Source Energy Services Ltd

TSX:SHLE

Earnings Call Transcript

[Operator]

Good day, and welcome to the Source Energy Services Third Quarter 2024 Results Conference Call. [Operator Instructions] Please note, today's event is being recorded.

I would now like to turn the conference over to Scott Melbourn, Chief Executive Officer. Please go ahead.

[Scott Melbourn, executive]

Thank you. Good morning, and welcome to Source Energy Services Third Quarter 2024 Conference Call. My name is Scott Melbourn, 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, 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 were posted 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, 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. Strong business performance in the third quarter resulted in the third consecutive quarter of record sand volumes total revenues and EBITDA. The business performed well in all areas, including record volumes in the last-mile logistics and 83% utilization on the Sahara fleet. With the maturities of both our notes and ABL facility approaching, we have made significant progress on our refinancing.

After taking the appropriate time to let the business performance improve, which ultimately unlock the additional refinancing options. We have now chosen partners and are working towards closing the transactions. We expect to be in a position to release further information on these transactions in the fourth quarter. At the end of September, our senior secured note balance was $140.5 million. We had drawn $13.6 million on our ABL facility. We also had a net working capital surplus of $57.6 million.

During the third quarter, Source acquired the sand trucking assets of the PVT Group to further grow its fleet and enhance its last-mile logistics offering. The trucking acquisitions, coupled with the unit train terminals in Chetwynd and Taylor truly enhances our logistics capabilities within the basin and specifically in Northeast BC. The Northern Montney will continue to be the resource play that feeds the West Coast LNG exports. The combination of Source's terminal infrastructure in Wembley, Chetwynd, Taylor, the last-mile trucking fleet and the domestic sand in Peace River provides Source with an unparalleled offering to support growth in the region.

Ultimately, Source believes that by utilizing its Northern White and domestic sand offerings that we will be able to offer the lowest landed cost in the region. Highlights for the third quarter included sand volumes of 964,000 metric tonnes and sand revenue of $142.2 million. These are new records for Source and represent a $40 million increase in sand revenue from the third quarter of 2023. Total revenue was $183.1 million, a $54.8 million increase from Q3 last year.

Gross margin was $33.7 million, while adjusted gross margin was $43.3 million, an increase of 34% and 41%, respectively, when compared to Q3 of 2023. Net income was $10.2 million, while adjusted EBITDA was $35.3 million, a 55% improvement from the same period of -- of 2023. Closed the acquisition of 9 sand trucks and related trailers during the quarter, bringing the total fleet size to 37 trucks, further strengthening Source's last mile logistics. Free cash flow for the third quarter was $20.1 million, an increase of $12.7 million compared to last year. improved operating results and lower financing expense were the principal reasons for the improvement. Year-to-date free cash flow has reached $49.1 million and is $21 million ahead of the first 9 months of 2023.

With that, I'll now turn it over to Derren to provide a brief overview of our financial results for the quarter.

[Derren Newell, executive]

Thanks, Scott. As Scott mentioned, sand revenue for the third quarter of '24 increased by $41.1 million over the third quarter of '23. The increase was due to a 254,000 metric tonne and 36% increase in sand volumes and a $3.67 per metric tonne or 3% increase in the average realized sand price. Sand volumes were impacted by continued strong activity levels from our customers and the addition of a new customer last quarter as well as the successful pad trial with another new E&P customer. Sand revenues were also impacted by an improved performance from the Peace River facility. While sand revenue realized from mine gate sales lowered the average realized sand price in the quarter by $1.33 per metric tonne. It did have a favorable impact on cost of sales and gross margins by improving production efficiencies and yields. Wellsite revenues for the third quarter of '24 was $39.9 million, an increase of $18.2 million or 84% compared to the third quarter of last year.

Last mile solutions trucking volumes increased 70% compared to Q3 '23. And as Scott mentioned, this is the highest volume handled by that team. Sahara revenue was flat compared to Q3 '23, a 35% increase in Canadian Sahara revenue was offset by lower activity for the U.S. Sahara unit in the quarter. Sahara can did begin operations in Alaska later in the quarter. Terminal service revenue for Q3 of '24 was [ $0.9 million ], an increase of $0.1 million compared to Q3 '23 due to improved chemical elevation revenues. Cost of sales, excluding depreciation, increased by $45.9 million compared to the third quarter of '23.

This increase was due to higher sales volumes, higher last-mile logistics volume and higher rail costs. Sahara-related costs were also higher due to the improved Canadian activity levels and higher regular maintenance costs in the quarter. The weaker Canadian dollar on our U.S. denominated costs increased our cost by $2.08 per metric tonne compared to the same period last year. Gross margins increased by $8.6 million compared to third quarter of '23. The increase in gross margins arose from higher sand sales volumes and the 86% increase in gross margin of the last mile logistics group in the quarter. Excluding gross margins from mine gate volumes, adjusted gross margin per metric tonne was $45.89 per metric tonne compared to $46.60 per metric tonne for the same period last year.

Adjusted gross margin in Q3 were impacted by the extremely heat experienced in the quarter which impacted rail transportation and led to servicing customers from non-optimal terminals. A weaker Canadian dollar during the third quarter reduced the adjusted gross margin by $0.92 per metric tonne as the foreign exchange impact on the U.S. denominated costs was more than the positive impact on the U.S. denominated revenue realized in the quarter. We target to remain in a naturally balanced FX position. We will continue to monitor our FX and actively manage it if required. Total operating general and admin expenses in the quarter increased by $1.6 million operating expenses by $1.2 million from the third quarter of '23, primarily due to increased compensation expense and higher royalty costs related to shipping more sand from the mine with royalties as well as our insurance costs. General and administrative expenses increased $0.4 million in the third quarter compared to the same period in primarily due to higher compensation expense and higher professional fees.

Finance expense was $8.2 million for the third quarter of '24, a decrease of $0.6 million from the same period last year. The decrease was due to lower interest incurred on the senior secured notes due to the impact of the repurchases that occurred over the last year and lower other interest charges. Interest incurred on the ABL was higher than the prior year due to higher average draws outstanding on that facility to support the higher activity levels. On September 30, principal outstanding in our notes was $140.5 million and Source had $13.6 million drawn under the ABL facility, leaving $45.2 million of available liquidity. As Scott mentioned, we've looked at multiple term sheets for refinancing our ABL lender notes, and we explored several options, which we are several options. We are now actively working on the refinancing charges actions.

And with that, I'll turn it back to you, Scott.

[Scott Melbourn, executive]

Thanks, Derren. As we look ahead, we continue to believe industry activity levels will favorably impact sand supply and demand fundamentals in the Western Canadian Sedimentary Basin. These strong Canadian industry fundamentals driven by growth in Northeast BC coupled with Source's capabilities, will continue to support market share gains and strong financial results for the remainder of '24 and beyond. We believe the increase in demand for natural gas by LNG exports, increased natural gas pipeline export capabilities and power generation facilities will drive incremental demand for Source's services. We see the completion of LNG Canada, the FID on Cedar LNG and the work on other proposed projects such as wood fiber and KSI, as positive developments for the basin and for our business.

Source continues to focus on enhancing our industry-leading frac sand logistics chain. And we have and will continue to execute a number of opportunities to grow the company and further our competitive advantage without impacting the balance sheet goals. In addition to growth in our core markets, we continue to explore opportunities to diversify and expand our service offerings and to further utilize our existing Western Canadian terminals. Thank you for your time this morning.

That concludes the formal portion of the call. We'll now ask the operator to open the lines for questions.

[Operator]

[Operator Instructions] Today's first question comes from Nick Corcoran with Acumen Capital.

[Nick Corcoran, analyst]

Just a few questions for me. We're partway through the fourth quarter. Any indication how volumes are trending in the quarter?

[Scott Melbourn, executive]

Yes. Sorry, Nick, you just broke up there a little bit, so let me repeat the question. How are volumes trending in the fourth quarter?

[Nick Corcoran, analyst]

Exactly, yes.

[Scott Melbourn, executive]

Yes. So we're -- the fourth quarter for Source is always a little bit of a wildcard and the seasonality with the seasonality in the completions industry. I think as we look at it today and as we sit here today, we're pleasantly surprised with the activity levels in Q4. We've seen a few of our customers pull capital from 2025 into Q4. And so we're cautiously optimistic that we're going to have a fairly favorable Q4 volumetrically. Still obviously lots of the quarter. So at this point, we're just cautiously optimistic.

[Nick Corcoran, analyst]

Good. And then maybe switching gears. How was the construction of Taylor progressing? And maybe a broader question about the relationship with Trican and whether there's potential for that to expand with time?

[Scott Melbourn, executive]

Yes. Just a quick update on Taylor. The facility is currently under construction right now. We're targeting for -- the first phase, which is a rail-to-truck facility to be complete within the next month and for the first stand to be flowing through that facility in the first month. So on target, the ultimate completion of that facility will be in 2025 when we've completed the storage and the rest of the infrastructure build. So it's progressing well and it's for the most part on time.

In terms of the relationship with Trican, I think whenever you enter into commercial arrangements like we have at the -- for the Taylor facility. There's always an opportunity to continue to further that relationship and work together and to work together constructively.

So obviously, nothing to report right now, but I think we -- we continue to look forward to working with Tricon and continue to look forward to working with our partner in that facility.

[Nick Corcoran, analyst]

That's helpful. And maybe a question for Derren. There's a working capital build in the quarter, I think it's largely driven by AP. Can you give any color on what the driver of this was and what you'd expect to happen with the working capital in the fourth quarter?

[Derren Newell, executive]

The working capital build really in the quarter was primarily just driven off of timing differences between end of last quarter and this quarter. No one more real event drove anything. As we look forward to the fourth quarter, which we will often see if you look back at history, especially if activity slows down a little bit, we would expect working capital will naturally draw back a bit and then often will build out again as we get busy in the first quarter of next year. But looking forward, we expect it to reduce a little bit as we close the year out.

[Nick Corcoran, analyst]

Great. And then maybe one last question for me. How are you thinking about your debt target for 2025?

[Derren Newell, executive]

We really haven't changed our target at all. We're still wanting to continue to delever. Obviously, keenly focused on the refinance transaction. I think that just gives us a new vehicles to continue to delever the business, and that's going to remain a priority for a while, yes.

[Operator]

And our next question today comes from Jesus Sanchez Leon with Castañar Investment.

[Jesus Sanchez Leon, analyst]

My first question will be about the forex impact. I read in your press release that the weakening of the Canadian dollar negatively impacted our gross margins. But my understanding is that we collect revenues in U.S. dollars and then we translate it to Canadians. So we still be favor on a weak Canadian dollar?

[Derren Newell, executive]

Yes. So -- so on foreign currency, you're correct. As, we both have U.S. dollar revenue streams and obviously, a large chunk of our production costs related to the Wisconsin operations are U.S. dollar denominated costs. Both get translated in the quarter. We saw the impact of the cost being slightly higher than the revenues. A good chunk of that is just the particular customers that we have sold to during the quarter happened to have a little more Canadian dollar revenue than previously. It's something we monitor very closely. And if you look back in our history, we'll see in the past, we have used various foreign exchange contracts to help us manage that and keep it in check.

[Jesus Sanchez Leon, analyst]

Can you quickly remind me the product mix or revenue mix in U.S. dollars and Canadian?

[Derren Newell, executive]

We don't typically break it down, but I would say we're generally naturally balanced between our U.S. dollar cost and our U.S. dollar revenues.

[Jesus Sanchez Leon, analyst]

And my last question will be, if you can add any information on the progress for the refinancing for next year of our debt?

[Derren Newell, executive]

Other than kind of what we said is we picked parties. We're working on the refinancing transaction and hope to have some more news out soon.

[Operator]

And our next question comes from Paul Tepsich with High Rock Capital.

[Paul Tepsich, analyst]

Congrats, guys. Great quarter. And on that front, given the recent operating performance that you've seen over the past several quarters or even 2 years now in the build. Are you willing to give some forward guidance with a bit more meat on the bones for us?

[Scott Melbourn, executive]

Yes. Paul, it's an excellent question. And we kind of weigh this every year, whether we're able to give additional guidance on what we see coming at us. And we'll endeavor to each year as we see the year unfolding to give as much guidance as we're comfortable with. So as we start to get ultimate capital programs from our customers and we start to see volumes sort of shape up for the year, we'll be in a much better position to -- to provide a little more insight on 2025 and what we see in 2025, and we'll certainly endeavor to provide our investors with a little more info with what we're seeing.

[Paul Tepsich, analyst]

Okay. It seems like the street is a little bit light looking forward. Just another question or 2. What do you think or estimate your market share is in the Western Canadian Sedimentary Basin right now?

[Scott Melbourn, executive]

Yes. We would estimate we're in and around 45% to, call it, 48% market share right now. So that's obviously going to jump around a little bit quarter-to-quarter and month-to-month just depending on how active our customer base is versus the rest of the basin. But on average, we should be ranging around that kind of 45% to 48%.

[Paul Tepsich, analyst]

Damn close to 50%. So the final question, and you don't have to comment, but given your stock right now is probably trading about 2.3x next 12 months, unbelievably cheap. Are you in any discussions with potential acquirers given you've got 50% market share?

[Scott Melbourn, executive]

Yes. We're not in any discussions right now. I'd say -- happy to comment on that. And I would agree with you 100% we're incredibly cheap.

[Operator]

Our next question comes from John Gibson with BMO Capital Markets.

[John Gibson, analyst]

Congrats on the record quarter here. I just had one and it's -- I'm just going to try to ask in a different way for 2025. Let's just say activity levels hold flat into 2025. What type of a volume uplift could we expect just given the customer additions that you've added here in 2024?

[Scott Melbourn, executive]

Yes, John, excellent question. I think if we look at it, and we just say right now that activity and overall sand volumes would be flat. So no other change in sand volumes, just given our customer additions. I think we would be ranging between kind of the 5% and 10% in overall volume growth. And still, it's a little bit early days because we don't have our final capital plan from our customer group yet. But that would be ballpark. So -- and then I think, I do expect from our core customer base that we're going to see a little bit of growth even if their well count and capital is flat, we'll just see a little bit of growth in increasing well intensity.

So -- so kind of ballpark 5% to 10%, I think, would be a good number, just based on customer additions and then maybe a slight uptick on well intensities if capital was completely flat year-over-year.

[John Gibson, analyst]

Okay. Got it. And then one follow-up, I guess. How should we think about the contract structures in 2025 versus 2024 and I guess, in terms of pricing for your major customers?

[Scott Melbourn, executive]

Yes. I think how -- probably the really easy way to answer that is fairly consistent from 2024 to 2025 in terms of the amount under contract and the pricing. The customer base, obviously, every year changes a little bit with some acquisitions in -- or sorry, some consolidation of E&Ps in the market. I would say it is fairly consistent on a year-over-year basis.

[Operator]

This concludes the question-and-answer session. I'd like to turn the conference back over to the company for any closing remarks.

[Scott Melbourn, executive]

Thank you, everyone, for joining us today. If anyone has any follow-up questions, please reach out to myself or Derren.

[Operator]

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.