EXHIBIT 99.2
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ADVANTAGE ENERGY INCOME FUND
CONSOLIDATED FINANCIAL STATEMENTS
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
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 fulfills its financial
reporting and internal control responsibilities. The Audit Committee is
responsible for meeting regularly with Management, the external auditors, and
the internal auditors 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.
PricewaterhouseCoopers LLP, an independent firm of Chartered Accountants,
appointed by the Board of Directors as the external auditor of the Fund, has
audited the consolidated balance sheet as at December 31, 2007 and the
consolidated statements of income, comprehensive income, accumulated deficit
and cash flows for the year then ended. KPMG LLP, an independent firm of
Chartered Accountants, has audited the consolidated balance sheet as at
December 31, 2006 and the consolidated statements of income, accumulated
deficit and cash flows for the year then ended. The external auditors conducted
their audits in accordance with Canadian generally accepted auditing standards
and have unlimited and unrestricted access to the Audit Committee.
/s/ Kelly I. Drader /s/ Peter A. Hanrahan
Kelly I. Drader Peter A. Hanrahan
CEO VP Finance & CFO
March 5, 2008
Advantage Energy Income Fund - 1
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Management of Advantage Energy Income Fund (the "Fund") is responsible for
establishing and maintaining adequate internal control over financial reporting
for the Fund as such term is defined in Rule 13a-15(f) of the Securities
Exchange Act of 1934, as amended. Under the supervision of our Chief Executive
Officer and Chief Financial Officer, we have conducted an evaluation of the
effectiveness of our internal control over financial reporting based on the
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission ("COSO"). Based on our assessment, we
have concluded that as of December 31, 2007, our internal control over
financial reporting was effective.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP, the Fund's independent firm of Chartered
Accountants, was appointed by the Board of Directors to audit and provide
independent opinions on both the Consolidated Financial Statements and the
Fund's internal control over financial reporting as at December 31, 2007, as
stated in their Auditor's Report. PricewaterhouseCoopers LLP has provided such
opinions.
/s/ Kelly I. Drader /s/ Peter A. Hanrahan
Kelly I. Drader Peter A. Hanrahan
CEO VP Finance & CFO
March 5, 2008
Advantage Energy Income Fund - 2
INDEPENDENT AUDITORS' REPORT
To the Unitholders of Advantage Energy Income Fund
We have completed an integrated audit of the consolidated financial statements
and internal control over financial reporting of Advantage Energy Income Fund
(the "Fund") as at December 31, 2007. Our opinions, based on our audits, are
presented below.
CONSOLIDATED FINANCIAL STATEMENTS
We have audited the accompanying consolidated balance sheet of the Fund as at
December 31, 2007, and the related consolidated statements of income (loss) and
comprehensive income (loss) and accumulated deficit and cash flows for the year
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 audit.
We conducted our audit of the Fund's financial statements in accordance with
Canadian generally accepted auditing standards and the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform an audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit of
financial statements includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. A financial statement
audit also includes assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Fund as at
December 31, 2007 and the results of its operations and its cash flows for the
year then ended in accordance with Canadian generally accepted accounting
principles.
The financial statements as at December 31, 2006 and for the year then ended
were audited by other auditors who expressed an opinion without reservation on
those statements in their report dated March 21, 2007.
INTERNAL CONTROL OVER FINANCIAL REPORTING
We have also audited Advantage Energy Income Fund's internal control over
financial reporting as at December 31, 2007, based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Fund's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting, included in the accompanying Management's Report on Internal Control
over Financial Reporting. Our responsibility is to express an opinion on the
effectiveness of the Fund's internal control over financial reporting based on
our audit.
We conducted our audit of internal control over financial reporting in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over
financial reporting was maintained in all material respects. An audit of
internal control over financial reporting includes obtaining an understanding
of internal control over financial reporting, assessing the risk that a
material weakness exists, testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk, and performing
such other procedures as we consider necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control
over financial reporting includes those policies and procedures that (i)
pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the
company; (ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management
and directors of the company; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our opinion, the Fund maintained, in all material respects, effective
internal control over financial reporting as at December 31, 2007 based on
criteria established in Internal Control -- Integrated Framework issued by the
COSO.
/s/ PricewaterhouseCoopers LLP
Chartered Accountants
Calgary, Canada
March 5, 2008
Advantage Energy Income Fund - 3
CONSOLIDATED BALANCE SHEETS
(thousands of dollars) DECEMBER 31, 2007 DECEMBER 31, 2006
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ASSETS
Current assets
Accounts receivable $ 95,474 $ 79,537
Prepaid expenses and deposits 21,988 16,878
Derivative asset (note 12) 7,027 9,840
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124,489 106,255
Deposit on property acquisition - 1,410
Derivative asset (note 12) 174 593
Fixed assets (note 4) 2,177,346 1,753,058
Goodwill (note 3) 120,271 120,271
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$ 2,422,280 $ 1,981,587
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LIABILITIES
Current liabilities
Accounts payable and accrued liabilities $ 122,087 $ 116,109
Distributions payable to Unitholders 16,592 18,970
Current portion of capital lease obligations (note 5) 1,537 2,527
Current portion of convertible debentures (note 6) 5,333 1,464
Derivative liability (note 12) 2,242 -
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147,791 139,070
Derivative liability (note 12) 2,778 -
Capital lease obligations (note 5) 5,653 305
Bank indebtedness (note 7) 547,426 410,574
Convertible debentures (note 6) 212,203 170,819
Asset retirement obligations (note 8) 60,835 34,324
Future income taxes (note 9) 66,727 61,939
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1,043,413 817,031
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UNITHOLDERS' EQUITY
Unitholders' capital (note 10) 2,027,065 1,592,758
Convertible debentures equity component (note 6) 9,632 8,041
Contributed surplus (note 10) 2,005 863
Accumulated deficit (note 11) (659,835) (437,106)
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1,378,867 1,164,556
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$ 2,422,280 $ 1,981,587
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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:
/s/ Rodger A. Tourigny /s/ Kelly I. Drader
Rodger A. Tourigny, Director Kelly I. Drader, Director
Advantage Energy Income Fund - 4
CONSOLIDATED STATEMENTS OF INCOME (LOSS),
COMPREHENSIVE INCOME AND ACCUMULATED DEFICIT
YEAR ENDED YEAR ENDED
(thousands of dollars, except for per Trust Unit amounts) DECEMBER 31, 2007 DECEMBER 31, 2006
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REVENUE
Petroleum and natural gas $ 538,764 $ 414,430
Realized gain on derivatives (note 12) 18,594 5,297
Unrealized gain (loss) on derivatives (note 12) (11,049) 10,242
Royalties, net of Alberta Royalty Credit (98,614) (76,456)
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447,695 353,513
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EXPENSES
Operating 127,309 82,911
General and administrative 21,449 13,738
Management fee (note 13) - 887
Performance incentive (note 13) - 2,380
Management internalization (note 13) 15,708 13,449
Interest 24,351 18,258
Interest and accretion on convertible debentures 17,436 13,316
Depletion, depreciation and accretion 272,175 194,309
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478,428 339,248
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Income (loss) before taxes and non-controlling interest (30,733) 14,265
Future income tax reduction (note 9) (24,642) (37,087)
Income and capital taxes (note 9) 1,444 1,509
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(23,198) (35,578)
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Net income (loss) before non-controlling interest (7,535) 49,843
Non-controlling interest - 29
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NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS) (7,535) 49,814
Accumulated deficit, beginning of year (437,106) (269,674)
Distributions declared (215,194) (217,246)
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ACCUMULATED DEFICIT, END OF YEAR $ (659,835) $ (437,106)
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Net income (loss) per Trust Unit (note 10)
Basic $ (0.06) $ 0.62
Diluted $ (0.06) $ 0.61
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see accompanying Notes to Consolidated Financial Statements
Advantage Energy Income Fund - 5
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED YEAR ENDED
(thousands of dollars) DECEMBER 31, 2007 DECEMBER 31, 2006
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OPERATING ACTIVITIES
Net income (loss) $ (7,535) $ 49,814
Add (deduct) items not requiring cash:
Unrealized loss (gain) on derivatives 11,049 (10,242)
Unit-based compensation 929 -
Performance incentive - 2,380
Management internalization 15,708 13,449
Non-cash interest expense 890 -
Accretion on convertible debentures 2,569 2,106
Depletion, depreciation and accretion 272,175 194,309
Future income tax (24,642) (37,087)
Non-controlling interest - 29
Expenditures on asset retirement (6,951) (5,974)
Changes in non-cash working capital (15,060) 20,303
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Cash provided by operating activities 249,132 229,087
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FINANCING ACTIVITIES
Units issued, net of costs (note 10) 104,215 141,908
Debentures redeemed (note 6) (19,406) -
Increase (decrease) in bank indebtedness 28,893 (30,767)
Reduction of capital lease obligations (3,184) (1,019)
Distributions to Unitholders (170,915) (185,015)
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Cash used in financing activities (60,397) (74,893)
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INVESTING ACTIVITIES
Expenditures on property and equipment (148,725) (159,487)
Property acquisitions (16,051) (244)
Property dispositions 1,037 8,727
Acquisition of Sound Energy Trust (note 3) (22,307) -
Acquisition of Ketch Resources Trust (note 3) - (10,109)
Changes in non-cash working capital (2,689) 6,919
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Cash used in investing activities (188,735) (154,194)
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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 $ 42,017 $ 34,680
Taxes paid $ 2,062 $ 1,783
see accompanying Notes to Consolidated Financial Statements
Advantage Energy Income Fund - 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2007
All tabular amounts in thousands except as otherwise indicated
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 wholly-owned
subsidiary, AOG. 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. Distributions from the
Fund to Unitholders are entirely discretionary and 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, taxability to Unitholders, working
capital requirements, and other potential cash expenditures.
Distributions are announced monthly and are based on the cash available
after retaining a portion to meet such spending requirements. The level
of distributions are primarily determined by cash flows received from the
production of oil and natural gas from existing Canadian resource
properties and are highly dependent upon our success in exploiting the
current reserve base and acquiring additional reserves. Furthermore,
monthly distributions we pay to Unitholders are highly dependent upon the
prices received for such oil and natural gas production. It is our
long-term objective to provide stable and sustainable distributions to
the Unitholders, while continuing to grow the Fund.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Management of the Fund prepares its consolidated financial statements
in accordance with Canadian generally accepted accounting principles
("Canadian GAAP") and all amounts are stated in Canadian dollars. The
preparation of consolidated financial statements requires Management to
make estimates and assumptions that affect 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 - 7
(b) FIXED ASSETS
(i) PETROLEUM AND NATURAL GAS PROPERTIES
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 and completion, 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. There has been no impairment of the Fund's
petroleum and natural gas properties since inception.
(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 since inception.
(d) DISTRIBUTIONS
Distributions are calculated on an accrual basis and are paid to
Unitholders monthly.
(e) FINANCIAL INSTRUMENTS
Effective January 1, 2007, the Fund adopted CICA Handbook sections 3855
"Financial Instruments - Recognition and Measurement", 3862 "Financial
Instruments - Disclosures", 3863 "Financial Instruments - Presentation",
and 3865 "Hedges".
Advantage Energy Income Fund - 8
Section 3855 "Financial Instruments - Recognition and Measurement"
establishes criteria for recognizing and measuring financial instruments
including financial assets, financial liabilities and non-financial
derivatives. Under this standard, all financial instruments must
initially be recognized at fair value on the balance sheet. Measurement
of financial instruments subsequent to the initial recognition, as well
as resulting gains and losses, are recorded based on how each financial
instrument was initially classified. The Fund has classified each
identified financial instrument into the following categories: held for
trading, loans and receivables, held to maturity investments, available
for sale financial assets, and other financial liabilities. Held for
trading financial instruments are measured at fair value with gains and
losses recognized in earnings immediately. Available for sale financial
assets are measured at fair value with gains and losses, other than
impairment losses, recognized in other comprehensive income and
transferred to earnings when the asset is derecognized. Loans and
receivables, held to maturity investments and other financial liabilities
are recognized at amortized cost using the effective interest method and
impairment losses are recorded in earnings when incurred. Upon adoption
and with all new financial instruments, an election is available that
allows entities to classify any financial instrument as held for trading.
Only those financial assets and liabilities that must be classified as
held for trading by the standard have been classified as such by the
Fund. As the Fund frequently utilizes non-financial derivative
instruments to manage market risk associated with volatile commodity
prices, such instruments must be classified as held for trading and
recorded on the balance sheet at fair value as derivative assets and
liabilities. Section 3865 "Hedges" provides an alternative to recognizing
gains and losses on derivatives in earnings if the instrument is
designated as part of a hedging relationship and meets the necessary
criteria. Under the alternative hedge accounting treatment, gains and
losses on derivatives classified as effective cash flow hedges are
included in other comprehensive income until the time at which the hedged
item is realized. The Fund does not utilize derivative instruments for
speculative purposes but has elected not to apply hedge accounting.
Therefore, gains and losses on these instruments are recorded as
unrealized gains and losses on derivatives in the consolidated statement
of income, comprehensive income and accumulated deficit in the period
they occur and as realized gains and losses on derivatives when the
contracts are settled. Since unrealized gains and losses on derivatives
are non-cash items, there is no impact on the statement of cash flows as
a result of their recognition.
In some instances, derivative financial instruments can be embedded
within other contracts. Embedded derivatives within a host contract must
be recorded separately from the host contract when their economic
characteristics and risks are not clearly and closely related to those of
the host contract, the terms of the embedded derivatives are the same as
those of a freestanding derivative, and the combined contract is not
classified as held for trading or designated at fair value. The Fund
selected January 1, 2003, as its accounting transition date for any
potential embedded derivatives and has not identified any embedded
derivatives that would require separation from the host contract and fair
value accounting.
Transaction costs are frequently attributed to the acquisition or issue
of a financial asset or liability. Section 3855 requires that such
transaction costs incurred on held for trading financial instruments be
expensed immediately. For other financial instruments, an entity can
adopt an accounting policy of either expensing transaction costs as they
occur or adding such transaction costs to the fair value of the financial
instrument. The Fund has chosen a policy of adding transaction costs to
the fair value initially recognized for financial assets and liabilities
that are not classified as held for trading.
The Fund has adopted the new standards prospectively as required which
allows amendments to the carrying values of financial instruments,
effective as of the adoption date, to be recognized as an adjustment to
the beginning balance of accumulated deficit. As the new standards have
not resulted in any significant changes to the recognition and
measurement of the Fund's financial instruments, no adjustment to
accumulated deficit was required. The new standards also require several
additional disclosures in the notes to the financial statements. Among
the disclosures required, the Fund must disclose the exposure to various
risks associated with financial instruments and the policies that exist
to manage these risks.
(f) COMPREHENSIVE INCOME
Effective January 1, 2007, the Fund adopted CICA Handbook section 1530
"Comprehensive Income". Comprehensive income consists of net income and
other comprehensive income ("OCI") with amounts included in OCI shown net
of tax. Accumulated other comprehensive income is a new equity category
comprised of the cumulative amounts of OCI. To date, the Fund does not
have any adjustments in OCI and therefore comprehensive income is
currently equal to net income.
(g) CONVERTIBLE DEBENTURES
The Fund's convertible debentures are financial liabilities consisting of
a liability with an embedded conversion feature. As such, the debentures
are 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 and expensed accordingly. As
debentures are converted to Trust Units, an appropriate portion of the
liability and equity components are transferred to Unitholders' capital.
Advantage Energy Income Fund - 9
(h) 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 obligations 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 fixed assets. 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. 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 obligations are charged
against the obligation to the extent of the liability recorded.
(i) 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.
(j) UNIT-BASED COMPENSATION
Advantage accounts for compensation expense based on the "fair value" of
rights granted under its unit-based compensation plans. The Fund has
Trust Units held in escrow relating to the management internalization
(note 13) as well as a unit-based compensation plan for external
directors of the Fund, a Restricted Trust Unit Plan and Trust Units
issuable for the retention of certain employees of the Fund (note 10).
The escrowed Trust Units relating to the management internalization vest
equally over three years, the period during which employees are required
to provide service to receive the Trust Units. Therefore, the management
internalization consideration is being deferred and amortized into income
as management internalization expense over the specific vesting periods
during which employee services are provided, including an estimate of
future Trust Unit forfeitures.
Awards under the external directors' unit-based compensation plan vest
immediately with associated compensation expense recognized in the
current period earnings and estimated forfeiture rates are not
incorporated in 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.
Advantage's current employee compensation includes a Restricted Trust
Unit Plan (the "Plan"), as approved by the Unitholders on June 23, 2006,
and Trust Units issuable for the retention of certain employees of the
Fund. The Plan authorizes the Board of Directors to grant Restricted
Trust Units ("RTUs") to directors, officers, or employees of the Fund.
The number of RTUs granted is based on the Fund's Trust Unit return for a
calendar year and compared to a peer group approved by the Board of
Directors. The Trust Unit return is calculated at the end of the year and
is primarily based on the year-over-year change in the Trust Unit price
plus distributions. The RTU grants vest one third immediately on grant
date, with the remaining two thirds vesting evenly on the following two
yearly anniversary dates. The holders of RTUs may elect to receive cash
upon vesting in lieu of the number of Trust Units to be issued, subject
to consent of the Fund. Compensation cost related to the Plan is
recognized as compensation expense over the service period and
incorporates the period end Trust Unit price, the estimated number of
RTUs to vest, and certain management estimates. The maximum amount of
RTUs granted in any one calendar year is limited to 175% of the base
salaries of those individuals participating in the Plan for such period.
(k) 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.
Advantage Energy Income Fund - 10
(l) 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 granted to directors and
the management internalization escrowed Trust Units.
(m) MEASUREMENT UNCERTAINTY
The amounts recorded for depletion and depreciation of property and
equipment, the provision for asset retirement obligation costs and
related accretion expense, impairment calculations for fixed assets and
goodwill, derivative fair value calculations, future income tax
provisions, as well as fair values assigned to any identifiable assets
and liabilities in business combinations 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, 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.
(n) ACCOUNTING CHANGES
Effective January 1, 2007, the Fund adopted the revised recommendations
of CICA section 1506 "Accounting Changes". The new recommendations permit
voluntary changes in accounting policy only if they result in financial
statements which provide more reliable and relevant information.
Accounting policy changes are applied retrospectively unless it is
impractical to determine the period or cumulative impact of the change.
Corrections of prior period errors are applied retrospectively and
changes in accounting estimates are applied prospectively by including
the changes in earnings. The guidance was effective for all changes in
accounting polices, changes in accounting estimates and corrections of
prior period errors initiated in periods beginning on or after January 1,
2007.
(o) RECENT ACCOUNTING PRONOUNCEMENTS ISSUED BUT NOT IMPLEMENTED
The CICA has issued section 1535 "Capital Disclosures", which will be
effective January 1, 2008 for the Fund. Section 1535 will require the
Fund to provide additional disclosures relating to capital and how it is
managed. It is not anticipated that the adoption of section 1535 will
impact the amounts reported in the Fund's financial statements as they
primarily relate to disclosure.
(p) COMPARATIVE FIGURES
Certain comparative figures have been reclassified to conform to the
current year's presentation.
3. ACQUISITIONS
(a) SOUND ENERGY TRUST
On September 5, 2007, Advantage acquired all of the issued and
outstanding Trust Units and Exchangeable Shares of Sound Energy Trust
("Sound") for $21.4 million cash consideration, 16,977,184 Advantage
Trust Units and $0.9 million of acquisition costs. Sound Unitholders and
Exchangeable Shareholders could elect to receive 0.30 Advantage Trust
Units for each Sound Trust Unit or receive $0.66 in cash and 0.2557
Advantage Trust Units for each Sound Trust Unit. All of the Sound
Exchangeable Shares were exchanged for Advantage Trust Units on the same
ratio as the Sound Trust Units based on the conversion ratio in effect at
the effective date of the acquisition. Sound was an energy trust engaged
in the development, acquisition and production of, natural gas and crude
oil in western Canada. The acquisition is being accounted for using the
"purchase method" with the results of operations included in the
consolidated financial statements as of the closing date of the
acquisition.
The purchase price has been allocated as follows:
NET ASSETS ACQUIRED AND LIABILITIES ASSUMED: CONSIDERATION:
Fixed assets $ 509,656 16,977,184 Trust Units issued $ 228,852
Accounts receivable 27,433 Cash 21,403
Prepaid expenses and deposits 3,873 Acquisition costs incurred 904
Derivative asset, net 2,797 ----------
Bank indebtedness (107,959) $ 251,159
Convertible debentures (101,553) ----------
Accounts payable and accrued liabilities (35,396)
Future income taxes (29,430)
Asset retirement obligations (16,695)
Capital lease obligations (1,567)
------------
$ 251,159
------------
Advantage Energy Income Fund - 11
The value of the Trust Units issued as 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
due to the realization of estimates and is subject to further refinement
as additional cost estimates and tax balances are finalized.
(b) KETCH RESOURCES TRUST
On June 23, 2006, Advantage acquired all of the issued and outstanding
Trust Units of Ketch Resources Trust ("Ketch") in return for 32,870,465
Advantage Trust Units, utilizing an exchange ratio of 0.565 Advantage
Trust Units for each Ketch Trust Unit outstanding. Ketch was an energy
trust engaged in the development, acquisition and production of, natural
gas and crude oil in western Canada. The acquisition is being accounted
for using the "purchase method" with the results of operations included in
the consolidated financial statements as of the closing date of the
acquisition. The purchase price has been allocated as follows:
NET ASSETS ACQUIRED AND LIABILITIES ASSUMED: CONSIDERATION:
Fixed assets $ 877,463 32,870,465 Trust Units issued $ 688,636
Goodwill 74,798 Acquisition costs incurred 10,109
Accounts receivable 55,806 ----------
Prepaid expenses and deposits 6,406 $ 698,745
Cash 2,713 ----------
Bank indebtedness (191,578)
Convertible debentures (69,952)
Accounts payable (46,834)
Asset retirement obligations (7,930)
Capital lease obligation (2,147)
-------------
$ 698,745
-------------
The value of the Trust Units issued as 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.
4. FIXED ASSETS
ACCUMULATED NET BOOK
DECEMBER 31, 2007 COST DEPLETION AND DEPRECIATION VALUE
------------------------------------------------------------------------------------------------------------------------
Petroleum and natural gas properties $ 3,016,243 $ 844,671 $2,171,572
Furniture and equipment 10,548 4,774 5,774
------------------------------------------------------------------------------------------------------------------------
$ 3,026,791 $ 849,445 $2,177,346
------------------------------------------------------------------------------------------------------------------------
ACCUMULATED NET BOOK
DECEMBER 31, 2006 COST DEPLETION AND DEPRECIATION VALUE
------------------------------------------------------------------------------------------------------------------------
Petroleum and natural gas properties $ 2,324,948 $ 576,707 $1,748,241
Furniture and equipment 8,175 3,358 4,817
------------------------------------------------------------------------------------------------------------------------
$ 2,333,123 $ 580,065 $1,753,058
------------------------------------------------------------------------------------------------------------------------
During the year ended December 31, 2007, Advantage capitalized general and
administrative expenditures directly related to exploration and
development activities of $9,653,000 (2006 - $6,444,000).
Costs of $60,238,000 (2006 - $43,467,000) for unproved properties have
been excluded from the calculation of depletion expense, and future
development costs of $190,146,000 (2006 - $123,464,000) have been included
in costs subject to depletion.
Advantage Energy Income Fund - 12
The Fund performed a ceiling test calculation at December 31, 2007 to
assess the recoverable value of fixed assets. Based on the calculation,
the carrying amounts are recoverable as compared to the sum of the
undiscounted net cash flows expected from the production of proved
reserves based on the following benchmark prices:
WTI CRUDE OIL EXCHANGE RATE AECO GAS
YEAR ($US/BBL) ($US/$CDN) ($CDN/MMBTU)
-------------------------------------------------------------------------------------------
2008 $ 89.61 $ 1.00 $ 6.51
2009 $ 86.01 $ 1.00 $ 7.22
2010 $ 84.65 $ 1.00 $ 7.69
2011 $ 82.77 $ 1.00 $ 7.70
2012 $ 82.26 $ 1.00 $ 7.61
2013 $ 82.81 $ 1.00 $ 7.78
-------------------------------------------------------------------------------------------
Approximate escalation rate after 2013 2.0% - 2.0%
-------------------------------------------------------------------------------------------
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 fixed assets. Future minimum
lease payments at December 31, 2007 consist of the following:
2008 $ 1,906
2009 2,040
2010 2,200
2011 1,925
---------------------------------------------------
8,071
Less amounts representing interest (881)
7,190
Current portion (1,537)
---------------------------------------------------
$ 5,653
---------------------------------------------------
On June 23, 2006, Advantage assumed a total capital lease obligation of
$2.1 million in the acquisition of Ketch (note 3). The lease ends in March
2008 and interest expense is recognized at 5.3%.
During the second quarter of 2007, Advantage entered a new lease
arrangement that resulted in the recognition of a fixed asset addition and
capital lease obligation of $4.1 million. The lease obligation bears
interest at 5.8% and is secured by the related equipment. The lease term
expires June 2011 with a final purchase obligation of $1.5 million at
which time ownership of the equipment will transfer to Advantage.
Effective September 4, 2007, Advantage entered a new lease arrangement
that resulted in the recognition of a fixed asset addition and capital
lease obligation of $1.8 million. The lease obligation bears interest at
6.7% and is secured by the related equipment. The lease term expires
August 2010 with a final payment obligation of $0.7 million. Distributions
to Unitholders are not permitted if the Fund is in default of such capital
lease.
On September 5, 2007, Advantage assumed two capital lease obligations in
the acquisition of Sound (note 3) resulting in the recognition of capital
lease obligations of $1.6 million. Both of the lease obligations bear
interest at 5.6% and are secured by the related equipment. The lease terms
expire December 2009 and April 2010 with a total final payment obligation
of $0.9 million.
Fixed assets subject to capital leases are depreciated 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 is included in depletion and depreciation expense.
Advantage Energy Income Fund - 13
6. 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. The details of the convertible debentures
including fair market values initially assigned and issuance costs are as
follows:
10.00% 9.00% 8.25% 8.75%
------------------------------------------------------------------------------------------------
Trading symbol AVN.DB AVN.DBA AVN.DBB AVN.DBF
Issue date Oct. 18, 2002 July 8, 2003 Dec. 2, 2003 June 10, 2004
Maturity date Matured Aug. 1, 2008 Feb. 1, 2009 June 30, 2009
Conversion price Matured $ 17.00 $ 16.50 $ 34.67
Liability component $ 52,722 $ 28,662 $ 56,802 $ 48,700
Equity component 2,278 1,338 3,198 11,408
------------------------------------------------------------------------------------------------
Gross proceeds 55,000 30,000 60,000 60,108
Issuance costs (2,495) (1,444) (2,588) -
------------------------------------------------------------------------------------------------
Net proceeds $ 52,505 $ 28,556 $ 57,412 $ 60,108
------------------------------------------------------------------------------------------------
7.50% 6.50% 7.75% 8.00% TOTAL
-----------------------------------------------------------------------------------------------------------
Trading symbol AVN.DBC AVN.DBE AVN.DBD AVN.DBG
Issue date Sep. 15, 2004 May 18, 2005 Sep. 15, 2004 Nov. 13, 2006
Maturity date Oct. 1, 2009 June 30, 2010 Dec. 1, 2011 Dec. 31, 2011
Conversion price $ 20.25 $ 24.96 $ 21.00 $ 20.33
Liability component $ 71,631 $ 66,981 $ 47,444 $ 14,884 $387,826
Equity component 3,369 2,971 2,556 26,561 53,679
-----------------------------------------------------------------------------------------------------------
Gross proceeds 75,000 69,952 50,000 41,445 441,505
Issuance costs (3,190) - (2,190) - (11,907)
-----------------------------------------------------------------------------------------------------------
Net proceeds $ 71,810 $ 69,952 $ 47,810 $ 41,445 $429,598
-----------------------------------------------------------------------------------------------------------
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
-----------------------------------------------------------------------------------------------------
9.00% 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
-----------------------------------------------------------------------------------------------------
8.75% After June 30, 2007 and on or before June 30, 2008 $1,050
After June 30, 2008 and before June 30, 2009 $1,025
-----------------------------------------------------------------------------------------------------
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
-----------------------------------------------------------------------------------------------------
6.50% After June 30, 2008 and on or before June 30, 2009 $1,050
After June 30, 2009 and before June 30, 2010 $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
-----------------------------------------------------------------------------------------------------
8.00% After December 31, 2009 and on or before December 31, 2010 $1,050
After December 31, 2010 and before December 31, 2011 $1,025
-----------------------------------------------------------------------------------------------------
Advantage Energy Income Fund - 14
The balance of debentures outstanding at December 31, 2007 and changes in
the liability and equity components during the years ended December 31,
2007 and 2006 are as follows:
10.00% 9.00% 8.25% 8.75%
------------------------------------------------------------------------------------------------------
Debentures outstanding $ - $ 5,392 $ 4,867 $ 29,839
------------------------------------------------------------------------------------------------------
Liability component:
Balance at Dec. 31, 2005 $ 2,453 $ 7,259 $ 8,150 $ -
Assumed on Ketch acquisition - - - -
Accretion of discount 30 107 103 -
Converted to Trust Units (1,019) (2,131) (3,577) -
------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2006 1,464 5,235 4,676 -
Assumed on Sound acquisition - - - 48,700
Accretion of discount 22 98 91 96
Converted to Trust Units (1,486) - - (8)
Redeemed for cash - - - (19,406)
------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2007 $ - $ 5,333 $ 4,767 $ 29,382
------------------------------------------------------------------------------------------------------
Equity component:
Balance at Dec. 31, 2005 $ 100 $ 323 $ 441 $ -
Assumed on Ketch acquisition - - - -
Converted to Trust Units (41) (94) (193) -
------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2006 59 229 248 -
Assumed on Sound acquisition - - - 11,408
Converted to Trust Units - - - (10,556)
Expired (59) - - -
------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2007 $ - $ 229 $ 248 $ 852
------------------------------------------------------------------------------------------------------
7.50% 6.50% 7.75% 8.00% TOTAL
----------------------------------------------------------------------------------------------------------------------
Debentures outstanding $ 52,268 $ 69,952 $46,766 $ 15,528 $224,612
----------------------------------------------------------------------------------------------------------------------
Liability component:
Balance at Dec. 31, 2005 $ 62,321 $ - $45,898 $ - $126,081
Assumed on Ketch acquisition - 66,981 - - 66,981
Accretion of discount 897 380 589 - 2,106
Converted to Trust Units (13,436) - (2,722) - (22,885)
----------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2006 49,782 67,361 43,765 - 172,283
Assumed on Sound acquisition - - - 14,884 63,584
Accretion of discount 889 731 595 47 2,569
Converted to Trust Units - - - - (1,494)
Redeemed for cash - - - - (19,406)
----------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2007 $ 50,671 $ 68,092 $44,360 $ 14,931 $217,536
----------------------------------------------------------------------------------------------------------------------
Equity component:
Balance at Dec. 31, 2005 $ 2,865 $ - $ 2,430 $ - $ 6,159
Assumed on Ketch acquisition - 2,971 - - 2,971
Converted to Trust Units (617) - (144) - (1,089)
----------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2006 2,248 2,971 2,286 - 8,041
Assumed on Sound acquisition - - - 26,561 37,969
Converted to Trust Units - - - (25,763) (36,319)
Expired - - - - (59)
----------------------------------------------------------------------------------------------------------------------
Balance at Dec. 31, 2007 $ 2,248 $ 2,971 $ 2,286 $ 798 $ 9,632
----------------------------------------------------------------------------------------------------------------------
Advantage Energy Income Fund - 15
As part of the acquisition of Ketch (note 3), the 6.50% convertible
debentures, originally issued May 18, 2005, were assumed by Advantage on
June 23, 2006.
Due to the acquisition of Sound (note 3), 8.75% and 8.00% convertible
debentures were assumed by Advantage on September 5, 2007. As a result of
the change in control of Sound, the Fund was required by the debenture
indentures to make an offer to purchase all of the outstanding convertible
debentures assumed from Sound at a price equal to 101% of the principal
amount plus accrued and unpaid interest. On October 17, 2007, the expiry
date of the offer, 911,709 Trust Units were issued and $19.9 million in
total cash consideration was paid in exchange for $29,665,000 8.75%
convertible debentures and 2,220,289 Trust Units were issued in exchange
for $25,507,000 8.0% convertible debentures.
During the year ended December 31, 2007, $24,000 debentures (2006 -
$24,333,000) were converted resulting in the issuance of 1,386 Trust Units
(2006 - 1,286,901 Trust Units) and all of the remaining $1,470,000 10%
convertible debentures matured on November 1, 2007 and were settled with
the issuance of 127,493 Trust Units.
7. BANK INDEBTEDNESS
Advantage has a credit facility agreement with a syndicate of financial
institutions which provides for a $690 million extendible revolving loan
facility and a $20 million operating loan facility. The loan's interest
rate is based on either prime, US base rate, LIBOR or bankers' acceptance
rates, at the Fund's option, subject to certain basis point or stamping
fee adjustments ranging from 0.00% to 1.25% depending on the Fund's debt
to cash flow ratio. The credit facilities are secured by a $1 billion
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 renewal due in June 2008. Various borrowing options are available
under the credit facilities, including prime rate-based advances, US base
rate advances, US dollar LIBOR 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. The only
financial covenant is a requirement for AOG to maintain a minimum cash
flow to interest expense ratio of 3.5:1, determined on a rolling four
quarter basis. Breach of any covenant will result in an event of default
in which case AOG has 20 days to remedy such default. If the default is
not remedied or waived, and if required by the majority of lenders, the
administrative agent of the lenders has the option to declare all
obligations of AOG under the credit facilities to be immediately due and
payable without further demand, presentation, protest, or notice of any
kind. 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. For the year ended
December 31, 2007, the effective interest rate on the outstanding amounts
under the facility was approximately 5.7% (2006 - 5.1%).
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 required to settle its
asset retirement obligations is approximately $243.9 million which will be
incurred between 2008 to 2057. A credit-adjusted risk-free rate of 7% and
an inflation factor of 2% were 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, 2007 DECEMBER 31, 2006
---------------------------------------------------------------------------------------
Balance, beginning of year $ 34,324 $ 21,263
Accretion expense 2,795 1,684
Assumed in Sound acquisition (note 3) 16,695 -
Assumed in Ketch acquisition (note 3) - 7,930
Liabilities incurred 13,972 9,421
Liabilities settled (6,951) (5,974)
---------------------------------------------------------------------------------------
Balance, end of year $ 60,835 $ 34,324
---------------------------------------------------------------------------------------
Advantage Energy Income Fund - 16
9. 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. On
December 14, 2007, the Federal government enacted legislation phasing in
corporate income tax rate reductions which will reduce federal tax rates
from 22.1% to 15.0% by 2012. Rate reductions will also apply to the new
tax on distributions of income trusts and other specified investment
flow-through entities as of 2011, reducing the tax rate in 2011 to 29.5%
and in 2012 to 28.0%. These rates include a deemed provincial rate of 13%.
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, 2007 DECEMBER 31, 2006
-----------------------------------------------------------------------------------------------------------------
Income (loss) before taxes $ (30,733) $ 14,265
-----------------------------------------------------------------------------------------------------------------
Canadian combined federal and provincial income tax rates 32.57% 34.78%
Expected income tax expense (recovery) at statutory rates (10,011) 4,961
Increase (decrease) in income taxes resulting from:
Amounts included in trust income (57,766) (39,940)
Change in enacted tax rates 550 (5,692)
Management internalization 4,554 4,678
Specified Investment Flow-Through 42,862 -
Non-deductible Crown charges - 6,925
Resource allowance - (8,108)
Other (4,831) 89
-----------------------------------------------------------------------------------------------------------------
Future income tax reduction (24,642) (37,087)
Income and capital taxes 1,444 1,509
-----------------------------------------------------------------------------------------------------------------
$ (23,198) $ (35,578)
-----------------------------------------------------------------------------------------------------------------
The components of the future income tax liability are as follows:
DECEMBER 31, 2007 DECEMBER 31, 2006
------------------------------------------------------------------------------------------------------------------
Fixed assets in excess of tax basis $ 29,240 $ 85,648
Asset retirement obligations (16,330) (10,141)
Non-capital tax loss carry forward (20,369) (8,851)
Trust assets in excess of tax basis 82,642 -
Other (8,456) (4,717)
------------------------------------------------------------------------------------------------------------------
Future income tax liability $ 66,727 $ 61,939
------------------------------------------------------------------------------------------------------------------
AOG has a non-capital tax loss carry forward of approximately $76 million
of which $1 million expires in 2008, $18 million in 2011, $11 million in
2012 and $46 million after 2020.
Advantage Energy Income Fund - 17
10. UNITHOLDERS' EQUITY
(a) UNITHOLDERS' CAPITAL
(i) AUTHORIZED
Unlimited number of voting Trust Units
(ii) ISSUED
NUMBER OF UNITS AMOUNT
----------------------------------------------------------------------------------------------
Balance at December 31, 2005 57,846,324 $ 681,574
2005 non-cash performance incentive 475,263 10,544
Issued on conversion of debentures 1,286,901 23,974
Issued on conversion of exchangeable shares 127,014 2,398
Issued on exercise of Trust Unit rights 122,500 682
Issued for Ketch acquisition (note 3) 32,870,465 688,636
Management internalization 1,913,842 38,716
2006 non-cash performance incentive 117,662 2,380
Distribution reinvestment plan 2,005,499 27,722
Issued for cash, net of costs 8,625,000 141,399
----------------------------------------------------------------------------------------------
Balance at December 31, 2006 105,390,470 1,618,025
Issued on conversion of debentures 128,879 1,494
Issued on exercise of Trust Unit rights 37,500 562
Issued for cash, net of costs 8,600,000 104,094
Distribution reinvestment plan 4,028,252 46,657
Issued for Sound acquisition, net of costs (note 3) 16,977,184 228,583
Issued on offer to purchase Sound debentures (note 6) 3,131,998 37,209
Management internalization forfeitures (24,909) (503)
----------------------------------------------------------------------------------------------
138,269,374 $ 2,036,121
----------------------------------------------------------------------------------------------
Management internalization escrowed Trust Units (9,056)
----------------------------------------------------------------------------------------------
Balance at December 31, 2007 $ 2,027,065
----------------------------------------------------------------------------------------------
On January 20, 2006, Advantage issued 475,263 Trust Units to satisfy the
obligation related to the 2005 year end performance incentive fee.
On June 23, 2006, Advantage issued 32,870,465 Trust Units as consideration
for the acquisition of Ketch (note 3). Concurrent with the Ketch
acquisition, Advantage internalized the external management contract
structure and eliminated all related fees for total original consideration
of 1,933,208 Advantage Trust Units initially valued at $39.1 million and
subject to escrow provisions over a 3-year period, vesting one-third each
year beginning June 23, 2007 (note 13). For the year ended December 31,
2007, a total of 24,909 Trust Units issued for the management
internalization were forfeited (2006 - 19,366 Trust Units) and $15.7
million has been recognized as management internalization expense (2006 -
$13.4 million). As at December 31, 2007, 1,193,622 Trust Units remain held
in escrow (December 31, 2006 - 1,822,098 Trust Units). The Fund also
issued 117,662 Trust Units on June 23, 2006, valued at $2.4 million, to
satisfy the final obligation related to the 2006 first quarter performance
fee.
On July 24, 2006, Advantage announced that it adopted a Premium
Distribution(TM), Distribution Reinvestment and Optional Trust Unit
Purchase Plan (the "Plan"). The Plan commenced with the monthly cash
distribution payable on August 15, 2006 to Unitholders of record on July
31, 2006. For eligible Unitholders that elect to participate in the Plan,
Advantage will settle the monthly distribution obligation through the
issuance of additional Trust Units at 95% of the Average Market Price (as
defined in the Plan). Unitholder enrollment in the Premium
Distribution(TM) component of the Plan effectively authorizes the
subsequent disposal of the issued Trust Units in exchange for a cash
payment equal to 102% of the cash distributions that the Unitholder would
otherwise have received if they did not participate in the Plan. During
the year ended December 31, 2007, 4,028,252 Trust
Advantage Energy Income Fund - 18
Units (2006 - 2,005,499 Trust Units) were issued under the Plan,
generating $46.7 million (2006 - $27.7 million) reinvested in the Fund.
On August 1, 2006, Advantage issued 7,500,000 Trust Units, plus an
additional 1,125,000 Trust Units upon full exercise of the Underwriters'
over-allotment option on August 4, 2006, at $17.30 per Trust Unit for net
proceeds of $141.4 million (net of Underwriters' fees and other issue
costs of $7.8 million). The net proceeds of the offering were used to pay
down bank indebtedness and to subsequently fund capital and general
corporate expenditures.
On February 14, 2007 Advantage issued 7,800,000 Trust Units, plus an
additional 800,000 Trust Units upon exercise of the Underwriters'
over-allotment option on March 7, 2007, at $12.80 per Trust Unit for
approximate net proceeds of $104.1 million (net of Underwriters' fees and
other issue costs of $6.0 million).
On September 5, 2007, Advantage issued 16,977,184 Trust Units, valued at
$228.9 million, as partial consideration for the acquisition of Sound
(note 3). Trust Unit issuance costs of $0.3 million were incurred for the
Sound acquisition.
Due to the acquisition of Sound (note 3), 8.75% and 8.00% convertible
debentures were assumed by Advantage on September 5, 2007. As a result of
the change in control of Sound, the Fund was required by the debenture
indentures to make an offer to purchase all of the outstanding convertible
debentures assumed from Sound at a price equal to 101% of the principal
amount plus accrued and unpaid interest. On October 17, 2007, the expiry
date of the offer, 911,709 Trust Units were issued and $19.9 million in
total cash consideration was paid in exchange for $29,665,000 8.75%
convertible debentures and 2,220,289 Trust Units were issued in exchange
for $25,507,000 8.0% convertible debentures.
(b) CONTRIBUTED SURPLUS
YEAR ENDED YEAR ENDED
DECEMBER 31, 2007 DECEMBER 31, 2006
------------------------------------------------------------------------------------------------
Balance, beginning of year $ 863 $ 1,036
Unit-based compensation 1,255 -
Expiration of convertible debentures equity component 59 -
Exercise of Trust Unit Rights (172) (173)
------------------------------------------------------------------------------------------------
Balance, end of year $ 2,005 $ 863
------------------------------------------------------------------------------------------------
(c) TRUST UNITS RIGHTS INCENTIVE PLAN
Effective June 25, 2002, a Trust Units Rights Incentive Plan for external
directors of the Fund was established and approved by the Unitholders of
Advantage. A total of 500,000 Trust Units have been reserved for issuance
under the plan with an aggregate of 400,000 rights granted since
inception. 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.
SERIES B
NUMBER PRICE
---------------------------------------------------------------------------
Balance at December 31, 2005 225,000 $ 13.63
Exercised (37,500) -
Reduction of exercise price - (2.66)
---------------------------------------------------------------------------
Balance at December 31, 2006 187,500 10.97
Exercised (37,500) -
Reduction of exercise price - (1.77)
---------------------------------------------------------------------------
Balance at December 31, 2007 150,000 $ 9.20
---------------------------------------------------------------------------
Expiration date June 17, 2008
---------------------------------------------------------------------------
Advantage Energy Income Fund - 19
(d) UNIT-BASED COMPENSATION
Advantage's current employee compensation includes a Restricted Trust Unit
Plan (the "Plan"), as approved by the Unitholders on June 23, 2006, and
Trust Units issuable for the retention of certain employees of the Fund.
The purpose of the long-term compensation plans is to retain and attract
employees, to reward and encourage performance, and to focus employees on
operating and financial performance that results in lasting Unitholder
return.
The Plan authorizes the Board of Directors to grant Restricted Trust Units
("RTUs") to directors, officers, or employees of the Fund. The number of
RTUs granted is based on the Fund's Trust Unit return for a calendar year
and compared to a peer group approved by the Board of Directors. The Trust
Unit return is calculated at the end of the year and is primarily based on
the year-over-year change in the Trust Unit price plus distributions. The
RTU grants vest one third immediately on grant date, with the remaining
two thirds vesting evenly on the following two yearly anniversary dates.
The holders of RTUs may elect to receive cash upon vesting in lieu of the
number of Trust Units to be issued, subject to consent of the Fund. As the
Fund did not meet the 2007 or 2006 grant thresholds, there were no RTU
grants made during these years.
For the year ended December 31, 2007, the Fund has accrued unit-based
compensation expense of $0.9 million recorded in general and
administrative expense (December 31, 2006 - nil) and has capitalized $0.3
million (December 31, 2006 - nil) related to Trust Units issuable for the
retention of certain employees of the Fund.
(e) NET INCOME (LOSS) PER TRUST UNIT
The calculation of basic and diluted net income (loss) per Trust Unit are
derived from both income (loss) available to Unitholders and weighted
average Trust Units outstanding calculated as follows:
YEAR ENDED YEAR ENDED
DECEMBER 31, 2007 DECEMBER 31, 2006
-----------------------------------------------------------------------------------------------
Income (loss) available to Unitholders
Basic and Diluted $ (7,535) $ 49,814
-----------------------------------------------------------------------------------------------
Weighted average Trust Units outstanding
Basic 119,604,019 80,958,455
Trust Units Rights Incentive Plan - Series A - 43,548
Trust Units Rights Incentive Plan - Series B - 78,287
Management Internalization - 113,556
-----------------------------------------------------------------------------------------------
Diluted 119,604,019 81,193,846
-----------------------------------------------------------------------------------------------
The calculation of diluted net income per Trust Unit excludes all series
of convertible debentures for the years 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, 2007 were 9,083,663
(2006 - 7,182,276). As at December 31, 2007, the total convertible
debentures outstanding were immediately convertible to 9,847,253 Trust
Units (2006 - 8,334,453).
All of the Series B Trust Unit Rights and Management Internalization
escrowed Trust Units have been excluded from the calculation of diluted
net income per Trust Unit for the year ended December 31, 2007, as the
impact would be anti-dilutive. Total weighted average Trust Units issuable
in exchange for the Series B Trust Unit Rights and Management
Internalization escrowed Trust Units and excluded from the diluted net
income per Trust Unit calculation for the year ended December 31, 2007
were 42,918 and 582,861, respectively. All of the remaining Series A Trust
Unit Rights were exercised July 7, 2006.
Exchangeable Shares have been excluded from the calculation of diluted net
income per Trust Unit for the year ended December 31, 2006 as the impact
would have been anti-dilutive. All of the remaining Exchangeable Shares
were redeemed May 9, 2006. Total weighted average Trust Units issuable in
exchange for the Exchangeable Shares and excluded from the diluted net
income per Trust Unit calculation for the year ended December 31, 2006
were 36,448.
Advantage Energy Income Fund - 20
11. ACCUMULATED DEFICIT
Accumulated deficit consists of accumulated income and accumulated
distributions for the Fund since inception as follows:
DECEMBER 31, 2007 DECEMBER 31, 2006
---------------------------------------------------------------------------------------
Accumulated Income $ 219,988 $ 227,523
Accumulated Distributions (879,823) (664,629)
---------------------------------------------------------------------------------------
Accumulated Deficit $ (659,835) $ (437,106)
---------------------------------------------------------------------------------------
The Fund has historically paid distributions in excess of accumulated
income as distributions are typically based on cash flows generated in the
period while accumulated income is based on such cash flows less other
non-cash charges such as depletion, depreciation, and accretion expense
recorded on the original investment in petroleum and natural gas
properties and management internalization expense. For the year ended
December 31, 2007 the Fund declared $215.2 million in distributions
representing $1.77 per distributable Trust Unit (2006 - $217.2 million in
distributions representing $2.66 per distributable Trust Unit).
12. FINANCIAL INSTRUMENTS
Financial instruments of the Fund include accounts receivable, deposits,
accounts payable and accrued liabilities, distributions payable to
Unitholders, bank indebtedness, convertible debentures and derivative
assets and liabilities.
Accounts receivable and deposits are classified as loans and receivables
and measured at amortized cost. Accounts payable and accrued liabilities,
distributions payable to Unitholders and bank indebtedness are all
classified as other liabilities and similarly measured at amortized cost.
As at December 31, 2007, 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 indebtedness.
The Fund has convertible debenture obligations outstanding, of which the
liability component has been classified as other liabilities and measured
at amortized cost. The convertible debentures have different fixed terms
and interest rates (note 6) resulting in fair values that will vary over
time as market conditions change. As at December 31, 2007, the estimated
fair value of the total outstanding convertible debenture obligation was
$215.4 million (December 31, 2006 - $180.0 million). The fair value of the
liability component of convertible debentures was determined primarily
based on a discounted cash flow model assuming no future conversions and
continuation of current interest and principal payments as well as taking
into consideration the current public trading activity of such debentures.
The Fund applied discount rates of between 7 and 8% considering current
available market information, assumed credit adjustments, and various
terms to maturity.
Advantage has an established strategy to manage the risk associated with
changes in commodity prices by entering into derivatives, which are
recorded at fair value as derivative assets and liabilities with gains and
losses recognized through earnings. As the fair value of the contracts
varies with commodity prices, they give rise to financial assets and
liabilities. The fair values of the derivatives are determined through
valuation models completed by third parties. Various assumptions based on
current market information were used in these valuations, including
settled forward commodity prices, interest rates, foreign exchange rates,
volatility and other relevant factors. The actual gains and losses
realized on eventual cash settlement can vary materially due to subsequent
fluctuations in commodity prices as compared to the valuation assumptions.
CREDIT RISK
Accounts receivable, deposits, and derivative assets are subject to credit
risk exposure and the carrying values reflect Management's assessment of
the associated maximum exposure to such credit risk. Substantially all of
the Fund's accounts receivable are due from customers and joint operation
partners concentrated in the Canadian oil and gas industry. As such,
accounts receivable are subject to normal industry credit risks. Advantage
mitigates such credit risk by closely monitoring significant
counterparties and dealing with a broad selection of partners that
diversify risk within the sector. The Fund's deposits are primarily due
from the Alberta Provincial government and are viewed by Management as
having minimal associated credit risk. To the extent that Advantage enters
derivatives to manage commodity price risk, it may 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.
In addition, the Fund generally enters into derivative contracts with
investment grade institutions that are members of Advantage's credit
facility syndicate to further mitigate associated credit risk.
Advantage Energy Income Fund - 21
LIQUIDITY RISK
The Fund is subject to liquidity risk attributed from accounts payable and
accrued liabilities, distributions payable to Unitholders, bank
indebtedness, convertible debentures, and derivative liabilities. Accounts
payable and accrued liabilities, distributions payable to Unitholders and
derivative liabilities are primarily due within one year of the balance
sheet date and Advantage does not anticipate any problems in satisfying
the obligations due to the strength of cash provided by operating
activities and the existing credit facility. The Fund's bank indebtedness
is subject to a $710 million credit facility agreement which mitigates
liquidity risk by enabling Advantage to manage interim cash flow
fluctuations. The credit facility constitutes 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 terms
of the credit facility are such that it provides Advantage adequate
flexibility to evaluate and assess liquidity issues if and when they
arise. Additionally, the Fund regularly monitors liquidity related to
obligations by evaluating forecasted cash flows, optimal debt levels,
capital spending activity, working capital requirements, and other
potential cash expenditures. This continual financial assessment process
further enables the Fund to mitigate liquidity risk.
Advantage has several series of convertible debentures outstanding that
mature from 2008 to 2011 (note 6). Interest payments are made
semi-annually with excess cash provided by operating activities. As the
debentures become due, the Fund can satisfy the obligations in cash or
issue Trust Units at a price determined in the applicable debenture
agreements. This settlement alternative allows the Fund to adequately
manage liquidity, plan available cash resources and implement an optimal
capital structure.
To the extent that Advantage enters derivatives to manage commodity price
risk, it may be subject to liquidity risk as derivative liabilities become
due. While the Fund has elected not to follow hedge accounting, derivative
instruments are not entered for speculative purposes and Management
closely monitors existing commodity risk exposures. As such, liquidity
risk is mitigated since any losses actually realized are subsidized by
increased cash flows realized from the higher commodity price environment.
INTEREST RATE RISK
The Fund is exposed to interest rate risk to the extent that bank
indebtedness is at a floating rate of interest and the Fund's maximum
exposure to interest rate risk is based on the effective interest rate and
the current carrying value of the bank indebtedness. The Fund monitors the
interest rate markets to ensure that appropriate steps can be taken if
interest rate volatility compromises the Fund's cash flows. A 1% interest
rate fluctuation for the year ended December 31, 2007 could potentially
have impacted net income by approximately $3.0 million for that period.
PRICE AND CURRENCY RISK
Advantage's derivative assets and liabilities are subject to both price
and currency risks as their fair values are based on assumptions including
forward commodity prices and foreign exchange rates. The Fund enters
derivative financial instruments to manage commodity price risk exposure
relative to actual commodity production and does not utilize derivative
instruments for speculative purposes. Changes in the price assumptions can
have a significant effect on the fair value of the derivative assets and
liabilities and thereby impact net income. It is estimated that a 10%
change in the forward natural gas prices used to calculate the fair value
of the natural gas derivatives at December 31, 2007 could impact net
income by approximately $8.7 million for the year ended December 31, 2007.
As well, a change of 10% in the forward crude oil prices used to calculate
the fair value of the crude oil derivatives at December 31, 2007 could
impact net income by $3.7 million for the year ended December 31, 2007. A
change of 10% in the forward power prices used to calculate the fair value
of the power derivatives at December 31, 2007 could impact net income by
$0.1 million for the year ended December 31, 2007. A similar change in the
currency rate assumption underlying the derivatives fair value does not
have a material impact on net income.
Advantage Energy Income Fund - 22
As at December 31, 2007 the Fund had the following derivatives in place:
DESCRIPTION OF DERIVATIVE TERM VOLUME AVERAGE PRICE
----------------------------------------------------------------------------------------------------------------
NATURAL GAS - AECO
Fixed price November 2007 to March 2008 7,109 mcf/d Cdn$9.54/mcf
Fixed price April 2008 to October 2008 14,217 mcf/d Cdn$6.85/mcf
Fixed price April 2008 to March 2009 14,217 mcf/d Cdn$7.10/mcf
Fixed price April 2008 to March 2009 14,217 mcf/d Cdn$7.06/mcf
Fixed price November 2008 to March 2009 14,217 mcf/d Cdn$7.77/mcf
Collar November 2007 to March 2008 9,478 mcf/d Floor Cdn$8.44/mcf
Ceiling Cdn$10.29/mcf
Collar November 2007 to March 2008 7,109 mcf/d Floor Cdn$8.70/mcf
Ceiling Cdn$10.71/mcf
CRUDE OIL - WTI
Fixed price February 2008 to January 2009 2,000 bbls/d Cdn$90.93/bbl
Collar February 2008 to January 2009 2,000 bbls/d Sold put Cdn$70.00/bbl
Purchase call Cdn$105.00/bbl
Cost Cdn$1.52/bbl
ELECTRICITY - ALBERTA POOL PRICE
Fixed price January 2008 to December 2008 3.0 MW Cdn$54.00/MWh
As at December 31, 2007, the fair value of the derivatives outstanding
resulted in an asset of approximately $7,201,000 (December 31, 2006 -
$10,433,000) and a liability of approximately $5,020,000 (December 31,
2006 - nil). For the year ended December 31, 2007, $11,049,000 was
recognized in income as an unrealized derivative loss (December 31, 2006 -
$10,242,000 unrealized derivative gain) and $18,594,000 was recognized in
income as a realized derivative gain (December 31, 2006 - $5,297,000).
As a result of the Sound acquisition (note 3), the Fund assumed several
derivatives, which had an estimated net fair market value of $2,797,000 on
closing.
13. MANAGEMENT FEE, PERFORMANCE INCENTIVE, AND MANAGEMENT INTERNALIZATION
Concurrent with the Ketch acquisition (note 3), Advantage internalized the
external management contract structure and eliminated all related fees.
The Fund reached an agreement with Advantage Investment Management Ltd.
("AIM" or the "Manager") to purchase all of the outstanding shares of AIM
pursuant to the terms of the Plan of Arrangement for total original
consideration of 1,933,208 Advantage Trust Units. The Trust Units were
initially valued at $39.1 million using the weighted average trading value
for Advantage Trust Units on the Unitholder approval date of June 22, 2006
and are subject to escrow provisions over a 3-year period, vesting
one-third each year beginning in 2007. The management internalization
consideration is being deferred and amortized into income as management
internalization expense over the specific vesting periods during which
employee services are provided, including an estimate of future Trust Unit
forfeitures. For the year ended December 31, 2007, a total of 24,909 Trust
Units issued for the management internalization were forfeited (2006 -
19,366 Trust Units) and $15.7 million has been recognized as management
internalization expense (2006 - $13.4 million). As at December 31, 2007,
1,193,622 Trust Units remain held in escrow (2006 - 1,822,098 Trust
Units). The Fund also issued 117,662 Trust Units to satisfy the final
obligation related to the 2006 first quarter performance fee along with
$0.9 million in cash to settle the first quarter management fee. AIM
agreed to forego fees from the period April 1, 2006 to the closing of the
Arrangement.
Prior to the internalization, the Manager received both a management fee
and a performance incentive fee as compensation pursuant to the Management
Agreement approved by the Board of Directors. Management fees were
calculated based on 1.5% of operating cash flow defined as revenues less
royalties and operating costs and were paid quarterly.
The Manager of the Fund was also entitled to earn an annual performance
incentive fee when the Fund's total annual return exceeded 8%. The total
annual return was calculated at the end of the year by dividing the
year-over-year change in Unit price plus cash distributions by the opening
Unit price, as defined in the Management Agreement. Ten percent of the
amount of the total annual return in excess of 8% was 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 Management Agreement provided
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
Advantage Energy Income Fund - 23
price of $22.19 to satisfy the 2005 performance fee obligation. The
Manager did not receive any form of compensation in respect of acquisition
or divestiture activities nor was there any form of stock option or bonus
plan for the Manager or the employees of Advantage outside of the
management and performance fees prior to the internalization. The
management fees and performance fees were shared amongst all management
and employees.
14. COMMITMENTS
Advantage has several lease commitments relating to office buildings. The
Fund has assumed office lease commitments from prior corporate
acquisitions and has renegotiated leases to accommodate the growth of the
Fund. The estimated annual minimum operating lease rental payments for
buildings are as follows:
2008 $ 5,319
2009 4,111
2010 4,127
2011 1,731
2012 1,314
---------------------------------------
$16,602
---------------------------------------
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, in most respects, conforms to generally accepted accounting
principles in the United States. Any differences in accounting principles
between Canadian GAAP and US GAAP, as they apply to Advantage, are not
material, except as described below.
(a) UNIT-BASED COMPENSATION
Advantage accounts for compensation expense based on the fair value of the
equity awards on the grant date and the initial fair value is not
subsequently remeasured. Advantage's unit-based compensation consists of a
Trust Units Rights Incentive Plan, Trust Units held in escrow subject to
service requirement provisions, and Trust Units issuable for the retention
of certain employees of the Fund. The initial fair value is expensed over
the vesting period of the Trust Units or rights granted.
Under US GAAP, the Fund adopted SFAS 123(R) "Share-Based Payment" on
January 1, 2006 using the modified prospective approach and applies the
fair value method of accounting for all Unit-based compensation granted
after January 1, 2006. A US GAAP difference exists as unit-based
compensation grants are considered liability awards for US GAAP and equity
awards for Canadian GAAP. Under US GAAP, the fair value of a liability
award is measured at the grant date and is subsequently remeasured at each
reporting period. When the rights are exercised and the Trust Units
vested, the amount recorded as a liability is recognized as temporary
equity and the fair value at adoption of the new standard has been charged
to income as the cumulative effect of a change in accounting policy.
(b) CONVERTIBLE DEBENTURES
The Fund applies CICA 3863 "Financial Instruments - Presentation" in
accounting for convertible debentures which results in their
classification as 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 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 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 - 24
(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, and an
impairment loss of $535.4 million in 2006, $477.8 million net of tax. The
impairment loss decreases net book value of property and equipment which
reduces depletion and depreciation expense subsequently recorded as well
as future ceiling test calculations.
(e) 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, 2007 and 2006. The differences between Canadian GAAP and US
GAAP relate to future income tax impact on GAAP differences for fixed
assets.
Under US GAAP, an entity that is subject to income tax in multiple
jurisdictions is required to disclose income tax expense in each
jurisdiction. The total amount of income taxes in 2006 and 2007 is
entirely at the provincial level.
(f) 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.
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. Changes in the
redemption value from year-to-year are charged to deficit. All components
of Unitholders' equity related to Trust Units 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
Advantage Energy Income Fund - 25
value increases net income available to Unitholders. For the years ended
December 31, 2007 and 2006, net income available to Unitholders was
increased by $390.3 million and $898.0 million corresponding to changes in
the Trust Units redemption value for the respective periods.
A continuity schedule of significant equity accounts for each reporting
period is required disclosure under US GAAP. The following table is a
continuity of deficit, the Fund's only significant equity account:
DEFICIT YEAR ENDED YEAR ENDED
(thousands of Canadian dollars) DECEMBER 31, 2007 DECEMBER 31, 2006
------------------------------------------------------------------------------------------------
Balance, beginning of year $ (402,158) $ (665,627)
Net income (loss) and comprehensive income (loss) 50,610 (417,274)
Distributions declared (215,194) (217,246)
Change in redemption value of temporary equity 390,349 897,989
------------------------------------------------------------------------------------------------
Balance, end of year $ (176,393) $ (402,158)
------------------------------------------------------------------------------------------------
(g) BALANCE SHEET DISCLOSURE
US GAAP requires disclosure of certain line items for balances that would
be aggregated in the Canadian GAAP financials. The following are the
additional line items to be disclosed for accounts receivable and accounts
payable:
(thousands of Canadian dollars) DECEMBER 31, 2007 DECEMBER 31, 2006
------------------------------------------------------------------------------------------------
Accounts receivable
Trade receivables $ 94,959 $ 78,698
Other receivables 515 839
------------------------------------------------------------------------------------------------
Total accounts receivable $ 95,474 $ 79,537
------------------------------------------------------------------------------------------------
(thousands of Canadian dollars) DECEMBER 31, 2007 DECEMBER 31, 2006
------------------------------------------------------------------------------------------------
Accounts payable and accrued liabilities
Accounts payable $ 72,691 $ 75,500
Accrued liabilities 48,994 39,999
Other payables 402 610
------------------------------------------------------------------------------------------------
Total accounts payable and accrued liabilities $ 122,087 $ 116,109
------------------------------------------------------------------------------------------------
(h) 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.
(i) KETCH ACQUISITION
On June 23, 2006, Advantage acquired all of the issued and outstanding
Trust Units of Ketch to benefit from an increase in property
diversification, the ability to pursue a greater range of high impact
growth opportunities available to a larger entity and complimentary
summer/winter drilling programs. The merger provides increased liquidity
and presence in the Canadian markets as well as greater exposure to the
United States capital markets for previous Ketch Unitholders through
Advantage's NYSE listing.
The purchase price for the acquisition and resulting goodwill is due to
both US and Canadian GAAP requiring the purchase price to be determined
using Trust Unit prices at the announcement date, while the fair value of
the assets and liabilities is determined at the closing date of the
acquisition. As commodity prices decreased significantly between the
announcement and closing dates, the fair value of the assets acquired also
decreased and as a result, goodwill was recorded.
Advantage Energy Income Fund - 26
(j) SOUND ACQUISITION
On September 5, 2007, Advantage acquired all of the issued and outstanding
Trust Units and Exchangeable Shares of Sound. The accounting for business
combinations is effectively the same under US and Canadian GAAP. However,
the purchase price under US GAAP is different as a result of AOG realizing
a future income tax asset from previously unrecognized temporary
differences. The purchase price under US GAAP has been allocated as
follows:
NET ASSETS ACQUIRED AND LIABILITIES ASSUMED: CONSIDERATION:
Fixed assets $ 480,226 16,977,184 Trust Units issued $ 228,852
Future income tax asset 29,430 Cash 21,403
Accounts receivable 27,433 Acquisition costs incurred 904
Prepaid expenses and deposits 3,873 ----------
Derivative asset, net 2,797 $ 251,159
Bank indebtedness (107,959) ----------
Convertible debentures (101,553)
Accounts payable and accrued liabilities (35,396)
Future income tax liability (29,430)
Asset retirement obligations (16,695)
Capital lease obligations (1,567)
------------
$ 251,159
------------
(k) RECENT US ACCOUNTING PRONOUNCEMENTS ISSUED BUT NOT IMPLEMENTED
SFAS 157 FAIR VALUE MEASUREMENTS: This Statement defines fair value,
establishes a framework for measuring fair value in GAAP, and expands
disclosures about fair value measurements. This Statement applies under
other accounting pronouncements that require or permit fair value
measurements. Accordingly, this Statement does not require any new fair
value measurements. The implementation effective date for this standard is
as of the beginning of the first interim or annual reporting period that
begins after November 15, 2007. The Fund has assessed the impact of this
interpretation and does not anticipate any significant impact on the
consolidated financial statements.
SFAS 141 (R) BUSINESS COMBINATIONS: This Statement requires assets and
liabilities acquired in a business combination, contingent consideration,
and certain acquired contingencies to be measured at their fair values as
of the date of acquisition. In addition, acquisition-related and
restructuring costs are to be recognized separately from the business
combination. This standard applies to business combinations entered into
after January 1, 2009. The Fund has not yet assessed the full impact, if
any, of this standard on the consolidated financial statements.
Advantage Energy Income Fund - 27
The application of US GAAP would have the following effect on net income
as reported:
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME YEAR ENDED YEAR ENDED
(thousands of Canadian dollars, except for per Trust Unit amount DECEMBER 31, 2007 DECEMBER 31, 2006
------------------------------------------------------------------------------------------------------------------
Net income (loss) - Canadian GAAP, as reported $ (7,535) $ 49,814
US GAAP Adjustments:
General and administrative - note 15 (a) 606 1,453
Management internalization - note 15(a) 7,450 4,684
Interest and accretion on convertible debentures - note 15(b) 1,741 1,254
Depletion, depreciation and accretion - notes 15(c) and (d) 72,990 (528,734)
Future income tax reduction - note 15(e) (24,642) 55,526
------------------------------------------------------------------------------------------------------------------
Net income (loss) before cumulative effect of a
change in accounting principle 50,610 (416,003)
Cumulative effect of a change in accounting principle - note 15(a) - (1,271)
------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS) - US GAAP $ 50,610 $(417,274)
------------------------------------------------------------------------------------------------------------------
Net income (loss) per Trust Unit before cumulative effect of a change in
accounting principle - US GAAP:
Basic $ 0.42 $ (5.14)
Diluted $ 0.42 $ (5.14)
Net income (loss) per Trust Unit before change in redemption value of
Trust Units - US GAAP:
Basic $ 0.42 $ (5.15)
Diluted $ 0.42 $ (5.15)
Net income per Trust Unit - US GAAP:
Basic $ 3.69 $ 5.94
Diluted $ 3.54 $ 5.59
------------------------------------------------------------------------------------------------------------------
Advantage Energy Income Fund - 28
The application of US GAAP would have the following effect on the balance
sheets as reported:
DECEMBER 31, 2007 DECEMBER 31, 2006
----------------- -----------------
CONSOLIDATED BALANCE SHEETS CANADIAN US CANADIAN US
(thousands of Canadian dollars) GAAP GAAP GAAP GAAP
-------------------------------------------------------------------------------------------------------------------------
ASSETS
Deferred charge - note 15(b) $ - $ 1,984 $ - $ 2,810
Fixed assets, net - notes 15(c) and (d) 2,177,346 1,673,251 1,753,058 1,205,465
LIABILITIES AND UNITHOLDERS' EQUITY
Current portion of convertible debentures 5,333 5,392 1,464 1,485
- note 15(b)
Trust Unit liability - note 15(a) - 7,515 - 7,633
Convertible debentures - note 15(b) 212,203 219,674 170,819 179,245
Future income taxes - note 15(e) 66,727 - 61,939 -
Temporary equity - note 15(f) - 1,104,831 - 1,067,790
Unitholders' capital - note 15(f) 2,027,065 - 1,592,758 -
Convertible debentures equity component 9,632 - 8,041 -
- note 15(b)
Contributed surplus - note 15(a) 2,005 - 863 -
Accumulated deficit - note 15(f) (659,835) (176,393) (437,106) (402,158)
Advantage Energy Income Fund - 29