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Edited Transcript of SHLE.TO earnings conference call or presentation 2-May-19 1:30pm GMT

Q1 2019 Source Energy Services Ltd Earnings Call

CALGARY Jun 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Source Energy Services Ltd earnings conference call or presentation Thursday, May 2, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bradley J. Thomson

Source Energy Services Ltd. - CEO, President & Director

* Derren J. Newell

Source Energy Services Ltd. - CFO

* Joe Jackson

Source Energy Services Ltd. - SVP of Commercial Development

* Scott Melbourn

Source Energy Services Ltd. - COO

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Conference Call Participants

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* Aaron MacNeil

TD Securities Equity Research - Analyst

* Daine Biluk

CIBC Capital Markets, Research Division - Associate

* Elias A. Foscolos

Industrial Alliance Securities Inc., Research Division - Equity Research Analyst

* Garett Dwayne Ursu

Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research

* Ian Brooks Gillies

GMP Securities L.P., Research Division - Director of Institutional Research and Research Analyst of Energy Services & Infrastructure

* Michael Mazar

BMO Capital Markets Equity Research - Equity Analyst of Oil and Gas Services

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Presentation

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Operator [1]

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Good morning. My name is Adam, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Source Energy Services 2019 First Quarter Financial Results Conference Call. (Operator Instructions)

Thank you. Mr. Thomson, you may begin your conference.

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [2]

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Great. Thank you, operator. Good morning, and welcome to Source Energy Services first quarter 2019 conference call. My name is Brad Thomson, and I'm the CEO of Source. I'm joined today by Derren Newell, our CFO; Scott Melbourn, our COO; and Joe Jackson, our Senior Vice President of Commercial Development. The formal portion of the call will be covered by Derren Newell and myself, and Joe and Scott will be available for questions after the call.

Before we get started, I'd like to refer everybody to the financial statements and the MD&A that were posted to the SEDAR and to the company's new website last night. I'd also like to remind you of the advisory on forward-looking information found in our MD&A and our press release.

On this call, Source's numbers are in Canadian dollars, metric tonnes and refer to adjusted gross margin, EBITDA, adjusted EBITDA, which are all non-IFRS measures that are described in our MD&A. With the exception of the items just mentioned, our financial information is prepared in accordance with IFRS. We'll begin by discussing Source's performance in the first quarter of 2019, then I'll speak to what we're seeing in the markets and our expectations for the remainder of the year.

I'll start with the key highlights for the first quarter of 2019, which include sand sales of 698,000 metric tonnes and sand revenue of $91.1 million, this is an increase of 9% and 5% respectively, quarter-over-quarter; a 17% growth in sand sales volumes from Q4 2019 that were all made in the Western Canadian Sedimentary Basin; distribution of more than 733,000 metric tonnes of product, which includes third party sand and other products distributed through Source's WCSB terminal network; extension to 2021 of a major existing frac sand sales and logistics services contract with a leading Canadian oil and gas company; substantial completion of our 2019 growth capital program, including the expansion at our Fox Creek terminal to support our supply contract with Shell; the deployment of a second Sahara unit into the Marcellus; and finally, advancement of our diversification initiatives by obtaining permits to ship crude by rail from our Wembley facility.

Looking at things in greater detail, late last year, the first quarter of 2019 had its winter weather challenges. As we faced extremely cold weather and significant amounts of snow in Canada and at our Western -- Wisconsin production facilities. However, Source was in a better position this year to deal with severe weather in Q1, thanks to our 2018 capital program that added approximately 70,000 tonnes of storage to our in-basin terminals such as our Fox Creek terminal, which is the only [per] unit train [capable terminal] service into Duvernay and our expanded Wembley terminal which is now the largest frac sand terminal servicing the Montney.

Utilizing this new storage capacity, Source will replace nearly 200,000 metric tonnes of inventory at our in-basin terminals ahead of the winter storms, enabling Source to fill a much higher percentage of its Q1 orders year-over-year.

While our expanded capacity helped mitigate the impact of severe Q1 weather, we still experienced some short term inventory stockouts that resulted in lost sales as well as additional logistic costs in servicing our contracted customers. The stockouts in Q1 2019 were not as significant as those in Q1 of 2018 and with the recent concluded expansion at Fox Creek and other measures that are going to be taken by Source, we're confident that we'll see fewer weather-related stockouts in the future.

As I mentioned, sand sales volumes in the first quarter of 2019 were 698,000 metric tonnes, which is a 9% increase within the same quarter of 2018 and 87% higher than the fourth quarter of 2018.

Whereas the first quarter of 2018, approximately 10% of Source's sand sales were made at the mine gate in Wisconsin, the first quarter of 2019 saw 100% of Source's sand sales made to our Canadian terminals. This is due to a combination of Source securing additional in-basin contracts for Canadian sales and lower U.S. demand for Northern White sand.

The growth in Source's sales volumes in the quarter when the rest of the industry have seen a slowdown is a testament to our ability to uniquely serve the needs of our customers who are focused on high efficient -- efficiency completion activities. Today's fracs not only need large volumes of sand, but they also need the sand delivered over a very short period of time. This is where Source shines, and this is the type of jobs that resulted in an increase in Source sales volumes for the quarter.

Now looking specifically at our financial results for the quarter, Source had adjusted EBITDA of $14.8 million, which was a decrease of 5.87 -- $5.7 million when compared to the $20.5 million of adjusted EBITDA generated in the first quarter of 2019. There are several factors that contributed to this year-over-year decrease in adjusted EBITDA. On the revenue side, higher in-basin sales volumes were not able to fully offset the lower average selling price per metric tonne. Lower average selling prices per metric tonne were driven by changes in location where our sand was delivered as well as lower priced Duvernay -- as our lower priced Duvernay sales grew in the quarter and replaced some of our higher-priced margin sales seen in the previous year.

The lower sand sales price can also be attributed to changes in our customer mix as lower vintage contract customers represented a greater percentage of sales volumes and the changes in our product mix as lower margin sized products represented a higher percentage of sales.

On the frac side, we had a higher logistics costs as severe weather caused temporary stockouts, as I mentioned before. [In that] various terminals throughout the quarter, we are forced to increase our trucking costs. We also experienced higher insurance costs during the quarter due to the impact of a onetime U.S. insurance adjustment.

Now I'd like to turn our attention to the outlook for 2019. Completion activities across the WCSB in the first quarter of 2019 improved from Q4 2018 but were significantly lower than the volumes we saw in Q1 of 2018. Regardless of these lower overall completion activity within the basin [into] Q1 2019, Source's market share increased as more of the Source's sales were made under contract to customers that made up a bigger piece of the activity in Western Canada. Today, around 80% of Source's sales are made directly to operating companies.

For the second quarter, we expect to see very similar sale books from the perspective of volume, customer and location of our -- and product mix as we saw in Q1. However in Q2, we always have to worry about the implications of a prolonged spring breakup. Spring breakup has not been a major factor for Source for the last few years, but there's always a possibility that breakup will impact the completion activities in Q2.

While Source continues to have conversations with the operators, we want to move more into manufacturing mode in the Montney and the Duvernay. Uncertainty around takeaway capacity and government policy towards oil and gas sectors have certainly weighed heavily on the upstream capital investment decisions. This has resulted in what we can only describe as record low visibility on the activity through the last half of this year. This situation is not unique to Source. It's a challenge faced by every oilfield service company operating in the WCSB.

Source's strategy for navigating through these uncertain times is to leverage our assets base to maximize opportunities when they arise. As spring weather provides faster turn times on our rail cars, we are restocking our terminals during Q2 in anticipation of Q3 spot sales demand that will have tighter time frame from order to pickup than what's been customary. By having more in-basin storage than all other providers combined, Source is in the best position to capitalize on demand space.

As I previously mentioned, Source has also witnessed a significant improvement in the frac efficiency on the jobs that we're serving. The increase in frac efficiency doesn't change the amount of sand that needs to reach the well, but it does change the amount of sand that's required each day. These higher delivery standards render the logistics capacity from certain competitors inadequate to serve the needs of today's larger frac. Today, Source is working on numerous Duvernay jobs acquiring more than 2,000 metric tonnes, 1 [mesh side] of the product per day. Earlier this month, we moved over 3,500 tonnes, metric tonnes of proppant to a single pad in a single day to our customer. This is an incredible amount of frac sand being delivered to 1 particular location.

The tendency towards the fast use of large volumes of sand has and will continue to put a spotlight on our logistics capabilities, taking Source's unit train-enabled high storage capacity terminals, as well as our Sahara units more valuable than ever. This trend towards higher efficiency fracs, Source has recently won new customers that were previously using local sand as our solutions offer more value to the oil and gas company when all factors are considered.

Now turning to Sahara. Source has deployed 5 Sahara units in the WCSB, under various contractual arrangements. And in late Q4, we opened our first U.S. field solutions locations in the Marcellus. There we deployed our [6th.] Sahara unit to the region.

Based on the positive market receptions in the Marcellus, we've also delivered the newest unit in our fleet, Sahara unit #7 to the U.S. Northeast. As with all our units, the decision of where we deploy additional Sahara units will be driven by customer demand. We will only be building additional Sahara units when we secure contractual commitments to support them.

On the profit of capital spending, our 2019 capital spending program has not changed, and it mainly consists of a modest amount of maintenance capital expenditures and capital for the additional storage at our Fox Creek terminal which is underpinned by a long term dedicated contract. In the first quarter, we spent approximately $15.8 million of our $23 million capital budget, leaving the large majority of the capital spend over the last 3 quarters related to maintenance capital. Even with this very modest capital spend over the last 3 quarters, Source is well-positioned to immediately ramp up its production volumes at its terminals and its throughput when the resumption of robust WCSB completion activities commence.

Now I'll turn things over to Derren Newell, who'll provide you more detail on our first quarter results.

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Derren J. Newell, Source Energy Services Ltd. - CFO [3]

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Thanks, Brad. Turning to first quarter 2019, Source implemented the new IFRS standard on leasing with no restatement of its 2018 results as allowed under the standard. The adoption of the standard effectively moves the accounting from what used to be operating leases to match the accounting of finance leases. For Source, the adoption of this standard and the change in accounting has a significant impact on our balance sheet as we recorded $76.1 million of right of use assets and $76.1 million in lease liabilities.

From an EBITDA perspective, when we moved the operating lease costs from cost of sales operating costs and G&A cost to depreciation and interest, while our net incomes does not change, EBITDA does go up in 2019 versus 2018. Over the course of 2019, EBITDA should increase approximately $25 million if EBIT [is] changed. If the 2018 results were restated, they would have been in a similar impact within Q2 results as seen in 2019.

Clarity in the numbers I'm about to talk to you for 2019 including accounting for these changes while the comparative period does not.

Source recorded a net loss of $7.3 million for the first quarter of $0.12 per share compared to net income of $2.7 million or $0.06 per share for the first quarter of 2018. Source's revenue in the first quarter of 2019 increased by $2.8 million or a 3% compared with the first quarter of 2018.

Sand revenues increased by 5% [of the] 55,574 metric tonne increase in sand volumes was partially offset by a 3% increase in the average realized sand price.

Due to the increased sales of finer sands increase in the lower stock market sales in quarter. Compared to the fourth quarter of 2018, Q1 sand revenues increased by 45.7 million owing to an 87% increase in sand volume which was compounded by an $8.70 per metric tonne increase in the average realized sand price because of higher mine gate sales in the fourth quarter of 2018.

Mine gate sales represented 15% of sales in the fourth quarter of 2018 versus 0% for the first quarter of 2019. Wellsite solutions revenue for the first quarter of 2019 decreased by $1.8 million compared with the first quarter of 2018 due to a 15% decrease in trucking revenues as that ancillary business was down in Q1 of 2019. The trucking revenue decreases partially offset by an increase in Sahara revenues as there were 7 units that were 74% revised versus 3 units of 84% in Q1 '18. Wellsite solutions revenue increased by $8.2 million sequentially from the fourth quarter primarily due to a 74% increase in Sahara-related revenues and 132% increase in trucking revenues, and volumes were 87% higher when compared to the fourth quarter of 2018.

Adjusted gross margin in the first quarter was $34.85 per metric tonne, which was $6.33 per metric tonne lower than the adjusted gross margin realized in the first quarter of 2018 as the decline in the average realized sand price more than offset the lower cost of sales per metric tonne.

Operating costs for the first quarter were $5.2 million which was $1.9 million higher than the first quarter of 2018 due to higher selling costs that [hurt] the sales volumes and an increase in the U.S. insurance expense that I had mentioned previously as a result of the earned premium adjustment for 2018. General and admin costs of $4.8 million in the quarter were consistent with prior year.

Finance expenses increased $2.1 million to $6.9 million in the first quarter 2019 compared to the same period 2018 due primarily to the $1.5 million increase related to lease liability arising from the IFRS change and the increase in the interest cost on the additional $50 million of Notes that were issued during the second quarter of 2018.

On March 31, Source borrowed $24.5 million on its asset-backed loan facility and was using its facility to support $21.7 million of letters of credit, leaving us $25.5 million of liquidity available. As the activity picks up in the first quarter compared to the fourth quarter, working capital levels [fell] which are required to draw on the ABLs.

Source recorded a tax recovery in the first quarter 2019 of $2.2 million compared to tax expense of $1.8 million in the first quarter of '18. Source is not expecting to record any current tax expense in 2019. Capital expenditures for the first quarter were $15.8 million focused on the terminal expansion at Fox Creek and capital costs for Sahara #8 and Sahara upgrade optimization projects that are planned as well as [overburden] of the results.

Thank you for your time this morning, and that concludes the formal portion of our call. We'll ask the operator to open the lines for question.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And the first question comes from Daine Biluk from CIBC World Markets.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [2]

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Can you talk a little bit about where spot pricing for mine gate 40/70 and 30/50 has moved so far in 2019 relative to Q4 of last year? I realized you didn't have any mine gate sales in Q1, but I'm just trying to get a sense of that pricing trend purely for Northern White sand.

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [3]

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Yes, absolutely. Let me turn it over to Joe Jackson to answer that.

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Joe Jackson, Source Energy Services Ltd. - SVP of Commercial Development [4]

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Hey, Daine, good morning. Good question. Just to touch on Q4 last year, as we noted on that call, there was a very soft market from Northern White mine gate. And if there were volumes that could clear, they were at the industry's average marginal costs so you're looking at low-20s per tonne. And today for 40/70, we're seeing spot prices in the low-30s. So there's been some recovery in that space. But again, we're looking to maximize the amount of 40/70 leading to our in-basin terminals. On 30/50, demand for 30/50 remains challenged because of our unit train capacity at multiple CN margins. We will have some opportunities to participate in 30/50, but for the most part, 30/50 demand remains under pressure, mine gate.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [5]

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Okay. Thank you, that is a great color. And then I guess maybe just on to some of the sales in the quarter, can you share how much would have been 100 mesh?

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Joe Jackson, Source Energy Services Ltd. - SVP of Commercial Development [6]

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Daine, this is Joe. We're looking at 100 mesh portfolio in Canada that's growing. We could see getting as high as 10% here for the year. We're a little bit under that in Q1.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [7]

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Got you. Okay. Perfect. I guess shifting gears a little bit, within the wellsite solutions segment, some of the softness you discussed around the ancillary with this fixed revenue, was that anything specific to Q1 or is that something we should expect to continue going forward? Just kind of given the customers you're currently working with?

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [8]

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Yes, I'll answer that one, Daine. It was specific to Q1. In Q1, with the cold weather and rail outages, we were forced to truck from more distant locations. That adds to our logistics costs. So that was a substantial impact, which was weather-related. Q2 we're not seeing that, and of course, we don't anticipate we'll see that going forward. As I mentioned in my portion of the call, what we're going to be doing next year is we're going to be taking some extra measures to preplace some inventories and in a few different locations, and we'll be bringing down that logistics costs associated with the trucking to more distant locations. Scott, did you have anything like to add to that?

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Scott Melbourn, Source Energy Services Ltd. - COO [9]

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No, I think you covered it.

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [10]

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Okay. Good. Thanks, Daine.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [11]

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Okay. Perfect. And then I think maybe just 1 more for me. For the 8 Sahara units that you all have delivered in Q2, will that be either going to the WCSB or Marcellus? Or is there any possibility we could see that heading to a new geography?

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [12]

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Yes. Daine, maybe I'll jump in on that one. Right now, we're talking to a number of customers on Sahara #8. And so yes, it's likely that it will end up at either in the WCSB or in the Marcellus, but we won't rule out that it can end up at a different geography. We have certainly had some inbounds or availability of the Sahara unit in other basins in the lower 48. So we're certainly weighing all of those inbounds with the discussions that we're having at our current operating basins in Canada and in the Marcellus.

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Operator [13]

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Your next question comes from Elias Foscolos from Industrial Alliance Securities.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [14]

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I got 2 questions, a few have been asked earlier. The trend for mine gate sales for the rest of the year, should we look at Q1 as indicative of what we might see or likely will see going forward given the, I guess, the U.S. producer's desire to find more in-basin sales?

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Joe Jackson, Source Energy Services Ltd. - SVP of Commercial Development [15]

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Elias, this is Joe. Good question. We actually see a much more [constructed] view on our mine gate opportunities for the balance of the year. The challenge for Source is going to be ensuring that we're maximizing the volume that goes to our terminals. So we look for spot opportunities to sell mine gate as a secondary option. But from Q4 to Q1, there were some significant developments for the mine gate market, and we see those as continuing to mature over the course of the year. So there's definitely an opportunity for Source to capitalize on some opportunities for incremental margin for mine gate sales as the year plays out.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [16]

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Okay. So the way we can look at it is you'll be opportunistic, marginal -- there should be a marginal increase in costs more than marginally offsetting the sales price, and it's something along that line.

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [17]

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Yes. So right now, Elias, we are seeing margins have returned on the mine gate sales. We're on 40/70 and 100 mesh. We're moving all our products in Canada right now and a large portion of 30/50. But if opportunity arises and we have products that's produced in the U.S., yes, we will take advantage of capturing margin on mine gate sales.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [18]

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Great. Shifting over to my last question, it's more on the financial statements, and I'm trying to reconcile something. I'm happy, thanks for the color on the IFRS 16 impact. But what I'm trying to reconcile is how depreciation and the cost of sales moved up. I expected it to move up in lockstep with IFRS 16, but it didn't. It seems to be a bit higher. And I'm wondering is there some sort of accounting change that's going on also the way you're looking at something?

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Derren J. Newell, Source Energy Services Ltd. - CFO [19]

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No, it's more of an operational change that occurred. So Q1 over Q1, we brought up more of our mines earlier in the quarter, and therefore have more overburden related activities. And so that actually increased our depreciation, along with the increase in IFRS 16.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [20]

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So is it possible that, that might normalize down over the next few quarters?

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Derren J. Newell, Source Energy Services Ltd. - CFO [21]

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We are always a little bit [near] on the mining side. Relative to last year absolutely, but in terms of absolute -- you'll see a bit of an increase in Q2 and Q3 as activity picked up in the mines that may have tail off in Q4. That should be much more comparable activity-wise to the prior year.

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Operator [22]

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And your next question comes from Michael of BMO Capital Markets.

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Michael Mazar, BMO Capital Markets Equity Research - Equity Analyst of Oil and Gas Services [23]

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Derren, can you isolate for the first quarter the IFRS 16 impact on your quarter [just the impact] ?

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Derren J. Newell, Source Energy Services Ltd. - CFO [24]

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So over the course of the year, we're into payment of the $25 million impact. And so if you would have annualized that, you see a little bit over $6 million in the quarter. It should be comparable to what you would have seen a year ago.

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Michael Mazar, BMO Capital Markets Equity Research - Equity Analyst of Oil and Gas Services [25]

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So, say, if I subtract $6 million from the $14.8 million, that's the right comparison, if one sort of looked what the year-over-year...

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Derren J. Newell, Source Energy Services Ltd. - CFO [26]

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Yes. Or if you added $6 million to last year's number, that would also be a great comparison.

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Operator [27]

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And your next question comes from Garett Ursu of Cormark Securities.

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Garett Dwayne Ursu, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [28]

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A couple questions for me guys just on the crude-by-rail initiative, I'm curious if you can talk about potential capacity in terms of barrels per day when you are kind of planning or hoping to see some kind of take-up on that. Obviously when differentials widen again, I guess potentially mid-2020. And just a little bit more about the partnership with Tidewater if you can.

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [29]

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Yes. Joe is going to take this one for us, Garett.

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Joe Jackson, Source Energy Services Ltd. - SVP of Commercial Development [30]

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So on throughput capacity, we're quite happy to see the opportunity for moving some liquids to get some other products to our terminals. Wembley's a really exciting terminal for Source to have unit train capacity, the dual track, all the storage. There's another feature of Wembley, and it's all the real estate that we have. So there's a lot of diversification opportunities that we're looking at. And we look to have opportunities to disclose those as we develop. But on the crude-by-rail side today, we see a couple thousand barrel a day facility being the right fit for that market right now. And there's an opportunity to expand that in the very near term depending on the basin commercial developments may come to fruition. So when it comes to how we're going to partner and how we're going to make alliances with the industry, there's more to come on that front. But for now on the capacity side, it will [move] some manifest barrels. [Move some] barrels from the area. And there's an opportunity to do something much larger there if the market supported the...

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [31]

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So Garett, I'll just wait a little bit. So in the many areas in Alberta when an operator start producing their wells, they use crude by rail in order to move the volumes out until pipeline is put in place. We're certainly seeing that in the Pipestone region and then down in the Kakwa as well where there are barrels that have to move up by rail. We are the most convenient location where barrels can be loaded. So initially we will manifest the business, we're [re-moving] a few rail cars out every day, as described by Joe. And then as volumes pick up, then you made the decision as to whether you put in a facility that will allow you to [use to] move the entire of unit trains out. Let's see again as Wembley is that we can't move the entire unit train, so that's where we [got] in the long run. Did that answer your question?

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Garett Dwayne Ursu, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [32]

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Yes, yes. And I guess so you're not really affected by the WCS differential being really tight below rail here just because there's no other option for those barrels to move out effectively out of the area?

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [33]

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That's correct.

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Garett Dwayne Ursu, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [34]

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Okay. And then I guess on the chemical side, have you seen any take up in terms of storage or some of those ancillary services there?

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [35]

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Scott, do you want to take that one?

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Scott Melbourn, Source Energy Services Ltd. - COO [36]

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Yes. So on the chemical side, our current businesses, we move hydrochloric acid through the terminal network. And we've actually seen an increase in hydrochloric acid in Q1. And we expect a little bit of an increase to continue, although hydrochloric acid is a little bit of a difficult one to forecast. In terms of the additional products, I think it may be a little bit too early to start discussing the opportunities, but we certainly are working hard on bringing additional products into the terminal network, and we will have something to announce on that in the very near future.

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Operator [37]

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Your next question comes from Aaron MacNeil of TD Securities.

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Aaron MacNeil, TD Securities Equity Research - Analyst [38]

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So for the 2021 contract extension, can you comment on when the new contract terms came into effect? And what, if any, the pricing impact was in relative terms like whether, is it up, down, flat or -- and how much of your volume in Q1 would this contract have comprised?

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Joe Jackson, Source Energy Services Ltd. - SVP of Commercial Development [39]

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Yes, absolutely. Aaron, it's Joe. So this contract, the renewal is effective January 1. It was a value deal where we were able to get significantly extended term. We didn't have to give up some on the upside but for an asset leverage company like us, that's what we need to see, it's continued strong volume. We're able to get a couple of other wins in that renegotiation as well. So we really like the quality of the contract. We're very well-positioned. We've got a great relationship with that customer. And we definitely see opportunities to do more deals like that in the future. So there was a little bit a give on margin, but it does position Source for success in the future. In terms of percentage of the business, that contract represented about a quarter of our revenue in the first quarter. Those are very active producer relative to the rest of the basin. We see that business as being an important part of Source going forward as you model those out. But certainly, we'll have more demand from other customers in the quarters to come this year.

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Aaron MacNeil, TD Securities Equity Research - Analyst [40]

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Okay. But safe to say whatever impact that had would have shown in Q1.

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Joe Jackson, Source Energy Services Ltd. - SVP of Commercial Development [41]

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Correct.

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Aaron MacNeil, TD Securities Equity Research - Analyst [42]

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Yes. Okay. And then keeping on pricing, there's obviously a lot of movement on a quarter-over-quarter and year-over-year basis to sand sales revenue per metric tonne. And obviously there might be another wrench in there with more in basin -- oh, sorry, mine gate sand sales. But can you give any guidance on what you think that mix might look like, I guess, Q1 a good representation of what average pricing might look like going forward?

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Scott Melbourn, Source Energy Services Ltd. - COO [43]

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Well, of course, Q1 was a very soft quarter across the sector. You really saw a completion in activity drop-off relative to the previous year. And you're seeing that with all the bumpers. We've kept our volumes [up is the] fact that we can move the big volumes of product up to the company that were still active in the quarter. We don't see that changing because, of course, we've got that infrastructure that allows us to continue to serve the customer. But what I think we did observe though in Q1 at a point in time when products are getting tight, there definitely was a price response. This leaves us to believe that as things come back in the basin we're going to see here a recovery of price. There's not a lot of extra supply pointed at the basin, so we'll see a recovery of price. I don't know if we will ever rebound to where it was at the heyday back in '14, '15, but certainly, we think there's going to be a strengthening of price as activity levels resume. If activity levels stay where they're at, if they stay flat through the year, then we would have pretty much the same sort of pricing [situation] that we're in Q1 and really in Q2. Maybe a little bit more mine gate sales because things they're picking up in the U.S.

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Joe Jackson, Source Energy Services Ltd. - SVP of Commercial Development [44]

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Scott, I'll just add on to that. And when you look at our customer mix in Q1, the significantly slower time in WCSB here resulted in the vast majority of our sales going to people with long term to commit contracts. Obviously they have the lowest top line pricing. So there is certainly going to be contribution from the spot market and contribution from other contracts over the year which should be constructive to our pricing.

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Aaron MacNeil, TD Securities Equity Research - Analyst [45]

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Okay. And then maybe just to ask the question differently then. With Q1 from your contracted customers, would the Q1 mix of revenue be representative going forward? So if you strip out all the mine gate stuff and all the spot stuff, if we can look at Q1 as pretty representative of what the contract [could face] .

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Joe Jackson, Source Energy Services Ltd. - SVP of Commercial Development [46]

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Yes. That's right.

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Aaron MacNeil, TD Securities Equity Research - Analyst [47]

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Okay. And then maybe last one for Derren, this is just housekeeping. But for the capital program, can you say how much the spending in Q1 represented growth versus maintenance?

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Derren J. Newell, Source Energy Services Ltd. - CFO [48]

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Sorry, [can we have the graph] than that and I had a little bit of. A little over half -- a little bit more of an -- 2/3 a little bit would have been growth I think and then rest would have been maintenance. The growth is pretty much done in through the year, as Scott said.

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Aaron MacNeil, TD Securities Equity Research - Analyst [49]

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And is it fair to assume that there'd be a pretty even profile spending over the next few quarters?

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Derren J. Newell, Source Energy Services Ltd. - CFO [50]

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Yes.

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [51]

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So the maintenance capital as Derren was referring to here is primarily mining -- it's capital that had just capitalized -- the mining's maintenance spending gets capitalized. So, yes, it is pretty well spread out over the year, directly tied to our production activity levels.

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Operator [52]

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And our next question comes from Ian Gillies at GMP.

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Ian Brooks Gillies, GMP Securities L.P., Research Division - Director of Institutional Research and Research Analyst of Energy Services & Infrastructure [53]

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Can you quantify the price and margin impact in Q here -- the gross margin and tonne impact in Q1 from some of the -- I guess what are related issues just as an -- in an effort to try and true up what gross margin tonne may look like in future quarters?

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Derren J. Newell, Source Energy Services Ltd. - CFO [54]

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So we would have a couple of items that would have brought you on sort of a onetime basis in. And then we would put it in the category as sort of $2 million to $3 million of kind of onetime thing, most of which would have had, except for the insurance thing they had talked about that affected the margin.

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Scott Melbourn, Source Energy Services Ltd. - COO [55]

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Yes, so that's $2 million to $3 million this year of costs incurred associated with the -- around the weather. There's an additional trucking costs and this is in addition to that [earned during] that point in time. Some of it is rail cost, we're railing product to the destination. You don't really want to, but that's where the services are available. The other thing that happened of course is the weather. We did have some as I mentioned some outages and some shortage in the sales, and we think that was around 100,000 tonnes. So that had a pretty significant impact, too. And again, I think we're going to be getting into a much better position next year because we're adding more storage at Fox Creek, and that's on the mine now. So and then we're just going to take some other measures to make sure we [fully replace] the inventory to soften that up in next winter.

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Ian Brooks Gillies, GMP Securities L.P., Research Division - Director of Institutional Research and Research Analyst of Energy Services & Infrastructure [56]

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And I mean as a follow-on to that, I mean, if we go back in timing, at one point, there was guidance around moving towards $50 a tonne in gross margin. Obviously market dynamics has shifted dramatically since that time as well as the implementation of IFRS 16. I mean is there any updated guidance or color you maybe want to provide around goals moving forward. Or where you'd like to get to for that metric?

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [57]

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Yes. So we are guiding everyone in the mid-30s, and we think that's still achievable. Of course, [to tap the hidden identity] that were -- we were talking about the $50 margins in the past, Ian. So certainly that's what we're still trying to shoot for. And you're right, Q1 was a very choppy quarter because we had the volumes going through, but there's a lot of other things that are affecting our business. We think that's normalized and will be heading back towards that mid-30s. Breaking that down a little bit, just so you have a breakdown and understand how we support that. Again, we can generate somewhere north of $20, $20 to $25 on our logistics chain, particularly in areas where we have the advantage of position and infrastructure. And then as Joe were saying, mine gate margins or commodity margins have returned to around $10 a tonne. So that gets you to that 35-ish. If there's, of course, spiking activity levels for whatever reason, then that will go higher. But that's not what we will guide you towards.

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Operator [58]

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We have no further questions at this time.

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [59]

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Great. Thank you very much for joining Source Energy Services Q1 conference call.

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Operator [60]

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And this does conclude today's conference call. You may now disconnect.