e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
FOR
THE TRANSITION PERIOD FROM
________ TO ________
Commission File Number 0-29370
ULTRA PETROLEUM CORP.
(Exact name of registrant as specified in its charter)
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Yukon Territory, Canada
(State or other jurisdiction of
incorporation or organization)
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N/A
(I.R.S. Employer
Identification Number) |
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363 North Sam Houston Parkway, Suite 1200, Houston, Texas
(Address of principal executive offices)
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77060
(Zip code) |
(281) 876-0120
(Registrants telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act.
Large Accelerated Filer þ Accelerated Filer o Non-Accelerated Filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). YES o NO þ
The number of common shares, without par value, of Ultra Petroleum Corp., outstanding as of October
20, 2006 was 151,950,897.
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
ULTRA PETROLEUM CORP.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
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For the Three Months Ended |
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For the Nine Months Ended |
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September 30, |
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September 30, |
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2006 |
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2005 |
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2006 |
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2005 |
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(In U.S. Dollars) |
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Revenues: |
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Natural gas sales |
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$ |
116,364,900 |
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$ |
110,665,181 |
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$ |
330,201,795 |
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$ |
266,692,797 |
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Oil sales |
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29,001,147 |
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23,714,106 |
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96,307,105 |
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67,685,543 |
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Total operating revenues |
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145,366,047 |
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134,379,287 |
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426,508,900 |
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334,378,340 |
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Expenses: |
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Production expenses and taxes |
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29,207,499 |
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22,718,722 |
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78,879,336 |
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58,959,388 |
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Depletion and depreciation |
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22,541,118 |
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13,270,825 |
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59,229,047 |
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37,166,738 |
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General and administrative |
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4,225,197 |
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4,019,706 |
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12,141,587 |
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10,712,319 |
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Total operating expenses |
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55,973,814 |
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40,009,253 |
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150,249,970 |
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106,838,445 |
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Operating income |
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89,392,233 |
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94,370,034 |
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276,258,930 |
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227,539,895 |
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Other income (expense): |
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Interest expense |
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(872,120 |
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(787,604 |
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(1,183,167 |
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(2,856,011 |
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Interest income |
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284,952 |
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177,463 |
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1,629,094 |
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371,020 |
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Total other income (expense) |
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(587,168 |
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(610,141 |
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445,927 |
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(2,484,991 |
) |
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Income, before income tax provision |
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88,805,065 |
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93,759,893 |
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276,704,857 |
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225,054,904 |
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Income tax provision |
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36,329,569 |
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32,909,724 |
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106,080,054 |
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78,994,271 |
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Net income |
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52,475,496 |
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60,850,169 |
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170,624,803 |
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146,060,633 |
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Retained earnings, beginning of period |
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511,737,865 |
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250,498,775 |
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393,588,558 |
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165,288,311 |
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Retained earnings, end of period |
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$ |
564,213,361 |
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$ |
311,348,944 |
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$ |
564,213,361 |
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$ |
311,348,944 |
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Income per common share basic |
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$ |
0.34 |
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$ |
0.40 |
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$ |
1.10 |
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$ |
0.96 |
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Income per common share fully diluted |
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$ |
0.33 |
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$ |
0.38 |
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$ |
1.05 |
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$ |
0.90 |
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Weighted average common shares outstanding basic |
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153,350,518 |
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153,719,760 |
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154,591,379 |
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152,515,660 |
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Weighted average common shares outstanding
fully diluted |
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160,919,594 |
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162,231,248 |
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162,446,569 |
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161,538,906 |
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3
ULTRA PETROLEUM CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
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Nine Months Ended |
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September 30, |
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2006 |
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2005 |
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(In U.S. Dollars) |
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Cash provided by (used in): |
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Operating activities: |
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Net income for the period |
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$ |
170,624,803 |
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$ |
146,060,633 |
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Adjustments to reconcile net income to net cash provided by operating activities: |
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Depletion and depreciation |
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59,229,047 |
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37,166,738 |
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Deferred income taxes |
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82,908,405 |
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78,994,271 |
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Excess tax benefit from stock based compensation |
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(9,515,806 |
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Stock compensation |
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1,021,632 |
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2,271,832 |
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Net changes in non-cash working capital: |
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Restricted cash |
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(2,007 |
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(1,399 |
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Accounts receivable |
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(12,075,313 |
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(7,127,575 |
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Inventory |
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794,000 |
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(292,776 |
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Prepaid expenses and other current assets |
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21,956 |
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644,321 |
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Accounts payable and accrued liabilities |
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32,296,436 |
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16,708,441 |
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Deferred revenue |
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1,506,580 |
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137,500 |
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Other long-term obligations |
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5,255,044 |
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4,474,803 |
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Taxes payable |
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(3,174,990 |
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(195,000 |
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Net cash provided by operating activities |
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328,889,787 |
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278,841,789 |
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Investing activities: |
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Oil and gas property expenditures |
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(342,537,507 |
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(188,197,911 |
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Change in capital cost accrual |
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34,798,341 |
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(3,604,699 |
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Inventory |
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(2,555,087 |
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(18,938,712 |
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Purchase of capital assets |
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(565,615 |
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(881,165 |
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Net cash used in investing activities |
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(310,859,868 |
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(211,622,487 |
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Financing activities: |
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Borrowings on long-term debt, gross |
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110,000,000 |
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22,000,000 |
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Payments on long-term debt, gross |
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(99,000,000 |
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Repurchased shares |
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(174,318,943 |
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Stock issued for compensation |
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1,741,003 |
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Excess tax benefit from stock based compensation |
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9,515,806 |
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Proceeds from exercise of options |
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7,492,982 |
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16,051,102 |
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Net cash used in financing activities |
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(45,569,152 |
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(60,948,898 |
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(Decrease)/Increase in cash during the period |
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(27,539,233 |
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6,270,404 |
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Cash and cash equivalents, beginning of period |
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44,394,775 |
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16,932,661 |
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Cash and cash equivalents, end of period |
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$ |
16,855,542 |
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$ |
23,203,065 |
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Supplemental disclosures of Cash Flow information: |
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Non-cash tax benefit of stock options exercised |
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$ |
39,352,436 |
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4
ULTRA PETROLEUM CORP.
CONSOLIDATED BALANCE SHEETS
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September 30, |
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December 31, |
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2006 |
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2005 |
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(unaudited) |
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(In U.S. Dollars) |
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Assets |
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Current assets |
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Cash and cash equivalents |
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$ |
16,855,542 |
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$ |
44,394,775 |
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Restricted cash |
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215,906 |
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213,899 |
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Accounts receivable |
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87,731,344 |
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75,656,031 |
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Deferred tax asset |
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501,381 |
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Inventory |
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23,161,272 |
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22,062,585 |
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Prepaid expenses and other current assets |
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106,088 |
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128,044 |
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Total current assets |
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128,571,533 |
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142,455,334 |
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Oil and gas properties, net, using the full cost method of accounting |
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Proved |
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918,543,819 |
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612,960,790 |
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Unproved |
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70,882,131 |
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89,702,465 |
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Capital assets |
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2,013,150 |
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2,147,528 |
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Total assets |
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$ |
1,120,010,633 |
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$ |
847,266,117 |
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Liabilities and shareholders equity |
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Current liabilities |
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Accounts payable and accrued liabilities |
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$ |
81,894,297 |
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$ |
49,297,861 |
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Deferred revenue |
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1,506,580 |
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Current taxes payable |
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390,000 |
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3,564,990 |
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Capital cost accrual |
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81,677,630 |
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46,879,289 |
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Total current liabilities |
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165,468,507 |
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99,742,140 |
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Long-term debt |
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110,000,000 |
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Deferred income tax liability |
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229,640,436 |
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155,746,465 |
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Other long-term obligations |
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27,239,113 |
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20,576,574 |
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Shareholders equity |
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Share capital |
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24,642,866 |
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178,806,030 |
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Treasury stock |
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(1,193,650 |
) |
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(1,193,650 |
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Retained earnings |
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564,213,361 |
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|
393,588,558 |
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Total shareholders equity |
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587,662,577 |
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571,200,938 |
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Total liabilities and shareholders equity |
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$ |
1,120,010,633 |
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$ |
847,266,117 |
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5
ULTRA PETROLEUM CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Nine months ended September 30, 2006 and 2005 expressed in U.S. dollars unless otherwise noted)
DESCRIPTION OF THE BUSINESS:
Ultra Petroleum Corp. (the Company) is an independent oil and gas company engaged in the
acquisition, exploration, development, and production of oil and gas properties. The Company is
incorporated under the laws of the Yukon Territory, Canada. The Companys principal business
activities are in the Green River Basin of Southwest Wyoming and Bohai Bay, China.
1. SIGNIFICANT ACCOUNTING POLICIES:
The accompanying financial statements, other than the balance sheet data as of December 31, 2005,
are unaudited and were prepared from the Companys records. Balance sheet data as of December 31,
2005 was derived from the Companys audited financial statements, but does not include all
disclosures required by U.S. generally accepted accounting principles. The Companys management
believes that these financial statements include all adjustments necessary for a fair presentation
of the Companys financial position and results of operations. All adjustments are of a normal and
recurring nature unless specifically noted. The Company prepared these statements on a basis
consistent with the Companys annual audited statements and Regulation S-X. Regulation S-X allows
the Company to omit some of the footnote and policy disclosures required by generally accepted
accounting principles and normally included in annual reports on Form 10-K. You should read these
interim financial statements together with the financial statements, summary of significant
accounting policies and notes to the Companys most recent annual report on Form 10-K.
(a) Basis of presentation and principles of consolidation: The consolidated financial statements
include the accounts of the Company and its wholly owned subsidiaries UP Energy Corporation, Ultra
Resources, Inc. and Sino-American Energy Corporation. The Company presents its financial statements
in accordance with U.S. GAAP. All material inter-company transactions and balances have been
eliminated upon consolidation.
(b) Accounting principles: The consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States.
(c) Cash and cash equivalents: We consider all highly liquid investments with an original maturity
of three months or less to be cash equivalents.
(d) Restricted cash: Restricted cash represents cash received by the Company from production sold
where the final division of ownership of the production is unknown or in dispute. Wyoming law
requires that these funds be held in a federally insured bank in Wyoming.
(e) Capital assets: Capital assets are recorded at cost and depreciated using the declining-balance
method based on a seven-year useful life.
(f) Oil and gas properties: The Company uses the full cost method of accounting for exploration and
development activities as defined by the Securities and Exchange Commission (SEC). Under this
method of accounting, the costs of unsuccessful, as well as successful, exploration and development
activities are capitalized as properties and equipment on a country-by-country basis. This includes
any internal costs that are directly related to exploration and development activities but does not
include any costs related to production, general corporate overhead or similar activities. The
carrying amount of oil and gas properties also includes estimated asset retirement costs recorded
based on the fair value of the asset retirement obligation when incurred. Gain or loss on the sale
or other disposition of oil and gas properties is not recognized, unless the gain or loss would
significantly alter the relationship between capitalized costs and proved reserves of oil and
natural gas attributable to a country.
The sum of net capitalized costs and estimated future development costs of oil and gas properties
are amortized using the unit-of-production method based on the proven reserves as determined by
independent petroleum engineers. Oil and gas reserves and production are converted into equivalent
units based on relative energy content. Operating fees received related to the properties in which
the Company owns an interest are netted against expenses. Fees received in excess of costs incurred
are recorded as a reduction to the full cost pool.
6
Oil and gas properties include costs that are excluded from capitalized costs being amortized.
These amounts represent investments in unproved properties and major development projects. The
Company excludes these costs on a country-by-country basis until proved reserves are found or until
it is determined that the costs are impaired. All costs excluded are reviewed at least quarterly to
determine if impairment has occurred. The amount of any impairment is transferred to the
capitalized costs being amortized (the depreciation, depletion and amortization (DD&A) pool) or a
charge is made against earnings for those international operations where a reserve base has not yet
been established. For international operations where a reserve base has not yet been established,
an impairment requiring a charge to earnings may be indicated through evaluation of drilling
results, relinquishing drilling rights or other information.
Under the full cost method of accounting, a ceiling test is performed each quarter. The full cost
ceiling test is an impairment test prescribed by SEC Regulation S-X Rule 4-10. The ceiling test
determines a limit, on a country-by-country basis, on the book value of oil and gas properties. The
capitalized costs of proved oil and gas properties, net of accumulated DD&A and the related
deferred income taxes, may not exceed the estimated future net cash flows from proved oil and gas
reserves, generally using prices in effect at the end of the period held flat for the life of
production excluding the estimated abandonment cost for properties with asset retirement
obligations recorded on the balance sheet and including the effect of derivative contracts that
qualify as cash flow hedges, discounted at 10%, net of related tax effects, plus the cost of
unevaluated properties and major development.
(g) Inventories: Crude oil products and materials and supplies inventories are carried at the lower
of current market value or cost. Inventory costs include expenditures and other charges directly
and indirectly incurred in bringing the inventory to its existing condition and location and the
Company uses the weighted average method to record its inventory. Selling expenses and general and
administrative expenses are reported as period costs and excluded from inventory cost. Inventories
of materials and supplies are valued at cost or less. Drilling and completion supplies inventory of
$23.2 million primarily includes the cost of pipe that will be utilized in the Companys drilling
activities.
(h) Derivative transactions: The Company has, in the past, used derivative instruments as one way
to manage its exposure to commodity prices. As of September 30, 2006, the Company had no open
derivative contracts to manage its price risk on its production.
The Company, to a larger extent utilizes fixed price forward gas sales contracts at southwest
Wyoming delivery points to manage its commodity exposure. The Company had the following fixed price
physical delivery contracts in place on behalf of its interest and those of other parties at
September 30, 2006. (The Companys approximate average net interest in physical gas sales is 80%.)
|
|
|
|
|
|
|
|
|
Remaining |
|
Volume - |
|
Average |
Contract |
|
MMBTU |
|
Price / |
Period |
|
/ day |
|
MMBTU |
Calendar 2006 |
|
|
70,000 |
|
|
$ |
5.86 |
|
The above forward gas sales contracts represent approximately 24% of the Companys currently
forecasted gas production for the balance of 2006.
(i) Income taxes: Income taxes are accounted for under the asset and liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their
respective tax basis and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable income in the years
in which those temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date. (See Note 9).
(j) Earnings per share: Basic earnings per share is computed by dividing net earnings attributable
to common stock by the weighted average number of common shares outstanding during each period.
Diluted earnings per share is computed by adjusting the average number of common shares outstanding
for the dilutive effect, if any, of common stock equivalents. The Company uses the treasury stock
method to determine the dilutive effect. The earnings per share information has been updated to
reflect the 2 for 1 stock split on May 10, 2005.
7
The following table provides a reconciliation of the components of basic and diluted net income per
common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net income |
|
$ |
52,475,496 |
|
|
$ |
60,850,169 |
|
|
$ |
170,624,803 |
|
|
$ |
146,060,633 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common
shares outstanding during the
period |
|
|
153,350,518 |
|
|
|
153,719,760 |
|
|
|
154,591,379 |
|
|
|
152,515,660 |
|
Effect of dilutive instruments |
|
|
7,569,076 |
|
|
|
8,511,488 |
|
|
|
7,855,190 |
|
|
|
9,023,246 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common
shares outstanding during the
period including the effects
of dilutive Instruments |
|
|
160,919,594 |
|
|
|
162,231,248 |
|
|
|
162,446,569 |
|
|
|
161,538,906 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share |
|
$ |
0.34 |
|
|
$ |
0.40 |
|
|
$ |
1.10 |
|
|
$ |
0.96 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share |
|
$ |
0.33 |
|
|
$ |
0.38 |
|
|
$ |
1.05 |
|
|
$ |
0.90 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(k) Use of estimates: Preparation of consolidated financial statements in accordance with
accounting principles generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, and the reported amounts
of revenues and expenses during the reporting period. Actual results could differ from those
estimates.
(l) Reclassifications: Certain amounts in the financial statements of the prior years have been
reclassified to conform to the current year financial statement presentation.
(m) Accounting for share-based compensation: On January 1, 2006, the Company adopted Statement of
Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R)
which requires the measurement and recognition of compensation expense for all share-based payment
awards made to employees and directors including employee stock options based on estimated fair
values. SFAS No. 123R supersedes the Companys previous accounting under Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25) for periods
beginning in fiscal year 2006. In March 2005, the SEC issued Staff Accounting Bulletin No. 107
(SAB 107) relating to SFAS No. 123R. The Company has applied the provisions of SAB 107 in its
adoption of SFAS No. 123R.
The Company adopted SFAS No. 123R using the modified prospective transition method, which requires
the application of the accounting standard as of January 1, 2006, the first day of the Companys
fiscal year 2006. The Companys Consolidated Financial Statements as of and for the nine months
ended September 30, 2006 reflect the impact of SFAS No. 123R. In accordance with the modified
prospective transition method, the Companys Consolidated Financial Statements for prior periods
have not been restated to reflect, and do not include, the impact of SFAS No. 123R. Share-based
compensation expense recognized under SFAS No. 123R for the nine months ended September 30, 2006
was $721,633, which consisted of stock-based compensation expense related to employee stock
options. There was no stock-based compensation expense related to employee stock options recognized
during the nine months ended September 30, 2005. (See Note 5 for additional information.)
SFAS No. 123R requires companies to estimate the fair value of share-based payment awards on the
date of grant using an option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as expense over the requisite service periods in the
Companys Consolidated Statement of Income. Prior to the adoption of SFAS No. 123R, the Company
accounted for stock-based awards to employees and directors using the intrinsic value method in
accordance with APB No. 25 as allowed under Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation (SFAS No. 123). Under the intrinsic value method, no
stock-based compensation expense had been recognized in the Companys Consolidated Statement of
Income because the exercise price of the Companys stock options granted to employees and directors
equaled the fair market value of the underlying stock at the date of grant.
Under SFAS No. 123R, share-based compensation expense recognized during the period is based on the
value of the portion of share-based payment awards that is ultimately expected to vest during the
period. Share-based compensation expense recognized in the Companys Consolidated Statement of
Income for the nine months ended September 30, 2006 includes compensation expense for share-based
payment awards granted subsequent to January 1, 2006 based on the grant date fair value estimated
in accordance with the provisions of SFAS No. 123R. As of December 31, 2005, all stock options
granted to date had fully vested. Compensation expense attributable to awards granted subsequent to
January 1, 2006 is recognized using the straight-line method. As share-based compensation expense
recognized in the Consolidated Statements of Income for the first nine months of 2006 is based on
awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123R
requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent
periods if actual forfeitures differ from those estimates. In the
Companys pro forma information required under SFAS No. 123 for the periods prior to January 1, 2006, the Company
accounted for forfeitures as they occurred.
8
Under SFAS No. 123 (and APB No. 25), the Company utilized a Black-Scholes option pricing model to
measure the fair value of stock options granted to employees. For additional information, see Note
5. The Companys determination of fair value of share-based payment awards on the date of grant
using an option-pricing model is affected by the Companys stock price as well as assumptions
regarding a number of highly complex and subjective variables. These variables include, but are not
limited to, the Companys expected stock price volatility over the term of the awards, and actual
and projected employee stock option exercise behaviors.
Option-pricing models were developed for use in estimating the value of traded options that have no
vesting or hedging restrictions and are fully transferable. Because (1) the Companys employee
stock options have certain characteristics that are significantly different from traded options,
and (2) changes in the subjective assumptions can materially affect the estimated value, in
managements opinion, the existing valuation models may not provide an accurate measure of the fair
value of the Companys employee stock options. Although the fair value of employee stock options is
determined in accordance with SFAS No. 123R and SAB 107 using a Black-Scholes option-pricing model,
that value may not be indicative of the fair value observed in a willing buyer/willing seller
market transaction. The Company is responsible for determining the assumptions used in estimating
the fair value of its share-based payment awards.
(n) Revenue Recognition. Within the Companys United States segment, natural gas revenues are
recorded on the entitlement method. Under the entitlement method, revenue is recorded when title
passes based on the Companys net interest. The Company records its entitled share of revenues
based on estimated production volumes. Subsequently, these estimated volumes are adjusted to
reflect actual volumes that are supported by third party pipeline statements or cash receipts.
Since there is a ready market for natural gas, the Company sells the majority of its products soon
after production at various locations at which time title and risk of loss pass to the buyer. Gas
imbalances occur when the Company sells more or less than its entitled ownership percentage of
total gas production. Any amount received in excess of the Companys share is treated as a
liability. If the Company receives less than its entitled share, the underproduction is recorded as
a receivable. Oil revenues are recognized when production is sold to a purchaser at a fixed or
determinable price, when delivery has occurred and title is transferred.
In China, revenues are recognized when production is sold to a purchaser at a fixed or determinable
price, when delivery has occurred and title is transferred.
(o) Impact of recently issued accounting pronouncements: As of January 1, 2006, the Company adopted
SFAS No. 154, Accounting for Changes and Error Corrections, a replacement of APB Opinion No. 20
and SFAS No. 3 (SFAS No. 154). SFAS No. 154 requires retrospective application of voluntary
changes in accounting principles, unless it is impracticable. The Company does not expect this
standard to have a material impact on its financial statements.
In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48 (FIN
No. 48), Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS No. 109, which
clarifies the accounting for uncertainty in income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes. FIN No. 48 prescribes a recognition threshold and measurement
attribute for the measurement and financial statement recognition of a tax position taken or
expected to be taken in a tax return. The interpretation also provides guidance on de-recognition,
classification, interest and penalties, accounting in interim periods, disclosure and transition.
For the Company, the provisions of FIN No. 48 are effective January 1, 2007. The Company is
evaluating what impact FIN No. 48 will have, but currently believes that its implementation will
not have a material impact on consolidated results of operations, financial position or liquidity.
In September 2006, the SEC staff issued Staff Accounting Bulletin 108, Financial Statements
Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year
Financial Statements (SAB 108). SAB 108 addresses how a registrant should quantify the effect
of an error on the financial statements and concludes that a dual approach should be used to
compute the amount of a misstatement. Specifically, the amount should be computed using both the
rollover (current year income statement perspective) and iron curtain (year-end balance sheet
perspective) methods. For the Company, the provisions of SAB 108 are effective January 1, 2007.
The Company does not expect that the implementation of SAB 108 will have a material impact on
consolidated results of operations, financial position or liquidity.
9
2. ASSET RETIREMENT OBLIGATIONS:
The Company has recorded a liability of $5,008,843 ($3,730,078 U.S and $1,278,765 China) at
September 30, 2006 to account for the retirement of tangible, long-lived assets that result from
the acquisition, construction, development and/or normal use of the assets.
3. OIL AND GAS PROPERTIES:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Developed Properties: |
|
|
|
|
|
|
|
|
Acquisition, equipment, exploration, drilling and environmental costs Domestic |
|
$ |
1,015,620,232 |
|
|
$ |
700,425,880 |
|
Acquisition, equipment, exploration, drilling and environmental costs China |
|
|
91,935,200 |
|
|
|
43,890,413 |
|
Less accumulated depletion, depreciation and amortization Domestic |
|
|
(167,493,316 |
) |
|
|
(118,172,467 |
) |
Less accumulated depletion, depreciation and amortization China |
|
|
(21,518,297 |
) |
|
|
(13,183,036 |
) |
|
|
|
|
|
|
|
|
|
|
918,543,819 |
|
|
|
612,960,790 |
|
|
|
|
|
|
|
|
|
|
Unproven Properties: |
|
|
|
|
|
|
|
|
Acquisition and exploration costs Domestic |
|
|
27,418,418 |
|
|
|
17,647,300 |
|
Acquisition and exploration costs China |
|
|
43,463,713 |
|
|
|
72,055,165 |
|
|
|
|
|
|
|
|
|
|
$ |
989,425,950 |
|
|
$ |
702,663,255 |
|
|
|
|
|
|
|
|
4. LONG-TERM LIABILITIES:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Bank indebtedness |
|
$ |
110,000,000 |
|
|
$ |
|
|
Other long-term obligations |
|
|
27,239,113 |
|
|
|
20,576,574 |
|
|
|
|
|
|
|
|
|
|
$ |
137,239,113 |
|
|
$ |
20,576,574 |
|
|
|
|
|
|
|
|
Bank indebtedness: The Company (through its subsidiary) participates in a revolving credit facility
with a group of banks led by JP Morgan Chase Bank, N.A. The agreement specifies a maximum loan
amount of $500 million, an aggregate borrowing base of $950 million and a commitment amount of $200
million. The commitment amount may be increased up to the lesser of the borrowing base amount or
$500 million at any time at the request of the Company. Each bank shall have the right, but not the
obligation, to increase the amount of their commitment as requested by the Company. In the event
that the existing banks increase their commitment to an amount less than the requested commitment
amount, then it would be necessary to bring additional banks into the facility. At September 30,
2006, the Company had $110.0 million outstanding and $90.0 million unused and available under the
current committed amount.
The credit facility matures on May 1, 2010. The note bears interest at either (A) the banks prime
rate plus a margin of zero percent (0.00%) to three-quarters of one percent (0.75%) based on the
percentage of available credit drawn or at (B) LIBOR plus a margin of one percent (1.00%) to one
and three-quarters of one percent (1.75%) based on the percentage of available credit drawn. For
purposes of calculating interest, the available credit is equal to the borrowing base. An average
annual commitment fee of 0.25% to 0.375%, depending on the percentage of available credit drawn, is
charged quarterly for any unused portion of the commitment amount.
The borrowing base is subject to periodic (at least semi-annual) review and re-determination by the
banks and may be decreased or increased depending on a number of factors, including the Companys
proved reserves and the banks forecast of future oil and gas prices. If the borrowing base is
reduced to an amount less than the balance outstanding, the Company has sixty days from the date of
written notice of the reduction in the borrowing base to pay the difference. Additionally, the
Company is subject to quarterly reviews of compliance with the covenants under the bank facility
including minimum coverage ratios relating to interest, working capital and advances to
Sino-American Energy Corporation. In the event of a default under the covenants, the Company may
not be able to access funds otherwise available under the facility. As of September 30, 2006, the
Company was in compliance with required covenants of the bank facility.
Any debt outstanding under the credit facility is secured by a majority of the Companys proved
domestic oil and gas properties.
Other long-term obligations: These costs relate to the long-term portion of production taxes
payable, a liability associated with imbalanced production, the long-term portion of costs
associated with our compensation programs and our asset retirement obligations (See Note 2).
10
5. SHARE BASED COMPENSATION:
Share-Based Payment Arrangements
The Companys Stock Incentive Plans are administered by the Compensation Committee of the Board of
Directors (the Plan Administrator). The Plan Administrator may make awards of stock options to
employees, directors, officers and consultants of the Company as long as the aggregate number of
common shares issuable to any one person pursuant to incentives does not exceed 5% of the number of
common shares outstanding at the time of the award. In addition, no participant may receive during
any fiscal year of the Companys awards of incentives covering an aggregate of more than 500,000
common shares. The Plan Administrator determines the vesting requirements and any vesting
restrictions or forfeitures that occur in certain circumstances. Incentives may not have an
exercise period longer than 10 years. The exercise price of the stock may not be less than the fair
market value of the common shares at the time of award, where fair market value means the average
high and low trading price of the common shares on the date of the award.
On April 29, 2005, the shareholders approved the adoption of the 2005 Stock Incentive Plan (2005
Stock Incentive Plan). The 2005 Stock Incentive Plan authorizes the Plan Administrator to award
incentives from the effective date of the 2005 Stock Incentive Plan. The 2005 Stock Incentive Plan
is in addition to the Companys existing stock option plans (the 2000 Option Plan and the 1998
Stock Plan). The 2000 Option Plan and the 1998 Stock Plan remain effective and the Company will
make grants under each of the existing plans.
The purpose of the 2005 Stock Incentive Plan is to foster and promote the long-term financial
success of the Company and to increase shareholder value by attracting, motivating and retaining
key employees, consultants and directors and providing such participants in the 2005 Stock
Incentive Plan with a program for obtaining an ownership interest in the Company that links and
aligns their personal interests with those of the Companys shareholders, thus enabling such
participants to share in the long-term growth and success of the Company. To accomplish these
goals, the 2005 Stock Incentive Plan permits the granting of incentive stock options, non-statutory
stock options, stock appreciation rights, restricted stock, and other stock-based awards, some of
which may require the satisfaction of performance-based criteria in order to be payable to
participants. The 2005 Stock Incentive Plan is an important component of the total compensation
package offered to employees and directors, reflecting the importance that the Company places on
motivating and rewarding superior results with long-term, performance-based incentives.
The purposes of the 2000 Option Plan and the 1998 Stock Plan are: (i) to associate the interests of
management of the Company and its subsidiaries and affiliates closely with the stockholders to
generate an increased incentive to contribute to the Companys future success and prosperity, thus
enhancing the value of the Company for the benefit of its stockholders; (ii) to maintain
competitive compensation levels thereby attracting and retaining highly competent and talented
directors, employees and consultants; and (iii) to provide an incentive to such management for
continuous employment with the Company.
Accounting for share-based compensation
In December 2004, the FASB issued SFAS No. 123R. SFAS No. 123R is a revision of SFAS No. 123 and
supersedes APB No. 25. Among other items, SFAS No. 123R eliminates the use of APB No. 25 and the
intrinsic value method of accounting, and requires companies to recognize the cost of employee
services received in exchange for awards of equity instruments, based on the grant date fair value
of those awards, in the financial statements. Pro forma disclosure is no longer an alternative
under the new standard. Accordingly, the Company adopted SFAS No. 123R as of January 1, 2006.
SFAS No. 123R provides specific guidance on income tax accounting and clarifies how SFAS No. 109,
Accounting for Income Taxes, should be applied to stock-based compensation. For example, the
expense for certain types of option grants is only deductible for tax purposes at the time that the
taxable event takes place, which could cause variability in the Companys effective tax rates
recorded throughout the year. SFAS No. 123R does not allow companies to predict when these
taxable events will take place. Furthermore, it requires that the benefits associated with the tax
deductions in excess of recognized compensation cost be reported as a financing cash flow, rather
than as an operating cash flow as required under SFAS No. 123. These future amounts cannot be
estimated, because they depend on, among other things, when employees exercise stock options.
11
Valuation and Expense Information under SFAS 123R
The following table summarizes share-based compensation expense related to employee stock options
under SFAS 123R for the nine months ended September 30, 2006 which was allocated as follows:
|
|
|
|
|
|
|
Nine Months |
|
|
Ended |
|
|
September 30, 2006 |
Total cost of share-based payment plans |
|
$ |
1,405,980 |
|
Amounts capitalized in inventory and oil and gas properties |
|
|
684,347 |
|
Amounts recognized in income for amounts previously capitalized in inventory and fixed assets |
|
|
|
|
Amounts charged against income, before income tax benefit |
|
$ |
721,633 |
|
Amount of related income tax benefit recognized in income |
|
$ |
253,293 |
|
Cumulative effect from adoption of SFAS No. 123R on : |
|
|
|
|
Income from continuing operations |
|
$ |
721,633 |
|
Income before income taxes |
|
$ |
721,633 |
|
Net income |
|
$ |
468,340 |
|
Cash flow from operations |
|
$ |
(9,515,806 |
) |
Cash flow from financing activities |
|
$ |
9,515,806 |
|
Basic earnings per share |
|
|
|
|
Diluted earnings per share |
|
|
|
|
The fair value of each share option award is estimated on the date of grant using a Black-Scholes
pricing model based on assumptions noted in the following table. The Companys employee stock
options have various restrictions including vesting provisions and restrictions on transfers and
hedging, among others, and are often exercised prior to their contractual maturity. Expected
volatilities used in the fair value estimate are based on historical volatility of the Companys
stock. The Company uses historical data to estimate share option exercises, expected term and
employee departure behavior used in the Black-Scholes pricing model. Groups of employees
(executives and non-executives) that have similar historical behavior are considered separately for
purposes of determining the expected term used to estimate fair value. The assumptions utilized
result from differing pre- and post-vesting behaviors among executive and non-executive groups. The
risk-free rate for periods within the contractual term of the share option is based on the U.S.
Treasury yield curve in effect at the time of grant.
|
|
|
|
|
|
|
|
|
|
|
Non-Executives |
|
Executives |
Expected volatility |
|
|
44.2-45.8 |
% |
|
|
43.5 |
% |
Expected dividends |
|
|
0 |
% |
|
|
0 |
% |
Expected term (in years) |
|
|
2.75-4.71 |
|
|
|
3.58 |
|
Risk free rate |
|
|
4.56-5.03 |
% |
|
|
4.84 |
% |
Expected forfeiture rate |
|
|
20.0 |
% |
|
|
20.0 |
% |
Securities Authorized for Issuance Under Equity Compensation Plans
As of September 30, 2006, the Company had the following securities issuable pursuant to outstanding
award agreements or reserved for issuance under the Companys previously approved stock incentive
plans. (Upon exercise, shares issued will be newly issued shares).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of |
|
|
|
|
|
|
|
|
|
|
Securities to |
|
|
|
|
|
|
Number of Securities |
|
|
|
Be Issued |
|
|
|
|
|
|
Remaining Available for |
|
|
|
Upon |
|
|
Weighted- |
|
|
Future Issuance Under |
|
|
|
Exercise |
|
|
Average |
|
|
Equity Compensation |
|
|
|
of |
|
|
Exercise Price of |
|
|
Plans (Excluding |
|
|
|
Outstanding |
|
|
Outstanding |
|
|
Securities Reflected in |
|
Plan Category |
|
Options |
|
|
Options |
|
|
the First Column) |
|
Equity compensation plans approved by security holders |
|
|
9,085,256 |
|
|
$ |
10.24 |
|
|
|
10,856,044 |
|
Equity compensation plans not approved by security holders |
|
|
n/a |
|
|
|
n/a |
|
|
|
n/a |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
9,085,256 |
|
|
$ |
10.24 |
|
|
|
10,856,044 |
|
12
Changes in Stock Options and Stock Options Outstanding
The following table summarizes the changes in stock options for the year ended December 31, 2005
and the nine months ended September 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Average |
|
|
Number of |
|
Exercise Price |
|
|
Options |
|
(US$) |
Balance, December 31, 2004
|
|
|
12,703,400 |
|
|
$ 0.25 to $24.31 |
|
|
|
|
|
|
|
Granted
|
|
|
1,529,000 |
|
|
$23.90 to $58.71 |
Exercised
|
|
|
(4,793,700 |
) |
|
$ 0.32 to $25.68 |
Forfeited
|
|
|
(50,000 |
) |
|
$25.68 to $25.68 |
|
|
|
|
|
|
|
Balance, December 31, 2005
|
|
|
9,388,700 |
|
|
$ 0.26 to $58.71 |
|
|
|
|
|
|
|
Granted
|
|
|
264,966 |
|
|
$46.05 to $67.73 |
Exercised
|
|
|
(566,400 |
) |
|
$ 0.46 to $40.00 |
Forfeited
|
|
|
(2,010 |
) |
|
$63.05 to $63.05 |
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2006
|
|
|
9,085,256 |
|
|
$ 0.25 to $67.73 |
|
|
|
|
|
|
|
The following tables summarize information about the stock options outstanding at September 30,
2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
|
|
|
|
Weighted |
|
Weighted |
|
|
|
|
|
|
|
|
Average |
|
Average |
|
Aggregate |
Range of Exercise |
|
Number |
|
Remaining |
|
Exercise Price |
|
Intrinsic Value |
Price ($US) |
|
Outstanding |
|
Contractual Life |
|
($US) |
|
($US) |
$0.38 0.46 |
|
|
2,577,500 |
|
|
|
2.33 |
|
|
$ |
0.46 |
|
|
$ |
122,818,065 |
|
$0.25 0.57 |
|
|
760,000 |
|
|
|
3.54 |
|
|
$ |
0.34 |
|
|
$ |
36,306,400 |
|
$1.49 2.61 |
|
|
1,355,000 |
|
|
|
4.46 |
|
|
$ |
1.90 |
|
|
$ |
62,610,900 |
|
$3.91 4.43 |
|
|
661,000 |
|
|
|
5.61 |
|
|
$ |
4.40 |
|
|
$ |
28,894,580 |
|
$4.83 7.10 |
|
|
856,600 |
|
|
|
6.61 |
|
|
$ |
5.05 |
|
|
$ |
36,886,262 |
|
$11.68 24.21 |
|
|
1,359,000 |
|
|
|
7.56 |
|
|
$ |
15.94 |
|
|
$ |
43,725,770 |
|
$23.90 58.71 |
|
|
1,253,200 |
|
|
|
8.73 |
|
|
$ |
35.45 |
|
|
$ |
16,805,110 |
|
$46.05 67.73 |
|
|
262,956 |
|
|
|
9.63 |
|
|
$ |
59.54 |
|
|
$ |
41,200 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Exercisable |
|
|
|
|
|
|
Weighted |
|
Weighted |
|
|
|
|
|
|
|
|
Average |
|
Average |
|
Aggregate |
Range of Exercise |
|
Number |
|
Remaining |
|
Exercise Price |
|
Intrinsic Value |
Price ($US) |
|
Exercisable |
|
Contractual Life |
|
($US) |
|
($US) |
$0.38 0.46
|
|
|
2,577,500 |
|
|
|
2.33 |
|
|
$ |
0.46 |
|
|
$ |
122,818,065 |
|
$0.25 0.57
|
|
|
760,000 |
|
|
|
3.54 |
|
|
$ |
0.34 |
|
|
$ |
36,306,400 |
|
$1.49 2.61
|
|
|
1,355,000 |
|
|
|
4.46 |
|
|
$ |
1.90 |
|
|
$ |
62,610,900 |
|
$3.91 4.43
|
|
|
661,000 |
|
|
|
5.61 |
|
|
$ |
4.40 |
|
|
$ |
28,894,580 |
|
$4.83 7.10
|
|
|
856,600 |
|
|
|
6.61 |
|
|
$ |
5.05 |
|
|
$ |
36,886,262 |
|
$11.68 24.21
|
|
|
1,359,000 |
|
|
|
7.56 |
|
|
$ |
15.94 |
|
|
$ |
43,725,770 |
|
$23.90 58.71
|
|
|
1,253,200 |
|
|
|
8.73 |
|
|
$ |
35.45 |
|
|
$ |
16,805,110 |
|
$46.05 67.73
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value in the preceding tables represents the total pre-tax intrinsic value,
based on the Companys closing stock price of $48.11 on September 30, 2006, which would have been
received by the option holders had all option holders exercised their options as of that date. The
total number of in-the-money options exercisable as of September 30, 2006 was 8,612,300.
The weighted-average grant-date fair value of share options granted during the nine months ended
September 30, 2006 was $24.06 per share. The total intrinsic value of share options exercised
during the nine months ended September 30, 2006 was $25.9 million.
At September 30, 2006, there was $3,693,488 of total unrecognized compensation cost related to
non-vested share-based compensation arrangements granted under the Stock Incentive Plans. That cost
is expected to be recognized over a weighted average period of 2.1 years.
13
Prior to adopting of SFAS No. 123R on January 1, 2006, the Company followed SFAS No. 123 which
allowed for the continued measurement of compensation cost for such plans using the intrinsic value
based method prescribed by APB Opinion No. 25 provided that pro forma results of operations were
disclosed for those options granted. Accordingly, the Company accounted for stock options granted
to employees and directors of the Company under the intrinsic value method. Had the Company
reported compensation costs as determined by the fair value method of accounting for option grants
to employees and directors, net income and net income per common share would approximate the
following pro forma amounts: (The earnings per share amounts have been adjusted to reflect the 2
for 1 stock split on May 10, 2005).
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, 2005 |
|
|
September 30, 2005 |
|
Net income as reported: |
|
$ |
60,850,169 |
|
|
$ |
146,060,633 |
|
Deduct: Stock based employee compensation, net of tax |
|
|
(3,842,861 |
) |
|
|
(7,335,492 |
) |
|
|
|
|
|
|
|
Pro Forma |
|
$ |
57,007,308 |
|
|
$ |
138,725,141 |
|
Basic Earnings per share: |
|
|
|
|
|
|
|
|
As Reported |
|
$ |
0.40 |
|
|
$ |
0.96 |
|
Pro Forma |
|
$ |
0.37 |
|
|
$ |
0.91 |
|
Diluted Earnings per share: |
|
|
|
|
|
|
|
|
As Reported |
|
$ |
0.38 |
|
|
$ |
0.90 |
|
Pro Forma |
|
$ |
0.35 |
|
|
$ |
0.86 |
|
For purposes of pro forma disclosures, the estimated fair value of options is amortized to expense
over the options vesting period. The weighted-average fair value of each option granted is
estimated on the date of grant using the Black-Scholes option pricing model with the following
assumptions at September 30, 2005:
|
|
|
|
|
Expected volatility |
|
|
30.8% 37.31 |
% |
Expected dividends |
|
|
0.0 |
% |
Expected term (in years) |
|
|
6.50 |
|
Risk free rate |
|
|
3.83% 4.32 |
% |
Expected forfeiture rate |
|
Actual forfeitures |
PERFORMANCE SHARE PLANS:
Long-Term Incentive Plan
In 2005, the Company adopted a Long-Term Incentive Plan (LTIP) in order to further align the
interests of key employees with shareholders and give key employees the opportunity to share in the
long-term performance of the Company by achieving specific corporate financial and operational
goals. Under the LTIP, the Compensation Committee establishes certain performance measures at the
beginning of each three-year overlapping performance period. Performance measures may vary for
performance periods. In the event of a change of control of the Company all outstanding awards are
paid at target levels in cash. The event of a change of control is not currently probable.
Each participant in the LTIP is assigned threshold, target and maximum award levels that are
expressed as a percentage of his or her base salary. Selected officers, managers and other key
employees are eligible to participate in the LTIP. Participants are recommended by the CEO and
approved by the Compensation Committee and are assigned to a specific eligibility level. The
participation levels are as follows (the respective percentage award is calculated based upon the
participants base salary at the beginning of the award period), (i) if threshold performance
objectives are attained, the incentive award opportunities range from 6% to 38%; (ii) if target
performance objectives are attained, the incentive award opportunities range from 20% to 125%; and
(iii) if maximum performance objectives are attained, the incentive award opportunities range from
30% to 188%. The threshold award level is not the minimum award, but is the award at the threshold
performance level. Awards are expressed as dollar targets and become payable in common shares
issued under the Companys stock incentive plans at the end of each three-year performance period
based on the overall performance of the Company during such period. A new three-year period begins
each January, beginning January 1, 2005. Participants must be employed by the Company at the end of
a performance period in order to receive an award. Employees joining the Company after January 1,
2005 will participate on a pro rata basis based on their length of employment during the
performance period.
The Compensation Committee has established the following performance measures for the 2005 LTIP and
2006 LTIP: return on equity, reserve replacement ratio, and production growth. At the discretion of
the Compensation Committee, additional metrics may be added to individual participants.
14
For the
nine months ended September 30, 2006, the Company recognized
$317,039 and $310,173 in
pre-tax compensation expense related to the 2005 LTIP and 2006 LTIP, respectively. The amounts
recognized during the first nine months of 2006 assumes that maximum performance objectives are
attained. If the Company ultimately attains maximum performance objectives, the associated total
compensation expense, estimated at September 30, 2006, for the three year performance periods would
be approximately $2.1 million and $2.2 million (before taxes) related to the 2005 LTIP and 2006
LTIP, respectively.
Best in Class
In 2005, the Company also established a Best in Class program for all full-time employees of the
Company, including executive officers. The purpose of the program is to recognize and financially
reward the collective efforts of all the Companys employees in achieving sustained industry
leading performance and the enhancement of shareholder value.
Under the Best in Class program, on January 1, 2005 or the employment date if subsequent to January
1, 2005, all employees of the Company received a contingent award of stock units equal to $50,000
worth of the Companys common stock based on the average of the high and low share price on the
date of grant. Employees joining the Company after January 1, 2005 will participate on a pro rata
basis based on their length of employment during the performance period. The number of units that
will vest and become payable is based on the Companys performance relative to the industry during
a three-year performance period beginning January 1, 2005 and ending December 31, 2007 and are set
at threshold (50%), target (100%) and maximum (150%) levels. For each vested unit, the participant
will receive one share of common stock.
The emphasis of this plan is to recognize and reward the Companys employees for performance that
is recognized in the industry as clearly outstanding. Performance metrics will be developed and
measured by an accepted third party research organization. The total vested award will be the sum
of the vesting percentage for each metric. The maximum units that may be vested is 150% of the
original award. Performance results will be determined after the end of the performance period and
publication of the applicable industry reports. A participant must be employed when payments are
made in order to receive an award.
For the
nine months ended September 30, 2006, the Company recognized
$94,883 in pre-tax
compensation expense related to the Best in Class Incentive Compensation Plan. The amount
recognized during the first nine months of 2006 assumes that target performance levels are
achieved. If the Company ultimately attains the target performance level, the associated total
compensation expense, estimated at September 30, 2006, for the entire three year performance period
would be approximately $2.0 million before income taxes.
6. SEGMENT INFORMATION:
The Company has two reportable operating segments, one domestic and one foreign, which are in the
business of natural gas and crude oil exploration and production. The accounting policies of the
segments are the same as those described in the summary of significant accounting policies. The
Company evaluates performance based on profit or loss from oil and gas operations before price-risk
management and other, general and administrative expenses and interest expense. The Companys
reportable operating segments are managed separately based on their geographic locations. Financial
information by operating segment is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
Domestic |
|
|
China |
|
|
Total |
|
|
Domestic |
|
|
China |
|
|
Total |
|
Oil and gas sales |
|
$ |
127,533,212 |
|
|
$ |
17,832,835 |
|
|
$ |
145,366,047 |
|
|
$ |
118,736,583 |
|
|
$ |
15,642,704 |
|
|
$ |
134,379,287 |
|
Costs and Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depletion and
depreciation |
|
|
19,555,958 |
|
|
|
2,985,160 |
|
|
|
22,541,118 |
|
|
|
12,121,758 |
|
|
|
1,149,067 |
|
|
|
13,270,825 |
|
Lease operating expenses |
|
|
5,410,445 |
|
|
|
2,104,000 |
|
|
|
7,514,445 |
|
|
|
2,318,646 |
|
|
|
1,079,000 |
|
|
|
3,397,646 |
|
Production taxes |
|
|
14,549,006 |
|
|
|
1,634,791 |
|
|
|
16,183,797 |
|
|
|
13,935,435 |
|
|
|
783,520 |
|
|
|
14,718,955 |
|
Gathering |
|
|
5,509,257 |
|
|
|
|
|
|
|
5,509,257 |
|
|
|
4,602,121 |
|
|
|
|
|
|
|
4,602,121 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment operating income |
|
|
82,508,546 |
|
|
|
11,108,884 |
|
|
|
93,617,430 |
|
|
|
85,758,623 |
|
|
|
12,631,117 |
|
|
|
98,389,740 |
|
General and
administrative |
|
|
|
|
|
|
|
|
|
|
4,225,197 |
|
|
|
|
|
|
|
|
|
|
|
4,019,706 |
|
Other expense (income) |
|
|
|
|
|
|
|
|
|
|
587,168 |
|
|
|
|
|
|
|
|
|
|
|
610,141 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before
income taxes |
|
|
|
|
|
|
|
|
|
$ |
88,805,065 |
|
|
|
|
|
|
|
|
|
|
$ |
93,759,893 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures |
|
$ |
151,381,055 |
|
|
$ |
5,216,332 |
|
|
$ |
156,597,387 |
|
|
$ |
72,225,419 |
|
|
$ |
4,762,429 |
|
|
$ |
76,987,848 |
|
Net oil and gas properties |
|
$ |
875,545,334 |
|
|
$ |
113,880,616 |
|
|
$ |
989,425,950 |
|
|
$ |
522,558,216 |
|
|
$ |
103,860,873 |
|
|
$ |
626,419,089 |
|
15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
|
Domestic |
|
|
China |
|
|
Total |
|
|
Domestic |
|
|
China |
|
|
Total |
|
Oil and gas sales |
|
$ |
358,172,639 |
|
|
$ |
68,336,261 |
|
|
$ |
426,508,900 |
|
|
$ |
285,546,319 |
|
|
$ |
48,832,021 |
|
|
$ |
334,378,340 |
|
Costs and Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depletion and
depreciation |
|
|
50,189,449 |
|
|
|
9,039,598 |
|
|
|
59,229,047 |
|
|
|
32,027,985 |
|
|
|
5,138,753 |
|
|
|
37,166,738 |
|
Lease operating expenses |
|
|
10,217,905 |
|
|
|
6,817,000 |
|
|
|
17,034,905 |
|
|
|
6,336,316 |
|
|
|
4,699,000 |
|
|
|
11,035,316 |
|
Production taxes |
|
|
41,222,962 |
|
|
|
7,000,151 |
|
|
|
48,223,113 |
|
|
|
33,162,191 |
|
|
|
2,442,986 |
|
|
|
35,605,177 |
|
Gathering |
|
|
13,621,318 |
|
|
|
|
|
|
|
13,621,318 |
|
|
|
12,318,895 |
|
|
|
|
|
|
|
12,318,895 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment operating income |
|
|
242,921,005 |
|
|
|
45,479,512 |
|
|
|
288,400,517 |
|
|
|
201,700,932 |
|
|
|
36,551,282 |
|
|
|
238,252,214 |
|
General and
administrative |
|
|
|
|
|
|
|
|
|
|
12,141,587 |
|
|
|
|
|
|
|
|
|
|
|
10,712,319 |
|
Other expense (income) |
|
|
|
|
|
|
|
|
|
|
(445,927 |
) |
|
|
|
|
|
|
|
|
|
|
2,484,991 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before
income taxes |
|
|
|
|
|
|
|
|
|
$ |
276,704,857 |
|
|
|
|
|
|
|
|
|
|
$ |
225,054,904 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures |
|
$ |
323,565,377 |
|
|
$ |
18,972,130 |
|
|
$ |
342,537,507 |
|
|
$ |
172,189,550 |
|
|
$ |
16,008,361 |
|
|
$ |
188,197,911 |
|
Net oil and gas properties |
|
$ |
875,545,334 |
|
|
$ |
113,880,616 |
|
|
$ |
989,425,950 |
|
|
$ |
522,558,216 |
|
|
$ |
103,860,873 |
|
|
$ |
626,419,089 |
|
7. LONG TERM CONTRACTS:
On December 19, 2005, the Company signed two Precedent Agreements with Rockies Express Pipeline,
LLC and Entrega Gas Pipeline LLC governing how the parties will proceed through the design,
regulatory process and construction of the pipeline facilities and, subject to certain conditions
precedent, the Company will take firm transportation service if and when the pipeline facilities
are constructed. The Companys Board of Directors approved the Precedent Agreements on February 6,
2006 and Kinder Morgan, as the Managing Member of the Rockies Express Pipeline LLC advised the
Company of their final approval of the Precedent Agreements, and their intent to proceed with the
construction of the Rockies Express Pipeline on February 28, 2006.
8. SHARE REPURCHASE PROGRAM:
On May 17, 2006, the Company announced that its Board of Directors authorized a share repurchase
program for up to an aggregate $1 billion of the Companys outstanding common stock which has been
and will be funded by cash on hand and the Companys senior credit facility. Pursuant to this
authorization, the Company has commenced an initial program to purchase up to $250.0 million of the
Companys outstanding shares through open market transactions or privately negotiated transactions.
Ultra Petroleum Corp. (Ultra Petroleum) owns 100% of UP Energy Corporation (UP Energy), which in
turn owns 100% of Ultra Resources, Inc. (Ultra Resources). Ultra Resources may, from time to time,
repurchase Ultra Petroleum publicly traded stock. On settlement, the repurchased stock will be
transferred to Ultra Resources. The stock repurchase will be funded with cash held in an Ultra
Resources bank account or the Companys senior credit facility.
At September 30, 2006, the Company had repurchased 3,481,032 shares of its common stock for an
aggregate $174.3 million at a weighted average price of $50.08 per share.
9. INCOME TAXES:
Income taxes are accounted for under the asset and liability method. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and their respective tax
basis and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in income in the period that includes the
enactment date.
In conjunction with the share repurchase program described in Note 8, a stock distribution to Ultra
Petroleum from Ultra Resources is treated as a dividend for U.S. tax purposes to the extent of
earnings and profits of UP Energy and Ultra Resources. U.S. tax rules, including rules under the
U.S.-Canada Income Tax Treaty, require a 5% withholding tax when a U.S. corporation distributes a
dividend to its sole corporate Canadian shareholder.
16
The following table summarizes the components of Income Tax Expense for the three and nine months
ended September 30, 2006 and 2005:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended September 30, |
|
|
For the nine months ended September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
$ |
|
|
Rate |
|
|
$ |
|
|
Rate |
|
|
$ |
|
|
Rate |
|
|
$ |
|
|
Rate |
|
Current: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
China |
|
$ |
390,000 |
|
|
|
0.4 |
% |
|
$ |
|
|
|
|
0.0 |
% |
|
$ |
14,215,000 |
|
|
|
5.1 |
% |
|
$ |
|
|
|
|
0.0 |
% |
Withholding taxes-stock distribution |
|
|
5,158,991 |
|
|
|
5.8 |
% |
|
|
|
|
|
|
0.0 |
% |
|
|
8,956,649 |
|
|
|
3.2 |
% |
|
|
|
|
|
|
0.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax expense |
|
|
30,780,578 |
|
|
|
34.7 |
% |
|
|
32,909,724 |
|
|
|
35.1 |
% |
|
|
82,908,405 |
|
|
|
30.0 |
% |
|
|
78,994,271 |
|
|
|
35.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Income Tax Provision |
|
$ |
36,329,569 |
|
|
|
40.9 |
% |
|
$ |
32,909,724 |
|
|
|
35.1 |
% |
|
$ |
106,080,054 |
|
|
|
38.3 |
% |
|
$ |
78,994,271 |
|
|
|
35.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10. LEGAL PROCEEDINGS:
The Company is currently involved in various routine disputes and allegations incidental to its
business operations. While it is not possible to determine the ultimate disposition of these
matters, the Company believes that the resolution of all such pending or threatened litigation is
not likely to have a material adverse effect on the Companys financial position, or results of
operations.
ITEM 2 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion of the financial condition and operating results of the Company
should be read in conjunction with the consolidated financial statements and related notes of the
Company. Except as otherwise indicated all amounts are expressed in U.S. dollars. We operate in one
industry segment, natural gas and oil exploration and development with two geographical segments:
the United States and China.
The Company currently generates the majority of its revenue, earnings and cash from the production
and sales of natural gas and oil from its property in southwest Wyoming. The price of natural gas
in the southwest Wyoming region is a critical factor to the Companys business. The price of gas in
southwest Wyoming historically has been volatile. The average annual realizations for the period
2003-2005 have ranged from $3.84 to $8.64 per Mcf. This volatility could be very detrimental to the
Companys financial performance. The Company seeks to limit the impact of commodity price movements
on its results by entering into forward sales contracts for gas in southwest Wyoming, and to a
lesser extent, derivative instruments. The average realization for the Companys gas during the
first nine months of 2006 was $6.18 per Mcf compared with $6.14 per Mcf for the same nine month
period in 2005. The Companys average realized crude oil price for its Bohai Bay production was
$56.62 USD per barrel for the nine months ended September 30, 2006 as compared to $41.98 USD per
barrel for the first nine months of 2005.
The Company has grown its natural gas and oil production significantly over the past three years
and management believes it has the ability to continue growing production by drilling already
identified locations on its leases in Wyoming and by bringing into production the already
discovered oilfields in China. The Company delivered 21% production growth on an Mcfe basis during
the nine months ended September 30, 2006 as compared to the same period in 2005.
The Company uses the full cost method of accounting for oil and gas operations whereby all costs
associated with the exploration for and development of oil and gas reserves are capitalized to the
Companys cost centers. Such costs include land acquisition costs, geological and geophysical
expenses, carrying charges on non-producing properties, costs of drilling both productive and
non-productive wells and overhead charges directly related to acquisition, exploration and
development activities. Separate cost centers are maintained for the United States and China.
Substantially all of the oil and gas activities are conducted jointly with others and, accordingly,
the amounts reflect only the Companys proportionate interest in such activities. Inflation has not
had a material impact on the Companys results of operations and is not expected to have a material
impact on the Companys results of operations in the future.
17
RESULTS OF OPERATIONS
QUARTER ENDED SEPTEMBER 30, 2006 VS. QUARTER ENDED SEPTEMBER 30, 2005
During the quarter ended September 30, 2006, production increased 25% on an equivalent basis to
23.6 Bcfe from 18.8 Bcfe for the same quarter in 2005 attributable to the Companys successful
drilling activities during 2005 and in the first nine months of 2006 including the addition of
production from new fields in China. Average realized price for natural gas decreased to $5.68 per
Mcf in the quarter ended September 30, 2006 compared to $6.86 per Mcf during the same period in
2005 while realized oil prices on our China production increased 4% to $50.14 per barrel during the
third quarter of 2006 from $48.44 per barrel during the same period in 2005. The increase in
production combined with higher realized oil prices contributed to an 8% increase in revenues for
the quarter ended September 30, 2006 to $145.4 million as compared to $134.4 million in 2005.
In Wyoming, lease operating expense (LOE) increased to $5.4 million for the quarter ended
September 30, 2006 compared to $2.3 million during the same period in 2005 due to increased
production volumes along with increased water disposal costs. On a unit of production basis, LOE
costs increased to $0.25 per Mcfe during the three months ended September 30, 2006 as compared to
$0.14 per Mcfe for the three months ended September 30, 2005. During the quarter ended September
30, 2006 production taxes were $14.5 million compared to $13.9 million during the same period in
2005, or $0.68 per Mcfe during quarter ended September 30, 2006
and $0.83 per Mcfe during the same
period in 2005. The decrease in per unit costs is attributable to the lower realized gas price
received during the quarter ended September 30, 2006 as compared to the same period in 2005.
Production taxes are calculated based on a percentage of revenue from production. Therefore, the
price received impacts the costs on a unit basis. Gathering fees increased to $5.5 million during
the third quarter of 2006 compared to $4.6 million during the quarter ended September 30, 2005
largely due to increased production volumes partially offset by revised gathering and processing
agreements. On a per unit basis, gathering fees decreased to $0.26 per Mcfe for the three months
ended September 30, 2006 from $0.27 per Mcfe for the same period in 2005. This decrease is
attributable to revised gathering and processing arrangements.
In Wyoming, depletion, depreciation and amortization (DD&A) expenses increased to $19.6 million
during the quarter ended September 30, 2006 from $12.1 million for the same period in 2005,
attributable to increased production volumes and a higher depletion rate, due to forecasted
increased future development costs. On a unit basis, DD&A increased to $0.91 per Mcfe for the
quarter ended September 30, 2006 from $0.72 per Mcfe for the same period in 2005.
In China, LOE was $2.1 million during the third quarter ended September 30, 2006 ($0.99 per Mcfe or
$5.94 per BOE) compared to $1.1 million ($0.56 per Mcfe or $3.36 per BOE) during the same quarter
in 2005. The increase in production costs is largely attributable to increased production during
the quarter ended September 30, 2006 along with one-time costs associated with new fields coming on
production compared to the same period in 2005. Severance taxes in China increased to $1.6 million
for the three months ended September 30, 2006 from $0.8 million for the three months ended
September 30, 2005. The increase is largely due to $0.8 million in Petroleum Special Profits Tax
levied by the Chinese government beginning in March 2006.
DD&A expense in China was $3.0 million ($1.40 per Mcfe or $8.40 per BOE) for the quarter ended
September 30, 2006 as compared to $1.1 million ($0.59 per Mcfe or $3.54 per BOE) for the same
period in 2005. This increase is primarily attributable to higher DD&A rates as a result of costs
being allocated from unevaluated properties to the full cost pool as well as increased production
volumes.
Net income before income taxes decreased 5% to $88.8 million for the quarter ended September 30,
2006 from $93.8 million for the same period in 2005, primarily as a result of increased DD&A
expenses due to a higher depletion rate, due to forecasted increased future development costs. The
income tax provision increased 10% to $36.3 million for the three months ended September 30, 2006
compared to $32.9 million for the three months ended September 30, 2005, largely attributable to
$5.2 million in withholding tax associated with the Companys share repurchase program (See Note
9). For the quarter ended September 30, 2006, net income decreased 14% to $52.5 million or $0.33
per diluted share as compared with $60.9 million or $0.38 per diluted share for the same period in
2005.
General and administrative expenses increased slightly to $4.2 million during the quarter ended
September 30, 2006 compared to $4.0 million for the same period in 2005. On a per unit basis,
general and administrative expenses decreased to $0.18 per Mcfe during the third quarter of 2006
compared with $0.21 per Mcfe for the same period in 2005 largely attributable to increased
production volumes.
18
NINE MONTHS ENDED SEPTEMBER 30, 2006 VS. NINE MONTHS ENDED SEPTEMBER 30, 2005
During the nine-months ended September 30, 2006, production increased 21% on an equivalent basis to
63.2 Bcfe from 52.4 Bcfe for the same nine-month period in 2005. The increase is primarily
attributable to the additional wells drilled and completed during 2005 along with the increased
drilling and completion during the first nine-months of 2006. Increased production coupled with
average realized oil prices on our China production increasing 35% to $56.62 per barrel during the
nine month period ended September 30, 2006 from $41.98 per barrel for the same period in 2005
contributed to a 28% increase in revenues to $426.5 million compared to $334.4 million in the first
nine months of 2005.
In Wyoming, LOE increased to $10.2 million for the nine months ended September 30, 2006 compared to
$6.3 million during the same period in 2005 due to increased production volumes along with
increased water disposal costs. On a unit of production basis, LOE costs increased to $0.18 per
Mcfe during the nine months ended September 30, 2006 as compared to $0.14 per Mcfe during the same
period ended September 30, 2005. During the nine months ended September 30, 2006 production taxes
were $41.2 million compared to $33.2 million during the same period in 2005, or $0.74 per Mcfe
during nine months ended September 30, 2006 as compared to $0.73 per Mcfe during the same period in
2005. Production taxes are calculated based on a percentage of revenue from production. Therefore,
the price received impacts the costs on a per unit basis. Gathering fees increased to $13.6 million
during the first nine months of 2006 compared to $12.3 million during the nine months ended
September 30, 2005. On a per unit basis, gathering fees decreased to $0.24 per Mcfe for the nine
months ended September 30, 2006 from $0.27 per Mcfe for the same period in 2005. This decrease is
attributable to revised gathering and processing arrangements.
In Wyoming, DD&A expenses increased to $50.2 million during the nine months ended September 30,
2006 from $32.0 million for the same period in 2005, attributable to increased production volumes
and a higher depletion rate, due to forecasted increased future development costs. On a unit basis,
DD&A increased to $0.90 per Mcfe for the nine months ended September 30, 2006 from $0.71 per Mcfe
for the same period in 2005.
In China, LOE was $6.8 million during the nine months ended September 30, 2006 ($0.94 per Mcfe or
$5.64 per BOE) compared to $4.7 million ($0.67 per Mcfe or $4.02 per BOE) during the same period in
2005. The increase is attributable to increased production volumes associated with nine fields
producing during 2006 compared with four during the same period in 2005. Severance taxes in China
increased to $7.0 million for the nine months ended September 30, 2006 from $2.4 million for the
same period in 2005. The increase is due to $3.6 million in Petroleum Special Profits Tax levied by
the Chinese government beginning in March 2006 combined with increased production volumes and
higher average realized prices.
DD&A expense in China was $9.0 million ($1.25 per Mcfe or $7.50 per BOE) for the nine months ended
September 30, 2006 as compared to $5.1 million ($0.74 per Mcfe or $4.44 per BOE) for the same
period in 2005. This increase is largely attributable to higher DD&A rates as a result of costs
being allocated from unevaluated properties to the full cost pool.
Net income before income taxes increased 23% to $276.7 million for the nine months ended September
30, 2006 from $225.1 million for the same period in 2005. The income tax provision increased 34% to
$106.1 million for the nine months ended September 30, 2006 as compared to $79.0 million for the
nine months ended September 30, 2005, attributable to an increase in pre-tax income combined with
$9.0 million in withholding tax associated with the Companys share repurchase program (See Note
9). For the nine months ended September 30, 2006, net income increased 17% to $170.6 million or
$1.05 per diluted share as compared with $146.1 million or $0.90 per diluted share for the same
period in 2005.
General and administrative expenses increased by 13% to $12.1 million during the first nine months
of 2006 compared to $10.7 million for the same period in 2005. On a per unit basis, general and
administrative expenses decreased to $0.19 per Mcfe during the nine months ended September 30, 2006
as compared to $0.20 per Mcfe for the nine months ended September 30, 2005.
The discussion and analysis of the Companys financial condition and results of operations is based
upon consolidated financial statements, which have been prepared in accordance with U.S. GAAP. In
addition, application of generally accepted accounting principles requires the use of estimates,
judgments and assumptions that affect the reported amounts of assets and liabilities as of the date
of the financial statements as well as the revenues and expenses reported during the period.
Changes in these estimates, judgments and assumptions will occur as a result of future events, and,
accordingly, actual results could differ from amounts estimated.
19
LIQUIDITY AND CAPITAL RESOURCES
During the nine month period ended September 30, 2006, the Company relied on cash provided by
operations and borrowings under its senior credit facility to finance its capital expenditures. The
Company participated in the drilling of 73 development and 37 exploratory wells for a total of 110
wells in Wyoming for aggregate capital expenditures of $323.6 million for the first three quarters
of 2006 and continued to participate in the exploration and development processes in the China
blocks including the ongoing batch drilling program for the development wells for aggregate capital
expenditures of $19.0 million for the first three quarters of 2006. For the nine month period ended
September 30, 2006, net capital expenditures were $342.5 million. The Companys positive cash
provided by operating activities, along with the availability under the senior credit facility, are
projected to be sufficient to fund the Companys budgeted capital expenditures for 2006, which are
currently projected to aggregate $450 million.
Of the $450 million budget, the Company plans to spend approximately $400 million of its 2006
budget in Wyoming and approximately $20 million in China with the balance allocated to evaluating
other areas. Of the $400 million for Wyoming, the Company plans to drill or participate in an
estimated 160 gross wells in 2006, of which approximately 25% will be exploration wells and the
remaining will be development wells. Of the $20 million budgeted for China, approximately 33% will
be for exploratory/appraisal activity and the balance will be for development activity. The Company
currently has no budget for acquisitions in 2006.
At September 30, 2006, the Company reported a cash position of $16.9 million compared to $23.2
million at September 30, 2005. Working capital at September 30, 2006 was a deficit of $36.9 million
compared to working capital at September 30, 2005 of $6.6 million. As of September 30, 2006, the
Company had $110.0 million in bank indebtedness outstanding and other long-term obligations of
$27.2 million comprised of items payable in more than one year, primarily related to production
taxes.
The Company (through its subsidiary) participates in a revolving credit facility with a group of
banks led by JP Morgan Chase Bank, N.A. The agreement specifies a maximum loan amount of $500
million, an aggregate borrowing base of $950 million and a commitment amount of $200 million. The
commitment amount may be increased up to the lesser of the borrowing base amount or $500 million at
any time at the request of the Company. Each bank shall have the right, but not the obligation, to
increase the amount of their commitment as requested by the Company. In the event that the existing
banks increase their commitment to an amount less than the requested commitment amount, then it
would be necessary to bring additional banks into the facility. At September 30, 2006, the Company
had $110.0 million outstanding and $90.0 million unused and available under the current committed
amount.
The credit facility matures on May 1, 2010. The note bears interest at either (A) the banks prime
rate plus a margin of zero percent (0.00%) to three-quarters of one percent (0.75%) based on the
percentage of available credit drawn or at (B) LIBOR plus a margin of one percent (1.00%) to one
and three-quarters of one percent (1.75%) based on the percentage of available credit drawn. For
purposes of calculating interest, the available credit is equal to the borrowing base. An average
annual commitment fee of 0.25% to 0.375%, depending on the percentage of available credit drawn, is
charged quarterly for any unused portion of the commitment amount.
The borrowing base is subject to periodic (at least semi-annual) review and re-determination by the
banks and may be decreased or increased depending on a number of factors, including the Companys
proved reserves and the banks forecast of future oil and gas prices. If the borrowing base is
reduced to an amount less than the balance outstanding, the Company has sixty days from the date of
written notice of the reduction in the borrowing base to pay the difference. Additionally, the
Company is subject to quarterly reviews of compliance with the covenants under the bank facility
including minimum coverage ratios relating to interest, working capital and advances to
Sino-American Energy Corporation. In the event of a default under the covenants, the Company may
not be able to access funds otherwise available under the facility. As of September 30, 2006, the
Company was in compliance with required covenants of the bank facility.
During the nine months ended September 30, 2006, net cash provided by operating activities was
$328.9 million, an 18% increase over the $278.8 million for the nine months ended September 30,
2005. The increase in net cash provided by operating activities was largely attributable to the
increase in production combined with increased realized average oil prices during the nine months
ending September 30, 2006.
During the nine months ended September 30, 2006, net cash used in investing activities was $310.9
million as compared to $211.6 million for the nine months ended September 30, 2005. The increase in
net cash used in investing activities is largely due to increased capital expenditures associated
with the Companys drilling activities.
20
During the nine months ended September 30, 2006, net cash used in financing activities was $45.6
million as compared to $60.9 million for the nine months ended September 30, 2005. The change in
net financing activities is primarily attributable to shares repurchased under the Companys share
repurchase program during the nine months ended September 30, 2006. (See Part II, Item 2).
OFF BALANCE SHEET ARRANGEMENTS
The Company did not have any off-balance sheet arrangements as of September 30, 2006.
CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISION OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995
This report contains or incorporates by reference forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act
of 1934 and the Private Securities Litigation Reform Act of 1995. All statements other than
statements of historical facts included in this document, including without limitation, statements
in Managements Discussion and Analysis of Financial Condition and Results of Operations regarding
our financial position, estimated quantities and net present values of reserves, business strategy,
plans and objectives of the Companys management for future operations, covenant compliance and
those statements preceded by, followed by or that otherwise include the words believe, expects,
anticipates, intends, estimates, projects, target, goal, plans, objective,
should, or similar expressions or variations on such expressions are forward-looking statements.
The Company can give no assurances that the assumptions upon which such forward-looking statements
are based will prove to be correct nor can the Company assure adequate funding will be available to
execute the Companys planned future capital program.
Other risks and uncertainties include, but are not limited to, fluctuations in the price the
Company receives for oil and gas production, reductions in the quantity of oil and gas sold due to
increased industry-wide demand and/or curtailments in production from specific properties due to
mechanical, marketing or other problems, operating and capital expenditures that are either
significantly higher or lower than anticipated because the actual cost of identified projects
varied from original estimates and/or from the number of exploration and development opportunities
being greater or fewer than currently anticipated and increased financing costs due to a
significant increase in interest rates. See the Companys annual report on Form 10-K for the year
ended December 31, 2005 for additional risks related to the Companys business.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Companys major market risk exposure is in the pricing applicable to its gas and oil
production. Realized pricing is primarily driven by the prevailing price for the Companys Wyoming
natural gas production. Historically, prices received for gas production have been volatile and
unpredictable. Pricing volatility is expected to continue. Gas price realizations averaged $6.18
per Mcf during the nine months ended September 30, 2006.
The Company primarily relies on fixed price forward gas sales to manage its commodity price
exposure. These fixed price forward gas sales are considered normal sales. The Company may, from
time to time and to a lesser extent, use derivative instruments as one way to manage its exposure
to commodity prices. The Company has periodically entered into fixed price to index price swap
agreements in order to hedge a portion of its production. The oil and natural gas reference prices
of these commodity derivatives contracts are based upon crude oil and natural gas futures, which
have a high degree of historical correlation with actual prices the Company receives. Under SFAS
No. 133 all derivative instruments are recorded on the balance sheet at fair value. Changes in the
derivatives fair value are recognized currently in earnings unless specific hedge accounting
criteria are met. For qualifying cash flow hedges, the gain or loss on the derivative is deferred
in accumulated other comprehensive income (loss) to the extent the hedge is effective. For
qualifying fair value hedges, the gain or loss on the derivative is offset by related results of
the hedged item in the income statement. Gains and losses on hedging instruments included in
accumulated other comprehensive income (loss) are reclassified to oil and natural gas sales revenue
in the period that the related production is delivered. Derivative contracts that do not qualify
for hedge accounting treatment are recorded as derivative assets and liabilities at market value in
the consolidated balance sheet, and the associated unrealized gains and losses are recorded as
current expense or income in the consolidated statement of operations. The Company currently does
not have any derivative contracts in place that do not qualify as a cash flow hedge.
21
The Company to a larger extent utilizes fixed price forward gas sales contracts at southwest
Wyoming delivery points to manage its commodity exposure. At September 30, 2006, the Company had no
open derivative contracts to manage price risk on its natural gas production. The Company had the
following fixed price physical delivery contracts in place on behalf of its interest and those of
other parties at September 30, 2006. (The Companys approximate average net interest in physical
gas sales is 80%.)
|
|
|
|
|
|
|
|
|
Remaining |
|
Volume - |
|
Average |
Contract |
|
MMBTU |
|
Price / |
Period |
|
/ day |
|
MMBTU |
Calendar 2006
|
|
|
70,000 |
|
|
$ |
5.86 |
|
The above forward gas sales contracts represent approximately 24% of the Companys currently
forecasted gas production for the balance of 2006.
ITEM 4 CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information
required to be disclosed in the Companys Exchange Act reports is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange Commissions rules
and forms and that such information is accumulated and communicated to our management, including
the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow for timely
decisions regarding required disclosure. In designing and evaluating the disclosure controls and
procedures, management recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control objectives, and
management is required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.
In connection with the preparation of the Companys Annual Report of Form 10-K for the year ended
December 31, 2005 (2005 10-K), an evaluation was performed under the supervision and with the
participation of the Companys management, including the Chief Executive Officer and the Chief
Financial Officer, of the effectiveness of the design and operation of the Companys disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act). The
Company concluded that control deficiencies in its internal control over financial reporting as of
December 31, 2005 constituted material weaknesses within the meaning of the Public Company
Accounting Oversight Boards Auditing Standard No. 2.
The material weaknesses identified by the Company were disclosed in its 2005 10-K, which was filed
with the SEC on March 31, 2006. Based on that and subsequent evaluations, the Chief Executive
Officer and Chief Financial Officer concluded that, as of September 30, 2006, the Companys
disclosure controls and procedures were not effective as a result of the previously-identified
material weaknesses in internal control over financial reporting. As reported in the 2005 10-K and
in the Companys Report on Form 10-Q for the quarters ended March 31, 2006 and June 30, 2006,
management is in the process of taking remedial steps to correct these weaknesses.
(b) Changes in Internal Control Over Financial Reporting
As reported in Item 9A of the 2005 10-K, the Company determined that material weaknesses in
internal control over financial reporting existed as of December 31, 2005. These material
weaknesses also existed as of September 30, 2006, and therefore are reported in this Form 10-Q:
|
|
|
The Company did not maintain effective company level controls. Specifically, (i)
certain of its accounting personnel in key roles did not possess an appropriate level of
technical expertise, and (ii) the Companys monitoring of the internal audit function was
not sufficient to provide management a basis to assess the quality of the Companys
internal control performance over time. These deficiencies resulted in more than a remote
likelihood that a material misstatement of the Companys annual or interim financial
statements would not be prevented or detected. |
|
|
|
|
The Company did not have adequate policies and procedures regarding supervisory review
of account reconciliations and account and transaction analyses. This deficiency resulted
in material errors (as reported in the 2005 10-K) which were corrected prior to the
issuance of the Companys 2005 consolidated financial statements. |
22
|
|
|
The Company did not have adequate policies and procedures to ensure that accurate and
reliable interim and annual consolidated financial statements were prepared and reviewed on
a timely basis. Specifically, the Company did not have sufficient personnel with the skills
and experience in the application of U.S. generally accepted accounting principles and
policies and procedures regarding the preparation and management review of footnote
disclosures accompanying the Companys financial statements. As a result of these
deficiencies, material errors were identified in the footnotes to the Companys preliminary
2005 consolidated financial statements. These errors were corrected by management prior to
the issuance of the Companys 2005 consolidated financial statements. |
Management, with oversight from the Audit Committee of the Board of Directors, has been addressing
the material weakness disclosed in its 2005 10-K and is committed to effectively remediating known
weaknesses as expeditiously as possible. Due to the fact that these remedial steps have not been
completed, the Company performed additional analysis and procedures in order to ensure that the
consolidated financial statements contained in this Form 10-Q were prepared in accordance with
generally accepted accounting principles in the United States of America. Although the Companys
remediation efforts are well underway, control weaknesses will not be considered remediated until
new internal controls over financial reporting are implemented and operational for a sufficient
period of time to allow for effective testing and are tested, and management and its independent
registered certified public accounting firm conclude that these controls are operating effectively.
In order to remediate the material weaknesses described in the 2005 10-K, to date the Company has:
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implemented an internal review and assessment process regarding its financial reporting and internal audit functions; |
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begun a reorganization and alignment of its financial reporting and internal audit functions; |
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engaged Protiviti to (1) review and assess current Sarbanes-Oxley process
and control documentation and compliance plans, (2) recommend remediation and project
plans for 2006, and (3) assist management with Sarbanes-Oxley compliance requirements
during 2006; and |
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engaged Grant Thornton LLP to assist in identifying and recommending any
necessary organization and procedural changes for improving the Companys controls for
the purposes of complying with Sarbanes-Oxley. |
Other than as described above, there has been no change in the Companys internal controls over
financial reporting during the fiscal quarter ended September 30, 2006 that has materially
affected, or is reasonably likely to materially affect, our internal controls over financial
reporting.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is currently involved in various routine disputes and allegations incidental to its
business operations. While it is not possible to determine the ultimate disposition of these
matters, the Company believes that the resolution of all such pending or threatened litigation is
not likely to have a material adverse effect on the Companys financial position, or results of
operations.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you should carefully consider the
factors discussed in Part I, Item 1A. Risk Factors, in our Annual Report on Form 10-K for the
fiscal year ended December 31, 2005, which could materially affect our business, financial
condition, or future results. Additional risks and uncertainties not currently known to us or that
we deem to be immaterial also may adversely affect our business, financial condition and results of
operations.
23
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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Maximum Number (or |
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Approximate Dollar |
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Total Number of Shares |
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Value) of Shares that |
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Purchased as Part of |
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may yet be Purchased |
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Total Number of Shares |
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Average Price Paid per |
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Publicly Announced |
Under the Plans or |
Period |
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Purchased |
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Share |
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Plans or Programs |
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Programs |
May 1 May 31, 2006 |
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283,417 |
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$ |
56.29 |
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283,417 |
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$984 million |
June 1 June 30, 2006 |
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1,147,157 |
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$ |
50.03 |
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1,147,157 |
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$927 million |
July 1 July 31, 2006 |
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572,858 |
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$ |
53.14 |
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572,858 |
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$896 million |
Aug 1 Aug 31, 2006 |
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278,900 |
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$ |
53.02 |
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278,900 |
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$881 million |
Sept 1 Sept 30, 2006 |
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1,198,700 |
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$ |
46.50 |
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1,198,700 |
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$826 million |
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TOTAL |
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3,481,032 |
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$ |
50.08 |
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3,481,032 |
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$826 million |
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On May 17, 2006, the Company announced that its Board of Directors authorized a share repurchase
program for up to an aggregate $1 billion of the Companys outstanding common stock which has been
and will be funded by cash on hand and the Companys senior credit facility. Pursuant to this
authorization, the Company has commenced an initial program to purchase up to $250.0 million of
shares of its common stock through open market transactions or privately negotiated transactions.
At September 30, 2006, the Company had repurchased 3,481,032 shares of its common stock for an
aggregate $174.3 million at a weighted average price of $50.08 per share.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Articles of Incorporation of Ultra Petroleum Corp. (incorporated by reference to Exhibit
3.1 of the Companys Quarterly Report on Form 10Q for the period ended June 30, 2001.)
3.2 By-Laws of Ultra Petroleum Corp (incorporated by reference to Exhibit 3.2 of the
Companys Quarterly Report on Form 10Q for the period ended June 30, 2001.)
3.3 Articles of Amendment to Articles of Incorporation of Ultra Petroleum Corp. (incorporated
by reference to Exhibit 3.3 of the Companys Report on Form 10-K/A for the period ended December
31, 2005)
4.1 Specimen Common Share Certificate (incorporated by reference to Exhibit 4.1 of the
Companys Quarterly Report on Form 10Q for the period ended June 30, 2001.)
31.1* Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2* Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1* Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2* Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
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ULTRA PETROLEUM CORP.
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Date: November 2, 2006 |
By: |
/s/ Michael D. Watford
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Name: |
Michael D. Watford |
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Title: |
Chairman, President and Chief Executive Officer |
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Date: November 2, 2006 |
By: |
/s/ Marshall D. Smith
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Name: |
Marshall D. Smith |
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Title: |
Chief Financial Officer |
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EXHIBIT INDEX
3.1 Articles of Incorporation of Ultra Petroleum Corp. (incorporated by reference to Exhibit
3.1 of the Companys Quarterly Report on Form 10Q for the period ended June 30, 2001.)
3.2 By-Laws of Ultra Petroleum Corp (incorporated by reference to Exhibit 3.2 of the
Companys Quarterly Report on Form 10Q for the period ended June 30, 2001.)
3.3 Articles of Amendment to Articles of Incorporation of Ultra Petroleum Corp. (incorporated
by reference to Exhibit 3.3 of the Companys Report on Form 10-K/A for the period ended December
31, 2005)
4.1 Specimen Common Share Certificate (incorporated by reference to Exhibit 4.1 of the
Companys Quarterly Report on Form 10Q for the period ended June 30, 2001.)
31.1* Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2* Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1* Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2* Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
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