Mar 10, 2011 17:41 ET
GASFRAC Announces Fourth Quarter 2010 Results
CALGARY, ALBERTA--(Marketwire - March 10, 2011) - GASFRAC EnergyServices Inc. ("GASFRAC") (TSX VENTURE:GFS) achieved revenue of $41.1million in the fourth quarter of 2010 as compared to $7.1 million in thefourth quarter of 2009. EBITDA was $6.1 million as compared to anEBITDA loss of ($1.3 million) in 2009.
Dwight Loree, Chief Executive Officer commented, "The results thisquarter show that GASFRAC has achieved a firm foothold in the Canadianmarket. Revenues for the quarter were well above our revenues for theentire 2009 year and more than five times 2009 fourth quarter results.Revenue of $96.9 million for 2010 were more than triple that of $30.4million in 2009. At the same time EBITDA for the year of $16.1 millionis more than five times the $3.0 million earned in 2009.
I am confident that we have the team that can support continuedgrowth in Canada as we add revenue producing capacity with our newequipment build. Further, I am optimistic that our USA operations inTexas will contribute to our growth with the delivery of two sets offracturing equipment in March and April."
Management's Discussion and Analysis
December 31, 2010
The consolidated financial statements have been prepared inaccordance with Canadian generally accepted accounting principles("GAAP"). Readers should also refer to the "Forward-Looking Statements"legal advisory at the end of this management discussion and analysis("MD&A"). This MD&A has been prepared using information that iscurrent to March 10, 2011.
All references to dollar amounts are in Canadian dollars. Figuresare in 000s except share and per share data or as otherwise noted.
Unless the context otherwise requires, all references in this MD&A to "we", "us" or "our" mean GASFRAC.
Business of GASFRAC
GASFRAC Energy Services Company Inc. ("GASFRAC" or the "Company")was incorporated on February 13, 2006 in Canada under the BusinessCorporations Act in the Province of Alberta. The Company is an oil andgas well fracturing company that has developed new technology, the "LPGFracturing Process", to enable wells to be fractured safely with LPG,more specifically propane and butane. The Company has three wholly-ownedsubsidiaries, GASFRAC Services GP Inc., GASFRAC Energy Services LimitedPartnership and GASFRAC Inc. (a U.S. incorporated entity).
Comparative Annual Financial Information
2010 2009 2008
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Revenue 96,906 30,428 23,522
Operating expenses 72,190 21,016 16,803
Selling, general and
administrative expenses 10,579 6,227 3,844
EBITDA (1) 16,112 2,973 4,549
Net income 5,053 (2,210) 4,096
Net income per share - basic 0.13 (0.07) 0.05
Weighted average number of shares
- basic 38,920,602 32,380,356 21,380,384
Treatments performed 419 142 142
Revenue per treatment 231 214 165
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(1) Defined under Non-GAAP Measures
Overview of 2010
2010 was a year of transition and expansion for GASFRAC. Thechanges, improvements and additions that took place should allow theCompany to continue to expand its operations to meet a growing demandfor its services. During the year advances made in our business strategyincluded:
- Growing revenue to $96.9 million from $30.4 million in 2009;
- Achieving a net income of $5.1 million compared to a loss of ($2.2 million) in 2009;
- Performing 419 fracturing treatments as compared to 142 in 2009;
- Building a strong management team with the addition of severalwell experienced personnel in operating, technical, sales and financialpositions;
- Increasing our revenue generating capacity with the addition ofequipment in 2010 and commitment to add further equipment - three setsto be delivered in Q1 of 2011 and 4 additional sets in Q4 of 2011;
- Performance of our first fracturing operations in Texas;
- Becoming a publicly traded company;
- Maintaining a strong balance sheet with equity financings of $65 million in June 2010 and $109 million in December 2010.
Financial Overview
Revenues
Revenue for the year increased 219% to $96.9 million from $30.4million in 2009. The increase reflects an increase of 195% in the numberof treatments performed in 2010 (419) as compared to 2009 (142)combined with an increase in average revenue per treatment to $231 in2010 from $214 in 2009. The increase in number of treatments was drivenby continued acceptance of the Company's technology in Canada and anincrease in equipment capacity for service delivery. The Companycontinues to balance the demands of its significant customers forlimited equipment with the requests of new customers to utilize the LPGtechnology. During the year, the Company earned revenues from more thanforty customers with three of these customers representing 63% ofrevenue.
Operating Expenses
With the increase in revenue, operating expenses increased to $72.2million (74.5% of revenue) during 2010 from $21.0 million (69.1% ofrevenue) in 2009. The increase as a percentage of revenue reflects thecost of maintaining the US operation during the fourth quarter ($1.3million), mobilization costs for equipment redeployed to Canada (
.3million) and recruiting and training personnel for equipment to bedelivered in the first quarter of 2011 ($3.0 million). Operating costsconsist primarily of product costs (propane, proppant, chemicals), costof field staff, equipment costs and the cost for maintaining twooperational bases. Components of the current operational infrastructurehave been developed to maintain and support a larger scale of operationsthan GASFRAC has experienced to date.
Selling, General and Administrative ("SG&A") Expenses
SG&A expenses increased to $10.6 million (10.9% of revenue)during 2010 from $6.2 million (20.5% of revenue) in 2009. The increaseis due to the hiring of administrative and operations staff to supportthe growth in both our Canadian and US operations. The relative decreasein SG&A as a percentage of revenue reflects the scalability of thiscost base.
Amortization
Amortization increased to $7.9 million in 2010 from $5.0 million in2009 reflecting an increase in operating capital assets of $83.4 millionduring 2010.
EBITDA
EBITDA increased to $16.1 million during 2010 from $3.0 million in 2009 as a result of increased revenues and margins.
Other Income
Other income during 2010 included $2.8 million for insuranceproceeds related to a business interruption loss from a mobilizationincident that took place in November 2009 and which has been settled infull.
Other income for 2009 is comprised of $638 business interruptionclaim from 2008 which has been settled in full, $583 from ScientificResearch and Experimental Development credits resulting from theCompany's research activities and $201 of interest income relating tointerest earned on short-term investments.
Net Income
As the Company has increased its activity and revenue levels thefixed costs have reduced as a percentage of revenue. In addition, asequipment becomes more effectively utilized, the relative cost ofamortization is reducing. As a result, the Company had net income forthe year of $5,053 compared to a net loss in 2009 of ($2,210).
Summary of Quarterly Results
(000s)
MAR. 31 JUN. 30 SEP. 30 DEC. 31
2009 2009 2009 2009
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Revenue $ 11,326 $ 2,295 $ 9,662 $ 7,145
Net income (loss) $ 901 $ (1,055) $ 782 $ (2,838)
Net income (loss)
per share (basic) $ 0.03 $ (0.03) $ 0.02 $ (0.09)
EBITDA (1) $ 2,376 $ (477) $ 2,396 $ (1,322)
Capital expenditures $ 5,724 $ 9,739 $ 6,658 $ 5,358
Working capital (2) $ 39,156 $ 29.031 $ 25,430 $ 19,513
Shareholders' equity $ 85,555 $ 84,553 $ 85,970 $ 83,731
MAR. 31 JUN. 30 SEP. 30 DEC. 31
2010 2010 2010 2010
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Revenue $ 15,906 $ 13,323 $ 26,590 $ 41,087
Net income (loss) $ 1,672 $ (1,266) $ 2,585 $ 2,062
Net income (loss)
per share (basic) $ 0.05 $ (0.04) $ 0.06 $ 0.04
EBITDA (1) $ 4,039 $ 624 $ 5,336 $ 6,113
Capital expenditures $ 6,247 $ 7,430 $ 35,871 $ 33,897
Working capital (2) $ 17,792 $ 13,484 $ 42,005 $ 118,744
Shareholders' equity $ 85,808 $ 85,379 $ 150,999 $ 258,721
(1) Defined under Non-GAAP Measures
(2) Working capital is defined as current assets less current liabilities
Revenues
Revenue for the fourth quarter of 2010 was $41.1 million, an almostsix-fold increase compared to $7.1 million in the fourth quarter of2009. There were 148 treatments performed in the fourth quarter of 2010at an average revenue of $278 per treatment as compared to 46 treatmentsin the same quarter of 2009 at an average revenue per treatment of$155. The increased volume of treatments reflects both the increasedacceptance of the Company's LPG fracturing technology and the increasednumber of equipment sets(crews) the Company has in place. The improvedaverage revenue per treatment in the quarter results from larger averagejob size in 2010 as compared to 2009 as the Company has deployed its100 tonne equipment in 2010 whereas only 32 tonne equipment wasavailable in 2009. In addition, during the fourth quarter of 2010 theCompany had a greater percentage of large vertical fracture jobs whichtend to have a greater average treatment revenue than horizontalfractures. The Company continues to balance the demands of itssignificant customers for limited equipment with the requests of newcustomers to utilize the LPG technology. During the quarter twocustomers accounted for 65.5% of the Company's revenue.
Operating Expenses
With the increase in revenue, operating expenses increased to $31.7million (77.1% of revenue) during the fourth quarter of 2010 from $6.3million (88.7% of revenue) in the fourth quarter of 2009. During thefourth quarter the Company redeployed fracturing equipment from Texas toCanada to meet the market demand in Canada. In anticipation ofmobilizing equipment back to the USA in the first quarter of 2011, theCompany did not downsize USA operations and, as such, incurred $1.3million of operating costs associated with those operations during thequarter. Further, the Company incurred costs of approximately
.3million to mobilize the equipment to Canada and approximately
.8million of training and staffing costs for crews hired in anticipationof delivery of additional fracturing sets in Q1 2011. Operating costsconsist primarily of product costs (propane, proppant, chemicals), costof field staff, equipment costs and the cost for two operational bases.Components of the current operational infrastructure have been developedto maintain and support a larger scale of operations than GASFRAC hasexperienced to date.
Selling, General and Administrative ("SG&A") Expenses
SG&A expenses increased to $3.3 million (8.0% of revenue) duringthe fourth quarter of 2010 from
.8 million (11.8% of revenue) in thefourth quarter of 2009. The increase is primarily due to the hiring ofadministrative and operations staff to support the growth in both ourCanadian and US operations. These costs represent the necessary costs ofbuilding a support infrastructure for the Company's added revenue baseand are anticipated to be able to support future revenue growth withoutsignificant additional growth to this cost base.
Amortization
Amortization increased to $2.5 million in the fourth quarter of 2010from $1.6 million in fourth quarter of 2009 reflecting an increase inoperating capital assets during the year.
EBITDA
EBITDA increased to $6.1 million during the fourth quarter of 2010from an EBITDA loss of ($1.3) million in the fourth quarter of 2009 as aresult of increased revenues and margins.
Other Income
Other income for the fourth quarter of 2010 included
.7 millionfor insurance proceeds related to a business interruption loss frommobilization incident that took place in November 2009 and which hasbeen settled in full.
Net Income
As the Company has increased its activity and revenue levels, thefixed costs have reduced as a percentage of revenue. In addition, asequipment becomes more effectively utilized, the relative cost ofamortization is reducing. As a result, the Company had net income forthe fourth quarter of 2010 of $2.1 million compared to a net loss in thefourth quarter of 2009 of ($2,838).
Liquidity and Capital Resources
Year ended December 31, 2010 2009
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Cash Provided by (used in)
Operating Activities $ 3,326 $ (438)
Financing Activities 167,135 100
Investing Activities (83,403) (5,972)
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$ 87,058 $ (6,310)
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As at December 31, 2010 the Company had $119 million of workingcapital compared to $19.5 million at December 31, 2009. The increase inworking capital is primarily due to funds provided from operations(asdefined under Non-GAAP Measures) of $16.9 million and $166.3 millionraised through the Company's June private placement and December boughtdeal financing offset by $83.2 million of capital expenditures made toincrease the revenue earning capacity.
The Company had approximately $41 million of capital commitmentsremaining in respect of its 2010 capital program and has initiated a2011 capital program of $150 million. The Company anticipates being ableto fund these capital expenditures through cash on hand, operating cashflows and current debt facilities.
Operating
The Company's funds provided by operations (as defined underNon-GAAP Measures) was $16.9 million for 2010 as compared to $4.4million in 2009. The increase is due to the Company's increased revenue.With the Company's growth, a large portion of these funds fromoperations was invested in added working capital ($13.6 million ascompared to $4.9 million in 2009).
Financing
Net cash provided by financing activities for 2010 was $167.1million largely consisting of a private placement of equity in June of$61.6 million and a bought deal equity financing in December of $104.7million. This compares to net cash from financing in 2009 of $100 fromthe exercise of stock options.
As at December 31, 2010 the Company had a $15 million demandrevolving loan facility and a $35 million committed revolving facility(see Note 10 of the consolidated financial statements). No amounts weredrawn on these facilities as at December 31, 2010 or as at the date ofthis MD&A. The Company is in compliance with all its debt covenants.
Investing
For 2010 the Company's net cash used for investing activities was$83.4 million as compared to $6.0 million in 2009. For 2010, the Companyinvested $83.2 million in capital equipment to add revenue producingcapacity and $1.4 million of long-term deposits on supplier agreementsfor key raw materials. Offsetting these investments was an increase of$1.4 million in accounts payable for capital equipment. In 2009, TheCompany invested $27.3 million in capital equipment which was offset byan increase in accounts payable of $1.5 million and a reduction in shortterm investments of $19.9 million.
Commitments and contractual obligations
The Company has operating lease commitments for vehicles and office space
as follows:
Year 2011 2012 2013 2014 2015
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Amount $ 2,197 $ 1,606 $ 911 $ 573 $ 573
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As at December 31, 2010, the Company has commitments totalingapproximately $41 million (2009 - $8 million) relating to theconstruction of fixed assets in 2011 and $86 million (2009 - $3 million)for the purchase of operating supplies.
Critical Accounting Policies and Estimates
This MD&A is based on the Company's annual consolidatedfinancial statements that have been prepared in accordance with CanadianGAAP. Management is required to make assumptions, judgments andestimates in the application of GAAP. GASFRAC's significant accountingpolicies are described in note 2 of the December 31, 2010 auditedconsolidated financial statements. The preparation of the consolidatedfinancial statements requires that certain estimates and judgments bemade concerning the reported amount of revenue and expenses and thecarrying values of assets and liabilities. These estimates are based onhistorical experience and management's judgment. Anticipating futureevents involves uncertainty and, consequently, the estimates used bymanagement in the preparation of the consolidated financial statementsmay change as future events unfold, additional experience is acquired orthe environment in which the Company operates changes. The followingaccounting policies and practices involve the use of estimates that havea significant impact on the Company's financial results.
Revenue Recognition
The Company's revenue is comprised of services and other revenue andis generally sold on agreed upon priced purchase orders or contractswith the customer. Contract terms do not include provisions forsignificant post-service delivery obligations. Service and other revenueis recognized when the services are provided and collectability isreasonably assured.
Allowance for Doubtful Accounts Receivable
The Company performs ongoing credit evaluations of its customers andgrants credit based upon a review of historical collection experience,current aging status, financial condition of the customer andanticipated industry conditions. Customer payments are regularlymonitored and a provision for doubtful accounts is established basedupon specific situations and overall industry conditions. In situationswhere the creditworthiness of a customer is uncertain, services areprovided on receipt of cash in advance or services are declined.GASFRAC's management believes that the provision for doubtful accountsis adequate.
Amortization
Amortization of the Company's property and equipment incorporatesestimates of useful lives and residual values. These estimates maychange as more experience is obtained or as general market conditionschange, thereby impacting the operation of the Company's property andequipment.
Income Taxes
The Company follows the liability method of accounting for incometaxes, which evaluates the differences between the financial statementtreatment and tax treatment of certain transactions, assets andliabilities. Future tax assets and liabilities are recognized for thefuture tax consequences attributable to differences between thefinancial statement amounts of existing assets and liabilities and theirrespective tax bases. Estimates of the Company's future taxable incomehave been considered in assessing the utilization of available taxlosses. GASFRAC's business is complex and the calculation of incometaxes involves many complex factors as well as the Company'sinterpretation of relevant tax legislation and regulations. GASFRAC'smanagement believes that the future income tax provision is adequate.
Stock based Compensation
The Company has a stock-based compensation plan, which is describedin Note 7. The Company applies the Black-Scholes option pricing model tovalue its stock options. Under this method, compensation costattributable to stock options granted is measured at fair value at thegrant date and expensed over the vesting period with a correspondingincrease to contributed surplus. Upon exercise of the stock options,consideration paid together with the amount previously recognized incontributed surplus is recorded as share capital. The Company has notincorporated an estimated forfeiture rate for stock options that willnot vest, rather the Company will account for actual forfeitures as theyoccur.
The Company has a performance share unit and a restricted share plan as described in note 7.
Recent Accounting Pronouncements
There have been no Canadian or US accounting pronouncements issuedfor the 2010 fiscal year which may have a material impact on theCompany's financial statements.
Off-Balance Sheet Arrangements
The Company is not party to any off balance sheet arrangements or transactions.
Related Party Transactions
During the year, the Company paid $287 (2009 - $334) in consultingfees to two Directors. These transactions were in the normal course ofoperations and have been measured at the exchange amounts.
Outstanding Share Data
Common Shares Warrants Stock Options
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Balance - December 31, 2008 32,370,000 2,602,500 2,621,000
Issued / granted 230,000 - 435,000
Issued / exercised 50,000 - (50,000)
Cancelled / forfeited - - (40,000)
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Balance - December 31, 2009 32,650,000 2,602,500 2,966,000
Issued / granted 26,061,700 - 670,000
Issued / exercised 1,514,666 (845,000) (669,666)
Cancelled / forfeited - - (246,167)
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Balance - December 31, 2010 60,226,366 1,757,500 2,720,167
Issued / exercised 368,500 (319,000) (49,500)
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Balance - March 10, 2011 60,594,866 1,438,500 2,670,667
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Financial Instruments
The Company's financial instruments recognized on the balance sheetconsist of cash and cash equivalents, short term investments, accountsreceivable, unearned revenue, accounts payable, and accrued liabilities.The following is a summary of the accounting model the Company haselected to apply to each of its significant categories of financialinstruments:
Cash and cash equivalents Held for trading
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Short term investments Held for trading
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Accounts receivable Loans and receivables
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Accounts payable and accrued liabilities Held for trading
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Credit risk
The Company's accounts receivable balances are with customers in theoil and gas industry and are subject to normal industry credit risks.The Company assesses the credit worthiness of all of its customers. TheCompany's trade receivables as at December 31, 2010 are aged as follows:
December 31, 2010 December 31, 2009
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Current (0 - 30 days) $ 9,752 $ 2,838
31 - 60 days 11,339 3,590
Over 61 Days 745 2,258
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Total $ 21,836 $ 8,686
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Fair values
The fair value of the Company's financial instruments included onthe consolidated balance sheet approximate their carrying amounts due totheir short term maturity.
The additional disclosures regarding fair value measurements offinancial instruments as required by recent amendments made to Section3862 Financial Instruments - presentation and disclosure of the CanadianInstitute of Chartered Accountants ("CICA") handbook are presentedbelow. A fair value hierarchy is presented below that distinguishes thesignificance of the inputs used in determining the fair valuemeasurements of various financial instruments. The hierarchy containsthe following levels: Level 1 uses inputs based on quoted prices, Level 2uses observable inputs other than quoted prices and Level 3 uses inputsthat are not based on observable market data.
Carrying Value as at Estimated Fair Value as at
December 31, December 31, 2010
2010 2009 Level 1 Level 2 Level 3
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Cash and cash equivalents $ 98,701 $ 11,643 $ - $98,701 $ -
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Liquidity risk
Liquidity risk is the risk that the Company will not be able to meetits financial obligations as they fall due. The Company has a positivecash position and further manages its liquidity risk by continuouslymonitoring forecasts and actual cash flows and has secured a credit linewith a major Canadian bank. Currently, the Company's cash and cashequivalents and the Company's secured line of credit are sufficient tomeet its financial obligations.
Market risk
Market risk is the risk that changes in market prices, such asinterest rates or foreign exchange rates will affect the Company'sincome or the value of its financial instruments. The Company does notbelieve that the results of operations or cash flow would be affected toa significant degree by a sudden change in market interest rates. TheCompany does not believe that that the results of operations or cashflow would be affected to a significant degree by a sudden change inforeign exchange rate.
Business Risks
The business of GASFRAC is subject to certain risks anduncertainties, including those listed below. Prior to making anyinvestment decision regarding GASFRAC, investors should carefullyconsider, among other things, the risk factors set forth below.
Volatility of Industry Conditions
The demand, pricing and terms for GASFRAC's fracturing and wellstimulation services largely depend upon the level of exploration anddevelopment activity for North American natural gas and, to a lesserextent, oil. Industry conditions are influenced by numerous factors overwhich GASFRAC has no control, including the level of oil and naturalgas prices, expectations about future oil and natural gas prices, thecost of exploring for, producing and delivering oil and natural gas, thedecline rates for current production, the discovery rates of new oiland natural gas reserves, available pipeline and other oil and naturalgas transportation capacity, weather conditions, political, military,regulatory and economic conditions, and the ability of oil and naturalgas companies to raise equity capital or debt financing. A materialdecline in global oil and natural gas prices or North American activitylevels as a result of any of the above factors could have a materialadverse effect on GASFRAC's business, financial condition, results ofoperations and cash flows. Because of the current economic environmentand related decrease in demand for energy, natural gas exploration anddevelopment in North America has decreased from peak levels in 2008.Warmer than normal winters in North America, among other factors, mayadversely impact demand for natural gas and, therefore, demand foroilfield services. If the economic conditions deteriorate further or donot improve, the decline in natural gas exploration and developmentcould cause a decline in the demand for GASFRAC's services. Such declinecould have a material adverse effect on GASFRAC's business, financialcondition, results of operations and cash flows.
Demand for Oil and Natural Gas
Fuel conservation measures, alternative fuel requirements,increasing consumer demand for alternatives to oil and natural gas, andtechnological advances in fuel economy and energy generation devicescould reduce the demand for crude oil and other hydrocarbons. GASFRACcannot predict the impact of changing demand for oil and natural gasproducts, and any major changes could have a material adverse effect onGASFRAC's business, financial condition, results of operations and cashflows.
Seasonality
GASFRAC's financial results are directly affected by the seasonalnature of the North American oil and natural gas industry. The firstquarter incorporates the winter drilling season when a disproportionateamount of the activity takes place in western Canada. During the secondquarter, soft ground conditions typically curtail oilfield activity inall of GASFRAC's Canadian operating areas such that many rigs are unableto move about due to road bans. This period, commonly referred to as"spring breakup", occurs earlier in the year in southeastern Albertathan it does in northern Alberta and northeastern British Columbia.Consequently, this is GASFRAC's weakest three-month revenue period.Additionally, if an unseasonably warm winter prevents sufficientfreezing, GASFRAC may not be able to access well sites and GASFRAC'soperating results and financial condition may therefore be adverselyaffected. The demand for fracturing and well stimulation services mayalso be affected by severe winter weather in North America. In addition,during excessively rainy periods in any of GASFRAC's operating areas,equipment moves may be delayed, thereby adversely affecting revenues.The volatility in the weather and temperature can therefore createunpredictability in activity and utilization rates, which can have amaterial adverse effect on GASFRAC's business, financial condition,results of operations and cash flows.
Concentration of Customer Base
GASFRAC's customer base consists of over forty oil and natural gasexploration and production companies, ranging from large multinationalpublic companies to small private companies. Notwithstanding GASFRAC'sbroad customer base, GASFRAC had three significant customers thatcollectively accounted for approximately 63 percent of GASFRAC's revenuefor the year ended December 31, 2010. GASFRAC's strong relationshipswith exploration and production companies may result in increasedconcentration of revenues during periods of reduced activity levels suchas the first three months of the year. However, there can be noassurance that GASFRAC's relationship with its primary customers willcontinue, and a significant reduction or total loss of the business fromthese customers, if not offset by sales to new or existing customers,would have a material adverse effect on GASFRAC's business, financialcondition, results of operations and cash flows.
Competition
Each of the markets in which GASFRAC participates is highlycompetitive. To be successful, a service provider must provide servicesthat meet the specific needs of oil and natural gas exploration andproduction companies at competitive prices. The principal competitivefactors in the markets in which GASFRAC operates are product and servicequality and availability, technical knowledge and experience,reputation for safety and price. GASFRAC competes with large nationaland multinational oilfield service companies that have greater financialand other resources. These companies offer a wide range of wellstimulation services in all geographic regions in which GASFRACoperates. In addition, GASFRAC competes with several regionalcompetitors. As a result of competition, it may suffer from asignificant reduction in revenue or be unable to pursue additionalbusiness opportunities.
Equipment Inventory Levels
Because of the long-life nature of oilfield service equipment andthe lag between when a decision to build additional equipment is madeand when the equipment is placed into service, the inventory of oilfieldservice equipment in the industry does not always correlate with thelevel of demand for service equipment. Periods of high demand often spurincreased capital expenditures on equipment, and those capitalexpenditures may add capacity that exceeds actual demand. This capitaloverbuild could cause GASFRAC's competitors to lower their rates andcould lead to a decrease in rates in the oilfield services industrygenerally, which could have a material adverse effect on GASFRAC'sbusiness, financial condition, results of operations and cash flows.
Sources, Pricing and Availability of Raw Materials and Component Parts
GASFRAC sources its raw materials, such as proppant, chemicals,nitrogen, carbon dioxide and diesel fuel, and component parts, from avariety of suppliers in North America. Should GASFRAC's suppliers beunable to provide the necessary raw materials and component parts at anacceptable price or otherwise fail to deliver products in the quantitiesrequired, any resulting delays in the provision of services could have amaterial adverse effect on GASFRAC's business, financial condition,results of operations and cash flows.
Capital-Intensive Industry
GASFRAC's business plan is subject to the availability of additionalfinancing for future costs of operations or expansion that might not beavailable, or may not be available on favourable terms. GASFRAC'sactivities may also be financed partially or wholly with debt, whichcould increase GASFRAC's debt levels above industry standards. The levelof GASFRAC's indebtedness from time to time could impair GASFRAC'sability to obtain additional financing in the future on a timely basisto take advantage of business opportunities that may arise. If GASFRAC'scash flow from operations is not sufficient to fund GASFRAC's capitalexpenditure requirements, there can be no assurance that additional debtor equity financing will be available to meet these requirements or, ifavailable, on favourable terms.
Patents and Proprietary Technology
GASFRAC's success will depend, in part, on its ability to obtainpatents, maintain trade secret protection and operate without infringingon the rights of third parties. The LPG Fracturing Process patents forthe U.S., Canada and International markets remain in examination.However, there can be no assurance that any issued patents will provideGASFRAC with any competitive advantages or will not be successfullychallenged by any third parties, or that the patents of others will nothave an adverse effect on the ability of GASFRAC to do business. Inaddition, there can be no assurance that others will not independentlydevelop similar products, duplicate some or all of GASFRAC's products,or, if patents are issued to GASFRAC, design their products so as tocircumvent the patent protection that may be held by GASFRAC. Inaddition, GASFRAC could incur substantial costs in lawsuits in whichGASFRAC attempts to enforce its own patents against other parties.
Operational Risks
GASFRAC's operations are subject to hazards inherent in the oil andnatural gas industry, such as equipment defects, malfunction andfailures, and natural disasters which result in fires, vehicleaccidents, explosions and uncontrollable flows of natural gas or wellfluids that can cause personal injury, loss of life, suspension ofoperations, damage to formations, damage to facilities, businessinterruption and damage to or destruction of property, equipment and theenvironment. These hazards could expose GASFRAC to substantialliability for personal injury, wrongful death, property damage, loss ofoil and natural gas production, pollution, contamination of drinkingwater and other environmental damages. GASFRAC continuously monitors itsactivities for quality control and safety, and although it maintainsinsurance coverage that it believes to be adequate and customary in theindustry, such insurance may not be adequate to cover GASFRAC'sliabilities and may not be available in the future at rates that GASFRACconsiders reasonable and commercially justifiable.
Availability of Qualified Staff
Attracting and retaining qualified workers is necessary for GASFRACto provide reliable services to its customers. With high industryactivity there is also high demand for qualified workers and, as such,it is a challenge for GASFRAC to add a significant number of workers tosupport its planned growth. The Company attempts to overcome thischallenge by offering an attractive compensation package, providing anin-depth training program, and offering career growth opportunities.
Availability of Debt Financing
The Company has facilities with its bank for $50 million of debtfinancing as discussed in Note 5 of the 2010 Consolidated AuditedFinancial Statements. Should GASFRAC be unable to renew these facilitiesin the amount it requires or on terms acceptable to it, significantliquidity issues could result.
Financing of future growth
GASFRAC's future growth strategy is subject to the availability offinancing to support the acquisition of additional capital equipment.This growth may be fully or partially financed with debt which may ormay not be available at the time required. Should such debt financingnot be available as required it could result in a delay in the Company'sability to grow its operations. Should the Company obtain debtfinancing there are no assurances that debt levels may increase aboveindustry standards due to the impact of seasonal or cyclical trends orother factors.
Management Stewardship
The successful operation of GASFRAC's business depends upon theabilities, expertise, judgment, discretion, integrity and good faith ofGASFRAC's executive officers, employees and consultants. In addition,GASFRAC's ability to expand its services depends upon its ability toattract qualified personnel as needed. The demand for skilled oilfieldemployees is high, and the supply is limited. If GASFRAC loses theservices of one or more of its executive officers or key employees, itcould have a material adverse effect on GASFRAC's business, financialcondition, results of operations and cash flows.
Regulations Affecting the Oil and Natural Gas Industry
The operations of GASFRAC's customers are subject to or impacted by awide array of regulations in the jurisdictions in which they operate.As a result of changes in regulations and laws relating to the oil andnatural gas industry, GASFRAC's customers' operations could be disruptedor curtailed by governmental authorities. The high cost of compliancewith applicable regulations could cause customers to discontinue orlimit their operations and may discourage companies from continuingdevelopment activities. As a result, demand for GASFRAC's services couldbe substantially affected by regulations adversely impacting the oiland natural gas industry. Changes in environmental requirements maynegatively impact demand for GASFRAC's services. For example, oil andnatural gas exploration and production may decline as a result ofenvironmental requirements (including land use policies responsive toenvironmental concerns). A decline in exploration and production, inturn, could materially and adversely affect GASFRAC.
Government Regulations
GASFRAC's operations are subject to a variety of federal,provincial, state and local laws, regulations and guidelines in all thejurisdictions in which it operates, including laws and regulationsrelating to health and safety, the conduct of operations, taxation, theprotection of the environment and the manufacture, management,transportation and disposal of certain materials used in GASFRAC'soperations. GASFRAC has invested financial and managerial resources toensure such compliance and expects to continue to make such investmentsin the future. Such laws or regulations are subject to change and couldresult in material expenditures that could have a material adverseeffect on GASFRAC's business, financial condition, results of operationsand cash flows. It is impossible for GASFRAC to predict the cost orimpact of such laws and regulations on GASFRAC's future operations. Inparticular, GASFRAC is subject to increasingly stringent laws andregulations relating to importation and use of hazardous materials,radioactive materials and explosives, environmental protection,including laws and regulations governing air emissions, water dischargesand waste management. GASFRAC incurs, and expects to continue to incur,capital and operating costs to comply with environmental laws andregulations. The technical requirements of these laws and regulationsare becoming increasingly complex, stringent and expensive to implement.These laws may provide for "strict liability" for damages to naturalresources or threats to public health and safety. Strict liability canrender a party liable for damages without regard to negligence or faulton the part of the party. Some environmental laws provide for joint andseveral strict liabilities for remediation of spills and releases ofhazardous substances.
GASFRAC uses and generates hazardous substances and wastes in itsoperations. In addition, some of GASFRAC's current properties are, orhave been, used for industrial purposes. Accordingly, GASFRAC couldbecome subject to potentially material liabilities relating to theinvestigation and cleanup of contaminated properties, and to claimsalleging personal injury or property damage as the result of exposuresto, or releases of, hazardous substances. In addition, stricterenforcement of existing laws and regulations, new laws and regulations,the discovery of previously unknown contamination or the imposition ofnew or increased requirements could require GASFRAC to incur costs orbecome the basis of new or increased liabilities that could reduceGASFRAC's earnings and cash available for operations. GASFRAC believesit is currently in substantial compliance with applicable environmentallaws and regulations.
GASFRAC is a provider of hydraulic fracturing services, a processthat creates fractures extending from the well bore through the rockformation to enable natural gas or oil to move more easily through therock pores to a production well. Bills pending in the United StatesHouse of Representatives and Senate have asserted that chemicals used inthe fracturing process could adversely affect drinking water supplies.The proposed legislation would require the reporting and publicdisclosure of chemicals used in the fracturing process. Thislegislation, if adopted, could establish an additional level ofregulation at the federal level that could lead to operational delaysand increased operating costs. The adoption of any future federal orstate laws or implementing regulations imposing reporting obligationson, or otherwise limiting, the hydraulic fracturing process could makeit more difficult to complete natural gas and oil wells and could have amaterial adverse effect on GASFRAC's business, financial condition,results of operations and cash flows.
Climate Change Initiatives
Canada is a signatory to the United Nations Framework Convention onClimate Change and has adopted the Kyoto Protocol established thereunderto set legally binding targets to reduce nation-wide emissions ofcarbon dioxide, methane, nitrous oxide and other so-called "greenhousegases". Details regarding Canada's implementation of the Kyoto Protocolremain unclear. On April 26, 2007, the Government of Canada released itsRegulatory Framework for Air Emissions which outlines proposed newrequirements governing the emission of greenhouse gases and industrialair pollutants in accordance with the Government's Notice of Intent toDevelop and Implement Regulations and Other Measures to Reduce AirEmissions, which was released on October 19, 2006. A further plansetting out the federal government's proposed framework for regulatinggreenhouse gas emissions was released on March 10, 2008. The frameworkand associated public documents provide some, but not full, detail onnew greenhouse gas and industrial air pollutant limits and compliancemechanisms that the government intends to apply to various industrialsectors, including oil and natural gas producers. Details on potentiallegislation to enact the proposed regulatory framework for greenhousegases remain unavailable.
Since November 2008, the Government of Canada has expressed aninterest in pursuing a potential harmonization of future Canadiangreenhouse gas regulation with future regulation in the United States,pursuant to a bilateral treaty, raising uncertain implications forgreenhouse gas emission requirements to be applied to Canadian industry,including the oil and natural gas sector. Future federal legislation,including potential international or bilateral requirements enactedunder Canadian law, together with provincial emission reductionrequirements, such as those in effect under Alberta's Climate Change andEmissions Management Act, and potential further provincialrequirements, may require the reduction of emissions or emissionsintensity from GASFRAC's operations and facilities. Mandatory emissionsreductions may result in increased operating costs and capitalexpenditures for oil and natural gas producers, thereby decreasing thedemand for GASFRAC's services. The mandatory emissions reductions mayalso impair GASFRAC's ability to provide GASFRAC's serviceseconomically. GASFRAC is unable to predict the impact of current andpending emission reduction legislation on GASFRAC and it is possiblethat such impact may have a material adverse effect on GASFRAC'sbusiness, financial condition, results of operations and cash flows.
Customers
Customers are generally invoiced for our services in arrears. As aresult, we are subject to our customers delaying or failing to payinvoices. Risk of payment delays or failure to pay is increased duringperiods of weak economic conditions due to potential reduction in cashflow and access to capital of our customers.
The Market Price of the Common Shares May Be Volatile
The trading price of securities of oilfield service companies issubject to substantial volatility. The volatility is often based onfactors both related to and not related to the financial performance orprospectus of the companies involved. The market price of the GASFRACCommon Shares could be subject to significant fluctuations in responseto our operating results, financial condition and other internalfactors. Factors that could affect the market price that are notdirectly related to GASFRAC's performance include commodity prices andmarket perceptions of the attractiveness of particular industries forinvestment. The price at which the Common Shares will trade cannot beaccurately predicted.
Internal Controls Over Financial Reporting
During the fourth quarter, GASFRAC initiated an evaluation of theCompany's internal controls under the supervision and with theparticipation of the Company's management, including the Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the designand operation of the Company's disclosure controls and procedures, asdefined in National Instrument 52-109. Based on the evaluation, theCompany's management, including the Chief Executive Officer and ChiefFinancial Officer, concluded that the Company's disclosure controls andprocedures were designed to provide a reasonable level of assurance overthe disclosure of material information, and are effective as ofDecember 31, 2010.
There have been no changes in the Company's internal controls overfinancial reporting during the period ended December 31, 2010 that havematerially affected, or are reasonably likely to materially effect, theCompany's internal controls over financial reporting.
International Financial Reporting Standards ("IFRS")
The Canadian Accounting Standards Board ("AcSB") published a newstrategic plan that outlines the convergence of Canadian generallyaccepted accounting principles with IFRS over an expected five yeartransitional period. The changeover date for publicly-listed companiesto use IFRS, replacing Canada's own generally accepted accountingprinciples is interim and annual financial statements for fiscal yearsbeginning on or after January 1, 2011 with the restatement forcomparative purposes of amounts reported by the Company for the yearended December 31, 2010.
The Company has completed a high-level review and preliminaryassessment of the differences between Canadian GAAP and IFRS and thepotential effects of IFRS to its accounting and reporting processes,information systems, business processes and external disclosures. Thisassessment has provided insight into what are anticipated to be the mostsignificant areas of difference applicable to the Company. The nextstep is to perform an in-depth review of the significant areas ofdifference and formulate ongoing accounting policies. Key areasaddressed will also be reviewed to determine any information technologyissues, the impact on internal controls over financial reporting and theimpact on business activities including the effect, if any, oncovenants and compensation arrangements.
The Company will also continue to monitor standards development asissued by the AcSB as well as regulatory developments as issued by theCanadian Securities Administrators, which may affect the timing, natureor disclosure of its adoption of IFRS.
The following IFRS standards are considered most relevant to the Company's conversion process:
IFRS 1 - First-time Adoption of IFRS, which generally requires thatan entity apply all IFRS standards retrospectively, with specificmandatory exemptions, and a limited number of optional exemptions. Apreliminary assessment of the available exemptions has been completed.
Elections made upon transition to IFRS can have a significant impacton the level of time and effort needed for the conversion to IFRS. Thefollowing optional exemptions are the most applicable to the Company:
a) Fair value as deemed cost - This exemption provides the Companywith the option to elect specific fair values as the deemed cost of anyqualifying item of property and equipment;
b) Business combinations - This exemption provides the Company withthe option of not applying IFRS 3, Business Combinations to businesscombinations that took place before the date of transition; and
c) Share-based payments - This exemption provides the Company withthe option of not applying IFRS 2, Share-Based Payments toequity-settled share-based payment transactions issued after November 7,2002 and which have vested before the date of transition.
The Company has completed a more detailed analysis of each of thespecific areas identified in the high-level comparison of Canadian GAAPto IFRS.
GASFRAC does not anticipate that the transition to IFRS will requiresignificant changes to its accounting systems. The most significantsystem changes relate to its fixed asset sub-system in order toseparately track the components of its fixed assets.
During the fourth quarter of 2010 GASFRAC substantially completedcalculations for IFRS compliant quarterly financial statements for eachof the first three quarters of 2010 as these comparatives will berequired for 2011 reporting. In addition, during the fourth quarter of2010 GASFRAC has substantially completed; white-papers for accountingpolicies and IFRS 1 elections; preparation of required transitiondisclosures and schedules; January 1, 2010 IFRS opening balance sheetamounts; testing of the calculation of the opening balance sheet amountsas well as the quarterly financial statements for each of the firstthree quarters of 2010.
Changes in Accounting Policies
There were no new or amended accounting policies issued for adoption in the current period.
Non-GAAP Measures
Certain supplementary measures in this MD&A do not have anystandardized meaning as prescribed under Canadian GAAP and, therefore,are considered non-GAAP measures. These measures have been described andpresented in order to provide shareholders and potential investors withadditional information regarding the Company's financial results,liquidity and ability to generate funds to finance its operations. Thesemeasures may not be comparable to similar measures presented by otherentities, and are further explained as follows:
EBITDA is defined as net income before interest income and expense,taxes, depreciation, amortization and non-controlling interest. EBITDAis presented because it is frequently used by securities analysts andothers for evaluating companies and their ability to service debt.
EBITDA was calculated as follows:
(
00s) Three months ended Twelve months ended
December 31 December 31
----------------------------------------
2010 2009 2010 2009
----------------------------------------------------------------------------
Net income 2,062 (2,838) 5,053 (2,210)
Add back (deduct):
Interest income (71) (16) (107) (201)
Amortization 2,452 1,525 7,929 5,024
Future income tax provision 1,670 7 3,237 360
----------------------------------------------------------------------------
EBITDA 6,113 (1,322) 16,112 2,973
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Funds provided by operations is defined as cash and cash equivalentsprovided by (used for) operating activities before the net change innon-cash operating working capital. Funds provided by operations is ameasure that provides shareholders and potential investors withadditional information regarding the Company's liquidity and its abilityto generate funds to finance its operations. Management utilizes thesemeasures to assess the Company's ability to finance operating activitiesand capital expenditures.
Funds provided by operations was calculated as follows:
(
00s) Three months ended Twelve months ended
December 31 December 31
----------------------------------------
2010 2009 2010 2009
----------------------------------------------------------------------------
Cash and cash equivalents provided by
(used for) operating activities 1,004 404 3,326 (438)
Add back (deduct):
Net changes in non-cash working
capital 5,621 (1,209) 13,601 4,885
----------------------------------------------------------------------------
Funds provided by operations 6,625 (805) 16,927 4,447
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Outlook
We expect the North American pressure pumping market will remainstrong in 2011 due to the service intensity of the wells being drilled,energy demand and service supply levels. Although there is projected tobe a significant amount of new horsepower being added to the market in2011, it is still estimated that the market will be undersupplied basedon projected rig activity. As natural gas prices continue to be soft wehave observed customers targeting more of their capital budgets in oiland liquids-rich reservoirs. Further, development activity is focused ondeep, unconventional and horizontal wells often requiring multi-stagefracturing.
As noted above, we expect that overall demand for fracturingservices will continue to be strong for 2011 and this, combined withgrowing knowledge and acceptance of the Company's LPG fracturingtechnology, should support continued growth of our Canadian revenuebase. We do note however that we anticipate a reduction in anticipatedrevenues for the first quarter of 2011 due to the Company's self imposedcessation of operations for 19 days while it investigated (andresolved) a well-site incident as described in our press releases ofJanuary 16, 2011 and January 20, 2011. The incident has been fullyresolved and we do not expect any further interruption of services as aresult of this incident.
As in Canada, more drilling activity in the USA is being focused onoil and liquids rich gas. While industry dynamics are similar to Canadafor GASFRAC, the key element of our initial growth in the USA will beobtaining customer acceptance of our LPG fracturing technology and onfocusing on key basins where we can quickly reach sufficient mass toensure high utilization rates. We are planning for deployment of twosets of equipment to USA locations early in 2011 and are optimistic thatcustomer acceptance of the technology will result in significantutilization of the equipment.
With the backdrop of anticipated strong demand in the overallfracturing industry in North America, growing acceptance of theCompany's technology and added revenue producing capacity at GASFRACwith the added capital equipment, we expect to be able to continue toincrease our revenue base through 2011.
Forward-Looking Statements
This document contains certain statements that constituteforward-looking statements under applicable securities legislation. Allstatements other than statements of historical fact are forward-lookingstatements. In some cases, forward-looking statements can be identifiedby terminology such as "may", "will", "should", "expect", "plan","anticipate", "believe", "estimate", "predict", "potential", "continue",or the negative of these terms or other comparable terminology. Thesestatements are only as of the date of this document and we do notundertake to publicly update these forward looking statements except inaccordance with applicable securities laws. These forward lookingstatements include, among other things:
- expectations that GASFRAC's innovative technology will provideGASFRAC with opportunities to expand GASFRAC's market share in Albertaand British Columbia;
- estimates of additional investment required to complete ongoing capital projects;
- expectations of securing financing for additional capital expenditures beyond 2010;
- expectations that GASFRAC has or can obtain sufficient funding to meet its capital plan;
- expectations that additional operating equipment will be deliveredand provide GASFRAC the ability to service demand for large multi-stagetreatments;
- expectations that additional fluid management equipment will allow the Company to increase the utilization of its horsepower;
- assumption that environmental protection requirements will nothave a significant impact on GASFRAC's operations or capital budget;
- expectations as to GASFRAC's future market position in the industry;
- expectations as to the supply of raw materials;
- expectations as to the pricing of GASFRAC's services;
- expectations as to the timing of additional capital equipment in Canada and the USA;
- expectations as to the potential for GASFRAC's services in the United States;
- expectations of fracturing industry pricing and the pricing of GASFRAC services in North America in 2011;
- expectations of oil and natural gas commodity prices in 2011;
- expectations of the amount of net fracturing horsepower beingadded to the North American market in 2011 and its impact on GASFRAC'sservice prices;
- expected timing for completion of the assessment and implementation phases of GASFRAC's project plan for transition to IFRS;
These statements are only predictions and are based on currentexpectations, estimates, projections and assumptions, which we believeare reasonable but which may prove to be incorrect and therefore suchforward-looking statements should not be unduly relied upon. In additionto other factors and assumptions which may be identified in thisdocument, assumptions have been made regarding, among other things,industry activity; effect of market conditions on the demand for theCompany's services; the ability to obtain qualified staff, equipment andservices in a timely manner; the effect of current plans; the timing ofcapital expenditures and receipt of added equipment operating capacity;future oil and natural gas prices and the ability of the Company tosuccessfully market its services.
By its nature, forward-looking information involves numerousassumptions, known and unknown risks and uncertainties, both general andspecific, that contribute to the possibility that the predictions,forecasts, projections and other forward-looking statements will notoccur. These risks and uncertainties include: changes in drillingactivity; fluctuating oil and natural gas prices; general economicconditions; weather conditions; regulatory changes; the successfuldevelopment and execution of technology; customer acceptance of newtechnology; the potential of competing technologies by marketcompetitors; the availability of qualified staff; raw materials andcapital equipment.
GASFRAC ENERGY SERVICES INC.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE TWELVE MONTHS ENDED
DECEMBER 31, 2010
GASFRAC ENERGY SERVICES INC.
Consolidated Balance Sheets
(000s)
As at: Dec 31, 2010 Dec 31, 2009
----------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 98,701 $ 11,643
Accounts receivable 24,500 9,469
Inventory 7,018 5,499
Prepaid expenses 6,839 519
----------------------------------------------------------------------------
137,058 27,130
FUTURE INCOME TAX BENEFIT (Note 6) - 775
LONG TERM DEPOSITS 3,176 1,790
PROPERTY AND EQUIPMENT (Note 3) 136,749 61,295
OTHER ASSETS (Note 4) 420 358
----------------------------------------------------------------------------
$ 277,403 $ 91,348
----------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 14,828 $ 7,617
Unearned revenue 3,486 -
----------------------------------------------------------------------------
18,314 7,617
FUTURE INCOME TAX (Note 6) 368 -
----------------------------------------------------------------------------
18,682 7,617
----------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
SHARE CAPITAL (Note 7) 251,326 81,293
CONTRIBUTED SURPLUS (Note 8) 1,712 1,808
RETAINED EARNINGS 5,683 630
----------------------------------------------------------------------------
258,721 83,731
----------------------------------------------------------------------------
$ 277,403 $ 91,348
----------------------------------------------------------------------------
See accompanying notes
On behalf of the Board:
Dwight Loree, Director
Gerald Roe, Director
GASFRAC ENERGY SERVICES INC.
Consolidated Statements of Operations, Comprehensive Income (Loss) and
Retained Earnings (000s)
Twelve Months Ended Dec 31, 2010 Dec 31, 2009
----------------------------------------------------------------------------
REVENUE $ 96,906 $ 30,428
----------------------------------------------------------------------------
EXPENDITURES
Operating 72,190 21,016
Selling, general and administrative 10,579 6,227
Stock based compensation (Note 2) 708 1,273
Amortization 7,929 5,024
Foreign exchange loss 73 160
----------------------------------------------------------------------------
91,479 33,700
----------------------------------------------------------------------------
OTHER INCOME
Business interruption claim (Note 15) 2,756 638
Scientific research and experimental
development - 583
Interest income 107 201
----------------------------------------------------------------------------
2,863 1,422
----------------------------------------------------------------------------
NET INCOME (LOSS) BEFORE INCOME TAXES 8,290 (1,850)
FUTURE INCOME TAXES EXPENSE (Note 6) 3,237 360
----------------------------------------------------------------------------
NET INCOME (LOSS) / COMPREHENSIVE
INCOME (LOSS) 5,053 (2,210)
RETAINED EARNINGS
BALANCE, BEGINNING OF THE YEAR 630 2,840
----------------------------------------------------------------------------
BALANCE, END OF THE YEAR $ 5,683 $ 630
----------------------------------------------------------------------------
Income (Loss) per share
Basic $ 0.13 ($ 0.07)
----------------------------------------------------------------------------
Diluted $ 0.12 ($ 0.07)
----------------------------------------------------------------------------
See accompanying notes
GASFRAC ENERGY SERVICES INC.
Consolidated Statements of Cash Flows (000s)
Twelve Months Ended Dec 31, 2010 Dec 31, 2009
----------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS PROVIDED BY (USED
FOR):
OPERATING ACTIVITIES
Net Income (Loss) / Comprehensive Income (Loss) $ 5,053 $ (2,210)
Items not effecting cash:
Amortization 7,929 5,024
Future income taxes expense 3,237 360
Stock based compensation 708 1,273
----------------------------------------------------------------------------
16,927 4,447
Net change in non-cash working capital (Note 12) (13,601) (4,885)
----------------------------------------------------------------------------
3,326 (438)
----------------------------------------------------------------------------
FINANCING ACTIVITIES
Issuance of common shares (net of share issue
costs) 167,135 100
----------------------------------------------------------------------------
INVESTING ACTIVITIES
Decrease in short term investments - 19,883
(Increase) decrease in long term deposits (1,386) 162
Purchase of property and equipment (83,248) (27,349)
Purchase of other assets (197) (130)
Net changes in non-cash working capital 1,428 1,462
----------------------------------------------------------------------------
(83,403) (5,972)
----------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents
For the year 87,058 (6,310)
Cash and cash equivalents at beginning of year 11,643 17,953
----------------------------------------------------------------------------
BALANCE, END OF THE YEAR $ 98,701 $ 11,643
----------------------------------------------------------------------------
See accompanying notes
GASFRAC ENERGY SERVICES INC.
Notes to the Consolidated Financial Statements
December 31, 2010 and December 31, 2009
(Figures in text and tables are in 000s except share data and certain other exceptions as indicated)
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
GASFRAC Energy Services Inc. ("GASFRAC" or the "Company") wasincorporated on February 13, 2006 in Canada under the BusinessCorporations Act in the Province of Alberta. The Company is a an oil andgas well fracturing company that has developed new technology, the "LPGFracturing Process", to enable wells to be fractured safely with LPG,more specifically propane and butane.
These consolidated financial statements include the accounts of theCompany's wholly owned subsidiaries GASFRAC Energy Services LimitedPartnership, GASFRAC Services GP Inc., and GASFRAC Inc. (a USincorporated entity).
The Company's financial statements have been prepared in Canadiandollars in accordance with Canadian generally accepted accountingprinciples ("GAAP"). Management is required to make estimates andassumptions that affect reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenue and expensesduring the reported period. The significant estimates of the Companyinclude estimates relating to accounts receivable, property andequipment, stock based compensation, and future income tax. Actualresults could differ from these estimates.
The Company's financial results are directly affected by theseasonal nature of the North American oil and natural gas industry. Thefirst and fourth quarter incorporates the winter drilling season when adisproportionate amount of the activity takes place in western Canada.During the second quarter, commonly referred to as "spring breakup",soft ground conditions typically curtail oilfield activity in all of theCompany's Canadian operating areas. In addition, during excessivelyrainy periods in any of the Company's operating areas, equipment movesmay be delayed, thereby adversely effecting revenues.
On August 6, 2010, the Company amalgamated with Kierland CapitalCorporation ("Kierland"). The amalgamation was accounted for as areverse takeover of Kierland, an entity that did not constitute abusiness by the Company. Pursuant to the terms of the transaction: (i)all of the issued and outstanding common shares of Kierland wereexchanged for 156,250 common shares of Amalco; and (ii) each of the46,585,833 issued and outstanding GASFRAC shares were exchanged for oneAmalco share. Upon completion of the transaction, the continuing entitychanged its name to GASFRAC Energy Services Inc.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies used in the preparation of these financial statements:
Consolidation
These consolidated financial statements include the accounts of theCompany and its subsidiaries, all of which are wholly owned. Allinter-company balances and transactions have been eliminated onconsolidation.
Cash and cash equivalents
Cash and cash equivalents are held for the purpose of meetingshort-term cash commitments and include bank balances and short-terminvestments with maturities of less than 90 days.
Scientific research and experimental development ("SRED")
Non-refundable investment tax credits for SRED activities arerecorded when the Company has reasonable assurance that the credit willbe realized. Management makes a number of estimates and assumptions indetermining the expenditures eligible for the investment tax creditclaim.
Inventory
Inventory consists of liquefied petroleum gas, chemicals, andproppants used to stimulate well production and is stated at the lowerof cost and net realizable value. Cost is determined using the weightedaverage method.
Property and equipment
Property and equipment are recorded at cost and are amortized overtheir estimated economic useful lives using the straight-line methodover the following terms:
Equipment 3 - 10 Years
----------------------------------------------------------------------------
Leasehold Improvements Lease term
----------------------------------------------------------------------------
Furniture and fixtures 5 Years
----------------------------------------------------------------------------
Assets under construction are not amortized until put into service.
Management estimates the useful life and salvage value of propertyand equipment on expected utilization, effectiveness of maintenanceprograms and expected impact of technological change. Althoughmanagement believes the estimated useful lives of the property andequipment are reasonable, it is possible that changes in estimates couldoccur which may affect the expected useful lives and salvage values ofthe property and equipment.
Major betterments are capitalized. Repairs and maintenanceexpenditures which do not extend the useful life of the property andequipment are expensed.
Impairment of Long-Lived Assets
Long-lived assets include property and equipment and other assets.They are tested for impairment when events or changes in circumstancesindicate that the carrying value may not be recoverable. An impairmentloss is recognized when the carrying amount of the assets exceeds thesum of the undiscounted future cash flows expected from use and eventualdisposal. Estimates of undiscounted future net cash flows arecalculated using estimated future utilization, sales prices and margins,operating expenditures and other costs. These estimates are subject torisk and uncertainties, and it is possible that changes in estimatescould occur which may impact the expected recoverability of theCompany's long-lived assets.
Other assets
Other assets including deferred development costs, patents andintellectual property that meet certain criteria related to technology,market and financial feasibility under Canadian generally acceptedaccounting principles, are deferred. Such costs are amortized over theestimated economic life of the related product starting uponcommencement of commercial sales. Costs that do not meet such criteriaare charged to income in the period of expenditure.
Revenue recognition
The Company's revenue is comprised of services and other revenue andis generally sold on agreed upon priced purchase orders or contractswith the customer. Contract terms do not include provisions forsignificant post-service delivery obligations. Service and other revenueis recognized when the services are provided and collectability isreasonably assured.
Income taxes
The Company follows the liability method of determining theprovision for income taxes. Under this method, future incomes taxes aredetermined based on temporary differences between the tax bases ofassets and liabilities and their carrying amounts in the financialstatements, using the substantively enacted tax rates. Future tax assetsare recognized where their recoverability is more likely than not.
The calculation of the provision for income taxes involves taxregulations, legislation and interpretations which are subject tochange. There are also tax matters that have yet to be confirmed bytaxation authorities; however; management believes the provision forincome taxes is reasonable.
Stock based compensation
The Company has a stock-based compensation plan, which is describedin Note 7. The Company applies the Black-Scholes option pricing model tovalue its stock options. Under this method, compensation costattributable to stock options granted is measured at fair value at thegrant date and expensed over the vesting period with a correspondingincrease to contributed surplus. Upon exercise of the stock options,consideration paid together with the amount previously recognized incontributed surplus is recorded as share capital. The Company has notincorporated an estimated forfeiture rate for stock options that willnot vest, rather the Company will account for actual forfeitures as theyoccur.
The Company has a performance share unit and a restricted share plan as described in note 7.
Translation of foreign currencies
Transactions in foreign currencies are translated into Canadiandollars at rates in effect at the date of the transaction. Assets andliabilities denominated in foreign currencies are translated at theexchange rates in effect at each accounting period end date. Exchangegains or losses are included in net income.
For the Company's wholly owned integrated foreign subsidiary, thetemporal method of translating foreign currencies has been used. Underthis method, monetary items are translated into Canadian dollars at theexchange rates in effect at each accounting period end date.Non-monetary items and their related amortization are translated attheir historical exchange rates. Revenues and expenses are translated ataverage exchange rates during the period. Gains or losses arising fromthe translation of the financial statements of these foreignsubsidiaries are included in net income.
Earnings per share
Basic earnings per share is calculated using the weighted averagenumber of shares outstanding during the year. Under the treasury stockmethod, diluted earnings per share is calculated based on the weightedaverage number of shares outstanding during the year, adjusted by thetotal of additional common shares that would have been issued assumingexercise of all stock options, restricted shares and warrants withexercise prices at or below the average market price for the year,offset by the reduction in common shares that would be purchased withthe exercise proceeds.
Recently issued accounting pronouncements
Business combinations, consolidated financial statements and non-controlling interests
In January 2009, CICA issued Section 1582, Business Combinations;Section 1601, Consolidated Financial Statements; and Section 1602,Non-controlling Interests. These sections replace the former Section1581, Business Combinations, and Section 1600, Consolidated FinancialStatements, and establish new sections for accounting for anon-controlling interest in a subsidiary. Section 1582 is effective forbusiness combinations for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or afterJanuary 1, 2011. Sections 1601 and 1602 apply to interim and annualconsolidated financial statements relating to years beginning on orafter January 1, 2011. The Company is currently assessing the effectthese standards may have on its results of operations and consolidatedfinancial statements.
3. PROPERTY AND EQUIPMENT
December 31, December 31,
As at: 2010 2009
----------------------------------------------------------------------------
Cost:
Equipment $ 103,983 $ 59,037
Furniture & Fixtures 156 59
Leasehold Improvements 55 51
Assets Under Construction 47,392 9,194
----------------------------------------------------------------------------
151,586 68,341
----------------------------------------------------------------------------
Accumulated Depreciation:
Equipment 14,788 7,019
Furniture & Fixtures 38 21
Leasehold Improvements 11 6
Assets Under Construction - -
----------------------------------------------------------------------------
14,837 7,046
----------------------------------------------------------------------------
Net Book Value:
Equipment 89,195 52,018
Furniture & Fixtures 118 38
Leasehold Improvements 44 45
Assets Under Construction 47,392 9,194
----------------------------------------------------------------------------
$ 136,749 $ 61,295
----------------------------------------------------------------------------
----------------------------------------------------------------------------
As at December 31, 2010 and December 31, 2009, assets underconstruction are not subject to amortization as the assets are not yetavailable for use.
4. OTHER ASSETS
December 31, December 31,
2010 2009
----------------------------------------------------------------------------
Cost:
Patents & Intellectual Property $ 477 $ 312
Deferred Development Costs 230 198
Prepaid Lease Agreements 31 31
----------------------------------------------------------------------------
738 541
----------------------------------------------------------------------------
Accumulated Depreciation:
Patents & Intellectual Property 163 82
Deferred Development Costs 131 84
Prepaid Lease Agreements 24 17
----------------------------------------------------------------------------
318 183
----------------------------------------------------------------------------
Net Book Value:
Patents & Intellectual Property 314 230
Deferred Development Costs 99 114
Prepaid Lease Agreements 7 14
----------------------------------------------------------------------------
$ 420 $ 358
----------------------------------------------------------------------------
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5. LONG-TERM DEBT
During 2010, the Company entered into the new credit facility with aCanadian chartered bank. The new credit facility includes a $15 milliondemand revolving loan ("Operating Loan") and a $35 million committedrevolving facility ("Revolving Facility"). The Operating Loan bearsinterest at prime plus 1.25% and is margined by the Company's accountsreceivable. The Revolving Facility bears interest at prime plus 1.4% toprime plus 1.9%, shall not exceed 50% of the net book value of theCompany's capital assets, may be extended annually, if not extendedshall be repayable in eight equal quarterly instalments. Both facilitiesare secured by a floating charge over all of the assets of the Companyand are subject to certain financial covenants.
6. FUTURE INCOME TAX
The net income tax provision differs from that expected by applyingthe combined federal and provincial income tax rate of 28.65% (2009 -29.85%) to income taxes for the following reasons:
Year ended December 31, 2010 2009
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Expected combined federal and provincial income tax $ 2,375 $ (530)
Statutory and other rate differences 299 441
Non-deductible expenses 203 177
Future income tax rate reduction (294) 64
Valuation allowance 654 208
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Effective / Actual $ 3,237 $ 360
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The components of the future income tax asset and liability are as follows:
As at December 31, 2010 2009
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Property and equipment and other assets $ (4,809) $ (3,274)
Non-capital loss carry forwards 2,338 3,062
Financing costs 2,571 830
Other 394 394
Valuation Allowance (862) (237)
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Total future income tax (liability) benefit $ (368) $ 775
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The Company has $ 5,897 (2009 - $ 10,413) of tax pools related tonon-capital losses available for carry forward to reduce taxable incomein future years and expire between 2027 and 2029. The Company also has $1,569 (2009 - $1,569) of tax pools related to SR&ED available forcarry forward to reduce taxable income in future years and do notexpire.
7. SHARE CAPITAL
Authorized
Unlimited number of common shares.
Unlimited number of preferred shares issuable in series with thedesignation, rights, privileges, restrictions and conditions of eachseries to be determined by the board of directors.
Issued common shares
2010 2009
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Shares Amount Shares Amount
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(#) ($) (#) ($)
Balance - January 1 32,650,000 81,293 32,370,000 80,205
Issued on private placement 13,000,000 61,551 - -
Issued on bought deal 12,929,450 104,698 - -
Issued on exercise of options 669,666 1,397 50,000 110
Issued on share exchange (Note 1) 156,250 453 - -
Issued upon exercise of warrants 845,000 2,030 -
Issued for services 30,000 128 230,000 978
Reclassified as restricted shares (130,000) (552) - -
Released from restricted shares 76,000 328 - -
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Balance - December 31 60,226,366 251,326 32,650,000 81,293
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On June 30, 2010 GASFRAC closed a private placement of 13,000,000subscription receipts by the Company at a price of $5.00 per receipt forgross proceeds of $65 million (net cash proceeds of $60.6 million afterbroker fees and transaction costs and deferred tax recovery of $1.0million).
On December 22, 2010 GASFRAC closed a bought deal of 12,929,450common shares by the Company at a price of $8.45 for gross proceeds of$109 million (net cash proceeds of $104 million after broker fees andtransaction costs and deferred tax recovery of $1.1 million).
Restricted shares
2010 2009
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Shares Amount Shares Amount
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(#) ($) (#) ($)
Balance - January 1 127,917 542 - -
Granted 310,000 1,394 130,000 553
Released to common shares (76,000) (329) (2,083) (11)
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Balance - December 31 361,917 1,607 127,917 542
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The Company has granted restricted shares for certain employees withan annual vesting period over five years from the date of the grant.During the year, the Company granted 310,000 restricted shares andrestricted stock compensation of $163 was recognized.
Performance share units
The Company grants performance share units to officers and employeeswith the amount of the grant earned being linked to corporateperformance and grants vesting over three years from date of grant. Theperformance stock units are settled either in cash or Company shares.During the year, the Company granted 250,000 performance share units and20,833 vested (2009 - nil). During the year, $191 of compensationexpense was recognized for performance share units (2009 - nil).
Changes in the Company's obligations under performance share units,which arise from fluctuations in the market value of the Company'sshares underlying the compensation program, are recorded as the shareprice changes.
Stock options
The Company calculates the fair value of its options using theBlack-Scholes option pricing model. The following weighted averageassumptions were used to determine the fair value of the options at thedate of grant.
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Risk-free interest rate 1.5%
Expected life 3 years
Maximum life 5 years
Volatility 0% - 55%
Expected dividend 0
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A summary of the status of the Company's outstanding stock options is
presented below:
2010 2009
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Average Average
Exercise Exercise
Options Price Options Price
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(#) ($) (#) ($)
Balance - January 1 2,966,000 2.89 2,621,000 2.63
Granted 670,000 4.51 435,000 4.25
Exercised for common shares (669,666) 2.00 (50,000) 2.00
Forfeited and expired (246,167) 3.14 (40,000) 2.00
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Balance - December 31 2,720,167 3.47 2,966,000 2.89
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Stock options vest over three years and expire five years from thedate of grant. The 2,720,167 options outstanding (1,295,333 exercisable)at December 31, 2010 had exercise prices ranging from $2.00 to $5.00per share with expiry dates ranging from 2011 to 2015. When stockoptions are exercised the proceeds, together with the amount ofcompensation expense previously recorded in contributed surplus areadded to share capital. During the year, $229 of compensation expensewas recognized.
Warrants
2010 2009
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Average Average
Exercise Exercise
Warrants Price Warrants Price
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(#) ($) (#) ($)
Balance - January 1 2,602,500 1.32 2,602,500 1.32
Exercised for common shares (845,000) 1.57 - -
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Balance - December 31 1,757,500 1.20 2,602,500 1.32
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As part of an employment agreement with the founding officer ofthe Company, 1,500,000 share purchase warrants were issued effective May10, 2006, entitling the founding officer to purchase common shares ofthe Company at $1.00 per share, vesting based on performance conditionsand expiring on August 12, 2012. As at August 12, 2010 all of thepurchase warrants were vested. As at December 31, 2010 1,400,000 (2009 -1,500,000) founder warrants were outstanding.
In 2006, as part of the terms of a financing agreement, the Companyissued 262,500 brokers warrants, entitling the holders to purchasecommon shares of the Company at $1.00 per share. In 2007, as part of theterms of a financing agreement, the Company issued 840,000 brokerswarrants, entitling the holders to purchase common shares of the Companyat $2.00 per share. As at December 31, 2010, 357,500 (2009 - 1,102,500)broker warrants, expiring May 22, 2011, were outstanding.
During the year, $49 of compensation expense was recognized ($49 - founders warrants, Nil - broker warrants).
8. CONTRIBUTED SURPLUS
2010 2009
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Amount Amount
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Balance - January 1 $ 1,808 $ 1,527
Stock option SBC expense 229 255
Fair value of warrants 49 36
Exercise of stock options (133) (10)
Exercise of warrants (629) -
Issuance of restricted stock 388 -
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Balance - December 31 $ 1,712 $ 1,808
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9. CONTRACTUAL OBLIGATIONS
The Company has operating lease commitments for vehicles and office space as
follows:
Year 2011 2012 2013 2014 2015
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Amount $ 2,197 $ 1,606 $ 911 $ 573 $ 573
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As at December 31, 2010, the Company has commitments totalingapproximately $41 million (2009 - $8 million) relating to theconstruction of fixed assets in 2011 and $86 million (2009 - $3 million)for the purchase of operating supplies over the two year period endingDecember 31, 2012.
10. CAPITAL MANAGEMENT
The Company's strategy is to maintain a capital structure to sustainfuture growth of the business and retain creditor, investor and marketconfidence. Recognizing the cyclical nature of the oilfield servicesindustry, the Company strives to maintain a conservative balance betweenlong-term debt and shareholders' equity. The Company's capitalstructure is currently comprised of shareholders' equity and undrawnlong-term bank debt. The Company may occasionally need to increase itslevel of long-term debt to total capitalization to facilitate growthactivities.
The company has a $15 million operating demand revolving loanfacility and a $35 million committed revolving facility which aresubject to various financial and non financial covenants. The covenantsare monitored on a regular basis and controls are in place to ensure theCompany maintains compliance with these covenants. As at December 31,2010, the Company is in compliance with all the covenants related withthis facility.
The Company monitors its capital structure and makes adjustments inlight of changing market conditions and new opportunities, whileremaining cognizant of the cyclical nature of the oilfield servicessector. To maintain or adjust its capital structure, the Company mayrevise its capital spending, issue new shares, issue new debt, or drawon its current operating line facility.
11. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
The Company's financial instruments recognized on the balance sheetconsist of cash and cash equivalents, short term investments, accountsreceivable, unearned revenue, accounts payable, and accrued liabilities.The following is a summary of the accounting model the Company haselected to apply to each of its significant categories of financialinstruments:
Cash and cash equivalents Held for trading
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Accounts receivable Loans and receivables
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Accounts payable and accrued liabilities Held for trading
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Credit risk
The Company's accounts receivable balances are with customers in theoil and gas industry and are subject to normal industry credit risks.These balances represent the Companies total credit exposure. During theyear, the Company earned revenues from more than forty customers withthree of these customers representing 63% of revenue. The Companyassesses the credit worthiness of all of its customers and none of thesebalances are impaired (2009 - Nil). The Company's trade receivables asat December 31, 2010 are aged as follows:
December 31, December 31,
2010 2009
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Current (0 - 30 days) $ 9,752 $ 2,838
31 - 60 days 11,339 3,590
Over 61 Days 745 2,258
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Total $ 21,836 $ 8,686
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Fair values
The fair value of the Company's financial instruments included onthe consolidated balance sheet approximate their carrying amounts due totheir short term maturity.
The additional disclosures regarding fair value measurements offinancial instruments as required by recent amendments made to Section3862 are presented below. A fair value hierarchy is presented below thatdistinguishes the significance of the inputs used in determining thefair value measurements of various financial instruments. The hierarchycontains the following levels: Level 1 uses inputs based on quotedprices, Level 2 uses observable inputs other than quoted prices andLevel 3 uses inputs that are not based on observable market data.
Estimated Fair Value as at
Carrying Value as at December 31, 2010
December 31,2010 Level 1 Level 2 Level 3
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Cash and cash equivalents $ 98,701 $ - $ 98,701 $ -
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Estimated Fair Value as at
Carrying Value as at December 31, 2009
December 31,2009 Level 1 Level 2 Level 3
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Cash and cash equivalents $ 11,643 $ - $ 11,643 $ -
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Liquidity risk
Liquidity risk is the risk that the Company will not be able to meetits financial obligations as they fall due. The Company has a positivecash position and further manages its liquidity risk by continuouslymonitoring forecasts and actual cash flows and has secured a credit linewith a major Canadian bank (Note 10). Currently, the Company's cash andcash equivalents and the Company's secured line of credit aresufficient to meet its financial obligations.
Market risk
Market risk is the risk that changes in market prices, such asinterest rates or foreign exchange rates will affect the Company'sincome or the value of its financial instruments. The Company does notbelieve that the results of operations or cash flow would be affected toa significant degree by a sudden change in market interest rates. TheCompany does not believe that that the results of operations or cashflow would be affected to a significant degree by a sudden change inforeign exchange rate.
12. SUPPLEMENTAL CASH FLOW INFORMATION
December 31, December 31,
Year Ended 2010 2009
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Changes in non-cash working capital from
Operations:
Accounts receivable $ (15,031) $ (1,319)
Inventory (1,519) (4,702)
Prepaid expenses (6,320) 1,038
Accounts payable and accrued liabilities 5,783 98
Unearned revenue 3,486 -
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Net change in non-cash working capital $ (13,601) $ (4,885)
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13. GEOGRAPHICAL AREAS
During the year, the Company had revenue in the US of $5,623 (2009 - $2,601).
14. RELATED PARTY TRANSACTIONS
During the year, the Company paid $287 (2009 - $334) in consultingfees to two Directors. These transactions were in the normal course ofoperations and have been measured at the exchange amounts.
15. BUSINESS INTERRUPTION CLAIM
In 2010, the Company submitted an insurance claim for repair costsand business interruption loss from a mobilization incident thatoccurred in 2009.
The Company will host a conference call on Friday, March 11, 2011 at10:00 a.m. MT (11:00 a.m. ET) to discuss the Company's 2010 results.
To participate in the Q&A session, please call the conferencecall operator at 1-866-226-1792 fifteen minutes prior to the call'sstart time and ask for "GASFRAC Fourth Quarter Results Conference Call".
A replay of the call will be available until March 19, 2011 bydialing 1-800-408-3053 (North America) or 1-905-694-9451 (outside NorthAmerica). Playback passcode: 7636633.
GASFRAC is an oil and gas service company headquartered in Calgary,Alberta, Canada, whose primary business is to provide LPG fracturingservices to oil and gas companies in Canada and the USA.
Requests for shareholder information should be directed to James M Hill.
Neither TSX Venture Exchange nor its Regulation Services Provider(as that term is defined in policies of the TSX Venture Exchange)accepts responsibility for the adequacy or accuracy of this release.