Greetings, and welcome to Target Hospitality's Third Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Mr. Narinder Sahai, Senior Vice President, Treasurer, and Investor Relations. Thank you, Mr. Sahai, you may begin.

Thank you. Good morning, and welcome to Target Hospitality's third quarter 2019 earnings conference call. The news release we issued yesterday and the presentation for today's call are posted on the Investors section of our Web site. Joining me on the call today are, Brad Archer, our President and Chief Executive Officer; and Eric Kalamaras, our EVP and Chief Financial Officer. After prepared remarks by Brad and Eric, there will be a question-and-answer session. Troy Schrenk, our Chief Commercial Officer, will also join us for the Q&A session. Before we begin, I'd like to remind you that some of these statements, including a discussion of our 2019 outlook and responses to your questions in this conference call may include forward-looking statements. As such, they are subject to future events and uncertainties that could cause the actual results to differ materially from these forward-looking statements. Known material factors that could cause our actual results to differ from those implied by the forward-looking statements are described in our news release issued yesterday, our most recent 10-K, most recent 10-Q, and other periodic filings with the U.S. Securities and Exchange Commission. We wish to caution you to not place undue reliance on any forward-looking statements, all of which speak only as of the date hereof. We undertake no obligation to publicly update or revise any of our forward-looking statements after the date they are made. In addition, on today's call, we will reference certain non-GAAP measures. More information regarding these non-GAAP measures, including reconciliations to the most comparable GAAP measures are included in the news release issued yesterday. With that, I'll now turn the call over to Brad.

Thanks Narinder, and good morning everyone. Thank you for joining us today to discuss our third quarter 2019 results. Before we get into the specifics, I want to thank the 800 women and men of Target Hospitality for their hard work and dedication in taking care of our customers each and every day. Their commitment to delighting our guests in every interaction, big or small, is exemplary and a true reflection of our customer-centered culture and service promise. Now, let's turn to the quarter. As you know, our energy end-market customers are predominantly in the Permian Basin. This is our largest segment and a significant driver of revenue and earnings growth for the company. Drilling and completions activity in the Permian Basin experienced a deceleration in the third quarter. Frontloading of exploration and production as well as energy service capital spending for the first-half of this year has constrained activity for the second-half as future capital needs are assessed. This, combined with keeping production spending within cash flows, is having cascading effects. The Equipment Utilization Index is at its lowest level, since 2016, for oilfield services firms, and construction employment in the Permian Basin has experienced some contraction through the end of the third quarter. Amid this backdrop, I am proud of the resilience of our business as the third quarter was a solid operational quarter for us, and we delivered strong financial results. As promised, we executed on our growth strategy, generated attractive margins, and at the same time initiated shareholder returns. Our cash generation was the highest it has ever been allowing us the flexibility to simultaneously grow the company and return capital to our shareholders. We had tremendous operational momentum in the quarter. Our system-wide total beds reached 13,000 for the first time. This helped us cross…

Thank you, Brad, and good morning, everyone. This is my inaugural call with Target Hospitality, and I am pleased to be joining a high quality organization with excellent leadership and great growth potential. As Brad indicated, we delivered solid third quarter results. I will begin with discussion of our results, review our capital program, and follow-up with details of our updated 2019 outlook. In the third quarter, we continue to benefit from our growing network. New builds and expansions, the successful integration of our recent Superior Lodging and ProPetro acquisitions, as well as a sharp focus on operational execution. Well, overall results were modestly impacted by the slower-than-expected pace of the TCPL project and slower growth in our energy end-market we still achieved nice year-over-year growth in both revenue and adjusted EBITDA. Total revenue increased 35% to $82 million, and adjusted EBITDA increased 30% to $41 million, and an adjusted EBITDA margin of nearly 50%. The year-over-year growth in adjusted EBITDA was a result of higher sales and improved operational cost leverage. With improvements from an increase in utilized beds, our total cost of services declined. Recurring corporate expenses for the quarter were $9 million. The increase from last year is primarily associated with the transition to being a public company, as well as infrastructure investments that allow us to scale the business and to support additional growth with minimal incremental costs. We expect our recurring corporate costs to remain around $8 million to $9 million per quarter. Turning to our segment performance, the Permian Basin delivered third quarter revenue of $57 million, an increase of 65% versus the prior year quarter. This increase was primarily driven by an increase in average utilized beds as a result of the signal integration, as well as new community additions and expansions. We…

Thanks, Eric. In summary, our continued solid operational momentum and execution is delivering strong financial results. We have continued to deliver on our growth strategy and our relationships. And contracts with our core customers underpin the stability of our business. And this was clearly evident in this quarter. We grew our bed count in the quarter and generated exceptional cash flow from operations. While we cannot control the market, our value proposition to shareholders is the confidence that we have in the structural advantages in our business. We maintain a line of sight on a significant majority of our revenues. And as I reiterated today, we are actively working to further increase our mix of business from high quality integrated producers and large oilfield service company. We are also focused on returns. Our solid balance sheet and significant cash generation ability allows us to execute our growth strategy without sacrificing returns for our shareholders. Our team is committed to executing our strategy, winning in our markets, and delivering outstanding results. Thank you again for your interest in Target Hospitality. Operator, you may now open up the line for questions.

Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Stephen Gengaro with Stifel. Please proceed with your question.

Thank you, and good morning gentlemen. Can I start with the fourth quarter guidance? When we sort of back of the envelope try to figure out what your fourth quarter contracted revenue looks like, we came up with a number of around $77 million, and I think your revenue guide implied $73 million to $83 million. Can you talk about the moving pieces in the fourth quarter that kind of lead to variance in your range of about $10 million and kind of what portion of that is part of that sort of 85% of revenue that's contracted?

Hey, Stephen, this is Brad. Thanks for joining here today. Let me take high level kind of on the business, and then if Eric wants to jump in and give some more color to more specifically on that number he can, but look, as we've mentioned in the past, our core business is our strength, and this part of the business is still intact. We've got great visibility on the business due to our long-term contracts. Now, conversely, the un-contracted portion of our business which can be variable, we have less direct visibility on, and we experienced softness in this portion of our business, specifically two areas, the spot transient market and commercial opportunities which pushed to the right. Look, we believe this softness is short-term through the fourth quarter, and when budgets reset in the first of the year, we expect this portion of the business to improve. And here's why I say that. I'm out there quite a bit, Troy is, and the business hasn't gone away, and the market's not shut down in the Permian, it's still very busy. The good thing is a lot of the work we don't have to rebid for, because it's under our exclusivity contracts. So when budgets reset, we're set up to get this work back. And I look at this and some customers maybe had dropped some headcount in the fourth quarter, they haven't went away, and in talks with them, we know some of this work is coming back in the New Year. So again, not rebidding it, if they come back to the basin, they go into our room. So, that's a good point to look forward for past the fourth quarter. And then I'd tell you, remember, on a high level, the goal is to always convert this variable portion of our business to long-term guaranteed contracts, and we'll continue to gain momentum in doing this.

I think -- Stephen, good morning. This is Eric Kalamaras. I think the only thing that I would add is, as we think about fourth quarter relative to what we've seen in 2019, our structural contracts have not changed, right. So there's no real change there in what we’ve seen historically, what we're seeing now into Q4, and frankly into 2020 for that matter. A substantial portion of that revenue, as you mentioned, is fully contracted, and I wouldn't quarrel with your number, I think it's directionally correct, but look, I mean nothing structurally has really changed here. I think as Brad mentioned, the variable portion of the business has been impacted, and that's really what's driving the spread in the outlook.

Okay, thank you. And then when you think about 2020, you mentioned it just now, when you think about the comments you've made over the last several quarters at 85% of revenue contracted, I'm assuming that 85% was based off of a 2019 guidance number. Is that -- because what I'm getting at is, when I think about that, it would seem to suggest that there's $280 million to $300 million of revenue contracted and visible for 2020, and I'm just trying to get a sense on is that a reasonable number, is that too high, is that too low?

Sure, no, thank you for the question. So, I would say this, so we're not ready to give a certain -- more of a detailed 2020 outlook at this time, okay. Here's what I can say, right, so what I guess what I would say is we see these short-term activity levels that have come down. We are seeing some impact on the variable portion of the business. I do expect some of these commercial opportunities to re-emerge through 2020. I don't want to specifically opine on what the contracted portion of the business looks like until we get to our business flooding cycle through the back part of this year. So, it allows us to come back with a more fulsome update on that, and I would just leave it at that for now.

Okay, but it -- was I right in saying that when you talk about 85% being contracted, that that was relative to your 2019 revenue guidance?

That is correct. The one thing I would add I think that would help, as you think about 2020 and in the meantime is, we have no significant roll-offs contractually coming through into 2020. So, I think as you think about that, look, the outlook that was previously provided certainly was predicated upon the prior 86% number. So you're directionally right on that.

Okay, great. Thank you.

Our next question comes from the line of Scott Schneeberger with Oppenheimer. Please proceed with your question.

Good morning, guys. It's Daniel on for Scott. Honing on utilization a little bit, you noted in the release that the year-over-year decrease was due to a higher number of new bed additions in the third quarter not being contracted by quarter end. How have you progressed in the fourth quarter '19 with contracting those beds, and how will utilization be impacted by the 200 additional beds at the new communities?

Hi, Daniel. Good morning. It's Troy. I appreciate the question. Look, as we look forward and think about the fourth quarter, we do expect utilization to be soft as it was in the third quarter. And again, largely that's attributable to the variable portion of the business, which is the uncontracted portion. Look, I'm pleased with some of the progress that we've made. But candidly, as Eric and Brad had both mentioned, and we mentioned in our remarks, is that we have had several commercial opportunities that have been deferred in 2019. Now, that work hasn't gone away. We have direct line of sight on that work, and we have reasonable confidence in there in 2020 that we can capture that work by virtue of our exclusive contracts as Brad mentioned, right, we're set up very well to really capture that work on its return when budgets reset first-half of the year, is that helpful?

Got it now. Perfect. Thank you. Switching gears to ADR a little bit. You know that excluding the Signor communities, ADR has been pretty stable at remaining communities on a year-over-year basis. Could you provide us a perspective on ADR in the fourth quarter here both excluding Signor and including Signor how we should think about it both quarter-over-quarter and a year-over-year basis?

Sure, I'll make a comment. And I'd like Troy to jump in as well. I think as you think about ADR moving or would you see modification mix as we head into Q4, right so I think you may actually see some positive trends there heading into heading into Q4 and perhaps into part of 2020. So I think it's going to be a really a mix issue, more than -- really more than anything else.

Yes. So Daniel, I think the only thing that I would add I mean again, just to reiterate, as we've said, the cores is intact and this portion of the business is not impacted by the spot or the transient including ADR. Look, I think it's important to recognize that we're carefully balancing price terms, utilization to maximize profitability. So when you think about the uncontacted portion, we're focused on balancing those prices, that pricing that ADR in the terms and utilization again for max profitability, but that core is intact from an ADR perspective.

Daniel, it's Brad. Just one addition there and just to call it back out, when you look at Q3 versus Q2, our top 30 customers spent more with us in Q3 than they did in Q2, so when we continue to say our core is intact, that's part of it, right? And then, you take it down further too, we're still 90% plus on our renewals. So those things hold up consistently, and that renewal is even in the variable part of our business. So, the business part of that we feel good about it fundamentally continuing on not just in the fourth quarter, but as we roll into 2020.

Got it. Thank you very much.

Our next question comes from a line of Jeff Grampp with Northland Capital Markets. Please proceed with your question.

Good morning, guys. I was curious, Brad, you talked about in your prepared remarks, evaluating maybe some new end markets for the company. I was hoping maybe dig into that a bit more, can you kind of touch on maybe from a high-level characteristics of the market that you guys might be looking at and how you kind of see target fitting into kind of the ecosystem, if you will, of whatever markets and, understanding, maybe you don't want to get too specific here, but just trying to get a little bit more, I guess, details on how you guys are seeing that opportunity.

Sure, and I'll hit this on a kind of a larger scale too, yes starting with look, we're going to continue to invest in the Permian. We continue to look at organic and inorganic, where there's good returns and visibility. We invest there because we believe it's a long-term play. And that has a trend, so that part of our, the way we look at the business has not changed at all, it will continue to be disciplined and how we deploy the capital, as we have for many, many years. On the diversification piece, we're in the early stages of this. I would tell you, the great thing is with our cash flows, which I don't think can be overstated, gives us the ability to be optimistic as we look at adjacent markets and industries to add diversification. So we've started that process. I'm not going to tell you the playbook because to be honest with we're not too far down that road. But it is something that we look at internally and we'll keep pushing forward. The last part of that is -- we will always put our capital work in the areas to deliver the best returns for shareholders. So when I tell, we will continue to invest in the Permian. There're other things out there that we are looking at such as diversification.

Got it, got it. I appreciate that. And my follow-up, I'm trying to frame, I guess 2020 understanding that you guys are still in early process and don't want to get too specific. But on the capital side, excluding any potential acquisitions or new build communities. Is there any other CapEx, we should be thinking about outside of maintenance CapEx, whether that's maybe upgrades at acquired facilities or things like that?

Good morning. This is Eric. It's a great question, we really have -- we're very fortunate to have really flexible capital plan at this point. And so, I would say heading as we head into 2020, we're still trying to shore up what that looks like, but really, we have pretty, pretty minimal capital needs. The caveat there would be again, we have some deferred commercial opportunities, right. So that would be the one hole that we would look to fill but right now it's pretty flexible.

And then I would just add for Eric there remember, our playbook still the same. If we don't have a contract that supports that returns, we're not going to go out and invest in a new facility or a new build or an add-on. So as they come, we'll take a look at them. That's the organic piece of the business. And even the same thing with the inorganic, it's a buy versus build scenario, as we look at that, we're not going to get the returns, even though we have the cash to go and prosecute this, then we're not going to do it. So we're going to be very disciplined in that approach.

Yes, I think the other thing that I would add is partially off of Brad's comment is we generate a lot of cash in this business, AND so, to the extent that we have minimal capital spending heading into 2020. There's a lot of discretionary cash flow that's available to us. And so, that's a pretty enviable position to be in for us as we look to move the business forward and to grow it.

Understood, I appreciate the time, guys.

Thank you.

Our next question comes from a line of Kevin McVeigh with Credit Suisse. Please proceed with your question.

Thank you. Hey, can you just give a sense of how much ProPetro and Superior Lodging contributed to Q3? And what the impact is on the full-year 2019 guidance?

Sure, hi Kevin good morning, I don't want to give specific numbers on that, suffice to say that there wasn't, there was a contribution there. Mid to -- mid-single digits or so in terms of EBITDA but I don't want to give specific numbers. That's okay.

That's fine. And then, I guess the thing, it looks like the midpoint of the range kind of implies Brad to your point, kind of a 17% decline in revenue, but Q3, seasonally, stronger. It didn't happen this time. Just as you think about again, I know you're not given 2020 guidance, but is that based 280 to 300? Is that a reasonable like is that the worst downside scenario as we think about, at least a bottom-up from a modeling perspective?

Again, I'm not sure we're ready to give that number here's what I'd say high-level, right? And that is what I wouldn't do is take the fourth quarter '19 is a parameter for predicting our future business. We feel good about the business. We have a lot of long-term contracts. We believe this fourth quarter is a short-term scenario. We have talked to, we've doubled down talking to our customers and making sure, we understand where they're at next year, what they believe their customers doing. No significant role-offs in 2020. By the way, we think we have a lot of protection on that side of our business and you look back at history is supportive. So I'm not going to give you a number. What I would tell you that again, fourth quarter '19 is not the parameter to be looking at for '20.

Yes. And I think Kevin, the other thing that you're seeing in the outlook as well, as recall that this year alone, right, we've had a decent amount of TransCanada, kind of what to call base revenue coming through from some of the pre-work activities, while we're waiting for the larger contract, which was, certainly additive to growth beyond the outlook, during the second-half, we won't see much in a way of that at all right, so that also impacts Q4, that's also embedded in the outlook as well.

Got it. And then Eric, if it's too specific, I get it, but from the TCPL, any sense of where you thought that was going to be versus where it came in?

I would say. Look, I don't have specific numbers on that.

Sure.

I would just say, just look generally, I would say for Q3, it was probably about half what we thought it might be, I would say for Q4, just to put in order of magnitude on it, it's probably looking to be about a third if not more.

Great, thank you.

Our next question comes from the line of Ashish Sabadra with Deutsche Bank. Please proceed with your question.

Thanks for taking my question. So the items was reiterated in on the last call which was in mid August, I am just wondering how quickly if the environment change. Can you just talk about the trends in the quarter and how we exited the quarter? Thanks.

I am sorry. Can you repeat your question? We were breaking up here.

Sorry about that. Yes, I was just -– my question was just the guidance was reiterated on the last quarter and that it excluded the expansion and the acquisition. And so my question was how quickly did the environment change. Can you just talk about the trends in the quarter and how - like when you entered the quarter versus exiting the quarter?

Yes, high level. Again, I point you back to definitely the core business remained intact. We were good at kind of putting our finger in that. The variability part of our business that variable portion definitely that was the change that we see started sometime in Q3 going what we believe is a deeper down which we changed the range for Q4. That's what the biggest portion of that as well as the deferred commercial opportunities that have moved to the right. Look, these were fairly sizable on that. And we think those don't go away. They are moved to the right. And then TCPL was a portion of that as well. So, those three things really made up the -- what we are telling today for the fourth quarter.

Yes, and the biggest pace -– the only thing I will add is the biggest portion of that was really the deferral of opportunities that really started kind of picking up in back half of Q3, and really haven't started seeing that until really just a month or so ago.

That's helpful. And just given where the stock price is how do you think about the use of capital for growth versus just buyback? You have a lot of authorization still remaining -– buyback authorization still remaining. So just as we think about use of capital going forward?

Sure. This is Eric. So I made a couple of comments on cash flow and capital combined. They do go hand in hand. So we generated about $43 million in cash flow from ops ex-interest expense. So, gives us a lot of flexibility. And when we think about that and we look at it relative our return of capital opportunities, we like the idea of being opportunistic. We are going to continue to invest in this business for growth. And so I can't comment on certainly specific plans for any capital market activity, buyback included. But look, we are going to execute all options that are in concert with our bigger strategic plans. And so to the extent buybacks are part of that. Great, but I think at the end of the day, we are growth company. And we are going to facilitate growth for the best long run use of capital and shareholder returns.

That's helpful. Thanks. And maybe one final question on the gross margins or gross profits in the Permian. Those moderated a bit from second to third quarter. How should we think about that trajectory going forward? Thanks.

Sure, no problem. So, look, I think as we move forward, we clearly express that there is a little more challenge in the variable part of the market. However, some of that is offset by some higher ADR mix as we talked about. So, look, I think you see a little bit degradation on the margin on the Permian. I wouldn't -– I don't think it's -– I wouldn't call it substantial though.

Okay, thanks.

Our next question is a follow-up question from Stephen Gengaro with Stifel. Please proceed with your question.

Thanks. A couple of things actually, but just following up on the prior question on cash flow flexibility, in oil service world, companies with debt or a lot of debt - and you don't have a lot of debt from a leverage perspective, but like from debt cap perspective, people see it as having a lot of debt. There is a desire to see a reduction in leverage over buying back stock. And I understand how you feel about your valuation and your free cash flow visibility, but have you thought about those that as another option as far as de-levering and kind of getting this debt to equity conversion, if the multiple remains the same, and how do you think about that relative to just buying back stock?

Yes, sure. Look, it's a great question. There's always a balance there, right. It really comes down, Steven, to strategic intentions as to how you want to execute and prosecute growth of your business going forward, right. So, what's more advantageous to you? I think what you're hearing us say is, look, we're investing in our assets for the long run here. We do have $70 million in pre-payable debt, and if you just think about the cash we generated this quarter, look, you could theoretically put pay down all your revolver in a couple quarters. So, we look at our leverage at roughly 2.5 times or less and think about where that pretends in the future. And frankly, we feel pretty, pretty good about it. So look, I think we want to maintain flexibility there, but we'll just play it by year, but I would just tell you that we're pretty pleased with where we are from balance sheet perspective, albeit, I'd love to have more flexible, you know, more flexible capital structure through time, and will always look at ways to maximize that.

Okay, thank you. And you mentioned -- Brad, I think you mentioned twice with your top 30 customers. Are you willing to tell us what percentage of the revenue they account for?

No. I won't do that, but I appreciate the question.

I didn't take your words, but I figure out that.

You had to ask it, right.

Okay, and then just as a final from me. When you think about your mix, and I'm not sure if you can add a little color here, but when you look at the mix of revenue from oil service companies versus revenue from the E&P providers, I think some of the oil service companies are larger customers and clearly in oil service world, and we see all of U.S. pressure pumping companies et cetera seeing a pretty sharp drop-off in the fourth quarter with an expected recovery in 1Q, but can you give us a sense for the relative importance from a revenue perspective of the service companies versus the E&Ps?

Yes, Stephen, this is Troy. Good morning, by the way. Look, good question, and look, the way to think about this, and I think it is the two new facilities, Greenfield that we announced and built this year in the Permian Basin, both of which were integrated producers in the Permian Basin. Clearly, I think that's a good example of us really migrating the business and leaning into the E&P that are there for the long-term, look at the Permian as a long-term investment. And so, look, our business has matched that, right. So, make no mistake, oilfield service sector is an important part of the business on the upstream side, and will continue to be, but as we think about the Permian on a long-term basis, we have made a concerted effort strategically to lean into the integrated producers and other E&P companies that have strong balance sheets, strong free cash flow, and a great operating base with great acreage in the Permian. I think we've had -- I think we've demonstrated great success thus far, and we've got a pipeline that remains intact for further organic growth with those producers.

Look, I will add just one statement to that, it's doing business with the right people in the right places. We continue to say that, and I think it's proven true today and will prove true in 2020. When you look just at the Permian Basin it's a fairly bifurcated market today. We have lodges that we are totally sold out of; you can't put another person in, and then there's a few areas that are softer, which is where we're seeing some of this variability. But when you look at some of the large integrated producers, as Troy said where we're leaning into, those guys are continuing to spend, continuing to add rigs, and some of the others are becoming more disciplined in their approach until they get some of their financial orders in place, but overall, that business is very healthy for us out there. So, again, doing business with the right people in the right places continues to pay-off for us.

Thank you. Just one final, quick one, yes, I think you alluded to this earlier that the sort of other segment without visibility on the pipeline work, I mean is that going to kind of be a $1 million per quarter revenue run rate type business until we hear more about pipeline work, is that reasonable?

Yes. Look, I would say, probably for Q4, it's maybe little more than that, going out it's probably -- your number is probably about right.

Okay, great. Thank you, gentlemen.

Thank you.

Thank you. We have reached the end of the question-and-answer session. Mr. Archer, I would now like to turn the floor back over to you for closing comments.

Sure, thanks. I would like to thank you for joining the call today. We appreciate your continued interest in Target Hospitality, and look forward to speaking to you next quarter. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.