Good morning and welcome to the Target Hospitality Second Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mark Schuck, Senior Vice President of Investor Relations. Please go ahead.

Thank you. Good morning, everyone and welcome to Target Hospitality's 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. This same language applies to statements made on today's conference call. This call will contain time-sensitive information as well as forward-looking statements which are only accurate as of today, August 9, 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's periodic filings with the SEC. We will discuss non-GAAP financial measures on today's call. Please refer to the tables in our earnings release posted in the 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 Kalamaras, 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 will now turn the call over to our Chief Executive Officer, Brad Archer.

Thanks, Mark. Good morning, everyone and thank you for joining us on the call today. Target's record-setting second quarter results illustrate the benefit of Target's strategically located network and superior operating capabilities which have supported Target's ability to efficiently meet our customers' varying needs. Target has intentionally aligned itself with premier customers, including the United States government, who find increased value in the flexibility and premium service offering Target provides. We continue to experience consistent increases in customer demand across our HFS segments, supported by strong demand fundamentals. Target HFS 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 an over 90% customer renewal rate for more than six years and an 18% 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 HFS segment. Target's operating capabilities and network flexibility provided the foundation to expand our critical service offering to the United States Government through the 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 support services for a population of approximately 6,400 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's financial profile. Target's 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 Target's end markets, while simultaneously high-grading counterparty exposure and contract structure. These accomplishments have materially strengthened Target's financial position and establish the foundation to continue pursuing strategic growth initiatives. These elements, along with Target's unmatched operating capabilities and distinct core competencies create the optimal scenario to pursue a balanced portfolio of value-enhancing growth initiatives. These opportunities span Target's 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, Brad. In the 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 to $45 million in the same period last year. The significant increase was attributed to the expanded humanitarian contract that we announced on July 6 which had an effective date of May 16, 2022. As a result, the new humanitarian contract contributed approximately six weeks of earnings during the quarter. As a reminder, Target's 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 HFS segments delivered strong second quarter revenue of $34 million compared to $29 million in the same period last year. This increase was driven by sustained momentum in customer demand for Target's premium service offerings, supported by constructive economic and demand fundamentals. While Target has significantly grown its revenue and adjusted EBITDA over the past year, we have remained diligent in appropriately managing cost components 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 this 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…

Thanks, Eric. Our record-setting second quarter results are a direct reflection of our superior operating capabilities and unmatched network flexibility which supports Target's unique position as North America's largest provider of premium vertically integrated hospitality services and solutions. These attributes have supported strong demand from our world-class customers, including the United States government which has significantly strengthened Target's financial profile. This operating platform creates the ideal scenario to continue pursuing value-enhancing growth initiatives, focused on expanding Target's long-term growth pipeline. We believe this intentional focus creates the 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.

[Operator Instructions] First question will come from Scott Schneeberger with Oppenheimer.

I'd like to start off by asking just about how the ramp-up is going with the expansion of the West Texas government facility. Do you see that progressing as on pace with the original schedule that you had anticipated? Just any additional color on that.

Scott, this is Brad. Thanks. Look, no change from the last time we all talked, it's 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 sometime in early October.

That’s great. And then with that how should we think about -- I don’t know if you’re going to quantify exactly but how should we think about the ramp in utilization levels in that facility. And then really the second part of that question is, how should we anticipate a margin progression in the back half of this year as well?

Scott, it's Eric. Yes. So as we think about this, the thing about utilization there, we're not going to be specifically disclosing what that trend looks like. Bear in mind that the entire -- the entirety of the facility 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, it will depend partially on how the government decides to nominate its variable component which is a question mark for us. 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, the government will make its elections as it sees fit. As we think about the margin movement, what I would say is this. So look, there is a ramp, as you can imagine, right, in a big project like this. And so as we think about moving this forward, you obviously have the numbers that we put out for Q2. Look, those will continue to move in the right direction as we move through time here. Is there something specific on the margin that you're thinking about as opposed to just speaking of generalities?

No. Thanks, Eric. Yes, I guess we’ll watch 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 overall corporate rate. That’s actually what I’m getting at. Just kind of circling back by year-end, Brad mentioned probably the expansion should be largely complete or certainly the bed parts by October if everything goes as planned, 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’s kind of to this as well. So you have kind of a 2-part to response there.

Yes. I'll let Brad address the trend in terms of how we think about the -- what the government disposition may be. Look, on the margin specifically, a couple of things to bear in mind. So you're right, as we continue to get occupancy levels there, that does -- that margin will continue to get better. However, there's also an effective economic promote, if you will, in terms of how we think about the margin, because there's the minimum revenue piece and then there's the variable piece. Those margins are not created the same, right? And so as you get additional per head numbers, occupancy in the variable piece, that incremental margin actually steps down slightly from the minimum. So you have to just think about it in terms of if 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 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. And hopefully, that helps. So we can certainly talk about that more offline to put a little finer point on that if we need to.

Sorry, maybe on your ramp-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 and the contracts so they can ramp up. I would just say 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 telling that's going to happen but I think there's -- as you look at this, that's what you think would happen as the year goes on, right?

Yes, totally understood. Got that, Brad. And Eric, I think you made a good point. Even if on the side, even if yes, you do have diminishing on the improving incremental margin, your absolute dollars are still going up is, I think, the takeaway point there. So thanks. I've asked a bunch of I'll turn it over but one last kind of high level. I'm guessing there's no update but just any thoughts on long-term extension of this government contract, it's a frequent question. Just want to see if you have any incremental comments.

Yes. 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 a purpose-built really look at this very similar to what happened at our Dilley project and it’s being built for the long term and we expect that to continue on. Even though it’s a one year with a six month option on this first contract, we look at this as does our partners as a long-term solution.

Our next question will come from Greg Gibas with Northland Securities.

Congrats on the results. Just curious if -- 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 maybe changed with respect to your full year expectations?

Greg, so regarding full year, no change there. Look, it's -- I think any way you cut it, this has been a transformative project for the company and extremely accretive and so no change there. As it relates to the outperformance, look, this is a large project. And it is a substantial project in terms of not just operational scope but also financial positioning. And so I think the outperformance you're largely seeing is a function of when you do projects like this, sometimes the margin in the early months can be front line a bit. And so that's effectively what we saw in this quarter. Bear in mind that does normalize. And so we'll continue to -- as we talked about that progressive occupancy continues to get better on an incremental margin basis. But at some point in time, it does normalize, right? So look but that's largely driving the outperformance. And I think as well as just look good, solid operational execution was what drove that.

Great. Good to hear. And I guess, any commentary you can provide on how the new contract might impact cadence in the back half, maybe if we think about kind of traditional seasonality, if there’d be any change there this year?

Wouldn't expect any modifications in terms of seasonality there. Sometimes we see -- we do see a little -- a couple of percent degradation in that fourth quarter on the HFS side specifically just from holiday turnover, particularly in December time frame. 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 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. Just wondering if you can comment on any -- maybe what your assumptions are for that?

So we have not, as you know, specifically given a variable occupancy component or an occupancy component at all. So it makes it -- it does make it challenging to address that question. Partially, it’s -- primarily, it’s a function of the -- our partners and the government have to make their nominations on the variable side, right? And so until you know that number, you can’t -- you really can’t determine too much more in terms of upside. I would say this. We are absolutely enthusiastic about the project, excited about the opportunity here. But I wouldn’t make any modifications to what we put out thus far.

Our next question will come from Stephen Gengaro with Stifel.

Just a couple of things. And I think the first was the HFS South piece of the business, it feels like -- and I want to sort of get your sense for this but it feels like the revenue growth sort of was lagging rig activity and completion activity in the quarter. And I think you guys incur more baseload demand. So maybe you don’t -- you’re not -- you don’t swing as much as maybe activity does. But can 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 we've really had for some time. We have talked a while about the market there continuing to get better over time and that is what has happened. However, I think even last quarter, I had indicated that the pace of progression has started to slow and moderate to levels that are feeling much more stable. So I think that's really what you're seeing. If you're looking at the top line, we did a little bit of an improvement there. We did have some degradation on margin, although that has nothing to do with the activity level, that is more of a function of some lower costs we had last year relative to some higher costs we had this year and just as part of enhancing the business, a little bit of mismatching cost there which impacted the margin. But look, our margins were up in HFS, South, specifically 100 basis points quarter-to-quarter sequentially. So I would say that is continuing to move in the right direction. The last thing I would say is that labor is a -- look, it is a lagging component by a quarter or so, typically three, four months. And so as an improvement gets better in the market, we will tend to see that increase from the labor side. But it is not a kind of a prompt corollary of activity.

Okay, it's not a huge piece. I just kind of wanted to triangulate the model a bit. So two things on the government side of the business. And just one question that I get pretty often is when you're bidding on this work and you're looking at additional opportunities maybe along the same lines, maybe in 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, right? So I'm sort of just trying to get a sense of what's the competitive landscape when you're bidding on the government contracts?

Look, this is Brad. I'm not going to call out the names but there's definitely competition out there, right? I would tell you, I mean, your point is right, not a lot of folks that are setting with the assets that we have, the ability to get those installed, construction done in just really a few short months. Also just the track record we've had for years with Dilley and we have some great partners. So there's 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. And then just one final one. The variable component of the new contract, I think it’s like $185 million a year. A, is that linear with the 6,400 beds as far as utilization? And I think the other question around that is, I would think -- and 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 to be very high. Can you comment on that?

Sure. As it relates to -- I'll take the first part first. So as it relates to the linearity, it is not exactly linear because when I was talking to Scott about the margin movement and the promote in that, that causes it not to be quite linear. But it is -- look, it is proportional in movement, okay? So as that is to say differently, that as you do see additional occupancy there, you will continue to see nominal dollars continue to increase, albeit at a slightly lower rate than you would have seen in prior quarters, okay, on prior volume periods. So hopefully, that does help a little bit. We can certainly try to unpack this a little bit more if we need to. As it relates to your point on spend and volume, it has been our expectation that look this facility will be utilized to a level that a government sees fit. And to a level that will obviously give them satisfaction as it relates to the amount of dollars that are being spent as they're part of their humanitarian solution. So we'll have to wait and see exactly what that looks like over time. But certainly, to your point, it's certainly something that the government obviously is intending to use at a fairly fulsome level. Otherwise, they would have chosen a different decision.

[Operator Instructions] Our next question will be a follow-up from Stephen Gengaro from Stifel.

Well, thanks. I should have just asked the question, I guess.

You never know, Stephen, you never know.

I didn’t want to be rude, so I figured I’d get back in line. So -- when you guys look out -- and you -- I guess there’s 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 end markets that you feel like your capabilities are most applicable to?

Yes. Look, I think there are several right from building maintenance to facilities management, inclusive of catering. A lot of that, I think, fits within exactly what we do today. And it's a huge market out there that's just -- it's untapped for us. And that's really more looking at something different. If you look the organic side for us, it's continuing on with what we're doing, growing some of the HFS side but more getting into the 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 -- on our government contract. So continuing to expand that. I mean government reaches many different directions. And some of it, we just haven't went after. But we have a great name to continue to go out there and take advantage of.

I think, Stephen, the other point that I would mention and Brad had in this is if you look at the entirety of the solutions that we provide today, generally, those are full turnkey solutions. And there is a lot of white space to, in many ways, perhaps disintermediate some of that, right? So meaning maybe you don't provide all the solutions, maybe provide a 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 has 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, whether -- 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 it's 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 it in a way that's been very, very complementary to what we're doing. And look, we have seen a number of opportunities. And frankly, we've passed on a number of opportunities and I'm speaking transaction, of course. And the reason is because it hasn't either met the return objective and/or they have not met the operational and commercial scope where there are just clear eye synergies that are -- that fit very nicely 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'll continue to do so. But to Brad's point, there are a lot of opportunities for us, whether it be full turnkey or whether it be in a disintermediate fashion.

And the other one I wanted to hit on was -- so you have $330-ish million in long-term debt. If our model is correct, then you have a lot of visibility, you’re going to generate probably $200 million-plus of free cash in ‘22 -- excuse me, in ‘23 and ‘24. What do you do? I mean, do you delever? Do you refinance the debt to cheaper levels now that you have this contract visibility? Do you start an aggressive program of giving capital back to shareholders, either dividend or share repurchase? How should we think about the benchmarks you look at and the ratios you’re comfortable with when you start to maybe give more cash back to shareholders?

Sure. So a couple of things. So look, you're right. You're right on your perspective on amounts of cash generation. As it relates to capital structure, return of capital and just general use of cash. There are like five users, right? You pay down debt, you can repurchase stock, you can do a dividend, you can make transactions, et cetera. As we think about this cascade of those, there's an orderly operation of events there for us. And so let's walk through a couple of those. The immediate 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 continue to harvest cash in the short run. And then -- look, initially, then looking at the balance sheet in ways that we can optimize that a little bit. I've mentioned before, I've never been comfortable with the cost of capital on the debt side. We certainly have mechanisms in our place to look at that. High-end markets 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 kind of priority number one. As we think about priority number two, it will be to continue to have excess capital where we can be additive to a transaction. And put ourselves in a spot where we can have maximum accretion from a transaction perspective. Then look, failing either priorities one or two, that puts you back in the spot to think about dividend share repurchases, et cetera. But again, there's a lot of progression that we need to go through. And 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 the things Eric mentioned is none of them are mutually exclusive, right? With the cash we're going to generate over time. There's multiple things at once that we could go after to maximize shareholder value.

Do you have a -- is there a priority either at the Board level or with the major shareholders of dividends versus buybacks?

I wouldn't say that there is a priority over the either two of those at this point.

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 you 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. With 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.

Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.