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Executives

James Hill – CFO

Dwight Loree – Founder and Director

Analysts

Jason Sawatzky – Alta Corp Capital

Chris Currie – Milford Capital Management Inc

Michael Mazar – BMO Capital Markets

Elliott Maltz – Lightwater Partners

Mark Hamby – KMS Financial Services

Richard Feldman – Axiom Capital Management, Inc.

Gasfrac Energy Services, Inc. (OTCPK:GSFVF) Q3 2012 Earnings Call November 8, 2012 11:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the Gasfrac Third Quarter Results Conference Call. I would now like to turn the meeting over to Mr. James Hill. Please go ahead, Mr. Hill.

James Hill

Good morning, ladies and gentlemen. I'm here with, our founder and one of our directors, Dwight Loree. I will provide a brief financial overview and a discussion of some of the key operating actions we’ve taken during the quarter and then turn it over for questions.

In terms of revenue, we earned revenue of $40.9 million during the quarter compared to $16.7 million in Q2 of this year and $57.4 million in Q3 of 2011.

In Q3 of 2011, in that $57.4 million there was a product sale of approximately $20.9 million. When we adjust for that our year over year comparison of services revenues shows a 12% growth. We had 91 revenue days during the quarter at an average of $448,000 per day as compared to 87 days in 2011 at $420,000 a day.

Geographically, looking at Canada, we had $26.7 million in revenue this quarter which was a 12% increase over the $23.9 million of services revenues in Q3 of 2011 and as I mentioned, we also had $20.9 million of products revenue in Q3 of 2011.

There were 57 pumping days at $468,000 a day versus 57 pumping days also in 2011 at $419,000 a day.

In the US, revenues of $14.1 million were up 12% on the $12.6 million achieved in 2011. This was on 34 pumping days at $415,000 per day as compared to 30 days at $420,000 a day.

On the cost side, on a consolidated basis, cost of sales were $22.2 million or 54.3% of revenue as compared to $33.2 million or 57.8% of revenue in 2011.

Direct costs were $13.2 million comprised of $8.2 million of fixed costs and $5 million of variable costs, those variable costs running at 12.2% of revenues.

The cost split up geographically, cost of sales in Canada were $13 million or 48.5% of revenues as compared to $26.6 million or 59.3% of revenues in 2011.

The direct operating costs were $7.9 million, $4.9 million of that being fixed, $3 million being variable or 11.2% of revenue. Direct operating costs in 2011 were $6.7 million, $4.1 million being fixed and $2.6 million variable and that’s 10.9%. So we had about an $800,000 increase in fixed costs which was comprised almost all of additional staffing in the comparative quarters.

In the US, cost of sales were $9.2 million or 65.2% of revenues versus $6.6 million or 52.5% of revenues in 2011. The high level of cost of sales is a combination of some issues we had with “discipline” particularly around logistics efficiencies that were passed on to customers as well as seeing some pricing pressures in the US.

In terms of direct operating costs, those were $5.3 million comprised of $3.3 million fixed and $2 million or 14% variable as compared to $2.3 million in 2011, $1.7 million being fixed and $600,000 or 5% being variable.

So that’s brief financial overview and of course you’ll see more details in the MD&A which we released last night. In terms of an operations update, as most of you are aware, we went through a rate sizing of our organization during the latter half of September, early October where we reduced our overhead levels in the US. We reduced manned sets to five manned sets of equipment, three in Canada and two in the US, parking the remaining equipment. This resulted in staff reductions in field and support staff of about 20% and in the US we’re in general refocusing our sales efforts so that our salesmen are paying attention to the Canadian western sedimentary base in south Texas and Colorado.

We amended our bank agreement to address the impact of the poor results in the second quarter of this year where we had negative EBITDA of $10 million and that of course has a continuing impact on our trailing 12 month EBITDA calculation which is used in certain bank covenants. We were able to suspend those covenants through the period of time that that $10 million loss would be impacting them.

Also, we are in the midst of conducting a search for a CEO. We have utilized a search firm to do this for us. There have been a number of interviews already conducted and it is our anticipation that towards the end of this year or early into the first quarter of next year we will be in a position to announce the results of that search.

Finally, before opening it up to questions, I realize this has been a difficult transition period although quick and I would like to thank all of the GASFRAC staff for their hard work and support during these changes.

Now I’ll open it up to questions operator.

Question-and-Answer Session

Operator

Thank you Mr. Hill. (Operator instructions). The first question is from Jason Sawatzky with Alta Corp Capital. Please go ahead.

Jason Sawatzky – Alta Corp Capital

Hi Jim. How are you doing? Just two questions. First question would be just on the customer mix. So top three customers at 69% of revenue in Q3. That’s up from obviously 47% in Q3 2011. So does this mean obviously pure customers more reliant on Husky and Black Bush and just wondering if you can speak a little more to adoption rates in Canada and the US.

James Hill

Well, in Canada I’m more confident that we’re beginning to see adoption. We’ve tracking as trending and converted I guess. So trending would be they’re beginning to us more consistency and converted is we’ve seen that they will be a continuing customer. So in Canada, we have a number of customers in those categories and really we’ve seen relatively reasonably that that has happened. So we have confidence of adding t o the customer base in Canada. In the US, that’s a little more concerning.

As I said we really focus the attention of those guys on the South Texas and Colorado because obviously the sales time is a precious resource and right now we have manned equipment there and although there may be future demand in other basins in the States, we didn’t feel it’s worth the time of the direct sales guys to focus on that. That would be more business development and we’ve got them focused on independents who tend to be earlier adopters of technology. Again we’ve seen a couple of those, but I’m not as confident that we’re as further down the road in adoption. It’s really I’d say another four to six months before we can really begin to talk about how the US is going to trend over and above what we already have in place.

Jason Sawatzky – Alta Corp Capital

Okay. And then just when you’re saying independent in the US, would those typically be smaller companies or would they be larger companies?

James Hill

Yeah. I guess similarly to what we saw in Canada, it was really the smaller companies that number one you can sit face to face with all of the decision makers, from the completions guys to the production guys to the reservoir guys so that they’re looking at this service holistically. And secondly they don’t necessarily have huge field developments where they’ve got processes and supply chains et cetera in place where there’s a big cost to changing that even when they see the benefit of our service. So those companies might be anywhere from $1 billion to $15 billion in market capitalization, but they’re more nimble than the much larger players.

Jason Sawatzky – Alta Corp Capital

Okay, that’s great. Then just in terms of the balance sheet again here. So the banks have been suspended for your fine until the end of Q1, just wondering on the five surplus spreads, do you consider selling those potentially to right size the business a little more? Or if you do sell those, does that limit the future growth potential? What are your thoughts on those five excess spreadsheets?

James Hill

Well, certainly there has been no intent to sell off either of them, Jason. There is some excess equipment that we would consider selling under the right circumstances just to enhance the liquidity, but it would be a set or a last, the mindset that we have. It’s more for flexibility than we feel a compelling need.

Jason Sawatzky – Alta Corp Capital

Great, okay. And I guess the other question becomes, given the market right now for pressure pumping, a lot of overcapacity. Are there buyers out there for the gas prospect?

James Hill

Well, again it’s not something that we’re pursuing vigorously. And again it wouldn’t be a spread so much as the individual pieces of equipment and I think on that basis there are players out there that would be interested.

Jason Sawatzky – Alta Corp Capital

Right. Okay, that’s great. Thanks, Jim.

Operator

The next question is from Chris Currie with Milford Capital. Please go ahead.

Chris Currie – Milford Capital Management Inc

Thank you, operator. Good morning gentlemen. I just want to ask a couple of questions about the bank debt and first of, what rate are you paying on that debt? Did the rate change when they relaxed the covenants?

James Hill

The rate is based on a grid and what they’ve done is just added an additional matrix to that grid such that when our ratios exceed certain levels the cost is more.

Chris Currie – Milford Capital Management Inc

Okay. What would be the base cost that you were paying?

James Hill

Sorry I don’t have that right in front of me right now. We’re paying basically based on the level we’re at anywhere from primer plus three quarters to prime plus two and a half.

Chris Currie – Milford Capital Management Inc

Great. Okay, thank you. Just another question if I could on the US operations. Looks like the utilization is half of what it is in Canada and it appears to be in the third quarter operating loss. Any thoughts when you might just say well let’s focus in Canada and bring the equipment back?

James Hill

No. Again as I was mentioning to Jason, it’s earlier days in the US. I think there are some improvements that we’ve already made since early September that will begin to have an impact during Q4 and forward, although we don’t have a very large customer base right now. We do believe that we can penetrate that marketplace and frankly it doesn’t take a whole lot of customers if we get a half a percentage of the market. That’s going to be all we really need to keep those two sets busy. But that said, we need to make money doing it and we’re taking those actions today, that 65.2% of cost of sales is not acceptable in the long term and we’ve dealt with some of those issues already in terms of how the process will work and how we’re managing those costs as well as the revenue attached to those costs and the right sizing of the crews and as well as the overheads in the US is already having an impact.

Chris Currie – Milford Capital Management Inc

Great. Okay, thank you.

Operator

Thank you. The next question is from Michael Mazar with BMO Capital Markets. Please go ahead.

Michael Mazar – BMO Capital Markets

Hey Jim, good morning. Just following on from Sawatzky’s question, but taking a bit different direction, the idle equipment, is it worth considering or is it practical for you guys to consider just utilizing that equipment in conventional fracturing not using the LPG equipment itself and just doing regular fracturing?

James Hill

Number one, that would be a relatively large strategic change which I myself wouldn’t want to make until we’ve made a decision on our CEO. Secondly, I’m not sure that right now is the time to attempt to penetrate the water fracking market, particularly down south given where pricing is. So my answer is no, Mike. I think it’s – we need to focus our efforts on the adoption in Canada which we’re beginning to see some momentum on and in the US it’s going to be more hard work because it’s as I said earlier days and its’ a refocusing on the type of customer that we’re looking at and the initiatives that we’re taking in terms of how we deliver the operations to be successful down there. So I strongly believe that that’s what we should be spending our time on.

Michael Mazar – BMO Capital Markets

Sure. So units that we’re see theoretically possible it’s – it would be with a physic extraction basically versus what’s (inaudible).

James Hill

That’s my belief, yes.

Michael Mazar – BMO Capital Markets

Okay, that’s perfect. Thanks.

Operator

(Operator instructions). The next question is from David Manson with (inaudible) Minerals. Please go ahead.

Unidentified Analyst

Yes. One of your managers came and spoke to the Society of Petroleum Engineers in Dallas and afterwards we managed to greet him a bit and he indicated that there was a possibility of your being able to shift from using propane to being able to fracture with natural gas liquids instead of propane and how is that moving along?

James Hill

As you may know from listening to other calls, I don’t like to speak about initiatives that’s not undergone, that are still in the test phase and I don’t understand the whole profit model. But that said, we have performed work with a different mix in the US successfully and that’s something that we’re examining on a case by case basis as we go forward here, but that is not a fully developed imitative at this point.

Unidentified Analyst

The second question I have is your present equipment that delivers about 200,000 pounds per stage, have you indicated that you were in the process of changing that to where you might be able to do 600,000 pounds per stage. Has that been developed?

James Hill

Again I don’t like to speak about initiatives that haven’t been introduced to the market or fully developed so I’m not going to comment on that.

Unidentified Analyst

Any idea of timing along things?

James Hill

Again I’m not going to comment on that.

Unidentified Analyst

How can we stay informed?

James Hill

Well, as we are comfortable in rolling out new initiatives we will advise you, but at this stage as I said we’re not in a position where I can talk about something like that in detail.

Unidentified Analyst

Fine. Thank you very much.

Operator

The next question is from Elliott Maltz with Lightwater Partners. Please go ahead.

Elliott Maltz – Lightwater Partners

Question about your pricing for your services. We note that your gross margins in this quarter are down to 13% versus 26% in the last quarter or a couple of quarter in 2011. So just wondering if you could (a) comment on that and (b) whether or not we’ll continue to see further deterioration of your gross margins.

James Hill

I think when you’re looking at gross margins you really have to segregate that out which is what I attempted to do in my discussion as well as the MD&A because that’s a combination of direct cost of sales for Richfield margin and then direct operating costs which are comprised of both fixed and variable portion and what you saw in the quarter is a couple of things. One, fixed costs were too high as we were overstaffed and as I mentioned since early September we have taken actions to reduce those fixed costs in which the impact of that in Q4 and going forward. Secondly, we saw not in Canada, but in the US the field margin being lower than it should be and again with the changes that we’ve made we’ve taken some initiatives to address that particular issue. So I would expect going forward that we will see improved gross margins.

Elliott Maltz – Lightwater Partners

Wouldn’t one of those fixed costs be covered in your SG&A as opposed to your direct operating cost?

James Hill

No. A large portion of our fixed costs is the salary component for our field staff.

Elliott Maltz – Lightwater Partners

So wouldn’t that be a variable cost?

James Hill

No. there’s a portion that’s fixed to their salary and then depending on whether it’s US or Canada they will get a job bonus or overtime for the actual hours worked.

Elliott Maltz – Lightwater Partners

So as you reduce the number of staffs do you not reduce those costs?

James Hill

Yes, that’s what I said.

Elliott Maltz – Lightwater Partners

So wouldn’t those be variable costs then?

James Hill

That’s not my definition of a variable cost. A variable cost is directly variable with the level of revenue. So if we keep a person on and pay the salary, whether we earn $1 of revenue or $10 of revenue, that salary stays fixed. So those costs have been reduced.

Elliott Maltz – Lightwater Partners

Thank you.

Operator

The next question is from Mark Hamby with KMS Financial Services. Please go ahead.

Mark Hamby – KMS Financial Services

I’ve got one question for you. You’ve got plenty of benefit or advantages’ for using your technology, but are there any drawbacks or what type of objections are you seeing from customers or potential customers who are using your technology?

James Hill

Again I draw your attention to the outlook section of the MD&A where we have some what I hope is wholesome discussion about that. But it’s not so much drawbacks because I guess it’s like any new technology or new service. There is a timeframe for adoption. So one of the push backs that we see as I mentioned in the larger companies they’ve got large field developments where they’ve got processes in place. They’ve got a supply chain to bring water in to work with the disposal wells et cetera. So we’re introducing a new service that is only part of that drilling and completions and production process and they need to fit that in and often it’s easier for them to say I’m going to wait till the next big field development rather than interrupt what I’m doing now because what I’m doing now is not broken. What you provide for me may be better, but I don’t want to change. So that’s one push back. Another is price. We are more expensive as an upfront cost although on a cost benefit when our customer looks at their production they get a higher net present value over the life. However, upfront cost is something that they do consider. Some of the initiatives that we have taken that allow the customer to get some monetary recovery on the fluid address that issue. So those are a couple that we see.

Mark Hamby – KMS Financial Services

Thank you.

Operator

The next question is from Dick Feldman with Axiom Capital. Please go ahead.

Richard Feldman – Axiom Capital Management, Inc.

Good morning. In the outlook section of the MD&A, you say that you’ve taken initiatives which will reduce the cost of our service to our customers. These include equipment configuration and fracturing program design. I wonder if you could elaborate on what these changes are.

James Hill

Well, there’s a couple there. Often on frac programs what we’re finding is that we’re able to deliver the same or better results with less volume of product. So to the extent that we’re able to work with our customers on that basis that gives them a benefit on the total cost of the frac to them. The others I mentioned to the previous gentlemen is methodologies to recover the fluid used so that the net cost of the fluid for customers is less.

Richard Feldman – Axiom Capital Management, Inc.

Thank you. Another question is, when you look into the fourth quarter in the US, it seems that you’re focusing on fewer basins. Should we then assume that that alone could lower your cost as you have less expense moving sets around?

James Hill

Yes, that is certainly true and that’s allowed us to also reduce our snapping levels a little bit and it just provides for efficiencies and gives us the opportunity for greater utilization on the equipment because it’s not spending days traveling on the road.

Richard Feldman – Axiom Capital Management, Inc.

And I guess the last question is, how much of an improvement in EBITDA do you need over the next quarter or two so that you can be conformed to the bank lines?

James Hill

Sorry, I hadn’t thought about that exactly that way, but…

Richard Feldman – Axiom Capital Management, Inc.

Well, then however you want to present it.

James Hill

Yeah. It means that the bank lines come to two require us to have funded debt to EBITDA no greater than three times, trailing EBITDA no greater than three times. As I’ve talked about before, really the draw on the line of credit is being driven by the level of our accounts receivable more than anything right now because we don’t have a lot of capital spend on. So if I make the assumption of a certain level of growth, we’re going to have draws on that line in the neighborhood of $35 million to $40 million and on that basis we would need something like $12 million of trailing EBITDA for four quarters.

Richard Feldman – Axiom Capital Management, Inc.

Okay, that sounds like it should be doable. Okay, those are my questions and thank you.

Operator

Thank you. The next question is from Robert (inaudible) with (inaudible) Brown. Please go ahead.

Unidentified Analyst

Thank you Jim and Dwight. Can you provide any detail on how did October go and how do the next couple of months ago regarding do you have business or any more detail on the fourth quarter revenues?

James Hill

I can provide some, we’re certainly seeing improvement over the third quarter. what that level will be is highly dependent on – not highly, it’s dependent on two things again that we attempted to discuss in the outlook section of the MD&A. first is particularly in Canada how much work happens post Christmas as you may be aware often between the 25th and sort of the first week of January the oilfield tends to shut down. We have some opportunity to have one or two clients working during that time period and that’s certainly what we will attempt to do. And the other frankly is how busy Black Bush continues to be during the remainder of the quarter. They’ve been, we completed two wells for them during October and we anticipate them having two more wells in a position for us t work on shortly. But again that work has been a bit stop and start over the time period and so I put some level of risk there, although relatively low.

Operator

(Operator instructions). There are no further questions registered at this time. I’d now like to turn the meeting back over to Mr. Hill.

James Hill

Okay, well thank you, Dave and thank you everyone for participating in our call and again if you’ve got other questions please do not hesitate to give us a call and I’d also like to thank Dwight for sitting in with me. Thanks very much.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.

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