Good morning, and welcome to the Target Hospitality third quarter 2022 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone phone. To withdraw your question, please press star then two. 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 third quarter 2022 earnings call. The press release we issued this morning outlining our third quarter results can be found in the investor section of our website. In addition, a replay of this call will be archived on our website for a limited time. Please note the cautionary language regarding forward-looking statements contained in the press release. 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, November 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 investor 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'll be joined by Troy Schrenk, Chief Commercial Officer, and open the call for questions. I'll now turn the call over to our Chief Executive Officer, Brad Archer.
Thanks, Mark. Good morning, everyone, and thank you for joining us on the call today. Target's record-setting third quarter results are a direct reflection of our continued commitment to enhance operational flexibility while increasing financial strength and maximizing asset utilization. We generated record operating cash flow, executed multiple long-term contracts, and achieved our strategic objective to materially strengthen our financial position, resulting in over $220 million of cumulative debt reduction since 2020, with over $300 million of liquidity.
These accomplishments created the ideal platform to continue capitalizing on value-enhancing initiatives across our operating segments. In our HFS segments, we continue to experience positive trends in customer activity, resulting in three consecutive quarterly increases in customer demand. Target's 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 seven years and a 14% increase in utilization from the third quarter of 2021. This strong momentum supported multiple extensions to large HFS contracts during the quarter for customers that represented over 20% of Target's third quarter HFS revenue. We anticipate these contracts will contribute over $75 million of cumulative revenue through 2025, highlighting our long-standing partnership with these world-class customers.
These meaningful contract extensions illustrate our commitment to preserving the premier customer base we have been committed to serving for over a decade while simultaneously growing and diversifying the business. In the government segment, our priority during the quarter was to substantially complete the infrastructure enhancement required to service the expanded humanitarian community, which we announced in July.
To facilitate the timely completion of these critical enhancements, increase Target's network optimization, and materially increase project returns, we deliberately chose to maximize the use of existing assets. This decision has enhanced our operating efficiencies by creating a more fully utilized network, particularly within the HFS-Midwest region.
In recent years, we have evaluated a range of scenarios aimed at rationalizing a portion of the HFS-Midwest assets but have been unable to meet our desired economic returns. We have now accomplished that objective. Ultimately, the opportunity to reallocate these assets to the government segment was the ideal outcome and resulted in a significantly higher return on assets than we had previously anticipated.
We are pleased with the progress of the expanded humanitarian community and believe it is on track to meet or exceed Target's medium and long-term objectives while continuing to fill the critical humanitarian mission it was designed to service. In connection with the substantial completion of the infrastructure enhancements, we entered an 11-year partnership with our national nonprofit partner.
The long-term agreement solidifies our joint commitment to continue providing critical humanitarian services to the United States government at this highly customized campus. Further, we believe this reinforces our collective belief that this purpose-built community will remain an ongoing fixture in supporting domestic humanitarian aid missions. Target's government segment represented over 77% of third quarter 2022 revenue and is expected to represent over 70% 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 supported the achievement of our strategic objective to materially strengthen Target's financial position and establish the ideal platform to continue pursuing strategic initiatives focused on accelerating the value creation for our shareholders. I'll now turn the call over to Eric to discuss our third quarter financial results, financial outlook and capital allocation initiatives in more detail.
Thank you, Brad. In the third quarter, we experienced continued strong demand fundamentals and positive momentum in customer activity, predominantly driven by the materially expanded humanitarian community we announced earlier this year. Third quarter 2022 total revenue was $160 million, and adjusted EBITDA was approximately $84 million. Our government segment produced quarterly revenue of approximately $123 million compared to $46 million in the same period last year.
The significant increase was attributed to the expanded humanitarian community we announced in July. As a reminder, Target's government segment, including the expanded humanitarian community, center around annual minimum revenue commitments. Additionally, the expanded humanitarian community includes variable services revenue that aligns with monthly changes to community population. Our HFS segment delivered third quarter revenue of $36 million compared to $33 million in the same period last year.
This increase was driven by sustained momentum and customer demand for Target's premium service offerings, supported by constructive economic demand fundamentals. Recurring corporate expenses for the quarter were approximately $10 million and illustrate our ability to significantly grow the business while incurring minimal incremental costs. As a result of the scale of the business model, we anticipate recurring corporate expenses to remain around $10 million per quarter for the remainder of the year.
Total capital expenditures for the quarter were approximately $74 million, with $70 million related to the substantial infrastructure enhancements required at the expanded humanitarian community. With the completion of the community enhancements by year-end 2022, we expect a more moderate pace of capital expenditures into 2023.
We ended the quarter with $177 million of cash and over $300 million of available liquidity, with zero borrowings under the company's $125 million revolving credit facility and a net leverage ratio of 0.8x . Further, Target anticipates additional balance sheet strengthening continuing into next year with the expectation of having zero net debt by the second half of 2023.
Now turning to our financial outlook and capital allocation initiatives. To complete the expanded humanitarian community in the most efficient way, we deliberately chose to utilize a larger portion of existing assets versus acquiring new equipment. This decision has significantly enhanced asset optimization and created a more balanced operating structure. In addition, the use of existing assets resulted in a substantial increase in project returns than originally anticipated.
However, this decision modified the accounting treatment for previously anticipated capitalized costs and resulted in one-time mobilization expenses in 2022. These expenses will not impact subsequent periods. As a result, we have updated our full year 2022 financial outlook, which now consists of revenue between $495 million and $500 million.
Adjusted EBITDA between $263 million and $268 million. Discretionary cash flow between $255 million and $260 million. Capital spending between $130 million and $135 million. While Target has experienced a significant increase in consolidated revenue and associated net income, it intends to utilize a significant portion of its remaining net operating loss carryforwards to offset its 2022 cash tax obligations.
As such, Target anticipates 2022 cash tax payments of between $6 million and $8 million, resulting in effective cash tax rate between 7% and 9%. Target's enhanced end market portfolio and contract structure has supported increased minimum revenue commitments and provided greater visibility on long-term revenue and cash flow. As a result, the company is providing a preliminary 2023 financial outlook, which includes a minimum revenue of $525 million and maximum revenue of $710 million, with minimum adjusted EBITDA of $365 million.
Including acquisitions, 2023 capital spending should approach more normal levels between $10 million and $20 million per year, with approximately 70% allocated towards growth capital. The range of preliminary 2023 revenue reflects the possible contribution of variable service revenue associated with the expanded humanitarian community.
Target Hospitality anticipates variable service revenue will contribute between $50 million and $185 million of additional 2023 revenue above the anticipated minimum revenue of $525 million. The amount of variable service revenue will depend on the scale and timing of U.S. government mobilizations. Target Hospitality's enhanced balance sheet will allow the company to continue evaluating a range of capital allocation initiatives focused on maximizing long-term shareholder value while simultaneously expanding long-term growth opportunities.
These growth opportunities include continuing to pursue diversifying adjacent end market acquisitions, as well as select opportunities to strengthen our existing end market portfolio. In addition to broaden the range of potential value enhancing capital allocation initiatives, Target Hospitality's board of directors has authorized a stock repurchase program for up to $100 million.
This plan will allow the company to evaluate a more holistic capital allocation opportunity set while focusing on maximizing value creation through all available means. We believe Target's enhanced financial position and balanced strength creates the ideal platform to continue pursuing these value enhancing opportunities into 2023. With that, I will turn the call back over to Brad for closing comments.
Thanks, Eric. Our record-setting third quarter results illustrate our commitment to enhance operational flexibility, maximize asset utilization, and provide unmatched value to our customers, which has supported the achievement of our strategic objectives. We are well positioned entering 2023, and we'll utilize this momentum to continue pursuing initiatives focused on accelerating value creation for our shareholders. I appreciate everyone joining us on the call today, and thank you again for your interest in Target Hospitality.
We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up the handset before pressing the key. To withdraw your question, please press star then two. At this moment, we will pause momentarily to assemble our roster. The first question comes from Scott Schneeberger with Oppenheimer. Please go ahead.
Thank you very much, and good morning, all. I guess I'll start out with the West Texas government contract extension of the facility. Could you provide an update? It was mentioned in the press release completed by the end of the year, and it sounds like you're on track, but just wanna get an update on the status of that and how complete that is. Then a couple follow-ups on that theme. Thanks.
Yeah. Scott, this is Brad. Nice speaking with you this morning. Yeah, to answer your question, look, we're substantially complete. We're tying up a few loose ends on site. Other than that, we're on track to finish up pretty quickly here in the fourth quarter.
Great. Thank you. Thanks, Brad. I guess a couple things, a few different directions to go in. First off, are you at a point now where you can get an indication from the government customer of what type of utilization levels you may see in the West Texas facility now going forward because you're largely done with the expansion? If you don't have that clarity yet, when might you anticipate that clarity?
Hey, Scott. Good morning. It's Eric. Thanks for joining this morning. The question regarding the occupancy levels and the variability, you know, therein, you know, as we talked about a couple times in August and then in July, you know, that variability amount is really largely dependent upon the government's allocations in terms of how they're seeing the flows and how they wanna nominate to just across the portfolio. It's always hard to say. I think at this point in time, you know, give us a little more time to figure out how that manifests itself.
As Brad mentioned, the facility is not even, you know, fully open yet. It's a new program for everyone, and so we're all learning all about exactly what that's going to look like, you know, going forward. I think a couple things to bear in mind, though, you know, while we wait and try to get more clarity over time is that, you know, there is a little bit of seasonality in terms of the flows in migration. We do have to bear all that in mind. The government will allocate, you know, with all that. You know, hopefully, when we have something, you know, specific, we will provide you updated information accordingly as well.
Hey, Scott, maybe just a little bit more color as well, around that. Definitely to Eric's point. Look, we need to finish everything. There'll be a ramp-up period before they utilize this more fully. Taking you back to when we first started this contract over a year, well over a year ago, our first contract, there was 19 temporary facilities holding kids throughout the United States.
Today, there's only two ICF facilities nationwide. This is where they start to cull the temporary facilities, start to get into using the purpose-built facilities. We're the only purpose-built facility in the United States that uses permanent construction, and again, only one purpose-built. There's a ramp-up period here, but all of the moves that they're making are really positive for us and everything that we've talked about.
Excellent. Sounds good. I want to kind of take this further with. I thought I heard in prepared remarks. I don't believe it was in the press release. This is more for Brad, but Eric will get into the one-time mobilization expense. Midwest HFS-Midwest, it sounds like you're now tying facilities there into your extended partnership with your not-for-profit partner and the government contract. Could you elaborate a little bit on how the HFS-Midwest is being included? I guess I'll finish up here and turn it over.
Eric, also, after Brad goes there, could you discuss kind of this one-time charge, how it impacted the quarter versus expectations, how it may impact the fourth quarter versus prior impact versus prior expectations? Clearly it's not going into next year from what you said, just a little more elaboration there. Thank you both.
Yeah. Scott, on the rebalancing, we have been chipping away at this for, heck, five years. You know, we'd get a project, we would cost it in, and we'd move some units that were either not utilized at all or underutilized in North Dakota. We'd move them around. This project itself and the decision we made a few months ago to use our own assets really allowed us to rebalance our portfolio in one fell swoop. Not only in North Dakota, we actually moved some product around in Texas as well. They were utilized, but not 100%.
This project, as large as it is, it allowed us to really look holistically at all of our assets anywhere in the country and say, "How are we gonna rebalance this to get more revenue out of it?" We think it's a great move for the company. It's gonna pay off long-term for us, the investors, et cetera. Today, again, we're pretty much done now with the rebalancing of it. That's what it allowed us to do.
Scott, related to your question on that from more of a financial perspective, I mean, here's kind of the calculus that one has to think through, right? Which is, this is if we look at an expense shift, in this instance, you know, just call it about $10 million or so as effectively a one-time mobilization expense impact in Q3.
Then we juxtapose that against a capital spend reduction of, let's say, close to $60 million, right? You know, look, that's a kind of a six-to-one payoff that you would make that trade every day. So when we think about that, there's de minimis impact into Q4 and, of course, as you mentioned, nothing into 2023. Just to kind of calibrate how we think about the return impact on that was effectively the calculus in that. Hopefully that gives you a little bit of clarity in terms of your question and the impact in Q3.
Okay. Thanks. Yeah, I will turn it over, but I'm just curious, Brad, I guess on this rebalancing, is the government going to be tied into the assets in North Dakota, or are you moving those assets down to Texas? Just, I don't know if you're able to share.
Yeah.
What exactly is happening in this rebalancing? Thanks.
Yeah, absolutely. We actually moved the units from one location, if you will, or several locations in North Dakota and some across Texas to the government project, right? Now all of the rooms that we moved are always getting paid the warm status, right? Then at some point the variability piece as well comes into to a deal. We looked at this and said, "Where can we get payment every day of the week on the rooms?" It was simple as that. This project allowed us for it to be paid for it to be moved, set up again, et cetera, and saved us money from buying new product.
Scott, this was an important modification because, you know, as Brad mentioned, this has been something that had been worked on for a significant period of time. When you make that shift like that, you know, that's, you know, nothing's ever permanent, but that's a pretty substantial shift in the asset mix in a way where the market up there was not really allowing, right? To Brad's point, that was a pretty important structural shift. We were taking assets that were pretty underutilized and now getting not only your high grading customer, your high grading contract, you've also, you know, high graded margin, you know, exponentially on it.
Yeah, it helps in efficiencies as well, right? When your utilization goes up, you can just look at Midwest compared to last year, what it is today, you're starting to see that flow through on utilization. Efficiencies in operations, you're taking rooms out of the market. It should help us as we get into the future on pricing, those types of things as well. We think this was a great move, you know, that the government project allowed us to do.
Thanks, guys. I will turn it over, but just to clarify, if you can share, it sounds like these assets went from HFS now to government categorization, and I infer they moved from North Dakota down to Texas. If you can share, is that what occurred, or is it just they remain where they are and it was
No.
Repurposed.
Yep.
Go ahead.
They were moved from North Dakota. They were moved from North Dakota down to Texas and installed on the government project, and they're in use today. They were relocated.
Okay. Thank you both. I'll turn it over.
Thank you.
This question is from Stephen Gengaro with Stifel. Please go ahead.
Thanks. Good morning, everybody. A couple things for me. I guess the first pretty straightforward. 2023 guidance. Does EBITDA include any contribution from the variable revenue portion?
Nice, Stephen. Good morning. Yeah, it does. It does include a small amount there. You know, we've allocated, you know, approximately, you know, $50 million in revenue there. So, you know, again, we can look at that through time, but realizing we have a fair bit of runway as we move through 2023, we just felt given the material change in the business that it was appropriate to try to, you know, at least guide the market to something in 2023. You know, $50 million was a spot to start with.
Okay, thanks. When we think about, I'm not exactly sure how to ask this question, but when I think about your business and I think about the interest level and the commentary I get from investors and potential investors all the time, there's been a big diversification away from the oil patch, which is good, but there's now a customer concentration risk with this big government contract.
What I'm trying to figure out is any color you can add, and clearly this partnership is a big positive, but any color you can add in sort of your comfort level, reallocating rooms from the energy side and how we should think about, you know, milestones and data points to help us get comfortable that there is in fact gonna be a meaningful extension here down the road.
Yeah. I'll address part of this, then I'll let Eric jump in here too. Let me address the 11-year partnership. You know, we looked at this, it's partnership with our nonprofit partner, as you know, but it solidifies our joint commitment to continue providing the care and services that are needed by the U.S. government.
I think the bigger thing that we haven't discussed in the past calls is here recently, this is kind of in conjunction with the 11-year partnership, but here recently, we were requested by the government to provide a proposal for a 10-year lease on this facility. You know, I look at the 11-year partnership as really a precursor to something larger. It's playing out like that. You got to check a few boxes first.
We've been in this going on our second year. You know, construction's about finished. We've signed this 11-year partnership with our nonprofit partner. In turn, the government is already asking us for you know, a proposal to make this a more permanent fixture in their network. As I said earlier, remember, there was 19 of these facilities. It's down to two. We feel really good about getting a long-term deal done at some point. We're only six months into this contract. They do move a little slow, but we actually like the pace it's moving at this point. Very good about that moving forward, you know, long term.
Great. That's great color. The other question I had is when we think about, it feels like CapEx next year is down. You're lowering your debt levels pretty consistently, or at least your net debt levels. How do we think about? I mean, there's not a lot of moving parts, I don't think, between EBITDA and free cash flow next year, right? I mean, working capital maybe a little bit, but any parameters you can provide us as we think about getting from sort of 23 baseline EBITDA guide to free cash flow?
No, you're right, Stephen. There are not actually a lot of moving pieces, and you would expect that cash conversion to be pretty substantial. I think the one thing to remember, and I think you know this, is, you know, there is the $117 million amortization, which we've talked about before. It's in the release. Certainly happy to talk about it offline to the extent that we need to. You know, obviously that will be an adjustment to the operating cash flow. I think once you have adjusted for that and then taken normal working capital into consideration, everything else is pretty much status quo.
To your point, you end up with a significant amount of cash generation into 2023 and certainly into 2024 and beyond. You know, that obviously begs a host of other questions in terms of capital allocation. As you look at the model, once you've adjusted for that, what you're probably seeing is what you're gonna get.
Thank you. Then I just thought of one final, and I'll pass it over. When you think about the oil patch, I think the utilization of your available rooms in the Permian HFS-South was, like, 89% in quarter. When you move rooms and reallocate rooms for government, does this tighten capacity in the Permian and give you any underlying pricing power?
It does, and I mentioned this a little bit earlier, right? It builds in some efficiencies, 'cause your utilization goes up, you get more efficient. And it should bring us some pricing power as well. It also gives us an opportunity to look in some areas. Is there some equipment out there? Look, we're definitely continuing to grow the HFS. We're not running away from it. It's a great business that produces a great margin, and we have great contracts. It's a great business. We'll continue to look at some things there to continue to grow that business as well. Yes, on the pricing power.
Okay, great. I appreciate the color. Thanks.
Thank you.
Again, if you have a question, please press star then one.
Next comes from Greg Gibas with Northland Securities. Please go ahead.
Hey. Yeah, good morning, Brad and Eric. Thanks for taking the questions. You know, I just wanted to follow up on kind of the significance from a high level of that 11-year partnership. You know, congrats on that. You know, is it more kind of removing competition risks, or should we think about maybe encouraging the government to work with your partner more? Just maybe high-level significance of that.
Yeah. High level, look, I think it shows solidarity, right? That we both produce a great service, a great product. The government knows that we have proven performance. It's showing them our alignment. We've always said that we think this is a long-term solution for the government. It's gonna be in their long-term plans. Look, we were proven right.
They've asked for this proposal. We've submitted. We think they take their time, if you will, in doing something. We're just now opening up. We think the 11-year partnership is very significant, in just terms of, again, checking the boxes and the next step. This is something we knew we were gonna have to do. Not only it shows a working relationship.
Remember our nonprofit partner does more work than just in Pecos. To be able to work with them in other locations as well, it's not what this partnership covers, but it does show, you know, their willingness to work with us. We'll continue to further that. Specifically, we think it's a big outcome for us and has more to go.
Yeah. I think, Greg, this is Eric. I think the other thing, too, is as Brad pointed out, it doesn't necessarily cover this explicitly, but there is a framework now that is provided whereby there are other opportunities over time from a business development perspective to partner with our nonprofit in other applications, right?
You know, that's not necessarily something that is, you know, contractually drafted in this exclusivity agreement. However, I would absolutely say that there is a commercial commitment among parties to do just that, right? To go out and explore other opportunities together. You know, this is. It's certainly important from a contract perspective, but it's also important just from a commercial arrangement perspective.
Great. Yeah, it makes a lot of sense. If I could just follow up, you know, I know you already kind of spoke a little bit on the variable revenue component of next year's expectations, but you know, pretty wide range. I know you said, you know, within the EBITDA outlook, I think $50 million of revenue is expected from that. From maybe investor standpoint or, you know, how does it make sense to assume maybe the low end of the range, or do you have better visibility into something like the midpoint or? You know, anything you can kind of talk to there regarding that wide range?
Sure. Look, it's a great question. I appreciate the question. It's an obvious question. Couple points. The range that we put out on revenue is designed to give a sense of goalposts as to where things could ultimately be and to provide at least some directionality. Be that as it may, what we're saying is, look, we still have, you know, 15 months, 14 months to get to that kind of timeframe, right? We felt it was important at least to put some guideposts out there by the company. As it relates to the EBITDA portion, we also felt it was appropriate to provide something at a minimum level, albeit realizing it could certainly be materially higher than that.
We just don't know exactly what that will be at this point in time. You know, look, I think if I were you all, I would be towards what we provided. You know, look, as time shifts forward, you know, we can all modify it, you know, accordingly. I think we wanna be sensitive to it and not presuppose what the government may or may not do over time. It's just too early to tell. I think, you know, look, we operate this, look, to be a conservative management team and, you know, deliver what we say we're going to deliver. You know, that's how I would position you at this point in time.
Great. Very helpful. You know, I guess last, I just wanted to follow up on the updated guidance. Is the reduction in EBITDA this year is that completely a result of the mobilization expense, or are there other factors as well?
It's the lion's share of it. You know, I mean, look, that was really the big piece.
Okay. Have you quantified the, I guess, expense there?
Sure. We've said. We haven't, but I will. We said about $10million-$12 million or so is the net impact.
Got it.
Certainly from an EBITDA perspective.
Okay. Thanks, guys.
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 want to express how proud I am of our team, our people, and the many accomplishments we've achieved this past year. In 2022 alone, we have set records for revenues, cash generation, and EBITDA, and today sit with more dry powder than ever before with more than $300 million of liquidity.
We are proud of the record-setting results, which have more than doubled the size of the business, including increasing adjusted EBITDA by $135 million from our original 2022 outlook. Lastly, we said we would diversify our business, and we have, and we will continue to deliver on that promise. I can't be more excited about the future of Target Hospitality as we head into 2023.
While we are extremely proud of what we have accomplished to date, there is more to do. Make no mistake, with the strong momentum we've created, I have no doubt the future for Target Hospitality is even brighter. Thanks for joining us on the call today, and I look forward to speaking again in the first quarter of 2023. Operator, that concludes our call for today.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.