Q2 2020 Target Hospitality Corp Earnings Call

Second quarter 2020 earnings conference call.

At this time, all participants are gonna listen only mode. They question answer session will follow the public presentation. If you like to ask a question. You May proceed star one on your telephone keypad.

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A reminder, this conference is being recorded it is now my pleasure to introduce your host Mr. Mark shook senior Vice President of Investor Relations. Thank you you may begin.

Thank you good morning, everyone and welcome to target hospitality second quarter 2020 earnings call.

First we issued this morning outlining our second quarter 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.

The same language applies and statements made on todays conference call. This.

This call will contain time sensitive information as well as forward looking statements, which are only accurate as of today August 2020.

Target hospitality expressly disclaims any obligation to update or when 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 periodic filings with the S. You see.

We will discuss non-GAAP financial measures on todays call. Please refer to the table in our earnings release post in the Investor section of our website to find a reconciliation of non-GAAP financial measures referenced in today's call inner corresponding GAAP measures.

Leading the call today will be Brad Archer, President and Chief Executive Officer, followed by Eric <unk> calendar Executive Vice President and Chief Financial Officer. After their prepared remarks wont be joined by choice shrink Chief commercial officer.

Open the call for questions.

I'll now turn the call over to our Chief Executive Officer, Brad Archer.

Thanks, Mark Good morning, everyone and thank you for John joining us on the call. Today. In addition to discussing our second quarter performance I will touch on our continued focus around capital discipline and cost reductions as well as a recent trends we have seen from our energy end market customers.

And that's challenging environment created by the Cobot 19, pandemic and simultaneous shocks to global commodity markets target delivered solid second quarter results. We took decisive steps in reaction to what was a pronounced reduction and customer activity and utilization levels.

These steps a line target customer demand and supported continued strong cash generation with discretionary cash flow for the second quarter of approximately $15 million.

As a covert 19 pandemic accelerated in entering the second quarter target quickly implemented an operational response plan to ensure the health and wellbeing of our employees and customers.

We have maintained this focus and as are resolved we have not had any cases of cobot night King impact our business.

We also took immediate action to appropriately position the business for what we anticipated to be a challenging 2020.

I met sharply declining utilization, we began dynamically managing capacity across our network to align with demand and our customers needs while quickly reducing cost across the organization.

Our cost reduction initiatives remain on track and our second quarter results reflect meaningful reductions in capital spending cost of services and recurring corporate expenses.

These cumulative steps have allowed target to maintain operating leverage and preserve robust cash generation in this challenging environment.

We have positioned target for long term success and as market dynamics evolve there is a potential do organically gain additional market share as we returned to a more normalized pace of activity.

Now turning to the recent trends we have seen across the business.

As we exited the second quarter, we began to see signs of activity stabilizing from our energy end market customers and incremental gains and targets occupancy and utilization trends.

We have seen improvement in these metrics from lows that occurred in late May.

Albeit modest we have seen these positive trends continue through June and July.

As a result, we have reopen several lodges that were temporarily closed early in the second quarter, Jimmy increasing customer demand and both the Bakken and Permian.

However, like many other industries as we continue to move through 2020, there as downside risk from potential slower economic recovery or multiple ways of cobot 19 related shutdown.

We remain cautious on a meaningful increase and activity levels through the remainder of 2020.

But do anticipate marginal improvements as we move into the third and fourth quarter.

Followed by seasonal deceleration late in the year.

Even with incremental improvements in the second half 2020 progress is likely to be uneven in the near term.

As activity progressive towards normalizing, we will provide the market a revised 2020 outlook when enough clarity is available.

We have position target to be successful through a variety of business cycles. While this one is certainly different we will benefit from incremental improvements in activity levels. As the result of our high quality top tier customer base and expansive networks and the most economical basin.

These are key factors that differentiate target, allowing us to appropriately manage the business and challenging environments.

The second quarter results are indicative of our ability to navigate an unprecedented situation and remain focused on ensuring the long term success of target hospitality.

Now I'll turn the call over to Eric to discuss our second quarter results in more detail.

Thank you Brad and good morning, everyone.

I will begin with discussion of our results review, our capital program and conclude with details on our progress mitigating financial impacts from an economic uncertainty we are experiencing.

As we anticipated we experienced a sharp decline utilization in the second quarter due to cope with 19 pandemic and declining global commodity markets.

However in this challenging environment, we were able to produce strong quarterly results.

Second quarter 2020, total revenue was approximately $54 million adjusted EBITDA was approximately $14 million and discretionary cash flow was approximately $15 million.

Turning to our segment performance the Permian Basin delivered second quarter revenue of $21 million compared to $52 million in the same period last year.

This decrease was driven by lower utilization.

As customer demand was sharply reduced in response to be accelerating global pandemic and crude oil price volatility.

In the Bakken.

As a result of the temporary closure of all our communities in may 2nd quarter revenue was negligible.

I have seen incremental improvements in customer activity end demand in the region and have recently reopened lodges in response to this increase in demand.

Our government segment remained consistent with quarterly revenue of approximately $17 million.

Our all other segment, which consists primarily of construction fee revenue from TC energy pipeline project.

Had revenue of approximately $16 million for the second quarter compared to $3 million in the same period last year.

Revenue increased as a result, pcms announcement to proceed with the project in March.

However, as a result in the Supreme Court ruling in July we anticipate limited activity associated with this project for the remainder of 2020.

Recurring corporate expenses for the quarter were approximately $7 million, we took decisive steps to reduce cash expense across the company and restructured the organization to match activity where appropriate.

These measures contributed to an over 7% reduction recurring corporate expenses from the first quarter and we're on track to contribute annualized savings of approximately 20%.

With our expense reductions, we anticipate recurring corporate expenses, driven mainly around $67 million per quarter for the remainder of 2020.

We generated cash flow from operations of approximately $15 million from second quarter, and a 27% discretionary cash flow yield of revenue, which illustrates the significant resiliency in our business model.

Even in this challenging environment, we expect to continue generating robust operating and discretionary cash flow, providing sufficient capacity to fund all normal course business activities as well as to strengthen our balance sheet.

Capital expenditures for the second quarter were approximately $1 million, including minimal maintenance capital.

As a result of lower aggregate demand and reduced customer activity levels.

Bargain anticipates capital expenditures to be less than $3 million for the remainder of 2020.

Or $7 million to $10 million for the full year.

We ended the quarter with $425 million long term debt, including $85 million drawn our revolving credit facility.

And consolidated net leverage a 3.4 times.

As a reminder, our long term debt consists of $340 million and senior secured notes due 2024.

And 125 million dollar ABL facility.

Which have no near term maturities or immediate financial covenants, providing us significant flexibility and liquidity within our capital structure.

In addition, we anticipate outstanding debt balance to be reduced in the second half 2020, some continued cash generation, which will only further.

Our available available liquidity.

Now turning to the progress we've made in mitigating the effects of the ongoing economic uncertainties.

The second quarter results illustrate the pronounced reduction connectivity and utilization levels, we anticipated.

However, we took the sites decisive action to reduce costs during the quarter and were able to reduce our Permian and Bakken cost of service by over 30% compared to the first quarter.

As we previously outlined we took proactive steps to modify select commercial contracts for the long term benefit of target.

These discussions resulting in a mutually beneficial outcome.

Providing lower committed beds to our customers in 2020, while maintaining contract integrity by preserving HDR and margins for target in future years.

In addition, we gained greater visibility on long term revenue and cash flow by extending contract commitments, including exclusivity from 2021 into 2025.

As part of our negotiations we obtained approximately $60 million up additional minimum revenue MMS at attractive margins.

This also significantly reduces near term contract renewal risk that was coming up into 2021.

These modifications appropriately positioned target to participate in increased demand given an enhanced market share capture as we progressed to a more normal operating environment next year.

Our Q our cumulative response to these economic uncertainties has been taken with the focus of preserving liquidity protecting our balance sheet and retaining financial flexibility.

Our cost reduction initiatives, along with our focus on capital discipline.

Allowed us to exit the challenging quarter with approximately $60 million liquidity, an increase of $14 million from first quarter. This year.

We believe the strength of our balance sheet and cash position along with a continued focus on cash capital stewardship will provide the opportunity for target to prevail stronger more resilient company as we returned to more balanced market.

With that I will turn the call back over to Brad for closing comments.

Thanks, Eric we anticipated the second quarter to be challenging and it was we witnessed a significant reduction in our energy end market customer activity, which resulted in a pronounced reduction in utilization across our network and a challenging environment. Our strong second quarter results are a testament to.

Targets ability to quickly react to an unprecedented situation.

We protected our balance sheet and exited the quarter with an enhanced liquidity position.

We have intentionally established targets expansive network. When then most economical basins in North America, while aligning with first class customers and the best operators in the region.

These factors underscore our ability to continue to succeed in challenging environments.

While the scale and pace of an improving economic outlook is difficult to predict.

Target is well positioned to adapt to changing market conditions and take advantage of the eventual recovery.

I appreciate everyone joining us on the call today and thank you again for your interest and target hospitality.

Operator, you May now open the line for questions.

Thank you the fourth how open for questions. If he would like to ask a question. Please press star one on your telephone keypad at this time a confirmation tell indicate your line is in the question Q you May press star to if he would like to remove your question from the Q for participants using speaker equipment. It may be necessary to pick up their handsets before pressing the star keys.

Once again that is star one to register questions at this time.

First question is coming from Jeff Grampp.

Capital markets. Please go ahead.

Morning, guys.

I was curious first off.

Commentary on how that intra quarter unsecured what you guys are seeing thus far in Threeq was hoping to dive and on that a little bit more do you guys haven't have any sense, I guess or any level of confidence at this point to be able to say that to Q was kind of the trough. If we look at just kind of the energy business ex Keystone because I know that's kind of separate.

Dynamic there, but if we just kind of look at the core Permian Bakken exposure do you guys feel that Twoq was was the trough given what you've seen thus far in Threeq you or can you just kind of talk about how you're seeing in directionally the remainder of the you're playing out.

Yeah, Jeff this Brad.

Let me take that first an air can jump in as well.

But.

We do believe it's the trough, though I think the question is how fast and how steady does it does it continue to rise right. If you look at the trough in May we think 10 consecutive weeks now of increase in our occupancy.

We think that definitely shed some light on.

Thus, calling it the trough I think theres definitely things out there they could change depending on what happens with Covance and how it goes but if it's a steady state we believe it's still a slow crawl up.

But we see better occupancy as we continue to move into the third and fourth quarter.

Hey, Jeff said Mark Good morning, I think you know as we as we indicated last quarter.

I wouldn't say a lot has changed in our in our outlook as we think about the back half of the year certainly.

The one positive thing that has there has been helpful is that the the movement off the trough is fat little faster than what we had initially modeled which is which is helpful.

I think it's Brad indicated as you look out going into Q3 and into Q4 to some extent we do expect this this movement up but I think from a planning perspective, we're cautiously optimistic but we are being sober about there are certainly a number of unknowns and we'll have to play those out as we as we move through the year, but.

We're certainly looking forward to some positive momentum as we continue some some trajectory here.

Great real really helpful. My follow up on the our side.

Our Permian outperformed quite a bit than than what we were expecting was up a decent amount sequentially.

Anything going on there that you can kind of point too and is that a good baseline to think about going forward or just how we should think about maybe our I'd gone for the rest here. Thanks, Sherri, Let's say, Greg Greg question.

And you're right, yes, there is something going on there and so if you recall, we had worked through some contract modifications with a handful of large key customers and some of those discussions there were there were amounts owed to us that we imputed as part of the change in contract then so what you're seeing in purchase.

Actually this quarter was with some of that revenue coming through and hitting and hitting HDR positively, but certainly doing it with no no increase in utilization certainly no cost of service attached to it so that had the net benefit of increasing the 80 are above and beyond what you otherwise would have expected I.

Thank you you look to normalize those out.

Fine you I would take take a few dollars off of that as we look out in the future and I wouldn't say Grady our will be much different than it was let's say in let's say first quarter.

If you think about first quarter relative to third fourth quarter that play probably puts you on a better spot moving forward.

Got it really helpful. Thanks for the time guys.

Thank you. Our next question is coming from Stephen Gengaro of Stifel. Please go ahead.

Thanks, and good morning, everybody.

I guess, while you're on the topic you were just I'll ask you have your your Permian gross profit margin.

ER was down.

Hi, I know occupancy was down and then a market was awful.

But the eight but given that hbr move.

If you get back to a similar HDR going forward.

How I guess I'm getting at how much of the change is aer related and how much is kind of under absorption as we try to think about back half margins in the permanent.

Sure. So so let's take a step back and you're asking a great question, but let's say, let's take a step back though so so when we look at when we looked at their contracts and had the discussions with some of the Counterparties. We may be election, as this year to be constructive and work with our with our customers and a handful of.

Of customers at that which did impact how we how we think about the business in the perform to the business as we move through 2020, but and that it has a positive impact to us in 2021 through nearly 2025 at this morning, guys. So there was absolutely some positive things to us and so.

When you think about the your question, it's really a function of occupancy at that point and we came out of this with a better contract structure.

But the reality is that the occupancy was down substantially and we did give on some of the committed revenue than we otherwise would have expected, which had the net impact of hurting the margin.

Now, we expect to get substantially a substantial portion that back into 2021, it's particularly 2022. So I think I think when we when you look at it you have to look at in totality and not just look at it in 2020.

Okay. Thank you and then.

The.

Can you talk about.

So we look at the Premier numbers and they were they were better than expected in aggregate when we look at.

The monthly progression through the quarter.

And we look at.

In July and we're on August 10th So I figure pretty good visibility into August right now how does.

So how does the first what's that trajectory look like in Howard how is the third quarter occupancy shaping up.

Relative to the second quarter, and that's sort of the that the monthly progression because you know you're halfway through the quarter almost I figure you have pretty good sense for the first couple of months.

Well look I'll take that said again air can jump in if he wants but trajectory is a little slow it started off class fairly fairly quick hit the bottom and as I said 10 straight weeks of increase in our occupancy.

But we've seen that it's still on a trajectory going upwards, but it slowed some.

In the past few weeks, so look we look for that to continue upwards.

As we continue into the third and fourth quarter or the question is how fast right right. Now we believe that's going to be a slow crawl up definitely throughout 2020 in parts of 2021.

Yeah, I think I think Steve we are you can't look you're you're asking great questions. I think the reality is this there are so many unknowns that.

We are not expecting.

A out what I'll call something that that's a meaningful improvement.

Until kind of mid next year and based on what we know today now we're not getting that feedback necessarily from from customers were giving that feedback from our from our experience in these businesses and then how long it takes to typically come up cycles.

And kind of peak to trough and all that and I'm not saying, there's a peak and year certainly either I'm, saying that we don't expect there to see meaningful improvement in so I.

I think what were you know look we're planning on 12 to 18 months before we are at a approaching levels of utilization and HDR.

ERP Ics that are.

Consistent with what we would have expected this business.

Kind of mid cycle basis, and so we think we're a little bit away from that but but we'll continue to make some proven.

Hi, Thanks in just one more if you don't mind I'll get back in line, but.

What I think about the Permian revenue.

And you look at though revenues for the quarter the occupancy utilize your arms or the utilize rooms.

Physically utilized for just rooms that are paid for.

The utilization definition, our rooms that are effectively that effectively paid for now remember.

We modified caught a select number of contracts that drove the lions share of that down this quarter and into Q3 as well. Okay. So so you have to bear that in mind. So so in the short run it feels much more like occupancy.

Until we get into 2021, we're where those modifications in the contracts will start we'll start taking hold and a more from way in terms of minimum revenue commitments.

But.

So it looks it looks a little bit different to what you're used to seeing but but it is technically off of the revenue.

Which which gets back to the utilization.

Oh, great. Thank you.

Once again, ladies gentlemen that its star one if you would like to register a question at this time.

Our next question is coming from Kevin Mcveigh of Credit Suisse. Please go ahead.

Great. Thanks, Hey, I Wonder if you could just gives a sense. Some of this contract renegotiations, what you were able to benefit from obviously, you're working with those partners pretty close but is there anything you'd call out.

As you look forward just based on incremental benefit to target.

Sure I'll tell you kinda give them at a higher level than what we're trying to accomplish in what we need to effectively did accomplish.

So we gave certainly to some extent for 2020 and really gave them a relief that many of them needed and we've got we're talking about a handful of large customers writes a large large our customers and and kind of giving them breaks of over six to nine months, but in return what we're getting our.

Our two things one meaningful extensions of the backend some of which we're talking about we've put in the release right for the $60 million of additional revenue commitments. In addition to that we have an extended term on the initial contracts that were dealing with today. So those are those are the two positives third thing we're getting is.

As we have in many cases nearly all cases, we've kept 80 our.

Nearly static or in some cases of have increased so we've kept pricing and kept margin. So what happens is removed through time, you have the minimum revenue commitments kicking in and escalating rate as we move through time.

At margins that are nearly equal to or in some cases better than what we're at today.

While we're doing that we're also able to remove a number of deferral mechanisms, which were which were in other contracts, which we do you have so we look at this Kevin in total we look at it and say look we gave some things in 2020, but when we look at the structure of the contract and we look the duration of the contracts and we.

Look the present value of the revenues going further out in time.

We think we did quite well for the long term benefit of target.

That makes sense and then just.

On the competitive side, obviously, there's a lot uncertainty but.

And just thoughts on that used to catch the keep it is there any strategic acquisition just any thoughts on capital allocation within.

Context.

Some of your competitors.

Yeah look I.

Hey, Brett.

Or not how you doing Kevin what you're not going to see if it's going and you know.

Spending the money in the Permian doing acquisitions or or anything like that I think the the cash flows will be put towards debt I think we've been.

Pretty open about that I think the great thing is we were able to reset our cost we did not have to negotiate on these contracts and we could have had a a much better 2021.

Than what we're sitting here today, telling you what we think.

Renegotiating that being a good partner with our customers allows us to really do even much better in the outer years, you know so I think the cash as you talked about definitely continues to grow we continue to put that towards the at this point.

Toward towards the debt what I would also tell you we've been talking about diversification for awhile.

Something.

We still have top of mind, something we will do.

Looking at it different facilities management catering those types of things the it's what we already do.

In some of our locations. We think that's a business that we can scale pretty quickly helps diversify us into many other.

Industries. So it's something we're going to keep a focus on its nothing that we have right at hand today.

But we think it comes so I think I think Kevin everything out and though that is that we are when you think about transactional activity and as Brad mentioned, we don't see the need or reason to do a lot in the Permian one of the reasons for that is that we have already picked up effective market share.

Just based upon what's happened in the environment, there what's happened with our competition.

The the contractual amounts cases, we've made and the extending exclusivity out a number of years.

For contracts that maybe we had exclusively in the year to have now been moved out 345 years and so so we have picked up effective marketshare and we see much less of a need to go out and do some transactional India and the Permian within allows us to do in the meantime, strengthen the balance sheet as Brad mentioned, but to really focus much more.

Diligently on expanding the diversification on cash flows.

This is very helpful. Thank you.

Thank you. Our next question is coming from Stephen Gengaro with Stifel. Please go ahead.

Hi, Thanks.

Just a follow up one more time on that so I understand the dynamics. If have you thought about the second quarter margins in the Permian and then sort of thought about I don't it doesn't really matter exactly what timeframe, but whether it's back after this year or first half of 2021 of the progression wouldn't have it what are the stepping stones, because I think you have.

Costs out you have HDR is normalizing from second quarter levels, and then you maybe have higher occupancy ER and I'm, just trying think about the cost structure Leds in place relative to the occupancy in the variable cost associated with adding maybe some more people to the rooms.

Just trying to get a better hit on the but what we should think about from a progression perspective. So it can.

Stephen is your is your question around that margin expansion and the movement and sort of work.

Yes, yes, so puts and take really what are the I guess it takes to the margins in that as we go over the next several quarters. Okay. So so a couple of things when we so when the in the midst of the pandemic when those happening premium written mid March for we did not see start seeing these are meaningful impact to us until really the first or second.

Week of April right. So we were probably behind things by about a month from where you were feeling in real time.

And so so what I think ends up happening is we ended up moving cost down low pretty substantially but it was albeit delayed from probably where where people might might expect just because we had just still continue to facilitate the customer and so now what we're looking at as a spot where.

Really we have cost almost completely caught up and as we increase occupancy as we move through time and has some HDR pick up through some additional.

Service.

What I expect is that we are margin expansion because now we've got cost better and balance right. So.

Yeah, I think that's the piece that I want to put a number on that.

Steve about tell you that the there should be a better bigger spread between between revenue and cost at this point as we move forward in time.

There's always a static caustic just how things go down and as utilization increases.

Pick up as you say only 10% remember we've talked before about the split so roughly 70 30, when we look at cost of services about this is average of about 30% more of a fixed nature, but 70% more variable nature. So obviously as you bring the revenue pull down.

Your fixed pool is going to start becoming a bit are bigger allocation about right.

So as we start moving revenue backup and occupancy increasing now your fixed spread is going to start coming back down on and so you should see you start seeing some margin expansion as we move through time.

And you go back we're July and August started in June.

From a margin basis or just in general from a revenue perspective, and maybe you don't want to it's not directly.

If I see.

It is directionally as we've indicated as to where it is continuing to be direction positive thing with Brad was saying before was that the pace from may through June that positive slope of the curve is quite high what we're seeing now is the slope of the curve is coming down, but it's still upward sloping so so.

Yes. It is positive, but I think we want to just I think just want to caution you look don't make it linear through the model was all we're saying, okay because because.

We just don't know, but what what end of Q3 in Q4 really looks like.

Sure I understand you have extra extra and then and then just one more and that is.

Do you think about your occupancy and I look at a market right now that will seemingly have a meaningfully lower average rig count in the third quarter.

Rising completion.

Well count and more Frac crews is there way to think about.

Those competing factors.

On your utilization as we need that even maybe not your third quarter just going forward like are there more people on the completion side more people in the drilling side of the fairly close if we get completion rising 20% of drilling falling 10% is that good or bad is there we think about those two dynamics.

That's okay pre buy it's getting pretty binary.

Well, because it's clearly the completion activities rising drilling it's yeah, I mean right it to be out to be fair. I mean, there are more people that are that are doing the servicing when you're doing perforations in indirect fracking them refrac and all that than there is an actually.

Drilling right.

No question about that what we are seeing.

Our customers taking advantage of of of lower rig rates and in some producers are drilling more more wells right, but they are not completing them. Okay. So so.

I think what you would expect to see over time as pricing allows it is for an influx of completions was then provides more opportunity for for human capital command.

But look there's a lot that can happen between here and there.

Okay and the data we see suggested completion crews or are rising pretty nicely drilling activity down quarter over quarter just on average.

Is that it's somewhat bird I mean, if you look at who's on our lodges is definitely the completion crews when it came back right Oh gosh.

Yes, so we're definitely seeing that I think again I question goes back.

How does that continue going forward, how fast out what's what's the pace the pace of that but we've had some of these come back really nicely, especially our larger customers right.

So we like where that's headed it's just not as fast as we'd like to see it at this point.

Okay.

You did make a note earlier that you like you've gained some share throughout this.

Yeah, I mean, we've done this in the last time it will happen in North Dakota here, what we're seeing is and I don't think it's a secret what's you're going to see the larger customers a bigger.

Spend of capital.

In the Permian right I mean from the from the larger MPS and then your larger service companies are going to get the lions share of that and we're starting to see that today some of the bankruptcies that have taken place.

Are.

There are affecting us in a nice way.

You are seeing chevron by Nova we all know their customer of ours does that affect that we think at some point it affects the positive way, we don't think the consolidation in the basin is done and we're we're setting.

What these contracts in the reason we wanted to work with a customer for many reasons, but one of them is we believe in the basin, where theres going to be more and more capex spent there as the market recovers and we're going to be set in a very very good position to take advantage of that.

Great now this is very good color. Thank you gentlemen.

That.

Thank you this brings us to the end of the question and answer session I would like to turn the floor back over to Mr. Brad.

At Archer for closing comments.

Sure. Thank you thanks, everyone for your time today and we appreciate your continued interest in target hospitality and we look forward to speaking again next quarter. Thanks.

Ladies and gentlemen, thank you for your participation. This concludes today's event you may disconnect or lock up at the time and have a wonderful day.

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