Source Energy Services Reports Q3 2020 Results

Calgary, Alberta (October 29, 2020) TSX: SHLE

Source Energy Services Ltd. (“Source” or the “Company”) is pleased to announce its 2020 third quarter financial results.

SUMMARY

Against a backdrop of continued volatility and uncertainty resulting from the ongoing coronavirus pandemic (“COVID-19”), Source achieved the following results for the three months ended September 30, 2020:

– realized sand sales volumes of 609,469 metric tonnes (“MT”), an 11% increase over the third quarter of 2019, and sand revenue of $65.2 million;
– distributed total volumes through Source’s Western Canadian Sedimentary Basin (“WCSB”) terminal network of 625,868 MT;
– even with higher activity levels seen in the third quarter, Source maintained cost control measures, resulting in a reduction of 30% for operating and general and administrative expense compared to the third quarter of 2019;
– successfully completed the renegotiation of certain rail car lease contracts, effective September 2020, resulting in significant savings for monthly lease payments and a reduction to Source’s total lease obligations outstanding;
– realized gross margin of $7.0 million and Adjusted Gross Margin(1) of $17.3 million;
– realized Adjusted EBITDA(1) of $13.0 million;
– reduced net loss for the three months ended September 30, 2020 to $7.9 million, or $(0.13) per share; and
– announced a proposed Recapitalization Transaction (as defined below) subsequent to quarter end, which will provide a stronger long-term capital structure for Source. This capital structure will enhance liquidity and increase financial flexibility, allowing Source to withstand industry volatility while still building on its position as the largest frac sand provider in the WCSB.

Note:
(1) Adjusted EBITDA and Adjusted Gross Margin (including on a per MT basis) are not defined under IFRS, refer to ‘Non-IFRS Measures’ below.

RESULTS OVERVIEW

Notes:
(1) One MT is approximately equal to 1.102 short tons.
(2) The average Canadian to US dollar exchange rate for the three and nine months ended September 30, 2020 was $0.7507 and $0.7385, respectively (2019 - $0.7573 and $0.7523, respectively).
(3) Adjusted EBITDA and Adjusted Gross Margin (including on a per MT basis) are not defined under IFRS, refer to ‘Non-IFRS Measures’ below.

Q3 2020 RESULTS

Results for the third quarter of 2020 reflect a rebound in activity levels in the WCSB, favorably impacting sand sales volumes which increased by 11% compared to the third quarter of 2019. While higher volumes were achieved, sand revenue and total sales revenue were lower by $2.4 million and $1.3 million, respectively, for the third quarter of 2020 compared to the same period last year, due to lower realized sand prices. Wellsite solutions revenue for the third quarter of 2020 was also favorably impacted by the increase in activity levels, with higher trucking revenue and higher Sahara-related revenue compared to the third quarter of 2019.

Cost of sales, excluding depreciation and depletion, continues to be favorably impacted by previously implemented cost savings initiatives and production efficiencies. Reductions in cost of sales have been further impacted by ongoing optimization efforts related to logistics costs.

With the onset of COVID-19, in the second quarter of 2020 Source took immediate steps to ensure the safety of its employees and customers, and implemented a COVID-19 program to protect the health and well-being of employees. In order to further mitigate the impact of the operating environment, Source implemented operational cost reductions and other measures which continued into the third quarter and will continue for the balance of 2020, including the following:

– reduced staff levels and hours of operations;
– reduced board of directors, executive and salaried employee compensation and benefits;
– eliminated all discretionary expenditures;
– reduced capital expenditures;
– negotiated deferral of interest payment obligation on the Notes (as defined below);
– received proceeds from the US Small Business Administration’s Paycheck Protection Program (the “US PPP Loan”); and
– received proceeds from the Canadian Emergency Wage Subsidy (“CEWS”) program.

In addition to the initiatives noted above, Source also worked closely with certain rail car lease vendors to negotiate more favorable long-term contracts. Source has finalized these negotiations, effective September 2020, resulting in the execution of amended rail car lease contracts which significantly reduce ongoing monthly lease payments and lowered Source’s long-term obligations for these leases.

Gross margin and Adjusted Gross Margin decreased by $0.7 million and $1.4 million, respectively, compared to the third quarter of 2019. The reductions were attributed to lower pricing realized, partially offset by the aggressive cost reduction initiatives implemented, as discussed above, as well as logistics efficiencies achieved.

Compared to the prior year’s third quarter, operating and general and administrative expenses for the three months ended September 30, 2020 were lower by $2.2 million, or 30%. Workforce optimization efforts implemented in 2019 as well as cost control measures undertaken in response to COVID-19, as discussed below, drove further reductions in people costs. Operating and general and administrative expenses were also favorably impacted by the receipt of proceeds from the CEWS program of $0.5 million in the quarter.

For the three months ended September 30, 2020, Adjusted EBITDA was $13.0 million, $1.0 million higher than the $12.0 million of Adjusted EBITDA generated in the three months ended September 30, 2019.

PROPOSED RECAPITALIZATION TRANSACTION

On October 7, 2020, the Company announced a proposed recapitalization transaction (the “Recapitalization Transaction”) in a news release (the “Transaction Announcement”), designed to provide the Company with a stronger, long-term capital structure and provide enhanced liquidity and financial flexibility. For additional details and key terms related to the Recapitalization Transaction, please refer to the Transaction Announcement, the interim order news release dated October 26, 2020 and Source’s Management’s Discussion and Analysis dated October 29, 2020.

COVID-19 AND FUTURE OPERATIONS

In March 2020, COVID-19 was declared a global pandemic by the World Health Organization. Measures enacted to prevent the spread of the virus have resulted in global business disruption with significant economic repercussions. At the end of the first quarter of 2020, as a result of the weakening economic climate and demand for crude oil, the Company carried out an assessment of the recoverable value of its operations, resulting in an impairment loss recognized in the first quarter of 2020. For the three months ended September 30, 2020, the Company determined that no additional indicators of impairment were present and concluded no further impairment analysis was required.

In May 2020, as a result of the weakened operating climate, the Company obtained covenant relief from its banking syndicate, including the waiver of the application of the fixed charge coverage ratio from May 31, 2020 and subsequently through October 30, 2020. In June 2020, Source entered into a Support and Interest Deferral Agreement (as amended, the “Deferral Agreement”) with noteholders holding approximately 72% of Source’s Notes. Under the Deferral Agreement, the June 15, 2020 interest payment on the Notes has been deferred until October 31, 2020. The Company recently announced the proposed Recapitalization Transaction and the interim order, as referenced above. However, there can be no assurance that the Recapitalization Transaction will be completed, and therefore there is material uncertainty that may cast doubt on the Company’s ability to continue as a going concern.

Source’s condensed consolidated interim financial statements have been prepared on a going concern basis and do not reflect adjustments and classifications of assets, liabilities, revenues and expenses which would be necessary if the Company were unable to continue as a going concern. Such adjustments could be material.

LIQUIDITY AND CAPITAL RESOURCES

The Company has a banking operating facility, comprised of an asset backed loan facility (“ABL”) and a standby letter of credit facility (collectively, with the ABL, the “Credit Facility”). As of September 30, 2020, Source had $25.7 million drawn under its ABL. The Credit Facility was also being used to support $16.0 million of letters of credit leaving $21.0 million of available liquidity. Source is subject to externally imposed capital requirements for the Credit Facility, requiring Source Energy Services Canada LP to maintain a springing fixed charge ratio of 1.25:1 to be measured when Source’s excess availability is less than 20% of the lesser of the borrowing base and the operating facility. In February 2020 an amendment to the ABL was completed, effective January 1, 2020, which included a reduction of the springing fixed charge ratio from 1.25:1 to 1.10:1 for all periods ending on or before December 31, 2020. In May 2020, as a result of the weakened operating environment, as noted above, Source obtained covenant relief from its banking syndicate, including the waiver of the application of the fixed charge coverage ratio from May 31, 2020 through October 30, 2020.

In the third quarter of 2020, capital expenditures were $0.4 million, $1.4 million lower than the same period last year. Source previously announced that capital spending for 2020 was expected to be limited to $5.6 million. Previous investment in processing assets and logistics infrastructure will allow for modest capital expenditures through 2020 and beyond even as industry activity returns to more normalized levels.

BUSINESS OUTLOOK

While Source’s results for the third quarter were encouraging, the rebound in economic activity remains uncertain as recent surges in the number of active COVID-19 cases raises the question of a potential second wave of the virus, further emphasizing a slow and gradual recovery. The Company expects lower revenue and profitability for the remainder of 2020 and the potential for continued volatility in industry activity into 2021.

Source cannot predict the extent of the impact COVID-19 may have on energy demand, or how the Organization of the Petroleum Exporting Countries will react to those changes in demand and how those events could impact the Company’s operations. Source cannot reasonably estimate the period of time that adverse business conditions will persist, the impact they will have on the Company’s business, liquidity, consolidated results of operations and consolidated financial condition, or the pace of any subsequent recovery.

Beyond 2020, we continue to remain optimistic about the longer-term industry prospects, including increased demand for WCSB natural gas driven by LNG, coal to natural gas conversions and increased gas pipeline capacity. In addition, analysis of oil pipeline egress capacity and the potential for additional hydrocarbon shipments by rail continue to support the Company’s expectation that activity levels should substantially increase in the coming years.

Source has seen exploration and production (“E&P”) companies drive additional efficiencies in their completion programs by completing fracs over much shorter periods of time, requiring larger volumes of frac sand. Source’s terminal network and logistics capabilities have become a key component in the success of these accelerated frac programs, further enhanced by the delivery capability of the Sahara units. Source is ideally positioned to serve the increase in demand for frac sand and logistics services as activity levels rebound.

Source continues to focus on improving logistics for other items needed at the wellsite, in response to customer requests to expand its service offerings, and continues to develop opportunities to further utilize its existing Western Canadian terminals to provide additional diversification of its business. Over the longer-term, Source anticipates that these new terminal services will be a meaningful part of its business.

ABOUT SOURCE ENERGY SERVICES

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

Source’s full-service approach allows customers to rely on its logistics platform 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.

IMPORTANT INFORMATION

These results should be read in conjunction with each of Source’s unaudited condensed consolidated interim financial statements for the three and nine months ended September 30, 2020 and 2019, and Source’s audited consolidated financial statements for the year ended December 31, 2019, together with the accompanying notes (the “Financial Statements”) and its corresponding MD&A for such periods. The Financial Statements and MD&A and other information relating to Source, including the Annual Information Form (“AIF”), are available under the Company’s SEDAR profile at www.sedar.com. The Financial Statements and comparative statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board. Unless otherwise stated, all amounts are expressed in Canadian dollars.

NON-IFRS MEASURES

In this press release Source has used the terms Adjusted Gross Margin and Adjusted EBITDA, including per MT, which do not have standardized meanings prescribed by IFRS and Source’s method of calculating these measures may differ from the method used by other entities and, accordingly, they may not be comparable to similar measures presented by other companies. These financial measures should not be considered as an alternative to, or more meaningful than, net income (loss), gross margin and other measures of financial performance as determined in accordance with IFRS. For additional information regarding non-IFRS measures, including their use to management and investors and reconciliations to measures recognized by IFRS, please refer to the MD&A, which is available online at www.sedar.com and through Source’s website at www.sourceenergyservices.com.

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, results of operations and Source’s future performance (both operational and financial) and business prospects. In certain cases, forwardlooking 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 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: the Recapitalization Transaction and the capital structure of Source after such Recapitalization Transaction is completed; our continued optimism for longer term industry prospects and increased demand for LNG on WCSB activity levels; anticipated improvements in pipeline egress and transportation capacity, coal to natural gas power generation conversions and the potential for additional hydrocarbon shipments by rail; outlook for operations and sales volumes; expectations respecting future conditions; revenue and profitability; industry activity levels; the unknown impact of COVID-19 on the global economy and the effect it may continue to have on the Company’s business, liquidity, operations and financial condition and the pace of any subsequent recovery; expectations regarding market share; industry conditions pertaining to the frac sand industry; the benefits that Source’s “last mile” services provide to customers; expectations regarding customer relationships and counterparty risk; the anticipated effect of terminal services on Source’s business; expectations regarding funding for future working capital and capital expenditures; Source’s planned cash outflows relating to lease commitments and financial liabilities; the ability to secure future funding; expectations on Source’s ability to meet their capital needs; uncertainty regarding Source’s ability to continue as a going concern if the Recapitalization Transaction is not completed; expectations regarding fluctuations in foreign currency; expectations regarding the severity and outcome of legal claims and proceedings; expectations regarding the impact of climate change; risks associated with information systems and cyber security; and operational risks.

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: our ability to complete the Recapitalization Transaction, the ability to obtain the third party consents required to complete same and the timeframe in which such consents will be obtained; 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: the inability to obtain the consents required to complete the Recapitalization Transaction, and, thus, our inability to complete the Recapitalization Transaction; the 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.

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