FIVE YEAR FINANCIAL HISTORY
Dollars in 000’s except per share amounts
(1) Refer to MD&A: see “NON-GAAP MEASUREMENTS”
(2) Quarterly dividend was suspended in November 2015
(3) Equipment additions exclude non-cash additions
(4) Revenues and Adjusted gross margin % for 2012 to 2016 exclude Discontinued Operations. 2012 to 2015 amounts have been restated from prior presentation. Refer to note 10 in the audited financial statements
Table of contents
2 Report to Shareholders
5 Management's Discussion and Analysis
21 Management's Report
22
Independent Auditors' Report
23 Consolidated Financial Statements
27 Notes to Consolidated Financial Statements
47 Officers and Directors
Annual General Meeting:
Shareholders are invited to attend the Annual General Meeting which will be held at 2:00 pm on June 7, 2017 at our Head Office 6030 – 3 Street SE,
Calgary, Alberta.
Cathedral Energy Services Ltd. - 2016 Annual Report
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20162015201420132012Revenues80,866$ 106,243$ 208,655$ 150,850$ 139,935$ Adjusted gross margin % (1)22%18%21%22%30%Total Adjusted EBITDAS (1)5,840$ 7,699$ 38,487$ 32,815$ 40,824$ Diluted per share0.16$ 0.21$ 1.06$ 0.91$ 1.08$ Funds from continuing operations (1)1,031$ 4,410$ 32,114$ 25,359$ 33,270$ Gain on disposal / (Write-down of) recovery on investment in associate and related assets10,865$ -$ 177$ (13,070)$ -$ Write-downs of goodwill, equipment and inventory(277)$ (12,773)$ -$ -$ -$ Write-down of deferred taxes related to CRA settlement-$ (10,346)$ -$ -$ -$ Earnings (loss) before income taxes(722)$ (24,894)$ 8,112$ 5,241$ 13,861$ Basic per share(0.02)$ (0.69)$ 0.22$ 0.14$ 0.37$ Diluted per share(0.02)$ (0.69)$ 0.22$ 0.14$ 0.37$ Net earnings (loss)(5,779)$ (35,342)$ 10,283$ (1,542)$ 14,797$ Basic per share(0.16)$ (0.97)$ 0.28$ (0.04)$ 0.40$ Diluted per share(0.16)$ (0.97)$ 0.28$ (0.04)$ 0.39$ Cash dividends declared per share (2)-$ 0.1200$ 0.3300$ 0.3075$ 0.3000$ Property and equipment additions (3)899$ 6,908$ 30,763$ 28,283$ 30,650$ Weighted average shares outstandingBasic (000s)36,295 36,295 36,244 36,171 37,376 Diluted (000s)36,295 36,295 36,255 36,241 37,756 Working capital39,324$ 13,550$ 38,135$ 26,031$ 29,173$ Total assets136,017$ 155,610$ 230,534$ 205,375$ 224,080$ Loans and borrowings excluding current portion26,322$ 30,477$ 56,142$ 38,462$ 46,151$ Shareholders' equity90,772$ 96,607$ 128,368$ 126,612$ 137,932$ 2015 to 2012 restated for Discontinued Operations (4)
REPORT TO SHAREHOLDERS
In our report to shareholders for 2015, we described 2015 as a “challenging year” for the oilfield services industry and Cathedral. In hindsight, the
challenges of 2015 were merely a dress rehearsal for an even more challenging and demanding business environment for most of 2016. Although
we were faced with very strong head winds throughout most of 2016, we made significant progress in strengthening our financial position, mitigating
liabilities and improving our business operations. As the saying goes - what doesn’t kill you makes you stronger.
2016 opened with a significant decline in WTI oil prices into the $30/bbl U.S. dollar (“USD”) range and hitting lows in the $26/bbl range in January and
February. These price declines were all largely related to a persistent oversupply situation in the market. With many producing plays uneconomic at
price levels below $40/bbl and bankers putting pressure on energy companies’ borrowing bases, the industry quickly jumped into survival mode. The
average number of active drilling rigs in the U.S. declined 73% from 1,862 on average in calendar 2014 to a low of 404 active rigs in May 2016 (source:
Baker Hughes Rig Count data). A similar rig count drop was experienced in Canada exasperated by the annual spring break-up activity slowdown,
which in 2016 was more economically driven than by the onset of warmer weather. In Canada, there was an average of 48 rigs operating in 2016 Q2
compared to 96 rigs in the comparable quarter in 2015. As goes the rig count, so goes oilfield service company activity levels, especially those
leveraged to drilling such as Cathedral.
Our strategic themes for 2016 expanded on the objectives we set out in 2015 to get through the downturn:
1. Fiscal Management - Continue to balance our cost structure and short-term revenue prospects to ensure we meet our financial obligations and
not impact the long-term viability of the business.
2. Retaining Key Employees - Preserve our key employee base so when industry conditions improve we are able to ramp up our business quickly.
3. Operational Excellence - Continue to pursue operational and technology improvements to mitigate the impact of reduced activity levels and
pricing pressure and ensure we offer high operational performance levels to attract and retain customer work.
4. Enhance Sales Effectiveness – Focus on short and long-term revenue generation and market share growth opportunities.
A summary of our key accomplishments in each of these areas follows:
Fiscal Management
At the beginning of 2016, further wage rollbacks were implemented in the U.S. and Canada. Due to very low activity levels in Canada for the first half
of 2016, additional layoffs were required at the end of February to further contain costs. We also continued working with our suppliers to reduce costs
in many areas of our business. Of note were savings we negotiated with our landlords to reduce facility related expenditures and savings we achieved
by rationalizing our facilities.
At the same time activity levels were decreasing, we came under increasing price pressure from our customers. For most of 2016, the only source of
competitive differentiation for Cathedral and the oil field industry in general was price. This was despite the fact Cathedral can demonstrate to
customers the ability to reduce drilling days and thereby reduce their total well costs. Fortunately, many of our clients acknowledged our “Better
Performance Every Day” value proposition and we were still able to source and maintain work in early 2016.
With the declining cash flow in our business continuing from 2015 we were challenged to maintain our banking covenants in 2016. By the end of June,
following two amendments to our credit facility in the first half of 2016, we were under serious pressure from our banking syndicate to reduce our debt
levels. This pressure was further augmented by the lending syndicate members having different views on the outlook for our business and their
respective longer-term commitment to us as a client. In early summer, our lending syndicate dictated a significant reduction in our credit facility
availability starting in 2016 Q3.
In early 2016, we had approached Export Development Canada ("EDC") to assist with securing additional liquidity. EDC has a mandate to support
the energy industry and in particular, companies with growing international operations like Cathedral. In August, EDC joined our lending syndicate
allowing the prior lending syndicate members to reduce their lending exposure while at the same time also allowing Cathedral to increase our available
credit by $3,000. EDC came into support Cathedral at what was the darkest hour for the industry and we are truly grateful for their support and their
belief in our business strategy.
By mid-2016, it was beginning to appear that the supply and demand fundamentals for oil and natural gas were starting to improve as WTI prices
moved into the $45/bbl range. As a result, customer and investor confidence in the sector started to improve and more funds were dedicated to drilling
and completions activity. This was evidenced in the uptick in the rig count from the lows in May and increases in our activity levels starting in the late
summer. At the same time our lenders were reducing our credit availability, we recognized we would need funds to hire staff, ensure our equipment
fleet was sufficient to meet demand and to fund the working capital needs associated with increasing accounts receivables. This situation, in part, led
us to consider a strategic alternatives process.
In August, Cathedral’s board analyzed the various alternatives available to the Company to provide its stakeholders with the best solution to achieve
the growth prospects available to the Company with improving industry conditions. The result of this was a proactive decision to retain the services
of an investment-banking firm to assist us with securing additional financial capacity and examine ways for Cathedral to gain future size and scale in
order to maximize our potential for our shareholders.
In late 2016, as a result of the strategic alternatives process, we elected to divest our Flowback and Production Testing (“F&PT”) division for proceeds
of $17,800. Due to low activity levels in 2016, we had made the decision to downsize and restructure our U.S. F&PT business. The challenges with
restarting the U.S. F&PT business along with the value we extracted for the assets relative to their future cash flow generating potential supported the
decision to divest the business.
Subsequent to the sale of the F&PT business, in mid-January we finalized our seventh amendment to our credit facility with the Bank of Nova Scotia
and EDC continuing to support us. Immediately thereafter, we were able to complete an equity financing in mid-February for gross proceeds of
$14,100. The public equity financing, conducted by way of a bought deal offering, was oversubscribed by investors resulting in us increasing the
offering size. Management and the board participated in the financing by way of a private placement. The net proceeds from this financing were
initially used to repay bank indebtedness. Post financing, our bank debt will effectively be nil, except for outstanding letters of credit, down from
$56,000 at the end of 2014. The F&PT divestiture and the equity financing gives Cathedral capacity to fund ongoing working capital requirements
driven by increased business activity, increase our productive capacity through funding equipment upgrades and capital expenditures and to support
other growth initiatives.
At the same time we were dealing with the above challenges, we also made progress on dealing with a number of other corporate matters and
contingent liabilities. In 2016 Q1, Cathedral completed the sale of its wholly owned Barbados subsidiary, Directional Plus International Ltd. ("DPI”).
DPI held the Company’s investment in Venezuela and this sale completed Cathedral’s exit from carrying on a business in Venezuela. Although the
net sale proceeds on sale of DPI were $nil, the purchaser assumed liabilities of approximately $13 million. In 2016 Q3, we negotiated a settlement
of our collective action wage and hour lawsuits in the U.S. We employed an innovative approach to dealing with this challenge which involved a
Cathedral Energy Services Ltd. - 2016 Annual Report
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structured payment plan. It was important to deal with this liability as it was creating significant uncertainty in the market with investors and consuming
a large amount of management’s time and energy. In 2016 Q4 we also resolved a dispute with a customer related to an alleged down-hole drilling
incident under favorable terms to both parties along with a structured payment plan.
Going into 2017, Cathedral has a very strong balance sheet and we can now focus our full attention on operations and exploring ways to further grow
our business both organically and through potential transactions.
Retaining Key Employees
Although we have had to reduce our employee base significantly over the past two years, we have retained our core team. Retaining this team was
critical to ensuring we had the capability to ramp our business back up. Having a talented team in place is important as attracting people back to the
industry is going to be a key challenge in 2017. The fact that our core team is intact was facilitated in part by favoring salary and wage rollbacks over
layoffs during the downturn. We sincerely thank our staff for their support over the past 2 years.
Operational Excellence
As a consequence of a lower commodity price environment, energy companies are acutely focused on cost reduction and performance. Our value
proposition, “Better Performance Every Day”, positions Cathedral favorably with our customers from a cost impact perspective as we have the ability
to reduce their drilling days for a well. Our value proposition is supported by three key attributes; our proprietary technology, our Drilling Optimization
offering and the quality and experience of our people. In addition, due to our size and scale, we offer larger customers the ability to assist them on
larger multi-well drilling programs and across the many geographies we operate in North America.
In 2016 we continued to set records for drilling performance with customers in both Canada and the U.S. which was key to retaining customers during
the downturn and attracting new customers as industry prospects improved.
In 2016 we continued with the introduction of a new organizational function to ensure Cathedral’s in-house technology and operating standards are
better leveraged across all locations in which we operate. This product line management function has allowed us to achieve better control over capital
asset allocation, equipment repair and parts procurement, training, policies, procedures and standards.
We also continued to develop our Drilling Optimization offering. This engineering team is focused on working closer with customers on the technical
aspects of their drilling programs to analyze factors contributing to better performance and make recommendations on how to improve performance
on a daily and even hourly basis. This contrasts with the traditional view of drilling optimization in our industry where performance and improvements
are typically only addressed at the end-of-well. Drilling Optimization will assist us with client retention, securing new business, incremental revenue
generation and exploiting operational efficiencies to improve job margins and return on assets employed.
We initiated a strategic initiative called Target Zero aimed at reducing personnel on the rig site. This initiative involves rethinking our operational
processes and the people involved, considering new designs, configurations and logistics for deploying our equipment and improving and leveraging
our management information systems including our remote drilling capability.
In 2016 we continued to make incremental improvements to our proprietary Measurement-While-Drilling (“MWD”) and drilling motor technology to
improve the capabilities of this equipment and also to improve its reliability. Improving equipment reliability has been a continual focus due to the
downhole drilling environment being increasingly more demanding as rigs get more powerful and wellbores get longer.
On the new technology front, of note in 2016 was our downhole generator technology reaching commercial status. The downhole generator uses
mud flow to create power for the MWD equipment thereby reducing battery use and the associated high costs of batteries. The downhole generator
also facilitates improved Electro-Magnetic (“EM”) MWD data transmission capabilities to improve its performance and allow it to be used in difficult
formations and areas where competitor technologies have limitations. We will start building out a fleet of downhole generators in 2017.
Workplace safety is extremely important to Cathedral and our customers. In our Health, Safety and Environment (“HSE”) area we continued to promote
our Work Smart Live Well philosophy which has corporate risk management as its central tenant. More on this innovative program can be found on
our website. We achieved our corporate performance targets for HSE including having zero lost time injuries and zero environmental incidents and
we exceeded our injury frequency targets (on an activity compensated basis) which is a key industry comparative metric. These achievements
demonstrate that Cathedral has a clear HSE vision, strong leadership, and a workforce that is committed to excellence and delivering outstanding
results, even during the most formidable fiscal times.
Enhance Sales Effectiveness
We continue to implement new sales strategies and processes in our business to ensure we are targeting customers and regions where our equipment
and services can result in a material reduction in well costs by reducing days drilled or offering other customer benefits. We also have developed a
sales program focused on capturing the key players in each of the basins where we operate (e.g. Montney and Permian).
The success of these programs can be quantified based on our North American market share growth. We measure market share based on the
rigs/jobs we are working on in a particular week versus the active rigs drilling directional wells as reported weekly by Baker Hughes. In the U.S. we
have doubled our market share from where it was in 2014 with most of the gains made in 2016. In Canada we have maintained our market share at
historical levels despite a severe contraction in this market and intense competitive pressure including coming from the major international oilfield
services companies.
Going forward we see the biggest opportunities for Cathedral in the U.S. market. We are still a small player in this market and believe there are more
growth opportunities for us in the U.S. relative to Canada. Our success in the U.S. to date has been a result of having differentiated technology and
having an active presence and growing reputation in the key U.S. basins such as the Permian.
Our Focus in 2017
Going into 2017 we expect to be impacted positively or negatively by three key themes:
•
•
•
continued commodity price volatility – with the potentially to impacting activity levels throughout the year;
intense competitive pressure and continued customer attention on drilling costs - impacting pricing; and,
labour availability and vendor supply and price challenges - impacting expenses
Although the above factors potentially sound forbidding, we believe they are no more intimidating than what we have faced over the past two years
and we are confident in our ability to manage around them. With our balance sheet now in a strong position, we can focus our attention on operational
improvements and growth initiatives and make the necessary investments to ramp up our business profitably.
Cathedral Energy Services Ltd. - 2016 Annual Report
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With hopefully the worst of the past two years behind us, as we look to the future we will continue to focus on the aspects of our business we can
control - improving and deploying our proprietary technology and expertise to assist our customers reduce their costs and continuing to demonstrate
our quality, safety and integrity with our employees and customers.
We thank our employees for their continued dedication and hard work and our customers, vendors and business partners for their support though the
trying times experienced over the past couple of years. Finally, we thank our shareholders for their support and confidence in our business prospects
and strategy.
Sincerely,
Signed: "P. Scott MacFarlane"
P. Scott MacFarlane
President and Chief Executive Officer
Cathedral Energy Services Ltd.
March 2, 2017
Cathedral Energy Services Ltd. - 2016 Annual Report
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MANAGEMENT’S DISCUSSION & ANALYSIS
This Management's Discussion and Analysis ("MD&A") for the year ended December 31, 2016 provides an analysis of the consolidated results of
operations, financial position and cash flows of Cathedral Energy Services Ltd. (the "Company" or "Cathedral") and should be read in conjunction with
the audited consolidated financial statements and notes thereto for the year ended December 31, 2016, as well as the Company's 2016 interim
MD&A's. This MD&A is intended to assist the reader in the understanding and assessment of significant changes and trends, as well as the risks and
uncertainties, related to the results of the operations and financial position of the Company. Currency amounts are in '000's except for day rates and
per share amounts. This MD&A is dated March 2, 2017.
FORWARD LOOKING STATEMENTS
This MD&A contains certain forward-looking statements and forward-looking information (collectively referred to herein as "forward-looking
statements") within the meaning of applicable Canadian securities laws. All statements other than statements of present or historical fact are forward-
looking statements. Forward-looking statements are often, but not always, identified by the use of words such as "anticipate", "achieve", "believe",
"plan", "intend", "objective", "continuous", "ongoing", "estimate", "outlook", "expect", "may", "will", "project", "should" or similar words suggesting future
outcomes. In particular, this MD&A contains forward-looking statements relating to, among other things: expectation we will see continued price
volatility going forward; favorably to capitalize on an upturn in our industry; explore and execute ways to grow and manage our business in what we
hope is an improved business environment going forward compared to the past two years; projected capital expenditures and commitments and the
financing thereof; anticipate that we will not reinstate dividend payments until industry conditions and operating cash flow improves; Cathedral expects
to comply with all covenants during 2016; and long-term intent of the Company to pay quarterly dividends to shareholders.
The Company believes the expectations reflected in such forward-looking statements are reasonable as of the date hereof but no assurance can be
given that these expectations will prove to be correct and such forward-looking statements should not be unduly relied upon.
Various material factors and assumptions are typically applied in drawing conclusions or making the forecasts or projections set out in forward-looking
statements. Those material factors and assumptions are based on information currently available to the Company, including information obtained
from third party industry analysts and other third party sources. In some instances, material assumptions and material factors are presented elsewhere
in this MD&A in connection with the forward-looking statements. You are cautioned that the following list of material factors and assumptions is not
exhaustive. Specific material factors and assumptions include, but are not limited to:
the performance of Cathedral's businesses, including current business and economic trends;
oil and natural gas commodity prices and production levels;
capital expenditure programs and other expenditures by Cathedral and its customers;
the ability of Cathedral to retain and hire qualified personnel;
the ability of Cathedral to obtain parts, consumables, equipment, technology, and supplies in a timely manner to carry out its activities;
the ability of Cathedral to maintain good working relationships with key suppliers;
the ability of Cathedral to market its services successfully to existing and new customers and reliance on major customers;
risks associated with technology development and intellectual property rights;
the ability of Cathedral to maintain safety performance;
the ability of Cathedral to obtain timely financing on acceptable terms;
the ability to obtain sufficient insurance coverage to mitigate operational risks;
currency exchange and interest rates;
risks associated with foreign operations;
risks associated with acquisitions and business development efforts;
environmental risks;
changes under governmental regulatory regimes and tax, environmental and other laws in Canada and U.S.; and
competitive risks.
Forward-looking statements are not a guarantee of future performance and involve a number of risks and uncertainties some of which are described
herein. Such forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause the Company's actual
performance and financial results in future periods to differ materially from any projections of future performance or results expressed or implied by
such forward-looking statements. These risks and uncertainties include, but are not limited to, the risks identified in this MD&A and in the Company's
Annual Information Form under the heading "Risk Factors". Any forward-looking statements are made as of the date hereof and, except as required
by law, the Company assumes no obligation to publicly update or revise such statements to reflect new information, subsequent or otherwise.
All forward-looking statements contained in this MD&A are expressly qualified by this cautionary statement. Further information about the factors
affecting forward-looking statements is available in the Company's current Annual Information Form which has been filed with Canadian provincial
securities commissions and is available on www.sedar.com.
CORPORATE OVERVIEW
Cathedral Energy Services Ltd. (the "Company" or "Cathedral") is incorporated under the Business Corporations Act (Alberta) (the "Act"). The
Company is publicly traded on the Toronto Stock Exchange under the symbol "CET". The Company together with its wholly owned subsidiary,
Cathedral Energy Services Inc. (“INC”), is engaged in the business of providing directional drilling services to oil and natural gas companies in western
Canada and the U.S.
In late 2016, the Company made the decision to sell its Flowback and Production Testing (“F&PT”) business and focus its resources fully on the
directional drilling business where it believes it has a strong competitive advantage and better future growth prospects. A definitive agreement to sell
the assets of this division was executed in December 2016 and the sale closed in January 2017.
Cathedral is a trusted partner to North American energy companies requiring high performance directional drilling services. We work in partnership
with our customers to tailor our equipment and expertise to meet their specific geographical and technical needs. Our experience, technologies and
responsive personnel enable our customers to achieve higher efficiencies and lower project costs.
Cathedral Energy Services Ltd. - 2016 Annual Report
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FINANCIAL HIGHLIGHTS
(1) Refer to MD&A: see “NON-GAAP MEASUREMENTS”
(2) Quarterly dividend was suspended in November 2015
(3) Equipment additions exclude non-cash additions
FISCAL 2016 KEY TAKEAWAYS
Although revenues decreased by $25,377 or 24% Adjusted EBITDAS from continuing operations increased $2,230 or 43% due to cost reduction and
containment measures that were the focus of everyone in the Company;
2016 Q4 financial results improved significantly year-over-year and sequentially to 2016 Q3 as a result of improved activity levels and continued focus
on expense management and sales and marketing initiatives. Adjusted EBITDAS from continuing operations was $4,367 in 2016 Q4 an increase of
$4,248 from 2015 Q4;
Adjusted gross margin increased from 18% to 22% due to reduced equipment repairs and field labour rates;
In December, the Company executed a definitive agreement to sell its F&PT assets for net proceeds of $17,241. This sale closed in January 2017;
During 2016 Q1, the Company completed the sale of its wholly owned Barbados subsidiary, Directional Plus International Ltd. ("DPI"), for net proceeds
of $nil which resulted in a non-cash gain on sale of $10,865. DPI held the Company’s investment in Venezuela and this sale completes Cathedral’s
exit from carrying on a business in Venezuela;
During 2016 Q2, the Company negotiated a settlement of our collective action wage and hour lawsuits in the United States (“U.S.”);
In 2016 Q3, Export Development Canada (“EDC”) joined Cathedral’s lending syndicate resulting in an increase in Cathedral’s credit facility through to
March 31, 2017; and
In February 2017, the Company closed a bought deal public offering and insider private placement financing for total gross proceeds of $14,130. As
a consequence of this financing and the sale of the F&PT assets, the Company currently has no bank debt (excluding letters of credit).
OUTLOOK
Throughout the second half of 2016, we continued to see improvements in the prospects for the energy industry and in particular our activity levels.
After hitting a low of 404 active rigs in May 2016, the U.S. rig count grew to 658 active rigs at the end of December 2016. This improvement in active
rigs drilling was largely attributable to improvements in oil and natural gas pricing in the second half of 2016 as a result of anticipation that supply and
demand fundamentals were coming into balance. Further confidence in the oil pricing was secured at the end of November with Saudi Arabia and
OPEC finally announcing production cuts. Since then, WTI has maintained a price range in the $50/bbl to $55/bbl range. This is the price level we
Cathedral Energy Services Ltd. - 2016 Annual Report
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201620152014Revenue80,866$ 106,243$ 208,655$ Adjusted gross margin % (1)22%18%21%Adjusted EBITDAS from continuing operations (1)7,459$ 5,229$ 25,758$ Diluted per share0.21$ 0.14$ 0.71$ As % of revenues9%5%12%Total Adjusted EBITDAS (1)5,840$ 7,699$ 38,487$ Diluted per share0.16$ 0.21$ 1.06$ Funds from operations (1)1,031$ 4,410$ 32,114$ Gain on disposal of foreign subsidiary10,865$ -$ -$ Write-downs of goodwill, inventory and equipment(277)$ (12,773)$ -$ Provision for settlements(4,217)$ -$ -$ Write-down of deferred taxes related to CRA settlement-$ (10,346)$ -$ Earnings (loss) before income taxes(722)$ (24,894)$ 8,112$ Basic per share(0.02)$ (0.69)$ 0.22$ Diluted per share(0.02)$ (0.69)$ 0.22$ Net earnings (loss) from continuing operations2,617$ (28,841)$ 10,283$ Basic per share0.07$ (0.79)$ 0.28$ Diluted per share0.07$ (0.79)$ 0.28$ Net earnings (loss)(5,779)$ (35,342)$ 10,283$ Basic per share(0.16)$ (0.97)$ 0.28$ Diluted per share(0.16)$ (0.97)$ 0.28$ Cash dividends declared per share (2)-$ 0.1200$ 0.3300$ Property and equipment additions (3)899$ 6,908$ 30,763$ Weighted average shares outstandingBasic (000s)36,295 36,295 36,244 Diluted (000s)36,295 36,295 36,255 Working capital39,324$ 13,550$ 38,135$ Total assets136,017$ 155,610$ 230,534$ Long-term debt excluding current portion26,322$ 30,477$ 56,142$ Shareholders' equity90,772$ 96,607$ 128,368$
previously anticipated requiring to see an improvement in our activity levels which would in turn provide the job volume to contribute favorably against
our fixed cost burden.
The improvement in Cathedral’s business prospects starting in 2016 Q4 has been dramatic. Our active job count has doubled since September 2016
and more than tripled since the lows in early 2016. This has presented a completely new set of challenges as we have had to aggressively ramp up
our business. Compared to the last two years, these are good challenges to have. The big issue for Cathedral and our industry in this improved
environment has been staffing up to meet demand. Attracting workers back to the industry has been a challenge particularly in Canada due to the
industry seasonality factors. After being in contraction mode for the past couple years, there are also challenges managing the impact of increasing
activity levels on our administration resources and ensuring our people, systems and processes are continuing to deliver quality services. The industry
supply chain is also suffering from the same challenges. Lead times on parts and equipment has increased significantly since mid-2016 and we are
experiencing cost pressure from vendors.
In addition to labor supply concerns, we are managing our business cautiously with the expectation we will see continued price volatility going forward.
With the increased productivity of North American shale wells, the industry now has the capability to ramp up production and inventories quickly which
could put pressure on prices. OPEC’s adherence to their proposed production cuts has historically always been a wildcard. On the competitive side,
there is still an oversupply of equipment in the market and further rationalization of suppliers is required. Competing based on price alone is not a
sustainable strategy for our competitors and we are fortunate that we are in a position to compete based on offering verifiable performance
improvements to our customers.
We are fortunate that many of the aspects of our business that we focused on in the face of adversity have set us up favorably to capitalize on an
upturn in our industry. Many of the strategic initiatives we have been working on over the last two years have been focused on making sure we can
ramp up our business effectively. On the sales side, we have strategies to help us secure higher pricing for our services. On the operations side, we
are looking at ways to better manage our labor pool, keep our expenses in line and continue to deliver a high quality service. Our technology group
continues to make equipment improvements and explore new products aimed at revenue generation and expense and capital cost reductions.
We will continue to explore and execute ways to grow and manage our business in what we hope is an improved business environment going forward
compared to the past two years.
RESULTS OF OPERATIONS - 2016 COMPARED TO 2015
Overview
As the Company entered into a definitive agreement to dispose of its F&PT assets in December 2016, at December 31, 2016, these assets are
classified as held for sale and the related operations are presented as discontinued operations. This MD&A will focus on the results from the continuing
directional drilling related operations.
The Company completed 2016 with revenues of $80,866 compared to 2015 revenues of $106,243 a decrease of 24%. However, 2016 Adjusted
EBITDAS from continuing operations was $7,459 ($0.21 per share diluted) which represents a $2,230 or 43% increase from $5,229 ($0.14 per share
diluted) in 2015. The increase in Adjusted EBITDAS from operations was primarily a result of operational efficiencies and cost savings initiatives. In
2016 the Company’s net loss was $5,779 ($0.16 per share) compared to net loss of $35,342 ($0.21 per share) in 2015.
Revenues 2016 revenues were $80,866, which represented a decrease of $25,377 or 24% from 2015 revenues of $106,243. Both Canadian and
U.S. operations experienced decreases due mainly to overall decline in drilling activity because of a reduction in commodity prices. In late 2016, due
to a limited supply of motors, the Company made the decision to reduce the number of rental motors available in both Canada and the U.S. in favor
of redirecting CLAW™ motors on jobs where both equipment and staff are deployed and the total cash flow contribution is typically higher.
Canadian revenues (excluding motor rental revenues) decreased to $16,164 in 2016 from $33,593 in 2015; a 52% decrease. This decrease was the
result of: i) a 35% decrease in activity days to 2,440 in 2016 from 3,766 in 2015; and ii) a 26% decrease in the average day rate to $6,625 in 2016
from $8,920 in 2015. Partially offsetting these declines was an increase of $781 on the rental of motors, particularly Cathedral's CLAW™ motor. Motor
rental revenues for 2016 were $6,056 (2015 - $5,275).
The decrease in activity days was mainly due to overall reductions in activity levels in Canada as well as certain of Cathedral's customers reducing
their drilling programs. The average active land rig count for Canada was down 34% in 2016 compared to 2015. The decrease in day rates was in
part due to the type of work performed, but mainly due to decreases in day rates charged to customers, which were a result of competitive pressure,
and pricing concessions provided to customers to secure work.
U.S. Directional Drilling revenues (excluding motor rental revenues) decreased to $55,451 in 2016 from $65,038 in 2015; a 15% decrease. This
decrease was the result of: i) a 6% decrease in activity days to 5,145 in 2016 from 5,496 in 2015; and ii) a 9% decrease in the average day rate to
$10,778 in 2016 from $11,834 in 2015 (when converted to Canadian dollars). The activity days for the Rocky Mountain and Northeast regions were
down, but these were offset by increases in the Texas and Oklahoma operating areas. The average active land rig count for the U.S. was down 46%
in 2016 compared to 2015. Rates in USD fell to $8,124 USD in 2016 from $9,323 USD in 2015; a 13% decline. U.S. day rate decreases were partially
tempered by the U.S. division providing footage drilling services to certain clients, which can result in higher relative day rates. U.S. motor rental
revenues for 2016 were $3,195 compared to $2,337 in 2015.
Gross margin and adjusted gross margin Gross margin for 2016 was 7% compared to 3% in 2015. Adjusted gross margin (see Non-GAAP
Measurements) for 2016 was $17,875 or 22% compared to $18,726 or 18% for 2015.
The Company implemented a number of cost reductions throughout 2015 and 2016 including reducing wages for field, support and office staff,
implementing work force reductions and reducing other direct cost items. Even with lower revenue day rates in many districts the adjusted gross
margin improved due to reduced field labour costs and repairs, however, these reductions were offset by higher equipment rentals and battery costs
on a percentage of revenue basis.
Additionally, there was a reduction in the fixed component of cost of sales of 22% compared with 2015 amount. However, on a percentage of revenue
basis, fixed cost of sales were greater in 2016 increasing 1% over 2015.
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 7
Revenues20162015Canada22,220$ 38,868$ United States58,646 67,375 Total80,866$ 106,243$
Depreciation allocated to cost of sales decreased to $12,358 in 2016 from $15,189 in 2015. Depreciation included in cost of sales as a percentage of
revenue was 15% for 2016 and 14% in 2015.
Selling, general and administrative expenses ("SG&A") SG&A expenses were $15,185 in 2016; a decrease of $2,373 compared with $17,558
in 2015. As a percentage of revenue, SG&A was 19% in 2016 and 17% in 2015.
Excluding the non-cash items of depreciation and share-based compensation, SG&A was $14,921 in 2016 compared to $17,231 in 2015, a decrease
of $2,310 or 13%. SG&A decreased primarily due to work force reductions, wage rollbacks and reductions in variable compensation. SG&A wage
rollbacks were implemented February 1, 2015 at a range of 5% to 15% and a further 5% to 9% on January 1, 2016. There were additional reductions
to staffing levels in 2015 and 2016. Staffing costs included in SG&A include executive, sales, accounting, human resources, payroll, safety, technology
support and related support staff. As well, there were year-over-year reductions in virtually every other SG&A item due to efforts to reduce
expenditures.
Gain on disposal of equipment During 2016, the Company had a gain on disposal of equipment of $3,212 compared to $3,257 in 2015. These
gains mainly relate to equipment lost-in-hole. Proceeds from clients on lost-in-hole equipment are based on amounts specified in service agreements
and, in most cases, these proceeds exceed the net book value of the equipment and result in a gain. The timing of lost-in-hole recoveries is not in the
control of the Company and therefore can fluctuate significantly from quarter-to-quarter. In 2015 Q1, the Company completed the sale and leaseback
of its Oklahoma City operating facility. This resulted in a gain on sale of land and buildings of $456.
Finance costs Finance costs consist of interest expenses on operating loans, loans and borrowings and bank charges of $2,061 for 2016 versus
$1,613 for 2015. The increase in finance costs relate to increases in interest rates partially offset by a decreased utilization of the Company’s credit
facility.
Foreign exchange loss The Company had a foreign exchange gain of $1,438 in 2016 compared to a loss of $(4,374) in 2015 due to the fluctuations
of the Canadian dollar relative to the U.S. dollar. The Company’s foreign operations are denominated in a currency other than the Canadian dollar
and therefore, upon consolidation, gains and losses due to fluctuations in the foreign currency exchange rates are recorded in other comprehensive
income (“OCI”) on the balance sheet as a component of equity. However, gains and losses in the Canadian entity on U.S. denominated intercompany
balances continue to be recognized in the statement of income. Included in the 2016 foreign currency gains are unrealized gains of $1,455 (2015 –
loss of $4,191) related to intercompany balances.
Provision for settlement In 2016 Q2, the Company entered into a Settlement Agreement and Release (the “Settlement Agreement”) in respect of
two wage and hour lawsuits (the “Collective Actions”) that were filed against the Company’s wholly owned subsidiary, INC. The Collective Actions
alleged that INC employed or contracted Measurement While Drilling (“MWD”) and Directional Drilling (“DD”) operators were entitled to recover unpaid
or incorrectly calculated overtime wages under the Fair Labor Standards Act (“FLSA”).
The Settlement Agreement resolved all claims from INC employed and contracted MWD and DD operators. Under the terms of the Settlement
Agreement, the parties established an initial settlement fund of up to $3,400 USD. The final determination of the settlement fund amount was based
on the number of claimants that participated in the settlement at the end of December 2016, which under the terms of the Settlement Agreement is
confidential. The settlement fund payments will be paid quarterly by the Company over a three-year period with the final payment due on or before
September 2019. The quarterly payments may be accelerated in the event Cathedral meets certain financial targets over the payment period and can
be deferred if a scheduled payment would put Cathedral in violation of its credit facility covenants subject to not more than three payments being
deferred. Any FLSA settlement fund payments made by Cathedral exceeding $200 USD are subject to the approval of Cathedral’s banking syndicate.
During 2016, payments of $851 were made.
In 2017 Q1, the Company entered a settlement with one of its U.S. clients related to a down-hole drilling incident, which impacted two of their wells in
December 2013. The settlement is payable based on an initial payment in 2017 Q1 and the remainder in quarterly installments concluding in 2021.
During 2016 Q1, the Company completed the sale of its wholly-owned Barbados subsidiary,
Gain on disposal of foreign subsidiary
Directional Plus International Inc. ("DPI"), for net proceeds of $nil which resulted in a non-cash gain on sale of $10,865. DPI held the Company’s
investment in Venezuela and this sale completed Cathedral’s exit from carrying on a business in Venezuela.
Write-down of goodwill In 2015 Q3 the Company recorded an impairment of goodwill of $5,848. The recoverable amount of each cash-generating
unit ("CGU") was determined using a value in use calculation based on cash flow projections over the expected life of the assets. The cash flow
projections were based on expected outcomes taking into account past experience and management's expectations for future market conditions.
$1,624 of the impairment related to the directional drilling CGU and $4,224 related to the flowback and production testing CGU. This impairment
represented the total amount of goodwill allocated to each CGU.
Write-down of equipment Due to the reduction in demand for services, in 2015 Q4, the Company carried out a review of equipment and wrote-
down those where there was a significant lack of demand by clients. The result of this review was a write-down of equipment of $3,189.
Write-down of inventory
The Company’s inventory is used to construct new tools and maintain existing tools. Due to the decrease in operating
activities and the reduction in capital build out programs, there was a reduction in inventory turnover. As the prospect of recovery has been further
delayed, in 2015 Q4 the Company conducted a review of inventory items and the projected usage for the various lines of inventory and wrote-down
the value of inventory by $3,736. $2,607 of this write-down relates to parts for third party, non-Cathedral manufactured motors, which currently have
lower utilization and demand from clients. In 2016 Q1, an additional $277 was written-down.
Net loss from discontinued operations In 2016 Q4, the Company made the decision to sell its F&PT assets and focus its attention and resources
fully on the directional drilling business where it believes it has a strong competitive advantage and better future growth prospects. The proceeds from
this sale were used to pay down debt As such, operating results for the years ended December 31, 2016 and 2015 for the F&PT business have been
included in the statements of operations and retained earnings and statements of cash flows as discontinued operations. For 2016, the net loss from
discontinued operations was $4,089 compared to $6,501 for 2015.
Write-down of assets held for sale from discontinued operations, net of tax The F&PT assets have been written down by $5,900 to their net
realizable value of approximately $17,241. This write-down of $5,900 was offset by a deferred tax recovery of $1,593.
Income tax For 2016, the Company had an income tax recovery of $3,339 compared to an expense of $(3,947) in 2015. Excluding the non-cash
gain on disposal of foreign subsidiary, write-down of goodwill and adjustments to prior years' tax provisions, the effective tax rate was 31% for 2016
and 31% for 2015. Income tax expense is booked based upon expected annualized effective rates.
Included in the 2015 Q2 amount is a charge to earnings of $10,346 related to a write-off of a portion of the tax attributes obtained as part of the
December 18, 2009 conversion from an income trust to a corporation ("Conversion"). Cathedral elected to enter into the agreement with Canada
Revenue Agency (“CRA”) as a highly satisfactory solution to avoid potential costly and time consuming legal proceedings and allow management to
focus its efforts on business operations and enhancing shareholder value. The CRA agreement did not give rise to any cash outlay by Cathedral for
prior taxation years. Cathedral continues to have access to a portion of the tax attributes obtained as part of the Conversion to offset federal and
provincial taxes in subsequent taxation years.
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 8
LIQUIDITY AND CAPITAL RESOURCES
Overview On an annualized basis, the Company’s principal source of liquidity is cash generated from operations. In addition, the Company has
the ability to fund liquidity requirements through its credit facility and the issuance of debt and/or equity. For the year ended December 31, 2016, the
Company had funds from operations (see Non-GAAP Measurements) of $1,031 (2015 - $4,410). The decrease in funds from operations is due to a
reductions in cash from operations due to lower activity levels and reductions in revenue day rates.
Working capital At December 31, 2016 the Company had working capital of $39,324 (2015 - $13,550) and a working capital ratio of 3.3 to 1 (2015
– 1.5 to 1). Included in the December 31, 2016 balance is $17,241 related to Assets held for sale. This amount has previously been classified as
equipment and categorized as part of non-current assets. $17,200 of proceeds on this sale were used to repay the secured revolving term loan in
January 2017. Excluding Assets held for sale, the December 31, 2016 working capital was $22,083 and the increase in this amount compared to
$13,550 at December 31, 2015 was mainly due to an increase in accounts receivable due to the overall increase in revenues in 2016 Q4.
Credit facility The Company has a committed revolving credit facility (the "Facility") that expires in December 2018. The Facility is secured by a
general security agreement over all present and future personal property.
The current Facility has been amended seven times. These amendments have certain restrictions, including, but not limited to; paying dividends,
utilization of the accordion feature, enhanced lender financial reporting and a cap on any litigation settlement payments without lender approval. As
well, effective 2015 Q4, the Company includes lost-in-hole equipment proceeds in the definition of Bank EBITDA (as defined in the credit agreement).
The financial covenants associated with the amended Facility are as follows:
Quarter ending:
December 31, 2016
March 31, 2017
June 30, 2017
September 30, 2017
December 31, 2017
March 31, 2018 and thereafter
Maximum Funded Debt to Bank EBITDA
Ratio
Minimum Debt Service Ratio
Waived
3.50:1
3.50:1
3.50:1
3.25:1
3.00:1
Waived
2.00:1
2.50:1
3.00:1
3.00:1
3.00:1
Under the Fourth Amending Agreement dated August 9, 2016, the working capital covenant in the Facility was waived.
Under the Fifth Amending Agreement dated September 2, 2016, Export Development Canada (“EDC”) joined Cathedral’s lending syndicate resulting
in the lending exposure from the prior lending syndicate members being reduced and the Facility increasing by $3,000 from that contained in the
Fourth Amendment, and the maturity of the Facility was extended by three months to November 2017. The Fifth Amendment provided for credit
availability of $36,000, further reducing to $33,000 by December 31, 2016.
The Sixth Amending Agreement, dated December 22, 2016 the Maturity Date of the facility was extended to February 2018.
The Seventh Amending Agreement, dated January 16, 2017, required a minimum cumulative Bank EBITDA of $2,500 for the three months ended
December 31, 2016. In addition, the aggregate commitment was reduced to $23,000 after $17,200 was repaid upon the sale of F&PT CGU assets
and the maturity date was extended to December 2018.
After the amendments discussed above, the Facility bears interest at the bank’s prime rate plus 0.50% to 5.00% or bankers’ acceptance rate plus
1.75% to 6.25% with interest payable monthly. Interest rate spreads for the Facility depend on the level of funded debt to the 12 month trailing Bank
EBITDA. The Facility provides a means to lock in a portion of the debt at interest rates through bankers' acceptance (“BA”) based on the interest rate
spread on the date the BA was entered into.
Based on current available information, Cathedral expects to comply with all covenants for the next twelve months.
The Company's financial ratios in the 2016 Q4 waiver period were:
Ratio
Debt service ratio
Funded debt to Bank EBITDA ratio
Working capital ratio
Minimum Bank EBITDA for the three months ended December 31, 2016
Actual
3.34:1
3.83:1
3.31:1
$4,522
Required
Waived
Waived
Waived
$2,500
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 9
The following table outlines the drawings on the credit facility and the Company’s Net Debt as at December 31, 2016 and 2015:
Contractual obligations In the normal course of business, the Company incurs contractual obligations and those obligations are disclosed below.
As at December 31, 2016, the Company had a commitment to purchase equipment of approximately $384. Cathedral anticipates expending these
funds 2017 Q1.
The Company has issued three standby letters of credit, two of which relate to property leases and renew annually to landlords. The first letter of
credit is $700 CAD for the first ten years of the lease and then reduces to $500 for the last five years of the lease. The second letter of credit is for
$542 USD and increases annually based upon annual changes in rent. The final letter of credit is for $75 USD issued in relation to U.S. WCB coverage.
The following table outlines the anticipated payments related to purchase commitments subsequent to December 31, 2016:
Subsequent events In January 2017, the Company completed the Seventh Amendment to its credit facility. The Seventh Amending Agreement
reduced the aggregate commitment to $23,000 after $17,200 was repaid upon the sale of F&PT assets and extended the expiry to December 2018.
The sale of F&PT assets closed in January 2017 for net proceeds of $17,241.
In February 2017, the Company closed a bought deal public offering of 11,500,000 common shares of the Company at a price of $1.12 per share,
which includes 1,500,000 common shares pursuant to the exercise in full of the over-allotment option, for gross proceeds of $12,880 (the “Offering”).
Concurrent with the closing of the Offering, certain directors and officers of Cathedral purchased 1,116,071 common shares at a price of $1.12 per
share on a private placement basis for gross proceeds of approximately $1,250 (the “Concurrent Private Placement”). The gross proceeds from the
Offering and Concurrent Private Placement totaled approximately $14,130.
Share capital At March 2, 2017, the Company has 48,916,451 common shares and 2,470,083 options outstanding with a weighted average exercise
price of $1.52.
In 2016, the Company issued 30,000 stock options to employees with an exercise price of $0.43 per option. In January 2017, the Company issued
1,141,250 options to staff and directors with an exercise price of $1.13 per option.
Related party transactions
officers and directors.
Cathedral has determined that the key management personnel of the Company consist of its executive
In addition to their salaries and director's fees, the Company also provides non-cash benefits to directors and executive officers including participation
in the Company’s share option program (see note 16).
Certain executive officers have employment agreements. Upon resignation at the Company’s request, they are entitled to termination benefits
including: i) 1.5 to 2.0 times base salary; ii) 1.5 to 2.0 times average annual bonus over the past 3 years; and iii) health, dental, life insurance and
disability coverage for 18 to 24 months.
Key management personnel (including directors) compensation comprised:
Key management personnel and director transactions
Directors and executive officers of the Company control 5% of the common shares of the Company.
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 10
December 31December 3120162015Total credit facility33,000$ 60,000$ Drawings on credit facility:Operating loan2,105 2,484 Revolving term loan26,250 30,000 Letters of credit1,528 1,554 Total drawn facility29,883$ 34,038$ Undrawn portion of credit facility3,117$ 25,962$ Net debt (see NON-GAAP MEASUREMENTS):Loans and borrowings, net of current portion26,322$ 30,477$ Working capital:Current assets56,368$ 41,575$ Current liabilities(17,044) (28,025) Working capital39,324$ 13,550$ Net debt(13,002)$ 16,927$ Total20172018201920202021ThereafterPurchase obligations384$ 384$ -$ -$ -$ -$ -$ Secured revolving term loan 26,250 - 26,250 - - - - Operating lease obligations35,330 3,577 3,495 2,969 2,747 2,723 19,819 Finance lease obligations541 488 34 19 - - - Total62,505$ 4,449$ 29,779$ 2,988$ 2,747$ 2,723$ 19,819$ 20162015Short-term employment benefits1,850$ 1,897$ Share-based compensation99 124 Total expense recognized as share-based compensation1,949$ 2,021$
There have been no other transactions over the reporting period with key management personnel (2015 - nil), and no outstanding balances exist as
at period end (2015 - nil).
OFF-BALANCE SHEET ARRANGEMENTS
As at December 31, 2016, the Company has entered into $35,330 of commitments under operating leases for premises and issued a standby letters
of credit in the amounts of $700 CAD and $617 USD (refer to notes 23 and 24 to the audited consolidated financial statements). Pursuant to such
obligations, the Company indemnifies its directors and officers, to the extent permitted by law, against any and all claims or losses (including amounts
paid in settlement of claims) incurred as a result of their service to the Company. The maximum amount payable under these indemnities cannot be
reasonably estimated. The Company expects that it would be covered by insurance for most, but not all, tort liabilities.
2016 CAPITAL PROGRAM
During the year ended December 31, 2016 Company invested $899 (2015 - $6,908) in equipment. The following table details the net equipment
additions:
The growth additions are primarily for MWD system enhancements, replacement capital is primarily to replace items, which have been lost-in-hole,
and maintenance capital is required to maintain existing capacity levels. Proceeds from disposal of property and equipment are primarily related to
equipment lost-in-hole. At December 31, 2016, the Company had 126 MWD systems (2015 – 140).
2017 CAPITAL PROGRAM
Cathedral's 2017 capital budget reviewed by the Board of Directors in December 2016 was for expenditures of $3,400 with $350 for growth capital
and $1,500 for replacement and $1,550 for maintenance capital. The growth additions are primarily for additional MWD systems and motors and the
maintenance capital is primarily to replace items that have been lost-in-hole. The 2017 capital budget will be reviewed quarterly and board of directors
who have approved capital expenditures for 2017 Q1 of $1,050. The capital program may increase as 2017 progresses based on improving activity
levels and improved capital availability achieved through the F&PT sale and the Offering. Cathedral intends to finance its 2017 capital budget from
cash flow from operations, proceeds from redundant asset sales or assets lost-in-hole, working capital (cash) and credit facility availability.
DIVIDENDS
Based on the reductions in commodity prices and the resulting decline in industry activity levels in 2015 and 2016 and uncertainties around future
expected activity levels, the Board of Directors made the decision to suspend the payment of Cathedral's quarterly dividend in late 2015. The decision
to suspend the dividend was made in order to preserve cash, to manage liquidity, invest selectively in capital asset additions and pursue operational
initiatives to better position the Company for improved industry conditions. The Board of Directors will review dividend distributions on a quarterly basis
considering current performance, historical and future trends in the business and the expected sustainability of those trends in addition to considering
the growth and maintenance capital expenditures required to support the business and other factors impacting the business. It is the long-term intent
of the Company to pay quarterly dividends to shareholders.
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 11
December 31December 3120162015Property and equipment additions:Growth capital (1)324$ 4,571$ Maintenance capital (1)105 1,171 Replacement capital (1)470 510 Infrastructure capital (1)- 656 Total cash additions899 6,908 Less: proceeds on disposal of property and equipment(5,286) (4,944) Less: proceeds on disposal of land and buildings- (6,174) Net property and equipment additions (disposals) (1)(4,387)$ (4,210)$ (1)See "NON-GAAP MEASUREMENTS"
RESULTS OF OPERATIONS – THREE MONTHS ENDED DECEMBER 31
Revenues and operating expenses
Revenues 2016 Q4 revenues were $28,009, which represented an increase of $6,848 or 32% from 2015 Q4 revenues of $21,161. Both Canada
and U.S. operations had increases due to increase in drilling activity. In late 2016, due to a limited supply of the Company’s proprietary CLAW motors,
the Company made the decision to reduce the number of rental motors available in both Canada and the U.S. in favor of redirecting CLAW™ motors
on jobs where both equipment and staff are deployed and the total cash flow contribution is typically higher.
Canadian revenues (excluding motor rental revenues) increased to $6,509 in 2016 Q4 from $5,086 in 2015 Q4; a 28% increase. This increase was
the result of: i) a 48% increase in activity days to 995 in 2016 Q4 from 671 in 2015 Q4; net of ii) a 14% decrease in the average day rate to $6,542 in
2016 Q4 from $7,580 in 2015 Q4. Partially offsetting these increases was a decrease of $1,019 on the rental of motors. Motor rental revenues for
2016 Q4 were $919 (2015 Q4 - $1,938).
The average active land rig count for Canada was down 3% in 2016 Q4 compared to 2015 Q4. The increase in the Company’s activity days relative
to the active rigs drilling was a result of sales and marketing efforts and the Company’s performance on client jobs. The decrease in day rates was in
part due to type of work performed, but mainly due to decreases in day rates charged to customers, which were a result of competitive pressure, and
pricing concessions provided to customers to secure work.
U.S. Directional Drilling revenues (excluding motor rental revenues) increased to $20,032 in 2016 Q4 from $12,786 in 2015 Q4; a 57% increase. This
increase was the result of: i) an 83% increase in activity days to 1,899 in 2016 Q4 from 1,038 in 2015 Q4; net of ii) a 14% decrease in the average
day rate to $10,549 in 2016 Q4 from $12,318 in 2015 Q4 (when converted to Canadian dollars). All operating areas saw increases in activity days.
The average active land rig count for the U.S. was down 25% in 2016 Q4 compared to 2015 Q4. Again, due to efforts of sales and marketing staff
and performance, the Company was able to increase market share compared to 2015 Q4. Rates in USD fell to $7,907 USD in 2016 Q4 from $9,259
USD in 2015 Q4; a 15% decline. U.S. day rate increases were partially tempered by the U.S. division providing footage drilling services to certain
clients, which can result in higher relative day rates. U.S. motor rental revenues for 2016 Q4 were $549 compared to $1,351 in 2015 Q4.
Gross margin and adjusted gross margin Gross margin for 2016 Q4 was 13% compared to negative 1% in 2015 Q4. Adjusted gross margin
(see Non-GAAP Measurements) for 2016 Q4 was $6,634 or 24% compared to $3,773 or 18% for 2015 Q4.
Even with lower revenue day rates in many districts, the adjusted gross margin improved due to reduced repairs, however, these reductions were
offset by increases in field labour and higher equipment rentals on a percentage of revenue basis.
Additionally, there was a reduction in the fixed component of cost of sales of 12% compared with 2015 Q4 amount. These costs were 8% lower on a
percentage of revenue basis in 2016 compared to 2015 with the decrease largely attributable to the increase in revenues in the comparable periods.
Depreciation allocated to cost of sales decreased to $3,073 in 2016 Q4 from $4,036 in 2015 Q4. Depreciation included in cost of sales as a percentage
of revenue was 11% for 2016 Q4 and 19% in 2015 Q4.
Selling, general and administrative expenses ("SG&A") SG&A expenses were $3,857 in 2016 Q4; a decrease of $784 compared with $4,641
in 2015 Q4. As a percentage of revenue, SG&A was 14% in 2016 Q4 and 22% in 2015 Q4.
Excluding the non-cash items of depreciation and share-based compensation, SG&A was $3,804 in 2016 Q4 compared to $4,550 in 2015 Q4, a
decrease of $746 or 16%. SG&A decreased primarily due to work force reductions, wage rollbacks and reductions in variable compensation. SG&A
wage rollbacks were implemented February 1, 2015 at a range of 5% to 15% and a further 5% to 9% on January 1, 2016. There were additional
reductions to staffing levels in 2016. Staffing costs included in SG&A include executive, sales, accounting, human resources, payroll, safety,
technology support and related support staff. As well, there were year-over-year reductions in virtually every other SG&A item due to efforts to reduce
expenditures.
Gain on disposal of equipment During 2016 Q4, the Company had a gain on disposal of equipment of $1,010 compared to $377 in 2015 Q4.
These gains mainly relate to equipment lost-in-hole. Proceeds from clients on lost-in-hole equipment are based on amounts specified in service
agreements and, in most cases; these proceeds exceed the net book value of the equipment and result in a gain. The timing of lost-in-hole recoveries
is not in the control of the Company and therefore can fluctuate significantly from quarter-to-quarter.
Finance costs Finance costs consist of interest expenses on operating loans, loans and borrowings and bank charges of $679 for 2016 Q4 versus
$377 for 2015 Q4. The increase in finance costs relate to increases in interest rates partially offset by a decreased utilization of the Company’s credit
facility.
Foreign exchange loss The Company had a foreign exchange loss of $701 in 2016 Q4 compared to a loss of $1,103 in 2015 Q4 due to the
fluctuations of the Canadian dollar relative to the U.S. dollar. The Company’s foreign operations are denominated in a currency other than the Canadian
dollar and therefore, upon consolidation, gains and losses due to fluctuations in the foreign currency exchange rates are recorded in OCI on the
balance sheet as a component of equity. However, gains and losses in the Canadian entity on U.S. denominated intercompany balances continue to
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 12
2016 Q42015 Q4$ Change% ChangeRevenues 28,009 21,161 6,848 32%Cost of sales(24,454) (21,439) (3,015) 14%Gross margin - $3,555 (278) 3,833 -1379%Gross margin - %13%-1%14%Adjusted gross margin $ (1)6,634 3,773 2,861 76%Adjusted gross margin % (1)24%18%6%(1) Refer to MD&A "NON-GAAP MEASUREMENTS"Revenues20162015Canada7,428$ 7,024$ United States20,581 14,137 Total28,009$ 21,161$
be recognized in the statement of comprehensive income (loss). Included in the 2016 Q4 foreign currency gains are unrealized loss of $719 (2015
Q4 – loss of $1,188) related to intercompany balances.
Provision for settlement During 2016 Q4, the participation rate related to the FLSA matter was finalized. Additionally in 2017 Q1, the Company
entered a settlement with one of its U.S. clients related to an alleged down-hole drilling incident, which impacted two of their wells in December 2013.
This settlement is payable based on an initial payment in 2017 Q1 and the remainder in quarterly installments concluding in 2021. As a consequence
of the above there was an increase the settlement provision of $421. During Q4, there were payments related to the above matters of $281.
Write-down of equipment Due to the reduction in demand for services, in 2015 Q4, the Company carried out a review of equipment and wrote-
down those where there was a significant lack of demand by clients. The result of this review was a write-down of equipment of $3,189.
Write-down of inventory
The Company’s inventory is used to construct new tools and maintain existing tools. Due to the decrease in operating
activities and the reduction in capital build out programs, there was a reduction in inventory turnover. As the prospect of recovery has been further
delayed, in 2015 Q4, the Company conducted a review of inventory items and the projected usage for the various lines of inventory and wrote-down
the value of inventory by $3,736. $2,607 of this write-down relates to parts for third party, non-Cathedral manufactured motors, which currently have
lower utilization and demand from clients.
Net loss from discontinued operations In 2016 Q4, the Company made the decision to sell its F&PT assets and focus its attention and resources
fully on the directional drilling business where it believes it has a strong competitive advantage and better future growth prospects. The proceeds from
this sale were used to pay down debt. As such, operating results for the years ended December 31, 2016, 2016 Q4 and 2015 Q4 for the F&PT
business have been included in the statements of comprehensive income (loss) and retained earnings and statements of cash flows as discontinued
operations. For 2016 Q4, the net earnings from discontinued operations was $424 compared to $(952) net loss for 2015 Q4.
Write-down of assets held for sale from discontinued operations, net of tax The F&PT assets have been written down by $5,900 to their net
realizable value of approximately $17,241. This write-down of $5,900 was offset by a deferred tax recovery of $1,593.
Income tax For 2016 Q4, the Company had an income tax expense of $1,444 compared to recovery of $3,398 in 2015 Q4. Excluding adjustments
to prior years' tax provisions, the effective tax rate was 25% for 2016 Q4 and 26% for 2015 Q4. Income tax expense is booked based upon expected
annualized effective rates.
SUMMARY OF QUARTERLY RESULTS
A significant portion of the Company's operations are carried on in western Canada where activity levels in the oilfield services industry are subject to
a degree of seasonality. Operating activities in western Canada are generally lower during "spring breakup" which normally commences in mid to late
March and continues through to May. Operating activities generally increase in the fall and peak in the winter months from December until late March.
Additionally, volatility in the weather and temperatures not only during this period, but year round, can create additional unpredictability in operational
results. Activity levels in the oil and natural gas basins in the U.S. are not subject to the seasonality to the same extent that it occurs in the western
Canada region.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's audited consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles (“GAAP”)
and significant accounting policies utilized by the Company are described in note 3 to the Company's audited consolidated financial statements.
Management believes the accounting principles selected are appropriate under the circumstances and the Audit Committee of the Company has
approved the policies selected.
Under GAAP, the Company is required to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the audited consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. The estimates and assumptions utilized are based on experience and other information available to
management at the time the estimate or assumption is made. The estimates and assumptions used by management are constantly evaluated for
relevance under the circumstances and if circumstances on which the estimates or assumptions were based change, the impact is included in the
results of operations for the period in which the change occurs. Management believes the estimates, judgments and assumptions involved in its
financial reporting are reasonable.
The following accounting policies require management's more significant judgments and estimates in the preparation of the Company's audited
consolidated financial statements, and as such, are considered critical.
Equipment The Company makes estimates about the residual value and expected useful life of equipment. These estimates are based on
management’s historical experience and industry norms. Expected useful life and depreciation rates are as disclosed in note 3 (d) (iii) to the audited
consolidated financial statements.
Impairment of long-lived assets Goodwill was assessed for impairment when circumstances suggest that the carrying amount may exceed the
recoverable amount for the asset or at least annually. Equipment and intangibles are assessed for impairment when circumstances suggest that the
carrying amount may exceed the recoverable amount for the asset. These calculations require estimates and assumptions and are subject to change
as new information becomes available. These estimates include number of years of cash flow available from the assets, growth rates, pre-tax discount
rates as well as various estimates and assumptions used in the preparation of revenues and expenses used in the cash flow analysis. The assumptions
used in the impairment test of equipment and goodwill are disclosed in notes 8 and 9 to the audited consolidated financial statements.
Cathedral Energy Services Ltd. - 2016 Annual Report
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DecSepJunMarDecSepJunMarThree month periods ended20162016201620162015201520152015Revenues28,009$ 19,489$ 14,624$ 18,744$ 21,161$ 26,366$ 21,920$ 36,796$ Total Adjusted EBITDAS (1)3,829$ 2,173$ (1,638)$ 1,476$ (169)$ 3,319$ (1,237)$ 5,786$ Adjusted EBITDAS (1) per share - diluted0.11$ 0.06$ (0.05)$ 0.04$ (0.00)$ 0.08$ (0.03)$ 0.16$ Net earnings (loss)(6,420)$ (2,126)$ (6,916)$ 9,683$ (10,500)$ (8,852)$ (15,266)$ (724)$ Net earnings (loss) per share - basic and diluted(0.18)$ (0.06)$ (0.19)$ 0.27$ (0.29)$ (0.24)$ (0.42)$ (0.02)$ Dividends declared per share-$ -$ -$ -$ -$ 0.04$ 0.04$ 0.04$ (1) Refer to MD&A: see "NON-GAAP MEASURMENTS"
Trade accounts receivable Trade accounts receivable require estimates to be made regarding the financial stability of the Company’s customers
and the environment in which they operate in order to assess if accounts receivable balances will be received. Credit risks for outstanding accounts
receivable are assessed regularly and an allowance for doubtful accounts is recorded based upon specific customer information and experience as
well as for groups of similar assets. See note 27 to the audited consolidated financial statements “Credit risk” for further details.
Trade accounts payable Inventory is reviewed periodically in order to determine if there is obsolescence. This estimate is based upon historic
data and management’s estimates of future demand. See note 7 for discussion of the 2015 and 2016 write-downs of inventory.
Income taxes The Company uses the asset and liability method of accounting for future income taxes whereby deferred income tax assets and
liabilities are determined based on temporary differences between the accounting basis and the tax basis of the assets and liabilities, and are measured
using substantively enacted tax rates and laws expected to apply when these differences reverse. As a result, a projection of taxable income is
required for those years, as well as an assumption of the ultimate recovery/settlement period for the temporary differences.
The business and operations of the Company are complex and the Company has executed a number of significant financings, reorganizations,
acquisitions and other material transactions over the course of its history. The computation of income taxes payable as a result of these transactions
involves many complex factors as well as the Company's interpretation of relevant tax legislation and regulations. The Company's management
believes that the provision for income tax is adequate and in accordance with GAAP and applicable legislation and regulations. However, tax filing
positions are subject to review by taxation authorities who may successfully challenge the Company's interpretation of the applicable tax legislation
and regulations.
FUTURE ACCOUNTING POLICIES
A number of new accounting standards, amendments to accounting standards and interpretations are effective for annual periods beginning on or
after January 1, 2017 and have not been applied in preparing the Consolidated Financial Statements for the year ended December 31, 2016. The
standards applicable to the Company are as follows and will be adopted on their respective effective dates:
(i) Revenue Recognition
On May 28, 2015, the IASB issued IFRS 15, “Revenue From Contracts With Customers” (“IFRS 15”) replacing International Accounting
Standard 11, “Construction Contracts” (“IAS 11”), IAS 18, “Revenue” (“IAS 18”), and several revenue-related interpretations. IFRS 15
establishes a single revenue recognition framework that applies to contracts with customers. The standard requires an entity to recognize
revenue to reflect the transfer of goods and services for the amount it expects to receive, when control is transferred to the purchaser in
accordance with a five step model. Disclosure requirements have also been expanded.
The new standard is effective for annual periods beginning on or after January 1, 2018, with earlier adoption permitted. The standard may
be applied retrospectively or using a modified retrospective approach.
The Company will adopt the new standard on the effective date of January 1, 2018. As the Company continues its analysis, it will also
quantify the impact, if any, on prior period revenues. The Company will address any system and process changes necessary to compile the
information to meet the disclosure requirements of the new standard. As the Company is currently evaluating the impact of this standard, it
has not yet determined the effect on its consolidated financial statements.
(ii) Financial Instruments
On July 24, 2015, the IASB issued the final version of IFRS 9, “Financial Instruments” (“IFRS 9”) to replace IAS 39, “Financial Instruments:
Recognition and Measurement” (“IAS 39”).
IFRS 9 introduces a single approach to determine whether a financial asset is measured at amortized cost or fair value and replaces the
multiple rules in IAS 39. The approach is based on how an entity manages its financial instruments in the context of its business model and
the contractual cash flow characteristics of the financial assets. For financial liabilities, IFRS 9 retains most of the IAS 39 requirements;
however, where the fair value option is applied to financial liabilities, the change in fair value resulting from an entity’s own credit risk is
recorded in OCI rather than net earnings, unless this creates an accounting mismatch. In addition, a new expected credit loss model for
calculating impairment on financial assets replaces the incurred loss impairment model used in IAS 39. The new model will result in more
timely recognition of expected credit losses. IFRS 9 also includes a simplified hedge accounting model, aligning hedge accounting more
closely with risk management. Cathedral does not currently apply hedge accounting and does not value any financial liabilities at fair value.
IFRS 9 is effective for years beginning on or after January 1, 2018. Early adoption is permitted if IFRS 9 is adopted in its entirety at the
beginning of a fiscal period. As the Company does not apply hedge accounting and does not measure any financial liabilities at fair value it
is anticipated that the impact of adopting IFRS 9 will not have a material impact on the Consolidated Financial Statements.
(iii) Leases
In January 2016, the IASB issued IFRS 16 Leases which provides a single lease accounting model for lessees, which require the recognition
of most leases as finance leases on the balance sheet.
This will result in the recognition of a lease liability and a corresponding recognition of a leased asset called right-of-use asset. On the
statement of net earnings and comprehensive income, lease expense will be recognized and will consist of two components, depreciation
expense of the right-of-use asset and interest expense related to the lease liability. Finance lease exemptions exist for short-term leases
where the term is 12 months or less and for leases of low value items.
For lessors, the accounting treatment remains the same which provides a lessor the choice of classifying a lease as either a finance or
operating lease. IFRS 16 comes into effect on January 1, 2019. The Company is currently evaluating the impact of adopting IFRS 16 on
the Consolidated Financial Statements.
(iv) Amendments to IAS 7, Statement of Cash Flows
In January 2016, the IASB issued Disclosure Initiative (Amendments to IAS 7) which requires reporting issuers to provide disclosures that
enable users of financial statements to evaluate changes in liabilities arising from financing activities. The amendment is effective for annual
reporting periods beginning on or after January 1, 2017 with earlier adoption permitted. Comparative information is not required to be
disclosed when entities first apply the amendments. The effect of this initiative will only relate to the Company’s disclosures and will be
adopted on January 1, 2017.
Cathedral Energy Services Ltd. - 2016 Annual Report
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CONTROLS AND PROCEDURES
In order to ensure that information with regard to reports filed or submitted under securities legislation present fairly in all material respect the financial
information of the Company, management including the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO") are responsible for
establishing and maintaining disclosure controls and procedures, as well as internal controls over financial reporting based upon The Committee of
Sponsoring Organizations of the Treadway Commission (2013 framework).
Disclosure controls and procedures The Company's disclosure controls and procedures are designed to provide reasonable assurance that
information required to be disclosed by the Company is reported within the time periods specified under securities laws, and include controls and
procedures that are designed to ensure that information is communicated to management of the Company, including the CEO and CFO, to allow
timely decisions regarding required disclosure. An evaluation of the effectiveness of the Company's disclosure controls and procedures (as defined
in Multilateral Instrument 52-109, Certification of Disclosure in Issuers' Annual Financial and Interim Filings) was conducted as at December 31, 2016.
Based on this evaluation, the CEO and CFO of Cathedral have concluded that the design and operation of the Company's disclosure controls and
procedures were effective as at December 31, 2016.
Internal controls over financial reporting Management is responsible for establishing and maintaining adequate internal controls over financial
reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with GAAP. The CEO and CFO have designed or have caused such internal controls over financial reporting (as defined in
Multilateral Instrument 52-109, Certification of Disclosure in Issuers' Annual Financial and Interim Filings) to be designed under their supervision to
provide reasonable assurance regarding the reliability of financial reporting and preparation of the Company's financial statements for external
purposes in accordance with GAAP. In addition, the CEO and CFO directed the assessment of the design and operating effectiveness of the
Company's internal controls over financial reporting as at December 31, 2016 and based upon that assessment determined that the Company's internal
controls over financial reporting were, in all material respects, appropriately designed and operating effectively.
Management of the Company believe that "cost effective" disclosure controls and procedures and internal controls over financial reporting, no matter
how well conceived or implemented, can only provide reasonable assurance, and not absolute assurance, that the objective of controls and procedures
are met. Because of inherent limitations, disclosure controls and procedures and internal control over financial reporting may not prevent errors or
fraud.
There has been no change in the Company's internal controls over financial reporting during the year ended December 31, 2016 that has materially
affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting.
RISK FACTORS
Crude Oil and Natural Gas Prices
Demand for the services provided by Cathedral is directly impacted by the prices that Cathedral's customers
receive for the crude oil and natural gas they produce. The prices received and the volumes produced have a direct correlation to the cash flow
available to invest in drilling activity and other oilfield services. The markets for oil and natural gas are separate and distinct and are largely driven by
supply and demand factors. Oil is a global commodity with a vast distribution network. As natural gas is most economically transported in its gaseous
state via pipeline, its market is dependent on pipeline infrastructure and is subject to regional supply and demand factors. Recent developments in
the transportation of liquefied natural gas ("LNG") in ocean going tanker ships could introduce more of an element of globalization to the natural gas
market. Crude oil and natural gas prices are quite volatile, which accounts for much of the cyclical nature of the oilfield services business.
Prices for oil and natural gas are subject to large fluctuations in response to relatively minor changes in the supply of, and demand for, oil and natural
gas, market uncertainty and a variety of additional factors beyond the control of Cathedral. These factors include economic conditions in the U.S. and
Canada, the actions of the Organization of Petroleum Exporting Countries ("OPEC"), government regulation, political stability in the Middle East and
elsewhere, the foreign supply of oil and natural gas, risks of supply disruption, the price of foreign imports, technological advances improving the
efficiency of oil and natural gas extraction and production, and the availability of alternative fuel sources and other advances that reduce energy use
efficiency impacting consumption. In addition to pricing determined based on worldwide or North American supply and demand factors, there are a
number of regional factors that also influence pricing such as transportation capacity, oil and natural gas physical properties and local supply and
demand. Petroleum prices are expected to remain volatile for the near future as a result of market uncertainties over the supply and the demand of
these commodities related to the current state of the world economies, OPEC actions and credit availability and liquidity concerns in the energy
industry.
During 2016, the price of West Texas Intermediate Crude more than doubled from its February low of approximately US$26/bbl to end the year at
approximately US$54/bbl. This price improvement positively impacted the Company’s business; however, crude prices remain approximately 50%
below the price of approximately US$108/bbl achieved in June 2014. Commodity prices at the current levels may not be supportive of oil and natural
gas development and exploration spending historically. Furthermore, continued price movements of this magnitude may impact E&P companies’
willingness to commit to capital spending, which in turn may have a significant adverse effect on the Company’s business and financial results.
World crude oil prices and North American natural gas prices, including LNG, are not subject to control by Cathedral. With that in mind, Cathedral
attempts to partially manage this risk by way of maintaining cost structure that can be adjusted to reflect activity levels. A significant portion of
Cathedral's fieldwork is performed by sub-contractors and employees paid on a day rate or hourly basis which allows us to operate with lower variable
costs and fixed overhead costs in seasonally low activity periods as well as extended downturns in the oilfield services sector. In addition, Cathedral
also strives to continuously improve its operational efficiencies and reduce the cost of the equipment it deploys.
Take Away Capacity for Cathedral's Customers
Cathedral's customers rely on various transportation methods to deliver the produced oil
and natural gas to the end market including: pipelines, truck and railway. If such take away capacity becomes full and incremental capacity is not
added, the price and production of hydrocarbons may be adversely impacted resulting in lower oilfield service industry activity levels. This could have
a material adverse effect on Cathedral's business operations, financial condition, results of operations, cash flow and the ability to pay dividends to
shareholders.
Alternatives to and Changing Demand for Hydrocarbon Products Fuel conservation measures, alternative
increasing
consumer demand for alternatives to oil and natural gas, and technological advances in fuel economy and energy generation devices could reduce
the demand for crude oil and other liquid hydrocarbons. The Company cannot predict the impact of changing demand for oil and natural gas products,
and any major changes may have a material adverse effect on the Cathedral's business, financial condition, results of operations and cash flows and
therefore on the dividends declared on the common shares.
fuel requirements,
Cash Dividends to Shareholders are Dependent on the Performance of Cathedral
to
shareholders is dependent upon the operations and business of Cathedral. In November 2015, the Board made the decision to suspend the payment
of the Company's quarterly dividend based the reductions in commodity prices and the resulting decline in industry activity levels in 2015 and
uncertainties around expected activity levels in the future. There is no assurance that dividends will be declared at all in the future and, if declared,
there is no assurance regarding the amounts of cash that may be available from Cathedral's operations and business that could be available to fund
such future dividends. The actual amount of any dividends will depend on a variety of factors, including without limitation, the current performance,
to make dividend payments
Cathedral's ability
Cathedral Energy Services Ltd. - 2016 Annual Report
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historical and future trends in the business, the expected sustainability of those trends, enacted tax legislation which will affect future taxes payable
as well as required long-term debt repayments, maintenance capital expenditures required to sustain performance, future growth capital expenditures,
effect of acquisitions or dispositions on Cathedral's business, compliance with debt covenants and other factors that may be beyond the control of
Cathedral or not anticipated by management of Cathedral.
Cathedral's dividend policy is subject to change at the discretion of its Board of Directors. In addition, Cathedral's credit facility covenants include
certain restrictions on the payment of cash dividends without the consent of the lenders in certain circumstances.
Performance of Obligations
The Company's success depends in large part on whether it fulfills its obligations with clients and maintains
client satisfaction. If Cathedral fails to satisfactorily perform its obligations, makes errors in the provision of its services, or does not perform its services
to the expectations of its clients, its clients could terminate working relationships, including master service agreements, exposing Cathedral to loss of
its professional reputation and risk of loss or reduced profits, or in some cases, the loss of a project and claims by customers for damages. Typically,
Cathedral's master service agreements do not contain any guaranteed payments and are cancellable on 30 or less days' notice.
Access to Capital The credit facilities of Cathedral contain covenants that require it to meet certain financial tests and that restrict, among other
things, the ability of Cathedral to incur additional debt, make significant acquisitions, dispose of assets or pay dividends in certain circumstances. To
the extent the cash flow from operations is not adequate to fund Cathedral's cash requirements, external financing may be required. Lack of timely
access to such additional financing, or which may not be on favorable terms, could limit the future growth of the business of Cathedral and, potentially
have a material adverse effect on the amount of cash available for dividends. To the extent that external sources of capital, including public and
private markets, become limited or unavailable, Cathedral's ability to make the necessary capital investments to maintain or expand its current business
and to make necessary principal payments under its credit facility may be impaired.
Forward-looking Information May Prove Inaccurate Numerous statements containing forward-looking information are found in this AIF,
documents incorporated by reference herein and other documents forming part of Cathedral's public disclosure record. Such statements and
information are subject to risks and uncertainties and involve certain assumptions, some, but not all, of which are discussed elsewhere in this document.
The occurrence or non-occurrence, as the case may be, of any of the events described in such risks could cause actual results to differ materially from
those expressed in the forward-looking information.
Interest Rates
facility, it is at risk of rising interest rates. Management continually monitors interest rates and would consider locking in the rate of its term debt.
Cathedral's current credit facility bears interest at a floating interest rate and, therefore, to the extent Cathedral borrows under this
Debt Service
Cathedral has a committed extendible revolving credit facility with a syndicate of lenders consisting of The Bank of Nova Scotia
and Export Development Canada in the amount of $18 million (excluding the $5 million swingline facility) with a maturity date of December 31, 2018.
Although it is believed that the credit facility and amendments thereto is sufficient, there can be no assurance that the amount will be adequate for the
financial obligations of Cathedral. As well, if Cathedral requires additional financing such financing may not be available or, if available, may not be
available on favorable terms. Cathedral's lenders have been provided with security over substantially all of the assets of Cathedral. There is no
assurance that the existing credit facility will be extended beyond its maturity date.
In light of the current volatility in oil and gas prices and uncertainty regarding commodity price levels in the future there is a risk that the Company
could temporarily breach the covenants included in its credit facility. If the Company does temporarily breach these covenants, the secured revolving
term loan could become due and payable on demand.
Additional Shares
common shares, existing shareholders may suffer significant dilution.
If the Board of Cathedral decides to issue additional common shares, preferred shares or securities convertible into
Unpredictability and Volatility of Share Price The prices at which the common shares trade cannot be predicted. The market price of the common
shares could be subject to significant fluctuations in response to variations in quarterly operating results and other factors. In addition, in the event a
dividend is paid the annual dividend yield on the common shares as compared to the annual yield on other financial instruments may also influence
the price of common shares in the public trading markets. An increase in prevailing interest rates will result in higher yield on other financial instruments,
which could adversely affect the market price of the common shares. The market price of the common shares may also be impacted by other factors
including the net asset value of our assets which will vary from time to time depending on factors beyond our control.
In addition, the securities markets have experienced significant market wide and sectorial price and volume fluctuations from time to time that often
have been unrelated or disproportionate to the operating performance of particular issuers. Such fluctuations may adversely affect the market price of
the common shares.
Income Tax Matters
The business and operations of Cathedral are complex and Cathedral and its predecessors have executed a number
of significant financings, reorganizations, acquisitions and other material transactions over the course of its history. The computation of income taxes
payable as a result of these transactions involves many complex factors as well as Cathedral's interpretation of relevant tax legislation and regulations.
Cathedral's management believes that the provision for income tax is adequate and in accordance with generally accepted accounting principles and
applicable legislation and regulations. However, tax filing positions are subject to review by taxation authorities who may successfully challenge
Cathedral's interpretation of the applicable tax legislation and regulations. It is also possible that tax authorities may retroactively or prospectively
amend tax legislation or its interpretation, which could affect Cathedral's current and future income taxes. It should be noted that effective July 1, 2015
the general corporate tax rate in the Province of Alberta was increased from 10% to 12%.
Key Personnel and Employee/Sub-contractor Relationships
Shareholders must rely upon the ability, expertise, judgment, discretion,
integrity and good faith of the management and employees of Cathedral. The success of Cathedral is dependent upon its personnel and key sub-
contractors. The unexpected loss or departure of any of Cathedral's key officers, employees or sub-contractors could be detrimental to the future
operations of Cathedral. Cathedral does not maintain key man insurance on any of its officers. The success of Cathedral's business will depend, in
part, upon Cathedral's ability to attract and retain qualified personnel as they are needed. Additionally, the ability of Cathedral to expand its services
is dependent upon its ability to attract additional qualified employees. Historically, Cathedral has not had any significant issues with respect to attracting
and the retention of quality office, shop and field staff. During high levels of activity, attracting quality staff can be challenging due to competition for
such services. As a consequence of the industry downturn experienced since mid-2014 resulting in workforce reductions, many former industry
workers have left the industry either temporarily or permanently. As a consequence of this, attracting and retaining staff may be more challenging in
the future than in the past. Cathedral provides its staff with a quality working environment, effective training, tools with current technology and
competitive remuneration packages that allows it to attract and retain the quality of its workforce, whether in the field, shop or office. There can be no
assurance that Cathedral will be able to engage the services of such personnel or retain its current personnel.
Competition
The oil and natural gas service industry in which Cathedral and its operating entities conduct business is highly competitive.
Cathedral competes with other more established companies which have greater financial, marketing and other resources and certain of which are
large international oil and natural gas service companies which offer a wider array of oil and natural gas services to their clients than does Cathedral.
At any time there may be an excess of certain classes of oilfield service equipment in North America in relation to current levels of demand. The supply
Cathedral Energy Services Ltd. - 2016 Annual Report
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of equipment in the industry does not always correlate to the level of demand for that equipment. Periods of high demand often spur increased capital
expenditures on oilfield service equipment, and those capital expenditures may result in equipment levels which exceed actual demand. In periods of
low demand, there may be excess equipment available within the industry. Excess equipment supply in the industry could cause competitors to lower
their rates and could lead to a decrease in rates in the oilfield services industry generally, which could have an adverse effect on revenues, cash flows
and earnings in the industry and for the Company.
The ability of Cathedral to compete and expand
Access to Parts, Consumables and Technology and Relationships with Key Suppliers
will be dependent on Cathedral having access, at a reasonable cost, to equipment, parts and components for purchased equipment for the
development and acquisition of new competitive technologies. An inability to access these items and delays in accessing these items could have a
material adverse effect on Cathedral's business, financial condition, results of operations and cash flow. Cathedral's equipment may become obsolete
or experience a decrease in demand due to competing products that are lower in cost, have enhanced performance capabilities or are determined by
the market to be more preferable for environmental or other reasons. Although Cathedral has very good relationships with its key suppliers, there can
be no assurances that those sources of equipment, parts, components or relationships with key suppliers will be maintained. If these are not
maintained, Cathedral's ability to compete may be impaired. If the relationships with key suppliers come to an end, the availability and cost of securing
certain parts, components and equipment may be adversely affected.
Technology
The success and ability of Cathedral to compete depends in part on the technologies that it brings to the market, and the ability
of Cathedral to prevent others from copying such technologies. Cathedral currently relies on industry confidentiality practices ("trade secrets"), including
entering into industry standard confidentiality agreements and in some cases patents (or patents pending) to protect its proprietary technology.
Cathedral may have to engage in litigation in order to protect its intellectual property rights, including patents or patents pending, or to determine the
validity or scope of the proprietary rights of itself or others. This kind of litigation can be time-consuming and expensive, regardless of whether or not
Cathedral is successful.
The intellectual property rights of Cathedral may be invalidated, circumvented, challenged, infringed or required to be licensed to others. It cannot be
assured that any steps Cathedral may take to protect its intellectual property rights and other rights to such proprietary technologies that are central
to Cathedral's operations will prevent misappropriation or infringement.
Cathedral competes with other more established companies which have greater financial resources to develop new technologies. Competitors may
also develop similar tools, equipment and technology to Cathedral's thereby adversely affecting Cathedral's competitive advantage in one or more of
its businesses. Additionally, there can be no assurance that certain tools, equipment or technology developed by Cathedral may not be the subject of
future patent infringement claims or other similar matters which could result in litigation, the requirement to pay licensing fees or other results that
could have a material adverse effect on Cathedral's business, results of operations and financial condition.
Potential Replacement or Reduced Use of Products and Services Certain of Cathedral's equipment or systems may become obsolete or
experience a decrease in demand through the introduction of competing products that are lower in cost, exhibit enhanced performance characteristics
or are determined by the market to be more preferable for environmental or other reasons. Cathedral will need to keep current with the changing
market for oil and natural gas services and technological and regulatory changes. If Cathedral fails to do so, this could have a material adverse effect
on its business, financial condition, results of operations and cash flows.
Operating Risks and Insurance
Cathedral has an insurance and risk management plan in place to protect its assets, operations and
employees. However, Cathedral's oilfield services are subject to risks inherent in the oil and natural gas industry, such as equipment defects,
malfunctions, failures, natural disasters and errors by staff, some of which may not be covered by insurance. These risks could expose Cathedral to
substantial liability for personal injury, loss of life, business interruption, property damage or destruction, pollution and other environmental damages.
Cathedral attempts to obtain indemnification from our customers by contract for some of these risks in addition to having insurance coverage. These
indemnification agreements may not adequately protect against liability from all of the consequences described above. In addition, Cathedral's
operating activities includes a significant amount of transportation and therefore is subject to the inherent risks including potential liability which could
result from, among other things, personal injury, loss of life or property damage derived from motor vehicle accidents. Cathedral carries insurance to
provide protection in the event of destruction or damage to its property and equipment, subject to appropriate deductibles and the availability of
coverage. Liability insurance is also maintained at prudent levels to limit exposure to unforeseen incidents. An annual review of insurance coverage
is completed to assess the risk of loss and risk mitigation alternatives. It is anticipated that insurance coverage will be maintained in the future, but
there can be no assurance that such insurance coverage will be available in the future on commercially reasonable terms or be available on terms as
favorable as Cathedral's current arrangements. The occurrence of a significant event outside of the coverage of Cathedral's insurance policies could
have a material adverse effect on the results of the Company. If there is an event that is not fully insured or indemnified against, or a customer or
insurer does not meet its indemnification or insurance obligations, it could result in substantial losses.
Business continuity, disaster recovery and crisis management
Inability to restore or replace critical capacity in a timely manner may impact
business and operations. A serious event could have a material adverse effect on Cathedral's business, results of operations and financial condition.
This risk is mitigated by the development of business continuity arrangements, including disaster recovery plans and back-up delivery systems, to
minimize any business disruption in the event of a major disaster. Insurance coverage may minimize any losses in certain circumstances.
Risks of Foreign Operations
Cathedral may conduct a portion of its business outside North America through a number of means including
projects, joint ventures and partnerships and other business relationships. As such, Cathedral could be exposed to risks inherent in foreign operations
including, but not limited to: loss of revenue, property and equipment as a result of expropriation and nationalization, war, civil and/or labour unrest,
strikes, terrorist threats, civil insurrection and other political risks; fluctuations in foreign currency and exchange controls; increases in duties, taxes
and governmental royalties and renegotiation of contracts with governmental entities; trade and other economic sanctions or other restrictions imposed
by the Canadian government or other governments or organizations; as well as changes in laws and policies governing operations of foreign‐based
companies.
Carrying on business outside of Canada gives rise to the risk of dealing with business and political systems that are different than Cathedral is
accustomed to in Canada.
Cathedral made the decision to terminate its pursuit of operations in Venezuela in 2014 which were provided through a joint venture with a wholly-
owned subsidiary of PDVSA, the state-owned oil and natural gas Company of the Bolivarian Republic of Venezuela. The joint venture company,
Vencana, was owned 60% by the PDVSA wholly-owned subsidiary and 40% by Cathedral's wholly-owned subsidiary, DPI. On February 29, 2016,
Cathedral announced it had closed the sale of its Venezuelan investment by way of selling its wholly-owned Barbados subsidiary, DPI.
Weather and Seasonality
A significant portion of Cathedral's operations are carried on in western Canada where activity levels in the oilfield
services industry are subject to a degree of seasonality. Operating activities in western Canada are generally lower during "spring breakup" which
normally commences in March and continues through to May. Operating activities generally increase in the fall and peak in the winter months from
December until late March. Additionally, volatility in the weather and temperatures not only during this period, but year round, can create additional
unpredictability in operational results. Activity levels in the oil and natural gas basins in the U.S. are not subject to the seasonality to the same extent
that it occurs in the western Canada region.
Cathedral Energy Services Ltd. - 2016 Annual Report
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Foreign Currency Exchange Rates Cathedral derives revenues from the U.S. which are denominated in the local currency. This causes a degree
of foreign currency exchange rate risk which Cathedral attempts to mitigate by matching local purchases in the same currency. Furthermore,
Cathedral's Canadian operations are subject to foreign currency exchange rate risk in that some purchases for parts, supplies and components in the
manufacture of equipment are denominated in U.S. dollars. Cathedral's foreign currency policy is to monitor foreign current risk exposure in its areas
of operations and mitigate that risk where possible by matching foreign currency denominated expense with revenues denominated in foreign
currencies. Cathedral strives to maintain limited amounts of cash and cash equivalents denominated in foreign currency on hand and attempts to
further limit its exposure to foreign currency through collecting and paying foreign currency denominated balance in a timely fashion.
In addition, Cathedral is exposed to currency exchange risk on those of its assets denominated in U.S. dollars. Since Cathedral presents its financial
statements in Canadian dollars, any change in the value of the Canadian dollar relative to the U.S. dollar during a given financial reporting period
would result in a foreign currency loss or gain on the translation of its assets measured in other currencies into Canadian dollars. Consequently,
Cathedral's reported earnings could fluctuate materially as a result of foreign exchange translation gains or losses. Other than natural hedges arising
from the normal course of business in foreign jurisdictions, Cathedral does not currently have any hedging positions.
Acquisition Risks
Cathedral expects to continue to selectively seek acquisitions in connection with its growth strategy. Cathedral's ability
to consummate and to integrate effectively any future acquisitions on terms that are favourable to it may be limited by the number of attractive
acquisition targets, internal demands on Cathedral's resources, and to the extent necessary, Cathedral's ability to obtain financing on satisfactory
terms for larger acquisitions, if at all. Acquisitions may expose Cathedral to additional risks, including: difficulties in integrating administrative, financial
reporting, operational and information systems and managing newly-acquired operations and improving their operating efficiency; difficulties in
maintaining uniform standards, controls, procedures and policies through all of Cathedral's operations; entry into markets in which Cathedral has little
or no direct prior experience; difficulties in retaining key employees of the acquired operations; disruptions to Cathedral's ongoing business; and
diversion of management time and resources.
In implementing its strategy, Cathedral may pursue new business or growth opportunities. There is no
Business Development Risks
assurance that Cathedral will be successful in executing those opportunities. Cathedral may have difficulty executing the its strategy because of,
among other things, increased competition, difficulty entering new markets or geographies, difficulties in introducing new products, the ability to attract
qualified personnel, barriers to entry into geographic markets, and changes in regulatory requirements.
Credit Risk
All of Cathedral's accounts receivables are with customers involved in the oil and natural gas industry, whose revenue may be
impacted by fluctuations in commodity prices. Although collection of these receivables could be influenced by economic factors affecting this industry
and thereby have a materially adverse effect on operations, management considers risk of significant loss to be minimal at this time. To mitigate this
risk, Cathedral's customers are subject to an internal credit review along with ongoing monitoring of the amount and age of receivables balances
outstanding.
Management of Cathedral believes it currently has a good mix of customers. In 2016, approximately 13% of
Reliance on Major Customers
the Company’s revenue was attributable to sales transactions with a single customer. In 2015, two different customers represented approximately
12% and 10% of the Company’s revenue. While Cathedral believes that its relationship with existing customers is good, the loss of any one or more
of these customers, or a significant reduction in business done with Cathedral by one or more of these customers, if not offset by sales to new or
existing customers, could have a material adverse effect on Cathedral's business, results of operations and prospects and therefore on the ability to
pay dividends to shareholders in the future. Mergers and acquisitions activity in the oil and natural gas exploration and production sector can impact
demand for our services as customers focus on internal reorganization prior to committing funds to significant oilfield services. In addition, demand
for Cathedral's services could be negatively affected in that upon completion, the merger and acquisitions customers may re-direct their work to
Cathedral's competitors.
Environmental Risks
Cathedral is subject to various environmental laws and regulations enacted in the jurisdictions in which it operates which
govern the manufacture, processing, importation, transportation, handling and disposal of certain materials used in Cathedral's operations. Cathedral
has established procedures to address compliance with current environmental laws and regulations and monitors its practices concerning the handling
of environmentally hazardous materials. However, there can be no assurance that Cathedral's procedures will prevent environmental damage
occurring from spills of materials handled by Cathedral or that such damage has not already occurred. On occasion, substantial liabilities to third
parties may be incurred. Cathedral may have the benefit of insurance maintained by it or the operator; however Cathedral may become liable for
damages against which it cannot adequately insure or against which it may elect not to insure because of high costs or other reasons.
There is growing concern about the apparent connection between the burning of fossil fuels and climate change. The issue of energy and the
environment has created intense public debate in Canada, the U.S. and around the world in recent years that is likely to continue for the foreseeable
future and could potentially have a significant impact on all aspects of the economy including the demand for hydrocarbons and resulting in lower
demand for Cathedral's services. There can be no assurance that the provincial, state and local governments or the federal governments of Canada
and U.S. and other jurisdictions in which Cathedral enters into to provide its services will not adopt new environmental regulations, rules or legislation
or make modifications to existing regulations, rules or legislation which could increase costs paid by Cathedral's customers. An increase in
environmental related costs could reduce Cathedral's customers' earnings and/or it could make capital expenditures by Cathedral's customers
uneconomic.
Over the past two years both the Canadian federal government and the Government of Alberta have announced various programs related to climate
change and have made certain commitments regarding regulating greenhouse gases ("GHG") and other air pollutants. These proposals also
contemplate taxes on GHG emissions to be paid by the users of hydrocarbons and caps on emissions by producers of hydrocarbons such as oilsands
and energy companies.
As a result of these programs still being developed and their implementation still in the early stages, Cathedral is unable to predict the total impact of
the potential and forthcoming regulations upon its business. As a user of hydrocarbons in its business for heating and vehicles, Cathedral is impacted
on an operational cost basis. Cathedral's customers may face increases in operating costs in order to comply with legislation which could have the
effect of curtailing exploration and development by oil and natural gas producers and that in turn, could adversely affect Cathedral's operations by
reducing demand for its services.
Government Regulation
The oil and natural gas industry in Canada and the U.S. is subject to federal, provincial, state and municipal legislation
and regulation governing such matters as land tenure, commodity prices, production royalties, production rates, environmental protection controls, the
exportation of crude oil, natural gas and other products, as well as other matters. The industry is also subject to regulation by governments in such
matters, including laws and regulations relating to health and safety, the conduct of operations, the protection of the environment and the manufacture,
management, transportation, storage and disposal of certain materials used in Cathedral's operations.
Government regulations may change from time to time in response to economic or political conditions. The exercise of discretion by governmental
authorities under existing regulations, the implementation of new regulations or the modification of existing regulations affecting the crude oil and
natural gas industry could reduce demand for Cathedral's services or increase its costs, either of which could have a material adverse impact on
Cathedral.
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 18
There can be no assurance that the provincial, state and local governments or the federal governments of Canada and U.S. and other jurisdictions in
which Cathedral enters into to provide its services will not adopt a new royalty regime or modify the methodology of royalty calculation which could
increase the royalties paid by Cathedral's customers. An increase in royalties could reduce Cathedral's customers' earnings and/or it could make
capital expenditures by Cathedral's customers uneconomic. Although Cathedral is not a direct investor in the oil and natural gas market, it does affect
Cathedral's customers' cash flow available to invest in drilling activity and other oilfield services.
Cathedral has programs in place to address compliance with current safety and regulatory standards. Cathedral has a
Safety Performance
corporate safety manager responsible for maintaining and developing policies and monitoring operations consistent with those policies. Poor safety
performance could lead to lower demand for Cathedral's services. Standards for accident prevention in the oil and natural gas industry are governed
by company safety policies and procedures, accepted industry safety practices, customer-specific safety requirements, and health and safety
legislation. Safety is a key factor that customers consider when selecting an oilfield service company. A decline in Cathedral's safety performance
could result in lower demand for services, and this could have a material adverse effect on revenues, cash flows and earnings. Cathedral is subject to
various health and safety laws, rules, legislation and guidelines which can impose material liability, increase costs or lead to lower demand for services.
Conflict of Interest
Certain directors of Cathedral are also directors of oil and natural gas exploration and/or production entities and conflicts
of interest may arise between their duties as officers and directors of Cathedral and as officers and directors of such other companies. Such conflicts
must be disclosed in accordance with, and are subject to such other procedures and remedies as apply under the Business Corporations Act (Alberta).
Legal Proceedings
proceedings or that the ultimate resolution of any legal proceedings will not have a materially adverse effect on Cathedral.
Cathedral is involved in litigation from time to time. No assurance can be given as to the final outcome of any legal
GOVERNANCE
The Audit Committee of the Board of Directors has reviewed this MD&A and the related audited consolidated financial statements and recommended
they be approved by the Board of Directors. Following a review by the full Board, the MD&A and audited consolidated financial statements were
approved.
SUPPLEMENTARY INFORMATION
Additional information regarding the Company, including the Annual Information Form ("AIF"), is available on SEDAR at www.sedar.com.
NON-GAAP MEASUREMENTS
Cathedral uses certain performance measures throughout this document that are not defined under GAAP. Management believes that these measures
provide supplemental financial information that is useful in the evaluation of Cathedral’s operations and are commonly used by other oilfield companies.
Investors should be cautioned, however, that these measures should not be construed as alternatives to measures determined in accordance with
GAAP as an indicator of Cathedral’s performance. Cathedral’s method of calculating these measures may differ from that of other organizations, and
accordingly, may not be comparable.
The specific measures being referred to include the following:
"Adjusted gross margin" - calculated as gross margin plus non-cash items (depreciation and share-based compensation); is considered a primary
i)
indicator of operating performance (see tabular calculation);
"Adjusted gross margin %" - calculated as adjusted gross margin divided by revenues; is considered a primary indicator of operating performance
ii)
(see tabular calculation);
iii)
"Total Adjusted EBITDAS" - defined as earnings before share of income/loss from associate, write-down/recovery on investment in associate
finance costs, unrealized foreign exchange on intercompany balances, unrealized foreign exchange due to hyper-inflation accounting, taxes, non-
recurring gains and losses on disposal of equipment (see non-GAAP measurement), depreciation, write-down of goodwill, write-down of equipment,
write-down of inventory and share-based compensation; is considered an indicator of the Company's ability to generate funds flow from operations
prior to consideration of how activities are financed, how the results are taxed and measured and non-cash expenses (see tabular calculation). This
measure includes both discontinued F&PT operations and continuing Directional Drilling operations;
iv)
"Adjusted EBITDAS from discontinued operations" – Total Adjusted EBITDAS as calculated above from discontinued F&PT operations only;
"Adjusted EBITDAS from continuing operations" – Total Adjusted EBITDAS as calculated above for ongoing Directional Drilling as well as
v)
corporate administrative costs;
vi) "Funds from operations" - calculated as cash provided by operating activities before changes in non-cash working capital and income taxes paid
less current tax expense; is considered an indicator of the Company's ability to generate funds flow from operations on an after tax basis but excluding
changes in non-cash working capital which is financed using the Company's operating loan (see tabular calculation);
vii)
“Growth equipment additions” or “Growth capital” – is capital spending which is intended to result in incremental revenues or decreased operating
costs. Growth capital is considered to be a key measure as it represents the total expenditures on equipment expected to add incremental revenues
and funds flow to the Company;
viii) “Maintenance equipment additions” or “Maintenance capital” – is capital spending incurred in order to refurbish or replace previously acquired
other than “replacement equipment additions” described below. Such additions do not provide incremental revenues. Maintenance capital is a key
component in understanding the sustainability of the Company’s business as cash resources retained within Cathedral must be sufficient to meet
maintenance capital needs to replenish the assets for future cash generation;
ix)
“Replacement equipment additions” or “Replacement capital” – is capital spending incurred in order to replace equipment that is lost downhole.
Cathedral recovers lost-in-hole costs including previously expensed depreciation on the related assets from customers. Such additions do not provide
incremental revenues. The identification of replacement equipment additions is considered important as such additions are financed by way of
proceeds on disposal of equipment (see discussion within the MD&A on “gain on disposal of equipment);
“Infrastructure equipment additions” or “Infrastructure capital” – is capital spending incurred on land, buildings and leasehold improvements.
x)
Infrastructure capital is a component in understanding the sustainability of the Company’s business as cash resources retained within Cathedral must
be sufficient to meet maintenance capital needs;
xi)
“Non-recurring gains and losses on disposal of equipment” – are disposals of equipment that do not occur on a regular or periodic basis. Unlike
the lost-in-hole recoveries, the proceeds from these gains are not used on equivalent replacement property. These are often on non-field equipment
such as land and buildings;
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 19
“Net equipment additions” – is equipment additions expenditures less proceeds on the regular disposal of equipment (the proceeds on sale of
xii)
land and buildings have been excluded). Cathedral uses net equipment additions to assess net cash flows related to the financing of Cathedral’s
equipment additions; and
xiii) “Net debt” – is loans and borrowing less working capital. Management uses net debt as a metric to shows the Company's overall debt level.
The following tables provide reconciliations from GAAP measurements to non-GAAP measurements referred to in this MD&A:
Adjusted gross margin
Total Adjusted EBITDAS
Funds from operations
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 20
Three months ended December 31Year ended December 312016201520162015Gross margin3,555$ (278)$ 5,503$ 3,487$ Add non-cash items included in cost of sales:Depreciation3,073 4,036 12,358 15,189 Share-based compensation6 15 14 50 Adjusted gross margin6,634$ 3,773$ 17,875$ 18,726$ Adjusted gross margin %24%18%22%18%Three months ended December 31Year ended December 312016201520162015Earnings (loss) before income taxes(1,093)$ (12,947)$ (722)$ (24,894)$ Add:Depreciation included in cost of sales3,073 4,036 12,358 15,189 Depreciation included in selling, general and administrative expenses34 45 134 177 Share-based compensation included in cost of sales6 15 14 50 Share-based compensation included in selling, general and administrative expenses19 46 130 150 Finance costs679 377 2,061 1,613 Subtotal2,718 (8,428) 13,975 (7,715) Unrealized foreign exchange (gain) loss on intercompany balances719 1,188 (1,455) 4,191 Write-down of goodwill- - - 1,624 Write-down of property and equipment- 3,189 - 3,189 Write-down of inventory- 3,736 277 3,736 Provision for settlement421 - 4,217 - Gain on disposal of foreign subsidiary- - (10,865) - Non-recurring expenses509 434 1,310 660 Non-recurring gain on disposal of land and building- - - (456) Adjusted EBITDAS from continuing operations4,367 119 7,459 5,229 Adjusted EBITDAS from discontinued operations(538) (288) (1,619) 2,470 Total Adjusted EBITDAS3,829$ (169)$ 5,840$ 7,699$ Three months ended December 31Year ended December 312016201520162015Cash flow from operating activities(479)$ 1,794$ 4,140$ 25,931$ Add (deduct):Changes in non-cash operating working capital2,537 (2,790) (1,570) (25,794) Income taxes paid (recovered)407 278 (1,433) 3,539 Current tax recovery (expense)(429) (707) (106) 734 Funds from (used in) operations2,036$ (1,425)$ 1,031$ 4,410$
MANAGEMENT’S REPORT
The consolidated financial statements have been prepared by the management in accordance with International Financial Reporting Standards which
now are the basis for Canadian generally accepted accounting principles and, where appropriate, reflect estimates based upon management's
judgment. Financial information contained elsewhere in the annual report has been prepared on a consistent basis with that in the consolidated
financial statements.
Management is also responsible for a system of internal controls which is designed to provide reasonable assurance that the Company's assets are
safeguarded and accounting systems provide timely, accurate financial reports.
The Audit Committee of the Board of Directors has reviewed in detail the consolidated financial statements with management and the external auditor.
The Board of Directors has approved the consolidated financial statements on the recommendation of the Audit Committee.
KPMG LLP, an independent firm of chartered accountants, have examined the Company's consolidated financial statements in accordance with
Canadian generally accepted auditing standards and provided an independent professional opinion. The auditors have full and unrestricted access
to the Audit Committee to discuss their audit and their related findings as to the integrity of the financial reporting process.
Signed: "P. Scott MacFarlane"
P. Scott MacFarlane
President and Chief Executive Officer
Signed: "Michael F. Hill"
Michael F. Hill
Chief Financial Officer
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 21
INDEPENDENT AUDITORS' REPORT
To the Shareholders of Cathedral Energy Services Ltd.
We have audited the accompanying consolidated financial statements of Cathedral Energy Services Ltd., which comprise the consolidated statements
of financial position as at December 31, 2016 and December 31, 2015, the consolidated statements of comprehensive income (loss), changes in
shareholders’ equity and cash flows for the years then ended, and notes, comprising a summary of significant accounting policies and other explanatory
information.
Management’s Responsibility for the consolidated Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International
Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated
financial statements that are free from material misstatement, whether due to fraud or error.
Auditors’ Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance
with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the
audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The
procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements,
whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the entity’s preparation and fair presentation
of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies
used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated
financial statements.
We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of Cathedral Energy
Services Ltd. as at December 31, 2016 and December 31, 2015, and its consolidated financial performance and its consolidated cash flows for the
years then ended in accordance with International Financial Reporting Standards.
Signed: "KPMG LLP"
Chartered Professional Accountants
March 3, 2017
Calgary, Canada
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 22
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
December 31, 2016 and 2015
Dollars in ‘000s
Approved by the Directors:
Signed: "P. Scott MacFarlane"
Signed: "Rod Maxwell"
P. Scott MacFarlane
Director
Rod Maxwell
Director
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 23
December 31December 3120162015AssetsCurrent assets:Cash and cash equivalents (notes 5 and 27)1,898$ 1,426$ Trade receivables (note 6)26,245 23,107 Current taxes recoverable 1,336 2,962 Prepaid expenses and deposits1,611 1,988 Inventories (note 7)8,037 12,092 Assets held for sale (note 10)17,241 - Total current assets56,368 41,575 Equipment (note 8)68,158 108,918 Intangible assets (note 9)1,978 2,006 Deferred tax assets (note 11)9,513 3,111 Total non-current assets79,649 114,035 Total assets136,017$ 155,610$ Liabilities and Shareholders' EquityCurrent liabilities:Operating loans (note 12)2,105$ 2,484$ Trade and other payables (note 13)12,837 20,198 Loans and borrowings (note 14)459 686 Provision for settlements (note 15)1,643 - Deferred revenue- 4,657 Total current liabilities17,044 28,025 Loans and borrowings (note 14)26,322 30,477 Provision for settlement (note 15)1,879 - Deferred tax liabilities (note 11)- 501 Total non-current liabilities28,201 30,978 Total liabilities45,245 59,003 Shareholders' equity:Share capital (note 16)74,481 74,481 Contributed surplus9,620 9,470 Accumulated other comprehensive income11,371 11,577 Retained earnings (deficit)(4,700) 1,079 Total shareholders' equity90,772 96,607 Total liabilities and shareholders' equity136,017$ 155,610$ Subsequent events (note 25)See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Years ended December 31, 2016 and 2015
Dollars in ‘000s except per share amounts
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 24
20162015 (See note 10) Revenues (note 22)80,866$ 106,243$ Cost of sales (notes 7 and 19):Direct costs(62,991) (87,517) Depreciation(12,358) (15,189) Share-based compensation(14) (50) Total cost of sales(75,363) (102,756) Gross margin5,503 3,487 Selling, general and administrative expenses (note 19):Direct costs(14,921) (17,231) Depreciation(134) (177) Share-based compensation(130) (150) Total selling, general and administrative expenses(15,185) (17,558) (9,682) (14,071) Gain on disposal of equipment3,212 3,257 Gain on disposal of land and buildings (note 8)- 456 Loss from operating activities(6,470) (10,358) Finance costs (note 20)(2,061) (1,613) Foreign exchange gain (loss) (note 20)1,438 (4,374) Provision for settlements (note 15)(4,217) - Gain on disposal of foreign subsidiary (note 18)10,865 - Write-down of inventory (note 7)(277) (3,736) Write-down of equipment (note 8)- (3,189) Write-down of goodwill (note 9)- (1,624) Loss before income taxes(722) (24,894) Income tax recovery (expense) (note 11):Current(106) 734 Deferred3,445 (4,681) Total income tax recovery (expense)3,339 (3,947) Net earnings (loss) from continuing operations2,617 (28,841) Net loss from discontinued operations (note 10)(4,089) (6,501) Write-down of assets held for sale from discontinued operations, net of tax (note 10)(4,307) - Net loss(5,779) (35,342) Other comprehensive income (loss): Foreign currency translation gain on disposal of foreign subsidiary (note 18) 1,348 - Foreign currency translation differences for foreign operations(1,554) 7,727 Total comprehensive loss(5,985)$ (27,615)$ Net earnings (loss) from continuing operations per share (note 17)Basic and diluted0.07$ (0.79)$ Net loss from discontinued operations per share (note 17)Basic(0.23)$ (0.18)$ Net loss per share (note 17)Basic(0.16)$ (0.97)$ See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2016 and 2015
Dollars in ‘000s except per share amounts
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 25
AccumulatedotherRetainedTotalContributedcomprehensiveearningsshareholders'Share capitalsurplusincome (loss)(deficit)equityBalance at December 31, 201474,481$ 9,261$ 3,850$ 40,776$ 128,368$ Total comprehensive income (loss) for the year ended December 31, 2015 - - 7,727 (35,342) (27,615) Transactions with shareholders, recorded directly in equity contributions by and distributions to shareholders for the year ended December 31, 2015:Dividends to equity holders - - - (4,355) (4,355) Share-based compensation- 209 - - 209 Total contributions by and distributions to shareholders- 209 - (4,355) (4,146) Balance at December 31, 201574,481$ 9,470$ 11,577$ 1,079$ 96,607$ Total comprehensive loss for the year ended December 31, 2016 - - (206) (5,779) (5,985) Transactions with shareholders, recorded directly in equity contributions by and distributions to shareholders for the year ended December 31, 2016:Share-based compensation- 150 - - 150 Total contributions by and distributions to shareholders- 150 - - 150 Balance at December 31, 201674,481$ 9,620$ 11,371$ (4,700)$ 90,772$ See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2016 and 2015
Dollars in ‘000s except per share amounts
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 26
20162015 (See note 10) Cash provided by (used in):Operating activities:Net earnings (loss) from continuing operations2,617$ (28,841)$ Items not involving cashDepreciation12,492 15,366 Share-based compensation144 200 Income tax expense(3,339) 3,947 Gain on disposal of equipment(3,212) (3,257) Gain on disposal of land and building- (456) Finance costs2,061 1,613 Unrealized foreign exchange (gain) loss on intercompany balances(1,455) 4,191 Provision for settlements4,217 - Gain on disposal of foreign subsidiary(10,865) - Write-down of inventory277 3,736 Write-down of equipment- 3,189 Write-down of goodwill- 1,624 Cash flow from continuing operations2,937 1,312 Cash flow from (used in) discontinued operations (note 10)(1,800) 2,364 Changes in non-cash operating working capital (note 21)1,570 25,794 Income taxes paid1,433 (3,539) Cash flow from operating activities4,140 25,931 Investing activities:Property and equipment additions(899) (6,908) Intangible asset additions(160) (289) Proceeds on disposal of property and equipment5,286 4,944 Proceeds on disposal of land and building- 6,174 Changes in non-cash investing working capital (note 21)(762) (1,012) Cash flow from investing activities3,465 2,909 Financing activities:Change in operating loan(388) 1,448 Interest paid(1,605) (1,989) Advances of loans and borrowings1,250 - Repayments on loans and borrowings(5,499) (25,626) Payment on settlements(851) - Dividends paid- (7,350) Cash flow used in financing activities(7,093) (33,517) Effect of exchange rate on changes on cash(40) 994 Change in cash and cash equivalents472 (3,683) Cash and cash equivalents, beginning of year1,426 5,109 Cash and cash equivalents, end of year1,898$ 1,426$ See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016 and 2015
Dollars in ‘000s except per share and per option amounts
1. Reporting entity
Cathedral Energy Services Ltd. (the “Company” or “Cathedral”) is a company domiciled in Canada. The Company is a publicly traded company listed
on the Toronto Stock Exchange under symbol "CET". The consolidated financial statements of the Company as at and for the year ended December
31, 2016 comprise the Company and its 100% owned subsidiary, Cathedral Energy Services Inc. ("INC"), (together referred to as “Cathedral”). INC
is incorporated in the United States of America ("U.S.") and its functional currency is U.S. dollars ("USD").
The Company and INC are primarily involved and engaged in the business of providing directional drilling services to oil and natural gas companies
in western Canada and the U.S.
During 2016 Q1, the Company disposed of its 100% interest in Directional Plus International Inc. ("DPI"). See note 18 for further details.
2. Basis of preparation
(a) Statement of compliance
The consolidated financial statements have been prepared in accordance with Canadian Generally Accepted Accounting Principles (“GAAP”) which
are defined as International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board (“IASB”). The
consolidated financial statements were authorized for issue by the Board of Directors on March 2, 2017.
(b) Basis of measurement
The consolidated financial statements have been prepared on the historical cost basis.
(c) Functional and presentation currency
These consolidated financial statements are presented in Canadian dollars ("CAD"), which is the Company’s presentation and functional currency. All
financial information presented in dollars has been rounded to the nearest thousand except for per share amounts.
(d) Use of estimates and judgments
The preparation of the consolidated financial statements in conformity with GAAP requires management to make judgments, estimates and
assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may
differ from these estimates.
Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the
estimates are revised and in any future periods affected.
Areas that require management to make significant judgment and estimates in determining the amounts recognized in these consolidated financial
statements include, but are not limited to the following:
Judgments
(i) Current and deferred income taxes
The Company must make determinations on whether to record amounts for various tax pools it has available for future use. In making this
determination, the Company looks at its history and future expectations to determine what amounts, if any can be recognized. The Company also
reviews all tax assessments to determine which assessments it concurs with and will record in its records and which assessments it disputes and
which it expects to be changed. If the Company believes the assessment was incorrect, it does not make a provision for a liability in its accounts.
As such the provisions for current and deferred income taxes are subject to measurement uncertainty.
(ii)
Identification of cash generating units (“CGU”)
In the prior annual assessment of goodwill, the Company had to perform the impairment test at the CGU level, which is defined as the smallest
group of assets that generates independent cash flow. Significant judgment is required in this assessment and changes to this assessment could
materially impact the level at which impairment tests are performed. All goodwill was written off in 2015.
(iii) Recognition of contingent liabilities
The determination if a contingent liability requires an accrual in the financial statements or only requires disclosure is an area that requires significant
judgment. In making this determination, management reviews the specific details of the contingency and may seek professional help if the matter
is of sufficient complexity. For items not recorded as contingent liabilities, there is also a determination required if the amount of claim would be
material, as only material amounts are disclosed in financial statements. As at December 31, 2016, the Company had no material contingent
liabilities.
Estimates
(i) Equipment
The Company makes estimates about the residual value and expected useful life of equipment. These estimates are based on management’s
historical experience and industry norms. Expected useful life and depreciation rates are as disclosed in note 3 (d) (iii).
(ii)
Impairment of assets
Equipment and intangibles are assessed for impairment when circumstances suggest that the carrying amount may exceed the recoverable amount
for the asset. These calculations require estimates and assumptions and are subject to change as new information becomes available. These
estimates include number of years of cash flow available from the assets, growth rates, pre-tax discount rates as well as various estimates and
assumptions used in the preparation of revenues and expenses used in the cash flow analysis. The assumptions used in the 2015 and 2016
impairment tests of equipment are disclosed in note 8.
Trade accounts receivable require estimates to be made regarding the financial stability of the Company’s customers and the environment in which
they operate in order to assess if accounts receivable balances will be received. Credit risks for outstanding accounts receivable are assessed
regularly and an allowance for doubtful accounts is recorded based upon specific customer information and experience as well as for groups of
similar assets. See note 27 “Credit risk” for further details.
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Inventory is reviewed periodically in order to determine if there is obsolescence. This estimate is based upon historic data and management’s
estimates of future demand. The estimates used in the 2015 and 2016 write-downs of inventory are discussed in note 7.
(iii)
Income taxes
The Company uses the asset and liability method of accounting for future income taxes whereby deferred income tax assets and liabilities are
determined based on temporary differences between the accounting basis and the tax basis of the assets and liabilities, and are measured using
substantively enacted tax rates and laws expected to apply when these differences reverse. As a result, a projection of taxable income is required
for those years, as well as an assumption of the ultimate recovery/settlement period for the temporary differences.
The business and operations of the Company are complex and the Company has executed a number of significant financings, reorganizations,
acquisitions and other material transactions over the course of its history. The computation of income taxes payable resulting from these
transactions involves many complex factors as well as the Company's interpretation of relevant tax legislation and regulations. The Company's
management believes that the provision for income tax is adequate and in accordance with GAAP and applicable legislation and regulations.
However, tax-filing positions are subject to review by taxation authorities who may successfully challenge the Company's interpretation of the
applicable tax legislation and regulations.
(iv) Share-based compensation
The Company accounts for share-based compensation using the fair value method of accounting as calculated under the Black-Scholes option
valuation method. This method for share-based compensation requires that management make assumptions on model inputs including forfeiture
rate and volatility that could result in material differences if the assumptions were changed. Management uses historical data to make these
estimates, which are disclosed in note 16.
(v) Liquidity
As part of its capital management process, the Company prepares a forecast / budget. Management and the board of directors use the forecast /
budget to direct and monitor the strategy and ongoing operations and liquidity of the Company. Forecasts / budgets are subject to significant
judgment and estimates relating to activity levels, future cash flows and the timing thereof and other factors which may or may not be within the
control of the Company. See further discussions relating to liquidity in note 27.
3. Significant accounting policies
The accounting policies set out below have been applied consistently by the Company to all periods presented in these consolidated financial
statements unless otherwise indicated.
(a) Basis of consolidation
Business combinations are accounted for using the acquisition method of accounting in which the identifiable assets acquired, liabilities assumed and
any non-controlling interest are recognized and measured at their fair value at the date of acquisition. Any excess of the purchase price plus any non-
controlling interest over the fair value of the net assets acquired is recognized as goodwill. Any deficiency of the purchase price over the fair value of
the net assets acquired is credited to net earnings.
At acquisition, goodwill is allocated to each of the CGUs to which it relates. Subsequent measurement of goodwill is at cost less any accumulated
impairment losses.
(i) Subsidiaries
Subsidiaries are entities controlled by Cathedral. The financial statements of subsidiaries are included in the consolidated financial statements from
the date that control commences until the date that control ceases. The accounting policies of subsidiaries align with the policies adopted by
Cathedral.
(ii) Transactions eliminated on consolidation
Intra-group balances and transactions, and any unrealized income, expenses, gains or losses arising from intra-group transactions, are eliminated
in preparing the consolidated financial statements.
(b) Foreign currency
(i) Foreign currency transactions
All transactions that are not denominated in an entity's functional currency are foreign currency transactions. These transactions are initially
recorded in the functional currency by applying the appropriate daily rate which best approximates the actual rate of transaction.
CAD is the functional and presentation currency of the Company. The functional currency of Cathedral's subsidiary is listed in note 1.
Monetary assets and liabilities denominated in foreign currencies at the reporting date are retranslated to the functional currency at the exchange
rate at that date. All differences are recognized in the consolidated statement of comprehensive income.
Non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the
transaction.
(ii) Foreign operations
The assets and liabilities of foreign operations are translated to CAD at exchange rates at the reporting date. The income and expenses of foreign
operations are translated to CAD at exchange rates at the dates of the transactions.
Foreign currency differences are recognized in other comprehensive income and have been recognized in accumulated other comprehensive
income (‘AOCI’) in the cumulative translation. When a foreign operation is disposed of, the relevant amount in AOCI (in the cumulative translation
account) is transferred to profit or loss as part of the profit or loss on disposal. On the partial disposal of a subsidiary that includes a foreign operation,
the relevant proportion of such cumulative amount is reattributed to non-controlling interest. In any other partial disposal of a foreign operation, the
relevant proportion is reclassified to profit or loss.
(c) Financial instruments
At December 31, 2016 and 2015, Cathedral has the following financial instruments: cash and cash equivalents, loans and receivables.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(i) Non-derivative financial assets
Cathedral initially recognizes trade and other receivables on the date that they originate. All other financial assets (including assets designated at
fair value through profit or loss) are recognized initially on the trade date at which Cathedral becomes a party to the contractual provisions of the
instrument.
Cathedral derecognizes a financial asset when the contractual rights to the cash flows from the asset expire, or it transfers the rights to receive the
contractual cash flows on the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are
transferred. Any interest in transferred financial assets that is created or retained by Cathedral is recognized as a separate asset or liability.
Financial assets and liabilities are offset and the net amount presented in the statement of financial position when, and only when, Cathedral has a
legal right to offset the amounts and intends either to settle on a net basis or to realize the asset and settle the liability simultaneously.
Cash and cash equivalents
Cash and cash equivalents comprise cash balances and call deposits with original maturities of three months or less.
Loans and receivables
Loans and receivables are financial assets with fixed or determinable payments that are not quoted in an active market. Such assets are recognized
initially at fair value plus any directly attributable transaction costs. Subsequent to initial recognition, loans and receivables are measured at
amortized cost using the effective interest method, less any impairment losses.
(ii)
Non-derivative financial liabilities
Cathedral initially recognizes debt securities issued on the date that they are originated. Cathedral derecognizes a financial liability when its
contractual obligations are discharged or cancelled or expire.
Financial assets and liabilities are offset and the net amount presented in the statement of financial position when, and only when, Cathedral has a
legal right to offset the amounts and intends either to settle on a net basis or to realize the asset and settle the liability simultaneously.
Cathedral has the following non-derivative financial liabilities: loans and borrowings, operating loan and trade and other payables.
Such financial liabilities are recognized initially at fair value plus any directly attributable transaction costs. Subsequent to initial recognition, these
financial liabilities are measured at amortized cost using the effective interest method.
(d) Equipment
(i) Recognition and measurement
Items of equipment are measured at cost less accumulated depreciation and accumulated impairment losses.
Cost includes expenditure that is directly attributable to the acquisition of the asset. The cost of self-constructed assets includes the cost of materials
and direct labour, any other costs directly attributable to bringing the assets to a working condition for their intended use, the costs of dismantling
and removing the items and restoring the site on which they are located, and borrowing costs on qualifying assets.
Purchased software that is integral to the functionality of the related equipment is capitalized as part of that equipment.
When parts of an item of equipment have different useful lives, they are accounted for as separate items (major components) of equipment.
Gains and losses on disposal of an item of equipment are determined by comparing the proceeds from disposal with the carrying amount of
equipment, and are recognized net within other income in profit or loss.
(ii) Subsequent costs
The cost of replacing a part of an item of equipment is recognized in the carrying amount of the item if it is probable that the future economic benefits
embodied within the part will flow to Cathedral, and its cost can be measured reliably. The carrying amount of the replaced part is derecognized.
The costs of the day-to-day servicing of equipment (repair and maintenance) are recognized in profit or loss as incurred.
(iii) Depreciation
Depreciation is calculated over the depreciable amount, which is the cost of an asset, or other amount substituted for cost, less its residual value.
Depreciation is recognized in profit or loss on either a straight-line or diminishing balance basis over the estimated useful lives of each part of an
item of equipment. Leased assets are depreciated over the shorter of the lease term and their useful lives unless it is reasonably certain that
Cathedral will obtain ownership by the end of the lease term. Land is not depreciated.
Items of equipment are depreciated from the date that they are installed and are available for use, or in respect of internally constructed assets,
from the date that the asset is completed and available for use.
The estimated useful lives, depreciation rates and depreciation methods for the current and comparative periods are as follows:
Cathedral Energy Services Ltd. - 2016 Annual Report
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Estimated life in yearsDepreciation ratesDepreciation methodDirectional drilling equipment15.5 to 2013 to 20%Declining balanceProduction testing equipment11.5 to 15.515 to 20%Declining balanceOffice and computer equipment3.0 to 11.520 to 55%Declining balanceAutomotive equipment8 to 11.520 to 30%Declining balanceBuildings554%Declining balanceAutomotive equipment under capital lease3 to 420% or 33%Straight-lineLeasehold improvements520%Straight-line
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Depreciation methods, useful lives and residual values are reviewed at each financial year-end and adjusted if appropriate. Effective January 1,
2015 the estimated useful life of the following equipment:
Equipment type
Certain vehicles
Certain computer hardware
Certain Directional Drilling equipment
Certain Directional Drilling equipment
Prior estimated useful life Revised estimated useful life
10 years
8 years
15 years
25 years
8 years
5 years
12 years
20 years
These changes in estimates have been accounted for prospectively beginning January 1, 2015.
(e)
Intangible assets
(i) Goodwill
Goodwill that arises upon the acquisition of subsidiaries is included in the financial statements. For measurement of goodwill at initial recognition,
see note 3(a).
(ii)
Internally generated intangible asset - Research and development
Expenditure on research activities, undertaken with the prospect of gaining new scientific or technical knowledge and understanding, is recognized
in profit or loss as incurred.
Development activities involve a plan or design for the production of new or substantially improved products and processes. Development
expenditure is capitalized only if development costs can be measured reliably, the product or process is technically and commercially feasible, future
economic benefits are probable, and Cathedral intends to and has sufficient resources to complete development and to use or sell the asset. The
expenditure capitalized includes the cost of materials, direct labour, overhead costs that are directly attributable to preparing the asset for its intended
use, and borrowing costs on qualifying assets. Other development expenditure is recognized in profit or loss as incurred.
Capitalized development expenditure is measured at cost less accumulated amortization and accumulated impairment losses.
(iii) Subsequent expenditure
Subsequent expenditure is capitalized only when it increases the future economic benefits embodied in the specific asset to which it relates. All
other expenditure, including expenditure on internally generated goodwill and brands, is recognized in profit or loss as incurred.
(iv) Amortization
Amortization is calculated on the cost of the asset less its residual value.
Amortization is recognized in profit or loss on a straight-line basis over the estimated useful lives of intangible assets, other than goodwill, from the
date that they are available for use, since this most closely reflects the expected pattern of consumption of the future economic benefits embodied
in the asset. The estimated useful life for capitalized development costs is 5 years.
Amortization methods, useful lives and residual values are reviewed at each financial year-end and adjusted if appropriate.
(f) Leased assets
Leases in terms of which Cathedral assumes substantially all the risks and rewards of ownership are classified as finance leases. Upon initial
recognition, the leased asset is measured at an amount equal to the lower of its fair value and the present value of the minimum lease payments.
Subsequent to initial recognition, the asset is accounted for in accordance with the accounting policy applicable to that asset.
Other leases are operating leases and the leased assets are not recognized in Cathedral’s statement of financial position.
(g)
Inventories
Inventories are measured at the lower of cost and net realizable value. The cost of inventories is based on the average cost principle, and includes
expenditure incurred in acquiring the inventories, production or conversion costs and other costs incurred in bringing them to their existing location
and condition.
Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and selling expenses.
(h)
Impairment
(i) Financial assets (including receivables)
A financial asset other than those carried at fair value through profit or loss is assessed for indicators of impairment at each reporting date. A
financial asset is impaired if objective evidence indicates that a loss event has occurred after the initial recognition of the asset, and that the loss
event had a negative effect on the estimated future cash flows of that asset that can be reliably estimated.
Cathedral considers evidence of impairment for receivables at both a specific asset and collective level. All individually significant receivables are
assessed for specific impairment. All individually significant receivables found not to be specifically impaired are then collectively assessed for any
impairment that has been incurred but not identified. Receivables that are not individually significant are collectively assessed for impairment by
grouping together receivables with similar risk characteristics.
In assessing collective impairment Cathedral uses historical trends of the probability of default, timing of recoveries and the amount of loss incurred,
adjusted for management’s judgment as to whether current economic and credit conditions are such that the actual losses are likely to be greater
or less than suggested by historical trends.
(ii) Non-financial assets
The carrying amounts of Cathedral’s non-financial assets, other than inventories and deferred tax assets are reviewed at each reporting date to
determine whether there is any indication of impairment. If any such indication exists, then the asset’s recoverable amount is estimated.
The recoverable amount of an asset or cash-generating unit is the greater of its value in use and its fair value less costs to sell. In assessing value
in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments
of the time value of money and the risks specific to the asset. For the purpose of impairment testing, assets that cannot be tested individually are
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows
of other assets or groups of assets (the “cash-generating unit", or "CGU”). For the purposes of goodwill impairment testing, goodwill acquired in a
business combination is allocated to CGUs that are expected to benefit from the synergies of the combination. This allocation is subject to an
operating segment ceiling test and reflects the lowest level at which that goodwill is monitored for internal reporting purposes.
Cathedral’s corporate assets do not generate separate cash inflows. If there is an indication that a corporate asset may be impaired, then the
recoverable amount is determined for the CGU to which the corporate asset belongs.
An impairment loss is recognized if the carrying amount of an asset or its CGU exceeds its estimated recoverable amount. Impairment losses are
recognized in profit or loss. Impairment losses recognized in respect of CGUs are allocated first to reduce the carrying amount of any goodwill
allocated to the units, and then to reduce the carrying amounts of the other assets in the unit (group of units) on a pro rata basis.
An impairment loss in respect of goodwill is not reversed. In respect of other assets, impairment losses recognized in prior periods are assessed at
each reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change
in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does
not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized.
(i) Employee benefits
(i) Termination benefits
Termination benefits are recognized as an expense when Cathedral is committed demonstrably, without realistic possibility of withdrawal, to a formal
detailed plan either to terminate employment before the normal retirement date, or to provide termination benefits because of an offer made to
encourage voluntary redundancy. Termination benefits for voluntary redundancies are recognized as an expense if Cathedral has made an offer of
voluntary redundancy, it is probable that the offer will be accepted, and the number of acceptances can be estimated reliably. If benefits are payable
more than 12 months after the reporting period, then they are discounted to their present value.
(ii) Short-term employee benefits
Short-term employee benefit obligations are measured on an undiscounted basis and are expensed as the related service is provided.
A liability is recognized for the amount expected to be paid under short-term cash bonus or profit-sharing plans if Cathedral has a present legal or
constructive obligation to pay this amount because of past service provided by the employee, and the obligation can be estimated reliably.
(iii) Share-based payment transactions – equity settled
The grant date fair value of share-based payment awards granted to employees, directors and consultants is recognized as an employee expense,
with a corresponding increase in equity, over the period that the employees unconditionally become entitled to the awards (vesting period). The
amount recognized as an expense is adjusted to reflect the number of awards for which the related service and non-market vesting conditions are
expected to be met, such that the amount ultimately recognized as an expense is based on the number of awards that do meet the related service
and non-market performance conditions at the vesting date.
Share-based payment arrangements in which Cathedral receives goods or services as consideration for its own equity instruments are accounted
for as equity-settled share-based payment transactions.
(j) Revenue
Revenue is recognized when there is persuasive evidence that an arrangement exists (usually when executed), the risks and rewards have been
transferred to the buyer, the service has been provided, the rate is fixed, the associated costs can be estimated reliably, the collection of the amounts
billed to the customer is considered probable and revenue can be measured reliably. Cathedral considers persuasive evidence to exist when a formal
contract is signed or customer acceptance is obtained. Contract terms do not include a provision for significant post-service delivery obligations.
Cathedral’s services are generally sold based upon service orders or contracts with customers that include fixed or determinable prices based upon
daily, hourly or job rates.
(k) Lease payments
Payments made under operating leases are recognized in profit or loss on a straight-line basis over the term of the lease. Lease incentives received
are recognized as an integral part of the total lease expense, over the term of the lease.
Minimum lease payments made under finance leases are apportioned between the finance expense and the reduction of the outstanding liability. The
finance expense is allocated to each period during the lease term to produce a constant periodic rate of interest on the remaining balance of the
liability.
Determining whether an arrangement contains a lease
At inception of an arrangement, Cathedral determines whether such an arrangement is or contains a lease. A specific asset is the subject of a lease
if fulfillment of the arrangement is dependent on the use of that specified asset. An arrangement conveys the right to use the asset if the arrangement
conveys to Cathedral the right to control the use of the underlying asset.
At inception or upon reassessment of the arrangement, Cathedral separates payments and other consideration required by such an arrangement
into those for the lease and those for other elements on the basis of their relative fair values. If Cathedral concludes for a finance lease that it is
impracticable to separate the payments reliably, an asset and a liability are recognized at an amount equal to the fair value of the underlying asset.
Subsequently the liability is reduced as payments are made and an imputed finance charge on the liability is recognized using Cathedral’s
incremental borrowing rate.
(l) Finance income and costs
Finance costs comprise interest expense on borrowings, bank charges and other interest and foreign exchange gains or losses. Borrowing costs that
are not directly attributable to the acquisition, construction or production of a qualifying asset are recognized in profit or loss using the effective interest
method.
Foreign currency gains and losses are reported on a net basis.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(m) Income tax
Income tax expense comprises current and deferred tax. Current tax and deferred tax are recognized in profit or loss except to the extent that it relates
to a business combination, or items recognized directly in equity or in other comprehensive income.
Current tax is the expected tax payable or receivable on the taxable income or loss for the year, using tax rates enacted or substantively enacted at
the reporting date, and any adjustment to tax payable in respect of previous years.
Deferred tax is recognized in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for taxation purposes. Deferred tax is not recognized for the following temporary differences: the initial recognition of assets or
liabilities in a transaction that is not a business combination and that affects neither accounting nor taxable profit or loss, and differences relating to
investments in subsidiaries and jointly controlled entities to the extent that it is probable that they will not reverse in the foreseeable future. In addition,
deferred tax is not recognized for taxable temporary differences arising on the initial recognition of goodwill. Deferred tax is measured at the tax rates
that are expected to be applied to temporary differences when they reverse, based on the laws that have been enacted or substantively enacted by
the reporting date. Deferred tax assets and liabilities are offset if there is a legally enforceable right to offset current tax liabilities and assets, and they
relate to income taxes levied by the same tax authority on the same taxable entity, or on different tax entities, but they intend to settle current tax
liabilities and assets on a net basis or their tax assets and liabilities will be realized simultaneously.
A deferred tax asset is recognized for unused tax losses, tax credits and deductible temporary differences, to the extent that it is probable that future
taxable income will be available against which they can be utilized. Deferred tax assets are reviewed at each reporting date and are reduced to the
extent that it is no longer probable that the related tax benefit will be realized.
(n) Earnings per share
Cathedral presents basic and diluted earnings per share ("EPS") data for its common shares. Basic EPS is calculated by dividing the profit or loss
attributable to common shareholders of the Company by the weighted average number of common shares outstanding during the period. Diluted EPS
is determined by adjusting the profit or loss attributable to common shareholders and the weighted average number of common shares outstanding,
adjusted for own shares held, for the effects of all dilutive potential common shares, which comprise share options granted to employees, directors
and consultants.
(o) New standards not yet adopted
A number of new accounting standards, amendments to accounting standards and interpretations are effective for annual periods beginning on or
after January 1, 2017 and have not been applied in preparing the Consolidated Financial Statements for the year ended December 31, 2016. The
standards applicable to the Company are as follows and will be adopted on their respective effective dates:
(i) Revenue Recognition
On May 28, 2015, the IASB issued IFRS 15, “Revenue From Contracts With Customers” (“IFRS 15”) replacing International Accounting
Standard 11, “Construction Contracts” (“IAS 11”), IAS 18, “Revenue” (“IAS 18”), and several revenue-related interpretations. IFRS 15
establishes a single revenue recognition framework that applies to contracts with customers. The standard requires an entity to recognize
revenue to reflect the transfer of goods and services for the amount it expects to receive, when control is transferred to the purchaser in
accordance with a five step model. Disclosure requirements have also been expanded.
The new standard is effective for annual periods beginning on or after January 1, 2018, with earlier adoption permitted. The standard may
be applied retrospectively or using a modified retrospective approach.
The Company will adopt the new standard on the effective date of January 1, 2018. As the Company continues its analysis, it will also
quantify the impact, if any, on prior period revenues. The Company will address any system and process changes necessary to compile the
information to meet the disclosure requirements of the new standard. As the Company is currently evaluating the impact of this standard, it
has not yet determined the effect on its consolidated financial statements.
(ii) Financial Instruments
On July 24, 2015, the IASB issued the final version of IFRS 9, “Financial Instruments” (“IFRS 9”) to replace IAS 39, “Financial Instruments:
Recognition and Measurement” (“IAS 39”).
IFRS 9 introduces a single approach to determine whether a financial asset is measured at amortized cost or fair value and replaces the
multiple rules in IAS 39. The approach is based on how an entity manages its financial instruments in the context of its business model and
the contractual cash flow characteristics of the financial assets. For financial liabilities, IFRS 9 retains most of the IAS 39 requirements;
however, where the fair value option is applied to financial liabilities, the change in fair value resulting from an entity’s own credit risk is
recorded in OCI rather than net earnings, unless this creates an accounting mismatch. In addition, a new expected credit loss model for
calculating impairment on financial assets replaces the incurred loss impairment model used in IAS 39. The new model will result in more
timely recognition of expected credit losses. IFRS 9 also includes a simplified hedge accounting model, aligning hedge accounting more
closely with risk management. Cathedral does not currently apply hedge accounting and does not value any financial liabilities at fair value.
IFRS 9 is effective for years beginning on or after January 1, 2018. Early adoption is permitted if IFRS 9 is adopted in its entirety at the
beginning of a fiscal period. As the Company does not apply hedge accounting and does not measure any financial liabilities at fair value it
is anticipated that the impact of adopting IFRS 9 will not have a material impact on the Consolidated Financial Statements.
(iii) Leases
In January 2016, the IASB issued IFRS 16 Leases which provides a single lease accounting model for lessees, which require the recognition
of most leases as finance leases on the balance sheet.
This will result in the recognition of a lease liability and a corresponding recognition of a leased asset called right-of-use asset. On the
statement of net earnings and comprehensive income, lease expense will be recognized and will consist of two components, depreciation
expense of the right-of-use asset and interest expense related to the lease liability. Finance lease exemptions exist for short-term leases
where the term is 12 months or less and for leases of low value items.
For lessors, the accounting treatment remains the same which provides a lessor the choice of classifying a lease as either a finance or
operating lease. IFRS 16 comes into effect on January 1, 2019. The Company is currently evaluating the impact of adopting IFRS 16 on
the Consolidated Financial Statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(iv) Amendments to IAS 7, Statement of Cash Flows
In January 2016, the IASB issued Disclosure Initiative (Amendments to IAS 7) which requires reporting issuers to provide disclosures that
enable users of financial statements to evaluate changes in liabilities arising from financing activities. The amendment is effective for annual
reporting periods beginning on or after January 1, 2017 with earlier adoption permitted. Comparative information is not required to be
disclosed when entities first apply the amendments. The effect of this initiative will only relate to the Company’s disclosures and will be
adopted on January 1, 2017.
4. Determination of fair values
A number of Cathedral’s accounting policies and disclosures require the determination of fair value, for both financial and non-financial assets and
liabilities. Fair values have been determined for measurement and/or disclosure purposes based on the following methods. When applicable, further
information about the assumptions made in determining fair values is disclosed in the notes specific to that asset or liability.
(a) Equipment
The fair value of equipment recognized because of a business combination is based on market values. The market value of equipment is the estimated
amount for which a property could be exchanged on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction
after proper marketing wherein the parties had each acted knowledgeably and willingly. The fair value of items of equipment is based on the market
approach and cost approaches using quoted market prices for similar items when available and replacement cost when appropriate.
(b)
Intangible assets
The fair value of development costs is based on the discounted cash flows expected to be derived from the use of the assets.
(c)
Inventories
Inventories consist of operating supplies and parts to be used in repairing equipment. The fair value of inventories is determined based on the net
realizable value of these items.
(d) Trade and other receivables
The fair value of trade and other receivables is estimated as the present value of future cash flows, discounted at the market rate of interest at the
reporting date. This fair value is determined for disclosure purposes.
(e) Non-derivative financial liabilities
Fair value, which is determined for disclosure purposes, is calculated based on the present value of future principal and interest cash flows, discounted
at the market rate of interest at the reporting date. For finance leases, the market rate of interest is determined by reference to similar lease
agreements.
(f) Share-based payment transactions
The fair value of the employee share options is measured using the Black-Scholes option-pricing model. Measurement inputs include the share price
on measurement date, the exercise price of the instrument, the expected volatility (based on weighted average historic volatility adjusted for changes
expected due to publicly available information), the weighted average expected life of the instruments (based on historical experience and general
option holder behavior), the expected dividends, forfeiture rate per annum and the risk-free interest rate (based on government bonds). Service and
non-market performance conditions are not taken into account in determining fair value.
5. Cash and cash equivalents
All of the Company’s amounts consist of bank balances. This balance does not include any term deposits and temporary investments or bank
overdrafts. The Company’s exposure to interest rate risk and a sensitivity analysis for financial assets and liabilities is disclosed in note 25.
6. Trade receivables
All of the Company’s amounts are trade receivables. This balance does not include any related party amounts or other loans and receivables. All
amounts are current assets. The Company’s exposure to credit and currency risks, and impairment losses related to trade and other receivables is
disclosed in note 27.
7.
Inventories
All of the Company’s inventories are composed of raw materials, consumables and work-in-progress. There are no finished goods inventories. For
the year ended December 31, 2016, raw materials and consumables recognized as cost of sales were $28,211 (2015 - $34,913). During 2015 Q4, a
review of expected demand for inventory balances to be used in equipment repairs was conducted. A write-down of $3,736 was recognized related
to obsolete or slow moving inventory. In 2016 Q1, a further write-down of $277 was recognized.
8. Equipment
Cathedral Energy Services Ltd. - 2016 Annual Report
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Effects ofBalancemovements inBalanceDecember 31Disposals andexchangeDecember 31Cost2014Additionswrite-downsrates2015Directional Drilling equipment158,924$ 4,442$ (19,032)$ 436$ 144,770$ Flowback and production testing equipment62,554 1,345 (212) 361 64,048 Automotive equipment1,210 181 (259) 176 1,308 Office and computer equipment7,810 273 (3) 359 8,439 Buildings3,698 604 (4,680) 378 - Land415 - (451) 36 - Automotive equipment under capital lease3,523 - (1,183) 469 2,809 Leasehold improvements1,266 63 112 1,441 Total239,400$ 6,908$ (25,820)$ 2,327$ 222,815$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On December 16, 2016, the Company entered into a definitive agreement to sell the fixed assets of its flowback and production testing (“F&PT”)
CGU. As such, the net realizable value of the F&PT equipment has been reclassified as assets held for sale on the consolidated balance sheet (see
note 10).
Due to the reduction in demand for services, in 2015 Q4 the Company carried out a review of equipment and wrote-down those where there was a
significant lack of demand by clients. The result of this review was a write-down of equipment of $3,189.
On March 30, 2015, the Company closed the sale of its land and building in Oklahoma City, Oklahoma and entered into a lease for these premises.
As the lease was classified as an operating lease and the sale proceeds were at fair market value, the entire amount of the gain was recognized in
2015. The net proceeds were $6,174 and the resulting gain on sale of land and building was $456.
Leased automotive equipment
The Company leases equipment under a number of finance lease agreements. The leased equipment secures lease obligations (see note 14). During
2016, there were non-cash fixed asset additions of $46 (2015 - $nil) related to finance lease arrangements.
Review for impairment
The Company reviews the carrying value of equipment and intangible assets at each reporting period where there are indicators of impairment. In
addition to the review of goodwill conducted at September 30, 2015 discussed in note 9, the Company also conducted a review for impairment of
equipment as at December 31, 2015 and December 31, 2016.
The recoverable amount of each CGU was determined using the discounted cash flow model for value-in-use for each CGU. This was determined
based on a detailed budget of revenues was prepared based upon revenue forecasted by heads of sales departments. The budget was prepared
with consultation of senior operating managers and accounting staff based upon existing costs, historical information and anticipated cost reductions.
The detailed budget was used to prepare a high level for the next two years. Variable costs were adjusted based on percentage of sales, while fixed
costs were maintained at current levels, with increases to wages as the recovery progresses. Cash flow projections thereafter have been extrapolated
based on a 5% (2015 – 1.5%) per annum growth rate and incorporate a future 25% downturn in the 11th year of the forecast.
The forecasted cash flows are based on management’s best estimates of pricing, activity levels, costs to maintain equipment and a pre‐tax discount
rate of 14% (2015 - 19%) per annum. A terminal value was used based on the annual growth rate for cash flows through the remainder of the
segment’s life.
Based on these cash flows to determine value in use, there was no impairment of equipment or intangible assets for either CGU at December 31,
Cathedral Energy Services Ltd. - 2016 Annual Report
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Effects ofBalancemovements inBalanceDecember 31Disposals andexchangeDecember 31Accumulated depreciation2014Additionswrite-downsrates2015Directional Drilling equipment66,710$ 13,876$ (14,284)$ 260$ 66,562$ Flowback and production testing equipment31,855 4,854 (144) 183 36,748 Automotive equipment880 85 (182) 162 945 Office and computer equipment5,611 879 - 309 6,799 Buildings- - - - - Automotive equipment under capital lease1,558 569 (722) 263 1,668 Leasehold improvements909 179 - 87 1,175 Total107,523$ 20,442$ (15,332)$ 1,264$ 113,897$ Effects ofBalancemovements inBalanceDecember 31Disposals andexchangeDecember 31Cost2015Additionswrite-downsrates2016Directional Drilling equipment144,770$ 591$ (2,461)$ (78)$ 142,822$ Flowback and production testing equipment64,048 41 (64,023) (66) - Automotive equipment1,308 - (98) (34) 1,176 Office and computer equipment8,439 41 (3) (59) 8,418 Automotive equipment under capital lease2,809 46 (517) (77) 2,261 Leasehold improvements1,441 226 (531) (22) 1,114 Total222,815$ 945$ (67,633)$ (336)$ 155,791$ Effects ofBalancemovements inBalanceDecember 31Disposals andexchangeDecember 31Accumulated depreciation2015Additionswrite-downsrates2016Directional Drilling equipment66,562$ 11,391$ (1,142)$ (43)$ 76,768$ Flowback and production testing equipment36,748 3,773 (40,489) (32) - Automotive equipment945 104 (82) (23) 944 Office and computer equipment6,799 570 - (47) 7,322 Automotive equipment under capital lease1,668 363 (369) (41) 1,621 Leasehold improvements1,175 112 (293) (16) 978 Total113,897$ 16,313$ (42,375)$ (202)$ 87,633$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2015 or 2016.
9.
Intangible assets and write-down of goodwill
The Company’s intangible assets consist of internally generated development costs related to its Directional Drilling division. To date the Company
has recorded no impairment losses on these assets.
Impairment testing for cash-generating units containing goodwill
For the purpose of impairment testing, goodwill was allocated to the Company’s cash generating units, which represent the lowest level within the
Company at which the goodwill is monitored for internal management purposes, which is not higher than the Company’s operating segments.
The aggregate carrying amounts of goodwill allocated to each unit was as follows:
During the period ended September 30, 2015 the Corporation determined that the further decline in commodity prices and the impact on drilling and
completion activity levels was an indicator of impairment and performed an impairment test on the carrying values of equipment and goodwill for the
Directional Drilling and F&PT CGUs.
The recoverable amount of each CGU was determined using a value in use calculation based on cash flow projections over the expected life of the
assets. The cash flow projections were based on expected outcomes taking into account past experience and management expectation of market
conditions.
Management anticipated that the current downturn in the oilfield service industry would continue through 2016. Cash flow projections for 2017 to 2019
assumed a gradual recovery to historical activity levels. Cash flow projections thereafter were extrapolated based on a 1.5% per annum growth rate
and incorporated a future 25% downturn in the 9th year of the forecast. The forecasted cash flows were based on management’s best estimates of
pricing, activity levels, costs to maintain equipment and a pre‐tax discount rate of 19% per annum. A terminal value was used assuming 1.5% annual
growth rate for cash flows through the remainder of the segment’s life.
The results of the tests indicated a recoverable amount of approximately $140,000 and an impairment of goodwill at September 30, 2015 of $5,848,
with $1,624 related to the Directional Drilling CGU and $4,224 related to the Flowback and Production Testing CGU. This impairment represented the
total amount of goodwill allocated to each CGU. There was no impairment in the carrying value of equipment based upon the value in use calculation.
10. Assets held for sale and discontinued operations
On December 16, 2016, the Company entered into an agreement to sell the fixed assets of its F&PT CGU. As such, the net realizable value of the
F&PT equipment has been reclassified as assets held for sale on the consolidated balance sheet and the related operations have been presented as
discontinued operations for 2016 and 2015. The sale closed in January 2017, and as at December 31, 2016 the assets were written down to their
estimated net realizable value of $17,241.
Cathedral Energy Services Ltd. - 2016 Annual Report
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20162015CostBalance at January 12,505$ 4,971$ Internally developed additions160 289 Write-off of fully amortized balances- (2,755) Balance at end of year2,665$ 2,505$ Accumulated amortizationBalance at January 1499$ 3,066$ Amortization for year188 188 Write-off of fully amortized balances- (2,755) Balance at end of year687$ 499$ Net carrying value at end of year1,978$ 2,006$ 2014Directional Drilling1,624$ Flowback and Production Testing4,224 Total5,848$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Operating results related to this division have been included in loss from discontinued operations on the consolidated statements of comprehensive
income (loss). Comparative periods have been reclassified to include this division as discontinued operations. The following table provides information
with respect to amounts included in the statements of operations related to discontinued operations.
The following table provides information with respect to amounts included in the statements of cash flows related to discontinued operations.
Cathedral Energy Services Ltd. - 2016 Annual Report
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20162015Revenues 6,305$ 29,836$ Cost of sales:Direct costs(6,318) (24,922) Depreciation(4,010) (5,377) Share-based compensation- (10) Total cost of sales(10,328) (30,309) Gross margin(4,023) (473) Selling, general and administrative expenses:Direct costs(1,787) (2,550) Depreciation(1) (1) Share-based compensation(6) - Total selling, general and administrative expenses(1,794) (2,551) (5,817) (3,024) Gain (loss) on disposal of property and equipment(48) 105 Write-down of goodwill- (4,224) Loss from operating activities(5,865) (7,143) Finance costs (18) (51) Loss before income taxes(5,883) (7,194) Income tax recovery:Deferred1,794 693 Total income tax recovery1,794 693 Net loss from discontinued operations(4,089) (6,501) Write-down of assets held for sale from discontinued operations, net of tax(4,307) - Total loss from discontinued operations(8,396)$ (6,501)$ 20162015Cash provided by (used in):Operating activities:Total loss from discontinued operations(8,396)$ (6,501)$ Items not involving cashDepreciation4,011 5,378 Share-based compensation6 10 Income tax recovery(1,794) (693) (Gain) loss on disposal of property and equipment48 (105) Finance costs18 51 Write-down of assets held for sale 4,307 - Write-down of goodwill- 4,224 Cash flow from (used in) discontinuing operations(1,800)$ 2,364$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Deferred tax assets and income tax expense
Recognized deferred tax assets and liabilities
Deferred tax assets are attributable to the following:
Deferred tax liabilities are attributable to the following:
Movement in temporary differences during the year
The income taxes are based upon the estimated annual effective rates of 27% (2015 – 26%) for Canadian entities and 36% (2015 – 37%) for U.S.
entities. The income tax expense for the period is comprised as follows:
On April 21, 2015, the Company received a proposal letter from the Canada Revenue Agency (“CRA”) which stated its intention to challenge the tax
consequences of the Company’s December 2009 conversion transaction. CRA was seeking to apply the general anti-avoidance rules of the Income
Tax Act (Canada) to the conversion transaction. The Company made a proposal for settlement that was accepted by CRA on June 30, 2015. The
result of the settlement was a reduction to the tax pools in the conversion transaction. No cash taxes were payable for prior periods. As a result of
the reduction in pool balances there was a charge to earnings in 2015 in the amount of $10,346 with the offset to eliminate the deferred tax asset and
the remaining amount increasing the deferred tax liability.
Cathedral Energy Services Ltd. - 2016 Annual Report
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20162015Property and equipment(10,402)$ (10,658)$ Inventory valuation allowance772 737 Provision for settlement1,250 - Intangible assets223 231 Investment tax credits3,247 2,339 Non-capital loss carry forwards9,547 5,686 Scientific research and development expenditures 4,876 4,776 Total9,513$ 3,111$ 20162015Property and equipment-$ (835)$ Inventory valuation adjustment- 334 Total-$ (501)$ BalanceImpact ofBalanceDecember 31CRA proposalRecognizedRecognizedDecember 312014in profitin profitin OCI2015Property and equipment(11,243)$ -$ (102)$ (148)$ (11,493)$ Inventory valuation allowance- 1,071 1,071 Intangible assets240 (9) - 231 Investment tax credits4,920 (2,261) (320) - 2,339 Non-capital loss carry forwards3,377 (3,377) 5,686 - 5,686 Scientific research and development expenditures9,451 (4,708) 33 - 4,776 Total6,745$ (10,346)$ 6,359$ (148)$ 2,610$ BalanceBalanceDecember 31RecognizedRecognizedDecember 312015in profitin OCI2016Property and equipment(11,493)$ 1,106$ (15)$ (10,402)$ Inventory valuation allowance1,071 (299) - 772 Provision for settlement- 1,250 - 1,250 Intangible assets231 (8) - 223 Investment tax credits2,339 908 - 3,247 Non-capital loss carry forwards5,686 3,861 - 9,547 Scientific research and development expenditures4,776 100 - 4,876 Total2,610$ 6,918$ (15)$ 9,513$ 20162015Current tax (expense) recovery:Current period(161)$ 373$ Adjustment to prior period provisions55 361 Total current tax (expense) recovery(106) 734 Deferred tax (expense) recovery:Origination and reversal of temporary differences3,534 5,430 Adjustment to prior period provisions(89) (10,111) Total deferred tax (expense) recovery3,445 (4,681) Income tax (expense) recovery3,339$ (3,947)$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Income tax expense for 2016 and 2015 differs from the amount that would be expected by applying the expected statutory income tax rates for the
following reasons:
12. Operating loans
The Company has a $5,000 swingline facility (2015 - $5,000) with a major Canadian bank. The terms and conditions of this loan are as disclosed in
note 14.
13. Trade and other payables
The Company’s exposure to currency and liquidity risk related to trade and other payables is disclosed in note 27.
14. Loans and borrowings
During 2016, there were advances of $1,250 and repayments of $5,000 on the Company's secured revolving term loan.
Terms and debt repayment schedule
The Company has a committed revolving credit facility (the "Facility") that expires in December 2018. The Facility is secured by a general security
agreement over all present and future personal property.
The current Facility has been amended seven times. These amendments have certain restrictions, including, but not limited to; paying dividends,
utilization of the accordion feature, enhanced lender financial reporting and a cap on any litigation settlement payments without lender approval. As
well, effective 2015 Q4, the Company includes lost-in-hole equipment proceeds in the definition of Bank EBITDA (as defined in the credit agreement).
The financial covenants associated with the amended Facility are as follows:
Quarter ending:
December 31, 2016
March 31, 2017
June 30, 2017
September 30, 2017
December 31, 2017
March 31, 2018 and thereafter
Maximum Funded Debt to Bank EBITDA
Ratio
Minimum Debt Service Ratio
Waived
3.50:1
3.50:1
3.50:1
3.25:1
3.00:1
Waived
2.00:1
2.50:1
3.00:1
3.00:1
3.00:1
Under the Fourth Amending Agreement dated August 9, 2016, the working capital covenant in the Facility was waived.
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 38
20162015Expected statutory tax rate27.01%26.07%Loss before income tax(722)$ (24,894)$ Effective tax rate applied to loss before income tax195$ 6,490$ Adjustment to deferred taxes for change in effective tax rates39 (71) Income taxed in jurisdictions with different tax rates(302) 1,611 Non-deductible expenses3,251 (1,708) Adjustment to prior year tax provisions(34) (10,111) Non-taxable portion of gain on disposal of property and equipment177 (214) Other13 56 Total tax expense3,339$ (3,947)$ 20162015Canadian dollar operating loan1,250$ 2,370$ U.S. dollar operating loan855 114 Total2,105$ 2,484$ 20162015Trade payables9,325$ 16,208$ Accrued payables3,512 3,990 Total12,837$ 20,198$ 20162015Current liabilities:Current portion of finance lease liabilities459$ 686$ Non-current liabilities:Finance lease liabilities72$ 477$ Secured revolving term loan26,250 30,000 Total26,322$ 30,477$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Under the Fifth Amending Agreement dated September 2, 2016, Export Development Canada (“EDC”) joined Cathedral’s lending syndicate resulting
in the lending exposure from the prior lending syndicate members being reduced and the Facility increasing by $3,000 from that contained in the
Fourth Amendment, and the maturity of the Facility was extended by three months to November 2017. The Fifth Amendment provided for credit
availability of $36,000, further reducing to $33,000 by December 31, 2016.
The Sixth Amending Agreement, dated December 22, 2016 the Maturity Date of the facility was extended to February 2018.
The Seventh Amending Agreement, dated January 16, 2017, required a minimum cumulative Bank EBITDA of $2,500 for the three months ended
December 31, 2016. In addition, the aggregate commitment was reduced to $23,000 after $17,200 was repaid upon the sale of F&PT CGU assets
and the maturity date was extended to December 2018.
After the amendments discussed above, the Facility bears interest at the bank’s prime rate plus 0.50% to 5.00% or bankers’ acceptance rate plus
1.75% to 6.25% with interest payable monthly. Interest rate spreads for the Facility depend on the level of funded debt to the 12 month trailing Bank
EBITDA. The Facility provides a means to lock in a portion of the debt at interest rates through bankers' acceptance (“BA”) based on the interest rate
spread on the date the BA was entered into.
Based on current available information, Cathedral expects to comply with all covenants for the next twelve months.
The Company's financial ratios in the 2016 Q4 waiver period were:
Ratio
Debt service ratio
Funded debt to Bank EBITDA ratio
Working capital ratio
Minimum Bank EBITDA for the three months ended December 31, 2016
Actual
3.34:1
3.83:1
3.31:1
$4,522
Required
Waived
Waived
Waived
$2,500
The Company’s loans and borrowings to total capitalization and Bank EBITDA ratios at the end of the reporting period were as follows:
Cathedral Energy Services Ltd. - 2016 Annual Report
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20162015Loans and borrowings, current portion459$ 686$ Loans and borrowings, long-term portion26,322 30,477 Loans and borrowings, including current portion26,781$ 31,163$ Shareholders' equity90,282$ 96,607$ Less Accumulated other comprehensive income ("AOCI")(11,371) (11,577) Shareholders' equity excluding AOCI78,911 85,030 Loans and borrowings, including current portion26,781 31,163 Total capitalization105,692$ 116,193$ Loans and borrowings, including current portion to total capitalization0.25 0.27 Loans and borrowings, including current portion26,781$ 31,163$ Operating loans2,105 2,484 Less cash balances(2,235) (2,085) Letter of credit1,528 1,554 Funded debt per credit agreement28,179$ 33,116$ Year endedYear ended20162015Loss before income taxes(722)$ (24,894)$ Add (deduct):Depreciation included in cost of sales12,358 15,189 Depreciation included in selling, general and administrative expenses134 177 Share-based compensation included in cost of sales14 50 Share-based compensation included in selling, general and administrative expenses130 150 Finance costs2,061 1,613 Unrealized foreign exchange (gain) loss on intercompany balances(1,455) 4,191 Gain on sale of land and buildings- (456) Non-recurring expenses1,310 766 Write-down of goodwill- 1,624 Write-down of equipment- 3,189 Write-down of inventory277 3,736 Provision for settlement4,217 - Gain on disposal of foreign subsidiary(10,865) - Adjusted EBITDAS on discontinued operations(1,619) 2,364 - - Adjusted EBITDAS as per MD&A5,840 7,699 Gain on disposal of equipment(3,164) (3,257) Proceeds from disposal of equipment per credit agreement4,673 3,803 Trailing twelve months Bank EBITDA7,349$ 8,245$ Funded debt to Bank EBITDA3.83 4.02
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Finance lease liabilities
Finance lease liabilities bear interest at rates between 4.0% and 6.2% with maturities from 2017 to 2019 and are payable as follows:
These amounts are secured by the automotive equipment under capital lease which has a net book value of $640 (2015 - $1,141).
15. Provisions for settlement
In 2016 Q2, the Company entered into a Settlement Agreement and Release (the “Settlement Agreement”) in respect of two wage and hour lawsuits
(the “Collective Actions”) that were filed against the Company’s wholly owned subsidiary, INC. The Collective Actions alleged that INC employed or
contracted Measurement While Drilling (“MWD”) and Directional Drilling (“DD”) operators were entitled to recover unpaid or incorrectly calculated
overtime wages under the Fair Labor Standards Act (“FLSA”).
The Settlement Agreement resolved all claims from INC employed and contracted MWD and DD operators. Under the terms of the Settlement
Agreement, the parties established an initial settlement fund of up to $3,400 USD. The final determination of the settlement fund amount was based
on the number of claimants that participated in the settlement at the end of December 2016, which under the terms of the Settlement Agreement is
confidential. The settlement fund payments will be paid quarterly by the Company over a three-year period with the final payment due on or before
September 2019. The quarterly payments may be accelerated in the event Cathedral meets certain financial targets over the payment period and can
be deferred if a scheduled payment would put Cathedral in violation of its credit facility covenants subject to not more than three payments being
deferred. Any FLSA settlement fund payments made by Cathedral exceeding $200 USD are subject to the approval of Cathedral’s banking syndicate.
During 2016, payments of $851 were made.
In 2017 Q1, the Company entered a settlement with one of its U.S. clients related to a down-hole drilling incident, which impacted two of their wells in
December 2013. The settlement is payable based on an initial payment in 2017 Q1 and the remainder in quarterly installments concluding in 2021.
16. Share capital
Authorized: An unlimited number of common shares and an unlimited number of preferred shares (issuable in series).
Common shares issued:
Issuance of common shares
There were no shares issued in 2016 or 2015. .
Dividends
Cathedral declared dividends in the amount of $nil in 2016 (2015 - $4,355 or $0.12 per share.) Effective November 10, 2015 the Company suspended
quarterly dividend payments.
Issuance of share options
The Company's share based compensation plan is a "rolling number" type option plan which provides that the number of authorized but unissued
common shares that may be subject to options granted under the share option plan at any time can be up to 10% of the number of common shares
outstanding from time to time.
Under the plan, the exercise price of each option at the date of issuance equals the fair market value of the Company's common shares on the day
immediately prior to the grant, and has a maximum term till expiry of ten years. Options issued in 2015 Q4 and subsequent vest over a period of two
years, options issued in 2015 Q3 and previously vest over three years from the date of grant as employees, directors or consultants render continuous
service to the Company.
A summary of the status of the Company's equity based compensation plan as at December 31, 2016 and 2015, and changes during the years then
ended is presented below:
Cathedral Energy Services Ltd. - 2016 Annual Report
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FuturePresent valueFuturePresent valueminimum leaseof minimumminimum leaseof minimumpaymentsInterestlease paymentspaymentsInterestlease paymentsLess than one year456$ (5) 451$ 382$ (3)$ 379$ Between one and four years85 (5) 80 811 (27) 784 Total541$ (10)$ 531$ 1,193$ (30)$ 1,163$ 20162015NumberAmountNumberAmountIssued, beginning and end of year36,295,380 74,481$ 36,295,380 74,481$ 2016201520162015WeightedWeightedaverageaverageNumberexercise priceNumberexercise priceOutstanding, beginning of year2,146,597 3.18$ 1,233,863 6.94$ Granted30,000 0.43 1,389,500 1.49 Expired or forfeited(826,097) 5.27 (476,766) 7.99 Outstanding, end of year1,350,500 1.85$ 2,146,597 3.18$ Exercisable, end of year506,806 2.27$ 687,097 6.25$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The range of exercise prices for the options outstanding at December 31, 2016 is as follows:
During the year ended December 31, 2016, the Company has recorded share-based compensation expense of $150 (2015 - $209) related to the
share option plan.
During the year ended December 31, 2016, the Company granted 30,000 share options. The following table sets out the assumptions used in applying
the Black-Scholes option-pricing model for the options issued as well as the resulting fair value:
17. Earnings (loss) per share
Basic earnings per share
The calculation of basic earnings per share at December 31, 2016 was based on the profit (loss) attributable to common shareholders of $(5,779)
being net earnings from continuing operations and net loss of $(7,697) (2015 – loss $(35,342); continuing operations loss $(28,841); discontinued
operations loss $(6,501)) and a weighted average number of common shares outstanding of 36,295,380 (2015 – 36,295,380), calculated as follows:
Weighted average number of ordinary shares
Diluted earnings per share
For 2015 and 2016, there is no diluted earnings per share as there are no dilutive potential common shares.
Weighted average number of common shares (diluted)
At December 31, 2016, 1,350,500 options (2015 – 2,146,597) were excluded from the diluted weighted average number of common shares calculation
as their effect would have been anti-dilutive. The average market value of the Company’s common shares for purposes of calculating the dilutive effect
of share options was based on quoted market prices for the period during which the options were outstanding.
18. Gain on disposal of foreign subsidiary
During 2016 Q1, the Company completed the sale of its DPI foreign subsidiary for net proceeds of $nil plus assumption of obligations of DPI which
resulted in a non-cash gain on sale of $10,865. DPI held the Company’s investment in Venezuela and this sale completes Cathedral’s exit from
carrying on a business in Venezuela.
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 41
WeightedWeighted averageaverage remainingWeighted averageExercise price rangeNumberexercise pricelife (in years)Numberexercise price$0.37 to $1.50586,500 0.73$ 1.93 185,494 0.75$ $1.51 to $3.00604,000 2.13 2.21 201,313 2.13 $3.01 to $4.5010,000 3.96 0.18 10,000 3.96 $4.51 to $5.05150,000 4.92 1.37 109,999 4.93 $0.37 to $5.05 total1,350,500 1.85$ 1.98 506,806 2.27$ Total outstanding optionsExercisable2016 Q3Number of options issued30,000 Exercise price per option0.43$ Fair value per option (weighted average)0.19$ Expected annual dividend per share-$ Risk-free interest rate (weighted average)0.6%Expected share price volatility (weighted average)86.4%Forfeiture rate per annum10.0%20162015Issued January 136,295,380 36,295,380 Effect of share options exercised- - Weighted average number of common shares at end of year36,295,380 36,295,380 20162015Weighted average number of common shares (basic)36,295,380 36,295,380 Effect of share options on issue- - Weighted average number of common shares (diluted) at end of year36,295,380 36,295,380
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
19. Nature of expenses
The nature of expenses can be specified as follows:
20. Foreign exchange gain (loss) and finance costs
21. Changes in non-cash working capital
The components of changes in non-cash working capital are as follows:
22. Operating segments
The Company and its wholly owned subsidiaries are engaged in the business of providing directional drilling services to oil and natural gas companies
in western Canada and selected basins in the U.S., and is viewed as a single operating segment by the chief operating decision maker of the Company
for the purpose of resource allocation and assessing performance.
Cathedral Energy Services Ltd. - 2016 Annual Report
Page 42
Selling, generalCost of salesand administrativeTotalYear ended December 31, 2016Depreciation(12,358)$ (134)$ (12,492)$ Share-based compensation(14) (130) (144) Staffing costs, excluding share-based compensation(28,795) (9,991) (38,786) Repairs and maintenance(17,207) - (17,207) Other expenses(16,989) (4,930) (21,919) Total(75,363)$ (15,185)$ (90,548)$ Year ended December 31, 2015Depreciation(15,189)$ (177)$ (15,366)$ Share-based compensation(50) (150) (200) Staffing costs, excluding share-based compensation(43,061) (11,513) (54,574) Repairs and maintenance(24,492) - (24,492) Other expenses(19,964) (5,718) (25,682) Total(102,756)$ (17,558)$ (120,314)$ 20162015Foreign exchange gain (loss):Realized foreign exchange loss(17)$ (183)$ Unrealized foreign exchange gain on intercompany balances1,455 (4,191) Foreign exchange gain (loss)1,438$ (4,374)$ Finance costsInterest on revolving term loan(1,455)$ (1,195)$ Interest on operating loan(114) (66) Standby fees(141) (143) Interest on finance lease liabilities(17) (76) Other interest(334) (133) Finance costs(2,061)$ (1,613)$ 20162015Trade receivables(3,139)$ 35,663$ Inventories2,294 1,301 Prepaid expenses and deposits(142) 720 Trade and other payables1,823 (15,003) Deferred revenue- 753 Impact of foreign exchange rate differences(28) 1,348 Total changes in non-cash working capital808 24,782 Changes in investing non-cash working capital(762) (1,012) Changes in operating non-cash working capital1,570$ 25,794$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Directional drilling services are currently being provided in both Canada and the U.S. The amounts related to each geographic segment are as follows:
Geographical information
The Company conducts operations in the following geographic areas:
Major customer
In 2016 revenues from a customer of the Company represented approximately 13% (2015 – two different customers represented approximately 22%)
of the Company’s total revenues.
23. Commitments
In the normal course of business, the Company incurs contractual obligations and those obligations are disclosed in the Company’s annual financial
statements for the year ended December 31, 2016. As at December 31, 2016, the Company’s commitment to purchase equipment is approximately
$384. Cathedral anticipates expending these funds in 2017 Q1.
The Company has issued three standby letters of credit, two of which relate to property leases and renew annually to landlords. The first letter of
credit is $700 for the first ten years of the lease and then reduces to $500 for the last five years of the lease. The second letter of credit is for $542
USD and increases annually based upon annual changes in rent. The final letter of credit is for $75 USD issued in relation to U.S. WCB coverage.
24. Operating leases
Leases as lessee
The Company leases a number of offices, warehouse and operating facilities under operating leases. The leases typically run for a period of at least
five years, with an option to renew the lease after that date. Leases incurred in relation to sale and leaseback transactions have longer lease terms.
Current leases have expiries ranging from February 2017 to March 2030. Certain leases have set annual increases. The total future minimum lease
payments are as follows:
2017
2018
2019
2020
2021
Thereafter
$3,577
3,495
2,969
2,747
2,723
19,819
Certain vehicle leases have been renewed on a month-to-month term at the expiration of the finance type lease. These leases have been classified
as operating leases.
During the year ended December 31, 2016, an amount of $4,080 was recognized as an expense in profit or loss in respect of operating leases (2015
- $3,952).
25. Subsequent events
In January 2017, the Company completed the Seventh Amendment to its credit facility. The Seventh Amending Agreement reduced the aggregate
commitment to $23,000 after $17,200 was repaid upon the sale of F&PT assets and extended the expiry to December 2018.
The sale of F&PT assets closed in January 2017 for net proceeds of $17,241.
In February 2017, the Company closed a bought deal public offering of 11,500,000 common shares of the Company at a price of $1.12 per share,
which includes 1,500,000 common shares pursuant to the exercise in full of the over-allotment option, for gross proceeds of $12,880 (the “Offering”).
Concurrent with the closing of the Offering, certain directors and officers of Cathedral purchased 1,116,071 common shares at a price of $1.12 per
share on a private placement basis for gross proceeds of approximately $1,250 (the “Concurrent Private Placement”). The gross proceeds from the
Offering and Concurrent Private Placement totaled approximately $14,130.
26. Related parties
Key management personnel compensation
Cathedral has determined that the key management personnel of the Company consist of its executive officers and directors.
In addition to their salaries and director's fees, the Company also provides non-cash benefits to directors and executive officers including participation
in the Company’s share option program (see note 16).
Certain executive officers have employment agreements. Upon resignation at the Company’s request, they are entitled to termination benefits
including: i) 1.5 to 2.0 times base salary; ii) 1.5 to 2.0 times average annual bonus over the past 3 years; and iii) health, dental, life insurance and
disability coverage for 18 to 24 months.
Key management personnel (including directors) compensation comprised:
Cathedral Energy Services Ltd. - 2016 Annual Report
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Year endedYear endedDecember 31, 2016December 31, 2015December 31, 2016December 31, 2015Canada22,220$ 38,868$ 45,741$ 110,067$ United States58,646 67,375 33,908 3,968 Total80,866$ 106,243$ 79,649$ 114,035$ RevenuesNon-current assets20162015Short-term employment benefits1,850$ 1,897$ Share-based compensation99 124 Total expense recognized as share-based compensation1,949$ 2,021$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Key management personnel and director transactions
Directors and executive officers of the Company control 5% of the common shares of the Company.
There have been no other transactions over the reporting period with key management personnel (2015 - nil), and no outstanding balances exist as
at period end (2015 - nil).
27. Financial risk management and financial instruments
Overview
The Company has exposure to the following risks from its use of financial instruments:
●
●
●
credit risk
liquidity risk
market risk
This note presents information about the Company’s exposure to each of the above risks, the Company’s objectives, policies and processes for
measuring and managing risk, and the Company’s management of capital.
Risk management framework
The Board of Directors has overall responsibility for the establishment and oversight of the Company’s risk management framework. The Company’s
risk management policies are established to identify and analyze the risks faced by the Company, to set appropriate risk limits and controls, and to
monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions and the
Company’s activities.
Credit risk
Credit risk is the risk of financial loss to the Company if a customer or counterparty to a financial instrument fails to meet its contractual obligations,
and arises principally from the Company’s receivables from customers.
Trade and other receivables
The Company’s exposure to credit risk is influenced mainly by the individual characteristics of each customer. However, management also considers
the demographics of the Company’s customer base, including the default risk of the industry and country in which customers operate, as these factors
may have an influence on credit risk. Approximately 13% of the Company’s revenue is attributable to sales transactions with a single customer. In
2015, two different customers were approximately 12% and 10% of the Company’s revenue.
The Company has established a credit policy under which each new customer is analyzed individually for creditworthiness before the Company’s
standard payment and delivery terms and conditions are offered. The Company’s review includes external ratings, when available. Customers that fail
to meet the Company’s benchmark creditworthiness generally are restricted to services on a prepayment basis only.
In monitoring customer credit risk, customers are grouped according to their credit characteristics, including whether they are an individual or legal
entity, geographic location, industry, aging profile, maturity and existence of previous financial difficulties. Customers that are considered as “high risk”
are closely monitored, and future sales may be made on a prepayment basis.
The Company does not require collateral in respect of trade and other receivables.
The Company establishes an allowance for impairment that represents its estimate of incurred losses in respect of trade and other receivables and
investments. The main components of this allowance are a specific loss component that relates to individually significant exposures, and a collective
loss component established for groups of similar assets in respect of losses that have been incurred but not yet identified. The collective loss allowance
is determined based on historical data of payment statistics for similar financial assets.
Exposure to credit risk
The carrying amount of financial assets represents the maximum credit exposure. The maximum exposure to credit risk at the reporting date was.
Carrying amount
The maximum exposure to credit risk for trade and other receivables at the reporting date by geographic region was:
Carrying amount
The Company’s most significant customer accounts for $5,151 of the trade receivables carrying amount at December 31, 2016 (2015 - $6,168).
Cathedral Energy Services Ltd. - 2016 Annual Report
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20162015Trade receivables26,245$ 23,107$ 20162015Canada7,753$ 8,593$ United States18,492 14,514 Total26,245$ 23,107$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Impairment losses
The aging of trade and other receivables at the reporting date was:
The movement in the allowance for impairment in respect of trade and other receivables during the year was as follows:
At December 31, 2016 an impairment loss of $433 (2015 - $460) was recognized relating to customers that have been unable to make payments in
accordance with normal terms and conditions, mainly due to economic circumstances. The Company believes that the unimpaired amounts that are
past due are still collectible, based on historic payment behavior and an analysis of the underlying customers’ ability to pay.
Based on historic default rates, the Company believes that, apart from the above, no impairment allowance is necessary in respect of trade receivables
not past due.
Impairment losses
The allowance accounts in respect of trade and other receivables are used to record impairment losses unless the Company is satisfied that no
recovery of the amount owing is possible; at that point the amounts are considered irrecoverable and are written off against the financial asset directly.
Liquidity risk
Liquidity risk is the risk that the Company will encounter difficulty in meeting the obligations associated with its financial liabilities that are settled by
delivering cash or another financial asset. The Company’s approach to managing liquidity is to ensure, as far as possible, that it will always have
sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage
to the Company’s reputation.
The following are the contractual maturities of financial liabilities, including estimated interest payments and excluding the impact of netting agreements
based upon the secured revolving term loan being renewed on the same terms and not converted to a non-revolving term loan.
It is not expected that the cash flows included in the maturity analysis could occur significantly earlier, or at significantly different amounts.
Market risk
Market risk is the risk that changes in market prices, such as foreign exchange rates, interest rates and equity prices will affect the Company’s income
or the value of its holdings of financial instruments. The objective of market risk management is to manage and control market risk exposures within
acceptable parameters, while optimizing the return.
Currency risk
The Company is exposed to currency risk on working capital and borrowings that are denominated in a currency other than the respective functional
currencies of Company entities, primarily CAD, but USD. The currencies in which these transactions primarily are denominated are CAD and USD.
Generally, borrowings are denominated in currencies that match the cash flows generated by the underlying operations of the Company, primarily
dollar. This provides a partial economic hedge without derivatives being entered into and therefore hedge accounting is not applied in these
circumstances.
Cathedral's foreign currency policy is to monitor foreign current risk exposure in its areas of operations and mitigate that risk where possible by
matching foreign currency denominated expense with revenues denominated in foreign currencies. Cathedral strives to maintain limited amounts of
cash and cash equivalents denominated in foreign currency on hand and attempts to limit its exposure to foreign currency through collecting and
paying foreign currency denominated balance in a timely fashion.
Cathedral Energy Services Ltd. - 2016 Annual Report
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GrossImpairmentGrossImpairmentNot past due22,680$ -$ 15,576$ -$ Past due 61-90 days3,176 - 4,180 - Past due over 91 days822 (433) 3,811 (460) Total26,678$ (433)$ 23,567$ (460)$ 2016201520162015Balance, beginning of year460$ 188$ Impairment loss recognized- 272 Reversals of losses previously recognized(27) - Balance, end of year433$ 460$ December 31, 2016 Carrying amount Contractual cash flow Under 6 months 6-12 months 1-2 years 2-5 years ThereafterDemand bank loans2,105$ 2,105$ 2,105$ -$ -$ -$ -$ Secured revolving term loan26,250 26,250 - - 26,250 - - Finance lease liabilities531 541 308 180 34 19 - Trade and other payables12,837 12,837 12,837 - - - - 41,723$ 41,733$ 15,250$ 180$ 26,284$ 19$ -$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company’s exposure to foreign currency risk related to USD denominated balances as follows:
The following significant exchange rates applied during the year:
Sensitivity analysis
A 10% strengthening of CAD against USD at December 31 would decrease equity and other comprehensive income by $1,126 (2015 - $20). The
analysis assumes that all other variables, in particular interest rates remain constant. The analysis is performed on the same basis for 2015, albeit that
the reasonably possible foreign exchange rate variances were different.
A weakening of CAD at December 31 would have had the equal but opposite effect on USD amounts, on the basis that all other variables remain
constant.
Interest rate risk
At the reporting date the interest rate profile of the Company’s interest-bearing financial instruments was:
Cash flow sensitivity analysis for variable rate instruments
A 1% increase in the Company’s bank’s lending rate would cause interest expense to increase by approximately $284 (2015 - $325) per annum based
upon the balance of bank indebtedness and long-term debt with a floating interest rate outstanding as at December 31, 2016.
Fair values of financial instruments
The Company has designated its trade and other payables as other financial liabilities carried at amortized cost. Accounts receivable are designated
as loans and receivables, measured at amortized cost. The Company’s carrying values of these items approximate their fair value due to the relatively
short periods to maturity of the instruments. Loans and borrowings have been designated as other financial liability, and are measured at amortized
cost. The fair value of loans and borrowings included in the consolidated statement of financial position approximates carrying values as the
indebtedness is subject to floating rates of interest.
The basis for determining fair values is disclosed in note 4.
Capital management
The Board of Directors’ policy is to maintain a strong capital base to maintain investor, creditor and market confidence and to sustain future
development of the business. Management and the Board of Directors monitor capital using loans and borrowings, including current portion to total
capitalization and funded debt to earnings before interest, taxes, depreciation, amortization and share-based compensation (“ Bank EBITDA”) both of
which are defined in the credit agreement and are calculated below.
The Board of Directors seeks to maintain a balance between the higher returns that might be possible with higher levels of borrowings and the
advantages and security afforded by a sound capital position. In response to the overall decline in activity levels and profitability, the Company
implemented a number of cost cutting initiatives to protect the Company’s balance sheet. Throughout 2016 and into 2016 management instituted
significant cost reductions including reduction in amounts paid to suppliers plus wage rollbacks and lay-offs. In addition, the Board of Directors reduced
the quarterly dividend 52% for 2015 Q1 and suspended the quarterly dividend effective November 10, 2015.
The Company’s loans and borrowings to total capitalization and Bank EBITDA ratios at the end of the reporting period are disclosed in note 14.
There were no changes in the Company’s approach to capital management during the year.
Cathedral Energy Services Ltd. - 2016 Annual Report
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USD20162015Cash1,577$ 1,202$ Trade receivables13,772 10,490 Demand bank loan- (82) Trade payables(5,827) (10,759) Finance lease liabilities(301) (695) Total9,221$ 156$ 20162015December 31, 2016December 31, 2015USD $1 to CAD $1.33$ 1.27$ 1.34$ 1.38$ Average rateReporting date spot rateFixed rate carrying valueVariable rate carrying valueFixed rate carrying valueVariable rate carrying valueFinancial liabilities531$ 28,355$ 1,163$ 32,484$ December 31, 2016December 31, 2015
OFFICERS
P. Scott MacFarlane, President and Chief Executive Officer
Randy H. Pustanyk, Executive Vice President, Product Line Management
Michael F. Hill, Chief Financial Officer
David Diachok, Vice President, Sales
DIRECTORS
Rod Maxwell
Jay Zammit
Scott Sarjeant
Ian S. Brown
Dale Tremblay
P. Scott MacFarlane
Randy H. Pustanyk
AUDITORS
KPMG LLP
Calgary, Alberta
LEGAL COUNSEL
Burstall Winger Zammit LLP
Calgary, Alberta
REGISTRAR AND TRANSFER AGENT
Computershare Trust Company of Canada
Calgary, Alberta
BANKER
The Bank of Nova Scotia
Export Development Canada
STOCK EXCHANGE LISTING
Toronto Stock Exchange (TSX: CET)
6030 – 3rd Street S.E.
Calgary, Alberta T2H 1K2
Tel: 403.265.2560 Fax: 403.262.4682
www.cathedralenergyservices.com