Greetings and welcome to the Target Hospitality Fourth Quarter 2019 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to our host, Mark Schuck, Senior Vice President of Investor Relations. Thank you. You may begin.

Good morning, everyone, and welcome to Target Hospitality's fourth quarter and full year 2019 earnings call. The press release we issued yesterday outlining our fourth quarter and full year 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. 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, March 12, 2020. 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 on 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'll now turn the call over to our Chief Executive Officer, Brad Archer.

Thanks Mark. Good morning, everyone, and thank you for joining us today to discuss our fourth quarter and full year 2019 results. Before we get started, I would like to take a second to acknowledge the recent volatility in global financial and commodity markets, which have consequently put significant pressure on the price of crude oil. These events have created macro uncertainties that have rippled through the markets, and we will continue to closely monitor any potential effects to our business. Now, turning back to 2019. I want to first look at the cumulative steps we have taken in the first year of being a public company to solidify our competitive advantage and add to our unmatched network of first-class communities and service offerings, while strategically positioning Target to produce industry-leading returns over the long term. We created strong operational momentum throughout 2019 and continue to position Target as the leading provider of specialty hospitality accommodations and services in the U.S. We successfully integrated two acquisitions and combined with organic bed additions, increased our average utilized beds 44% to a record of over 12,000. We expanded multiple communities as demand for our premier full turnkey services remained strong in the heart of the Permian Basin, the dominant hub of U.S. energy production. We have effectuated this growth in a manner consistent with our core focus of aligning with the right customers in the right locations and being disciplined with our capital allocation, which has consistently allowed us to achieve attractive returns. In the second half of 2019, we saw a reduction of growth in the domestic shale plays, and the Permian Basin has not been immune to this moderation of activity. This impacted capital spending levels in the second half of 2019 and was more pronounced than expected, impacting our…

Thank you, Brad, and good morning, everyone. I will begin with the discussion of our results, review our capital program, and conclude with details on our recently announced 2020 outlook. In the fourth quarter and full year, we continued to benefit from our growing network, including acquisitions, new builds and expansions and remain focused on operational execution and the integration of these assets into our network. While our fourth quarter results were modestly impacted by the headwinds that persisted within the energy end market, as well as a slower than expected pace the TransCanada pipeline project, we still achieved excellent margins with a growing network of available beds and. importantly, continue to generate significant discretionary cash flow. For full year 2019, total revenue was $321 million, an increase of 33%, compared to full year 2018. Adjusted EBITDA was $159 million, an increase of 36% compared with the same period last year with an adjusted EBITDA margin of 50%. The year-over-year growth in adjusted EBITDA was primarily driven by approximately 4,400 new bed additions as a result of the Signor acquisition and approximately 1,500 new bed additions from new communities and expansions, which contributed to over 40% growth in both average available beds and average utilized beds. Turning to our segment performance. The Permian Basin delivered fourth quarter revenue of $53 million, an increase of 6% versus the prior year quarter. This increase was primarily driven by an increase in average utilized beds as a result of the Signor integration, as well as new community additions and expansions. Average available beds increased by over 2,000 or 29% compared to 2018. ADR decreased by $2.80 primarily from lower average ADRs at acquired Signor communities and softness in the uncontracted portion of the business. We have completed the Signor enhancement program and continue…

Thanks, Eric. Before we close, I want to acknowledge the ongoing global concern over the coronavirus. We take very seriously the commitment to provide safe and healthy hospitality services to our customers, and the coronavirus has not impacted our lodges, employees or customers. We continue to monitor the situation and take all necessary steps to ensure a healthy workforce in our lodges. In summary, while we did experience sustained headwinds through the back half of 2019, this provided an excellent illustration of the value proposition we’re able to provide our shareholders through the competitive advantages we have created. We entered 2020 with positive momentum in our core business. While we continue to generate significant discretionary cash flow, we remain focused on disciplined capital allocation and aligning with the right customers, which we believe truly differentiates Target. Our committed focus of developing long-standing relationships with large well capitalized customers provides an unmatched mutually beneficial relationship that is truly a win-win for both parties. We have positioned Target with a solid financial foundation from which to execute on its strategy, while maintaining consistent and attractive returns for our shareholders. I appreciate everyone joining us on the call today and thank you again for your interest in Target Hospitality. Operator, you may now open up the line for questions.

Thank you. [Operator Instructions] Our first question comes from Stephen Gengaro with Stifel. Please state your question.

Thanks and good morning. The...

Good morning.

Good morning.

When we think about the guidance that you guys provided, and maybe you could sort of help sort of, I guess, with the definitions of the terms you're using to help me kind of triangulate, but – so 55% of the midpoint of your guidance is, I think, $172 million of revenue. So, I'm taking that to be locked and loaded and unwavering. What's the difference between the 55% and the 85% and how much wiggle room is there in that 30% of revenue?

Hi, Stephen. Good morning. This is Eric. So, the 30% that you're referencing is really – there are really customers that are under contract agreements, most of which have exclusivity provisions tied to them. So, those are rooms though that while they're connected to our network, they have yet to determine the timing or necessarily the amount of rooms that they would eventually take. So, said differently, if they are – in many cases, if they are going to use rooms, they're going to use them in our network, but they have yet to specifically define time or an amount.

Let me just add to that a little bit. This is Brad. Eric talks about not committing maybe time and amount; these are folks that are using the large in most cases today. That could be used in 50 rooms, in some of these companies; it could be used in 300 rooms on the exclusivity. So, when you talk about wiggle room here, let's just – we all know what happened in the past four to five days. What we don't see, if the guy that has 300 employees going down to zero. So there's some – will there be movement in his number if he loses some work? Yes. But he still require to use us if he is in the Permian Basin. Okay? So that's kind of the wiggle room in that. You can't stay in a hotel, you can't stay in another competitor's lodge within 40 to 50 miles of ours. So there is some wiggle room there, but it can't just all of it go away unless he loses all of his business. So, it really depends on that customer, but there is definitely a contractual nature between both us and that group.

So, is it fair to say that that 30% is almost – it's almost completely dependent on that customer's activity level, whereas the 55% is – you'll get paid regardless of activity levels?

Yes. The 55% is meant to designate really regardless of activity level. The 30%, as Brad mentioned, we can have those customers today, but that can be variable based upon their activity amount. It just happens to be that when they do have usage is going to be in our facilities.

Okay. And…

Yes, and just one. Some of these are some of your largest oilfield service companies with many lines of business, right, under this exclusivity agreement. So, that's where I take a view on the business that it's not going to all go away. These are long-term mutually beneficial relationships, it's been there 10-plus years some of them. And now they're just under an exclusivity contract that gives them some more flexibility.

So, one follow-up and then one other question, just – I just try and make sure I understand completely, are there customers, let's say that are part of both buckets, both part of the 55% and part of the 85%?

Generally not, no.

Okay. Okay. And then, can you just give us a quick update on the government side, what's the status of the contract? How do you feel about it going forward? When does the renewal discussions come up, etcetera?

Yes. Look, the government pieces, and I always say this on the call. It's a very predictable business, right. It's facilities management, we do the catering and it just continues to perform year-after-year. We feel great about that contract. It doesn't come up for renewal until late next year in 2021 so sometime after late in the year is when we'll start to have those discussions in early into 2021 with the counterparty, but at this point, there is no changes in that facility.

Great, thank you.

Our next question comes from Jeff Grampp with Northland Capital Markets. Please state your question.

Good morning, guys. Maybe sticking on the last topic with you with the government question, is it – are those discussions based on kind of how you guys see this playing out predicated at all on this upcoming election cycle or is that just more related to the timeline of – in relation to when the contract term is ending up? Just kind of wondering how you guys view, I guess, the timing of that,

This was built under a democratic President. We don't see that playing into it too much. There is definitely a need. We're the only one in the U.S. like it. So it is more about just when the contract ends and when we start those negotiations, and not more, if you will, about the Presidential race.

Got it. Understood. And I was hoping you guys could maybe talk about obviously super-volatile oil pricing environment. Can you guys talk about your experience in the past in terms of conversations you have with customers. When you see these periods, have they or do they tend to come back in terms of asking for any type of modifications of the contract, whether that's ADR or number of beds in the contract. And maybe if you guys can just touch on empirically how that process has kind of gone in the past in terms of kind of revisiting contract?

Yes. Let me first just say, being that the action taken by OPEC just happened, what, 45 days ago. It is too early for us to determine the impact of the events, we'll continue to monitor it, but, look, we have been through this before as the management team years ago and we fared well. We have long-term customers – long-term contracts with them. And look, there will be some of those discussions. I mean, I think all of us right now believe there's going to be a shrinkage of activity, but we're trying to figure out how deep and how wide, right. And when those discussions happen, we'll go back to how we do business, looking at making sure they continue to cash flow. We have some discussions with customers setting down with them, maybe trading term for some rate. Absolutely, we will do that, and that's kind of how we did it in the past. There will be triggers in there to get those rates back up, but we'll always continue, you know it's got to be a win-win for both sides. And then, again, anything that we give is going to be looked at, we're going to continue to generate the free cash flow on that contract.

Got it. Understood. I appreciate the comments, guys.

Thank you. The next question comes from Kevin McVeigh with Credit Suisse. Please state your question.

Great, thanks. Hi. I guess, just on the 2020 outlook, how are you thinking about what price of oil is at 2020 outlook based on? And then, just any thoughts around you kind of utilization levels? And then, ultimately would you expect to see an uptick in bad debt expense based on history in the past or the contract such that there's not a lot of real bad debt exposure?

Sure. Hi. Hi, Kevin. Good morning.

Hi, Eric.

Yes. I mean, a couple of comments on the outlook and then address the bad debt expense, which is a good question. So clearly the world changed a lot from two weeks ago. Look, I mean, it changed a lot from Saturday quite frankly. We will update the outlook and we'll do it thoughtfully. A couple of things to bear in mind, so, if there are, as we think about the 2020 outlook, and there are have events like we had just over the past week or two. There are second and third order effects here that our customers need to react to, so we haven't seen these reactions yet. We will monitor those and we'll work that process with our customers. We also have some variable cost aspects that we can employ here to manage margin, which is historically how we've been able to manage margin through these types of cycles and keep margins at really surprisingly healthy levels, which I think you'll see as we move forward here. So, we'll take all that into account and we'll take that into the [indiscernible] look at some point in time when we get some additional clarity here. I think in the meantime, I just recall that Target because of our cash flow profile of the margin profile, we generate a lot of cash even in difficult markets. Now, because of that, we tend to not see in the nature of our customer base. We tend to not see a meaningful amount of bad debt expense. We did not see a meaningful amount in the back end of Q4, which is what we could have seen, we did not see that. So, I wouldn't expect to see a lot going forward, but we'll continue to monitor it. And like I said, to the extent we have modifications, we should update the market when we can.

That's helpful. And then, just real quick, obviously the business generates a lot of cash. How are you thinking about capital allocation within the context of the near-term uncertainty, particularly given the way the stocks reacted in the near-term – in terms of buyback versus maybe M&A or just any thoughts on, Stephen, the business overall?

Sure. So, I'll give you some context, take a step back on capital and then we'll dovetail that into the allocation aspect of it. When we entered into 2020, we effectively felt like the market was fully supplied and we were really shifting our approach more from Greenfield development to more of a supply and utilization and [work optimization] focus. And the whole objective of that was to focus the business on optimizing the scale that we've built over the past few years. And so, that was the posture we had coming into 2020. What we did as a function of that was, we meaningfully pulled down capital spending, which is what we demonstrated in the outlook that we had put forth. And when we kind of fast forward to today, look, the equity value is absolutely discounted from what we think will ultimately be realistic levels moving forward. So certainly significant value here today, I would say though we generated a lot of cash and even in challenging conditions, but I think it's important to maintain a position of balance sheet strength. So, while I can't comment on specific capital market activities and stock buybacks can be an option. I think the near-term focus really needs to be balance sheet optionality versus optimization at this point. So, we'll continue to evaluate share repurchases just as a part of our capital allocation approach, but I think really what we'd like to do is be able to take advantage of whatever commercial opportunities present themselves over time and put ourselves in the best spot to do that.

Understood. Thank you.

Thank you. Our next question comes from Scott Schneeberger with Oppenheimer. Please state your question.

Good morning. This is Daniel on for Scott. Could we dwell into a little bit on the Permian ADR and utilization trends? Discuss what you've been seeing so far into 2020 and help us with some perspective on how we might develop in the next couple of quarters here as far as what's underlying your outlook?

Sure. So, when we think about the outlook. I think we need to just take, like I had mentioned before, you take the temperature of where our customers are? A lot has changed in the past really in the past week. And so, our customers, we think about the nature of our customer base, I think you have to bear in mind that a lot of our customers are not direct E&Ps, right. Most of them are large integrated producers, very large service firms, and so they are representing a number of, in many cases, a number of a number of clients of their own. And so, like I mentioned before, there are second and kind of third order effects here that they need to evaluate as they think about their labor movements as well. And so, I think, at this point in time, let us evaluate what that looks like, and then we can come back and give you a thoughtful response when we've had a chance to survey that with our customers and they've had a chance to react as well.

Got it. Thank you. That's helpful. If we think about the quarterly cadence of EBITDA and cash flow as it stands now, how do you recommend us to think about that cadence in 2020?

So, I'll take you back to my prior thoughts around how we develop the outlook initially. We were expecting to see and are seeing and we're seeing a ramp up from Q4 through Q3 even a week ago. We were seeing a nice progression of activity really from Q4 levels. And so, we would have expected to see a gradual build up through Q1, Q2 and kind of culminating to Q3, which we always see a little bit of seasonal movement in Q4. So that's what we would have expected. So, you kind of would have seen this natural progression of a glide path heading up into Q2 and Q3. And I think, given what we've seen in the past, in the past week or so, certainly our expectations are likely to move and how we see that glide path. Certainly, I think we can all point to trends that are feeling less certainly less positive than we were even or even a week ago and two weeks ago. So, I think it's important to, as I mentioned before, will continue to evaluate what the market conditions look like, and then we'll have to just see where we go from there and just update accordingly.

Got it. And also, a final one from me, what are you doing with your with your customers to test new work as you're starting at your communities from outside the area to attempt to keep the virus spread from occurring at your locations?

Can you repeat that questions? This is Troy.

Yes, hi. Sorry. So I'm curious on what are you guys doing with the customers if you test new work, is it just starting your communities from outside the area to attempt to keep the virus spread from occurring at your locations? So, it's a coronavirus question.

Yes. Thanks, Daniel. So, look, we've been actively engaged with our customers for several weeks in advance and continue to monitor the situation very closely. We're in active communication with their health, safety and environmental teams of the major customer's preparation for such issues. We have worked very closely and publishing documents and information related to containing such viruses the cold and flu prevention steps that we've all been very become very familiar with in the recent weeks really have leaned on the guidance from the CDC and working very closely with our customers. And I want to reiterate what Brad has said on his prepared remarks, which is, we have not had any incidents related to the coronavirus thus far, and the line is fully prepared with our customers to maintain a safe high-quality environment for our employees and our customers.

Yes. Daniel, I'd just add a little bit to that on what Troy said. Look, we are in the hospitality business in the Food Services business. And this is something we have to do and have done for years in this business. It is the – you kind of take yourself back to when you were growing up, but it's the normal things you should be doing that we have to continually reinforce even more today, but it is the cleaning, it is the coughing in your – into your sleeve or into a napkin. It's the simple things that you have to make people aware of and do, right. I don't want to sound like, I don't want to downplay it, as it is big, but it is something we've looked at for years and it's something we have to continue to do and even it's more focused now we're making sure our customers are involved on a daily and weekly basis. We have calls, we have level 1, level 2, level 3 scenarios. We have a pandemic plan. We're all over this, and it have been. We think it's going to continue on for a little while, but as Troy said, it hasn't affected us yet, but we have a plan in place and we'll continue pushing forward.

Got it. Thank you very much for your time. Our next question comes from Ashish Sabadra with Deutsche Bank. Please state your question.

[My question]. So, just a question on the cost, you talked about a good portion being variable versus fixed, I was wondering if you could talk about what percentage of the cost is truly variable, like if the utilization does boil down significantly. Do you have the optionality of even potentially closing those launches or do you have to keep it open? So, how much is truly variable versus fixed cost?

Yes, this is Brad. Thanks. Good question. One good thing about our business is, there is a lot of variable cost in your cost of goods, really at your large level. Right. If you see utilization start to drop, some of our biggest things is labor, food and those things you can do very quickly to help defend your cash flow, right. So, within – literally within a few days. So, it goes even to electricity, water, things that add up when you have as many locations as we do if you start to see this flow. As far as a percentage, I'll kind of let Eric talk more on specifics, but we – this is exactly if you will, but what I talked about is the playbook, we had to go to back in 2015 to help again to fund the cash flows, keep the margins up, there's a lot of variability there that we can start to pull levers on if we see this start to deteriorate in the utilization.

Sure. So, to Brad's point, there are a number of levers we can pull. When you look at the operating cost lines, there are well cost short run efficiencies you can take, and then there are more kind of intermediate to long-term efficiencies you can take. When you look at the operating cost numbers, I would say, on a short run basis, Ashish you're probably talking about half the costs that are more short-term and variable in nature. So, you think about food costs, certain labor costs, what we call, camp supply costs which can move fairly, fairly quickly up and down with the actual occupancy levels themselves. There are other costs that can be moderated through time, but are not quite as efficiently done. And those tend to be cost that have a longer lead time, they have to manage through. So, there is a short run and a little bit longer term, the longer terms and they're not, we're not talking years, right. We're talking literally a quarter or two or sometimes three, but generally I would say, when you look at that cost bucket of the total operating cost line, you've got roughly 70% there. That's variable. I would say, of that, 70% – the initial 50% is variable kind of on almost on a weekly basis, the delta is done more of on an intermediate term basis.

That's very helpful. And maybe a similar question on the cash flow side. A lot of your expenses as you pointed out are discretionary. For example, growth CapEx you can flex that around. Are there other costs also from a cash perspective, your ability to sustain the free cash flow even in the scenario of utilization coming down, if you can provide any incremental color on that front? Thanks.

Sure. So, you're right. If you think about my comments of a bit ago regarding how we were coming into 2020 and thinking about the market and supply and how we are positioning capital spending, out of the $10 million to $20 million that we had provided us an outlook. We can look at that number, and I would say that there is probably two-thirds to maybe even three quarters of that that is still discretionary in nature. Today, meaning that we can, we can bring back a reasonably decent amount of discretionary spending and which will then flow into obviously the cash flow line. So, further enhancing that, right. So – which is positive, and so we do have a nice flexibility there. And we are actively evaluating that right now and have already begun measures of curtailing some of the discretionary spending. So, from our perspective, look, we have some flexibility of about an additional 15% to 20% on the discretionary cash flow outlook that we already provided. And we'll have to take it and see from there how much more flexibility wealth we'll have, but I would give you that number to work with right now.

That's very helpful. Thanks a lot.

Our next question comes from Stephen Gengaro with Stifel. Please state your question.

Thanks. Just as a follow-up and sort of back to the cash flow question. I know this is probably a hard one to sort of triangulate, but I mean, the way – if we run the numbers, and I just take a draconian case, right, where you're basically utilization your revenue is 55% or 60% of your published guidance. It still looks like you generate reasonably good free cash flow is, I mean, given the leverage you have to pull and given how you're thinking about it, is that reasonable. I mean, I still think you generate $30 to $40 million of free cash, but I'm just trying to figure out for missing something in the, as we work through the income statement. If you want something like that or not or…

Yes. So look, I appreciate the question. We, look, I can't comment specifically on the numbers that you’ve quoted, but I will tell you this, I think I would tell you based on what you've described those feel like awfully conservative numbers to me, but the business generates a lot of cash we have flexibility. There is the ability to have margin, certainly [indiscernible] and it's not environment for margin expansion, but I would call it more margin maintenance that does exist here. And so, look, I think you're – we saw your note. You are on the right track, but let's just wait and see how things play out and maybe we can give you some more color, a little bit through timing.

Great. Thank you.

You're welcome.

Thank you, ladies and gentlemen, we have reached the end of the question-and-answer session. I will now turn the call over to Brad Archer for closing remarks. Thank you.

Thank you. Before we end the call today, I would just like to thank of the employees at Target Hospitality for their hard work and dedication. I could not be more proud of the effort they deliver 365 [years a day] to our customer. Finally, we look forward to updating you in just a few months on our first quarter call. Thanks and have a good day.

Thank you. This concludes today’s conference. All parties can disconnect. Have a good day.