Source Energy Announces Recapitalization Transaction with Substantial Support of Key Stakeholders

Calgary, Alberta (October 7, 2020) TSX: SHLE

Source Energy Services Ltd. (together with its affiliates, “Source” or the “Company”) announced today a proposed recapitalization transaction (the “Recapitalization Transaction”) designed to provide the Company with a stronger, long-term capital structure to withstand current industry challenges and build on its position as the largest frac sand provider in the Western Canadian sedimentary basin (“WCSB”). The Recapitalization Transaction is supported by holders of approximately 74% of the principal obligations under the Company’s 10.5% senior secured first lien notes due 2021 (the “Notes”) and shareholders holding approximately 45% of Source’s common shares.

The Recapitalization Transaction will, among other things:

• proactively address the maturity and obligations (including all accrued and unpaid interest) under the Notes through an exchange of the Notes for a combination of new senior secured first lien notes due March 15, 2025 (the “New Secured Notes”), resulting in a $32.7 million decrease of the principal amount and the issuance of new common shares of Source, constituting approximately 62.5% of the common shares outstanding on a fully diluted basis, immediately following completion of the Recapitalization Transaction (the “New Common Shares”);
• enable Source to access new funding under a $20.0 million term loan facility (the “BDC Facility”) from Business Development Bank of Canada (“BDC”), with participation from the Company’s existing lending syndicate, as contemplated under a non-binding term sheet executed between the Company and BDC;
• provide enhanced liquidity and financial flexibility as a result of the terms of the New Secured Notes and the BDC Facility, which enable the Company to pay interest in kind, rather than in cash, on the New Secured Notes for all quarterly interest payments up to and including February 15, 2022 and on the BDC Facility for all interest payments during its first 12 months;
• enable Source to obtain the support of its lending syndicate through an amendment to Source’s revolving credit facility (the “Credit Facility”) providing the Company with an extended maturity date, ongoing financial flexibility and access to liquidity under the amended Credit Facility (the “Amended Credit Facility”);
• result in existing shareholders (the “Shareholders”) retaining approximately 37.5% of the outstanding common shares on a fully-diluted basis following completion of the Recapitalization Transaction; thereby allowing Shareholders to participate in the anticipated future growth of Source’s business as market conditions improve in the WCSB; and
• lower the Company’s annual lease payments by approximately 45%, when compared to 2019, through renegotiation of its equipment and rail car leases.

Under the proposed Recapitalization Transaction, Source will continue to satisfy its obligations to customers, suppliers, employees and governmental authorities in the ordinary course of business.

In connection with the Recapitalization Transaction, the Company has entered into a support agreement (the “Noteholder Support Agreement”) with holders of approximately 74% of the principal amount of the Notes (the “Initial Consenting Noteholders”) and a support agreement (the “Shareholder Support Agreement”) with Shareholders holding approximately 45% of Source’s common shares (the “Supporting Shareholders”). Pursuant to the support agreements, the Initial Consenting Noteholders and the Supporting Shareholders have, among other things and pursuant to the terms thereof, agreed to support the Recapitalization Transaction.

As previously announced, Source has also entered into a Support and Interest Deferral Agreement with the Initial Consenting Noteholders pursuant to which the Initial Consenting Noteholders have agreed to defer the payment of the June 15, 2020 interest payment on the Notes until October 31, 2020. As the June 15, 2020 interest payment will be addressed as part of the Recapitalization Transaction, the Company intends to settle this interest payment to the holders of the Notes (the “Noteholders”) through the issuance of New Secured Notes.

“The Recapitalization Transaction is the culmination of extensive efforts by Source, working in collaboration with its key stakeholders and under the oversight of a special committee of independent members of our Board, to improve the Company’s capital structure and address the liquidity challenges arising from the historic downturn in the Western Canadian oil and gas industry,” said Brad Thomson, Chief Executive Officer of Source. “We’re pleased with the stakeholder support for the Recapitalization Transaction from our noteholders, shareholders, lending syndicate and lessors, and the willingness of BDC to provide new financing to the Company at this important juncture. Completion of the Recapitalization Transaction will result in a capital structure that will provide enhanced liquidity and financial flexibility, and position Source to build on its business as industry conditions improve.”

Source intends to implement the Recapitalization Transaction by way of a corporate plan of arrangement (a “CBCA Plan”) under the Canada Business Corporations Act (the “CBCA”).

Key Terms of the Recapitalization Transaction

The proposed Recapitalization Transaction includes the following key elements:

The Notes

• The Company’s Notes in the aggregate principal amount of approximately $157.71 million plus accrued and unpaid interest will be exchanged for the following (collectively, the “Noteholder Consideration”): (i) New Secured Notes in an aggregate principal amount of $125 million plus accrued interest on the Notes to and including June 15, 2020, and (ii) New Common Shares constituting approximately 62.5% of the common shares on a fully diluted basis outstanding immediately following the implementation of the Recapitalization Transaction.
• In addition to its entitlement to the Noteholder Consideration, each Noteholder that votes in favour of the CBCA Plan prior to an early consent date to be announced by the Company, or otherwise supports the CBCA Plan in a manner acceptable to the Company (a “Consenting Noteholder”), will also be entitled to receive its pro rata share (determined based on the total principal amount of Notes held by such Consenting Noteholder as a percentage of the aggregate principal amount of Notes outstanding) of additional New Secured Notes in a principal amount equal to all accrued interest on the Notes from June 16, 2020 to the closing of the Recapitalization Transaction.
• The New Secured Notes will include the following key economic terms: (i) a March 15, 2025 maturity date; (ii) interest payable quarterly on February 15, May 15, August 15 and November 15, at an annual rate of 10.5% for cash interest payments and 12.5% for all interest paid in kind; (iii) for each interest payment due on or before February 15, 2022, the Company will pay interest in kind through the issuance of additional New Secured Notes rather than in cash, (iv) secured by a first ranking security interest on the collateral over which the Notes currently have priority (the “Notes Priority Collateral”) and a security interest in the existing collateral that is not Notes Priority Collateral ranking immediately subordinate to the obligations under the Credit Facility and the BDC Facility; (v) a cash sweep mechanism pursuant to which 50% of the amount, if any, by which the Company’s excess cash flow (determined by reference to a specific formula) for each fiscal year commencing with the fiscal year ending December 31, 2021 exceeds $10 million shall be used to repay the outstanding principal and interest obligations under the New Secured Notes at par.

Existing Equity

• Upon completion of the Recapitalization Transaction, Shareholders will retain their existing common shares, subject to a share consolidation (the “Share Consolidation”) to be implemented in connection with the completion of the Recapitalization Transaction, such that Shareholders will own approximately 37.5% of the common shares of Source on a fully diluted basis (including dilution resulting from the Class B shares) outstanding immediately following the implementation of the Recapitalization Transaction.

Other Key Terms

• Completion of the Recapitalization Transaction is conditional on, among other things, the execution of the Amended Credit Facility, the BDC Facility and an amended or new intercreditor agreement giving effect to the priorities and rights among the Amended Credit Facility, the BDC Facility and the New Secured Notes, in each case on terms acceptable to the Company and Initial Consenting Noteholders holding not less than 50% of the principal amount of Notes held by all Initial Consenting Noteholders. The principal terms of the Amended Credit Facility and the BDC Facility are contained in non-binding term sheets agreed to by the Company and the applicable lenders.
• Subject to the terms and conditions of the non-binding term sheet agreed to between the Company and BDC, BDC has agreed to make the $20 million BDC Facility available to Source on completion of the Recapitalization Transaction, which will mature in four years from closing and will be available in up to four separate advances in the first 12 months from closing. The interest rate under the BDC Facility will be 5% per annum in its first year and will increase each year thereafter. Interest relating to the first 12 months of the BDC Facility will be paid in kind through the increase in the principal amount of the BDC Facility.
• Subject to the terms and conditions of the non-binding term sheet agreed to between the Company and the lending syndicate, the Amended Credit Facility will provide Source with a $88 million operating facility (subject to a borrowing base) and a USD$5 million or greater standby letter of credit facility. The Amended Credit Facility will mature on September 30, 2023.
• It is expected that Source’s common shares will continue to be listed on the Toronto Stock Exchange (the “TSX”) following completion of the Recapitalization Transaction.
• The Company will continue to satisfy its obligations to customers, suppliers, employees and governmental authorities in the ordinary course of business and these stakeholders will be unaffected by the Recapitalization Transaction.
• Completion of the Recapitalization Transaction is subject to customary conditions. Subject to the satisfaction or waiver (where permitted) of such conditions, the Company will work to complete the Recapitalization Transaction by December 31, 2020.

Additional Information about the Recapitalization Transaction

The Recapitalization Transaction is the result of a process undertaken by the Company, with the assistance of its legal and financial advisors and in consultation with key stakeholders, to review potential strategic alternatives to address its current liquidity challenges, to respond to the impact of the COVID-19 pandemic, and to strengthen the overall financial position of the Company. The Company’s review of strategic alternatives was overseen by an independent special committee (the “Independent Committee”) of the Board of Directors formed in May 2020 to oversee these initiatives. The Company has carefully reviewed and considered, among other things, its overall capital structure and financial condition, the cash interest obligations and upcoming maturity under the Notes, the Company’s liquidity requirements, the ability to remain in compliance with the Credit Facility and the Notes, challenging industry conditions and oil and gas pricing and the resultant impact on demand for the Company’s products and services, potential investment, financing, transaction and other strategic alternatives, the Company’s objective of improving its capital structure and financial flexibility, its comprehensive discussions with the Initial Consenting Noteholders and their advisors, and the terms of the proposed Recapitalization Transaction and all other alternatives reasonably available to the Company, including the status quo.

National Bank Financial Inc. (“NBF”), an independent financial advisor to the Independent Committee and the Board of Directors, has provided opinions to the Independent Committee and the Board of Directors that, subject to the scope of review, assumptions and limitations set forth in its opinions: (i) the Recapitalization Transaction, if implemented, is fair, from a financial point of view, to the Company, and (ii) the Recapitalization Transaction, if implemented, is fair, from a financial point of view, to the Noteholders and the Shareholders.

Following the Company’s review and consultation process, and after careful consideration and based on a number of factors (including those set forth above), the opinions and financial advice of NBF, and advice from the Independent Committee and Company’s legal counsel, the Independent Committee and the Board of Directors have unanimously determined that the Recapitalization Transaction represents the best available option to address the current liquidity challenges facing the Company and provide Source with a sustainable long-term capital structure that will maximize recovery for all stakeholders. The Board of Directors unanimously recommends that Noteholders and Shareholders support the Recapitalization Transaction.

Required Approvals and Implementation of the Recapitalization Transaction

Noteholder Approvals

Source intends to implement the Recapitalization Transaction through a corporate plan of arrangement under the CBCA. To proceed by way of a CBCA Plan, Source intends to bring an application before the Court of Queen’s Bench of Alberta (the “Court”) for an interim order authorizing the Company to hold a meeting of Noteholders (the “Noteholder Meeting”) to vote on the CBCA Plan giving effect to the Recapitalization Transaction. The record date for voting at the Noteholder Meeting and additional information in respect of the Noteholder Meeting will be announced by the Company in due course. To date, Noteholders holding approximately 74% of the principal amount of the Notes have entered into the Noteholder Support Agreement and agreed to support the CBCA Plan.

Shareholder Approvals

The Recapitalization Transaction will also require certain approvals of Shareholders under applicable corporate law and the policies of the TSX, which Source intends to seek as a matter of special business at the Company’s annual meeting of Shareholders.

The date of any applicable meeting of Shareholders, the record date for voting at the meeting, and additional information in respect of the meeting, the Share Consolidation and the Recapitalization Transaction will be announced and made available by the Company.

Implementation of the Recapitalization Transaction

The Company has agreed to take commercially reasonable actions to complete the Recapitalization Transaction, subject to all requisite approvals and the other conditions to completion of the Recapitalization Transaction being obtained, satisfied or waived. These conditions include receipt of required Noteholder and Shareholder approvals, receipt of TSX approval, execution of definitive documents (including definitive documentation with respect to the New Secured Notes, the Amended Credit Facility and the BDC Facility), and the satisfaction or waiver of applicable conditions precedent in the Noteholder Support Agreement. The Recapitalization Transaction will require approval of the CBCA Plan by the Court, such other approvals as may be required by the Court, and the satisfaction or waiver of applicable conditions precedent in the CBCA Plan.

Additional Information and Materials

The form of Noteholder Support Agreement and Shareholder Support Agreement (subject to redactions for certain confidential and/or commercially sensitive information contained in such agreements) will be filed by Source on SEDAR (www.sedar.com) and Source’s website (www.sourceenergyservices.com). Additional information and key dates in connection with implementation of the Recapitalization Transaction, including with respect to Noteholder and Shareholder approvals, the CBCA Plan, and meeting dates and times will be made publicly available by the Company. Noteholders and Shareholders are urged to review such information carefully and in its entirety.

The Company’s legal advisors in connection with the Recapitalization Transaction are Goodmans LLP, while Norton Rose Fulbright Canada LLP and NBF acted for the Independent Committee. The Initial Consenting Noteholders are advised by Bennett Jones LLP and FTI Consulting Canada Inc.

This press release is not an offer of securities for sale in the United States. Securities may not be offered or sold in the United States absent an exemption from registration under the Securities Act of 1933.

ABOUT SOURCE ENERGY SERVICES

Source is a logistics company that focuses on the supply and distribution of high quality Northern White frac sand. Source provides its customers with a full end-to-end solution supported by its Wisconsin mines and processing facilities, its Western Canadian terminal network and its “last mile” logistics capabilities. In addition to its industry leading frac sand transload terminal network and in-basin frac sand storage capabilities, Source also provides storage and logistics services for other bulk oil and gas well completion materials that are not produced by Source. Source has also developed Sahara, a proprietary wellsite mobile sand storage and handling system.

Source’s full-service approach allows customers to rely on its logistics capabilities to increase reliability of supply and to ensure the timely delivery of their requirements for frac sand and other bulk completion materials at the wellsite.

FORWARD-LOOKING STATEMENTS

Certain statements contained in this press release constitute forward-looking statements relating to, without limitation, expectations, intentions, plans and beliefs, including information as to the future events, the Recapitalization Transaction, the CBCA Plan, the Amended Credit Facility, the BDC Facility, results of operations and Source’s future performance (both operational and financial) and business prospects. In certain cases, forward-looking statements can be identified by the use of words such as “expects”, “estimates”, “forecasts”, “intends”, “anticipates”, “believes”, “plans”, “seeks”, “projects” or variations of such words and phrases, or state that certain actions, events or results “may” or “will” be taken, occur or be achieved. Such forward-looking statements reflect Source’s beliefs, estimates and opinions regarding the Recapitalization Transaction and related transactions, its future growth, results of operations, future performance (both operational and financial), and business prospects and opportunities at the time such statements are made, and Source undertakes no obligation to update forward-looking statements if these beliefs, estimates and opinions or circumstances should change. Forward-looking statements are necessarily based upon a number of estimates and assumptions made by Source that are inherently subject to significant business, economic, competitive, political and social uncertainties and contingencies. Forward-looking statements are not guarantees of future performance. In particular, this press release contains forward-looking statements pertaining, but not limited, to: expectations regarding the Recapitalization Transaction, including the terms, timing and implementation of the Recapitalization Transaction and related financings, including the Amended Credit Facility and the BDC Facility; expectations regarding demand for and sales volumes of sand in light of the COVID-19 pandemic; expectations regarding the price of proppants and sensitivity to changes in such prices; outlook for operations and sales volumes; expectations respecting future competitive conditions; industry activity levels; expectations regarding market share; industry conditions pertaining to the frac sand industry; expectations regarding customer relationships and counterparty risk; drilling and well completion activity in 2020; expectations regarding the impact of direct-source contracts; sand sales volumes and sand spot pricing in 2020; expectations regarding future working capital and capital expenditures; the ability to secure future funding; expectations regarding fluctuations in foreign currency; expectations regarding the severity and outcome of legal claims and proceedings; expectations regarding insurance coverage and proceeds; expectations regarding the impact of climate change; risks associated with information systems and cyber security and operational risks. Statements relating to mineral resources are deemed to be forward looking-statements, as they involve the implied assessment, based on certain estimates and assumptions, that the mineral resources described exist in the quantities predicted or estimated and that the mineral resources described might be able to be profitably produced in the future.

By their nature, forward-looking statements involve numerous current assumptions, known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Source to differ materially from those anticipated by Source and described in the forward-looking statements.

With respect to the forward-looking statements contained in this press release, assumptions have been made regarding, among other things: the Recapitalization Transaction; proppant market prices; future oil, natural gas and natural gas liquids prices; future global economic and financial conditions; future commodity prices, demand for oil and gas and the product mix of such demand; levels of activity in the oil and gas industry in the areas in which Source operates; the continued availability of timely and safe transportation for Source’s products, including without limitation, Source’s rail car fleet and the accessibility of additional transportation by rail and truck; the maintenance of Source’s key customers and the financial strength of its key customers; the maintenance of Source’s significant contracts or their replacement with new contracts on substantially similar terms and that contractual counterparties will comply with current contractual terms; operating costs; that the regulatory environment in which Source operates will be maintained in the manner currently anticipated by Source; future exchange and interest rates; geological and engineering estimates in respect of Source’s resources; the recoverability of Source’s resources; the accuracy and veracity of information and projections sourced from third parties respecting, among other things, future industry conditions and product demand; demand for horizontal drilling and hydraulic fracturing and the maintenance of current techniques and procedures, particularly with respect to the use of proppants; Source’s ability to obtain qualified staff and equipment in a timely and cost-efficient manner; the regulatory framework governing royalties, taxes and environmental matters in the jurisdictions in which Source conducts its business and any other jurisdictions in which Source may conduct its business in the future; future capital expenditures to be made by Source; future sources of funding for Source’s capital program; Source’s future debt levels; the impact of competition on Source; and Source’s ability to obtain financing on acceptable terms.

A number of factors, risks and uncertainties could cause results to differ materially from those anticipated and described herein including, among others: Source’s ability to complete the Recapitalization Transaction and obtain requisite stakeholder and Court approvals; the final terms, timing and implementation of the Recapitalization Transaction and related transactions; effects of competition and pricing pressures; risks inherent in key customer dependence; effects of fluctuations in the price of proppants; risks related to indebtedness and liquidity, including Source’s leverage, restrictive covenants in Source’s debt instruments and Source’s capital requirements; risks related to interest rate fluctuations and foreign exchange rate fluctuations; changes in general economic, financial, market and business conditions in the markets in which Source operates; changes in the technologies used to drill for and produce oil and natural gas; Source’s ability to obtain, maintain and renew required permits, licenses and approvals from regulatory authorities; the stringent requirements of and potential changes to applicable legislation, regulations and standards; the ability of Source to comply with unexpected costs of government regulations; liabilities resulting from Source’s operations; the results of litigation or regulatory proceedings that may be brought against Source; the ability of Source to successfully bid on new contracts and the loss of significant contracts; uninsured and underinsured losses; risks related to the transportation of Source’s products, including potential rail line interruptions or a reduction in rail car availability; the geographic and customer concentration of Source; the impact of climate change risk; the ability of Source to retain and attract qualified management and staff in the markets in which Source operates; labour disputes and work stoppages and risks related to employee health and safety; general risks associated with the oil and natural gas industry, loss of markets, consumer and business spending and borrowing trends; limited, unfavourable, or a lack of access to capital markets; uncertainties inherent in estimating quantities of mineral resources; sand processing problems; implementation of recently issued accounting standards; the use and suitability of Source’s accounting estimates and judgments; and the impact of information systems and cyber security breaches.

Although Source has attempted to identify important factors that could cause actual actions, events or results to differ materially from those described in the forward-looking statements, there may be other factors that cause actions, events or results not to be as anticipated, estimated or intended. There can be no assurance that forward-looking statements will materialize or prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. The forward-looking statements contained in this press release are expressly qualified by this cautionary statement. Readers should not place undue reliance on forward-looking statements. These statements speak only as of the date of this press release. Except as may be required by law, Source expressly disclaims any intention or obligation to revise or update any forward-looking statements or information whether as a result of new information, future events or otherwise.