Target Hospitality Corp. (TH) Q1 2021 Earnings Report, Transcript and Summary

Good day, and welcome to the Target Hospitality First Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mark Schuck. Please go ahead.

Thank you. Good morning, everyone, and welcome to Target Hospitality's first quarter 2021 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 24, 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'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. In addition to discussing our first quarter performance, I will touch on the continued momentum we are experiencing across the business and indications of further strengthening through the balance of 2021. We continue to see signs of an improving global economic recovery. Increasing global vaccine distribution is fostering renewed commercial activity and global demand. These factors have supported meaningful improvements in Target's operating metrics through the first quarter of 2021. This is even more impressive considering the severe winter weather experienced in February, which had an unprecedented impact on regional commerce within our Permian Basin segment. As a result of the storm, we experienced limited financial impact of less than $1 million and no lasting network disruptions. This is notable and illustrates our operational continuity and network integrity, which enabled us to meet customer demands with few service interruptions. The new partnership within our Government Services segment is off to a strong start and illustrates Target's superior operational flexibility and scale. These attributes allowed us to rapidly mobilize and begin servicing our customers' needs. Now turning to the first quarter operational trends. We continue to see positive momentum in customer demand, which contributed to increases in occupancy and utilization during the quarter. Utilization increased 800 basis points from the fourth quarter of 2020 as customer activity and labor allocation for our premium service offerings continue to build. The efficient operating structure we have created allowed us to meet increasing customer demand with little incremental cost. This supported sequential margin expansion of 900 basis points from the fourth quarter of 2020. Our network scale, combined with our premium service offerings is unmatched. These attributes enabled us to effectively increase our market share, our service offerings and capabilities to continue to drive customer pool. In the first quarter alone, we added over 20 new customers and continue to realize an over 90% customer renewal rate. As we think about the second half of 2021 and into 2022, we are encouraged by the improving economic outlook. The pace and momentum of post-pandemic reopenings continues to improve, providing greater confidence in the cadence of demand recovery. We continue to benefit from our expansive network and premier service offerings where our first-class customers find added value in allocating labor to our premium network. We have seen meaningful increases in labor allocation from our top 10 customers who continue to see headcount demand increase as commercial activity strengthens. This promoted enhanced network optimization, with several lodges being fully utilized during the quarter. Additionally, the expansion of our Government Services segment illustrates Target's ability to expand customer reach while securing high-quality contracts that provide significant revenue visibility. This positions Target as a trusted provider of critical hospitality service offerings and solutions, establishing a platform to continue developing strategic long-term partnerships with government and nonprofit organizations. Target has a unique set of capabilities and core competencies that translate across a variety of end markets. These attributes position Target to evaluate a range of organic and strategic growth opportunities, both within our core business segments and adjacent end markets. As we continue to evaluate a pipeline of diversification and expansion opportunities, we will remain vigilant on the principles of identifying scalable opportunities that increase revenue visibility while enhancing our financial strength. We entered 2021 encouraged by signs of improving customer demand, supported by global stimulus and sustained progress in post-pandemic reopenings. The pace of these improvements have exceeded our expectations. We anticipate these elements will continue to support positive momentum in customer activity and provide the backdrop to further enhance our financial strength through the balance of 2021. I'll now turn the call over to Eric to discuss our first quarter financial results in more detail.

Thank you, Brad, and good morning, everyone. In the first quarter, we experienced continued improvements in our operating metrics and realized sequential quarterly improvements in utilization as we continue to see increasing demand for our premium service offerings. First quarter 2021 total revenue was $45 million, and adjusted EBITDA was approximately $16 million. Due to the SEC's recent guidance change regarding warrants issued by Specialty Purpose Acquisition Companies, which Target merged with in early 2019, Target restated its previously issued 2020 10-K on May 6. The change will result in the warrants being classified as liabilities rather than equity, as has been historical practice. The restatement will be noncash in nature and does not impact the previously communicated non-GAAP metrics, including adjusted gross profit, adjusted EBITDA or discretionary cash flow. Now turning to our segment performance. Our Energy segment delivered first quarter revenue of $26 million compared to $54 million in the same period last year. This decrease was driven by lower utilization due to the pandemic, which created a meaningful reduction in customer demand. Our Government segment produced quarterly revenue of approximately $18 million compared to $17 million in the same period last year. The increase was a result of the $118 million revenue contract executed on March 18, 2021, which contributed approximately $5 million of revenue in the quarter. The year-over-year increase was offset by a noncash decrease in deferred revenue as a result of the successful renewal and extension of our legacy government services contract, which occurred on September 2020. As a reminder, the legacy contract extension added five years of term and approximately $265 million of [committed] (ph) revenue. Recurring corporate expenses for the quarter were approximately $8 million. We have created an efficient operating structure that will allow us to continue meeting customer demand and support additional growth with minimal incremental costs. We anticipate recurring corporate expenses to remain around $8 million per quarter through 2021. Total capital expenditures for the quarter were approximately $3 million, including maintenance capital of $2 million. We ended the quarter with $6 million of cash and $400 million of total debt. Because we are achieving a high level of cash generation, coupled with minimal capital spending, we have a high return on invested capital from our new contract that allowed us to meaningfully reduce debt after quarter end. As of May 24, Target had approximately $379 million of total debt and had outstanding borrowings of $39 million under the company's $225 million revolving credit facility. As a result, the company has advanced its year-end 2021 Target net leverage ratio to below 3.5 times. Now turning to our 2021 outlook. The economic recovery continues to build, buoyed by global fiscal and monetary stimulus and continued post pandemic reopenings. These elements supported Target's strong first quarter results and provide encouraging signs of continued momentum through the balance of 2021 and into 2022. Target anticipates consistent improvements within its legacy markets, where it continues to benefit from its premium service offerings, network scale and efficient operating structure. The improvements in customer demand have outpaced our expectations, providing support in the pace of recovery through the balance of the year. Well, additionally, approximately 94% of Target's 2021 revenue is under contract and approximately 72% of contracted revenue has committed payment provisions supporting increases in the 2021 revenue outlook. As a result, we have raised our full year 2021 financial outlook by 10% for revenue and 11% for adjusted EBITDA and 70% for discretionary cash flow. Our 2021 outlook now consists of revenue between $260 million and $270 million, adjusted EBITDA between $97 million and $107 million and discretionary cash flow between $65 million and $70 million. We have changed our capital spending outlook to $15 million to $20 million. We anticipate our discretionary cash flow to be largely directed towards further strengthening of our balance sheet and are targeting a net leverage ratio below 3.5 times by year-end 2021, with well over $125 million of net liquidity. We expect this trend of continued balance sheet improvement to continue well into 2022. We believe Target is well positioned to continue benefiting from improving global demand and continued post pandemic reopenings. The structural advantages of our business model provide for significant cash generation while allowing us to be prudent with our capital allocation. Our disciplined approach aligns with Target's objectives of identifying and executing and value-enhancing initiatives, while continuing to create value for our shareholders. With that, I will turn the call back over to Brad for closing comments.

Thanks, Eric. We have created a premium network and developed a unique set of core competencies, which allow us to provide comprehensive hospitality service offerings and solutions to best-in-class customers. Our first quarter performance exemplifies our strong operating position and ability to provide customized solutions to meet our customers' varying needs. As the economic outlook improves and momentum builds, Target's operational flexibility, network scale and capabilities position the company to quickly respond and serve a variety of customers across diverse end markets. These attributes underpin our ability to continue producing strong financial results while utilizing this momentum to materially enhance the financial posture of the business. I appreciate everyone joining us on the call today, and thank you again for your interest in Target Hospitality.

[Operator Instructions] And the first question comes from Stephen Gengaro with Stifel. Please go ahead.

A couple of things for me, if you don't mind. And what I'd like to start with, if you don't mind, is when I look at the Permian piece of the business and I think about the gross margins, and they had kind of come down from the mid- to high 50s in 2019 to the low 40s currently. How should they progress? Like so when you think about the guidance that you've given for the year on EBITDA, will they move back towards the 50% level this year? It seems like they would have to, to get to your guidance. But I was just curious if you could add some color to that.

This is Brad. Let me speak on that first. As we looked at 2020 with the pandemic, you would expect to -- they definitely decreased throughout that. But towards the back half of 2020, we started to see that increase, and we're still seeing that today. So what I -- when you put back in the government piece as well and start to increase your margins throughout the back half of the year and into -- even into 2022, we definitely see these margins coming back to pre-pandemic levels quickly as we move throughout the year, especially when you add in the government piece of the business.

Yes. Steve, I think the one thing that I might add is where we've seen some of the pressure on the margin is really what we call the Tier 3 revenue, right, which is really the uncontracted portion. And that part can switch on and off quite quickly. As we see the ongoing normalization across -- really across the energy value chain, we'd expect that to come back, [Indiscernible] back pretty sharply towards the back half of the year, we'll see how it goes. But then can come back pretty quickly.

But is my assumption that based on the government margins and the piece of the business that's government, you -- I can't get the model to the EBITDA guidance without having Permian margins on the gross profit margin level getting to 50%. Is that -- is my math right?

Your -- I mean maybe we can take it offline and see what the timing of it, what it looks like. But I would say you're going to have to see a continued improvement to the back half of 2021 to get the numbers, which is what we're expecting. So let's have to talk through what -- kind of where you're at

And it's the way it's trending now.

That is the way it's trending. And so I think you're on the right -- you're on the right track. Call, Mark, and we can sort out.

Okay. No, I appreciate it. That's helpful. And then the other question I had was just as it pertains to the contracted revenue. So you obviously have a large chunk of revenue under committed contracts and a portion of that's government, a portion of that's clearly in the Permian as well. Are you -- what are you seeing on the oil and gas side as far as conversations with customers, renewals, et cetera. I would imagine it's trending well, but I was just curious to get your take on kind of how the market's been developing.

Stephen, this is Troy. Yes, in regards to the oil and gas, the energy front, conversations with customers are very constructive. They remain consistent. And as we think about renewals, look, we're proud of the fact that we've been able to maintain, even through the pandemic, that 90% customer renewal rate. And that hit rate is pretty impressive. But it comes with a lot of work, great relationships, doing business with customers for a very, very, very long time and continuing to deliver on our service quality and flexibility on the network. So as we look at the top 10 customers, they've really returned to work very kind of fulsomely here in the first quarter. And we expect that 2021 will be a steady increase in activity kind of throughout the year, especially in that kind of top 10 category that's contracted on a long-term basis. So very constructive and a positive outlook really for the balance of the year.

The next question comes from Scott Schneeberger with Oppenheimer. Please go ahead.

Gentlemen, just curious about on the new government partnership contract. It looks like, I think you had quantified what that total number of beds was and then discussed what number of beds that was actually in the Permian. I was just curious what is occurring, the delta, the implied delta there. What are those new beds, where are those beds coming from? And then I'll ask a follow-up.

Yes, Scott, maybe try rephrasing that a little bit. I'm not sure I entirely caught the intent of your question. Is it about where the beds are being displaced from and where they went to? Is that the question?

Exactly. Yes. To be specific on the numbers, the Permian, it's said 2,400 were reallocated. And then the total under the new contract is 4,000. So the difference of 1,600, just if you could speak to that a little bit. I mean, to both pieces of it, just give us a little bit more perspective of what that activity that is? Is it new build? Just a little bit more color around that.

No. None of it's new build that we did. Look, one of the things that's probably a little confusing is it's the number of beds per room, where we have mostly one. Some of this to fulfill the contract they wanted, if you will, 2 per room. So we're looking at beds versus rooms, but we did not go out and spend capital on purchasing new equipment. It was all in place. And some of it was mothball that we reopened and put back in this contract.

Yes. And what makes this a little bit -- you don't have real run rates to work with right now based upon the first quarter numbers, right? So let's do this. So I think we can get you there, but let's do it offline because it's -- you're only dealing with a couple of weeks in the quarter. And so you don't have prompt numbers to look at. So we can try to -- try to help get you there a little bit closer offline.

Okay. I appreciate that. And then -- and I may have missed it in there when you were speaking to the overall contracted value, but I don't think so. The -- this new partnership is a 1-year contract. I don't think I heard you say that it was extended another year, but that is something that is a possibility of a consideration. Could you just discuss what time frame for consideration of that occurring, how we should think about that as far as potential to extend and when that may occur potentially?

Yes, Scott, we just recently signed this, has been in this deal for two months. It's the 1-year deal. So towards the back half of the year, I would say, third quarter, those start to heat up a little bit. That's what we want to see happen. But I would say, look, they're very happy with where we're at today, the performance. So we fully expect this to continue on but true renewal discussions little early to have that discussion at this point. So towards the back half of the year, I think those pick up steam a little bit.

Understood. And then just a final little quick one in there. Just on the pipeline, the revenue was up year-over-year, but I know that's in a bit of a wind-down phase. If you could just address why that was a little bit larger than we may have expected in the first quarter and [stats] (ph) going forward in that category?

Yes. And I think the -- I guess the good question I would ask is back is if you give me a little color exactly where you want to, I guess, get out of the question because I'm not sure I fully caught what you were trying to get at.

Yes. No, I was surprised to see that the Keystone project was up year-over-year in revenue. And just wondering what that was, what was driving it because I wasn't expecting a lot of activity there.

No, it's a good question. So you have to remember that there is a -- this is a long-duration project, right? And so as even though the activity got some press, there were still some activities that we still had to wind down, right? So that's really all it is. And so I think you would expect -- look, I think we're probably not going to see much more of that. But that's really what that was. And again, it was only -- it's a minimal amount, right, particularly when you look at the gross profit or on an EBITDA basis, but there was a little bit of revenue that was residual.

That's what I thought. I was just checking to see if there was something unforeseen there that may add to that stream, but it doesn't sound like it.

No. I wish it was.

[Operator Instructions] The next question comes from Doug Becker with Northland Capital Markets. Please go ahead.

You addressed the potential of extending the nonprofit contract. I was wondering if you could just give any color about the potential of expanding it just given the problem isn't going away. So I just wanted to get any color you could offer there.

Sure. This is Brad. Let me just touch on our overall sales pipeline, and then I'll touch on government. But our overall sales pipeline today is stronger than I've seen it in a long time. What's encouraging is the potential demand we're seeing across diverse markets. We haven't seen that in a while, especially since the pandemic set in. So this provides a lot of opportunity, not only in the government, but other areas as well, natural resources, government services, infrastructure projects, et cetera. So strong pipeline -- sales pipeline right now. And then on the government, let me just say that the projects we have in process today, they're going well. The end user is very happy with our performance, which helps to set us up for other opportunities. The demand for the same services we're providing now has not went away. It's still very strong and very real. So I think we're set up to do some things down the road. I don't want to comment on them directly, but we're definitely setting in a good pole position for some of these as we move forward.

Definitely sounds encouraging. And as we think about that pipeline, any way you can frame the opportunity outside the oilfield, whether it's government or not government?

Troy, do you want to touch on that?

Sure. Yes. Doug, Troy Schrenk here. Look, good question. Look, I think Brad captured really the view on the pipeline. Pretty robust as we think about it outside of energy and natural resources. You look at the opportunities, again, related to the new administration and their focus as a government and where those dollars will be spent, those are opportunities that were in pursuit of, right? So it's clear on our end, as we think about the business from a capital projects perspective and infrastructure and government services, that there's an ideal opportunity set out there for us to prosecute. And look, I think we're well underway. I align with Brad that don't want to forecast when those are going to occur, but I think we're much more optimistic today than we were in 2020, certainly on a pipeline basis for sales opportunities.

And I might have missed it, but just the bump in CapEx, just what's driving that?

Sure. So a couple of things. So one, we have seen some additional -- I think as we indicated in the script and in the release, we're continuing to see positive improvement across the energy space, right? So we are expecting some additional capital there. But also, as it relates to the new contract that we're seeing as well, there's some additional moneys that we'll be spinning on that as well.

[Operator Instructions] The next question comes again from Stephen Gengaro with Stifel. Please go ahead.

Just one follow-up. I was -- when you're looking at CapEx, and it seems like you're going to be generating pretty strong free cash for the next couple of years. Is there a target -- I mean, I know you gave good guidance and you improve the target leverage at the end of the year. Is there a target at which point you start to think about other uses of free cash as far as returning to shareholders? And I know we're not there yet, but you're going to be generating a lot of cash. Just curious how you're thinking about that.

Yes. It's a good question. And it's -- and thanks for asking it. So the answer is yes. I think returning cash to shareholders can happen in a number of forms, right? And so that can come through, obviously, dividend share repurchases, outright -- and debt reduction and which then lends you to have the ability to pursue transactions. And so look, I think we don't want to get in front of the Board on where we are with all that. I would suffice to say that we are intent on growing the business. And I think that would lead you to more of a conclusion that's more transaction-oriented. But the reality is that all things remain on the table all the time. And clearly, we are -- and you're right, we will be in a spot to use the balance sheet and some capacity to accrete value to the shareholder. And so we will look at all ways to do that.

And one more -- and this might be for Troy, but the -- we hear more and more about sort of digitalization in the oil patch. And we've clearly heard some things on -- obviously, with COVID, there's maybe a little bit of a higher awareness of folks at the well site. It doesn't seem like there's a big impact on your business from that perspective. But I'm just curious, when I think about your Permian/Bakken activity growth, do you think it's fair to think about rig counts and completion activity as still being pretty basically pretty good drivers to understand the growth in that business over the next couple of years?

Yes. Stephen, yes, look, clearly, we still evaluate those data points, right, as you think about completions and new well additions, permits. There's -- as we've talked about in the past, there are several key data points that we continue to monitor very, very closely on a leading indicator basis. Look, and there's no better intel than straight from the field. And I think that's where as we start to triangulate on the data versus what's happening in the field, we do such a good job of that and putting those two together and really coming up with a good sound fundamental view of the business. And I think that's where we have really excelled, right? We've got the network to be able to service the customer based on the demand forecast that they've given us, and then we pair that up with the data sets. And I think that it gives us a pretty good view of the business in ‘21 along, obviously, with the visibility on off of our contracts. So short answer, yes on those two key data points. In addition, we're always evaluating other data points as well to drive the business.

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

Thanks to all of you for participating in the call today, and thanks for your interest in Target Hospitality. We look forward to speaking with you on our second quarter call. Thanks. Have a good day.

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