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Edited Transcript of SHLE.TO earnings conference call or presentation 6-Mar-20 2:30pm GMT

Q4 2019 Source Energy Services Ltd Earnings Call

CALGARY Mar 13, 2020 (Thomson StreetEvents) -- Edited Transcript of Source Energy Services Ltd earnings conference call or presentation Friday, March 6, 2020 at 2:30:00pm 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. - VP & CFO

* Scott Melbourn

Source Energy Services Ltd. - COO

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Conference Call Participants

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* Daine Biluk

CIBC Capital Markets, Research Division - Associate

* Jeffrey Eric Fetterly

Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst

* Matthew Weekes

Industrial Alliance Securities Inc., Research Division - Analyst

* Tim Monachello

AltaCorp Capital Inc., Research Division - Analyst of Institutional Equity Research for Energy Services

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Presentation

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Operator [1]

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Thank you for standing by. This is the conference operator. Welcome to the Source Energy Services Fourth Quarter Results Conference Call. (Operator Instructions) The conference is being recorded. (Operator Instructions) I would now like to turn the conference over to Mr. Brad Thomson, CEO. Please go ahead, sir.

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

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Thank you, operator. Good morning, and welcome to Source Energy Services Fourth Quarter 2019 Conference Call. My name is Brad Thomson, I'm the CEO of Source. I'm joined today by Derren Newell, our CFO; and Scott Melbourn, our COO.

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

On this call, Source's numbers are all in Canadian dollars and metric tonnes and will refer to adjusted gross margins, EBITDA and adjusted EBITDA, which are all non-IFRS measures as described in our MD&A.

Except for the items just mentioned, our financial statements are prepared in accordance with IFRS.

We'll begin by reviewing the highlights of Source's performance in the fourth quarter, and then I'll speak to a couple of specific items in our financial statements. And finally, the level of oil and gas development activities were seen in the WCSB today, and what we expect to see for the rest of 2020. Then I'll turn things over to Scott, who will talk about Source's operations, and Derren will wrap things up by doing a deeper dive on our financial results.

By all measures, 2019 was a challenging year for the energy industry in Western Canada, and it was especially challenging for oilfield service companies. The industry faced lower commodity prices, uncertain regulatory conditions, which slowed, if not stopped major infrastructure projects and a significant erosion in investor confidence.

For those who have the fortitude to invest in the energy industry, they have relentlessly demanded that the industry's capital spending be kept within available cash flows, resulting in significant spending decreases on both drilling and completions in the WCSB.

With this backdrop, Source recognized a number of accomplishments in the fourth quarter and for the year ended December 31, 2019, that demonstrates our ability in tough times and also provides us with a glimpse with how we position to succeed as the industry levels recover in Western Canada. In the fourth quarter, Source generated $9.2 million of adjusted EBITDA, which is an increase of $12.4 million over the $3.2 million loss recognized in the fourth quarter of 2018.

In the fourth quarter, we sold 479,017 metric tonnes of sand into the Western Canadian Sedimentary Basin, which is an increase of 51% over Q4 of 2018.

In December, we were able to showcase our logistics capabilities as well as set new daily throughput records that saw Source deliver over 16,000 metric tonnes in a single day. We also had our entire Canadian fleet of 6 Sahara units fully utilized in the month. This fleet is well positioned to continue to service our customers in 2020.

And finally, in the quarter, we collected an additional $5.9 million of insurance proceeds from the Fox Creek incident that occurred in Q2. We'll continue to work on this claim, but the timing and outcome of further proceeds is, of course, less defined at this point in time.

Looking at our highlights for the entire year. In 2019, we sold 2,325,000 tonnes of sand. And even though this is only down 3% from our 2018 sales levels that represented an attractive growth in market share as completion activities in the WCSB were down 20% from the previous year.

In 2019, we delivered 84% of our sand under contracts with large customers that required reliable supply and the ability to deliver it at increasingly higher daily volumes. We continue to work at our mines, Source was also able to increase our indicated resource base by 47.4 million tonnes in the year at a minimal cost. And we advanced our diversification strategy by starting to transload pipe and magnetite, and we've entered into contracts with the transloading of these products for the 2020 year.

And finally, for the year ended 2019, we realized adjusted EBITDA of $48.6 million. Looking back to the fourth quarter of 2019, the quarter started slowly as was expected in the industry, but then picked up steam in December as customers spent the balance of their capital budgets. We also saw customers begin their 2020 programs immediately after Christmas, which is earlier than what we've seen in the last couple of years. This resulted in Source setting a number of throughput records in December. The rapid change in completion activity levels that we witnessed in December, as well as the volatility in activity levels seen over the last couple of quarters, has become a common theme in the Western Canada.

Oilfield service companies are constantly being asked to move from periods of inactivity to record levels of performance in very short periods of time. This tests our business, but Source is now uniquely established to handle these swings in activity levels. From our production facilities through to our in-basin storage facilities and our logistics operations, Source's previous investment in infrastructure and our focus on improving operational flexibility has paid dividends for us through 2019.

These prior expenditures have also allowed us to minimize the amount of capital we need to spend in 2020 and subsequent years to serve the WCSB. We now have a very scalable business that can deal with the peaks and valleys of the energy industry, while still having capacity to provide service to a more diversified customer base at our terminals.

Scott will talk to our operating efficiencies in just a few moments.

Now turning to our outlook. Despite the challenging operating environment, Source grew market share in 2019, with Source's year-over-year decline in WCSB volumes lower than the overall decline in completion activity levels across the basin.

Source continues to address the competitive market and manage markets -- margins to the ongoing focus of operating cost efficiencies, further diversification of revenue streams and broadening of our service platform to the delivery of other service offerings at the well site to help reduce the impact of commodity cycles.

Source entered 2020 with 5 significant E&P customers under long-term contract arrangements. These contracted sales are in addition to sales to other E&P companies that wish to direct-source sand on noncontract basis as well as traditional sales to the pressure pumpers.

While Source's total sales have decreased from 2018, existing direct sales contracts are expected to help Source continue growing its market share through 2020. As we exited 2019, we also found that our sales to pressure pumpers grew as our logistics capabilities allow them to meet customers' expectations. E&P companies continue to push for additional efficiencies in their completion programs by completing fracs over a much shorter period of time than in the past. In some cases, we're seeing the timeline for frac programs reduced by as much as 50%. In order to be successful supporting these accelerated programs, larger volumes of frac sand needs to be available over shorter periods of time. In Source's terminals network, logistics capabilities have become a key component in the success of these accelerated frac programs in Western Canada. And our performance is further enhanced by the delivery capability of our Sahara units.

In 2020 -- with 2020 underway, commodity price volatility, driven by worldwide events reflects an uncertain demand for oil and gas in 2020. But Source remains cautiously optimistic that activity levels for the year will remain relatively flat to 2019. So perhaps even better in the back part of 2020 as customers prepare for additional pipeline capacity exiting the WCSB.

Beyond 2020, we continue to be excited about the longer-term industry prospects with anticipated improved pipeline capacity and other transportation capacity and the longer-term impacts of increased demand for LNG on the WCSB activity levels.

Analysis of pipeline egress capacity, coal to natural gas power generation conversions and the potential for additional hydrocarbon shipments by rail, support the company's position their activity levels should substantially increase in the coming years. Source believes that this direct sales contracts and proven sales levels will enable it to navigate through this challenging operating environment, utilities activity levels increase, and we continue to develop opportunities to further utilize our existing Western Canadian terminal to provide additional diversification of our business.

Over the longer term, Source anticipates its new terminal services will be a meaningful part of our business. Of course, Source also knows that customers will continue to be laser-focused on costs, in particular logistics costs. This will be applicable, not only for logistics associated with frac sand and will also be applicable to other bulk completion materials, such as water and chemicals, as well as crude oil and liquids that need to be shipped by rail. This presents an opportunity and not a threat to Source because as we've seen in our -- with our customers, they continue to look for Source for solutions that involve our in-basin distribution network and our logistics capabilities.

Now regardless of the levels of activities in the WCSB, Source is going to focus -- the Source's focus for 2020 is clear. We'll continue to be a leader in the provision of bulk completion materials to the Western Canadian Sedimentary Basin.

We'll continue to diversify our service offering at our terminals. And finally, with our capital programs now complete, Source will focus on improvements to our balance sheet. Now I'd like to turn things over to Scott.

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Scott Melbourn, Source Energy Services Ltd. - COO [3]

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Thank you, Brad, and good morning. This morning, I want to take a few minutes to address 3 important topics. First is Source's initiatives designed to drive free cash flow in 2020; secondly, provide some additional color on what we're seeing on completion design and what that means for sand logistics; and finally, provide an update on terminal services.

In 2019, we introduced a number of cost-saving measures across the organization that significantly improved our per tonne metrics. The benefits from these past initiatives will endure into 2020 and beyond, and we will continue to drive additional savings into 2020.

In addition, we have or will be doing several things to enhance our free cash flow, which will include railcar fleet optimization, mine and terminal optimization. Previously announced, our capital budget for 2020 has been greatly reduced, not by simply deferring needed capital, but by optimizing our material movements within the mine. We would expect the lower per tonne mine development and overall maintenance capital numbers to be reflective of ongoing requirements. With respect to trends in the market, we continue to see efficiency gains in the completion design and the execution of these designs.

The new normal for Canada seems to be 16 to 20 hours of pumping time per day with targets of up to 22 hours of pump time per day. We're also seeing a number of E&Ps moving to dual completion programs to drive additional efficiencies.

These trends further highlight the importance of having the correct logistics infrastructure to service the new completion design and to ensure the efficiencies gained on the design and execution are not eroded away by core sand logistics.

In addition to the size of the infrastructure, of equal importance is the location of the infrastructure. Any extra trucking distance from the terminal or the mine dramatically increases the trucking roster, which in turn, increases the cost and the execution risk. Over the past few years, Source has invested in the infrastructure in the correct location required to service the modern completion programs, and we have continued to innovate to ensure we are ahead of the trend.

In early 2020, we will be introducing a new high capacity driver for Sahara, which will further enhance our leading position in sand logistics. With respect to terminal services, as Brad has previously mentioned, we continue to diversify the revenue stream.

In 2019, we provided terminal services for a large diameter pipe, magnetite and chemicals. As we look forward to 2020, we anticipate the introduction of additional bulk products via terminal network and 1 to 2 midstream opportunities at select locations. Since launching the diversification initiatives, demand has been strong for terminal services, and we continue to evaluate a number of opportunities.

Now I'd like to turn things over to Derren for a financial review of Q4 and of 2019.

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Derren J. Newell, Source Energy Services Ltd. - VP & CFO [4]

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Thanks, Scott. Source generated revenue in the fourth quarter of 2019 of $68.6 million, which was an increase of $14.6 million or 27% compared to the fourth quarter of 2018. Sand revenues increased by 28% due to 105,846 metric tonne increase in sand volumes. If you remove the mine gate sales from the 2018 volumes to compare only volumes sold at WCSB, sand volumes increased by 161,318 metric tonne in the fourth quarter of 2019. Activity levels in the WCSB increased dramatically, especially in December of 2019. And as Brad mentioned earlier, we set some daily throughput records in the month of December. We realized sand pricing was comparable to the fourth quarter of 2018.

Q3 2019 compared to Q4 sand revenues. Q4 revenues decreased by $9.2 million as lower activity levels in Q4 led to a 13% decrease in sand volumes that combined with the decrease in the average realized sand price of $0.89 a metric tonne. As was expected in -- the fourth quarter was slower than the third quarter, but it did not slow down as drastically as was expected or as drastically as had been seen in prior years.

For the year, sand revenues decreased by $60.6 million or 18%, due to a 13% increase in sand volumes and a 6% decrease in average realized prices. Sand sales volumes of WCSB, however, only declined 3% on the approximately 256,000 tonne -- metric tonnes of mining sales were removed from the 2018 sales volumes.

WCSB sand volumes were down for the year due to an estimated 20% decrease in the completion activity year-over-year, as E&P company's capital spending was targeted to be within their cash flows. Pricing was down due to lower pricing on contract renewals done in a challenging environment, lower spot sale pricing as well as changes in terminal product mix. Wellsite solutions revenue for the fourth quarter of 2019 increased $1.9 million compared to the fourth quarter of 2018 due to a 26% increase in trucking revenues and a 28% increase in Sahara revenues. Both trucking and Sahara revenues were impacted by higher activity in the basin in the Q4 2019.

The 8 Sahara units were 40% utilized in 2019 versus 5 units being 37% utilized in the fourth quarter of '18.

In December of 2019, Source had all 6 Canadian Sahara units fully utilized, and demand for these units remained strong in the first quarter of 2020, and demand remains strong for the unit in 2020.

Wellsite solutions revenue decreased by $1.8 million sequentially from the third quarter of 2019 primarily due to decreased trucking volumes due to lower activity in the fourth quarter overall. For the year ended December 31, 2019, wellsite solutions revenue was down by $21.1 million as a 37% decrease in trucking revenue was combined with a 2% decrease in Sahara revenues.

Adjusted gross margin in the fourth quarter of 2019 was $35.43 per metric tonne. This is an increase of $16.79 per metric ton when compared to the fourth quarter of 2018. As the small increase in the average realized sand price was offset by much lower cost of sales per metric ton in the fourth quarter of 2019. Higher sales activity levels, cost control performance in both the production and logistics components and not having fixed railcar and heavy equipment leases in the adjusted gross margin due to the adoption of IFRS 16 in 2019 were the principal drivers in the lower cost of goods sold in the fourth quarter of 2019.

Compared to the third quarter of 2019 adjusted gross margin in the fourth quarter was $1.51 per metric tonne higher as the lower average realized sand price in the fourth quarter was more than offset by improved cost performance.

For the full year of 2019, adjusted gross margin of $35.67 compared to $34.87 realized in 2018 as the impact of being $7.49 per metric ton decrease in average realized price was more than offset by the impact of adopting IFRS for heavy equipment and railcar leases and the impact of cost saving emission systems throughout the production and logistics components of the business.

Operating expenses for the fourth quarter were $5.4 million, which was $1.8 million lower than the fourth quarter of 2018. Due to a lower selling cost as a recost of certain costs in the fourth quarter of 2018 were partially offset by the increased incentive costs recognized in the fourth quarter of 2019.

General and admin costs of $2.7 million in the quarter were below the prior year quarter by $0.5 million because office leases and non MG&A expense with the adoption of IFRS 16. Cost-saving initiatives also helped reduce G&A costs throughout 2019.

Compared to the third quarter of 2019, operating costs were $0.7 million lower -- were $0.7 million due to increased incentive compensation costs and timing differences on some operational costs.

G&A costs in the fourth quarter were $0.3 million higher than the third quarter due to higher incentive costs. We continue to look at business cost structure relative to activity to ensure we have rightsized the organization to service its markets.

For the full year, operating costs are $2.3 million higher than 2018 due to higher staffing levels to support the larger Sahara fleet, higher selling costs, higher property taxes and higher and less insurance costs.

G&A costs for the full year of 2019 are $2.7 million lower than 2018 due to the treatment of the IFRS on office leases, the impact of cost-saving initiatives as well as lower professional fees.

Finance expenses increased by $1.2 million to $7.1 million in the fourth quarter of 2019 compared to the same period in 2018 due to $1.2 million of interest costs related to lease liabilities arising from the IFRS change for lease accounting, higher interest on the ABL facility due to higher draws on the facility in the quarter. On a year-to-date basis, finance expenses increased $7.1 million as a result of the $5.2 million of interest costs related to lease liabilities arising from the IFRS 16 change, the interest cost on the $50 million of notes issued in the second quarter of 2018 and a higher average draws on the ABL facility in 2019 versus 2018.

At December 31, 2019, Source had borrowed $29 million on its asset-backed loan facility and was also using this facility to support $17.5 million of letters of credit, leaving us with $18.4 million of liquidity available.

Borrowings under the ABL facility increased by $6.8 million since the third quarter of 2019 due to increased working capital levels with the increased activity.

As Brad mentioned, rate at the end of the quarter, we received $5.9 million of additional insurance proceeds related to Fox Creek.

As we look ahead to 2020, Source is anticipating it will be free cash flow neutral. We have announced a significantly reduced capital spending program for 2020, which will help us achieve this target. Finally, Source is working -- continuing to work on the best options to address its bonds that mature in the -- in 22 months.

Source recorded tax expense in the fourth quarter of 2019 of $0.4 million compared to a recovery of $0.4 million in the fourth quarter of 2018.

The tax expense arose in the quarter from having a tax recovery on the net loss is offset by tax expense caused by changes in movements related to unrecognized deferred tax assets that arose from the continuity of interest accounting that occurred as part of our IPO. Source is not expecting to record a recurring tax in 2020. For the full year, a tax recovery of $23.9 million was reported on the pretax loss.

For the fourth quarter 2019, Source reported a net loss of $2.6 million or $0.05 per share compared to a net loss of $14.8 million in the fourth quarter of 2018. The improved operating results and cost recovery benefit from the insurance proceeds were principal reasons for the improvement.

Capital expenditures for the fourth quarter were a recovery of $3.9 million, including the additional insurance proceeds from Fox Creek, actual expenditures in the quarter were focused on the optimization project at our plants as well as overburden removal.

On a year-to-date basis, capital expenditures are at $19.7 million and expenditures in the year were focused mainly on the Fox Creek terminal, production optimization and overburden removal and wellsite solutions. And as we previously mentioned, our 2020 program is significantly smaller as prior year capital expenditures have positioned us to deal with the ups in the [oilfield] industry.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Tim Monachello with AltaCorp Capital.

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Tim Monachello, AltaCorp Capital Inc., Research Division - Analyst of Institutional Equity Research for Energy Services [2]

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Just wondering if you guys could elaborate a little bit more on what the trends were that you saw that really pushed December volumes up so much?

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Scott Melbourn, Source Energy Services Ltd. - COO [3]

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Yes, Tim, I'll jump in on that one. So I think we saw a number of our contracted and some spot customers as well, adding significant programs to their capital. And so we had the addition of probably 2 or 3 large pads in December. What was driving that, was probably a little bit of a movement in [ACO] price. There was potentially some other factors that were driving it, but that's kind of our best guess on what was driving the additional volumes in December.

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Derren J. Newell, Source Energy Services Ltd. - VP & CFO [4]

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Just to add on to that, Tim, the other thing that we saw as we went into January, is that a number of places in the basin, there was a shortage of crews. These are pumping crews. So there's a high possibility that pumpers were basically encouraging the customers to complete wells in December as well as being as busy there as they normally are in January. So, yes, it was a positive thing. And we think we'll see the same sort of thing in 2020 with December being stronger in the future than it has been in the past.

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Tim Monachello, AltaCorp Capital Inc., Research Division - Analyst of Institutional Equity Research for Energy Services [5]

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Okay. That's interesting. So it's safe to say that a lot of that stuff was dry gas oriented developments?

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [6]

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Yes. Certainly, more of it was. A couple of years ago, we hardly saw it very little -- we saw very little dry gas activity, but in December, in particular, we saw a pickup on drilling and completions from dry gas producers.

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Tim Monachello, AltaCorp Capital Inc., Research Division - Analyst of Institutional Equity Research for Energy Services [7]

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Okay. Next question for me. Just how is Q1 trending in terms of volumes on a year-over-year basis?

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Scott Melbourn, Source Energy Services Ltd. - COO [8]

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Yes, Tim, I'll jump in again. No, we're seeing Q1, kind of, start out as expected. There has been very little hiccups in Q1. And so and we've sort of guided everyone that year-over-year, it's going to be flat. So we're pleasantly surprised with how Q1 is trending right now.

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [9]

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The other question we get quite often, Tim, is what's -- what are rail outages and things like that doing to the space? And we've had over the last couple of quarters, we had, of course, a strike, we've had some weather outages, and we, of course, have blockades. But none of those things have affected the flow of materials to Source. So we've been in a very strong position that way.

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Tim Monachello, AltaCorp Capital Inc., Research Division - Analyst of Institutional Equity Research for Energy Services [10]

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Okay. That's good to know. And then are you having any conversations over the last couple of weeks with customers around what the weakness in commodity prices is going to do to their capital programs for the rest of the year? Any changes there?

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [11]

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We don't -- yes, we -- of course, we talk to our customers every day because we're active with them on their -- the programs have the growth things that Scott didn't touch on this. We have a very good -- in Q1, a very good spread of our customer covered. So some pretty good growth. But we don't, with our customer base, see them modifying their program significantly as a result of the changes -- recent changes in commodity prices.

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Tim Monachello, AltaCorp Capital Inc., Research Division - Analyst of Institutional Equity Research for Energy Services [12]

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Okay, great. And then just last one for me. Wondering if you could quantify what the impact to transload and terminaling revenues might be in 2020 over 2019 based on some of the contracts for pipe and magnetite that you mentioned.

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Derren J. Newell, Source Energy Services Ltd. - VP & CFO [13]

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Tim, I'll jump in there. We expect easily noticeable increase in it, but at this point I'm not giving more direct guidance on that.

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Scott Melbourn, Source Energy Services Ltd. - COO [14]

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And Tim, I'll just jump in. How we certainly view those. And I think Brad mentioned this in his remarks, is these are really a platform for growth. And so we really expect these to pick up steam over the next couple of years. So certainly it will have an impact in 2020, and we expect those to continue to grow into '21 and the '22. So they won't be a huge part of our business in 2020, but there certainly will be a platform for growth.

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [15]

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Yes. It was interesting in 2019, as we added on these new products going through our terminals. I think the word got out there. And what we're seeing in the early part of this year as we're being approached by a number of different parties that want to move chemicals and liquids and natural gas liquids and crude oil, and you name it to our terminals. Because of course, rail is becoming a pretty necessary piece of that whole logistics chain, both into the basin and out of the basin. So we're pretty optimistic about the prospects for this diversification initiative.

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Operator [16]

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Our next question comes from Daine Biluk with CIBC.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [17]

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So just getting started first on Sahara, you highlighted a fairly strong utilization in Canada through December. Was that related to certain customer wins? Or is there any sort of more color you can share on that?

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Scott Melbourn, Source Energy Services Ltd. - COO [18]

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Yes. Daine, I'll jump in on that. So it was related to certainly one customer win, and who was not a contracted customer. And so they were completing a dual program, which means there's 2 Sahara units out there. And the other pieces of it were related to sort of our longer-term customers, adding on additional works, which also sort of soft up the Sahara fleet.

So the kind of rounded out, we had 2 Saharas, were out on really spot or non-contracted work, and we have 4 Saharas that were out on contracted work. 2 of those were additions in December. So the work was not expected as we kind of entered into Q4, and 2 of those were out on expected work. So the program has already been set, and we expected them to be utilized in Q4.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [19]

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Got you. Okay. That's good color. And I guess maybe to follow-on, how are you expecting Sahara utilization to trend into Q1?

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Scott Melbourn, Source Energy Services Ltd. - COO [20]

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Yes, I'll jump in again. The -- we have strong Sahara utilization in Q1 and especially in Canada. And so we expect a strong utilization over Q1 and an uptick from the previous Q1 or 2018 Q1.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [21]

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Okay. Understood. Switching gears a bit. On the covenant relief you guys announced earlier in the year, I assume you would have had to pay a onetime fee there. Can you share the amount of that fee?

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Derren J. Newell, Source Energy Services Ltd. - VP & CFO [22]

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It was a normal market fee and was overly material.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [23]

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Okay. Okay. Fair enough. And then maybe just last one for me. You guys obviously talked about it on the opening comments a lot. But just on the $5.6 million budget for 2020, is it fair to think of that assuming flat sand sales year-over-year? And if sand sales were to increase, would that have to move higher to satisfy that?

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [24]

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No, it really doesn't have to. That $5.6 million will cover us even with substantially greater sand sales. So it would go up to a small amount, but definitely not double or anything like that.

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Scott Melbourn, Source Energy Services Ltd. - COO [25]

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Yes, Daine, and I'll just provide a little extra color. I certainly would increase a little bit with stronger sand sales because, of course, we are then developing the mine more, so we're moving more into the mine. But as Brad mentioned, it doesn't go up dramatically. So it's more on a per tonne basis. In terms of the capital, the true maintenance capital, that wouldn't change at all with sand sales. And then as Brad had previously mentioned in his remarks, we have spent all the capital that really is required for us to grow up to a significant growth in volumes. And so we wouldn't have any additional growth capital to meet any requirements if the volumes picked up dramatically.

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Operator [26]

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

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [27]

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Thank you, operator. We do have one other question from Jeff Fetterly, Peters & Company, operator.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [28]

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Just 2 questions. On the contract base, Brad, did I hear you correctly earlier when you talked about 80% of volumes in 2019 were under long-term contract?

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

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Yes, 84%. So we've actually been able to grow our contracted base. So we don't see that change -- that trend changing for us, Jeff.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [30]

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In that 84%, is that made up of the 5 E&Ps that you referenced? Or how broad is the customer base underneath that?

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

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It's 5 E&Ps as well as a couple of pumpers who signed up for contracts with us as well to provide them with supply under fixed-price contracts or set price contracts. So that will be in there. And yes, that would be the bulk of them, Jeff.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [32]

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So if you moved 1.8 million, 1.9 million tonnes under those contracts in 2019, what is your line of sight or expectation under those, call it, 7 contracts for 2020?

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

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Well, under those contracts, our expectation would be slightly up from those numbers based on what our customers are telling us. So let's say slightly up, probably up by 10%. But yes, that's really be.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [34]

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And Derren, just a clarification, how many railcars do you guys or did you guys have in on lease at the end of the year? And where do you expect that number to go over the course of 2020?

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Derren J. Newell, Source Energy Services Ltd. - VP & CFO [35]

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I think we're about 2,200 cars at the end of the year, and we would expect to hold that fairly consistently, but do you see an opportunity to our normal portfolio rollover to be able to bring those lease costs down through the course of the program.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [36]

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And on an annualized basis or run rate basis, how meaningful of a reduction do you think that could be across 2,200 cars?

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Derren J. Newell, Source Energy Services Ltd. - VP & CFO [37]

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It will be a noticeable amount, but then until everything is kind of contracted up, it's a little bit hard to guess up because while near-term cars are very, very cheap, longer-term cars are a little more expensive, and we need to find the right balance in the portfolio mix.

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [38]

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Certainly, Jeff, it's one of the areas that we see some great opportunity to generate additional free cash flow. We don't factor that in when we're talking about being free cash flow neutral, but it's low-hanging fruit for us.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [39]

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Okay. And last thing on the Sahara side. The 6 units in Canada, how many of those do you have commitments for, for 2020?

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Scott Melbourn, Source Energy Services Ltd. - COO [40]

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So we have commitments for the majority of those, and those commitments will vary over the year, depending on the customer's program. So we really try and Jeff run 1 unit as a spot unit available for spot work and to fill in any gaps where we have some overlapping in terms of our customers' programs.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [41]

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And where are things...

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Derren J. Newell, Source Energy Services Ltd. - VP & CFO [42]

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[is directly on the contracts...]

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [43]

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And sorry -- and where are things at in terms of the U.S. units?

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Scott Melbourn, Source Energy Services Ltd. - COO [44]

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Yes, we're still -- in terms of our Marcellus unit, that's a challenging market right now. And so we're not expecting much utilization out of that unit. And the expectation is that unit will probably move to a different basin in 2020. In terms of our Texas unit, we're optimistic about the prospects of that, and we're currently in discussions about getting that out on a pad shortly.

So it's -- I think, as you know, Jeff, the U.S. market has been a little more challenging, and the Marcellus is certainly challenged this year. So we're looking to focus on the Permian or potentially bring another unit back up into Canada, depending on the market dynamics.

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [45]

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Yes, Jeff, I'm going to add a little bit of color to that. So in Marcellus, the Permian, that you referred, all those basins are over equipped in many respects. But one of the trends that we've seen, particularly in the Permian is customers are looking to go to belly dumps. This is, of course, the way the sand is largely moved in Canada now.

People have gone away from the MATIC units. So that trend is starting down in the U.S. and of course, our Sahara unit is designed for that. That's what allows us to move the volumes we move as you have efficient trucks, and they can unload very, very quickly. So that's still giving us a lot of hope down in the U.S., but I can say, you still have some equipment overhang down there. So we'll see how it plays out over the next few months.

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Operator [46]

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Our next question is from Matthew Weekes with IA Securities.

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Matthew Weekes, Industrial Alliance Securities Inc., Research Division - Analyst [47]

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Just looking at kind of margins in the quarter and adjusted gross margin per metric tonne. They were pretty strong this quarter, up on a q-on-q basis and up quite a bit year-over-year. And looking at the last couple of years, it looks like margins typically have a tendency to contract in Q4 relative to Q3. What would you say it was mostly that drove the kind of quarter-over-quarter strength in margins? Was it mostly just kind of better-than-expected activity? Or was it production efficiencies or declining lease cost? I was just wondering if you'd be able to provide some color on that.

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

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So it will be the combination of all 3 payments that you just talked about, higher activity level always makes us more efficient in buying. The operations and logistics team did some great work throughout the year of getting both their costs down, which is always helpful. And then pulling the lease result has a big impact as well.

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Matthew Weekes, Industrial Alliance Securities Inc., Research Division - Analyst [49]

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Okay. And just kind of building on that a little bit. Would you say that it was a bit of an abnormal sort of quarter for margins? Or with the efficiencies you've achieved, are you expecting margins to be a bit stronger going forward in general?

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [50]

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Yes. No, I think it's sort of consistent with what we see for 2020. And then, of course, what we believe is that as activity levels increase above 2019 levels, you will see a price response on the commodity. The Western Canadian Basin does not have a lot of extra supply, particularly supply that can meet the daily volume requirements of the pumpers. So what we find is that on the days that activity levels pick up, spot prices move for us, and we anticipate that as the activity level picks up in general, hopefully, later in the year and into 2021, we'll see price response on the commodity.

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Operator [51]

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

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Bradley J. Thomson, Source Energy Services Ltd. - CEO, President & Director [52]

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Great. Thank you, operator, and thank you to everybody on the line for joining the Q4 2019 conference call. With that, we'll sign off. Have a great day. Thank you.

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Operator [53]

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