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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2004.
OR
|_| 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 - 7261
CHAPARRAL RESOURCES, INC.
----------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 84-0630863
------------------------------ ----------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
2 Gannett Drive, Suite 418
White Plains, New York 10604
--------------------------------------
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (866) 559-3822
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, and (2) has been subject to such filing
requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES |_| NO |X|
As of November 10, 2004 the Registrant had 38,209,502 shares of its
common stock, par value $0.0001 per share, issued and outstanding.
CHAPARRAL RESOURCES, INC.
FORM 10-Q
SEPTEMBER 30, 2004
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item l. Financial Statements
--------------------
Consolidated Condensed Balance Sheets as of 1
September 30, 2004 and December 31, 2003
Consolidated Condensed Statements of Operations 3
for the Three Months Ended September
30, 2004 and 2003 and Consolidated Condensed
Statements of Operations for the Nine
months Ended September 30, 2004 and 2003
Consolidated Condensed Statements of Cash Flows 4
for the Nine Months Ended September 30, 2004 and 2003
Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition 15
-----------------------------------------------------------
and Results of Operations
-------------------------
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
----------------------------------------------------------
Item 4. Controls and Procedures 21
-----------------------
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 22
---------------------------------------------------
Item 6. Exhibits 22
--------
Signatures 23
----------
Part I - Financial Information
Item 1 - Financial Statements
Chaparral Resources, Inc.
Consolidated Condensed Balance Sheets
September 30, December 31,
2004 2003
(Unaudited)
--------- ---------
$000 $000
Assets
Current assets:
Cash and cash equivalents 3,365 2,639
Accounts receivable:
Oil sales receivable 1,565 215
VAT receivable 3,194 2,907
Prepaid expenses 2,839 1,940
Prepaid expenses to affiliates 254 1,296
Crude oil inventory 116 544
--------- ---------
Total current assets 11,333 9,541
Materials and supplies 3,942 3,188
Property, plant and equipment:
Oil and gas properties, full cost:
Properties subject to depletion 142,772 118,347
Properties not subject to depletion 2,046 2,942
--------- ---------
144,818 121,289
Other Property, plant and equipment 9,284 9,408
--------- ---------
154,102 130,697
Less - accumulated depreciation, depletion, and amortization (57,199) (44,758)
--------- ---------
Property, plant and equipment, net 96,903 85,939
Other long- term assets 287 --
--------- ---------
Total assets 112,465 98,668
========= =========
See accompanying notes.
1
Chaparral Resources, Inc.
Consolidated Condensed Balance Sheets (continued)
September 30, December 31,
2004 2003
(Unaudited)
--------- ---------
$000 $000
Liabilities and stockholders' equity
Current liabilities:
Accounts payable 5,270 6,086
Accounts payable to affiliates 929 1,143
Accrued liabilities:
Accrued compensation 319 949
Other accrued liabilities 606 1,571
Current income tax liability 1,195 3
Accrued interest payable 690 776
Current portion of loans payable to affiliates 19,639 12,000
--------- ---------
Total current liabilities 28,648 22,528
Accrued production bonus 279 190
Loans payable to affiliates 14,000 21,284
Deferred tax liability 6,502 3,057
Minority interest 10,298 4,635
Long-term assets retirement obligation 1,075 804
Stockholders' equity:
Common stock - authorized, 100,000,000
shares of $0.0001 par value; issued and outstanding,
38,209,502 shares as of September 30, 2004 and
December 31, 2003 4 4
Capital in excess of par value 107,226 107,226
Preferred stock - 1,000,000 shares authorized, 925,000 shares
undesignated. Issued and outstanding - none -- --
Accumulated deficit (55,567) (61,060)
--------- ---------
Total stockholders' equity 51,663 46,170
--------- ---------
Total liabilities and stockholders' equity 112,465 98,668
========= =========
See accompanying notes.
2
Chaparral Resources, Inc.
Consolidated Condensed Statements of Operations (Unaudited)
For the Three months ended For the Nine months ended
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
$000 (except share data)
Revenue 22,078 23,308 55,158 39,594
Costs and expenses:
Transportation costs 3,327 4,617 9,546 7,921
Operating expenses 1,762 1,671 5,661 4,200
Marketing fee 114 -- 153 --
Depreciation and depletion 4,276 7,140 12,813 12,897
Management fee 157 -- 257 --
Advisory fee -- 75 100 225
Accretion expense 21 17 67 46
General and administrative 1,447 1,967 5,204 5,131
------------ ------------ ------------ ------------
Total costs and expenses 11,104 15,487 33,801 30,420
------------ ------------ ------------ ------------
Income from operations 10,974 7,821 21,357 9,174
Other income/(expense):
Interest income 9 -- 63 --
Interest expense (1,263) (1,100) (3,761) (3,362)
Minority interest (2,840) (2,134) (5,663) (2,550)
Currency exchange loss (197) -- (354) (107)
Loss on disposition of assets (2) -- (2) (8)
Other -- (37) -- 7
------------ ------------ ------------ ------------
Income before income taxes and cumulative effect of
change in accounting principle 6,681 4,550 11,640 3,154
Income tax expense (3,122) (2,479) (6,147) (3,160)
------------ ------------ ------------ ------------
Income/(loss) before cumulative effect of change in
accounting principle 3,559 2,071 5,493 (6)
Cumulative effect of change in accounting principle,
net of tax -- -- -- 1,018
------------ ------------ ------------ ------------
Net income available to common Stockholders 3,559 2,071 5,493 1,012
============ ============ ============ ============
Basic earnings per share:
Income per share before cumulative effect of change
in accounting principle $ 0.09 $ 0.05 $ 0.14 $ 0.00
Cumulative effect of change in accounting principle $ -- $ -- $ -- $ 0.03
Net income per share $ 0.09 $ 0.05 $ 0.14 $ 0.03
Weighted average number of shares outstanding (basic) 38,209,502 38,209,502 38,209,502 38,209,502
Diluted earnings per share:
Income per share before cumulative effect of change
in accounting principle $ 0.09 $ 0.05 $ 0.14 $ 0.00
Cumulative effect of change in accounting principle $ -- $ -- $ -- $ 0.03
Net income per share $ 0.09 $ 0.05 $ 0.14 $ 0.03
Weighted average number of shares outstanding (diluted) 38,209,502 38,408,726 38,209,502 38,408,726
See accompanying notes.
3
Chaparral Resources, Inc.
Consolidated Condensed Statements of Cash Flows (Unaudited)
For the
Nine Months Ended
--------------------
Sept 30, Sept 30,
2004 2003
-------- --------
$000 $000
Cash flows from operating activities
Net income 5,493 1,012
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation, depletion and amortization 12,813 12,897
Loss/(gain) on disposition of furniture and fixtures 2 8
Cumulative effect of change in accounting
principle -- (1,018)
Deferred income taxes 3,445 1,903
Accretion expense 67 46
Amortization of note discount 355 178
Minority interest 5,663 2,550
Changes in assets and liabilities:
(Increase)/decrease in:
Accounts receivable (1,636) 65
Prepaid expenses 142 81
Crude oil inventory 95 87
Increase/(decrease) in:
Accounts payable and accrued liabilities (1,230) 257
Accrued interest payable (86) 421
Other liabilities 90 129
-------- --------
Net cash provided by operating activities 25,213 18,616
-------- --------
Cash flows from investing activities
Additions to property, plant, and equipment (377) (792)
Capital expenditures on oil and gas properties (23,069) (15,366)
Materials and supplies inventory (754) (896)
Other long-term assets (287) --
-------- --------
Net cash used by investing activities (24,487) (17,054)
-------- --------
4
Chaparral Resources, Inc.
Consolidated Condensed Statements of Cash Flows (Unaudited) (continued)
For the
Nine Months Ended
-------------------
Sept 30, Sept 30,
2004 2003
------- -------
$ 000 $ 000
Cash flows from financing activities
Payments on loans from affiliates (7,000) (6,500)
Proceeds from loans from affiliates 7,000 4,500
------- -------
Net cash provided by financing activities -- (2,000)
------- -------
Net increase/(decrease) in cash and cash equivalents 726 (438)
Cash and cash equivalents at beginning of period 2,639 4,295
------- -------
Cash and cash equivalents at end of period 3,365 3,857
======= =======
Supplemental cash flow disclosure
Interest paid 3,682 3,207
Income taxes paid 708 --
Supplemental schedule of non-cash
investing and financing activities
Non-cash additions to oil and gas properties 491 2,519
See accompanying notes.
5
Chaparral Resources, Inc
Notes to Consolidated Condensed Financial Statements
(Unaudited)
1. General
Chaparral Resources, Inc. ("Chaparral") was incorporated in the state of
Colorado on January 13, 1972, principally to engage in the exploration,
development and production of oil and gas properties. Chaparral focuses
substantially all of its efforts on the exploration and development of the
Karakuduk Field, an oil field located in the Central Asian Republic of
Kazakhstan. In 1999, Chaparral reincorporated from Colorado to Delaware.
The consolidated financial statements include the accounts of Chaparral and its
greater than 50% owned subsidiaries, Closed Type JSC Karakudukmunay ("KKM"),
Central Asian Petroleum (Guernsey) Limited ("CAP-G"), Korporatsiya Mangistau
Terra International ("MTI"), Road Runner Services Company ("RRSC"), Chaparral
Acquisition Corporation ("CAC"), and Central Asian Petroleum, Inc. ("CAP-D").
Chaparral owns 80% of the common stock of CAP-G directly and 20% indirectly
through CAP-D. Hereinafter, Chaparral and its subsidiaries are collectively
referred to as the "Company." All significant inter-company transactions have
been eliminated.
As of September 30, 2004, Chaparral owns a 60% interest in KKM, a Kazakhstan
Joint Stock Company of Closed Type. KKM was formed to engage in the exploration,
development, and production of oil and gas properties in the Republic of
Kazakhstan. KKM's only significant investment is in the Karakuduk Field, an
onshore oil field in the Mangistau region of the Republic of Kazakhstan. On
August 30, 1995, KKM entered into an agreement with the Ministry of Oil and Gas
Industry for Exploration, Development and Production of Oil in the Karakuduk Oil
Field in the Mangistau Region of the Republic of Kazakhstan (the "Agreement").
KKM's rights and obligations regarding the exploration, development, and
production of underlying hydrocarbons in the Karakuduk Field are determined by
the Agreement.
KKM's rights to the Karakuduk Field may be terminated under certain conditions
specified in the Agreement. The term of the Agreement is 25 years commencing
from the date of KKM's registration. The Agreement can be extended to a date
agreed between the Ministry of Energy and Mineral Resources and KKM as long as
production of petroleum and/or gas is continued in the Karakuduk Field.
KKM is owned jointly by CAP-G (50%), MTI (10%) and KazMunayGaz JSC ("KMG")
(40%). In May 2002, Chaparral increased its ownership in KKM from 50% to 60%
through the acquisition of 100% of the outstanding stock of MTI, a Kazakh
company. KMG, the national petroleum company of Kazakhstan, is owned by the
government of the Republic of Kazakhstan.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States have been condensed or omitted. Reference should be made to
the relevant notes to the financial statements for both Chaparral and KKM
included in the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2003.
The unaudited information furnished herein was taken from the books and records
of the Company. However, such information reflects all adjustments which are, in
the opinion of management, normal recurring adjustments necessary for the fair
statement of the results for the interim periods presented. The results of
operations for the interim periods are not necessarily indicative of the results
to be expected for any future interim period or for the year.
Use of Estimates
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 and revenues and
expenses during the reporting period. Actual results could differ from those
estimates. The determination of proved oil and gas reserve quantities and the
application of the full cost method of accounting for exploration and production
activities requires management to make numerous estimates and judgments. The
change in the estimate of oil and gas reserves as of January 1, 2004, offset by
the increase in future estimated development cost, reduced the Company's
effective depletion rate by $0.34 per barrel from $6.43 per barrel to $6.09 per
barrel during the nine months ending September 30, 2003 and 2004, respectively.
6
Chaparral Resources, Inc
Notes to Consolidated Condensed Financial Statements (Unaudited)
(continued)
2. Recent Accounting Pronouncements
On March 31, 2004, the Financial Accounting Standards Board ("FASB") issued its
Exposure Draft, "Share-Based Payment," which is a proposed amendment to FASB
Statement No. 123, "Accounting for Stock-Based Compensation." The Exposure Draft
would require all share-based payments to employees, including grants of
employee stock options, to be recognized in the income statement based on their
fair values. The FASB expects that a final standard would be effective for
public companies for fiscal years beginning after December 15, 2004. As at
September 30, 2004, the Company no longer has any stock options in existence.
The Company did not adopt a fair-value based method of accounting for
stock-based employee compensation whilst the options were still in existence as
it was awaiting the issuance of a final standard by the FASB.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," which was revised in December 2003 (collectively
referred to as FIN 46). Variable interest entities are commonly referred to as
special purpose entities or off-balance sheet structures. FIN 46 requires a
variable interest entity to be consolidated by the primary beneficiary of that
entity when the primary beneficiary is subject to a majority of the risk of loss
from the variable interest entity's activities or it is entitled to receive a
majority of the entity's residual returns. The Company does not have any
variable interest entities and adoption of FIN 46 did not have any effect on the
Company's financial statements.
3. Going Concern
The Company's financial statements have been presented on the basis that it is a
going concern, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. The Company has a working capital
deficiency as of September 30, 2004 and there are uncertainties relating to the
Company's ability to meet projected cash flow requirements through 2005, which
could result in a default of the Company's outstanding loans and the loss of the
Company's interest in the Karakuduk Field. As of September 30, 2004, the Company
had a working capital deficiency of $17.31 million primarily due to principal
payments of $19.64 million due over the next twelve months under its outstanding
credit facilities (See Note 7). These conditions raise substantial doubt about
the Company's ability to continue as a going concern. The financial statements
do not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of these uncertainties.
The Company is seeking to alleviate these conditions by increasing cash flows
available from the sale of crude oil production from the Karakuduk Field. The
Company expects to finance the development of the Karakuduk Field primarily
through the production and sale of crude oil, which is currently approximately
8,700 barrels of oil per day. Management expects production to increase to
approximately 9,500 barrels of oil per day, by year-end 2004, by continuing the
development of the Karakuduk Field. In addition, the Company continues to seek
an amicable resolution of its attempts to reduce its obligation to supply a
portion of its production to the local refinery to meet domestic energy needs,
which generate substantially less revenue than oil sold on the export market. In
June 2004, the Company entered into an agency agreement with Nelson Resources
Limited ("Nelson") to assist the Company in maximizing its crude oil export
quotas as well as in the marketing of its crude oil (See Note 10). During the
first nine months in 2004, the Company exported approximately 91% of its
available production for sale, with the remaining 9% going to the local
refinery. The Company is also currently evaluating different options to obtain
debt financing to cover its working capital deficiencies. These options include
extending or refinancing the credit facility with JSC Kazkommertsbank
("Kazkommertsbank") (See Note 7) as well as modifying the development plan for
the Karakuduk Field.
No assurances can be provided, however, that oil production will be increased or
that the Company will be able to export a higher portion of its production or
that the Company will be able to obtain additional financing and cash flow from
operations to meet working capital requirements in the future.
7
Chaparral Resources, Inc
Notes to Consolidated Condensed Financial Statements (Unaudited)
(continued)
4. Prepaid Expenses
The breakdown of Prepaid Expenses is as follows:
$000
--------------------
Sept 30, Dec 31,
Description 2004 2003
----------- ---- ----
Prepaid transportation costs to KTO 254 1,296
Advanced payments for materials and supplies 1,604 1,616
Prepaid insurance 677 210
Prepaid taxes 283 --
Other prepaid expenses 275 114
------ ------
Total prepaid expenses 3,093 3,236
====== ======
Prepaid transportation costs represent prepayments of export tariffs to CJSC
KazTransOil ("KTO"), a 100% subsidiary of KMG, necessary to sell oil on the
export market, which is expensed in the period the related oil revenue is
recognized. Advanced payments for materials and supplies represent prepayments
for general materials and supplies to be used in the development of the
Karakuduk Field.
5. Asset Retirement Obligation
Effective January 1, 2003, the Company changed its method of accounting for
asset retirement obligations in accordance with FASB Statement No. 143,
"Accounting for Asset Retirement Obligations". Previously, the Company used an
amount equal to the undiscounted cash flows associated with the asset retirement
obligation ("ARO") in determining depreciation, depletion and amortization
("DD&A") rates. Under the new accounting method, FASB No. 143 requires entities
to record the fair value of the liability for the retirement obligation in the
period in which the liability is incurred, if a reasonable estimate of fair
value can be made. The associated asset retirement costs are capitalized as part
of the carrying amount of the long-lived asset.
The cumulative effect of the change in accounting principle, as a result of the
adoption of FASB No. 143 on January 1, 2003, resulted in a gain of $1.02
million, or $0.03 per share, which is included in income for the period ended
September 30, 2003.
Since 1995, the business of Chaparral has been the development of the Karakuduk
Field. The Company is still in the early stages of development and continues to
develop the field by drilling additional wells, expansion of its oil storage
capacity, installation of additional gathering and processing facilities, and
the full implementation of the central processing facility. The Company is
legally required under the Agreement to restore the field to its original
condition. The Company recognized the fair value of its liability for an asset
retirement obligation as of January 1, 2003 in the amount of $516,000 and
capitalized that cost as part of the cost basis of its oil and gas properties
and depletes it using the unit of production method over proved reserves.
8
Chaparral Resources, Inc
Notes to Consolidated Condensed Financial Statements (Unaudited)
(continued)
5. Asset Retirement Obligation (continued)
The following table describes all changes to the Company's asset retirement
obligation liability:
$000
--------------------
Sept 30, Sept 30,
2004 2003
---- ----
Asset retirement obligation at beginning of period 804 -
Liability recognized in transition - 516
Accretion expense 67 46
Additional provision for new wells 204 114
----- -----
Asset retirement obligation at end of period 1,075 676
===== =====
6. Change in Control
In May 2004, Nelson purchased from Central Asian Industrial Holdings, N.V.
("CAIH") 22,925,701 shares of Chaparral, representing 60% of Chaparral's issued
and outstanding common stock. As part of the transaction, a Stock Purchase
Warrant exercisable for 3,076,923 shares of the Company's common stock
originally issued to CAIH, and a promissory note of the Company payable to CAIH
(the "Note"), with a principal amount of $4 million (See Note 7), were
transferred by CAIH to Nelson. The total purchase price was $23.9 million.
7. Loans from Affiliates
The Note
- --------
In May 2002, the Company borrowed $4 million from CAIH in exchange for a three
year note bearing interest at 12% per annum. Along with the Note, CAIH received
a warrant to purchase 3,076,923 shares of the Company's common stock at $1.30
per share ("the Warrant"). The Note was recorded net of a $2.47 million
discount, based on the fair market value of the Warrant. The discount is
amortized using the effective interest rate over the life of the Note. The
principal balance is due on May 10, 2005 and accrued interest is payable
quarterly.
In June 2002, the Company prepaid $2 million of the $4 million outstanding
principal balance. As a result, the Company recognized an extraordinary loss on
the early extinguishment of debt of $1.22 million from the write-off of 50% of
the unamortized discount. In March 2004, the Company re-borrowed the $2 million
prepaid in June 2002, re-establishing the original principal balance. All terms
of the original promissory note remain in effect.
The Company recognized $656,000 in interest expense on the Note for the nine
months ended September 30, 2004, including $301,000 of interest on outstanding
principal and $355,000 in discount amortization. Comparably, the Company
recognized $358,000 in interest expense on the Note for the nine months ended
September 30, 2003, including $180,000 of interest on outstanding principal and
$178,000 in discount amortization.
As mentioned in Note 6, the Note was transferred to Nelson in May 2004. As of
September 30, 2004, the Company has paid $241,000 of interest to Nelson.
KKM Credit Facility
- -------------------
In May 2002, KKM established a five-year, $33 million credit line (the "KKM
Credit Facility") with Kazkommertsbank, an affiliate of CAIH. The KKM Credit
Facility consisted of a $30 million non-revolving line and a $3 million
revolving line, both of which were fully borrowed by KKM in May 2002. The
Company recognized $3.29 million and $3.45 million of interest expense on the
KKM Credit Facility for the nine months ended September 30, 2004 and 2003,
respectively.
9
Chaparral Resources, Inc
Notes to Consolidated Condensed Financial Statements (Unaudited)
(continued)
7. Loans from Affiliates (continued)
The non-revolving portion of the KKM Credit Facility accrues simple interest at
an annual rate of 14% and is repayable over a five-year period with final
maturity in May 2007. Accrued interest is payable quarterly, beginning in
December 2002, and KKM began making quarterly principal repayments in May 2003.
As of September 30, 2004, the Company had repaid $5 million in principal and the
Company and Kazkommertsbank have agreed to defer the 2004 remaining principal
payments of $5 million until 2005. The principal payment of $1 million due May
31, 2004 was deferred until August 31, 2004. Subsequently, this principal
payment, together with $2 million scheduled for payment on August 6, 2004 has
been deferred to January 31, 2005. A principal payment of $2 million scheduled
for payment on November 6, 2004 has been deferred until May 31, 2005.
The revolving portion of the KKM Credit Facility accrues simple interest at an
annual rate of 14%. The revolver is loaned to KKM for short-term periods up to
one year, but KKM has the right to re-borrow the funds through May 2006 with
final repayment due in May 2007. On December 30, 2003, Kazkommertsbank increased
the revolving portion of the KKM Credit Facility from $3 million to $5 million.
On the same date, KKM borrowed the additional $2 million to finance ongoing
operations. The additional $2 million accrues interest at 14%. The table below
shows how the revolving portion of the facility has been utilized and the
maturity dates of the outstanding amount.
$000
-------------------------------
Date Maturity Loan Repayment Balance
---- -------- ---- --------- -------
$000 $000 $000
May 2002 3,000 3,000
July 2002 3,000 -
July 2002 3,000 3,000
July 2003 3,000 -
July 2003 3,000 3,000
December 2003 2,000 5,000
June 2004 2,000 3,000
June 2004 December 14, 2004 2,000 5,000
August 2004 3,000 2,000
August 2004 February 9, 2005 3,000 5,000
All amounts due under the revolving portion of the KKM Credit Facility are
classified as current as of September 30, 2004. Accrued interest on the
revolving loan is payable at maturity, except as noted.
The original KKM Credit Facility included repayment terms of three years and
four years for the non-revolving and revolving portions, respectively, with an
option to extend the final maturity date for repayment of the entire KKM Credit
Facility to five years. KKM exercised the option as of May 2002.
KKM is subject to certain pledges, covenants, and other restrictions under the
KKM Credit Facility, including, but not limited to, the following:
(i) CAP-G pledged its 50% interest in KKM to Kazkommertsbank as
collateral for the KKM Credit Facility;
(ii) Chaparral has provided a written guarantee to Kazkommertsbank that it
will repay the KKM Credit Facility in the event KKM fails to do so;
(iii) KKM may not incur additional indebtedness or pledge its assets to
another party without the written consent of Kazkommertsbank; and
(iv) KKM may not pay dividends without the written consent of
Kazkommertsbank.
10
Chaparral Resources, Inc
Notes to Consolidated Condensed Financial Statements (Unaudited)
(continued)
7. Loans from Affiliates (continued)
The KKM Credit Facility stipulates certain events of default, including, but not
limited to, KKM's inability to meet the terms of the KKM Credit Facility, KKM's
failure to meet its obligations to third parties in excess of $100,000, and
KKM's involvement in legal proceedings in excess of $100,000 where an adverse
judgment against KKM occurs or is expected to occur. If an event of default does
occur and is not waived by the lender, Kazkommertsbank has a right to call the
KKM Credit Facility immediately due and payable and exercise its security
interest by enforcing its collateral right on the Company's shares in KKM.
Furthermore, in the event of a material adverse change in the financial or
credit markets, Kazkommertsbank has a right to unilaterally alter any terms and
conditions of the KKM Credit Facility, including the rate of interest, by
written request. KKM may either agree to the amended terms or repay the
outstanding KKM Credit Facility within 10 days of notification.
The maturity schedule of the Company's indebtedness as of September 30, 2004 is
as follows:
Principal
Date Amount Due
---- ----------
$000
2004 2,000
2005 20,000
2006 8,000
2007 4,000
-------
Total principal due 34,000
=======
Balances as of September 30, 2004 under the different facilities are as follows:
Principal
---------
Amount Due
----------
$000
KKM Credit Facility (Non - revolving) 25,000
KKM Credit Facility (Revolving) 5,000
The Note 4,000
-------
Total principal due 34,000
=======
The loans are shown in the balance sheet net of the loan discount, which
amounted to $361,000 at September 30, 2004 and $716,000 at December 31, 2003.
8. Income Taxes
Income tax expense as reported relates entirely to foreign income taxes provided
on the Company's operations within the Republic of Kazakhstan. KKM's principal
agreement with the government of the Republic of Kazakhstan for the exploration,
development and production of oil in the Karakuduk Field specifies the income
taxes and other taxes applicable to KKM, which is subject to the tax laws of the
Republic of Kazakhstan. The Company has used the best estimates available to
determine its current and deferred tax liabilities within Kazakhstan.
11
Chaparral Resources, Inc
Notes to Consolidated Condensed Financial Statements (Unaudited)
(continued)
9. Capital Commitments
As of September 30, 2004, the Company has a drilling contract with
KazMunayGas-Drilling ("KMGD"), an affiliate of KMG, for one development drilling
rig currently operating in the Karakuduk Field. The rig is contracted through
December 31, 2004. The minimum payments under the drilling contract with KMGD
for 2004 are $3.7 million. A tender was held for drilling services for 2005. The
successful bidder, a new contractor, has been notified and the Company is
proceeding with contract negotiations. The Company's other drilling and
operations related contracts can either be cancelled within 30 days or
terminated as required.
The Company has no other significant commitments other than those incurred
during the normal performance of the work program to develop the Karakuduk
Field.
10. Related Party Transactions
In August 2004, the Company approved a two-year agreement with Nelson to provide
corporate administrative services and financial advisory services (the "Service
Agreement") to support its business activities. The Service Agreement is
effective as of June 1, 2004 and can be terminated upon 30 days written notice
by either party. In consideration for these services Nelson will receive a fixed
monthly fee of $20,000 for administrative services and $25,000 for financial
advisory services (the "Management Fee"). As part of the Service Agreement,
Nelson is also required to provide personnel to cover Chaparral's executive and
managerial needs. The cost of executive and managerial personnel will be
allocated on the basis of the cost of personnel involved and on the percentage
of time actually spent by such personnel on matters related to Chaparral, as
mutually agreed by the parties from time to time. In addition, Nelson will use
its greater buying power to obtain more favorable rates for goods and services,
including insurance coverage, for Chaparral. These expenditures will be passed
to Chaparral at cost with a ten percent mark-up. As of September 30, 2004, the
Company has booked $1,083,000 for the Management Fee, the executive and
managerial cost, insurance coverage and the mark-up under the Service Agreement.
On June 3, 2004, KKM entered into a three year agency agreement with Nelson (the
"Marketing Agreement"), whereby Nelson becomes the duly authorized, exclusive
agent for the purpose of marketing crude oil, and is empowered to represent the
interests of KKM in relations with governmental authorities and commercial
organizations and also enter into contracts and agreements and any other
documents necessary for and related to the marketing of crude oil. The Marketing
Agreement is effective as of June 1, 2004 and can be terminated upon 90 days
written notice by either party. As consideration for the services provided under
the Marketing Agreement, KKM shall pay Nelson a fixed fee of $20,000 per month
and a variable fee of five US cents per barrel of total production in a
reporting calendar month, if the amount of supplies to the local market in that
month is more than 10% of the total amount of production, or eight US cents per
barrel of total production in a reporting calendar month, if the amount of
supplies to the local market in that month is less than 10% of the total amount
of production (the "Marketing Fee"). For the period ending September 30, 2004,
$153,000 was accrued under the Marketing Agreement.
In 2003, the Company approved a one-year agreement with OJSC Kazkommerts
Securities ("KKS"), an affiliate of Kazkommertsbank. The agreement was effective
as of January 7, 2003 and provided for KKS to assist the Company's senior
management with financial advisory and investment banking services. In
consideration for these services KKS received a monthly fee of $25,000 (the
"Advisory Fee"). The agreement with KKS was cancelled as of April 30, 2004.
Kazkommerts Policy, an affiliate of Kazkommertsbank, is the major insurer of KKM
oil and gas activities.
KKM has a contract to transport 100% of its oil sales through the pipeline owned
and operated by KTO, a wholly owned subsidiary of KMG, the 40% minority
shareholder in KKM. The rates for transportation are in accordance with those
approved by the government of the Republic of Kazakhstan. Currently, the use of
the KTO pipeline system is the only viable method of exporting KKM's production.
As KTO notifies KKM of the export sales allocated to KKM on a monthly basis, KTO
controls transportation of export sales.
12
Chaparral Resources, Inc
Notes to Consolidated Condensed Financial Statements (Unaudited)
(continued)
10. Related Party Transactions (continued)
KKM makes a prepayment for crude transportation costs based upon the allocation
of export sales received from the Ministry of Energy and Mineral Resources of
the Republic of Kazakhstan. This prepayment includes pipeline costs charged by
the operators of the pipeline systems outside Kazakhstan and is dependent upon
the point of sale of KKM's exports. For the nine months ended September 30,
2004, KKM incurred $8.3 million for transportation costs with KTO. As of
September 30, 2004, KKM had a prepayment balance of $0.3 million with KTO in
respect of sales to be made in October 2004. Comparably, for the nine months
ended September 30, 2003, KKM incurred $7.3 million for transportation costs
with KTO. As of December 31, 2003, KKM had a prepayment balance of $1.3 million
with KTO in respect of sales to be made in January 2004.
KTO charges KKM for associated costs of oil storage within their pipeline
system, sales commission, and customs clearance fees in respect of export sales.
KTO also provides KKM with water through the Volga Water pipeline. Amounts
recognized for these services during the nine months ended September 30, 2004
and 2003 were $185,000 and $237,000, respectively.
As mentioned above, KKM has a drilling contract with KMGD for one development
drilling rig currently operating in the Karakuduk Field. The rig is contracted
through December 31, 2004.
The total amounts of the transactions with the above related companies for the
nine months ended September 30, 2004 and 2003 are as follows:
$000
------------------------------
2004 2003
---- ----
Nelson 1,236 -
KKS 100 225
Kazkommerts Policy 539 563
KTO 9,594 8,646
KMGD 4,624 2,242
Accounts payable balance to affiliates as at September 30, 2004 and December 31,
2003 are as follows:
$000
------------------------------
2004 2003
---- ----
Nelson 929 -
Kazkommerts Policy - 48
KTO 185 97
KMGD 1,170 998
------ ------
2,284 1,143
====== ======
The loans with Kazkommertsbank and Nelson are disclosed in Note 7 and the
drilling contract with KMGD is described in Note 9. Prepaid transportation to
KTO is discussed in Note 4.
13
Chaparral Resources, Inc
Notes to Consolidated Condensed Financial Statements (Unaudited)
(continued)
11. Contingencies
Taxation
- --------
The existing legislation with regard to taxation in the Republic of Kazakhstan
is constantly evolving as the Government manages the transition from a command
to a market economy. Tax and other laws applicable to the Company are not always
clearly written and their interpretation is often subject to the opinions of the
local or main State Tax Service. Instances of inconsistent opinions between
local, regional and national tax authorities are not unusual.
Basis of Accounting
- -------------------
KKM maintains its statutory books and records in accordance with U.S. generally
accepted accounting principles ("GAAP") and calculates taxable income or loss
using the existing Kazakh tax legislation in effect on August 30, 1995, the date
the Agreement was signed. The Company considers these accounting methods correct
under the terms of the Agreement. The Republic of Kazakhstan currently requires
companies to comply with Kazakh accounting regulations and to calculate tax
profits or losses in accordance with these regulations as well as the prevailing
tax law.
14
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
1. Liquidity and Capital Resources
General Liquidity Considerations
- --------------------------------
Going Concern
- -------------
Our financial statements have been presented on the basis that we are a going
concern, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. We have a working capital
deficiency as of September 30, 2004 and there are uncertainties relating to our
ability to meet projected cash flow requirements through 2005, which could
result in a default of the Company's outstanding loans and the loss of the
Company's interest in the Karakuduk Field. As of September 30, 2004, the Company
had a working capital deficiency of $17.31 million primarily due to principal
repayments of $19.64 million due over the next twelve months under our
outstanding credit facilities (See Note 7 to the interim financial statements
presented in Item 1). These conditions raise substantial doubt about our ability
to continue as a going concern. The financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of these uncertainties.
We are seeking to alleviate these conditions by increasing cash flows available
from the sale of crude oil production from the Karakuduk Field. We expect to
finance the development of the Karakuduk Field primarily through the production
and sale of crude oil, which is currently approximately 8,700 barrels of oil per
day. Management expects production to increase to approximately 9,500 barrels of
oil per day, by year-end 2004, by continuing the development of the Karakuduk
Field. In addition, we continue to seek an amicable resolution of our attempts
to reduce the Company's obligation to supply a portion of its production to the
local refinery to meet domestic energy needs, which generate substantially less
revenue than oil sold on the export market. We recently entered into an agency
agreement with Nelson to assist in maximizing the Company's crude oil export
quotas as well as in the marketing of its crude oil (See Note 10 to the interim
financial statements presented in Item 1). During the first nine months in 2004,
KKM sold approximately 9% of its available production for sale to the local
refinery. We are also currently evaluating different options to obtain debt
financing to cover our working capital deficiencies. These options include
extending or refinancing the credit facility with Kazkommertsbank (See Note 7 to
the interim financial statements presented in Item 1) as well as modifying the
development plan for the Karakuduk Field.
No assurances can be provided, however, that oil production will be increased or
that the Company will be able to export a higher portion of its production and
that the Company will be able to obtain additional financing and cash flow from
operations to meet working capital requirements in the future.
Liquidity and Capital Resources
- -------------------------------
We are presently engaged in the development of the Karakuduk Field, which
requires substantial cash expenditures for drilling costs, well completions,
workovers, oil storage and processing facilities, pipelines, gathering systems,
water injection facilities, plant and equipment (pumps, transformer sub-stations
etc.), gas utilization and other field facilities. We have invested
approximately $23.07 million in the development of the Karakuduk Field for the
nine months ended September 30, 2004 compared to oil and gas capital
expenditures of $15.36 million incurred for the nine months ended September 30,
2003. The increase of $7.71 million is due to additional capital activities
during 2004 including the ongoing drilling program, a pressure maintenance
program and construction of water injection facilities. We anticipate full year
2004 capital expenditures of approximately $31 million.
We expect to finance the continued development of the Karakuduk Field primarily
through cash flows from the sale of crude oil and external financing as
necessary. We have agreed with Kazkommertsbank to defer the remaining $5 million
of principal payments due in 2004 on the non-revolving KKM Credit Facility
until 2005 (See Note 7 to the interim financial statements presented in Item 1).
15
During the third quarter of 2004 the Company continued with the development of
the Karakuduk Field. As of September 30, 2004 the producing well stock has risen
to 55 compared to 51 at the end of the second quarter. Of this total, one well
was ready for completion, and five were temporarily shut in due to operational
and work-over requirements.
Production during the third quarter totaled 99,714 tons or approximately 762,000
barrels, which is equivalent to 8,290 bopd (barrels of oil per day). This
represents an increase in production performance during 2004, from an average of
7,760 bopd for the first quarter and 7,956 bopd for the second quarter.
Drilling activity at Karakuduk continued throughout the third quarter with KKM
drilling 13,362m (4.5 wells) compared with 14,747m (4.9 wells) in the second
quarter. Field infrastructure development continued on gathering lines, access
roads, facilities upgrades and improvements to the field camp.
During October, production at Karakuduk increased slightly to 8,630 bopd. The
Company optimized the performance of the sucker rod pumps at the field and
increased the producing well stock to 57. Of this total, 47 were online as of
November 1st and production had reached 9,000 bopd. There are now two workover
rigs at the field, KKM having mobilized a 100 ton workover rig. This rig will be
used to complete at least four capital recompletions at the field to further
boost production. It will also prepare the wells for the upcoming hydraulic
fracturing program that is due to start mid November.
Under the current development plan, drilling and infrastructure development will
continue throughout the remainder of the year. It is now expected that 18 wells
in total will be drilled at the field in 2004, two more than originally planned.
Construction of a gas pipeline from the field to the heating station, located at
the midway point kilometer 15 of the field export pipeline, has commenced. When
completed in December, this line will significantly reduce KKM's operating costs
as the current diesel-fired oil heaters will be converted to run on produced
gas.
We expect that KKM's production will reach a level of 9,500 bopd by the end of
2004.
Our short and long-term liquidity is also impacted by local oil sales
obligations imposed on oil and gas producers within Kazakhstan to supply local
energy needs (the domestic market does not permit world market prices to be
obtained, resulting in approximately $8 to $12 lower cash flow per barrel) and
our ability to obtain export quota necessary to sell our crude oil production on
the international market. Under the terms of the Agreement, we have a right to
export, and receive export quota for, 100% of the production from the Karakuduk
Field. The government of the Republic of Kazakhstan has not allocated sufficient
export quota to allow us to sell all of our available crude oil production on
the world market. We are taking steps to reduce our local market obligations and
to obtain a quota that will enable us to sell all or a significant portion of
our crude oil production to the export market. We continue to seek an amicable
resolution with the government of our attempts to reduce our local market
obligations. In addition, we entered into an agency agreement with Nelson to
assist in reducing our Kazakhstan domestic market obligation (See Note 10 to the
interim financial statements presented in Item 1).
No assurances can be provided, however, that we will be able to export a higher
portion of our production and that we will be able to obtain additional
financing and cash flow from operations to meet working capital requirements in
the future.
Capital Commitments and Other Contingencies
- -------------------------------------------
As of September 30, 2004, the Company has a drilling contract with KMGD for one
development drilling rig currently operating in the Karakuduk Field. The rig is
contracted through December 31, 2004. The minimum payments under the drilling
contract with KMGD for 2004 are $3.7 million. A tender was held for drilling
services for 2005. The successful bidder, a new contractor, has been notified
and the Company is proceeding with contract negotiations. The Company's other
drilling and operations related contracts can either be cancelled within 30 days
or terminated as required.
The Company has no other significant commitments other than those incurred
during the normal performance of the work program to develop the Karakuduk
Field.
16
Our operations may be subject to other regulations by the government of the
Republic of Kazakhstan or other regulatory bodies responsible for the area in
which the Karakuduk Field is located. In addition to taxation, customs
declarations and environmental controls, regulations may govern such things as
drilling permits and production rates. Drilling permits could become difficult
to obtain or prohibitively expensive. Production rates could be set so low that
they would make production unprofitable. These regulations may substantially
increase the costs of doing business and may prevent or delay the starting or
continuation of any given exploration or development project.
All regulations are subject to future changes by legislative and administrative
action and by judicial decisions. Such changes could adversely affect the
petroleum industry in general and us in particular. It is impossible to predict
the effect that any current or future proposals or changes in existing laws or
regulations may have on our operations.
2. Results of Operations
Results of Operations for the Three Months Ended September 30, 2004 Compared to
- --------------------------------------------------------------------------------
the Three Months Ended September 30, 2003
- -----------------------------------------
Our operations for the three months ended September 30, 2004 resulted in a net
income of $3.56 million compared to a net income of $2.07 million for the three
months ended September 30, 2003. The $1.49 million increase in our net income is
primarily a result of higher crude prices. Lower sales volumes meant that
revenues were slightly lower, but this was more than offset by lower volume
related transportation costs and depletion charge.
Revenues. Revenues were $22.08 million for the third quarter of 2004 compared
with $23.31 million for the third quarter of 2003. The $1.23 million decrease is
the result of lower volumes sold partially offset by higher crude prices
achieved during the third quarter of 2004 as compared to the same period of
2003. During the third quarter of 2004, we sold approximately 674,000 barrels of
crude oil, recognizing $22.08 million in revenue, or $32.74 per barrel after
quality differential losses. Comparably, we sold approximately 1,098,000 barrels
of crude oil, recognizing $23.31 million in revenue, or $21.23 per barrel, for
the third quarter 2003. The result is a positive price variance of $7.76 million
offset by an unfavorable volume variance of $8.99 million. The volumes sold
during the third quarter of 2003 included approximately 200,000 barrels of crude
as a result of delayed delivery pertaining to the second quarter of 2003.
Transportation and Operating Expenses. Transportation costs for the third
quarter of 2004 were $3.44 million, or $5.10 per barrel, and operating costs
associated with sales were $1.76 million, or $2.61 per barrel. Comparatively,
transportation costs for the third quarter of 2003 were $4.62 million, or $4.21
per barrel, and operating costs associated with sales were $1.67 million, or
$1.52 per barrel. The increase in transportation cost per barrel during the
third quarter of 2004 is the result of higher tariffs imposed on the Company and
a greater proportion of total volumes sold being to the export market during
2004. The increase in operating cost is mainly due to increased work-over
maintenance activities during the three months ended September 30, 2004.
Depreciation and Depletion. Depreciation and depletion expense was $4.28 million
for the third quarter of 2004 compared with $7.14 million for the third quarter
of 2003. The $2.86 million decrease is the result of lower oil volumes sold and
lower effective depletion rates during the third quarter of 2004. During the
third quarter of 2004, the Company recognized a total depletion expense of $4.13
million or $6.12 per barrel, compared to $6.95 million or $6.33 per barrel for
the third quarter of 2003. The decrease in the effective depletion rate of $0.21
per barrel is due to additions to the Company's estimated proved oil and gas
reserves partially offset by increases in expected capital expenditures for the
development of the field for future years.
Estimates of our proved oil and gas reserves are prepared by an independent
engineering company in accordance with guidelines established by the Securities
and Exchange Commission ("SEC"). Those guidelines require that reserve estimates
be prepared under existing economic and operating conditions with no provisions
for increases in commodity prices, except by contractual arrangement. Estimation
of oil and gas reserve quantities is inherently difficult and is subject to
numerous uncertainties. Such uncertainties include the projection of future
rates of production, export allocation, and the timing of development
expenditures. The accuracy of the estimates depends on the quality of available
geological and geophysical data and requires interpretation and judgment.
17
Estimates may be revised either upward or downward by results of future
drilling, testing or production. In addition, estimates of volumes considered to
be commercially recoverable fluctuate with changes in commodity prices and
operating costs. Our estimates of reserves are expected to change as additional
information becomes available. A material change in the estimated volumes of
reserves could have an impact on the depletion rate calculation and the
financial statements.
Interest Expense. Interest expense increased from $1.1 million for the third
quarter of 2003 to $1.26 million for the third quarter of 2004, due to higher
financing costs as a result of the re-borrowing in March 2004 of the $2 million
prepayment of the Note (See Note 7 to the interim financial statements presented
in Item 1), additional temporary borrowings for operational purposes and lower
capitalized interest. Interest expense for the quarter ended September 30, 2004
includes a loan discount of $128,000 and is net of capitalized interest of
$60,000. Comparably, interest expense for the quarter ended September 30, 2003
includes a loan discount of $59,000 and is net of capitalized interest of
$151,000.
General and Administrative Expense. General and administrative costs decreased
from $1.97 million for the three months ended September 30, 2003 to $1.45
million for the three months ended September 30, 2004. The decrease of $0.52
million is the result of reductions in expatriate staff numbers, no office
leasing expenses and lower salaries and wages.
Results of Operations for the Nine Months Ended September 30, 2004 Compared to
- --------------------------------------------------------------------------------
the Nine Months Ended September 30, 2003
- ----------------------------------------
Our operations for the nine months ended September 30, 2004 resulted in a net
income of $5.49 million compared to a net income of $1.01 million for the nine
months ended September 30, 2003. The $4.48 million increase primarily relates to
(i) higher sales revenue as a result of higher volumes sold and higher prices
achieved, and (ii) improved operational results from the Karakuduk Field,
partially offset by (i) recognition in 2003 of a $1.02 million gain as a result
of the adoption of FASB 143, (ii) higher costs associated with increased debt
obligations, (iii) higher operational costs associated with increased sales, and
(iv) higher income tax provision.
Revenue. Revenues were $55.16 million for the nine months ended September 30,
2004 compared with $39.59 million for the nine months ended September 30, 2003.
The $15.57 million increase is the result of higher oil volumes sold and higher
prices achieved during the nine months ended September 30, 2004. During this
period, we sold approximately 2,029,000 barrels of crude oil, recognizing
revenue of $55.16 million, or $27.19 per barrel after quality differential
losses. Comparably, we sold approximately 1,917,000 barrels of crude oil,
recognizing $39.59 million in revenue, or $20.65 per barrel, for the nine months
ended September 30, 2003. The result is a positive price variance of $13.26
million in addition to a favorable volume variance of $2.31 million.
Transportation and Operating Expenses. Transportation costs for the nine months
ended September 30, 2004 were $9.69 million or $4.78 per barrel, and operating
costs associated with sales were $5.66 million, or $2.79 per barrel.
Comparatively, transportation costs for the nine months ended September 30, 2003
were $7.92 million or $4.13 per barrel, and operating costs associated with
sales were $4.2 million, or $2.19 per barrel. The increase in transportation
cost per barrel during 2004 is the result of higher tariffs imposed on the
Company, greater volumes sold to the export market during 2004, and a 160,000
barrel sale to the local market in 2003 that carried no transportation cost. The
increase in operating cost per barrel is mainly due to higher work-over
maintenance costs during the nine months ended September 30, 2004.
Depreciation and Depletion. Depreciation and depletion expense was $12.81
million for the nine months ended September 30, 2004 compared with $12.90
million for the nine months ended September 30, 2003. The $85,000 decrease is
the result of a lower effective depletion rate partially offset by slightly
higher oil volumes sold during the nine months ended September 30, 2004. During
the nine months ended September 30, 2004, the Company recognized a total
depletion expense of $12.35 million or $6.09 per barrel, compared to $12.33
million or $6.43 per barrel for the nine months ended September 30, 2003. The
decrease in the effective depletion rate of $0.34 per barrel is due to additions
to the Company's estimated proved reserves, partially offset by increased
expected capital expenditures for the development of the field for future years.
18
Interest Expense. Interest expense increased from $3.36 million for the nine
months ended September 30, 2003 to $3.76 million for the nine months ended
September 30, 2004. The $0.40 million increase is due to financing costs of
higher borrowings. In addition, interest expense for the period ended September
30, 2004 reflects a loan discount of $355,000 and is net of capitalized interest
of $324,000. Comparably, interest expense for the nine months ending September
30, 2003, reflected a loan discount of $178,000 and is net of capitalized
interest of $371,000.
General and Administrative Expense. General and administrative costs increased
slightly from $5.13 million for the nine months ended September 30, 2003 to
$5.20 million for the nine months ended September 30, 2004. The $70,000 increase
is mainly due to accrued severance payable to former executives of the Company,
offset by reduced costs as a result of economies in consultancy services and
salaries and wages.
Cumulative Effect of Change in Accounting Principle. As a result of the adoption
of FASB 143, the Company recognized a gain of $1.02 million as the cumulative
effect of change in accounting principle for the nine months ended September 30,
2003. There is no change in accounting principle effecting the nine month period
ended September 30, 2004.
3. Commodity Prices for Oil and Gas
Our revenues, profitability, growth and value are highly dependent upon the
price of oil. Market conditions make it difficult to estimate prices of oil or
the impact of inflation on such prices. Oil prices have been volatile, and it is
likely they will continue to fluctuate in the future. Various factors beyond our
control affect prices for oil, including supplies of oil available worldwide and
in Kazakhstan, the ability of OPEC to agree to maintain oil prices and
production controls, political instability or armed conflict in Kazakhstan or
other oil producing regions, the price of foreign imports, the level of consumer
demand, the price and availability of alternative fuels, the availability of
transportation routes and pipeline capacity, and changes in applicable laws and
regulations.
4. Inflation and Exchange Rates
We cannot control prices received from our oil sales and to the extent we are
unable to pass on increases in operating costs, we may be affected by inflation.
The devaluation of the Tenge, the currency of the Republic of Kazakhstan, can
significantly decrease the value of the monetary assets that we hold in
Kazakhstan as well as our assets in that country that are based on the Tenge.
KKM retains the majority of its cash and cash equivalents in U.S. dollars, but
KKM's statutory tax basis in its assets, tax loss carry-forwards, and VAT
receivables are all denominated in Tenge and subject to the effects of
devaluation. Local tax laws allow basis adjustments to offset the impact of
inflation on statutory tax basis assets, but there is no assurance that any
adjustments will be sufficient to offset the effects of inflation in whole or in
part. If not, KKM may be subject to much higher income tax liabilities within
Kazakhstan due to inflation or devaluation of the local currency. Additionally,
devaluation may create uncertainty with respect to the future business climate
in Kazakhstan and to our investment in that country. As of September 30, 2004,
the exchange rate was 134.56 Tenge per U.S. dollar compared to 144.22 as of
December 31, 2003.
5. Critical Accounting Policies
The preparation of the Company's consolidated financial statements requires
management to make estimates, assumptions and judgments that affect the
Company's assets, liabilities, revenues and expenses and disclosure of
contingent assets and liabilities. Management bases these estimates and
assumptions on historical data and trends, current fact patterns, expectations
and other sources of information it believes are reasonable. Actual results may
differ from these estimates under different conditions. For a full description
of the Company's critical accounting policies, see Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations in the
Company's 2003 Annual Report on Form 10-K.
6. Special Note Regarding Forward-Looking Statements
Some of the statements in this Quarterly Report on Form 10-Q constitute
"forward-looking statements." Forward-looking statements relate to future events
or our future financial performance. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "estimates," "believes," "predicts," "potential," "likely,"
19
or "continue," or by the negative of such terms or comparable terminology.
Forward-looking statements are predictions based on current expectations that
involve a number of risks and uncertainties. Actual events may differ
materially. In evaluating forward-looking statements, you should consider
various factors, including the risks discussed above. These factors may cause
our actual results to differ materially from any forward-looking statement.
Although we believe that these statements are reasonable, we cannot guarantee
future results, levels of activity, performance or achievements, and you are
encouraged to exercise caution in considering such forward-looking statements.
Unless otherwise required by law, we are not under any duty to update any of the
forward-looking statements after the date of this Quarterly Report on Form 10-Q
to conform these statements to actual results.
Item 3 - Quantitative and Qualitative Disclosures About Market Risks
Foreign Currency
The functional currency is the U.S. dollar. All transactions arising in
currencies other than U.S. dollars, including assets, liabilities, revenue,
expenses, gains, or losses are measured and recorded in U.S. dollars using the
exchange rate in effect on the date of the transaction.
Cash and other monetary assets held and liabilities denominated in currencies
other than U.S. dollars are translated at exchange rates prevailing as of the
balance sheet date (134.56 and 144.22 Tenge per U.S. dollar as of September 30,
2004 and December 31, 2003, respectively). Non-monetary assets and liabilities
denominated in currencies other than U.S. dollars have been translated at the
estimated historical exchange rate prevailing on the date of the transaction.
Exchange gains and losses arising from translation of non-U.S. dollar amounts at
the balance sheet date are recognized as an increase or decrease in income for
the period. See Item 2 section 4 for discussion on inflation and exchange rate
risks.
The Tenge is not a convertible currency outside of the Republic of Kazakhstan.
The translation of Tenge denominated assets and liabilities in these financial
statements does not indicate Chaparral could realize or settle these assets and
liabilities in U.S. dollars.
Commodity Prices for Oil
Our revenues, profitability, growth and value are highly dependent upon the
price of oil. Market conditions make it difficult to estimate prices of oil or
the impact of inflation on such prices. Oil prices have been volatile, and it is
likely they will continue to fluctuate in the future. Various factors beyond our
control affect prices for oil, including supplies of oil available worldwide and
in Kazakhstan, the ability of OPEC to agree to maintain oil prices and
production controls, political instability or armed conflict in Kazakhstan or
other oil producing regions, the price of foreign imports, the level of consumer
demand, the price and availability of alternative fuels, the availability of
transportation routes and pipeline capacity, and changes in applicable laws and
regulations.
In addition, under the terms of our Agreement with the government of the
Republic of Kazakhstan, the Company has the right to export, and receive export
quota for, 100% of the production from the Karakuduk Field. However, oil
producers within Kazakhstan are required to supply a portion of their crude oil
production to the local market to meet domestic energy needs. Local market oil
prices are significantly lower than prices obtainable on the export market. For
the nine months ended September 30, 2004, the Company sold 183,000 barrels of
crude oil, or 9% of its total oil sales, to the local market, compared to
253,000 barrels, or 13%, during the nine months ended September 30, 2003. Local
market prices obtained by the Company are approximately $8 to $12 per barrel
below export market prices, net of transportation costs. We have attempted, in
accordance with our Agreement, to effect the 100% export of all hydrocarbons
produced from the Karakuduk Field, through discussions with the government of
the Republic of Kazakhstan. We plan to continue to work with the government to
increase our export quota and minimize or eliminate future local sales
requirements. In addition, we entered into an agency agreement with Nelson to
assist in reducing our local market obligation (See Note 10 to the interim
financial statements presented in Item 1). However, no assurances can be
20
provided that we will be able to export a higher portion of our production and
that our cash flow from operations will be sufficient to meet working capital
requirements in the future, which may require us to seek additional debt or
equity financing in order to continue to develop the Karakuduk Field.
Item 4 - Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures designed to provide reasonable
assurance that information required to be disclosed in the periodic reports we
file with the SEC is recorded, processed, summarized and reported within the
time periods specified in the rules of the SEC. The Company carried out an
evaluation as of September 30, 2004, under the supervision and the participation
of our management, including our chief executive officer and chief financial
officer, of the design and operation of these disclosure controls and procedures
pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934. Based upon that evaluation, our chief executive officer and chief
financial officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information required to be
included in our periodic SEC filings.
Changes in Internal Controls over Financial Reporting
There have been no significant changes in internal controls over financial
reporting or other factors subsequent to December 31, 2003.
21
Part II- Other Information
Item 4 - Submission of Matters to a Vote of Security Holders
(a) The annual meeting of the shareholders of the Company was held on August 2,
2004.
(b) The following nominees were elected to serve one year terms on the
Company's Board of Directors and Ernst and Young was ratified as the
Company's independent auditor by the following votes:
Shares Shares
------ ------
Voted % of Voted % of Shares % of
----- ---- ----- ---- ------ ----
For OS Against OS Withheld OS
--- -- ------- -- -------- --
ELECT:
R. FREDERICK HODDER 32,498,365 85.05% - 0.00% 14,635 0.04%
NICHOLAS P. GREENE 32,501,882 85.06% - 0.00% 11,118 0.03%
PETER G. DILLING 32,496,928 85.05% - 0.00% 16,072 0.04%
ALAN D. BERLIN 32,498,350 85.05% - 0.00% 14,650 0.04%
SIMON K. GILL 32,498,390 85.05% - 0.00% 14,610 0.04%
RATIFY:
- ------
ERNST AND YOUNG AS
INDEPENDENT AUDITORS 32,510,617 85.09% 726 0.00% 1,657 0.00%
Item 6 - Exhibits
*31.1 CEO Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
*31.2 CFO Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
*32.1 CEO Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
*32.2 CFO Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
* Filed herewith.
22
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.
Dated: November 12, 2004
Chaparral Resources, Inc.
By: /s/ Simon Gill
-------------------------------
Simon Gill
Chief Executive Officer
By: /s/ Nigel Penney
--------------------------------
Nigel Penney
VP Finance and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
23