Target Hospitality Corp. Q1 FY2024 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Target Hospitality First Quarter 2024 Earnings Call Conference Call. At this time, all lines are in a listen-only mode. Follow the presentation, we will conduct the question and answer session. This call is being recorded on Wednesday, May 8, 2024. I would now like to turn the conference over to Mr. Mark Schuck. Please go ahead.

Thank you. Good morning, everyone, and welcome to Target Hospitality's first quarter 2024 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 the 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 8, 2024. 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. Finally, as previously announced on March 25, 2024, Arrow Holdings, an affiliate of TDR Capital, proposed to acquire all outstanding shares of common stock of Target Hospitality that it or its affiliates do not already own. The Board of Directors of Target Hospitality has established a special committee of independent directors to evaluate this proposal. The special committee has retained its own independent outside financial and legal advisers, and collectively, they have commenced their review and evaluation of the proposal. At this time, the Special Committee has made no decision with respect to the proposal. As a result, management will be unable to comment on the proposal or the evaluation process during today's call. Leading the call today will be Brad Archer, President and Chief Executive Officer, followed by Jason Vlacich, Chief Financial Officer and Chief Accounting Officer. 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.

Thanks, Mark. Good morning, everyone, and thank you for joining us on the call today. Our impressive first quarter performance reflects the benefits of our network capabilities, which allow us to maximize operational efficiencies while simultaneously providing world-class solutions to our customers. The scale and flexibility of our efficient operating structure continues to support seamless alignment with changes in customer demand, allowing us to preserve strong operating margins through cycles. These attributes have significantly enhanced our financial position and materially strengthened our balance sheet, supporting a highly durable and flexible operating model. In the government segment, these elements have supported the longevity of our PCC community, which has entered its fourth year of operations and is the longest operating influx care facility in the United States. Since its inception in 2021, this community has served approximately 2 million meals to unaccompanied children, a cornerstone to the government's influx care facility network. This established presence supports Target's continued engagement with the U.S. government and other strategic partners to jointly pursue the creation of a third ICF site not currently in the government's portfolio. We remain actively engaged and are pleased with continued dialogue regarding this opportunity. As we have previously stated, we anticipate additional details regarding the third ICF site in the back half of 2024. In addition, our South Texas Family Residential Center is entering its 10th year of operations, a testament to the operational success of that community. This community has evolved through multiple contract renewals across three different federal administrations, exemplifying its importance as a critical humanitarian solution for the U.S. government. Regarding our HFS segment, we continue to benefit from strong customer demand, which has supported positive momentum over the past year. This demand illustrates the value our world-class customers find in the network flexibility and premium hospitality solutions we provide. We have taken deliberate steps to enhance operational efficiencies across this segment, and we will continue to evaluate opportunities to optimize margin contribution through enhanced network optimization. Our ability to utilize the scale of our network to seamlessly align with changes in customer demand has consistently supported strong financial results. This focus has materially strengthened our financial position and established a robust balance sheet with significant liquidity. These elements continue to support impressive operating income and industry-leading cash conversion, which establishes the ideal position to continue evaluating a pipeline of growth initiatives. We believe these naturally adjacent opportunities will complement our existing service offer while establishing multiple avenues to expand Target's long-term growth opportunity set. In addition to the third ICF, we remain engaged with multiple federal agencies on a variety of solutions they are seeking to implement pertaining to increased activity along the U.S. Southern border. Further, we continue to actively pursue a robust pipeline of non-government growth initiatives. As we have previously discussed, these opportunities include large industrial projects throughout the U.S., including technology infrastructure, energy transition, and the increase in domestic rare-earth development. As a reminder, these growth opportunities tend to have longer sales cycles. While we are pleased with the active dialogue and progress of discussions, the timing and final outcomes are uncertain and can be difficult to predict. As we evaluate these initiatives, we remain committed to achieving defined objectives of our growth strategy. Our primary objective is focused on diversifying our customer base and contract portfolio, which we believe is essential in broadening our long-term growth pipeline. By accomplishing this, we will establish a foundation to identify and consistently execute repeatable growth opportunities while remaining focused on generating strong operating income and industry-leading cash conversion. In summary, we have established an enhanced financial position centered on the strength of our balance sheet and an efficient operating structure. These elements support our ability to provide a premier service offering to our customers while simultaneously delivering strong financial results and pursuing attractive growth opportunities. I'll now turn the call over to Jason to discuss our first quarter financial results in more detail.

Thank you, Brad. In the first quarter, our enhanced operating platform continued to support operational efficiencies across our network, allowing us to produce strong financial results driven by the strength in our core service offering. First quarter 2024 total revenue was approximately $107 million, and adjusted EBITDA was approximately $54 million. Our Government segment produced quarterly revenue of approximately $68 million. The decrease in revenue from the prior period was driven by the non-cash, non-recurring infrastructure enhancement revenue associated with the significant expansion that occurred at our PCC community in 2022, which was fully amortized as of November 2023. Our HFS and all other segments delivered quarterly revenue of $39 million compared to $38 million in the same period last year. This increase was driven by sustained momentum in customer demand for Target's premium service offerings, illustrating the value our customers find in our premier hospitality solutions. Recurring corporate expenses for the quarter were approximately $10 million, and we anticipate these will remain around $9 million to $10 million per quarter for the remainder of the year. Total capital spending for the quarter was approximately $10 million, with the majority focused on enhancing operational efficiencies through the purchase of previously leased equipment. The strength in our core service offering continues to support strong cash generation and an enhanced financial profile. We ended the quarter with $124 million in cash and $299 million of liquidity with zero borrowings under the company's $175 million revolving credit facility and a net leverage ratio of 0.2 times. These impressive financial results illustrate the strength of our operating platform and the sustained momentum we have created over the last several years. These elements support our reiterated preliminary 2024 financial outlook, which consists of total revenue of between $410 million and $425 million and adjusted EBITDA of between $195 million and $210 million, with anticipated 2024 capital expenditures of between $25 million and $30 million. Regarding our revenue and adjusted EBITDA ranges, as a reminder, there is minimal PCC variable revenue contemplated at the low end of our outlook ranges, and this revenue contribution was materially achieved during the first quarter of 2024. However, it's important to remember that PCC variable revenue contributions will inherently be uneven over the balance of the year. Any additional 2024 PCC variable revenue contribution will likely occur in the back half of the year. This enhanced financial profile supported our ability to return approximately $21 million to our shareholders by repurchasing approximately 2.3 million shares of common stock during the three months ended March 31, 2024. In addition, the strength of our balance sheet, high degree of revenue visibility, and continued strong cash conversion provides the ability to continue actively evaluating and pursuing a strong pipeline of organic growth initiatives. These opportunities are designed to jointly leverage Target's operating expertise and existing core competencies to establish a robust service offering across various U.S. government agencies and commercial applications. These initiatives encompass Target's existing full turnkey hospitality solutions while also focusing on opportunities to broaden Target's customer base and service offering portfolio. We are focused on establishing a platform to continue diversifying our revenue streams while simultaneously creating repeatable growth vectors. As previously stated, Target is seeking to allocate over $500 million of net growth capital to these opportunities over the next several years. Importantly, as we evaluate these initiatives, we will remain focused on maintaining the enhanced financial profile we have achieved through disciplined capital allocation and strong discretionary cash flow conversion. With that, I will turn the call back over to Brad for closing comments.

Thanks, Jason. Our strong first-quarter results continue to illustrate the benefits of our enhanced operating platform. The network scale and flexibility we have established allow us to deliver a premium service offering to our customers while simultaneously supporting strong financial results. This consistent execution is reflected in the strength of our balance sheet and enhanced financial position. With this foundation, we are continuing to evaluate and pursue the strongest pipeline of growth opportunities we have seen in many years and remain focused on expanding and diversifying our service offering. I appreciate everyone joining us on the call today, and thank you again for your interest in Target Hospitality.

Your first question comes from Scott Schneeberger from Oppenheimer. Please go ahead with your question.

It's Daniel on for Scott. Could you please elaborate a little bit on the new opportunities you see, the organic ones, and help us think about where you see the most opportunities and maybe some color on how ripe the pipeline could be?

Yes. Thanks. Look, the organic opportunities, as we mentioned, fall into a couple of different buckets. If you look at the government side, we talked about this in March as well, still making progress. Outside of the ICF here, we're engaging with other government agencies. So that's kind of front and center, still hot on the radar, lots of discussions there with multiple different agencies. I won't get into the agencies, but I would say it's not related to the ICF. With the ICF, we're still pursuing the third ICF contract, which we expect to be awarded sometime in the back half of 2024. So nothing's changed from our last call there. Again, as mentioned in our remarks earlier, if you look at some of the rare earths, some of the technologies, there are some very large bids, though it's very hard to predict the timing on when they will be awarded. However, we feel really good about some of these. We've had dialogues about some of these for over a year. So we believe that at some point, they will come to a conclusion, and we think we should be positive on some of these. Historically, when discussing organic growth, that's how we built the company, and we will continue to build the company by leveraging organic growth. It's hard to predict timing, but not hard to say that we've always been successful with some of these large projects, and we will continue to do that.

I saw in the release it was mentioned you focused on operational efficiency. I think you mentioned that in the prepared remarks as well. Could you speak to that, please? Are there any incremental initiatives you're pursuing that could be margin accretive as we look at?

Yes, sure. We're always continuing to evaluate those operational efficiency opportunities. We believe there are still operational efficiencies to be gained as we move through the year. We executed on some of those in Q1, as you saw with the operating performance that we've released in the announcement earlier today. So we do feel there are additional opportunities. That being said, we are running a highly efficient platform currently, so it becomes a little challenging to identify additional opportunities, but there are some, and we will continue to execute on those, all but marginal.

Your next question comes from Stephen Gengaro from Stifel. You can ask your question.

I guess two things for me. But the first is, can you give us some help and color around the government gross margins? I mean they were, I think, pretty flat sequentially from the fourth quarter, actually probably up a little bit. We had assumed that the mix shift in the new contract would affect that. But how should we think about those government gross margins assuming relatively low utilization at Pecos?

Yes, so good question. Over the years and working with this contract, we've gotten really good at controlling costs in response to occupancy level fluctuations. So that's essentially what you're seeing there as we move from Q4 into Q1 is executing on that operational efficiency strategy that we've had in place since the contract began, including the previous contract. So our margins, we expect to continue to be healthy as we move through the year. Obviously, there's a bit of margin expansion associated with lower occupancy levels as we control our costs.

Okay. So the quarter, there was nothing in that 77.6% in the first quarter that was an anomaly. That was just mix and efficiency.

Correct, yes.

Okay, great. And then the second one is just around HFS-South. I mean, we see what's going on in the Permian. Activity levels seem to be flat from these levels for the next couple of quarters. Do you agree with that? In that environment, if we assume flattish, is that how those revenues should act? Or are there any contracts or obligations or take or pay? Is there anything in there that would affect HFS-South from acting similarly to the drilling and completion activity in the Permian?

Yes, so we've seen moderate levels of improved utilization. We expect that to remain the case for the rest of the year. Overall, utilization will trend somewhat similar to last year, and that is what we expect to continue. There are no additional material changes that would cause us to believe otherwise as we move through the year with respect to utilization trends.

Okay, great. And then just one final one for me. The third ICF contract that is out there that you talked about, is that something to your knowledge that the government will award that they're considering awarding? Is that part of the mix with certainty, and is it just a real question of whether or not you're successful? Or might it not yet get awarded?

So based on all of our discussions, they definitely want, need, and plan to award the third ICF. For us, we're bidding on it, right? So we can't say we're going to get it. But we are pursuing this one aggressively, and we expect it to be awarded sometime in the back half of 2024.

Your next question comes from Greg Gibas from Northland Securities.

Brad and Jason, nice quarter. Just a follow-up on that third ICF site opportunity. You've been pretty clear on it being in the back half when we're going to hear additional details. Is it kind of a safe assumption that we should assume that contract will likely look similar to the first two awards? And are you seeing the same players bid for it?

Yes, I think it will be similar in design and structure. It’s too early to say yet if it will be exact in size and those types of things. So let’s get further into this. In August, we might have some more information. Right now, it's a bit too early. But I would say it will be very similar in nature, especially in terms of how we are going to take a look at it where we sit in the value chain as well.

Yes, mechanically, in terms of the revenue streams, it'll be very similar.

Got it. Fair enough. And could you just discuss, it sounds like there's just more of an emphasis now that the renewal of Pecos is no longer a priority or utilizing resources. Could you maybe discuss how you're shifting your resources towards targeting those non-government opportunities? It sounds like you're putting a little more emphasis on it. For that reason, I know you said they're typically longer sales cycles, but do you think about these potentially being contributors this year or more long-term opportunities?

I would tell you that the emphasis has always been there. If that came across that way, that's not the case. We have a team dedicated to everything outside of government. In fact, it's a larger team that's dedicated to government. So that pipeline is actually really large. It has been. It's just getting more active, meaning getting closer. I would tell you the final investment decisions and those types of things. Timing is still uncertain. They are large and very impactful if we get them. I'm not going to comment on the timing, but emphasis-wise, I wouldn't say that governments or rare earth or technology sides are really being pursued more than the other. They're all very high priority. It just depends on where we see the hotspots. So that's kind of where we shift. But today, I would tell you that they're pretty balanced. Lots of effort goes into the government as there are some front-and-center things we’re working on, as well as everything outside the government.

I guess if I could follow up on your commentary around multiple agencies within the government. I think you said they are also near the border. I understand that you don't want to comment until these are maybe closer to the finish line. But can you provide any color in terms of what agencies you're in discussions with or see opportunities with?

Look, I’d rather not talk about the agency-specific discussions. I will tell you that it is definitely not related to unaccompanied children on a lot of those. It's outside the ICF network, if you will.

I have one last question regarding the ongoing share repurchases. Can you provide an update on your capital priorities? We anticipate continued share repurchases, so could you remind us of the current authorization?

Yes. We continue to have the authorized program in place, which was initiated at a $100 million level, of which we've purchased $21 million of that. So roughly $78 million to $79 million left in that program. We're not going to comment on prospective activity, but that program continues to be authorized and will remain in place. It will continue to be a long-term capital allocation strategy as we move through time, where we see opportunities to execute on it. As a reminder, we executed on it in Q1 because we saw opportunities there with respect to repurchasing shares to the tune of $21 million.

You have a follow-up question from Stephen Gengaro from Stifel.

I'm not exactly sure how to ask you this. But when we think about the government business versus the HFS-South business, they're clearly different. You guys did a magnificent job in Texas with sort of the network of facilities. How do these other commercial opportunities fit? Are they more similar to one structure with 50 or 500 rooms? Or is it a family of facilities around a certain area? How do they compare to the two other pieces of your business?

Yes. I would say they’re more similar to the HFS model, if you will, concerning structural and physical types of setups and the way they're operated.

And would they come along with some type of term contract to support either construction or mobilization of assets?

Yes, absolutely. They would definitely support all of that and come along with a term contract to certainly support construction expansion, which would be part of our $500 million goal.

And our return models.

And our return models. These initiatives would consistently support our strong cash flow profile that we currently have overall in the business. So those are what these kinds of look like: long-term guaranteed contracts is what we’re talking about.

Okay, great. And then just one quick one. You repurchased $21 million of stock in the quarter. Does the pending bid impact your ability to return capital while it's being considered?

We’re certainly not going to comment on any impact that this offer has on our decision-making or potential future activity other than what we've disclosed in the release.

But there's no regulation or legal ruling related to a decision. Are you allowed to, I guess, is what I'm asking?

Look, I just think we're not going to comment on the possibility of whether we’re going to be in the market or not on the stock buyback right now. The plans are in place. We bought stock in the first quarter, and we'll continue to be opportunistic.

There are no further questions at this time. I would now like to turn the call back over to Brad Archer. Please continue.

Thank you all for joining us on our call today. We look forward to speaking to you again in August for our second quarter earnings report. Operator, that will conclude the call for today.

Sure. That concludes today's conference call. Thank you for your participation. You may now disconnect.