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

Welcome to the Source Energy Services Third 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 Third Quarter 2023 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'd 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 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. Volumetrically, the quarter was slower than anticipated due to a number of our customers moving pads from September to October. These schedule changes were driven by various customer operational issues. Despite the lower volume, Source once again delivered strong gross margin performance, which led to improvements in adjusted EBITDA over last year's third quarter. The lower sales volume during the quarter has not changed our outlook for the year, and we are expecting one of the strongest fourth quarters we have seen in a few years. Highlights for the quarter include sand sales of 709,000 tonnes and sand revenue of $102.2 million, a $5 million increase from the third quarter of 2022. On a per tonne basis, sand revenue increased 12% from the prior year. Total revenue for the quarter was $124.7 million, a $4.8 million increase from the third quarter of 2022. Strong Sahara performance set new records for the highest monthly revenue realized from the Sahara fleet in both Canada and the U.S. Gross margin for the quarter was $25 million, and adjusted gross margin was $30.8 million, representing increases of 53% and 46% when compared to Q3 of last year. Net income for the quarter was $3.7 million, which is a $7.6 million improvement from the third quarter of 2022 while realizing adjusted EBITDA of $22.7 million, a $6.4 million improvement over last year when the gain on forward FX contracts recognized last year is excluded. From a balance sheet perspective, the improved business performance allowed us to reduce the face value of the total debt by $17.1 million from the end of 2022, including the $2.5 million of notes repurchased during the quarter. Subsequent to quarter end, we purchased and retired an additional $7.1 million of notes. Free cash flow for the quarter was $7.4 million, a decrease of $7.2 million compared to last year. However, when the $9.7 million gain on FX contracts is excluded from the prior year, free cash flow improved by $2.5 million compared to Q3 of 2022. This improvement was driven by better gross margins and lower net capital expenditures in the quarter. Finance expenses were higher in 2023 as the August 2022 interest payment for the notes was delayed until after closing of the ABL facility in the fourth quarter of last year. Payments for the lease obligation were higher than the prior year due to the replacement of short-term rentals with lower-cost, longer-term leases for certain mine processing equipment and the impacts of a weaker Canadian dollar on U.S.-denominated leases. As business performance continues to improve and 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 remain confident that we will achieve our debt targets of funded debt to adjusted EBITDA of 1.5x or less by early to mid-2024. With that, I'll now turn it over to Derren to provide a brief overview of our financial results for the quarter.

Thanks, Scott. Sand revenue for the third quarter of '23 was $102.2 million, an increase of $5 million or 5% over the third quarter of '22. The increase was due to a 12% increase in the average realized sand price. Excluding mine gate sales, the average sand price increased by $15.47 per metric tonne compared to Q3 '22. While sand revenue realized from the mine gate sales lowered the average realized sand price in the quarter by $6.72 per metric tonne, it did have a favorable impact on cost to sales and gross margin by improving production efficiencies and yields. Sand sales volumes were 43,000 metric tonnes below the last year due to the impact of the customer operational delays predominantly in September. These delayed sales will be completed in the fourth quarter. Wellsite solutions revenues for the third quarter of '23 were $21.7 million, which was consistent with the revenue realized in the third quarter of last year. Last-mile solutions revenue was down marginally as customer delays resulted in slightly less volume being chart in the quarter. Sahara's operations in Canada set a monthly record for revenue in July but were down slightly for the full quarter due to lower utilization. The Canadian shortfalls were made up by improved performance from U.S. Sahara operations, which saw a 52% improvement in revenue in the quarter compared to Q3 '22. Terminal services revenue for Q3 was $0.8 million, a decrease of $0.2 million compared to the third quarter of '22. This reduction is due to a customer ending a storage arrangement with Source and the loss of rental income from the sale of the Berthold facility in Q2 of this year. Cost of sales excluding depreciation decreased by $4.9 million compared to the third quarter of '22. This decrease was due to lower sales volumes sold, lower transportation costs for rail and trucking due to lower fuel surcharges and operational efficiencies. These savings were partially offset by a shift in terminal sales mix and the impact of some rail interruptions that resulted in higher trucking costs in the quarter. The weaker Canadian dollar on our U.S.-denominated costs also have increased cost $2.49 compared to the same period last year. Gross margins increased by $8.6 million compared to the third quarter of '22. Excluding gross margins from mine gate sales, adjusted gross margin was $40.89 per metric tonne compared to $31.38 per metric tonne for the same period last year. The increase in gross margins arose from improved pricing, the impact of production efficiencies and lower fuel surcharges, partially offset by the increased trucking costs just discussed. Despite a weaker Canadian dollar during the third quarter, adjusted gross margin was favorably impacted by approximately $0.37 per metric tonne because of the effect of the movement in foreign exchange rates had on increased U.S. dollar-denominated revenue realized in the quarter. For the balance of '23, we are naturally balanced in our FX position. We will continue to monitor our FX exposure and actively manage if required in the future. Total operating, general and administrative expenses in the quarter increased $1.7 million to $8.4 million. Operating expenses increased by $0.7 million from the third quarter of '22 due to higher royalty costs, insurance costs and higher incentive compensation expenses. General and administrative expenses also increased $0.9 million in the quarter compared to the same period last year primarily due to higher compensation expenses and incentive compensation expenses in '23. Finance expenses were $8.8 million for the third quarter, which was comparable to the prior year, as higher accretion on the expense on the new ABL facility was partially offset by lower interest expense from the ABL facility due to the overall draws on the facility compared to the prior year. On September 30, the principal balance outstanding on our notes was $162.6 million, and Source had drawn $12 million under its ABL facility, leaving $17.9 million of available liquidity. In and after the third quarter, Source had repurchased a total of $9.6 million face value of its notes and generated a gain on debt extinguishment of $0.7 million. Currently, the outstanding face value of notes is at $155.5 million. Source will continue to renew the focus on lowering its leverage over the coming quarters as it works on achieving its step target Scott described earlier. Source's ABL facility has gone current in the quarter as its maturity is 6 months prior to the notes' maturity of March '25. With the improving debt metrics, we're confident in executing our long-term plans for the balance sheet. Source's net capital expenditures for the third quarter were $3.6 million, a decrease of $0.8 million compared to Q3 '22 due to lower spending at Peace River year-over-year being partially offset by higher spending on overburden removal. With that, I'll turn it back to Scott to talk about the outlook and wrap up the call.

Thanks, Derren. As we look ahead, we continue to believe strong industry activity levels will favorably impact frac sand's supply and demand fundamentals in the WCSB. We are expecting a very strong fourth quarter this year as customers catch up on delayed work and finish their programs off for 2023. Source believes the strong Canadian industry fundamentals, coupled with Source's leading service offering and logistics capability, will continue to support market share gains and strong financial results for the remainder of '23 and beyond. In the longer term, we believe the increase for -- 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 the Coastal GasLink Pipeline as a positive step forward in LNG Canada becoming a reality in late '24 and into '25. We have also seen a positive momentum on wood fiber and other proposed LNG projects in Canada, which has the potential to drive additional demand for our products and services. Source continues to focus on enhancing our industry-leading frac sand logistics chain. We believe we have a unique opportunity 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 market, we continue to explore opportunities to diversify and expand our service offerings and to further utilize the existing Canadian -- 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 up the lines for questions.

[Operator Instructions] The first question comes from Nick Corcoran of Acumen Capital.

I think you went over a lot of the question I have in the prepared remarks, but just a question on what you're seeing in pricing in terms of pricing in the spot market and how you expect that to translate into your results.

Yes. Nick, thanks for the question. I think the market has remained pretty stable in the spot market pricing. And so we haven't really seen the massive movements, up or down, in the spot market. So we do expect as we cycle into the balance of this year and into '24 that we'll start to see a little more movement in spot prices into '24 and especially in Q1 '24, where demand picks up -- or seasonal demand picks up. So we're expecting fairly consistent pricing for the balance of '23, and we're expecting a slight uptick in the spot prices beginning in '24.

And with Coastal Link (sic) [ Coastal GasLink ] coming online, what have the discussions with your core customers been in terms of what they're forecasting for demand into '24 and '25?

Yes. I think as we look at '24 and as we're getting an early look on programs from our core customers, we do expect an uptick in the overall sand volume in '24. And so we're cautiously optimistic with how '24 is starting to shape up and how we're looking at it today. And so as we sit today, we certainly expect a slight uptick in '24.

The next question comes from Ed Sollbach of Spartan Funds.

Congrats on the quarter. I noticed at the top, you referenced record monthly Sahara volumes. Is that -- so that is -- that goes into the wellsite solutions bucket? Is that right?

Yes, that's correct.

Okay. And is Sahara all of wellsite solutions?

No. Last-mile logistics business also gets reported in wellsite solution numbers.

Okay. Because if I look at wellsite solutions, it's down from last year. So does that mean in Q4, it's going to be better given you had the record monthly volumes on Sahara? Or how much of Sahara is wellsite solutions?

Yes. Wellsite solutions, because it encompasses our last mile and Sahara, it will be a bigger impact on a quarter-over-quarter or year-over-year basis will be driven by the wellsite solutions. And that's just the nature of the high revenue associated with the truck trips out to the wellsite. And so on any given quarter, depending on the length of the trip from the terminal or from Peace River out to the wellsite will have an outsized impact on wellsite solutions. So just looking at that line item will give you a good gauge on the Sahara performance, which will have a bigger EBITDA impact on wellsite solutions but a lower revenue impact on wellsite solutions. That makes sense, Ed?

Okay, okay. And how big is the -- so getting into -- like how big is the Sahara, just -- the wellsite is $21 million -- was $21 million for the quarter. Like how big would the Sahara be? Just...

It's not a number we're disclosing at this point. But...

Okay, okay. So just a couple of line items I was interested in. If I look at G&A and operating expenses, they were up like year-over-year about 15% and 50% for G&A. That was a big jump. Like -- so what's driving those numbers to go up and down like that? And where do you see them coming in for the year?

So in terms of OpEx, as we said in the remarks, you've seen higher royalty costs in the year. We've had higher compensation expenses. We've improved both base compensation and incentive compensation. There's a bit of a timing issue how we reported bonus programs between the 2 years. So that will start to level out in the fourth quarter. And then we've had higher insurance costs year-over-year. On the G&A side, it's been more on the compensation piece, but we've also had higher professional fees year-over-year just due to some things we've been working on. Where do we expect it to come in? I think probably Q3 revenue run rate is a pretty good indication of Q4 levels. So...

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. Any follow-up questions, feel free to reach out to myself or Derren.

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