EXHIBIT 99.2
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[GRAPHIC OMITTED]
[LOGO - ADVANTAGE ENERGY INCOME FUND]
AMENDED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
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AMENDED CONSOLIDATED FINANCIAL STATEMENTS
MANAGEMENT'S REPORT
Advantage Energy Income Fund Management takes responsibility for the preparation
and presentation of the amended consolidated financial statements together with
the operational information contained in the annual report. The financial
statements have been prepared by Management in accordance with Canadian
generally accepted accounting principles.
Estimates have been used in the preparation of the consolidated financial
statements when transactions affecting the reporting period cannot be finalized
until a later date. The carrying value of oil and gas interests reflects
Management's best judgement with regard to the underlying assets. Other
financial information contained throughout the annual report is consistent with
that provided in the consolidated financial statements.
Management has developed and maintains a system of internal control that
provides reasonable assurance that all transactions are accurately and reliably
recorded, that the consolidated financial statements accurately report the
Fund's operating and financial results, and that the Fund's assets are
safeguarded. The Audit Committee, comprised of non-management directors, acts on
behalf of the Board of Directors to ensure that Management fulfils its financial
reporting and internal control responsibilities.
The Audit Committee has reviewed the amended consolidated financial statements
with management and KPMG LLP, the Fund's external auditors, and has reported to
the Board of Directors thereon. The Board of Directors has approved these
amended consolidated financial statements.
/s/ Kelly I Drader /s/ Peter A. Hanrahan
- -------------------------- -----------------------------
Kelly I. Drader Peter A. Hanrahan
President & CEO VP Finance & CFO
August 11, 2005
AUDITORS' REPORT
To the Unitholders of Advantage Energy Income Fund:
We have audited the amended consolidated balance sheets of Advantage Energy
Income Fund as at December 31, 2004 and 2003 and the amended consolidated
statements of income and accumulated income and cash flows for the years then
ended. These amended financial statements are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these amended
financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these amended consolidated financial statements present fairly,
in all material respects, the financial position of the Fund as at December 31,
2004 and 2003 and the results of its operations and its cash flows for the years
then ended in accordance with Canadian generally accepted accounting principles.
(SIGNED) KPMG LLP
Chartered Accountants
Calgary, Canada
February 22, 2005, except for notes 2(l), 2(m), 7 and 9,
which are as at August 11, 2005.
AMENDED CONSOLIDATED BALANCE SHEETS
(thousands of dollars)
December 31, 2004 December 31, 2003
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(restated - notes 2(l) & (m)) (restated - notes
2(c) & (l))
Assets
Current assets
Accounts receivable $ 48,961 $ 34,181
Fixed assets (note 4)
Property and equipment 1,190,552 675,090
Accumulated depletion and depreciation (253,506) (155,155)
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937,046 519,935
Goodwill (note 3) 47,244 27,773
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$ 1,033,251 $ 581,889
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Liabilities
Current liabilities
Accounts payable and accrued liabilities $ 91,165 $ 72,558
Cash distributions payable to Unitholders 12,419 8,445
Current portion of capital lease obligations (note 6) 1,785 321
Hedging liability (note 12) 214 -
Bank indebtedness (note 5) 267,054 102,968
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372,637 184,292
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Capital lease obligations (note 6) 7,606 2,043
Convertible debentures (notes 7) 136,433 91,372
Asset retirement obligations (note 8) 17,503 13,892
Future income taxes (note 11) 112,266 77,999
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646,445 369,598
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Non-controlling Interest
Exchangeable shares (note 9) 30,842 -
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Unitholders' equity
Unitholders' capital (note 10) 515,544 281,328
Convertible debentures equity component (note 7) 6,764 4,726
Contributed surplus (note 10) 1,036 -
Accumulated income 102,637 78,599
Accumulated cash distributions (270,017) (152,362)
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355,964 212,291
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$ 1,033,251 $ 581,889
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Commitments (note 14)
Subsequent event (note 15)
SEE ACCOMPANYING NOTES TO AMENDED CONSOLIDATED FINANCIAL STATEMENTS
On behalf of the Board of Directors:
/s/ Rodger A. Tourigny /s/ Kelly I. Drader
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Rodger A. Tourigny Kelly I. Drader
Director Director
AMENDED CONSOLIDATED STATEMENTS OF INCOME AND ACCUMULATED INCOME
(thousands of dollars, except for per Unit amounts)
For the year ended For the year ended
December 31, 2004 December 31, 2003
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(restated - note 2(l)) (restated - notes
2(c) & (l))
Revenue
Petroleum and natural gas $ 241,481 $ 166,075
Unrealized hedging loss (note 12) (214) -
Royalties, net of Alberta Royalty Credit (47,828) (28,491)
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193,439 137,584
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Expenses
Operating 38,808 25,618
General and administrative 3,871 3,216
Unit-based compensation (note 10) 1,036 -
Management fee (note 1) 2,323 1,679
Performance incentive (note 13) 21,632 19,592
Interest 6,407 6,378
Interest and accretion on convertible debentures 10,425 5,521
Depletion, depreciation and accretion 99,277 54,027
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183,779 116,031
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Income before taxes 9,660 21,553
Future income tax recovery (note 11) (16,381) (18,203)
Income and capital taxes (note 11) 2,003 1,253
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(14,378) (16,950)
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Net income 24,038 38,503
Accumulated income, beginning of year as previously reported 72,022 36,581
Effect of change in accounting policies (notes 2(c) & (l)) 6,577 3,515
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Accumulated income, beginning of year as restated 78,599 40,096
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Accumulated income, end of year $ 102,637 $ 78,599
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Net income per Trust Unit (note 10)
Basic and diluted $ 0.59 $ 1.26
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SEE ACCOMPANYING NOTES TO AMENDED CONSOLIDATED FINANCIAL STATEMENTS
AMENDED CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands of dollars)
For the year ended For the year ended
December 31, 2004 December 31, 2003
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(restated - note 2(l)) (restated - notes
2(c) & (l))
Operating Activities
Net income $ 24,038 $ 38,503
Add (deduct) items not requiring cash:
Unit-based compensation 1,036 -
Non-cash performance incentive 16,570 19,592
Future income taxes (16,381) (18,203)
Unrealized hedging loss 214 -
Accretion on convertible debentures 1,724 816
Depletion, depreciation and accretion 99,277 54,027
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Funds from operations 126,478 94,735
Expenditures on asset retirement (673) (336)
Changes in non-cash working capital (480) (205)
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Cash provided by operating activities 125,325 94,194
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Financing Activities
Units issued, net of costs 62,465 76,436
Convertible debentures issued, net of costs 119,552 85,982
Increase (decrease) in bank debt 119,500 (11,254)
Reduction of capital lease obligations (321) -
Cash distributions to Unitholders (113,681) (79,815)
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Cash provided by financing activities 187,515 71,349
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Investing Activities
Expenditures on property and equipment (107,893) (75,876)
Property acquisitions (180,645) (1,848)
Property dispositions 6,539 6,112
Acquisition of Defiant Energy Corporation (note 3i) (31,254) -
Acquisition of MarkWest Resources Canada Corp. (note 3ii) - (97,025)
Changes in non-cash working capital 413 3,094
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Cash used in investing activities (312,840) (165,543)
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Net change in cash - -
Cash, beginning of year - -
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Cash, end of year $ - $ -
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Supplementary cash flow information
Interest paid $ 6,964 $ 6,414
Taxes paid $ 1,314 $ 858
SEE ACCOMPANYING NOTES TO AMENDED CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO AMENDED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004
All tabular amounts in thousands except for Units and per Unit amounts
1. BUSINESS AND STRUCTURE OF THE TRUST
Advantage Energy Income Fund ("Advantage", the "Trust" or the "Fund") was
formed on May 23, 2001 as a result of the conversion of Advantage Oil & Gas
Ltd. ("AOG") into a royalty trust. The purpose of the conversion was to
create a trust entity which distributes substantially all of its cash flow
to Unitholders on a monthly basis. The Fund's strategy is to minimize
exposure to exploration risk while focusing on growth through acquisition
and development of producing crude oil and natural gas properties.
Advantage is an open-ended mutual fund trust created under the laws of the
Province of Alberta pursuant to a Trust Indenture dated April 17, 2001
between AOG and Computershare Trust Company of Canada as trustee. The Trust
commenced operations on May 24, 2001. The beneficiaries of the Trust are
the holders of the Trust Units (the "Unitholders").
The principal undertaking of the Trust is to indirectly acquire and hold,
through its wholly-owned subsidiary, AOG, interests in petroleum and
natural gas properties and assets related thereto. The Trust's primary
assets are currently the common shares of AOG, a royalty in the producing
properties of AOG (the "AOG Royalty") and notes of AOG (the "AOG Notes").
In accordance with the terms of the Trust Indenture, the Trust will make
cash distributions to Unitholders of the interest income earned from the
AOG Notes and royalty income earned from the AOG Royalty. The AOG Royalty
and the AOG Notes result in the effective transfer of the economic interest
in the properties of AOG to the Trust. However, while the royalty is a
contractual interest in the properties owned by AOG, it does not confer
ownership in the underlying resource properties.
The Trust is managed by Advantage Investment Management Ltd. (the
"Manager"). The Manager receives a management fee and a performance
incentive fee pursuant to a Management Agreement as approved by the Board
of Directors. Management fees are calculated based on 1.5% of operating
cash flow which is defined as revenues less royalties and operating costs.
Management fees also include a performance incentive fee equal to 10% of
the amount by which the total return to investors exceeds 8% (see note 13).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The management of Advantage Energy Income Fund prepares its consolidated
financial statements in accordance with Canadian generally accepted
accounting principles. The preparation of consolidated financial statements
requires management to make estimates and assumptions that effect the
reported amount of assets and liabilities and disclosures of contingencies
at the date of the consolidated financial statements and the reported
amounts of revenues and expenses during the period. The following
significant accounting policies are presented to assist the reader in
evaluating these consolidated financial statements and, together with the
notes, should be considered an integral part of the consolidated financial
statements.
(a) CONSOLIDATION
These consolidated financial statements include the accounts of the Trust
and all wholly-owned subsidiaries, including AOG and Defiant Energy
Corporation. All intercompany balances and transactions have been
eliminated.
(b) PROPERTY AND EQUIPMENT
(i) PETROLEUM AND NATURAL GAS PROPERTIES AND RELATED EQUIPMENT
The Fund follows the full cost method of accounting in accordance
with the guideline issued by the Canadian Institute of Chartered
Accountants whereby all costs associated with the acquisition of and
the exploration for and development of petroleum and natural gas
reserves, whether productive or unproductive are capitalized in a
Canadian cost centre and charged to income as set out below. Such
costs include lease acquisition, drilling, geological and geophysical
costs and overhead expenses related to exploration and development
activities.
Gains or losses are not recognized upon disposition of petroleum and
natural gas properties unless crediting the proceeds against
accumulated costs would result in a change in the rate of depletion
of 20% or more.
Depletion of petroleum and natural gas properties and depreciation of
lease and well equipment is provided on accumulated costs using the
unit-of-production method based on estimated net proved petroleum and
natural gas reserves, before royalties, as determined by independent
engineers. For purposes of the depletion calculation, proven
petroleum and natural gas reserves are converted to a common
unit-of-measure on the basis of one barrel of oil or liquids being
equal to six mcf of natural gas.
The depletion and depreciation cost base includes total capitalized
costs, less costs of unproved properties, plus a provision for future
development costs of proven undeveloped reserves. Costs of acquiring
and evaluating unproved properties are excluded from depletion
calculations until it is determined whether or not proven reserves
are attributable to the properties or impairment occurs.
Petroleum and natural gas assets are evaluated in each reporting
period to determine that the carrying amount in a cost centre is
recoverable and does not exceed the fair value of the properties in
the cost centre (the "ceiling test"). The carrying amounts are
assessed to be recoverable when the sum of the undiscounted cash
flows expected from the production of proved reserves, the lower of
cost and market of unproved properties and the cost of major
development projects exceeds the carrying amount of the cost centre.
When the carrying amount is not assessed to be recoverable, an
impairment loss is recognized to the extent that the carrying amount
of the cost centre exceeds the sum of the discounted cash flows
expected from the production of proved and probable reserves, the
lower of cost and market of unproved properties and the cost of major
development projects of the cost centre. The cash flows are estimated
using expected future product prices and costs and are discounted
using a risk-free interest rate.
The Trust adopted the new accounting standard relating to full cost
accounting effective January 1, 2004 and as at January 1, 2004 and
December 31, 2004 no write-down to the carrying value of petroleum
and natural gas assets was required. Prior to January 1, 2004 the
ceiling test amount was the sum of the undiscounted cash flows
expected from the production of proved reserves, the lower of cost or
market of unproved properties and the cost of major development
projects less estimated future costs for administration, financing,
site restoration and income taxes. The cash flows were estimated
using period end prices and costs.
(ii) FURNITURE AND EQUIPMENT
The Fund records furniture and equipment at cost and provides
depreciation on the declining balance method at a rate of 20% per
annum which is designed to amortize the cost of the assets over their
estimated useful lives.
(c) ASSET RETIREMENT OBLIGATIONS
The Trust has adopted the asset retirement obligation method of recording
the future cost associated with removal, site restoration and asset
retirement costs. The fair value of the liability for the Trust's asset
retirement obligation is recorded in the period in which it is incurred,
discounted to its present value using the Trust's credit adjusted risk-free
interest rate and the corresponding amount recognized by increasing the
carrying amount of property and equipment. The asset recorded is depleted
on a unit-of-production basis over the life of the reserves. The liability
amount is increased each reporting period due to the passage of time and
the amount of accretion is charged to income in the period. Revisions to
the estimated timing of cash flows or to the original estimated
undiscounted cost could also result in an increase or decrease to the
obligation. Actual costs incurred upon settlement of the retirement
obligation are charged against the obligation to the extent of the
liability recorded.
Previously, the Trust recognized a provision for estimated future removal
and site restoration costs calculated on the unit-of-production method over
the remaining proved reserves. The effect of this change in accounting
policy has been recorded retroactively with restatement of prior periods.
The effect of the adoption is presented below as increases (decreases):
BALANCE SHEETS December 31, 2003 December 31, 2002
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Asset retirement costs, included in property and equipment $ 7,137 $ 3,856
Asset retirement obligations $ 13,892 $ 7,351
Provision for future site restoration $ (8,451) $ (5,396)
Future income taxes $ 581 $ 646
Accumulated income $ 1,115 $ 1,255
Year ended
STATEMENT OF INCOME December 31, 2003
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Accretion expense $ 515
Depletion and depreciation on asset retirement costs $ 997
Amortization of estimated future removal and site restoration liability $ (1,307)
Future taxes $ (65)
Net income impact $ (140)
Basic net income per Unit $ (0.00)
Diluted net income per Unit $ (0.00)
(d) MEASUREMENT UNCERTAINTY
The amounts recorded for depletion and depreciation of property and
equipment and the provision for asset retirement obligation costs are based
on estimates. The ceiling test calculation is based on estimates of proved
reserves, production rates, future oil and natural gas prices, future costs
and other relevant assumptions. By their nature, these estimates are
subject to measurement uncertainty and the effect on the consolidated
financial statements of changes in such estimates in future years could be
significant.
(e) JOINT OPERATIONS
The accounts of the Trust reflect its proportionate interest in exploration
and production activities conducted jointly with others.
(f) CASH DISTRIBUTIONS
Cash distributions are calculated on an accrual basis and are paid to
Unitholders monthly based on cash available for distributions.
(g) INCOME TAXES
The Fund is a taxable trust under the Income Tax Act (Canada). Any taxable
income is allocated to the Unitholders and therefore no provision for
current income taxes relating to the Fund is included in these financial
statements.
The Fund and its subsidiaries follow the liability method of accounting for
income taxes. Under this method future tax assets and liabilities are
determined based on differences between financial reporting and income tax
bases of assets and liabilities, and are measured using substantially
enacted tax rates and laws expected to apply when the differences reverse.
The effect on future tax assets and liabilities of a change in tax rates is
recognized in net income in the period in which the change is substantially
enacted.
(h) GOODWILL
Goodwill is the excess purchase price over the fair value of identifiable
assets and liabilities acquired. Goodwill is not amortized. Goodwill
impairment is assessed at year-end, or as economic events dictate, by
comparing the fair value of the reporting unit to its carrying value,
including goodwill. If the fair value of the reporting unit is less than
its carrying value, a goodwill impairment loss is recognized as the excess
of the carrying value of the goodwill over the fair value of the goodwill.
(i) UNIT-BASED COMPENSATION
The Trust has a unit-based compensation plan (the "Plan") for external
directors of the Trust, which is described in note 10. Advantage accounts
for its grants under the Plan in accordance with the fair value based
method of accounting for stock-based compensation. The exercise price of
the rights granted under the Plan is based on the market price at that time
and is reduced in future periods by distributions paid on the outstanding
Trust Units in accordance with the terms of the Plan.
Since awards under the Plan are vested immediately, associated compensation
expense is recognized in the current period earnings and estimated
forfeiture rates for such rights are not incorporated within the
determination of fair value. The compensation expense results in the
creation of contributed surplus until the rights are exercised.
Consideration paid upon the exercise of the rights together with the amount
previously recognized in contributed surplus is recorded as an increase in
Unitholders' capital.
(j) PER UNIT AMOUNTS
Net income per unit is calculated using the weighted average number of
Units outstanding during the year. Diluted net income per unit is
calculated using the treasury stock method to determine the dilutive effect
of unit-based compensation.
(k) REVENUE RECOGNITION
Petroleum and natural gas revenues are recognized when the title and risks
pass to the purchaser.
(l) FINANCIAL INSTRUMENTS
From time to time, the Fund uses various financial instruments to manage
risk associated with crude oil and natural gas price fluctuations. These
instruments are not used for trading or speculative purposes. Proceeds and
costs realized from holding the related contracts are recognized in
petroleum and natural gas revenues at the time that each transaction under
a contract is settled.
Effective January 1, 2004, CICA Accounting Guideline 13 "Hedging
Relationships" requires that hedging relationships be identified,
designated, documented and measured in order for the Fund to apply hedge
accounting. Advantage has chosen not to apply hedge accounting and will
instead use the fair value method based on future market prices and other
relevant factors. This method requires the fair value of the derivative
financial instruments be recorded at each balance sheet date (see note 12).
The Fund retroactively adopted the revised accounting standard Section 3860
"Financial Instruments - Presentation and Disclosure" as issued by the
Canadian Institute of Chartered Accountants ("CICA") effective January 1,
2005. The revised standard applies to financial instruments that may be
settled at the issuer's option in cash or its own equity instruments and
impacts the Fund's prior accounting for convertible debentures and the
performance incentive fee. The Fund previously classified the issuance of
convertible debentures and the performance fee obligation as components of
equity on the basis that the obligations could be settled with the issuance
of Trust Units. Interest expense and issuance costs related to the
debentures were charged to accumulated income as a component of equity.
Based on the revised standard, a financial instrument is presented based on
the substance of the contractual arrangement regardless of the means of
settlement. This results in the reclassification of convertible debentures
to long-term liabilities and the performance fee to current liabilities.
Additionally, a financial instrument with an embedded conversion feature
must be segregated between liabilities and equity based on the relative
fair market value of the liability and equity portions. Therefore, the
debenture liabilities are presented at less than their eventual maturity
values. The liability and equity components are further reduced for
issuance costs initially incurred. The discount of the liability component
as compared to maturity value is accreted by the effective interest method
over the debenture term. As debentures are converted to Trust Units, an
appropriate portion of the liability and equity components are transferred
to Unitholders' capital. Interest and accretion expense on the convertible
debentures are shown on the Consolidated Statement of Income.
The effect of this change in accounting policy has been recorded
retroactively with restatement of prior periods. The effect of the adoption
is presented below as increases (decreases):
BALANCE SHEETS December 31, 2004 December 31, 2003 December 31, 2002
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Current liabilities
Accounts payable and accrued liabilities $ 16,570 $ 19,592 $ 14,458
Long-term liabilities
Convertible debentures $ 136,433 $ 91,372 $ 50,513
Unitholders' equity
Convertible debentures $ (148,450) $ (99,984) $ (55,000)
Convertible debentures equity component $ 6,764 $ 4,726 $ 2,175
Unitholders' capital $ (20,503) $ (21,168) $ (14,406)
Accumulated income $ 9,186 $ 5,462 $ 2,260
Year ended Year ended
STATEMENTS OF INCOME December 31, 2004 December 31, 2003
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Interest and accretion on convertible debentures $ 10,425 $ 5,521
Net income $ (10,425) $ (5,521)
Net income per Trust Unit (basic and diluted) $ (0.04) $ (0.03)
(m) EXCHANGEABLE SHARES
In March 2005, the CICA's Emerging Issues Committee amended EIC-151
"Exchangeable Securities Issued by Subsidiaries of Income Trusts". The EIC
specifies the required criteria to present exchangeable shares as a
component of Unitholders' equity. Exchangeable shares that do not meet both
criteria are classified as either debt or non-controlling interest
depending on the nature of the instrument. Prior to the amendment,
Exchangeable Shares of AOG were shown as a component of Unitholders'
equity. However, the Exchangeable Shares do not meet the requirements of
the amended standard given that the shares are transferable, although not
publicly traded. Therefore, Exchangeable Shares are now classified as
non-controlling interest, outside of Unitholders' equity. The Exchangeable
Shares and Trust Units are considered economically equivalent since the
exchange ratio is increased on each date that a distribution is paid on the
Trust Units and all shares must be exchanged for either Trust Units or
cash, based on the current market price of the Trust Units. Since the
Exchangeable Shares are required to be exchanged, there is no permanent
non-controlling interest. As a consequence of presenting Exchangeable
Shares as non-controlling interest, a corresponding expense is recorded
that reflects the earnings attributable to the non-controlling interest.
When Exchangeable Shares are converted to Trust Units, the carrying value
of non-controlling interest on the balance sheet is reclassified to
Unitholders' capital. The Fund retroactively implemented the revised
standard but there was no income impact on periods prior to 2005 given that
the Exchangeable Shares were issued at the end of 2004.
3. ACQUISITIONS
(i) DEFIANT ENERGY CORPORATION
On December 21, 2004 Advantage acquired all of the issued and outstanding
shares of Defiant Energy Corporation ("Defiant") for consideration of
$144.2 million. Defiant is a corporation that was engaged in the
exploration for, and the development, acquisition and production of,
natural gas and crude oil in western Canada. The acquisition is being
accounted for using the purchase method with the results of operations
included in the consolidated financial statements as of the closing date of
the acquisition. The purchase price has been allocated as follows:
Net assets acquired and liabilities assumed: Consideration:
Property and equipment $ 232,750 Cash $ 34,000
Goodwill 20,328 3,666,286 Trust Units issued 77,982
Future income taxes (51,505) 1,450,030 Exchangeable Shares issued 30,842
Bank indebtedness (44,586) Acquisition costs incurred 1,326
------------
Capital lease obligations (7,347) $ 144,150
------------
Net working capital
(including cash of $4.1 million) (4,208)
Asset retirement obligations (1,282)
-----------
$ 144,150
The value of the Trust Units and Exchangeable Shares issued as partial
consideration was determined based on the weighted average trading value of
Advantage Trust Units during the two-day period before and after the terms
of the acquisition were agreed to and announced. The allocation of the
purchase price is subject to refinement as certain cost estimates are
realized and the tax balances are finalized.
(ii) MARKWEST RESOURCES CANADA CORP.
On December 2, 2003 Advantage acquired all of the issued and outstanding
shares of MarkWest Resources Canada Corp. ("MarkWest") for cash
consideration of $97.0 million. The acquisition is being accounted for
using the purchase method with the results of operations included in the
consolidated financial statements as of the closing date of the
acquisition. The purchase price has been allocated as follows:
Net assets acquired and liabilities assumed: Consideration:
Property and equipment $ 105,573 Cash $ 96,769
Goodwill 26,916 Acquisition costs incurred 256
------------
Net working capital (14,027) $ 97,025
------------
Capital lease obligation (2,054)
Future income taxes (17,635)
Future site restoration (1,748)
-----------
$ 97,025
(iii) ASSET ACQUISITION
On September 15, 2004 Advantage closed the acquisition of certain petroleum
and natural gas properties and related assets for net consideration of
$179.1 million. The asset retirement obligation assumed and recorded on
this acquisition was $6.6 million.
4. FIXED ASSETS
During the year ended December 31, 2004, Advantage capitalized general and
administrative expenditures directly related to exploration and development
activities of $2,401,000 (2003 - $1,804,000).
Costs of $25,700,000 (2003 - $22,300,000) for unproven properties have been
excluded from the calculation of depletion expense, and future development
costs of $64,200,000 (2003 - $43,152,000) have been included in costs
subject to depletion.
The Trust performed a ceiling test calculation at December 31, 2004 to
assess the recoverable value of property and equipment. Based on the
calculation, the carrying amounts are recoverable as compared to the sum of
the undiscounted cash flows expected from the production of proved reserves
based on the following benchmark prices:
WTI Crude Oil Exchange Rate AECO Gas
Year ($US/bbl) ($US/$Cdn) ($Cdn/mmbtu)
----------------------------------------------------------------------------------------------------------------------
2005 $44.29 $0.84 $6.97
2006 $41.60 $0.84 $6.66
2007 $37.09 $0.84 $6.21
2008 $33.46 $0.84 $5.73
2009 $31.84 $0.84 $5.37
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Percentage change each year after 2009 1.5% - 1.5%
----------------------------------------------------------------------------------------------------------------------
Benchmark prices are adjusted for a variety of factors such as quality
differentials to determine the expected price to be realized by the Trust
when performing the ceiling test calculation.
5. BANK INDEBTEDNESS
Advantage has a credit facility agreement with a syndicate of Canadian
chartered banks which provide for a $300 million extendible revolving loan
facility and a $10 million operating loan facility. The loan's interest
rate is based on either prime or bankers' acceptance rates at the Trust's
option subject to certain basis point or stamping fee adjustments ranging
from 0% to 2% depending on the Trust's debt to cash flow ratio. The credit
facilities are secured by a $500 million floating charge demand debenture,
a general security agreement and a subordination agreement from the Trust
covering all assets and cash flows. The credit facilities are subject to
review on an annual basis, with the next review anticipated to take place
in May 2005. Various borrowing options are available under the credit
facilities, including prime rate-based advances and bankers' acceptances
loans. The credit facilities constitute a revolving facility for a 364 day
term which is extendible annually for a further 364 day revolving period,
subject to a one year term maturity as to lenders not agreeing to such
annual extension. The credit facilities contain standard commercial
covenants for facilities of this nature, and distributions by AOG to the
Trust (and effectively by the Trust to Unitholders) are subordinated to the
repayment of any amounts owing under the credit facilities. Distributions
to Unitholders are not permitted if the Trust is in default of such credit
facilities or if the amount of the Trust's outstanding indebtedness under
such facilities exceeds the then existing current borrowing base. Interest
payments under the Debentures are also subordinated to indebtedness under
the credit facilities and payments under the Debentures are similarly
restricted.
At December 31, 2004, the effective interest rate on the outstanding
amounts under the facility was approximately 4.0%.
6. CAPITAL LEASE OBLIGATIONS
The Trust has capital leases on a variety of property and equipment. Future
minimum lease payments at December 31, 2004 consist of the following:
2005 $ 2,173
2006 2,174
2007 4,672
2008 1,218
----------------------------------------------------------
$ 10,237
Less amounts representing interest (846)
----------------------------------------------------------
9,391
Current portion (1,785)
----------------------------------------------------------
$ 7,606
----------------------------------------------------------
7. CONVERTIBLE DEBENTURES
The convertible unsecured subordinated debentures pay interest
semi-annually and are convertible at the option of the holder into Trust
Units of Advantage at the applicable conversion price per Unit plus accrued
and unpaid interest. Based on revised accounting standards (note 2(l)),
Advantage initially records the proceeds as a liability and equity
component, net of issue costs, based on their relative fair market values.
The details of the convertible debentures including fair market values
initially assigned, issuance costs and remaining outstanding balances as at
December 31, 2004, are as follows:
10.00% 9.00% 8.25% 7.75% 7.50% Total
------------------------------------------------------------------------------------------------------------------------
Issue Date Oct. 18, 2002 Jul. 8, 2003 Dec. 2, 2003 Sept. 15, 2004 Sept. 15, 2004
Maturity Date Nov. 1, 2007 Aug. 1, 2008 Feb. 1, 2009 Dec. 1, 2011 Oct. 1, 2009
Conversion Price $ 13.30 $ 17.00 $ 16.50 $ 21.00 $ 20.25
Liability component $ 52,722 $ 28,662 $ 56,802 $ 47,444 $ 71,631 $ 257,261
Equity component 2,278 1,338 3,198 2,556 3,369 12,739
------------------------------------------------------------------------------------------------------------------------
Gross proceeds 55,000 30,000 60,000 50,000 75,000 270,000
Issuance costs (2,495) (1,444) (2,588) (2,190) (3,190) (11,907)
------------------------------------------------------------------------------------------------------------------------
Net proceeds $ 52,505 $ 28,556 $ 57,412 $ 47,810 $ 71,810 $ 258,093
------------------------------------------------------------------------------------------------------------------------
Debentures outstanding $ 4,124 $ 11,109 $ 13,232 $ 50,000 $ 69,985 $ 148,450
------------------------------------------------------------------------------------------------------------------------
The changes in the liability and equity components during the years ended
December 31, 2004 and 2003 are as follows:
Liability component 10.00% 9.00% 8.25% 7.75% 7.50% Total
----------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2002 $ 50,513 - - - - $ 50,513
Issued for cash, net of costs (2) $ 27,282 $ 54,419 - - 81,699
Accretion of discount 485 249 82 - - 816
Converted to Trust Units (41,449) - (207) - - (41,656)
----------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2003 9,547 27,531 54,294 - - 91,372
Issued for cash, net of costs - - (68) $ 45,366 $ 68,584 113,882
Accretion of discount 116 438 643 182 345 1,724
Converted to Trust Units (5,740) (17,581) (42,632) - (4,592) (70,545)
----------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2004 $ 3,923 $ 10,388 $ 12,237 $ 45,548 $ 64,337 $ 136,433
----------------------------------------------------------------------------------------------------------------------
Equity component 10.00% 9.00% 8.25% 7.75% 7.50% Total
----------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2002 $ 2,175 - - - - $ 2,175
Issued for cash, net of costs - $ 1,274 $ 3,061 - - 4,335
Converted to Trust Units (1,771) - (13) - - (1,784)
----------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2003 404 1,274 3,048 - - 4,726
Issued for cash, net of costs - - - $ 2,444 $ 3,226 5,670
Converted to Trust Units (241) (802) (2,373) - (216) (3,632)
----------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2004 $ 163 $ 472 $ 675 $ 2,444 $ 3,010 $ 6,764
----------------------------------------------------------------------------------------------------------------------
On September 15, 2004 Advantage issued $75 million principal amount of
7.50% convertible unsecured subordinated debentures and $50 million
principal amount of 7.75% convertible unsecured subordinated debentures to
partially finance the acquisition of certain petroleum and natural gas
properties and related assets.
During the year ended December 31, 2004 $76,534,000 debentures were
converted resulting in the issuance of 4,637,187 Advantage Trust Units.
8. ASSET RETIREMENT OBLIGATIONS
The Trust's asset retirement obligations result from net ownership
interests in petroleum and natural gas assets including well sites,
gathering systems and processing facilities. The Trust estimates the total
undiscounted and inflated amount of cash flows required to settle its asset
retirement obligations is approximately $57.5 million which will be
incurred between 2005 to 2055. A credit-adjusted risk-free rate of 7% was
used to calculate the fair value of the asset retirement obligations.
A reconciliation of the asset retirement obligations is provided below:
Year ended Year ended
December 31, 2004 December 31, 2003
----------------------------------------------------------------------------------------------------------------------
Balance, beginning of year $ 13,892 $ 7,351
Accretion expense 926 515
Liabilities incurred 3,358 6,362
Liabilities settled (673) (336)
----------------------------------------------------------------------------------------------------------------------
Balance, end of year $ 17,503 $ 13,892
----------------------------------------------------------------------------------------------------------------------
9. EXCHANGEABLE SHARES
Number of Shares Amount
----------------------------------------------------------------------------------------------------------------------
Issued for acquisition of Defiant 1,450,030 $ 30,842
----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 1,450,030 $ 30,842
----------------------------------------------------------------------------------------------------------------------
AOG is authorized to issue an unlimited number of non-voting Exchangeable
Shares. As partial consideration for the acquisition of Defiant which
closed on December 21, 2004, AOG issued 1,450,030 Exchangeable Shares (see
note 3i). Each Exchangeable Share issued by AOG is exchangeable for
Advantage Trust Units at any time (subject to the provisions of the Voting
and Exchange Trust Agreement), on the basis of the applicable exchange
ratio in effect at that time. The exchange ratio was equal to one at
December 31, 2004 and will be increased on each date that a distribution is
paid by Advantage on the Advantage Trust Units by an amount equal to the
cash distribution paid divided by the five day weighted average unit price
preceding the record date. The Exchangeable Shares are not publicly traded.
However, holders of AOG Exchangeable Shares can exchange all or a portion
of their holdings at any time by giving notice to their investment advisor
or AOG's transfer agent, Computershare Trust Company of Canada.
The Exchangeable Shares will not be entitled to any vote at meetings of
shareholders of AOG but will, through a Special Voting Unit of Advantage
held by the Trustee as trustee under the Voting and Exchange Trust
Agreement, be entitled to vote (on the basis of the number of votes equal
to the number of Advantage Trust Units into which the Exchangeable Shares
are then exchangeable) with the holders of Advantage Trust Units as a
class. The Exchangeable Shares will be redeemable by AOG, in certain
circumstances, and will be retractable by holders of Exchangeable Shares,
in certain circumstances. Exchangeable Shares not previously redeemed or
retracted will be redeemed by AOG or purchased by Advantage on January 15,
2008. If the number of exchangeable shares outstanding is less than
100,000, the Trust can elect to redeem the Exchangeable Shares for Trust
Units or an amount in cash equal to the amount determined by multiplying
the exchange ratio on the last business day prior to the redemption date by
the current market price of a trust unit on the last business day prior to
such redemption date. It is not anticipated that dividends will be declared
or paid on the Exchangeable Shares.
The Fund retroactively implemented revised accounting standards for
Exchangeable Shares (note 2(m)) but there was no income impact on periods
prior to 2005 given that the Exchangeable Shares were issued at the end of
2004.
10. UNITHOLDERS' EQUITY
(i) UNITHOLDERS' CAPITAL
(a) Authorized
Unlimited number of voting Trust Units
(b) Issued
Number of Units Amount
----------------------------------------------------------------------------------------------------------------------
(restated - note 2(l))
----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 27,098,782 $ 147,046
2002 non-cash performance incentive 1,102,163 14,406
Issued for cash, net of costs 5,100,000 76,136
Issued on conversion of debentures 3,381,261 43,440
Issued on exercise of options 35,000 300
----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 36,717,206 $ 281,328
2003 non-cash performance incentive 1,099,104 19,592
Issued for cash, net of costs 3,500,000 62,207
Issued for acquisition of Defiant, net of costs 3,666,286 77,837
Issued on conversion of debentures 4,637,187 74,177
Issued on exercise of options 55,000 403
----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 49,674,783 $ 515,544
----------------------------------------------------------------------------------------------------------------------
On January 27, 2004 Advantage issued 1,099,104 Trust Units to satisfy the
obligation related to the 2003 year end performance incentive fee.
On September 15, 2004 Advantage issued 3,500,000 Trust Units at $18.80 per
Trust Unit to partially finance the acquisition of certain petroleum and
natural gas properties and related assets.
On December 21, 2004 Advantage issued 3,666,286 Trust Units as partial
consideration for the acquisition of Defiant (see Note 3i).
On January 19, 2005 Advantage issued 763,371 Trust Units to partially
satisfy the obligation related to the 2004 year end performance fee.
(c) Trust Units Rights Incentive Plan
Effective June 25, 2002 a Trust Units Rights Incentive Plan for external
directors of the Fund was established and approved by the Unitholders of
Advantage. A total of 500,000 Trust Units have been reserved for issuance
under the plan. The initial exercise price of rights granted under the plan
may not be less than the current market price of the Trust Units as of the
date of the grant and the maximum term of each right is not to exceed ten
years with all rights vesting immediately upon grant. At the option of the
rights holder the exercise price of the rights can be adjusted downwards
over time based upon distributions made by the Trust to Unitholders.
The Trust has elected to prospectively adopt amendments to CICA Handbook
Section 3870, "Stock-based Compensation and Other Stock-based Payments"
pursuant to the transitional provisions contained therein. Under this
amended standard, the Trust must account for compensation expense based on
the fair value of rights granted under its unit-based compensation plan.
Series A Series B
Number Price Number Price
- ---------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 175,000 $ 10.58 - -
Exercised (35,000) - - -
Reduction of exercise price - (2.71) - -
- ---------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 140,000 $ 7.87 - -
Exercised (55,000) - - -
Issued - - 225,000 $ 18.42
Reduction of exercise price - (2.82) - (1.67)
- ---------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 85,000 $ 5.05 225,000 $ 16.75
- ---------------------------------------------------------------------------------------------------------------------------
On June 17, 2004 the Fund issued 225,000 Series B Trust Unit rights to the
independent directors of Advantage at a price of $18.42 per right. During
the second quarter the Fund recorded a non-cash stock-based compensation
expense of $1.0 million to recognize the fair value of the rights granted.
As the rights vested immediately and are fully exercisable, no further
expense will be recognized related to the rights issuance. No Trust Unit
rights were issued in 2003 and there was no compensation expense recorded.
The Series A Trust Unit rights were issued in 2002 and the Trust was unable
to determine the fair value for the rights granted under the Plan at that
time. The Trust has disclosed pro forma results as if the Trust followed
the intrinsic value methodology in accounting for such rights. The
intrinsic value methodology would result in recording compensation expense
for the rights based on the underlying Trust Unit price at the date of
exercise or at the date of the financial statements for unexercised rights
as compared to the exercise price.
Pro Forma Results 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------
(restated - note 2(l)) (restated - notes
2(c) & (l))
Net income as reported $ 24,038 $ 38,503
Less compensation expense for rights issued in 2002 701 1,000
- ---------------------------------------------------------------------------------------------------------------------------
Pro Forma net income $ 23,337 $ 37,503
- ---------------------------------------------------------------------------------------------------------------------------
Net income per Trust Unit - basic and diluted
As reported $ 0.59 $ 1.26
Pro Forma $ 0.57 $ 1.23
- ---------------------------------------------------------------------------------------------------------------------------
(ii) PER UNIT AMOUNTS
The calculation of net income per Trust Unit is based on the basic and
diluted weighted average number of Trust Units outstanding during the year
ended December 31, 2004 of 41,008,308 and 47,126,467 respectively and basic
and diluted Trust Units outstanding of 30,536,236 and 34,040,645
respectively for the year ending December 31, 2003. Exchangeable Shares are
included within the calculation of diluted weighted average Trust Units
outstanding.
11. INCOME TAXES
The taxable income of the Fund is comprised of interest income related to
the AOG Notes and royalty income from the AOG Royalty less deductions for
Canadian Oil and Gas Property Expense and Unit issue costs.
The provision for income taxes varies from the amount that would be
computed by applying the combined Canadian federal and provincial income
tax rates for the following reasons:
For the year For the year
ended ended
Dec. 31, 2004 Dec. 31, 2003
- ---------------------------------------------------------------------------------------------------------------------------
(restated - notes 2(l)) (restated - notes
2(c) & (l))
Income before taxes $ 9,660 $ 21,553
- ---------------------------------------------------------------------------------------------------------------------------
Expected income tax expense at statutory rates 3,269 8,794
Increase (decrease) in income taxes resulting from:
Non-deductible Crown charges 7,537 7,029
Resource allowance (8,766) (8,798)
Amounts included in trust income and other (18,421) (25,228)
- ---------------------------------------------------------------------------------------------------------------------------
Future income tax recovery (16,381) (18,203)
Income and capital taxes 2,003 1,253
- ---------------------------------------------------------------------------------------------------------------------------
$ (14,378) $ (16,950)
- ---------------------------------------------------------------------------------------------------------------------------
The components of the future income tax liability at December 31 are as
follows:
2004 2003
- ---------------------------------------------------------------------------------------------------------------------------
(restated - note 2(c))
Property and equipment in excess of tax basis $ 127,130 $ 90,681
Asset retirement obligation (6,126) (4,736)
Non-capital tax loss carry forward (7,356) (8,327)
Other (1,382) 381
- ---------------------------------------------------------------------------------------------------------------------------
Future income tax liability $ 112,266 $ 77,999
- ---------------------------------------------------------------------------------------------------------------------------
The Fund has non-capital tax loss carry forward of approximately $21.0
million of which $0.3 million expires in 2006, $12.5 million in 2009 and
$8.2 million in 2010.
12. FINANCIAL INSTRUMENTS
Financial instruments of the Fund consist of accounts receivable, accounts
payable and accrued liabilities, cash distributions payable and capital
lease obligations. As at December 31, 2004, there are no significant
differences between the carrying amounts reported on the balance sheet and
the estimated fair values of the financial instruments due to the short
terms to maturity and the floating interest rate on the bank debt.
Substantially all of the Fund's accounts receivable are due from customers
in the oil and gas industry and are subject to normal industry credit
risks. The Trust is also exposed to interest rate risks to the extent that
bank debt is at a floating rate of interest.
The Fund uses various types of derivative financial instruments to reduce
its exposure to fluctuations in commodity prices. The fair value of these
derivative instruments are based on an estimate of the amounts that would
have been paid to or received from counterparties to settle these
instruments. The Fund is exposed to losses in the event of default by the
counterparties to these instruments. The Fund manages this risk by dealing
with financially sound counterparties.
As at December 31, 2004 the Fund had the following outstanding hedge
contract:
Volume Effective Period Price
- ------------------------------------------------------------------------------------------------------------------
Natural gas - AECO
10,450 mcf/d January 1, 2005 - March 31, 2005 $ 6.30/mcf
As at December 31, 2004 the settlement value of the hedge outstanding was
approximately $0.2 million and has been charged to income as an unrealized
hedging loss.
13. PERFORMANCE INCENTIVE
The Manager of the Fund is entitled to earn an annual performance incentive
fee which is calculated based on the total return of the Fund.
The Manager earns the performance incentive fee when the Fund's total
annual return exceeds 8%. The total annual return was calculated at the end
of the year by dividing the year over year change in Unit price plus cash
distributions by the opening Unit price. The 2004 opening and closing Unit
prices were $17.83 and $21.71 respectively (2003 opening and closing Unit
prices of $13.07 and $17.83 respectively). Cash distribution for the year
amounted to $2.82 per Trust Unit (2003 distribution of $2.71 per Trust
Unit). Ten percent of the amount of the total annual return in excess of 8%
is multiplied by the market capitalization (defined as the opening Unit
price multiplied by the weighted average number of Trust Units outstanding
during the year) to determine the performance incentive. The performance
incentive fee for 2004 was $21.6 million ($19.6 million in 2003). On
January 19, 2005 the Fund issued 763,371 Advantage Trust Units to satisfy
$16.6 million of the performance fee obligation. The remaining balance of
the performance fee obligation was settled in cash. The Manager does not
receive any form of compensation in respect of acquisition or divestiture
activities.
14. COMMITMENTS
Advantage has lease commitments relating to office buildings. The estimated
annual minimum operating lease rental payments for the buildings, after
deducting sublease income are as follows:
2005 $ 1,479
2006 1,355
2007 1,321
2008 541
-----------------------------------------------------------------
$ 4,696
-----------------------------------------------------------------
15. SUBSEQUENT EVENT
On February 9, 2005 Advantage issued 5,250,000 Trust Units at $21.65 per
Trust Unit for net proceeds of $107.6 million (net of Underwriters' fees
and other issue costs of $6.1 million). The net proceeds of the offering
will be used to pay down debt incurred in the acquisition of Defiant, for
2005 capital expenditures and for general corporate purposes.
[GRAPHIC OMITTED]
[LOGO KPMG]
KPMG LLP
CHARTERED ACCOUNTANTS Telephone (403) 691-8000
200-205 5 Avenue SW Fax (403) 691-8008
Calgary AB T2P 4B9 Internet www.kpmg.ca
AUDITORS' REPORT
To the Unitholders of Advantage Energy Income Fund:
We have audited the amended consolidated balance sheets of Advantage Energy
Income Fund as at December 31, 2004 and 2003 and the amended consolidated
statements of income and accumulated income and cash flows for the years then
ended. These amended financial statements are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these amended
financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these amended consolidated financial statements present fairly,
in all material respects, the financial position of the Fund as at December 31,
2004 and 2003 and the results of its operations and its cash flows for the years
then ended in accordance with Canadian generally accepted accounting principles.
(Signed) KPMG LLP
Chartered Accountants
Calgary, Canada
February 22, 2005, except for notes 2(l), 2(m), 7 and 9,
which are as at August 11, 2005.