Source Energy Services Ltd

TSX:SHLE

Earnings Call Transcript

[Operator]

Good morning. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the Source Energy Services Second Quarter Financial Results Conference Call. [Operator Instructions] Mr. Thomson, you may begin your conference.

[Bradley J. Thomson, CEO, President & Director]

Thank you, operator. Good morning and welcome to Source Energy Services' Second Quarter 2018 Conference Call. My name is Brad Thomson, I'm the CEO of Source. I'm joined today by Derren Newell, our CFO; Scott Melbourn, our COO; and Joe Jackson, our Senior Vice President of Commercial Development.The formal portion of the call will be covered by Derren and myself, and Joe and Scott will be available for questions later in the call.Before we get started, I'd like to refer everybody to the financial statements and the MD&A that were posted to SEDAR and to the company's website last night. I'd also like to remind you of the advisory on forward-looking information found in our MD&A and our press release. On this call, we'll refer to non-IFRS measures for adjusted gross margin, EBITDA and adjusted EBITDA, with the required disclosures around these measures available in our MD&A. Source's numbers discussed today will be in Canadian dollars, metric tonnes, and our financial information, with the exceptions just mentioned, is prepared in accordance with IFRS.For Source, the second quarter of 2018 proved to be a very strong quarter, despite the seasonal breakup. The Source team achieved another quarterly sales volume record of 813,995 metric tonnes in the quarter, which is a 96% increase compared to the same period last year and a 27% increase from Q1. 80% of -- 87% of our sales were delivered through Source's Canadian distribution network, with the remaining sales occurring at the mine gate in Wisconsin. We also achieved a new monthly sales record in May, where our sales totaled 305,000 metric tonnes.For the first half of 2018, Source sold a total of 1.45 million metric tonnes of sand, an increase of 75% over the first half of 2017. The sales volume captured by Source in the first 2 quarters of 2018 are evidence that our 2017 acquisitions and the recent additions to our terminaling network are starting to pay dividends. Regardless of the unprecedented rail interruptions faced by our sector in the first quarter and a very severe slowdown in activity levels during breakup in Q2, Source still continued to gain market share throughout the first half of 2018.Looking specifically at our financial results, Source generated adjusted EBITDA in the quarter of CAD 24.7 million, which is an increase of CAD 15.8 million when compared to the adjusted EBITDA of CAD 9 million generated in the second quarter of 2017. This was also an improvement of CAD 4.2 million when compared to the first quarter of 2018.Source recorded net income for the second quarter of CAD 9.2 million or $0.15 per. This was an improvement of CAD 18 million when compared to the second quarter of 2017.On a year-to-date basis, Source has now earned CAD 12.9 million of net income, a CAD 23.7 million increase from the first half of 2017.Adjusted gross margin realized for the second quarter was $39.32 per metric tonne. This has included the negative impact of lower margin mine gate sales of $2.65 per metric tonnes. The gross margin realized in the quarter was $7.36 per tonne higher than the margins realized in the second quarter of 2017. Adjusted gross margins were $1.86 per metric tonne, lower in the second quarter of 2018 than they were in the first quarter of 2018. This is attributed to the production disruption associated with rail interruptions, additional cost incurred to serve customers during the breakup and a Q2 sales mix in balance. All of these issues should have less impact on our results in the coming quarters than they did in Q2.In addition to our solid financial performance, we also significantly enhanced our liquidity during the quarter. During Q2, we successfully completed a CAD 50 million notes offering, and we expanded our bank lines. These steps were taken to reduce our overall borrowing cost and they also provide us with the financial flexibility and optionality we need for our growing business. Looking forward to the third quarter, a wet start to July caused delays to some of our customers' completion programs but we also saw a strong rebound in activity later in the month.In addition, we've seen CN executing on their 2018 capital program, and this should finally put to bed many of the rail issues that we experienced in the past. With an improvement in rail service and our continued focus on cost and efficiency of our operations, we're confident we'll see an increase in contribution margins in the coming quarters.When considering WCSB activity for the balance of 2018, we're seeing continued compelling fundamentals for the proppant market. We expect year-over-year WCSB demand for proppant to continue to show material growth. This is driven primarily by the increased activity levels in the liquids-rich portion of the Montney and the Duvernay. We're also continuing to see proppant intensity in the Canadian basins move up to the proppant intensity seen some of the -- in some of the leading basins in the United States.In the Montney and the Duvernay, we continue to see more companies move into manufacturing mode. These companies are well capitalized, and we're now also working with them on frac sand supply contracts that provide them with reliable frac sand supply. This is important to these operators because a contract with Source fixes a major piece of their -- of the operator's capital cost. And for us, of course, these contracts provide us with a reliable, long-term supply of revenue. A large majority of Source's sales contracts are now tied to these type of contracts, providing us with stable, predictable revenue streams.Looking to next year, we're expecting to see continued increase in proppant demand in the WCSB. In order to serve this expected increase in demand, Source has started to consider how to increase our production capacity. Source has identified 2 low-cost expansion opportunities at our Preston and our Blair facilities, and we're also advancing an Alberta project that could see Source develop a regional sand mine. Whether Source moves forward with any or all of these projects is a function of our ability to secure contracts to underpin the expansions. If the appropriate contractual agreements that are in the works are finalized, Source could move forward with these expansions in 2019. Of course, expansion opportunities, like the ones I just mentioned, are particularly important to Source if you see a West Coast LNG facility become a reality. In this reality -- in this regard, we're seeing more and more indications that these important Canadian energy projects are taking shape, and we're increasingly optimistic about a potential LNG investment in Western Canada.While our current forecast for continued growth doesn't factor in any new LNG projects, positive financial investment decisions by LNG proponents will support the case for step-changing growth in WCSB proppant demand.We believe Source is well positioned to capture its fair share of incremental demand, if it materializes.On Sahara, our fifth Sahara unit will be complete and deployed to customers in this month, in August. Our sixth and seventh units are scheduled to be online by the end of the year, with the eighth being operational in 2009 -- '19. While we originally anticipated units 6 through 8 to be deployed in the United States, we're currently evaluating how we serve additional demand that we're seeing for units in the WCSB.Now I'll turn things over to Derren Newell, who'll provide you with more detail on our financial results.

[Derren J. Newell, Chief Financial Officer]

Thanks, Brad. Source's revenue in the second quarter of 2018 increased by CAD 63.6 million, or 93% compared to the second quarter of 2017.Sand revenues increased by 118%, as the 399,709 metric tonne increase in sand volumes was bolstered by an 11% increase in average realized price due to contractual and other price increases, which have incurred through the back half of 2017 and into 2018. Compared to the first quarter of 2018, sand revenues increased by CAD 23.4 million due to a 27% increase in sand volumes and a CAD 0.31 per metric tonne increase in the average realized sales of sand prices. Second quarter revenue were impacted by an increase in mine gate sales, which lowered the average realized price by CAD 5.30 metric tonne compared to the first quarter of 2018. Mine gate sales represented 13% of sales in the second quarter versus 9% in the first quarter of 2018.For the first half of 2018, sand revenues have increased by CAD 95 million due to a 75% increase in sand volumes and a 10.5% increase in realized sand [ pricing ] compared to the first half of 2017.In the second quarter of 2018, wellsite solutions revenue increased by CAD 4.1 million compared to the second quarter of 2017 due to a 37% increase in trucking revenues, which was partially offset by a 21% decrease in Sahara revenues due to lower ancillary conveyor rental flow-through in the second quarter of 2018. Wellsite solutions revenue increased by CAD 3.5 million in the second quarter of 2018 compared with the first quarter of 2018, primarily due to a 29% increase in trucking revenues, partially offset by lower Sahara utilization, primarily due to spring breakup. Wellsite solutions revenue increased by CAD 10.9 million in the first half of 2018 compared to 2017, due to a 46% increase in trucking revenues, combined with 13% increase in Sahara-related revenue due to more volumes delivered to the wellsite and the more Sahara units in the fleet. Adjusted gross margin in the second quarter of 2018 reached CAD $39.32 per metric tonne, and as Brad mentioned, included a $2.65 negative impact to -- from mine gate sales for the quarter. This is CAD 7.36 metric tonne better than the adjusted gross margin realized in the second quarter of 2017.The mine gate sales mix impact of the second quarter of 2018 was CAD 1.60 per metric tonne larger than the second quarter of 2017. For the first half of the year, the realized adjusted gross margin is CAD 40.14 per metric tonne, and that includes a CAD 2.30 per metric tonne negative impact from mine gate sales in the year, and a CAD 1.30 per metric tonne impact from the preferred acquisition in [ Montney ] that was acquired at fair value last year.The adjusted gross margin has increased by a CAD 10.75 per metric tonne compared to the first half of 2017. And by CAD 13.40 per metric tonne is the impact among gate sales and the preferred inventory adjustment are included.Operating and general admin expenses for the second quarter were at CAD 7.6 million and are comparable to the first quarter of 2018 but increased by CAD 1.9 million compared to the second quarter of 2017.Costs are higher in 2018 due to higher facility costs as we have more operating locations, filling an admin cost increase due to higher costs related to being a public company that weren't present in the prior year.Finance expenses decreased by CAD 4.5 million to CAD 4.9 million in the second quarter of 2018 compared with the same period in 2017, due primarily to CAD 3.2 million of accretion expense being recognized in the second quarter of 2017 when CAD 22.3 million of notes was repaid during and CAD 1.7 million of professional fees from the 2017 IPO were incurred. These were partially offset by [ CAD 0.8 million ] increase in interest cost due to the issuance of the additional CAD 50 million of notes during the quarter.Source recorded a tax expense in the second quarter of 2018 about CAD 0.5 million compared to a recovery of CAD 0.6 million in the second quarter of 2017.The reorganization in April 2017 changed Source's organizational structure from a series of partnerships to a corporate structure, which caused a more traditional tax provision to be recorded. Source has not recorded any current tax exemptions in 2018, despite having taxable income, primarily due to the U.S. tax reform allowing 100% tax deductions on qualifying machinery and equipment purchases.Capital expenditures for the second quarter were and CAD 21.1 million, and we're focused on the Wembley terminal expansion, the addition of Sahara unit builds, the dryer expansion of Weyerhaeuser, the fleet pipeline project at Blair and other optimization projects and plans as well as overburden removal.Thank you for your time this morning. This concludes the formal portion of our call. We'd like to ask the operator to open the lines for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Tim Monachello with AltaCorp Capital.

[Tim Monachello, Analyst of Institutional Equity Research]

I was just wondering if you could expand on your commentary around the Sahara deployments. And is that commentary to say that they will not be deployed to the U.S. anymore? And is that because of the change in the dynamics of the U.S. in terms of acceptance of those units? Or is just because you've seen stronger demand in Canada?

[Bradley J. Thomson, CEO, President & Director]

Yes. Well, actually, we're seeing strong demand in the U.S. and we're seeing strong demand in Canada. So we're trying to balance that off, Tim, with the number of units we will have coming to us. So we're thinking about, yes, do we add additional units, or how do we -- to meet that demand? The demand in Canada is particularly picking up for those units. The other thing, of course, that we have to balance too, is when we deploy those units in the United States, we do receive 100% tax write-off on them. So there are some economic benefits of having -- continue to have those units deployed in the U.S.

[Tim Monachello, Analyst of Institutional Equity Research]

Okay. So it's safe to say that you guys haven't made a decision yet?

[Scott Melbourn, Chief Operating Officer]

Yes, Tim, it's Scott. Maybe I'll just add to that. I think, we're -- and we've said all along with the deployment of units 6 to 8 that we would follow the customer. And so I think it's more a timing issue. So -- because we're seeing additional demand coming from the Western Canadian sedimentary basin, this -- units 6 to 8 may go in Western Canada, and that doesn't mean we won't be deploying units to the lower 48. But that will just mean that some of the 2019 units will be deployed to the lower 48.

[Tim Monachello, Analyst of Institutional Equity Research]

Okay. And so the demand that you're seeing in Canada for those units, is that from customers that have had previous units or are these new customers that would be accepting it?

[Bradley J. Thomson, CEO, President & Director]

Yes -- no, it's generally companies that have used the units and as a result of that, have converted -- I believe that that's the unit they have to have on their well site. So as they move into their larger completion programs, they want to lock up the unit for months at a time.

[Operator]

Your next question comes from the line of Ian Gillies with GMP.

[Ian Brooks Gillies]

With respect to go-forward sales and customer mix, are you able to talk a little bit about how some of your conversations are going with new customers and I guess, direct sales into the EMPs?

[Bradley J. Thomson, CEO, President & Director]

Yes, we can. So I'll turn that over to Joe. He can answer that for you.

[Joe Jackson, Senior Vice President of Commercial Development]

Yes, thanks, Ian, this is Joe. As it relates to new contracts, we're seeing a very high amount of interest from new customers that are moving from delineation of their Montney and Duvernay positions to development. And they've seen the success of some of the larger players that have direct contracts with Source and they want to follow that model. So we've got a very compelling pipeline right now. And what we are really encouraged by is the visibility that this provides us. These operators are talking to us about multiyear programs, some of them starting this year, some of these starting early next year, and it gives us some very interesting opportunities to look at how we right-size our supply to match that new demand.

[Bradley J. Thomson, CEO, President & Director]

So Ian one of the things that we've talked about in the past is that we'd like to keep our contractual underpinning somewhere between 75% to 80% of our volumes that go through our company. That's very achievable. In fact, we could be 100% contracted. Securing contracts is not the issue for Source, the issue for Source is ensuring that we've got the reliable supply for our customers and then planning our expansion opportunities to meet the market opportunities.

[Ian Brooks Gillies]

Okay, that's helpful. With respect to the NCIB, I mean, I assume that there is some sort of rules in there around your senior notes. But could you maybe provide some color on how you may be able to ramp that up in future quarters and to why an NCIB over a dividend?

[Bradley J. Thomson, CEO, President & Director]

Yes, absolutely.

[Derren J. Newell, Chief Financial Officer]

Yes, Ian. So in terms of NCIBs, I would be kidding if I didn't say every institutional investor has probably asked us about a program like that in the last year. So we've come to the point where we can do that under the trust and I'm sure as you've pointed out, it does have a covenant in there of how much it can do. We thought an NCIB made more sense, given the nature of the industry and the stage of growth that we are as an organization versus dividends at this particular point in time in our development.

[Bradley J. Thomson, CEO, President & Director]

Yes, so the NCIB that we did announce yesterday is a small NCIB, as you've pointed out. But our plans would be as we -- as our capability expands, we'll likely expand that NCIB if we see it as an effective tool.

[Ian Brooks Gillies]

And Derren, last one for me, can you perhaps provide some guidance around or some thoughts around, I guess, the change in depreciation from Q1 to Q2? And how should we should we be thinking about that going forward?

[Derren J. Newell, Chief Financial Officer]

So I'm assuming you're talking about in the cost of sales category where it's stepped up quite a bit. That -- the Q1 and Q2 is really how active were we in terms of the mining activities and as we're more active, that number steps up. And so with the overburden removal and things stepping up as the [indiscernible] we got bit more active.

[Ian Brooks Gillies]

And so -- I mean, is that representative then of a good run rate in moving forward absent [indiscernible] maybe if you can significant [ PP&E ] additions?

[Derren J. Newell, Chief Financial Officer]

Yes, as you'd move into Q3 and there you'll probably see a tail down in Q4 as the ground firms up again and it gets harder to mine.

[Operator]

There are no further questions in queue at this time. I turn the conference back over to our presenters.

[Bradley J. Thomson, CEO, President & Director]

Well, thank you, operator. So that concludes the Source Energy Services Q2 Conference Call. Of course, we are always available, so please don't hesitate to give us a call if you have follow-on questions. Have a good morning. Thank you.

[Operator]

This concludes today's conference call. You may now disconnect.