Target Hospitality - Q1 2024

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and welcome to the Target Hospitality Q1 2024 earnings call conference call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star 0 for the operator. This call is being recorded on Wednesday, 8 May, 2024. I would like to turn the conference over to Mark Schuck. Please go ahead.

Mark Schuck (SVP of Investor Relations, and Financial Planning)

Thank you. Good morning, everyone, and welcome to Target Hospitality's Q1 2024 earnings call. The press release we issued this morning outlining our Q1 results can be found in the investor 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, 8 May 2024. 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 tables in our earnings release posted in the investor section of our website to find a reconciliation of non-GAAP financial measures referenced in today's call and their corresponding GAAP measures.

Finally, as previously announced on 25 March, 2024, Arrow Holdings, an affiliate of TDR Capital, proposed to acquire all outstanding shares of common stock of Target Hospitality it or affiliates do not already own. The board of directors of Target Hospitality has established a special committee of independent directors to evaluate this proposal. The special committee has retained their own independent outside financial and legal advisors, and collectively, they have commenced their review and evaluation of the proposal.

At this time, the special committee has made no decision with respect to the proposal. As a result, management will be unable to comment on the proposal or the evaluation process during today's call. Leading the call today will be Brad Archer, President and Chief Executive Officer, followed by Jason Vlacich, Chief Financial Officer and Chief Accounting Officer. After their prepared remarks, we'll open the call for questions. I'll now turn the call over to our Chief Executive Officer, Brad Archer.

James Bradley Archer (President, CEO, and Director)

Thanks, Mark. Good morning, everyone, and thank you for joining us on the call today. Our impressive Q1 performance reflects the benefits of our network capabilities, which allow us to maximize operational efficiencies while simultaneously providing world-class solutions to our customers. The scale and flexibility of our efficient operating structure continues to support seamless alignment with changes in customer demand, allowing us to preserve strong operating margins through cycles.

These attributes have significantly enhanced our financial position and materially strengthened our balance sheet, supporting a highly durable and flexible operating model. In the government segment, these elements have supported the longevity of our PCC community, which has entered its fourth year of operations and is the longest operating influx care facility in the United States.

Since its inception in 2021, this community has served approximately 2 million meals to unaccompanied children, illustrating its importance as a cornerstone to the government's influx care facility network. This established presence supports Target's continued engagement with the U.S. government and other strategic partners to jointly pursue the creation of a 3rd ICF site not currently in the government's portfolio. We remain actively engaged and are pleased with continued dialogue regarding this opportunity.

As we have previously stated, we anticipate additional details regarding the third ICF site in the back half of 2024. In addition, our South Texas Family Residential Center is entering its 10th year of operations, a testament to the operational success of that community. This community has evolved through multiple contract renewals across three different federal administrations, exemplifying its importance as a critical humanitarian solution for the U.S. government.

Regarding our HFS segment, we continue to benefit from strong customer demand, which has supported positive momentum over the past year. This demand illustrates the value that our world-class customers find in the network flexibility and premium hospitality solutions we provide. We have taken deliberate steps to enhance operational efficiencies across this segment and will continue to evaluate opportunities to optimize margin contribution through enhanced network optimization.

Our ability to utilize the scale of our network to seamlessly align with changes in customer demand has consistently supported strong financial results. This focus has materially strengthened our financial position and established a robust balance sheet with significant liquidity. These elements continue to support impressive operating income and industry-leading cash conversion, which establishes the ideal position to continue evaluating a pipeline of growth initiatives.

We believe these naturally adjacent opportunities will complement our existing service offer while establishing multiple avenues to expand Target's long-term growth opportunity set. In addition to the third ICF, we remain engaged with multiple federal agencies on a variety of solutions they are seeking to implement pertaining to increased activity along the U.S. southern border. Further, we continue to actively pursue a robust pipeline of non-government growth initiatives.

As we have previously discussed, these opportunities include large industrial projects throughout the U.S., including technology infrastructure, energy transition, and the increase in domestic rare earth development. As a reminder, these growth opportunities tend to have longer sales cycles. While we are pleased with the active dialogue and progressive discussions, the timing and final outcomes are uncertain and can be difficult to predict. As we evaluate these initiatives, we remain committed to achieving defined objectives of our growth strategy.

Our primary objective is focused on diversifying our customer base and contract portfolio, which we believe is essential in broadening our long-term growth pipeline. By accomplishing this, we will establish a foundation to identify and consistently execute repeatable growth opportunities while remaining focused on generating strong operating income and industry-leading cash conversion.

In summary, we have established an enhanced financial position centered on the strength of our balance sheet and an efficient operating structure. These elements support our ability to provide a premier service offering to our customers while simultaneously delivering strong financial results and pursuing attractive growth opportunities. I'll now turn the call over to Jason to discuss our Q1 financial results in more detail.

Jason Vlacich (CFO, and Chief Accounting Officer)

Thank you, Brad. In the Q1, our enhanced operating platform continued to support operational efficiencies across our network, allowing us to produce strong financial results driven by the strength in our core service offering. Q1 2024 total revenue was approximately $107 million, and adjusted EBITDA was approximately $54 million. Our government segment produced quarterly revenue of approximately $68 million.

The decrease in revenue from the prior period was driven by the non-cash, non-recurring infrastructure enhancement revenue associated with the significant expansion that occurred at our PCC community in 2022, which was fully amortized as of November 2023. Our HFS and all other segments delivered quarterly revenue of $39 million compared to $38 million in the same period last year. This increase was driven by sustained momentum in customer demand for Target's premium service offerings, illustrating the value our customers find in our premier hospitality solutions.

Recurring corporate expenses for the quarter were approximately $10 million, and we anticipate these will remain around $9-$10 million per quarter for the remainder of the year. Total capital spending for the quarter was approximately $10 million, with the majority focused on enhancing operational efficiencies through the purchase of previously leased equipment.

The strength in our core service offering continues to support strong cash generation and an enhanced financial profile. We ended the quarter with $124 million in cash and $299 million of liquidity, with zero borrowings under the company's $175 million revolving credit facility and a net leverage ratio of 0.2 times. These impressive financial results illustrate the strength of our operating platform and the sustained momentum we have created over the last several years.

These elements support our reiterated preliminary 2024 financial outlook, which consists of total revenue of between $410-$425 million and adjusted EBITDA of between $195-$210 million, with anticipated 2024 capital expenditures of between $25-$30 million. Regarding our revenue and adjusted EBITDA ranges, as a reminder, there is minimal PCC variable revenue contemplated at the low end of our outlook ranges, and this revenue contribution was materially achieved during the Q1 of 2024.

However, it's important to remember that PCC variable revenue contributions will inherently be uneven over the balance of the year. Any additional 2024 PCC variable revenue contribution will likely occur in the back half of the year. This enhanced financial profile supported our ability to return approximately $21 million to our shareholders by repurchasing approximately 2.3 million shares of common stock during the three months ended 31 March, 2024.

In addition, the strength of our balance sheet, high degree of revenue visibility, and continued strong cash conversion provides the ability to continue actively evaluating and pursuing a strong pipeline of organic growth initiatives. These opportunities are designed to jointly leverage Target's operating expertise and existing core competencies to establish a robust service offering across various U.S. government agencies and commercial applications.

These initiatives encompass Target's existing full turnkey hospitality solutions while also focusing on opportunities to broaden Target's customer base and service offering portfolio. We are focused on establishing a platform to continue diversifying our revenue streams while simultaneously creating repeatable growth vectors. As previously stated, Target is seeking to allocate over $500 million of net growth capital to these opportunities over the next several years.

Importantly, as we evaluate these initiatives, we will remain focused on maintaining the enhanced financial profile we have achieved through disciplined capital allocation and strong discretionary cash flow conversion. With that, I will turn the call back over to Brad for closing comments.

James Bradley Archer (President, CEO, and Director)

Thanks, Jason. Our strong Q1 results continue to illustrate the benefits of our enhanced operating platform. The network scale and flexibility we have established allow us to deliver a premium service offering to our customers while simultaneously supporting strong financial results. This consistent execution is reflected in the strength of our balance sheet and enhanced financial position.

With this foundation, we are continuing to evaluate and pursue the strongest pipeline of growth opportunities we have seen in many years and remain focused on expanding and diversifying our service offering. I appreciate everyone joining us on the call today, and thank you again for your interest in Target Hospitality.

Operator (participant)

Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the number one on your touch-tone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press the star followed by the number two. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for our first question. Your first question comes from Scott Schneeberger from Oppenheimer. Please ask your question.

Scott Schneeberger (Managing Director, and Senior Analyst)

It's Daniel for Scott. Could you please elaborate a little bit on the new opportunities you see, the organic ones, and help us think about where you see the most opportunities and maybe some color on how right that pipeline could be?

Jason Vlacich (CFO, and Chief Accounting Officer)

Good morning. Thanks. Look, the organic opportunities, as we mentioned, kind of a couple of different buckets if you look at government, and we talked about this in March as well, still making progress outside of the ICF here with other government agencies that's kind of front and center, still hot on the radar, lots of discussions there with multiple different agencies. I won't get into the agencies, but I'd just say it's not with the ICF. With the ICF, we're still going after the 3rd ICF, still pursuing that, expect that to award sometime in the back half of 2024 nothing's changed from our last call there.

Again, as mentioned in our remarks earlier, if you look at some of the rare earths, some of the technology, some very large bids, very hard to predict kind of timing on when they award. But I would tell you we feel really good about some of these. We've had dialogues from some of these have been going on for well over a year.

We think at some point they come to a conclusion, and we think we should be positive on some of these. I think if you just look over the history of Target, when you talk organic growth, that's how we built the company we'll continue to build the company off the backs of the organic growth. It's hard to predict timing, but it's not hard to say that we've always been successful on some of these large projects, and we'll continue to do that.

Scott Schneeberger (Managing Director, and Senior Analyst)

Thank you. I saw in the release was mentioned you focus on operational efficiency think you mentioned that in the prepared remarks as well. Could you speak to that, please? Is there any incremental initiatives you're pursuing that could be marginally creative as we look ahead?

Jason Vlacich (CFO, and Chief Accounting Officer)

Sure. We're always continuing to evaluate those operational efficiency opportunities. We believe there are still operational efficiencies to be gained as we move through the year we executed on some of those in Q1, as you saw with the operating performance that we've released in the release earlier today. We do feel there are additional opportunities. That being said, we are running a highly efficient platform currently, so it becomes a little bit challenging to identify additional opportunities, but there are some, and we will continue to execute on those, all but marginal.

Scott Schneeberger (Managing Director, and Senior Analyst)

Thanks so much, guys.

Operator (participant)

Your next question comes from Stephen Gengaro from Stifel. Please ask your question.

Stephen Gengaro (Managing Director)

Thanks. Good morning, everybody.

Jason Vlacich (CFO, and Chief Accounting Officer)

Hi. Good morning.

Stephen Gengaro (Managing Director)

I guess two things from me, but the first is, can you give us some help and color around the government gross margins? I mean, they were, I think, pretty flat sequentially from the Q4, actually probably up a little bit. We had assumed that the mix shift and the new contract would affect that how should we think about? those government gross margins, assuming relatively low utilization at Pecos?

Jason Vlacich (CFO, and Chief Accounting Officer)

Good question. Over the years and working with this contract, we've gotten obviously really good at controlling our cost and response to occupancy level fluctuations. That's essentially what you're seeing there as we move from Q4 into Q1, is executing on that operational efficiency strategy that we've had in place since the contract's been in place, including the old contract. Our margins, we expect to continue to be healthy as we move through the year and obviously, there's a bit of margin expansion associated with lower occupancy levels as we control our costs.

Stephen Gengaro (Managing Director)

Okay. The quarter, there was nothing in the 77.6% in the Q1 that was an anomaly. That was just mix and efficiency.

Jason Vlacich (CFO, and Chief Accounting Officer)

Correct. Yep.

Stephen Gengaro (Managing Director)

Thank you. And then the second one is just around HFS South i mean, we sort of see what's going on in the Permian, and it feels like activity levels are kind of flat from these levels for the next couple of quarters i'm not sure if you agree with that or not. In that environment of if we assumed flattish, is that how those revenues should act? Or are there any contracts or obligations or take or pays? Is there anything in there that would affect HFS South not sort of acting like the drilling and completion activity does in the Permian?

Jason Vlacich (CFO, and Chief Accounting Officer)

We've seen, obviously, moderate levels of improved utilization we expect that to remain the case for the rest of the year. I mean, overall, utilization will trend somewhat similar to last year, and that's what we expect to continue there's no additional material changes that would cause us to believe otherwise as we move through the year with respect to utilization trends.

Stephen Gengaro (Managing Director)

Great. Thanks and then just one final one from me. The 3rd ICF contract that is out there that you talked about, is that something, to your knowledge, that the government will award, that they're considering awarding? Is that part of the mix with certainty? And it's just a question of whether or not you're successful, or it might not get awarded?

Jason Vlacich (CFO, and Chief Accounting Officer)

Based on all of our discussions, they definitely want and need and plan to award the 3rd ICF. For us, we're bidding on it, right? We can't say we're going to get it, but we have one. We're going after this one aggressively, and we expect it to be awarded sometime in the back half of 2024.

Stephen Gengaro (Managing Director)

Okay. Great. Thank you for the details.

Jason Vlacich (CFO, and Chief Accounting Officer)

Yep.

Operator (participant)

As a reminder, if you wish to ask a question, please press star one. Should you wish to decline from the polling process, please press the star followed by the number two. Your next question comes from Greg Gibas from Northland Securities. Please ask your question.

Gregory Gibas (VP, and Senior Research Analyst)

Hey, good morning, Brad and Jason. Nice quarter. Thanks for taking the questions. Just to follow up on that third ICF site opportunity, you've been pretty clear on it being in the back half as to when we're going to hear additional details. Is it kind of a safe assumption that we should assume that contract will likely look similar to the first two awards? And are you kind of seeing the same players bid for it?

Jason Vlacich (CFO, and Chief Accounting Officer)

Look, I think it'll be similar, if you will, in design and structure. Too early to say yet if it'll be exact in size and those types of things. Well, let's get further into this. And maybe in August, we'll have some more info. But right now, it's a little early. But look, I would say very similar in nature, especially how we're going to take a look at it, where we sit in the value chain as well.

James Bradley Archer (President, CEO, and Director)

Mechanically, in terms of the revenue streams, they'll be very similar.

Jason Vlacich (CFO, and Chief Accounting Officer)

Yeah.

Gregory Gibas (VP, and Senior Research Analyst)

Got it. Fair enough. Curious if you could just discuss, it sounds like there's just more of an emphasis now that the renewal of Pecos is no longer a priority or utilizing resources. Could you maybe discuss how you're shifting? your resources towards targeting those non-government opportunities? I guess from a commentary perspective, it just sounds like you're putting a little more emphasis on it. For that reason, I know you said they're kind of typically longer sales cycles, Do we think about these potentially being contributors this year or more longer-term opportunities?

Jason Vlacich (CFO, and Chief Accounting Officer)

Well, I would tell you the emphasis has always been there. And if that came across that way, that's not the case we have a team that's dedicated to everything outside of government. In fact, it's a larger team that's dedicated to government. That pipeline is actually really large and has been. It's just getting more active, meaning they're getting closer, I would tell you, to final investment decisions and those types of things timing, still uncertain, right? They are large they're very impactful if we get them.

Not going to really comment on the timing but emphasis-wise, I wouldn't tell you that government or rare earths or technology side is really being sought after than the other. They're very high priority. And it just depends, right? What's kind of moving forward? Where do we put kind of our folks, and where do we go after? Where do we see the hotspots?

That's kind of where we shift. Today, I would tell you they're pretty balanced lots of effort going into the government as there's some front and center things that we're working on as well as everything outside of government.

Gregory Gibas (VP, and Senior Research Analyst)

Okay. That's fair and helpful. I guess if I could follow up on your commentary around multiple agencies within the government, I think you said them being kind of also near the border. I understand that you don't want to comment until these are maybe closer to the finish line, Any sense of? or can you provide any color in terms of what agencies? you're in discussions with or see opportunities with?

Jason Vlacich (CFO, and Chief Accounting Officer)

Look, I'd rather not talk about the agency-specific. I would tell you it is definitely not unaccompanied children on a lot of those it's outside the ICF network, if you will.

Gregory Gibas (VP, and Senior Research Analyst)

Got it. I guess just last one from me then as it relates to nice to see the continued share repurchases. Wondering if you could just give us an update on continued or I guess what are your capital priorities, right? we expect continued share repurchases, and then could you remind us on the current authorization?

Jason Vlacich (CFO, and Chief Accounting Officer)

We continue to have the authorized program in place, which was initiated at a $100 million level, right, of which we've purchased $21 million of that. Roughly $78-$79 million left in that program. We're not going to comment on prospective activity, but that program continues to be authorized and will remain in place and it'll continue to be a long-term sort of capital allocation strategy for us as we move through time where we see opportunities to execute on it as a reminder, we executed on it in Q1 because we saw opportunities there with respect to repurchasing shares at the tune of $21 million.

Gregory Gibas (VP, and Senior Research Analyst)

All right. Thanks, guys.

Operator (participant)

You have a follow-up question from Stephen Gengaro from Stifel. Please ask your question.

Stephen Gengaro (Managing Director)

Thanks for taking the follow-up. I'm not exactly sure how to ask you this, but when we think about the government business versus the HFS South business, they're clearly different. You guys did a magnificent job in Texas with sort of the network of facilities. How do these? other commercial opportunities, where do they fit? What are they more similar to? Is it one structure with 50 or 500 rooms, or is it a family of facilities around a certain area? How do they? kind of compare to the two other pieces of your business?

Jason Vlacich (CFO, and Chief Accounting Officer)

I would tell you they're more similar to the HFS model, if you will, if you're talking structural, physical-type structures in the way they're set up and operated.

Stephen Gengaro (Managing Director)

Would they come along with some type of term contract to support either construction or mobilization of assets?

Jason Vlacich (CFO, and Chief Accounting Officer)

Yeah, absolutely. They would definitely support all of that, come along with a term contract to certainly support construction expansion. Certainly would be part of our $500 million goal, right? Our return models, our return models. It would consistently support our strong cash flow profile that we currently have overall in the business. That's what these kind of look like. Long-term guaranteed contracts is what we're talking.

Stephen Gengaro (Managing Director)

Okay. Great. And then just one quick one. You repurchased $21 million of stock in the quarter. Does the pending bid impact your ability to return capital while it's being considered?

Jason Vlacich (CFO, and Chief Accounting Officer)

We're certainly not going to comment on any impact that that offer has on our decision-making or potential future activity other than what we've disclosed in the release.

Stephen Gengaro (Managing Director)

But it doesn't sort of there's no regulation. Is there a legal ruling here versus a decision? Are you allowed to, I guess, is what I'm asking.

Jason Vlacich (CFO, and Chief Accounting Officer)

Look, I just don't think we're going to comment on just the possibility if we're going to be in the market or not on the stock buyback right now. The plan's in place we bought in the Q1 we're going to need to be opportunistic.

Stephen Gengaro (Managing Director)

Okay. Great. Thanks. Thanks for all the details.

Jason Vlacich (CFO, and Chief Accounting Officer)

Yep.

Operator (participant)

There are no further questions at this time. I would now like to turn the call over back to Brad Archer. Please continue.

Jason Vlacich (CFO, and Chief Accounting Officer)

Thanks. Thank you all for joining us on our call today. We look forward to speaking to you again in August for our Q2 earnings report. Operator, that will conclude the call for today.

Operator (participant)

Sure. That concludes today's conference call. Thank you for your participation. You may now disconnect.