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

All right, guys. So this is one of my favorites because it's -- I've been able -- so those of you who do know, Eric Kalamaras is the CFO of the Target Hospitality, but he's also was a competitor of mine when I started. And I picked up in hostings conferences, it's getting up on...

We were just kids. We were kids.

It's a long time. So I'm happy to introduce you, and I'm going to turn the mic over to you to give sort of a state of the company and maybe a reminder of what Target Hospitality does.

Yes, absolutely. Well, one, it's great to be here in person. Great to see you and the team. Target Hospitality is a unique business in that we have a large remote accommodations platform. We have about 15,000 individuals that stay with us in any given day. Back about -- because about 4 or 5 years ago, we have moved into an energy focus but also into a government focus. And so we have a full turnkey remote accommodations business, whereby we care for 15,000 people, largely in the West Texas area, a little bit up in North Dakota. And people stay with us and we're operating these modular communities, right? So we have 26 communities. We have millions of square feet of modular space, and what do we do? We install and manage and facilitate and have hospitality services in small remote -- effectively, we create small modular in remote towns effectively, do full integration infrastructure. We have 50,000 rooms, as I mentioned. We have full hospitality services. We are one of the top 5 largest food providers and purchasers in the United States, caring for our 15,000 guests in any given day. And the business really start off is focusing on the energy companies who are our legacy customer base. And over the past few years, have -- we've broadened that out and also into government services. There is a large humanitarian population, specifically in West Texas and along the Southern border that we service. And currently, right now, we have about 6,400 people in any given day that we're servicing. This is a very attractive and highly economic business model we have. Margins are rivaling software companies in terms of margins -- 40%, 50%-type EBITDA margins, generate an extensive amount of cash. And so it's really an interesting and unique and an exciting business.

So we're on the other side of this, but whenever -- when COVID hit and things weren't great to be in the oil patch, you clearly pivoted. And can you talk a little bit how through the downturn you went from being more oil centric than to now being now over 50% of your business is government services, how are you able to utilize your existing assets to pivot there?

Sure. So when we think about our revenue stream, little bit different. We're not a hotelier where we're taking variable revenue. We have -- about 70% of our revenue was full fixed fee, take-or-pay and in over multiyear contracts that average about 4 years. So what we chose to do was recognizing that there is variability even though we have these full take-or-pay contracts, there is variability across the HFS side of the business, the HFS is hospitality and facility services. And the hospitality business does have that element of cyclicality to it. And so what we wanted to do was -- as we're a dominant player in the marketplace, we are about 4 to 5x the size of our next smallest competitor if you want to call them that. And we decided that we want to take some capacity out of the HFS side of the business out of the West Texas side of the business. And we dispatched that over to the government side. Now how are we able to do that? Our assets, our modular assets, they can be moved. They are built to -- we want them to stay. They're built to stay, but they can also be built to be moved. And so we moved them and we took out about 1/3 of the capacity out of the HFS side and put that over into the government side. So when we did that, we high graded contract, right? From a counterparty perspective, certainly, U.S. government is obviously a fantastic counterparty to have. We high graded duration. We high graded stability. We were able to increase utilization on our asset footprint dramatically. And it was a win-win across the board and something that we have worked a number of years to try to accomplish.

That's great. Congrats on it. So I'll jump to this question. So you -- I think you're 58% government services in the first quarter. Where do you think you'd get to, is there -- considering there's a backdrop here of an improving energy environment?

Sure. So our focus is, since we generate so much cash and it's really a very valuable item for us. We look to continue to grow the energy side of the business, but we want to do it really to use that to help diversify. And so we will deploy capital on the energy side, but it's not really the next evolution of the business, right? We do continue to see consistent growth across that HFS side. I think from a -- our business is a labor servicing business. And so when we think about labor head count, the energy marketplace continues to get efficient and gets increasingly efficient. And so this year, we'll see about year-over-year about 12% to 14% growth. Next year, we may see some additional growth as well. But I think as we look forward, the evolution is really to continue to focus on the government servicing portion. And it's not inconceivable that we look out a year or 2 down the road and where as opposed to being 55-45 today, we are 75% government and 25% HFS. And then from there, as that business continues to grow, there are a lot of other things that we can do with our assets beyond just what we're doing today.

You said on your last call, you expected mid-teens growth exit 4Q '21 to exit 4Q '22. You just mentioned the number of 12% to 14% growth. Was that for the HFS? And that makes sense, you're pointing towards a growth in government services. So that means government services could be 20%, maybe something like that or high teens, right?

Look, we are working on some things that could be very attractive on the government side. And I want to let those speak for themselves in time. But we put in place last year a contract that was a very attractive contract. We look to extend that contract. And we've also talked about this publicly about enhancing scope of that contract and those services perhaps quite meaningfully. And so we will let that contract speak for itself when we can announce something on that. But suffice to say that we see a really nice near-term opportunity.

And you mentioned something in late May, I think it was in a press release that -- I don't know. I think when the CEO was -- the announcement, you put to execute a highly attractive contract that's what you're referring to?

That's what I'm referring to.

I guess you're saying you execute a highly attractive contract. So I guess I'll just ask -- because it can speak for itself. So you made that maybe the answer, but how significant can this be?

Let me put some framework around this and some context. It's a great question, and I'm not trying to be vague. I think it's important to note that we are -- when we're dealing with contracts with the government and our other nonprofit counterparties. And so the way this works is, we work with nonprofit counterparties who are prime contractors to the government. But we provide all of the infrastructure and services, okay, for these humanitarian efforts. And the government has specifically said that they see approximately $9 billion annual need for -- specifically for displaced children. And we are providing a full campus lifestyle for thousands of children a day and under what is now becoming permanent infrastructure solutions for the government and for the United States. And so when we think about the scope there, the $9 billion incremental to what we are already doing today, our services are a meaningful portion of that $9 billion. And so I want the economics of that to come out when we're all collectively ready to disclose those and perhaps when the government is ready to disclose more. But suffice to say that it could be -- we're talking about billions of dollars of need here to which our services are a valuable part of all that.

So it's interesting. So has this -- under Biden administration has a little bit different of a policy of treatment of border children. Is it true that that's -- the Biden administration is more bullish for your business than if a Republican -- well, Trump were there versus -- or some other Republican?

It's a good question. We get the question a lot. If we go back about 8 years when we put the initial facilities in place, we had a request from the government to put in a facility for 80 acres for 2,400 displaced persons. And when we did that, that was under the Obama administration. That same contract, our full term take-or-pay contract existed under the Trump administration. It is now existing under the Biden administration. And the reason is because these are permanent infrastructure solutions. These are not temporary solutions, and there are a lot of temporary solutions. Ours is a full solution for the government that is expected to stay. And so I think while optically, it appears quite favorable, I think when you kind of peel back the onion, I mean, there is a constant recurring need, particularly when it comes to children. You've got to have the right facilities in place, and we provide that solution. In fact, we're one of the only companies in North America that can provide the solution. A year ago, when the government came to us -- just to put some scale on this, the government came to us and we put forth this modular town and really in the middle of nowhere in West Texas for the government for 4,000 people in about 90 to 120 days with 100 acres of assets with football field, medical center, a number of K-12 educational facilities that are state-of-the-art. And we're one of the few companies that really globally that can do this. And so when we think about changes in administration, we have seen now 3 changes in administration and the need has gotten bigger.

For this next contract, can you leverage existing combinations? Or is there some CapEx associated?

We will do both. There will be capital. There could be a meaningful amount of capital. The -- we'll also utilize some of our existing assets as well. And so we're pretty focused on how we manage the balance sheet. But there will be a -- there will definitely be a capital number there. I think what's important, though, is these are special contractual arrangements that we have. The way we think about it is we largely expect it to be balance sheet neutral. Think about it within a 6-month time period. And so -- and again, it just comes down to the special nature of the relationship that we have with the government and the needs that we're providing. And so it allows us to do things that are very capital efficient.

So you also mentioned something about you're focusing and broadening your reach into adjacent commercial end markets. Could you expand upon what that means?

Sure. So target hospitality -- when you look at what we do, we are effectively a construction management business, we're a real estate acquisitions business, we are a hospitality services and solutions business and we're a modular solutions business. And when you look at all those, we do all of those in scale. And we did those for our own account. We have 3 million square feet of modular space right now. So who's providing all the facilities management on the 3 million square feet? Well, we are. And could we not do that for other business in the industry, could we not do that for the United States government as well, right, and disintermediate that field solutions business and do that for other parties as a true revenue center? The answer is yes, we could absolutely do that. When we think about the modular servicing business, when we're talking about building perhaps 1,000 sites, right, across the West Texas area to facilitate contracts, how do you think about doing that perhaps for other applications, whether that be for business and industry or whether you do that for the government as well or other public sector entities. So there are a lot of other applications that we can explore. So we see a lot of white space. We've been so focused on pivoting the business and focusing on the strong relationship we have with the government that has really moved the EBITDA quite nicely and very, very attractively to the point where we're generating approximately $100 million a year in discretionary cash flow and getting our balance sheet in a good spot that we haven't really gone after some of that white space opportunity, but we believe it's there and we think could be very attractive. And there are some interesting opportunities out there for us. We want to let the upcoming contracts come to fruition, and then we'll look to pivot even more.

What's a specific example of that?

So there are applications where -- and we have looked at companies that do something like the following. So they will do aseptic cleaning, for instance, and field management for government hospitals, okay, not dissimilar for the same thing that we're doing in our medical facilities we have in our assets, okay, very similar. So very easy direct corollary there. Construction, they have construction management. We do construction management, right, because we're putting together all these buildings and managing all that. So there are a lot of different ways that we can do that. And then there are all sorts of government servicing companies that are very CapEx-light and very service oriented that are very attractive to us over time. There are some real estate potential opportunities that we have looked at in the past that could make a lot of sense. Those are predominantly tied to the United States government. And so I think when you have millions of square feet you have the significant land position, a hospitality servicing position, it allows you to do a lot of things.

Do you think a little differently about -- when you have a contract with the government, do you think about -- like something like this new project, do you think about going longer than 4 years with them? Is that something that -- is it a possibility?

Well, the government -- they have the annual appropriations budget cycle, right? And so they tend to think through things in shorter kind of shorter time periods. However, we just signed a year ago, we signed a 5-year deal for original asset that we had with the government for 2,400 people. We went from a 1-year deal originally to then became a couple of 5-year opportunities on that. So now we're looking at -- with the government, we try to get this next contract facilitated, and we'll see what the term on that looks like and whatever it is, we look to make that -- we will absolutely look to make that longer term. That's absolutely something that we desire ourselves.

Got it. So I think you gave me to answer. One of these -- how are you handling cost inflation and supply chain and labor shortages?

Yes. Great question, and we get this a lot, and it makes sense since we're such a large food purchasing company that we would have exposure to that, and we do. What's different about our model is since we have full turnkey capability around our food servicing, we don't operate set food menus. And we have very high quality and high class food in our locations. But it's not the same menu. So one of the -- where are we seeing inflation? Where you tend to be seeing inflation are areas where they require the next extra step in either distribution or manufacturing or processing. So for example, a lot of packaged food items are seeing tremendous inflation. So we're shifting away from prepackaged food items and moving directly to having our own chefs in our kitchens process those directly. It takes a little bit more time, but we can manage cost that way. One of the areas you're seeing a lot of inflation is in specific proteins. So I'll give you an example, chicken wings have gone up almost 200% over the past year. Some companies have actually stopped selling chicken wings all together. So what have we done? We have stopped buying any nor near as many and now working with a different sort of protein, and it's still accomplishing the same effect all while managing the inflation.

So what is the alternative for chicken wings?

Well, it's a tricky alternative, tends to be chicken thighs.

Because there could have been a revolt.

There could have been. But unlike a conventional restaurateur, we don't have set menus, right? So many people go to the same restaurant for the same item all the time, and the company has to then reflect for that. And now you start seeing the advent of kitchen appreciation fees, right? We don't have those because we just switch out our menu items to accommodate what we want to accommodate. On the labor front, since we operate in remote areas, we have staff that stay with us for approximately 6 weeks at a time. And the way we handle our hiring is we like to hire communities. It's much easier and much more effective and you get much better retention if you're hiring groups of people, friends, families and they come together and have the sense of community when they come with us. In addition, let's provide living quarters for them, and we provide all their food, 24/7 for the entire 6 weeks. They'll go back home and then they'll come back for another 6 week shift. When we look at that total compensation package, we're paying materially more than typical hospitality employee would receive. So there's a little bit of a premium because of the areas where they're working. But when we boil all that together, it's actually quite attractive. We have not had to do anything in terms of wage inflation at all. We'll see. Hopefully, we can manage that. But it's been -- we've been successful in that in the past few years.

And you have not had shortages of labor?

No. Even despite the meaningful growth that we've had in EBITDA, going from $65 million to $125 million to $135 million over the past 12 to 18 months, we still have not had an impact on...

Are there any cost mechanisms in your contracts or anything?

Generally not. Look, on the HFS side, we have a natural hedge there, right? So because you're tied to the energy side, which has an inflationary component tied to it, we picked that up through increased utilization on the energy side. So we've never felt the need -- we always felt like a double dip, right? So we never felt the need to do that. The government typically does not do those either. So how do you handle that? Well, you have to price that through into the contract, right? And our margins, we're not a company that has low margins. We have quite high margins. And so we can handle a little bit of ebb and flow in the cost.

So I'm trying to figure out your incremental margins. I took a look at consensus, and I saw revenues up 3%, but EBITDA is flat from '22 to '23, which doesn't even make sense to me. I think that's -- am I right, the consensus is way off?

I think we have -- look, we have provided an indicative and preliminary 2022 number and EBITDA of $125 million to $135 million of that. Look, we look to hopefully beat that over time, right? And we've had some demonstrated success of doing that. We put out preliminary numbers by design, and we'd like to come and update those as soon as we can. I'd never like to -- look, the market is always right, right? And so we'll -- the analysts do a great job, and we'll just let that speak for itself.

I appreciate your acknowledgment of our skills. Does your guidance include this potential contract when...

It does not. No, it does not. It's -- look, it's a meaningful contract that has not been adequately reflected because we haven't provided enough information to do so yet at this point.

Is that part of -- is that not included in the mid-teens growth? It's not?

It's not. No, because that's primarily tied to the HFS side of the business. And what we're talking about is perhaps a material expansion in the government services side.

Okay. I think you generated about $80 million pretax based on the numbers that you put out there. Just remind us -- so you did answer my question about CapEx ramping. What's the cash tax situation?

So we have a large NOL. And so right now, we have about $150 million of effective assets that we have. So as it stands right now, we'll pay very little in terms of cash taxes. It will be a few million dollars a year, largely due to Texas margin tax, which is based off of revenue. But I think heading into next year, we'll probably be in a spot to towards the end of the year sort of paying -- being cash taxpayer.

High-class problem, congratulations. So M&A, you've talked about these growth opportunities, consolidation versus expanding to new markets. Is that something you would consider?

So since we operate a unique business, there is not a lot of -- we do not see a lot of attractive near-term consolidation opportunities. However, we are a growth-oriented company, and we are looking to continue to grow the business. We haven't done a transaction in our organization in almost 3.5 years. We have looked at a number of opportunities. And despite our growth profile, despite our aspirations, why haven't we done a larger transaction or any at all? And the answer is because we have a really disciplined approach as to what kind of returns we're trying to achieve and what we're trying to achieve operationally. Because we've talked about target hospitality can do a number of things, and it's about putting scale into all those and doing it the right way and capturing the returns you want. So we've been quite patient, and we'll continue to be patient. We'll continue to generate cash. We'll continue to -- our focus has been on reducing debt. And we've taken the balance sheet down over $150 million in terms of debt over the past 18 months. We'll continue to do that over the near term. We'll continue to put the business in a highly effective operating footprint and look to do something more diversifying if and when the time comes.

So I remember all of a sudden, I missed it when your leverage went down so much. And I remember you were talking about getting under 4, then 3 and now you're below 2s by year-end in your view. So does that leave capacity for you to acquire possibly a debt fund? And I guess the larger question is how do you think about what the right leverage is supposed to be now?

Yes. Look, it's a great question. And I think our view has been to not do anything that shocks the system in any way and keep the balance sheet in the spot. We're continually flexible, we're continually opportunistic. Because the reality is you don't always know when opportunities are going to come by that you really want to extract on and really, really lean into. And the only way to really protect yourself from that and self-inflicted wounds is really through the balance sheet protection, all right? I mean that's really one of the things that management can continually control and to knock it over your skis. And we really pay attention to that. And so I think the right answer on the balance sheet side is to be in the low 3 area over -- right over time. But having said that, we have not been an overly acquisitive company. We don't have a lot of ebbs and flows. I think, over time, we get to that 3 area with the transaction, and then -- but it's going to have line of sight to bring that back quickly in line to a spot where we feel more comfortable, right? But having said that, you start getting into -- you start getting meaningfully below 2, and you start feeling a bit overequitized, right? And so it is that delicate balance, but somewhere in that 2 to 3 areas is a good place for us to live.

When I see this cash that you're generating. Does any of that come back to shareholders over the near term?

It's -- look, it's always on the table. It is something that is -- can be talked about, but I wouldn't say that, that is the primary focus. I think you have to ask the question, what do you really get, right, when you do that and what are you really trying to solve. And I think our experience over the years has been doing things to shrink your balance sheet on a perpetual basis while being in a growth mode, those don't always play nicely together. And so our focus has been growing the business with less actual cash return back than it has been to do something to the capital markets and try to actually get to shareholders back direct returns. So look, we'll evaluate it. We have looked at it. But no, we haven't done anything yet, and it's probably not one of the top priorities.

So it took me to a little over 25 minutes to get to the question about refinancing those bonds. And so how do you think about it? Is there a possibility that some of the cash is used to pay that down? That's the question.

Yes. Look, we are -- yes, it's the 800 pound gorilla out there. We need to do something there at some point. It's clearly top of mind. I would tell you that we're evaluating how to do that, the right structure. And really, it also comes down transactionally how quickly we expect to do something as well, right? Because the market is really shifting right now and whether or not -- when we start building up a large cash position, you have all your availability on your revolver, you have no more prepayable debt, you start now questioning what does my debt structure really need to look like, right? And should I be flipping over a new variable rate instrument? And so we're in that phase right now. But I think, look, I think over the next few months, we'll probably answer that question in one form or another. And the marketplace will likely be aware of what direction we're heading.

How do you get Moody's to drop the CCC on the unsecured...

It's always a constant educational process, and we will continue to educate them on our business. I am confident that they will ultimately come to the right conclusion.

It's a very formidable answer. I like it. Your investors, how are they thinking about their exit these days? Or what's their end game?

So TDR Capital owns 67% of the common equity. They've been in the business in both public and private forms for well over a decade at this point. They are very active sponsors in terms of supporting the business. They want target to succeed and accomplish all of its objectives. That being said, at some time, it would be good to -- for them to get some liquidity. It also would be good for the target story to have some liquidity -- more liquidity in the common market. The -- we have received from a number of shareholders saying, look, your liquidity in your stock is just not enough. And it's holding back your equity. And it has held back the equity. And management understands that. Sponsors understand that. And we're actively talking about ways for them to not only perhaps have a return of their own capital but also to help the company at the same time and to do that where both parties can win. So we're actively talking about that. And I think at some point in time, there will be a natural time for TDR to evaluate how much they want to do.

Does TDR have any funds exit considerations?

Well, I think it's one of the last holdings in the fund. They have plenty of -- they're patient. They have plenty of time left. It's really a function of doing the right thing for the business and how do you best get more liquidity into the stock. And it's really about doing the right thing for Target over the long run.

Okay. Coming back to -- I'm just -- are there any questions? I have one. And if you look at the questions I prepped, I wrote something, I didn't finish it. You -- we talked about incremental margins this year. I think it sits somewhere between 100 and 200 basis points. Am I remembering that correctly? That's right. So there was a lot of incremental -- there's a lot of -- you have some revenue growth. Obviously, we can see it. On the call itself, the equity analysts that model your company to perfection apparently, a lot of them are asking about the contract roll. And it was something I didn't understand. Is there some contract that's rolling off that's particularly high in revenue that they were concerned about the margins?

It's a function of, I think, just getting comfortable that the contract continues to live on. So there was contracts referring to last year where the government came in and asked us to participate in a new facility for 4,000 displaced people in the humanitarian side. And that contract had an initial 1-year term to it, but with rolling monthly evergreen options. That's the contract that we're working on now to not only extend out but also to increase scope on. And so I think the question was, where are we in that negotiation process? Or is that expected to live? And if it does live, are the economics similar to what they look like today? Then the answer is yes, we're working on that extension daily. This scope is increasing rapidly. It's tied to that $9 billion that I was referring to. And so it's a complex process with the government. And so we're working on that, but that's what they were referring to.

Yes. It didn't seem hard to believe that you'd have fairly large incremental margins when you're leveraging existing infrastructure. All right. Look, I think we're -- we've got 3 minutes left. I'll point out that Eric did note that last year I had a [ mod ] when this was done on video, which I've totally forgotten, really had an opportunity to have a good joke about that in a larger audience, but you guys got a good laugh at that.

It was epic.

It was pretty epic. I was not afraid. I definitely let it go. Actually, that was a thing. That was the luck. So we're Back to some normalcy. But again, I just -- Eric, glad to see you. This was a great conversation. And I'm glad you made the trip.

Thank you.

Thank you.