Good morning, welcome to the Target Hospitality First Quarter 2023 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please press star and zero. After today's presentation, there will be the opportunity to ask questions. To ask a question, you may press star and one on your touch-tone telephone. To withdraw your question, please press star and two. Please note the 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 first quarter 2023 earnings call. The press release we issued this morning outlining our first 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 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, May 9, 2023. 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 will 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. Our strong first quarter performance reflects the positive business momentum we have sustained over the past year, which has supported many strategic achievements. We have meaningfully diversified the business and revenue mix with over 70% of revenue now derived from committed contracts backed by the United States government.
These high-graded contracts have provided enhanced revenue and cash flow visibility, supporting over $339 million of Discretionary Cash Flow over the last 12 months, representing an impressive Discretionary Cash Flow yield to revenue of approximately 60% over that time. These accomplishments have solidified Target's balance sheet with over $350 million of cumulative debt reduction since 2020 and an 80% improvement in Target's net leverage ratio over the past year.
We have significantly transformed Target's operating platform while continuing to serve our existing world-class customers and simultaneously positioning the business to quickly respond to strategic growth opportunities. In our HFS – South segment, we have remained focused on providing premium full-service hospitality solutions to our world-class customers, many of whom have been customers for over a decade.
As a result, Target continues to benefit from consecutive quarterly increases in customer demand, resulting in a 15% year-over-year increase in utilization with consistent customer renewal rates over 90%, which we have enjoyed for over seven years. This continued strong demand and positive customer outlooks supported the acquisition of select community assets in the first quarter to appropriately align our network capacity with an existing customer's growing labor allocation requirements. In addition, the strategic location of these assets enhances Target's regional presence and provides opportunities to further expand our premier customer base.
We are pleased with our current HFS utilization and its ability to meet our strong customer demand while benefiting from the more fully optimized network we have created over the past year. Regarding our government segment, our purpose-built portfolio of assets continue to serve the critical humanitarian aid mission that they were designed to support while exceeding the expectation of our partners in the U.S. government since our first community was established in 2014. The U.S. government has continued to state its urgent need for additional humanitarian housing capacity, particularly with the impending removal of Title 42, which is anticipated to result in a substantial increase of individuals crossing the U.S. southwest border.
In preparation for this meaningful increase in demand and to ensure uninterrupted access to existing humanitarian housing solutions, including Target's expanded humanitarian community, the U.S. government has indicated it intends to exercise the existing contract six-month option. This decision will allow for seamless continuity of the service offering at the expanded humanitarian community and serve as a bridge prior to long-term contract specification being finalized.
As previously discussed, our nonprofit partner was awarded an indefinite delivery, indefinite quantity contract related to the extension of our humanitarian community in Pecos. As a reminder, this award consisting of a base five-year term with an additional five-year option establishes the contracting vehicle required by the U.S. government to appropriately fund multi-year contract awards. The IDIQ award to our nonprofit partner is one of the final steps in the government's contract award process prior to working through definitive agreements.
We remain highly pleased with the ongoing discussions with the U.S. government and our nonprofit partner, we anticipate working through additional contract specifications over the coming months, with likely culmination in the fall of this year. We look forward to solidifying the longevity of this community and the critical humanitarian mission it was purpose-built to support.
In summary, we have achieved our strategic objectives to materially strengthen Target's financial position while simultaneously diversifying our customer base and continuing to accelerate value creation for our shareholders. I'll now turn the call over to Eric to discuss our first quarter financial results, 2023 outlook, and capital allocation initiatives in more detail.
Thank you, Brad. In the first quarter, we experienced continued strong demand fundamentals and positive momentum in customer activity, which further solidified our strong financial position. First quarter 2023 total revenue was $148 million, and adjusted EBITDA was approximately $91 million. Our government segment produced quarterly revenue of approximately $110 million compared to $47 million in the same period last year.
This significant increase was attributable to the expanded humanitarian community. As a reminder, Target's government segment, including the expanded humanitarian community, centers around annual minimum revenue commitments. Additionally, the expanded humanitarian community includes variable services revenue that aligns with monthly changes to community population. This contract structure provides ideal flexibility for our customers as their occupancy requirements fluctuate over time, while providing meaningful minimum revenue commitments that create significant revenue and cash flow vis-visibility for Target.
We have found this structure is the optimal outcome for all parties, creating a sustainable basis for contract longevity while maximizing operational flexibility. Our HFS segment delivered first quarter revenue of $36 million compared to $32 million in the same period last year. This increase was driven by sustained momentum and customer demand for Target's premium service offerings.
Recurring corporate expenses for the quarter were approximately $9 million, and we anticipate recurring corporate expenses will remain around $9 million-$10 million per quarter for the remainder of the year. Total capital spending for the quarter was approximately $32 million, with the majority related to select HFS – South asset acquisitions focused on increasing capacity to appropriately match growing customer demand. We expect a more moderate pace of capital spending through the remainder of the year, excluding potential acquisitions.
We ended the quarter with $42 million of cash and over $167 million of liquidity, with zero borrowings under the company's $125 million revolving credit facility and a net leverage ratio of 0.5x . We previously announced on March 15th, we partially redeemed $125 million of the 9.5% Senior Secured Notes, which we view as a high risk-free cash return.
It relates to the outstanding Senior Notes, we continue to evaluate a range of possible liability management initiatives focused on further strengthening our financial position while balancing the expanding pipeline of strategic growth opportunities. This approach is centered on maximizing financial flexibility, enabling us to quickly react to value-enhancing growth opportunities as they arise. Turning to our financial outlook and capital allocation initiatives.
Target's enhanced end market portfolio and contract structure has supported increased and minimum revenue commitments and provided greater visibility on long-term revenue and cash flow. We believe the government's decision to issue an IDIQ contract award to our nonprofit partner solidifies the sustainability of this purpose-built facility by establishing the necessary mechanism to fund specific multi-year contract awards.
Further, the government's desire to exercise the existing contract's six-month option supports the importance of this community as the government prepares for a significant increase in demand for humanitarian housing following the lifting of Title 42. We continue to work closely with our nonprofit partner and anticipate additional contract specifics related to Target's critical hospitality solutions to be finalized later this year.
Further, in response to the government's stated urgent and compelling need for additional humanitarian housing solutions, we recently acquired a strategic humanitarian asset, which we believe will allow Target to react quickly in support of the government's demands for these humanitarian solutions.
Coupled with our ongoing business development efforts that have created the strongest project pipeline the company has seen in several years, the company is reiterating its preliminary 2023 financial outlook, which includes minimum revenue of $525 million, maximum revenue of $710 million, and minimum adjusted EBITDA of $365 million. Excluding acquisitions, 2023 capital spending should approach more normal levels between $20 million and $30 million per year, predominantly focused on organic growth capital.
The range of preliminary 2023 revenue reflects the possible contribution of variable services revenue associated with the expanded humanitarian community, along with other potential second-half weighted revenue catalysts. As it relates to Target's strategic initiatives, Target is pursuing an expanding pipeline of growth opportunities and partnerships.
These opportunities are designed to jointly leverage Target's operating expertise with contracting vehicles that will create a number of solutions across various U.S. government agencies for projects that support national defense, energy transition and other humanitarian projects for the U.S. government.
As previously stated, Target is prepared to allocate over $500 million of net real capital to these high return opportunities over the next several years. We are pleased with the progress of discussions for many of these projects and partnerships, and have achieved tangible milestones regarding some of these large-scale projects. We look forward to providing additional updates in the coming quarters as the opportunities fully progress. With that, I will turn the call back over to Brad for his closing comments.
Thanks, Eric. Our strong first quarter results reflect our ability to sustain momentum and continue achieving our strategic objectives. Over the past several years, we have exponentially grown the business, prudently managed our balance sheet, and significantly enhanced our financial flexibility.
These accomplishments have exceeded our expectations. We are excited about the operating platform we have created and are focused on pursuing an expanding pipeline of growth opportunities while continuing to accelerate 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 and one on your touch-tone telephone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star and two. The first question comes from Scott Schneeberger from Oppenheimer. Please go ahead.
Hey, good morning. It's Daniel on for Scott. Thanks for taking our questions here. Could you guys please elaborate on the on the May 15th update related to the work statement, please?
Sure. Good morning, Daniel, it's Brad. Look, this, what we talk about there is a performance work statement. What that is, it comes out before the task order, it's describing what's going to be in this task order. It sets out the requirements, what we will submit to the government, and to our partner.
You know, reading this performance work statement, it's very materially aligned to what we're already providing, we're happy to see that. Look, at some point here over the next few months, this task order will come out. We will submit to that, an award will be made. This is just really the next step that we've been waiting on to get that out there and get a long-term agreement.
Got it. Thank you. Sounds good. With Title 42 removal, has there been any conversations about, you know, removing the warm status of the Pecos facility?
Yes. Specifically on PCC, we've been in talks with them. There's been some calls about moving back into hot status. Nothing yet has been, you know, given to us on that other than the calls and conversations coming in, asking us how quickly we could ramp that up in anticipation of Title 42 going away and the need for those beds to be filled.
You know, furthermore, just across the board, I know there's probably gonna be this question on Title 42, just the amount of conversations we're having with different agencies or about PCC, they're staggering. There's been lots of them over the past few weeks, asking what we can do for them. Active conversations going on across the board through different agencies as well as for the PCC.
Got it. Thank you. Regarding the strategic asset purchase you made in the quarter related to the government segment, can you please elaborate that on a little bit and help us think about the financial implications and when we may get an update on that? The second part of the question is the CapEx spend of $31 million in the quarter in the HFS – South segment, if you could please help us think about how we should view that going forward as well.
Sure. Good morning, sir. Regarding the government, you know, asset, I think as you know, there has been a consistent need and desire for additional influx capacity and space. That's been well stated by the government, and then we keep hearing that same theme. What we chose to do was acquire a strategic asset, an asset that was priorly in use, for similar sort of capacity.
And really to try to offer the government a more immediate solution for other influx opportunities, because we know that, you know, additional influx sites are something that they're trying to evaluate as part of being an extension of the permanent portfolio. We wanna give them lots of different options, lots of different, you know, geographic opportunities, et cetera. That was the purpose of that.
But at this point in time, look, that very well can be part of the IDIQ and effectively the performance work statement, right? In addition to what we have today. I'm not saying that will be the case, but it certainly could be. That was one of the reasons why we wanted to strategically acquire that. As it relates to a cash flow contribution, what I would say is, you know, nothing to report on that yet, although, you know, we're hopeful that at some point here in the near future, we have something specific that we can, that we can say.
Specifically to your question regarding the Permian transaction, you know, we have talked for some time that we felt like we were Yeah, becoming a little bit net short in our, in our capacity. We want to take the opportunity to go ahead and increase and expand the market share that we have in the Permian Basin and did so, you know, with an asset that we've been looking at for a while. We feel like that was a nice, that was a nice addition to the portfolio. It, you know, comes to current cash flow.
It's, you know, it's not a, you know, super large transaction as you can see, but it's an important one and one that continues to give us additional breadth, additional customers and defend that market share. I wouldn't, from a modeling perspective, you know, it's of a such size that I wouldn't ascribe, and do much with it in terms of your modifications in EBITDA, because we are still integrating that asset and we have some expense from that. But look, I think it's a nice growth opportunity for us, and we'll continue to create those tuck-ins as we see fit in the future.
Let me just add one thing on the strategic facility acquisition. Eric talks about, you know, when we first did this, it was more to continue to expand the ICFs. Kinda what's evolved out of this is a lot of other conversations with multiple agencies, from CBP to others, in the government. You know, once you acquire this, we do a design, we go out, we lay this out in front of different agencies. With Title 42 up on us going away, lots of increased awareness about this facility, multiple discussions being had throughout different agencies.
While we talk ICF, I wouldn't be surprised if this ends up maybe even something else at this point. To Eric's point, to have it ready for us to be able to respond quickly, that's how you'd need to be set and ready on these large types of projects to help the government, especially in times like this. We think this will help us do that.
Got it. Thank you so much.
The next question comes from Greg Gibas from Northland Securities. Please go ahead.
Great. Good morning, Brad and Eric. Thanks for taking the questions. Congrats on the strong results in Q1. I wanted to just ask, I guess maybe the breakout between variable and fixed revenue on the humanitarian side in the quarter, and I guess just wondering if anything's changed with respect to your variable revenue expectations for the full year. I think it was previously $50 million as kind of a baseline assumption. Just trying to get a sense of whether anything's changed.
Yeah, sure. You know, there's not a large variable component for the quarter. Certainly we, look, we would like to see that higher, right? It was what we would consider to be at the minimum levels on that. You know, I wanna refrain from giving specific numbers on that, Greg. I think the important point is that, you know, we expected this kind of the seasonal slowdown, right? We got that. That was actually very much in line.
I think the thing that we have to wait for now is, you know, with Title 42, so many, so many, you know, people are being held, at the border that I think it's the question as to how quickly, we move into hot status and then to what extent. Because of that, and because we allocated approximately $50 million of variable revenue through the year, and because of the surge that we see during the, during the warm summer months and into the early fall time period, we just don't know what the extent of that's going to be.
And for that reason, we've chosen not to, not to change anything as it relates to our revenue outlook. Now, we-- frankly, I just think it's too early. We, we were, we were... You know, we were expecting, somewhere in the neighborhood of only 10% of the variable revenue contribution to be in the first, roughly in the first, call it, you know, quarter and a half anyway. We've... my point is, we've eaten very little into that, and there's a lot of upside opportunities still left of the year.
The thought on the business hasn't changed.
Hasn't changed one bit. No, look, the and the concept between, when we set up the contract, you know, jointly with our nonprofit partner and at the request of the government, was for this minimum revenue component, right? That was to keep this the facility ready and waiting for when the surge happens.
Look, that's the definition of the influx capacity. We are ready and waiting for that. When that revenue comes, it hits, it can be meaningful. For that reason, you know, has the timing shifted perhaps, to a little more back half-weighted? Sure. Sure. You know, would have expected maybe a little bit more by now, but frankly, not alarmed by that at all.
Great. Really appreciate the color. Helps a lot in kind of how you're thinking about it. Yes, do realize that that variable is a small component compared to the fixed. You know, was gonna ask on kind of getting back to that hot status from warm, I think you kind of already addressed that in discussions there. You know, regarding, I guess, the another step forward towards finalizing that multi-year contract, you know, you mentioned being one of the final steps before completion. Could you maybe discuss what the remaining steps we need to see are before we get that multi-contract e-extension finalized?
Yeah. Look, it goes from the PWS to the performance work statement to actually putting in our numbers on an initial task order, right? The government will issue this task order. We will put our RFQ in for that, if you will, our bid, and then an award, what we would think, you know, towards the latter part of the third quarter.
Yeah, I think the one thing, Greg, that I would add in addition to Brad's comments is when you take a step back and you think about the performance of work statement, what that is further defining any scope modifications, right? To which, and this is important, to which there weren't any. That's an important point, right? That I think that allows that fit that dovetails really nicely with the facility today. There's still, as we see it, there's nothing that needs incremental needs to be done today, which I think should help speed this process along, you know, fairly smoothly.
Yes. Design the same warm, hot status. The number of beds...
Everything is exactly the same.
All of that is backwards.
It's really a function of getting working through the task order process. Look, I think one could logically say, "Okay, well, you know, why does it need to be, you know, a few months, few more months down the road?" Part of the reason is because, as I mentioned earlier, the government wants to continue to look at their influx sites. Expanding those sites is not a bad thing.
They could come back and want more of these, not just one.
Yes. I think that's the important point. This isn't just about PCC. This is about the overall influx site demand, okay? And over and above PCC. There's more to it. There's more going on than just our specific asset today. To Brad's point, they very well could come back and say, "It's not one, it's two or three.
Got it. That's helpful. If I could follow up too on that, your comments relating to that recent strategic asset acquisition, seems to make a lot of sense just given what you're hearing from the government, still being that short capacity and there being a lot of demand there. You know, you kind of said, you know, don't expect anything in terms of contributions to financials this year.
You know, kind of guessing that, you know, are you in discussions right now with the government in terms of how to use that? Just trying to think about, you know, if we're not expecting to see something near term, when you, when you would think about timing of that facility beginning to be used.
Yeah. I'll touch on just conversations. Yes. I mentioned this earlier. We're having multiple discussions on this facility. Lots of activity there and a high level intere st is kind of where I'll leave it. That interest is just kinda picked up even more so with May 11th right around the corner and Title 42 going away. While we don't have anything in the numbers, the hope is at some point, you know, this is just not a real estate acquisition. It actually becomes accretive to us at some point. That's the goal, right?
Yeah. Greg Gibas, I would say if I misspoke and said I'm expecting them this year, that wasn't necessarily my intention. We may or not. I think the point is we, you know, look, we have the asset ready and available. What I'm saying is we're putting anything now, right? That doesn't mean to Brad's point, it doesn't mean something can't happen, as we work through this performance and work process. It doesn't mean something can't happen with that asset as part of that process.
Okay, perfect. Thanks for clarifying, and, appreciate the color, guys.
As a reminder, if you have a question, please press star and one. The next question comes from Alec Scheibelhoffer from Stifel. Please go ahead.
Hi. Good morning, everyone. Thanks for taking my question. Just to get us started here, just based on earnings and analysis from pressure pumpers that we've been hearing, it appears activity in the Permian is likely about flat at current levels for the balance of 23. Would you say that's in line with your view? Can you talk about demand in the Permian and expectations for activity over the next few quarters?
Sure. Sure. Sure. You know, look, as we have, as we said, you know, probably for the past few quarters, you know, we came off, you know, some, you know, pretty good growth. We, when, you know, we've seen that start to level off. I do think from a, you know, from a gross profit perspective, I would say that it's probably steady as she goes. I think we probably, you know, continue to see some very slight improvement that continues to matriculate. You know, this past quarter, as I mentioned, we did have some integration expenses from the asset purchase. That did have an impact to bring down margin a little bit and increasing costs.
Beyond that, look, I think that that business is a fantastic business. It continues to generate a significant amount of cash for us. As the marketplace there, you know, look, as there's additional consolidation, as they continue, the other producers and integrated companies continue to maintain their capital spending, you know, they too are expecting, you know, fairly low to single mid-digit growth as well. I think it tends to follow along with that. I think that's just fine for that business. It actually works out really, really well for us. I think in many ways, you know, we, you know, we prefer that type of environment right now while we continue to allocate capital on the government side as well. Then we can really do both at the same time here.
Brad, what would you say? Anything else?
I think we're as excited as that business is always. It's something that we've operated for a long time. It's a great customer base. It's something that just keeps on giving, you know. It's a great area to be in. Unlike, you know, what you say, it's not going to be hockey stick growth out there, but I think it'll be consistent.
I think the rates will come up over time as inflation subsides. It takes a while as we have these long-term contracts to continue to drive those rates up. To Eric's one point, you know, you mentioned some costs there that won't be ongoing. It was a one-time hit. That definitely downplayed on the, you know, on the overall profits there. I think this continues to tick up at a, you know, at a decent rate.
You know, the one thing I would say that we haven't touched on the call this morning is, you know, we do look to continue to expand that HFS business, though, in other areas, right? We've talked before about some of our commercial diversification efforts. That's really starting to take hold. My point in that is, all is not lost insofar as growth in that business. What we're saying in HFS – South is that we expect it to be pretty steady, and that's in that terms are true. However, there are some other things we're looking at that are very nice growth drivers there. Hopefully, more to come on those over time.
You know, there's a lot to continue to do in the HFS segment.
Yeah. Let's not get lost on the fact of, you know, when we added more government, we took up some of the HFS rooms, right? When you look as the company as a whole, totally different, much more profitable...
Mm-hmm.
than it was the past few years. We like the direction and the mix, at this point where it's at.
That's excellent color. Thank you for that. I'll turn it back.
This concludes our question and answer session. I would like to turn the conference back over to Brad Archer for any closing remarks.
Yeah. Just thanks again for joining us, on our call today, and we look forward to speaking again in August. Thank you.