Target Hospitality Q1 2023 Earnings Call Transcript

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May 9, 2023

There are 7 speakers on the call.

Operator

Morning, and welcome to the Target Hospitality First Quarter 2023 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be the opportunity to ask questions. Please note the event is being recorded. I would now like to turn the conference over to Mark Skook, Senior Vice President of Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you. Good morning, everyone, and welcome to Target Hospitality's Q1 2023 earnings call. The press release we issued this morning outlining our Q1 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 the press release.

Speaker 1

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.

Speaker 1

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. Calameras, Executive Vice President and Chief Financial After their prepared remarks, we will open the call for questions. I'll now turn the call over to our Chief Executive Officer, Brad Archer.

Speaker 2

Thanks, Mark. Good morning, everyone, and thank you for joining us on the call today. Our strong Q1 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 $339,000,000 of discretionary cash flow over the last 12 months, Representing an impressive discretionary cash flow yield to revenue of approximately 60% over that time.

Speaker 2

These accomplishments have solidified Target's balance sheet with over $350,000,000 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 and simultaneously positioning the business to quickly respond to strategic growth opportunities. In our HFF 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 7 years. This continued strong demand and positive customer outlooks Supported the acquisition of select community assets in the Q1 to appropriately align our network capacity with an existing customer's growing labor allocation requirements.

Speaker 2

In addition, the strategic location of these assets enhances Targets' 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.

Speaker 2

Further, the U. S. Government has continued to state in its urgent need for additional humanitarian housing Pasty, particularly with the impending removal of Title 42, which is anticipated to result in a Substantial increase of individuals crossing the U. S. Southwest border.

Speaker 2

In preparation for this meaningful increase in demand and to ensure uninterrupted The 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 6 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.

Speaker 2

As a reminder, this award consisting of a base 5 year term with an additional 5 year option establishes the contracting vehicle required by the U. S. Government to appropriately fund multiyear contract awards. The IDIQ award to our non profit partner is one of the final steps And the government's contract award process prior to working through definitive agreements. We remain highly pleased with the ongoing discussions with the U.

Speaker 2

S. Government and our profit partner and we anticipate working through additional contract specifications over the coming months Would 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 Q1 financial results, 2023 outlook and capital allocation initiatives in more detail.

Speaker 3

Thank you, Brad. In In the Q1, we experienced continued strong demand fundamentals and positive momentum in customer activity, which further solidified our strong financial position. Q1 2023 total revenue was $148,000,000 and adjusted EBITDA was approximately $91,000,000 Our government segment produced quarterly revenue of approximately $110,000,000 compared to $47,000,000 in the same period last year. The 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.

Speaker 3

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 1st quarter revenue of $36,000,000 compared to $32,000,000 in the same period last year. This increase was driven by sustained momentum and customer demand for Target's premium service offerings.

Speaker 3

Recurring corporate expenses for the quarter were approximately $9,000,000 and we anticipate recurring corporate expenses will remain around $9,000,000 to $10,000,000 per quarter for the remainder of the year. Total capital spending for the quarter was approximately $32,000,000 with 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 $42,000,000 of cash and over $167,000,000 of liquidity with 0 borrowings Under the company's $125,000,000 revolving credit facility and a net leverage ratio of 0.5 times. As we previously announced, on March 15, we partially redeemed $125,000,000 of the 9.5 percent senior secured notes, which we view as a high risk free cash return.

Speaker 3

As it relates to the outstanding senior notes, we continue to evaluate a range of 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 arise. Turning to our financial outlook and capital allocation initiatives. Target's enhanced end market portfolio and contract has supported increased and 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 necessary mechanism to fund specific multiyear contract awards.

Speaker 3

Further, the government's desire to exercise the existing contracts 6 month option supports the importance of this community as the government prepares Significant increase in demand for humanitarian housing following the lifting of Title 42. We continue to work closely with our non profit partner and Additional contract 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 $525,000,000 Maximum revenue of $710,000,000 and minimum adjusted EBITDA of $365,000,000 Excluding acquisitions, 2023 capital Spending should approach more normal levels between $20,000,000 $30,000,000 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 expanded pipeline of growth opportunities and partnerships.

Speaker 3

These opportunities are designed to jointly leverage Target's operating expertise 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.

Speaker 3

As previously stated, Target is prepared to allocate over $500,000,000 of 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 progressed. With that, I will turn the call back over to Brad for his closing comments.

Speaker 2

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 accomplishments 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,

Operator

We will now begin the question and answer session. The first question comes from Scott Schneeberger from Oppenheimer. Please go ahead.

Speaker 4

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

Speaker 2

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.

Speaker 2

It sets out the requirements, what we will Submit to the government and to 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.

Speaker 4

Got it. Thank you. Sounds good. And with Title 42 removal, Has there been any conversations about removing the warm status of the PayCo facility?

Speaker 2

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 than or about PCC, they're staggering. There's been lots of them over the past few weeks Asking what we can do for them.

Speaker 2

So active conversations going on across the board Through different agencies as well as for the PCC.

Speaker 4

Got it. Thank you. Regarding the strategic asset purchase you made in the quarter related to the government segment, could you please elaborate that 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 €31,000,000 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.

Speaker 3

Sure. Good morning. It's Eric. So regarding the government Yes, asset. I think as you know, there has been a consistent need and desire for additional influx capacity in space.

Speaker 3

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, an asset that was primarily In use for similar sort of capacity, and really to try to offer the government a more immediate solution on other influx 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, etcetera. So that was the purpose But at this point in time, look, 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 not saying that will be the case, but certainly could be.

Speaker 3

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 say. Specifically to your question regarding the Permian transaction, We have talked for some time that we felt like we were becoming a little bit net short in our capacity. So we want to take the You need 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's a nice addition to the portfolio.

Speaker 3

It comes to current cash flow. It's not Super large transaction, as you can see, but it's important and one that continues to give us additional breadth, additional customers and defend that market So, I wouldn't from modeling perspective, it's of a such size that I wouldn't describe and do much with it in terms of your modifications in EBITDA, Because we are still integrating that asset and we have some expense from that. But look, I think that's a nice growth opportunity We'll continue to create those tuck ins as we see fit in the future.

Speaker 2

Yes. Let me just add one thing on the strategic facility acquisition. Erik talks about When we first did this, it was more to continue to expand the ICS. 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 laid this out in front of different agencies with Title 42 up on us going away.

Speaker 2

Lots of increased Awareness about this facility, multiple discussions being had throughout different agencies. So While we talk ICF, I wouldn't be surprised if 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.

Speaker 4

Got it. Thank you so much.

Operator

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

Speaker 5

Great. Good morning, Brad and Eric. Thanks for Congrats on the strong results in Q1.

Speaker 2

I

Speaker 5

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 Your variable revenue expectations for the full year. I think it was previously $50,000,000 is kind of a baseline assumption. Just trying to get a sense of whether anything's changed.

Speaker 3

Yes, sure. So there was not a it's not a large variable component for the quarter. Certainly, we would always we would like to see that higher, Right. It was what we would certainly be at the minimum levels on that. But I want to refrain from Specific numbers on that, Greg.

Speaker 3

I think the important point is that we expected a this kind of the seasonal Slow down, right? We got that. That was actually very much in line. I think the thing that we have to wait for now With Title 42, so many people are being held at the border that I think it's the question is how quickly We move into hot status and then to what extent. So because of that and because we allocated approximately $50,000,000 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.

Speaker 3

And for that reason, we've chosen not to change anything as it relates to our revenue outlook. Frankly, I It's too early. We were expecting somewhere in the neighborhood of only 10% of the variable revenue contribution to be in 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 Jim, you

Speaker 2

still left of the year. The thought on the business hasn't changed.

Speaker 3

Hasn't changed one bit. No, and look, in the concept between when we set up the contract, Joining with our non profit partner and at the request of the government was for this minimum revenue component, right? And that was to keep 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.

Speaker 3

And when that revenue comes ahead, it can be meaningful. So For that reason, has the timing shifted perhaps to a little more back half weighted? Sure, sure. Would Would expect maybe a little bit more by now, but frankly not alarmed by that at all.

Speaker 5

Great. Really appreciate the color. It helps a lot in kind of how you're thinking about it. And yes, I do realize that that variable is a small component compared to the fixed. 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.

Speaker 5

Regarding, I guess, another step forward towards finalizing that multiyear contract, you mentioned being one of the Final steps before completion. Can you maybe discuss what the remaining steps we need to see are before we get that multi contract Extension finalized?

Speaker 2

Yes. It goes from the PWS 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 Q3.

Speaker 3

Yes. I think the one thing, Greg, that I would add in addition to Brad's comments, when you take a step back, think about the performance of work statement, what that is, is further defining any scope modifications, right, to which and this is important, to which there weren't any. And so that's an important point, right? Because I think that allows that fit that dovetails really nicely with the facility today. There's there as we see it, Incremental and it needs to be done today, which I think should help speed this process along.

Speaker 3

Yes.

Speaker 2

We designed the same warm, hot status, The number of things

Speaker 3

Everything is exactly

Speaker 2

I thought that exactly.

Speaker 3

So it's really a function of working through the task order process. And look, I think So you want to logically say, okay, well, why does it need to be a few months down the road? And 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, it's not a bad thing.

Speaker 2

They could come back a lot more, Yes. And I

Speaker 3

think that's the important that's the other point. This isn't just about PCC. This is about the overall influx site demand, Okay. And over and above PC. And so there's more to it there's more going on than just our specific asset today.

Speaker 3

And to Brett's point, they very well could come back and say, it's not 1, it's 2 or 3.

Speaker 5

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

Speaker 4

you kind of

Speaker 5

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?

Speaker 2

Yes, I'll touch on just conversations. Yes, I mentioned this earlier, we are having multiple discussions with different agencies On this facility, lots of activity there and a high level interest is kind of where I'll leave And that interest is just kind of picked up even more so with May 11 right around in 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?

Speaker 3

Yes. Greg, I would say, If I misspoke and said don't expect anything this year, that wasn't necessarily my intention. We may or may not. I think the point is we look, we have the asset Ready and available. So what I'm saying is, look for anything now, right?

Speaker 3

But that doesn't mean to Brett's point, it doesn't mean something can't happen as we work through this performance of work process. It It doesn't mean something can't happen with that asset as part of that process.

Speaker 5

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

Operator

The next question comes from Alek Sheyb Berghofer from Stifel. Please go ahead.

Speaker 6

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

Speaker 3

Sure, sure. Sure. So look, as we have as we said probably for the past few quarters, we came off Yes, some pretty good growth. And we've seen that start to level up. I do think Yes.

Speaker 3

From a gross profit perspective, I would say that it's probably steady as she goes. I think we probably continue to see some Very slight improvement that continues to matriculate. This past quarter, as I mentioned, we did have some integration expenses So the asset purchase, so that did have an impact to bring down margin a little bit and increasing costs. But beyond that, look, I think that business is a fantastic business. It It continues to generate significant amount of cash for us.

Speaker 3

As the marketplace there Look, as there's additional consolidation, as they continue all the 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 it 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 environment right now, we continue to allocate capital on the government side as well, and we can really do both at the same time here.

Speaker 3

So, I'll try what you say. Anything else?

Speaker 2

I think we're 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. Yes.

Speaker 2

And it's a great area to be in. And unlike what you say, it's not going to be hockey stick growth out there, but I think it will 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.

Speaker 2

It was a one time hit. So that's definitely Downplayed on the overall profits there. But I think this continues to tick up at a decent rate.

Speaker 3

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 that's really starting to take hold. And And my point in that is all is not lost insofar as growth in that business. What we're saying in HFS South Is that we expect it to be pretty steady and that's in that terms and true. But however, there are some other things we're looking at that are very nice growth drivers there.

Speaker 3

So hopefully, more to come on those over time, but there's a lot to continue doing the HFS segment.

Speaker 2

Yes, let's not get lost on the fact of When we added more government, we took up some of the HFF rooms, right? So when you look at the company as a whole, totally different, much more profitable than it was Past few years, so we like the direction and the mix at this point where it's at.

Speaker 6

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 any closing remarks.

Speaker 2

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

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Target Hospitality Q1 2023
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