Target Hospitality Corp. (TH) Earnings Call Transcript & Summary

Good afternoon, everybody. Next up, we have Target Hospitality, and we have Eric Kalamaras, the CFO. And we're happy to invite him back here for, I don't know how many years in a row you've been attending conferences, but it's been a while. I'm going to pass the mic to you to give a state of the union for Target, and then I will jump into Q&A. Just as a reminder, if you have any questions, please e-mail me or just use the conference moderation tool to present them. Eric, I pass you to mic.

Great. Thank you, Gregg. Thank you, everyone, for joining in. It's great to be at the conference again. It's been a long past year or so. So good to visit you folks. So a little bit of an introduction to Target Hospitality. Lots respire in the business over the past several months, and let me give you a few minutes on kind of what the business is. Target Hospitality operates a network of premium remote accommodation offerings. And in that, we also have a number of services that are truly unique to the industry. So the business is a suite of specialty rental assets that are primarily focused for remote accommodations, primarily in West Texas and in -- also in the Oklahoma area. And we do it in a way where we're trying to provide premium service offerings, we're offering food management services to our customers and also offer a variety of really accommodations, whether similarly you would see in a motel-type structure, albeit our assets are relocatable. We have historically had a meaningful presence with the energy industry, which is why much of our -- many of our clients were energy clients. We also have, over the past several years and has recently, expanded our business substantially into government services, specifically for asylum seeking women and children as well as for other displaced persons for humanitarian efforts that the United States governments are pursuing. And so what that's allowed us to do is take our business that is unique in that we have quite high margins. We have exceptionally strong cash flow generation. And we provide our services under long-term contracts, anywhere from 3 to 4 or 5-year contracts at very attractive margin profiles. And so we're able to engage in this business and do it in a way that provides premium service offering to our customers, but also attractive profile to also our stakeholders as well. And so, when we look at Target Hospitality, the transition over the past year or so, you -- clearly, the pandemic wasn't kind to a lot of industries. Target Hospitality was caught up into some of that. Although, we took that time to work on strategic intentions of continuing to diversify the business, and we did so recently by adding a new contract with the United States government and an affiliated nonprofit agency to materially shift the business as well. So we're -- right now, we're -- looking on a pro-forma basis, we will be about 50% government services and 50% remote workforce accommodations. That's a material shift from what we had a year ago. And we continue to see positive trends, not only in our existing remote accommodations and workforce accommodations business, but we're also seeing positive trends in other opportunity sets to work with the United States government as well as other projects that continue to grow the profile of the business and continue the balance sheet accretion that we've seen really over the past several months. Working hard to continue to reduce debt and increase our liquidity position, which has been quite dramatic over the past few months, and hopefully, we'll continue to see that going into the future. So with -- Gregg, with that, I will pause there and move to the Q&A.

There we go. So it seems like things are on the mend here in terms of your business. You recently increased your guidance by about 11% on EBITDA side. Could you talk about what's driving the improvement? And within that, are you still capturing some of the cost savings we talked about 6 months ago? Then maybe you could talk a little bit about utilization trends, where you see them growing?

Sure. All good questions. So as it relates to the guidance, two things. One, we have continued to see positive improvements across the remote accommodations and workforce accommodations side of the business. Clearly, that's more focused on the energy side, and that has continued to pick up. We have been positive recipients of that growth. And so, we made a number of changes in 2020 that, really due to the pandemic, were in support of our customers that we didn't have to do. Remember, we tend to work under long-term contracts. And so, we take it upon ourselves to work with our customer base and we leave some of that pressure from the contracts that we had, and that caused a little bit of volatility for our cash flows in 2020. And we didn't have to do that, but we chose to do it because we thought was the right long-term business decision. And right now, we're catching back up from some of those changes that we made. Not only we're providing some additional secular growth trends as the resurgence comes back, but we're also capturing what we have, frankly, lost in some of the cash flows from some of those contract modifications, and so that's coming back to us as well. So coupled with that, we also had an increase in activity on the government side of the business. And as a result of all those kind of confluence of events, Gregg, we chose to increase the guidance in the first quarter, and was up about 11%. And so, look, trends are continuing to move in the positive direction for us, and one of those trends is in the cost savings. We have -- certainly, as we look to expand the business. And we've seen additional increase in activity. Certain cost of services, we've been able to maintain pretty well. At the corporate level, we've maintained many of those costs as well. As we move through time and as we continue to increase utilization and make shifts in the portfolio to get utilization up, and then there will be some important utilization shifts coming up, what you'll see, I think, is relation is really starting to appear to approach what we'll call close to optimal levels. And right now, we've been able to put ourselves in a growth where we've been able to really increase our bed count substantially and to play really relatively very little capital. And so, that's been highly creative from a return perspective. And so, we'll look to harness as much of that as we can. At some point in time, we'll reach limitations on that. But I think as we go through the balance of 2021, we expect those -- many of those improvements we made during the pandemic to hold. And you'll just see where some of that shakes out on the personnel front and hiring and the level of people that we can get. But so far, we've been able to manage all of that and keep many of the costs in place.

And as you think about -- where do you see utilization get back to over the next year? Just remind us for what it was at the bottom.

Sure. So we had -- we took -- if we take you back 18 months ago, almost 2 years ago, we were running utilization, high-80s, even in certain months, maybe low-90s. And so, that got certainly lower during the pandemic. We have made some important shifts though. As we've taken and reallocated our assets out of the workforce accommodation side of the business and into the government side of the business, what is happening is you end up seeing this shift. And so, what you'll see relative to first quarter, for instance, is that as we go forward in the coming quarters, the utilization will become much more balanced, and we'll get back to where we were -- it had been previously. Bear in mind, what we're seeing from the government side is those are full take-or-pay contracts. And so, you're effective always at 100% committed utilization there. The part that's a little bit more variable is the workforce side. But again, we -- the way we're able to shift the business and do it capital-light was to take assets from the workforce side and shift that into the government side, that ends up having that effect of creating utilization opportunity on the sticky government side, and then creating utilization uplift that's meaningful on the full contracted part of the energy side. So I think we'll be in a spot where we're really well balanced and really well optimized here over the next couple of quarters.

So as you reallocated assets to government from workforce, did you have to transfer assets? And is that -- what were -- you mentioned the displaced people or that this was serving. Are you -- what market are you serving there?

Sure. So good question. So we had a little bit of mobilization work on existing assets, and that's really coming from having assets that were not being utilized at all and bring those back into service. Really very little capital. In this particular case, we -- one of the nice things that we were able to accomplish is use assets that were largely in place and really just effectively put personnel there. Obviously, we put the staff there. And so, we aren't needing to really move assets, which could certainly add additional costs. And so, we were able to use many of the assets in place. As it relates to people that are being served, it's, again, largely humanitarian efforts for the U.S. government. So the displaced persons are really anyone coming into the U.S. government feels -- that needs a combination. We have the South Texas residential facility in Dilley, Texas, that's been operating for 7 years now. That is as an example. That is for asylum seeking women and children. And so, we may look to shift that mix over time, depending on the U.S. government's needs. But that gives you a flavor of the types of folks that we're helping.

That's helpful. And I know you have some -- you have business related to the TCPL Keystone project. Is this -- is that dead, or is that something that you think there's any chance to come back?

Gregg, I've been doing this a long time, you never say never. But look, I think TCPL, the project, has been, I will say, definitely postponed. I think, there are -- they have not officially canceled that project, right? So certainly, they have done some things on their end. So, look, we remain hopeful. We remain optimistic, but we are not -- as I've said for a few different times in various discussions and calls, we don't -- we didn't have anything into the budget for 2020 in that project. We had very little coming into 2021 in that project. And so, look, we remain helpful, I mean, optimistic and positive around it. But I wouldn't hold out hope that, that project goes in any sort of short order.

Is that an opportunity for relocating assets?

Well, I don't think, in that particular case, there's much in the way of asset relocation. TC, effectively, had title to those assets. And so, I think, to the extent we would need any additional utilization, we've been doing it internally with our existing asset footprint we have on hand, which is -- which was key. We're not outlaying much in the way of new capital for additional units. And so, I think we would look to continue to utilize as much internal capacity we have to the extent we need to go outside, we'll certainly do that. One of the things that we did as opposed to -- we own -- trying to have high returns on invested capital. One of the things we would look to do is, and have done in the past, is not take direct title to it to a new facility, for instance, but perhaps we'll down leasing arrangement with somebody. That way, we are laying out as much capital, but yet, we're still receiving the benefits of the economics of the transaction or the the contract. But that reduces our capital spend. So we try to be flexible in that way. And so, we'll just have to look and see. I mean, there are some things that we're looking at through time that could be meaningful, that may require us to get additional units in place. We will take those on a case-by-case basis and see where we go. But I'll tell you, we're really pleased about where we sit today related to the cash flow profile, the return profile and the utilization profile.

So where -- as you're shifting your customer base, just remind us, what is the -- what's the mix today and percentages? And how do you see that changing over time?

Sure. So 1.5 years, 2 years ago, it was about 80% remote workforce accommodation, and it was about 20% government services. As we sit here today, we're looking at something that for 2021, we expect the average level on that to be closer to 50-50. As we move forward in time, we're hopeful that the shift is perhaps even greater than that. So it's -- and it's not so much about having workforce accommodation that's different than being on the government side. It's really a function of really how do you grow the mix of contracts, right? It's not so much picking and choosing industry per se, but it's really where can you grow contract as much as possible. We have a number of things we're looking at as well outside of certainly the energy space. The reason why energy had been a legacy component that was meaningful was because it was operating -- the Permian was an environment where there was not a lot of organic infrastructure, whether that be food servicing infrastructure, whether that be certainly housing infrastructure. And so, yes, we were able to take remote assets and place them there and put large communities in place for hundreds of thousands of personnel. And so, we're looking at other applications for that to which there could be several that we can take the exact same approach, but just tilt the mix in terms of the customer base. Then so, we've talked before about green infrastructure is an opportunity set for us that we would look to evaluate. I want to stop short of saying what kind of projects those are and where they are. But suffice to say, look, our backlog of opportunity sets commercially is better than we've seen in years. And so, it's a really exciting time for the company. But to answer your question, look, I think we see the mix continuing to shift, continuing to diversify, but yet, continuing to keep margins quite strong. Frankly, that rivals software companies, frankly. And so, we're doing it a way where it's pretty capital-attractive. And it's a unique business model with we have a footprint in ecosystem to scale that is the largest in North America and is not easily replicable.

And is -- so I appreciate that move. There is -- just -- if I recall correctly, a lot of your customers are larger companies. I'm curious if any of this consolidation has impacted that element of your business in any way that's noticeable.

Sure. So the consolidation you're speaking of is really more Permian ask consolidation, largely through E&Ps is really what you're describing. And so, the answer, do you see -- do we see direct benefits to that? Not directly. And then here's why. The customers that we have in the remote workforce side, specifically on the energy side, are very large companies that are either fully integrated or they are companies that are large, large service providers. The -- even a mid-cap E&P company, for instance, does not have a large personnel footprint. Most of that footprint is really coming from the ancillary service providers that are coming from that. And so, our client base, remember, we are focused on long-term contracts. And is there some stock market activities? Sure. But we're taking long-term contracts. And so, you have to think about how you can capture long-term contract 3, 4, 5 years and do that on a full committed revenue and take-or-pay basis. And you're really able to do that with large customers who can fully appreciate your scale of your asset base. That's the key. And use the Permian as an example. In West Texas, that's 87,000 square months. And so, you need to care customers who are capable and willing and need an ecosystem of 20 locations with 15,000 rooms across that base. So companies that have maybe 10,000 acres, that's just not the same as working with companies that are moving their labor and flowing that labor through 87,000 square miles. And so because of that, the consolidation is certainly helpful because, I think, it helps stabilize that particular part of the business, which is good. But really, most of it is coming from the large service companies and the large integrators.

Just as you think about -- I think about -- let me just [indiscernible], you were talking about buying into some other part of the foodservice industry. Where does that stand in terms of -- is that still something you're focused on doing? Can we see M&A there?

Sure. Great question. So let me give some context for the folks who may not have heard that discussion. So when we think about Target Hospitality, it's really 3 businesses that we think about, and that makes up the ecosystem of our company. The first one are the remote accommodations and specialty rental assets, which is really kind of the property, plant and equipment, if you will. The second piece is our hospitality services, right? So all the services that we go to caring for our guests. And the third piece is the logistics and food servicing and food management piece. And just to put in context, if we were to break out that piece of the food servicing and food management, Target Hospitality would be one of the top 25 food management providers in the entire country. We serve over 15 million meals a year of high-quality lean proteins and fresh vegetables. And so, when we think about that business, that really opens up a lot of opportunities for us. Now as we think about growth angle there, the pandemic really upset a lot of that with vacancies across a whole host of workforce areas. And so, Gregg, to answer your question, that is absolutely an area that we're looking at. Facilities management work is also an area we're looking at. But the pandemic has really shifted things on this -- for us on that. The other area we've looked at as well and continue to pursue are our strategic intentions of continuing to grow the government services business, and obviously, we're doing that organically. But we would absolutely look to do that and have looked at it at a corporate transaction level as well.

And as long as you're reviewing your business, maybe you can talk a little bit about your recontracting risks. I know you -- I believe, you have that at about a 6-year average life on your contracts. Can you just talk about how they roll off, and how much is rolling off in a year? Is it 1/6, or where are you in thinking about that?

Sure. So you're right. So we have a pretty extensive 6-year average life on the contracts. I think, the way you think about the contracts are as follows. We went through a pretty extensive initiative last year during the pandemic, as I had mentioned, to work with customers and to relieve them out of some of these true take-or-pay contracts. And we did that in a partnership role because we felt that was the right thing to do for our business longer term. In return for that, what we received was extra term, and in some cases, we received many years of extra term. And in so doing, we also kept rates quite steady. And so, because of that, what that means is our forward contract volatility in roll-off is really very minimal. And so, that was really one of the side benefits of doing that. And so, as we think about the next 2 or 3 years, we have very little roll-off coming off from the contracts. But really, I think, when I think about the bulk that roll-off will start happening in kind of 2023, '24 and '25. So we have a terrific headway before we even think about really even entering into any of those discussions at all.

So you're generating free cash flow now and you're paying down debt. Can you talk a little bit about how you think about returning value to shareholders? Is it simply just reduce leverage? I think, you actually reduced your target from 4x to 3.5x. But could you walk us through holistically how you're thinking about it?

Yes. That's a great question. So capital structure optimization is really important. And so the way we think about returning capital right now is, one, how do you position the business to have maximum flexibility and to facilitate their growth intent, okay? That, to us, is kind of rule #1. And then from there, there are other things you can think about in terms of creating value back to various stakeholders. But really for us, the most value all stakeholders are going to get is putting a capital structure in place that is patient and it's flexible, that's efficient. It allows the company to grow as rapidly as it can within all those appropriate constraint. And so when we reduced our leverage target, what we were saying was, look, here's a temporal target for 2021 that we're going to set, and we're going to lower that target down because cash generation is happening faster than we expected. It wasn't just say necessarily that, that's where we believe the ultimate leverage needs to be for the business. Now as we move forward, we'll take our target, and we'll get that to a more optimal spot. Eventually, for this business, I think the leverage target needs to be somewhere in the 3x area. Could even be a little bit less than that, depending on your strategic transaction opportunity sets and how you feel about balance sheet flexibility. So look, we'll continue in the meantime to reduce debt by all in any means possible. I think that's the best prudent thing. I don't want to get in front of the Board. We haven't -- but we have not brought any other sort of other initiatives to this point. But as we continue to create cash, all things remain open on that front. But I think, first and foremost, it's really about how do you position the business for additional growth, how do you position it for additional diversification, and how do you do that, while keeping the capital structure intact at levels that are at or better than where they are today.

As you think about additional growth, M&A, you talked about that in some part -- one part of the business. What is the opportunity set for you? And where will you future participate?

Sure. So looking at a number of transactions that are -- some are smaller in nature, some of it more bite-sized in nature, again, to try to cut the business in an appropriate way, really, to add on to various services that are complementary to what we do today, but not so large that we're looking at wholesale transformations here. Again, we do operate in an industry where we are a leader. And so we're looking at things that we think will add immediate value to the services that we offer, but will also bring immediate value to all of our stakeholders as well. And so we think about that, it really has to fit within those 3 pillars that I was describing earlier about how we think about Target Hospitality. We're not trying to go out and do anything that where we don't clearly understand all of our corporate development initiatives, right? We clearly understand where those are. And so we're seeking any opportunity that we can to, to continue to grow those value chains because that's where we think the best avenue of growth is over time. In addition to that, like I said, we also have a tremendous pipeline of organic opportunity sets that are building. And so there will be this natural tension between where do we allocate capital and how we allocate capital and how we position growth. And yes, we'll have to see how all those manifest and how those things germinate and make those decisions on a case-by-case basis. But we have line of sight on some things transactionally, and we'll just see where we'll go here through time.

And then just you sponsor, your largest shareholders. What's your sense of their -- how they exit this investment, what the timeline is?

Sure. It's always a tricky question because I think like any good shareholder when things are starting to have in a direction that you favor, when do you want to jump off the ship. So only thoughtful about TDR to your point here. They are a long-term investors. They've been in this business for really a long period of time. One of the unique things about TDR is that they have a really long-term horizon, and they're excellent partners in that way. And the opportunity set to continue to grow is, I think, really, first and foremost, for them as opposed to exit. I would say that we have a fair bit of work to do prior to any of that, but I always let them make that determination.

And I had a question here, but I'll ask someone else, hands up here, on the Veracast. It said, how are you thinking about refinancing the 9.5s there? And then, there's a lot of -- some other comments in here, but they're basically suggesting, why not now when the market conditions are favorable?

Sure. They are favorable, I don't disagree. And so, look, that is -- as I mentioned before, optimal capital structure is a favorable thing to have. I would just -- suffice to say that I'll never specifically speak about forward capital market activity. However, I would say that all things are on the table. And look, we're certainly mindful of the opportunity sets there. And we'll look at that on a case-by-case basis and make that determination against similar corporate initiatives that we have. But look, clearly, we see what they're seeing as well, and we certainly don't disagree with that. And so we'll look to take advantage of that when we can.

I recognize you don't admit carbon backside as a waste product. But I'm just -- I'm curious how you're thinking about the energy transition as in terms of you do serve some people that do that. And then in general, where are you with your ESG strategy? How is that impacting? Is that impacting your decision-making at all?

Yes. It's a great question. So the answer is yes. We certainly do think about it. I think you have to look at ESG in a broader context as opposed to hydrocarbon -- not hydrocarbon. I think we look at ESG in the context of holistically, how does that fit into our strategy of business growth and how does that fit into our strategic intentions as opposed to just ESG for ESG say? What that means for us is there are initiatives that are absolutely aligned with how we think about ESG. So when we think about green infrastructure, for instance, there is an opportunity set out there that continues to emerge, continues to be opportunistic for us. That fits exactly the wheelhouse to which we play. That clearly is ESG-oriented. It clearly is exactly what we do today. It has diversification benefits for all parties. And so those are the types of things that we look at as well. In addition to that, there are corporate things that we look at in terms of how we benefit and folks from the governance side of things as well that we'll look to explore over time. So for us, it has to be holistic in nature. And clearly, I think there's a transition on the energy front through time. That being said, there can also be an opportunity here where the energy side of the business, whatever your time cycle looks like, it could be able to open even intermediate term. Because of the ESG components and because the constraints put in place, it could actually turn out to be fairly favorable for the energy side of the business as well. So we want to be cautious about how we think about it. But suffice to say, it's not lost upon us, and we're absolutely pursuing initiatives that fit within the growth of our business as well as just being good corporate citizen.

And then, this is my last question for you. Just -- you talked about different opportunities on the M&A side. Do you take consolidation with some of your other large peers is part of -- is that reasonable to think that's going to happen in the sector, or do you think that's not likely?

Well, I think consolidation needs to have a strategic value to it, aside from just really scale, right? So scale for us is relevant. It's important. But to us, there's a much more impactful decision that can be made around what kind of scale are you bringing in and how are you doing it. If it's uncontracted scale, if it's scale that brings in volatility, those -- look, those are just much less interesting to us. What we are trying to do is position our business as we have in a way, which is contracted to this firm, which has a stickier customer base right where it's in an ecosystem where we think we have an element of competitive advantage versus in other parties. And so, I think, we want to be very mindful around diluting any of that. Not to be necessary we wouldn't look at it, we wouldn't evaluate it. But I think for us, there are opportunity sets out there that are as compelling or even more compelling for us. And so, we'll just evaluate those and see where it goes, but it's a question we get asked often, and it's a great question. Yes. But I just -- we just have to put that on par with some other strategic intentions that we have as well. And I'll just kind of benchmark those and see how we feel about them at the time.

I got one more question here. The question is, recent government contracts leave it to 1-year term. Have renewal discussions begun?

Yes. It's a great question. So effectively, all contracts with the U.S. government, in most cases, are appropriated annually. So even if you have a 5-year yield, for instance, you still are subject to annual appropriations. So what that means is that you have to be careful about how you think about the terms of multiyear contract deals with United States government when you know you go through an annual appropriation of the budget cycle. So what that means is when we signed initial 1-year agreement, it was with the intention that, that contract continues to roll in an evergreen fashion. And so we just put that contract in place. So contract discussions have not begun for a new role period, albeit because conventionally, we expect it to continue to roll. So we haven't entered those yet. There will be time to do that. But like I said, these are done in annual preparations basis anyway. I think when you have to sit back and look at the strategic nature of the services that we're providing and why we're providing them. And then, you have to ask yourself a question of, does that feel like a 1-year opportunity set for anybody? And certainly, we didn't expect that. And so I would ask the audience to think through that, and we'll see where all this goes. And we'd love to be able to spot to report that we're working through contract negotiations here. But we're still quite a way away from that. But like I said, we did that with the intention of the assets staying in place, just like they do with our Dilley facility. Again, that's appropriated annually as well. And so -- but in every year, that goes to the same budget appropriation. And so, that started off as a short-term deal and ended up, here we are, 7 years later, and now it is the gold standard for the industry and United States government.

Look, we're at the 35-minute marker. Just want to thank you, Eric, for attending the conference and making yourself available. And operator, we can end the call.

Thank you.