Garneau Inc. Annual Report 2006



    CALGARY, March 30 /CNW/ - Garneau Inc.'s primary business is the
application of high performance protective coatings and linings for oil and
gas pipeline protection and additionally, the design and manufacturing of
oilfield equipment for both domestic and international markets. During more
than 30 years of operating experience, Garneau Inc. ("Garneau") has developed
significant expertise and innovative technology, and has maintained a
long-term focus on continuously improving the pipe coating process with
cost-effective, quality coatings.

    
    Vision
    ------
           We are a company that uses technology and innovation to provide
           the world with ingenious, high-quality products and services for
           the oil industry.

    Mission
    -------
           We provide our customers, partners and alliances with what they
           need, when they need it ... always.

    Values
    ------
           We value innovation and ingenuity, keeping our commitments to each
           other and our stakeholders, open and honest relationships, and
           conducting our business in a way that is a "win/win" for all who
           work with us.
    

    Garneau Inc. is a public company with approximately 12.0 million shares
issued and outstanding, trading on the Toronto Stock Exchange under the symbol
GAR.

    To the Shareholders:

    INDUSTRY OVERVIEW

    Demand for Garneau's small diameter coating products has historically
been correlated to drilling activity. Oil and gas drilling activity exceeded
23,441 wells for 2006, a 7% increase over 2005. After a strong start to the
drilling season and momentum therefrom, drilling and subsequent coating
activity slowed down during the latter part of the year as commodity prices
declined.
    Industry drilling forecasts project a decrease to a total of 21,000 wells
to be drilled for the 2007 year. This is forecasted to be the first slowdown
in the petroleum industry activity since 2002. Initial first quarter 2007
coating activity is well below the 2006 results as clients utilize previously
coated inventory. A significant drop in gas well drilling is forecasted, while
a 2000 well increase on the crude oil side is projected.
    Domestic manufacturing activity remained active for the entire 2006 year
as high demand for oilfield drilling service and equipment resulted in
projects booked through to January 2007. A softening in new project quoting
requirements occurred during the fourth quarter of 2006 with initial 2007
domestic activity expected to be curtailed based on a slowdown in overall
industry activity.
    International opportunities continue to exist with additional
distribution agreements now in place to assist the Corporation in penetrating
new markets globally.
    Overall, a slowdown is forecasted for the Corporation for the first and
second quarter of 2007, with increased activity in the third and fourth
quarters. This forecast is contingent upon strong, stable commodity prices.

    Plan of Arrangement

    The Corporation announced on April 20, 2006 that it entered into a
definitive arrangement agreement whereby ShawCor Ltd. ("ShawCor") would
acquire all of the outstanding common shares of Garneau.
    The terms of the Plan of Arrangement were amended on May 18, 2006,
May 23, 2006 and June 29, 2006 to permit the Competition Bureau, Canada to
complete their inquiry pertaining to the Plan of Arrangement transaction. The
Competition Bureau, Canada requested an extension of their original request to
August 8, 2006 to consider the proposed acquisition.
    The Corporation announced on October 5, 2006 that the Plan of Arrangement
agreement dated April 19, 2006 with ShawCor had been terminated. As a result,
the proposed acquisition of Garneau shares by ShawCor would not proceed.
    The decision not to proceed was based on the inability of the parties to
resolve outstanding issues with the Competition Bureau and the prospect of
further delays.
    Termination of the ShawCor agreement resulted in Senior Management
refocusing on the long-term Strategic Plan for Garneau. Strategic Planning is
now underway with the future strategic direction of the Corporation expected
to be presented to the Garneau Board of Directors in the second quarter of
2007. Implementation of the Strategic Plan would commence shortly thereafter.

    STRATEGIC DIRECTION

    Notwithstanding the in-depth negotiations of the ShawCor transaction
during 2006 and Senior Management's involvement thereon, Senior Management
continued to focus on operating performance and profitability of the
Corporation with further progress in 2006 pertaining to our Strategic Plan
highlighted as follows.

    
    -  Design and Manufacturing Capability
    Garneau's fabrication and manufacturing capability continued to gain
momentum domestically as oilfield client relationships are cultivated. Client
satisfaction as to the quality of product fabricated and timely delivery are
keys to increasing future market penetration domestically. Further, the
Corporation is also continuing the process of evaluating rig designs to enable
the Manufacturing division to pursue this busy sector of oilfield work.

    -  Innovative Technology and Flexibility
    Garneau's second coating line became operational in January of 2004 and
provides increased capacity during peak operational periods. Flexibility in
scheduling is now also available to manage both large diameter and small
diameter coating projects with the Corporation utilizing both lines at near
capacity periodically in 2006. The $9 million dollar ACCESS project completed
in 2006 is considered to be a major stepping stone for Garneau in securing
future large diameter pipe coating project work.

    -  CCSI Joint Venture
    The Corporation signed a joint venture agreement in the third quarter of
2005 to develop cold weather joint coating applications and equipment for
future large diameter projects in the north. Initial trials and work on this
joint venture commenced in January 2006. However, this was put on hold during
the ShawCor transaction negotiations. Research and development for this Joint
Venture is scheduled to recommence in 2007.
    

    INTERNAL CONTROLS

    Senior Management commenced a review of the Corporation's internal
controls in the fourth quarter of 2006.
    Initial changes to the Corporation's internal controls and policy manual
have now been completed and implemented. However, the full review and
evaluation of internal controls over financial reporting is in progress but is
not expected to be finalized until the end of the second quarter of 2007.
Further evaluation and assessment of the Corporation's internal controls over
financial reporting will continue to be ongoing by Senior Management.

    OUTLOOK 2007

    Analysts are projecting 21,000 wells to be drilled in 2007, a 10%
decrease over 2006 actual results of 23,441 wells. This projected decrease
will result in a decrease in small diameter coating requirements which will
have a negative impact on our 2007 coating operations. This decrease in
drilling is compounded by clients reducing their inventory holdings of coated
pipe in stock.
    2006 was a very busy and difficult year for the employees of the
Corporation, as the uncertainty surrounding the ShawCor transaction put a
strain on our employee group morale during the most active year on record. I
would like to personally thank our dedicated employees for assisting the
Corporation through this difficult period and look forward to your continued
contribution toward future corporate objectives. The uncertainty regarding the
transaction also provided a strain on client relations this past summer and we
at Garneau would like to stress to our clients that we will do everything in
our power to restore and improve the level of service that you have been
accustomed to.
    Also, we announced in mid-November of 2006 that Mr. Chris Garneau,
formerly Vice President of Manufacturing, was retiring from the Corporation
after twenty nine years of service. I would personally like to thank Chris for
his contribution to Garneau over his tenure with the Corporation.
    The termination of the ShawCor agreement has resulted in the Corporation
getting back to business with a refreshed aggressive attitude which is
expected to be incorporated into our future strategic initiatives. This is
partially reflected in our $5 million Camrose plant capital program announced
in the fourth quarter of 2006. This capital program will include significant
improvements to both Camrose coating lines to help improve efficiencies and
increase capacity, together with an overhaul of yard equipment and further
land improvements to help improve yard efficiency. The Capital program
commenced during the fourth quarter and will be implemented in phases over an
eighteen month period.
    Operationally, 2006 was a record revenue year for Garneau, as both
divisions were very active throughout the most part of 2006. Revenue exceeded
$57 million and the Corporation was also successful in recording net earnings
of $947 thousand for the year, after absorbing transaction, retirement and
other non-operational costs totaling $1.8 million. This achievement in a year
surrounded by so much uncertainty is a testament to the dedication of the
Garneau employees which will lead the Corporation into the future.
    Industry activity slowed down significantly in the fourth quarter of
2006; however, we consider this slowdown to represent a temporary market
correction which will affect Garneau performance for the initial 6 months of
2007. Activity is projected to be restored in the industry in latter 2007,
contingent on no further deterioration of oil and gas commodity prices.
    Although international marketing and promotion activity was curtailed in
2006, international equipment projects continue to be bid upon. The
Corporation was successful in obtaining 1 major coating equipment contract in
2006 which is expected to be fully installed and commissioned during the first
quarter of 2007. Garneau's reputation in designing and manufacturing coating
equipment continues to grow and has led to the most recent awarding of a
$1.0 million project from ShawCor for installation in their new Camrose plant.
    We look forward to the completion of our revised Strategic Plan for the
Corporation which we envision to aggressively pursue future growth and value
for our Shareholders.

    Sincerely,


    (signed)


    Glen R. Garneau
    President and CEO
    Garneau Inc.


    A PIPE COATING PERSPECTIVE

    Garneau's Camrose facility overall operating usage increased during 2006,
a direct result of an increase in small diameter coating activity together
with the production on the ACCESS project during the year.
    Multiple shifts on both coating lines in Camrose were operating during
the first half of 2006 with a slowdown of activity experienced during the
third quarter of 2006, reducing production to 2 shifts for the remainder of
2006.
    Demand on yard operations, equipment requirements and staffing also
increased substantially in 2006 with the production of the ACCESS project. 
Additional space has been secured to store our customers' aged coated product
to free up valuable storage close to the plant for production of new coating
orders.
    Garneau's High Density Polyethylene Pipe production was put on hold in
2006 as a result of the ShawCor transaction negotiations and management's
focus on the ACCESS project. Garneau's strategy going forward for HDPE is
being re-evaluated as part of Strategic Planning sessions now underway.

    A MANUFACTURING PERSPECTIVE

    Manufacturing activity for the entire year was extremely busy with
multiple shifts worked throughout 2006. The Corporation was successful in
attaining a new $3.5 million coating plant order for a southern United States
corporation which commenced during the third quarter and has recently been
shipped for installation.
    The international exposure gained from large international contracts of
this nature continues to enhance Garneau's future image as a fully integrated
coating operation providing expertise in the following areas:

    
    -  Coating plant engineering and design
    -  Coating plant fabrication and installation
    -  Coating plant operational capability
    

    Garneau's over 30 year international history and technological
advancement in coating plant and pipeline equipment design remains an
attractive selling tool for the Corporation worldwide and continued coating
plant sales opportunities are projected for the Corporation in 2007.
    The flexibility of our engineering and design department remain intact
and poised to facilitate additions to our existing line of equipment products.
    Furthermore, the continued diversification of domestic manufacturing
products is projected to contribute to the long-term growth of the
Corporation's manufacturing division.
    A slowdown in manufacturing project activity is currently being
experienced by Garneau during the first quarter of 2007 as industry activity
has tailed off in recent months. We are aggressively pursuing new projects to
help offset the impact of this market slowdown.
    The labor shortage experienced during 2006 resulted in the Corporation
initiating recruitment programs overseas to satisfy labor requirements.  
Foreign workers are now on stream and the program is now fully operational at
Garneau. The slowdown in recent activity is projected by our clients to be
temporary, with the long-term foreign worker program expected to contribute to
future expansion of manufacturing operations.

    MANAGEMENT DISCUSSION AND ANALYSIS
    -------------------------------------------------------------------------
    RESULT OF OPERATIONS

    This report includes forward-looking statements that are based on the
Corporation's current expectations and therefore are subject to uncertainties
such as the level of industry drilling and coating activity, foreign exchange
fluctuations and worldwide economic conditions that may cause actual results
to differ materially.

    Revenues
    --------

    Consolidated revenues for the fourth quarter ended December 31, 2006
totaled $14.1 million, $2.4 million less than the comparative 2005 fourth
quarter total revenues of $16.5 million, primarily as a result of decreased
Camrose coating activity experienced in the fourth quarter of 2006. Total
consolidated revenues increased by 17.8% for the year ended December 31, 2006;
totaling $57.0 million compared to $48.4 million for the year ended
December 31, 2005. An increase in coating activity, increased domestic
manufacturing orders and the work completed on the $3.5 million international
order all contributed to the increased revenue recorded in 2006.
    Pipeline revenue totaled $8.5 million for the fourth quarter ended
December 31, 2006. This represents a $3.8 million decrease over the
$12.3 million recorded for the fourth quarter of 2005 and is attributed to
decreased small diameter coating requirements together with completion of the
ACCESS project in the third quarter of 2006. Decreased drilling activity
during the fourth quarter of 2006 together with a reduction of finished
inventory of pipe contributed to the reduction in the fourth quarter. Pipeline
revenue totaled $38.3 million for the year ended December 31, 2006 and
represents a 21.2% increase over the $31.6 million in pipeline revenue
recorded for the year ended December 31, 2005. The increase in pipeline
revenue is attributed to increased small diameter coating volume, together
with production on the ACCESS coating project throughout the first three
quarters of 2006.
    Manufacturing revenue for the fourth quarter ended December 31, 2006
totaled $5.6 million, compared to the $4.2 million recorded for the fourth
quarter of 2005. This $1.4 million increase is primarily attributed to the
$3.5 million international project in progress at year end 2006 together with
domestic activity remaining active throughout the fourth quarter.
Manufacturing revenues totaled $18.8 million for the year ended December 31,
2006, an 11.8% increase over the $16.8 million recorded for the year ended
December 31, 2005. Increased domestic manufacturing activity throughout the
2006 year, together with the work-in-progress on the $3.5 million
international contract, contributed to the increase in manufacturing revenue.

    Gross Margin
    ------------

    The Corporation's gross margin, as determined by deducting operating
costs which consists of all raw material, labor and plant overhead expenses
from revenue, for the fourth quarter ended December 31, 2006 totaled
$2.8 million compared to the $3.1 million recorded for the fourth quarter
ended December 31, 2005. This decrease of $0.3 million is attributed to
decreased coating revenues and margins recorded during the fourth quarter. The
Corporation's gross margin totaled $10.8 million (19.0%) for the year ended
December 31, 2006 compared to $8.8 million (18.2%) for the year ended
December 31, 2005. Increased manufacturing volumes and an increase in coating
orders contributed to the increased overall gross margin of $2.0 million.
    The pipeline division gross margin totaled $1.5 million (17.5%) for the
fourth quarter ended December 31, 2006, a $0.5 million decrease from the
$2.0 million (16.3%) recorded for the comparative quarter. This decrease is
attributed to decreased coating volumes recorded in the fourth quarter of
2006. The pipeline gross margin total of $6.1 million (15.9%) increased by
$1.7 million from $4.4 million (13.9%) recorded for the year ended
December 31, 2005, with the percentage increase reflecting increased coating
volumes and price increases instituted during 2006.
    The manufacturing division gross margin totaled $1.3 million (22.8%) for
the fourth quarter ended December 31, 2006, a $0.2 million increase over the
$1.1 million (26.7%) gross margin recorded for the comparative period. This
increase is primarily attributed to increased revenue generated during the
quarter. The manufacturing division gross margin of $4.7 million (25.3%) is
$0.3 million higher than the $4.4 million gross margin recorded for the year
ended December 31, 2005. The 25.3% in gross margin is lower than the 26.4%
recorded for the year ended December 31, 2005 and is attributed to some cost
overruns on new products built on domestic and international orders completed
in 2006.

    Expenses
    --------

    Selling, general and administrative expenses for the fourth quarter ended
December 31, 2006 totaled $2.4 million, a $1.0 million increase over the
$1.4 million recorded for the comparative quarter. Increased expenses are
attributed primarily to retirement allowances of $490 thousand and corporate
bonuses of $352 thousand paid to employees of Garneau. Selling, general, and
administrative expenses totaled $5.9 million (10.4% of revenue) for the year
ended December 31, 2006, as compared to the $4.4 million (9.2% of revenue) for
2005. Upward pressure on wages in the very active Alberta labor market
together with increased commissions on higher revenue and extraordinary costs
including the encashment of senior management stock options totaling
$258 thousand, a $490 thousand retirement allowance paid to a senior officer
and bonuses of $352 thousand paid to employees of the Corporation contributed
to the increase.
    The Corporation calculates amortization of its property, plant and
equipment based a straight-line basis. Total amortization of $536 thousand was
recorded for the fourth quarter ended December 31, 2006 with amortization
totaling $2.0 million for the year ended December 31, 2006, representing 3.5%
of revenue compared to $1.9 million for the year ended December 31, 2005
representing 3.9% of revenue. Increased amortization costs for the 2006 year
is primarily attributed to the increased capital expenditures totaling
$2.5 million incurred for the 2006 year.
    The Corporation's research and development department activities
decreased in 2006 as several new research and development projects initiated
in 2005 by the Corporation were put on hold during the ShawCor transaction
negotiations (see Plan of Arrangement below). Research and development
expenses totaled $96 thousand for the year ended December 31, 2006; a
$196 thousand decrease from the $292 thousand recorded for the comparative
period ended December 31, 2005.
    Manufacturing expenses totaled $1.1 million for the fourth quarter ended
December 31, 2006, as compared to expenses totaling $0.6 million for the
comparative period. The increase in expenses is primarily attributed to the
$490 thousand retirement allowance paid to the former Vice President of
Manufacturing. Manufacturing expenses totaled $2.8 million for the year ended
December 31, 2006, an increase of $0.6 million over the $2.2 million recorded
for the period ended December 31, 2005. The manufacturing division's overhead
costs increased primarily due to the $490 thousand retirement allowance and
upward pressure on wages and support services being increased to accommodate
increased activity.
    The pipeline division expenses totaled $1.8 million for the fourth
quarter ended December 31, 2006 compared to $1.1 million for the comparative
period with the increase of $0.7 million pertaining primarily to corporate
bonuses paid based on corporate financial performance together with increased
professional fees and upward pressure on wages incurred during the 2006 year.
The pipeline division expenses totaled $6.6 million for the year ended
December 31, 2006, an increase of $1.7 million over the $4.9 million for the
year ended December 31, 2005. The increase in pipeline divisional expenses is
due to ShawCor transaction costs, corporate bonuses paid, stock options
encashed and increased amortization expenses for Camrose property, plant and
equipment.
    Other income totaled $0.3 million for the fourth quarter ended
December 31, 2006 and consists primarily of various miscellaneous sources of
income. Other expenses totaled $0.8 million for the year ended December 31,
2006, an increase of $0.9 million from the comparative year end and include
transaction costs totaling $1.1 million, which pertain directly to
professional fees, severance payments, bonuses and other transaction costs
relating to the terminated Plan of Arrangement. These other expenses were
partially offset by various miscellaneous sources of income and a WCB refund
received in 2006.
    Interest costs totaled $612 thousand for the year ended December 31,
2006, an increase of $112 thousand over the $500 thousand recorded for the
year ended December 31, 2005. An increase in operating loans outstanding
during the year and increased receivables and unbilled revenue carrying costs
primarily from the ACCESS and International project accounted for the
increased interest expense.

    A Reduction of Future Income Taxes
    ----------------------------------

    A reduction of future income tax expense of $127 thousand arose in the
fourth quarter primarily as a result of the utilization of non-capital losses.
The generation of taxable income in 2006 has resulted in the utilization of
non-capital losses from prior periods. Future income tax expense for the year
ended December 31, 2006 totaled $478 thousand as compared to the $128 thousand
in 2005.

    Earnings
    --------

    Net earnings for the fourth quarter ended December 31, 2006 totaled
$37 thousand as compared to the $1.0 million net earnings recorded in the
comparative period, a result of decreased margins and increased expenses
incurred during the fourth quarter of 2006. Net earnings of $0.9 million were
recorded for the year ended December 31, 2006 compared to net earnings of
$1.6 million recorded for the year ended December 31, 2005. This $0.7 million
decrease is partially attributed to increased future income taxes recorded
during 2006. Net earnings were negatively affected by the transaction costs,
retirement allowance and options encashed totaling $1.8 million during 2006.
    Manufacturing division earnings of $0.2 million were recorded for the
fourth quarter ended December 31, 2006, a $0.4 million decrease from the
$0.6 million recorded for the fourth quarter of 2005. The decrease is
attributed to the retirement allowance of $490 thousand paid to a senior
officer. Manufacturing division earnings for the year ended December 31, 2006
totaled $2.0 million, compared to the $2.3 million recorded at December 31,
2005 and is directly attributed to the improved margins and revenue generated
during 2006, offset by the retirement allowance.
    Pipeline divisional losses totaled $0.3 million for the fourth quarter
ended December 31, 2006, compared to the $0.6 million net earnings recorded
for the comparative period and is primarily attributed to the decreased small
diameter coating volumes and completion of the ACCESS large diameter project
in the third quarter. Pipeline divisional losses for the year ended
December 31, 2006 totaled $0.6 million that reflect an increase of $0.1
million from the year ended December 31, 2005 losses of $0.5 million.
Increased activity and final production on the ACCESS project contributed to
improved divisional performance, albeit, the ShawCor transaction costs of $1.1
million together with $0.3 million in options encashed by senior management
resulted in the loss of $0.6 million for the year ended December 31, 2006.
Adjusted normalized earnings, adding the transaction costs and option
encashment costs back into operations would result in division profitability
of $0.8 million for the year 2006.

    Liquidity and Capital Resources
    -------------------------------

    Accounts receivable totaled $14.3 million at December 31, 2006, an
increase of $1.4 million over the $12.9 million recorded at December 31, 2005
and is attributed to receivables carried on domestic coating revenue and
domestic manufacturing revenues increasing from large projects completed at
year end. Unbilled revenue totaled $1.2 million at December 31, 2006, a
decrease of $0.5 million over the $1.7 million recorded at December 31, 2005
and pertains to decreased work-in-progress on manufacturing projects at
December 31, 2006.
    At December 31, 2006, operating and demand loan credit facilities
available to the Corporation included a demand revolving operating line of
credit of $6.3 million, a demand revolving evergreen loan of $3.0 million, and
a capital lease loan facility for $0.6 million pertaining to the manufacture
of polyethylene pipe and forklift acquisitions and demand loans in the amount
of $4.9 million.
    The Corporation has a $6.3 million operating line of credit available for
operating uses, of which $5.2 million was utilized and of which $1.1 million
was available and unused at December 31, 2006. Loans payable include the
evergreen term loan which was not fully drawn upon at December 31, 2006, and
has $0.2 million available to finance 100% of anticipated future capital
expenditures, consistent with $0.1 million available at December 31, 2005. A
further $2 million increase in the evergreen term loan facility limit was
approved by the Corporation's bank in January 2007 to assist with financing
future capital expenditures. This increased facility has not been drawn on to
date. Total capital leases outstanding at December 31, 2006 total
$584 thousand. A capital lease in the amount of $176 thousand was entered into
in January of 2007 to acquire one forklift to accommodate continued yard
activity for the Camrose plant. Loans payable also include demand bank loans
outstanding at December 31, 2006 totaling $4.9 million which were used for
purchase of the Nisku building and other long-term asset financing
requirements.
    Loans payable at December 31, 2006 total $4.9 million. The bank's working
capital covenants have been adjusted to remove principal payments scheduled
after 12 months from the working capital covenant calculation. Working capital
of $0.5 million is recorded at December 31, 2006. The adjusted working
capital, calculated by deducting $3.4 million of loans payable scheduled to be
repaid after 12 months, totals $3.9 million, an increase of $0.3 million from
the previous year ended December 31, 2005.
    Loans payable and capital lease obligations at December 31, 2006 totaled
$5.5 million, a decrease of $1.2 million from the $6.7 million recorded at
December 31, 2005. This decrease is attributed to the principal payments made
on demand loans during the course of the year. The Corporation continues to
draw on available term debt credit facilities to finance capital asset
purchases with repayment in accordance with existing bank agreements. All bank
covenants were met at December 31, 2006.
    Additions to capital equipment were $814 thousand in the fourth quarter
ended December 31, 2006 compared to $843 thousand in the comparative period
and consist primarily of new forklifts acquired for Camrose coating and Nisku
operations. Additions to property, plant and equipment were $2.6 million for
the year ended December 31, 2006, compared to $2.0 million for the year ended
December 31, 2005. Capital expenditures for 2006 were primarily related to
increased manufacturing operations equipment costs, additional fabrication,
mobile and coating equipment improvements required to accommodate increased
activity and production of the ACCESS project during the year ended
December 31, 2006. New accounting software and implementation was also
completed during the 2006 year, contributing to increased capital
expenditures.
    Cash generated from operations prior to changes in working capital, for
the fourth quarter ended December 31, 2006 totaled $0.4 million. Cash
generated from operations, prior to changes in working capital, was
$3.4 million for the year ended December 31, 2006, a decrease of $0.3 million
over the $3.7 million generated in the year ended December 31, 2005. The
decrease reflects a decrease in cash generated from operations from reduced
net earnings during the 2006 year.

    
    Selected Annual Information
    ---------------------------

    (In thousands, except per share data)
    -------------------------------------------------------------------------
    Year Ended           December 31/06     December 31/05    December 31/04
    -------------------------------------------------------------------------
    Total Revenues              $57,042            $48,365           $32,607
    -------------------------------------------------------------------------
    Net Earnings (Loss)             947              1,621              (408)
    -------------------------------------------------------------------------
    Basic Earnings
     (Loss) per Share              0.08               0.14             (0.04)
    -------------------------------------------------------------------------
    Diluted Earnings
     (Loss) per Share              0.08               0.14             (0.04)
    -------------------------------------------------------------------------
    Total Assets                 39,571             38,141            31,427
    -------------------------------------------------------------------------
    Long Term Capital
     Lease Obligations              241                535               489
    -------------------------------------------------------------------------
    

    The increase in manufacturing activity and coating activity resulted in
an improvement in net earnings being recorded for the December 31, 2006 year
end prior to allowing for transaction costs of $1.1 million recorded during
2006. The increased revenue generated also resulted in increased accounts
receivables outstanding during the course of 2006 which were funded by
increased payables and working capital generated from earnings.

    
    Selected Quarterly Information
    ------------------------------

    (In thousands, except per share data)
    -------------------------------------------------------------------------
                                                   2006
    -------------------------------------------------------------------------
    Three months             December    September         June        March
     ended                      31/06        30/06        30/06        31/06
    -------------------------------------------------------------------------
    Total Revenues            $14,134      $11,078      $13,020      $18,810
    -------------------------------------------------------------------------
    Net Earnings (Loss)            37           53         (273)       1,130
    -------------------------------------------------------------------------
    Basic Earnings (Loss)
     per Share                   0.00         0.00        (0.02)        0.10
    -------------------------------------------------------------------------
    Diluted Earnings (Loss)
     per Share                   0.00         0.00        (0.02)        0.09
    -------------------------------------------------------------------------
    Total Assets               39,571       34,709       38,424       38,635
    -------------------------------------------------------------------------
    Long Term Capital
     Lease Obligations            241          353          414          475
    -------------------------------------------------------------------------


    (In thousands, except per share data)
    -------------------------------------------------------------------------
                                                   2005
    -------------------------------------------------------------------------
    Three months             December    September         June        March
     ended                      31/05        30/05        30/05        31/05
    -------------------------------------------------------------------------
    Total Revenues            $16,472      $11,456       $7,953      $12,484
    -------------------------------------------------------------------------
    Net Earnings (Loss)           993          511         (990)       1,107
    -------------------------------------------------------------------------
    Basic Earnings (Loss)
     per Share                   0.08         0.05        (0.09)        0.10
    -------------------------------------------------------------------------
    Diluted Earnings (Loss)
     per Share                   0.08         0.05        (0.09)        0.09
    -------------------------------------------------------------------------
    Total Assets               38,141       33,499       30,372       35,696
    -------------------------------------------------------------------------
    Long Term Capital
     Lease Obligations            535          660          372          431
    -------------------------------------------------------------------------
    

    The seasonality of the pipe coating business and project nature of
international contracts results in wide quarterly fluctuations in revenue
generated by the Corporation and net earnings (loss) there from. The second
quarter ended June 30 is historically the slowest period for the Corporation
with the quarter ended March 31 the most active. The ACCESS coating project
continued in progress during the second quarter of 2006 and contributed to
improved second quarter performance. Quarterly net earnings (loss) reported
were negatively affected by transaction costs incurred totaling $1.1 million
for the year ended December 31, 2006. Fourth quarter earnings for the period
ended December 31, 2006 were also negatively affected by the retirement
allowance and corporate bonuses previously discussed. Manufacturing activity
remained active throughout 2006.

    New Accounting Policies
    -----------------------

    In January 2005, the Canadian Institute of Chartered Accountants ("CICA")
issued Handbook Section 3855, "Financial Instruments-Recognition and
Measurement", Handbook Section 1530, "Comprehensive Income", and Handbook
Section 3865, "Hedges." In 2006, the CICA issued Handbook Section 1506,
"Accounting Changes". These standards will apply to the Corporation effective
January 1, 2007. In December 2006, the CICA issued Handbook Section 1535,
"Capital Disclosures", Handbook Section 3862, "Financial
Instruments-Disclosures", Handbook Section 3863, "Financial
Instruments-Presentation". These new standards will apply to the Corporation
effective January 1, 2008. The Corporation is currently assessing the impact
of these new standards.

    Internal Controls over Financial Reporting
    ------------------------------------------

    The Corporation has historically operated with an implemented system of
internal controls over financial reporting that it believes adequately
protects the assets of the Corporation and is appropriate for the nature of
its business and the size of its operations. These internal controls include
disclosure controls and procedures designed to ensure that information
required to be disclosed by the Corporation is accumulated and communicated to
our management as appropriate to allow timely decisions regarding required
disclosure.
    It should be noted that while the Corporation's Chief Executive Officer
and Chief Financial Officer believe that the Corporation's disclosure controls
and procedures historically in place, provide a reasonable level of assurance
that the system of internal controls are sufficient, they do not guarantee
that the disclosure controls and procedures, will prevent all errors and
fraud. A control system, no matter how well conceived or operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met.
    The Chief Executive Officer and Chief Financial Officer of the
Corporation are responsible for designing internal controls over financial
reporting or causing them to be designed under their supervision in order to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in
accordance with Canadian generally accepted accounting principles.
    Management of the Corporation commenced an evaluation of these existing
internal controls over financial reporting. This evaluation was not fully
completed at December 31, 2006.
    The Corporation's Chief Executive Officer and Chief Financial Officer
have concluded based on their evaluation that, partially due to the limited
number of staff and resources at Garneau, inherent weaknesses in areas of
internal controls over financial reporting are present, including segregation
of duties, lack of financial expertise at certain levels in the finance
functions, documented review of financial reporting entries and
reconciliations, controlled use of spreadsheets, information technology
safeguards, risk assessment processes, physical controls, documentation
controls and controls at the entity level. The Corporation does not have fully
disciplined and developed processes and procedures in place to support
accounting estimates and documented accounting policies and procedures in
accordance with generally accepted accounting principles. As a result of these
weaknesses there is no guarantee that a material misstatement would not be
prevented or detected.
    The evaluation of existing internal controls over financial reporting is
continuing with a view to identifying control weaknesses. Implementation of
strengthened financial reporting controls will occur during 2007, where
required.

    Disclosure, Confidentiality and Trading Policy
    ----------------------------------------------

    The Corporation has formal disclosure controls and procedures in place
which promotes an understanding of the legal requirements among the
Corporation's directors, officers and employees as it pertains to the timely,
factual and accurate communications with the public for Garneau Inc., together
with compliance of trading requirements of Corporation securities and
confidentiality of non public disclosed information. The effectiveness of the
Corporation's disclosure controls and procedures at December 31, 2006 have
been evaluated by senior management and are in compliance with reporting
requirements at December 31, 2006. Furthermore, these disclosure controls and
procedures are in the process of being enhanced further in 2007.

    Critical Accounting Estimates
    -----------------------------

    The Corporation recognizes revenues related to equipment fabrication
contracts based on the percentage-of-completion of the individual contracts.
At December 31, 2006, significant fabrication contracts in progress include
domestic orders for oilfield tanks, buildings and catwalks totaling
$3.1 million. The international coating equipment contract in progress at
December 31, 2006 totaled $3.2 million. Revenues from contracts are determined
on the percentage-of-completion method, based on the ratio of costs incurred
to date over estimated total costs. The Corporation has a process whereby
progress on jobs is reviewed by management on a regular basis and estimated
costs to complete are updated. However, due to unforeseen changes in the
nature or cost of the work to be completed or performance issues, contract
profit can differ from earlier estimates.
    The Corporation provides an estimate for amortization of assets based on
the expected useful life of assets with coating and extrusion equipment
calculated based on a straight-line method.
    The Corporation evaluates the probability of collection of accounts
receivable and records an allowance for doubtful accounts, which reduces the
receivables to the amount management reasonably believes will be collected. In
determining the amount of allowance, the following factors are considered: the
length of time the receivable has been outstanding, specific knowledge of each
customer's financial condition and historical experience.
    The Corporation also provides estimates pertaining to the valuation of
long-lived assets, valuation of inventory, valuation of future income taxes
and other estimates provided in the normal course of business operations.

    Outstanding Shares Data
    -----------------------

    Outstanding options issued by the Corporation totaled 927,175, at
December 31, 2005. During 2006, 706,500 options were granted at $1.48;
26,850 options were cancelled at a weighted average price of $0.96; and
486,275 options were exercised at a weighted average price of $0.62. Options
totaling 200,000 were encashed at a weighted average price of $0.90. Options
outstanding at December 31, 2006 totaled 920,550 (214,050 vested) with a
weighted average exercise price of $1.31.
    Outstanding common shares of the Corporation at December 31, 2005 totaled
11,562,252. Options totaling 486,275 were exercised for $301 thousand during
the course of 2006 with outstanding common shares totaling 12,048,527 at
December 31, 2006. No options have been exercised to March 30, 2007 with
outstanding common shares totaling 12,048,527 at March 30, 2007.

    Disclosure of Contractual Obligations
    -------------------------------------

    The following schedule represents scheduled obligation payments required
    to be made by the Corporation.

    
    -------------------------------------------------------------------------
                                                                    2011 and
                                2007      2008      2009      2010    beyond
    -------------------------------------------------------------------------
    Loans Payable             $1,556    $1,087      $696      $540    $1,039
    -------------------------------------------------------------------------
    Capital Lease Obligations    368       132       121         -         -
    -------------------------------------------------------------------------
    Operating Leases             283       189       139        53        52
    -------------------------------------------------------------------------
    

    Please refer to notes 4(a) and (b) and note 6 of the consolidated
    financial statements for further details.

    Contingencies
    -------------

    During the year ended December 31, 2006, the Company was named defendant
in a lawsuit and has received claims in the aggregate amount of $1.5 million.
In the opinion of management, this matter is without substantial merit and no
provisions have been made for this claim in the accounts.

    Plan of Arrangement
    -------------------

    The Corporation announced on October 5, 2006 that the Plan of Arrangement
agreement dated April 19, 2006 with ShawCor Ltd. ("ShawCor") was terminated.
As a result, the proposed acquisition of Garneau Inc. shares by ShawCor did
not proceed.
    The decision not to proceed was based on the inability of the parties to
resolve outstanding issues raised by the Competition Bureau, Canada and the
prospect of further delays.
    Other expenses include costs pertaining to this terminated ShawCor
transaction totaling $1.1 million for the year ended December 31, 2006.

    BUSINESS RISKS

    Capital spending by pipeline transmission and oil and gas companies
drives the demand for Garneau Inc.'s coating products and domestic
manufacturing products. The Corporation's continued success is fundamentally
linked to the continued growth and stability of the energy industry, both
domestically and internationally. In addition, Garneau Inc.'s future success
depends upon the continued expansion of equipment fabrication, increasing its
market share of pipe coating services in Canada and further diversification.
Other uncertainties in the industry include domestic and foreign government
policies and regulations, foreign exchange rates, and world energy prices.
    The robust Alberta economy has resulted in a shortage of trades people
and general labor in both Nisku and Camrose during 2006. Managing human
resource requirements will present a challenge for the Corporation in this
market place.
    The Corporation's revenue is generated substantially from a core group of
13 oil industry clients. A concentration of credit risk exists with accounts
receivable outstanding at December 31, 2006 from this core group of clients,
which account for 89 % of total accounts receivable.
    Issued Letters of Credit outstanding at December 2006 totaled
$142 thousand ($122 thousand USD).
    The Corporation has one major local competitor in the pipeline business
segment that has significant market share and influence over product pricing
which could impact future corporate performance. Small diameter coating
activity for the Corporation is directly dependant on drilling activity in the
industry which has historically shown significant fluctuations from year to
year.
    International business is dependant on the Corporation's ability to
secure large project work internationally, which has inherent risks associated
with the fluctuation of foreign exchange rates, together with economic and
political risks of certain foreign countries. The Corporation will consider
hedging and other strategies designed to mitigate the impact of foreign
exchange fluctuation on future contracts obtained.

    OUTLOOK

    Garneau had a record year in 2006 with revenue exceeding $57 million.
Results in 2006 were positively impacted by the completion of the Access
project together with an increase in manufacturing activity experienced
throughout the year. Small diameter coating price increases were implemented
in January 2006 to help offset increased material and operating costs and
partially restore coating margins.
    The Corporation remains active internationally in pursuing pipe handling
and coating equipment orders, although the competitiveness of future bids may
be affected by the Canadian dollar and further foreign exchange rate
fluctuations. Garneau received a $3.5 million order for coating plant
equipment in July 2006 to be shipped and commissioned in the United States.
This order was near completion by year end with shipment and commissioning in
progress in January of 2007. A further equipment order from ShawCor in excess
of $1 million has been received for completion in the second quarter of 2007.
    Although 2006 drilling activity exceeded 23,400 wells, a softening of
commodity prices and activity was experienced in the third and fourth quarters
which resulted in decreased coating activity. This noticeable correction has
continued into the first quarter of 2007 with both coating and manufacturing
activity being curtailed significantly. Load out activity has continued in
excess of incoming bare pipe in the first quarter of 2007, reducing client
coated inventory in stock. Although our clients project this curtailed
activity to represent a short term market correction, steps are being taken by
management to reduce infrastructure costs accordingly.
    The second small diameter coating line in Camrose operated near capacity
throughout the first quarter of 2006 with continued usage during 2006. This
second line enables the Corporation to increase coating capacity in the busy
winter season together with the capability of handling future potential large
diameter projects like ACCESS simultaneously with day to day small diameter
coating demands from our existing clients. The Corporation is now able to
participate in a broader range of oil and natural gas projects in both small
and large diameter pipe. The doubling of the Corporation's coating capacity at
the Camrose plant, combined with the expansion of services into the large
diameter market, solidifies management's belief that the Corporation is well
positioned to increase its domestic market share over the long-term. The
successful completion of the ACCESS project will assist the corporation in
future large diameter marketing efforts.
    Management is of the opinion that achieving controlled growth will result
in sufficient working capital being generated from operations. This working
capital, together with external financing, is projected to meet the
Corporation's liabilities and commitments as they become payable. Future
operations will remain dependant on the Corporation's ability to generate
sustainable profits.
    The CCSI joint venture agreement was signed in the fall of 2005 and
initial trials began in January of 2006. Activity was suspended during ShawCor
negotiations in 2006; however, the venture is working towards bringing cold
weather application to the coating process and will resume activity in 2007.
If proven successful, this could lead to new revenue streams for the
Corporation on future large diameter projects.
    Garneau will continue to invest in research and development, while
actively pursuing potential new markets and focusing on profitable growth by
offering specialty products and services to complement our core coating and
manufacturing operation.
    Implementing a new strategic plan with new strategic initiatives during
fiscal 2007 will be a primary focus of the Corporation, in addition to
management controlling infrastructure costs, during this market slowdown.

    Edmonton, Canada
    March 30, 2007

    MANAGEMENT'S RESPONSIBILITY TO THE SHAREHOLDERS

    The accompanying consolidated financial statements and other financial
information included in Garneau Inc.'s Annual Report are the responsibility of
the management of Garneau Inc. and have been approved by the Board of
Directors. The financial statements have been approved by management, and are
prepared in conformity with Canadian generally accepted accounting principles.
The financial statements include estimates based on the experience and
judgment of management in order to ensure that the financial statements are
presented fairly in all material respects. Financial information presented
elsewhere in this Annual Report is consistent with that in the financial
statements.
    The management of the Corporation is responsible for the development and
maintenance of systems of internal accounting controls and management
practices designed to provide reasonable assurance that the financial
information is relevant, reliable and accurate. In addition, management is
responsible for programs of proper business conduct and risk management to
protect the Corporation's assets and operations and to give reasonable
assurance that transactions are properly authorized, assets are guarded from
loss or misuse and financial records are maintained to provide reliable
financial information for preparation of financial statements.
    The Board of Directors is responsible for ensuring that management
fulfils its responsibilities for financial reporting and internal control,
with the assistance of the Audit Committee. The Board appoints the Audit
Committee, whose members are Directors that are not corporate officers. This
committee meets periodically with management and the Corporation's external
auditors to discuss audit examinations, internal control, accounting policy
and financial reporting matters.
    The Audit Committee also reviews with management the annual and quarterly
consolidated financial statements of the Corporation prior to submission to
the Board of Directors for final approval. The external auditors have full and
unrestricted access to the Audit Committee. The Audit Committee recommends a
firm of external auditors, to be appointed by the shareholders. KPMG LLP has
been appointed the external auditors of the Company to provide an independent
audit opinion on the annual consolidated financial statements. The Auditors'
Report to the shareholders is also presented in this Annual Report.

    
    Sincerely,

    (signed)                                      (signed)

    Glen R. Garneau                               Frank Deys
    President, CEO                                Chief Financial Officer
    

    Edmonton, Canada
    March 30, 2007

    AUDITORS' REPORT TO THE SHAREHOLDERS OF GARNEAU INC.

    We have audited the consolidated balance sheets of Garneau Inc. as at
December 31, 2006 and 2005 and the consolidated statements of operations and
deficit and cash flows for the years then ended. These financial statements
are the responsibility of the Corporation's management. Our responsibility is
to express an opinion on these financial statements based on our audits.
    We conducted our audits in accordance with Canadian generally accepted
auditing standards. Those standards require that we plan and perform an audit
to obtain reasonable assurance whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation.
    In our opinion, these consolidated financial statements present fairly,
in all material respects, the financial position of the Corporation as at
December 31, 2006 and 2005 and the results of its operations and its cash
flows for the years then ended in accordance with Canadian generally accepted
accounting principles.

    (signed)

    KPMG LLP
    Chartered Accountants

    Edmonton, Canada
    March 30, 2007

    
    CONSOLIDATED BALANCE SHEETS

    -------------------------------------------------------------------------
    (In thousands)                                         at             at
                                                  December 31,   December 31,
                                                         2006           2005
    -------------------------------------------------------------------------

    Assets

    Current Assets:
      Accounts receivable                        $     14,293   $     12,855
      Unbilled revenue                                  1,162          1,699
      Inventory (note 12)                               3,067          3,172
      Prepaid expenses and deposits                        16             28
                                                       18,538         17,754
    Other assets                                           56              -
    Property, plant and equipment (note 3)             20,977         20,387

    -------------------------------------------------------------------------
                                                 $     39,571   $     38,141
    -------------------------------------------------------------------------
    Liabilities and Shareholders' Equity
    Current Liabilities:
      Operating loan (note 2)                    $      5,224   $      5,316
      Accounts payable and accrued liabilities          7,207          6,256
      Billings in excess of costs incurred and
       estimated earnings on uncompleted contracts        204            306
      Customer deposits                                   112             72
      Loans payable (note 4(a))                         4,918          5,761
      Current portion of capital lease obligations        343            372
    -------------------------------------------------------------------------
                                                       18,008         18,083

    Capital lease obligations (note 4(b))                 241            535
    Future income taxes (note 7)                          606            128
    -------------------------------------------------------------------------
                                                       18,855         18,746
    -------------------------------------------------------------------------

    Shareholders' Equity:
      Share capital (note 5)                           21,401         20,901
      Contributed surplus (note 5 (e))                     99            225
      Deficit                                            (784)        (1,731)
    -------------------------------------------------------------------------

    Commitments and contingencies (notes 2 and 6)      20,716         19,395

    -------------------------------------------------------------------------
                                                 $     39,571   $     38,141
    -------------------------------------------------------------------------

    The accompanying notes are an integral part of these consolidated
    financial statements.

    On behalf of the Board:

    (signed)                                      (signed)

    Dan Motyka                                    John Carruthers
    Director                                      Director


    CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT

    -------------------------------------------------------------------------
    (In thousands except per share data)           Year Ended     Year Ended
                                                  December 31,   December 31,
                                                         2006           2005
    -------------------------------------------------------------------------

    Revenue                                      $     57,042   $     48,365
    Operating costs                                    46,227         39,543
    -------------------------------------------------------------------------
                                                       10,815          8,822
    -------------------------------------------------------------------------

    Other operating expenses (income):
      Selling, general and administrative               5,918          4,443
      Amortization                                      2,012          1,883
      Research and development                             96            292
      Bad debts                                            78              -
      Foreign exchange losses (gains)                      (7)            27
      Write-down of property, plant and equipment           -            113
      Gain on disposal of property, plant and
       equipment                                         (100)            (8)
    -------------------------------------------------------------------------
                                                        7,997          6,750
    -------------------------------------------------------------------------

                                                        2,818          2,072
    Financing:
      Interest on operating loan                          244            159
      Interest on loans payable                           368            341
      Other                                                (4)           (12)
    Other expenses (income), net (note 11)                785           (165)
    -------------------------------------------------------------------------
    Earnings before income taxes                        1,425          1,749
    -------------------------------------------------------------------------

    Income taxes (note 7):
      Future                                              478            128
    -------------------------------------------------------------------------
                                                          478            128

    Net earnings                                          947          1,621

    -------------------------------------------------------------------------
    Deficit, beginning of year                         (1,731)        (3,352)
    -------------------------------------------------------------------------
    Deficit, end of year                         $       (784)  $     (1,731)
    -------------------------------------------------------------------------

    Earnings per share:
      Basic                                      $       0.08   $       0.14
      Diluted                                    $       0.08   $       0.14
    Weighted average common shares:
      Basic                                        11,788,102     11,480,350
      Diluted                                      12,065,424     11,718,850
    -------------------------------------------------------------------------

    The accompanying notes are an integral part of these consolidated
    financial statements.


    CONSOLIDATED STATEMENTS OF CASH FLOWS

    -------------------------------------------------------------------------
    (In thousands)                                 Year Ended     Year Ended
                                                  December 31,   December 31,
                                                         2006           2005
    -------------------------------------------------------------------------

    Cash provided by (used in):

    Operations (note 10):
      Net earnings                               $        947   $      1,621
      Items not involving cash:
        Amortization                                    2,012          1,883
        Stock-based compensation expense
         (note 5 (c))                                      74             10
        Gain on disposal of property, plant
         and equipment                                   (100)            (8)
        Write-down of property, plant and
         equipment                                          -            113
        Future income taxes                               478            128
    -------------------------------------------------------------------------
                                                        3,411          3,747

    Changes in non-cash operating working capital         105         (3,727)

    -------------------------------------------------------------------------
                                                        3,516             20
    -------------------------------------------------------------------------
    Financing:
      Proceeds from exercise of share purchase
       options                                            300             67
      Increase (decrease) in operating loan               (92)         2,547
      Repayment of loans payable                       (1,783)        (1,204)
      Advances under loans payable                        940            769
      Repayment of capital lease                         (323)          (255)
    -------------------------------------------------------------------------
                                                         (958)         1,924

    Investments:
      Other assets                                        (56)             -
      Proceeds from disposal of property, plant
       and equipment                                      140             17
      Additions to property, plant and equipment       (2,642)        (1,961)
    -------------------------------------------------------------------------
                                                       (2,558)        (1,944)
    -------------------------------------------------------------------------

    Change in cash                                          -              -

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

    The accompanying notes are an integral part of these consolidated
    financial statements.


    Notes to the Consolidated Financial Statements
    For the Years Ended December 31, 2006 and 2005

    Garneau Inc. (the Corporation) is incorporated under the Business
    Corporations Act of Alberta. Its principal business activities are the
    coating of pipe and the manufacturing of equipment for use in the oil and
    gas industry.

    In the notes to the consolidated financial statements, all dollar amounts
    are stated in thousands of Canadian dollars, except per share data,
    unless otherwise indicated.

    1.  SIGNIFICANT ACCOUNTING POLICIES:

    (a) Basis of presentation:

    These consolidated financial statements include the accounts of the
    Corporation and its subsidiaries.

    These consolidated financial statements have been prepared assuming that
    future operations will allow for the realization of assets and discharge
    of liabilities in the normal course of business. Management is of the
    opinion that sufficient working capital will be obtained from operations
    to meet the Corporation's liabilities and commitments as they become
    payable. These consolidated financial statements do not include any
    adjustments to the carrying value of assets and liabilities that might be
    necessary should the Corporation not continue operating in the normal
    course of business.

    (b) Measurement Uncertainty:

    The preparation of the financial statements in conformity with Canadian
    generally accepted accounting principles requires management to make
    estimates and assumptions that affect the reported amounts of assets and
    liabilities and disclosure of contingent assets and liabilities at the
    date of the financial statements and the reported amounts of revenues and
    expenses during the year. Significant items subject to such estimates and
    assumptions include the estimated useful life and carrying amount of
    property, plant and equipment, valuation of accounts receivable and
    inventory, the assessment of the percentage of completion on lump-sum
    contracts (including estimated costs and provision for estimated losses).
    The Corporation relies on assumptions regarding applicable industry
    performance and prospects, as well as general business and economic
    conditions that prevail and are expected to prevail. Assumptions
    underlying asset valuations are limited by the uncertainty of predictions
    concerning future events. By nature, asset valuations are subjective and
    do not necessarily result in precise determinations. Actual results could
    differ from those estimates.

    (c) Recognition of revenue:

    Revenue from product sales is recognized when products are shipped and
    the customer takes ownership and assumes risk of loss, collection is
    probable, persuasive evidence of an arrangement exists and the sales
    price is fixed and determinable.

    Revenue related to the coating of pipe is recognized as the services are
    provided and the collection of the relevant receivable is probable,
    persuasive evidence of an arrangement exists and the sales price is fixed
    and determinable.

    The Corporation performs the majority of its equipment fabrication
    activities under lump-sum contracts. Revenue on lump-sum contracts is
    recognized using the percentage-of-completion method, measured by the
    ratio of costs incurred to date to estimated total costs. Excluded from
    costs incurred to date, particularly in the early stages of the contract,
    are the costs of items that do not relate to performance of our
    contracted work. Contract project costs include all direct labour,
    material, subcontract, and equipment costs and those indirect costs
    related to contract performance such as indirect labour, supplies, and
    tools. General and administrative costs are charged to expense as
    incurred. Provisions for estimated losses on uncompleted contracts are
    made in the period in which such losses are determined. Changes in
    project performance, project conditions, and estimated profitability,
    including those arising from contract penalty provisions and final
    contract settlements, may result in revisions to costs and income that
    are recognized in the period in which such adjustments are determined.
    Revenue from contract change orders, which occurred in most large
    projects, is recognized when the owner has agreed to the change order in
    writing. The asset entitled "unbilled revenue" represents revenue
    recognized in advance of amounts invoiced. The liability entitled
    "billing in excess of costs incurred and estimated earnings on
    uncompleted contracts" represents amounts invoiced in excess of revenue
    recognized.

    (d) Inventory:

    Raw materials are stated at the lower of cost, on a first-in, first-out
    basis, and replacement cost. Finished goods and work-in-progress are
    valued at the lower of cost, on a first-in, first-out basis, and net
    realizable value.

    (e) Foreign currency translation:

    Monetary assets and liabilities denominated in foreign currencies are
    translated at prevailing rates of exchange at the balance sheet date.
    Revenue and expenses are translated at the exchange rates prevailing on
    the transaction date. Realized and unrealized exchange gains and losses
    are included in earnings.

    The operations of a wholly owned subsidiary, which is deemed to be an
    integrated foreign operation, are translated using the temporal method.
    Under this method, all monetary assets and liabilities are translated at
    the exchange rate in effect at the balance sheet date and all non-
    monetary assets and liabilities are translated using the exchange rates
    in effect when the balance originated. Revenues and expenses are
    translated at the average exchange rate prevailing during the year.
    Translation gains and losses arising from changes in exchange rates are
    included in the determination of earnings for the year.

    (f) Stock-based compensation plan:

    The Corporation has a stock-based compensation plan, which is described
    in note 5(c). Since January 1, 2002, the Corporation accounts for all
    stock-based compensation expense for stock options 5(c) granted to
    employees, officers and directors in accordance with the fair value based
    method of accounting. Under the fair value method, compensation cost is
    measured at fair value on the grant date using the Black-Scholes model
    and stock based compensation expense is recorded over the vesting period
    of the option, with a corresponding increase in contributed surplus. When
    the options are exercised, the proceeds received by the Corporation along
    with the amount in contributed surplus associated with the exercised
    options, will be credited to share capital.

    (g) Property, plant and equipment:

    Property, plant and equipment are stated at cost. Amortization is
    provided using the straight-line method at the following annual rates:

    -------------------------------------------------------------------------
    Asset                                                               Rate
    -------------------------------------------------------------------------
    Land improvements                                                     5%
    Buildings                                                             5%
    Machinery, equipment and extrusion plant                     6.25% - 33%
    Rental equipment                                                   12.5%
    -------------------------------------------------------------------------

    Equipment under capital lease is amortized using the same rates as
    similar owned assets.

    (h) Income Taxes:

    The Corporation uses the asset and liability method of accounting for
    income taxes. Under the asset and liability method, future tax assets and
    liabilities are recognized for the future tax consequences attributable
    to differences between the financial statement carrying amounts of
    existing assets and liabilities and their respective tax bases. Future
    tax assets and liabilities are measured using enacted or substantively
    enacted tax rates expected to apply to taxable income in the years in
    which those temporary differences are expected to be recovered or
    settled. The effect on future tax assets and liabilities of a change in
    tax rates is recognized in income in the period that includes the date of
    enactment or substantive enactment.

    (i) Impairment of Long Lived Assets:

    Long-lived assets, including property, plant and equipment are reviewed
    for impairment whenever events or changes in circumstances may indicate
    or cause their carrying value to exceed the total undiscounted cash flows
    expected from their use and eventual disposition. An impairment loss
    would be recorded as the excess of carrying value of the asset over its
    fair value, measured by either market value or estimated by calculating
    the present value of expected future cash flows related to the asset.

    (j) Earnings per Share:

    Basic earnings (loss) per share are computed by dividing net earnings
    (loss) available to common shareholders by the weighted average number of
    common shares outstanding during the period. Diluted per share amounts
    are calculated using the treasury stock method. The treasury stock method
    increases the diluted weighted average shares outstanding to include
    additional shares from the assumed exercise of stock options, if
    dilutive. The number of additional shares is calculated by assuming that
    outstanding in-the-money stock options were exercised and the proceeds
    from such exercises including any unamortized stock-based compensation
    cost, were used to acquire shares of common stock at the average market
    price during the year.

    2.  OPERATING LOAN

    At December 31, 2006, the Corporation had available a demand revolving
    operating loan of $6,250. As collateral for this loan and loans payable
    (note 4), the Corporation has provided a general security agreement
    creating a first charge over all assets, collateral mortgages of $8,400
    over the Corporation's land and buildings, and assignments of insurance.

    The operating loan bears interest at the lender's prime rate for Canadian
    and United States dollar borrowings. Interest is paid monthly. The amount
    available under the operating loan is subject to a borrowing base formula
    applied to the levels of accounts receivable and inventories.

    Letters of guarantee and credit for performance and bid guarantees, when
    issued, reduce the amount available for borrowing under the operating
    loan. Issued letters of credit outstanding at December 2006 totaled
    $142 thousand ($122 thousand USD).

    3.  PROPERTY, PLANT AND EQUIPMENT

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

    -------------------------------------------------------------------------
    2006
    -------------------------------------------------------------------------
                                                       Accumulated  Net book
                                                Cost  amortization     value
    -------------------------------------------------------------------------
    Land and land improvements              $  4,704   $   1,821   $   2,883
    Buildings                                  6,058       2,061       3,997
    Machinery, equipment and extrusion plant  26,602      13,897      12,705
    Leasehold improvements                       264         264           -
    Rental equipment                             353         342          11
    Equipment under construction                 172           -         172
    -------------------------------------------------------------------------
                                              38,153      18,385      19,768
    Equipment under capital lease              1,660         451       1,209
    -------------------------------------------------------------------------
                                            $ 39,813    $ 18,836    $ 20,977
    -------------------------------------------------------------------------

    -------------------------------------------------------------------------
    2005
    -------------------------------------------------------------------------
                                                       Accumulated  Net book
                                                Cost  amortization     value
    -------------------------------------------------------------------------
    Land and land improvements              $  4,567    $  1,666    $  2,901
    Buildings                                  5,944       1,769       4,175
    Machinery, equipment and extrusion plant  24,383      12,566      11,817
    Leasehold improvements                       264         264           -
    Rental equipment                             832         713         119
    -------------------------------------------------------------------------
                                              35,990      16,978      19,012
    Equipment under capital lease              1,660         285       1,375
    -------------------------------------------------------------------------
                                            $ 37,650    $ 17,263    $ 20,387
    -------------------------------------------------------------------------

    Equipment under construction is not amortized until it has been placed
    into service.

    4. (a) LOANS PAYABLE

        ---------------------------------------------------------------------
                                                          2006          2005
        ---------------------------------------------------------------------
        1. Demand evergreen bank loan, payable     $     2,814   $     2,914
           in monthly principal installments
           of $101. Interest is charged at the
           rate of bank prime plus 0.875%,
           secured as described in note 2.

        2. Demand bank loan, payable in monthly          2,104         2,497
           principal installments of $34.
           Interest is charged at the rate of
           bank prime plus 0.875%, secured as
           described in note 2.

        3. Vendor back mortgage. Interest is
           charged at 6%.                                    -           350

        ---------------------------------------------------------------------
                                                   $     4,918   $     5,761
        ---------------------------------------------------------------------

        The Evergreen bank loan is for financing the cost of capital upgrades
        and is limited to the lesser of 100% of the total cost of upgrades
        and $3,000.

        Loans payable to the Corporation's bank are payable upon demand and
        are classified as a current liability. Scheduled repayments are as
        follows:

                                               2007              $     1,556
                                                                   ----------
        Total scheduled repayments within 12 months              $     1,556
                                                                   ----------

                                               2008                    1,087
                                               2009                      696
                                               2010                      540
                                               2011                      372
                               And subsequent years                      667
                                                                   ----------
        Total scheduled repayments beyond 12 months              $     3,362
                                                                   ----------

    4. (b) CAPITAL LEASE OBLIGATIONS

        The Corporation has financed certain equipment by entering into
        capital leasing arrangements. Capital lease repayments are due as
        follows:

        ---------------------------------------------------------------------
                                                          2006          2005
        ---------------------------------------------------------------------
        2006                                       $         -   $       416
        2007                                               368           318
        2008                                               132           132
        2009                                               121           121
        ---------------------------------------------------------------------
        Total minimum lease payments                       621           987

        Less amount representing interest at rates
         ranging from 6% to 8%                              37            80
        ---------------------------------------------------------------------

        Present value of capital lease payments            584           907
        Current portion of capital lease obligations       343           372
        ---------------------------------------------------------------------
                                                   $       241   $       535
        ---------------------------------------------------------------------

    5.  SHARE CAPITAL

    (a) Authorized:

        Unlimited number of common shares.

    (b) Issued:

        ---------------------------------------------------------------------
                                              Number of shares       $ Value
        ---------------------------------------------------------------------
        Common shares outstanding at
         December 31, 2004                          11,445,302       $20,834
                                             --------------------------------
        Issued for cash during 2005 on
         exercise of options                           116,950            67
                                             --------------------------------
        Common shares outstanding at
         December 31, 2005                          11,562,252        20,901
                                             --------------------------------
        Issued for cash during 2006 on
         exercise of options                           486,275           300
                                             --------------------------------
        Transfer from contributed surplus
         for stock options exercised                         -           200
                                             --------------------------------
        Common shares outstanding at
         December 31, 2006                          12,048,517       $21,401


    (c) Stock-Based Compensation Plan:

        The Corporation has implemented a stock option plan for directors,
        officers, employees and consultants and reserved a rolling 10% of the
        outstanding common shares for the plan. The exercise price of the
        share purchase options reflects the market price of the shares at the
        date the options were granted. The Board of Directors, at their
        discretion, determines the vesting period at the time issuance. Stock
        options may be exercisable, subject to the provisions of the plan
        requiring acceleration of rights of exercise, until such date as may
        be determined from time to time by the Board of Directors provided
        that no stock option will be exercised more than 5 years from the
        date of grant.

        The continuity of the Corporation's outstanding and exercisable stock
        options of the year ended December 31, 2006 and 2005 is as follows:

                                 2006                        2005

                                        Weighted                    Weighted
                                         Average                     Average
                                        Exercise                    Exercise
                            Shares         Price        Shares         Price
        ---------------------------------------------------------------------
        Outstanding at
         beginning of
         year              927,175         $0.72       984,375         $0.67
        Granted            706,500         $1.48        79,000         $1.10
        Exercised         (486,275)        $0.62      (116,950)        $0.57
        Encashed          (200,000)        $0.90             -             -
        Cancelled          (26,850)        $0.96       (19,250)        $0.61
        ---------------------------------------------------------------------
        Outstanding at
         end of year       920,550         $1.31       927,175         $0.72
        ---------------------------------------------------------------------
        Options
         exercisable at
         end of year       214,050         $0.74       789,800         $0.72


        The following options are outstanding as of December 31, 2006:
        ---------------------------------------------------------------------
                       Number of Shares                             Exercise
                                                                       Price
                    Granted        Vested          Expiry date     per Share
        ---------------------------------------------------------------------
                     88,800        88,800   September 18, 2007    $     0.61
                     65,150        65,150     January 30, 2008    $     0.60
                     12,200        12,200   September 28, 2009    $     1.00
                     47,900        47,900    September 9, 2010    $     1.10
                    706,500             -    November 10, 2011    $     1.48
        ---------------------------------------------------------------------
                    920,550       214,050


    The fair value of stock options granted is estimated at the grant date
    using the Black-Scholes option pricing model using the following
    assumptions:

    Year Ended                                            2006          2005
                                                          ----          ----

    Expected dividends                                     NIL           NIL
    Risk-free interest rate                              3.91%         2.75%
    Expected life                                        3 yrs         5 yrs
    Expected volatility                                    60%           50%

    Total stock based compensation expense for the year ended December 2006
    totaled $74 (2005-$10). In 2006, the Corporation granted 706,500 options
    to purchase common shares at an average price of $1.48 under the
    Corporation's stock-option plan and the weighted average fair value of
    each option was determined to be $0.65.

    (d) Employee Ownership Plan

    The Corporation has an Employee Share Ownership Plan in place under which
    employees may contribute 3% of eligible compensation each year to
    purchase common shares of the Corporation. The Corporation will match the
    employee contribution and the Corporation's contribution vests on
    December 31 of each year. If the Corporation wishes, it is authorized to
    issue up to 1,000,000 common shares under the Plan.

    At December 31, 2006, 43 employees were participating under the Plan.
    Employee and Corporation contributions for 2006 totaled $67 and were used
    to purchase 39,577 common shares of the Corporation on the open market.

    (e) Contributed Surplus

    A summary of the status of the Corporation's contributed surplus account
    as of December 31, 2006 and 2005, and changes during the year ended, on
    those dates is presented below:

    Year Ended                                            2006          2005
                                                          ----          ----

    Contributed surplus at beginning of the year          $225          $215
    Stock-based compensation expense                        74            10
    Stock options exercised                               (200)            -
    -------------------------------------------------------------------------
    Contributed surplus at the end of year                 $99          $225
    -------------------------------------------------------------------------

    6.  COMMITMENTS AND CONTINGENCIES

        The Corporation is committed to operating lease payments for
        premises, automobiles, mobile and office equipment in the following
        approximate amounts:

                    2007     $    283
                    2008          189
                    2009          139
                    2010           53
                    2011           52

        The Corporation has been named defendant in a lawsuit and has
        received claims in the aggregate amount of $1.5 million. In the
        opinion of management, this matter is without substantial merit and
        no provision has been made for the claim in the accounts.

    7.  INCOME TAXES

        Income tax expense differs from the amount that would be computed by
        applying the combined Federal and Provincial statutory income tax
        rate of 33.6% (2005-33.6%) to income before income taxes. The reasons
        for the differences are as follows:

        ---------------------------------------------------------------------
                                                          2006          2005
        ---------------------------------------------------------------------
        Expected income taxes (recovery) at
         statutory rates                           $       457   $       588

        Increase (decrease) resulting from:
          Other amounts                                      9            65
          Change in valuation allowance                     12          (525)
                                                  ---------------------------
                                                   $       478   $       128
        ---------------------------------------------------------------------
        ---------------------------------------------------------------------

        The tax effects of temporary differences that give rise to
        significant portions of the future tax assets and future tax
        liabilities are presented below:

        ---------------------------------------------------------------------
                                                          2006          2005
        ---------------------------------------------------------------------
        Future tax assets:
          Losses carried forward                   $     1,051   $     1,588
          Other                                            224           261
        ---------------------------------------------------------------------
                                                         1,275         1,849
        Less valuation allowance                          (155)         (143)
        ---------------------------------------------------------------------
                                                         1,120         1,706

        Future tax liabilities:
          Property, plant and equipment - excess
           of net book value over undepreciated
           capital cost                                  1,726         1,834
        ---------------------------------------------------------------------
                                                         1,726         1,834
        ---------------------------------------------------------------------
        Net future tax liability                   $       606   $       128
        ---------------------------------------------------------------------
        ---------------------------------------------------------------------

    8.  FINANCIAL INSTRUMENTS

        (a) Market risks:
            The Corporation operates internationally, giving rise to exposure
            to market risks from changes in interest rates, foreign exchange
            rates and commodity prices. The Corporation has not hedged its
            exposure to these items.

        (b) Concentrations of credit risk:
            Reflective of normal business, substantially all the
            Corporation's accounts receivable are with companies in the oil
            and gas industry in Western Canada and with two international
            customers. The Corporation regularly monitors the activity and
            balances in these accounts to manage its credit risk. The
            Corporation's 13 largest customers accounted for 89% of accounts
            receivable outstanding at December 31, 2006.

        (c) Fair value:
            The fair values of the loans payable, capital lease obligations
            and letters of guarantee and credit are not significantly
            different from their carrying values. The fair value of all other
            financial instruments approximates their carrying values due to
            the short periods to maturity.

    9.  SEGMENT DISCLOSURES

        Management has determined that the Corporation operates in two
        reportable business segments which were Manufacturing and Pipeline.
        The accounting policies of the segments are the same as those
        described in the summary of significant accounting policies.

                                             Year ended
                            December 31, 2006           December 31, 2005
                       Manufacturing   Pipeline    Manufacturing   Pipeline
        Revenue        $    18,760    $   38,282    $   16,785    $   31,580
        Gross margin         4,747         6,068         4,425         4,397
                             25.3%         15.9%         26.4%         13.9%
        Other expenses
         and income
         before income
         taxes               2,766         6,626         2,168         4,905
        Earnings (loss)
         before income
         taxes               1,981          (556)        2,257          (508)

        Property, plant
         and equipment       2,151        37,662         2,172        35,478
        Accumulated
         amortization       (1,555)      (17,281)       (1,937)      (15,326)
        Net book value         596        20,381           235        20,152


        Two customers accounted for 14.0% and 13.4% of consolidated revenues
        respectively. Export sales, primarily from sale of pipe coating and
        handling equipment, totaled $3.4 million (2005-$4.4 million).

        Gross margin is determined by deducting operating costs from revenue.
        Operating costs consist of all direct material, labor and plant
        overhead costs.

    10. SUPPLEMENTARY CASH FLOW INFORMATION

        Year Ended                                        2006          2005
        ---------------------------------------------------------------------
        Interest paid                              $       612   $       500
        Income taxes paid                                    -             -


        Property, plant and equipment in the amount of Nil (2005-$450) were
        acquired by way of capital lease during of the year ended
        December 31, 2006.

    11. PLAN OF ARRANGEMENT

        The Corporation announced on October 5, 2006 that the Plan of
        Arrangement agreement dated April 19, 2006 with ShawCor Ltd.
        ("ShawCor") was terminated. As a result, the proposed acquisition of
        Garneau Inc. shares by ShawCor did not proceed.

        The decision not to proceed was based on the inability of the parties
        to resolve outstanding issues raised by the Competition Bureau,
        Canada and the prospect of further delays.

        Other expenses include costs pertaining to this terminated ShawCor
        transaction totaling $1.1 million for the year ended December 31,
        2006.

    12. INVENTORY

        ---------------------------------------------------------------------
        Inventory consists of the following:              2006          2005
        ---------------------------------------------------------------------

        Raw materials                              $     1,986   $     2,162
        Finished goods                                   1,081           886
        Work-in-progress                                     -           124
        ---------------------------------------------------------------------
                                                   $     3,067   $     3,172
        ---------------------------------------------------------------------

    13. COMPARATIVE FIGURES

        Certain of the Comparative figures have been reclassified to conform
        with the current year's presentation.


    DIRECTORS

    Glen Garneau
    President and Chief Executive Officer

    John W. Carruthers(1),(2),(3)
    Vice-President, Gas Services, Enbridge Inc.

    Daniel D. Laplante(1),(2),(3)
    Corporate Director, Okotoks, AB

    Daniel R. Motyka(1),(2),(3)
    Vice-President, Designer Emeritus, Questor Technology Inc.

    Chris Garneau
    President, CMG Design Inc.


    OFFICERS

    Glen Garneau
    President and Chief Executive Officer

    Frank Deys, CMA
    Executive Vice President and Chief Financial Officer

    Jay P. Reid
    Corporate Secretary                 (1) Member of Audit Committee
                                        (2) Member of Compensation Committee
                                        (3) Corporate Governance Committee

    HEADQUARTERS                      SALES OFFICE

    Garneau Inc.                      Garneau Inc.
    2003 - 5th Street                 No. 650, 407 - 2nd Street SW
    Nisku, Alberta                    Calgary, Alberta
    T9E 7X4                           T2P 2Y3
    Phone: (780) 955-2396             Phone: (403) 264-4880
    Fax: (780) 955-7715               Fax: (403) 290-0055

    AUDITORS                          LEGAL COUNSEL

    KPMG LLP                          Burnet, Duckworth & Palmer LLP
    10125-102nd Street                First Canadian Centre
    Edmonton, Alberta                 1400, 350 - 7th Avenue SW
    T5J 3V8                           Calgary, Alberta  T2P 3N9


    REGISTRAR AND TRANSFER AGENT    INVESTOR CONTACT
    EMAIL

    Olympia Trust Company           Frank Deys - frankd@garneau-inc.com
    Edmonton, Alberta               Head Office

    INVESTOR RELATIONS

    darlenek@garneau-inc.com


    STOCK EXCHANGE              SYMBOL    NOTICE OF ANNUAL AND SPECIAL
                                          MEETING OF SHAREHOLDERS

    TSX                         GAR       Tuesday, May 29, 2007
                                          Time: 3:00 p.m.
                                          The Westin Hotel
    GARNEAU INC. WEB SITE                 320 - 4th Avenue SW
                                          Calgary, Alberta
    http://www.garneau-inc.com            T2P 2S6



    About Garneau Inc.
    ------------------

    Garneau Inc.'s primary business is the application of high performance
protective coatings and linings for oil and gas pipeline protection.
Additionally, Garneau Inc. designs and fabricates oilfield equipment for both
domestic and international markets. During more than 30 years of operating
experience, Garneau Inc. has developed significant expertise and innovative
technology, and has maintained a long-term focus on continuously improving the
pipe coating process with cost-effective, quality coatings. A talented and
effective management team provides the vision and experience for long-term
profitable growth and increasing shareholder value. The company's Website can
be accessed at: http://www.garneau-inc.com
    





For further information:

For further information: Frank Deys, CFO, frankd@garneau-inc.com, Phone:
(780) 955-2396, Fax: (780) 955-7715

Organization Profile

GARNEAU INC.

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