EXHIBIT 99.3
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MANAGEMENT'S DISCUSSION & ANALYSIS
The following Management's Discussion and Analysis ("MD&A"), dated as of March
7, 2006, provides a detailed explanation of the financial and operating
results of Advantage Energy Income Fund ("Advantage", the "Fund", "us", "we"
or "our") for the year ended December 31, 2005 and should be read in
conjunction with the audited consolidated financial statements. The
consolidated financial statements have been prepared in accordance with
Canadian generally accepted accounting principles ("GAAP") and all references
are to Canadian dollars unless otherwise indicated. All per barrel of oil
equivalent ("boe") amounts are stated at 6:1 conversion rate for natural gas
to oil.
NON-GAAP MEASURES
The Fund discloses several financial measures in the MD&A that do not have any
standardized meaning prescribed under GAAP. These financial measures include
funds from operations and per Trust Unit, cash netbacks, and payout ratio.
Management believes that these financial measures are useful supplemental
information to analyze operating performance, leverage and provide an
indication of the results generated by the Fund's principal business
activities prior to the consideration of how those activities are financed or
how the results are taxed. Investors should be cautioned that these measures
should not be construed as an alternative to net income, cash provided by
operating activities or other measures of financial performance as determined
in accordance with GAAP. Advantage's method of calculating these measures may
differ from other companies, and accordingly, they may not be comparable to
similar measures used by other companies.
Funds from operations as presented is based on cash provided by operating
activities before changes in non-cash working capital and expenditures on
asset retirement. Funds from operations per Trust Unit is based on the number
of Trust Units outstanding at each cash distribution record date. Both cash
netbacks and payout ratio are dependent on the determination of funds from
operations. Cash netbacks include the primary cash revenues and expenses on a
per boe basis that comprise funds from operations. Payout ratio represents the
cash distributions declared for the period as a percentage of funds from
operations. Funds from operations reconciled to cash provided by operating
activities is as follows:
YEAR ENDED YEAR ENDED
($000) DECEMBER 31, 2005 DECEMBER 31, 2004
- ------------------------------------------------------------------------------------
Cash provided by operating activities $ 186,606 $ 125,325
Expenditures on asset retirement 2,025 673
Changes in non-cash working capital 22,910 480
- ------------------------------------------------------------------------------------
FUNDS FROM OPERATIONS $ 211,541 $ 126,478
- ------------------------------------------------------------------------------------
FORWARD-LOOKING INFORMATION
The information in this report contains certain forward-looking statements.
These statements relate to future events or our future performance. All
statements other than statements of historical fact may be forward-looking
statements. Forward-looking statements are often, but not always, identified
by the use of words such as "seek", "anticipate", "plan", "continue",
"estimate", "expect", "may", "will", "project", "predict", "potential",
"targeting", "intend", "could", "might", "should", "believe", "would" and
similar expressions. These statements involve substantial known and unknown
risks and uncertainties, certain of which are beyond Advantage's control,
including: the impact of general economic conditions; industry conditions;
changes in laws and regulations including the adoption of new environmental
laws and regulations and changes in how they are interpreted and enforced;
fluctuations in commodity prices and foreign exchange and interest rates;
stock market volatility and market valuations; volatility in market prices for
oil and natural gas; liabilities inherent in oil and natural gas operations;
uncertainties associated with estimating oil and natural gas reserves;
competition for, among other things, capital, acquisitions, of reserves,
undeveloped lands and skilled personnel; incorrect assessments of the value of
acquisitions; changes in income tax laws or changes in tax laws and incentive
programs relating to the oil and gas industry and income trusts; geological,
technical, drilling and processing problems and other difficulties in
producing petroleum reserves; and obtaining required approvals of regulatory
authorities. Advantage's actual results, performance or achievement could
differ materially from those expressed in, or implied by, such forward-looking
statements and, accordingly, no assurances can be given that any of the events
anticipated by the forward-looking statements will transpire or occur or, if
any of them do, what benefits that Advantage will derive from them. Except as
required by law, Advantage undertakes no obligation to publicly update or
revise any forward-looking statements.
Advantage Energy Income Fund - 1
OVERVIEW
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2005 2004 % CHANGE 2005 2004 % CHANGE
- ---------------------------------------------------------------------------------------------------------------
Funds from operations ($000) $ 60,906 $ 34,811 75% $ 211,541 $ 126,478 67%
per Trust Unit(1) $ 1.06 $ 0.75 41% $ 3.72 $ 3.05 22%
Net income ($000) $ 25,846 $ 4,855 432% $ 75,072 $ 24,038 212%
per Trust Unit - Basic $ 0.45 $ 0.11 309% $ 1.33 $ 0.59 125%
- Diluted $ 0.45 $ 0.11 309% $ 1.32 $ 0.58 128%
(1) Based on Trust Units outstanding at each cash distribution record date.
Funds from operations increased 75% for the three months and 67% for the year
ended December 31, 2005, as compared to the same periods of 2004. The growth
in funds from operations has been primarily due to increased production
through acquisitions and development activity combined with continued strong
commodity prices. These factors have also positively impacted net income which
increased 432% for the three months and 212% for the year ended December 31,
2005, as compared to 2004. Net income per Trust Unit increased 309% for the
three months and 125% for the year ended December 31, 2005. The primary factor
that causes significant variability of Advantage's funds from operations, cash
flows and net income is commodity prices. Refer to the section "Commodity
Prices and Marketing" for a more detailed discussion of commodity prices and
our price risk management.
CASH DISTRIBUTIONS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2005 2004 % CHANGE 2005 2004 % CHANGE
- ---------------------------------------------------------------------------------------------------------------
Cash distributions declared ($000) $ 43,265 $ 35,208 23% $ 177,366 $ 117,655 51%
per Trust Unit(1) $ 0.75 $ 0.75 - $ 3.12 $ 2.82 11%
Payout ratio (%) 71% 101% (30)% 84% 93% (9)%
(1) Based on Trust Units outstanding at each cash distribution record date.
Cash distributions are determined by Management and the Board of Directors. We
closely monitor our distribution policy considering forecasted cash flows,
optimal debt levels, capital spending activity, working capital requirements,
and other potential cash expenditures. Cash distributions are announced
monthly and are based on the cash available after retaining a portion to meet
such spending requirements. The level of cash distributions are primarily
determined by cash flows received from the production of oil and natural gas
from existing Canadian resource properties and will be susceptible to the
risks and uncertainties associated with the oil and natural gas industry
generally. If the oil and natural gas reserves associated with the Canadian
resource properties are not supplemented through additional development or the
acquisition of additional oil and natural gas properties, our cash
distributions will decline over time in a manner consistent with declining
production from typical oil and natural gas reserves. Therefore, cash
distributions are highly dependent upon our success in exploiting the current
reserve base and acquiring additional reserves. Furthermore, monthly cash
distributions we pay to Unitholders are highly dependent upon the prices
received for such oil and natural gas production. Oil and natural gas prices
can fluctuate widely on a month-to-month basis in response to a variety of
factors that are beyond our control. Declines in oil or natural gas prices
will have an adverse effect upon our operations, financial condition, reserves
and ultimately on our ability to pay distributions to Unitholders. It is our
long-term objective to provide stable and sustainable cash distributions to
the Unitholders. However, it is also our objective to continue growing the
Fund.
Total distributions increased 23% for the three months ended and 51% for the
year ended December 31, 2005. The higher total distributions reflect the
continued growth and development of the Fund. Cash distributions per Trust
Unit were $0.75 for the three months ended December 31, 2005 and 2004. For the
year ended December 31, 2005, cash distributions per Trust Unit were $3.12,
representing an increase of 11% compared to 2004. The increase in annual
distributions per Trust Unit was primarily achievable due to the significant
increase in funds from operations. Funds from operations per Trust Unit was
$1.06 for the three months and $3.72 for the year ended December 31, 2005,
representing increases of 41% and 22%, respectively. The considerably higher
funds from operations have allowed us to sustain a higher level of
distributions to the Unitholder while also reducing the payout ratio to 71%
Advantage Energy Income Fund - 2
for the three months ended December 31, 2005. During the fourth quarter and
the year ended December 31, 2005, funds from operations were reduced by $7.1
million and $14.0 million, respectively, for realized hedging losses.
Excluding these realized hedging losses, Advantage's payout ratio for the
fourth quarter would have been 64% and 79% for the year ended December 31,
2005. The hedges were concluded October 31, 2005 which allowed the Fund to
realize the full benefit of the resulting high commodity prices during the
remainder of the fourth quarter of 2005.
For Canadian holders of Advantage Trust Units, the distributions paid for 2005
were 60% non-taxable return of capital and 40% taxable. For U.S. unitholders,
distributions paid during 2005 were 56% non-taxable return of capital and 44%
taxable. All Unitholders of the Fund are encouraged to consult their tax
advisors as to the proper treatment of Advantage distributions for income tax
purposes.
REVENUE
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($000) 2005 2004 % CHANGE 2005 2004 % CHANGE
- -----------------------------------------------------------------------------------------------------------------
Natural gas excluding hedging $ 78,001 $ 51,539 51% $ 238,902 $ 181,571 32%
Realized hedging losses (6,749) (4,294) 57% (10,063) (9,711) 4%
- -----------------------------------------------------------------------------------------------------------------
Natural gas including hedging $ 71,252 $ 47,245 51% $ 228,839 $ 171,860 33%
- -----------------------------------------------------------------------------------------------------------------
Crude oil and NGLs excluding hedging $ 39,318 $ 29,497 33% $ 151,639 $ 69,621 118%
Realized hedging losses (398) - - (3,906) - -
- -----------------------------------------------------------------------------------------------------------------
Crude oil and NGLs including hedging $ 38,920 $ 29,497 32% $ 147,733 $ 69,621 112%
- -----------------------------------------------------------------------------------------------------------------
TOTAL REVENUE $ 110,172 $ 76,742 44% $ 376,572 $ 241,481 56%
- -----------------------------------------------------------------------------------------------------------------
Petroleum and natural gas revenues have increased significantly for the three
months and year ended December 31, 2005. The main contributing factors include
increased crude oil and natural gas liquids ("NGLs") production and the
considerable strength of commodity prices. The increased revenues have been
partially offset by realized hedging losses experienced during the applicable
periods. The hedges were concluded October 31, 2005.
PRODUCTION
THREE MONTHS END YEAR ENDED
DECEMBER 31 DECEMBER 31
2005 2004 % CHANGE 2005 2004 % CHANGE
- ------------------------------------------------------------------------------------------------------------------
Natural gas (mcf/d) 72,587 84,336 (14)% 78,561 77,188 2%
Crude oil (bbls/d) 5,900 5,723 3% 5,854 3,340 75%
NGLs (bbls/d) 1,206 1,092 10% 1,175 744 58%
- ------------------------------------------------------------------------------------------------------------------
TOTAL (BOE/D) 19,204 20,871 (8)% 20,123 16,949 19%
- ------------------------------------------------------------------------------------------------------------------
Natural gas (%) 63% 67% (4)% 65% 76% (11)%
Crude oil (%) 31% 28% 3% 29% 20% 9%
NGLs (%) 6% 5% 1% 6% 4% 2%
Natural gas production decreased 14% for the three months and was modestly
higher for the year ended December 31, 2005, as compared to 2004. Crude oil
production increased 3% for the three months and 75% for the year ended
December 31, 2005. NGLs production increased 10% for the three months and 58%
for the year ended December 31, 2005. The Fund's total daily production
averaged 19,204 boe/d for the fourth quarter, a decrease of 8%, and 20,123
boe/d for the year ended December 31, 2005, an increase of 19%, as compared to
the same periods of 2004. Due to the Fund's active capital development
program, production additions have been partially offset by high initial
production declines that are normally experienced with new production. This
situation is clearly evident from the 8% decrease in production for the fourth
quarter of 2005 as compared to the prior year. A significant portion of this
decline was attributable to the areas of Bantry, Medicine Hat, and Shouldice
where Advantage pursued an intense 2004 drilling program. However, as the
areas mature, per well production levels will stabilize with lower rates of
decline. Furthermore, Advantage disposed of some minor non-core areas in 2005
that attributed to 2% of the decrease. Additional production challenges
Advantage Energy Income Fund - 3
encountered by Advantage through 2005, as well as the entire sector, has
included delays in production additions due to extremely wet field conditions
during the spring of 2005, plant turnarounds, maintenance programs and
drilling and service rig availability.
The growth in annual production from 2004 was primarily the result of the
property acquisition from Anadarko Canada Corporation ("Anadarko") on
September 15, 2004 and the acquisition of Defiant Energy Corporation
("Defiant") on December 21, 2004. Production increases were also realized due
to Advantage's ongoing development program, especially relating to production
additions at Nevis, Alberta. Advantage's production continues to be primarily
natural gas weighted representing 63% of total production. However, crude oil
and NGLs production has increased to 37% of total production in the fourth
quarter of 2005. This has enabled the Fund to benefit from the significant
increase in crude oil commodity prices that has occurred over that period of
time. Advantage exited 2005 producing approximately 72.4 mmcf/d of natural
gas, 5,900 bbls/d of crude oil, and 1,200 bbls/d of NGLs resulting in total
estimated production of 19,200 boe/d.
COMMODITY PRICES AND MARKETING
NATURAL GAS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($/MCF) 2005 2004 % CHANGE 2005 2004 % CHANGE
- --------------------------------------------------------------------------------------------------------------
Realized natural gas prices
Excluding hedging $11.68 $ 6.64 76% $ 8.33 $ 6.43 30%
Including hedging $10.67 $ 6.09 75% $ 7.98 $ 6.08 31%
AECO monthly index $11.68 $ 7.09 65% $ 8.49 $ 6.79 25%
Realized natural gas prices, excluding hedging, increased 76% for the three
months and 30% for the year ended December 31, 2005, as compared to 2004. The
most significant development during the year that placed increased pressure on
natural gas prices was Hurricanes Katrina and Rita that ravaged the Gulf of
Mexico during the third quarter. Significant damage was sustained by drilling
platforms, production facilities, refineries and other facilities throughout
the region. Production has been slow to recover and supply concerns continue
with as much as 20% of production from the region still shut-in at year end.
Despite the supply difficulty, natural gas prices began to weaken near the end
of December and the weakness has continued into 2006 as mild winter weather
persists throughout North America. This weather has helped to alleviate
short-term supply concerns and uncertainty regarding adequacy of current
natural gas inventory levels. However, we believe that the long-term pricing
fundamentals for natural gas remain strong. These fundamentals include (i) the
continued strength of crude oil prices which has eliminated the economic
advantage of fuel switching away from natural gas, (ii) continued tightness in
supply that has resulted from increased demand and the decline in North
American natural gas production levels and (iii) ongoing weather related
factors such as hot summers, cold winters and annual hurricane season in the
Gulf of Mexico, all of which have an impact on the delicate supply/demand
balance that exists.
CRUDE OIL AND NGLS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($/BBL) 2005 2004 % CHANGE 2005 2004 % CHANGE
- --------------------------------------------------------------------------------------------------------------
Realized crude oil prices
Excluding hedging $ 61.11 $ 47.27 29% $ 61.02 $ 47.62 28%
Including hedging $ 60.37 $ 47.27 28% $ 59.20 $ 47.62 24%
Realized NGLs prices
Excluding hedging $ 55.42 $ 45.88 21% $ 49.54 $ 41.91 18%
Realized crude oil and NGLs prices
Excluding hedging $ 60.14 $ 47.05 28% $ 59.10 $ 46.58 27%
Including hedging $ 59.53 $ 47.05 27% $ 57.58 $ 46.58 24%
WTI ($US/bbl) $ 60.04 $ 48.28 24% $ 56.61 $ 41.43 37%
$US/$Cdn exchange rate $ 0.85 $ 0.82 4% $ 0.83 $ 0.77 8%
Advantage Energy Income Fund - 4
Realized crude oil and NGLs prices, excluding hedging, increased 28% for the
three months and 27% for the year ended December 31, 2005, as compared to the
same periods of 2004. Advantage's crude oil prices are based on the benchmark
pricing of West Texas Intermediate Crude ("WTI") adjusted for quality,
transportation costs and $US/$Canadian exchange rates. The price of WTI
fluctuates based on worldwide supply and demand fundamentals. There has been
significant price volatility experienced whereby WTI has increased 24% for the
three months and 37% for the year ended December 31, 2005, compared to 2004.
Many developments during the quarter and year have resulted in this price
increase, including significant geopolitical issues and Hurricanes Katrina and
Rita, which pushed WTI in relative terms to record levels not experienced in
over two decades. Production levels have been slower to recover from the
devastation of hurricane season than anticipated with considerable production
still shut-in at year end. Additional concerns have also been raised regarding
the lack of growth of North American refining capacity and the continued
strength of global demand. These key issues persist and will continue to
impact overall commodity prices. With the current high price levels, it is
notable that demand has remained considerably resilient and the economy does
not appear to be adversely impacted. We believe that the pricing fundamentals
for crude oil remain strong with many factors affecting the continued strength
including (i) supply management and supply restrictions by the OPEC cartel,
(ii) ongoing civil unrest in the Middle East, Venezuela and Nigeria, (iii)
increased world wide demand, particularly in China and India and (iv) North
American refinery capacity constraints. Partially offsetting the strength of
WTI oil prices has been the strength of the Canadian dollar relative to the
U.S. dollar.
COMMODITY PRICE RISK
The Fund's operational results and financial condition will be dependent on
the prices received for oil and natural gas production. Oil and natural gas
prices have fluctuated widely during recent years and are determined by
economic and in the case of oil prices, political factors. Supply and demand
factors, including weather and general economic conditions as well as
conditions in other oil and natural gas regions impact prices. Any movement in
oil and natural gas prices could have an effect on the Fund's financial
condition and therefore on the cash distributions to holders of Advantage
Trust Units. In the past, Advantage has entered into short term hedging
agreements which has had the effect of limiting downside risk associated with
changes in commodity prices while foregoing the benefits of price increases.
As a practice in the future, Advantage may manage the risk associated with
changes in commodity prices by entering into oil or natural gas price hedges
related only to specific acquisition or project economics. These commodity
hedging activities could expose Advantage to losses or gains. To the extent
that Advantage engages in risk management activities related to commodity
prices, it will be subject to credit risk associated with counterparties with
which it contracts. Credit risk is mitigated by entering into contracts with
only stable, creditworthy parties and through frequent reviews of exposures to
individual entities.
The Fund entered several such financial instruments for both natural gas and
crude oil in early 2005 for the period from April to October 2005. Advantage's
natural gas hedging program resulted in losses of $10.1 million during 2005 or
$0.35/mcf compared to hedging losses of $9.7 million or $0.35/mcf for 2004.
The slight increase in the hedging losses has been primarily due to the
stronger natural gas prices as compared to 2004, relative to the hedging
contract prices. The Fund's natural gas contracts on 56.9 mmcf/d expired at
the end of October 2005.
Advantage's crude oil hedging program resulted in losses of $3.9 million or
$1.82/bbl during 2005. Advantage did not have any crude oil hedges in place
for the same period of 2004. The Fund's oil hedge contracts for 3,500 bbls/d
expired at the end of September and October 2005.
ROYALTIES
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2005 2004 % CHANGE 2005 2004 % CHANGE
- ------------------------------------------------------------------------------------------------------------------------
Royalties, net of Alberta Royalty Credit ($000) $ 23,281 $ 15,587 49% $ 74,290 $ 47,828 55%
per boe $ 13.18 $ 8.12 62% $ 10.11 $ 7.71 31%
As a percentage of revenue,
excluding hedging 19.8% 19.2% 0.6% 19.0% 19.0% -
Advantage pays royalties to the owners of mineral rights from which we have
leases. The Fund currently has mineral leases with provincial governments,
individuals and other companies. Royalties are shown net of Alberta Royalty
Credit which is a royalty rebate provided by the Alberta government to certain
producers. Royalties have increased in total and on a boe basis as compared to
2004 as both production and commodity prices have increased substantially.
However, royalties as a percentage of revenue, excluding hedging, has remained
relatively consistent for the comparable periods.
Advantage Energy Income Fund - 5
OPERATING COSTS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2005 2004 % CHANGE 2005 2004 % CHANGE
- -----------------------------------------------------------------------------------------------------------------
Operating costs ($000) $ 17,381 $ 13,085 33% $ 57,941 $ 38,808 49%
per boe $ 9.84 $ 6.81 44% $ 7.89 $ 6.26 26%
Operating costs have increased 33% for the three months and 49% for the year
ended December 31, 2005, as compared to 2004 primarily due to costs associated
with properties acquired from Anadarko and Defiant during the end of 2004.
Operating costs per boe have increased 44% for the three months and 26% for
the year ended December 31, 2005. Operating costs have steadily increased over
the last year due to higher average operating costs for Anadarko properties
and significantly higher power and field costs associated with the shortage of
supplies and services that has resulted from the high level of industry
activity. Management of operating costs will be a persistent challenge as the
commodity price environment places additional strain on current available
support and service resources.
GENERAL AND ADMINISTRATIVE
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2005 2004 % CHANGE 2005 2004 % CHANGE
- --------------------------------------------------------------------------------------------------------------------
General and administrative expense ($000) $ 1,521 $ 1,329 14% $ 5,452 $ 3,871 41%
per boe $ 0.86 $ 0.69 25% $ 0.74 $ 0.62 19%
Employees at December 31 80 77 4%
General and administrative ("G&A") expense has increased 14% for the three
months and 41% for the year ended December 31, 2005, as compared to 2004. G&A
per boe for the three months increased 25% and for the year ended December 31,
2005 increased 19%. G&A expense has increased overall due to an increase in
staff levels that resulted from growth of the Fund. This is apparent given
that G&A on a boe basis for 2005 increased at much less than total G&A. The
current staff complement has Advantage well positioned to continue the present
growth strategy and to seize future opportunities.
MANAGEMENT FEES AND PERFORMANCE INCENTIVE
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2005 2004 % CHANGE 2005 2004 % CHANGE
- --------------------------------------------------------------------------------------------------------------------
Management fee ($000) $ 1,043 $ 721 45% $ 3,665 $ 2,323 58%
per boe $ 0.59 $ 0.38 55% $ 0.50 $ 0.37 35%
Performance incentive ($000) $ 10,544 $ 7,411 42% $ 10,544 $ 21,632 (51)%
The Manager receives 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 increased 45% for the three months and 58% for the year ended December
31, 2005, as compared to the same periods of 2004. Management fees per boe
have increased 55% for the three months and 35% for the year ended December
31, 2005. The increase in total management fees and management fees per boe is
primarily due to the considerable increase in revenue as a result of higher
production and commodity prices.
The Manager of the Fund is 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. For the year ending December 31,
2005, the total return of the Fund was 17% as compared to 38% in 2004 which
resulted in a lower performance incentive fee payable
Advantage Energy Income Fund - 6
at year end of $10.5 million compared to the prior year's fee of $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 of the Fund.
INTEREST
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2005 2004 % CHANGE 2005 2004 % CHANGE
- -----------------------------------------------------------------------------------------------------------------------
Interest expense ($000) $ 2,865 $ 2,085 37% $ 10,275 $ 6,407 60%
per boe $ 1.62 $ 1.09 49% $ 1.40 $ 1.03 36%
Average effective interest rate 4.4% 3.9% 0.5% 4.3% 4.0% 0.3%
Bank indebtedness at December 31 ($000) $ 252,476 $ 267,054 (5)%
Interest expense has increased 37% for the three months and 60% for the year
ended December 31, 2005, as compared to 2004. Interest expense per boe has
increased 49% for the three months and 36% for the year ended December 31,
2005. The increase in interest expense is primarily attributable to a higher
average debt level associated with the growth of the Fund. The increased debt
has been used to finance continued development activities and pursuit of
expansion opportunities. We monitor the debt level to ensure an optimal mix of
financing and cost of capital that will provide a maximum return to
Unitholders. Our current credit facilities have been a favorable financing
alternative with an effective interest rate of only 4.4% for the three months
ended December 31, 2005. The Fund's interest rates are primarily based on
short term Bankers Acceptance rates plus a stamping fee.
INTEREST AND ACCRETION ON CONVERTIBLE DEBENTURES
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2005 2004 % CHANGE 2005 2004 % CHANGE
- -----------------------------------------------------------------------------------------------------------------------
Interest on convertible debentures ($000) $ 2,727 $ 3,155 (14)% $ 11,210 $ 8,701 29%
per boe $ 1.54 $ 1.64 (6)% $ 1.53 $ 1.40 9%
Accretion on convertible debentures ($000) $ 532 $ 617 (14)% $ 2,182 $ 1,724 27%
per boe $ 0.30 $ 0.32 (6)% $ 0.30 $ 0.28 7%
Convertible debentures maturity
value at December 31 ($000) $ 135,111 $ 148,450 (9)%
Interest expense and accretion on convertible debentures has decreased 14% for
the three months ended December 31, 2005 as compared to the same period of
2004. This decrease has been due to the continual exchange of convertible
debentures to Trust Units that will pay distributions rather than interest.
The convertible debentures outstanding at year end have decreased 9% from the
prior year. For the year ended December 31, 2005, interest expense and
accretion on convertible debentures has increased 29% and 27%, respectively.
These increases are due to the issuance of $50 million 7.75% and $75 million
7.5% convertible debentures in September 2004 to partially finance the
Anadarko asset acquisition. This resulted in a higher average outstanding
debenture balance during 2005 than the prior year. The increased interest from
the additional debentures is partially offset by a general reduction in
interest expense related to the other outstanding debenture balances which
converted during the period. Interest and accretion will continue to decrease
in the future as debentures are continually converted to Trust Units.
Advantage Energy Income Fund - 7
CASH NETBACKS
THREE MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31, 2005 DECEMBER 31, 2004
$000 $ PER BOE $000 $ PER BOE
- -----------------------------------------------------------------------------------------------------------------
Revenue $ 117,319 $ 66.40 $ 81,036 $ 42.20
Hedging (7,147) (4.05) (4,294) (2.24)
Royalties (23,281) (13.18) (15,587) (8.12)
Operating costs (17,381) (9.84) (13,085) (6.81)
- -----------------------------------------------------------------------------------------------------------------
OPERATING $ 69,510 $ 39.33 $ 48,070 $ 25.03
General and administrative (1,521) (0.86) (1,329) (0.69)
Management fees (1,043) (0.59) (721) (0.38)
Performance incentive - - (5,062) (2.64)
Interest (2,865) (1.62) (2,085) (1.09)
Interest on convertible debentures (2,727) (1.54) (3,155) (1.64)
Taxes (448) (0.25) (907) (0.47)
- -----------------------------------------------------------------------------------------------------------------
FUNDS FROM OPERATIONS $ 60,906 $ 34.47 $ 34,811 $ 18.12
- -----------------------------------------------------------------------------------------------------------------
YEAR ENDED YEAR ENDED
DECEMBER 31, 2005 DECEMBER 31, 2004
$000 $ PER BOE $000 $ PER BOE
- -----------------------------------------------------------------------------------------------------------------
Revenue $ 390,541 $ 53.17 $ 251,192 $ 40.49
Hedging (13,969) (1.90) (9,711) (1.57)
Royalties (74,290) (10.11) (47,828) (7.71)
Operating costs (57,941) (7.89) (38,808) (6.26)
- -----------------------------------------------------------------------------------------------------------------
OPERATING $ 244,341 $ 33.27 $ 154,845 $ 24.95
General and administrative (5,452) (0.74) (3,871) (0.62)
Management fees (3,665) (0.50) (2,323) (0.37)
Performance incentive - - (5,062) (0.82)
Interest (10,275) (1.40) (6,407) (1.03)
Interest on convertible debentures (11,210) (1.53) (8,701) (1.40)
Taxes (2,198) (0.30) (2,003) (0.32)
- -----------------------------------------------------------------------------------------------------------------
FUNDS FROM OPERATIONS $ 211,541 $ 28.80 $ 126,478 $ 20.39
- -----------------------------------------------------------------------------------------------------------------
Funds from operations of Advantage for the year ended December 31, 2005
increased to $211.5 million from $126.5 million in the prior year. This
increase has resulted in a higher cash netback per boe of $28.80, an increase
of 41% as compared to the $20.39 per boe realized during 2004. The significant
contributing factor to the improved cash netback has been the substantial
increase in crude oil and natural gas commodity prices that has boosted
revenues 31% to $53.17 per boe, as compared to the prior years $40.49 per boe.
However, the positive impact on revenues from commodity prices has been
partially offset by higher cash expenses. The more noteworthy negative impacts
include hedging losses, royalties and operating costs. The Fund had
implemented a commodity price hedging program for the period from April to
October 2005 to provide stability to cash distributions for Unitholders. Due
to soaring commodity prices for 2005, losses of $14.0 million were
experienced. The hedging program ended October 31, 2005 and the Fund is
currently unhedged. Royalties increased as a direct result of the higher
commodity price environment, as would be expected. Advantage pays royalties to
the owners of mineral rights from which we have leases and we anticipate the
royalty rate as a percentage of revenues to remain relatively consistent with
past experience. Operating costs per boe for the year ended December 31, 2005
were $7.89 per boe, an increase of 26% from the $6.26 experienced in 2004.
Operating costs have steadily increased over the past year due to
significantly higher power and field costs associated with the shortage of
supplies and services that has resulted from the high level of industry
activity. Management of operating costs will be a persistent challenge as the
commodity price environment places
Advantage Energy Income Fund - 8
additional strain on current available support and service resources. The
annual performance incentive fee is not normally considered a cash expenditure
as it is settled through the distribution of Trust Units to the Manager.
However, in 2004 the annual performance incentive fee did impact funds from
operations and the cash netback to the extent that $5.1 million of the amount
was settled in cash to pay income taxes of the Manager.
DEPLETION, DEPRECIATION AND ACCRETION
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2005 2004 % CHANGE 2005 2004 % CHANGE
- ---------------------------------------------------------------------------------------------------------------
Depletion, depreciation & accretion ($000) $ 32,581 $ 34,142 (5)% $135,096 $ 99,277 36%
per boe $ 18.44 $ 17.78 4% $ 18.39 $ 16.00 15%
Depletion and depreciation of property and equipment is provided on the
"unit-of-production" method based on total proved reserves. The depletion,
depreciation and accretion ("DD&A") provision has decreased 5% for the three
months ended December 31, 2005 due to the 8% reduction of daily production
volumes partially offset by the 4% increase in DD&A rate per boe. The DD&A
annual provision was 36% higher as compared to the same period of 2004 as a
result of the 19% increased production volumes and a 15% higher per boe rate.
The increased DD&A rate is representative of industry challenges attributable
to necessary capital spending activity and resulting proved reserve additions.
It is common for a company to incur considerable capital spending but not to
realize the associated proved reserve additions until subsequent years when
there has been adequate production history. This is a particular difficulty
for any company that is an active developer, such as Advantage. Furthermore,
due to the intense industry competition created by the continued high
commodity price environment, there has been continued pressure placed on
general capital spending. These factors will persistently challenge the energy
sector and increase related DD&A rates.
TAXES
Current taxes paid or payable for the year ended December 31, 2005 amounted to
$2.2 million, compared to $2.0 million expensed in 2004. Current taxes
primarily represents Federal large corporations tax and Saskatchewan resource
surcharge. Federal large corporations tax is based on debt and equity levels
of the Fund at the end of the year and have increased due to Advantage's
growth. As a result of present legislation, large corporations taxes are to be
gradually eliminated over the next several years. Saskatchewan resource
surcharge is based on the level of activity within the province of
Saskatchewan. Given that the Fund has an increased presence in Saskatchewan
due to the Anadarko asset acquisition in September 2004, these taxes have
increased.
Future income taxes arise from differences between the accounting and tax
bases of the operating company's assets and liabilities. For the three months
ended December 31, 2005, the Fund recognized an income tax reduction of $1.1
million compared to a $0.2 million expense for 2004. The future income tax
reduction for the year ended December 31, 2005 was $11.4 million compared to
$16.4 million for the similar period ended December 31, 2004.
In the Fund's structure, payments are made between the operating company and
the Fund transferring income tax obligations to the Unitholders. Therefore, it
is expected, based on current legislation that no cash income taxes are to be
paid by the operating company or the Fund in the future, and as such, the
future income tax liability recorded on the balance sheet will be recovered
through earnings over time. As at December 31, 2005, the operating company had
a future income tax liability balance of $99.0 million. Canadian generally
accepted accounting principles require that a future income tax liability be
recorded when the book value of assets exceeds the balance of tax pools.
Accounting standards further requires that a future tax liability be recorded
on an acquisition when a corporation acquires assets with associated tax pools
that are less than the purchase price. As a result of finalizing the tax pools
related to the Defiant acquisition which closed on December 21, 2004, the
originally recorded future tax liability of $51.5 million was reduced to $49.6
million.
NON-CONTROLLING INTEREST
Non-controlling interest expense for the year ended December 31, 2005 was $0.2
million. Non-controlling interest expense represents the net income
attributable to Exchangeable Share ownership interests. The non-controlling
interest was created when Advantage Oil & Gas Ltd. ("AOG"), a subsidiary of
the Fund, issued Exchangeable Shares as partial consideration for the
acquisition of Defiant that occurred at the end of 2004. The Exchangeable
Shares and Trust Units are considered economically equivalent since all shares
must be exchanged for either Trust Units or cash over time, based on the
current market price of the Trust Units. Since the Exchangeable Shares are
required to be exchanged, there is no permanent non-controlling interest. At
December 31, 2005, only 104,672 Exchangeable Shares were outstanding and
non-controlling interest expense will therefore continue to be insignificant.
Advantage Energy Income Fund - 9
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Fund has contractual obligations in the normal course of operations
including purchases of assets and services, operating agreements,
transportation commitments, sales contracts and convertible debentures. These
obligations are of a recurring and consistent nature and impact cash flow in
an ongoing manner. The following table is a summary of the Fund's remaining
contractual obligations and commitments. Advantage has no guarantees or
off-balance sheet arrangements other than as disclosed.
PAYMENTS DUE BY PERIOD 2011 &
($ MILLIONS) TOTAL 2006 2007 2008 2009 2010 THEREAFTER
- ---------------------------------------------------------------------------------------------------------
Building lease $ 3.4 $ 1.4 $ 1.4 $ 0.6 - - -
Capital lease $ 1.8 $ 0.4 $ 1.4 - - - -
Pipeline/transportation $ 3.1 $ 2.4 $ 0.6 $ 0.1 - - -
Convertible debentures(1) $ 135.1 - $ 2.5 $ 7.6 $ 75.3 - $ 49.7
- ---------------------------------------------------------------------------------------------------------
TOTAL CONTRACTUAL OBLIGATIONS $ 143.4 $ 4.2 $ 5.9 $ 8.3 $ 75.3 - $ 49.7
- ---------------------------------------------------------------------------------------------------------
(1) As at December 31, 2005, Advantage had $135.1 million convertible debentures outstanding. Each
series of convertible debentures are convertible to Trust Units based on an established conversion
price. The Fund expects that the obligations related to convertible debentures will be settled
through the issuance of Trust Units.
LIQUIDITY AND CAPITAL RESOURCES
The following table is a summary of the Fund's capitalization structure.
($000, EXCEPT AS OTHERWISE INDICATED) DECEMBER 31, 2005
- ------------------------------------------------------------------------------
Bank indebtedness (long-term) $ 252,476
Working capital deficit (1) 31,612
- ------------------------------------------------------------------------------
Net debt $ 284,088
- ------------------------------------------------------------------------------
Trust Units outstanding (000) (2) 57,969
Trust Unit closing market price ($/Trust Unit) $ 22.43
- ------------------------------------------------------------------------------
Market value $ 1,300,245
- ------------------------------------------------------------------------------
Capital lease obligation (long-term) $ 1,346
Convertible debentures (maturity value) 135,111
- ------------------------------------------------------------------------------
TOTAL CAPITALIZATION $ 1,720,790
- ------------------------------------------------------------------------------
(1) Working capital deficit includes $10.5 million related to the annual
performance incentive fee which was settled in early 2006 through the
issuance of Trust Units.
(2) Trust Units outstanding includes Trust Units issuable for the outstanding
Exchangeable Shares at the applicable exchange ratio.
UNITHOLDERS' EQUITY, EXCHANGEABLE SHARES AND CONVERTIBLE DEBENTURES
Advantage has utilized a combination of Trust Units, Exchangeable Shares,
convertible debentures and bank debt to finance acquisitions and development
activities.
As at December 31, 2005 the Fund had 57.8 million Trust Units outstanding. On
January 19, 2005, Advantage issued 763,371 Trust Units to satisfy $16.6
million of the performance incentive fee obligation related to the 2004 year.
On February 9, 2005, Advantage issued 5,250,000 Trust Units at $21.65 per
Trust Unit for gross proceeds of $113.7 million, $107.6 million net of related
issuance costs. 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. As at March 7, 2006, Advantage had 59.4 million
Trust Units issued and outstanding.
As partial consideration for the acquisition of Defiant which closed on
December 21, 2004, AOG issued 1,450,030 Exchangeable Shares. Each Exchangeable
Share issued is exchangeable for Advantage Trust Units at any time 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. As of December 31, 2005, a total
of 1,345,358 Exchangeable
Advantage Energy Income Fund - 10
Shares have been exchanged for 1,374,300 Trust Units resulting in 104,672
Exchangeable Shares outstanding at year end. As at March 7, 2006, 83,398
Exchangeable Shares are outstanding that are exchangeable for the issuance of
99,656 Trust Units based on the exchange ratio of 1.19495.
As at December 31, 2005, the Fund had $135.1 million convertible debentures
outstanding that were convertible to 6.8 million Trust Units based on the
applicable conversion prices. During the year ended December 31, 2005, $13.3
million convertible debentures were exchanged for the issuance of 0.8 million
Trust Units. As at March 7, 2006, $114.4 million convertible debentures were
outstanding that are convertible to 5.8 million Trust Units.
INCLUSION IN S&P/TSX COMPOSITE INDEX AND NYSE LISTING
On October 11, 2005, Standard & Poor's confirmed that it was proceeding with
including income trusts in the S&P/TSX Composite Index. On December 19, 2005,
specific income trusts were included in the S&P/TSX Composite Index at a 50%
weighting with full inclusion expected to occur on March 20, 2006. We are
pleased that Advantage was selected as one of the trusts added to the Index.
The addition of income trusts to the Index is positive and we expect the move
to result in a broader investment base for the trust sector which will
increase liquidity and improve market efficiency.
On December 9, 2005, Advantage Trust Units began trading on the New York Stock
Exchange ("NYSE") under the symbol "AAV". Trading on the NYSE will result in
improved liquidity for all Unitholders, greater access to the U.S. capital
markets, and improved cost of capital for future acquisitions.
BANK INDEBTEDNESS, CREDIT FACILITY AND OTHER OBLIGATIONS
At December 31, 2005, Advantage had bank indebtedness outstanding of $252.5
million. The Fund has a credit facility agreement with a syndicate of four
Canadian chartered banks. The $355 million facility, consisting of a $345
million extendible revolving loan facility and a $10 million operating loan
facility and is due for renewal in May 2006 at the option of the syndicate.
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. Given amendments made in 2005 to the
repayment terms, the debt has been reclassified as a long-term liability on
the consolidated balance sheet.
At December 31, 2005, Advantage had a working capital deficiency of $31.6
million. Our working capital includes items expected for normal operations
such as trade receivables, prepaids, deposits, trade payables and accruals.
Working capital varies primarily due to the timing of such items and the
current level of business activity. Advantage has no unusual working capital
requirements. We do not anticipate any problems in meeting future obligations
as they become due given the strength of our funds from operations. It is also
important to note that working capital is effectively integrated with
Advantage's operating credit facility that is meant to assist with the timing
of cash flows. As at December 31, 2005, accounts payable and accrued
liabilities included $10.5 million related to the annual performance incentive
fee which was settled in early 2006 through the issuance of Trust Units, at
the option of the Manager.
Advantage generally does not make use of capital leases to finance development
expenditures. However, Advantage currently has one capital lease outstanding
at December 31, 2005 for $1.7 million that was assumed from a prior corporate
acquisition. In May 2005, we repaid two capital leases for $6.8 million that
were assumed by Advantage on the acquisition of Defiant in December 2004.
Advantage Energy Income Fund - 11
CAPITAL EXPENDITURES
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($000) 2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
Land and seismic $ 609 $ 956 $ 3,860 $ 3,034
Drilling, completions and workovers 24,293 14,411 77,794 68,327
Well equipping and facilities 2,758 13,187 20,322 35,655
Other 300 629 1,253 877
- ------------------------------------------------------------------------------------------------------------------
$ 27,960 $ 29,183 $ 103,229 $ 107,893
Acquisition of Anadarko properties - 2,815 - 179,115
Acquisition of Defiant Energy Corporation (1) 98 200,291 98 200,291
Property acquisitions (3) 1,530 210 1,530
Property dispositions 76 (5,748) (3,379) (6,539)
- ------------------------------------------------------------------------------------------------------------------
TOTAL CAPITAL EXPENDITURES $ 28,131 $ 228,071 $ 100,158 $ 482,290
- ------------------------------------------------------------------------------------------------------------------
(1) Represents consideration of $143.1 million plus net debt assumed of $57.3 million.
Advantage's growth strategy has been to concentrate in areas where we have
large land positions where the drilling opportunities are shallow to medium
depth with year round access. We focus on areas where past activity has
yielded long-life reserves with high cash netbacks. Our preference is to
operate a high percentage of our properties such that we can maintain control
of operations and cash flows.
For the three month period ended December 31, 2005, the Fund spent $28.1
million on capital expenditures. Approximately $24.3 million was expended on
drilling and completion operations where the Fund drilled a total of 13.9 net
(28 gross) wells. Capital expenditures for the year ended December 31, 2005
amounted to $100.2 million. Drilling and completion expenditures totaled $77.8
million resulting in the drilling of 53.6 net (102 gross) wells. Advantage's
Nevis property experienced the greatest activity with capital spending of
$36.8 million on drilling and corresponding facilities resulting in the
completion of 16.5 net (17 gross) wells. The Fund also pursued a number of
other opportunities and drilled multiple wells with high working interests in
Chain, Bantry, Sweetgrass, Retlaw and Provost.
The following table summarizes the various funding requirements during the
year ended December 31, 2005 and the sources of funding to meet those
requirements.
SOURCES AND USES OF FUNDS
YEAR ENDED
($000) DECEMBER 31, 2005
- -------------------------------------------------------------------------------
SOURCES OF FUNDS
Funds from operations $ 211,541
Units issued, net of costs 107,616
Property dispositions 3,379
- -------------------------------------------------------------------------------
$ 322,536
- -------------------------------------------------------------------------------
USES OF FUNDS
Capital expenditures $ 103,229
Asset retirement expenditures 2,025
Purchase adjustment of Defiant Energy acquisition 98
Property acquisitions 210
Distributions paid to Unitholders 175,323
Decrease in bank debt 14,578
Reduction of capital lease obligations 7,687
Increase in working capital 19,386
- -------------------------------------------------------------------------------
$ 322,536
- -------------------------------------------------------------------------------
Advantage Energy Income Fund - 12
ANNUAL FINANCIAL INFORMATION
The following is a summary of selected financial information of the Fund for the
periods indicated.
YEAR ENDED YEAR ENDED YEAR ENDED
DEC. 31, 2005 DEC. 31, 2004 DEC. 31, 2003
- ------------------------------------------------------------------------------------------------------------------------------
Total revenue (before royalties) ($000) $ 376,572 $ 241,481 $ 166,075
Net income ($000) (1) $ 75,072 $ 24,038 $ 38,503
Per Trust Unit - Basic $ 1.33 $ 0.59 $ 1.26
- Diluted $ 1.32 $ 0.58 $ 1.26
Total assets ($000) $ 1,012,847 $ 1,033,251 $ 581,889
Long term financial liabilities ($000) (2) $ 379,903 $ 144,039 $ 93,415
Cash distributions per Trust Unit $ 3.12 $ 2.82 $ 2.71
(1) Net income for 2003 and 2004 has been restated to reflect changes in accounting policies as disclosed in note 2 to the
Consolidated Financial Statements.
(2) Given amendments made in 2005 to the credit facility repayment terms, the bank indebtedness is classified as a
long-term liability while in 2003 and 2004 bank indebtedness was shown as a current liability. Long term financial
liabilities also exclude asset retirement obligations and future income taxes.
QUARTERLY PERFORMANCE
2005 2004
($000, EXCEPT AS OTHERWISE INDICATED) Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1
- -------------------------------------------------------------------------------------------------------------------------------
Daily production
Natural gas (mcf/d) 72,587 75,994 79,492 86,350 84,336 75,425 73,283 75,649
Crude oil and NGLs (bbls/d) 7,106 7,340 6,772 6,892 6,815 3,550 3,106 2,841
Total (boe/d) 19,204 20,006 20,021 21,284 20,871 16,121 15,320 15,449
Average prices
Natural gas ($/mcf)
Excluding hedging $ 11.68 $ 8.25 $ 7.27 $ 6.52 $ 6.64 $ 6.11 $ 6.65 $ 6.28
Including hedging $ 10.67 $ 7.79 $ 7.30 $ 6.47 $ 6.09 $ 5.76 $ 6.20 $ 6.28
AECO monthly $ 11.68 $ 8.15 $ 7.39 $ 6.70 $ 7.09 $ 6.62 $ 6.81 $ 6.60
Crude oil and NGLs ($/bbl)
Excluding hedging $ 60.14 $ 66.00 $ 56.57 $ 53.02 $ 47.05 $ 51.20 $ 45.36 $ 40.93
Including hedging $ 59.53 $ 61.10 $ 56.24 $ 53.02 $ 47.05 $ 51.20 $ 45.36 $ 40.93
WTI (US$/bbl) $ 60.04 $ 63.17 $ 53.13 $ 49.90 $ 48.28 $ 43.88 $ 38.31 $ 35.15
Total revenues (before royalties) $ 110,172 $ 95,715 $ 87,476 $ 83,209 $ 76,742 $ 56,722 $ 54,181 $ 53,836
Net income (1) $ 25,846 $ 18,674 $ 26,537 $ 4,015 $ 4,855 $ 4,965 $ 9,770 $ 4,448
per Trust Unit - basic and diluted(1) $ 0.45 $ 0.33 $ 0.46 $ 0.07 $ 0.11 $ 0.12 $ 0.25 $ 0.12
Funds from operations $ 60,906 $ 55,575 $ 49,705 $ 45,355 $ 34,811 $ 31,074 $ 30,693 $ 29,900
Cash distributions declared $ 43,265 $ 43,069 $ 44,693 $ 46,339 $ 35,208 $ 28,730 $ 27,450 $ 26,267
Payout ratio (%) 71% 77% 90% 102% 101% 92% 89% 88%
(1) Net income and net income per Trust Unit in 2004 has been restated to reflect changes in accounting policies as disclosed
in note 2 to the Consolidated Financial Statements.
The table above highlights the Fund's performance for the fourth quarter of
2005 and also for the preceding seven quarters. Advantage's net income and
funds from operations have improved over the last several quarters primarily
due to increased revenues. Significant increases in total revenues occurred in
the fourth quarter of 2004 through the fourth quarter of 2005 due to both
production and commodity price increases. Advantage completed the acquisition
of assets from Anadarko on September 15, 2004 and the acquisition of Defiant
on December 21, 2004. These two acquisitions resulted in an increase of daily
Advantage Energy Income Fund - 13
production volumes for the fourth quarter of 2004 and the first quarter of
2005. Production levels subsequently decreased due to both natural declines
and high initial production declines that are normally experienced with new
production. However, as the areas mature, per well production levels will
stabilize with lower rates of decline. Additional production challenges
encountered by Advantage through 2005, as well as the entire sector, has
included delays in production additions due to extremely wet field conditions,
plant turnarounds, maintenance programs, services availability and drilling
and service rig availability.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with GAAP requires
Management to make certain judgments and estimates. Changes in these judgments
and estimates could have a material impact on the Fund's financial results and
financial condition. Management relies on the estimate of reserves as prepared
by the Fund's independent qualified reserves evaluator. The process of
estimating reserves is critical to several accounting estimates. The process
of estimating reserves is complex and requires significant judgments and
decisions based on available geological, geophysical, engineering and economic
data. These estimates may change substantially as additional data from ongoing
development and production activities becomes available and as economic
conditions impact crude oil and natural gas prices, operating costs, royalty
burden changes, and future development costs. Reserve estimates impact net
income through depletion and depreciation of property and equipment, the
provision for asset retirement costs and related accretion expense, and
impairment calculations for property and equipment and goodwill. The reserve
estimates are also used to assess the borrowing base for the Fund's credit
facilities. Revision or changes in the reserve estimates can have either a
positive or a negative impact on net income and the borrowing base of the
Fund.
FINANCIAL REPORTING UPDATE
During 2005 there were several changes to financial reporting requirements.
The changes impacting Advantage are noted below.
FINANCIAL INSTRUMENTS - PRESENTATION AND DISCLOSURE
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.
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
Advantage Energy Income Fund - 14
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.
FINANCIAL INSTRUMENTS - RECOGNITION AND MEASUREMENT
In April 2005, a series of new accounting standards were released which
established guidance for the recognition and measurement of financial
instruments. These new standards includes Section 1530 "Comprehensive Income",
Section 3855 "Financial Instruments -- Recognition and Measurement", and
Section 3865 "Hedges". The new standards also resulted in a number of
significant consequential amendments to other accounting standards to
accommodate the new sections. The standards require all applicable financial
instruments to be classified into one of several categories including:
financial assets and financial liabilities held for trading, held-to-maturity
investments, loans and receivables, available-for-sale financial assets, or
other financial liabilities. The financial instruments are then included on a
company's balance sheet and measured at fair value, cost or amortized value,
depending on the classification. Subsequent measurement and recognition of
changes in value of the financial instruments also depends on the initial
classification. These standards are effective for interim and annual financial
statements for fiscal years beginning on or after October 1, 2006 and must be
implemented simultaneously. Advantage has not yet assessed the full impact, if
any, of these standards on the consolidated financial statements. However, the
Fund anticipates adoption of the new standards on January 1, 2007.
CONTROLS AND PROCEDURES
The Fund has established procedures and internal control systems to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
GAAP. Management of the Fund is committed to providing timely, accurate and
balanced disclosure of all material information about the Fund. Disclosure
controls and procedures are in place to ensure all ongoing reporting
requirements are met and material information is disclosed on a timely basis.
The President and Chief Executive Officer and Vice-President Finance and Chief
Financial Officer, individually, sign certifications that the annual financial
statements together with the other financial information included in the
annual filings fairly present in all material respects the financial
condition, results of operation, and cash flows as of the dates and for the
periods presented in the annual filings. The certifications further
acknowledge that the annual filings do not contain any untrue statement of a
material fact or omit to state a material fact required to be stated or that
is necessary to make a statement not misleading in light of the circumstances
under which it was made, with respect to the period covered by the annual
filings. During 2005, there were no significant changes that would materially
affect, or is reasonably likely to materially affect, the internal controls
over financial reporting.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Management of Advantage, including our President and Chief Executive Officer
and Vice-President and Chief Financial Officer, has evaluated the
effectiveness of the design and operation of the disclosure controls and
procedures as of December 31, 2005. Based on that evaluation, Management has
concluded that the disclosure controls and procedures are effective as of the
end of the period, in all material respects.
BUSINESS PROCESS PROJECT AND SARBANES-OXLEY
In 2002, the United States Congress enacted the Sarbanes-Oxley Act ("SOX")
that applies to all companies registered with the Securities and Exchange
Commission. Section 404 of the Act requires that Management identify,
document, assess and remediate internal controls and issue an opinion on the
effectiveness of internal controls surrounding the financial reporting
processes. The current deadline for Advantage to comply with the internal
controls assessment is December 31, 2006. The Fund established a business
process project with a team leader in May 2005 to ensure full compliance with
SOX by the given deadline. The business process project will also ensure full
compliance with any similar resulting Canadian regulations that will be
enacted. A comprehensive project plan has been established with full support
of Management and the Board of Directors. Regular updates on status of the
project and developments are provided to the Fund's Audit Committee.
CORPORATE GOVERNANCE
Advantage Investment Management Ltd. has been retained by the Trustee of the
Fund and by AOG to provide advisory and management services to the Fund and to
AOG. The Board of Directors' mandate is to supervise the management of the
business and affairs of the Fund including the business and affairs of the
Fund delegated to AOG. In particular, all decisions relating to: (i) the
acquisition and disposition of properties for a purchase price or proceeds in
excess of $2 million; (ii) the approval of annual operating and capital
expenditure budgets; and (iii) the establishment of credit facilities, will be
made by the Board.
Computershare Trust Company of Canada, the Trustee of the Fund, has delegated
certain matters to the Board of Directors. These include all decisions
relating to issuance of additional Trust Units and the determination of the
amount of distributions. Any amendment to any material contract to which the
Advantage Energy Income Fund - 15
Fund is a party will require the approval of the Board of Directors and, in
some cases, Unitholder approval.
The Board of Directors meets regularly to review the business and affairs of
the Fund and AOG and to make any required decisions.
The Board of Directors consists of eight members, six of whom are unrelated to
the Fund. The Independent Reserve Evaluation Committee has three members, all
of whom are independent. The Human Resources, Compensation and Corporate
Governance Committee and Audit Committee each have four members, all of whom
are independent. In addition, the Chairman of the Board is not related and is
not an executive officer of the Fund.
A further discussion of the Fund's corporate governance practices can be found
in the Management Proxy Circular.
OUTLOOK
Advantage's funds from operations in 2006 will continue to be impacted by the
volatility of crude oil and natural gas prices and the $US/$Cdn exchange rate.
Advantage will continue to distribute a significant portion of its cash flow
in 2006 with the distribution level set by the Board of Directors of AOG
dependent on the level of commodity prices and success of the Fund's drilling
and development program and acquisition activities. In 2006, Advantage will
continue to follow its strategy of acquiring properties that provide low risk
development opportunities and enhance long term cash flow. The market for
property acquisitions in 2006 will continue to be very competitive as a result
of strong commodity prices, ease of access to capital for acquiring companies,
and the increased demand for production that has resulted from the larger
number of trusts in the market place. Advantage will also continue to focus on
low cost production and reserve additions through low to medium risk
development drilling opportunities that have arisen as a result of the
acquisitions completed in prior years. Advantage's Board of Directors approved
a 2006 capital expenditures budget of $92 million which will include the
drilling, completion and tie-in of 116 gross wells (96.2 net) and the
recompletion of 56 gross wells (52.0 net). Approximately 56% of the budget
will be directed towards ongoing development of the Fund's crude oil
properties with the balance or 44% spent on natural gas projects. Drilling
activities are planned for 15 separate project areas with the most significant
being Nevis, Medicine Hat, Sunset and Sweetgrass, all in Alberta and Midale,
Saskatchewan. Recompletion activities are planned primarily at Medicine Hat,
Alberta and on properties in Southeast Saskatchewan. The natural gas projects
include the expenditure of $10.6 million for drilling and facility
construction related to 24.4 net coal bed methane wells ("CBM") on five
separate project areas in central Alberta. Advantage's CBM program in 2006
will be directed primarily to the development of Horseshoe Canyon Coals.
The following table indicates our funds from operations sensitivity to changes
in prices and production of natural gas, crude oil and NGLs, exchange rates
and interest rates for 2006 based on production of 19,200 boe/d comprised of
72.4 mmcf/d of natural gas and 7,100 bbls/d of crude oil and NGLs. Advantage
is considerably more sensitive to changes in natural gas prices as compared to
oil due to the Fund's higher natural gas weighting.
SENSITIVITIES ANNUAL
ANNUAL FUNDS FROM OPERATIONS
FUNDS FROM OPERATIONS PER TRUST UNIT
($000) ($/TRUST UNIT)
- -----------------------------------------------------------------------------------------------
Natural gas
AECO monthly price change of $0.25/mcf $ 5,200 $ 0.09
Production change of 1,000 mcf/d $ 1,800 $ 0.03
Crude oil and NGLs
WTI price change of US$1.00/bbl $ 2,100 $ 0.04
Production change of 200 bbls/d $ 3,100 $ 0.05
US$/Cdn$ exchange rate change of $0.01 $ 3,400 $ 0.06
Interest rate change of 1% $ 2,600 $ 0.04
ADDITIONAL INFORMATION
Additional information relating to Advantage can be found on SEDAR at
www.sedar.com and the Fund's website at www.advantageincome.com. Such other
information includes the annual information form, the annual information
circular - proxy statement, press releases, material contracts and agreements,
and other financial reports. The annual information form will be of particular
interest for current and potential Unitholders as it discusses a variety of
subject matter including the nature of the business, structure of the Fund,
description of our operations, general and recent business developments, risk
factors, reserves data and other oil and gas information.
Advantage Energy Income Fund - 16