Q2 2022 Target Hospitality Corp Earnings Call
Good morning, and welcome to the target hospitality second quarter 2022 earnings conference call. All participants will be in listen only mode should you need assistance. Please signal conference specialist by pressing the Starkey followed by zero.
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Please note. This event is being recorded I would now like.
To turn the conference or to Mark Schuck Senior Vice President of Investor Relations. Please go ahead.
Thank you.
Good morning, everyone and welcome to target hospitality second quarter 2022 earnings call. The press release, we issued this morning outlining our second quarter results can be found in the investors 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 this press release the 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 August 19 2022.
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 is 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 investors section of our website to find a reconciliation of non-GAAP financial measures referenced in today's call and their corresponding GAAP measures.
Leading the call today will be Brad Archer, President and Chief Executive Officer, followed by Eric Key Calomiris Executive Vice President and Chief Financial Officer. After their prepared remarks, we will be joined by Troy Schrenk, Chief Commercial officer and open the call for questions.
I'll now turn the call over to our Chief Executive Officer, Brad Archer.
Thanks, Mark and good morning, everyone and thank you for joining us on the call today.
Targets targets record setting second quarter results illustrate the benefit of target strategically located network and superior operating capabilities.
Which have supported targets ability to efficiently meet our customers' varying needs.
It has intentionally aligned itself with premier customers, including the United States government, who find increased value in the flexibility and premium service offerings target provides.
We continued to experience consistent increases in customer demand across our hff's segments supported by strong demand fundamentals.
Target Hff's customers continue to benefit from the size and scale of our network, which provides premium hospitality solutions and logistical flexibility for their dynamic labor allocation requirements. The intrinsic value of target's network has supported and over 90% customer renewal rate for more than six years and an 18%.
The increase in customer labor allocation from the second quarter of 2021.
We anticipate consistent increases in customer activity throughout 2022 and are well positioned to benefit from this positive momentum across our network and Hff's segment.
Target's operating capabilities and network flexibility provided the foundation to expand our critical service offering to the United States government there'll be expanded humanitarian contract, which we announced last month as a reminder, this contract represents a 60% increase from the initial contract we announced in 2021.
And includes significantly enhanced amenities and sport and support services for a population of approximately 6400 individuals.
These critical humanitarian services are centered around minimum revenue contracts backed by the United States government, which provide enhanced long term revenue and cash flow visibility.
Our intentional focus to expand the critical hospitality service offerings, we provide the United States government has materially strengthened target financial profile.
Targets. The government segment represented over 68% of second quarter 2022 revenue and is expected to represent approximately 73% of full year 2022 revenue.
This is a clear illustration of our commitment to diversify and expand targets end markets, while simultaneously high grading counterparty exposure and contract structure.
These accomplishments have materially strengthen targets financial position and establish the foundation to continue pursuing strategic growth initiatives.
These elements along with targets unmatched operating capabilities and distinct core competencies create the optimal scenario to pursue a balanced portfolio of value enhancing growth initiatives.
These opportunities span targets existing end market portfolio as well as naturally adjacent business and industry applications, which we believe creates the greatest opportunity to accelerate value creation.
We are encouraged by the sustained momentum experienced in the first half of 2022.
And believe we are well positioned to continue benefiting from our strategic position as north America's leading provider of comprehensive hospitality solutions and value added services.
I'll now turn the call over to Eric to discuss our second quarter financial results and ongoing growth initiatives in more detail.
Thank you Brett.
Second quarter, we experienced continued strong demand fundamentals and positive momentum in customer activity predominantly driven by the materially expanded government services contract, we announced last month.
Second quarter total revenue was $110 million and adjusted EBITDA was approximately $56 million.
Our government segment produced quarterly revenue of approximately $75 million compared with $45 million in the same period last year.
The significant increase was attributed to the expanded humanitarian contract that we announced on July 6th which had an effective date of may 16th 2022.
As a result, the new humanitarian contracts contribute approximately six weeks of earnings during the quarter.
As a reminder, targets government segment, including the expanded humanitarian contract center around annual minimum revenue commitments.
Additionally, the expanded humanitarian contract includes variable services revenue that will align with monthly changes to community population.
Our hff's segments delivered strong second quarter revenue of $34 million.
Third to $29 million in the same period last year.
This increase was driven by sustained momentum in customer demand for targets premium service offerings supported by constructive economic and demand fundamentals.
Well target has significantly grown its revenue and adjusted EBITDA over the past year.
We have remained diligent in appropriately managing cost to clients across the organization.
We take an active approach managing our input cost and benefit from our service offering flexibility, which allows us to adjust primary cost components to mitigate pricing pressure.
Recurring corporate expenses for the quarter were approximately $8 million and illustrate our ability to significantly grow the business, while incurring minimal incremental corporate costs.
As a result of the scalable business model, we anticipate recurring corporate expenses to remain around $8 million to $9 million per quarter through 2022.
Total capital expenditures for the quarter were approximately $37 million with $35 million related to the substantial infrastructure enhancements associated with the expanded humanitarian contract.
As a reminder, this expanded contract will result in a transitory increase in 2022 capital spending.
However, this increase will be balance sheet neutral with continuing leverage improvement occurring by year end 2022.
Further target anticipates additional balance sheet strengthening continuing into next year with the expectation of having zero net debt by year end 2023.
We ended the quarter with $10 million of cash and total available liquidity of $114 million.
Including $104 million available under the company spent $25 million revolving credit facility.
And then that leverage ratio of two three times.
We expect leverage to come down materially by year end 2022.
These strong business fundamentals and intentional focus on increasing our critical service offering and supported the nitrates government domestic humanitarian missions has materially strengthened target financial profile and contract structure. These.
Elements have resulted in significant increase in long term revenue visibility with approximately 99% of targets 2022 revenue under contract and approximately 75% of contracted revenue having minimum revenue commitments.
Targets enhanced balance sheet will allow the company to continue evaluating a range of capital allocation initiatives focused on maximizing long term shareholder value.
Additionally, the strong financial position creates the optimal platform to continue pursuing our strategic growth aspirations focused on further expanding the company's long term opportunities.
Our established and growing presence within the government services and market creates a natural opportunity to expand our reach across agencies and geographies.
These broad reaching opportunities utilized key elements of target's existing capabilities, including construction of facilities management off with long term growth opportunity pipelines.
These strategic growth initiatives will focus on utilizing targets existing operating capabilities to pursue a balanced portfolio of value enhancing opportunities across targets existing end market portfolio and adjacent end market applications, which we believe provides the greatest opportunity to continue accelerating long term.
New creation.
With that I will turn the call back over to Brad for closing comments.
Thanks, Eric a record setting second quarter results are a direct reflection of our superior operating capabilities and unmatched network flexibility, which supports targets unique position as north America's largest provider of premium vertically integrated hospitality services and solutions.
Attributes have supported strong demand from our world class customers, including the United States government, which has significantly strengthened targets financial profile.
This operating platform creates the ideal scenario to continue pursuing value enhancing growth initiatives focused on expanding targets long term growth pipeline.
We believe this intentional focus creates the growth greatest opportunity to continue accelerating value creation for our shareholders. I appreciate everyone joining us on the call today and thank you again for your interest in target hospitality.
We will now begin the question and answer session.
To ask a question you May Press Star then one you touched on some infused.
If you're using a speakerphone please pick up your handset before pressing the keys to.
To withdraw your question. Please press Star then two at this time, we will pause momentarily to assemble our roster.
Our first question will come from Scott Schneeberger with Oppenheimer you May now go ahead.
Thank you very much good morning, everyone.
I'd like to start out by asking just about how the ramp up is going with the expansion of the West Texas government facility.
Do you see that progressing.
On pace with your original schedule that you had anticipated to add just add any additional color on that.
Yes, Scott this is Brad Thanks look no change from the last time, we all we all talk is actually progressing very well we've hit all the milestones some of the turnover already on some of the buildings as well for the customer.
But fully on schedule and we anticipate that to continue on that way.
With a full turnover in some time in early October .
That's great. Thanks, and then.
With that.
How should we think about it.
I don't know if youre going to quantify exactly but how should we think about the ramp in utilization levels from that facility.
And then.
And then and then really the second part of that question is how should we anticipate.
Margin progression.
In the in the back half of this year as well thank you.
Thanks, Scott good morning.
Yes, so as we think about look at this as you think about utilization there.
We're not going to be specifically disclosing what that what that trend looks like you bear in mind that the <unk>.
The entirety of the facility is not is not up and running there are a couple of phases here. So we'll see that progressing as we move here over the next month or two and then specifically as it will dependent partially on how the government decides to nominated as variable it's variable component.
Which which.
Which is a question mark for us. So so look we expect it to continue to improve over the next few months and then we get to more of a steady state and then from there you know the government will make its elections as it sees fit.
As we think about the margin movement.
What I would say is this so there is a there is a ramp.
As you can imagine right integrated project like this and so as we think about moving this forward.
You, obviously have the numbers that we put out for Q2 most of those will continue to look to us to continue to move in the right direction as we are.
As we move through time here.
Is there something specific on the margin that that you were thinking about.
Yeah as opposed to just speaking in generalities.
Thanks, Eric.
Yeah, I guess I guess, we'll watch as that progression as that progresses I would imagine as occupancy increases we would see a bit of margin improvement.
Assuming that the margin rate the gross margin of the West, Texas facility will be attractive relative to the overall corporate rate.
Really what I'm getting at.
Just kind of circling back by year end that Brad mentioned, probably the expansion should be largely complete or certainly the bad parts by October if everything goes as planned and it sounds like it is could we see.
A potential maximum occupancy from the government by year end I know you don't want to speak because you don't know that yet but that kind of work through this as well. So you have kind of a two part of responses.
Yeah.
I addressed the trend in terms of how we think about the what the government its disposition maybe look on the on the margin specifically.
A couple of things to bear in mind. So you are right right as we as we continue to get occupancy levels. There that that does that margin will continue to get better. However, there is also a effective economic promote if you will in terms of how we think about the margin because there is no minimum revenue piece in there is the variable piece.
Margins are not created the same right and so as you get as you get additional.
Kind of additional per head numbers occupancy in the variable piece that incremental margin actually steps down slightly from the minimum. So so you have to just you have to just think about it in terms of a couple of different a couple of different tranches, so either way in the short run you'll see margin.
Get better as you move out in time and as you can get additional occupancy there there is a bit of a plateauing effect as it relates to margin and then once you get to kind of peak.
The incremental margin actually steps down slightly all the while nominal dollars start obviously getting bigger.
So hopefully that helps and we can certainly talk about that more offline too.
To put a little finer point on that if we need to.
Yes.
Yeah, sorry, Ben maybe on your wrap up question.
As well as you know, we don't control that part of it what we do control is delivering on time the number of beds in the contracts. So they can ramp up I would just say you know everybody knows how much money is being spent what type of facility. This is that we're delivering.
They'll have that ability to do that there's a big need for beds out there. The hope would be that they utilize this quickly and begin to ramp up not in our numbers. We're not we're not telling you that's going to happen.
But I think there is.
As you look at this that's what you think would happen as the year goes on right.
Yeah, that's totally understood got that Brad Thanks, and then Eric I think made a good point.
Even if.
Lindsay side, even if you do have diminishing weight on the improving incremental margin you're absolute dollars are still going up.
I think the takeaway point there so thanks.
I've asked a bunch, so I'll turn it over but one last kind of high level I'm guessing there is no update but just any thoughts on long term extension of this work is government contract. It's a it's a frequent question.
Just wanted to see if you have any incremental comments thanks guys.
Yeah really.
No update there Scott other than what we've all talked about.
You look at what's being spent upfront on this project just the overall design of it purpose built we really look at this very similar to what happened at our daily project and it's being built for the long term, we expect that to continue on even though it's a one year with a six month option on this first.
The first contract.
We look at this as does our partners as a long term solution.
Excellent Thanks, guys I'll turn it over.
Okay.
Our next question will come from Greg give us with Northland Securities.
You May now go ahead.
Hey, good morning, Brad and Eric Thanks for taking the questions Congrats on the results.
Just curious.
You know what maybe drove the upside to your outlook for Q2 here. It seems like it came in a little bit above your range and just kind of wondering if anything has maybe changed with respect to your full year expectation.
Thanks, Greg good morning.
Regarding full year no no change there look I'd say and then getting any way you anyway, you cut it this has been a.
Transformative project for the company and.
Extremely accretive and so no.
No change there as it relates to like as it relates to the outperformance look this is a large project and it is a substantial project in terms of not just not reasonable scope, but also also our financial positioning and so I think the outperformance you are largely seeing as a function of.
When you do projects like this sometimes the margin in the early months can.
Ken can again be frontline a bit and so that's effectively what we're what we saw in the in this quarter.
Bear in mind that does normalize and so.
We will continue that as we talked about the progression of occupancy continues to get better on incremental margin basis.
But as you know at some point in time that does normalize right. So.
But that's largely largely driven.
Driving the outperformance and I think as well as just look good solid operational execution.
What drove that.
Great good to hear and I guess any any commentary you can provide on how the new contract might.
Impact cadence in the back half, maybe if we think about kind of a traditional seasonality if there'd be any any change there this year.
Wouldn't we wouldnt expect any any modifications in terms of seasonality. There you know, sometimes we see we do see a little a couple of percent degradation in that fourth quarter on the HFF side, specifically just from holiday turnover, particularly in December timeframe, I wouldn't expect to see that here.
Okay, Great I guess, just last one kind of.
Maybe putting in perspective, how we should view potential upside to the guidance for the full year in terms of.
Maybe what you are kind of implying in your expectations on the variable side of the contract and just wondering if you can comment on in any.
You know maybe what your assumptions are for that.
So we have not as you know, especially given a variable I can see component, where an occupancy component at all so it makes it does make it challenging to address that question, partially it is primarily a function of.
No.
Our partners and the government has to make their nominations on the variable side right and so until you know that number.
You can't you really can't.
Determined to much more in terms of upside.
I would just I would say this we are absolutely.
Absolutely enthusiastic about the project I'm excited about the opportunity here.
I wouldn't I wouldn't.
I wouldn't make any modifications to what we do when we put out thus far.
Okay fair enough thanks, guys.
Thanks, Greg.
Our next question will come from Stephen <unk> with Stifel. You May now go ahead.
Thank you and good morning, everybody.
Okay.
Just a couple of things I think.
First was.
The HFF south piece of the business.
It feels like I don't want to sort of get your sense for.
It feels like the revenue growth.
Was lagging rig activity and completion activity in the quarter.
And I think you guys are more base load demand. So maybe you don't you're not US you don't swing as much as maybe activity does but could you just sort of give us a sense for what's going on.
In that part of the business.
Yes, sure a couple of things look I wouldn't say, there's anything going on that is not reflective of our expectations that you know that we've really had for some time, we have we have talked a while about the market, they're continuing to get to get better over time and that is what has happened. However, I think.
Last quarter I had indicated that the.
The pace of progression has started to slow and moderate to levels that are feeling much more stable.
So I think that's really that's really what you're seeing.
If youre looking at the topline we did that we did have a little bit of improvement. There. We did have some some degradation in margin although that has nothing to do with the activity level that is that as more of a function of.
Some lower costs, we had last year relative to some higher cost. We had this year just as part of enhancing the business and a little bit of Mitch mismatch in cost there.
Back to the margin, but our margins were up an HFF, south specifically 100 basis points quarter to quarter sequentially. So I would say I would say that that is continuing to move in the right direction.
The last thing I would say is that labor is a look at as a lagging component.
By you know a quarter or so you know typically three to four three or four months and so as that as an improvement gets better in the market.
Tend to see that increase from the labor side, but it is not it is not a kind of a prompt a corollary of activity.
Okay. No. Thanks, it's always huge piece I was just kind of wanted to triangulate the model a bit so.
Two things on the government side of the business and what just one question that I get pretty often is.
When youre bidding on this work and Youre looking at additional opportunities.
Maybe along the same lines, maybe different areas, who are you competing against because it doesn't feel like a lot of people have your track record and infrastructure.
To meet the demand so I'm sort of just trying to get a sense for what's the competitive landscape when you're bidding on.
The government contracts.
Yes.
Brad.
We're not going to call out the names, but theres definitely competition out there right I would tell you that.
<unk> right now.
Not a lot of folks that are setting with the.
The assets that we have the ability to.
To get those installed construction done and just really a few short months.
Also just the track record we've had for years would delay and and then we have some great partners. So theres definitely competition. They get competed.
But we're set up very well to continue to go after even new business, we have a great track record of performing.
Okay. Okay. Thanks, and then just one final one.
The variable component of the new contract I think it's like 185 million Bucks a year.
A is that.
Linear.
The 6400 beds as far as utilization and I think the other question around that is.
Mhm.
I would think you correct me, if I'm wrong, but as I look into next year.
The government wouldn't be spending this money if they didn't expect the occupancy rates on that piece.
<unk> to be very high.
Can you comment on that.
Sure.
As it relates to I'll take the first set in the first part first so as it relates to the linearity.
Is.
Is not exactly linear.
Because when I was when I was talking to Scott about the margin movement and they promote in that that causes it not to be quite linear but it is look it is proportional.
And movement Okay.
So as that is to say differently that as you as you do see additional occupancy. There you will continue to see nominal dollars continue to increase, albeit at a slightly lower rate than we than you would've seen in prior in our prior quarters or prior volume periods.
So hopefully that does help a little bit and we can certainly try to unpack this a little bit more if we need to look as it relates to your point on spend and volume it has been our expectation that the.
This facility will be will be utilized.
Two it to a at a level that is government sees fit and to a level that will that will obviously give them satisfaction as it relates to amount of dollars that are being spent as they are part of the humanitarian solution. So.
Wait and see exactly what that you know what that looks like over time, but certainly to your point, it's certainly something that the government obviously is intending to use it.
Fairly fulsome level, otherwise they would have chosen a different decision.
Got you all right I'll get back in line, but thank you for the color.
Thanks Steven.
Again, if you have a question. Please press Star then one.
Our next question will be a follow up from Stephen <unk> from Stifel. You May now go ahead.
Well. Thanks, I should have just asked a question I guess, but.
You never know, Steve and you never know.
I didn't want to be rude, so I figured I'd get back in line.
B.
When you guys look out.
And.
I guess Theres two things one is when you look out at other opportunities and you referenced this a little bit in the press release.
But in general terms like I mean outside of what you're already doing what are the kinds of of end markets that you feel like your capabilities are most applicable to.
Yeah look I think there are several right.
Building maintenance to facilities management.
Inclusive of catering.
That's a.
A lot of that I think fits within exactly what we do today.
And it's a huge market out there.
It's untapped for us.
And that's really more.
Looking at something different if you look at the organic side for us its continuing on with what we're doing and you know growing some of the HFF side, but more getting into full government services not just what we do today, but reaching out further into different government agencies and providing similar.
Product and services and what we offer at this point to are on a government contract. So continuing to expand that I mean government reaches at many different directions and some of it. We just haven't went after that but we have a great name to continue to go out there and take advantage of.
I think I think I think Stephen the other pointed out that I would mention in bread. He had and this is <unk>.
If you look at the entirety of the solutions that we provide.
Today generally those are triple turnkey solutions and there is a lot of white space to in many ways, perhaps dis intermediate some of that in right. So meaning maybe not provide air elder solutions maybe provide.
Handful of our suite of solutions to a variety of different applications I think at the end of the day, though what's the ultimate objective it's to take.
Target from a business that is talked about $500 million of revenue and very substantial margin and pushing that to over time close to $1 billion in revenue right with the numerous contracts.
Weather and look whether that's with government or whether that's with other business and industry or combined and so look that is the strategic objective and that is very much something that we have focused on and but doing it in a way that is smart doing it in a way that we are not putting.
A number of legs to the stool, so that none of them are meaningful at the end of the day doing them in a way that's been very very complementary to what we're doing and we've look we've seen a number of opportunities and frankly, we've passed on a number of opportunities and.
And when I'm speaking transaction of course, and the reason is because it hasn't either met the return objectives.
And or they have not met the operational and commercial scope, where there are just clear eyed synergies that are there that are fit very nicely with what we are with what we're trying to do today.
To be clear there are opportunities out there and we are looking and evaluating those and we will continue to do so.
But to Brad's point, there are a lot there are a lot of opportunities for us whether the whether it be full turnkey or whether it would be and then discriminator fashion.
Thanks.
The other one I wanted to hit on was.
So you have.
330 ish million in long term debt.
Our models correct and you have a lot of visibility youre going to generate probably 200 million plus of free cash in 'twenty two excuse me in 'twenty three 'twenty four.
What do you do I mean do you Delever do you refinance the debt to cheaper levels now that you have as contract visibility India start an aggressive.
Program of giving capital back to shareholders, either dividend or share repurchase how should we think about.
The <unk>.
Benchmarks are you look at in that.
Ratios youre comfortable with when you start to maybe give more cash back to shareholders.
Sure so.
So couple of things. So so look you are right.
You're right on your perspective amounts of cash generation.
As it relates to capital structure return of capital and and just general use of cash there are there are like five.
Five uses right E pay down debt you can you can you can repurchase stock you can you can do a dividend you can make transactions et cetera.
As we think about the Cascade of those there's an orderly orderly operation of events there for us.
So let's walk through a couple of those.
Media order of operations is not necessarily to return capital back to shareholders, but to continue to focus on the balance sheet right. Our objective is to get leverage down to a point, where we have maximum flexibility to continue to diversify the business. The way we've talked about just a moment ago. So what that means is continuing to harvest cash in the short run and then.
Look initially then looking at the balance sheet in ways that we can that we can optimize that a little bit.
Mentioned before I've never been comfortable with the cost of capital on the debt side, we certainly have mechanisms in our place to to look at that high yield market's a little bit it's been a little bit sloppy recently, we will continue to evaluate that but look.
Putting ourselves in a spot where we can reduce indebtedness.
Is is kind of priority number one is we think about <unk> number two it will be to continue to have excess capital, where we can be additive to a transaction and.
<unk> put ourselves in a spot where we can have maximum accretion from a transaction perspective, and then failing either priorities one or two that puts you back into spot to think about dividends share repurchases et cetera, but again theres a logical progression that we need to go through and when of course, we need the full cash accumulation to really even start those exercises.
But hopefully that gives you a kind of an order of cadence as to which we may think through this the only thing I would add there all.
All the things Eric mentioned is none of them are mutually exclusive rights with the cash we're going to generate over over time, there's multiple things at once that we could that we could go after to maximize shareholder value.
Do you do you have a.
Is there a priority either at the board level.
Or the major shareholders of dividends versus buybacks.
I wouldn't I wouldn't say that there is a primary over there either two of those at this point.
Okay great.
For all the color gentlemen.
Thank you sure thing Steven.
Okay.
This concludes our question and answer session I would like to turn the conference back over to Brad Archer for any closing remarks.
Thank you before we close I would just like to give a big thank you to all of our dedicated target hospitality team members.
Without your leading the way every day and taking care of our customers, we would not be able to deliver the record breaking results we did today.
Thank you again for your business or your relentless dedication to each other and for what you do every day.
It's very appreciated.
That said I would like to thank all of you who joined the call today and we look forward to speaking again in November .
Operator that concludes the call.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.