EXHIBIT 99.2
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CONSOLIDATED FINANCIAL STATEMENTS
MANAGEMENT'S REPORT
The Management of Advantage Energy Income Fund (the "Fund") is responsible for
the preparation and presentation of the consolidated financial statements
together with all operational and other financial information contained in the
annual report. The financial statements have been prepared by Management in
accordance with Canadian generally accepted accounting principles and utilize
the best estimates and careful judgments of Management, where appropriate.
Operational and 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 controls designed
to provide reasonable assurance that all transactions are accurately and
reliably recorded, that the consolidated financial statements accurately
report the Fund's operating and financial results within acceptable limits of
materiality, that all other operational and financial information presented is
accurate, and that the Fund's assets are properly 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 is
responsible for meeting regularly with Management, the external auditors, and
the internal auditor to discuss internal controls over financial reporting
processes, auditing matters and various aspects of financial reporting. The
Audit Committee reviewed the consolidated financial statements with Management
and the external auditors, and recommended approval to the Board of Directors.
The Board of Directors has approved these consolidated financial statements.
KPMG LLP, an independent firm of Chartered Accountants, appointed by the
Unitholders as the external auditor of the Fund, has audited the consolidated
financial statements in accordance with Canadian generally accepted auditing
standards. KPMG LLP have unlimited and unrestricted access to the Audit
Committee.
Kelly I. Drader Peter A. Hanrahan
President & CEO VP Finance & CFO
March 7, 2006
AUDITORS' REPORT
To the Unitholders of Advantage Energy Income Fund
We have audited the consolidated balance sheets of Advantage Energy Income
Fund as at December 31, 2005 and 2004 and the consolidated statements of
income and accumulated income and cash flows for the years then ended. These
financial statements are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these 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 consolidated financial statements present fairly, in all
material respects, the financial position of the Fund as at December 31, 2005
and 2004 and the results of its operations and its cash flows for the years
then ended in accordance with Canadian generally accepted accounting
principles.
Chartered Accountants
Calgary, Canada
March 7, 2006
Advantage Energy Income Fund - 1
CONSOLIDATED BALANCE SHEETS
(thousands of dollars) DECEMBER 31, 2005 DECEMBER 31, 2004
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(restated - note 2)
ASSETS
Current assets
Accounts receivable $ 51,788 $ 41,909
Prepaid expenses and deposits 7,791 7,052
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59,579 48,961
Fixed assets (note 4)
Property and equipment 1,295,235 1,190,552
Accumulated depletion and depreciation (387,440) (253,506)
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907,795 937,046
Goodwill (note 3) 45,473 47,244
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$ 1,012,847 $ 1,033,251
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LIABILITIES
Current liabilities
Accounts payable and accrued liabilities (note 13) $ 76,371 $ 91,165
Cash distributions payable to Unitholders 14,462 12,419
Current portion of capital lease obligations (note 5) 358 1,785
Hedging liability - 214
Bank indebtedness (note 6) - 267,054
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91,191 372,637
Capital lease obligations (note 5) 1,346 7,606
Bank indebtedness (note 6) 252,476 -
Convertible debentures (notes 2 and 7) 126,081 136,433
Asset retirement obligations (note 8) 21,263 17,503
Future income taxes (note 11) 99,026 112,266
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591,383 646,445
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NON-CONTROLLING INTEREST
Exchangeable shares (note 9) 2,369 30,842
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UNITHOLDERS' EQUITY
Unitholders' capital (note 10) 681,574 515,544
Convertible debentures equity component (notes 2 and 7) 6,159 6,764
Contributed surplus (note 10) 1,036 1,036
Accumulated income 177,709 102,637
Accumulated cash distributions (447,383) (270,017)
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419,095 355,964
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$ 1,012,847 $ 1,033,251
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COMMITMENTS (NOTE 14)
see accompanying Notes to Consolidated Financial Statements
On behalf of the Board of Directors of Advantage Oil & Gas Limited:
Rodger A. Tourigny, Director Kelly I. Drader, Director
Advantage Energy Income Fund - 2
CONSOLIDATED STATEMENTS OF INCOME AND ACCUMULATED INCOME
YEAR ENDED YEAR ENDED
(thousands of dollars, except for per Unit amounts) DECEMBER 31, 2005 DECEMBER 31, 2004
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(restated - note 2)
REVENUE
Petroleum and natural gas $ 376,572 $ 241,481
Unrealized hedging gain (loss) 214 (214)
Royalties, net of Alberta Royalty Credit (74,290) (47,828)
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302,496 193,439
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EXPENSES
Operating 57,941 38,808
General and administrative 5,452 3,871
Unit-based compensation (note 10) - 1,036
Management fee (note 13) 3,665 2,323
Performance incentive (note 13) 10,544 21,632
Interest 10,275 6,407
Interest and accretion on convertible debentures 13,392 10,425
Depletion, depreciation and accretion 135,096 99,277
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236,365 183,779
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Income before taxes and non-controlling interest 66,131 9,660
Future income tax reduction (note 11) (11,371) (16,381)
Income and capital taxes (note 11) 2,198 2,003
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(9,173) (14,378)
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Net income before non-controlling interest 75,304 24,038
Non-controlling interest (note 9) 232 -
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NET INCOME 75,072 24,038
Accumulated income, beginning of year as previously reported 93,451 73,137
Effect of change in accounting policies (note 2) 9,186 5,462
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Accumulated income, beginning of year as restated 102,637 78,599
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ACCUMULATED INCOME, END OF YEAR $ 177,709 $ 102,637
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Net income per Trust Unit (note 10)
Basic $ 1.33 $ 0.59
Diluted $ 1.32 $ 0.58
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see accompanying Notes to Consolidated Financial Statements
Advantage Energy Income Fund - 3
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED YEAR ENDED
(thousands of dollars) DECEMBER 31, 2005 DECEMBER 31, 2004
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(restated - note 2)
OPERATING ACTIVITIES
Net income $ 75,072 $ 24,038
Add (deduct) items not requiring cash:
Unit-based compensation - 1,036
Non-cash performance incentive 10,544 16,570
Future income taxes (11,371) (16,381)
Unrealized hedging loss (gain) (214) 214
Accretion on convertible debentures 2,182 1,724
Depletion, depreciation and accretion 135,096 99,277
Non-controlling interest 232 -
Expenditures on asset retirement (2,025) (673)
Changes in non-cash working capital (22,910) (480)
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Cash provided by operating activities 186,606 125,325
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FINANCING ACTIVITIES
Units issued, net of costs (note 10) 107,616 62,465
Convertible debentures issued, net of costs (note 7) - 119,552
Increase (decrease) in bank indebtedness (14,578) 119,500
Reduction of capital lease obligations (7,687) (321)
Cash distributions to Unitholders (175,323) (113,681)
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Cash provided by (used in) financing activities (89,972) 187,515
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INVESTING ACTIVITIES
Expenditures on property and equipment (103,229) (107,893)
Property acquisitions (210) (180,645)
Property dispositions 3,379 6,539
Acquisition of Defiant Energy Corporation (note 3) (98) (31,254)
Changes in non-cash working capital 3,524 413
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Cash used in investing activities (96,634) (312,840)
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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 $ 23,358 $ 13,915
Taxes paid $ 2,605 $ 1,314
see accompanying Notes to Consolidated Financial Statements
Advantage Energy Income Fund - 4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
All tabular amounts in thousands except for Units and per Unit amounts
1. BUSINESS AND STRUCTURE OF THE FUND
Advantage Energy Income Fund ("Advantage" or the "Fund") was formed on
May 23, 2001 as a result of a plan of arrangement. For Canadian tax
purposes, Advantage is an open-ended unincorporated mutual fund trust
created under the laws of the Province of Alberta pursuant to a Trust
Indenture originally dated April 17, 2001, and as occasionally amended,
between Advantage Oil & Gas Ltd. ("AOG") and Computershare Trust Company
of Canada, as trustee. The Fund commenced operations on May 24, 2001. The
beneficiaries of the Fund are the holders of the Trust Units (the
"Unitholders").
The principal undertaking of the Fund is to indirectly acquire and hold
interests in petroleum and natural gas properties and assets related
thereto. The business of the Fund is carried on by its subsidiary, AOG,
which is primarily owned by the Fund with a small residual interest,
represented by the Exchangeable Share ownership held by other parties
(see note 9). The Fund'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"). The Fund's strategy, through AOG, is
to minimize exposure to exploration risk while focusing on growth through
acquisition and development of producing crude oil and natural gas
properties.
The purpose of the Fund is to distribute available cash flow to
Unitholders on a monthly basis in accordance with the terms of the Trust
Indenture. The Fund's available cash flow includes principal repayments
and interest income earned from the AOG Notes, royalty income earned from
the AOG Royalty, and any dividends declared on the common shares of AOG
less any expenses of the Fund including interest on convertible
debentures. Cash received on the AOG Notes, AOG Royalty and common shares
of AOG result in the effective transfer of the economic interest in the
properties of AOG to the Fund. 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 extent of cash
distributions from AOG to the Fund are determined by Management and the
Board of Directors and are based on the cash available after retaining a
portion to meet expenditure requirements. The distribution policy is
closely monitored considering forecasted cash flows, optimal debt levels,
capital spending activity, working capital requirements, and other
potential cash expenditures. Cash inflows are predominantly dependent on
the current level of production and the prevailing commodity prices. It
is the Funds long-term objective to provide stable and sustainable cash
distributions to the Unitholders.
The Fund is actively managed by Advantage Investment Management Ltd. (the
"Manager"). As compensation, the Manager receives management fees
pursuant to a Management Agreement as approved by the Board of Directors
(see note 13).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Management of the Fund prepares its consolidated financial statements
in accordance with Canadian generally accepted accounting principles and
all amounts are stated in Canadian dollars. The preparation of
consolidated financial statements requires Management to make estimates
and assumptions that effect the reported amount of assets, liabilities
and equity 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 AND JOINT OPERATIONS
These consolidated financial statements include the accounts of the Fund
and all subsidiaries, including AOG. All intercompany balances and
transactions have been eliminated.
The Fund conducts exploration and production activities jointly with
other participants. The accounts of the Fund reflect its proportionate
interest in such joint operations.
Advantage Energy Income Fund - 5
(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 ("CICA") 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, production
facilities, asset retirement costs, 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
and depreciation of 20% or more.
Depletion of petroleum and natural gas properties and depreciation of
lease, well equipment and production facilities 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 and depreciation calculation, proved 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 thousand
cubic feet 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 proved undeveloped reserves. Costs of acquiring
and evaluating unproved properties are excluded from depletion
calculations until it is determined whether or not proved 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 net 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 net 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 net cash flows are
estimated using expected future product prices and costs and are
discounted using a risk-free interest rate.
(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) GOODWILL
Goodwill is the excess purchase price of a business over the fair value
of identifiable assets and liabilities acquired. Goodwill is stated at
cost less impairment and is not amortized. Goodwill impairment is
assessed at year-end, or as economic events dictate, by comparing the
fair value of the reporting unit (the Fund) to its carrying value,
including goodwill. If the fair value of the Fund is less than its
carrying value, a goodwill impairment loss is recognized by allocating
the fair value of the Fund to the identifiable assets and liabilities as
if the Fund had been acquired in a business acquisition for a purchase
price equal to the fair value. The excess of the fair value of the Fund
over the values assigned to the identifiable assets and liabilities is
the implied fair value of the goodwill. Any excess of the carrying value
of the goodwill over the implied fair value is the impairment amount and
is charged to income in the period incurred. There has been no impairment
of the Fund's goodwill.
(d) CASH DISTRIBUTIONS
Cash distributions are calculated on an accrual basis and are paid to
Unitholders monthly.
(e) FINANCIAL INSTRUMENTS
The Fund occasionally uses various types of derivative 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. For the
unrealized portion of such contracts, Advantage utilizes the "fair value"
method of accounting. The
Advantage Energy Income Fund - 6
fair value is based on an estimate of the amounts that would have been
paid to or received from counterparties to settle these instruments given
future market prices and other relevant factors. This method requires the
fair value of the derivative financial instruments to be recorded at each
balance sheet date. There were no derivative financial instruments
outstanding at December 31, 2005.
Effective January 1, 2005, the Fund retroactively adopted the revised
accounting standard Section 3860 "Financial Instruments - Presentation
and Disclosure" as issued by the CICA. 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 Statements 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):
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2004 DECEMBER 31, 2003
- -------------------------------------------------------------------------------------------------
Current liabilities
Accounts payable and accrued liabilities $ 16,570 $ 19,592
Long-term liabilities
Convertible debentures $ 136,433 $ 91,372
Unitholders' equity
Convertible debentures $ (148,450) $ (99,984)
Convertible debentures equity component $ 6,764 $ 4,726
Unitholders' capital $ (20,503) $ (21,168)
Accumulated income $ 9,186 $ 5,462
YEAR ENDED YEAR ENDED
CONSOLIDATED STATEMENTS OF INCOME DECEMBER 31, 2004 DECEMBER 31, 2003
- -------------------------------------------------------------------------------------------------
Interest and accretion on convertible debentures $ 10,425 $ 5,521
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Net income $ (10,425) $ (5,521)
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Net income per Trust Unit
Basic $ (0.04) $ (0.03)
Diluted $ (0.05) $ (0.03)
(f) ASSET RETIREMENT OBLIGATIONS
The Fund follows 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 Fund's asset retirement
obligation is recorded in the period in which it is incurred, discounted to
its present value using the Fund'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 consistent with
the Fund's depletion and depreciation policy for petroleum and natural gas
properties and related equipment. 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.
Advantage Energy Income Fund - 7
(g) INCOME TAXES
The Fund is considered an open-ended unincorporated mutual fund 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) 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.
(i) UNIT-BASED COMPENSATION
The Fund has a unit-based compensation plan (the "Plan") for external
directors of the Fund, which is described in note 10. Advantage 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 Fund must account for compensation expense based on the "fair value"
of rights granted under its unit-based compensation 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) REVENUE RECOGNITION
Revenue associated with the sale of crude oil, natural gas and natural
gas liquids is recognized when the title and risks pass to the purchaser,
normally at the pipeline delivery point for natural gas and at the
wellhead for crude oil.
(k) PER TRUST UNIT AMOUNTS
Net income per Trust Unit is calculated using the weighted average number
of Trust Units outstanding during the year. Diluted net income per Trust
Unit is calculated using the "if-converted" method to determine the
dilutive effect of convertible debentures and exchangeable shares and the
"treasury stock" method for trust unit rights.
(l) MEASUREMENT UNCERTAINTY
The amounts recorded for depletion and depreciation of property and
equipment, the provision for asset retirement obligation costs and
related accretion expense, and impairment calculations for property and
equipment and goodwill are based on estimates. These estimates are
significant and include proved and probable reserves, future production
rates, future crude oil and natural gas prices, future costs, future
interest rates, relevant fair value assessments, 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 material.
Advantage Energy Income Fund - 8
(m) COMPARATIVE FIGURES
Certain comparative figures have been reclassified to conform to the
current year's presentation.
3. ACQUISITIONS
(a) DEFIANT ENERGY CORPORATION
On December 21, 2004 Advantage acquired all of the issued and outstanding
shares of Defiant Energy Corporation ("Defiant") for consideration of
$143.1 million. Defiant was a corporation engaged in the exploration for,
and the development, acquisition and production of, natural gas and crude
oil in western Canada. The acquisition was 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. Defiant was amalgamated with AOG on January 1, 2005. The
purchase price has been allocated as follows:
Net assets acquired and liabilities assumed: Consideration:
Property and equipment $ 232,750 Cash $ 34,000
Goodwill 18,557 3,666,286 Trust Units issued 77,982
Future income taxes (49,636) 1,450,030 Exchangeable Shares issued 30,842
Bank indebtedness (44,586) Acquisition costs incurred 264
------------
Capital lease obligations (7,347) $ 143,088
------------
Net working capital
(including cash of $4.1 million) (5,368)
Asset retirement obligations (1,282)
-----------
$ 143,088
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 has been revised in 2005 due to the finalization of
net working capital acquired, tax balances and certain cost estimates. As
a result, net working capital deficit increased $1.2 million, future
income tax liability decreased $1.9 million, goodwill decreased $1.8
million and acquisition costs decreased $1.1 million.
(b) 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, 2005, Advantage capitalized general
and administrative expenditures directly related to exploration and
development activities of $3,293,000 (2004 - $2,401,000).
Costs of $17,805,000 (2004 - $25,700,000) for unproved properties have
been excluded from the calculation of depletion expense, and future
development costs of $ 87,843,000 (2004 - $64,200,000) have been included
in costs subject to depletion.
The Fund performed a ceiling test calculation at December 31, 2005 to
assess the recoverable value of property and equipment. Based on the
calculation, the carrying amounts are recoverable as compared to the sum
of the undiscounted net cash flows expected from the production of proved
reserves based on the following benchmark prices:
WTI CRUDE OIL EXCHANGE RATE AECO GAS
YEAR ($US/BBL) ($US/$CDN) ($CDN/MMBTU)
- ------------------------------------------------------------------------------------------------
2006 $ 60.81 $ 0.85 $ 11.58
2007 $ 61.61 $ 0.85 $ 10.84
2008 $ 54.60 $ 0.85 $ 8.95
2009 $ 50.19 $ 0.85 $ 7.87
2010 $ 47.76 $ 0.85 $ 7.57
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Percentage increase each year after 2010 1.5% - 1.5%
- ------------------------------------------------------------------------------------------------
Advantage Energy Income Fund - 9
Benchmark prices are adjusted for a variety of factors such as quality
differentials to determine the expected price to be realized by the Fund
when performing the ceiling test calculation.
5. CAPITAL LEASE OBLIGATIONS
The Fund has capital leases on a variety of property and equipment.
Future minimum lease payments at December 31, 2005 consist of the
following:
2006 $ 443
2007 1,364
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1,807
Less amounts representing interest (103)
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1,704
Current portion (358)
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$ 1,346
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6. BANK INDEBTEDNESS
Advantage has a credit facility agreement with a syndicate of Canadian
chartered banks which provides for a $345 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 Fund's option subject to certain basis point or stamping fee
adjustments ranging from 0.85% to 1.4% depending on the Fund'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 Fund 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 2006. 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 at the option of the
syndicate. If not extended, the revolving credit facility is converted to
a two year term facility with the first payment due one year and one day
after commencement of the term. The credit facilities contain standard
commercial covenants for facilities of this nature, and distributions by
AOG to the Fund (and effectively by the Fund to Unitholders) are
subordinated to the repayment of any amounts owing under the credit
facilities. Distributions to Unitholders are not permitted if the Fund is
in default of such credit facilities or if the amount of the Fund'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, 2005, the
effective interest rate on the outstanding amounts under the facility was
approximately 4.4%.
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 Trust Unit plus
accrued and unpaid interest. Based on revised accounting standards (see
note 2), 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 and issuance costs 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
- --------------------------------------------------------------------------------------------------------------------------
Advantage Energy Income Fund - 10
The convertible debentures are redeemable prior to their maturity dates,
at the option of the Fund, upon providing 30 to 60 days advance
notification. The redemption prices for the various debentures, plus
accrued and unpaid interest, is dependent on the redemption periods and
are as follows:
CONVERTIBLE REDEMPTION
DEBENTURE REDEMPTION PERIODS PRICE
- ----------------------------------------------------------------------------------------------
10.00% After November 1, 2005 and on or before November 1, 2006 $1,050
After November 1, 2006 and before November 1, 2007 $1,025
- ----------------------------------------------------------------------------------------------
9.00% After August 1, 2006 and on or before August 1, 2007 $1,050
After August 1, 2007 and before August 1, 2008 $1,025
- ----------------------------------------------------------------------------------------------
8.25% After February 1, 2007 and on or before February 1, 2008 $1,050
After February 1, 2008 and before February 1, 2009 $1,025
- ----------------------------------------------------------------------------------------------
7.75% After December 1, 2007 and on or before December 1, 2008 $1,050
After December 1, 2008 and on or before December 1, 2009 $1,025
After December 1, 2009 and before December 1, 2011 $1,000
- ----------------------------------------------------------------------------------------------
7.50% After October 1, 2007 and on or before October 1, 2008 $1,050
After October 1, 2008 and before October 1, 2009 $1,025
- ----------------------------------------------------------------------------------------------
The balance of debentures outstanding at December 31, 2005 and changes in
the liability and equity components during the years ended December 31,
2005 and 2004 are as follows:
10.00% 9.00% 8.25% 7.75% 7.50% TOTAL
- -------------------------------------------------------------------------------------------------------------------------
Debentures outstanding $ 2,534 $ 7,619 $ 8,646 $ 49,710 $ 66,602 $ 135,111
- -------------------------------------------------------------------------------------------------------------------------
Liability component:
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
Accretion of discount 55 168 198 616 1,145 2,182
Converted to Trust Units (1,525) (3,297) (4,285) (266) (3,161) (12,534)
- -------------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2005 $ 2,453 $ 7,259 $ 8,150 $ 45,898 $ 62,321 $ 126,081
- -------------------------------------------------------------------------------------------------------------------------
Equity component:
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
Converted to Trust Units (63) (149) (234) (14) (145) (605)
- -------------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2005 $ 100 $ 323 $ 441 $ 2,430 $ 2,865 $ 6,159
- -------------------------------------------------------------------------------------------------------------------------
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, 2005, $13,339,000 (2004 - $76,534,000)
debentures were converted resulting in the issuance of 783,870 Trust
Units (2004 - 4,637,187 Trust Units).
8. ASSET RETIREMENT OBLIGATIONS
The Fund's asset retirement obligations result from net ownership
interests in petroleum and natural gas assets including well sites,
gathering systems and processing facilities. The Fund estimates the total
undiscounted and inflated amount of cash flows
Advantage Energy Income Fund - 11
required to settle its asset retirement obligations is approximately $94
million which will be incurred between 2006 to 2056. 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, 2005 DECEMBER 31, 2004
- ------------------------------------------------------------------------------------------------
Balance, beginning of year $ 17,503 $ 13,892
Accretion expense 1,162 926
Liabilities incurred 4,623 3,358
Liabilities settled (2,025) (673)
- ------------------------------------------------------------------------------------------------
Balance, end of year $ 21,263 $ 17,503
- ------------------------------------------------------------------------------------------------
9. EXCHANGEABLE SHARES
NUMBER OF SHARES AMOUNT
- ------------------------------------------------------------------------------------------------
Issued for acquisition of Defiant (note 3) 1,450,030 $ 30,842
- ------------------------------------------------------------------------------------------------
Balance at December 31, 2004 1,450,030 30,842
Converted to Trust Units (1,345,358) (28,705)
Non-controlling interest in net income - 232
- ------------------------------------------------------------------------------------------------
Balance at December 31, 2005 104,672 $ 2,369
- ------------------------------------------------------------------------------------------------
Trust Units issuable 122,413
- ------------------------------------------------------------------------------------------------
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.
The value of the Exchangeable Shares issued 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. 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
1.16949 at December 31, 2005 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. It is not
anticipated that dividends will be declared or paid on the Exchangeable
Shares. 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 Fund 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.
Advantage Energy Income Fund - 12
10. UNITHOLDERS' EQUITY
(a) UNITHOLDERS' CAPITAL
(i) AUTHORIZED
Unlimited number of voting Trust Units
(ii) ISSUED
NUMBER OF UNITS AMOUNT
- --------------------------------------------------------------------------------------------------------
(restated - note 2)
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 (note 3) 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
2004 non-cash performance incentive 763,371 16,570
Issued for cash, net of costs 5,250,000 107,616
Issued on conversion of debentures 783,870 13,139
Issued on conversion of exchangeable shares 1,374,300 28,705
- --------------------------------------------------------------------------------------------------------
Balance at December 31, 2005 57,846,324 $ 681,574
- --------------------------------------------------------------------------------------------------------
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 for net proceeds of $62.2 million (net of Underwriters'
fees and other issue costs of $3.6 million) 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 3).
On January 19, 2005, Advantage issued 763,371 Trust Units to partially
satisfy the obligation related to the 2004 year end performance incentive
fee.
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
were used to pay down debt incurred in the acquisition of Defiant, for
2005 capital expenditures and for general corporate purposes.
On January 20, 2006, Advantage issued 475,263 Trust Units to satisfy the
obligation related to the 2005 year end performance incentive fee.
(b) 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 with an aggregate of 400,000 rights granted. 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 paid by the Fund to Unitholders.
Advantage Energy Income Fund - 13
SERIES A SERIES B
NUMBER PRICE NUMBER PRICE
- ----------------------------------------------------------------------------------------------
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
Reduction of exercise price - (3.12) - (3.12)
- ----------------------------------------------------------------------------------------------
Balance at December 31, 2005 85,000 $ 1.93 225,000 $ 13.63
- ----------------------------------------------------------------------------------------------
Expiration date August 16, 2006 June 17, 2008
- ----------------------------------------------------------------------------------------------
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 and
recorded a non-cash unit-based compensation expense of $1.0 million to
recognize the fair value of the rights granted. The fair value of the
Trust Unit rights was determined using the Black-Scholes-Merton model
which included the following assumptions: 4% risk-free interest rate,
approximate 4 year expected life, 15% expected volatility, and 15%
expected dividend yield. 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 2005 and there was no
compensation expense recorded.
The Series A Trust Unit rights were issued in 2002 and the Fund was
unable to determine the fair value for the rights granted under the Plan
at that time. Several essential factors required to value such rights
include expected future exercise price, distributions, exercise
timeframe, volatility and risk-free interest rates. In determining these
assumptions, both historical data and future expectations are considered.
However, when the Series A Trust Unit rights were originally granted,
Advantage had only been established during the prior year and there was
little historical information available that may suggest future
expectations concerning such assumptions. Therefore, it was concluded
that a fair value determination at that time was not possible. The Fund
has disclosed pro forma results as if the Fund 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.
YEAR ENDED YEAR ENDED
PRO FORMA RESULTS DECEMBER 31, 2005 DECEMBER 31, 2004
- ---------------------------------------------------------------------------------------------
(restated - note 2)
Net income, as reported $ 75,072 $ 24,038
Less compensation expense
for rights issued in 2002 300 701
- ---------------------------------------------------------------------------------------------
Pro forma net income $ 74,772 $ 23,337
- ---------------------------------------------------------------------------------------------
Net income per Trust Unit, as reported
Basic $ 1.33 $ 0.59
Diluted $ 1.32 $ 0.58
- ---------------------------------------------------------------------------------------------
Net income per Trust Unit, pro forma
Basic $ 1.32 $ 0.57
Diluted $ 1.31 $ 0.57
- ---------------------------------------------------------------------------------------------
Advantage Energy Income Fund - 14
(c) NET INCOME PER TRUST UNIT
The calculation of basic and diluted net income per Trust Unit are
derived from both income available to Unitholders and weighted average
Trust Units outstanding calculated as follows:
YEAR ENDED YEAR ENDED
DECEMBER 31, 2005 DECEMBER 31, 2004
- -------------------------------------------------------------------------------------------------
Income available to Unitholders
Basic $ 75,072 $ 24,038
Trust Units Rights Incentive Plan - Series A - -
Trust Units Rights Incentive Plan - Series B - -
Exchangeable shares 232 -
- -------------------------------------------------------------------------------------------------
Diluted $ 75,304 $ 24,038
- -------------------------------------------------------------------------------------------------
Weighted average Trust Units outstanding
Basic 56,593,303 41,008,308
Trust Units Rights Incentive Plan - Series A 76,698 72,287
Trust Units Rights Incentive Plan - Series B 69,800 19,473
Exchangeable shares 298,341 43,580
- -------------------------------------------------------------------------------------------------
Diluted 57,038,142 41,143,648
- -------------------------------------------------------------------------------------------------
The calculation of diluted net income per Trust Unit excludes all series
of convertible debentures as the impact would be anti-dilutive. Total
weighted average Trust Units issuable in exchange for the convertible
debentures and excluded from the diluted net income per Trust Unit
calculation for the year ended December 31, 2005 was 7,288,894 (2004 -
5,970,897). As at December 31, 2005, the total convertible debentures
outstanding were immediately convertible to 6,818,833 Trust Units
(December 31, 2004 - 7,602,487).
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, Trust Unit issue costs, and
interest on convertible debentures. Given that taxable income of the Fund
is allocated to the Unitholders, no provision for current income taxes
relating to the Fund is included in these financial statements. As at
December 31, 2005, the Fund had unrecognized deductible temporary
differences of $19.6 million.
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:
YEAR ENDED YEAR ENDED
DECEMBER 31, 2005 DECEMBER 31, 2004
- --------------------------------------------------------------------------------------------------------
(restated - note 2)
Income before taxes $ 66,131 $ 9,660
- --------------------------------------------------------------------------------------------------------
Expected income tax expense at statutory rates 25,080 3,269
Increase (decrease) in income taxes resulting from:
Non-deductible Crown charges 12,406 7,537
Resource allowance (15,390) (8,766)
Amounts included in trust income and other (33,467) (18,421)
- --------------------------------------------------------------------------------------------------------
Future income tax reduction (11,371) (16,381)
Income and capital taxes 2,198 2,003
- --------------------------------------------------------------------------------------------------------
$ (9,173) $ (14,378)
- --------------------------------------------------------------------------------------------------------
Advantage Energy Income Fund - 15
The components of the future income tax liability at December 31 are as
follows:
2005 2004
- ------------------------------------------------------------------------------------
Property and equipment in excess of tax basis $ 119,065 $ 127,130
Asset retirement obligation (7,230) (6,126)
Non-capital tax loss carry forward (11,228) (7,356)
Other (1,581) (1,382)
- ------------------------------------------------------------------------------------
Future income tax liability $ 99,026 $ 112,266
- ------------------------------------------------------------------------------------
AOG has non-capital tax loss carry forward of approximately $33.0 million
of which $0.3 million expires in 2007, $20.7 million in 2009, and $12.0
million in 2014.
12. FINANCIAL INSTRUMENTS
Financial instruments of the Fund include accounts receivable, deposits,
accounts payable and accrued liabilities, cash distributions payable,
capital lease obligations, and bank indebtedness. As at December 31,
2005, there were no significant differences between the carrying amounts
reported on the balance sheet and the estimated fair values of these
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 and joint venture partners in the oil
and gas industry and are subject to normal industry credit risks. Credit
risk is mitigated by entering into sales contracts with only stable,
creditworthy parties and through frequent reviews of exposures to
individual entities. The carrying value of accounts receivable reflects
Management's assessment of the associated credit risks. The Fund is
further exposed to interest rate risk to the extent that bank debt is at
a floating rate of interest.
In addition, the Fund has outstanding convertible debenture obligations
that are financial liabilities. The convertible debentures have different
fixed terms and interest rates (see note 7) resulting in fair values that
will vary over time as market conditions change. As at December 31, 2005,
the estimated fair value of the total outstanding convertible debenture
obligation was $137.5 million.
13. MANAGEMENT FEE AND PERFORMANCE INCENTIVE FEE
The Manager receives both a management fee and a performance incentive
fee as compensation pursuant to a Management Agreement 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 are paid quarterly and $1.0 million was
payable at December 31, 2005 (December 31, 2004 - $0.7 million).
The Manager of the Fund is also entitled to earn an annual performance
incentive fee when the Fund's total annual return exceeds 8%. The total
annual return is 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, as defined in the Management Agreement. The 2005
opening and closing Unit prices were $21.71 and $22.19, respectively
(2004 opening and closing Unit prices were $17.83 and $21.71,
respectively). Cash distributions for the year amounted to $3.12 per
Trust Unit (2004 cash distributions were $2.82 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 fee.
The performance incentive fee payable at year end for 2005 was $10.5
million (2004 - $21.6 million). The Management Agreement provides an
option to the Manager to receive the performance incentive fee in
equivalent Trust Units. The Manager exercised the option and on January
20, 2006, the Fund issued 475,263 Advantage Trust Units at the closing
Unit price of $22.19 to satisfy the performance fee obligation. The
Manager does not receive any form of compensation in respect of
acquisition or divestiture activities nor is there any form of stock
option or bonus plan for the Manager or the employees of Advantage
outside of the management and performance fees. The management fees and
performance fees are shared amongst all management and employees.
Advantage Energy Income Fund - 16
14. LEASE 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:
2006 $ 1,430
2007 1,397
2008 572
- ------------------------------------------------------------
$ 3,399
- ------------------------------------------------------------
15. RECONCILIATION OF FINANCIAL STATEMENTS TO UNITED STATES GENERALLY
ACCEPTED ACCOUNTING PRINCIPLES
The consolidated financial statements of Advantage have been prepared in
accordance with accounting principles generally accepted in Canada
("Canadian GAAP"). Canadian GAAP, in most respects, conforms to generally
accepted accounting principles in the United States ("US GAAP"). Any
differences in accounting principles between Canadian GAAP and US GAAP,
as they apply to Advantage, are not material, except as described below.
All adjustments are measurement differences only and disclosure items are
not noted.
(a) UNIT-BASED COMPENSATION
Effective January 1, 2003, the Fund prospectively adopted amendments to
CICA 3870 "Stock-based Compensation and Other Stock-based Payments".
Under this amended standard, the Fund must account for compensation
expense based on the fair value of rights granted under its unit-based
compensation plan. Under US GAAP, the Fund similarly adopted SFAS 123
"Accounting for Stock-Based Compensation" and applied prospective
transitional provisions of SFAS 148 relative to grants after January 1,
2003. As a result, both Canadian GAAP and US GAAP are substantially
similar with regards to accounting for such stock-based compensation
arrangements and there are no accounting differences for grants after
January 1, 2003.
For grants prior to January 1, 2003, no compensation cost was recognized
at the grant date given that the options were issued at market value. As
options are subsequently exercised under the unit-based compensation
plan, the consideration received is recorded as unitholders' capital.
However, the Fund does calculate compensation expense based on the
intrinsic value of the rights which is disclosed in the notes to the
consolidated financial statements along with the associated impact on net
income and net income per Trust Unit. Intrinsic value is calculated as
the difference between the quoted market price and the exercise price.
Under US GAAP, as the Trust Units Rights Incentive Plan is a variable
compensation plan, grants prior to January 1, 2003 continue to be
accounted for in accordance with Accounting Principles Board ("APB")
Opinion No. 25, whereby compensation expense is actually recorded each
period-end using the intrinsic value methodology. This different
accounting treatment has resulted in additional unit-based compensation
expense for the Fund related to options granted during 2002.
(b) CONVERTIBLE DEBENTURES
The Fund applies CICA 3860 "Financial Instruments - Presentation and
Disclosure" in accounting for convertible debentures which results in
their classification as long-term liabilities. The convertible debentures
also have an embedded conversion feature which 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, net of issuance costs,
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 Statements of
Income.
Under US GAAP, the entire convertible debenture balance would be shown as
a long-term liability. The embedded conversion feature would not be
accounted for separately as a component of equity. Additionally, under US
GAAP, issuance costs are generally shown as a deferred charge rather than
netted from the convertible debenture balance. As a result of these US
GAAP differences, the convertible debenture balance in long-term
liabilities represents the actual maturity value of the outstanding
debentures. Issuance costs are shown separately as a deferred charge and
are amortized to interest expense over the term of the debenture. Given
that the convertible debentures are carried at maturity value, it is not
necessary to accrete the balance over the term of the debentures which
results in an expense reduction. Interest and accretion on convertible
debentures represents interest expense on the convertible debentures and
amortization of the associated deferred issuance costs.
Advantage Energy Income Fund - 17
(c) DEPLETION AND DEPRECIATION
For Canadian GAAP, 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, based on forecast
prices and costs.
US GAAP provides for a similar accounting methodology except that
estimated net proved petroleum and natural gas reserves are net of
royalties and based on constant prices and costs. Therefore, depletion
and depreciation under US GAAP will be different since changes to royalty
rates will impact both proved reserves and production and differences
between constant prices and costs as compared to forecast prices and
costs will impact proved reserve volumes. Additionally, differences in
depletion and depreciation will result in divergence of net book value
for Canadian GAAP and US GAAP from year-to-year and impact future
depletion and depreciation expense as well as the net book value utilized
for future ceiling test calculations.
(d) CEILING TEST
Under Canadian GAAP, petroleum and natural gas assets are evaluated each
reporting period to determine that the carrying amount 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 net 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 net
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. For Canadian GAAP purposes, Advantage has not
recognized an impairment loss since inception.
Under US GAAP, the carrying amounts of petroleum and natural gas assets,
net of deferred income taxes, shall not exceed an amount equal to the sum
of the present value of estimated net future after-tax cash flows of
proved reserves (at current prices and costs as of the balance sheet
date) computed using a discount factor of ten percent plus the lower of
cost or estimated fair value of unproved properties. Any excess is
charged to expense as an impairment loss. Under US GAAP, Advantage
recognized an impairment loss of $49.5 million in 2001, $28.3 million net
of tax. The impairment loss decreased net book value of property and
equipment which reduced depletion and depreciation expense subsequently
recorded as well as future ceiling test calculations.
(e) FUTURE INCOME TAX
The future income tax accounting standard under Canadian GAAP is
substantially similar to the deferred income tax approach as required by
US GAAP. Pursuant to Canadian GAAP, substantively enacted tax rates are
used to calculate future income tax, whereas US GAAP applies enacted tax
rates. However, there were no tax rate differences for the years ended
December 31, 2005 and 2004. The differences between Canadian GAAP and US
GAAP relate to future income tax impact on GAAP differences for depletion
and depreciation, and impairments from ceiling test calculations.
(f) NON-CONTROLLING INTEREST
The Fund owns a significant majority of AOG and consolidates the entire
entity. As a result, non-controlling interest expense is presented which
represents the residual ownership interests. Accounting standards for the
determination of non-controlling interest under Canadian GAAP is
substantially similar as compared to US GAAP. The differences between
Canadian GAAP and US GAAP non-controlling interest expense relates
entirely to the non-controlling interests share of all other GAAP
difference that have impacted net income.
(g) UNITHOLDERS' EQUITY
Unitholders' equity of Advantage consists primarily of Trust Units. The
Trust Units are redeemable at any time on demand by the holders, which is
required for the Fund to retain its Canadian mutual fund trust status.
The holders are entitled to receive a price per Trust Unit equal to the
lesser of: (i) 85% of the simple average of the closing market prices of
the Trust Units, on the principal market on which the Trust Units are
quoted for trading, during the 10 trading-day period commencing
immediately after the date on which the Trust Units are surrendered for
redemption; and (ii) the closing market price on the principal market on
which the Trust Units are quoted for trading on the redemption date. For
Canadian GAAP purposes, the Trust Units are considered permanent equity
and are presented as a component of unitholders' equity.
Advantage Energy Income Fund - 18
Under US GAAP, it is required that equity with a redemption feature be
presented as temporary equity between the liability and equity sections of
the balance sheet. The temporary equity is shown at an amount equal to the
redemption value based on the terms of the Trust Units. The same accounting
treatment would be applicable to the Exchangeable Shares. Changes in the
redemption value from year-to-year are charged to deficit. All components
of unitholders' equity related to Trust Units and Exchangeable Shares are
eliminated. When calculating net income per Trust Unit, increases in the
redemption value during a period results in a reduction of net income
available to Unitholders while decreases in the redemption value increases
net income available to Unitholders. For the years ended December 31, 2005
and 2004, net income available to Unitholders was increased by $3.7 million
and reduced by $104.4 million corresponding to changes in the Trust Units
redemption value for the respective periods.
(h) COMPREHENSIVE INCOME
US GAAP requires the presentation of net income and comprehensive income.
Comprehensive income includes net income plus other comprehensive income
items as specifically identified by US GAAP. The Fund currently has no
financial items that qualify as other comprehensive income, and
therefore, net income and comprehensive income are equivalent.
(i) STATEMENTS OF CASH FLOW
The differences between Canadian GAAP and US GAAP have not resulted in
any significant variances concerning the statements of cash flows as
reported.
(j) RECENT US ACCOUNTING PRONOUNCEMENTS ISSUED BUT NOT IMPLEMENTED
SFAS 123R SHARE-BASED PAYMENT: SFAS 123R was issued December 2004 as a
revision to SFAS 123. This statement establishes accounting standards for
transactions in which an entity exchanges equity instruments for goods or
services. The standard also addresses transactions in which an entity
incurs liabilities in exchange for goods or services that are based on
the fair value of the entity's equity instruments or that may be settled
by the issuance of equity instruments. This statement focuses primarily
on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. The implementation
effective date for this standard is as of the beginning of the first
interim or annual reporting period that begins after June 15, 2005. The
Fund has not yet assessed the full impact, if any, of this standard on
the consolidated financial statements.
SFAS 153 EXCHANGES OF NONMONETARY ASSETS: This statement amends APB
Opinion No. 29, Accounting for Nonmonetary Transactions. APB Opinion No.
29 is based on the principle that exchanges of nonmonetary assets should
be measured based on the fair value of the assets exchanged with certain
exceptions to that basic principle. This statement eliminates the
exception for nonmonetary exchanges of similar productive assets and
replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. A nonmonetary exchange has
commercial substance if the future cash flows of the entity are expected
to change significantly as a result of the exchange. The implementation
effective date for this standard is for nonmonetary exchanges occurring
in fiscal periods beginning after June 15, 2005. The Fund does not expect
this statement to have a material impact on the consolidated financial
statements.
SFAS 154 ACCOUNTING CHANGES AND ERROR CORRECTIONS: This statement applies
to all voluntary changes in accounting principle and changes required by
an accounting pronouncement in the unusual instance that the
pronouncement does not include specific transition provisions. When a
pronouncement includes specific transition provisions, those provisions
should be followed. This statement replaces prior accounting standards
that required most voluntary changes in accounting principle be
recognized by including in net income of the period of the change the
cumulative effect of changing to the new accounting principle. This
statement requires retrospective application to prior periods' financial
statements of changes in accounting principle (with certain exceptions)
as if that principle had always been used or as the adjustment of
previously issued financial statements to reflect a change in the
reporting entity. When it is impracticable to determine the period
specific effects of an accounting change on one or more individual prior
periods presented, this statement requires that the new accounting
principle be applied to the balances of assets and liabilities as of the
beginning of the earliest period for which retrospective application is
practicable and that a corresponding adjustment be made to the opening
balance of retained earnings (or other appropriate components of equity
or net assets in the statement of financial position) for that period
rather than being reported in an income statement. When it is
impracticable to determine the cumulative effect of applying a change in
accounting principle to all prior periods, this statement requires that
the new accounting principle be applied as if it were adopted
prospectively from the earliest date practicable. The implementation
effective date for this standard is for accounting changes and
corrections of errors made in fiscal years beginning after December 15,
2005. The impact of this standard on the consolidated financial
statements will be dependent on the nature and extent of subsequent new
and revised accounting pronouncements.
Advantage Energy Income Fund - 19
The application of US GAAP would have the following effect on net income
as reported:
CONSOLIDATED STATEMENTS OF INCOME YEAR ENDED YEAR ENDED
(thousands of Canadian dollars, except for per Unit amounts) DECEMBER 31, 2005 DECEMBER 31, 2004
- ---------------------------------------------------------------------------------------------------------------------
(restated - note 2)
Net income - Canadian GAAP, as reported $ 75,072 $ 24,038
US GAAP Adjustments:
Unit-based compensation - note 15(a) (301) (641)
Interest and accretion on convertible debentures - note 15(b) 1,095 863
Depletion, depreciation and accretion - notes 15(c) and (d) 9,886 9,691
Future income tax reduction - note 15(e) (3,652) (3,460)
Non-controlling interest - note 15(f) (22) -
- ---------------------------------------------------------------------------------------------------------------------
Net income and comprehensive income - US GAAP $ 82,078 $ 30,491
- ---------------------------------------------------------------------------------------------------------------------
Net income per Trust Unit before change in redemption value of Trust Units
- US GAAP:
Basic $ 1.45 $ 0.74
Diluted $ 1.44 $ 0.74
Net income per Trust Unit - US GAAP:
Basic $ 1.52 $ (1.80)
Diluted $ 1.51 $ (1.80)
- ---------------------------------------------------------------------------------------------------------------------
The application of US GAAP would have the following effect on the balance
sheets as reported:
DECEMBER 31, 2005 DECEMBER 31, 2004
----------------- -----------------
CONSOLIDATED BALANCE SHEETS CANADIAN US CANADIAN US
(thousands of Canadian dollars) GAAP GAAP GAAP GAAP
- ------------------------------------------------------------------------------------------------------------------
ASSETS
Deferred charge - note 15(b) $ - $ 4,368 $ - $ 5,848
Property and equipment, net 907,795 888,936 937,046 908,301
- notes 15(c) and (d)
LIABILITIES AND UNITHOLDERS' EQUITY
Convertible debentures - note 15(b) $126,081 $ 135,111 $ 136,433 $ 148,450
Future income taxes - note 15(e) 99,026 92,613 112,266 102,201
Temporary equity - note 15(g) - 1,067,204 - 933,539
Deficit - note 15(g) - (665,627) - (574,060)
Unitholders' capital - notes 15 (a) and (g) 681,574 - 515,544 -
Exchangeable shares - note 15(g) 2,369 - 30,842 -
Convertible debentures equity component 6,159 - 6,674 -
- note 15(b)
Contributed surplus - note 15(a) 1,036 2,779 1,036 2,478
Accumulated income - note 15(g) 177,709 - 102,637 -
Accumulated cash distributions - note 15(g) (447,383) - (270,017) -
Advantage Energy Income Fund - 20