Target Hospitality Corp. Q2 FY2023 Earnings Call

Hello, and welcome to the Target Hospitality Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I would like now to turn the conference over to Mark Schuck, Senior Vice President of Investor Relations & Financial Planning. Please go ahead.

Thank you. Good morning, everyone and welcome to Target Hospitality’s second quarter 2023 earnings call. The press release we issued this morning outlining our second 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 9th, 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.

Thanks, Mark. Good morning, everyone, and thank you for joining us on the call today. Our record-setting second quarter performance reflects the positive business momentum we have sustained over the past year. We have established significant operational flexibility and scale, enabling us to appropriately match customer demand while continuing to generate strong financial results. We continue to benefit from our materially expanded presence providing critical hospitality solutions to the U.S. government. This intentional focus has resulted in over 70% of second quarter revenue being derived from committed contracts backed by the United States government, with 78% of second quarter revenue having minimum revenue commitments. These elements supported over $368 million of discretionary cash flow over the last 12 months, representing an impressive discretionary cash flow yield to revenue of over 61% over that time. This materially enhanced operating platform has allowed Target to efficiently serve its world-class customers while positioning the company to quickly respond to strategic growth opportunities, all while generating impressive operating income. 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 an 18% year-over-year increase in utilization with consistent customer renewal rates of over 90%, which we have enjoyed for over seven years. We continue to benefit from the strong demand fundamentals and the fully optimized network we have created over the past year. These elements have supported a more normalized pricing environment, and we anticipate continued positive momentum in the coming quarters. Regarding our government segment, our purpose-built portfolio of assets continues to serve the critical humanitarian aid mission they were designed to support while exceeding the expectations of our partners in the U.S. government since our first community was established in 2014. Target’s communities are frequently visited by the agencies they serve, as well as adjacent agencies, and consistently receive the highest government ratings on all of their operating specifications and metrics. This is a testament to the world-class solutions we have created to serve the specific needs of the U.S. government's humanitarian mission. Regarding our existing Pecos Children's Center community, as we previously announced, several key milestones have been achieved related to securing a long-term contract for this community. Our existing non-profit partner was awarded an indefinite delivery indefinite quantity contract, which establishes the contracting vehicle required by the U.S. government to appropriately fund multi-year contract awards. Importantly, the performance of work statement coincided with the IDIQ contract materially aligns with the existing specifications and capabilities of PCC. This is significant as our community has established a blueprint for the government's desired Influx Care Facility sites. Further in connection with the performance of work statement, the government outlines their desire to increase their ICF capacity to accommodate up to 10,000 individuals, requiring a total of three Influx Care Facility contract awards or two in addition to the established PCC community. As the government has continually stated, additional humanitarian housing capacity is urgently needed to manage the increasing number of unaccompanied children arriving in the U.S. These ICF sites are critical to the U.S. government and paramount to their ability to adequately support surge capacity in excess of existing shelter capacity, which has remained static for many years. In response to the government's stated desire to increase their ICF capacity, we have partnered with multiple established government service providers and jointly submitted several solutions for new ICF sites. These new ICF sites are in addition to the established PCC community and our ongoing relationship with our non-profit partner. In summary, we have positioned Target to participate in a much larger Influx Care opportunity set than just PCC. We remain committed to our existing non-profit partner and the exceptional community and service offerings we have jointly created at the Pecos facility. We have also expanded our strategic government service partnerships and jointly submitted several bids across numerous geographic locations for the creation of new ICF solutions for the U.S. government. I'll now turn the call over to Eric to discuss our second quarter financial results, expanding humanitarian focus, and capital allocation initiatives in more detail.

Thank you, Brad. In the second quarter, we continued to benefit from our established operational scale and ability to align with customer demand and consistently deliver strong financial results. Second quarter 2023 total revenue was $144 million, and adjusted EBITDA was approximately $91 million. Our government segment produced quarterly revenue of approximately $101 million compared to $75 million in the same period last year. A significant increase was attributed to expanded PCC community. Our HFS segments delivered quarterly revenue of $42 million, compared to $35 million in the same period last year. This increase was driven by sustained momentum and customer demand for Target's premium service offerings. Current corporate expenses for the quarter are 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 was approximately $16 million, with the majority related to expanding our government portfolio in anticipation of the government's request to increase the ICF network capacity. We expect a more moderate pace of capital spending through the remainder of the year, excluding potential acquisitions or government contract awards. We ended the quarter with $70 million cash and $195 million of liquidity, with zero borrowings under the company's $125 million revolving credit facility, and a net leverage ratio of 0.4 times. 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 expanded 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. Before we discuss the specifics around our expanding humanitarian opportunities, I would like to touch on the Influx Care Facility concept and its intended purpose in serving the government's humanitarian mission. As a reminder, the government has a network of shelter capacity that consists of smaller facilities located across the United States. These facilities are a fraction of the size of Target's existing PCC, ICF community. The government utilizes the shelter facilities to address the humanitarian housing solutions for unaccompanied minors prior to occupying Influx Care service. Influx Care Facilities are intended to manage surge capacity beyond the U.S. government's existing shelter capacity. However, the PCC and the government's desire for Influx Care network capacity play a critical and necessary role in supporting this humanitarian mission. Due to the small size of individual shelter sites, the government has focused on increasing Influx capacity that is urgently needed to manage the increasing and consistent numbers of unaccompanied children entering the U.S. that could strain the government's shelter network. Simply stated, the Influx Care network is an essential element, allowing the U.S. government to properly manage surge capacity in an efficient humanitarian and seamless manner. As a result, the occupancy at the government Influx Care Facilities, including PCC will fluctuate with meaningful changes in occupancy over any given period. Now turning to our expanded humanitarian community opportunities and ongoing organic growth initiatives to meet the desired ICF network capacity for unaccompanied minors, the United States government has indicated their intention to void a total of three ICF contracts supporting the population of up to 10,000 individuals. As it relates specifically to PCC, we believe the existing community and the solidified relationship with a non-profit partner will remain a critical solution to the government's ICF capacity. Furthermore, the alignment of existing PCC specifications and capabilities with this desire and government ICF blueprint provides additional confidence as we work through ongoing contract discussions. We remain pleased with the progress and anticipate additional contract specifications to be finalized later this year. In addition, Target has strategically partnered with another established government service provider and has jointly submitted several proposals supporting approximately $1 billion of cumulative capital deployment to create additional highly customized and purpose-built ICF solutions for the United States government. Importantly, these proposed solutions expand numerous geographic locations, providing the U.S. government with maximum flexibility as they determine the desired location for new ICF sites. As a reminder, Target recently acquired strategic humanitarian assets in anticipation of this request from the U.S. government. These assets have been proposed as a viable solution to meet the government's desired increase in ICF capacity. Furthermore, Target’s established presence providing these critical and highly customized solutions to the U.S. government is an essential element that we believe positions Target advantageously to pursue these additional ICF opportunities. We are excited about the opportunity to expand our critical humanitarian service offerings to the U.S. government and contribute to this humanitarian mission. We continue to evaluate an active pipeline of strategic growth opportunities, with a 2023 financial outlook that includes revenue between $550 million and $580 million, adjusted EBITDA between $346 million and $365 million, and excluding acquisitions, 2023 capital spending should approach more normal levels between $25 million and $35 million per year, predominantly focused on organic growth capital. As we discussed, by their very nature, ICF facilities are designed to support a dynamic population and can experience meaningful fluctuations in occupancy over any given period. The range of 2023 revenue reflects the adjustment of anticipated variable service revenue associated with the PCC community only for the remainder of 2023. 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 contract vehicles that will create a number of solutions across various U.S. government agencies for projects that support national defense, energy transition, and humanitarian projects. As previously stated, Target is prepared to allocate over $500 million of net growth capital to these high return opportunities over the next several years. We are pleased with the progress of discussion for many of these large-scale projects and look forward to providing additional updates for the coming quarters as the opportunities hopefully progress. With that, I'll turn the call back over to Brad for closing comments.

Thanks, Eric. A record-setting second quarter results are a testament to the operational efficiencies and scale we have created, enabling us to appropriately match customer demand while simultaneously generating strong financial results. We are well-positioned and excited to participate in the expanding Influx Care opportunity set. We are confident that the exceptional community and service offerings we have jointly created with our leading national non-profit partner will allow PCC to remain a critical solution for the U.S. government. In addition, we believe our new partnerships and the numerous ICF solutions we have proposed create exciting opportunities to potentially expand our critical service offerings to the U.S. government. We are well-positioned and remain focused on pursuing this expanded 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.

We will now begin the question-and-answer session. Our first question comes from Scott Schneeberger of Oppenheimer. Go ahead.

Thank you very much. Good morning, everyone. So, the first question. I'd like to inquire I guess Eric, this will be for you. The guidance range adjustment, low end and high end. What does that contemplate for occupancy at the Pecos Facility?

Hi, good morning, Scott, thanks for the question. When we look to modify the outlook, the regression that we stand were specifically related to the variable services revenue, right? So, as we think about going forward, specifically for 2023 at this point, we and our partners certainly were anticipating variable occupancy there, more than what we would have received for the first part of the year. And so, I think as we look at it going forward, we're not assuming that there's any variable services revenue at this point. But I think it's prudent based on what we've seen. And I think it's safe to say that we are all somewhat surprised by that. But having said that, nothing has changed about how we view the contract. Certainly its durability going forward. I think as we think about going and looking at all the opportunities we have ahead of us, we think about the upside, there's certainly a lot of opportunity where we can certainly fit towards the high end of that, just depending on the cadence and timing to when those opportunities materialize.

Thanks. There is currently no activity at Pecos. Could you compare and contrast this summer's flows with those of recent years? Please provide an update on seasonality considerations. It seems that this isn't reflected in your guidance, but based on what you've observed with flows and your discussions with the government, do you foresee any chance of utilization before the end of the year? Thanks.

Sure. I think it's still too early to determine. I always mention that we're not expecting an increase in RMC there. There's always that possibility. Keep in mind, we could receive just a week’s notice regarding government plans to raise that. In fact, going back to early summer, there were daily discussions around potentially placing significant occupants at that site. That's always an option at any time. It really depends on the current situation. For example, when we were considering Title 42, there was a considerable demand across various entry points. That might have influenced the timing a bit. We'll just have to wait and see how things evolve over time. It's quite difficult to predict.

I think it’s really important to kind of differentiate those two. Because if you look at utilization where we sit today, in Pecos, there is no correlation between utilization and the ultimate need for 10,000 ICF beds. The need is there for the government. They looked at this three years ago. They did Pecos; they’re moving in now to adding additional facilities as we've said in our release. But there's no correlation when you look at how many kids are in there today and the need and the change in how they're envisioning this. There’s a difference in what they're doing, and once they’re there, we can all look at order flows and see if it’s variable; there will absolutely be some variability. There's been some for many, many years, but this is for influx capacity.

Okay, thanks Brad. I appreciate that. Going up a level, some discussion on this call about the government looking at not just Pecos but a couple other locations. And I guess you won't be able to answer this with certainty because you don't know what the government customer will ultimately do. But do you get a sense from your discussions with them? That it's not in isolation, or are all these three? And does it feel more like the government may put them all together?

I don't know if.

That's it, Brad. Thanks.

I’m not sure if the issue is on our side or yours, but we only caught about 30% of what you said. I believe you were asking if all 10,000 beds would be awarded or if this is isolated. I didn't hear the entire question. If you can hear me well, I’ll provide an update on our thoughts regarding the IDIQ process. Can you hear us clearly?

Yeah, I heard everything you said. If you can hear me, you got the question. Do you think Pecos will be awarded in isolation and extension or all three being grouped together as the government considers it for its award? Thanks.

Yeah. And let me give everybody just kind of an update on where we're at in the IDIQ process. Last call, we had just received a performance of work statement. And literally, right before our call, we did not have time to go through it. Now, in our release, you see they're asking for 10,000 total beds, three separate facilities and they need that conversation with them we worked on our bids with our partners for the past several months. We submitted phase one technical proposals a few months ago. The government goes in, they grade your proposals. They look at your partnerships and how you're going to actually take on and get it done, right? We were selected to move forward with all of our bids into what they call phase two pricing. Phase two is the last phase of this bid before an award. So, it's important to note that there's a limited number of companies that were selected out of phase one to move into phase two. All of our bids were pushed into phase two. We submitted our bids on July 26th, our pricing for phase two. So, now it's a waiting game on when this gets awarded. We're being told the fourth quarter would be the award. And look, could these be staggered? They absolutely could be. These are very large, very big bids. So, even if some of those number three go on a little bit further than the fourth quarter. It absolutely could. But look, I definitely think there's an award happening in the fourth quarter. How many we will see. But definitely, there could be some staggering of the award just based on how large they are.

Okay, great. Thanks, I appreciate that color, Brad. I’ll pass it on.

Our next question comes from Stephen Gengaro of Stifel. Go ahead.

Thanks. Good morning, everyone. I have a couple of points to mention. First, I would like to clarify something. Are the 10,000 beds designed for both children and staff, or do they only cater to the unaccompanied minors?

Yes. There's definitely more to go here, right? This is just for children. This doesn't account for what we would have to supply for our partners and our own workforce for housing. So, at the end of the day, at each of these facilities, just like Pecos, there would be a number of beds also on top of this for staffing. Look, some of them are different, and depending on what locations they pick, some might be closer to a city where you can actually have something there. But there will be a number of extra rooms, and some fairly substantial depending on what locations they pick, would add to this number for us. And the contract would get bigger.

Okay, thanks. And then that does make sense, yes. Thanks, and then two other things. First, you addressed this to an extent, but I'm just curious. So, when we're looking at and these fact sheets that tell us utilization has been zero for several months, and then we sort of are trying to triangulate that into long-term demand, which you had noted on the call earlier was a flawed approach. When an unaccompanied minor enters the country, maybe it would be helpful for us to the extent you can, what are the different paths for this unaccompanied minor? And at what point would you be utilizing any Influx Care Facility versus the other parts of the system?

Sure. I'll let Eric elaborate on this, but I want to point out that the issue isn't about a flawed method for assessing border crossings that might eventually lead to an influx. It's more about a flawed understanding of the underlying needs. If you're only focusing on what's currently coming in, you're missing the larger picture. This problem has been recognized for many years, and the proposed solution is intended for the long term because influxes will continue. The challenge lies in predicting when these will occur. Therefore, it's important to recognize that you can't simply link those two aspects together.

To build on what Steve mentioned, the transition from shelters to influx is largely due to the limits of shelter capacity. There are approximately 9,000 beds in the shelter system, and many of these are quite small, spread over several states. This can lead to overcrowding at certain locations. When that occurs, the government will take logistical steps to manage the situation. However, when the shelter occupancy reaches a specific level, they will begin to initiate influx measures. Currently, the shelter system is about 70% to 75% occupied. If occupancy exceeds that threshold, the government starts to consider moving towards influx. While we're not at that point yet, it is imminent. In line with Brad’s point, having an influx plan is a necessary precaution regardless of the current shelter occupancy since exceeding capacity demands an immediate influx response. This urgency is the reason behind the IDIQ and our discussions around it. I hope this provides a clearer understanding of the process involved.

Yes, great. And then just one final question. I realize this may be a minor point, and you might not want to comment in detail. However, when we analyze the government revenue for the quarter, the data we have, which may not be entirely accurate, indicates that the utilization of the ICF was in the low 30s in the first quarter. Yet, there appears to be some revenue contribution in the second quarter, even though I had thought the facility was empty. Am I misunderstanding this, or is there still some variable revenue?

I believe we already discussed the variable contribution for each quarter, but if there were any contributions, they were minimal. We can explore this topic further if needed.

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

Hey, good morning. Good morning, Brad and Eric. Thanks for taking the questions. Congrats on the quarter. When we think about that 10,000-bed number that the government is demanding, how many incremental beds is that? Should we think about the 6,400-burn capacity at Pecos and then like 2,200 that you have in another contract with the government? I mean, how should we think about incremental beds? And I guess as kind of the follow-up there is the assets that you've acquired that aren't currently contracted with the government. Would you say those basically meet the government's needs or requirements, I guess, right now? And maybe as they stand today? Or would additional capacity or anything requiring capital be necessary?

Yes. The facility we acquired was certainly utilized in our bidding process, and we believe it addresses some of the requirements for this bid. As I mentioned earlier, there will definitely be additional accommodations for customers and employees, on top of the 3,000 per facility. However, for competitive reasons, I can't disclose the exact numbers or size at this moment. It wouldn't be appropriate to do so. Our hope is to secure the award, and then we can provide more details about the structure. The 3,000 beds for the government are confirmed, but we have not yet released information regarding the number of beds needed for the customer and employee side.

And Greg, to address the incrementalization of your question, specifically to Dilley, right, that's not included here, right? So, everything we're talking about is obviously over and above that. But PCC is effectively embedded with the net 10,000 number, right? So, effectively, if you think about PCC itself, you're thinking about an additional 6,000 beds, not just showing 3,000. So, this would be the additional 6,000 for children if that incremental. So, hopefully, that gives a little bit more clarification.

That does. Thanks for clarifying that. And I appreciate the color there. I guess just a follow-up on a previous question regarding variable revenue. I guess the reason for the maybe slight guide down in EBITDA is related to just less variable contributions you're expecting this year? And I guess, overall, just wondering what your updated assumptions for variable revenue are this year?

Typically, we observe stronger seasonality from late spring to the beginning of summer. However, I believe much of that was anticipated earlier due to Title 42. As we evaluate this earlier shift, we’ve adjusted our outlooks thoughtfully and conservatively. It's reasonable to make adjustments as we consider the remainder of the year. I want to clarify that there isn’t anything specific I can elaborate on at this moment. Currently, our capacity is at 70% to 75%, and exceeding that would likely indicate an influx of care.

Great, very helpful. I guess lastly, just anything you can share on your new government service provider partner and maybe how they offer new market opportunities versus your existing non-profit partner?

I'm not going to mention any names, but we are really excited about our partnership with a very large government services firm. This bid is significantly larger than our current projects, and we are pursuing all available bids. We’ve engaged with various facilities, and our geographic reach is expanding beyond our current locations. Partnering with this firm makes a lot of sense for us. I'm pleased with our existing partnership with PCC, with whom we have an 11-year agreement. We have met all their requests for the bid submission to the government. Our goal is to pursue all opportunities and expand our government business, and we believe this new partnership will enable us to achieve that.

Great, appreciate you guys.

Thank you.

Our next question comes from Stephen Gengaro of Stifel. Please go ahead.

Thanks for taking the follow-up. Just in the oil patch, just when we look at activity levels there, I mean, clearly, rig counts are down, completion activity is likely down in the second half of the year, but it does seem like we're stabilizing and looking at a recovery likely next year. Are you seeing much change in that piece of the business? It doesn't appear so from your guidance, but I just wanted to check that?

We indicated earlier this year that we anticipated some margin expansion as we invest in the latter half of the year. We began to see this development in the second quarter as inflation pressures eased and cost containment measures improved operational efficiencies. In that sense, the situation is improving. The core of your question pertains to future inflation, which is expected to change significantly. I wouldn't say we anticipate anything substantially different from our current high 70% utilization rate, which I expect to remain stable. Ideally, we will see continued improvement. There is some potential for consolidation, which is currently underway and could be beneficial over time. However, I believe any growth will be steady and slight, and I wouldn't expect anything significant at this stage.

Okay, thanks. And then just one other quick one on the government. Should we think about the potential structure of contracts to be similar to Pecos, where there's sort of this fixed piece to protect you and keep your assets? You're giving your assets for utilization for a long period of time, plus some variable portion. Is that the standard structure we should expect?

So, I think the way you think about these contracts going forward is the structure we have with PCC, specifically related to how that was structured from revenue piece to a variable piece as well as to the capital and the payback portions. I think you should think about those generally being roughly very similar in concept and structure.

Okay, great. Thank you for all the details.

Thanks, Steve.

Our next question comes from Scott Schneeberger of Oppenheimer. Go ahead.

Thank you for the follow-up. I wanted to check in on something that wasn't discussed much during this call due to the focus on the ICF. You previously led opportunities with other government agencies, and I was hoping you could provide an update on any non-ICF opportunities you are pursuing. Thank you.

Sure. And so definitely, there's some organic progress being made as far as - I’m not getting into specifics, but some of the same things we've always talked about from natural resources, also other government services besides the ICF piece. We continually are out trying to expand our government piece of the business. There's some even in the HFS side that could happen as well. But very strong pipeline organically out there. And we continue to say it's stronger than what we've had in many years past. Again, projects are very large. They take time to get done, but we're making headway on some.

Yeah. I think to that point, we have said over the past several quarters that we're continually looking to expand in further regions of the government, right? I think having the digital partner and having multiple sites, we're clearly executing on that. These are big, and I think we want to be fair around what we're looking at here. We're not taking our eye off of oil and continuing to grow the business really throughout the government. There are other things that we're working on in addition to these as well as Brad mentioned, with the government and of course, with other business and industry. So, look, the pipeline is robust, and we look forward to trying to execute on it.

Thank you. I have one last question. In the prepared remarks, you mentioned that capital expenditures would moderate towards the end of the year, yet the guidance for the year has increased. Was this related to your work with the newly acquired strategic asset in the second quarter? Am I on the right track, or is there more to consider? Also, what factors should we consider for capital expenditures in 2024? Thank you.

Sure. You're correct. Most of our spending occurred in the first half of the year, especially in the first quarter. That’s why I mentioned expecting a moderation in total spending for the latter half of the year. Looking ahead to 2024, I would estimate that our spending will resemble what we experienced in 2023. When it comes to capital spending, it could appear significant on a gross level, but if our projections are accurate regarding spending structures and contracts, the net capital level and inventory should be similar to this year. So while the overall figure may seem large, the net amount will not be as substantial.

Okay. Thanks very much.

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

Thanks for joining us on our call today. And thanks again for your interest in Target Hospitality. We look forward to speaking again in November on our third quarter call. Have a good day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.