Essential Energy Services Trust
TSX : ESN.UN

Essential Energy Services Trust

November 13, 2006 09:48 ET

Essential Releases Record Third Quarter Results and Comments on Taxation of Income Trusts

CALGARY, ALBERTA--(CCNMatthews - Nov. 13, 2006) - Essential Energy Services Trust (TSX:ESN.UN) ("Essential", or the "Trust") is pleased to release the operational and financial results for the three and nine months ended September 30, 2006 and to announce it has filed the complete Management Discussion and Analysis and unaudited financial statements for the three and nine months ended September 30, 2006 on SEDAR. An electronic copy of these documents may be obtained on the Trust's SEDAR profile at www.sedar.com.

These operational and financial results contain the results of the energy services division of Avenir Diversified Income Trust ("Avenir", TSX: AVF.UN) for the periods prior to May 31, 2006. Essential was formed on May 31, 2006 as a spin out from Avenir which took place as a special distribution to unitholders of Avenir on the basis of one unit of Essential for every two units of Avenir.



Third Quarter 2006 Financial Highlights

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Three Months Ended Nine Months Ended
(Unaudited) September 30 September 30
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$ thousands, except per unit % %
amounts and margins 2006 2005 Change 2006 2005 Change
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Financial Results
Revenue 25,267 9,906 155% 63,517 20,733 206%

EBITDA(1) 6,972 3,545 92% 19,140 6,740 181%
EBITDA margin (%)(1) 27.6% 35.8% 30.1% 32.5%

Net income 2,421 1,247 94% 7,135 2,523 182%
Net income margin (%) 9.6% 12.6% 11.2% 12.2%

Funds from operations(2) 6,293 3,464 82% 17,787 6,591 170%

Unit Information
Weighted average number of
units outstanding - basic
& diluted 27,217 n/a n/a 27,198 n/a n/a
Funds from operations per unit 0.23 n/a n/a 0.65 n/a n/a
Distributions per unit(3) 0.249 n/a n/a 0.332 n/a n/a
Earnings per unit - basic
& diluted 0.09 n/a n/a 0.26 n/a n/a
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(1) EBITDA is defined as earnings before non-controlling interests, interest, taxes, depreciation and amortization. We believe in addition to net income, EBITDA is a useful supplemental earnings measure as it provides an indication of the financial results generated by our principal business activities prior to consideration of how these activities are financed or how the results are taxed in various jurisdictions and before non-cash amortization expenses. EBITDA margin is calculated as EBITDA divided by revenue.

(2) Funds from operations is calculated by taking net income and adding back non-cash balances such as depreciation and amortization, (loss) gain on sale of property and equipment , non-cash unit compensation expense and non-controlling interest.

EBITDA, funds from operations and funds from operations per unit are not recognized measures under Canadian generally accepted accounting principles (GAAP). Management believes that these measures are useful supplemental measures to analyze operating performance as they demonstrate the Trust's ability to generate the funds from operations necessary to fund future distributions and capital investments. The Trust's method of calculating these measures may differ from other issuers, and accordingly, they may not be comparable to measures used by other issuers. Investors should be cautioned that EBITDA, funds from operations and funds from operations per unit should not be construed as alternatives to net income, cash flow from operating activities or other measures of financial performance calculated in accordance with GAAP.

(3) The distributions per unit for the nine months ended September 30, 2006 reflects only four months of distributions from Essential due to its spin out from Avenir on May 31, 2006..

n/a means not applicable as the comparative numbers for the period ended September 30, 2005 were those of Avenir Diversified Income Trust and would not be meaningful on a per unit basis to Essential unitholders.

Overview

The third quarter of 2006 saw Essential achieve significant milestones and record financial results which will set the stage for significant growth in a challenging environment. Year over year growth in revenue for the quarter increased by 155% over the comparable period while EBITDA increased 92% and net income increased by 94%. This marks nine consecutive quarters of growth since inception. "We are pleased with the results from the third quarter as this was a challenging period of integration following explosive growth and the initial spin out of Essential from Avenir." said James Burns, President and CEO. "We are now seeing the beginning of the typical winter season expansion of activity with better utilization and improved margins, particularly in our northern operations. The ongoing organic growth of Essential's fleet and the strong performance of the recent Jacar acquisition adds to our optimistic outlook for the winter months and beyond." Essential expected the distribution payout ratio in the third quarter to be high and anticipates a sharp drop in the payout ratio as business activity levels increase in the winter months of the fourth quarter of 2006 and first quarter of 2007. The payout ratio will decline to levels comparable to our peers at current industry activity levels as Essential's operations are focused on production services which helps to insulate the company from any drop in capital spending by our customers. The optimism for the winter is, however, tempered by the uncertainty created by the federal government's announcement on October 31, 2006 of their intent to change the tax treatment of income trusts. The Board of Directors and management of Essential are actively evaluating all strategies to ensure that unitholders realize the full value of the strong operations of Essential.

During the quarter, Essential expanded its Transport division in southern Alberta by purchasing all of the assets and business of Jacar Energy Services Partnership ("Jacar") from Jacar Hot Oil Service Ltd., a 72 unit fleet of tank trucks, pressure trucks, hot oilers and a chemical sales business operating out of 4 locations in southern Alberta. This acquisition, which only contributed to 12 days of operating results in the third quarter, is expected to exceed performance expectations as the operational synergies between Jacar and Richmound Energy Services L.P. ("Richmound") become apparent. The addition of Jacar significantly increases Essential's Transport division which now operates a full suite of services with its 183 revenue generating Transport units from northern BC and Alberta through central Alberta and into southern Alberta and Saskatchewan. The Transport division is now expected to contribute approximately 55% (previously 38%) of the revenue and EBITDA for Essential with the remaining 45% (previously 62%) contributed by the Rig division.

On the positive side, performance of the two service rig operations, Classic Well Servicing Partnership ("Classic") and Millard Oilfield Services Partnership ("Millard"), executed as expected for the quarter. Such performance allowed for implementation of a rig rate increase in October 2006. No fall in demand or utilization has been observed following these rate increases. The coil tubing operations at Kodiak Coil Tubing Limited Partnership ("Kodiak") and Endless Tubing Services Partnership ("Endless") saw slightly reduced revenue due to wet weather conditions, general industry slowdown and delays in equipment delivery, but managed to control costs and meet cash flow objectives. Our swabbing rig division, HK Well Service ("HK"), is in a highly competitive pricing environment for swabbing services in southern Alberta. Steady improvements to HK's operations will improve fourth quarter results. Operationally, we have moved the one rod rig that HK was operating into Cardinal Well Services Partnership ("Cardinal") resulting in improved utilization and margins.

On the challenges side, continued delays in the delivery of new equipment and repairs and upgrading of other equipment affected third quarter operating results which otherwise would have been even stronger. These equipment and repair delivery delays are a direct result from a booming western Canadian economy with chronic shortages of parts, equipment and skilled personnel. Cardinal has had three new rod rigs on order since early 2006. Delivery of the first unit occurred in late October with two more units scheduled to be delivered in November or early December. Cardinal also had at least one rig out of service on a rotating basis throughout the third quarter for refurbishment, thereby reducing the operating fleet to only 8 units from the expected 12 rigs. Endless also saw its fleet throughout the third quarter at 8 or 9 coil tubing rigs rather than the 11 units that were expected for the quarter. The impact of these delays resulted in revenue which did not materialize and increased costs for the third quarter as these operating entities had staffed up with trained individuals and maintained higher staff levels in anticipation of larger equipment fleets. Having qualified personnel and increased staff levels to operate equipment despite the delay in equipment delivery was a conscious decision by management to absorb the short-term costs in this quarter than to face a shortage of qualified staff in our challenging labour market when the equipment does get delivered in the fourth quarter. Essential expects these delivery and repair delays to have only temporarily affected financial results and margins in the third quarter with improvements likely in the fourth quarter.

The third quarter also saw operational challenges in our northern and central Transport operations of Cascade Services Partnership ("Cascade") and Westvac Energy Services Partnership ("Westvac"). Utilization in the third quarter at Cascade fell by approximately 30% from our expectations, largely due to bad weather negatively affecting cash flow margins of a more remote fixed cost operation. The onset of colder weather in the fourth quarter is improving utilization and we expect another busy and profitable winter for Cascade. Westvac's operations generated revenue in line with our expectations. However, the integration of assets acquired in June including 4 rod rigs, a permanent 100 man camp, and several tank trucks proved more difficult than expected and resulted in temporarily increased operating and administrative costs that negatively impacted the cash flow contribution of the operation. These issues have been resolved by strengthening Westvac's management and placing management of the rod rigs under Cardinal which specializes in rod rigs. Higher utilization with improved margins is now being observed with these changes.

Overall Essential had a maximum of only 46 operational rigs at any one time during the third quarter. Including the expected decommissioning of one rod rig, the available rig fleet for the fourth quarter will total 61 units with improved utilization as is typical in the industry for the fourth quarter. Improving utilization and margins at Cascade and more effective cost control at Westvac will return these operations to expected cash flow contribution levels. Significant upgrading of the fleet through refurbishment, aggressive repair and maintenance programs, delivery of new equipment, more experienced management and improved systems are all contributing to improving performance and a strong outlook for the fourth quarter and into 2007.

Taxation on Income Trusts

On October 31, 2006, the Minister of Finance announced its proposal to amend the Income Tax Act (Canada) to apply a Distribution Tax on distributions from publicly-traded income trusts. Under the proposal, existing income trusts will be subject to the new measures commencing in their 2011 taxation year, following a four-year grace period. The Minister of Finance issued a Notice of Ways and Means Motion to Amend the Income Tax Act and on November 7, 2006 obtained approval from Parliament to enact the proposal.

In simplified terms, under the proposed tax plan, income distributions will first be taxed at the trust level at a special rate estimated to be 31.5%. Income distributions to individual unitholders will then be treated as dividends from a Canadian corporation and eligible for the dividend tax credit. Income distributions to corporations resident in Canada will be eligible for full deduction as tax free inter-corporate dividends. Tax-deferred accounts (RRSPs, RRIFs and Pension Plans) will continue to pay no tax on distributions. Non-resident unitholders will be taxed on distributions at the non-resident withholding tax rate for dividends. The net impact on Canadian taxable investors is expected to be minimal because they can take advantage of the dividend tax credit. However, as a result of the 31.5% Distribution Tax at the trust level, distributions to tax-deferred accounts will be reduced by approximately 31.5%, and distributions to non-residents will be reduced by approximately 26.5%.

Following the Minister's announcement, the market's reaction was immediate and significant, with a widespread sell-off across the entire trust sector that eliminated billions of dollars in unitholder value. Income trusts comprise a significant portion of the public issuers in Canada, and trusts provide an important income stream for individuals, especially retirees and those planning retirement.

We encourage Essential's unitholders to read the full transcript of the government's plan at: www.fin.gc.ca/news06/06-061e.html and consult with their personal financial and tax advisors regarding potential tax consequences based on their individual circumstances. Unitholders may also express their views directly to the Minister of Finance, whose contact information is available at www.fin.gc.ca/admin/contact-e.html.

Essential has joined with other energy income trusts to form the Coalition of Canadian Energy Trusts (the "Coalition") to lobby for changes to the legislation. The Coalition includes the largest, most successful and most influential energy trusts in Canada. Essential has joined with the Coalition to try and seek relief for our unitholders.

Given the four-year grace period before existing trusts will be taxed, Essential has an opportunity to examine its strategy, and if warranted, modify it to provide the best possible return for its unitholders. At the same time, Essential's investors have an opportunity to arrange their investments before 2011 to minimize the impact of the proposed tax changes on their portfolios. The long-term effect of the proposed tax changes announced is yet to be determined.

Forward Looking Statements: Certain information set forth in this document, including a discussion of future plans and operations, contains forward looking statements that involve substantial known and unknown risks and uncertainties. These forward looking statements are subject to numerous risks and uncertainties, some of which are beyond the Trust's and management's control, including but not limited to, the impact of general economic conditions, industry conditions, fluctuation of commodity prices, fluctuation of foreign exchange rates, environmental risks, industry competition, availability of qualified personnel and management, stock market volatility, timely and cost effective access to sufficient capital from internal and external sources. Actual results, performance or achievement could differ materially from those expressed in or implied by, these forward looking statements.

The TSX Exchange has not reviewed and does not accept responsibility for the adequacy or accuracy of this release.

Contact Information

  • Essential Energy Services Trust
    James Burns
    President & CEO
    (403) 263-6778
    or
    Essential Energy Services Trust
    Duncan Au
    Vice President - Business Development & CFO
    (403) 263-6778
    or
    Essential Energy Services Trust
    Suite 950, 330 - 5th Ave SW
    Calgary, Alberta T2P 0L4
    (403) 263-6778
    (403) 263-6737 (FAX)