Source Energy Services Ltd
TSX:SHLE
Earnings Call Analysis
Q4-2023 Analysis
Source Energy Services Ltd
Source achieved its best annual financial performance in history with all-time high revenues, adjusted EBITDA, and free cash flow. Sand revenue alone was up 35% from 2022, with total revenue increasing by 37%. Elevated performance led to a significant debt reduction by $26.7 million and generated a substantial working capital surplus of $45.4 million by the year's end.
Operational success was mirrored by the Sahara units' higher utilization rates and a 115% hike in trucked volumes in the fourth quarter, contributing to gross margin and adjusted gross margin increases of 161% and 131% respectively for the quarter. Full-year margins also improved, with net income turning from a loss of $12.2 million to a gain of $153 million, primarily due to the reversal of previous impairments on assets and recognition of deferred tax assets.
Despite higher fourth-quarter capital expenditures caused by expenses on terminal expansion and equipment malfunction, free cash flow for the year stood at $37.3 million, a $33.5 million improvement from the previous year. This was, however, tempered by increased lease costs due to additional rail car costs, a full-year lease at Peace River, and the impact of a weaker Canadian dollar on U.S.-denominated leases.
The weaker Canadian dollar in the fourth quarter had no significant impact on adjusted gross margins due to successful mitigation through positive effects on U.S.-denominated revenue.
As 2023 concluded, Source's notes outstanding were reduced to $149.7 million, and an additional $2 million was repurchased post-quarter. A mandatory redemption of $4.5 million is set for the first quarter of the following year, further decreasing the debt balance. Source is intent on lowering its leverage while sticking to its debt reduction targets and long-term balance sheet plans.
Looking ahead, the company anticipates that heightened industry activity levels will boost the frac sand supply and demand market. Source expects increased natural gas demands to propel its services, particularly with developments in Canadian industry fundamentals and LNG projects. The completion of projects like the Coastal Gas Link pipeline is set to bolster demand through late 2024 and 2025, offering opportunities for growth without compromising balance sheet goals. Source also plans to explore opportunities to diversify and expand service offerings using its existing Western Canadian terminals.
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Thank you for standing by. This is the conference operator. Welcome to the Source Energy Services Fourth Quarter 2023 Results Conference Call. [Operator Instructions] The conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Scott Melbourn, CEO. Mr. Melbourn, please proceed.
Thank you, operator. Good morning, and welcome to Source Energy Services Fourth Quarter and Year-End 2023 Conference Call. My name is Scott Melbourn, and I'm the CEO of Source. I'm joined today by Derren Newell, our CFO. This morning, we will provide a brief overview of the quarter and the year, which will immediately be followed by a question-and-answer period. Before I get started, I would like to refer everyone to the financial statements and the MD&A that we'll post to SEDAR and the company's website last night. And remind you of the advisory on forward-looking information found in our MD&A and press release.
On this call, Source's numbers are in Canadian dollars and metric tonnes, and we will refer to adjusted gross margin, adjusted EBITDA and free cash flow, which are non-IFRS measures as described in our MD&A. Except for the items just mentioned, our financial information is prepared in accordance with IFRS. Volumetrically, Source delivered the best fourth quarter in the history of the company, with total sales volumes of 819,000 tonnes. Along with the record volume, Source also delivered strong gross margin performance, which led to adjusted EBITDA being more than 4x higher than last year's fourth quarter. The strong fourth quarter performance contributed to Source achieving the best annual financial performance in the history of the company, with record revenue, adjusted EBITDA and free cash flow performance. Source's strong operational performance has translated into meaningful balance sheet repair. The principal of our debt outstanding is reduced by $26.7 million from December 31, 2022, including repurchasing, $15.4 million of senior secured notes during the year, and another $2 million after year-end. Our working capital surplus at the end of the year was $45.4 million. Additional highlights in the fourth quarter and the year include sand revenue of $124.3 million, a $54 million increase from the fourth quarter of 2022. On a per tonne basis, sand revenue increased 22% from the prior year. For the full year, we realized sand sales volume of just over 3.1 million tonnes, and sand revenue of $460.2 million, an increase of $119 million or 35% from 2022. Total revenue for the quarter was $154.4 million, a $67 million increase from the fourth quarter of 2022. On a full year basis, we generated total revenue of $569.7 million, a $154 million increase or 37% from 2022. Wellsite solutions' strong performance in the fourth quarter was due to an increase in Sahara utilization in both Canada and the U.S. and a 115% increase in volumes trucked for the quarter compared to last year. For 2023, Source achieved utilization of 80% across the nine-unit Sahara fleet, compared to 75% utilization for 2022. Gross margin for the fourth quarter was $27.7 million, and adjusted gross margin was $36.4 million, representing increases of 161% and 131% when compared to the fourth quarter of last year. For the year, Source realized gross margins of $109.4 million, and adjusted gross margins of $135.2 million, representing increases of 88% and 71%, respectively. Net income for the quarter was $153 million compared to a loss of $12.2 million last year. The impairment realized on property, plant and equipment in 2019 and 2020 was reversed along with the recording of deferred tax assets, which was also written off then. Adjusted EBITDA, which is not affected by these items, improved $21.9 million to $28.3 million for the quarter. For the full year, net income was $167.3 million due to strong operating results and the items I just mentioned, while full year adjusted EBITDA was $99.1 million, a $37.6 million increase from 2022. Free cash flow for the fourth quarter was $9.3 million, an increase of $27.8 million compared to last year. Improved operating results and lower financing expenses were the principal reasons for the improvement. Financing expense were lower -- finance expense were lower in the fourth quarter of 2023, and the August 2022, interest payment on the senior secured notes was delayed until the new ABL facility was closed in the fourth quarter of 2022.
Capital expenditures in the fourth quarter 2023 were higher due to expenditures on terminal expansion activities, overburden removal, and cost to rebuild the conveyor that malfunctioned earlier in the year, which is fully recoverable from insurance proceeds. For 2023, free cash flow was $37.3 million, an increase of $33.5 million from the prior year as improved operating performance was partly offset by increased lease costs due to a full year of the Peace River lease, incremental rail car costs on the renewal of leases and the impact of a weaker Canadian dollar on U.S. denominated leases.
In the fourth year, we executed an additional contract with a customer to build the 11th Sahara unit, which will also be used in the State of Alaska. As with the 10th Sahara unit, the customer will be fully funding the build of the unit. We also executed a new sand and logistics contract with a major Montney E&P company.
As we continue to generate additional free cash flow, we remain focused on reducing overall debt levels to ensure we have an appropriate amount of leverage in the business. We are confident that we will achieve our debt target of funded debt to adjusted EBITDA of 1.5x or less by early to mid-2024. With that, I will turn it over to Derren to provide a brief overview of our financial results.
Thanks, Scott. Sand revenue for the fourth quarter of '23 was $124.3 million, an increase of 77% over the fourth quarter of '22. The increase was due to 253,000 metric tonnes or a 45% increase in sales volumes, and a 22% increase in average realized sand price. While sand revenue realized from mine gate sales lowered the average realized sand price in the quarter by $13.02 per metric tonne, it did have a favorable impact on cost of sales and gross margins by improving production efficiencies and yields. Sales volumes were above last year due to customer operational delays in Q3 '23 that move volumes to the fourth quarter and otherwise strong fourth quarter activity. As Scott already mentioned, for the full year, we realized sand sales volumes of 3.1 million and sand revenue increased 35% from 2022. Wellsite solutions revenue for the fourth quarter of '23 was $29.4 million, an increase of $13.2 million or 82% compared to the fourth quarter of '22. Last mile solutions trucking volumes increased 115% compared to Q4 '22 as the prior year was impacted by certain customers' operational delays and permitting challenges. Sahara revenue was up 27% compared to Q4 '22, primarily due to an 11% increase in days, the Canadian Sahara fleet was utilized, and a 17% increase in Sahara U.S. revenues.
Terminal services for Q4 '23 was $0.8 million, a decrease of $0.2 million compared to the fourth quarter of '22. The reduction is due to the customer ending a storage arrangement with Source, and the loss of rental income from the sale of the Berthold facility earlier this year.
Cost of sales excluding depreciation increased $46.3 million compared to the fourth quarter of '22. This increase was due to higher sales volumes, higher trucking costs for the additional volume moved to the Wellsite and higher rail transportation costs. Offsetting these increases were fewer third-party sand purchases in the quarter and operational efficiencies. The weaker Canadian dollar on our U.S. denominated costs also increased our cost $0.68 per metric tonne compared to the same period last year. On a full year basis, cost of sales was impacted by the weaker Canadian dollar, increased volumes trucked to the Wellsite, higher rail transportation costs and terminal mix changes year-over-year. These increases were partially offset by lower production costs at all facilities and less third-party sand purchases. The weaker Canadian dollar on our U.S. denominated costs increased our cost by $3.84 per metric tonne compared to the same period last year. Gross margin increased by $17.1 million compared to the fourth quarter of '22, excluding gross margins from mine gate sales. Adjusted gross margin was $47.45 per metric tonne compared to $30.15 per metric tonne last year. The increase in gross margins arose from improved spot pricing and contract renewals and the impact of production efficiencies.
Despite a weaker Canadian dollar during the fourth quarter, gross -- adjusted gross margin was not impacted by foreign exchange, the impact on cost of sales was fully mitigated by a positive impact on U.S. denominated revenue realized in the quarter.
In '24, we remain in a naturally balanced FX position. We will continue to monitor our exposures and actively manage if required. For the year, gross margin increased by $51.3 million or 88% compared to '22. Excluding gross margin from mine gate sales, adjusted gross margin was $46.07 per metric tonne compared to $29.80 per metric tonne in '22. As lower production costs improved pricing, overall, the impact of terminal sales mix and higher rail transportation costs, improved wellsite solution results also let improvements in adjusted gross margin compared to '22. Again, the weakening of the Canadian dollar relative to '22, which negatively impacted cost of sales was fully mitigated by the increase on U.S.-denominated revenues. Total operating general and admin expenses in the quarter decreased $0.6 million to $8.4 million. Operating expenses decreased by $0.7 million from the fourth quarter of '22, primarily due to lower repairs and maintenance, especially at Peace River facilities and lower incentive compensation cost due to the timing of the recognition in '22. These decreases were partially offset by higher royalty costs as more sand was sold in higher insurance costs. G&A expenses increased $0.1 million in the fourth quarter compared to the same period in '22, primarily due to higher IT-related costs and incentive compensation expense in '23 compared to '22.
On a full year basis, operating expenses increased by $2.8 million compared to '22, primarily due to higher selling costs related to the higher royalty costs, and people and variable incentive compensation costs. These increases were offset by a reduction in repairs and maintenance and equipment costs as discussed above.
General and admin costs increased $3.9 million due to higher salaries and variable incentive compensation compared to last year. Finance expenses were $9.1 million for the fourth quarter, an increase of '23 -- an increase of $0.3 million in the same period last year. The increase was due to higher accretion expense that was partly offset by lower interest occurred on the senior secured notes, give you the impact of repurchases that occurred during the third and fourth quarter, and lower interest incurred for lease obligations compared to the fourth quarter of last year.
For the year, finance expense increased $3.2 million compared to '22, mainly due to an increase in accretion expense. Higher accretion expenses were partly offset by a $1 million reduction in interest on the ABL facility because of lower overall jobs during the year and lower interest occurred on the notes due to the repurchases. Interest on the notes was also reduced because the February '23 interest payment was made in cash at a rate of 10.5%, while the February '22 payments was paid in time at a rate of 12.5%. Higher interest for outstanding lease cost is resulting from the full year addition of the Peace River facility also contributed to the increase in finance expense for '23. At year-end, because of continued strong industry activity, significant improvements in Source's financial results and an improved business outlook, Source carried on the assessment of its recoverable value of its operations, the assessment resulted in a reversal of $128.6 million of impairment losses previously realized in property planned equipment in '19 and '20. This is further described in Note 7 in the financial statements. As part of its work, Source also reversed the valuation allowance related to its deferred tax assets, resulting in a recovery of $18.3 million. For the year, capital expenditures net of proceeds on disposal was $13 million, a decrease of $0.2 million compared to '22. Higher capital expenditures for the existing terminal expansion activities, as Scott previously noted, as well as higher overburden removal costs for mining operations were more than offset by lower expenditures for the Peace River facility, and proceeds from the sale of excess property planned equipment, including Berthold, which I previously mentioned.
Capital expenditures incurred for the rebuild of the equipment that malfunctioned and construction costs related to building Source's 10th and 11th Sahara units were fully recovered during the year.
On December 31, the principal outstanding of our notes were $149.7 million, and Source at $15.2 million drawn under its ABL facility, leaving $17.3 million of available liquidity. And after the fourth quarter, Source has purchased an additional $2 million of face value of its Notes. And currently, the face value outstanding is $147.7 million.
For the year ended December 31, '23, a mandatory redemption of $4.5 million arising from the cash fleet is payable by March 30, reducing the outstanding balance further.
Source will continue to remain focused on lowering its leverage over the coming quarters as it works to achieving its debt targets Scott described earlier. Source's ABL facility remains current, even though its maturity was extended to 4 months prior to the notes maturity in March '25 during the quarter. With the improved metrics, we are confident on executing our long-term plans for the balance sheet. And with that, I'll turn it back to Scott to wrap up.
Thanks, Derren. As we look ahead, we continue to believe industry activity levels will favorably impact frac sand supply and demand fundamentals in WCSB. In 2024, we expect this trend to continue as our E&P customers continue to see value in our leading service offerings and logistics capabilities. We believe the strong Canadian industry fundamentals, coupled with Source's capabilities, will continue to support market share gains and strong financial results for 2024 and beyond. For the longer term, we believe the increased demand for natural gas driven by power generation facilities, increased natural gas pipeline export capabilities, and LNG exports will drive incremental demand for Source's services. We see the completion of coastal gas link pipeline is a positive step forward in LNG Canada becoming a reality in late '24 and into '25.
We've also seen positive momentum on wood fiber and other proposed LNG projects, which has the potential to drive additional demand for our products and services. We continue to focus on enhancing our industry-leading frac and logistics chain, and we believe we have unique opportunities in front of us to grow the company and further our competitive advantage without impacting the balance sheet goals. In addition to growth in our core markets, we will continue to explore opportunities to diversify and expand our service offerings and to further utilize our existing Western Canadian terminals.
Thank you for the time this morning. That concludes the formal portion of our call. We'll now ask the operator to open the lines for questions.
[Operator Instructions] The first question comes from Nick Corcoran of Acumen Capital.
Congrats on the strong quarter. Just the first question for me. Revenue per metric tonne was really strong in the quarter. Can you maybe give some indication what drove this? And what factor higher spot prices might have been?
Yes. I think, obviously, we've seen pricing kind of increase over -- throughout the balance of the year from '23. And so we're obviously pleased with where pricing is at in the market, and we're pleased with where pricing was at in Q4.
As you kind of look forward, we expect the spot market to stay fairly stable into '24, and we've seen a few players, and I would say, they're probably more fringe players moving price to chase volume. But for the most part, the spot price has stayed fairly stable. So looking forward, we expect sort of similar pricing into '24 and with maybe a slight uptick.
And are there -- was there anything to note in the quarter between kind of the contract pricing and spot pricing that you realized?
There really wasn't a tonne that would have driven a big change between those two. And Scott said, they've both been relatively stable, and we've been pretty happy with the overall performance.
That's helpful. And then maybe switching gears to the revaluation of the assets. Were there any specific assets that drove the valuation?
No. I mean, this is a lovely accounting exercise that you get to do. To do this, you need to look at sort of the overall, how you love the company and compare it to your net value of the assets, and then you take that, in this case, right out and apply it across all assets in accordance with how they were originally written now. So there was no particular assets that were the driver. It was more of the overall business performance.
Good. And then maybe if you think about the first quarter, where most of [indiscernible] through, how are activity levels compared to the fourth quarter?
Yes. I think as everybody in Western Canada experienced, it was a slower start to the first quarter. And now it's just driven by the extreme cold weather that hit us at the very beginning of January. And so post sort of that week or 1.5 week period, activity levels have been strong. We've witnessed some very high activity levels as expected, and we expect that to continue through the balance of Q1 and into Q2. And so we're pleasantly -- we're pleased with that activity levels and what we've seen for the beginning of Q1.
And maybe one last question from me. I know in the past, you've given guidance. I'm just wondering, other than your -- the debt target that you mentioned, is there any guidance you want to put out there at this time?
At this time, we're not going to provide specific guidance. We'll kind of point to -- we do expect this year to see a little bit of growth in '24 over what we saw in '23. And given how the beginning of the year has shaped up, we still expect that to transpire. However, it's very early in the year. And so there's lots of moving pieces. And so we'll stay close to it and keep everyone updated with what we see in the market. But that's how we kind of see the market transpiring right now.
[Operator Instructions] The next question comes from Josef Schachter of Schachter Energy Research.
With the big upside, if we get more of these LNG projects approved and more activity picks up in Northeast BC, Northwest Alberta, do you need to build more infrastructure? You mentioned the Peace River bills there. Would you need to put some facilities in Northeast BC over time? And how big of a price would that be to build out, to take a strong market share as more drilling occurs to fill the potentially new LNG facilities?
Yes. Excellent question, Josef. Like the -- I think, the very short answer to your question is, yes, we would look to build out more infrastructure in Northeast BC. And our infrastructure probably comes in the way of unit train facilities and receipt facilities for both our Peace River sand and our Northern White sand. In terms of the price tag of where we think we would need to land to sort of build out what the ultimate solution would be for Northeast BC, that's a little bit tougher to put a peg on it. Just broad brush, these facilities are big unit train facilities, are probably $20 million to $30 million to construct one of them and to construct them properly. And so they're fairly high price tag. But given our footprint in Northeast BC, we have a facility in Chetwynd, which we have the ability to expand out for, obviously, a much lower price tag.
As we mentioned in the prepared remarks, we're looking at some unique ways of growing and which would include growing our logistics capability in Northeast BC without impacting our balance sheet as much. And so I think we'll have more to say on both potential expansions and unique ways to grow in the next couple of months. But that's kind of how we view the area.
So short, and just to summarize, short answer is yes, we would need to build additional infrastructure if we saw additional growth in LNG and LNG-related activity. And we think we're in an excellent position to be able to grow with our existing footprint and with some unique deals that we're looking at. So...
Okay. The second one, this is probably for Derren. The bonds mature next year, March 2025. Are you looking to do another high-yield bond with the stock having such fabulous performance in '23, early '24 is a convertible debt, something that you might want to consider for part of it at lower interest cost, of course. How do you see refinancing that piece of debt? And would an equity component, like to convert, makes sense as part of that?
[indiscernible] I mean, first and foremost, we think, by getting our debt down to the target levels that we talked about in the prepared remarks, that opens up largest number of options for us to be able to explore the refinancing. Beyond that, Josef, we're keeping all of our options open at the moment and would consider every and all options that would be available at the time we get down to our targeted debt levels, but we're not ruling one in or one out at the moment.
This concludes the question-and-answer session. I would like to turn the conference back over to Scott Melbourn for any closing remarks.
Thank you, everyone, for joining our conference call. If you have any follow-on questions, please feel free to reach out to myself or Derren. Thanks, and have a great day.
This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.