Target Hospitality Corp (TH) 2021 Q3 法說會逐字稿

Good morning, and welcome to the Target Hospitality's Third Quarter 2021 Earnings Call. (Operator Instructions)

Please note this event is being recorded. I'd now like to turn the conference over to Mark Schuck, Senior Vice President of Investor Relations. Please go ahead.

Thank you. Good morning, everyone, and welcome to Target Hospitality's Third Quarter 2021 Earnings Call.

The press release we issued this morning outlining our third 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, November 12, 2021. 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 table 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.

Thanks, Mark. Good morning, everyone, and thank you for joining us on the call today. Demand fundamentals have strengthened throughout 2021 and have supported consistent increases in demand for Target's premium hospitality service offerings.

Since year-end 2020, Target has experienced an over 40% increase in customer demand across its hospitality and facility services segments. This robust demand has resulted in an expansion of operating margins and utilization throughout 2021 and has supported the continued execution of our strategic objectives. Target's exceptional third quarter results are a direct reflection of the intentional action we have taken to appropriately position Target to take advantage of building customer demand.

Target's top 10 HFS customers have increased their labor allocation by over 95% since mid-2020. This demonstrates the value of our best-in-class customers find in allocating labor to Target's world-class network and premier holistic service offerings. These attributes continue to support an over 90% customer renewal rate which we have enjoyed for many years.

As Target's utilization increases, we are approaching an ideal level of network optimization and are beginning to benefit from the scale and efficiencies we have created within our operating structure. This network optimization creates an ideal operating environment and maximizes the margin contribution from each utilized bed with negligible capital requirements.

This efficient operating structure has resulted in meaningful cash flow generation which has been directed towards significant debt reduction and accelerated the strengthening of Target's financial position. This intentional focus has resulted in a 52% reduction in Target's net leverage ratio in 2021. These accomplishments have allowed Target to materially enhance its operational flexibility while simultaneously diversifying its business mix and establishing a robust growth pipeline.

Additionally, Target has advanced its diversification focus, with its government segment now representing over 50% of third quarter and anticipated full year revenue. As we continue to focus on network optimization, we recently relocated a number of assets from our HFS Midwest segment to be utilized in servicing our existing contracts within our government segment. This illustrates the flexibility of our network and our ability to optimize assets to generate the highest returns.

We have illustrated our ability to appropriately position the company to systematically execute on its strategic objectives. By doing so, we have established the trajectory in which to continue pursuing our growth strategy, focused on enhancing value through a diversified portfolio of service offerings.

Target's unique capabilities translate across a range of end markets and provide the opportunity to pursue a variety of value-enhancing growth initiatives. Target will pursue these opportunities while simultaneously remaining focused on expanding its reach providing critical support to the United States government.

Our established platform creates avenues to utilize our existing core competencies to support critical services, including humanitarian aid efforts across a variety of federal agencies. Additionally, Target's holistic service offerings create a broad suite of commercial opportunities across a range of end markets. These services extend beyond our legacy accommodation offerings and include facilities management, building operation, asset maintenance and other critical support services.

Target has identified and is currently evaluating a robust pipeline of expansion and diversification initiatives within the government and commercial services markets. These multiple growth levers are underpinned by the existing strength in Target's core offerings and include both inorganic focus initiatives and broadening our existing commercial portfolio.

As it relates to our government services opportunity set, we continue to have active and productive conversation with various government agencies regarding their continued need for permanent humanitarian solutions. Target's premier and comprehensive service offering is viewed favorably by the U.S. government, providing multiple avenues to expand Target's offering in support of these critical humanitarian solutions. While we can never be sure of a successful contract outcome, we are very encouraged by the frequency and scope of our ongoing dialogue with the U.S. government.

We have strategically positioned Target as North America's leader in premier vertically integrated hospitality solutions. We have accomplished this by intentionally identifying and transitioning Target's business mix to capture the greatest value creation and expand its long-term growth pipeline.

Target has intentionally enhanced its operational and leadership capabilities to effectively identify and evaluate these growth opportunities, which it believes provides the greatest opportunity to accelerate value creation. We have been encouraged by the sustained momentum experienced throughout 2021 and as our results have illustrated the benefits of our strategic positioning as North America's premier provider of vertically integrated hospitality solutions. The progress we have made in executing our strategic initiatives is impressive and has exceeded our expectations.

This positive momentum is illustrated in our recently raised 2021 financial outlook which represents the second increase to our financial outlook this year. We anticipate this progress to continue as we progress to 2021 and into 2022 while staying focused on our strategic priorities and creating value for our shareholders.

I'll now turn the call over to Eric to discuss our third quarter financial results and ongoing growth initiatives in more detail.

Thank you, Brad, and good morning, everyone. In the third quarter, we experienced continued improvements in our operating metrics and realized a fifth consecutive quarterly improvement in demand for premium modular accommodations and value-added hospitality solutions. This supported our exceptional third quarter performance with total revenue of $89 million and adjusted EBITDA of approximately $38 million, with discretionary cash flow of $35 million, representing an impressive 39% discretionary cash flow yield to revenue.

Our government segment produced quarterly revenue of approximately $46 million compared to $16 million in the same period last year. The significant increase was a result of the U.S. government contract 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 United States government over their respective contract terms.

Our HFS segment delivered second quarter revenue of $32 million compared to $20 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 activity within our commercial service areas. As the pace of momentum of our economic activity continues to build, we continue to monitor the supply chain impacts and inflationary pressure resulting from strengthening economic demand and then the associated impacts on our cost of services. We take an active approach managing our input costs and benefit from our service offering flexibility, which allows us to adjust primary cost components to mitigate pricing pressure. As such, our input costs have remained within our expected ranges and have not materially impacted the margin at this point. And we have reflected our expectation for cost of services within our recently updated financial outlook.

Recurring corporate expenses for the quarter were approximately $10 million. Despite the significant increase in revenue and EBITDA, we have not had commensurate increases within our corporate costs. We have a highly scalable business model that allows us to substantially expand growth with minimal excess costs. As a result, we anticipate recurring corporate expenses to remain around $10 million per quarter through 2021.

Total capital expenditures for the quarter were approximately $9 million, including approximately $6 million directed towards enhancements within our Government Services segment and the new Government Services award as well as an additional $3 million in maintenance capital. We remain focused on maximizing return on invested capital and do not anticipate significant non-growth capital requirements for the remainder of 2021.

We ended the quarter with $31 million of cash and $340 million of total debt, providing available liquidity of approximately $156 million, with a net leverage ratio of 3.1x. Because we are achieving a high level of cash generation, coupled with minimal capital spending, we have industry-leading return on invested capital which has significantly enhanced Target's financial flexibility. Importantly, for Target and our investors, we expect this trend to continue over the next several quarters as we remain focused on balance sheet flexibility so that we can continue to accelerate our growth. As a result, the company has made significant progress towards our year-end 2021 target net leverage ratio being below 3x.

We are excited by the strengthening commercial activity and associated demand for our service offerings. These elements supported Target's strong third quarter results and provide confidence in the cadence of our customer demand for the remainder of 2021. From a contractual perspective, approximately 99% of Target's 2021 and midpoint revenue outlook is under contract and approximately 73% of contracted revenue has committed payment provisions with 53% of committed revenue related to government services.

Now as a result, we recently raised our 2021 financial outlook, which now consists of revenue between $280 million and $285 million, adjusted EBITDA between $110 million and $113 million and discretionary cash flow between $75 million and $80 million, with $25 million to $30 million in capital spending, excluding acquisitions and a target net leverage ratio below 3x by year-end of 2021.

The sustained momentum Target has experienced throughout 2021 is impressive and has led to multiple increases to our full year outlook. Our current 2021 financial outlook represents a 25% and 42% increase over full year 2020 revenue and adjusted EBITDA, respectively.

The positive momentum target has experienced has accelerated our ability to execute on our strategic initiatives. With significant progress made in enhancing our financial flexibility through meaningful debt reduction, we anticipate turning our focus to strategic growth.

Target's growth strategy will focus on utilizing its core competencies to pursue a balanced portfolio of service offerings while expanding its reach within the government services end market as well as select adjacent commercial markets. We believe these opportunity sets offer the greatest potential to enhance Target's value proposition.

The foundation of our existing modular solutions network and broad-reaching capabilities creates a platform to add additional growth channels to our portfolio of services and solutions.

Target has strategically positioned itself as North America's market leader in providing premier vertically integrated hospitality solutions. We accomplished this by intentionally focusing on markets and world-class customers that offer the greatest long-term revenue growth potential while optimizing our existing asset fleet and unique capabilities to maximize economic returns. These principles have established a highly attractive financial profile that generates best-in-class margins with substantial cash flow conversion. Additionally, our asset fleet requires little maintenance capital, leading to significant discretionary cash flow.

This efficient financial profile allows us to reinvest cash flows into complementary growth markets, aligning with Target's strategic principles and expanding Target's long-term growth pipeline. These characteristics of our growth strategy meaningfully increase revenue visibility and strengthen economic returns, which we believe create the greatest opportunity to accelerate value creation for our stakeholders. We look forward to discussing our progress as these opportunities materialize.

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

Thanks, Eric. Target's impressive third quarter results illustrate the benefits of Target's unique position as North America's leader in modular accommodation and hospitality solutions while simplifying our commitment to executing on our strategic objectives. Target's strategic position and operational strength has allowed us to meet and exceed our customers' varying needs, while significantly enhancing Target's financial position and supporting our commitment to pursuing our growth strategy. We have created and sustained a tremendous amount of momentum in 2021. And as we look into 2022, we will utilize this momentum to focus on our strategic growth initiatives.

We have taken intentional steps to enhance our capabilities to effectively identify and evaluate a range of growth opportunities focused on enhancing value through a balanced portfolio of service offerings. This opportunity set expands across a variety of end markets, including providing additional critical support services to the United States government. Importantly, these growth initiatives utilize Target's existing core competencies, which we believe creates the optimal scenario to accelerate value creation for our shareholders.

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

(Operator Instructions) Our first question comes from Scott Schneeberger with Oppenheimer.

I guess I'd like to start by asking, are there any new developments with regard to potential new contracts with the government? And then a follow-up question I'll ask upfront as well is, has the government contract that was established in March of 2021, believe that was a 1-year contract, has that been renewed, extended? Any discussions with regard to developments there?

Scott, this is Brad. Let me -- I'll cover off on expansion and extensions here in the government segment. So look, our existing contracts performing -- they're performing as expected. We continue to receive high marks on the premium services that we offer to the U.S. government. We continue to have active and consistent conversations with the customer on extending the contract -- the existing contract in West Texas. I think it's important to remember the existing contract term runs through March of 2022, and we feel very confident on a successful extension by the end of the first quarter of 2022.

So look, we've got about 40% left on this contract. And I think we -- again, discussions are happening, but it gets -- it moves further down the road after the first of the year and comes to a conclusion by the end of the first quarter. Additionally, I would say that Target has established itself as the trusted long-term provider of premier comprehensive hospitality solutions throughout the U.S. government.

It's also important to remember, Target has established this reputation by providing 2 of the largest permanent hospitality solutions for the U.S. government humanitarian aid efforts. That's now spanned 3 different administrations. So I think that's an important point.

With this backdrop, and more on expansions in the new government business, we are having active and productive conversations with various government agencies regarding their growing need for more humanitarian aid solutions.

While the outcome can never be certain, we do feel very good about this segment and moving forward in 2022. Very active conversations, very mature conversations, and I'll kind of leave it at that, but we feel very good about where both of these are headed.

Last thing I would say on this is this is very similar in how we approach Dilley. We built a great location. We built a permanent facility. It started out as a year-to-year basis. And now we're 7 years on that contract. This is not new to us. It's not new to the government. They move a little slower than most, but that's normal. So we feel very comfortable with how this is moving along.

Great. Just one quick, more a follow-up and then I'll pass it over, but I'll keep it in the government segment, this is probably for Eric. The average daily revenue $78 in the third quarter. I think that was up from $76 in the second quarter. I think you probably had gotten full quarter contribution from the March contract win in second quarter. So just curious what that increase is? Is that an inflation-based escalator or something else there?

Sure, Scott. Are you referring to the sequential quarter?

Yes, quarter over quarter.

Sure. So it's a good question. So look, the reality is you've got increase from just the pro rata benefit, right, as you move through the quarter. That's really all it is. So you can see that in the number. Recall, last quarter, we had a -- we did have a first quarter benefit. But as we were moving through that process of change orders, there are -- that was really a large project that was still moving into scale and scope. So as a result of that, we got additional benefit this quarter from that. So that's really what you're seeing -- so recognizing it was there in Q2, but there were some positive movements. As it relates to the ADR, we can scope and scale in Q3.

Got it. And has it probably topped off here or maybe a little bit more or wait and see?

No, look, good question. The scope and scale is -- look, the government is looking at a lot of things. And so I think what we're seeing is increase in scope and scale, not a decrease in scope and scale. I'm not going to say that there's not positive movement there. I mean I would work with what we have posted right now. But look, there's always opportunity for that to increase.

Our next question comes from Stephen Gengaro with Stifel.

3 things for me. Well, I'll start with just -- can you give us your expectations on the bridge to the fourth quarter because it feels like -- it seems like you're guiding to like $24.5 million to $27.5 million of adjusted EBITDA, which is a little down sequentially. I know there's seasonality, but is there anything else in there we should be thinking about?

Yes, no. I don't think so. Look, there is -- you're right, we have the seasonality. That does impact things a couple of percent in the quarter. So you need to bear that in mind. I think you probably have accounting for that. But I don't think there's anything specific going on there that we haven't already talked about. Look, if you want, after the call, happy to get on the phone and walk through any specific nuances that you think are of interest, but nothing specific really going on in Q3.

Okay. When we -- we're hearing 20% to 25% upstream spending growth in the U.S. next year, which I think is reasonable if you get something like that and there's inflation, there's other cost. But activity is probably up mid-teens. Will your utilized beds rise at roughly that same rate in the HFS segment?

Sure. Good question. So look, to the extent our customer capital spending is tied directly to the human capital allocation. Sure. I think it's important to remember that we haven't seen those large capital spending numbers coming from the integrated providers that are really the bulk of our customers.

And so I think with the numbers we're seeing and we're seeing the same thing, which is really from smaller private companies, right? So there's certainly a component of that anticipated 2022 capital that is not due to human capital, right? So just from other inflationary pressures as well.

So I would just caution that we would see a direct correlation there to that capital spending. We do expect to continue to see positive momentum in 2022, just like we've seen all through 2021. And so we don't see any abatement there necessarily. I would just be cautious though at this point in time of -- until we put out our 2022 outlook to read too much into the headline capital spending numbers that they are seeing.

And I think -- and you can correct me if I'm wrong, but I think you do -- more of your work is directly oil service-related than directly E&P. So does it matter if the privates or publics are spending, if Liberty and Halliburton and others are just as busy?

Sure. It matters to the extent that the bulk of the capital spending where that comes from, right? And so obviously, if you're dealing with companies like Chevron, Exelon, et cetera, that can obviously swing where the total nominal capital spending number comes from. And so I just think you need to bear that in mind. But your concept is not wrong. Just want to be cautious about tying a one-to-one correlation to that.

The other thing that I would point out is we tend to have about a quarter lag between capital spending today versus what happens at the headcount level. So just bear that in mind as well that we do tend to be a little bit lagging on that as well.

Great. And one more quick one for me, and I'll get back in the line. The potential or pending acquisition of FTSI. I'm pretty sure you had an FTS Lodge. I'm not sure if that's still open, but I imagine you'd do business with them. Does that impact you at all? Or do you do business with the potential buyer? Just curious if there's anything I should be aware of on that front because I think that 13 frac fleets working third quarter?

Stephen, this is Troy. Good question regarding that potential business combination. We definitely are continuing to service that customer and have for a long time. And as that transaction moves forward, we anticipate that, that relationship which has been intact for, again, for a long period of time, will continue. So I think your question regarding there was an FTSI facility at one point, while that facility is not open specifically, we are servicing them throughout the entire Permian Basin and continue to and expect that to continue in the future.

Can you comment if you're doing business with their potential buyer and whether it could actually be additive, if you're not?

Look, when we think about mergers and acquisitions and business combinations, as we've talked in the past, Stephen, I think it's always been more favorable than not, right, because of who we're doing business with, the size of the network that we have and the sheer number of customers that we service across that 85,000 square mile piece of Permian Basin real estate. So with that said, I would tell you that given our penetration into the marketplace, I fully expect this to continue to do work with FTSI and other large oilfield service customers regardless of the M&A outcomes.

(Operator Instructions) Our next question comes from Doug Becker with Benchmark Research.

Just looking for a little more color on what drove the sequential decrease in gross margins in government services in HFS-South and just a little more detail on what the expectation is going forward given that decline.

Sure. So good question on both. I'll take government first. So it was similar to the answer that I was giving Scott, which is that contract had a pretty substantial ramp period when it first started. Similar to many other contracts that we do, you're getting full minimum revenue commitment but you may not be getting full occupancy for the contract. And so what happens is you end up with a higher front-loaded margin just due to higher revenue relative to the cost you're spending to facilitate the contract that as the contracts mature through time, as occupancy comes up and you get to more of a steady state, you end up seeing margins start to normalize, right? So it's normalizing off of a -- but unfortunately, you're looking at it off of a higher comp number. So that's really the driver there.

Similar effect that you see in the HFS-South segment. You're seeing increased occupancies, which is a good thing. You've got a larger portion of minimum revenue commitments, which is also a good thing. You can have periods where we saw pretty good movement up the second quarter -- sorry in the third quarter. And when that happens, you obviously continue to have the cost increase on that. So all that has to moderate to the contract. But when you see these movements up in occupancy levels that happen pretty quick over short periods of time, you can't have an element where the margin does come down on a temporary basis.

Is it fair to say that for government that we move back to say a 60% gross margin and then in HFS-South kind of going back to upper 40s? Or should we...

Yes. On the government side, I think the leading-edge margin we have right now that you're seeing this quarter is the one that I would guide you to. Again, when the new contract comes in, particularly a contract of that scale that does have a tendency to tilt things. And so I would use what we have right now as kind of the leading edge number. Of course, when we update 2022 outlook, we'll of course give a fresh view on that. But that's what I would use for now.

That makes sense. For both government and HFS-South?

Well, look, no -- actually, no. That's related to government. On the HFS-South side of things, look, I think there's continued positivity there in terms of margin over time, right? I mean, as the marketplace there continues to strengthen, as we have really tightened up utilization there significantly over the past 6 months, what that does is it puts us in a spot to be able to increase prices to a certain extent and which obviously is a benefit to the market.

And then just as you are looking to expand outside of your traditional end markets, there's acquisitions, we're just hoping you could help frame what the potential size of the contract that you're looking at might be just to help frame expectations there.

Sure. Yes, good question and I appreciate it, Doug. Congratulations on the new hunt, by the way, before I forget. Look, I think as it relates to M&A, we don't want to specifically opine on the size of this transaction because the reality is they can vary, right? There have been things that we've tucked in and looked at during tuck-in that are -- they're a little smaller. There are some things we've looked at that are certainly a little larger and in some cases can be called transformative in certain ways.

Look, I think our bias regardless of what we do, it's to do it in a way where we come out of it with a greater degree of operational scale, come out of it with a still flexible balance sheet where we can continue to explore various growth avenues.

And look, the whole goal around this is to continue to increase the enterprise value of the business, right? We think there's a lot of operating leverage in this business. We think there's a lot of commercial opportunity in this business. And I think there are a lot of ways that we can look to explore that.

And frankly, we think enterprise value business is worth significantly more than where the marketplace has us. And so whatever we do and whatever scale and size that is -- and it doesn't have to be a one and done, right? This can be a multistep approach. But whatever we do, it's going to be with an eye towards continuing to increase the value of the business in a meaningful way, but to do it in a thoughtful way.

Yes. And just one thing to add on that. We're talking more inorganic growth right now. I think let's not forget about our organic growth. And I think it's good, Troy, take a few seconds here and speak to our pipeline and what we have organically because it's very robust. It's very actionable. And I think it's very meaningful aside from the inorganic growth.

Okay. Yes, Brad, I think that's the right way to think about it. In addition to the inorganic opportunities that Eric was talking about, look, we continue to evaluate a very mature pipeline of organic opportunities across multiple commercial applications. We're very excited about that. When we look at the opportunities, they encompass a variety of commercial applications, including green energy, energy transition and infrastructure projects also our integrated facilities management. I would characterize the mature pipeline: number one, it's robust; number two, it's actionable; and three, it's diverse, right? So look, I think that's exciting for the business. We continue to pursue it, as I said, very mature, very actionable and very diverse.

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

Yes. Just want to say thanks to all of you for joining us on the call today, and we look forward to speaking again after the new year.

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