. It’s something that we’ve operated for a long time. It’s a great customer base. It’s something that just keeps on giving and it’s a great area to be in and I’m like, what you say, it’s not going to be hot and stick growth out there, but I think it’ll be consistent. I think the rates will come up over time as inflation subsides. But it takes a while as we have these long-term contracts to continue to drive those rates up. To Eric’s one point, you mentioned some costs there that won’t be ongoing. It was the onetime hit. So that definitely downplayed on the overall profits there. But I think this continues to tick up at a decent rate.

[Eric T. Kalamaras]

The one thing I would say that, we haven’t touched on the call this morning is, we do look to continue to expand that HFS business though in other areas, right? And we’ve talked before about some of our commercial diversification efforts, and they’re really – that’s really starting to take hold. And so and my point in that is, all is not lost in so far as growth in that business, it we’re saying in HFS-South is that we’ve expect it to be pretty steady, and that’s a 100% true. But however, there are some other things we’re looking at that, that are very nice growth drivers there. So hopefully more to come on those over time. But there’s a lot to continue to do in the HFS segment.

[Brad Archer, President and Chief Executive Officer]

Yes. Let’s time get lost on the fact of, when we added more government, we took up some of the HFS rooms, right? So when you look at the company at a whole totally different, much more profitable than it was the past few years. So we like the direction in the mix at this point where it’s at.

[Alec Scheibelhoffer, Stifel]

That’s excellent color. Thank you for that. And I’ll turn it back.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Brad Archer for closing remarks.

[Brad Archer, President and Chief Executive Officer]

Thanks again for joining us on our call today, and we look forward to speaking again in August. Thank you.