Earnings Call Transcript - TH Q1 2022

Operator, Operator

Good morning, and welcome to the Target Hospitality First Quarter 2022 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Mr. Mark Schuck, Senior Vice President of Investor Relations. Please go ahead, sir.

Mark Schuck, Senior Vice President of Investor Relations

Thank you, and good morning, everyone, and welcome to Target Hospitality’s First Quarter 2022 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. The 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 10, 2022. 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 will be joined by Troy Schrenk, Chief Commercial Officer, and open the call for questions. I will 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. Target’s first quarter results continue to exemplify the strength of Target’s operating position, which continues to benefit from positive momentum in customer activity across Target’s premier network of communities. Target’s top-tier customers continue to find added value in the size and scale of our network, which provides premium hospitality solutions and unmatched logistical flexibility for their labor allocation requirements. Our superior operating capabilities and world-class network has supported a 65% increase in customer demand since the first quarter of 2021. Additionally, the intrinsic value of Target’s network has supported an over 90% customer renewal rate for more than 6 years. The strong demand fundamentals and superior operating capabilities allow Target to efficiently respond to increasing customer demand while generating top-tier operating margins and strong financial results. Target’s HFS segment continues to benefit from its premium network and world-class service offering. These elements have supported continued strength in customer activity, resulting in 6 consecutive quarterly increases in HFS-South customer demand. Additionally, these strong demand fundamentals and Target strategically located communities supported the reopening of previously idled assets during the first quarter of 2022. We anticipate consistent increases in customer activity throughout 2022 and are well positioned to benefit from this positive momentum across our network. Additionally, Target continues to benefit from its increased concentration of critical humanitarian support services it provides to the United States government. Target’s Government segment represented over 58% of first quarter 2022 revenue, supported by fully committed minimum revenue contracts backed by the U.S. government. This is a clear illustration of our commitment to diversify and expand Target’s end markets while enhancing counterparty exposure and contract structure. These accomplishments have allowed Target to materially enhance its financial strength while simultaneously diversifying its business mix and establishing a foundation to continue pursuing strategic growth initiatives. These growth initiatives are focused on broadening Target’s end markets while significantly expanding our long-term growth opportunities. Target will pursue these initiatives while also remaining focused on expanding the critical support services it provides to the United States government. Target has intentionally established itself as the premier provider of permanent hospitality solutions for U.S. government long-term domestic humanitarian aid missions. Target’s premier and comprehensive service offering is viewed favorably by the U.S. government, and our scale and operational capabilities are unmatched in North America. As it relates to our latest government service contract, which began in March of last year, we continue to have active discussions regarding the extension of this contract. These discussions include the potential for a meaningful increase in contract scope due to the continued strong demand for Target’s critical service offering. Additionally, the U.S. government has recently outlined its intention to expand capacity and enhance capabilities to address its ongoing domestic humanitarian aid missions. As part of the U.S. government’s plan, there has been a fiscal year 2022 annual appropriation of approximately $8.8 billion. This annual appropriation illustrates the magnitude of the humanitarian aid mission and the volume of resources needed to appropriately respond. We continue to work diligently with our customer on finalizing contract terms and are highly confident in the successful outcome of these contract discussions. We are encouraged by the sustained momentum experienced in the first quarter of 2022 and believe we are well positioned to continue benefiting from our strategic position as North America’s leading provider of comprehensive hospitality solutions and value-added services. I’ll now turn the call over to Eric to discuss our first quarter financial results and ongoing growth initiatives in more detail.

Eric T. Kalamaras, Executive Vice President and Chief Financial Officer

Thank you, Brad. In the first quarter, we experienced continued strong demand fundamentals and positive momentum in customer activity. First quarter 2022 total revenue was $80 million and adjusted EBITDA was approximately $33 million. Our Government segment produced quarterly revenue of approximately $47 million compared to $18 million in the same period last year. The significant increase was attributable to an additional U.S. government contract award executed in March of 2021, which contributed approximately $33 million of revenue in the quarter. As a reminder, Target’s Government segment is supported by minimum revenue contracts, which are fully backed by the U.S. government. Our HFS segment delivered first quarter revenue of $33 million compared to $26 million in the same period last year. This increase was driven by sustained momentum in customer demand for Target’s premium service offerings, supported by strengthening economic fundamentals. While Target has significantly grown its revenue and adjusted EBITDA over the past year, we’ve remained diligent in appropriately managing cost components. We take an active approach to managing our input costs and benefit from our service offering flexibility, which allows us to adjust primary cost components to mitigate pricing pressure. As a matter of practice, Target maintains a disciplined approach to managing costs across the organization. This provides significant flexibility, which has allowed Target to preserve margins through a variety of operating environments. Recurring corporate expenses for the quarter were approximately $7 million. As a result of this scalable business model, we anticipate recurring corporate expenses to remain around $7 million to $8 million per quarter through 2022. Total capital expenditures for the quarter were approximately $4 million. Target continues to benefit from an efficient operating structure and scalable business model, which has allowed the company to match increasing customer demand with little incremental capital requirements. We ended the quarter with $6 million of cash and total available liquidity of $115 million, including $109 million available under the company’s $125 million revolving credit facility. The company has remained focused on preserving financial strength it achieved over the last few years and has a net leverage ratio of 2.6x, which represents a 60% improvement from the first quarter of 2021. We are excited by the continued strength in customer activity we experienced during the first quarter and anticipate the cadence of customer demand to continue as we progress through 2022. Additionally, we are pleased with the progress made in contract discussions regarding the extension and expansion of our 2021 humanitarian aid contract award. These discussions have evolved to include the potential for a significant increase in contract scope, including expansion of existing facility amenities due to the strong continued demand for this critical service offering. The United States government has recently published a detailed summary outlining the capacity and facility requirements for its domestic humanitarian aid program, which encompasses the services Target is continuing to provide as part of the 2021 contract. This summary outlines the anticipated increases in scope needed to support the existing program. The U.S. government has allocated a meaningful amount of resources to address this ongoing humanitarian crisis, including the appropriation of approximately $8.8 billion for unaccompanied children in fiscal 2022 alone, highlighting the critical nature of the humanitarian support services Target is providing. As a result, Target has executed short-term contract extensions to ensure the continuity of our critical services while contract terms are being finalized. The economics of these short-term contract extensions reasonably mirror the terms of the original contract award and will remain in place until final contract execution. As a reminder, the government’s direct prime counterparty to this contract is a leading national nonprofit organization. Target is the subcontractor to this agreement, providing comprehensive hospitality solutions to our nonprofit customer through a fully committed contract backed by the U.S. government. As a result of Target’s and our customers’ past performance, we are pleased with the direction of contract renewal and extension discussions and look forward to providing additional information in the foreseeable future. As a result, we reiterated our preliminary 2022 financial outlook, which consists of revenue between $325 million and $335 million, and adjusted EBITDA between $125 million and $135 million with $12 million to $17 million of capital spending. Our preliminary outlook is representative of Target’s current business operations only. We intend to provide an updated 2022 financial outlook to appropriately reflect the outcome of the contract renewal and extension discussions. Target has strategically positioned itself as North America’s leader in premier modular accommodations in hospitality solutions. Our superior network and capabilities create a highly scalable and efficient operating structure. These attributes support robust operating margins and strong cash flow generation, creating an ideal scenario to simultaneously pursue strategic growth aspirations focused on expanding Target’s long-term growth opportunities. Our strategic growth initiatives are centered around the strength in Target’s existing core service offerings, which offer the opportunity to unlock value through unique elements of our core competencies. Our established presence within the government services end market creates a platform to expand our unique offering to other agencies and geographies. Additionally, our unique capabilities offer opportunities to enter adjacent commercial end markets. Key elements of Target’s holistic hospitality solutions naturally translate across a wide range of commercial and industrial applications, including disciplines such as construction and facilities management, modular solutions, hospitality services, and logistics. The foundation of our existing network and broad-reaching capabilities creates a platform to pursue these opportunities with limited capital requirements, creating impressive returns on invested capital while simultaneously preserving the financial flexibility we have created. These characteristics of our growth strategy meaningfully increase revenue visibility and strength in economic returns while enhancing Target’s unique value proposition. We believe these attributes significantly increase Target’s long-term growth pipeline and create opportunities to accelerate value creation for all our shareholders. With that, I will turn the call back over to Brad for closing comments.

Brad Archer, President and Chief Executive Officer

Thanks, Eric. Our strong first quarter results illustrate Target’s ability to efficiently meet our various customers’ needs while positioning the company to continue pursuing value-enhancing growth opportunities. We are excited about the sustained momentum experienced during the first quarter and believe we are well positioned to continue benefiting from strong customer demand throughout 2022. We remain committed to pursuing strategic initiatives focused on expanding our long-term growth initiatives, which we believe creates the greatest opportunity to accelerate value creation for our shareholders. Before we wrap up, I want to comment on the leadership transition we announced earlier this year. The transition has continued in normal business course, and the Board of Directors has commenced an executive search process. As this process continues, I will continue to lead the company in my current role until December 31, 2022. We will provide additional information on the transition and executive search as they become available. I appreciate everyone joining us on the call today, and thank you again for your interest in Target Hospitality.

Operator, Operator

Our first question will come from Stephen Gengaro with Stifel.

Stephen Gengaro, Analyst

A couple of things for me, if you don’t mind. If we can start with the HFS-South business. Everything we’ve seen has been positive from an activity perspective, and the outlook seems pretty bright. I’m just trying to reconcile sort of the sequential utilized room change. I know it’s minor, but just curious what’s going on there. I mean I know there were some weather disruptions early in the quarter. I’m just trying to sort of triangulate what happened there and then how we should think about kind of room demand in HFS-South as we go forward here?

Eric T. Kalamaras, Executive Vice President and Chief Financial Officer

Let me provide a high-level overview to set the stage. This quarter's performance aligns with our plans, and there are no surprises. We entered the year expecting low teens revenue growth from Q4 2021 to Q4 2022, and that is happening as anticipated. It's important to note that there were fewer days in the quarter, which affects revenue. While we see steady demand, there is usually a lag between demand and actual revenue at the spot level, typically lasting a few months to a couple of quarters based on market shifts. As commodity prices rise and development occurs, this lag is something to consider. On a positive note, we are noticing consistent improvement in the HFS-South sector. It's also crucial to highlight that the company is committed to maintaining capital spending discipline, and our major customers are doing the same. Looking ahead, we expect margin expansion of a couple of hundred basis points throughout the year. Overall, we observe encouraging trends and remain optimistic, although we anticipate that the latter half of the year may be stronger due to the lag we discussed.

Stephen Gengaro, Analyst

Okay. And the occupancy, can you just remind us a relative split between kind of E&P personnel and service personnel?

Eric T. Kalamaras, Executive Vice President and Chief Financial Officer

It’s going to be primarily more service integrated. I would be reluctant to use E&P specifically to suggest that it’s independent. It’s going to be large integrated and then very large services.

Stephen Gengaro, Analyst

Okay. I'm curious about the Government side, and I know you could provide a lot more details. When you consider the extension you're discussing and your confidence in your position, I wonder who else could take this on. Considering the competitive landscape, it seems like you're in a strong position, but are there really any other alternatives?

Brad Archer, President and Chief Executive Officer

Stephen, this is Brad. Look, I’m sure there are some options out there. I would just point you back to how long we’ve serviced the government and we’re in place today. This is not a question, if you will, on signing a new contract on the facility we have. It’s more about how big is the expansion going to be, taking it from an emergency influx care facility to a more permanent care facility, which adds a lot of things, and you’ve probably seen some of the public memos out there, it’s education, it’s medical. So I would tell you, we sit in a very good position to continue to move forward with this and get a contract signed fairly quickly. So we’re very confident in a successful outcome there. I don’t know that I could point you to anybody that could do exactly what we do out there. We are one of those companies. We have the buildings, we have the construction, we have the land, we have the permits, we have a great name and a successful track record which is huge, especially when you’re taking care of children. And on top of that, we have a great nonprofit customer that has a great track record as well.

Stephen Gengaro, Analyst

That’s very helpful. And then just one final one for me. The cash flow in the quarter, I mean, there was a big working capital driven. I imagine it’s timing related. But can you just maybe comment on that and how working capital likely plays out for the remainder of the year?

Eric T. Kalamaras, Executive Vice President and Chief Financial Officer

Yes. Good question. Good catch. Look, I think the way to think about working capital to give you a little bit of context in this is when we structured the large government contract last year, we had a large upfront payment on that. So you did see in the quarter about a $25 million shift in deferred revenue, right? So you can see that shift in the balance sheet and then flowing through, of course, to the cash flow statement. And that’s largely a function of having the upfront payments there and then seeing the deferred revenue associated with that. Very essentially, that’s why you had 4 months of payment without the work happening in 2021. So we’re catching up for that now. Look, as we see things moving forward as it stands today, bear in mind, in the outlook that we provided, it’s business as usual, right? So you’ll see another month of kind of the effective working capital shift that I just described. And then from there, things will normalize from more of a normal working capital trend than you would have previously expected.

Operator, Operator

The next question will come from Greg Gibas with Northland Securities.

Greg Gibas, Analyst

Congrats on the strong quarter. I wanted to ask about the government humanitarian aid contract. When that’s finalized, do you expect your existing capacity to be sufficient to fulfill the increase in scope that they’re kind of looking for?

Brad Archer, President and Chief Executive Officer

Yes, we do. We should be able to address, especially where we’re at today with them. It is a sizable increase in bed capacity. But with what some of the idle equipment we have that we can move around, we should be able to take care of that for them.

Greg Gibas, Analyst

Okay, great. And I guess just wanted to confirm that you’re saying it’s rolling over month-to-month, the existing contract that is safe to assume that, that was extended through the end of May.

Eric T. Kalamaras, Executive Vice President and Chief Financial Officer

Greg, It’s not quite through the end of May, but you’re in the right ZIP code, and that’s an evergreen. So it will just continue to roll over. Technically from a contractual perspective, it’s month-to-month. We’ve done things a little bit shorter than that for the last iteration or 2. But look, we hope that that’s a signal that there’s an announcement hopefully soon.

Brad Archer, President and Chief Executive Officer

Yes. Greg, to provide a bit more detail, we started with the initial 30. As we approach the final contract, the timelines may become a bit shorter, which is a positive development for us. We believed we had completed the final design just last week, but they requested an increase in scope. Consequently, we had to add some buildings and adjust our pricing due to the increased square footage. Nevertheless, we expect to complete the project fairly quickly. While this is a significant endeavor for us and the government, it's important to recognize that it represents only a small portion of the broader immigration issues the government is addressing. Our focus is solely on unaccompanied minors, while there are many other related matters they need to manage. Although it's a large project, we're doing what we can to move things along. However, ongoing changes from their side are prolonging the timeline. We are optimistic that progress will be made soon.

Greg Gibas, Analyst

Great. Very helpful. That is exactly what I was trying to figure out. So I appreciate the color there. If I could just turn over to your strategic initiatives, talking about kind of translating your existing capabilities to new applications or end markets. How are you kind of weighing or thinking about doing so via M&A versus organically?

Brad Archer, President and Chief Executive Officer

Well, I think your first step is definitely organic when you start to talk about the government piece even the HFS. So your initial growth is going to continue to come from that organic. The first thing we always concentrate on every morning we wake up is to try to fill the rooms that we already own, right? At the same time, with the cash this business continues to generate, we’re also looking at inorganic growth. So Eric continues to build that pipeline on inorganic growth. Looking at some acquisitions that fit within the company. So we’re going to prosecute both of those avenues at the same time at this point.

Eric T. Kalamaras, Executive Vice President and Chief Financial Officer

Yes. I think, Greg, the other thing I would point out and Brad hit on this. As we think about the core competencies of Target, there are a number of things that we can do. It’s a thought process of taking organic activity and operations we have today and how can we perhaps disintermediate some of that over time and be more bespoke to certain customers, right? For example, in facilities management, construction management, modular solutions, hospitality services, all those things we currently do as an integrated platform today. There are also applications to do that on a separate basis as well. And so that’s certainly something we look at. I mean we’re highly disciplined in how we look at return objectives when we look at transactions. There have been a number of things we’ve looked at, and frankly, that we have passed on just because the risk and the return just wasn’t there. We’re looking for opportunities that fit really well with us commercially and operationally. We’ll continue to look at those, but we’re also disciplined, and so we’ll just keep you posted. I think we’ve got some exciting things that we’re looking at, and hopefully, we can push those across the finish line.

Greg Gibas, Analyst

Great. Yes. I look forward to updates. I guess last one for me, and sorry if you already addressed this. But kind of implicit in your guidance, wondering if you could discuss kind of cadence on how you’re thinking about the remainder of the year? Are you expecting maybe difficult seasonality there?

Eric T. Kalamaras, Executive Vice President and Chief Financial Officer

Sure. So from an outlook perspective, level set. There’s no additional upside we’ve assumed, obviously, from any modifications to the government contracts, right? So I think on the HFS side of the business, as I mentioned, we’re probably looking at about 10% year-over-year growth on that kind of Q4 to Q4 exit. Look, I do think there’s going to be additional margin expansion there on the HFS side. On the government side, because there was a pretty significant ramp-up period for the government occupancy last year, you probably see on a relative basis that margin come down a little bit. However, corporate-wide, you’ll continue to see the margin increase in the neighborhood of kind of 50 to 100, 150 basis points through the course of the year. So I think what you’re seeing, really, as you look at the performance this quarter, we continue to see that getting better as we move through the year. And then, of course, hopefully, we have some other things that we can announce that will obviously propel that.

Operator, Operator

Our next question will be a follow-up from Stephen Gengaro with Stifel.

Stephen Gengaro, Analyst

I'm curious about Brad's comments regarding the contract discussions. Can we reasonably assume that the ADRs and margins will remain similar to their current levels?

Brad Archer, President and Chief Executive Officer

Yes. That’s the assumption that they’ll be very similar to what it is today.

Stephen Gengaro, Analyst

If I turn my attention back to HFS-South, there appears to be a difference in rate between committed rooms and any kind of callout rooms. I'm interested in understanding how we should consider rooms under contract that are included in your guidance compared to potential callout rooms, and how that might influence ADRs.

Eric T. Kalamaras, Executive Vice President and Chief Financial Officer

Sure. So look, there is a really pretty big spread between think about spot rates versus what we’re seeing, first of all, for contractual rates, right? That’s the first thing. And maybe the second thing to bear in mind here is that be a little bit careful on the ADR because the ADR in certain contracts, particularly for some of these large contracts, is really just a function of the number of rooms that have come through the system based upon the revenue based on the contract. So if we have a fixed revenue amount that’s coming from the contract and you bring more rooms to us, right, your effective ADR actually comes down slightly. And that could have a weighting on the ADR, all the while our revenue actually continues to go up, which is why I was saying before, I think we continue to have margin expansion there. So a little bit careful on the ADR and focusing on that too much as a metric going forward, albeit it is important. But the other thing that’s happening, too, is the market is tightening, right? So some of the pricing pressure we were seeing a year or so ago or even 6 months ago, we are starting to see the market tighten particularly on the spot side, and that will help on the ADR up as well.

Stephen Gengaro, Analyst

Okay, great. One final question that just came to mind. Considering the pressure pumping sector, with Liberty and OneStim merging and ProFrac acquiring FTSI along with other movements in the market, has this consolidation had a positive or negative effect on you?

Troy Schrenk, Chief Commercial Officer

Stephen, this is Troy. Great question. As we’ve talked about in the past related to consolidation because of the size of our network and the nature of our agreements as a preferred provider for the largest publicly traded oilfield service companies operating in the Permian Basin, consolidation, we absolutely benefit from some of those names that you’ve mentioned. Clearly, we’ll continue to support the Permian today on a consolidated basis or on an individual basis. So absolutely, we look forward to that and welcome more consolidation as it makes sense.

Operator, Operator

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