Source Energy Services Ltd. (SHLE) Earnings Call Transcript & Summary

Thank you for standing by. This is the conference operator. Welcome to the Source Energy Services Second Quarter 2023 Results Conference Call. [Operator Instructions] And 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 second quarter 2023 conference call. My name is Scott Melbourn, I'm the CEO of Source. I'm joined today by Derren Newell, our CFO. Today, Darren and I will cover the formal part of the call, and we will be available to answer any questions you now. 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 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 these items just mentioned, our financial information is prepared in accordance with IFRS. Source has had a strong second quarter operationally and financially, despite the impacts of the wildfires, floods and rail disruptions, which delayed a number of our customers' jobs. These delays ultimately ended up shifting approximately 100,000 tonnes of sales into the last half of this year. Highlights for the second quarter include sand sales volume of 702,000 tonnes and sand revenue of $102 million, an $8.4 million increase from the second quarter of 2022. On a per tonne basis, sand revenue increased by 24% when compared to the same period last year. Total revenue was $127 million, a 14% increase from the second quarter of 2022, and the third highest quarterly revenue generated since the inception of Source. New operational records were set for the largest daily sand volume fed into a blender in a 24-hour period and for daily sand volume throughput at our Wembley terminal. Wellsite solutions had another strong quarter, recording utilization of 82% for the Canadian Sahara fleet and 67% for the U.S. Sahara fleet. Last mile trucking saw a 48% increase in revenues and a 28% increase in tonnes hauled compared to the second quarter of last year. We realized gross margin of $24.9 million and adjusted gross margin of $30.2 million, increases of 51% and 39%, when compared to Q2 of 2022. Net income for the quarter was $2.7 million, a $2.6 million improvement from the second quarter of 2022, when excluding the unrealized gain on derivative instruments recognized last year. Adjusted EBITDA was $20.4 million, a 38% increase from the second quarter of 2022. During the quarter, we entered into a contract to build and operate Source's 10th Sahara unit. It's a unique deal where our customer will be fully funding the construction of the unit. Once the unit is constructive, it will be delivered to Alaska, where we will operate it for an initial term of 3 years. At the end of the 3-year period, the agreement can be renewed, the customer can elect to purchase the unit at fair market value for use only in Alaska, or the unit can be returned to Source for use in the existing fleet. Sahara 10 is expected to be fully operational in the second quarter of 2024. Free cash flow for the second quarter was $7.8 million, which was 408% higher than the $1.5 million generated for the second quarter of 2022. The increase is due to a $5.6 million increase in adjusted EBITDA, reflecting improved adjusted gross margins compared to the prior year and lower net capital expenditures in the quarter. This is partially offset by an increase in payments for lease obligations and the associated interest expense due to an increase in renewal rates on railcars and the impact of a weaker Canadian dollar on U.S. denominated components. As business performance continues to improve in 2023, and we continue to generate additional free cash flow, we will remain focused on reducing debt levels and ensure we have an appropriate amount of leverage in the business, or the cyclicality of our industry. We remain confident that we will achieve our debt reduction targets in 2023 and early 2024. With that, I will turn it over to Darren to provide a brief overview of our financial results for the quarter.

Thanks, Scott. Sand revenue for the second quarter of '23 was $102 million, an increase of $8.4 million or 9% over the second quarter of '22. The increase was due to a 24% increase in average realized sand price, excluding mine gate sales, the average realized sand price increased by $29.33 per metric tonne compared to Q2 '22. While sand revenue realized from mine gate sales lowered the average realized sand price in the quarter by $7.29 per metric tonne, it did have a favorable impact on cost of sales and gross margins by increasing production efficiencies in yields. Sand sales volumes were 98,000 metric tonnes below last year due to the impact of the fires and floods. Wellsite solutions revenue for the second quarter of '23 was $24 million, an increase of 46% or $7.5 million compared to the second quarter of last year. In the quarter, we trucked 20% more volume than we did a year ago and saw a 48% increase in trucking revenue. Sahara-related revenue increased 40%, due to a 22% increase in days utilized across the 9-unit fleet. Sahara units operating in the U.S. generated a revenue increase of $0.9 million or 119% compared to the second quarter of last year, while the Canadian fleet generated increased revenue of $1.1 million or 26%. Terminal services revenue for Q2 of '23 was $1 million, a decrease of $0.6 million compared to the second quarter of '22. The decrease was due to a onetime, special order of ceramic proppant in the second quarter of last year. Cost of sales, excluding depreciation, increased by $6.9 million in Q2 compared to the second quarter of '22. This increase was primarily due to higher transportation costs for rail and trucking and a shift in terminal sales mix. The weaker Canadian dollar on our U.S. denominated costs also increased our costs $5.15 per metric tonne compared to the same period last year. These increases were partially offset by production efficiencies achieved, attributed in part to the introduction of an additional mesh size earlier this year. Gross margins increased by $8.4 million compared to the second quarter of '22. Excluding gross margins from mine gate volumes, adjusted gross margins were $46.73 per metric tonne, compared to $29.07 per metric tonne for the same period last year. The increase in gross margins arose from improved pricing and improved gross margins from wellsite solutions. Despite a weaker Canadian dollar during the second quarter, adjusted gross margin was favorably impacted by approximately $0.89 per metric tonne because of the effect of movement in foreign exchange rates. On our U.S. increased U.S. dollar denominated revenue realized in the quarter. For the balance of '23, we are in a naturally balanced FX position, but we will continue to monitor FX exposure and actively manage, if required. Total operating and general and administrative expenses in the quarter increased $2.4 million to $9.9 million. Operating expenses increased by $1.1 million from the second quarter of 2020, due to higher equipment costs for repair of a maintenance Peace River, the impact of an executive severance and higher variable incentive complication. General and administrative expenses also increased $1.2 million in the second quarter of '23 compared to the same period in '22, primarily due to higher compensation expense, the timing of recognizing variable incentive compensation in '23 compared to '22, and higher professional legal fees incurred. The timing difference and the variable incentive compensation is largely expected to resolve itself by year-end. Finance expense was $9.2 million for the second quarter, a $1.3 million increase over the prior year, due to higher accretion expense on the new ABL facility, increased interest on renewed lease obligations and increased fees on the standby letter of credit facility and other various interest charges. These increases were partially offset by lower interest expense from the ABL, due to overall lower draws on the facility compared to the prior year period. On June 30, the principal outstanding of our notes was $165.1 million and Source at $17.1 billion drawn under the ABL facility, leaving $13.6 million of available liquidity. Source's net capital expenditures for the second quarter $23.6 million. Source spent $6.2 million, an increase of $2.6 million compared to the same period last year. The increase in expenditure was primarily related to beginning with the construction of Sahara terminal that's got addressed earlier, and which has been fully offset by the receipt of our customers first and solely on the unit. Overburden spending was also slightly higher during the quarter. We had excess equipment and property sales, which generated proceeds of $3.3 million in Q2 '23, and management continues to assess equipment and other assets required to service our operations to ensure optimal levels are maintained on an on-going basis. And with that, I'll turn it back to you, Scott to wrap up the call.

Thanks, Darren. As we look ahead, we continue to believe strong industry activity levels will continue to favorably impact frac sand, supply and demand fundamentals in the Western Canadian Sedimentary Basin. We are expecting a very strong third quarter. And as we've seen in prior years, we are waiting more clarity from customers on fourth quarter activity levels, as they find a balance between budgeted expenditures and commodity price. Source believes the strong Canadian industry fundamentals, coupled with Source's leading service offerings and logistics capability will continue to support market share gains and strong financial results for the remainder of 2023 and beyond. In 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 in the WCSB. We continue to see an increased demand from our customers that are primarily focused on the development of natural gas and natural gas liquids properties in the Montney, Duvernay and Deep Basin. This trend is consistent with Source's view that natural gas will be an important transition fuel that is critical for the successful movement to a less carbon-intensive world. Source continues to focus on increasing its involvement in the provision of logistic services to expand its service offering and further utilize its Western Canadian terminal network. 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 Instructions] The first question comes from Nick Corcoran from Acumen Capital Partners.

Just a couple of questions from me. You mentioned that wildfires and floods had an impact in the second quarter. Can you provide any indication of that they carry over in the third quarter?

Yes. So as we mentioned, we had a number of jobs that were delayed due to the wildfires and/or the flood after the pads. All of those jobs are transitional, and then they weren't canceled. So most of them moved into Q3. I suspect we're going to see just because of the level of concentration of activity in Q3 for some of that work to them sliding into Q4, just given the level of our activity in Q3. And so I think to answer your question, Nick, is we expect all of those pads to proceed and will proceed in Q3 and/or Q4.

That's helpful. And then in terms of spot prices, are you seeing any movement in the price of frac sand?

Yes. No, we're -- we really didn't see a lot of movement in Q2, which is actually a very positive thing for the frac sand market. Just given there was some lower activity levels in Q2 due to wildfires and just due to the seasonality of Q2. If we were going to see any weakness in spot price, we would probably see it in Q2. And -- we didn't experience any weakness in spot pricing in Q2. And so we really do view the spot price has stabilized, and we forecast it to remain fairly stable for the balance of 2023.

Good. And then maybe one last question for me just on the strategic priorities. I know you mentioned the debt reduction targets in your prepared remarks. How are you thinking for CapEx and M&A going forward?

Yes. I think we're right now very focused on reducing our leverage and reducing the ultimate leverage in the company to a level that we feel is going to be sustainable in any sort of all markets up or down. And so that's our #1 priority. But with that, we also recognize there is an opportunity for growth, and we don't want to stand still as a company. And so as we look at the Sahara 10 build, that's a one example of how we're able to grow and grow the company without impacting our cash flow and without impacting our ability to reduce our debt levels. So we continue to focus on maybe some unique opportunities of the market where we can maintain our desire to reduce our debt levels and still grow. And then as we get to the balance sheet in a position to -- that we like, I think that -- at that point, we have a number of opportunities that we would look to deploy some grow capital. But it really won't be until we get that balance sheet in a position that we want to do. Thanks, Nick.

[Operator Instructions] The next question comes from John Gibson from BMO Capital Markets.

Congrats on the solid quarter considering the fire and weather impact. I just had one on the balance sheet. If you could maybe just give us a sense, I mean, you've generated $8 million in free cash flow this quarter. Maybe just give a sense if all things go according to plan, volumes sort of hold up as the market expecting. Where do you see the balance sheet at year-end '23? And then maybe as we look into 2024 when the facility -- or facility and notes come due, what are your expectations for potential refinancing?

Yes. Thanks, John, and thanks for the question. I'll let Darren lead into that.

So I think what we're trying to do, John, is when we take all of our free cash flow, we can generate out of the business this year and apply as much as possible, while we keep our liquidity even get a spot against the debt. We think that will have a noticeable impact on the debt levels. We're also looking at other things that are on the balance sheet, where there's cash that we can access and try to figure out how we can best get those sorts of settled and then use that excess cash to begin to pay down yields as well. So without giving the number specifically, we're really focused on it. Ideally, we'd like to get this business down on the note side or about one times kind of EBITDA is the longer-term target.

Okay. Great. I'll turn it back.

Thanks, John.

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

Thanks, operator. I think we see one more question in the queue.

The next question comes from Josef Schachter from CER (sic) [ SER ].

[indiscernible] me up for the last couple of questions. One, how much does the Sahara fleet or Sahara unit cost to build? Just trying to get an idea of the cost there for building that for Alaska?

Yes. So the Sahara unit will -- and it will depend a little bit on the -- what the total package looks like. Obviously, for an Alaska package, we have some cold weather items, for a Texas package, it looks a little different. So it will range kind of from that USD 3.5 million to USD 4 million for a total Sahara package.

Okay. And you're up 82% utilization in Canada. Do you need to start contemplating adding another unit in Canada given the growth from LNG and the activity in Northeast B.C.?

I think the easy answer to that question is, yes. We continue to look and look at the opportunities to add additional units to our Sahara fleet. I think we're seeing opportunities not only in -- with the increase of activity level in Northeast B.C., but we're also seeing some pull from the customers in the U.S. for additional Sahara units. But like I said before, we want to be very focused and deliberate. And so the first priority will be to pay down debt and reduce leverage on the balance sheet. And as -- when we get that into the position that we wanted, then we'll look to additional units in the U.S. or in Canada. But we do see opportunity for an additional unit or 2 in Canada to support the growth in Northeast B.C. And we also probably see an additional unit or 2 in the U.S. to support growth in the lower 48.

Okay. And my last one, I asked this prior to -- in prior discussions. You've got a fabulous logistics system; you've mentioned in the past that it might be worthwhile to find businesses that could use the advantage of it and have created extra revenue and lower your operating costs. Has anything material come out of that yet?

Yes. We continue to do evaluate opportunities, and we continue to see a number of opportunities come out on that front. We don't really have anything to report on that this quarter, and we're hopeful that we'll have some more opportunities to report on it, next quarter. But we continue to look at the opportunities, and we can continue to chase some of those opportunities.

Okay. Congratulations on the improvement.

Thanks, Josef.

The next question comes from [ Pavel Nikolayevich from Bura bank ].

Hello, gentlemen. Congratulations on a very good quarter. All the challenges notwithstanding. I've been impressed to how you've continued to execute and have raised the profile of Source Energy Services over the past couple of years. And again, yes, we're hoping to see more visibility in terms of what metrics are needed, what numbers you need to hit in order to start paying down debt. But one question, there's been some change in terms of the registered holders of Source Energy Services. Can you comment on Jeff Belford's investment in the company?

Pavel, thanks for the question. At this time, I don't think we would comment on anyone's investments in the company or outside the company. Jeff Belford is a Board member and has been an investor in the company since the -- since really the inception of Source, and sell and he still remains a Board member, and it still remains an active number of Source.

At this time, we have no more questions in the queue. 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 your time today. Please feel free to reach out to myself or Darren, if you have any follow-up questions. 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.