----------------------------------------------------------------------- Compton Petroleum Corporation Notes to the Consolidated Financial Statements December 31, 2005 (unaudited) (Tabular amounts in thousands of dollars, unless otherwise stated) ------------------------------------------------------------------------- 1. Significant accounting policies Compton Petroleum Corporation (the "Company" or "Compton") is in the business of the exploration for and production of petroleum and natural gas reserves in the Western Canada Sedimentary Basin. a) Basis of presentation The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in Canada within the framework of the accounting policies summarized below. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The consolidated financial statements also include the accounts of Mazeppa Processing Partnership in accordance with Accounting Guideline 15 ("AcG-15") "Consolidation of Variable Interest Entities", as outlined in Note 3. All amounts are presented in Canadian dollars unless otherwise stated. b) Measurement uncertainty The timely preparation of financial statements requires that Management make estimates and assumptions and use judgment regarding assets, liabilities, revenues, and expenses. Such estimates relate primarily to transactions and events that have not settled as of the date of the financial statements. Accordingly, actual results may differ from estimated amounts as future confirming events occur. Amounts recorded for depletion and depreciation, and amounts used in impairment test calculations are based upon estimates of petroleum and natural gas reserves and future costs to develop those reserves. By their nature, these estimates of reserves, costs, and related future cash flows are subject to uncertainty, and the impact on the consolidated financial statements of future periods could be material. The calculation of asset retirement obligations include estimates of the ultimate settlement amounts, inflation factors, credit adjusted discount rates, and timing of settlement. The impact of future revisions to these assumptions on the consolidated financial statements of future periods could be material. The values of pension assets and obligations and the amount of pension costs charged to net earnings depend on certain actuarial and economic assumptions which by their nature are subject to measurement uncertainty. c) Property and equipment i) Capitalized costs The Company follows the full cost method of accounting for its petroleum and natural gas operations. Under this method all costs related to the exploration for and development of petroleum and natural gas reserves are capitalized. Costs include lease acquisition costs, geological and geophysical expenses, costs of drilling both producing and non-producing wells, production facilities, asset retirement costs, and certain general and administrative expenses directly related to exploration and development activities. Proceeds from the sale of properties are applied against capitalized costs, without any gain or loss being realized, unless such sale would significantly alter the rate of depletion and depreciation. Expenditures related to renewals or betterments that improve the productive capacity or extend the life of an asset are capitalized. Maintenance and repairs, other than major turnaround costs, are expensed as incurred. Major turnaround costs are included in property and equipment when incurred and charged to depletion and depreciation in the consolidated statement of earnings over the estimated period of time to the next scheduled turnaround. ii) Depletion and depreciation Depletion and depreciation of property and equipment is provided using the unit-of-production method based upon estimated proved petroleum and natural gas reserves. The costs of significant undeveloped properties are excluded from costs subject to depletion until it is determined whether or not proved reserves are attributable to the properties or impairment has occurred. Estimated future costs to be incurred in developing proved reserves are included in costs subject to depletion. For depletion and depreciation purposes, relative volumes of natural gas production and reserves are converted at the energy equivalent conversion rate of six thousand cubic feet of natural gas to one barrel of crude oil. Depreciation of certain midstream facilities is provided for on a straight line basis over 30 years and depreciation of office equipment is provided for on a declining balance basis at 20% per year. iii) Impairment test At each reporting period the Company performs an impairment test to determine the recoverability of capitalized costs associated with reserves. An impairment loss is recognized when the carrying amount of a cost centre exceeds its fair value. The carrying amount of the cost centre is not recoverable if the carrying amount exceeds the sum of the undiscounted cash flows from proved reserves plus the costs of unproved properties. If the sum of the cash flows is less than the carrying amount, the impairment loss is limited to the amount by which the carrying amount exceeds the sum of the fair value of proved and probable reserves and the costs of unproved properties that have been subject to a separate impairment test and contain no probable reserves. iv) Asset retirement obligations The Company recognizes the fair value of estimated asset retirement obligations on the consolidated balance sheet when a reasonable estimate of fair value can be made. Asset retirement obligations include those legal obligations where the Company will be required to retire tangible long-lived assets such as well sites, pipelines, and facilities. The asset retirement cost, equal to the initially estimated fair value of the asset retirement obligation, is capitalized as part of the cost of the related long-lived asset. Changes in the estimated obligation resulting from revisions to estimated timing or amount of undiscounted cash flows are recognized as a change in the asset retirement obligation and the related asset retirement cost. Asset retirement costs are amortized using the unit-of-production method and are included in depletion and depreciation in the consolidated statement of earnings. Increases in the asset retirement obligations resulting from the passage of time are recorded as accretion of asset retirement obligations in the consolidated statement of earnings. Actual expenditures incurred are charged against the accumulated obligation. v) Inventories Physical inventory held for exploration, development, and operating activities is included in property and equipment and is valued at cost. d) Goodwill Goodwill is recorded on a corporate acquisition when the purchase price is in excess of the fair values assigned to assets acquired and liabilities assumed. Goodwill is not amortized and an impairment test is performed at least annually to evaluate the carrying value. To assess impairment the fair value of the consolidated entity, excluding the Mazeppa Processing Partnership, is determined and compared to the carrying value. If fair value is less than the carrying value then a second test is performed to determine the amount of the impairment. Any loss recognized is equal to the difference between the implied fair value and the carrying value of the goodwill. e) Financial instruments Financial instruments consist mainly of accounts receivable and other, accounts payable, and long-term debt. The Company uses financial instruments for non-trading purposes to manage fluctuations in commodity prices, foreign currency exchange rates, and interest rates as described in Note 16. The Company has elected not to designate any of its current risk management activities as accounting hedges and accounts for all derivative financial instruments using the mark-to-market accounting method. f) Joint operations Certain petroleum and natural gas activities are conducted jointly with others. These consolidated financial statements reflect only the Company's proportionate interest in such activities. g) Flow-through shares Resource expenditure deductions for income tax purposes related to exploration and development activities funded by flow-through share arrangements are renounced to investors in accordance with income tax legislation. The liability for future income taxes is increased and capital stock is reduced by the estimated tax benefits transferred to shareholders at the time the resource expenditure deductions are renounced. h) Earnings per share amounts The Company uses the treasury stock method to determine the dilutive effect of stock options. This method assumes that proceeds received from the exercise of in-the-money stock options are used to repurchase common shares at the average market price for the period. Basic net earnings per common share are determined by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed by giving effect to the potential dilution that would occur if stock options were exercised. i) Income taxes Income taxes are recorded using the liability method of accounting. Future income taxes are calculated based on the difference between the accounting and income tax basis of an asset or liability, using the substantively enacted income tax rates. Changes in income tax rates that are substantively enacted are reflected in the accumulated future income tax balances in the period the change occurs. j) Revenue recognition Revenue associated with the production and sale of crude oil, natural gas, and natural gas liquids owned by the Company is recognized when the purchaser takes possession of the commodity product. Other revenue is recognized in the period that the service is provided to the customer. k) Stock-based compensation plan The Company records compensation expense in the consolidated statements of earnings for stock options granted to Directors, Officers, and employees using the fair-value method. Compensation costs are recognized over the vesting period and the fair values are determined using the Black-Scholes option pricing model. The Company also has an employee stock savings plan. The contributions are recorded as compensation expense as incurred. l) Deferred financing charges Financing costs related to the issuance of senior term notes are deferred and are amortized over the term of the notes on a straight-line basis. If the notes are retired, in whole or in part, prior to maturity, a pro-rata share of the unamortized balance is expensed in the consolidated statement of earnings. m) Foreign currency translation Monetary assets and liabilities of the Company that are denominated in foreign currencies are translated into Canadian dollars at the period-end exchange rate, with any resulting gain or loss recorded in the consolidated statement of earnings. n) Dividend policy The Company has neither declared nor paid any dividends on its common shares. The Company intends to retain its earnings to finance growth and expand its operations and does not anticipate paying any dividends on its common shares in the foreseeable future. o) Defined benefit pension plan The Company accrues for obligations under a defined benefit pension plan and the related costs, net of plan assets. The cost of the pension is actuarially determined using the projected benefit method based on length of service and reflects Management's best estimate of expected plan investment performance, salary escalation, and retirement age of employees. 2. Business combinations On April 12, 2004 and November 15, 2004, respectively, the Company acquired 100% of the issued and outstanding shares of Redwood Energy, Ltd. and Mayfair Energy Ltd. for total cash consideration of $12.1 million plus the assumption of $12.1 million of debt. Both entities were independent exploration and production companies with operations in the Company's core areas. The business combinations have been accounted for using the purchase method with results of operations included in the consolidated financial statements from the date of acquisition. Goodwill recognized on these transactions amounted to $7.9 million. During the year ended December 31, 2004, both companies were wound up into Compton Petroleum Corporation and dissolved. 3. Non-controlling interest Mazeppa Processing Partnership ("MPP" or "the Partnership") is a limited partnership organized under the laws of the province of Alberta and owns certain midstream facilities, including gas plants and pipelines in Southern Alberta. The Company processes a significant portion of its production from the area through these facilities pursuant to a processing agreement with MPP. The Company does not have an ownership position in MPP, however, the Company, through a management agreement, manages the activities of MPP and is considered to be the primary beneficiary of MPP's operations. Pursuant to AcG-15, these consolidated financial statements include the assets, liabilities, and operations of the Partnership. Equity in the Partnership, attributable to the partners of MPP, is recorded on consolidation as a non-controlling interest and is comprised of the following: As at December 31, 2005 2004 ------------ ------------ Non-controlling interest, beginning of year $ 71,537 $ (110) Proceeds from issue of Partnership units, net - 74,343 Earnings attributable to non-controlling interest 6,533 3,418 Distributions to limited partner (9,172) (6,114) ------------ ------------ Non-controlling interest, end of year $ 68,898 $ 71,537 ------------ ------------ ------------ ------------ Commencing May 1, 2004, pursuant to the terms of a processing agreement between Compton and MPP, Compton pays a monthly fee to MPP for the transportation and processing of natural gas through the MPP owned facilities. The fee is comprised of a fixed base fee of $764 thousand per month plus MPP operating costs, net of third party revenues. These amounts are eliminated from revenues and expenses on consolidation. The processing agreement has a five year term ending April 1, 2009, at which time Compton may renew the agreement under terms determined at that time or purchase the Partnership units for the predetermined amount of $55 million, deemed to be fair value. In the event that the Company does not renew the processing agreement nor exercise the purchase option, the Limited Partner may dispose of the Partnership units to an independent third party. MPP has guaranteed payment of certain obligations of its limited partner under a credit agreement between the limited partner and a syndicate of lenders. The maximum liability of the Partnership under the guarantee is limited to amounts due and payable to MPP by the Company pursuant to the processing agreement. The maximum liability at December 31, 2005 was $30.6 million (2004 - $39.7 million) payable over the remaining term of the processing agreement. The Company has determined that its exposure to loss under these arrangements is minimal, if any. 4. Property and equipment Accumulated depletion and As at December 31, 2005 Cost depreciation Net ------------ ------------ ------------ Exploration and development costs $ 1,553,543 $ (366,902) $ 1,186,641 Production equipment and processing facilities 436,948 (52,771) 384,177 Inventory 6,469 - 6,469 Future asset retirement costs 10,365 (3,771) 6,594 Office equipment 7,641 (4,151) 3,490 ------------ ------------ ------------ $ 2,014,966 $ (427,595) $ 1,587,371 ------------ ------------ ------------ ------------ ------------ ------------ Accumulated depletion and As at December 31, 2004 Cost depreciation Net ------------ ------------ ------------ Exploration and development costs $ 1,161,396 $ (281,614) $ 879,782 Production equipment and processing facilities 317,477 (34,150) 283,327 Inventory 6,187 - 6,187 Future asset retirement costs 9,576 (3,111) 6,465 Office equipment 6,005 (3,216) 2,789 ------------ ------------ ------------ $ 1,500,641 $ (322,091) $ 1,178,550 ------------ ------------ ------------ ------------ ------------ ------------ Employee salaries and insurance costs of $4.7 million at December 31, 2005 (2004 - $4.6 million) directly related to exploration and development activities were capitalized. No other general and administrative costs are capitalized. As at December 31, 2005 future capital expenditures of $192.9 million (2004 - $89.1 million, 2003 - $62.4 million), as estimated by independent reserve engineers, relating to the development of proved reserves have been included in costs subject to depletion. Undeveloped properties with a cost at December 31, 2005 of $251.3 million (2004 - $187.8 million, 2003 - $161.9 million) included in exploration and development costs, have not been subject to depletion. The prices used in the evaluation of the carrying value of the Company's reserves for the purposes of the impairment test are: Natural As at December 31, 2005 gas Oil NGL ------------ ------------ ------------ $ per mcf $ per bbl $ per bbl 2006 $11.86 $61.58 $61.87 2007 $10.76 $60.97 $61.64 2008 $9.16 $57.38 $58.19 2009 $8.33 $54.11 $55.05 2010 $8.09 $51.85 $52.58 Approximate % increase thereafter 2% 2% 2% 5. Credit facilities As at December 31, 2005 2004 ------------ ------------ Authorized $ 289,000 $ 240,000 ------------ ------------ ------------ ------------ Prime rate $ 22,900 $ 3,000 Bankers' Acceptance 155,000 217,000 ------------ ------------ Utilized $ 177,900 $ 220,000 ------------ ------------ ------------ ------------ As at December 31, 2005, the Company had arranged authorized senior credit facilities with a syndicate of Canadian banks in the amount of $289 million. Advances under the facilities can be drawn and currently bear interest as follows: Prime rate plus 0.15% Bankers' Acceptance rate plus 1.15% LIBOR rate plus 1.15% Margins are determined based on the ratio of total consolidated debt to consolidated cash flow. The facilities reach term on July 5, 2006 and, if not renewed, will mature 366 days later on July 6, 2007. Accordingly, the 2005 facilities have been classified as a non-current liability. The senior credit facilities are secured by a first fixed and floating charge debenture in the amount of $600 million covering all the Company's assets and undertakings. 6. Senior term notes As at December 31, 2005 2004 ------------ ------------ Senior term notes US$300 million, 7.625% due December 1, 2013 $ 349,770 $ - US$6.75 million, 9.90% due May 15, 2009 (2004 - US$165 million) 7,870 198,594 ------------ ------------ $ 357,640 $ 198,594 ------------ ------------ ------------ ------------ In November 2005, a wholly owned subsidiary of the Company issued US$300 million senior term notes maturing December 1, 2013. The notes bear interest at 7.625% and are subordinate to the Company's bank credit facilities. The 7.625% notes are not redeemable prior to December 1, 2009, except in limited circumstances. After that time, they can be redeemed in whole or part, at the rates indicated below: December 1, 2009 103.813% December 1, 2010 101.906% December 1, 2011 and thereafter 100.000% In November 2005, the Company and a wholly owned subsidiary of the Company completed a tender offer and consent solicitation to amend the Indenture relating to the 9.90% notes. The Company and a wholly owned subsidiary of the Company paid 107.195% plus accrued and unpaid interest for the US$158.25 million 9.90% notes tendered by the note holders. Information related to the tender costs is included in Note 8. The remaining US$6.75 million of 9.90% notes are not redeemable prior to May 15, 2006. After that time, they can be redeemed in whole or part, at the rates indicated below: May 15, 2006 104.950% May 15, 2007 102.475% May 15, 2008 and thereafter 100.000% 7. Interest and finance charges Amounts charged to expense during the year ended are as follows: Years ended December 31, 2005 2004 2003 ------------ ------------ ------------ Interest on bank debt, net $ 11,520 $ 9,662 $ 6,611 Interest on senior term notes 20,912 21,281 21,711 Finance charges 2,519 2,790 2,273 ------------ ------------ ------------ Total $ 34,951 $ 33,733 $ 30,595 ------------ ------------ ------------ ------------ ------------ ------------ Finance charges include the amortization of deferred charges and other current year expenses. 8. Deferred financing charges and other The following table presents the reconciliation of the beginning and ending aggregate carrying amount of deferred financing charges associated with the issue of senior term notes: Years ended December 31, 2005 2004 ------------ ------------ Deferred financing charges and other, beginning of year $ 9,729 $ 11,532 Issue costs on 7.625% Senior Notes 12,670 - Pro-rata reduction on repayment of 9.90% Senior Notes (7,053) - Amortization expense (2,119) (2,133) Other (71) 330 ------------ ------------ Deferred financing charges and other, end of year $ 13,156 $ 9,729 ------------ ------------ ------------ ------------ Costs incurred on the tender for the 9.90% senior term notes in 2005 were as follows: Premium payment $ 7,814 Consent solicitation fee 5,883 Pro-rata reduction of deferred financing charges on repayment of 9.90% Senior Notes 7,053 ------------ Total $ 20,750 ------------ ------------ 9. Foreign exchange (gain) loss Amounts charged to foreign exchange (gain) loss during the year ended were as follows: Years ended December 31, 2005 2004 2003 ------------ ------------ ------------ Foreign exchange gain on translation of US$ debt $ (7,808) $ (14,652) $ (47,388) Other foreign exchange loss 455 21 20 ------------ ------------ ------------ Total $ (7,353) $ (14,631) $ (47,368) ------------ ------------ ------------ ------------ ------------ ------------ 10. Asset retirement obligations The following table presents the reconciliation of the beginning and ending aggregate carrying amount of the obligations associated with the retirement of oil and natural gas assets: As at December 31, 2005 2004 ------------ ------------ Asset retirement obligations, beginning of year $ 18,006 $ 17,329 Liabilities incurred 5,218 3,357 Liabilities settled and disposed (1,275) (4,350) Accretion expense 1,975 1,670 Revision of estimates (3,154) - ------------ ------------ Asset retirement obligations, end of year $ 20,770 $ 18,006 ------------ ------------ ------------ ------------ The total undiscounted amount of estimated cash flows required to settle the obligations was $185.8 million (2004 - $148.9 million), which has been discounted using a credit-adjusted risk free rate of 10.7% (2004 - 10.8%). The majority of these obligations are not expected to be settled for several years or decades into the future. Settlements will be funded from general Company resources at the time of retirement and removal. 11. Capital stock a) Authorized The Company is authorized to issue an unlimited number of common shares and an unlimited number of preferred shares, issuable in series. b) Issued and outstanding As at December 31, 2005 2004 --------------------- --------------------- Number Number of of Shares Amount Shares Amount ---------- ---------- ---------- ---------- (000s) (000s) Common shares outstanding, beginning of year 117,354 $ 135,526 116,423 $ 131,577 Shares issued for cash, net 7,500 87,294 - - Shares issued for property - - 110 875 Shares issued under stock option plan 2,926 4,424 1,271 3,589 Shares repurchased (517) (800) (450) (515) ---------- ---------- ---------- ---------- Common shares outstanding, end of year 127,263 $ 226,444 117,354 $ 135,526 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- In February 2005, the Company issued 7,500,000 common shares for gross proceeds of $90.0 million before underwriters' fees and issue expenses of $4.1 million. The Company maintains a Normal Course Issuer Bid program on an annual basis. Under the current bid, the Company may purchase for cancellation up to 6,000,000 of its common shares, representing approximately 5.0% of the issued and outstanding common shares at the time the bid received regulatory approval. During the year, the Company purchased for cancellation 516,600 common shares at an average price of $11.84 per share (2004 - 450,100 common shares at an average price of $8.90 per share) pursuant to the normal course issuer bid. The excess of the purchase price over book value has been charged to retained earnings. c) Shareholder rights plan The Company has a shareholder rights plan (the "Plan") to ensure all shareholders are treated fairly in the event of a take-over offer or other acquisition of control of the Company. Pursuant to the Plan, the Board of Directors authorized and declared the distribution of one Right in respect of each common share outstanding. In the event that an acquisition of 20% or more of the Company's shares is completed and the acquisition is not a permitted bid, as defined by the Plan, each Right will permit the holder to acquire common shares at a 50% discount to the market price at that time. 12. Stock-based compensation plans a) Stock option plan The Company has implemented a stock option plan for Directors, Officers, and employees. The exercise price of each option approximates the market price for the common shares on the date the option was granted. Options granted under the plan before June 1, 2003 are generally fully exercisable after four years and expire ten years after the grant date. Options granted under the plan after June 1, 2003 are generally fully exercisable after four years and expire five years after the grant date. The following tables summarize the information relating to stock options: As at December 31, 2005 2004 --------------------- --------------------- Weighted Weighted average average Stock exercise Stock exercise options price options price ---------- ---------- ---------- ---------- (000s) (000s) Outstanding, beginning of year 11,655 $3.51 10,672 $2.54 Granted 2,930 $11.89 2,549 $7.34 Exercised (2,926) $1.32 (1,271) $2.56 Cancelled (213) $8.30 (295) $5.26 ---------- ---------- ---------- ---------- Outstanding, end of year 11,446 $6.13 11,655 $3.51 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Exercisable, end of year 6,219 $3.38 7,812 $2.19 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- The range of exercise prices of stock options outstanding and exercisable at December 31, 2005 were as follows: Outstanding Options Exercisable Options ----------------------------------- ----------------------- Weighted average Weighted Weighted Range of Number of remaining average Number of average exercise options contractual exercise options exercise prices outstanding life (years) price outstanding price ----------- ------------- ----------- ----------- ----------- ----------- (000s) (000s) $0.80 - $2.99 2,644 2.7 $1.55 2,644 $1.55 $3.00 - $3.99 1,509 5.3 $3.47 1,279 $3.40 $4.00 - $4.99 1,598 6.1 $4.30 1,215 $4.24 $5.00 - $6.99 1,188 2.9 $5.87 597 $5.88 $7.00 - $9.99 1,485 3.4 $7.62 427 $7.62 $10.00 - $12.99 2,690 4.2 $11.58 42 $10.60 $13.00 - $17.38 332 4.7 $13.70 15 $13.44 ----------- ----------- ----------- ----------- ----------- 11,446 4.1 $6.13 6,219 $3.38 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- The Company has recorded stock-based compensation expense in the consolidated statement of earnings for stock options granted to Directors, Officers, and employees after January 1, 2003 using the fair value method. The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model with weighted average assumptions for grants as follows: Years ended December 31, 2005 2004 2003 ------------ ------------ ------------ Weighted average fair value of options granted $5.45 $3.70 $3.01 Risk-free interest rate 3.6% 3.9% 4.3% Expected life (years) 5.0 5.0 6.1 Expected volatility 43.9% 49.6% 56.0% The following table presents the reconciliation of contributed surplus with respect to stock-based compensation: As at December 31, 2005 2004 ------------ ------------ Contributed surplus, beginning of year $ 3,840 $ 760 Stock-based compensation expense 5,903 3,410 Stock options exercised (570) (330) ------------ ------------ Contributed surplus, end of year $ 9,173 $ 3,840 ------------ ------------ ------------ ------------ The Company has not recorded stock-based compensation expense in the consolidated statement of earnings related to stock options granted prior to 2003. If the Company had applied the fair value method to options granted prior to 2003, the effect would have been as follows: Years ended December 31, 2005 2004 2003 ------------ ------------ ------------ Reduction in net earnings $1,007 $1,545 $2,317 Reduction in net earnings per common share - basic and diluted $0.01 $0.01 $0.02 b) Share appreciation rights plan CICA Handbook section 3870 requires recognition of compensation costs with respect to changes in the intrinsic value for the variable component of fixed share appreciation rights ("SARs"). During the years ended December 31, 2005 and 2004, there were no significant compensation costs related to the outstanding variable component of these SARs, (2003 - $33,000). The liability related to the variable component of these SARs amounts to $1.4 million, which is included in accounts payable as at December 31, 2005 (2004 - $1.7 million). All outstanding SARs having a variable component expire at various times through 2011. 13. Per share amounts The following table summarizes the common shares used in calculating net earnings per common share: Years ended December 31, 2005 2004 2003 ------------ ------------ ------------ (000s) (000s) (000s) Weighted average common shares outstanding - basic 125,627 117,244 116,267 Effect of stock options 6,040 6,789 5,856 ------------ ------------ ------------ Weighted average common shares outstanding - diluted 131,667 124,033 122,123 ------------ ------------ ------------ ------------ ------------ ------------ In calculating diluted earnings per common share for the year ended December 31, 2005, the Company excluded 331,800 options (2004 - 288,000, 2003 - 615,100) as the exercise price was greater than the average market price of its common shares in those years. 14. Defined benefit pension plan Substantially all of the employees of MPP are enrolled in a co-sponsored, defined benefit pension plan. The Company does not have a pension plan for other employees. Information relating to the MPP retirement plan is outlined below: As at December 31, 2005 2004 ------------ ------------ Accrued benefit obligation $ 7,562 $ 5,855 ------------ ------------ Fair value of plan assets $ 5,839 $ 5,221 ------------ ------------ Funded status Plan assets less than benefit obligation $ (1,723) $ (634) Unamortized net actuarial loss (gain) 891 (269) Unamortized past service costs 862 933 ------------ ------------ Accrued benefit asset, included in deferred financing charges and other $ 30 $ 30 ------------ ------------ ------------ ------------ Economic assumptions used to determine benefit obligation and periodic expense were: Years ended December 31, 2005 2004 ------------ ------------ Discount rate 5.0% 6.3% Expected rate of return on assets 7.0% 7.0% Rate of compensation increase 3.5% 4.5% Average remaining service period of covered employees 15 years 15 years Actuarial evaluations are required every three years, the next evaluation being January 1, 2006. Pension expense, included in MPP operating costs, is as follows: Years ended December 31, 2005 2004 ------------ ------------ Current service cost $ 232 $ 190 Interest on accrued benefit obligation 372 336 Interest on assets (364) (333) Amortization on past service cost 69 67 ------------ ------------ Pension expense, included in general and administrative expense $ 309 $ 260 ------------ ------------ ------------ ------------ MPP expects to contribute $340 thousand to the plan in 2006. Contributions by the participants to the pension plan were $75 thousand for the year ended December 31, 2005. 15. Income taxes a) The following table reconciles income taxes calculated at the Canadian statutory rate with actual income taxes: Years ended December 31, 2005 2004 2003 ------------ ------------ ------------ Earnings before taxes and non-controlling interest $ 145,247 $ 103,234 $ 142,093 ------------ ------------ ------------ Canadian statutory rate 37.6% 38.6% 40.6% Expected income taxes $ 54,613 $ 39,848 $ 57,690 Effect on taxes resulting from: Non-deductible Crown charges 15,061 17,611 23,922 Resource allowance (11,980) (13,535) (16,485) Non-deductible stock-based compensation 2,221 1,316 309 Federal capital tax 1,896 2,526 2,497 Effect of tax rate changes (5,764) (8,359) (37,130) Non-taxable portion of capital items - (2,831) (8,202) Other 1,341 (393) 722 ------------ ------------ ------------ Provision for income taxes $ 57,388 $ 36,183 $ 23,323 ------------ ------------ ------------ ------------ ------------ ------------ Current Income taxes $ 3,175 $ 225 $ 785 Federal capital taxes 1,896 2,526 2,497 Future 52,317 33,432 20,041 ------------ ------------ ------------ $ 57,388 $ 36,183 $ 23,323 ------------ ------------ ------------ ------------ ------------ ------------ Effective tax rate 39.5% 35.0% 16.4% ------------ ------------ ------------ ------------ ------------ ------------ A significant portion of the Company's taxable income is generated by a partnership. Income taxes are incurred on the majority of the partnership's taxable income in the year following its inclusion in the Company's consolidated net earnings. Current income tax is dependent upon the amount of capital expenditures incurred and the method of deployment. b) The net future income tax liability is comprised of: As at December 31, 2005 2004 ------------ ------------ Future income tax liabilities Property and equipment in excess of tax values $ 232,258 $ 199,931 Timing of partnership items 93,532 67,089 Foreign exchange gain on long-term debt 11,466 10,169 Future income tax assets Attributed Canadian royalty income (8,830) (9,015) Asset retirement obligations (6,984) (6,057) Other (9,325) (921) ------------ ------------ Net future income tax liability $ 312,117 $ 261,196 ------------ ------------ ------------ ------------ 16. Financial instruments a) Derivative financial instruments and risk management activities The Company is exposed to risks from fluctuations in commodity prices, interest rates, and Canada/US currency exchange rates. The Company utilizes various derivative financial instruments for non-trading purposes to manage and mitigate its exposure to these risks. Effective January 1, 2004, the Company elected to account for all derivative financial instruments using the mark-to-market method. Risk management activities during the periods, utilizing derivative instruments, relate to commodity price hedges and cross currency interest rate swap arrangements and are summarized below: i) Commodity price hedges The Company enters into hedge transactions relating to crude oil and natural gas prices to mitigate volatility in commodity prices and the resulting impact on cash flow. The contracts entered into are forward transactions providing the Company with a range of prices on the commodities sold. Outstanding hedge contracts at December 31, 2005 are: Daily Mark- Notional Average to-Market Commodity Term Volume Price gain (loss) --------- ---- -------- ------- ----------- Natural gas Nov. 1/05 - $8.70 - Collar Mar. 31/06 38,095 mcf $12.74/mcf $ (929) Nov. 1/05 - Fixed Mar. 31/06 9,524 mcf $9.03/mcf (1,735) Apr. 1/06 - $8.73/mcf - Collar Oct. 31/06 42,857 mcf $12.87/mcf (929) ----------- (3,593) Crude Oil Jan. 1 - US$55.00 - Collar Dec. 31/06 3,000 bbls $75.17/bbl 443 ----------- Unrealized risk management loss $ (3,150) ----------- ----------- The Company has not entered into any additional contracts subsequent to December 31, 2005. At December 31, 2004 the mark-to-market valuation of commodity contracts resulted in a $2.0 million unrealized risk management asset. ii) Deferred risk management loss As at January 1, 2004, the Company elected not to designate any of its risk management activities as accounting hedges and accordingly accounts for all derivative instruments using the mark-to-market method. As a result, on January 1, 2004, the Company recorded a liability and a deferred risk management loss of $10.9 million relating to then outstanding commodity hedges and the interest rate swap. During the year ended December 31, 2005, $1.6 million (2004 - $3.6 million) of the deferred loss was charged to earnings. The remaining balance of $5.6 million at December 31, 2005 (2004 - $7.3 million) relates to the interest rate swap and will be charged to earnings in annual amounts of $1.6 million until eliminated in 2009. iii) Cross currency interest rate swap Concurrent with the closing of the 9.90% senior notes offering in 2002, the Company entered into interest rate swap arrangements with its banking syndicate that convert fixed rate U.S. dollar denominated interest obligations into floating rate Canadian dollar denominated interest obligations. This arrangement resulted in an effective interest rate of 7.63% during period ended December 31, 2005 (2004 - 7.24%, 2003 - 7.85%) net of gains realized. On purchase of the majority of the 9.90% senior notes in November 2005, the Company elected not to collapse the cross currency interest rate swap and incur the associated costs of approximately $12.2 million. Accordingly, the swap remains outstanding and at December 31, 2005, the Company valued the liability relating to future unrealized losses on the swap arrangements to be $14.8 million (2004 - $11.4 million) on a mark-to-market basis. iv) Risk management (gains) losses Risk management (gains) and losses recognized during the periods relating to the above are summarized below: Commodity Interest Year ended December 31, 2005 Contracts Rate Swap Total ------------ ------------ ------------ Unrealized Amortization of deferred loss $ - $ 1,642 $ 1,642 Change in fair value 5,136 3,393 8,529 ------------ ------------ ------------ 5,136 5,035 10,171 Realized Cash settlements 9,663 (532) 9,131 ------------ ------------ ------------ Total loss $ 14,799 $ 4,503 $ 19,302 ------------ ------------ ------------ ------------ ------------ ------------ Commodity Interest Year ended December 31, 2004 Contracts Rate Swap Total ------------ ------------ ------------ Unrealized Amortization of deferred loss $ 2,001 $ 1,642 $ 3,643 Change in fair value (3,986) 2,522 (1,464) ------------ ------------ ------------ (1,985) 4,164 2,179 Realized Cash settlements 9,151 (2,522) 6,629 ------------ ------------ ------------ Total loss $ 7,166 $ 1,642 $ 8,808 ------------ ------------ ------------ ------------ ------------ ------------ Risk management loss of $4.1 million for year ended December 31, 2003 reflects realized losses recognized under hedge accounting. b) Other financial instruments and risk i) Credit risk management Accounts receivable include amounts receivable for oil and natural gas sales which are generally made to large credit worthy purchasers and amounts receivable from joint venture partners which are recoverable from production. Accordingly, the Company views credit risks on these amounts as low. The Company is exposed to losses in the event of non-performance by counter-parties to financial instruments. The Company deals with major institutions and believes these risks are minimal. ii) Fair value of financial assets and liabilities Other than its senior term notes, the fair values of the Company's financial assets and liabilities that are included in the Company's consolidated balance sheet as at December 31, 2005, approximate their carrying value. The estimated fair value of senior term notes was $361.1 million as at December 31, 2005 (2004 - $218.5 million) based upon market information. iii) Foreign currency risk management The Company is exposed to fluctuations in the exchange rate between the Canadian dollar and the U.S. dollar. Crude oil and to a certain extent natural gas prices are based upon reference prices denominated in U.S. dollars, while the majority of the Company's expenses are denominated in Canadian dollars. When appropriate, the Company enters into agreements to fix the exchange rate of Canadian dollars to U.S. dollars in order to manage the risk. During 2003, a gain of $2.5 million was realized and included in revenue. Subsequent to December 31, 2005 the Company entered into the following forward contracts: Notional Exchange Foreign Currency Term Amount Rate ---------------- ---- -------- -------- Currency forward Jan. 1 - Dec. 31/06 US$55,000/day 1.1530 Currency forward Jan. 1 - Dec. 31/06 US$55,000/day 1.1630 17. Cash flow Changes in non-cash working capital items increased (decreased) cash as follows: Years ended December 31, 2005 2004 2003 ------------ ------------ ------------ Accounts receivable and other $ (17,371) $ (20,176) $ (16,593) Accounts payable 78,385 39,598 23,635 Taxes payable (301) (2,526) 1,541 ------------ ------------ ------------ $ 60,713 $ 16,896 $ 8,583 ------------ ------------ ------------ ------------ ------------ ------------ Net change in non-cash working capital Relating to: Operating activities $ 8,441 $ (12,594) $ 1,318 Financing activities (1,829) 324 (1,387) Investing activities 54,101 29,166 8,652 ------------ ------------ ------------ $ 60,713 $ 16,896 $ 8,583 ------------ ------------ ------------ ------------ ------------ ------------ Amounts paid during the year relating to interest expense and capital taxes were as follows: Years ended December 31, 2005 2004 2003 ------------ ------------ ------------ Interest paid $ 31,444 $ 28,604 $ 26,923 ------------ ------------ ------------ ------------ ------------ ------------ Current income taxes paid $ 4,101 $ 4,952 $ 1,485 ------------ ------------ ------------ ------------ ------------ ------------ 18. Commitments and contingent liabilities a) Commitments The Company has committed to certain payments over the next five years, as follows: 2006 2007 2008 2009 2010 -------- --------- --------- --------- --------- Operating leases $ 11,277 $ 4,809 $ 2,609 $ - $ - Office rent 1,356 249 - - - MPP partnership distributions 9,172 9,172 9,172 3,057 - 9.90% senior notes - - - 7,870 - Other 52 - - - - -------- --------- --------- --------- --------- $ 21,857 $ 14,230 $ 11,781 $ 10,927 $ - -------- --------- --------- --------- --------- -------- --------- --------- --------- --------- b) Legal proceedings The Company is involved in various legal claims associated with normal operations. These claims, although unresolved at the current time, in management's opinion, are minor in nature and are not expected to have a material impact on the financial position or results of operations of the Company. FORWARD LOOKING STATEMENTS Certain information regarding the Company contained herein constitutesforward-looking statements under the meaning of applicable securities laws,including the United States Private Securities Litigation Reform Act of 1995.Forward-looking statements include estimates, plans, expectations, opinions,forecasts, projections, guidance, or other statements that are not statementsof fact, including statements regarding (i) reserve estimates, net presentvalue of reserves cash flow, 2006 Guidance and (ii) other risks anduncertainties described from time to time in the reports and filings made byCompton with securities regulatory authorities. Although Compton believes thatthe expectations reflected in such forward-looking statements are reasonable,it can give no assurance that such expectations will prove to have beencorrect. There are many factors that could cause forward-looking statementsnot to be correct, including risks and uncertainties inherent in the Companybusiness. These risks include, but are not limited to: crude oil and naturalgas price volatility, exchange rate fluctuations, availability of services andsupplies, operating hazards and mechanical failures, uncertainties in theestimates of reserves and in projection of future rates of production andtiming of development expenditures, general economic conditions, and theactions or inactions of third-party operators. Compton may, as considerednecessary in the circumstances, update or revise forward looking information,whether as a result of new information, future events, or otherwise. TheCompany's forward-looking statements are expressly qualified in theirentirety by this cautionary statement. CONFERENCE CALL Compton will be conducting a conference call and audio webcast Tuesday,March 21, 2006 at 9:30 a.m. Mountain Standard Time (11:30 a.m. EST) to discussthe Company's 2005 fourth quarter and 2005 annual financial and operatingresults. To participate in the conference call, please contact the ConferenceOperator at 9:20 a.m. (MST), ten minutes prior to the call. Conference Operator Dial-in Number: Toll-Free 1-800-814-4861 Local Toronto: 1-416-644-3424 Audio webcast URL:http://www.newswire.ca/en/webcast/viewEvent.cgi?eventID(equal sign)1371260 The audio replay will be available two hours after the conclusion of theconference call and will be accessible until Tuesday, March 28, 2006. Callersmay dial toll-free 1-877-289-8525 and enter access code 21176659 (followed bythe pound key). Compton Petroleum Corporation is a Calgary-based public company activelyengaged in the exploration, development, and production of natural gas,natural gas liquids, and crude oil in the Western Canada Sedimentary Basin.Compton's shares are listed on the Toronto Stock Exchange under the symbol CMTand on the New York Stock Exchange under the symbol CMZ.

Source: prnewswire