Source Energy Services Ltd

TSX:SHLE

Earnings Call Transcript

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the Source Energy Services Fourth Quarter 2024 Results Conference Call.

[Operator Instructions] The conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Scott Melbourn. Mr. Melbourn, please proceed.

[Scott Melbourn, executive]

Thank you, operator. Good morning, and welcome to Source Energy Services 2024 Year-End 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 would 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 these items just mentioned, our financial information is prepared in accordance with IFRS.

Source had a very successful year on several fronts. We sold record volume to our customers, delivered record volumes through our well site solutions teams and generated record adjusted EBITDA and free cash flow. In the fourth quarter, as we often do, we saw a seasonal slowdown from the very strong pace we had throughout 2024. Even with this slowdown in activity, Source still delivered 768,000 tonnes of sand and generated $25.8 million of adjusted EBITDA.

As we announced on December 20, we completed the refinancing of our senior secured notes and our ABL facility. These transactions have pushed out our maturities, improved our liquidity and lowered our overall cost of borrowing. The mandatory amortization and a quarterly cash flow sweep on the term facility will ensure we continue to deleverage the balance sheet, which remains an ongoing priority for the business.

Few highlights from 2024 include sand sales volume of 3.5 million tonnes and total revenue of $674 million, a $104.2 million increase from 2023. This improvement was created by all parts of the business. Gross margins for the year were $127.3 million and adjusted gross margins were $162.6 million, increases of 16% and 20% respectively, when compared to 2023.

We generated adjusted EBITDA of $123.9 million, a $24.8 million improvement over 2023. We announced a partnership with Trican to construct a unit train facility located in Taylor, British Columbia. The first phase of this project is now operational and we anticipate it to be fully operational in the second quarter of 2025.

We closed 2 acquisitions for sand trucking assets, further strengthening Source's last mile logistics. At the Chetwynd facility, we completed a rail track expansion into a full unit train facility, which will become a key terminal as the sand market in Northeast BC continues to expand. Source's 10th and 11th Sahara units were both constructed and deployed to Alaska, where they are both fully contracted to operate on the North Slope, helping drive utilization of 78% across the 11 unit Sahara fleet for the year.

We generated $55.2 million of free cash flow for the year, an increase of $17.9 million from the prior year when excluding transaction costs related to the refinancing. As we look at industry activity in 2025, we believe the continued development of the Montney will be a key driver for the industry. In response to the growth in the Montney, Source is focused on the development of its logistics capabilities in Northeast BC with the expansion of the Chetwynd terminal, the development of the Taylor terminal and the acquisition of the trucking assets.

When these logistics capabilities are combined with our Peace River facility, Source can provide an unparalleled mine to well site offering for both Northern White and domestic sand. Ultimately, by utilizing our Northern White and domestic sand, we are able to offer the lowest landed cost in the Montney.

In 2025, we will upgrade the Peace River facility and increase its production capacity to 1 million tonnes. We began this process in 2024 and have been working with our customers to help fund a portion of the project. The build-out, when complete, will make the facility more reliable, increase capacity and allow us to better meet the growing demand from our customers who are looking for a blend of domestic and Northern White sand. This project is expected to be fully operational in the second half of the year and will cost approximately $7 million to complete, net of the $6 million in payments received from customers to help fund the expansion.

As with all of our recent major capital expenditures, we have fully contracted the additional production capacity. With the planned expenditure on the Peace River facility this year, we are anticipating our capital expenditures for the year to be between $28 million and $33 million, with the majority of the year-over-year increase related to the Peace River expansion and mine development activities in Alberta and Wisconsin.

Before I turn it over to Derren, I'd like to discuss the results in more detail, I'd like to touch on recent announcements by the U.S. government to impose tariffs on goods imported from Canada and the Canadian government's retaliatory tariffs on some goods imported from the U.S. While we believe in the short term that the tariffs are not likely to have a material impact on our customers' activities, in the longer term, they may impact the capital plans of the industry.

The additional export capability via LNG Canada and the announced expedited permit of additional LNG projects will help mitigate any potential impacts. However, the overall impact to the industry and Source is difficult to predict More concerning in the short term is the Canadian government's retaliatory tariffs, which include frac sand.

While Source's contracts do allow for the flow-through of these type of charges, any additional cost on the industry while facing a tariff on their exports, and there is no readily available alternative, is disappointing and counterproductive. In the event of retaliatory tariffs, we will work with industry participants and the federal government to seek an exemption on frac sand.

With that, I will 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, Source sold 768,000 metric tonnes of sand in Q4 '24 from which we generated $117.7 million in sand revenue. Sand volumes were 6% lower than '23, while sand revenue decreased by $6.6 million.

Q4 '23 was an unusually busy fourth quarter. Source usually see its customer activity slowdown in the fourth quarter as capital budgets are exhausted. In '23, however, this was not the case as work was completed that had been delayed by the wildfires in the summer of that year. During the fourth quarter of '24, volumes from mine gate sales lowered our average realized sand price by $0.76 per metric tonne. However, the sale of lower-value mine gate sales had a favorable impact on production costs by creating sand processing efficiencies.

Well site solutions revenue for Q4 '24 was $26.7 million, a decrease of $2.7 million or 9% compared to Q4 '23. Lower sand sales volumes also impacted volumes hauled to the well site, resulting in lower trucking revenue for the quarter. The U.S. Sahara fleet was 85% utilized during the fourth quarter with the 2 units now fully operational on the North Slope in Alaska. In Canada, the Sahara units were 48% utilized for the quarter due to lower activity levels.

Terminal services revenue was $0.6 million, a decrease of $0.2 million compared to the fourth quarter of '23 due to the lower revenue from chemical elevation realized in the period.

On a total year basis, total revenue grew by $104.2 million or 18% to $674 million. The addition of new customers, strong customer activity throughout the year drove improved sand sales and record volumes were delivered by the last mile logistics teams, while the completion of the 2 new Saharas late in the year helped contribute to solid utilization rates for the Sahara fleet in '24, all of that boosting well site solutions revenue for the year.

Cost of sales, excluding depreciation, was $7 million lower in Q4 than '23 due to lower sand volumes and lower volumes handled by last mile logistics group as well as lower rail transportation costs. People costs and repairs and maintenance expenses were higher in Q4 '24 compared to '23 due to the impact of the sand trucking assets purchased in the year.

The weaker Canadian dollar on U.S.-denominated costs increased our cost of sales by $2.72 per metric tonne in Q4 '23. The impact was largely offset by U.S. dollar denominated revenue for the quarter.

On a full year basis, cost sales, excluding depreciation, increased during '23 due to higher sand sales volumes and increased transportation costs. These volumes driven increases were partially offset by lower cost to produce sand across all mining facilities and the cost savings realized through the acquisition of the sand trucking assets. The weaker Canadian dollar on a full year basis increased cost by $1.59 per metric tonne compared to '23. This was largely offset by the movement in exchange rates on revenue in U.S. dollars for the year.

Gross margins decreased by $2.3 million in Q4 '24 because of lower sand sales volumes, lower truck volumes and lower Sahara utilizations compared to the same period last year. Excluding gross margin from mine gate, adjusted gross margin per metric tonne was $44.88 compared to $47.45 in Q4 '23. Adjusted gross margin for the quarter was impacted by lower activity levels and higher trucking expenses related to severe weather conditions experienced late in the quarter.

These impacts were partly offset by incremental gross margin generated from the sand trucking assets acquired in the year. The weaker Canadian dollar reduced adjusted gross margin by $0.35 per metric tonne as the foreign exchange impact on U.S.-denominated costs was more than the positive impact on U.S.-denominated revenue. We continue to target to remain in a naturally balanced position, and we'll continue to monitor our FX exposure and manage it if required.

On a full year basis, gross margin increased by $17.9 million or 16%. Excluding gross margin from mine gate sales volumes, adjusted gross margin was $46.99 per metric tonne compared to $46.07 in '23. Again, adjusted gross margin benefited from higher sales volumes, more sand being trucked, lower production costs, as well as $3.2 million of incremental gross margin generated from the sand trucking assets acquired during the year. On a year-to-date basis, adjusted gross margin had a negative impact of $0.31 per metric tonne on our gross margin.

Total operating and G&A expenses increased by $2.9 million compared to the fourth quarter of '23. During Q4 '24, expenses increased by $0.9 million due to higher compensation expense and increased selling and administration arising from increased royalty costs related to sand shipments from mines that require royalty payments as well as increased insurance expense.

G&A expenses increased $2 million during the fourth quarter, largely due to higher compensation expense. Selling and administrative costs also increased due to higher IT expenses incurred for our new cloud-based ERP system.

Operating expenses increased by $2.6 million for the full year due to higher royalty costs associated with increased sales volumes, increased insurance costs and compensation. G&A was up $5.5 million, largely as a result of higher people costs due to increased well activity, the trucking assets acquired as well as legal and IT expenses.

Finance expense was $9.1 million for Q4 '24, which was comparable to last year. Interest expense was lower due to the impact of the note repurchases through the last 2 years and lower average draws on our ABL facility as well as lower accretion expense. This was largely offset by higher interest incurred on lease obligations and the interest realized from the promissory notes that were issued as part of the trucking acquisitions. On a full year basis, finance costs were down $1.7 million, primarily driven by lower interest on the notes and lower accretion expense.

Capital expenditures net of proceeds on disposal and setting aside Taylor expenditures were $5.5 million for the quarter, a reduction of $1.1 million compared to last year. If you include all capital expenditures with the -- increased with the commencement of the construction on the Taylor facility and improvements being made at the Peace River mining facility were partly offset by lower capital costs incurred for a piece of equipment, which malfunctioned at a terminal last year and lower overburden removal costs in the quarter.

On a full year basis, net capital expenditures related -- excluding expenditures related to Taylor increased by $6 million. And including the Taylor, increases were primarily driven by the Taylor facility; the construction of the 10th and 11th Sarah units, which were fully reimbursed by customer expenditures; the rail expansion at Chetwynd; and higher amounts of overburden removal compared to the prior year. We also had the purchase of the trucking assets contributing to the increase.

As Scott mentioned, on December 20, we entered into a new term loan agreement with Silver Point LLC for USD 135 million facility, which also has a USD 25 million delayed draw available through the end of this year. This facility matures in December of '29. It has a 5% annual amortization that is paid in quarterly installments and a quarterly excess cash flow sweep, which will ensure we are continuing to delever the balance sheet. The coupon is SOFR plus 5.25% and SOFR does have a floor at 4.25%.

Key covenants are; a fixed charge coverage ratio of 1.25:1, the total leverage at 2.25:1 that declines down to 1.75 over the term of the facility, and a current ratio covenant at 1.25:1. As Scott mentioned, this facility was deliberately oversized to improve Source's liquidity. The proceeds of this facility were used to repay the notes, the old ABL facility and pay off the promissory notes issued in the trucking acquisitions.

On the same day, we entered a new ABL facility with CIBC for a CAD 40 million ABL. This facility matures December 2027. It is backed by accounts receivable, inventory, and its coupon, using primary, ranges from prime to prime plus 25 basis points. The facility has a springing fixed charge of 1:1 if availability is less than 10%. The facility has never been drawn. And at year-end, Source had available liquidity of $68.8 million.

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 WCSB. 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 2025 and beyond.

We believe the increased demand for natural gas, driven 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 and the continued work on other proposed LNG projects such as Cedar, Woodfibre 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 on a number of opportunities to grow the company and further our competitive advantage. In addition to the growth in our core market, we continue to explore opportunities to diversify and expand our service offerings and further utilize our Western Canadian terminals.

Thank you for your time this morning. That concludes the formal portion of our 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 the first question for me. We're about 2 months into the quarter. Any indication how activity levels have been to start the year?

[Scott Melbourn, executive]

Yes. The early indications are in the quarter, this is a very, very strong start to the year. We've -- Q1 is always a strong quarter for us. And I would say Q1 2025 is shaping up the same. As we look out into the balance of 2025 and despite some macro noise around the tariffs, we expect a very strong year for 2025 with growth in volumes over 2024.

[Nick Corcoran, analyst]

Good. And with all the talk of the tariffs, are you positioning for the tariffs with any additional inventory in the basin?

[Derren Newell, executive]

Yes. We preposition inventory in Q1 really to deal with any weather-related impacts, which really affect us in Q1. We'll take a look at prepositioning inventory in response to the tariffs. However, it's very difficult to do at this point in time, just given the lack of clarity around the timing or the lack of clarity around what is actually happening with the tariffs.

So, the plan would be to run the business as normal. And if there's an opportunity to pre-position some inventory, then we'll fill it up. But it's a very short-term, 2-week to 3-week positioning of inventory that we can save on the tariffs. Other than that, we don't have enough inventory in the basin to position much more.

[Nick Corcoran, analyst]

Good. And maybe one last question for me. The refinance was completed late last year. Any indication where your capital allocation priorities are going forward?

[Scott Melbourn, executive]

Yes. I think as we mentioned on the call, we obviously have a -- what we view as an amazing opportunity in front of us at Peace River. And so, we'll expand that facility. Apart from Peace River, we will continue to look to pay down debt. And apart from that, I expect that we've had some conversations at the Board level, and I expect we'll be announcing something in terms of an NCIB or something different to return some cash flow to shareholders in short order.

[Operator]

The next question comes from Jesus Sanchez Leon with Castanar Investment.

[Jesus Sanchez Leon, analyst]

Congrats on the results. My question is about CapEx. You touched a little bit about that, but maybe you can add more color and break it a little bit down why -- what drove the increase in CapEx?

[Scott Melbourn, executive]

Yes. Jesus, maybe I'll start with that, and then I'll toss it out to Derren. Really, on a year-over-year basis, what we're looking at in terms of an increase in CapEx is the expansion at the Peace River facility, which will be approximately $7 million for us and about $6 million in customer funded. And so that will drive most of the increase on the year-over-year capital.

As we get busier, we will need more mine development activities. So it's just removal of overburden and just more mining activities as there's more volume going through the logistics chain. And that drives really the balance of the increase in capital on a year-over-year basis.

[Derren Newell, executive]

Nothing to add to that. We did talk through last year there were a number of projects that went on, the Chetwynd expansion, the 2 Saharas, the trucking assets, all things that have helped us set up for the future, and we think we're in a good spot to be able to utilize those to serve the Montney better.

[Jesus Sanchez Leon, analyst]

So, for this 2025, we still expect that CapEx to decrease and go to more like 2023 levels, discounting this $7 million investment in Peace River?

[Derren Newell, executive]

No, we expect our 2025 to be more in the $28 million to $33 million range.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Melbourn for any closing remarks.

[Scott Melbourn, executive]

Thank you for your time today. If anyone has any follow-up questions, please feel free to reach out to myself or Derren.

[Operator]

This brings to a close today's conference call. You may now disconnect your lines. Thank you for participating, and have a pleasant day.