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

Good afternoon, everybody. Welcome to the afternoon session of Bank of America Leverage Finance Conference. It's my pleasure to have Eric Kalamaras, CFO of Target Hospitality. It's always my pleasure to introduce Eric as he was at one point, my competitor. And however, it has been many years now of us sitting together on stage or just now virtually having chat, whether it's full presentations or like what we do now, which is more of a virtual fireside. So I'm going to turn it over to Eric to just provide state of the union for Target, and then I'm going to jump into some questions.

Great. Thanks, Gregg. Thanks, everyone, for joining. And to Target, Gregg it has been well over a decade since we setting at the safe seats together. Well, thanks everyone for participating in discussion today. And hopefully, we'll make this informative and interesting for you all. Target Hospitality is an interesting story. It's unique story in the marketplace where we have about 26 locations of remote modular accommodation and hospitality service offerings. And we engage our business in a variety of applications, both for business and industry in the natural resources space and also for the United States government, where on any given day, we may have over 14,000 guests staying in our 26 locations. And so we operate our facilities on a turnkey basis, and you effectively come in one of our modular towns, if you will, that ranges anywhere between a couple of hundred people each to maybe as many as 4,000 each. And we offer full-service chunky hospitality solutions. The past year through COVID, it's been really an acceleration year for us. We've put a new contract in place with the United States government, and that really expanded that part of our portfolio. We are working on a number of other commercial industries as well that are really transitioning Target, Gregg, into more of a little more a growth story over the next few years, which is something we're trying to accomplish. And so we really nice momentum doing that over the past several quarters, transitioning from about 70%, 80% of our business to energy natural resources this year 2021. And close to 50-50 between government and then energy. And then of course, as we look in the future, we're looking to really expand the portfolio in the footprint, not only on the hard asset side, but also in the service offering side. And so that's really an exciting strategy for us that we're looking to execute over the next coming quarters.

So I feel you like perforated to my first few questions. So you pointed out your business mix has changed somewhat. You were 67% hospitality facilities to now 44% and now you're back up to 50%. And from -- excuse me, to 44% incumbents increased materially. So where do you see the mix going forward because especially considering that energy seems to be -- is suppressed to rebound? And maybe give a start there.

Sure. So let me first touch on our energy and natural resources assets and business. So in our Hospitality and Facility Services segment, which really is substantial portion of the energy side. That business is really fully stabilized. And we are harvesting the cash on that business. It generates a tremendous amount of cash flow. Our business is really unique in that the margins are quite exceptional. And so where we manage capital spending quite tightly. So we generate a lot of cash. We've generated nearly $100 million of discretionary cash flow as we projected through the outlook of this year. So that's a substantial amount of cash on our revenue base. So as we look at the energy side though, look, that is a stabilizing business. We are restricting capital there to some extent, we're really looking hardly at any hard of any capital we spend there. We are driving on our debt substantially, materially increasing our flexibility from a revolver having fully undrawn revolver. So when we think about the energy side, we're looking at that as really a mechanism to grow our other areas, which I think is really going to be really beneficial for us. The more areas that can be, in some cases, a little more asset light, a little more service-oriented to really expand the footprint beyond just energy, beyond government services and really kind of loss on the entire target portfolio of services, if you will.

So you talk about expanding. And I think if you look at food management, logistics, how do you grow that? Can you grow organically here? Or do you need to buy more assets?

So a couple of different things we can do. So around -- look, around the energy side, we are really focused on keeping the assets that we have in place and optimizing those as fully as we can. In many cases, we've actually dispatched assets out of the MD side and moved over to the Government Services side. But we capture stability there of course, is the U.S. government as your -- as a substantial customer there, creates a lot of stability for us. And so we've really high-graded those contracts, which is kind of how we think about it and taking that same asset really high grade that asset. But we can do the same thing on the services side as well. And so when we think about Target Hospitality, what is it really 3 stools -- 3 legs of the stool. The first leg is certainly the modular asset piece of it. The second leg is really the hospitality solutions piece. And that third leg is really the facilities management. And so when we look at those regardless of whether your government, regardless of whether your energy, those 3 service offerings and those 3 legs of the stool apply to a lot of different businesses. And so yes, we're looking at acquisitions to really expand that commercial footprint, about facilities management, modular solutions and hospitality solutions. But also, we have a large number of organic opportunities in front of us. Many years ago, we were originally the sole-provider of housing for the Keystone XL pipeline, right, a 6,000-person facility, hundreds of millions of dollars of revenue. There are a variety of other projects that are like that, that are long lead time, long cycle times, but fit really well into our existing organic business model, but do it away from necessarily the energy side. And so with a lot of opportunities like that. And then of course, Gregg, we talked about disintermediating our 3 legs of our stool and taking those same facilities management, hospitality solutions and putting those into other value corners of the marketplace through different end markets. It's a lot of different opportunities for us, both transactionally as well as organically.

So maybe to get more into the transactional line. So how -- you've been -- you've generated a lot of free cash flow. You've been using that to pay down debt. Is there -- Is there a point where you think you could become more acquisitive, that would potentially allow you to grow to getting greater scale? And does your balance sheet today have some restriction on that?

Yes, great question. I think Target has reached an inflection point or getting closer to reaching a bit of an inflection point as to how it evaluates its growth cycle. Certainly, when your balance sheet is a priority, reducing indebtedness, enhancing liquidity, enhancing capital flexibility that had to be priority number one for us. And that still is priority number one. By maintaining flexibility really is critically important regardless of where you are in your kind of your growth cycle and your growth evolution. And so that's really important. But I think as you get that to a scale where it's a bit more optimized, right? So leverage at 3x and trending lower. Once you start getting to that level, I think you want to start looking and saying, okay, what are some of the good uses of that capital. That can continue to keep the balance sheet in check by growing EBITDA, right, not stressing the balance sheet. And so I think right now, we're at the point of being able to perhaps prosecute some of those opportunities that we've been looking at over really the past several quarters that have been quite -- we've been quite selective. We continue to look at some opportunities. I wouldn't say spending imminent per se. But I do think the evolution and more of the EBITDA growth elements are starting to show through here and starting to bear some fruit since coming out of COVID. So I do think we're getting closer to that inflection point.

I think you've said you've been targeting net leverage of less than 3x by the end of the year. What is the longer-term target? And is there a total debt number that's part of that target?

Well, I think where we are right now is continuing to work our leverage down. It's really through growth in EBITDA since the revolver is fully paid, not a lot of prepayable debt, not much that we can do there. In fact, we're sitting on a pretty substantial amount of cash on the balance sheet, and that will continue to grow through time. So first thing we'll do is continue to look at opportunities where we can continue to grow margin and restrict our capital spending, and that will really enhance the discretionary cash flow. We'll continue to accrete that on the balance sheet. We've got the notes that are out. And so we'll look at doing something with the notes. Perhaps we modify the mix a little bit there, perhaps not. We'll have to wait and see here next another few quarters, and just got to see how things materialize there. But some things we can do around the mode to try to enhance the capital structure there a little bit. But I think for us, in the meantime, it's really about executing the business, enhancing market, enhancing the value chain, continuing to diversify and growing the EBITDA while we're doing that in ways where we capture nice long-term contracts, which is substantially 90% of our cash flows are under long-term contract. 75% of it is true take-or-pay contract, right, which is highly unusual for a business that generates margins that are 40%, 45% EBITDA margins like we do. And so I think we have a nice opportunity here to take the balance sheet we have with the continuing declining leverage profile and continue to grow the EBITDA and hopefully do it with a couple of transactions, which we think really propels us into some other value chains that are really additive to what we're doing today.

So you said next couple of quarters to address the debt. If I do the math, it basically suggests you're waiting for the call price to step down. Is that how you are thinking about or some more ...

Yes --I think we can always look at it in time. It's really a function of what the marketplace gives us. But I do think look, I do think having that call price call premium come down. Obviously, it's beneficial to any sort of transaction, right? So never say give us certain time on it. But I would tell you that we're looking at it hard, and love to do something sooner rather than later.

That makes some great sense. So just coming back, just getting into numbers. So you put the third quarter results, you increased your revenue guidance by 7% for the year. Your EBITDA by 9%. You highlighted increasing customer demand. What are you seeing for '22? And what's the opportunity for margin expansion to basically take advantage of excess capacity or whatever else you think you can do to expand margins?

Sure. So as it relates to 2022, we haven't put our outlook out yet. We'll wait and do that once we complete our budget cycle towards the end of the year and into the early part of it to the first quarter to about 2022. So I want to be thoughtful about what I can say about that. What I can say is we see margin opportunities from a revenue perspective really across the -- particularly in the oil and gas side. We continue to see some revenue opportunities there on the margin side. We did monitor the inflationary aspects. A big portion of our cost of goods sold is food, right? When you are when you are feeding 14,500 people a day, those numbers do add up on you. So we need to be thoughtful about that. We have been able to manage that so far. So with the amount to how revenue increases are adjusted for relative to any sort of cost of goods sold increases. But so far, we've been able to maintain margin. I do think given the activity that's been happening in the natural resource space, I think we do think we do see some opportunity to raise prices there. The government side of the business, those are fixed term contracts, many of like they are on the energy side, but those contracts are pretty sticky. And so we don't have escalators in those contracts. So we'll work to manage the margin on the government side as we look today into any new contracts. And of course, there's a bit of a latent margin opportunity, which we don't talk about as much. But that's relative to any sort of new service contracts we put in place that are capital light. So for instance, if we take out some of our existing service offerings and use those offerings for other competitors or other companies, those are margin enhancing because you're still increasing EBITDA with no additional capital increase. And so your ROIC is effectively increasing on a net basis, which is how we look at it. We don't look at it just on the P&L side. We look at it across the total capital base and that effectively increases your return on invested capital. So we look at that as being margin enhancing to us. So we look to be able to announce something where contract or 2 in the next couple of quarters where we have some additional contracts that increase the margins and people can get a flavor for what we're really talking about as we think about expanding the footprint.

So you touched on some things there. So do you feel a lot of mouths there's food because you have to buy food? What is your ability to pass through some of the inflationary -- the inflation in your cost? And just in general, how are you seeing inflation impacting your business?

So the way we manage costs are not so much passing through from a revenue perspective because, again, most of our contracts are fixed price in nature, right? So we do that by design, so we capture cash flow stability. So how do we manage the cost then relative to that revenue profile? The way we manage the cost is we effectively shift the service offering. And so effectively, the way we do it at all of our locations, almost all of our locations, we give the personnel there an effective budget to work with for their cost, and they get to shift the menu at our locations. Because remember, we're offering 24/7 culinary services for our 14,000 guests. And so the chefs at these locations have the ability to manage their cost. And so what they do is they flex their menu. They're evaluating pricing on a lot of their protein items, and they'll ship the menu mix. And so unlike a conventional restaurant, which has a fixed menu, we have the ability to vary the menu literally on a weekly basis. And that -- so that's how we've been able to manage the costs. We're effectively not giving up any quality, but we're shifting the components of our items. And that's how we've been able to manage cost thus far. And we'll see how things materialize heading into 2022. I suspect we continue to see some elements of inflationary pressure. But I think when you're dealing with the scale that we have, we -- our food service business, for instance, is one of the top 25 food service businesses in the country from a revenue perspective. Of course, we don't report it that way, but that's effectively what it is. So we have a massive amount of scale. And so yes, I think we'll see what happens in the next quarter or 2. But I think so far, we've been able to manage the cost pressures. And I expect we'll be able to do so heading into 2022 as well.

So it's an interesting thing to hear. So you talked about adjusting -- flexing the menu so that your customers, sounds that they could save money, but in an environment where there's shortages of labor. And so I guess the question is what type of -- what are you replacing -- what type of food you're replacing that are lower cost presumably, I assume are good, but it's too ongoing with us, people are asking for more of these days, not less?

Sure. So you don't have to give quality to maintain the cost objectives. So it's really a function of shifting mix. So for instance. Remember, we're buying we're buying massive batches on a weekly and bi-monthly basis. And so we may shift protein mixes. So if any given week, there's no supply, I'm going to make an example of. But if there's no supply, it's certainly versus hamburger, for instance, and our marginal cost allows us to buy additional sirloin and hold that. We'll do that as opposed to perhaps -- and we see an increase in -- I'll tell you one thing we saw to increase on those chicken wings. And so we were able to shift the mix of cooking fewer chicken wings going more to chicken side, for instance, in bringing down the cost, but people like those just as well. And so that's how you're able to do it, right? You've got to remember, we're doing some pretty large scale batch buying. And so we're able to buy and advance sometimes. Remember, we are very large food service provider. And so we are able to manage that pretty well. On the labor front, again, we are a little bit different in that our labor pool has embedded savings opportunity by coming to work for Target Hospitality because you're staying with us, and so we're providing your logging as well as you're staying with us, which means we're also providing you all your food. And so there's an additional material savings to our personnel who are with us in the field. That is not something that they could get -- they really could get elsewhere in many other service functions.

Got it. You mentioned there were a couple of contracts that you thought might be -- we might be notching some -- you might be notching some wins this year, where are they? Are they in the traditional energy areas? Or are they government? Or are they something else?

There are -- Gregg, great question. We are exploring contracts, have really -- and I think we've mentioned this in the past few calls, the contract backlog that we are evaluating is the biggest we've seen in several years. And so it stretches from green energy to infrastructure, to rare earth to facilities management to government services, it's across the gamut. And so sometimes, these do take longer gestation cycles. Some of these projects that we're evaluating are in the billions of dollars for the counterparty. And so it takes them a long time to go to a full FID and a full financial investment decision. But the reality is that the backlog is substantial. And so I think that's one of the things the marketplace doesn't necessarily see in Target is the ability to grow this business through time, through some of these large contracts, which will be fully committed under multiyear arrangements. And so that's one of the nice things that hopefully we'll be able to deliver some of those as we head into 2022. Again, they're long sales cycles. So I don't want to make promises, and we haven't given our 2022 outlook. But suffice to say that the backlog is significant, and we'd love to deliver on some of our diversification efforts.

Got it. One last question for you. Just -- the -- do you have a very concentrated shareholder base? What's the plan here? How do they return on their investment, is it ultimately a dividend? And they're happy to hold beyond? Is there an asset that they need to -- just kind of thinking about an exit either through sale or just getting larger become small enough?

Sure. So I would say, look, our sponsor has been exceptionally supportive and really been pleasure to work with. I think any like any sponsor you always want to own a creator investment, right? And so ours is certainly no different. There is a -- I think there's an absolute willingness to grow alongside of us. They want us to grow, of course, they are willing to help us to do that. I think eventually, our partners will need to unwind and monetize their position at some point. And so we'll just have to wait and see whenever that time comes. But I think right now, there's a lot of value that we see in Target Hospitality. And we are reaching an inflection point where we've got the balance sheet in a good spot. We've got the margins where we want them. We have the commercial opportunities where we need them. And so now it's just really about executing those. It feels that over the next year or so, a lot can happen to Target. And so look, we'll just wait and see what our sponsor does whenever they do it, we don't know. But it just feels like there's a lot of untapped opportunity here.

But there isn't necessarily a plan to once you get to a leverage Target to dividend? Is that something you can see them looking into? Or are they evaluating?

Well, yes, I can tell you that -- look, I can tell you, I don't want to speak for our sponsor. I can tell you that growing the business has been far more important than the topic of discussion than doing something that shrinks the capital structure, if you will, right, which is what the sort of activities would be. So I think when we look at those sort of operations, that's not the mode Target is in. The mode Target is in is trying to grow and enhance and create value to everybody, right, including the sponsor, the debt holders and of course, the equity holders. And that's the mode we're in. And -- so look, I would just -- I would leave that there and whatever our sponsor wants to do. I'm sure we'll keep the marketplace posted at that time.

Well, Eric, I am looking here. You have a -- there's a decent amount of attendees here, but no questions from them if I look at the moderator poll, but I'll let you off the hook with a minute left. I just want to thank you for your time. And operator, we can end the call.

Thank you, Gregg. It's been a pleasure. Thank you, everyone, for attending the session today.