Trinidad Energy Services Income Trust announces fourth quarter and year end results - December 31, 2006



    TSX SYMBOL: TDG.UN

    CALGARY, March 1 /CNW/ - The following is management's discussion and
analysis ("MD&A") concerning the operating and financial results for the three
and twelve months ended December 31, 2006 and its outlook based on information
available as at February 20, 2007. The MD&A is based on the Trinidad Energy
Services Income Trust (the "Trust" or "Trinidad") consolidated financial
statements for the year ended December 31, 2006 which were prepared in
accordance with Canadian generally accepted accounting principles. The
following discussion should be read in conjunction with the consolidated
financial statements and attached notes contained in this report. Additional
information is also available on the Trust's website(www.trinidaddrilling.com)
and all previous public filings, including the most recently filed Annual
Report and Annual Information Form, which are available through SEDAR
(www.sedar.com).

    
    FINANCIAL HIGHLIGHTS

    For the years ended December 31,
    (thousands except unit
     and per unit data)                       2006         2005         2004
    -------------------------------------------------------------------------
    Revenue                                579,855      288,332      138,477
    Gross margin(1)                        269,584      120,415       56,827
    EBITDA(1)                              210,319       91,116       42,803
      Per unit (diluted)                      2.48         1.52         1.14
    EBITDA before unit based
     compensation(1)                       217,424       94,319       42,973
      Per unit (diluted)                      2.57         1.57         1.15
    Funds flow before change in
     non-cash working capital(1)           196,924       87,299       38,906
      Per unit (diluted)                      2.33         1.45         1.04
    Distributions paid and declared        105,475       51,905       23,698
    Distributions paid and declared
     per unit (basic)                         1.27         0.88         0.64
    Payout ratio(2)                             54%          59%          61%
    Net earnings                           123,706       47,427       20,790
      Per unit (basic)                        1.49         0.81         0.56
      Per unit (diluted)                      1.46         0.79         0.55
    Net earnings before unit
     based compensation                    130,811       50,630       20,960
      Per unit (diluted)                      1.55         0.84         0.56
    Units outstanding - basic
     (weighted average)(3)              83,078,833   58,850,122   36,833,388
    Units outstanding - diluted
     (weighted average)(3)              84,644,439   60,134,317   37,513,167

    (1) Readers are cautioned that gross margin, EBITDA and funds flow before
        change in non-cash working capital and the related per unit
        information do not have a standardized meaning prescribed by GAAP and
        therefore may not be comparable to similar measures presented by
        other issuers; however, the Trust does compute gross margin, EBITDA
        and funds flow before change in non-cash working capital on a
        consistent basis for each reporting period. EBITDA refers to earnings
        of the Trust before interest, taxes, depreciation and amortization
        and gain or loss on investment in long-term assets and funds flow
        before change in non-cash working capital refers to the amount of
        cash that is expected to be available for distribution to
        unitholders. Funds flow before change in non-cash working capital has
        replaced the term cash flow before change in non-cash working capital
        as shown in previous filings.
    (2) Payout ratio is calculated as distributions paid and declared divided
        by funds flow before changes in non-cash working capital.
    (3) Basic and diluted units outstanding include trust units to be issued
        upon conversion of exchangeable shares.



    OPERATING HIGHLIGHTS

    For the years ended December 31,          2006         2005         2004
    -------------------------------------------------------------------------
    Operating days - drilling
      Canada                                12,531       12,298        7,829
      United States                          7,046          272            -
    Rate per drilling day (CDN $)
      Canada                                24,191       20,783       16,922
      United States                         23,724       22,782            -
    Utilization rate - drilling
      Canada                                    62%          64%          66%
      United States                             84%          85%           -
    CAODC industry average                      55%          59%          53%
    Number of drilling rigs
      Canada                                    60           54           51
      United States                             31           17            -
    Utilization rate for service rigs           62%          61%          54%
    Number of service rigs                      18           16            8
    Number of coring and surface casing rigs    17           18            -
    


    FORWARD-LOOKING STATEMENTS

    The MD&A contains certain forward-looking statements relating to the
Trust's plans, strategies, objectives, expectations and intentions.
Expressions such as "anticipate", "expect", "project", "believe", "estimate",
and "forecast" should be used to identify these forward-looking statements.
The Trust believes that the expressions reflected in those forward-looking
statements are reasonable; however, such statements are subject to a number of
known and unknown risks, uncertainties and other factors that may cause actual
results to differ materially from those anticipated in our forward-looking
statements. These statements speak only as of the date of the MD&A and the
Trust does not intend, and does not assume any obligation, to update these
forward-looking statements.

    NON-GAAP MEASURES

    This MD&A contains references to the term "funds flow before change in
non-cash working capital" to refer to the amount of cash that is expected to
be available for distribution to unitholders, the term "EBITDA" to refer to
earnings of the Trust before interest, taxes, depreciation and amortization
and gain or loss on investment in long-term assets and the term "Gross Margin"
to refer to revenue less operating expenses, which the Trust believes are
measures followed by the investment community and therefore provide useful
information. The terms "funds flow before change in non-cash working capital"
and "EBITDA" are not measures recognized by Generally Accepted Accounting
Principles ("GAAP") and do not have standardized meanings prescribed by GAAP
and accordingly may not be comparable to similar measures presented by other
companies. However, the Trust computes "funds flow before change in non-cash
working capital" and "EBITDA" on a consistent basis for each reporting period.

    OVERVIEW

    In 2005 Trinidad's operations were primarily focused in the deeper
drilling sector of the Western Canadian Sedimentary Basin. In order to
increase the stability of the overall funds flow the Trust began the process
of strategically diversifying its operations into the US. This commenced with
the announcement of the Trust's commitment to construct an additional 29
drilling rigs of which 17 were to be deployed in the US, all backed by
long-term take-or-pay contracts. These long-term contracts along with the
acquisition of Cheyenne Drilling at the end of 2005 created a stable drilling
base in the US. Throughout 2006 an additional 10 rigs were released into the
US market under the rig construction program and Cheyenne Drilling deployed
two rigs that were under construction at the time of acquisition and two
inactive rigs were refurbished and placed into operations. This significantly
increased the rig count in the US from 17 at the end of 2005 to 31 at the end
of 2006, an increase of 82.4% in a market which typically operates at
utilization rates of 85%. Additionally, the fully functional drilling fleet in
the US for the entire year produced significantly higher revenues and funds
flow throughout the period.
    The second dramatic change in the Trust's operations throughout the year
was the acquisition of Mastco Derrick Services Ltd. ("Mastco"), a company with
the expertise to design, manufacture, sell and refurbish drilling rigs and
related equipment. This acquisition provided Trinidad with increased
flexibility over the current rig construction program providing an improved
ability to control the delivery schedule of its rigs. As a result of this, six
Canadian rigs were completed and put into operations throughout 2006 and the
remainder are expected to be delivered in the first and second quarter of
2007. The integration of Mastco into the Trust's operations also improves the
Trust's ability to complete required repairs and maintenance and
recertifications.
    Activity levels slowed in the Canadian market throughout 2006 as a result
of declines in commodity prices and concerns over high storage levels.
Trinidad has been able to mitigate the impact of these reductions through a
focus on longer term contracts and its US diversification which resulted in
overall utilization levels exceeding industry averages throughout the year.
Furthermore, the Trust continues to focus its efforts on the deeper drilling
market which is less impacted by seasonal fluctuations and commodity price
volatility. Despite a slower market the Trust has continued to grow in both
revenue and funds flow due to increases in the Trust's drilling capacity and
increased day rates across the market.

    
    RESULTS FROM OPERATIONS

    Canadian Drilling Operations

    For the years ended December 31,
    (thousands)                               2006         2005     % Change
    -------------------------------------------------------------------------
    Revenue                                364,278      282,938        28.7
    Operating expense                      196,665      164,701        19.4
                                     ----------------------------------------
    Gross margin                           167,613      118,237        41.8
                                     ----------------------------------------
    Gross margin percentage                   46.0%        41.8%

    Operating days - drilling               12,531       12,298         1.9
    Rate per drilling day (CDN $)           24,191       20,783        16.4
    Utilization rate - drilling                 62%          64%       (3.1)
    CAODC industry average                      55%          59%       (6.8)
    Number of drilling rigs                     60           54        11.1

    Utilization rate - well servicing           62%          61%        1.6
    Number of service rigs                      18           16        12.5
    Number of coring and surface rigs           17           18        (5.6)
    


    Reduced activity levels throughout the Canadian drilling sector continued
to be an issue as commodity prices declined from record highs in 2005 to more
stable levels in 2006. These weakening conditions affected the overall
utilization across the sector with reductions in the utilization rates from
59% in 2005 to 55% in 2006, a level more consistent with usual seasonal
patterns. Despite the reduction in overall utilization, Trinidad was able to
minimize the impact of this slow down by focusing on the deeper drilling
market which is less impacted during softer market conditions and execution of
long-term contracts with oil and gas producers. This allowed the Trust to
continue to exceed industry utilization levels by 12.7% despite slight
reductions year-over-year. As a result overall revenues in the Canadian
drilling market continued to grow and increased by 28.7% to $364.3 million in
2006.
    The acquisition of Mastco in the first quarter of 2006 facilitated the
expansion of the Trust's Canadian drilling fleet from 54 rigs at the end of
2005 to 60 rigs at the end of 2006. The expansion of the rig fleet and
increases in day rates contributed to overall growth in revenue throughout the
period. The acquisition of Summit Energy Services in the third quarter of 2005
continues to provide additional depth in the well servicing sector increasing
overall revenue and utilization levels throughout the period. Finally, the
increased involvement of the surface and coring operations in the oil sands
projects throughout 2006 generated revenue growth.
    Operating expenses in the Trust's Canadian drilling operations increased
by $32.0 million, from $164.7 million in 2005 to $196.7 million in 2006.
Consolidated gross margin percentages also increased from 41.8% to 46.0% as
increased depth capacity of the Trust's fleet throughout 2006 produced
increased work at higher margins. Furthermore the execution of long-term
contracts has allowed for increased growth in margin levels. Throughout 2005
several of the Trust's well servicing rigs were relocated from Lloydminster
where they were predominately focused on maintenance and workover services to
Grande Prairie where they focused on higher margin completions work. This
relocation allowed the Trust to benefit from higher margin work throughout
2006 positively impacting margins throughout the period. Finally, the surface
casing and coring division's involvement in oil sands projects generated more
revenue at higher margins in 2006.

    
    United States Drilling Operations

    For the years ended December 31,
    (thousands)                               2006         2005     % Change
    -------------------------------------------------------------------------
    Revenue                                166,498        5,394      2,986.7
    Operating expense                       77,676        3,216      2,315.3
                                     ----------------------------------------
    Gross margin                            88,822        2,178      3,978.1
                                     ----------------------------------------
    Gross margin percentage                   53.3%        40.4%

    Operating days - drilling                7,046          272      2,490.4
    Rate per drilling day (CDN $)           23,724       22,782          4.1
    Utilization rate - drilling                 84%          85%        (1.2)
    Number of drilling rigs                     31           17         82.4
    


    Growth of the US drilling operations throughout the 2006 fiscal year was
instrumental in achieving stability of the Trust's funds flow throughout the
year and increasing the capability of the Trust to meet the needs of oil and
gas producers on a more comprehensive basis. The strategic decision to expand
geographically into a region that is uninterrupted by the seasonal conditions
present in the Canadian marketplace resulted in utilization levels in the US
marketplace of 84% through the year on an expanded drilling fleet which
totaled 31 rigs at year-end. In 2005 the Trust announced its intent to
construct a total of 29 drilling rigs, of which 17 were to be deployed into
the US market and backed by long-term take-or-pay contracts. By the end of the
2006 fiscal year, 11 of these rigs had been put into operations expanding the
drilling capacity and significantly increasing revenues throughout the period.
Furthermore, the acquisition of Cheyenne Drilling at the end of 2005 provided
the Trust with 10 days of revenue on a fleet of 16 rigs. The Trust reaped the
benefits of having this fully functional drilling fleet operating throughout
the entire year in 2006 and expanded the fleet by an additional four rigs, two
of which were under construction and two that required refurbishment at the
time of acquisition. The combined impact of these two factors resulted in
tremendous growth in revenue to $166.5 million in 2006 from $5.4 million in
2005.
    Operating expenses grew as a result of the overall growth in revenue
throughout the period from $3.2 million in 2005 to $77.7 million in 2006.
Furthermore, the US operations increased gross margin by 31.9% from 40.4% in
2005 to 53.3% in 2006. As the 2005 fiscal year was predominately a year of
growth and construction in the US marketplace the resulting increases in
margins throughout 2006 are due to improved operational efficiency and
expanding knowledge in the US and are more indicative of the future outlook in
this market. In addition, the execution of the rig build program, which is
backed by long-term take-or-pay contracts, promoted stability in utilization
rates and revenues throughout the year.

    
    Construction Operations
    For the years ended December 31,
    (thousands)                               2006         2005     % Change
    -------------------------------------------------------------------------
    Revenue                                111,128            -            -
    Operating expense                       97,979            -            -
                                     ----------------------------------------
    Gross margin                            13,149            -            -
                                     ----------------------------------------
    Gross margin percentage                   11.8%           -
    


    The acquisition of Mastco was an instrumental factor in the deployment of
six rigs since March 2006 and placed the Trust in a favourable position to
deploy the remaining four Canadian rigs committed under the current rig
construction program. Throughout 2006 Mastco concentrated its operations on
the completion of Trinidad's rig construction program and completed much of
the recertification work required on the Trust's current fleet. As a result,
Mastco recognized inter-segment revenue and costs of $62.0 million with the
Canadian and US drilling operations. Additionally, revenues of $49.1 million
were generated on sales to external customers completed throughout the year.
Costs of $35.9 million on these sales generated a gross margin of 26.9%
throughout the period.

    
    GENERAL AND ADMINISTRATIVE EXPENSE

    For the years ended December 31,
    (thousands)                               2006         2005     % Change
    -------------------------------------------------------------------------
    General and administrative expenses     51,627       26,183         97.2
    % of revenue                               8.9%         9.1%
    


    General and administrative expenses increased to $51.6 million from
$26.2 million as a result of the Trust's growth over the past year. Increases
in the general and administrative expenses resulted from Trinidad's growth and
expansion into the US marketplace and the diversification of its Canadian
operations. However, despite these overall increases, the Trust continues to
focus on maintaining conservative expenditure levels to ensure accretive
growth for unitholders by creating internal efficiencies, centralizing certain
required functions and integrating its management team. This focus has enabled
overall reductions in general and administrative expenses as a percentage of
revenue from 9.1% in 2005 to 8.9% in 2006.

    
    INTEREST

    For the years ended December 31,
    (thousands)                               2006         2005     % Change
    -------------------------------------------------------------------------
    Interest                                20,724        5,600        270.1
    


    In April 2006 the Trust closed a new debt agreement which increased the
principal available from $250.0 million to a debt facility with total Canadian
dollar equivalent capacity of approximately $495.7 million. This new debt
facility encompasses both US and Canadian term and revolving facilities which
bear interest at the LIBOR and BA rates, respectively, plus a spread. Upon
closure of the new debt facility the entire $125.0 million (USD) balance was
drawn on the US term loan and $175.0 million on the Canadian term and
revolving facilities increasing the overall debt levels of the Trust. This new
debt facility was used throughout the year to fund the execution of the
Trust's commitment to construct an additional 29 drilling rigs, of which 15
were released in the current year and four were released in 2005.
Additionally, the Trust funded approximately $93.2 million of the capital
requirements on the remaining 10 rigs expected to be released in the first and
second quarter of 2007 and $33.8 million on the additional five rigs announced
January 2007. The increased debt levels of the Trust from $105.5 million at
the end of 2005 to $391.5 million at the end of 2006 resulted in higher
interest expense throughout the year. Excess cash throughout the period, which
was not utilized to fund capital expenditures, was invested in short term
investments which generated interest income of approximately $1.9 million
during the year.
    Furthermore, throughout 2005 the Trust paid interest at a fixed borrowing
rate. With the inception of the new debt facility Trinidad is obligated to pay
interest at a floating BA or LIBOR rate for both the Canadian and US
facilities, respectively. This increased the Trust's overall exposure to
fluctuations in the floating rate. In order to mitigate this risk Trinidad
entered into an interest rate swap at the beginning of the third quarter on
50% of the outstanding Canadian and US term facilities. As a result changes in
the structure of the debt facilities impacted the overall interest expense
incurred throughout the period.

    
    UNIT BASED COMPENSATION

    For the years ended December 31,
    (thousands)                               2006         2005     % Change
    -------------------------------------------------------------------------
    Unit based compensation                  7,105        3,203        121.8
    


    The Trust has established a Trust Unit Incentive Plan to assist
directors, officers, employees and consultants of the Trust and its affiliates
to participate in the growth and development of the Trust and uses the fair
value method to calculate compensation expense associated with rights granted
under the Plan. This compensation expense is recognized into earnings over the
vesting period of the rights granted with a corresponding increase in
contributed surplus. As a result of applying the fair value method, unit based
compensation increased from $3.2 million in 2005 to $7.1 million in 2006, an
increase of $3.9 million. Increases are a result of the continuing growth of
the Trust and three additional option grants completed in the year.

    
    FOREIGN EXCHANGE (GAIN) LOSS

    For the years ended December 31,
    (thousands)                               2006         2005     % Change
    -------------------------------------------------------------------------
    Foreign exchange (gain) loss               533          (87)       712.6
    


    In the third quarter of 2005, the commencement of operations through the
release of the first newly constructed drilling rig in the United States
resulted in a revaluation of the US operations into Canadian currency for the
purposes of financial reporting. The acquisition of Cheyenne Drilling and
continued deployment of drilling rigs in the United States has reduced the US
reliance on the Canadian operations, resulting in the US operations being
considered a self-sustaining operation effective January 1, 2006. Therefore,
upon consolidation of the US operations, gains and losses due to fluctuations
in the foreign currency exchange rates are deferred on the balance sheet as a
component of equity; however, gains and losses in the Canadian entity on US
denominated balances continue to be recognized in the income statement. For
the year ended 2006, the Trust recognized a loss of $0.5 million in comparison
with a gain of $0.1 million in 2005 which was attributable to fluctuations in
the Canadian and US currency rates. The Trust has mitigated its overall
exposure to currency fluctuations through the increased financial independence
of the US operations as a result of the US debt facility which was closed in
April 2006 and through utilizing funds flows generated from the US market to
fund the ongoing operations.

    
    DEPRECIATION AND AMORTIZATION

    For the years ended December 31,
    (thousands)                               2006         2005     % Change
    -------------------------------------------------------------------------
    Depreciation                            50,983       27,939         82.5
    Amortization                             1,218          284        328.9
    (Gain) loss on sale of assets           (1,879)         263        814.4
    


    Depreciation increased 82.5% on year-to-date basis from $27.9 million in
2005 to $51.0 million in 2006. Changes in the composition of Trinidad's asset
base through acquisitions and the current rig construction program have
resulted in the addition of drilling rigs with increased drilling depth,
increasing the capital cost of the Trust's asset base. This increased the per
day depreciation rates by $381 per drilling day to $2,604 in 2006 from $2,223
in 2005. Increased rates per drilling day and increases in the number of
drilling days from 12,570 in 2005 to 19,577 in 2006 produced higher
depreciation in the current year. This increase has been offset as a result of
management re-assessing the useful life of the drilling and well servicing
rigs as of January 1, 2006 and increasing the useful life of its drilling rigs
from 3,300 drilling days (10% salvage value) to 4,200 drilling days (10%
salvage value) and its well servicing rigs from 15 years (20% salvage value)
to 24,000 hours (20% salvage value) to be more reflective of the actual useful
life of the assets.
    Amortization expense increased from $0.3 million in 2005 to $1.2 million
in 2006 as a result of the Trust closing its new debt agreement. Previously
deferred financing costs of $0.8 million at the end of 2005 associated with
the old facility were expensed in 2006 and the financing costs related to the
new debt facility were capitalized and amortized into income throughout the
period.
    Throughout the year Trinidad disposed of one of its drilling rigs for
proceeds of $5.4 million which resulted in a one time gain of $2.0 million
being recognized into earnings. This gain was offset through several smaller
dispositions throughout the year netting to a gain of $1.9 million in 2006.

    
    INCOME TAXES

    For the years ended December 31,
    (thousands)                               2006         2005     % Change
    -------------------------------------------------------------------------
    Current income tax                        (388)       1,420       (127.3)
    Future income tax                       15,955        8,183         95.0
    


    In the second quarter the Canadian government passed the 2006 Federal
Budget which enacted several tax reductions for corporations, specifically a
reduction in general corporate tax rates from 21.0% to 19.0% phased in from
2008 to 2010, the elimination of the federal large corporation tax effective
January 1, 2006 and the elimination of the corporate surtax effective
January 1, 2008. Additionally, the Alberta government also substantively
enacted a reduction in corporate tax rates from 11.5% to 10.0% effective
April 1, 2006. Despite increases in the Trust's capitalization, the recovery
position in 2006 resulted from the reversal of previously booked federal large
corporation tax as well as realization of the tax reductions that were
substantively enacted.
    Future income tax expenses increased 95.0% from $8.2 million in 2005 to
$16.0 million in 2006. The increase in future income tax expense resulted from
higher depreciation rates for tax purposes which increased the taxable
temporary difference between the accounting value and the tax value on the
Trust's capital assets. This increase was offset by lower future income tax
rates as a result of the Federal Budget changes and further reductions to the
Trust's taxable income from increases in monthly distributions to unitholders.
    On December 21, 2006, the Minister of Finance released for comment draft
legislation concerning the taxation of certain publicly traded trusts. The
legislation reflects proposals originally announced by the Minister on
October 31, 2006. Under the proposed legislation, Income Trusts will be taxed
on a basis similar to corporations, where distributions made from the Trust to
unitholders will be taxed at the Trust level. Under the proposed plan, income
distributions will first be taxed at the Trust level at a special rate
estimated to be 31.5%, and for taxable Canadian residents distributions will
be treated as dividends from a Canadian corporation and will be eligible for
the dividend tax credit. The government is proposing a four-year transition
period for existing Trusts and as such Trinidad will not be subject to the
proposed measures until it's 2011 taxation year. It is not known at this time
if or when the proposal will be enacted by Parliament.
    We encourage our unitholders to read the full transcript of the
government's plan at www.fin.gc.ca/news06/06-061e.html and to consult their
personal financial and tax advisors regarding the potential tax consequences.
Unitholders may also express their views directly to the Minister of Finance,
whose contact information is available at www.fin.gc.ca/admin/contract-e.html.

    
    NET EARNINGS AND FUNDS FLOW

    For the years ended December 31,
    (thousands)                               2006         2005     % Change
    -------------------------------------------------------------------------
    Net earnings                           123,706       47,427        160.8
      Per unit (diluted)                      1.46         0.79         84.8
    Funds flow from operations             196,924       87,299        125.6
      Per unit (diluted)                      2.33         1.45         60.7
    


    Trinidad increased consolidated net earnings by 160.8% from $47.4 million
to $123.7 million achieved through the diversification of the Trust's
operations in both Canada and the US. Despite lower industry wide utilization
levels in Canada, stabilization of net income was obtained through the Trust's
expansion into the US market. This provided overall stability to annualized
funds flow and net earnings through its growth into a market which is
uninterrupted by the seasonal conditions that are present in the Canadian
operations. This growth in net income reflects the expansion of Trinidad's
fleet through its current rig construction program. The acquisition of Mastco
in the first quarter of 2006 placed Trinidad in a favourable position to
execute on its rig construction program resulting in the Trust releasing six
Canadian rigs throughout the year. The further deployment of US rigs committed
under the current rig construction program continues to generate increased
revenues. Throughout the period the Trust's ongoing focus on delivering
superior performance to its customers has allowed us to exceed industry
utilization levels. Trinidad's ability to execute on market opportunities is
expanding the Trust's overall operations to ensure greater future stability of
net income and funds flow. Higher operating margins and conservative general
and administrative expenditures also contributed to net earnings, offset by
increased interest and depreciation expense that were triggered through the
growth of the Trust's operations.
    Funds flow from operations before change in non-cash working capital for
the year increased from $87.3 million ($1.45 per unit (diluted)) in 2005 to
$196.9 million ($2.33 per unit (diluted)) in 2006 as a result of significant
growth in revenues and increases in gross margin throughout the period. The
Trust continues to follow an investment strategy designed to ensure accretive
growth for unitholders, including the expansion into the US market as well as
diversification of the Trust's asset base which contributed to the overall
growth in funds flow throughout the period.

    
    FOURTH QUARTER ANALYSIS

    ---------------------------------------------------------------
                                                2006
    (millions except per
     unit data)                   Q4        Q3        Q2        Q1
    ---------------------------------------------------------------
    Financial Highlights

    Revenue                    161.9     150.6     104.5     162.9
    Gross margin(1)             74.9      66.9      43.1      84.7

    Net earnings (loss)         31.3      31.6      20.8      40.0
    Depreciation and
     amortization               15.4      14.0       9.7      13.1
    (Gain) loss on assets        0.1      (2.0)        -         -
    Unit based compensation      1.8       0.7       0.8       3.8
    Future income tax expense
     (recovery)                  6.2       4.6      (8.7)     13.9
    Unrealized foreign
     exchange loss (gain)       (0.1)        -       0.2      (0.2)
    Other                          -       0.1      (0.3)      0.1
                            ---------------------------------------
    Funds flow before change
     in non-cash working
     capital(1)                 54.7      49.0      22.5      70.7

    Earnings (loss) per unit
     (diluted)                  0.37      0.38      0.24      0.48
    Funds flow before change
     in non-cash working
     capital per unit
     (diluted)(1)               0.65      0.57      0.26      0.84

    Operating Highlights

    Operating days - drilling
      Canada                   3,163     3,358     1,826     4,184
      United States            2,105     1,891     1,603     1,447
    Rate per drilling day
     (CDN $)
      Canada                  26,328    23,083    23,927    23,579
      United States           24,621    24,042    24,089    21,596
    Utilization rate -
     drilling
      Canada                      61%       64%       36%       86%
      United States               85%       85%       82%       85%
    CAODC industry average        47%       57%       34%       81%
    Number of drilling rigs
      Canada                      60        59        57        56
      United States               31        26        22        21
    Utilization for service rigs  64%       68%       31%       85%
    Number of service rigs        18        18        17        17
    Number of coring and
     surface casing rigs          17        17        17        17
    ---------------------------------------------------------------


    -------------------------------------------------------------------------
                                                2005                    2004
    (millions except per
     unit data)                   Q4        Q3        Q2        Q1        Q4
    -------------------------------------------------------------------------
    Financial Highlights

    Revenue                    106.4      75.3      32.5      74.1      58.8
    Gross margin(1)             46.4      31.8       7.8      34.5      26.8

    Net earnings (loss)         19.4      13.8      (1.8)     16.0      15.1
    Depreciation and
     amortization                9.3       8.0       3.4       7.5       5.5
    (Gain) loss on assets        0.2       0.1         -         -       0.5
    Unit based compensation      0.6       0.5       2.0       0.1      (4.8)
    Future income tax expense
     (recovery)                  5.5       1.7      (4.0)      5.0       3.5
    Unrealized foreign
     exchange loss (gain)          -         -         -         -         -
    Other                          -         -         -         -         -
                            -------------------------------------------------
    Funds flow before change
     in non-cash working
     capital(1)                 35.0      24.1      (0.4)     28.6      19.8

    Earnings (loss) per unit
     (diluted)                  0.29      0.21     (0.03)     0.31      0.33
    Funds flow before change
     in non-cash working
     capital per unit
     (diluted)(1)               0.51      0.37     (0.01)     0.56      0.43

    Operating Highlights

    Operating days - drilling
      Canada                   3,795     3,487     1,472     3,544     3,011
      United States              235        37         -         -         -
    Rate per drilling day
     (CDN $)
      Canada                  23,280    19,196    19,448    20,121    18,942
      United States           19,245    20,122         -         -         -
    Utilization rate -
     drilling
      Canada                      78%       73%       31%       76%       76%
      United States               83%      100%        -         -         -
    CAODC industry average        71%       63%       32%       71%       62%
    Number of drilling rigs
      Canada                      54        52        52        52        51
      United States               17         1         -         -         -
    Utilization for service rigs  67%       61%       41%       69%       61%
    Number of service rigs        16        16         9         9         8
    Number of coring and
     surface casing rigs          17        18        18         -         -
    -------------------------------------------------------------------------
    (1) Readers are cautioned that gross margin and funds flow before change
        in non-cash working capital and per unit information do not have a
        standardized meaning prescribed by GAAP; however, the Trust does
        compute gross margin and funds flow before change in non-cash working
        capital and the per unit information on a consistent basis for each
        reporting period. Funds flow before change in non-cash working
        capital has replaced the term cash flow before change in non-cash
        working capital as shown in previous filings.
    

    Throughout the fourth quarter of 2006, reduction in activity levels seen
earlier in the year throughout the drilling industry continued to be present
as the overall market softened due to declines in commodity prices from the
comparable quarter in 2005. This resulted in a reduction in utilization rates
across the industry from 71% in the fourth quarter of 2005 to 47% in 2006.
Throughout this period of interim instability Trinidad continued to exceed
industry utilization by 29.8% despite slight decreases from the third quarter
2006. A continued focus on long-term contracts and the deeper drilling market
shielded the Trust from some of the market turbulence throughout this period.
Additionally, in the Canadian drilling market, two of the rigs that were
completed at the end of the prior quarter were put into operation and the
completion of one more rig increased overall revenue quarter-over-quarter. The
US drilling operations continued to provide increased stability to revenues
and funds flow throughout the fourth quarter, maintaining utilization rates of
85% at drilling rates of $24,621 per day. As the US operations are not subject
to the seasonal conditions and have less susceptibility to the fluctuations in
the Canadian market, this has been a significant factor in the growth of
revenue and funds flow throughout the year. These factors resulted in
increased revenue of $11.3 million from $150.6 million in the third quarter to
$161.9 million in the fourth quarter of 2006; and increased revenue on a
quarter-over-quarter basis from $106.4 million in 2005 to $161.9 million in
2006.
    Consolidated gross margin increased for the fourth quarter of 2006 to
$74.9 million from $46.4 million in 2005 and gross margin percentages
increased to 46.3% from 43.6% in 2005, an increase of 6.2%. The increased
contribution of the US operations, which currently generates higher margins
than the Canadian market, resulted in the increases quarter-over-quarter.
    Net earnings in the fourth quarter of 2006 increased by 61.3% from
$19.4 million in 2005 to $31.3 million due to the significant growth of the
Trust's operations and increases in revenue and gross margins as operations
have been expanded. This increase was offset by increases in depreciation and
amortization of 65.6% from $9.3 million in the fourth quarter of 2005 to
$15.4 million in 2006 and increase in general and administrative expenses of
$4.4 million to $13.8 million in 2006. Interest expense for the quarter also
increased to $7.0 million in 2006 from $1.6 million in 2005 as a result of
advances which were made on the debt facility throughout the quarter as
Trinidad executed on its build commitment.


    
    LIQUIDITY AND CAPITAL RE

SOURCES For the years ended December 31, (thousands) 2006 2005 2004 ------------------------------------------------------------------------- Working capital 58,246 45,289 11,884 Bank overdraft - - 1,988 Operating line of credit - - 8,000 Current portion of long-term debt 3,232 9,494 6,482 Long-term debt 388,276 95,956 60,909 ---------------------------------------- Total debt 391,508 105,450 77,379 ---------------------------------------- Total debt as a percentage of assets 31.4% 12.7% 20.8% Net debt(1) 330,030 50,667 49,025 Net debt as a percentage of assets(1) 26.5% 6.1% 13.2% Total assets 1,245,633 833,316 372,454 Total long-term liabilities 434,065 125,344 79,001 Total long-term liabilities as a percentage of assets 34.8% 15.0% 21.2% Unitholders' equity 698,092 641,430 255,055 Total debt to unitholders' equity 56.1% 16.4% 30.3% Net debt to unitholders' equity(1) 47.3% 7.9% 19.2% (1) Readers are cautioned that net debt does not have a standardized meaning prescribed by GAAP and therefore may not be comparable to similar measures presented by other issuers; however, the Trust does compute net debt on a consistent basis for each reporting period. Net debt refers to the Trust's long-term debt less it's working capital position and is indicative of the Trust's overall indebtedness. Effective April 18, 2006, the Trust closed a new syndicated loan agreement in both Canada and the US that increased the principal available from $250.0 million to a facility comprised of a $250.0 million Canadian revolver, a $100.0 million Canadian five-year term facility and a $125.0 million US five-year term facility, representing a total debt facility of approximately $495.7 million. On closing, the Trust drew down on both the $125.0 million US term facility and $175.0 million of the Canadian term and revolving facilities. The debt drawn on the new agreement was used to repay amounts previously drawn under the prior debt facility and the remainder was retained for the execution of the Trust's rig construction program. As a result of the draw down on the new debt facility and the further execution of our rig construction program total debt increased by $286.1 million from the prior year of which approximately $54.0 million was drawn in the fourth quarter of 2006. These advances, along with funds flow from operations, have been used to fund capital additions of $111.3 million throughout the quarter and $357.9 million year-to-date. Expected costs to complete the current rig construction program are estimated to be $44.8 million and will be funded through total cash available under the debt facilities of approximately $104.2 million, cash on hand and funds flow from operations. Effective June 2005 Trinidad closed an equity issuance to fund the capital requirements on the rig construction program for net proceeds of $118.6 million. The proceeds from this issuance were used to repay debt facilities that were previously drawn, reducing the overall debt levels of the Trust. Throughout 2005, as the Trust executed its rig construction program, advances were made on the debt facility to fund the capital requirements of the rig construction program of which only $82.5 million of the $401.0 million total costs of construction were paid, resulting in abnormally low debt levels at the end of 2005. In 2006, as Trinidad executed on the rig build program, advances on the debt facility increased both total debt as a percentage of assets and net debt as a percentage of assets. Despite the total growth in debt from $105.5 million to $391.5 million debt as a percentage of assets only increased from 12.7% to 31.4%. Internally generated funds flow resulting from the deployment of additional rigs throughout 2006 in both Canada and the US has been utilized to further advance the rig construction program. As the Trust continues to deploy additional rigs throughout the early part of 2007, the additional funds generated will be utilized to complete both the remaining obligations under the current rig construction program as well as complete the additional five rigs announced in January 2007. Working capital increased by $13.0 million throughout the year from $45.3 million to $58.2 million. This increase is primarily a result of increases in accounts receivable of $55.2 million from the prior year, offset by an increase in accounts payable and accrued trust unit distributions of $41.6 million due to the expansion of the Trust's activities. Additionally with the acquisition of Mastco, working capital was increased through the inventory levels being maintained on the Trust's construction operations of $7.5 million. Despite reductions in market activity the Trust continues to exceed industry utilization and is in a favourable working capital position moving into 2007. Unitholders' equity increased as a result of the 1.5 million trust units ($24.7 million) that were issued to the former shareholders of Mastco and net earnings, net of distributions paid, of $19.0 million. Additionally proceeds on options and rights exercised throughout the period of $8.3 million increased overall unitholders' equity throughout the period. Effective September 14, 2006, Trinidad announced its intent to acquire for cancellation up to 10% (7,336,882 trust units) of the Trust's publicly traded units by way of a Normal Course Issuer Bid ("NCIB") commencing September 18, 2006 and extending to September 17, 2007. During the year the Trust repurchased 66,500 units at a cost of $0.9 million which were cancelled in the year. Purchases under the NCIB are at the discretion of management and will be made with internal funds flow generated throughout the year. The Trust has several capital and operating lease agreements on buildings and equipment. The future lease obligations for the next five years are summarized below: (thousands) ------------------------------------------------------------------------- 2007 3,024 2008 2,774 2009 2,412 2010 2,052 2011 7,154 In 2005 and early 2006, Trinidad announced its intent to expand its existing drilling fleet through the construction of 29 new diesel electric drilling rigs which will be deployed in both Canada and the US. This construction program has enabled the Trust to actively pursue growth opportunities in both markets and provide accretive growth to its unitholders. All of the rigs are backed by take-or-pay contracts which provide for committed drilling days and drilling rates over the next three to five years. Furthermore, the cost of construction on five of the rigs has been partially financed through customer contributions, to be returned based on drilling days over the term of the contract. Total capital costs of construction are expected to be $401.0 million, of which approximately $356.2 million has been paid as at December 31, 2006. Four of these rigs were completed and deployed in 2005 and an additional 15 throughout 2006 with the remainder scheduled to be delivered in the first and second quarter of 2007. The rig construction program continues to be a major focus of the Trust and the acquisition of Mastco at the end of the first quarter of 2006 positioned Trinidad favorably to execute on its rig construction program and increased Trinidad's influence over the ability to meet delivery schedules. On January 26, 2007, Trinidad announced the construction of an additional five new customer backed rigs to the rig construction program. All five rigs will be operating in the US, each backed by take-or-pay contracts, providing committed drilling days and drilling rates over the next three years. Total capital costs of construction are estimated to be $80.0 million which is being funding through Trinidad's recently expanded credit facility and internal cash flow. Approximately $33.8 million has been paid as at February 20, 2007. ------------------------------------------------------------------------- UNITHOLDERS' CAPITAL For the years ended December 31, (thousands) 2006 2005 ------------------------------------------------------------------------- Unitholders' capital 669,584 621,972 Exchangeable shares 5,777 19,602 ------------------------------------------------------------------------- Unitholders' capital increased from the 2005 year-end by $47.6 million, with the issuance of an additional 4.1 million trust units. This increase resulted from the conversion of 347,100 Initial Series exchangeable shares ($2.7 million) to 403,332 trust units, 1,048,817 Series C exchangeable shares ($11.1 million) to 1,102,298 trust units and the conversion of 1,138,287 options and rights ($8.3 million) into trust units. Furthermore, the expansion of the Trust's operations through the acquisition of Mastco also increased unitholders' capital through the issuance of 1.5 million trust units ($24.7 million). This acquisition has improved the Trust's operational flexibility by enhancing its ability to deliver on its current rig construction program, complete future rig recertifications and execute on ongoing maintenance programs. Under the Trust's Normal Course Issuer Bid program, the Trust purchased and cancelled 66,500 units at a cost of $0.9 million for the year ended December 31, 2006. The excess of the purchase price over the carrying amount of the units purchased of $0.4 million is recorded as reduction of accumulated earnings. Unitholders' capital on February 20, 2007 was $670.7 million (83,092,336 units). ------------------------------------------------------------------------- DISTRIBUTIONS Three months ended Twelve months ended December 31, December 31, (thousands except unit and per unit data - Unaudited) 2006 2005 2006 2005 ------------------------------------------------------------------------- Cash flow from operating activities 32,584 18,476 152,478 54,219 Net change in non-cash operating working capital 22,116 16,485 44,446 33,080 --------------------------------------------------- Funds flow before change in non-cash working capital 54,700 34,961 196,924 100% 87,299 100% Distributions paid & declared (28,629) (17,216) (105,475) 54% (51,905) 59% --------------------------------------------------- Funds retained for growth, debt reduction & future distribution 26,071 17,745 91,449 46% 35,394 41% Funds flow before change in non-cash working capital per unit (basic(1)) 0.65 0.53 2.37 1.48 Distributions paid & declared per unit (0.34) (0.26) (1.27) (0.88) --------------------------------------------------- Funds retained per unit 0.31 0.27 1.10 0.60 Quarter ending annualized distribution per unit 1.38 1.02 ------------------------------------------------------------------------- (1) Includes trust units to be issued upon conversion of exchangeable shares. During the year, Trinidad distributed $105.5 million, an increase of $53.6 million or 103.2%, from the comparative quarter in the prior year. The Trust's focused strategy of identifying accretive acquisitions while sustaining the distributable funds flow from its current operations continues to provide opportunities for increased distributions to unitholders. This strategy has allowed the Trust to increase its annualized distribution levels twice throughout 2006 from $1.02 per unit at the beginning of the year to $1.38 per unit as at December 31, 2006. The Trust manages its distributions based on a payout ratio goal of up to 75%, and the remainder is retained for future growth opportunities, debt repayment, or incremental distributions to unitholders. CRITICAL ACCOUNTING ESTIMATES The preparation of the consolidated financial statements requires that certain estimates and judgements be made with regard to the reported amount of revenues and expenses and the carrying values of assets and liabilities. These estimates are based on historical experience and management judgement. Anticipating future events involves uncertainty and consequently the estimates used by management in the preparation of the consolidated financial statements may change as future events unfold, additional experience is acquired or the Trust's operating environment changes. Depreciation The accounting estimate that has the greatest impact on the Trust's financial results is depreciation. Depreciation of the Trust's property and equipment incorporates estimates of useful lives and residual values. These estimates may change as more experience is obtained or as general market conditions change impacting the operation of the Trust's capital assets. Effective January 1, 2006, the Trust re-assessed the useful life of its drilling and well servicing rigs for purposes of determining depreciation expense. As a result of this evaluation the Trust has increased the useful life of its drilling rigs from 3,300 drilling days (10% salvage value) to 4,200 drilling days (10% salvage value). This change in estimate has been applied prospectively and resulted in a reduction of depreciation expense of $9.1 million for the year ended December 31, 2006. In addition, the Trust has changed its policy for depreciating its well servicing rigs from 15 years (20% salvage value) to 24,000 hours (20% salvage value) to be more reflective of the useful life of the assets. This change in policy has been applied retroactively. The impact on prior years was immaterial for restatement and resulted in an increase of $0.4 million in depreciation expense for its well servicing rigs for the year ended December 31, 2006. The acquisition of Mastco in the second quarter diversified the Trust's operations providing it with the capability to design, manufacture, sell and refurbish drilling rigs and related equipment. As a result the Trust's asset base has been diversified to include rig construction and related equipment, creating an additional asset class for the Trust. This rig construction and related equipment has been assigned a useful life of five to 20 years and will be depreciated on a straight-line basis (with a 10% salvage value). Unit based compensation Compensation expense associated with rights at grant date are estimates based on various assumptions such as volatility, annual distribution yield, risk free interest rate and expected life using the Black-Scholes methodology to produce an estimate of the fair value of such compensation. Allowance for doubtful accounts receivable The Trust performs credit evaluations of its customers and grants credit based on past payment history, financial conditions and anticipated industry conditions. Customer payments are regularly monitored and a provision for doubtful accounts is established based on specific situations and overall industry conditions. The Trust's history of bad debt losses has been minimal and generally limited to specific customer circumstances; however, given the cyclical nature of the oil and gas industry, the credit risks can change suddenly and without notice. Goodwill In accordance with Canadian Generally Accepted Accounting Principles, the Trust performs an annual goodwill impairment test in the first quarter of each fiscal year. This test was performed and no goodwill impairment exists. NEW ACCOUNTING POLICIES Foreign currency translation Effective January 1, 2006, the Trust changed from the temporal method of foreign currency translation to the current rate method to account for the Trust's US operations. Based on events since December 31, 2005, Trinidad Drilling US is now considered a self-sustaining operation; hence the revenues and expenses of the subsidiary are translated at the average exchange rate for the period while assets and liabilities are translated at the current exchange rate in effect at the balance sheet date. Gains or losses resulting from these translation adjustments are included in the cumulative translation account in unitholders' equity. The change in accounting policy has been applied prospectively and resulted in a foreign exchange loss of $2.1 million being deferred and recorded in the cumulative translation account as at January 1, 2006. Derivative financial instruments The Trust has entered into contracts to manage economic exposure to market risks relating to interest rates. The Trust is impacted by interest rate changes based on the amount of floating rate debt outstanding. Derivative financial instruments are not used for trading or speculative purposes. The Trust formally documents all relationships between hedging instruments and the hedged items, the risk management objective and the method for assessing the effectiveness of the hedge. The effectiveness of the hedge is assessed both at inception of the hedge and throughout its term. If the derivative is deemed effective, and qualifies for hedge accounting, gains and losses are deferred until settlement of the derivative contract. If a derivative does not qualify for hedge accounting, gains and losses resulting from fluctuations in the fair value of the derivative are recognized into income in the period that they occur. DISCLOSURE CONTROLS & PROCEDURES Disclosure controls and procedures are designed to provide reasonable assurance that all information required to be disclosed by the Trust is recorded, processed, summarized and reported to senior management, including the CEO and CFO, in an appropriate manner to allow timely decisions regarding required disclosure. Trinidad Energy Services Income Trust has evaluated the effectiveness of the design and operation of disclosure controls and procedures, under the supervision of the CEO and the CFO. Internal controls over financial reporting are designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with Canadian GAAP. Based on the evaluation, the Trust has concluded that the disclosure controls and procedures and the design of internal controls over financial reporting, as defined under Multilateral instrument 52-109, Certification of Disclosures in Annual and Interim Filings were effective as of the end of the period covered by this report. The business process controls of Mastco have not been assessed at the process level as at December 31, 2006. In light of the short time period between the date of acquisition and the reporting date, a complete assessment over the design of internal controls was not feasible and as a result have relied on management review to assess the accuracy of the financial statements at each reporting date. Management is in the process of evaluating the design effectiveness of the process level controls at Mastco. There have been no changes in the Trust's internal controls over financial reporting during the year ended December 31, 2006 that have materially affected or are reasonably likely to materially affect the internal controls over financial reporting. OUTLOOK Trinidad will continue to develop its key competitive strengths: deeper drilling focus, modern rig fleet, and investment in both technology and personnel. With these initiatives effective throughout 2006 and 2007, Trinidad is favourably positioned to address the recent adjustment in customer drilling programs, as the primary decline has been focused on shallow gas drilling. Approximately 80% of Trinidad's drilling rigs, including the current rig construction program, are tailored to the medium and deeper drilling market with depths in excess of 2,000 metres. The focus on longer term contracts at fixed day rates and utilization levels has stabilized operational performance throughout the period. The current fleet will allow the Trust to effectively capitalize on the busy first quarter of 2007 and continue to deliver strong utilization performance. The US market has delivered exceptional results for 2006 and this is expected to remain stable as the US drilling industry is not affected by seasonal conditions and has been less impacted by the recent fluctuation in commodity prices. As the US operations become an even stronger force in 2007, the benefits to the stability and growth of the Trust's overall funds flow will surpass that of 2006, allowing the Trust to further optimize unitholders' return in the coming year. With the acquisition of Mastco, Trinidad has diversified its operations by integrating its current rig fleet with the expertise of a company that designs, manufactures, sells and refurbishes drilling rigs and related equipment. This provides Trinidad with increased flexibility over the current rig construction program and enhances the overall ability of the Trust to control the development of new rig designs and investment in technology. These benefits will allow Trinidad to complete one of the larger build programs undertaken in the Canadian drilling industry by the second quarter of 2007. We are focused on continuing to add to our distribution capabilities by accretively growing our business and continuing to be the market leader. All future capital investments will continue to be evaluated based on return on capital and focused on low risk operating environments. Trinidad Energy Services Income Trust is a growth-oriented oil and natural gas services provider based in Calgary, Alberta. Focusing on deeper drilling, modern rig fleets, in-house design and technology-based advancement, Trinidad has positioned itself as a premium service provider. Trinidad's growth is driven by chasing and capturing new horizons - advancing technologies, offering new services, entering new markets and performing strategic acquisitions. With the completion of the current rig construction programs, the Trust will have 106 drilling rigs ranging in depths from 1,000 - 6,500 metres. In addition to its drilling rigs, Trinidad has 18 service rigs that have been completely retrofitted or are new within the past five years and 17 pre-set and coring rigs. Trinidad is focused on providing modern, reliable, expertly designed equipment operated by well-trained and experienced personnel. Trinidad's drilling fleet is one of the most adaptable and competitive in the industry. "signed" Michael E. Heier "signed" Brent J. Conway ----------------------------- ----------------------------- Chairman of the Board Chief Financial Officer Chief Executive Officer The Toronto Stock Exchange has neither approved nor disapproved the information contained herein. ------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS As at December 31, (thousands) 2006 2005 ------------------------------------------------------------------------- Assets Current assets Cash and cash equivalents 9,413 11,749 Accounts receivable 151,990 96,764 Inventory 7,451 - Prepaid expenses 2,868 2,092 Future income taxes (note 6) - 1,226 ------------------------- 171,722 111,831 Deposit on capital assets 42,172 73,859 Capital assets (note 4) 903,111 567,387 Goodwill 123,483 79,429 Other long-term assets 5,145 810 ------------------------- 1,245,633 833,316 ------------------------- Liabilities Current liabilities Accounts payable and accrued liabilities 88,083 49,275 Accrued trust distributions 9,543 6,707 Current portion of deferred revenue 9,090 1,066 Current portion of long-term debt (note 5) 3,232 9,494 Future income taxes (note 6) 3,528 - ------------------------- 113,476 66,542 Deferred revenue 7,070 388 Long-term debt (note 5) 388,276 95,956 Future income taxes (note 6) 38,719 29,000 ------------------------- 547,541 191,886 Unitholders' equity Unitholders' capital (note 7) 669,584 621,972 Exchangeable shares (note 8) 5,777 19,602 Contributed surplus (note 7) 11,722 5,949 Cumulative translation adjustment (750) - Accumulated trust distributions (189,984) (84,509) Accumulated earnings 201,743 78,416 ------------------------- 698,092 641,430 ------------------------- 1,245,633 833,316 ------------------------- (See Notes to the Consolidated Financial Statements) Commitments (note 11) ------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS AND ACCUMULATED EARNINGS For the years ended December 31, (thousands except unit and per unit data) 2006 2005 ------------------------------------------------------------------------- Revenue Oilfield services 577,199 287,612 Other 2,656 720 ------------------------- 579,855 288,332 ------------------------- Expenses Operating 310,271 167,917 General and administrative 51,627 26,183 Interest 20,724 5,600 Unit based compensation 7,105 3,203 Foreign exchange (gain) loss 533 (87) Depreciation and amortization 52,201 28,223 (Gain) loss on sale of assets (1,879) 263 ------------------------- 440,582 231,302 ------------------------- Earnings before income taxes 139,273 57,030 Income taxes (note 6) Current tax expense (recovery) (388) 1,420 Future tax expense 15,955 8,183 ------------------------- 15,567 9,603 ------------------------- Net earnings 123,706 47,427 Charges for normal course issuer bid (note 7) (379) - Accumulated earnings - beginning of year 78,416 30,989 ------------------------- Accumulated earnings - end of year 201,743 78,416 ------------------------- Earnings per unit Basic 1.49 0.81 Diluted 1.46 0.79 Weighted average number of trust units Basic 83,078,833 58,850,122 Diluted 84,644,439 60,134,317 (See Notes to the Consolidated Financial Statements) ------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, (thousands) 2006 2005 ------------------------------------------------------------------------- Cash provided by (used in) Operating activities Net earnings for the year 123,706 47,427 Items not affecting cash Depreciation and amortization 52,201 28,223 (Gain) loss on assets (1,879) 263 Unit based compensation 7,105 3,203 Future income tax expense 15,955 8,183 Unrealized foreign exchange loss (gain) (164) - ------------------------- Funds flow from operations before change in non-cash working capital 196,924 87,299 Net change in non-cash operating working capital (44,446) (33,080) ------------------------- 152,478 54,219 ------------------------- Investing activities (Increase) decrease in deposits on capital assets 30,292 (46,480) Acquisition of Titan Surface Casing (note 3(a)) - (11,300) Acquisition of Summit Energy Services (note 3(b)) - (18,040) Acquisition of Cheyenne Drilling (note 3(c)) - (176,287) Acquisition of Mastco Derrick Services (note 3(d)) (15,804) - Purchase of capital assets (371,303) (98,231) Proceeds from dispositions 6,752 1,566 Change in non-cash working capital - accounts payable and accrued liabilities 12,166 16,061 ------------------------- (337,897) (332,711) ------------------------- Financing activities Decrease in bank overdraft - (1,988) Decrease in line of credit - (8,000) Increase in long-term debt 285,066 38,059 Increase in deferred revenue 195 - Net proceeds from unit issues (note 7) 8,272 310,499 Purchased units (note 7) (916) - Debt financing costs (5,258) (377) Trust unit distribution (105,475) (51,905) Change in non-cash working capital item - accrued distributions 2,836 3,953 ------------------------- 184,720 290,241 ------------------------- Cash flow from operating, investing, and financing activities (699) 11,749 Effect of translation on foreign currency cash (1,637) - ------------------------- Increase (decrease) in cash for the year (2,336) 11,749 Cash - beginning of year 11,749 - ------------------------- Cash - end of year 9,413 11,749 Interest paid 17,317 5,494 Taxes paid 1,207 866 (See Notes to the Consolidated Financial Statements) NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1. STRUCTURE OF THE TRUST Organization Trinidad Energy Services Income Trust ("Trust") is an unincorporated open-ended investment trust formed under the laws of the Province of Alberta. The Trust was formed by way of an arrangement ("the Arrangement") under the Business Corporations Act of Alberta pursuant to an arrangement agreement dated August 8, 2002 between the Trust, Trinidad Drilling Ltd. and Acquisition Corp., a wholly-owned subsidiary of the Trust. The Arrangement involved the exchange of Trinidad Drilling Ltd. securities on a one-to-one basis for trust units of the Trust. The effective date of the Trust indenture was September 17, 2002. 2. ACCOUNTING POLICIES AND ESTIMATES These consolidated financial statements are prepared by management, in accordance with Canadian Generally Accepted Accounting Principles. The preparation of financial statements in accordance with Canadian Generally Accepted Accounting Principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, disclosure of contingent amounts and the reported amounts of revenues and expenses. Actual results could differ from these estimates. Principles of consolidation The consolidated financial statements include the accounts of the Trust and its subsidiaries, all of which are wholly-owned at December 31, 2006. Any reference to the Trust throughout these consolidated financial statements refers to the Trust and its subsidiaries. All intercompany transactions have been eliminated. Foreign currency translation Effective January 1, 2006, the Trust changed from the temporal method of foreign currency translation to the current rate method to account for the Trust's US operations. Revenues and expenses of the subsidiary are translated at the average exchange rate for the period while assets and liabilities are translated at the current exchange rate in effect at the balance sheet date. Gains or losses resulting from these translation adjustments are included in the cumulative translation account in unitholders' equity. The change in accounting policy has been applied prospectively and resulted in a foreign exchange loss of $2.1 million being deferred and recorded in the cumulative translation account as at January 1, 2006. Revenue recognition Revenue from contract drilling services are recognized based upon purchase orders or contracts with customers that specify fixed prices calculated on a daily or hourly base. Customer contracts do not include a provision for post-service delivery obligations. Revenue is recognized when services are performed and only when collectability is reasonably assured. Construction operations recognize revenue on a percentage of completion basis and only when collectability is reasonably assured. Losses are provided for in full when first determined. Deposits received on future contracts are recorded as deferred revenue and recognized as services are performed. Cash and cash equivalents Cash and cash equivalents consist of cash and short term investments with maturities of three months or less. Inventory Inventory consists of parts, materials and labour related to the construction, recertification and refurbishment of rigs and rig related equipment. Inventory is valued at the lower of cost (principally on the specific identification method) or net realizable value. Capital assets Capital assets are recorded at cost less accumulated amortization. Major renewals and improvements, which extend the future life of the asset, are capitalized, while repair and maintenance expenses are charged to operations as incurred. Disposals are removed at carrying costs less accumulated amortization with any resulting gain or loss reflected in operations. Any deposits or advances on the Trust's build programs are held as deposits on capital assets and any costs incurred internally on the construction of rig and rig related equipment are recorded as assets under construction. These costs will be held as deposit on capital assets or assets under construction until the related asset is ready for use at which time it will be capitalized. Depreciation is based on the estimated useful lives of the assets and is as follows: --------------------------------------------------------------------- Drilling rigs and related 4,200 drill days Unit-of-production equipment (10% salvage value) Drilling pipe and collars 1,300 drill days Unit-of-production Well servicing rigs 24,000 hours Unit-of-production (20% salvage value) Construction equipment 5 to 20 years Straight-line Buildings 25 years Straight-line Office furniture and other 5 years Straight-line equipment Automotive equipment 4 years Straight-line (10% salvage value) --------------------------------------------------------------------- Effective January 1, 2006, the Trust re-assessed the useful life of its drilling and well servicing rigs for purposes of determining depreciation expense. As a result of this evaluation the Trust has increased the useful life of its drilling rigs from 3,300 drilling days (10% salvage value) to 4,200 drilling days (10% salvage value). This change in estimate has been applied prospectively and resulted in a reduction of depreciation expense of $9.1 million for the year ended December 31, 2006. In addition, the Trust has changed its policy for depreciating its well servicing rigs from 15 years straight-line basis (20% salvage value) to 24,000 hours (20% salvage value) to be more reflective of the useful life of the assets. This change in policy has been applied retroactively. The impact on prior years was immaterial for restatement and resulted in an increase of $0.4 million in depreciation expense for its well servicing rigs for the year ended December 31, 2006. Goodwill Goodwill represents the excess of the purchase price over the fair values of the assets purchased. Goodwill is not subject to amortization, but is tested for impairment at least annually by applying a fair value based test. Any goodwill impairment will be recognized as an expense if the carrying amount of the goodwill exceeds its fair value. Deferred finance costs Costs associated with obtaining financing are deferred and amortized on a straight line basis over five years. The amortization is included in depreciation and amortization expense. Income tax The Trust follows the liability method of accounting for income tax. Under this method, income tax liabilities and assets are recognized for estimated tax consequences attributable to differences between the amounts reported in the financial statements and their respective tax basis, using substantively enacted income tax rates. The effect of a change in income tax rates on future tax liabilities and assets is recognized in income in the period that the change occurs. The Trust is a taxable entity under the Canadian Income Tax Act and is taxable only on the income that is not distributed or distributable to unitholders (note 6). Unit based compensation The Trust has established a Trust Unit Incentive Plan ("the Plan") to assist directors, officers, employees and consultants of the Trust and its affiliates to participate in the growth and development of the Trust. Compensation expense associated with rights granted under the Plan is deferred and recognized into earnings over the vesting period of the rights granted with a corresponding increase in contributed surplus. The Trust uses the fair value method using the Black-Scholes model to calculate compensation expense. Exchangeable shares Exchangeable shares which were issued by a subsidiary of the Trust are convertible into trust units based on an exchange ratio, which is adjusted monthly to reflect the distributions paid on the Trust units. These exchangeable shares are not transferable to third parties and can only be disposed of by exchanging them for trust units. As a result the exchangeable shares have been classified as part of unitholders' equity. Financial instruments The Trust's financial assets and liabilities consist of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, deferred revenue and long-term debt. The fair value of these financial assets and liabilities approximate their carrying value, unless otherwise noted. It is management's opinion that the Trust is not exposed to significant interest or credit risks other than such risk relating to non-hedged floating rate debt. Derivative financial instruments The Trust utilizes derivative financial instruments to manage economic exposure to market risks relating to fluctuations in interest rates. The Trust is impacted by interest rate changes based on the amount of floating rate debt outstanding. Derivative financial instruments are not used for trading or speculative purposes. The Trust formally documents all relationships between hedging instruments and the hedged items, the risk management objective and the method for assessing the effectiveness of the hedge. The effectiveness of the hedge is assessed both at inception of the hedge and throughout its term. If the derivative is deemed effective, and qualifies for hedge accounting, gains and losses are deferred until settlement of the derivative contract. If a derivative does not qualify for hedge accounting, gains and losses resulting from fluctuations in the fair value of the derivative are recognized into income in the period that they occur. Earnings per unit Earnings per unit is calculated using the weighted-average number of units and exchangeable shares outstanding during the year. Diluted calculations have been completed using the treasury method. 3. ACQUISITIONS (a) Acquisition of shares of Titan Surface Casing Ltd. On April 29, 2005 Trinidad Drilling, a subsidiary of the Trust, purchased all of the outstanding shares of Titan Surface Casing Ltd. ("Titan"), effective April 1, 2005, for consideration of $33.0 million. The acquisition was funded through the issuance of 1,961,132 exchangeable shares with a value of $20.8 million, the issuance of 85,960 trust units with a value of $0.9 million and cash of $3.4 million. As part of the Titan acquisition, at the time of closing, Trinidad was obligated to repay the $3.8 million of long- term debt and $4.1 million of shareholder loans. The exchangeable shares can be converted (at the option of the holder) into trust units at any time. The exchangeable shares are a new series of exchangeable shares which are not publicly traded and have an exchange ratio of 1:1 at the time of issuance. The exchangeable shares are exchangeable into trust units at any time up to five years after issuance, based on an exchange ratio that adjusts each time the Trust makes a distribution to its unitholders. The consideration paid for this acquisition has been allocated under the purchase method as follows: (thousands) 2005 --------------------------------------------------------------------- Purchase price allocated as follows: Working capital, net 13 Other assets 60 Goodwill 21,985 Capital assets 12,450 Future income taxes (1,496) ------------ 33,012 ------------ Financed as follows: Trust units 911 Exchangeable shares 20,788 Cash, net of working capital 11,300 ------------ 32,999 Plus: working capital 13 ------------ 33,012 ------------ Goodwill from this acquisition is not tax deductible. (b) Acquisition of assets of Summit Energy Services Inc. On September 30, 2005 Trinidad Well Servicing, a subsidiary of the Trust, purchased substantially all of the well servicing assets of Summit Energy Services Inc. for consideration of $18.0 million. The acquisition was funded through internal funds flow. The consideration paid for this acquisition has been allocated under the purchase method as follows: (thousands) 2005 --------------------------------------------------------------------- Capital assets 12,716 Goodwill 5,324 ------------ 18,040 ------------ Financed as follows: ------------ Internal funds flow 18,040 ------------ The total amount of goodwill arising from this acquisition that is tax deductible is $4.0 million. (c) Acquisition of assets of Cheyenne Drilling LP On December 20, 2005 Trinidad Drilling LP, a subsidiary of the Trust, purchased substantially all of the assets of Cheyenne Drilling LP ("Cheyenne") for consideration of $231.4 million. The acquisition was funded through $175.9 million in cash proceeds raised through the issuance of 10,666,667 trust units for gross proceeds of $189.9 million and the issuance of 3,696,786 trust units at a price of $15.00 to the shareholders of Cheyenne. The consideration paid for this acquisition has been allocated under the purchase method as follows: (thousands) 2005 --------------------------------------------------------------------- Capital assets 189,425 Goodwill 42,314 ------------ 231,739 ------------ Financed as follows: New equity raised net of issue costs 176,287 New equity issued to shareholders of Cheyenne 55,452 ------------ 231,739 ------------ The total amount of goodwill arising from this acquisition that is tax deductible is $42.3 million. (d) Amalgamation of Mastco Derrick Services Ltd. Effective March 16, 2006, the Trust amalgamated one of its wholly- owned subsidiaries with Mastco Derrick Services Ltd. ("Mastco") for consideration of $62.4 million less outstanding debts adjusted for net working capital. Mastco's purchase price is subject to a working capital adjustment which has not been finalized to date. The acquisition was funded through internal funds flow of $15.8 million and the issuance of 1,494,557 trust units with a value of $24.7 million. The consideration paid for this acquisition has been preliminarily allocated under the purchase method as follows: (thousands) 2006 --------------------------------------------------------------------- Purchase price allocated as follows: Working capital, net (21,808) Other assets 329 Goodwill 42,837 Capital assets 17,148 Future income taxes 2,018 ------------ 40,524 ------------ Financed as follows: Trust units 24,720 Cash, net of working capital adjustment 15,804 ------------ 40,524 ------------ Goodwill from this acquisition is not tax deductible. 4. CAPITAL ASSETS 2006 As at December 31, Accumulated Net Book (thousands) Cost Amortization Value --------------------------------------------------------------------- Rigs and rig related equipment 860,144 96,674 763,470 Automotive equipment and other equipment 15,288 4,592 10,696 Construction equipment 615 52 563 Building 23,234 938 22,296 Land 12,346 - 12,346 Assets under construction 93,740 - 93,740 ----------------------------------------- 1,005,367 102,256 903,111 ----------------------------------------- 2005 As at December 31, Accumulated Net Book (thousands) Cost Amortization Value --------------------------------------------------------------------- Rigs and rig related equipment 593,758 50,055 543,703 Automotive equipment and other equipment 8,064 2,041 6,023 Construction equipment - - - Building 11,156 133 11,023 Land 6,638 - 6,638 Assets under construction - - - ----------------------------------------- 619,616 52,229 567,387 ----------------------------------------- 5. LONG-TERM DEBT As at December 31, (thousands) 2006 2005 --------------------------------------------------------------------- Credit facilities(a) 382,037 95,080 Building loans(b) 8,752 9,100 Vehicle loans(c) 719 1,270 ------------------------- 391,508 105,450 Less: current portion of long-term debt (3,232) (9,494) ------------------------- 388,276 95,956 ------------------------- a) Effective April 18, 2006, the Trust closed a new syndicated loan facility to increase the principal available from $250.0 million to a facility comprised of a $250.0 million Canadian revolver and a $100.0 million Canadian five-year term facility. The Canadian revolving facility requires monthly interest payments and is renewable annually subject to the mutual consent of the lenders and the Trust. To the extent that the facility is not renewed the drawn down principal would be due 364 days later. The Canadian term loan requires monthly interest payments based on a spread over the one, two or three month BA rate and requires repayment based on one percent annual amortization and a balloon payment at its maturity date of May 1, 2011. A US subsidiary of the Trust closed a $125.0 million US dollar five-year term facility to fund the current US operations. This facility requires monthly interest payments based on a spread over the one, two or three month LIBOR rate and requires repayment based on one percent annual amortization and a balloon payment at its maturity date of May 1, 2011. The new facilities represent a combined Canadian dollar equivalent debt capacity of approximately $495.7 million and were structured by GE Energy Financial Services and syndicated by GE Capital Markets, Inc. The members of the syndicate group include major Canadian, United States and International financial institutions. This debt is secured by a general guarantee over the assets of the Trust. The effective interest rate on this facility was 7.6% for the year-ended. b) On December 15, 2005, Trinidad entered into a $9.1 million non-revolving credit facility with GE Canada on properties held by the Trust. The facility requires monthly interest payments at a rate of 6.26% per annum, matures June 2011 and is secured by the respective properties. c) The vehicle loans are payable over various periods from 24 months to 40 months at interest rates varying from 0% to 9%, and are secured by the related assets. 6. INCOME TAXES For the years ended December 31, (thousands) 2006 2005 --------------------------------------------------------------------- Net income before tax 139,273 57,834 Corporate tax rate 32.98% 34.16% ------------------------- Tax expense at statutory rate 45,932 19,756 Tax reduction arising from trust income distribution (26,765) (12,656) Non deductible expenses 2,156 1,136 Statutory and other rate differences (1,656) - Effect of change in expected tax rate (2,912) (344) Large corporation tax expense (388) 1,334 Other (800) 377 ------------------------- Total tax expense 15,567 9,603 ------------------------- The liability and asset for future income taxes on the Trust's balance sheet is comprised of the following temporary differences: As at December 31, (thousands) 2006 2005 --------------------------------------------------------------------- Loss carry forward 2,057 1,226 Unbilled revenue (5,585) - ------------------------- Future tax liability (3,528) 1,226 ------------------------- Loss carry forward 18,836 4,768 Capital assets (57,657) (33,731) Financing costs 102 (37) ------------------------- Future tax liability (38,719) (29,000) ------------------------- Loss carry forwards of $61.8 million have been recognized for income tax purposes of which $55.3 million have been recorded as a non- current future tax asset and are due to expire between 2025 and 2026. On December 21, 2006, the Minister of Finance released for comment draft legislation concerning the taxation of certain publicly traded trusts. The legislation reflects proposals originally announced by the Minister on October 31, 2006. Under the proposed legislation, income trusts will be taxed on a basis similar to corporations, where distributions made from the Trust to unitholders will be taxed at the Trust level. Under the proposed plan, income distributions will first be taxed at the Trust level at a special rate estimated to be 31.5%, and for taxable Canadian residents distributions will be treated as dividends from a Canadian corporation and will be eligible for the dividend tax credit. The government is proposing a four-year transition period for existing trusts and as such Trinidad will not be subject to the proposed measures until its 2011 taxation year. It is not known at this time if or when the proposal will be enacted by Parliament. 7. UNITHOLDERS' CAPITAL AND CONTRIBUTED SURPLUS a) Unitholders' Capital Authorized Unlimited number of trust units, voting, participating For the years ended December 31, (thousands except unit data) 2006 2005 --------------------------------------------------------------------- Number of Amount Number of Amount Units $ Units $ ------------------------------------------------ Unitholders' capital - opening balance 78,909,976 621,972 45,898,116 222,815 Trust units issued - for cash, net of issue costs - - 24,590,144 308,522 Trust units issued on acquisitions 1,494,557 24,720 3,782,746 56,363 Trust units issued on conversion of exchangeable shares 1,505,630 13,825 4,158,022 31,986 Trust units issued on exercise of options and rights 1,138,289 8,272 480,948 1,977 Trust units repurchased under normal course issuer bid (66,500) (537) - - Contributed surplus transferred on exercised options and rights - 1,332 - 309 ------------------------------------------------ Unitholders' capital - ending balance 82,981,952 669,584 78,909,976 621,972 ------------------------------------------------ Effective September 14, 2006 Trinidad announced its intent to acquire for cancellation up to 10% (7,336,882 trust units) of the Trust's publicly traded units by way of a normal course issuer bid ("NCIB") commencing September 18, 2006 and extending to September 17, 2007. During the year ended December 31, 2006 the Trust purchased 66,500 units at a cost of $0.9 million. The excess of the purchase price over the carrying amount of the units purchased and cancelled is recorded as a reduction of accumulated earnings. The per unit trust amounts were calculated on the weighted average number of units outstanding of 83,078,833 (2005 - 58,850,122). In the current year the calculated additional diluted units are 1,565,606 (2005 - 1,284,195) due to the dilutive impact of employee and director rights and options. b) Contributed surplus For the years ended December 31, (thousands) 2006 2005 --------------------------------------------------------------------- Contributed surplus - opening balance 5,949 3,055 Unit based compensation expense 7,105 3,203 Contributed surplus transferred on exercise of rights (1,332) (309) ------------------------- Contributed surplus - ending balance 11,722 5,949 ------------------------- 8. EXCHANGEABLE SHARES A subsidiary of the Trust has issued the following exchangeable shares: For the years ended December 31, (thousands except unit data) 2006 2005 --------------------------------------------------------------------- Number of Amount Number of Amount Shares $ Shares $ ------------------------------------------------ Exchangeable shares - opening balance 2,007,883 19,602 3,948,718 30,800 Exchangeable shares issued, Series C - Titan purchase - - 1,961,132 20,788 Exchangeable shares exchanged, Initial Series (347,100) (2,707) (1,707,162) (13,316) Exchangeable shares exchanged, Series B - - (1,641,026) (12,800) Exchangeable shares exchanged, Series C (1,048,817) (11,118) (553,779) (5,870) ------------------------------------------------ Exchangeable shares - ending balance 611,966 5,777 2,007,883 19,602 ------------------------------------------------ The exchange ratio for the 253,430 initial series exchangeable shares is 1.23871 and the trust units issuable upon conversion are 313,926. All Series B exchangeable shares were converted in the prior year. The exchange ratio for the 358,536 Series C exchangeable shares is 1.13161 and the trust units issuable upon conversion are 405,722. 9. UNIT OPTION AND RIGHTS PLAN Unit Option Plan The Trust Unit Option Plan provides for unit options to assist directors, officers, employees and consultants of the Trust and its affiliates to participate in the growth and development of the Trust. All options issued shall vest in equal proportions over a period of three years from the date of grant (unless otherwise determined by the Board of Directors at the time of issue) and, shall be exercisable for a period of five years from the date of grant. The options will have an exercise price not exceeding the closing trading price for the units on the Toronto Stock Exchange on the date immediately preceding the date of grant and not less than the price permitted by applicable securities law. The following summarizes the unit options that are outstanding under the Unit Option Plan as at December 31, 2006 and 2005 and the changes during these periods: For the years ended December 31, 2006 2005 --------------------------------------------------------------------- Weighted Weighted Average Average Number of Exercise Number of Exercise Options Price Options Price ------------------------------------------------ Outstanding - beginning of period 19,850 2.25 107,729 1.97 Granted during the period - - - - Exercised during the period (19,850) 2.25 (87,879) 1.91 Forfeited during the period - - - - ------------------------------------------------ Outstanding - end of period - - 19,850 2.25 ------------------------------------------------ All outstanding options at the beginning of the period were exercised during the year; hence there are no unit options outstanding as of December 31, 2006. For options granted in 2002, the Trust has elected to disclose the pro forma results as if the amended accounting standard had been applied retroactively. On May 24, 2002, the Trust issued 172,000 options under the Unit Option Plan at an exercise price of $1.58. The Trust recognized no compensation expense in respect of the options granted under its Unit Option Plan. The estimated fair value of these options, computed using the Black-Scholes model was approximately $120,000. If the Trust applied the fair value method of accounting for stock based compensation, the estimated fair value of $120,000 would be recognized as additional compensation expense over the vesting period of the options. The pro forma effect of applying this method of accounting would have no impact for the 2006 fiscal year (2005 - $15,781). There would be no effect on the basic and diluted earnings per trust unit. Trust Unit Rights Incentive Plan On May 2, 2003 the Trust established the Trust Unit Rights Incentive Plan for unit rights to assist directors, officers, employees and consultants of the Trust and its affiliates to participate in the growth and development of the Trust. The Trust Unit Rights Incentive Plan restricts the number of rights reserved for issuance such that it does not exceed 10% of the trust units outstanding. Rights granted vest 50% immediately and 25% on the first and second anniversary from the date of grant (unless otherwise determined by the Board of Directors at the time of issuance) and, shall be exercisable for a period of five years from the date of grant. The rights will have an exercise price not exceeding the closing trading price for the units on the Toronto Stock Exchange on the date immediately preceding the date of grant and not less than the price permitted by applicable securities law. The exercise price of rights may be adjusted downwards at the option of the rights holder from time to time by the amount, if any, that the distributions to unitholders in any calendar quarter exceed 2% (8% annually) of the Trust's net book value of capital assets. The following summarizes the unit rights that are outstanding under the Trust Unit Rights Incentive Plan as at December 31, 2006 and 2005 and the changes during these periods: For the years ended December 31, 2006 2005 --------------------------------------------------------------------- Weighted Weighted Average Average Number of Exercise Number of Exercise Rights Price Rights Price ------------------------------------------------ Outstanding - beginning of period 5,746,326 9.64 3,928,738 7.62 Granted during the period 3,890,818 15.13 2,257,724 12.22 Exercised during the period (1,118,437) 7.36 (393,069) 4.60 Forfeited during the period (271,868) 13.09 (47,067) 6.34 ------------------------------------------------ Outstanding - end of period 8,246,839 12.43 5,746,326 9.64 ------------------------------------------------ The range of exercise prices for the unit rights outstanding at December 31, 2006 is as follows: --------------------------------------------------------------------- Total Rights Outstanding Exercisable Rights Weighted Weighted Average Weighted Average Remaining Average Range of Exercise Life Exercise Exercise Prices Number Price (years) Number Price --------------------------------------------------------------------- $2.78 - $4.00 31,250 2.78 1.34 31,250 2.78 $4.01 - $6.00 252,537 5.30 1.86 252,537 5.30 $6.01 - $9.00 889,662 8.36 2.46 889,662 8.36 $9.01 - $12.50 3,358,262 11.23 3.23 2,663,757 10.97 $12.51 - $16.83 3,715,128 15.06 4.41 1,460,505 15.46 --------------------------------------------------------------------- $2.78 - $16.83 8,246,839 12.43 3.63 5,297,711 11.47 --------------------------------------------------------------------- The Trust uses the Black-Scholes option-pricing model to determine the estimated fair value of the unit rights issued subsequent to January 1, 2003. The per unit weighted average fair value of stock options granted during the year ended December 31, 2006 was $2.15 (2005 - $1.70). For the year ended December 31, 2006 the Trust recognized compensation expense included in the calculation of net earnings of $7.1 million (2005 - $3.2 million) using the following weighted average assumptions: For the years ended December 31, 2006 2005 --------------------------------------------------------------------- Expected volatility 35.3% 37.1% Annual distribution yield 8.4% 8.5% Risk free interest rate 3.5% 3.3% Expected life (years) 3.3 3.5 --------------------------------------------------------------------- 10. FINANCIAL INSTRUMENTS Effective July 1, 2006, Trinidad entered into two interest rate swap agreements to hedge the floating interest rates on fifty percent of the outstanding balances of the Canadian and US term debt facilities. These interest rate swaps mature concurrently with the long-term debt facility on May 1, 2011 allowing the Trust to mitigate its risk of interest rate fluctuations over the term of the debt agreement. Fifty percent of the outstanding balance of the Canadian term facility swapped interest based on a spread over the one month BA for a fixed interest rate of 5.362%. Simultaneously the Trust hedged fifty percent of the US term facility swapping interest based on a spread over the one, two or three month LIBOR for fixed interest of 6.108%. The effectiveness of the interest rate swaps were evaluated and found to be effective. As such the Trust has applied hedge accounting. For the year ended December 31, 2006, a loss of $0.5 million was recorded in interest expense. 11. COMMITMENTS The Trust has several capital and operating lease agreements on buildings and equipment. The future lease obligations for the next five years are summarized below: (thousands) --------------------------------------------------------------------- 2007 3,024 2008 2,774 2009 2,412 2010 2,052 2011 7,154 In 2005 and early 2006, Trinidad announced its intent to expand its existing drilling fleet through the construction of 29 new diesel electric drilling rigs which will be deployed in both Canada and the United States. This construction program has enabled the Trust to actively pursue growth opportunities in the market and provide accretive growth to its unitholders. All of the rigs are backed by take-or-pay contracts which provide for committed drilling days and drilling rates over the next three to five years. Furthermore, the cost of construction on five of the rigs has been partially financed through customer contributions, to be returned based on drilling days over the term of the contract. Total capital costs of construction are expected to be $401.0 million, of which approximately $356.2 million was paid as at December 31, 2006. Four of these rigs were completed and deployed in 2005 and an additional fifteen throughout 2006. The remaining rigs are scheduled to be delivered in the first and second quarter of 2007. 12. SEGMENTED INFORMATION The acquisition of Cheyenne Drilling, which closed December 20, 2005, and the current rig construction program have diversified the Trust's operations from its primary geographic focus in Western Canada to include locations in the United States, including the Rocky Mountain region, Mid Continent region, and the Texas and Oklahoma regions. This acquisition added additional rigs of varying depths and capabilities to the current drilling fleet operating in the Canadian market complementing the current drilling operations. Despite the similarities in the assets acquired, the increased management depth in the United States and the varying conditions between the Canadian and United States market has resulted in management evaluating the Trust's drilling operations performance on a geographically segmented basis. In addition, the acquisition of Mastco further broadened the operations of the Trust to include the capability to design, manufacture, sell and refurbish drilling rigs, and related equipment. The unique characteristics of this subsidiary from the Trust's core drilling operations have resulted in management's separate evaluation of its results. Transactions between the segments are recorded at cost and have been eliminated upon consolidation. --------------------------------------------------------------------- For the year ended United Inter- December 31, Canadian States Construc- segment 2006 Drillings Drilling tion Elimin- (thousands) Operations Operations Operations ations Total --------------------------------------------------------------------- Revenue 364,278 166,498 111,128 (62,049) 579,855 Operating expense 196,665 77,676 97,979 (62,049) 310,271 ------------------------------------------------------ Gross margin 167,613 88,822 13,149 - 269,584 Interest 12,151 8,424 149 - 20,724 Depreciation and amortization 30,749 20,994 458 - 52,201 (Gain) loss on assets (1,852) (27) - - (1,879) ------------------------------------------------------ Income before corporate items 126,565 59,431 12,542 - 198,538 General and administrative 51,627 Unit based compensation 7,105 Foreign exchange (gain) loss 533 Income taxes 15,567 ------------------------------------------------------ Net earnings 123,706 ------------------------------------------------------ Capital expenditures (including acquisitions and deposits) 158,517 199,358 74 - 357,949 Total assets 680,591 528,872 36,170 - 1,245,633 Goodwill 38,155 42,491 42,837 - 123,483 --------------------------------------------------------------------- --------------------------------------------------------------------- For the year ended United Inter- December 31, Canadian States Construc- segment 2005 Drillings Drilling tion Elimin- (thousands) Operations Operations Operations ations Total --------------------------------------------------------------------- Revenue 282,938 5,394 - - 288,332 Operating expense 164,701 3,216 - - 167,917 ------------------------------------------------------ Gross margin 118,237 2,178 - - 120,415 Interest 5,600 - - - 5,600 Depreciation and amortization 27,255 968 - - 28,223 (Gain) loss on assets 263 - - - 263 ------------------------------------------------------ Income before corporate items 85,119 1,210 - - 86,329 General and administrative 26,183 Unit based compensation 3,203 Foreign exchange (gain) loss (87) Income taxes 9,603 ------------------------------------------------------ Net earnings 47,427 ------------------------------------------------------ Capital expenditures (including acquisitions and deposits) 135,859 293,069 - - 428,928 Total assets 558,665 274,651 - - 833,316 Goodwill 37,115 42,314 - - 79,429 --------------------------------------------------------------------- 13. SUBSEQUENT EVENT On January 26, 2007, Trinidad announced the construction of an additional 5 new customer backed rigs to the rig construction program. All five rigs will be operating in the United States, each backed by take-or-pay contracts, providing committed drilling days and drilling rates over the next three years. Total capital costs of construction are estimated to be $80 million to be funded through Trinidad's recently expanded credit facility and internal cash flow. Approximately $33.8 million has been paid as at February 20, 2007. 14. COMPARATIVE FIGURES Certain of the comparative figures have been reclassified to conform to current year's presentation. Such reclassification did not impact previously reported net income or retained earnings.

For further information:

For further information: Michael Heier, Chairman & Chief Executive
Officer or Brent Conway, Chief Financial Officer at: Phone: (403) 265-6525,
Fax: (403) 265-4168; E-mail: twood@trinidaddrilling.com

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Trinidad Drilling Ltd.

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