EXHIBIT 99.1
------------
WESTERN OIL SANDS
INTERIM REPORT FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2005
MESSAGE TO SHAREHOLDERS
WESTERN OIL SANDS INC. ("WESTERN") IS PLEASED TO REPORT RECORD THIRD QUARTER
2005 RESULTS AND PROVIDE AN OPERATIONAL UPDATE FOR THE ATHABASCA OIL SANDS
PROJECT (THE "PROJECT" OR THE "AOSP"). DURING THE THIRD QUARTER OF 2005, WESTERN
SURPASSED MANY KEY FINANCIAL AND OPERATIONAL RECORDS SET IN THE SECOND QUARTER
OF 2005 AND GENERATED NEW RECORD RESULTS INCLUDING: NET REVENUE OF $185.7
MILLION, EBITDAX OF $111.0 MILLION, CASH FLOW FROM OPERATIONS OF $95.0 MILLION
($0.59 PER SHARE) AND NET EARNINGS OF $79.4 MILLION ($0.50 PER SHARE). BY
COMPARISON, IN THE THIRD QUARTER OF 2004, WESTERN GENERATED NET REVENUE OF
$104.1 MILLION, EBITDAX OF $47.8 MILLION, CASH FLOW FROM OPERATIONS OF $32.5
MILLION ($0.21 PER SHARE) AND NET EARNINGS OF $42.4 MILLION ($0.27 PER SHARE).
Relative to the third quarter of 2004, financial results during the third
quarter of 2005 were positively impacted by a seven per cent increase in
production, a 44 per cent increase in West Texas Intermediate ("WTI") prices and
reduced volumes subject to fixed priced hedge contracts. These positive factors
were partially offset by marginally wider light to heavy crude oil price
differentials. Relative to the second quarter of 2005, results were positively
impacted by a further 19 per cent increase in WTI prices combined with a
narrowing of heavy crude oil differentials. In the third quarter of 2005, a
total of $31.9 million of unrealized foreign exchange and risk management gains
($26.2 million net of tax) was included in net earnings, compared to a foreign
exchange gain of $34.4 million ($28.7 million net of tax) for the third quarter
of 2004. Excluding the impact of Western's hedging and risk management
activities, EBITDAX was $138.8 million, cash flow from operations was $122.9
million ($0.77 per share) and net earnings were $105.5 million ($0.66 per share)
in the third quarter of 2005 compared to $87.5 million, $72.2 million ($0.46 per
share) and $82.1 million ($0.52 per share), respectively, in the third quarter
of 2004.
HIGHLIGHTS
o During the third quarter of 2005, the Project achieved production rates
exceeding the record production level set in the second quarter of 2005
despite lower production rates in September 2005 as a result of reduced
availability of third-party hydrogen to the Upgrader together with
minor planned maintenance at other third-party facilities servicing the
AOSP. Third quarter production averaged approximately 165,200 barrels
per day (33,040 barrels per day net to Western), an increase of seven
per cent compared to 154,300 barrels per day (30,860 barrels per day
net to Western) in the third quarter of 2004. Production over the last
two consecutive quarters averaged 164,500 barrels per day (32,900
barrels per day net to Western), with year-to-date production averaging
154,000 barrels per day (30,800 barrels per day net to Western).
Performance for the nine months ended September 30, 2005 demonstrates
the Project's ability to sustain reliable operations for successive
periods with production levels exceeding name plate capacity for the
facilities. These sustained record quarterly production levels are a
result of continual process improvements and increased plant
availability. Increased levels of maintenance and its associated costs
are required to achieve these higher availability rates. Higher
maintenance costs, together with inflationary pressures on materials
and services in a high commodity price environment, resulted in a
moderate increase in unit operating costs to $20.58 per processed
barrel for the quarter.
o On October 3, 2005, Western announced a strategic risk management
program to fund future AOSP expansion requirements. The program
consists of a series of purchased WTI put options combined with the
sale of a series of WTI call options. This 'collar' strategy provides a
floor price of US$52.42 per barrel on 20,000 barrels per day of
production from 2007 to 2009 with a ceiling price of US$92.41 on an
average 13,333 barrels per day over the same time period. The average
overall cost of the program is US$3.74 per put
1
barrel, payment of which is deferred until the applicable option
period. This program provides greater cash flow certainty during years
where Western's capital expenditures for expansion initiatives are
expected to be significant, thereby creating a much more solid
financial position.
AOSP EXPANSION UPDATE
The Joint Venture Partners continue to make progress on the first phase of the
AOSP expansion leading to a final investment decision which is expected to occur
in mid-2006. The Joint Venture has now secured world-class Engineering
Procurement and Construction Management firms to assist in the upcoming
expansion initiatives. The AMEC-Colt engineering joint venture was selected as
the major contractor for the Mine expansions while Bechtel Canada Co. was
selected for the Upgrader expansions. As previously communicated, the expansions
are part of a larger `building block' strategy where successive back-to-back
100,000 barrel per day expansion phases will be completed over the next eight to
ten years to increase total production to over 500,000 barrels per day (100,000
barrels per day net to Western). The capital profile associated with this
building block strategy applies more capital to the first phase as critical
infrastructure items such as permanent camps, utilities, pipelines, etc. will be
built now in order to serve subsequent phases. Also included in the first phase
are profitability-driven capital investments such as a solvent deasphalting
plant at the Upgrader to capture the value associated with heavy crude oil
differentials. Through this additional investment, the Upgrader expansion will
produce less heavy oil and, as a result, reduce Western's exposure to light to
heavy oil differentials and improve the value of the synthetic crude oil blends.
Capital costs of up to $200 per annual barrel of production are expected for the
first phase of expansion, with lower capital intensities anticipated for
subsequent phases. Capital costs are higher than initially envisioned, due in
large part to a significant increase in materials costs and skilled labour.
Certain long lead items have already been ordered with a corresponding capital
outlay to ensure these critical items are delivered on site at the appropriate
time.
The Project's environmental permit for the first phase is before the Energy
Utilities Board and was filed on April 29, 2005. The review of this permit is
proceeding according to schedule and the Owners anticipate final approval in
mid-2006. Baseline work and planning continues to progress with respect to the
omnibus application for the next phases of the AOSP expansion. The Joint Venture
expects to have the associated permits relating to this application in place by
mid-2008, coinciding with a final investment decision on the second and third
phases.
The primary focus of Western's management team is to deliver the AOSP value
proposition by optimizing the existing operations to safely produce consistent
results and by delivering the Project's expansion phases in the most cost
effective manner possible.
On behalf of the Board of Directors
(signed)
James C. Houck
President & Chief Executive Officer
October 26, 2005
2
MANAGEMENT'S DISCUSSION & ANALYSIS
THE FOLLOWING DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS WAS
PREPARED AS OF OCTOBER 26, 2005 AND SHOULD BE READ IN CONJUNCTION WITH THE
INTERIM UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS FOR THE PERIODS ENDED
SEPTEMBER 30, 2005 AND 2004 AND THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AT
DECEMBER 31, 2004 INCLUDED IN THE ANNUAL REPORT. IT OFFERS MANAGEMENT'S ANALYSIS
OF OUR FINANCIAL AND OPERATING RESULTS AND CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS RELATING BUT NOT LIMITED TO OUR OPERATIONS, ANTICIPATED FINANCIAL
PERFORMANCE, BUSINESS PROSPECTS AND STRATEGIES. FORWARD-LOOKING INFORMATION
TYPICALLY CONTAINS STATEMENTS WITH WORDS SUCH AS "ANTICIPATE", "ESTIMATE",
"EXPECT", "POTENTIAL", "COULD", OR SIMILAR WORDS SUGGESTING FUTURE OUTCOMES. WE
CAUTION READERS TO NOT PLACE UNDUE RELIANCE ON FORWARD-LOOKING INFORMATION
BECAUSE IT IS POSSIBLE THAT PREDICTIONS, FORECASTS, PROJECTIONS AND OTHER FORMS
OF FORWARD-LOOKING INFORMATION MAY DIFFER MATERIALLY FROM ACTUAL RESULTS
ACHIEVED BY WESTERN. WESTERN DOES NOT MAINTAIN A POLICY NOR IS UNDER ANY
OBLIGATION TO UPDATE PUBLICLY OR REVISE ANY FORWARD-LOOKING INFORMATION
CONTAINED IN THE FOLLOWING DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS AS A RESULT OF NEW INFORMATION OR EVENTS.
BY ITS NATURE, OUR FORWARD-LOOKING INFORMATION INVOLVES NUMEROUS ASSUMPTIONS,
INHERENT RISKS AND UNCERTAINTIES. A CHANGE IN ANY ONE OF THESE FACTORS COULD
CAUSE ACTUAL EVENTS OR RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED IN THE
FORWARD-LOOKING INFORMATION. THESE FACTORS INCLUDE, BUT ARE NOT LIMITED TO, THE
FOLLOWING: MARKET CONDITIONS, LAW OR GOVERNMENT POLICY, OPERATING CONDITIONS AND
COSTS, PROJECT SCHEDULES, OPERATING PERFORMANCE, DEMAND FOR OIL, GAS, AND
RELATED PRODUCTS, PRICE AND EXCHANGE RATE FLUCTUATIONS, COMMERCIAL NEGOTIATIONS
OR OTHER TECHNICAL AND ECONOMIC FACTORS.
OVERVIEW
Western Oil Sands Inc. ("Western") is a Canadian oil sands corporation that
holds a 20 per cent undivided ownership interest in a multi-billion dollar Joint
Venture that is exploiting the recoverable bitumen resources found in oil sands
deposits in the Athabasca region of Alberta, Canada. Shell Canada Limited and
Chevron Canada Limited hold the remaining 60 per cent and 20 per cent undivided
ownership interests, respectively, in the Joint Venture. The Athabasca Oil Sands
Project (the "AOSP" or the "Project"), which includes facilities owned by the
Joint Venture and third parties, uses established processes to mine oil sands
deposits, extract and upgrade the bitumen into synthetic crude oil and vacuum
gas oil. Currently, apart from our interest in the Project, we have no other
material assets nor do we have any other ongoing operations. Western continues,
however, as a part of an ongoing strategic planning process, to identify and
evaluate other large hydrocarbon resources and related business opportunities in
order to create additional shareholder value.
3
HIGHLIGHTS
- ---------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------------------------------------------
2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------
OPERATING DATA (BBLS/D)
Bitumen Production 33,034 30,862 30,789 28,827
Synthetic Crude Sales 43,240 42,546 40,776 38,014
Operating Expense per Processed Barrel ($/bbl) 20.58 17.67 21.50 19.39
FINANCIAL DATA ($ THOUSANDS, EXCEPT AS INDICATED)
Net Revenue 185,689 104,105 425,599 280,064
Realized Crude Oil Sales Price ($/bbl) (1) (2) 58.79 38.63 49.62 36.58
EBITDAX(1) (3) 111,003 47,847 222,482 109,047
Cash Flow from Operations (4) 95,048 32,528 173,837 60,945
Cash Flow per Share - Basic ($/Share) (1) (5)(9) 0.59 0.21 1.09 0.39
Net Earnings(6) 79,373 42,378 106,079 27,516
Net Earnings Per Share - Basic ($/Share)(9) 0.50 0.27 0.66 0.18
Net Capital Expenditures (7) 15,960 13,456 20,614 26,175
Long-term Financial Liabilities(8) 736,918 695,411 736,918 695,411
Weighted Average Shares Outstanding - Basic 160,229,593 158,226,603 160,103,854 155,955,408
(Shares)
- ---------------------------------------------------------------------------------------------------------------
(1) PLEASE REFER TO PAGE 17 FOR A DISCUSSION OF NON-GAAP FINANCIAL MEASURES.
(2) THE REALIZED CRUDE OIL SALES PRICE IS THE REVENUE DERIVED FROM THE SALE OF
WESTERN'S SHARE OF THE PROJECT'S SYNTHETIC CRUDE OIL, NET OF HEDGING
ACTIVITIES, DIVIDED BY THE CORRESPONDING VOLUME. PLEASE REFER TO PAGE 6 FOR
CALCULATION.
(3) EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION, DEPLETION, AMORTIZATION,
STOCK BASED COMPENSATION, ACCRETION ON ASSET RETIREMENT OBLIGATION, FOREIGN
EXCHANGE AND RISK MANAGEMENT AS CALCULATED ON PAGE 13.
(4) CASH FLOW FROM OPERATIONS IS EXPRESSED BEFORE CHANGES IN NON-CASH WORKING
CAPITAL.
(5) CASH FLOW PER SHARE IS CALCULATED AS CASH FLOW FROM OPERATIONS DIVIDED BY
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, BASIC.
(6) WESTERN HAS NOT PAID DIVIDENDS IN ANY OF THE ABOVE REFERENCED PERIODS.
(7) NET CAPITAL EXPENDITURES ARE CAPITAL EXPENDITURES NET OF ANY INSURANCE
PROCEEDS RECEIVED DURING THE PERIOD.
(8) LONG-TERM FINANCIAL LIABILITIES INCLUDESOPTION PREMIUM LIABILITY.
(9) PER SHARE AMOUNTS FOR FISCAL 2004 TIME PERIODS HAVE BEEN RESTATED TO TAKE
INTO ACCOUNT THE THREE-FOR-ONE STOCK SPLIT.
OPERATING RESULTS
PRODUCTION
During the third quarter of 2005, production from the Mine rose seven per cent
and averaged 165,170 barrels per day (33,034 barrels per day net to Western) of
bitumen compared to 154,310 barrels per day (30,862 barrels per day net to
Western) in the third quarter of 2004. This establishes a new quarterly
production record despite an approximate three week slowdown of the entire
operation during September due to reduced availability of third-party hydrogen
at the Upgrader and planned maintenance related to some third-party facilities
servicing the AOSP. During this slowdown, planned maintenance was also conducted
at both the Mine and Upgrader. The three months ended September 30, 2005 marks
the first time since operations commenced where production has exceeded design
rate capacity for two successive quarters. The Joint Venture Partners continue
to make significant process improvements enhancing the reliability of the
Project.
4
REVENUE
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NET REVENUE THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
----------------------------------------------------
($ thousands, except as indicated) 2005 2004 2005 2004
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REVENUE
Oil Sands (1) 235,181 151,193 554,419 380,963
Marketing 39,455 53,291 129,698 98,045
Transportation 555 452 1,424 1,266
------------ ------------- ------------ ------------
Total Revenue 275,191 204,936 685,541 480,274
============ ============= ============ ============
PURCHASED FEEDSTOCKS AND TRANSPORTATION
Oil Sands 49,512 47,339 128,175 100,966
Marketing 39,374 53,032 130,217 97,598
Transportation 616 460 1,550 1,646
------------ ------------- ------------ ------------
Total Purchased Feedstocks and Transportation 89,502 100,831 259,942 200,210
============ ============= ============ ============
NET REVENUE
Oil Sands (1) 185,669 103,854 426,244 279,997
Marketing 81 259 (519) 447
Transportation (61) (8) (126) (380)
------------ ------------- ------------ ------------
Total Net Revenue 185,689 104,105 425,599 280,064
============ ============= ============ ============
SYNTHETIC CRUDE SALES (BBLS/D) 43,240 42,546 40,776 38,014
============ ============= ============ ============
REALIZED CRUDE OIL SALES PRICE ($/BBL) (2) 58.79 38.63 49.62 36.58
============ ============= ============ ============
- ---------------------------------------------------------------------------------------------------------------
(1) OIL SANDS REVENUE AND NET REVENUE ARE PRESENTED NET OF WESTERN'S HEDGING
ACTIVITIES.
(2) REALIZED CRUDE OIL SALES PRICE ($/BBL) IS CALCULATED AS OIL SANDS REVENUE
LESS ANY TRANSPORTATION COSTS DIVIDED BY SYNTHETIC CRUDE SALES VOLUME. FOR
THREE AND NINE MONTHS ENDED SEPTEMBER 2005, $1.3 MILLION AND $2.1 MILLION,
RESPECTIVELY, HAVE BEEN INCURRED FOR TRANSPORTATION COSTS RELATED TO OIL
SANDS.
Western recorded crude oil sales revenue of $275.2 million in the third quarter
of 2005, including $235.2 million from proprietary production compared to $204.9
million in the third quarter of 2004, which included $151.2 million from
proprietary production. This 34 per cent year-over-year increase is mainly the
result of a seven per cent increase in production, combined with a 52 per cent
increase in our realized crude oil sales price due to higher underlying crude
oil prices and fewer physical barrels subject to fixed price swap contracts,
partially offset by a strengthening of the Canadian dollar relative to the US
dollar and slightly wider light to heavy crude oil differentials.
Oil sands sales volumes, including bitumen and purchased feedstocks, averaged
43,240 barrels per day in the third quarter of 2005, surpassing the 42,546
barrels per day recorded in the third quarter of 2004.
The third quarter of 2005 experienced a further strengthening in commodity
prices with WTI averaging US$63.19 per barrel, representing a 44 per cent
increase over the comparable prior year period and a 19 per cent increase
compared to the second quarter of 2005. Heavy oil differentials in the third
quarter of 2005 were marginally wider than the same period in 2004; however,
heavy oil differentials in the third quarter of 2005 improved significantly from
the second quarter of 2005 where the differential had widened to approximately
40 per cent of WTI from the historical norm of approximately 30 per cent of WTI.
With heavy oil products in the overall sales mix, absolute commodity prices and
heavy oil market differentials affect average synthetic crude oil price
realizations. Compared to the third quarter of 2004, the differential to
Edmonton PAR increased in large part due to a higher percentage of heavy crude
oil in the overall sales mix combined with a slight widening of the light to
heavy oil differential. Compared to the second quarter of 2005, Western's price
differential narrowed due to heavy oil differentials returning to more
5
historical norms, partially offset by a greater percentage of heavy oil products
in the overall sales mix as a result of the planned maintenance in September
2005.
Western generated net revenue of $185.7 million in the third quarter of 2005,
after deducting the cost of purchased feedstocks and transportation costs
downstream of Edmonton and hedging activities. This represents an increase of 78
per cent compared to the third quarter of 2004 where net revenues totaled $104.1
million. Feedstocks are crude products introduced at the Upgrader. Some are
introduced into the hydrocracking/hydrotreating process and others are used to
create various blends of synthetic crude oil products. The cost of these
feedstocks depends on world oil markets and the spread between heavy and light
crude oil prices.
During the third quarter of 2005, Western's hedging activities resulted in an
overall decrease to net revenue of $27.8 million or $6.99 per barrel compared to
an overall decrease to net revenue of $20.8 million or $5.14 per barrel in the
second quarter of 2005 and $39.7 million or $10.14 per barrel during the prior
year period. Western's hedged volumes during the third quarter were 7,000
barrels per day compared to 20,000 barrels per day during the third quarter of
2004. Western's hedged volumes for the balance of 2005 remain at 7,000 barrels
per day at US$26.87 WTI. In 2006, Western has no volumes subject to hedging
contracts. Should WTI prices remain at current levels, there will be a material
positive impact on 2006 net earnings and cash flows over our reported 2005
results. Western has not, at this point, executed additional crude oil hedge
transactions for fiscal 2006 although as detailed in the Financial Risks section
of this MD&A, Western has completed a strategic risk management program covering
fiscal 2007 through 2009.
OPERATING COSTS
Western's unit cash operating costs increased to $20.58 per processed barrel in
the third quarter of 2005 compared to $17.67 per processed barrel for the third
quarter of 2004 and $19.38 per processed barrel in the second quarter of 2005.
This increase is a function of the price of various inputs, such as natural gas,
which directly correlate to the price of crude oil. As crude oil appreciates,
the costs of these inputs increase as well. In the third quarter of 2005, the
average natural gas price rose 23 per cent compared to the comparable period in
2004 and 11 per cent compared to the second quarter of 2005. Operating costs in
the third quarter also include additional maintenance expenses as the overall
operation conducted planned maintenance during the month of September due to
reduced third-party hydrogen availability and similar planned maintenance at
third party facilities. No such costs were incurred in the third quarter of 2004
or in the second quarter of 2005. The Project continues to focus on reducing
operating costs in all areas of operations despite the cost pressures associated
with a high commodity price environment and the increased demand within the
industry.
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THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
----------------------------------------------------------
($ thousands, except as indicated) 2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES FOR BITUMEN SOLD
Operating Expense - Income Statement 64,810 50,766 179,300 155,419
Operating Expense - Inventoried (979) 875 3,095 (1,758)
--------------- -------------- -------------- ------------
Total Operating Expenses For Bitumen Sold 63,831 51,641 182,395 153,661
=============== ============== ============== ============
SALES (BARRELS PER DAY)
Total Synthetic Crude Sales 43,240 42,546 40,766 38,014
Purchased Upgrader Blend Stocks 9,532 10,786 9,702 9,096
--------------- -------------- -------------- ------------
Synthetic Crude Sales Excluding Blend Stocks 33,708 31,760 31,074 28,918
=============== ============== ============== ============
OPERATING EXPENSES PER PROCESSED BARREL ($/BBL) (1) 20.58 17.67 21.50 19.39
=============== ============== ============== ============
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(1) OPERATING EXPENSES PER PROCESSED BARREL ($/BBL) IS CALCULATED AS TOTAL
OPERATING EXPENSES FOR BITUMEN SOLD DIVIDED BY SYNTHETIC CRUDE SALES
EXCLUDING BLEND STOCKS.
6
The above table calculates operating expenses per processed barrel on the basis
of the operating costs that are associated with the synthetic crude sales,
excluding purchased blend stocks, for the relevant period. This calculation
recognizes that, intrinsic in the Project's operations, bitumen production from
the Mine receives an approximate three per cent uplift as a result of the
hydrotreating/hydroconversion process, which is included in synthetic crude
sales excluding blendstocks.
ROYALTIES
Royalties of $1.4 million in the third quarter of 2005 were slightly higher than
the third quarter of 2004 as a result of higher deemed bitumen royalty prices
together with increased bitumen production volumes. Royalties were comparable to
the second quarter of 2005.
CORPORATE RESULTS
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses ("G&A") were $2.7 million for the third
quarter of 2005 compared to $1.9 million for the third quarter of 2004 due to an
increased number of employees within Western and higher regulatory compliance
costs. G&A expenses were $0.2 million higher in the third quarter compared to
the prior quarter due to higher regulatory costs and other professional fees.
INSURANCE EXPENSE
Insurance expenses were $1.9 million for the third quarter of 2005 compared to
$2.6 million in the third quarter of 2004. This decrease is due to lower
premiums associated with the various corporate policies, combined with the
strengthening of the Canadian dollar over the comparable periods, as the
premiums are paid in US dollars but reported for financial statement purposes in
Canadian dollars. Insurance expenses in the third quarter of 2005 were
comparable to those incurred in the second quarter of 2005.
RESEARCH AND BUSINESS DEVELOPMENT
Western incurred $3.8 million in AOSP-related research and other business
development expenses during the third quarter of 2005. Of this amount, $1.9
million relates to initiatives involving heavy oil upgrading technologies which
were previously capitalized. A small portion of Western's capital budget is
directed to new business development activities. These activities include:
research and development efforts with the objective of identifying ways to add
value to our existing assets; the addition of some internal technical
capabilities in order to evaluate opportunities as they arise either through our
Joint Venture partners or independently; and finally, as part of Western's
long-range strategy, plans include expanding our organizational capabilities to
evaluate business opportunities, domestically or internationally, by taking our
core competencies and skills and applying them to new ventures which represent
long-life projects with significant hydrocarbon resource potential.
INTEREST EXPENSE
Interest expense totaled $13.6 million in the third quarter of 2005 compared to
$14.9 million in the third quarter of 2004. This decrease is a result of the
Canadian dollar strengthening against the US dollar during this period compared
to the prior year period, thereby reducing interest charges on our US
denominated Notes which are reported in Canadian dollars. The decrease is also a
function of lower absolute bank debt levels as excess free cash flows over the
last several quarters have been applied to reduce bank debt. Interest expense
decreased by $2.1 million in the third quarter of 2005 compared to the second
quarter of 2005, primarily as a result of a decrease in the carrying costs under
the Revolving Credit Facility, combined with a further strengthening of the
Canadian dollar against the US dollar during this time period.
7
DEPRECIATION, DEPLETION AND AMORTIZATION
Depreciation, depletion and amortization ("DD&A") totaled $13.1 million for the
third quarter of 2005 similar to the $13.1 million recorded in the third quarter
of 2004. Higher production, which increases the amount recorded for DD&A, was
offset by a larger reserve base as at December 31, 2004 used for the purposes of
DD&A rates in fiscal 2005.
FOREIGN EXCHANGE
During the third quarter of 2005, Western reported a foreign exchange gain of
$28.1 million compared to a gain of $34.3 million in the third quarter of 2004.
As reference points, the noon-day closing foreign exchange rate on September 30,
2004 was $1.2639 Cdn/US compared to $1.2256 Cdn/US on June 30, 2005 and $1.1611
Cdn/US on September 30, 2005. In terms of average rates for the respective
periods, the third quarter of 2004 was $1.3072 Cdn/US compared to $1.2439 Cdn/US
for the second quarter of 2005 and $1.2014 Cdn/US for the third quarter of 2005.
RISK MANAGEMENT ACTIVITIES
In the third quarter of 2005, Western implemented strategic crude oil hedges in
order to provide greater cash flow certainty during those years where
significant AOSP expansion capital expenditures are expected. Western employed a
collar strategy whereby a series of put and call options were purchased and sold
with a number of major financial institutions. The program established a
weighted average floor price on 20,000 barrels per day of US$52.42 and a ceiling
price of US$92.41 on an average 13,333 barrels per day for the period January
2007 through to December 2009.
Western will not utilize hedge accounting treatment under Canadian GAAP for this
program and, as a result, will have certain mark-to-market adjustments flowing
through our financial statements. These adjustments are created from the changes
in the fair market value of the financial instruments employed over the time
period in question. These adjustments have no impact on cash flow from
operations but will affect reported net earnings. For the period ended September
30, 2005, Western's risk management assets increased in value from the time the
financial instruments were executed, resulting in a mark-to-market gain of $1.7
million. The overall cost of the program was US$3.74 per put barrel purchased,
the payment of which is deferred until the actual option period, therefore, no
cash outlay will occur until the respective option periods expire. In this way,
Western matches the net cash expense of the options to the cash flows received
from our physical crude sales.
INCOME TAXES
For the third quarter of 2005, Western had an income tax expense of $34.0
million compared to $11.4 million for the same period last year. Included in
this expense is a future income tax expense of $33.4 million (2004 - $11.2
million) which reflects the expected use of Western's non-capital loss
carry-forwards during the third quarter of 2005, and a corresponding reduction
in the future income tax assets associated with these carry-forwards.
NET EARNINGS
Western reported record net earnings of $79.4 million ($0.50 per share) in the
third quarter of 2005 compared to net earnings of $42.4 million ($0.27 per
share) in the third quarter of 2004. Net earnings include the impact of
unrealized foreign exchange gains on both our US dollar denominated debt and
option premium liability together with the mark-to-market gain from risk
management activities. In the third quarter of 2005, there were unrealized
foreign exchange and risk management gains of $31.9 million compared to an
unrealized gain of $34.4 million in the third quarter of 2004. Excluding the
impact of Western's hedging activities and mark-to-market gains on our recent
risk management activities, net earnings were $105.5 million in the third
quarter of 2005.
8
The following table provides the reconciliation between Net Earnings, Cash Flow
from Operations (before changes in non-cash working capital) and EBITDAX:
RECONCILIATION: NET EARNINGS TO EBITDAX
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THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------------------------------------------------
($ thousands) 2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------
NET EARNINGS ATTRIBUTABLE TO 79,373 42,378 106,079 27,516
COMMON SHAREHOLDERS
Add (Deduct):
Depreciation, Depletion and Amortization 13,119 13,092 36,654 35,424
Accretion on Asset Retirement Obligation 141 124 425 374
Stock-based Compensation 625 189 2,348 733
Interest Expense on Option Premium Liability 324 -- 324 --
Unrealized Foreign Exchange Gain (30,206) (34,425) (20,306) (12,825)
Unrealized Gain on Risk Management (1,697) -- (1,697) --
Future Income Tax Expense 33,371 11,170 50,651 9,723
Cash Settlement on Performance Share Units -- -- (596) --
Cash Settlement on Asset Retirement Obligation (2) -- (45) --
- ----------------------------------------------------------------------------------------------------------
CASH FLOW FROM OPERATIONS, BEFORE CHANGES
IN NON-CASH WORKING CAPITAL 95,048 32,528 173,837 60,945
Add:
Interest (excluding interest on Option Premium 13,262 14,908 44,008 46,830
Liability)
Realized Foreign Exchange Loss 2,103 155 2,106 291
Large Corporations Tax 588 256 1,890 981
Cash Settlement on Performance Share Units -- -- 596 --
Cash Settlement on Asset Retirement Obligation 2 -- 45 --
- ----------------------------------------------------------------------------------------------------------
EBITDAX 111,003 47,847 222,482 109,047
- ----------------------------------------------------------------------------------------------------------
EBITDAX (Earnings before Interest, Taxes, Depreciation, Depletion, Amortization,
Stock-based Compensation, Accretion on Asset Retirement Obligation, Foreign
Exchange and Risk Management) was $111.0 million for the third quarter of 2005,
reflecting a 132 per cent increase over the $47.8 million recorded for the third
quarter of 2004, establishing a new quarterly record for Western. Excluding the
impact of Western's hedging and risk management activities, EBITDAX was $138.8
million for the third quarter of 2005 compared to $87.5 million for the third
quarter of 2004, an increase of 59 per cent. Third quarter 2005 EBITDAX
increased $26.9 million over the second quarter of 2005. Excluding the impact of
hedging activities, EBITDAX in the third quarter of 2005 improved $33.9 million
or 32 per cent compared to the second quarter of 2005. Higher EBITDAX, both from
the previous year's comparative quarter and the previous quarter, is the result
of higher bitumen production, together with improved sale price realizations
offset by a strengthening of the Canadian dollar relative to the US dollar.
Cash flow from operations before changes in non-cash working capital ("cash flow
from operations") increased 192 per cent to a new record of $95.0 million for
the third quarter of 2005 compared to $32.5 million in the third quarter of
2004. This increase is the result of higher bitumen production, combined with
stronger price realizations due to 13,000 fewer barrels per day subject to fixed
priced swap contracts, offset by a strengthening of the Canadian dollar relative
to the US dollar compared to the prior year period. Cash flow from operations in
the third quarter of 2005 increased
9
$27.0 million or 40 per cent over the record set in the second quarter of 2005
mainly as a result of improved sales price realizations.
FINANCIAL POSITION
BANK DEBT
During the third quarter of 2005, we reduced our Revolving Credit Facility by
$129 million as a result of record cash flow from operations and the receipt of
Section III insurance settlement proceeds of $19.4 million. We will continue to
reduce our bank debt to the extent that cash flow from operations exceeds
capital expenditures.
Western has $299 million in capacity under its $340 million Revolving Credit
Facility. This capacity is a function of the before tax net present value of
Western's share of the proved reserves associated with the Project based on a
constant price discounted at 10%. As at September 30, 2005, $75 million had been
drawn on this Revolving Credit Facility. Subsequent to the quarter end, Western
amended the terms contained in the Revolving Facility in two key areas. First,
the structure of the Facility has been modified from a 364 day revolving credit
facility with a two year term-out provision for non-revolving allocations to a
three year revolving facility maturing initially on October 31, 2008, extendible
annually at the lending institutions' discretion. Western's Revolving Credit
Facility will no longer provide for a non-revolving term-out portion. Second,
the pricing applicable to both amounts drawn and undrawn under the facility has
been reduced to reflect recent current market conditions and the significant
improvement in Western's credit profile. This should result in lower bank debt
servicing costs on a go-forward basis.
CAPITAL EXPENDITURES
Western's capital expenditures totaled $16.2 million in the third quarter of
2005 compared to $13.5 million in the third quarter of 2004. Insurance proceeds
of $0.2 million offset this amount to realize a net addition to capital assets
of $16.0 million.
ANALYSIS OF CASH RESOURCES
Cash balances totaled $5.1 million at September 30, 2005 compared to $4.4
million at June 30, 2005. Cash inflows included: $95.0 million cash flow from
operations, a $49.8 million decrease in non-cash working capital, $1.1 million
from the exercise of employee stock options and $0.2 million from insurance
proceeds. Cash outflows included a $129.0 million decrease in bank lines, $16.2
million of capital expenditures and $0.3 million in repayment of obligations
under capital lease and deferred charges.
The decrease in non-cash working capital during the third quarter of 2005 was
the result of a $24.7 million decrease in accounts receivable largely due to the
collection of the $19.4 million Section III insurance settlement, combined with
lower sales volumes in September as a result of the slowdown to accommodate
planned maintenance, a $23.8 million increase in accounts payable and a $4.1
million decrease in prepaid expenses offset by a $2.8 million increase in
inventory. The increase in accounts payable reflects five months of accrued
interest on Western's long-term notes at September 30, 2005 compared to two
months accrued at June 30, 2005 and increased amounts owed under hedging
10
contracts. Inventory is higher as a result of the increased volumes and costs
associated with feedstock inventory in addition to higher levels of finished
product volumes.
INSURANCE CLAIMS
As announced on June 27, 2005, the Joint Venture reached a settlement for the
loss of profits policy referred to as Section III in the amount of $220 million.
Western's pro rata share is $44 million. Western has received $19.4 million to
date of this amount. The remaining balance is being withheld by certain insurers
who are common to Western's cost overrun and start-up delay policy, known as
Section IV. Western is attempting to finalize a contingent settlement for the
balance of $24.6 million.
With respect to Western's $200 million Section IV policy, arbitration
proceedings are continuing with hearings expected to commence in mid-2006.
Following these hearings, we expect to receive a binding decision from the panel
regarding this claim which, in turn, will finalize the payments that have been
withheld to Western under Section I and Section III. The total amount claimed by
Western from insurers is $244 million, none of which has been recognized in the
financial statements.
FINANCIAL RISKS
The objective of Western's risk management programs is to mitigate exposure to
the volatility of crude oil prices, thereby providing greater certainty of
future cash flows from the sale of our synthetic crude products. This risk
management strategy is intended to protect the base and future capital programs
and ensure the funding of debt obligations. To this end, Western has the
following financial instruments outstanding as at September 30, 2005:
(a) Hedge Accounting Treatment
As at September 30, 2005, Western had the following commodity-pricing agreements
that are accounted for as hedges:
- -------------------------------------------------------------------------------------------------------------------
Unrealized Decrease
Instrument Notional Volume Hedge Period Swap Price to Future Revenue
(bbls/d) (US$/bbl) (Cdn $ Thousands)
- -------------------------------------------------------------------------------------------------------------------
WTI Swaps 7,000 October 1, 2005 to December 31, 2005 US$26.87 $ (25,281)
===================================================================================================================
As a result of the continued strength in crude oil prices since this program was
initiated, Western has not realized the full impact of increases in Edmonton PAR
to the extent of our hedged volumes. The impact of this program on Western's
revenue is described in the following table:
Three months ended Nine months ended
September 30 September 30
- -------------------------------------------------------------------------------------------------------------------
(Unaudited) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------------
Decrease in Revenue - $ thousands 27,821 39,682 85,418 84,305
Decrease in Revenue - $/bbl 6.99 10.14 7.67 8.09
===================================================================================================================
11
(b) Fair Value Accounting Treatment
As at September 30, 2005, Western's outstanding put and call options are as
follows:
- ------------------------------------------------------------------------------------------------------------
Period (calendar year)
-------------------------------------------------------------------
2007 2008 2009
- ------------------------------------------------------------------------------------------------------------
Put options purchased (bbls/d) 20,000 20,000 20,000
Call options sold (bbls/d) 10,000 15,000 15,000
Avg. put strike price (US$/bbl) 52.50 54.25 50.50
Avg. call strike price (US$/bbl) 92.50 94.25 90.50
============================================================================================================
Three Months Ended Nine Months Ended
September 30 September 30
- ------------------------------------------------------------------------------------------------------------
(Unaudited) ($ thousands) 2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------
Risk Management Asset - Beginning of Period -- -- -- --
Net Premium 84,976 -- 84,976 --
Increase in Fair Value 1,697 -- 1,697 --
- ------------------------------------------------------------------------------------------------------------
Risk Management Asset - End of Period 86,673 -- 86,673 --
============================================================================================================
OUTLOOK FOR THE REMAINDER OF 2005
The three months ended September 30, 2005 represented another successful quarter
both operationally and financially. New records were established for many key
financial metrics including net earnings, cash flow from operations and EBITDAX.
Western's strong financial position allowed us to undertake a strategic hedging
program within a prescribed budget while, at the same time, allowing for
considerable upside in commodity prices. The Project achieved record production
during the third quarter, doing so despite a temporary slowdown for planned
maintenance at the Upgrader and Mine during September. As a result of continued
strong operational performance expectations, together with stable crude oil
prices, Western's guidance for the balance of 2005 is as follows: annual
production is expected to average between 155,000 and 160,000 barrels per day
(31,000 to 32,000 barrels per day net to Western), resulting in annual 2005 cash
flow from operations of approximately $290 million and net earnings of
approximately $160 million. The net earnings estimate does not include potential
fourth quarter mark-to-market adjustments on the Risk Management Asset, which
may be significant. This guidance is based on a forecasted WTI price of US$60
and a US/Cdn exchange rate of $0.82 for the balance of fiscal 2005, and includes
the impact of existing crude oil hedges for the remainder of the year. Based on
these assumptions, and a capital program totaling $70 to $80 million in 2005,
Western expects to have sufficient free cash flow to pay down our Revolving
Credit Facility in 2005.
BUSINESS RISKS
Western is subject to a number of business risks that are typical given the
nature of Western's operations. These risks are described in Western's previous
public disclosures, including the 2004 Annual Report, which are available on the
Company's website.
NON-GAAP FINANCIAL MEASURES
Western includes cash flow from operations per share, cash flow from operations
excluding hedging activities, earnings before interest, taxes, depreciation,
depletion and amortization, stock-based compensation, accretion on asset
retirement obligation, foreign exchange gains and gains or losses on risk
management activities ("EBITDAX"),
12
EBITDAX excluding hedging activities and net earnings excluding hedging
activities as investors may use this information to better analyze our operating
performance. We also include certain per barrel information, such as realized
crude oil sales price, to provide per unit numbers that can be compared against
industry benchmarks, such as the Edmonton PAR benchmark. The additional
information should not be considered in isolation or as a substitute for
measures of operating performance prepared in accordance with Canadian Generally
Accepted Accounting Principles ("GAAP"). Non-GAAP financial measures do not have
any standardized meaning prescribed by Canadian GAAP and are therefore unlikely
to be comparable to similar measures presented by other issuers. Management
believes that, in addition to Net Earnings per Share and Net Earnings
Attributable to Common Shareholders (both Canadian GAAP measures), cash flow
from operations per share and EBITDAX provide a better basis for evaluating our
operating performance, as they both exclude fluctuations on the US dollar
denominated Senior Secured Notes and certain other non-cash items, such as
depreciation, depletion and amortization, and future income tax recoveries. In
addition, EBITDAX provides a useful indicator of our ability to fund our
financing costs and any future capital requirements.
ACCOUNTING POLICY
Derivative Financial Instruments
Western utilizes financial instruments to manage our exposure to fluctuations in
foreign currency exchange rates and commodity prices. These derivative financial
instruments are not used for speculative purposes. Western has in place,
policies and procedures with respect to the required documentation and approvals
for the use of financial instruments and specifically ties their use, in the
case of commodities, to the mitigation of market price risk associated with cash
flows expected to be generated. Where applicable, Western identifies
relationships between financial instruments and anticipated transactions, as
well as our risk management objectives and the strategy for undertaking the
economic hedge transaction. Western assesses, both at inception and on an
ongoing basis, whether the financial instrument used in the particular
transaction is effective in offsetting changes in fair values or cash flows of
the transaction.
The fair values of these financial instruments are based on an estimate of the
amounts that would have been received or paid to settle these instruments prior
to maturity. Western considers all of these financial instruments to be
effective economic hedges, however, certain of the our financial instruments do
not qualify or have not been designated as hedges for accounting purposes in
accordance with Accounting Guideline 13.
In accordance with EIC 128 "Accounting for Trading, Speculative or Non-Hedging
Derivative Financial Instruments", financial instruments that do not qualify as
hedges or have not been designated as hedges, are recorded using the
mark-to-market method of accounting, whereby instruments are recorded in the
consolidated balance sheet as either an asset or a liability with changes in
fair value recognized in net earnings. Financial instruments that do qualify as
hedges under Accounting Guideline 13 and are designated as hedges are not
recognized on the consolidated balance sheet and gains and losses on the hedge
are deferred and recognized in revenues in the period the hedge sale transaction
occurs.
13
Consolidated Balance Sheets
AS AT SEPTEMBER 30 AS AT DECEMBER 31
($ THOUSANDS) 2005 2004
- ----------------------------------------------------------------------------------------------------------
(UNAUDITED)
ASSETS
Current Assets
Cash $ 5,140 $ 3,715
Accounts Receivable 83,943 62,564
Inventory 25,767 14,186
Prepaid Expense 4,493 5,771
----------------------------------------
119,343 86,236
----------------------------------------
Capital Assets (NOTE 2) 1,339,086 1,351,745
Risk Management (NOTE 13) 86,673 --
Deferred Charges 16,498 18,378
Future Income Taxes (NOTE 11) -- 14,511
----------------------------------------
1,442,257 1,384,634
----------------------------------------
$ 1,561,600 $ 1,470,870
LIABILITIES
Current Liabilities
Accounts Payable and Accrued Liabilities $ 107,382 $ 87,679
Current Portion of Long-term Debt (NOTE 3) -- 95,000
Current Portion of Lease Obligations (NOTE 4) 3,895 5,230
----------------------------------------
111,277 187,909
Long-term Liabilities
Long-term Debt (NOTE 3) 597,495 662,620
Lease Obligations (NOTE 4) 55,304 53,474
Option Premium Liability (NOTE 5) 84,119 -
Asset Retirement Obligation (NOTE 6) 8,571 8,191
Future Income Tax (NOTE 11) 36,140 -
----------------------------------------
781,629 724,285
----------------------------------------
892,906 912,194
----------------------------------------
SHAREHOLDERS' EQUITY
Share Capital (NOTE 7) 547,886 545,699
Contributed Surplus (NOTE 10) 2,997 1,245
Retained Earnings 117,811 11,732
----------------------------------------
668,694 558,676
----------------------------------------
$ 1,561,600 $ 1,470,870
----------------------------------------
Commitments and Contingencies (NOTE 12)
Subsequent Event (NOTE 15)
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
14
Consolidated Statements of Operations
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED - $ THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------------
REVENUES (NOTE 13) $ 275,191 $ 204,936 $ 685,541 $ 480,274
LESS PURCHASED FEEDSTOCKS AND TRANSPORTATION 89,502 100,831 259,942 200,210
-------------------------------------------------------
185,689 104,105 425,599 280,064
-------------------------------------------------------
EXPENSES:
Operating 64,810 50,766 179,300 155,419
Research and Business Development 3,859 -- 7,994 --
Royalties 1,407 1,019 2,954 2,467
General and Administrative 2,725 1,874 7,204 5,669
Insurance 1,885 2,599 5,665 7,462
Interest (NOTE 9) 13,586 14,908 44,332 46,830
Stock-based Compensation (NOTE 10) 625 189 2,348 733
Accretion on Asset Retirement Obligation (NOTE 6) 141 124 425 374
Depreciation, Depletion and Amortization 13,119 13,092 36,654 35,424
-------------------------------------------------------
102,157 84,571 286,876 254,378
-------------------------------------------------------
NET EARNINGS BEFORE OTHER INCOME AND INCOME TAXES 83,532 19,534 138,723 25,686
OTHER INCOME:
Foreign Exchange Gain 28,103 34,270 18,200 12,534
Risk Management Gain (NOTE 13) 1,697 -- 1,697 --
-------------------------------------------------------
NET EARNINGS BEFORE INCOME TAXES 113,332 53,804 158,620 38,220
Income Tax Expense (NOTE 11) 33,959 11,426 52,541 10,704
-------------------------------------------------------
NET EARNINGS 79,373 42,378 106,079 27,516
Retained Earnings (Deficit) at Beginning of Period 38,438 (22,582) 11,732 (7,720)
-------------------------------------------------------
RETAINED EARNINGS AT END OF PERIOD $ 117,811 $ 19,796 $ 117,811 $ 19,796
-------------------------------------------------------
NET EARNINGS PER SHARE (NOTE 8)
Basic $ 0.50 $ 0.27 $ 0.66 $ 0.18
Diluted $ 0.49 $ 0.26 $ 0.65 $ 0.17
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
15
Consolidated Statements of Cash Flows
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED - $ THOUSANDS) 2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY (USED IN):
OPERATING ACTIVITIES
Net Earnings $ 79,373 $ 42,378 $ 106,079 $ 27,516
Non-cash Items:
Stock-based Compensation (NOTE 10) 625 189 2,348 733
Accretion on Asset Retirement Obligation (NOTE 6) 141 124 425 374
Depreciation, Depletion and Amortization 13,119 13,092 36,654 35,424
Interest Expense on Option Premium Liability (NOTE 5) 324 -- 324 --
Unrealized Gain on Risk Management (NOTE 13) (1,697) -- (1,697) --
Unrealized Foreign Exchange Gain (NOTE 3 AND 5) (30,206) (34,425) (20,306) (12,825)
Future Income Tax Expense (NOTE 11) 33,371 11,170 50,651 9,723
Cash Items:
Cash Settlement of Asset Retirement Obligation (NOTE 6) (2) -- (45) --
Cash Settlement of Performance Share Unit Plan (NOTE10) -- -- (596) --
-------------------------------------------------
CASH FROM OPERATIONS 95,048 32,528 173,837 60,945
Decrease (Increase) in Non-Cash Working Capital (NOTE 14) 25,355 18,002 (18,033) 12,052
-------------------------------------------------
120,403 50,530 155,804 72,997
-------------------------------------------------
FINANCING ACTIVITIES
Issue of Share Capital (NOTE 7) 1,142 1,052 2,187 70,156
Share Issue Expenses (NOTE 7) -- (69) -- (2,934)
Repayment of Long-term Debt, Net (129,000) (42,000) (141,000) (114,000)
Deferred Charges -- (30) -- (56)
Repayment of Obligations Under Capital Lease (336) (335) (1,006) (1,006)
-------------------------------------------------
CASH USED (128,194) (41,382) (139,819) (47,840)
-------------------------------------------------
INVESTING ACTIVITIES
Capital Expenditures (16,164) (13,456) (43,026) (32,606)
Insurance Proceeds (NOTE 12) 204 -- 22,412 6,431
Decrease (Increase) in Non-Cash Working Capital (NOTE 14) 24,488 3,801 6,054 (734)
-------------------------------------------------
CASH GENERATED (USED) 8,528 (9,655) (14,560) (26,909)
-------------------------------------------------
Increase (Decrease) in Cash 737 (507) 1,425 (1,752)
Cash at Beginning of Period 4,403 2,525 3,715 3,770
-------------------------------------------------
CASH AT END OF PERIOD $ 5,140 $ 2,018 $ 5,140 $ 2,018
-------------------------------------------------
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
16
Notes to the Consolidated Financial Statements
(TABULAR DOLLAR AMOUNTS IN THOUSANDS)
The interim consolidated financial statements include the accounts of Western
Oil Sands Inc. and its subsidiaries (the "Corporation"), and are presented in
accordance with Canadian Generally Accepted Accounting Principles. The interim
consolidated financial statements have been prepared using the same accounting
policies and methods of computation as the consolidated financial statements for
the year ended December 31, 2004, except as described in Note 1. The disclosures
provided below are incremental to those included in the annual consolidated
financial statements. The interim consolidated financial statements should be
read in conjunction with the consolidated financial statements and the notes
thereto in the Corporation's annual report for the year ended December 31, 2004.
1. ACCOUNTING POLICY
DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation utilizes financial instruments to manage its exposure to
fluctuations in foreign currency exchange rates and commodity prices. These
derivative financial instruments are not used for speculative purposes. The
Corporation has in place, policies and procedures with respect to the required
documentation and approvals for the use of financial instruments and
specifically ties their use, in the case of commodities, to the mitigation of
market price risk associated with cash flows expected to be generated. Where
applicable, the Corporation identifies relationships between financial
instruments and anticipated transactions, as well as its risk management
objectives and the strategy for undertaking the economic hedge transaction. The
Corporation assesses, both at inception and on an ongoing basis, whether the
financial instrument used in the particular transaction is effective in
offsetting changes in fair values or cash flows of the transaction.
The fair values of these financial instruments are based on an estimate of the
amounts that would have been received or paid to settle these instruments prior
to maturity. The Corporation considers all of these financial instruments to be
effective economic hedges, however, certain of the corporation's financial
instruments do not qualify or have not been designated as hedges for accounting
purposes in accordance with Accounting Guideline 13.
In accordance with EIC 128 "Accounting for Trading, Speculative or Non-Hedging
Derivative Financial Instruments", financial instruments that do not qualify as
hedges or have not been designated as hedges, are recorded using the
mark-to-market method of accounting whereby instruments are recorded in the
consolidated balance sheet as either an asset or a liability with changes in
fair value recognized in net earnings. Financial instruments that do qualify as
hedges under Accounting Guideline 13 and are designated as hedges are not
recognized on the consolidated balance sheet and gains and losses on the hedge
are deferred and recognized in revenues in the period the hedge sale transaction
occurs.
17
2. CAPITAL ASSETS
SEPTEMBER 30, 2005 (UNAUDITED) COST ACCUM. DD&A* NET BOOK VALUE
- -------------------------------------------------------------------------------------------------------------------
Athabasca Oil Sands Project $ 1,341,353 $ (92,183) $ 1,249,170
Athabasca Oil Sands Project Assets Under Capital Lease 52,705 (3,775) 48,930
Other Assets 42,262 (1,276) 40,986
- -------------------------------------------------------------------------------------------------------------------
$ 1,436,320 $ (97,234) $ 1,339,086
- -------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004
Athabasca Oil Sands Project $ 1,341,395 $ (58,955) $ 1,282,440
Athabasca Oil Sands Project Assets Under Capital Lease 52,705 (2,439) 50,266
Other Assets 20,105 (1,066) 19,039
- -------------------------------------------------------------------------------------------------------------------
$ 1,414,205 $ (62,460) $ 1,351,745
- -------------------------------------------------------------------------------------------------------------------
* ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION
3. LONG-TERM DEBT
SEPTEMBER 30, 2005 DECEMBER 31, 2004
- -------------------------------------------------------------------------------------------------------------------
(UNAUDITED)
US$450 million Senior Secured Notes $ 522,495 $ 541,620
Senior Credit Facility -- 95,000
Revolving Credit Facility 75,000 121,000
- -------------------------------------------------------------------------------------------------------------------
597,495 757,620
Less: Current Portion of Long-term Debt -- (95,000)
- -------------------------------------------------------------------------------------------------------------------
$ 597,495 $ 662,620
- -------------------------------------------------------------------------------------------------------------------
The Corporation's US dollar denominated Senior Secured Notes (the "Notes") are
translated into Canadian dollars at the period end exchange rate. The unrealized
foreign exchange gain arising on the Notes for the three and nine month periods
ending September 30, 2005 was $29.0 million and $19.1 million, respectively
(September 30, 2004 - $34.4 million and $12.8 million). As at September 30,
2005, a total of $186.3 million of unrealized foreign exchange gains had been
recognized from the inception of the Notes, approximately $92 million of which
has been capitalized as the unrealized gains were recognized prior to commercial
operations.
4. LEASE OBLIGATIONS
SEPTEMBER 30, 2005 DECEMBER 31, 2004
- -------------------------------------------------------------------------------------------------------------------
(UNAUDITED)
Obligations Under Capital Lease $ 50,602 $ 51,609
Operating Lease Guarantee Obligation 8,597 7,095
- -------------------------------------------------------------------------------------------------------------------
59,199 58,704
Less : Current Portion (3,895) (5,230)
- -------------------------------------------------------------------------------------------------------------------
$ 55,304 $ 53,474
- -------------------------------------------------------------------------------------------------------------------
The capital lease obligation relates to the Corporation's share of capital costs
for the hydrogen-manufacturing unit within the Athabasca Oil Sands Project
("AOSP"). Repayments of the principal obligation are $1.3 million per year and
are scheduled to remain at that level until repaid.
18
Under the Operating Lease for Mobile Equipment, the Corporation is committed to
pay its 20 per cent share of an amount equal to 85 per cent of the original cost
of the equipment to the lessor at the end of the terms of the lease.
Accordingly, the Corporation recognizes, as a liability, a portion of this
future payment as it relates to the service life of the equipment that has
passed. During the three and nine month periods ending September 30, 2005, the
Corporation paid nil and $1.5 million, respectively, in regard to this
obligation (September 30, 2004 - nil).
5. OPTION PREMIUM LIABILITY
The Corporation deferred payment and receipt of the premiums associated with the
options described in Note 13(b) until the settlement of the option contracts
between 2007 and 2009. The total net premiums payable by the Corporation are
US$21.9 million for 2007, US$32.4 million for 2008 and US$27.8 million for 2009.
On the dates that the option contracts were entered, a net liability was
recognized on the consolidated balance sheet at the estimated present value of
the net premiums payable. Subsequent to the inception dates of the option
contracts, interest expense is recognized, with a corresponding increase to the
liability, at annual rates ranging from 4.25% and 4.50%. During the three and
nine month periods ended September 30, 2005, $0.3 million of interest expense
was recognized (September 30, 2004 - nil). The option premium liability is
denominated in US dollars and is translated into Canadian dollars at the period
end exchange rate. The unrealized foreign exchange gain arising on the option
premium liability for the three and nine months ended September 30, 2005 was
$1.2 million (September 30, 2004 - nil).
The following table reconciles the change in the net option premium liability:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED) 2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------
Option Premium Liability - Beginning of Period $ -- $ -- $ -- $ --
Net Premiums 84,976 -- 84,976 --
Interest Expense 324 -- 324 --
Unrealized Foreign Exchange Gain (1,181) -- (1,181) --
- ---------------------------------------------------------------------------------------------
OPTION PREMIUM LIABILITY - END OF PERIOD $ 84,119 $ -- $ 84,119 $ --
- ---------------------------------------------------------------------------------------------
6. ASSET RETIREMENT OBLIGATION
The Corporation, in association with its 20 per cent working interest in the
AOSP, is responsible for its share of future dismantlement and site restoration
costs in the mining, extracting and upgrading activities. During the nine months
ended September 30, 2005, the Corporation incurred $0.05 million in costs
associated with this obligation (September 30, 2004 - nil). The following table
presents the reconciliation of the Asset Retirement Obligation for the three and
nine month periods ending September 30, 2005 and 2004:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED) 2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------
Asset Retirement Obligation at Beginning of Period $ 8,432 $ 7,388 $ 8,191 $ 7,138
Liabilities Settled (2) -- (45) --
Accretion on Asset Retirement Obligation 141 124 425 374
- ---------------------------------------------------------------------------------------------
Asset Retirement Obligation at End of Period $ 8,571 $ 7,512 $ 8,571 $ 7,512
- ---------------------------------------------------------------------------------------------
19
7. SHARE CAPITAL
The number of common shares and stock options outstanding reflect a
three-for-one split of the Corporation's common shares on May 30, 2005.
ISSUED AND OUTSTANDING
(UNAUDITED) NUMBER OF SHARES AMOUNT
- -------------------------------------------------------------------------------------------------------------
COMMON SHARES
Balance at December 31, 2004 159,836,286 $ 545,699
Issued for Cash 494,297 2,187
- -------------------------------------------------------------------------------------------------------------
TOTAL ISSUED SHARE CAPITAL AT SEPTEMBER 30, 2005 160,330,583 $ 547,886
- -------------------------------------------------------------------------------------------------------------
OUTSTANDING
STOCK OPTIONS 3,656,311
- --------------------------------------------------------------------------------
DILUTED SHARES AT SEPTEMBER 30, 2005 163,986,894
- --------------------------------------------------------------------------------
8. NET EARNINGS PER SHARE
The basic and diluted weighted average number of common shares outstanding, both
current and prior period, reflect a three-for-one stock split of the
Corporation's common shares on May 30, 2005. The basic weighted average number
of common shares for the three and nine month periods ended September 30, 2005
are 160,229,593 and 160,103,854 respectively (September 30, 2004 - 158,226,603
and 155,955,408 respectively). The diluted weighted average number of common
shares for the three and nine month periods ended September 30, 2005 were
162,479,152 and 162,398,905 respectively (September 30, 2004 - 161,264,319 and
159,037,827 respectively).
9. INTEREST EXPENSE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------
Interest on Long-term Debt $ 12,619 $ 14,415 $ 42,175 $ 45,381
Interest on Obligations Under Capital Lease 643 493 1,833 1,449
Interest on Option Premium Liability 324 -- 324 --
- -------------------------------------------------------------------------------------------------------------
$ 13,586 $ 14,908 $ 44,332 $ 46,830
- -------------------------------------------------------------------------------------------------------------
Cash interest paid for the three and nine month periods ending September 30,
2005 was $1.7 million and $33.2 million, respectively (September 30, 2004 - $2.6
million and $33.8 million, respectively). Cash interest received for the three
and nine month periods ending September 30, 2005 was nil and $0.1 million,
respectively (September 30, 2004 - nil and $0.1 million, respectively).
The Corporation recognized interest expense on its deferred option premium
liability (Note 5) of $0.3 million for the three and nine month period ended
September 30, 2005 (September 30, 2004 - nil).
20
10. STOCK-BASED COMPENSATION
(a) STOCK OPTION PLAN
Under the Corporation's stock-based compensation plan, 30,000 options were
granted during the three month period ended September 30, 2005 at an average
exercise price of $27.75 (September 30, 2004 - 30,000 options at an average
exercise price of $11.73). The fair values of all options granted during the
period are estimated as at the grant date using the Black-Scholes option-pricing
model. The weighted-average fair values of the options and the assumptions used
in their determination are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------
Granted 30,000 30,000 383,670 228,549
Weighted-average Fair Value $ 12.60 $ 4.54 $ 7.60 $ 4.16
Risk Free Interest Rate 3.72% 4.48% 3.86% 4.37%
Expected Life (in Years) 6.00 6.00 6.00 6.00
Expected Volatility * 41% 30% 26-41% 30%
Dividend Per Share $ -- $ -- $ -- $ --
- -------------------------------------------------------------------------------------------------------------
* SOURCE: BLOOMBERG L.P.
(b) PERFORMANCE SHARE UNIT PLAN (PSUP)
At September 30, 2005, there were 171,174 PSUP units outstanding, after
considering the three-for-one stock split effective May 30, 2005.
(c) STOCK-BASED COMPENSATION
During 2003, the Corporation adopted CICA 3870 "Stock-based Compensation and
Other Stock-based Payments" which results in the recognition of compensation
expense for any options or PSUP units granted on or after January 1, 2003 under
the fair value method. For the three and nine month periods ending September 30,
2005, the Corporation has recognized $0.6 million and $2.3 million,
respectively, in stock-based compensation for these options and PSUP units
(September 30, 2004 - $0.2 million and $0.7 million, respectively).
Under CICA 3870, no compensation expense is required to be recognized for stock
options granted before January 1, 2003. Had compensation expense been determined
based on the fair value method for awards made on or after January 1, 2002 but
before January 1, 2003, the Corporation's net earnings and net earnings per
share would have been adjusted to the proforma amounts indicated below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------
Compensation Expense $ 225 $ 220 $ 667 $ 669
Net Earnings 79,373 42,378 106,079 27,516
- -------------------------------------------------------------------------------------------------------------
Proforma Net Earnings $ 79,148 $ 42,158 $ 105,412 $ 26,847
- -------------------------------------------------------------------------------------------------------------
Basic Net Earnings Per Share
As Reported $ 0.50 $ 0.27 $ 0.66 $ 0.18
Proforma $ 0.49 $ 0.27 $ 0.66 $ 0.18
- -------------------------------------------------------------------------------------------------------------
Diluted Net Earnings Per Share
As Reported $ 0.49 $ 0.26 $ 0.65 $ 0.17
Proforma $ 0.49 $ 0.26 $ 0.65 $ 0.17
- -------------------------------------------------------------------------------------------------------------
21
(d) CONTRIBUTED SURPLUS
The following table presents the reconciliation of Contributed Surplus for the
three-month and nine month periods ending September 30, 2005 and 2004:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------------
Contributed Surplus Beginning of Period $ 2,372 $ 822 $ 1,245 $ 278
Stock-based Compensation Expense 625 189 2,348 733
Cash Settlement of Performance Share Unit Plan -- -- (596) --
- -------------------------------------------------------------------------------------------------------------------
Contributed Surplus End of Period $ 2,997 $ 1,011 $ 2,997 $ 1,011
- -------------------------------------------------------------------------------------------------------------------
11. INCOME TAX
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------------
Large Corporations Tax $ 588 $ 256 $ 1,890 $ 981
Future Income Tax Expense 33,371 11,170 50,651 9,723
- -------------------------------------------------------------------------------------------------------------------
INCOME TAX EXPENSE $ 33,959 $ 11,426 $ 52,541 $ 10,704
- -------------------------------------------------------------------------------------------------------------------
The future income tax (liability) asset consists of:
SEPTEMBER 30, 2005 DECEMBER 31, 2004
- -------------------------------------------------------------------------------------------------------------
Future Income Tax Assets:
Net Losses Carried Forward $ 7,686 $ 61,697
Share Issue Costs 1,051 1,355
Impairment of Long-lived Assets 796 796
Future Income Tax Liabilities:
Capital Assets in Excess of Tax Values (25,353) (34,242)
Unrealized Foreign Exchange Gain (15,863) (12,648)
Unrealized Gain on Risk Management (859) --
Debt Issue Costs (3,598) (2,447)
- -------------------------------------------------------------------------------------------------------------
NET FUTURE INCOME TAX (LIABILITY) ASSET $ (36,140) $ 14,511
- -------------------------------------------------------------------------------------------------------------
The following table reconciles income taxes calculated at the Canadian statutory
rate of 37.62% (2004 - 38.87%) with actual income taxes:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------
Earnings Before Income Taxes $ 113,332 $ 53,804 $ 158,620 $ 38,220
- -------------------------------------------------------------------------------------------------------------
Income Tax Expense at Statutory Rate 42,635 20,914 59,672 14,856
Effect of Tax Rate Changes and Timing of Use 313 1,016 1,349 102
Non-taxable Portion of Foreign Exchange Gain (6,040) (7,530) (3,980) (2,765)
Impact of Resource Allowance (3,772) (3,230) (7,814) (7,234)
Provision to Actual -- -- 764 4,764
Stock-based Compensation 235 -- 660 --
Large Corporations Tax 588 256 1,890 981
- -------------------------------------------------------------------------------------------------------------
INCOME TAX EXPENSE $ 33,959 $ 11,426 $ 52,541 $ 10,704
- -------------------------------------------------------------------------------------------------------------
22
12. COMMITMENTS AND CONTINGENCIES
During the three months ended June 30, 2005, the AOSP reached a settlement in
respect of the insurance coverage provided under Section III of the Joint
Venture construction policies for the loss of profits claim arising from the
January 6, 2003 fire that occurred at the Muskeg River Mine. During the
three-month period ended September 30, 2005, the Corporation received $19.4
million as part of this settlement and is attempting to finalize a contingent
settlement for its remaining share of the settlement proceeds in the amount of
$24.6 million from those insurance underwriters that also subscribed to the
Corporation's cost overrun and start up delay policy, known as Section IV. This
remaining settlement amount would become payable to the Corporation in the event
that it is successful in the arbitration proceedings that are presently ongoing
against the Section IV insurance underwriters. The $19.4 million settlement was
applied against the cost of the AOSP, as the Corporation capitalized the costs
related to this claim as they were incurred prior to the date commercial
operations commenced.
During the three months ended September 30, 2005, the Corporation received $0.2
million in respect of a settlement negotiated by the AOSP relating to initial
construction, these proceeds have been applied against the cost of the AOSP.
No amounts have been recognized in these statements relating to the claims under
the Corporation's insurance policies, nor will any further amount be recognized
until the proceeds are received or settled.
13. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
The Corporation has entered into various commodity-pricing agreements designed
to mitigate the exposure to the volatility of crude oil prices in US dollars,
thereby providing greater certainty of future cash flow from the sale of the
Corporation's synthetic crude oil products. This risk management strategy is
intended to protect the Corporation's base and future capital programs and
ensure the funding of debt obligations. Certain of these commodity-pricing
agreements are accounted for as hedges, as they qualify for hedge accounting
under Accounting Guideline 13 and were designated as hedges, while other
commodity-pricing agreements are accounted for under fair value accounting as
they did not qualify or have not been designated as hedges for accounting
purposes.
(a) Hedge Accounting
As at September 30, 2005, the Corporation had the following commodity-pricing
agreements that are accounted for as hedges:
Unrealized
Decrease
Notional to Future
Volume Swap Price Revenue
Instrument (bbls/d) Hedge Period (US$/bbl) (Cdn $'s)
- -----------------------------------------------------------------------------------------------------------
WTI Swaps 7,000 October 1 to December 31, 2005 US$26.87 $ 25,281
In accordance withts accounting policy for derivative financial instruments
accounted for as hedges, the Corporation includes any settlement of these risk
management activities in revenue. The following summarizes the impact these risk
management activities had on revenue:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED) 2005 2004 2005 2004
- -----------------------------------------------------------------------------------------------------------
Decrease to Revenue $ 27,821 $ 39,682 $ 85,418 $ 84,305
- -----------------------------------------------------------------------------------------------------------
23
(b) Fair Value Accounting
During the three months ended September 30, 2005, the Corporation purchased put
options at strike prices ranging from US$50.00 to US$55.00 per barrel, averaging
US$52.42 per barrel for the three year period beginning January 1, 2007. The
premiums for the purchased put options were partially offset through the sale of
call options at strike prices ranging from US$90.00 to US$95.00 per barrel,
averaging US$92.41 per barrel for the three year period beginning January 1,
2007, resulting in a net premium liability. Payment of the net premium liability
is deferred until the settlement of the option contracts between 2007 to 2009.
As at September 30, 2005, the Corporation's outstanding put and call options are
as follows:
2007 2008 2009
- ---------------------------------------------------------------------------------------------------------
Barrels Per Day
Put Options Purchased 20,000 20,000 20,000
Call Options Sold 10,000 15,000 15,000
US$ Per Barrel
Average Put Strike Price US$52.50 US$54.25 US$50.50
Average Call Strike Price US$92.50 US$94.25 US$90.50
- ---------------------------------------------------------------------------------------------------------
The fair value of the option contracts were recognized on the consolidated
balance sheet on the dates they were entered into. During the three and nine
month period ended September 30, 2005, the Corporation recognized an unrealized
gain of $1.7 million on the Risk Management Asset, marking it to the fair value
at the end of the period (September 30, 2004 - nil). The counterparties to these
put and call options have investment grade credit ratings, thereby partially
mitigating the credit risk associated with these financial instruments. The
following table reconciles the movement in the fair value of these option
contracts that have not been designated as hedges:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------
Risk Management Asset - Beginning of Period $ -- $ -- $ -- $ --
Net Premium 84,976 -- 84,976 --
Increase in Fair Value 1,697 -- 1,697 --
- -------------------------------------------------------------------------------------------------------------
RISK MANAGEMENT ASSET - END OF PERIOD $ 86,673 $ -- $ 86,673 $ --
- -------------------------------------------------------------------------------------------------------------
14. CHANGES IN NON-CASH WORKING CAPITAL
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
(UNAUDITED) 2005 2004 2005 2004
- -------------------------------------------------------------------------------------------------------------
Source (Use):
Operating Activities
Accounts Receivable $ 5,336 $ (9,624) $(21,379) $(18,065)
Inventory (2,810) (770) (11,581) (8,482)
Prepaid Expense 4,134 3,212 1,278 5,137
Accounts Payable and Accrued Liabilities 18,695 25,184 13,649 33,462
- -------------------------------------------------------------------------------------------------------------
$ 25,355 $ 18,002 $(18,033) $ 12,052
- -------------------------------------------------------------------------------------------------------------
Investing Activities
Accounts Receivable $ 19,380 $ -- $ -- $ 614
Accounts Payable and Accrued Liabilities 5,108 3,801 6,054 (1,348)
- -------------------------------------------------------------------------------------------------------------
$ 24,488 $ 3,801 $ 6,054 $ (734)
- -------------------------------------------------------------------------------------------------------------
24
15. SUBSEQUENT EVENT
Subsequent to September 30, 2005, the Corporation amended certain terms
contained in its Revolving Credit Facility. The first term that was amended was
the 364 day revolving feature with a two year term-out for non-revolving
allocations, which was amended to a three year revolving maturity, extendible
annually at the lending institutions' discretion, with a first maturity of
October 31, 2008. The second term that was amended was the margins associated
with the lender's prime lending rate, and the banker's acceptance rate or the
Libor rate. Initially, these margins were 100 to 200 basis points and, after the
amendment, these margins are nil to 225 basis points. There were no further
changes to the financial covenants or any other terms associated with the
Revolving Credit Facility.
25