Wellco Energy Services Trust
TSX : WLL.UN

Wellco Energy Services Trust

March 05, 2007 06:01 ET

Wellco Announces 2006 Fourth Quarter and Annual Results

Wellco Energy Services Trust (TSX:WLL.UN) is pleased to announce its financial results for the three and twelve months ended December 31, 2006, with comparisons to the comparable periods of 2005

CALGARY, ALBERTA--(CCNMatthews - March 5, 2007) - Wellco Energy Services Trust (TSX:WLL.UN):

MANAGEMENT DISCUSSION AND ANALYSIS ("MD & A")



FINANCIAL HIGHLIGHTS
(Expressed in thousands of $, except per unit amounts)

For the 3 months ended For the 12 months ended
December 31, December 31,
---------------------------- ---------------------------
2006 2005 Change 2006 2005 Change
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Revenue $ 26,217 $ 30,257 (13%) $110,660 $ 84,376 31%
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Gross Margin 10,307 12,717 (19%) 44,253 34,753 27%
Gross Margin % 39% 42% (3%) 40% 41% (1%)
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G&A Expenses 3,631 4,166 (13%) 15,880 12,552 27%
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Funds from
operations (1) 6,174 8,179 (25%) 27,049 21,399 26%
Per unit diluted 0.34 0.55 (38%) 1.55 1.47 5%
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Cash distributions
declared 4,828 3,692 31% 18,672 13,676 37%
Cash Payout
Ratio (1) 78% 45% (33%) 69% 64% (5%)
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EBITDA (1) 6,676 8,551 (22%) 28,373 22,201 28%
Per unit diluted 0.37 0.58 (36%) 1.62 1.53 6%
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Net earnings (loss) (4,901) 6,044 (181%) 8,577 14,199 (40%)
Per unit diluted (0.27) 0.41 (166%) 0.49 0.98 (50%)
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Net earnings
before impairment
of goodwill 3,699 6,044 (39%) 17,177 14,199 21%
Per unit diluted 0.21 0.41 (49%) 0.98 0.98 0%
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Number of units
outstanding
Basic 17,881,107 14,644,346 22% 17,415,239 14,344,632 21%
Diluted 17,903,962 14,790,898 21% 17,486,523 14,540,473 20%
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(1) Refer to the "NON-GAAP Measures" section for further details.


This MD&A for the Trust, dated March 5, 2007, focuses on key statistics from the consolidated financial statements and pertains to known risks and uncertainties relating to the oilfield services industry. This discussion should not be considered all-inclusive, as it excludes changes that may occur in general economic, political and environmental conditions. This discussion and analysis of the financial condition and results of operations for the three and twelve months ended December 31, 2006, should be read in conjunction with the audited annual consolidated financial statements for the year ended December 31, 2006 and related notes and material contained in other parts of this report as well as the Trust's Annual Information Form ("AIF").

Additional information relating to Wellco, including Wellco's AIF, may be found on SEDAR at www.sedar.com, and is supplemental to, the consolidated financial statements and related notes contained in this report for the three and twelve months ended December 31, 2006. This MD&A was prepared effective March 5, 2007. The consolidated financial statements contained in this Annual Report have been prepared in accordance with Canadian Generally Accepted Accounting Principles ("GAAP") in Canadian dollars.

This MD&A and President's Message may contain forward looking statements. All statements other than statements of historical fact contained herein are forward-looking statements, including without limitation, statements regarding the Trust's future financial position, business strategy, projected costs and plans and objectives of management for future operations. Many of these statements can be identified by looking for words such as "believe", "will", "intends", "projects", "anticipates", "estimates", "continues" or similar words or the negative thereof. The Trust cannot assure that the plan, intentions or expectations upon which its forward-looking statements are based will occur. The Trust's forward-looking statements are subject to risks, uncertainties and assumptions, including those discussed elsewhere in this MD&A. Although the Trust believes that the expectations represented in such forward-looking statements are reasonable, the Trust cannot assure that its expectations will prove to be correct. Some of the risks, among others noted in "Business Risks", which could affect the Trust's future results and could cause results to differ materially from those expressed in the Trust's forward-looking statements include, but are not limited to: risks inherent in the future prices of oil and natural gas and risks inherent in the prices for services and government fiscal regimes. Actual results may differ from those forecasted and such variations may be material.

PROFILE

Wellco Energy Services Trust ("Wellco" or "the Trust") provides a comprehensive array of integrated oilfield drilling and production services to organizations engaged in the exploration and production of oil and natural gas in Western Canada.

Wellco Energy Services Trust provides the following products and services:

- Accommodations (both camps and wellsite trailers)

- Full service catering

- Wastewater treatment

- Surface equipment rentals

- Production testing and frac blow-back tanks

- Service rigs

Wellco is committed to supporting our clients' operational needs through an integrated suite of oilfield products and services. Our commitment to professional and timely service has given us the opportunity to build lasting, long-term working relationships with our clients.

ANNUAL GENERAL MEETING

The Annual General Meeting of the unitholders will be held in the Viking Room of the Calgary Petroleum Club, 319 - 5th Avenue SW, Calgary, Alberta on Thursday, May 10, 2007 at 10:00 a.m. Mountain Time.

PRESIDENT'S MESSAGE TO UNITHOLDERS

Introduction

On behalf of the Board of Directors of Wellco Energy Services, I am pleased to report on a successful year for the Trust. Although faced with declining commodity prices and a resultant drop in drilling activity, the Trust realized increases over the prior year in many operating and financial performance measures. These increases reflect the investments made during 2005, the significant capital build program undertaken in 2006 and the Company's efforts to maintain its market share and utilization rates during 2006. They are also reflective of a significant decline in activity for the production testing part of our production services segment.

Financial Commentary

Fourth quarter revenue declined ($4.0) million or (13%) over the same period in 2005. Fiscal 2006 revenue increased $26.3 million or 31% as compared to fiscal 2005. Funds from operations (see the non-GAAP measures section later in this MD&A, for a full discussion on how we determine and use this measure) for the fourth quarter of 2006 were down ($2.0) million or (25%) as compared to the same time period of 2005. Fiscal 2006 funds from operations were up $5.7 million or 26% as compared to fiscal 2005.

Operations Review

Our business successes in 2006 included our accommodation and catering division where revenue was up 36% year over year. This is an area to which we have dedicated considerable capital over the past several years, making Wellco a significant participant in the remote accommodation market.

In our 2006 build program we added a new type of accommodation product, the wider 14' unit, which we are able to configure for crew sizes of 26 to 100 persons accommodated in single rooms. The larger unit and flexible configuration make this kind of camp better suited to longer term deployment.

During the fourth quarter of 2006 and the first quarter of 2007, we placed a number of camps in the Ft. McMurray area, the Company's first major exposure to this important area of development in Alberta. This is also proving to be fertile ground for the deployment of our waste water treatment units as well as many of our surface rental products.

A second area of significant growth for the Company over the past 2 years has been our waste-water product line. We now boast a fleet of 235 membrane type waste-water units ranging in capacity from 10 to 250 man. We believe our portable treatment systems are unmatched in the industry for environmental performance and as a result our estimates show a Western Canadian market share exceeding 60%.

During 2006 we took delivery of our eight and ninth new service rigs. This business was one of our most consistent revenue producers through 2006 and indications are it will continue to carry the momentum into 2007.

Two areas of our business which struggled through 2006 are the surface rental equipment and our production testing division. Both enjoyed a strong first quarter as compared to 2005, followed by significant reductions in utilization over the following three quarters of the year.

Our surface rental business has been concentrated in Northern Alberta and north-eastern British Columbia. Reduced drilling activity, through the second and third quarters did not return with the winter drilling season. This was particularly true in British Columbia and as a result we have redeployed some of this equipment into our Ft. McMurray operation.

There is no way to soften the blow; production testing has had a terrible year. Reduced activity levels following the first quarter resulted in revenue levels for 2006 that were 40% below our expectations. The most dramatic decline was experienced in the south central Alberta area where shallow gas drilling projects were most severely cut. Production testing operating results in the northern Alberta area were somewhat better, as they finished 2006 at 22% below our expectations. As a result of the declines in activity and revenue in both these areas in 2006, we have realized an impairment to goodwill in our production services segment of $8.6 million (please refer to the Goodwill section of this MD&A for further details).

Strategic Commentary

In my message to unitholders last year I made the following remark:

"Our vision is to create an integrated, multi-service company, generating sufficient funds from operations to provide stable distributions (distributing in the range of 60% of funds from operations) and maximum return to our unitholders. We will do this by investing in products and services that have a logical operational connection (synergy) with each other, generate a consolidated gross margin in excess of 40% and in which we believe we have the potential to become a prominent market participant. Our long term goal is to achieve sufficient market capitalization to attract a broader range of investors, achieve the improved financial stability of a larger economic entity, and ultimately reduce our cost of capital."

How did we perform against this strategy during 2006:

As in 2005, we again made significant additions to our asset base. Our 2006 capital program consisted of expenditures on new assets as well as some rebuilds and modifications. The bulk of the funds were expended on additions to our accommodation business as well as our waste water treatment business.

Additions in these two areas have made us a prominent player in both markets, particularly in waste water where we believe we are now a dominant industry supplier of portable waste water rental units. We believe that we provide the most efficient system available in our industry.

We have maintained a stable level of distribution to unitholders, although our cash distribution payout ratio has crept upwards as funds from operations have been impacted by lower activity levels. Declared distributions for 2006 were 69% of funds from operations.

Our consolidated gross margin for 2006 came in at 40%. We managed to maintain this level of return despite a very challenging year in several of our divisions.

We have not added any new products and we have continued with our aggressive integration program, improving the synergies available in our product mix. Good evidence of this effort is the deployment of equipment in Ft. McMurray where we have been able to package accommodations of various kinds with several other rental products.

We made little headway during the year toward our long-term goal of increasing our market capitalization. Although our capital program significantly expanded our asset base, adding to our ability to generate revenue and income, external factors which changed the activity levels in the industry, and tax changes which affected public valuations, have precipitated an overall decline in our market cap.

Integration Efforts

We have always described ourselves as an integrator of businesses acquired. Through 2006 these efforts continued, and we exited the year with area managers who have grown individually as leaders and stronger as a team.

Our integrated structure and team environment will enhance our ability to deal with the lean times through the middle of 2007 predicted by most analysts.

What is our strategy going forward?

Our strategy going forward has not changed. We remain committed to growth, particularly in those markets (accommodation and waste-water treatment) where we have an established position. Although during 2006 we were unable to find what we considered to be prudent business acquisitions, we will continue to seek acquisitions that fit our strategy and make economic sense for our company and its unitholders.

The Future

The business of predicting the direction of commodity prices has now come to include meteorology, foreign policy and international relations as well as the traditional measures of supply and demand. It isn't surprising therefore that gas and oil prices will move on news of a cold week in New York or a political development somewhere in the world.

Although there is arbitrage in this kind of analysis, it does not provide a logical basis on which to make decisions in an operating business. Rather, an operating business must establish a view on the fundamentals, and make its investments accordingly.

The investment decisions we have made with respect to 2007 reflect our view that drilling activity is going to be soft through to at least the third quarter of the year. Indeed, this is the prediction of most of the industry's analysts and the oilfield's professional organizations in Western Canada. In fact the Petroleum Services Association of Canada (PSAC) predicts a drop in drilling activity from approximately 22,000 wells in 2006 to 21,000 wells in 2007. Notwithstanding the drop in wells drilled, operating days are predicted to go from approximately 175,000 to 159,000 indicating a greater number of deep wells being drilled in the current year.

At Wellco, we have paused. Our capital build program for 2007 is, at this point, very modest (see capital expenditure section included in the MD&A). Our decision was based principally on the effect of high gas storage levels on drilling activity in Canada. We will re-examine our position as the year unfolds, and may readdress it part way through the year.

As we go into this low period in the cycle, we are well positioned to deal with the short-term slow-down. In the longer term, we plan our business around a healthy oil and gas industry in Western Canada.

Our industry will undoubtedly become subject to a greater level of environmental regulation, will continue to struggle to find people to staff its activities and, apparently, will be challenged by governments. However, we will also continue to fulfill our responsibility to supply the world's energy demands, and therein lays opportunity for Wellco.

We have made a significant entry into the opportunities in Ft. McMurray and will continue to expand our presence there.

Our build program through 2006 has provided us an expanded asset base with which to exploit the opportunities that inevitably follows a low point in the cycle.

Our balance sheet coming into 2007 is reasonably strong, giving us the flexibility needed during these slower periods, and potentially the ability to become a more significant consolidator.

Our ability to continue to generate cash flow, even when portions of our business are experiencing depressed activity levels, sustains our distributions.

Finally, our Company is organized in such a way as to make short-term cost containment a manageable prospect.

As always at this time of year I would like to extend personal thanks to all who have contributed during the past year. There are many employees who have worked very hard, many through a very frustrating period; thank-you for your efforts, and congratulations on your achievements. Our directors have provided insight throughout the year, and we look forward to their guidance as we manoeuvre ourselves through the future challenges faced by business trusts. Our many unitholders have been frustrated with the drop in value of their investment; our efforts are dedicated to ensuring your returns are maximized and we thank-you for your continued support.

DESCRIPTION OF OPERATIONS

Accommodations and Catering

Wellco operates a fleet of mobile trailers which can be configured to accommodate crews ranging from 10 - 100 or more people. These camps, which are a rental service, provide sleeping, washroom, recreation and dining facilities for personnel principally on oil and gas drilling locations.

In addition, we have a fleet of single free-standing accommodation trailers which provide living and working quarters for wellsite professionals at the drill site.

Wellco also provides full catering (food, preparation and service) as a supplement to its camp rental operations.

Wastewater Treatment Systems

Wellco's portable wastewater systems, the majority being membrane technology, treat black and grey water in a bacterial culture which, over the course of an 18 hour cycle, produces an effluent that is safe for surface disposal. Wellco has various sizes of wastewater treatment systems, to match the size of the group accommodated.

Surface Equipment Rentals

Wellco provides a broad variety of ancillary oilfield rental equipment including vacuum, hydro-vac and water trucks, flare tanks, floc tanks, incinerators, ash bins, refuse bins (both environmental and waste), rig matting and containment tanks. Wellco also provides a variety of environmental consulting services including site and fluid assessments.

Service Rigs

Wellco's fleet of service rigs operates primarily in southeastern Alberta. The rigs are used to provide completion, production, work-over and abandonment services on producing oil and gas wells.

Production Testing and Frac Blow-Back Tanks

Production testing involves the measurement of pressure and flow rate of fluids flowing from a producing wellbore. The equipment involved includes a pressure vessel along with piping (to connect to the wellhead), and instrumentation. Also measured are the presence and quantity of produced fluids including gas, oil and water.

Following a fracturing operation, frac fluids flow to the surface and are collected in our fleet of frac blow-back tanks. Fluids collected in the tanks are transferred to vacuum trucks and disposed of in an environmentally safe manner.

FOURTH QUARTER HIGHLIGHTS

For the first time in six quarters, Wellco's operating results were lower than the comparable quarter in the prior year. Results for the fourth quarter ended December 31, 2006 fell below expectations and prior year by most measures including revenue, funds from operations and net earnings. Revenue of $26.2 million and funds from operations of $6.2 million in the fourth quarter of 2006 represent decreases of 13% and 25% respectively, compared with the same period of 2005. Funds from operations as a percentage of revenue for the fourth quarter of 2006 were 24% as compared to 27% for the comparable period in 2005. The Trust's net loss for the fourth quarter of 2006 was ($4.9) million or ($0.27) cents per diluted unit, which included a $8.6 million impairment of goodwill from our production services segment (see goodwill section of this MD&A for further details). The Trust's net earnings before the impairment of goodwill were $3.7 million or $0.21 cents per unit diluted compared with $6.0 million or $0.41 cents per diluted unit for the fourth quarter of 2005. These unfavourable variances are a direct result of decreased market activity, slightly offset by increased equipment capacity from internal growth.

The fourth quarter of 2006 witnessed reductions in activity levels throughout the drilling industry as a result of continued overall softening in the oil and gas market. The persistent downward trend in commodity prices in 2006, natural gas in particular, led to lower fourth-quarter demand for the majority of Wellco's services in the Western Canadian areas in which we operate. Wellco's overall strategy has been, and will continue to be, to strengthen and grow our current product lines to add stability to the Trust's overall profitability. Spot prices continued to decline throughout the period as a result of concerns over higher storage levels in North America, causing many oil and gas producers to reduce drilling programs, primarily in the shallow gas market. These reductions caused an overall decline in drilling rig utilization for the fourth quarter of 2006. Drilling rig utilization dropped to 57% for the quarter, a decline of 26% versus the same period in 2005. Drilling rig utilization was the lowest it has been in the fourth quarter since 2002.

The Trust did have positive results for the fourth quarter compared to the same period of 2005 in three of its five product lines; accommodations and catering, wastewater treatment and service rigs. This can be attributed to increased equipment capacity as well as a dedicated sales focus on customer retention and quality services. The lower commodity prices negatively impacted our production testing product line. For the fourth quarter production testing failed to meet our internal expectations as the result of this slow activity. As we mentioned in our third quarter analysis, some key producers reduced their capital programs in the latter part of 2006 due to the sliding natural gas prices, particularly in areas of shallow gas drilling, resulting in lower than expected utilization in our production testing product line. In addition, the production testing segment was impacted by the suspension of much of the planned shallow gas and coal bed methane drilling and development activities by many of our key customers. Although we continue to solicit new customers to offset this decline, the combination of these influences resulted in financial performance below expectations during the fourth quarter of 2006. The surface equipment rentals product line, also performed below expectations for the quarter. This can be attributed to a large equipment build-up by our competitors, which placed considerable pressure on the marketplace. This excess inventory, accompanied with the market slowdown, resulted in a much more competitive environment as compared to 2005.

In May of 2006 we increased our distributions to unitholders by 5.9% to 9 cents per unit per month or $1.08 per unit annually. Distributions declared to unitholders for the three month period ended December 31, 2006 were $4.8 million or 27 cents per unit, representing 78% of funds from operations for the period as compared to distributions of $3.7 million or 25.5 cents per unit, representing 45% of funds from operations for the same period of 2005. The period over period 33% increased cash payout ratio as a percentage of funds from operations reflects the decreased oil and gas drilling activity that affected our industry for the last two quarters of 2006.



OVERALL PERFORMANCE

Twelve months ended
($ thousands) December 31
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2003 2004 2005 2006
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Revenues 20,943 59,573 84,376 110,660
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Twelve months ended
($ thousands) December 31
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2003 2004 2005 2006
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Declared Distributions 4,337 11,724 13,676 18,672
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Funds from Operations 3,387 16,257 21,399 27,049
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Despite only a 1% increase in wells drilled on a completion basis in the oil and gas industry in Western Canada compared to the same twelve month period in 2005, the Trust continued to grow over the prior twelve month comparable period as a result of its strategic growth plans via capital builds and prior year acquisitions. A softening of natural gas prices over the course of 2006 curtailed capital being spent on natural gas exploration by some producers, which negatively impacted our production testing product line. The surface equipment rental division was also down compared to 2005 due to increased competition in the marketplace and decreased drilling activity. The Trust has however maintained year over year revenue and funds from operations growth through continued success in the accommodations and catering, wastewater treatment, and service rig product lines.



For the 3 months ended For the 12 months ended
December 31, December 31,
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2006 2005 Change 2006 2005 Change
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Wells Drilled -
Completion Basis 6,758 6,759 (0%) 22,127 21,925 1%
Western Canada (1)
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Drilling Rig
Utilization (1) 57% 83% (26%) 63% 69% (6%)
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(1) Source: Daily Oil Bulletin ("DOB") & Canadian Association of Oilwell
Drilling Contractors ("CAODC")


The Trust recorded record revenues in 2006 of $110.7 million, an increase of $26.3 million or 31% versus the same period of 2005. Net earnings for the twelve months ended December 31, 2006 were $8.6 million, or 49 cents per unit diluted, a decrease of 40% as compared with $14.2 million, or 98 cents per unit diluted, achieved for the equivalent period in 2005. This was the result of the impairment of goodwill write-down of $8.6 million on the production services segment recognized in the fourth quarter of 2006. Net earnings before the impairment of goodwill for the twelve months ended December 31, 2006 were $17.2 million, or 98 cents per unit diluted, an increase of 21% as compared with $14.2 million, or 98 cents per unit diluted, achieved for the equivalent period in 2005. This year over year growth was driven by the full year impact of four strategic acquisitions in 2005, Wellco's 2006 capital build program and overall increased demand for our drilling services product lines.

Wellco's operations are reported in two segments. The drilling services segment includes accommodations and catering, waste-water treatment and surface equipment rentals. The production services segment includes our service rigs, production testing and blow back product lines. The following is a discussion of these two operating segments:

- For fiscal 2006, $77.1 million or 70% of the Trust's total revenue was derived from Drilling Services as compared to $63.1 million or 75% for the same period in 2005. The $14.0 million or 22% increase in revenue over the same period of 2005 was the result of capital additions and improved pricing in a number of the segments' product lines. For the fourth quarter of 2006 Drilling Services generated revenue of $19.3 million or 73% of the Trust's total revenue, compared to $20.1 million or 66% for the comparable period in 2005. The $0.8 million or 4% decrease in revenue over the same period of 2005 can mainly be attributed to the market slow-down accompanied by the increased competitive activity in the surface equipment rental product line.

- The Production Services operating segment contributed $33.6 million in revenue or 30% of the Trust's total revenue for fiscal 2006, versus $21.3 million or 25% for the same period in 2005. The $12.3 million or 58% increase over 2005 was the result of acquisitions made during fiscal 2005 and internal capital expenditures. The Production Services operating segment generated $6.9 million in revenue or 27% of the Trust's total revenue for the three months ended December 31, 2006, compared to $10.2 million or 34% for the same period in 2005. The $3.3 million or 32% decrease in revenue versus the same quarter of 2005 was driven by the poor performance of the production testing product line which was due to declines in industry activity, attributable to lower demand brought about primarily by the decline in natural gas prices.

For the year ended December 31, 2006, funds from operations were $27.0 million, or $1.55 per unit diluted, a 26% increase as compared to $21.4 million, or $1.47 per unit diluted in the same period of 2005. The increase in funds from operations is attributable to acquisitions made by the Trust in 2005 as well as the capital build program that was focused on our drilling services segment that performed to our expectations. Funds from operations as a percentage of revenue was 24% for fiscal 2006, compared to 25% for the same period in 2005. The cash payout ratio for 2006 was 69% as compared to 64% for 2005. The Trust's target is to distribute in the range of 60% to 65% of its funds from operations. The slightly higher result of 69% in 2006 was mainly the result of the decline in market activity in the latter half of this year, and the Trust maintaining its distribution levels to unitholders.

Wellco's overall success in 2006 can be attributed to increased demand from our customers for most of our services, as well as the integration of our operations into a single and standardized corporate culture. We continue to focus our culture around four key areas; excellence, by exceeding our customers' expectations both in the quality of our products and the integrity and performance of our people. Secondly, expertise, by being a key player in each of our product lines to ensure that we maintain and grow our market position. Both of these, in addition to our continued dedication to safety and providing a respectful workplace, are the focus of our day-to-day activities which have resulted in the overall success of the Trust. As well, with the significant investment in capital and acquisitions over the past two years, Wellco is committed to meeting the demands of our customers and becoming a prominent service company in all of the Trust's areas of operation.

SELECTED ANNUAL FINANCIAL INFORMATION

Selected annual financial information derived from the audited consolidated financial statements for the three most recently completed financial years is outlined below and is prepared in accordance with Canadian generally accepted accounting principles ("GAAP").



(Expressed in thousands of dollars, except per unit amounts)

2006 2005 2004
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Revenues $110,660 $ 84,376 $ 59,573
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Net Earnings 8,577 14,199 9,963
Per Trust Unit:
Basic 0.49 0.99 0.80
Diluted 0.49 0.98 0.79
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Net Earnings before Impairment of Goodwill 17,177 14,199 9,963
Per Trust Unit:
Basic 0.99 0.99 0.80
Diluted 0.98 0.98 0.79
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Total Assets 168,791 148,752 103,869
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Total long-term financial liabilities
(excludes current portion and future taxes) 31,203 25,664 6,305
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Cash distributions per Trust Unit 1.06 0.975 0.96
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Revenue increased in 2006 by 31% as compared to 2005 and was 86% higher than 2004. This increase is a result of four acquisitions completed in fiscal 2005, and having the full year impact of those additions in 2006; Wellco's internal capital build program as well as pricing initiatives implemented in early 2006. The increase in 2005 as compared to 2004 is a result of the full year impact of 2004 acquisitions, the acquisitions completed in 2005 which significantly expanded Wellco's fleet of equipment in both the Drilling Services and Production Services operating segments, and the 2005 internal capital build program.

Net earnings decreased in 2006 by 40% as compared to 2005 and decreased 14% versus 2004; which is a direct result of the impairment of goodwill write-down of $8.6 million on the production services segment recognized in the fourth quarter of 2006. Net earnings before goodwill impairment increased in 2006 by 21% as compared to 2005 and increased 72% versus 2004. This increase reflects the capacity growth of Wellco, driven by a total of nine acquisitions completed in 2004 and 2005 and large capital build programs in 2005 and 2006.

The Trust's total assets have increased in 2006 by 13% as compared to 2005 and increased 63% since 2004. Total assets have increased close to $65 million since 2004, while long-term liabilities have increased only $25 million. The Trust has utilized the remaining funds from operations after distributions and new equity to finance the growth in our assets and keep our debt at reasonable levels.

The Trust declared distributions to unitholders of $18.7 million ($1.06/unit), or 69% of funds from operations during fiscal 2006 compared to declared distributions of $13.7 million ($0.975/unit) or 64% of funds from operations for fiscal 2005. In 2004 declared distributions were $11.7 million ($0.96/unit) or 72% of funds from operations. In both October 2005 and May 2006 Wellco increased its distributions to unitholders by 0.5 cents per unit respectively. Wellco's current distributions to unitholders is $1.08 per unit annually. The Trust's target is to distribute in the range of 60% to 65% of its funds from operations. Although the softening marketplace continued throughout the latter half of 2006, we maintained our distributions to unitholders and overall were able to keep our distributions as compared to funds from operations close to our target.

RESULTS OF OPERATIONS

Revenue

Revenue of $26.2 million was generated during the fourth quarter of 2006 compared to $30.3 million for the same period in 2005, a decrease of 13%. This decrease was a direct result of decreased industry activity which saw a decline in both drilling and service rig activity as well as the overall number of rigs working. These declines were attributable to lower demand associated with the decline in natural gas prices. For the twelve months ended December 31, 2006, Wellco posted record revenues of $110.7 million compared to $84.4 million in the same period of 2005, an increase of 31%. The period over period increase was due in large part to the Trust's capital build program targeted at expanding market share and meeting customer demands. In addition, corporate acquisitions completed in 2005 impacted our overall year over year growth.



A summary of the Trust's mix of revenues from our two operating segments is
shown in the following table:

Three months ended Twelve months ended
December 31, December 31,
-------------------- ---------------------
2006 2005 2006 2005
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REVENUE SOURCE
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Drilling Services:
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Accommodations & Catering 47% 36% 41% 39%
Surface Equipment Rentals 12% 17% 15% 20%
Wastewater Treatment 14% 12% 14% 12%
Directional Drilling (divested Oct
2005) 0% 1% 0% 4%
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TOTAL - DRILLING SERVICES 73% 66% 70% 75%
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Production Services:
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Production testing/blow-back tanks 12% 23% 17% 12%
Service rigs 15% 11% 13% 13%
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TOTAL - PRODUCTION SERVICES 27% 34% 30% 25%
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TOTAL 100% 100% 100% 100%
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At the beginning of 2006, we had estimated an allocation between drilling services and production services revenue to be 64% and 36% respectively. However, based on the recent market developments negatively impacting the production testing product line, accompanied by the fact that accommodations and catering have exceeded expectations, we completed 2006 with an allocation of revenues of 70% drilling services and 30% production services. Our allocation of revenues for 2007 will follow much this same split with drilling services representing 70% and production services 30% of revenue respectively.

Direct Costs and Gross Margin

For the three month period ended December 31, 2006 direct costs were $15.9 million (39% gross margin) as compared to $17.5 million (42% gross margin) in the same period of 2005. Direct costs for fiscal 2006 were $66.4 million (40% gross margin) as compared to $49.6 million (41% gross margin) in the corresponding period of 2005.

Overall, lower activity in both the third and fourth quarters of 2006 contributed to increased operating costs. Given the increased cost structure to conduct business in the oil and gas services industry over the past two years, the Trust through our integrative operating strategy was able to maintain 2005 and 2006 margin levels in the 40% to 41% range. One of the areas that has impacted the Trust's economics is the cost of labour. It has been a challenge to find and maintain quality staffing levels given the labour shortages seen in the marketplace. To help with this, management continually reviews the compensation platform to ensure it offers a competitive reward package as well as developmental training to enhance skills and career advancement within the organization. As a result, direct costs were affected by higher compensation expenses. We also had anticipated slightly higher costs as a percentage of revenue in 2006 vs. 2005, due to our business mix being impacted by the production testing businesses we acquired in 2005. The production testing product line has a lower gross margin than our other product lines. We have and will continue to focus on operating efficiencies and selective price increases, if warranted, to help offset the increases in the Trust's operating costs.

General and Administrative Expenses

General and administrative expenses ("G&A") for the three month period ended December 31, 2006 were $3.6 million (14% of revenue) compared to $4.2 million (14% of revenue) in the comparable period of 2005. This $0.6 million decrease in G&A expenses as compared to the fourth quarter of 2005 was due to bonus reductions given that the Trust did not meet various internal targets for the year. G&A expenses were $15.9 million (14% of revenue) for fiscal 2006, compared to $12.6 million (15% of revenue) for the same period in 2005. The year over year increase of $3.3 million is primarily attributable to the overall head count and infrastructure additions associated with the Trust's considerable growth. As well, the increase is due to higher employee compensation costs required to remain competitive in the industry. Despite the increase in total G&A, the amount as a percentage of revenue for 2006 (14%) has decreased compared to the same period of 2005 (15%).

Depreciation and Amortization

For the three months ended December 31, 2006 depreciation expense was $2.6 million and amortization of intangible assets and deferred financing costs totalled $0.1 million, an overall increase of 42% compared to $1.8 million of depreciation and $0.1 million of amortization in the corresponding period of 2005. Depreciation and amortization was 10.4% and 6.3% of revenues for the three month period ending December 31 of 2006 and 2005 respectively. For the full year 2006 depreciation expense was $9.2 million and amortization of intangibles and deferred financing totalled $0.5 million compared to $6.9 million of depreciation and $0.4 million of amortization in the corresponding period of 2005 for an overall increase of 35%. For fiscal 2006 and 2005, depreciation and amortization was 8.8% and 8.6% of revenues respectively. The overall increases in depreciation and amortization are a direct result of the Trust's internal capital build program and prior year's business acquisitions as our property and equipment value on our balance sheet has increased by 38% year over year.

Goodwill

Goodwill is recorded at cost and is not amortized. In the fourth quarter of 2006, in conjunction with the Trust's annual impairment test, management reviewed the estimated fair value of goodwill for both the drilling and production services segments. Management estimated the fair value using a number of industry accepted valuation methodologies including discounted future cash flows, available industry valuation multiples based on actual results obtained in 2006, recent trading activity and capital market pricing of the Trust's units and other valuation considerations. The result of this analysis indicated that the implied fair value of the goodwill in the production services segment exceeded the carrying amount by $8.6 million and accordingly an impairment loss in this amount was recognized at December 31, 2006. The net impact on earnings per unit was a reduction of 49 cents per unit for the year ended December 31, 2006. Our drilling services segment met all annual impairment tests regarding its goodwill, and thus did not require any type of impairment charge.

Interest - Long-Term and Other Debt

For the fourth quarter of 2006 interest expense on long-term and other debt was $506 thousand, as compared to $394 thousand in the corresponding period of 2005, representing an increase of $112 thousand or 28%. For fiscal 2006 interest expense on long-term and other debt was $1.5 million, as compared to $1.0 million in the corresponding period of 2005, representing an increase of $0.5 million or 56%. This was due to increased monthly balances of long-term debt in 2006 as compared to 2005. The increase of interest expense on long-term and other debt was also partially due to the Canadian prime bank rate change from 5.0% at December 31, 2005 to 6.0% at December 31, 2006. During the fourth quarter of 2006 a drawdown of our credit facility in the amount of $12.5 million occurred to fund the remaining 2006 internal capital expenditure program.

(Gain) Loss on Disposal of Property and Equipment

The loss on disposal of property and equipment for the three month period ending December 31, 2006 was $123 thousand compared to a ($1.3) million gain in 2005. For the twelve months ended December 31, 2006, the loss on disposal of property and equipment was $341 thousand compared to a gain of ($1.3) million for the prior year. The 2006 loss is mainly related to the write-off of one wellsite trailer due to a fire and the sale or write-off of service equipment, primarily vehicles, during fiscal 2006. The gain in 2005 was entirely the result of the sale of directional drilling assets during the fourth quarter of 2005.

Income Taxes Expense (Recovery)

Income tax recovery for the fourth quarter of 2006 was ($371) thousand as compared to a $1.5 million expense in the corresponding period of 2005. The total reduction for income taxes for fiscal 2006 was ($458) thousand compared to an expense amount of $1.1 million in 2005. At the expected combined federal and provincial tax rate of 32.5%, net earnings before income taxes for the twelve month period ended December 31, 2006 of $8.1 million would have resulted in an income tax provision of $2.6 million compared to the actual recovery provision booked of ($458) thousand. The variance of $3.1 million in the provision from what would be expected was the result of a reduction to the provision of $5.6 million for income allocated to unitholders, a reduction of $0.5 million resulting from announced decreases in corporate tax rates and increases of $2.8 million in the provision for non-deductible impairment of goodwill expense and $0.2 million in the provision for non-deductible expenses and other items for income tax purposes.

Distributions

The distributions declared to unitholders for the twelve month period ending December 31, 2006, were $18.7 million ($1.06/unit) or 69% of funds from operations compared to $13.7 million ($0.98/unit) or 64% of funds from operations in 2005. The increase in the payout ratio by 5% for fiscal 2006, compared to the same period of 2005 is primarily driven by the third and fourth quarter soft oil and gas market conditions in 2006.

Pursuant to the trust indenture, distributions may be reduced, increased or suspended entirely depending on the operations of Wellco and the performance of its assets. The actual funds from operations available for distribution to holders of the trust units is a function of numerous factors including: the financial performance of the company; debt covenants and obligations; working capital requirements; maintenance and expansion capital requirements for the purchase of property and equipment; and the number of trust units outstanding.

For Canadian tax purposes, the non-taxable portion of distributions reduces a unitholders adjusted cost base of Trust units. Further corporate acquisitions and financing could serve to increase or decrease the non-taxable portion of distributions. The ultimate proportion of taxability of distributions will be determined each year based on the Trust's activities. The Trust recommends that unitholders consult their tax advisors regarding the tax implications of their investment in Trust units (see Business Risks section of this MD&A for further information).



Distributable Cash from Operations

Three months ended Twelve months ended
December 31, December 31,
-------------------- ---------------------
(in thousands of $) 2006 2005 2006 2005
---------------------------------------------------------------------------
Funds from operations before
changes in non-cash working
capital items (1) $ 6,174 $ 8,179 $ 27,049 $ 21,399
Less:
Scheduled debt repayment (328) (74) (1,480) (1,329)
Maintenance capital expenditures
net of proceeds (435) (60) (850) (1,636)
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Distributable cash from operations 5,410 8,045 24,719 18,434

Less: Cash distributions declared 4,828 3,692 18,672 13,676
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Cash available for
distribution and growth 582 4,353 6,047 4,758
---------------------------------------------------------------------------
Distributable cash payout ratio (2) 89% 46% 76% 74%
---------------------------------------------------------------------------
(1) Changes in non-cash working capital items have been excluded as such
changes are financed using the Trust's operating line of credit
facility. Please see reconciliation of cash flow provided by operating
activities in the non-GAAP measure section of this MD&A.
(2) Distributable cash payout ratio is calculated as distributions declared
for the period divided by distributable cash from operations


The amount of cash available for distribution may vary from quarter to quarter and is dependent upon the seasonality of the Trust's operations and the timing of when capital expenditures are incurred. However, it is the Trust's policy to pay consistent distributions throughout the year despite the seasonality of Wellco's operations.

Maintenance capital expenditures are capital expenditures incurred during the period to maintain existing levels of service. This includes capital expenditures to replace property, building, and equipment disposed of and any costs incurred to enhance the operational life of existing property, building and equipment. As a result of the Trust's equipment being relatively new and the existence of a regular maintenance program for our equipment (such repairs and maintenance costs are expensed in operating expenses), expenditures for maintenance capital are currently minimal. Maintenance capital expenditures can fluctuate from period to period depending on requirements for upgrades or replacement of Wellco assets.

Management of the Trust review the level and nature of distributions on an on-going basis giving consideration to current performance, historical and future trends in the business and expected sustainability of those trends as well as required long-term debt repayments, maintenance capital expenditures required to sustain performance and future growth capital opportunities.

For the year ended December 31, 2006 distributable cash from operations ("DCFO") exceeded distributions declared, this represents management's decision to retain a portion of DCFO to finance growth capital expenditures and debt repayment. It is not management's intent to distribute 100% of distributable cash from operations. DCFO is not a recognized measure under GAAP. DCFO is a main performance measurement used by management and investors to evaluate the performance of the Trust.



SUMMARY OF QUARTERLY RESULTS

(Expressed in thousands of $'s, except per unit amounts)
---------------------------------------------------------------------------
Q4 Q3 Q2 Q1
2006 2006 2006 2006
---------------------------------------------------------------------------
Revenue $ 26,217 $ 25,105 $ 17,490 $ 41,848
Net earnings (loss) (4,901)(1) 3,539 917 9,022
Per unit - basic (0.27)(1) 0.20 0.05 0.56
Per unit - diluted (0.27)(1) 0.20 0.05 0.56
---------------------------------------------------------------------------
---------------------------------------------------------------------------


---------------------------------------------------------------------------
Q4 Q4 Q2 Q1
2005 2005 2005 2005
---------------------------------------------------------------------------
Revenue $ 30,257 $ 18,517 $ 10,795 $ 24,807
Net earnings (loss) 6,044 2,689 (192) 5,658
Per unit - basic 0.41 0.18 (0.01) 0.40
Per unit - diluted 0.41 0.18 (0.01) 0.40
---------------------------------------------------------------------------
---------------------------------------------------------------------------
(1) Includes impairment of goodwill charge of $8.6 million


Seasonality and Weather

The Trust's operations are carried out exclusively in Western Canada. The oilfield service industry in Western Canada can be extremely cyclical as commodity price fluctuations can be compounded by seasonal trends. Accordingly, there could be a wide fluctuation in financial performance from quarter to quarter; year over year and quarterly results should not be annualized. The industry's ability to relocate heavy equipment in the traditional Canadian exploration and production areas is dependent on weather conditions. Seasonally, the first quarter is usually the most active and prosperous as winter ground conditions typically allow complete access to most well locations. In the second quarter, spring weather can soften ground conditions and can accordingly slow oilfield service activity. With the onset of spring bringing melting snow together with frost leaving the ground, this can render many secondary roadways incapable of supporting the weight of heavy equipment. Subject to dry weather, activity resumes and may gain momentum in the third and fourth quarters. During excessively rainy periods equipment moves may be delayed thereby adversely affecting operations. The timing of these periods, "spring break-up" and "winter freeze-up", have a direct bearing upon the Trust's activity levels. Accordingly, the Trust's prime operating seasons are usually November through mid-March and July through late September.

LIQUIDITY AND CAPITAL RESOURCES

Operating Activities

Funds from operations were $6.2 million ($0.34 per unit diluted) for the fourth quarter of 2006 as compared to $8.2 million ($0.55 per unit diluted) for the comparable period of 2005. Funds from operations for fiscal 2006 were $27.0 million ($1.55 per unit diluted) as compared to $21.4 million ($1.47 per unit diluted) for fiscal 2005. Funds from operations represent net cash provided by operating activities before including the impact of the change in non-cash working capital items. Net cash from operating activities is calculated by taking funds from operations and applying the impact of the change in non-cash working capital items. Net cash provided by operating activities was $3.1 million for the fourth quarter of 2006 vs. $1.3 for the same time period of 2005. For fiscal 2006 net cash provided by operating activities was $26.8 million as compared to $9.7 million for fiscal 2005. Funds from operations provided by operating activities are reliant on the generation of adequate earnings before non-cash items. The Trust reinvests the remaining funds from operations provided by operating activities, after distribution payments to unitholders, into internal growth, acquisitions, and the repayment of long-term debt. Changes in the industry activity can and will have impacts on funds from operations and net cash provided by operating activities.

Financing Activities

Net cash generated by financing activities for the three months ended December 31, 2006 was $8.2 million (2005 - $12.5 million) and for fiscal 2006 it was $18.7 million (2005 - $11.7 million). A summary of our financing activities for the year ended December 31, 2006 include:

- Issue of trust units, net of costs of $31.1 million, representing a three million unit financing that was completed in March 2006. The funds raised from the financing were utilized for the 2006 internal capital build and to pay down long-term debt

- Net proceeds from long-term debt and operating line of credit of $37.6 million to fund our internal capital build program and working capital requirements

- Repayment of long-term debt of $31.7 million

- Payment of $18.3 million in Trust distributions to our unitholders

Investing Activities

Net cash utilized in investing activities for the fourth quarter of 2006 was $11.3 million (2005 - $13.9 million) and for the full year was $45.4 million (2005 - $21.4 million). For the year ended December 31, 2006, the investment activities were:

- $51.1 million expended on property and equipment additions

- Proceeds on disposal of property and equipment of $8.1 million

- Changes in non-cash working capital items in investing activities of $2.4 million

Liquidity

The Trust had working capital (defined as current assets less current liabilities excluding the current portion of long-term debt) of $11.4 million at December 31, 2006, compared to $10.7 million at December 31, 2005. The Trust's current ratio (defined as current assets divided by current liabilities excluding the current portion of long-term debt) remained strong over the period at 1.7:1.0, as compared to 1.5:1.0 at December 31, 2005.

Credit Facility

The Trust has a credit facility in place with total availability of $60 million. At December 31, 2006, $39.8 million of the available $60 million was drawn and outstanding. The facility consists of an extendible revolving operating credit line of $20 million and an extendible revolving acquisition and capital expenditure facility of up to $40 million to finance corporate and internal growth. Various borrowing options are available under the facilities including prime rate based advances and banker's acceptance notes. The cost of borrowing under these facilities at the end of 2006 was 6.0%, and at the end of 2005 was 5.0% as the prime rate increased year over year. All covenants of the banking facility were satisfied at December 31, 2006. The Trust does not anticipate any covenant issues restricting its future ability to pay distributions, or fund operating, investing or financing activities and believes that it has sufficient liquidity to operate its business and execute its strategic plan for the foreseeable future.

On February 23, 2006, the Trust closed a unit offering of 3,000,000 trust units. The offering was made on a bought-deal basis through a syndicate of underwriters. At closing, a total of 3,000,000 trust units were issued at a price of $10.75 per trust unit for gross proceeds of $32.3 million. The net proceeds of the offering of $30.5 million were used to reduce bank indebtedness, which has been redrawn and applied to finance the Trust's 2006 capital build program. Management also believes that, dependent on capital and market conditions, the Trust has the ability to raise additional capital through the public or private issuance of additional trust units, if required.



Contractual Obligations

Wellco's contractual financial obligations are summarized as follows:

Payments Due by Period
---------------------------------------------------------------------------
Contractual Next 12 1-3 4-5 After 5
Obligations Total months years Years years
---------------------------------------------------------------------------
Long-term debt $ 36,708 $ 5,816 $ 18,141 $ 12,751 $ -
---------------------------------------------------------------------------
Operating leases $ 25,519 $ 3,153 $ 4,932 $ 4,485 $ 12,949
---------------------------------------------------------------------------
Obligations under
capital lease $ 542 $ 230 $ 312 $ - $ -
---------------------------------------------------------------------------
Total Contractual
Obligations $ 62,769 $ 9,199 $ 23,385 $ 17,236 $ 12,949
---------------------------------------------------------------------------
---------------------------------------------------------------------------


Capital Expenditures

For the year ended December 31, 2006, $51.1 million was expended on additions to property and equipment which included $6.3 million on lands and buildings under construction and $0.4 million for deposits on assets under construction. During fiscal 2005 the Trust purchased land in Brooks, Alberta and Fort St. John, British Columbia, then contracted a construction company to erect a building on each piece of land to the Trust's specifications and requirements; this accounted for $5.0 million of the $6.3 million expended on lands and buildings. On September 28, 2006, the Trust completed the sale and leaseback of these facilities for gross proceeds of $7.8 million which was equal to their carrying value. The agreement to leaseback these assets will be accounted for as an operating lease. The remaining $1.3 million of the $6.3 million is related to costs incurred to date with regards to the Grande Prairie facility expansion; once completed will be handled in the same manner as the Brooks and Fort St. John building transactions were.



The additions to property and equipment, excluding additions to lands and
buildings under construction, consisted of:

- $ 21.2 million for accommodations and related equipment;
- 12.0 million for wastewater treatment systems;
- 4.4 million for service rigs and related equipment;
- 3.0 million for production testing and blow-back tank equipment;
- 1.2 million for surface rental equipment;
- 1.4 million for revenue producing vehicles related to various product
lines; and
- 1.6 million for ancillary operating equipment and infrastructure
costs.
------
$ 44.8 million
------
------


The Trust's Board of Directors recently approved a capital budget of $7.7 million for 2007, reflecting current industry conditions. Approximately $1.8 million reflects sustaining maintenance capital, $1.4 million is for infrastructure capital with the remaining $4.5 million directed towards growth capital mainly in our accommodations and catering product line. The 2007 capital expenditures will be financed predominately with internally generated funds from operations and our credit facility, if required.



The 2007 capital build program, totalling approximately $7.7 million,
consists of the following:

- $ 2.6 million for accommodations and related equipment;
- 0.3 million for wastewater treatment systems;
- 1.2 million for service rigs and related equipment;
- 0.1 million for production testing and blow-back tank equipment;
- 0.4 million for revenue producing vehicles related to various product
lines; and
- 3.1 million for ancillary operating equipment and infrastructure
costs (incl. land)
------
$ 7.7 million
------
------


Outstanding Trust Unit / Option Data

The following table summarizes Wellco's capitalization at December 31, 2006
and February 28, 2007:

Outstanding Balance as at,
Dec. 31, 2006 Feb 28, 2007
-------------------------------
Trust units 17,882,158 17,882,158
Trust unit options 1,307,692 92,503


Between January 1, 2007 and February 28, 2007, a total of 1,215,189 trust unit options were surrendered and cancelled by directors, officers and employees.

On January 15, 2007 a new long-term incentive plan ("LTIP") was adopted, which includes awards of both restricted and performance plan units based on certain criteria.

The number of plan units reserved for issuance under the plan will not exceed 5 percent of the total number of issued and outstanding trust units. The initial company grant in January 2007 was for 481,500 units or approximately 2.7% of the aggregate number of issued and outstanding trust units. Granted units will vest as to 50% on the 18th month and 50% on the 36th month following the date of the grant. Vesting of performance units will be additionally based on attainment of performance criteria. Over the three year term the units will attract distributions. The Trust is currently required to settle its plan obligations in cash. The Trust will seek unitholder approval at Wellco's Annual General Meeting on Thursday, May 10, 2007 for the option to issue trust units in settlement of payment under the plan.

OFF BALANCE SHEET ARRANGEMENTS

Wellco has not entered into any off-balance sheet arrangements (other than operating leases which are disclosed in the contractual obligation section of this MD&A) that have, or are reasonably likely to have, a current or future effect on the results of its operations or its financial condition.

TRANSACTIONS WITH RELATED PARTIES

There were no transactions with related parties during the year ended December 31, 2006.

CRITICAL ACCOUNTING ESTIMATES

In the opinion of management, the material accounting estimates in the financial statements as contained herein involve the valuation of property and equipment, unit-based compensation, goodwill and intangible assets, the determination of depreciation and amortization expense, collectibility of accounts receivable and the provision for income taxes.

Depreciation is determined, taking into account the estimated useful lives of assets and their residual values. These estimates could change for a variety of reasons, including, but not limited to, abnormal wear and tear conditions and changes in technology and other economic factors that could result in obsolescence. Such changes could have a material effect on future depreciation expense. A schedule of these estimates is contained in note 2 (d) of the 2006 audited annual consolidated financial statements.

Unit-based compensation expense, associated with unit options at grant date, is subject to changes in risk-free interest rates, unit price volatility and distribution yield rates. This estimate may vary due to changes in actual unit price.

The value of goodwill and intangible assets are subject to market conditions in the oil and gas industry and are subject to annual impairment tests. See note 2 (f) and (g) in the notes to the 2006 audited annual consolidated financial statements for further information.

The Trust performs credit evaluations of its customers and grants credit based on past payment history, financial conditions and anticipated industry conditions. Customer payments are monitored regularly and an allowance for doubtful accounts provision is established based on specific situations. Given the cyclical nature of the oil and gas industry, these credit risks are subject to change.

The Trust has estimated its tax pools for the income tax provision. The actual tax pools that the Trust may be able to use could be materially different in the future. See note 10 in the notes to the 2006 audited annual consolidated financial statements for further information.

CHANGES IN ACCOUNTING POLICIES

Management did not change existing accounting policies during the 2006 fiscal year but will adopt new accounting policies as required under GAAP.

FINANCIAL INSTRUMENTS

Wellco's financial instruments consist of accounts receivable, an operating line of credit, accounts payable and accrued liabilities, distributions payable and long-term debt. There are no significant differences between the carrying values of these financial instruments and their estimated fair values. Of Wellco's financial instruments, only its accounts receivable represents credit risk. Management views the credit risks with its customers as normal for the industry. Approximately 15% of the Trust's total sales for fiscal 2006 were derived from one customer. The customer is considered a senior oil and gas producer and is among the largest in the industry. See note 13 in the notes to the 2006 audited annual consolidated financial statements for further information.

NON-GAAP MEASURES

The financial statements have been prepared in accordance with GAAP. Certain supplementary information and measures not recognized under GAAP are provided where Management believes they assist the reader in understanding Wellco's results. These measures include:

1. Funds from operations - Funds from operations is defined as funds generated from operating activities before changes in non-cash working capital items. Funds from operations is not a recognized measure under GAAP. Management believes that funds from operations is a useful supplementary measure as it provides an indication of funds generated by operations before working capital adjustments. Investors should be cautioned, however, that funds from operations should not be construed as an alternative to cash provided by (used in) operating activities, determined in accordance with GAAP, as an indicator of the Trust's performance. The Consolidated Statement of Cash Flows in the interim consolidated financial statements at December 31, 2006 includes a reconciliation of funds from operations. Wellco's method of calculating funds from operations may differ from those of other companies, and accordingly, funds from operations may not be directly comparable to measures used by other companies.



The following is a reconciliation of cash flow provided by operating
activities to funds from operations:

Three months ended Twelve months ended
December 31, December 31,
-------------------- ---------------------
(in thousands of $) 2006 2005 2006 2005
---------------------------------------------------------------------------
Cash flow provided by operating
activities $ 3,083 $ 1,314 $ 26,752 $ 9,719
Changes in non-cash working
capital items (3,091) (6,865) (297) (11,680)
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Funds from operations 6,174 8,179 27,049 21,399
---------------------------------------------------------------------------
---------------------------------------------------------------------------


2. EBITDA - EBITDA is defined as earnings before interest, taxes, depreciation and amortization and (gain) or loss on sale of property and equipment. EBITDA is not a recognized measure under GAAP. Management believes, however, that EBITDA is a useful supplementary measure as it provides an indication of the operating results without regard to how these activities were financed or how the results were taxed. Investors should be cautioned, however, that EBITDA should not be construed as an alternative to net income determined in accordance with GAAP as an indicator of the Trust's performance. Wellco's method of calculating EBITDA may differ from those of other companies, and accordingly, EBITDA may not be directly comparable to measures used by other companies.



The following is a reconciliation of net income to EBITDA:

Three months ended Twelve months ended
December 31, December 31,
-------------------- ---------------------
(in thousands of $) 2006 2005 2006 2005
---------------------------------------------------------------------------
Net earnings (loss) (4,901)(1) $ 6,044 8,577(1) $ 14,199
Add:
Depreciation and amortization 2,719 1,902 9,775 7,245
Impairment of goodwill 8,600 0 8,600 0
Interest - long-term debt 456 312 1,169 798
Interest - other 50 82 369 185
(Gain) loss on disposal of
property and equipment 123 (1,310) 341 (1,299)
---------------------------------------------------------------------------
---------------------------------------------------------------------------
7,047 7,030 28,831 21,128

Income taxes:
Current (recovery) (1) 30 (39) 31
Future (reduction) (370) 1,491 (419) 1,042
---------------------------------------------------------------------------
EBITDA 6,676 8,551 28,373 22,201
---------------------------------------------------------------------------
---------------------------------------------------------------------------
(1) Includes impairment of goodwill charge of $8.6 million


3. Cash Payout Ratio - Cash payout ratio is calculated as cash distributions declared divided by funds from operations. Cash payout ratio is not a recognized measure under GAAP. Management believes this ratio provides an indication of the amount of cash retained for future growth opportunities, debt repayment or incremental future distribution to unitholders. Wellco's method of calculating Cash Payout Ratio may differ from those of other companies, and accordingly, may not be directly comparable to measures used by other companies.

BUSINESS RISKS

Certain activities of the Trust are affected by factors that are beyond its control or influence, some of which are summarized below. Additional risks and uncertainties that management may be unaware of, or that they determine to be immaterial may also become important factors which affect the Trust.

Oil and Gas Industry Conditions

The demand for Wellco's services is highly reliant on the levels of capital expenditures made by oil and gas companies on exploration, development and production activities. Exploration and production companies base their capital expenditures on several factors, including but not limited to hydrocarbon prices, production levels of their reserves, exploration and development prospects in various jurisdictions and access to capital. Oil and gas producers and explorers tend to examine long-term fundamentals affecting the foregoing factors before they adjust their capital expenditure plans. Risk factors associated with the Trust's operations relate to business factors and changes in government regulations. Should one or more of these risks materialize, actual results may vary materially from those currently anticipated. In recent years, commodity prices, and therefore, the level of drilling, production and exploration activity have been volatile. Any prolonged, substantial reduction in commodity prices will likely affect the activity levels of the exploration and production companies and the demand for the Trust's products or services. A significant prolonged decline in commodity prices would have a material adverse effect on the Trust's business, results of operations and financial condition.

Competitive Conditions

The various service lines in which the Trust operates are highly competitive. The Trust competes with several large national and multinational companies in the drilling and production equipment rentals and services businesses. Many of these companies have greater financial and other resources than the Trust. There can be no assurance that such competitors will not substantially increase the resources devoted to the development and marketing of products and services that compete with those of the Trust or that new competitors will not enter the various markets in which the Trust is active. In certain aspects of its business, the Trust also competes with a number of small and medium-sized organizations, which, like the Trust, have certain competitive advantages such as low overhead costs and specialized regional strengths.

Availability of Qualified Employees

The ability of the Trust to provide service is dependent upon attracting and retaining skilled personnel. The Trust attempts to overcome this by offering competitive compensation packages and training to enhance skills and career prospects with Wellco. The ability to secure the services of skilled personnel is constrained in times of strong industry demand.

Availability of Equipment or Parts and Relationships with Key Suppliers

The Trust's ability to expand its operations and provide reliable service is dependent upon timely delivery of new equipment and replacement parts from fabricators and suppliers. A lack of skilled labour to build equipment, combined with new competitors entering the oilfield service sector, is placing a strain on some fabricators which has substantially increased the order time on new equipment and increased uncertainty surrounding final delivery dates. Significant delays in the arrival of new equipment from expected dates may impact future growth and the financial performance of the Trust. The Trust attempts to mitigate this risk by maintaining strong business relationships with key fabricators and suppliers.

Tax Implications

On October 31, 2006 the Canadian Federal Department of Finance made an announcement relating to proposed changes to the taxation of income trusts. Included in this announcement was "a distribution tax on distributions from publicly traded income trusts and limited partnerships". The proposals would result in a two-tiered tax structure whereby distributions would be subject to a 31.5% tax at the Trust level commencing in 2011 and then unitholders would be subject to tax on the distribution as if it were a taxable dividend paid by a taxable Canadian corporation. This proposed change still needs to be approved by the Canadian government before becoming legislation. The proposed new tax measures will impair the flow-though nature of Wellco's current tax structure. The tax announcement had a significant impact on the Canadian equity markets with a significant devaluation of Trust unit prices. Despite the devaluation of Wellco's unit price following the taxation announcement, the Trust's core business remains unchanged. Wellco management is currently assessing the draft legislation and alternatives with respect to the future structure of the Trust.

DISCLOSURE CONTROLS

The Chief Executive Officer ("CEO") and the Chief Financial Officer ("CFO") have evaluated the effectiveness of the Trust's disclosure controls and procedures, as at the end of 2006 covered by the annual filings, and have concluded that such disclosure controls and procedures were effective to provide reasonable assurance that material information related to the Trust or its subsidiaries is made known to them. It should be noted that while the Trust's Chief Executive Officer and Chief Financial Officer believe that the Trust's disclosure controls and procedures provide a reasonable level of assurance that they are effective, they do not expect that the disclosure controls and procedures will prevent all errors and fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objective of the control system is met.

INTERNAL CONTROL OVER FINANCIAL REPORTING

Internal control over financial reporting is designed to provide reasonable assurance regarding the design and preparation of financial statements in accordance with Canadian GAAP and the reliability of financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting for Wellco Energy Services Trust. Wellco's management, including the CEO and CFO, have evaluated the design of the Trust's internal control over financial reporting using the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") framework and criteria. Based on this, Wellco has documented the business processes and internal controls over financial reporting and management has concluded that such controls have been designed effectively as of December 31, 2006.

OUTLOOK

Overall, 2006 was a successful year for Wellco. The Trust's success stemmed from the integration of the various acquisitions completed in 2005, as well as the completion of Wellco's largest capital build program to date. The growth of the Trust in 2006 was driven by our drilling services segment as our customers demand for these product lines continued to show stable growth. Our production testing product line was negatively impacted in 2006 by the continuing concerns over natural gas prices. The decrease in these prices caused many of our customers to review the financial viability of gas exploration, drilling and their development programs.

We expect continued weakness in the Western Canadian drilling market throughout the majority of 2007. Overall, it is our view that drilling and completion work will continue its year over year downward trend through to late summer, before beginning a recovery in the fourth quarter of 2007. This reduction is anticipated due to the weakness in natural gas prices, which has also affected the urgency with which our customers are approaching their drilling programs. Although a slowdown in drilling activity will continue to impact both our drilling and production services segments, we believe the fundamentals remain strong in relation to the expansion of major oilsands projects and investment in infrastructure and capital projects moving into the latter part of 2007. The Trust remains very well positioned to take advantage of this anticipated return to higher activity levels given the significant amount of capital committed to the growth of the Trust in 2006.

The Canadian Association of Oilwell Drilling Contractors ("CAODC") 2007 forecast of drilling activity was dominated by weaker gas prices stating in the range of 19,000 wells to be completed in 2007, representing a 14% decline from 2006. The Petroleum Services Association of Canada ("PSAC") has predicted a total of 21,000 wells to be rig released in 2007, the first slowdown in the industry's field activity since 2002. These anticipated declines are focused in shallow gas areas, as well as coal-bed methane. The CAODC also notes that it anticipates similar rig activity to 2003 with an average of 427 active rigs and anticipated utilization will decrease from 63% in 2006 to a projected 51% in 2007. At 51%, the 2007 utilization would be slightly above the 46% recorded in 2002, the last year dominated by weak commodity prices. Early indications show us that these reduced forecasts are highly probable as in January 2007, usually one of the busiest months for drillers; rig utilization was at 69%, compared to 88% in January 2006, and 89% in January 2005.

Although not enacted into law as of yet, the proposed tax on trusts is delayed four years, which provides us time to monitor the situation and formulate a longer-term plan. We must also remember that these proposed changes have no direct or immediate impact on the day-to-day operations of the Trust. Those operations remain a function of the oil and gas industry fundamentals. The Trust's policy of maintaining unitholder distributions in the range of 60% to 65% of funds from operations remains unchanged under the current tax regime.

We continue to strive for excellence in our services to our customers and ensure the safety of our valued employees and customers remains as always a high priority. We will continue to invest in personnel, new equipment, and employee training to ensure we are able to continue to meet our valued customer's expectations. These facets are the cornerstone of our organization, and our dedication to them will help with the long-term success of the Trust.

The Trust continually monitors strategies for reducing costs and achieving further market penetration in all areas which we operate. As stated in last quarter's report to unitholders, Wellco management is prepared to respond quickly to any prolonged or broader based slowdown in the industry. For 2007 we plan to be very focused on maximizing unitholder value by optimizing our prior capital investments. Wellco is committed to meeting our increased customer demand for our complementary group of product lines and is well positioned to deliver solid financial and operational performance moving forward.

Kenneth M. Bagan, President & Chief Executive Officer

Corey Zahn, Vice President, Finance & Chief Financial Officer



WELLCO ENERGY SERVICES TRUST
Consolidated Balance Sheets

December 31, 2006, with comparative figures for 2005
(Expressed in thousands of dollars)

---------------------------------------------------------------------------
2006 2005
---------------------------------------------------------------------------
(restated -
note 4)
Assets
Current assets:
Accounts receivable $ 25,338 $ 28,661
Inventory 1,145 558
Prepaid expenses and deposits 714 2,274
---------------------------------------------------------------------------
27,197 31,493
Property and equipment (note 6) 122,081 88,642

Intangible assets (note 7) 1,617 2,069

Goodwill 17,693 26,293

Deferred financing costs 203 255
---------------------------------------------------------------------------
$ 168,791 $ 148,752
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Liabilities and Unitholders' Equity

Current liabilities:
Operating line of credit (note 8) $ 3,803 $ 2,200
Accounts payable and accrued liabilities 10,389 17,345
Distributions payable 1,609 1,251
Income taxes payable - 39
Current portion of long-term debt (note 9) 6,047 7,316
---------------------------------------------------------------------------
21,848 28,151

Long-term debt (note 9) 31,203 25,664

Future income tax liability (note 10) 9,909 10,328

Unitholders' equity:
Trust units (note 11(b)) 119,533 88,060
Exchangeable shares (note 11(b)) - 293
Contributed surplus (note 11(c)) 416 279
Deficit (14,118) (4,023)
---------------------------------------------------------------------------
105,831 84,609
Commitments (note 12)
Contingencies (note 16)
Subsequent events (note 17)
---------------------------------------------------------------------------
$ 168,791 $ 148,752
---------------------------------------------------------------------------
---------------------------------------------------------------------------

See accompanying notes to consolidated financial statements.


Approved on behalf of the Board of Directors of Wellco Energy Services
Inc., Administrator of Wellco Energy Services Trust:

Kenneth M. Bagan, Director

Martin Hall, Director


WELLCO ENERGY SERVICES TRUST
Consolidated Statements of Earnings and Deficit

Years ended December 31, 2006 and 2005
(Expressed in thousands of dollars, except per unit amounts)

---------------------------------------------------------------------------
2006 2005
---------------------------------------------------------------------------
Revenue $ 110,660 $ 84,376

Direct costs 66,407 49,623
---------------------------------------------------------------------------
44,253 34,753
Expenses:
General and administrative 15,880 12,552
Depreciation and amortization 9,775 7,245
Impairment of goodwill (note 3) 8,600 -
Interest - long-term debt 1,169 798
Interest - other 369 185
(Gain) loss on disposal of property and
equipment 341 (1,299)
---------------------------------------------------------------------------
36,134 19,481

---------------------------------------------------------------------------
Earnings before income taxes 8,119 15,272

Income taxes (note 10):
Current (recovery) (39) 31
Future (reduction) (419) 1,042
---------------------------------------------------------------------------
(458) 1,073

---------------------------------------------------------------------------
Net earnings 8,577 14,199

Deficit, beginning of year (4,023) (4,546)

Cash distributions declared (18,672) (13,676)
---------------------------------------------------------------------------
Deficit, end of year $ (14,118) $ (4,023)
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Earnings per unit (note 11(d)):
Basic $ 0.49 $ 0.99
Diluted $ 0.49 $ 0.98
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Weighted average number of units
outstanding (note 11(d)):
Basic 17,415,239 14,344,632
Diluted 17,486,523 14,540,473
---------------------------------------------------------------------------
---------------------------------------------------------------------------

See accompanying notes to consolidated financial statements.


WELLCO ENERGY SERVICES TRUST
Consolidated Statements of Cash Flows

Years ended December 31, 2006 and 2005
(Expressed in thousands of dollars)

---------------------------------------------------------------------------
2006 2005
---------------------------------------------------------------------------
Cash provided by (used in):

Operating:
Net earnings $ 8,577 $ 14,199
Items not affecting cash:
Depreciation 9,249 6,881
Impairment of goodwill (note 3) 8,600 -
Future income taxes (reduction) (419) 1,042
Amortization 526 364
(Gain) loss on disposal of property and
equipment 341 (1,299)
Trust unit option compensation (note 11(c)) 175 212
---------------------------------------------------------------------------
27,049 21,399

Net change in non-cash working capital items
(note 14) (297) (11,680)
---------------------------------------------------------------------------
26,752 9,719
Financing:
Proceeds of long-term debt 36,000 30,461
Repayment of long-term debt (31,730) (7,462)
Issue of trust units, net of costs
(note 11(b)) 31,142 1,320
Distribution payments (18,314) (13,499)
Operating line of credit 1,603 1,038
Increase in deferred financing costs (22) (207)
---------------------------------------------------------------------------
18,679 11,651
Investing:
Purchase of property and equipment (51,083) (23,984)
Proceeds on disposal of property and equipment 8,054 14,738
Change in non-cash working capital (note 14) (2,402) 5,340
Business acquisitions net of cash acquired - (17,464)
---------------------------------------------------------------------------
(45,431) (21,370)
---------------------------------------------------------------------------
Change in cash position - -

Cash, beginning of year - -
---------------------------------------------------------------------------
Cash, end of year $ - $ -
---------------------------------------------------------------------------
---------------------------------------------------------------------------

See accompanying notes to consolidated financial statements

WELLCO ENERGY SERVICES TRUST
Notes to Consolidated Financial Statements

Years ended December 31, 2006 and 2005
(Amounts expressed in thousands of dollars, except per unit amounts)
---------------------------------------------------------------------------


1. Structure of the Trust:

Wellco Energy Services Trust (the "Trust") is an open-ended unincorporated investment trust governed by laws of the Province of Alberta and created pursuant to a Declaration of Trust dated May 28, 2002. The Trust was established as part of a Plan of Arrangement (the "Arrangement") that became effective on August 2, 2002.

The Trust is a diversified Canadian energy services trust operating in western Canada. The Trust has two operating segments which provide drilling and production services to oil and gas contractors and producers. The operating business of the Trust is carried on by Wellco Energy Services Partnership ("WESP"), which is owned by Wellco Energy Services Inc. ("WESI") and Wellco Operations Inc. ("WOI"). The Trust owns 100% of the common shares of WESI and WESI owns 100% of WOI. The activities of WESI, WOI and WESP are financed through interest bearing notes from the Trust and third party debt as described in the notes to the financial statements. The Trust owns all of the interest bearing notes of WESI, which represents the right to receive cash available for distribution from WESI through WESI's ownership of WOI and WESP. The management of WESI is responsible for the administration of the Trust and the management of WESI, WOI and WESP.

2. Significant accounting policies:

The financial statements of the Trust have been prepared in accordance with Canadian generally accepted accounting principles. Because a precise determination of many assets and liabilities is dependent upon future events, the preparation of periodic financial statements necessarily involves the use of estimates and assumptions, which have been made using careful judgment. The most significant of these are the valuation of accounts receivable, the estimated useful life of property and equipment, the valuation of intangible assets and goodwill and the provision for income taxes. Actual results could differ from these estimates. The financial statements have, in management's opinion, been properly prepared within reasonable limits of materiality and within the framework of the significant accounting policies described below:

(a) Principles of consolidation:

These annual consolidated financial statements of Wellco Energy Services Trust include the accounts of Wellco Energy Services Trust and its subsidiaries, which are all wholly-owned (collectively referred to as "Wellco" or "the Trust").

(b) Cash and cash equivalents:

Cash and cash equivalents consist of cash and short-term investments with maturities of less than three months.

(c) Inventory:

Inventories of camp catering supplies, materials for resale and supply parts are carried at the lower of cost and net realizable value, on a first-in, first-out basis.

(d) Property and equipment:

Property and equipment are recorded at cost less accumulated depreciation. Depreciation is provided taking into consideration the estimated useful lives of the assets and their residual values, using the following methods and annual rates:



---------------------------------------------------------------------------
Assets Method Rate
---------------------------------------------------------------------------

Service equipment Straight-line 6 - 15 years
Office and shop equipment Declining-balance 20% to 30%
Building Declining-balance 4%
Land - -
---------------------------------------------------------------------------
---------------------------------------------------------------------------


(e) Long-lived assets:

Management assesses the carrying value of long-lived assets on a periodic basis for indications of impairment. Indications of impairment include an ongoing lack of profitability and significant changes in technology. When an indication of impairment is present, a test for impairment is carried out by comparing the carrying value of the asset to its net fair value. If the carrying amount is greater than the net fair value, the asset would be considered impaired and an impairment loss would be realized to reduce the asset's carrying value to its estimated fair value.

(f) Intangible assets:

Intangible assets, consisting of customer relationships and non-competition agreements, are recorded at cost, which is equal to the fair value upon acquisition and are amortized using the straight-line method over their estimated useful lives of five years. Amortization is included in amortization expense.

(g) Goodwill:

Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amounts allocated to the assets acquired, less liabilities assumed, based on their fair values. Goodwill is allocated as of the date of the business combination to the Trust's reporting segments that are expected to benefit from the business combination.

Goodwill is not amortized and is tested for impairment annually in the fourth quarter, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test is carried out in two steps. In the first step, the carrying amount of the reporting segment is compared to its fair value. When the fair value of a reporting segment exceeds its carrying amount, goodwill of the reporting segment is considered not to be impaired and the second step of the impairment test is unnecessary. The second step is carried out when the carrying amount of the reporting segment's goodwill exceeds its fair value, in which case the implied fair value of the reporting segment's goodwill is compared with its carrying amount to measure the amount of the impairment loss, if any. The implied fair value of goodwill is determined in the same manner as the value of the goodwill is determined in a business combination described in the previous paragraph, using the fair value of the reporting segment as if it was the purchase price. When the carrying amount of the reporting segment's goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to the excess.

(h) Deferred financing costs:

Costs associated with the issuance of long-term debt are deferred and amortized by the straight-line method over the term of the debt. The amortization is included in amortization expense.

(i) Cash distributions:

Cash distributions are recorded when declared and are paid to unitholders monthly based on cash available for distribution.

(j) Income taxes:

The Trust is a mutual fund trust for purposes of the Income Tax Act (Canada), and is only subject to statutory income taxes on taxable income not distributed to the Unitholders. There is no recognition of any future income tax assets or liabilities on "temporary differences" (differences between the accounting basis and the tax basis of the assets and liabilities) within the Trust, however, the asset and liability method of accounting for income taxes is followed within the corporate subsidiaries of the Trust.

Under the asset and liability method, future income tax assets and liabilities are recognized for the estimated income tax recoverable or payable that would arise if assets and liabilities were recovered and settled at the financial statement carrying amounts. Future income tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. Changes to these balances are recognized in earnings in the period in which they occur. The amount of future income tax assets recognized is limited to the amount that is more likely than not to be realized.

(k) Unit-based compensation:

The Trust has a trust unit option plan, as outlined in note 11(c). Compensation expense attributable to unit options granted is measured at fair value at the grant date and expensed over the vesting period, with a corresponding increase in contributed surplus. The Trust does not incorporate an estimated forfeiture rate for options that will not vest; rather actual forfeitures are accounted for as they occur.

(l) Revenue recognition:

The Trust's services are generally provided based upon purchase orders or contracts with its customers that include fixed or determinable prices based upon monthly, daily, hourly or job rates. Revenue is recognized when services and equipment rentals are rendered and only when collectability is reasonable assured.

(m) Per unit amounts:

Basic earnings per unit is calculated using the weighted average number of Trust Units and Exchangeable Shares outstanding during the period. Diluted earnings per unit is calculated using the "treasury stock" method whereby outstanding options and warrants are only dilutive if, and to the extent that, they are "in the money".

(n) Comparative figures:

Certain comparative figures have been reclassified to conform with the current year financial statement presentation.

3. Goodwill:

The Trust performed its annual goodwill impairment test as of December 31, 2006. The carrying amount of each reporting unit was compared to the unit's fair value. This first step indicated an impairment of goodwill in the production services unit. The second step of the impairment test was performed in order to compare the implied fair value of the production services unit's goodwill with its carrying amount. The result of this step indicated that the implied fair value of the goodwill exceeded the carrying amount by $8,600 and accordingly an impairment loss in this amount was recognized as at December 31, 2006.

4. Lands and buildings under construction:

During fiscal 2005 the Trust purchased land in Brooks, Alberta and Fort St. John, British Columbia, then contracted a construction company to erect a building on each piece of land to the Trust's specifications and requirements. On September 28, 2006, the Trust completed the sale and leaseback of these facilities for gross proceeds of $7,750 which was equal to their carrying value. The agreement to leaseback these assets will be accounted for as an operating lease. At December 31, 2005, costs related to the construction of these facilities, in the amount of $2,759 were included in current assets. The balance sheet at December 31, 2005 has been restated to include these amounts in property and equipment.

5. Acquisitions:

For the year ended December 31, 2005:

(a) BK Oilfield Disposal:

On March 31, 2005, the Trust purchased substantially all of the operating assets of BK Oilfield Disposal Ltd. and BK Disposal Ltd., businesses involved in oilfield rentals and services. The purchase price of $2,214 was paid by way of $2,200 in cash, plus transaction costs of $14.

(b) Trueline Oilfield Services:

On May 31, 2005, the Trust acquired all of the issued and outstanding shares of Trueline Oilfield Services Inc., a business involved in the deployment of production testing units and various ancillary rentals. The purchase price of $6,866 was paid by way of $2,592 in cash and 454,060 Trust Units at a price of $9.36 per unit, plus transaction costs of $24.

(c) Flo-Safe Systems:

On October 3, 2005, the Trust acquired all of the issued and outstanding shares of Flo-Safe Systems Ltd., a business involved in the deployment of production testing units and various ancillary rentals. The purchase price of $8,831 was paid by way of $8,800 in cash, plus transaction costs of $31.

(d) Arctic Energy:

On December 2, 2005, the Trust acquired all of the issued and outstanding shares of Arctic Energy Systems Inc. and Arctic Incinerators Inc., businesses involved in the deployment of production testing units and various ancillary rentals. The purchase price of $5,916 was paid by way of $4,329 in cash and 156,571 Trust Units at a price of $9.74 per unit, plus transaction costs of $62.

The acquisitions were accounted for by the purchase method with the results of the operations of the acquired business being included in the financial statements from the date of acquisition. The allocations of the purchase prices are as follows.



---------------------------------------------------------------------------
BK Trueline Flo-Safe Arctic Total
---------------------------------------------------------------------------

Acquired cash $ - $ 546 $ - $ 42 $ 588
Current assets 16 1,184 - 1,925 3,125
Property and equipment 1,805 3,548 7,415 3,618 16,386
Intangible assets 200 1,100 365 590 2,255
Goodwill 193 4,822 3,414 2,875 11,304
Current liabilities - (3,371) - (1,864) (5,235)
Long-term debt - (267) - (343) (610)
Future income tax liability - (696) (2,363) (927) (3,986)

---------------------------------------------------------------------------
$ 2,214 $ 6,866 $ 8,831 $ 5,916 $23,827
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Consideration:
Cash, including costs $ 2,214 $ 2,616 $ 8,831 $ 4,391 $18,052
Trust units - 4,250 - 1,525 5,775

---------------------------------------------------------------------------
$ 2,214 $ 6,866 $ 8,831 $ 5,916 $23,827
---------------------------------------------------------------------------
---------------------------------------------------------------------------


6. Property and equipment:

---------------------------------------------------------------------------
Accumulated Net book
2006 Cost depreciation value
---------------------------------------------------------------------------

Service equipment $139,993 $ 24,011 $115,982
Office and shop equipment 4,486 1,432 3,054
Building and leasehold improvements 1,363 84 1,279
Land 1,766 - 1,766

---------------------------------------------------------------------------
$147,608 $ 25,527 $122,081
---------------------------------------------------------------------------
---------------------------------------------------------------------------

2005 (restated - note 4)
---------------------------------------------------------------------------

Service equipment $ 97,750 $ 15,713 $ 82,037
Office and shop equipment 3,298 790 2,508
Building and leasehold improvements 2,430 15 2,415
Land 1,682 - 1,682

---------------------------------------------------------------------------
$105,160 $ 16,518 $ 88,642
---------------------------------------------------------------------------
---------------------------------------------------------------------------


Included in property and equipment at December 31, 2006 is certain equipment under capital lease with a cost of $1,180 (2005 - $2,646) and a net book value of $974 (2005 - $2,267). This equipment is classified as service equipment and is depreciated on the same basis as other service equipment (note 2(d)).

The Trust has made various deposits on assets under construction totaling $418 (2005 - Nil) which is included with service equipment above. These amounts are not depreciated until the equipment is received and put into use by the Trust. In addition, no depreciation has been accounted for building costs in the amount of $542 (2005 - $1,872) currently under construction.

During 2005 management evaluated and determined that the directional drilling assets were non-core to its existing operations. As a result, management committed to a plan to dispose of these assets. On October 21, 2005, the Trust closed the sale of the directional drilling assets for cash consideration of $5,000. After severance and disposal costs, the net proceeds were $4,622 resulting in a gain on disposal of $1,401. The directional drilling assets were classified in Drilling services for segmented information purposes.



7. Intangible assets:

---------------------------------------------------------------------------
Accumulated Net book
2006 Cost depreciation value
---------------------------------------------------------------------------

Customer relationships and other $ 2,255 $ 638 $ 1,617
---------------------------------------------------------------------------
---------------------------------------------------------------------------

2005
---------------------------------------------------------------------------

Customer relationships and other $ 2,255 $ 186 $ 2,069
---------------------------------------------------------------------------
---------------------------------------------------------------------------


8. Operating line of credit:

The Trust has a $20,000 (2005 - $20,000) extendible revolving operating credit facility. Drawings bear interest at bank prime rate. The facility is secured by a general security agreement covering all of the assets of the Trust. The effective interest rate at December 31, 2006 was 6.0% (2005 - 5.0%). At December 31, 2006, $3,803 (December 31, 2005 - $2,200) was drawn on the facility.



9. Long-term debt:

---------------------------------------------------------------------------
2006 2005
---------------------------------------------------------------------------
Extendible revolving acquisition facility of up to
$40,000 requiring no principal payments during the term,
secured by a general assignment of book debts and a
security arrangement covering all assets of the Trust;
bearing interest at bank's prime rate of 6.0% at
December 31, 2006 or at banker's acceptance rates plus
a stamping fee of 1.25%. The facility expires on
May 30, 2007 renewable at the lenders option, for an
additional 364 day period. If not renewed, the facility
is repayable over a period of three years with a four
year amortization $ 36,000 $ 30,250

Term debt, repayable in monthly installments of $80 plus
interest at rates varying from 0% to 10.9%, maturing
between January 2007 and December 2009 secured by
the specific equipment 708 1,659

Obligations under capital leases, repayable in monthly
installments of $25 plus interest at rates varying
from 0% to 14.55%, secured by the specific equipment 542 1,071
---------------------------------------------------------------------------
37,250 32,980

Less current portion 6,047 7,316

---------------------------------------------------------------------------
$ 31,203 $ 25,664
---------------------------------------------------------------------------
---------------------------------------------------------------------------

The estimated principal repayments on all long-term debt including capital
leases due in each of the next four years are as follows:

---------------------------------------------------------------------------

2007 $ 6,047
2008 9,406
2009 9,047
2010 12,750
---------------------------------------------------------------------------
$ 37,250
---------------------------------------------------------------------------
---------------------------------------------------------------------------

The obligations under capital leases are repayable in blended monthly
installments including interest at a weighted average rate of 6.37%. At the
end of each lease the Trust has a purchase option to acquire the leased
assets. Estimated payments under the leases are as follows:

---------------------------------------------------------------------------

2007 $ 245
2008 293
2009 38
---------------------------------------------------------------------------
576
---------------------------------------------------------------------------

Less amount representing interest 34

---------------------------------------------------------------------------
$ 542
---------------------------------------------------------------------------
---------------------------------------------------------------------------


10. Income taxes:

The taxable income of the Trust is comprised of interest income related to
notes receivable from a subsidiary less deductions for unit issue costs and
general and administrative expenses.

The provision for income taxes differs from the amount computed by applying
the combined Canadian federal and provincial statutory income tax rate for
the following reasons:

---------------------------------------------------------------------------
2006 2005
---------------------------------------------------------------------------

Earnings before income taxes $ 8,119 $ 15,272

Statutory income tax rate 32.50% 33.62%
---------------------------------------------------------------------------

Expected income tax provision 2,639 5,134
Increase (decrease) resulting from:
Income allocated to unitholders (5,585) (4,215)
Non-deductible impairment of goodwill 2,795 -
Reduction in tax rates (461) -
Non-deductible expenses 155 143
Other (1) 11
---------------------------------------------------------------------------
Actual expense (recovery) $ (458) $ 1,073
---------------------------------------------------------------------------
---------------------------------------------------------------------------

The components of the net future income tax liability are as follows:

---------------------------------------------------------------------------
2006 2005
---------------------------------------------------------------------------
Future income tax liability:
Property and equipment $ (15,843) $ (13,855)
Partnership income (3,363) (3,011)

Future income tax asset:
Non-capital losses 9,297 6,538

---------------------------------------------------------------------------
$ (9,909) $ (10,328)
---------------------------------------------------------------------------
---------------------------------------------------------------------------

At December 31, 2006, the Trust had non-capital losses for Canadian federal
income tax purposes of approximately $28,944 (2005 - $19,447). The
non-capital losses expire as follows:

---------------------------------------------------------------------------

2007 $ 41
2008 399
2009 1,853
2010 3,503
2014 5,004
2015 8,612
2026 9,532

---------------------------------------------------------------------------
$ 28,944
---------------------------------------------------------------------------
---------------------------------------------------------------------------


The Trust has unrecognized deductible temporary differences of $2,846 (2005 - $2,168) as at December 31, 2006.

On October 31, 2006, the government of Canada announced proposed measures that will, if enacted, result in certain publicly traded income trusts being taxed on an equivalent basis to corporations in 2011. The Trust is a publicly traded income trust and therefore, as a result of these proposed measures, may be subject to income taxes on some or all its operations in 2011. It is not possible for the Trust to make an estimate of the financial effect of these proposals until the proposed new tax measures are enacted into tax law.

The Trust is evaluating the potential impact of the proposed measures on its net earnings and cash flows, the valuation of long lived assets including goodwill, and its debt covenants, all of which could be material.

11. Trust units and exchangeable shares:

(a) Authorized:

An unlimited number of Trust units

A maximum of 1,300,000 Series A Exchangeable shares

An unlimited number of Series B Exchangeable shares

An unlimited number of Series C Exchangeable shares

(b) Issued:



---------------------------------------------------------------------------
Trust Units: Number Amount
---------------------------------------------------------------------------

Balance, December 31, 2004 13,423,176 $ 78,916
Issued on business acquisitions (note 5) 610,631 5,775
Issued on exchange of exchangeable shares 491,163 1,973
Issued on exercise of options 197,650 1,396
---------------------------------------------------------------------------
Balance, December 31, 2005 14,722,620 88,060
Issued for cash 3,000,000 32,250
Issued on exercise of options 102,814 742
Issued on exchange of exchangeable shares 56,724 293
Issue costs - (1,812)
---------------------------------------------------------------------------
Balance, December 31, 2006 17,882,158 $ 119,533
---------------------------------------------------------------------------
---------------------------------------------------------------------------

On February 23, 2006, the Trust closed a public unit offering of 3,000,000
Trust Units at a price of $10.75 per Trust Unit less issue costs of $1,812
for net proceeds of $30,438.

---------------------------------------------------------------------------
Exchangeable Shares: Number Amount
---------------------------------------------------------------------------

Series A
Balance, December 31, 2004 20,001 $ 54
Exchanged for trust units (20,001) (54)
---------------------------------------------------------------------------
Balance, December 31, 2005 and 2006 - -

Series B:
Balance, December 31, 2004 327,500 1,562
Exchanged for trust units (327,500) (1,562)
---------------------------------------------------------------------------
Balance, December 31, 2005 and 2006 - -

Series C:
Balance, December 31, 2004 104,000 650
Exchanged for trust units (57,200) (357)
---------------------------------------------------------------------------
Balance, December 31, 2005 46,800 293
Exchanged for trust units (46,800) (293)
---------------------------------------------------------------------------
Balance, December 31, 2006 - -

---------------------------------------------------------------------------
Balance, December 31, 2006 - $ -
---------------------------------------------------------------------------
---------------------------------------------------------------------------


The exchangeable shares are exchangeable for Trust units based upon an exchange ratio, initially being one-to-one but then cumulatively adjusted each time a distribution is made to unitholders. The exchangeable shares are non-transferable and automatically convert to Trust units on certain dates based on class.

Effective December 15, 2005 the exchange ratio on the Series "C" Exchangeable shares was 1.2023 Trust units per share. On January 26, 2006 the remaining Series "C" Exchangeable shares were converted to 56,724 Trust units based on an exchange ratio of 1.2121 Trust units per share.

(c) Trust unit option plan:

In January 2003 a trust unit option plan was established providing for the issue of units. At December 31, 2006 a total of 1,788,216 options to purchase trust units are reserved to be granted to employees and directors. Of the amount reserved, 1,307,692 options have been granted. Under this plan, the exercise price of each option equals the market value of the Trust units on the date of the grant and an option's maximum term is five years. The exercise price may be adjusted downwards if trust distributions exceed certain levels. Options vest equally over a period of three years from the date of grant as employees or directors render continuous service to the Trust.



Changes in the number of options, with their weighted average exercise
prices are summarized below:

---------------------------------------------------------------------------
December 31, 2006 December 31, 2005
------------------ -------------------
Weighted Weighted
Average average
Number of exercise Number of exercise
options price options price
---------------------------------------------------------------------------

Total options outstanding,
beginning of year 1,402,510 $ 9.38 1,184,835 $ 8.22
Granted 152,500 10.47 735,500 10.34
Exercised (102,814) 6.85 (197,650) 6.68
Forfeitures (144,504) 9.08 (320,175) 8.95

---------------------------------------------------------------------------
Outstanding, end of year 1,307,692 $ 9.74 1,402,510 $ 9.38
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Exercisable at year end 529,633 $ 9.16 240,987 $ 7.90
---------------------------------------------------------------------------
---------------------------------------------------------------------------


---------------------------------------------------------------------------
Options outstanding Options exercisable
---------------------------------- --------------------
Weighted
Range of Number average Weighted Number Weighted
Exercise outstanding remaining average exercisable average
Prices at December contractual exercise at December exercise
Outstanding 31, 2006 life (months) price 31, 2006 price
---------------------------------------------------------------------------

$ 5.00 - 6.35 82,504 18 $ 5.35 75,670 $ 5.26
$ 8.70 - 10.00 478,355 32 $ 9.36 251,987 $ 9.28
$ 10.05 - 11.59 746,833 45 $10.46 201,976 $10.48
---------------------------------------------------------------------------
---------------------------------------------------------------------------


The fair value of options issued during the year was estimated using a modified Black-Scholes pricing model with the following assumptions: risk-free interest rate ranging from 4.0% to 4.2%; volatility ranging from 25% to 30%, life of 5 years; distribution yield rates between 8% and 10.4%, and corresponding changes in exercise prices during the life of the option.



The following table reconciles the Trust's contributed surplus:

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2006 2005
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Balance, beginning of year $ 279 $ 143

Unit based compensation expense 175 212
Option exercised (38) (76)
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Balance, end of year $ 416 $ 279
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(d) Earnings per unit:

The basic weighted average number of Trust units and exchangeable shares outstanding for the year was 17,415,239 (2005 - 14,344,632) using the average exchange ratios for the series of exchangeable shares outstanding during the year.

The diluted per unit amounts reflect the diluted effect of options outstanding. The diluted weighted average number of units and exchangeable shares outstanding for the year was 17,486,523 (2005 - 14,540,473).



12. Commitments:

The Trust rents premises and equipment under multiple lease contracts with
varying expiration dates. The minimum lease payments under these leases
are as follows:

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2007 $ 3,153
2008 2,792
2009 2,140
2010 2,166
2011 2,319
Thereafter 12,949

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$ 25,519
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13. Financial instruments:

Financial instruments of the Trust consist of accounts receivable, operating line of credit, accounts payable and accrued liabilities, distributions payable and long-term debt.

(a) Credit risk:

Concentration of credit risk on the Trust's trade accounts receivable exists in the oil and gas industry. The Trust manages this risk through various internal processes including credit checks, special conditions applied to customers based on historical experience, monitoring the amount and age of balances outstanding and management of accounts receivable exposure to any one customer at any one period of time. Except as disclosed in note 15 the Trust does not have a significant exposure to any individual customer or other party.

(b) Interest rate risk:

The Trust manages its exposure to interest rate risk through a combination of fixed and floating rate borrowings.

(c) Fair values of financial assets and liabilities:

There are no significant differences between the carrying values of the financial instruments and their estimated fair values due to the relatively short period to maturity or in the case of long-term debt, the availability of comparable market terms and conditions.



14. Supplemental cash flow information:

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2006 2005
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Interest paid $ 1,543 $ 983
Interest received 12 17
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Income taxes paid $ 42 $ 235
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Changes in non-cash working capital components:
Accounts receivable $ 3,323 $ (6,729)
Inventory (587) (25)
Prepaid expenses and deposits 1,560 (1,552)
Accounts payable and accrued liabilities (4,554) (3,241)
Income taxes payable (39) (133)
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(297) (11,680)
Changes in non-cash working capital items in
investing activities (2,402) 5,340

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Change in non-cash working capital items in
operating activities $ (2,699) $ (6,340)
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15. Segmented information:

The Trust operates exclusively in western Canada, in two industry segments. Drilling services includes accommodations and catering, wastewater treatment systems and surface equipment rentals. Production services includes service rigs, production testing and frac blow back tanks.

The Drilling services operating segment includes services and rentals which assist oil and gas companies and contractors in drilling the oil and gas wells. The Production services operating segment includes services and rentals which assist oil and gas companies produce from the successful drilling of the oil and gas wells.



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Drilling Production
2006 Services Services Corporate Total
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Revenue $ 77,093 $ 33,567 $ - $110,660
Depreciation and amortization 6,997 1,809 969 9,775
Impairment of goodwill - 8,600 - 8,600
Interest on long-term debt - - 1,169 1,169
Net earnings (loss) 21,360 (2,144) (10,639) 8,577
Intangible assets 130 1,487 - 1,617
Goodwill 12,695 4,998 - 17,693
Property and equipment 87,777 32,412 1,892 122,081
Capital expenditures 40,276 9,674 1,133 51,083
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Approximately 15.3% of the Trust's total sales in 2006 were derived from
one customer. This accounts for 22.2% of the revenue in the Drilling
services segment and 0.1% of the Production services segment revenue.

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Drilling Production
2005 Services Services Corporate Total
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Revenue $ 63,083 $ 21,293 $ - $ 84,376
Depreciation and amortization 5,806 836 603 7,245
Interest on long-term debt - - 798 798
Net earnings (loss) 16,468 6,352 (8,621) 14,199
Intangible assets 170 1,899 - 2,069
Goodwill 12,695 13,598 - 26,293
Property and equipment 59,852 27,587 1,203 88,642
Capital expenditures(1) 18,679 4,562 743 23,984
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Approximately 23.4% of the Trust's total sales in 2005 were derived from
two customers. This accounts for 23.9% of the revenue in the Drilling
services segment and 22.1% of the Production services segment revenue.

(1) Excludes business acquisitions


16. Contingencies:

The Trust, in the normal course of business, is subject to legal proceedings and actions being brought against it. The amounts involved in such legal proceedings are not reasonably estimable due to uncertainty as to the final outcome, and the Trust does not believe these proceedings will have a material adverse effect on the Trust's consolidated financial position or results of operations.

17. Subsequent events:

(a) Long-term incentive plan:

Subsequent to year end, the Trust established a long-term incentive plan. On January 15, 2007, the Trust issued 481,500 deferred units to management, senior employees and directors. The deferred units granted were either restricted units or performance based units. The number of units reserved for issuance under the plan shall not exceed 5 percent of the total number of issued and outstanding units. Granted units vest as to 50 percent on the 18th month and 50 percent on the 36th month following the date of grant. Vesting of performance units is based on attainment of certain performance criteria. Over the three year term the units will accrue distributions and the Trust is currently obligated to settle its plan obligations in cash.

(b) Trust unit options:

Subsequent to year end, between January 1, 2007 and February 28, 2007, a total of 1,215,189 trust unit options were voluntarily surrendered and cancelled by directors, officers and employees, leaving a balance outstanding as at February 28, 2007 of 92,503. The Trust does not anticipate granting additional options to purchase units under the existing trust unit option plan.

Contact Information

  • Wellco Energy Services Trust
    Kenneth M. Bagan
    President & Chief Executive Officer
    (403) 232-6334
    or
    Wellco Energy Services Trust
    Corey Zahn
    Vice President, Finance & Chief Financial Officer
    (403) 232-6334
    (403) 232-6338 (FAX)
    Email: info@wellcoenergy.com
    Website: www.wellcoenergy.com