U.S. Markets closed

Edited Transcript of TH.OQ earnings conference call or presentation 12-Mar-20 1:00pm GMT

Q4 2019 Target Hospitality Corp Earnings Call

Mar 30, 2020 (Thomson StreetEvents) -- Edited Transcript of Target Hospitality Corp earnings conference call or presentation Thursday, March 12, 2020 at 1:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Eric T. Kalamaras

Target Hospitality Corp. - Executive VP & CFO

* James Bradley Archer

Target Hospitality Corp. - CEO, President & Non-Independent Director

* Mark Schuck

Target Hospitality Corp. - SVP of IR

* Troy C. Schrenk

Target Lodging Management LLC - Chief Commercial Officer

================================================================================

Conference Call Participants

================================================================================

* Ashish Sabadra

Deutsche Bank AG, Research Division - Research Analyst

* Daniel Erik Hultberg

Oppenheimer & Co. Inc., Research Division - Associate

* Jeffrey Scott Grampp

Northland Capital Markets, Research Division - MD & Senior Research Analyst

* Kevin Damien McVeigh

Crédit Suisse AG, Research Division - MD

* Stephen David Gengaro

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Greetings, and welcome to the Target Hospitality Fourth Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, this conference is being recorded.

I will now turn the conference over to our host, Mark Schuck, Senior Vice President of Investor Relations. Thank you. You may begin.

--------------------------------------------------------------------------------

Mark Schuck, Target Hospitality Corp. - SVP of IR [2]

--------------------------------------------------------------------------------

Good morning, everyone, and welcome to Target Hospitality's Fourth Quarter and Full Year 2019 Earnings Call.

The press release we issued yesterday, outlining our fourth quarter and full year 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 the press release. This same language applies to statements made on today's conference call. This call will contain time-sensitive information as well as forward-looking statements, which are only accurate as of today, March 12, 2020.

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 table 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 T. 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.

--------------------------------------------------------------------------------

James Bradley Archer, Target Hospitality Corp. - CEO, President & Non-Independent Director [3]

--------------------------------------------------------------------------------

Thanks, Mark. Good morning, everyone, and thank you for joining us today to discuss our fourth quarter and full year 2019 results. Before we get started, I would like to take a second to acknowledge the recent volatility in global financial and commodity markets, which have consequently put significant pressure on the price of crude oil. These events have created macro uncertainties that have rippled through the markets, and we will continue to closely monitor any potential effects to our business. Now turning back to 2019.

I want to first look at the cumulative steps we have taken in the first year of being a public company to solidify our competitive advantage and add to our unmatched network of first-class communities and service offerings, while strategically positioning Target to produce industry-leading returns over the long term. We created strong operational momentum throughout 2019, and continued to position Target as the leading provider of specialty hospitality accommodations and services in the U.S. We successfully integrated 2 acquisitions and, combined with organic bed additions, increased our average utilized beds, 44%, to a record of over 12,000. We expanded multiple communities as demand for our premier full turnkey services remained strong in the heart of the Permian Basin, the dominant hub of U.S. energy production. We have effectuated this growth in a manner consistent with our core focus of aligning with the right customers in the right locations and being disciplined with our capital allocation, which has consistently allowed us to achieve attractive returns.

In the second half of 2019, we saw a reduction of growth in the domestic shale plays and the Permian Basin has not been immune to this moderation of activity. This impacted capital spending levels in the second half of 2019 and was more pronounced than expected, impacting our results as we move towards year-end. However, these challenges prove the resiliency of our business model as we saw meaningful growth in full year 2019 revenue and adjusted EBITDA, while maintaining strong EBITDA margins of approximately 50%, all while generating record cash flow.

While we were beginning to see activity levels stabilize and even start to increase as we moved into 2020, the recent global macro events will likely cause reduced activity levels to persist until there is a clear understanding as to how our customers will address any impacts to their business. However, it is important to note that as we sit here today, we have not had conversations with our core customers regarding modifications to their existing contracts due to recent macro uncertainty. While our core larger customers have performed well, the reduced gross rates and activity in the fourth quarter impacted our uncontracted business, which represents about 15% of our revenue as these customers represent less predictable workloads. We remain focused, as always, on converting these customers into a contract, but realized that one size does not fit all. We are cognizant of varying customer needs throughout our community footprint and will offer a varying degree of terms to capture the marginal customer.

Now let me touch on our business and what differentiates Target. The industry experienced lower activity in the second half of 2019. And our results were not immune to this, as we also experienced a reduction in utilization and ADR, most notably in our fourth quarter results. However, there are several key points that differentiates Target from other business. First, throughout 2019, we maintained robust margin of 50%, while generating significant discretionary cash flow. As I have said before, we have positioned Target to be successful through a variety of business cycles. We believe this is evidenced by our 2020 outlook, where we expect Target to generate meaningful discretionary cash flow. This significant cash generation allows us to further strengthen the financial posture of the business, predominantly through debt reduction, while simultaneously evaluating other potential growth vectors.

Second, one of the key tenets of our business strategy is a disciplined approach to capital allocation. Our capital expenditures are highly discretionary and allow us to carefully evaluate investments, ensuring we maintain a high degree of return certainty in all environments. In addition, we underpin these capital investment decisions with long-term contracts, which provide a high degree of revenue visibility years in the future.

Third, paramount to maintaining this high degree of revenue visibility is our commitment to focusing on a long-term contract structure while doing business with well-capitalized customers that have long-term investment horizons. These large customers are far less correlated to short-term fluctuations in commodity prices and demand consistent high-quality accommodations for their employees, while benefiting from the efficiencies our network provides. Our first-class network provides unparalleled flexibility, which allows us to seamlessly grow utilized beds with our customers' needs. This is illustrated by the 2 announcements we made earlier this year. Executing major contract renewals with 4 key customers, which represented approximately 20% of 2019 energy revenue and the expansion of our El Capitan facility, which marked the second expansion of this community within the first year of operation and was driven exclusively by customer demand.

We have created a structurally sound business with a strong financial position and a proven track record of creating consistent and profitable growth. This foundation provides the ability to continue evaluating potential growth opportunities, including strategic value-enhancing acquisitions and other value-added adjacent markets. As we evaluate potential growth vectors, any opportunities will squarely fall within Target's core competencies and lean on the competitive advantage we have created through years of experience in the hospitality industry.

When considering Target suite of competitive advantages, it is important to remember that we are not simply a provider of bare-bone sleeping accommodations. We are a full-service hospitality provider with many expert core competencies. This is illustrated in the fact that while we added approximately 1,500 rooms to our network in 2019, we provided 2.8 million service nights, washed more than 4.1 million sheets, towels and linens, served over 11 million meals consisting of more than 2.4 million pounds of lean protein, nearly 3.5 million fresh oranges and over 206,000 pounds of bananas. Our customers know, we keep their people well fed, well rested and well prepared for the next workday.

As we reflect on 2019, we are pleased with the results and momentum we are able to sustain while navigating late year headwinds and feel we have positioned Target for continued success.

I'll now turn the call over to Eric to discuss our fourth quarter and full year financial results as well as our 2020 outlook in more detail.

--------------------------------------------------------------------------------

Eric T. Kalamaras, Target Hospitality Corp. - Executive VP & CFO [4]

--------------------------------------------------------------------------------

Thank you, Brad, and good morning, everyone. I will begin with a discussion of our results, review our capital program and conclude with details on our recently announced 2020 outlook. In the fourth quarter and full year, we continued to benefit from our growing network, including acquisitions, new builds and expansions, and remain focused on operational execution and the integration of these assets into our network. While our fourth quarter results were modestly impacted by the headwinds that persisted within the energy end market as well as a slower-than-expected pace of the TransCanada pipeline project, we still achieved excellent margins with a growing network of available beds, and importantly, continue to generate significant discretionary cash flow.

For full year 2019, total revenue was $321 million, an increase of 33% compared to full year 2018. Adjusted EBITDA was $159 million, an increase of 36% compared with the same period last year, with an adjusted EBITDA margin of 50%. The year-over-year growth in adjusted EBITDA was primarily driven by approximately 4,400 new bed additions as a result of the Signor acquisition and approximately 1,500 new bed additions from new communities and expansions, which contributed to over 40% growth in both average available beds and average utilized beds.

Turning to our segment performance. The Permian Basin delivered fourth quarter revenue of $53 million, an increase of 6% versus the prior year quarter. This increase was primarily driven by an increase in average utilized beds as a result of the Signor integration as well as new community additions and expansions. Average available beds increased by over 2,000 or 29% compared to 2018. ADR decreased by $2.80, primarily from lower average ADRs at acquired Signor communities, and softness in the uncontracted portion of the business. We have completed the Signor enhancement program and continue to focus on opportunities to convert these customers to a more typical legacy Target pricing model over time.

In the Bakken, we rightsized our footprint in 2018, which drove the expected decline in average utilized beds while significantly improving utilization and creating cost efficiencies. Revenue declined by 29%, mainly due to this decrease in average utilized beds at lower ADR, reflecting lower activity levels compared to the same period last year. Our government segment remains very consistent with revenue for the quarter up slightly to $17 million. The fixed contractual nature of this asset provides relatively stable ADR, utilization and revenue.

Our all other segment, which consists primarily of construction fee revenue from the TransCanada project, had revenue of $2 million and adjusted gross profit margin of 21% for the fourth quarter. This was driven by significantly lower-than-anticipated pre-FID activities. While we are hopeful for a contract start in 2020, we have taken a conservative approach and have not included revenue associated with this project in our 2020 outlook.

Recurring corporate expenses for the quarter and full year were approximately $8 million and $31 million, respectively. The increase from last year is primarily associated with the transition to becoming a public company as well as infrastructure investments that will allow us to scale the business to support additional growth with minimal incremental costs. We expect our recurring corporate costs to remain around $8 million to $9 million per quarter. We generated cash flow from operations of approximately $16 million and $61 million, respectively, for the fourth quarter and full year.

Since much of our capital spending is discretionary given nominal maintenance capital needs, fourth quarter, along with full year 2019, provides a clear picture of the exceptional cash flow generation ability of our business. We expect to continue to generate meaningful cash flow, providing the flexibility to execute on a variety of value-creating opportunities predominantly focused on enhancing our capital structure through debt reduction or other accretive stakeholder initiatives. In addition, we have developed a pipeline of growth opportunities including strategic diversifying acquisitions in adjacent markets, which align with Target's core competencies and business strategy. As we continue to evaluate these opportunities over time, it's paramount to remember we will not execute on growth opportunities if it does not meet our rigorous return criteria.

Capital expenditures in 2019 were $116 million. Almost all of this capital spending was for revenue-enhancing investments, including $79 million related to new community developments and expansions in high grading of legacy Signor communities as well as $35 million for the acquisitions of Superior and ProPetro Lodges. Maintenance capital spending was $2 million.

We ended the year with $420 million of total long-term debt including $80 million drawn on our revolving credit facility and consolidated net leverage of 2.6x. As a reminder, our long-term debt consists of $340 million in senior secured notes due 2024 and $125 million asset-based lending facility, which had no near-term maturities or immediate financial covenants providing significant flexibility within our capital structure.

Since commencing the share repurchase program in August 2019, we have repurchased shares for approximately $24 million or approximately 32% of the total share repurchase authorization.

Turning to our full year 2020 financial outlook. Our core business is resilient, with approximately 85% of 2020 revenue under long-term contracts, with approximately 55% expect to have committed payment provisions and an additional 30% that have exclusivity provisions. Further, as Brad mentioned, we have no material contracts due for renewal in 2020. The energy markets did experience headwinds exiting 2019, and the recent global macro events have created near-term uncertainties throughout markets, which were not accounted for in our previously announced 2020 outlook. We will continue to monitor the impact of these macro uncertainties, its effects on our customers and any potential impact to Target, but remain confident in our core contracted business, which provides a high degree of cash-generating capability.

The discretionary nature of our capital expenditures will allow us to generate a high level of discretionary cash flow. As we navigate the current market environment and the effects of the recent events, we will remain prudent in our capital allocation and moderate our growth capital spending to ensure continued value creation. The structural advantages of our business model provides for a significant cash generation and allow us to control not only the quantum, but also the pace of our capital spending. Our disciplined approach to capital allocation aligns with Target's objectives of deploying capital into long run value-enhancing initiatives, while continuing to create value for our shareholders.

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

--------------------------------------------------------------------------------

James Bradley Archer, Target Hospitality Corp. - CEO, President & Non-Independent Director [5]

--------------------------------------------------------------------------------

Thanks, Eric. Before we close, I want to acknowledge the ongoing global concern over the coronavirus. We take very seriously the commitment to provide safe and healthy hospitality services to our customers and the coronavirus has not impacted our lodges, employees or customers. We continue to monitor the situation and take all necessary steps to ensure a healthy workforce at our lodges.

In summary, while we did experience sustained headwinds through the back half of 2019, this provided an excellent illustration of the value proposition we were able to provide our shareholders through the competitive advantages we have created. We entered 2020 with positive momentum in our core business. While we continue to generate significant discretionary cash flow, we remain focused on disciplined capital allocation and aligning with the right customers, which we believe truly differentiates Target.

Our committed focus of developing long-standing relationships with large, well-capitalized customers provides an unmatched mutually beneficial relationship that is truly a win-win for both parties. We have positioned Target with a solid financial foundation from which to execute on its strategy, while maintaining consistent and attractive returns for our shareholders.

I appreciate everyone joining us on the call today, and thank you again for your interest in Target Hospitality. Operator, you may now open up the line for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Stephen Gengaro with Stifel.

--------------------------------------------------------------------------------

Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [2]

--------------------------------------------------------------------------------

When we think about the guidance that you guys provided and maybe you could sort of help to sort of, I guess, with the definitions of the terms you're using and helps -- help me kind of triangulate -- but -- so 55% of the midpoint of your guidance is, I think, $172 million of revenue. So I'm kicking that to be locked and loaded and unwavering. But what's the difference between the 55% and the 85%? And how much wiggle room is there in that 30% of revenue?

--------------------------------------------------------------------------------

Eric T. Kalamaras, Target Hospitality Corp. - Executive VP & CFO [3]

--------------------------------------------------------------------------------

Stephen, this is Eric. So the 30% that you're referencing is really -- they're really customers that are under contract agreements, most of which have exclusivity provisions tied to them. So those are rooms, though, that while they're connected to our network, they have yet to determine -- so the timing or and the amount of rooms that they would eventually take. So said differently, if they are, in many cases, if they are going to use rooms, they're going to use them in our network, but they have yet to specifically define a time or an amount.

--------------------------------------------------------------------------------

James Bradley Archer, Target Hospitality Corp. - CEO, President & Non-Independent Director [4]

--------------------------------------------------------------------------------

Let me just add to that a little bit. This is Brad. When Eric talks about not committing a maybe time and amount, these are folks that are using the lodge in most cases today. They could be using 50 rooms. Some of these companies could be using 300 rooms under the exclusivity. So when you talk about wiggle room here, let's just -- we all know what happened in the past 4 to 5 days. What we don't see is the guy that has 300 employees going down to 0. So there's some -- there's -- will there be movement in his number if he loses some work? Yes, but he's still required to use us if he's in the Permian Basin, okay? So that's kind of the wiggle room in that. You can't stay in a hotel. You can't stay in another competitor's lodge within 40 to 50 miles of ours. So there's some wiggle room there. But it can't just all of it go away unless he loses all of his business. So it really depends on that customer, but there's definitely a contractual nature between both us and that group.

--------------------------------------------------------------------------------

Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [5]

--------------------------------------------------------------------------------

So is it fair to say that, that 30% is almost -- it's almost completely dependent on that customer's activity level? Whereas the 55% is you're getting paid regardless of activity levels?

--------------------------------------------------------------------------------

Eric T. Kalamaras, Target Hospitality Corp. - Executive VP & CFO [6]

--------------------------------------------------------------------------------

Yes, the 55% is meant to designate really regardless of activity level. The 30%, as Brad mentioned, right, we can have those customers today, but that can be variable based upon their activity amount. It just happens to be that when they do have usage is going to be in our facilities.

--------------------------------------------------------------------------------

James Bradley Archer, Target Hospitality Corp. - CEO, President & Non-Independent Director [7]

--------------------------------------------------------------------------------

Yes. And just one -- some of these are some of your largest oilfield service companies. So with many lines of business, right, under this exclusivity agreement. So that's where I take a view on the business, that it's not going to all go away. These are long-term mutually beneficial relationships, been there for 10-plus years, some of them. And now they're just under an exclusivity contract that gives them some more flexibility.

--------------------------------------------------------------------------------

Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [8]

--------------------------------------------------------------------------------

Okay. So one follow-up and then one other question, but just -- I'm just trying to make sure I understand it completely. Are there customers let's -- that are part of both buckets? Both part of the 55% and part of the 85%?

--------------------------------------------------------------------------------

Eric T. Kalamaras, Target Hospitality Corp. - Executive VP & CFO [9]

--------------------------------------------------------------------------------

Generally not. No.

--------------------------------------------------------------------------------

Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [10]

--------------------------------------------------------------------------------

Okay, okay. And then can you just give us a quick update on the government side. What's the status of that contract? How do you feel about it going forward, when do the renewal discussions come up, et cetera?

--------------------------------------------------------------------------------

James Bradley Archer, Target Hospitality Corp. - CEO, President & Non-Independent Director [11]

--------------------------------------------------------------------------------

Yes. Look, the government piece is, and I always say this on the call. It's a very predictable business, right? It's facilities management. We do the catering and it just continues to perform year after year. We feel great about that contract. It doesn't come up for renewal until late next year in 2021. So sometime after late in the year is when we'll start to have those discussions and early into 2021 with the counterparty. But at this point, there's no changes in that facility.

--------------------------------------------------------------------------------

Operator [12]

--------------------------------------------------------------------------------

Our next question comes from Jeff Grampp with Northland Capital Markets.

--------------------------------------------------------------------------------

Jeffrey Scott Grampp, Northland Capital Markets, Research Division - MD & Senior Research Analyst [13]

--------------------------------------------------------------------------------

Maybe sticking on the last topic with the government question. Is it -- are those discussions based on kind of how you guys see this playing out, predicated at all on this upcoming election cycle? Or is that just more related to the time line of -- in relation to when the contract term is ending up? Just kind of wondering how you guys view, I guess, the timing of that.

--------------------------------------------------------------------------------

James Bradley Archer, Target Hospitality Corp. - CEO, President & Non-Independent Director [14]

--------------------------------------------------------------------------------

Look, this was built under a democratic president. We don't see that playing into it too much. There's definitely a need. We're the only one in the U.S. like it. So it is more about just when the contract ends, and when we start those negotiations and not more, if you will, about the Presidential race.

--------------------------------------------------------------------------------

Jeffrey Scott Grampp, Northland Capital Markets, Research Division - MD & Senior Research Analyst [15]

--------------------------------------------------------------------------------

Got it. Understood. And I was hoping you guys could maybe talk about, obviously, super volatile oil pricing environment. Can you guys talk about your experience in the past in terms of conversations you have with customers when you see these periods, have they or do they tend to come back in terms of asking for any type of modifications of the contract, whether that's ADR or number of beds in the contract? And maybe if you guys can just touch on it empirically, how that process has kind of gone in the past in terms of kind of revisiting contracts?

--------------------------------------------------------------------------------

James Bradley Archer, Target Hospitality Corp. - CEO, President & Non-Independent Director [16]

--------------------------------------------------------------------------------

Yes, let me first just say, being that the action taken by OPEC just happened at, what, 4 to 5 days ago, it is too early for us to determine the impact of the events. So we'll continue to monitor it. But look, we have been through this before as a management team years ago, and we fared well. We have long-term customers, long-term contracts with them. And look, there will be some of those discussions. I mean, I think all of us right now believe there's going to be a shrinkage of activity. But we're trying to figure out how deep and how wide, right? And when those discussions happen, we'll go back to how we do business, looking at making sure they continue the cash flow. But we have some discussions with customers, sitting down with them, maybe trading term for some rate, absolutely. We will do that. And that's kind of how we did it in the past. There will be triggers in there to get those rates back up, but we'll always continue -- it's got to be a win-win for both sides. And then again, anything that we give is going to be looked at. We're going to continue to generate the free cash flow on that contract.

--------------------------------------------------------------------------------

Operator [17]

--------------------------------------------------------------------------------

Your next question comes from Kevin McVeigh with Crédit Suisse.

--------------------------------------------------------------------------------

Kevin Damien McVeigh, Crédit Suisse AG, Research Division - MD [18]

--------------------------------------------------------------------------------

Great. I guess, just on the 2020 outlook, how are you thinking about what price of oil is that 2020 outlook based on? And then just any thoughts around kind of utilization levels? And then ultimately, would you expect to see an uptick in bad debt expense based on history in the past? Or are the contracts such that there's not a lot of real bad debt exposure?

--------------------------------------------------------------------------------

Eric T. Kalamaras, Target Hospitality Corp. - Executive VP & CFO [19]

--------------------------------------------------------------------------------

Sure. Kevin, so I mean a couple of comments on the outlook and then address the bad debt expense, which is a good question. So clearly, the world changed a lot from 2 weeks ago. Look, I mean, it changed a lot from Saturday, quite frankly. We will update the outlook, and we'll do it thoughtfully. A couple of things to bear in mind. So there are -- as we think about the 2020 outlook, there are a number of events like we had just over the past week or 2, now there are second and third order effects here that our customers need to react to. So we haven't seen these reactions yet, and we'll monitor those, and we'll work with that process with our customers. We also have some variable cost aspects that we can employ here to manage margin, which is historically how we've been able to manage margin through these types of cycles and keep margins at really surprisingly healthy levels, which I think you'll see as we move forward here. So we'll take all that into account. And we'll bake that into the -- to an outlook at some point in time when we get some additional clarity here. I think, in the meantime, just recall that Target, because of our cash flow profile and the margin profile, we generate a lot of cash even in difficult markets. Now because of that, we tend to not see, in the nature of our customer base, we tend to not see a meaningful amount of bad debt expense. We haven't -- we did not see a meaningful amount in the back end of Q4, which is what we're -- which is one could have seen. We did not see that. So I wouldn't expect to see a lot going forward, but we'll continue to monitor it. And like I said, to the extent we have modifications, we'll sort of be sure to update the market when we can.

--------------------------------------------------------------------------------

Kevin Damien McVeigh, Crédit Suisse AG, Research Division - MD [20]

--------------------------------------------------------------------------------

That's helpful. And then just real quick on -- obviously, the business generates a lot of cash. How are you thinking about capital allocation within the context of the near term uncertainty, particularly given the way the stocks reacted in the near-term in terms of buyback versus maybe the M&A? Or just any thoughts on just even the business overall?

--------------------------------------------------------------------------------

Eric T. Kalamaras, Target Hospitality Corp. - Executive VP & CFO [21]

--------------------------------------------------------------------------------

Sure. So I'll give you some context, take a step back on capital, and then we'll dovetail that into the allocation aspect of it. When we entered into 2020, we effectively felt like the market was fully supplied. And we were really shifting our approach more from greenfield development to more of a supply and utilization and then maybe the optimization focus. And the whole objective of that was to focus the business on optimizing the scale that we built over the past few years. And so that was the posture we had coming into 2020. What we did as a function of that was we meaningfully pulled down capital spending, which is what we demonstrated in the outlook that we had -- that we have put forth. When we kind of fast forward to today, look, the equity value is absolutely discounted from what we think will ultimately be realistic levels moving forward. So certainly, significant value here today.

I would say though, look, we generate a lot of cash and even in challenged conditions. But I think it's important to maintain a position of balance sheet strength, so while I can't comment on specific capital market activities -- and look, stock buybacks can be an option. I think the near-term focus really needs to be balance sheet optionality versus optimization at this point. So we'll continue to evaluate share repurchases as just as a part of our capital allocation approach. But I think really, what we'd like to do is be able to take advantage of whatever commercial opportunities present themselves over time and put ourselves in the best spot to do that.

--------------------------------------------------------------------------------

Operator [22]

--------------------------------------------------------------------------------

Our next question comes from Scott Schneeberger with Oppenheimer.

--------------------------------------------------------------------------------

Daniel Erik Hultberg, Oppenheimer & Co. Inc., Research Division - Associate [23]

--------------------------------------------------------------------------------

This is Daniel on for Scott. Could we delve into a little bit on the Permian ADR utilization trends, discuss what you've been seeing so far into 2020? And get -- help us with some perspective on how it might develop in the next couple of quarters here as far as what's underlying your outlook?

--------------------------------------------------------------------------------

Eric T. Kalamaras, Target Hospitality Corp. - Executive VP & CFO [24]

--------------------------------------------------------------------------------

Sure. So when we think about the outlook, I think we need to just take -- like I've mentioned before, we have to take the temperature of where our customers are. A lot has changed in the past, really in the past week. And so our customers, if you think about the nature of our customer base, I think you have to bear in mind that a lot of our customers are not direct E&P's right? Most of them are large integrated producers, pretty large service firms. And so they're representing a number of, in many cases, a number of clients of their own. And so like I've mentioned before, there are second and kind of third order effects here that they need to evaluate as they think about their labor movements as well. And so I think at this point in time, let us evaluate what that looks like. And then we can come back and give you a thoughtful response when we've had a chance to survey that with our customers, and they've had a chance to react as well.

--------------------------------------------------------------------------------

Daniel Erik Hultberg, Oppenheimer & Co. Inc., Research Division - Associate [25]

--------------------------------------------------------------------------------

Got it. That's helpful. If we think about the quarterly cadence of EBITDA and cash flow as it stands now, how do you recommend us to think about that cadence in 2020?

--------------------------------------------------------------------------------

Eric T. Kalamaras, Target Hospitality Corp. - Executive VP & CFO [26]

--------------------------------------------------------------------------------

Sure. So I'll take you back to my prior thoughts around how we develop the outlook initially. We were expecting to see, as we -- and are seeing, and we're seeing a ramp-up from Q4 through even a week ago, we were seeing a nice progression of activity, really what we've -- from Q4 levels. And so we would have expected to see a gradual buildup through Q1, Q2 and kind of culminating to Q3, which we always see like a little bit of seasonal movement in Q4. So that's what we would have expected. So you kind of would have seen this natural progression of a glide path heading up into Q2 and Q3. And I think given what we've seen in the past week or so, certainly, our expectations are likely to move on how we see that glide path. Certainly, I think we can all point to trends that are feeling less -- certainly less positive than we were even a week ago and 2 weeks ago. So I think it's important to, as I've mentioned before, we'll continue to evaluate what the market conditions look like. And then we'll have to just see where we go from there and just update accordingly.

--------------------------------------------------------------------------------

Daniel Erik Hultberg, Oppenheimer & Co. Inc., Research Division - Associate [27]

--------------------------------------------------------------------------------

Got it. And also, a final one for me. What are you doing with your customers to test new work as you're starting at your communities from outside the area to attempt to keep the virus spread from occurring at your locations?

--------------------------------------------------------------------------------

Troy C. Schrenk, Target Lodging Management LLC - Chief Commercial Officer [28]

--------------------------------------------------------------------------------

I'm sorry. Can you repeat that question? This is Troy.

--------------------------------------------------------------------------------

Daniel Erik Hultberg, Oppenheimer & Co. Inc., Research Division - Associate [29]

--------------------------------------------------------------------------------

Sorry. So I'm curious on what are you guys doing with the customers, if you test new work? Is it just starting at your communities from outside the area to attempt to keep the virus spread from occurring at your location? So it's a coronavirus question.

--------------------------------------------------------------------------------

Troy C. Schrenk, Target Lodging Management LLC - Chief Commercial Officer [30]

--------------------------------------------------------------------------------

Thanks, Daniel. So look, we've been actively engaged with our customers for several weeks in advance and continue to monitor the situation very closely. We're in active communication with their health, safety and environmental teams of the major customers in preparation for such issues. We have worked very closely and publishing documents and information related to containing such viruses, the cold and flu prevention steps that we've all been very -- become very familiar with in the recent weeks. Really have leaned on the guidance from the CDC and working very closely with our customers. And I want to reiterate what Brad had said on his prepared remarks, which is we have not had any incidents related to the coronavirus thus far. And the lodge is fully prepared with our customers to maintain a safe, high-quality environment for our employees and our customers.

--------------------------------------------------------------------------------

James Bradley Archer, Target Hospitality Corp. - CEO, President & Non-Independent Director [31]

--------------------------------------------------------------------------------

Yes, Daniel, I'll just add a little bit to that on what Troy said is, look, we are in the hospitality business, in the Food Services business and this is something we have to do and have done for years in this business. It is the -- you kind of take yourself back to when you were growing up, but it's the normal things you should be doing that we have to continually reinforce even more today, but it is the cleaning. It is the coughing in your -- into your sleeve or into a napkin. It's the simple things that you have to make people aware of and do, right? I don't want to sound like -- I don't want to downplay it as it is big. But it is something we've looked at for years, and it's something we have to continue to do. And even it's more focused now, where we're making sure our customers are involved on a daily and weekly basis. We have calls. We have Level 1, Level 2, Level 3 scenarios. We have a pandemic plan. We're all over this and have been as we think it's going to continue on for a little while. But as Troy said, it hasn't affected us yet. But we have a plan in place, and we'll continue pushing forward.

--------------------------------------------------------------------------------

Operator [32]

--------------------------------------------------------------------------------

Our next question comes from Ashish Sabadra with Deutsche Bank.

--------------------------------------------------------------------------------

Ashish Sabadra, Deutsche Bank AG, Research Division - Research Analyst [33]

--------------------------------------------------------------------------------

So just a question on the cost. You talked about a good portion being variable versus fixed. I was wondering if you could talk about what percentage of the cost is truly variable. Like if the utilization does fall down significantly, do you have the optionality of even potentially closing those lodges? Or do you have to keep it open? So how much is truly variable versus fixed cost?

--------------------------------------------------------------------------------

James Bradley Archer, Target Hospitality Corp. - CEO, President & Non-Independent Director [34]

--------------------------------------------------------------------------------

Yes, this is Brad. Thanks. Good question. One good thing about our business is there's a lot of variable cost in your cost of goods really at your lodge level, right? If you see utilization start to drop, some of our biggest things is labor, food, and those things you can do very quickly to help defend your cash flow, right? So within -- literally within a few days. So it goes even to electricity, water, things that add up when you have as many locations as we do if you start to see this flow. As far as a percentage, I'd kind of let Eric talk more on specifics, but we -- this is exactly, if you will, what I've talked about is the playbook we had to go to back in '15 and to help, again, defend the cash flows, keep the margins up. And there's a lot of variability there that we can start to pull levers on, if we see this start to deteriorate in the utilization.

--------------------------------------------------------------------------------

Eric T. Kalamaras, Target Hospitality Corp. - Executive VP & CFO [35]

--------------------------------------------------------------------------------

Sure. So to Brad's point, there are a number of levers we can pull. When you look at the operating cost lines, there are what I would call short run. Efficiencies you can take, and then there are more kind of intermediate to long-term efficiencies you can take. When you look at the operating cost numbers, I would say, on a short run basis, Ashish, you're probably talking about half the costs are more short-term and variable in nature. So you think about food cost, certain labor costs. What we call camp supply costs, which can move fairly quickly up and down with the actual occupancy levels themselves.

There are other costs that can be moderated through time but are not quite as efficiently done. And those tend to be costs that have -- just have a longer lead-time they have to manage through. So there is a -- they're short run and a little bit longer term. The longer terms, we're not talking years, right? We're talking literally a quarter or 2 or sometimes 3. But generally, I would say, when you look at that cost bucket, of the total operating cost line, you've got roughly 70% there that's variable. I would say, of that 70%, the initial 50% is variable kind of almost on a weekly basis. The delta is done more of on an intermediate term basis.

--------------------------------------------------------------------------------

Ashish Sabadra, Deutsche Bank AG, Research Division - Research Analyst [36]

--------------------------------------------------------------------------------

That's very helpful. And maybe a similar question on the cash flow side. A lot of your expenses, as you pointed out, are discretionary. For example, growth CapEx, you can flex that around. Are there other costs also or from a cash perspective, your ability to sustain the free cash flow even in the scenario of utilization coming down? If you can provide any incremental color on that front.

--------------------------------------------------------------------------------

Eric T. Kalamaras, Target Hospitality Corp. - Executive VP & CFO [37]

--------------------------------------------------------------------------------

Sure. So you're right. The -- if you think about my comments a bit ago regarding how we were coming into 2020 and thinking about the market and supply and how we are positioning capital spending. Out of the $10 million to $20 million that we had provided as an outlook, we can look at that number, and I would say that there is probably 2/3 to maybe even 3/4 of that, that is still discretionary in nature today. Meaning that we can bring back a reasonably decent amount of discretionary spending. And which would then flow into the, obviously, the cash flow line. So further enhancing that, right? So -- which is positive. And so we do have nice flexibility there. And we are actively evaluating that right now and have already begun measures of curtailing some of that discretionary spending. So from our perspective, look, we have some flexibility of about an additional 15% to 20% on the discretionary cash flow outlook that we already provided. And we'll just have to take it and see from there, how much more flexibility we ultimately have, but I would give you that number to work with right now.

--------------------------------------------------------------------------------

Operator [38]

--------------------------------------------------------------------------------

Our next question comes from Stephen Gengaro with Stifel.

--------------------------------------------------------------------------------

Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [39]

--------------------------------------------------------------------------------

Just as a follow-up, and sort of back to that cash flow question. I know this is probably a hard one to sort of triangulate, but I mean, the way -- if we run the numbers, and I just take a draconian case, right, where you're basically utilization -- your revenue is 55% or 60% of your published guidance. It still looks like you generate reasonably good free cash flow. Is -- I mean, given the leverage you have to pull and given how you're thinking about it. Is that reasonable? I mean, I still think you generate $30 million to $40 million in free cash, but I'm just trying to figure out if we're missing something in the -- as we work through the income statement. So if you run something like that or not or?

--------------------------------------------------------------------------------

Eric T. Kalamaras, Target Hospitality Corp. - Executive VP & CFO [40]

--------------------------------------------------------------------------------

Yes. So look, I appreciate the question. We -- look, I can't comment specifically on the numbers that you quoted, but I will tell you this. I think -- I would tell you, based on what you described, those feel like awfully conservative numbers to me. But look, the business generates a lot of cash. We have flexibility. There is the ability to have margin certainly setting them in fire, and it's not environment for margin expansion, but I would call it more margin maintenance that does exist here. And so, look, I think your -- we saw your note, you're on the right track. But let's just wait and see how things play out. And maybe we can give you some more color a little bit through time here.

--------------------------------------------------------------------------------

Operator [41]

--------------------------------------------------------------------------------

Ladies and gentlemen, we have reached the end of the question-and-answer session. I will now turn the call over to Brad Archer for closing remarks.

--------------------------------------------------------------------------------

James Bradley Archer, Target Hospitality Corp. - CEO, President & Non-Independent Director [42]

--------------------------------------------------------------------------------

Thank you. Before we end the call today, I would just like to thank all of the employees at Target Hospitality for their hard work and dedication. I cannot be more proud of the effort they delivered 365 years a day (sic) [days of the year] to our customer. Finally, we look forward to updating you in just a few months on our first quarter call. Thanks, and have a good day.

--------------------------------------------------------------------------------

Operator [43]

--------------------------------------------------------------------------------

Thank you. This concludes today's conference. All parties can disconnect. Have a good day.