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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, 2003
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)
16945 Northchase Drive, Suite 1620
Houston, Texas 77060
--------------------
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (281) 877-7100
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, 2003 the Registrant had 38,209,502 shares of its common
stock, par value $0.0001 per share, issued and outstanding.
Part I - Summarized Financial Information
Item 1 - Financial Statements
Chaparral Resources, Inc.
Consolidated Balance Sheets
(In Thousands)
September 30, December 31,
2003 2002
(Unaudited)
--------- ---------
Assets
Current assets:
Cash and cash equivalents $ 3,857 $ 4,295
Accounts receivable:
Oil sales receivable 772 1,993
VAT receivable 3,155 1,999
Prepaid expenses 2,380 2,456
Crude oil inventory 618 548
--------- ---------
Total current assets 10,782 11,291
Materials and supplies 3,353 2,457
Other -- 5
Property, plant and equipment:
Oil and gas properties, full cost:
Properties subject to depletion 102,312 84,833
Properties not subject to depletion 9,111 8,814
--------- ---------
111,423 93,647
Furniture and fixtures and other equipment 9,202 8,210
--------- ---------
120,625 101,857
Less - accumulated depreciation, depletion, and amortization (39,806) (28,302)
--------- ---------
Property, plant and equipment, net 80,819 73,555
--------- ---------
Total assets $ 94,954 $ 87,308
========= =========
See accompanying notes.
2
Chaparral Resources, Inc.
Consolidated Balance Sheets (continued)
(In Thousands)
September 30, December 31,
2003 2002
(Unaudited)
--------- ---------
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 6,365 $ 2,809
Accrued liabilities:
Accrued compensation 229 227
Other accrued liabilities 2,976 2,432
Current income tax liability 614 1,939
Accrued interest payable 671 250
Current portion of loans payable to affiliates 9,000 6,000
--------- ---------
Total current liabilities 19,855 13,657
Loans payable to affiliates, net of discount 23,176 27,998
Deferred tax liability 2,649 746
Long-term assets retirement obligation 676 --
Accrued production bonus 606 477
--------- ---------
Long-term liabilities 27,107 29,221
Minority interest 2,871 321
--------- ---------
Total liabilities 49,833 43,199
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, 2003 and
December 31, 2002 4 4
Capital in excess of par value 107,226 107,226
Accumulated deficit (62,109) (63,121)
--------- ---------
Total stockholders' equity 45,121 44,109
--------- ---------
Total liabilities and stockholders' equity $ 94,954 $ 87,308
========= =========
See accompanying notes.
3
Chaparral Resources, Inc.
Consolidated Statements of Operations (Unaudited)
(In Thousands, Except Share Data)
For the Three Months Ended For the Nine Months Ended
------------------------------ ------------------------------
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenue $ 23,308 $ 13,446 $ 39,594 $ 32,471
Costs and expenses:
Transportation costs 4,617 2,397 7,921 7,028
Operating expenses 1,671 2,212 4,200 5,953
Depreciation and depletion 7,140 3,709 12,897 9,708
Advisory fee 75 -- 225 --
Hedge losses -- -- -- 762
Accretion expense 17 -- 46 --
General and administrative 1,967 1,557 5,131 4,840
------------ ------------ ------------ ------------
Total costs and expenses 15,487 9,875 30,420 28,291
------------ ------------ ------------ ------------
Income from operations 7,821 3,571 9,174 4,180
Other income (expense):
Interest expense (1,100) (1,097) (3,362) (4,449)
Minority interest (2,134) -- (2,550) --
Currency exchange gain/(loss) -- 7 (107) (147)
Other (37) (16) (1) (9)
------------ ------------ ------------ ------------
Total other income (expense) (3,271) (1,106) (6,020) (4,605)
------------ ------------ ------------ ------------
Income/(loss) before income taxes, extraordinary gain
and cumulative effect of change in accounting
principle 4,550 2,465 3,154 (425)
Income tax expense (2,479) (352) (3,160) (871)
------------ ------------ ------------ ------------
Income (loss) before extraordinary gain and
cumulative effect of change in accounting
principle 2,071 2,113 (6) (1,296)
Extraordinary gain -- -- -- 5,338
Cumulative effect of change in accounting principle,
net of tax -- -- 1,018 --
------------ ------------ ------------ ------------
Net income available to common Stockholders $ 2,071 $ 2,113 $ 1,012 $ 4,042
============ ============ ============ ============
Basic earnings per share:
Income (loss) per share before extraordinary gain and
cumulative effect of change in accounting principle $ 0.05 $ 0.06 $ (0.00) $ (0.05)
Extraordinary gain $ -- $ -- $ -- $ 0.20
Cumulative effect of change in accounting principle $ -- $ -- $ 0.03 $ --
Net income per share $ 0.05 $ 0.06 $ 0.03 $ 0.15
Weighted average number of shares outstanding
(basic) 38,209,502 38,209,502 38,209,502 26,903,950
Chaparral Resources, Inc.
Consolidated Statements of Operations (continued) (Unaudited)
(In Thousands, Except Share Data)
For the Three Months Ended For the Nine Months Ended
------------------------------ ------------------------------
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Diluted earnings per share:
Income/(loss) per share before extraordinary gain
and cumulative effect of change in accounting
principle $ 0.05 $ 0.05 $ (0.00) $ (0.05)
Extraordinary gain $ -- $ -- $ -- $ 0.19
Cumulative effect of change in accounting principle $ -- $ -- $ 0.03 $ --
Net income per share $ 0.05 $ 0.05 $ 0.03 $ 0.14
Weighted number of shares outstanding (diluted) 38,408,726 39,134,622 38,408,726 27,396,822
See accompanying notes.
5
Chaparral Resources, Inc.
Consolidated Statements of Cash Flows (Unaudited)
(In Thousands)
For the Nine Months Ended
-----------------------------
September 30, September 30,
2003 2002
-------- --------
Cash flows from operating activities
Net income $ 1,012 $ 4,042
Adjustments to reconcile net income to
net cash provided in operating activities:
Depreciation, depletion, and amortization 12,897 9,708
Loss on disposition of assets 8 15
Deferred income taxes 1,903 419
Cumulative effect of change in accounting
Principle (1,018) --
Accretion expense 46 --
Hedge losses -- 762
Amortization of debt issuance costs 178 211
Extraordinary gain on restructuring of debt -- (5,338)
Non cash interest expense -- 2,753
Minority interest 2,550 --
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable 65 (5,273)
Prepaid expenses 81 (1,000)
Crude oil inventory 87 (292)
Increase (decrease) in:
Accounts payable and accrued liabilities 257 (7,564)
Accrued interest payable 421 1,752
Other liabilities 129 (190)
-------- --------
Net cash provided by operating activities $ 18,616 $ 5
-------- --------
Cash flows from investing activities
Additions to furniture, fixtures, and other equipment $ (792) $ (649)
Acquisition of 10% interest in KKM, net of cash
Required -- (644)
Additions to oil and gas properties (15,366) (5,697)
Materials and supplies inventory (896) 270
Proceeds from disposition of assets -- 5
-------- --------
Net cash used in investing activities $(17,054) $ (6,715)
-------- --------
6
Chaparral Resources, Inc.
Consolidated Statements of Cash Flows (continued) (Unaudited)
(In Thousands)
For the Nine Months Ended
-----------------------------
September 30, September 30,
2003 2002
-------- --------
Cash flows from financing activities
Proceeds from loans from affiliates $ 4,500 $ 40,000
Payments on loans from affiliates (6,500) (5,000)
Proceeds from sale of stock -- 8,000
Payments on Shell Capital loan -- (30,450)
Debt restructuring costs -- (2,518)
Redemption of Series A Preferred Stock -- (2,300)
-------- --------
Net cash provided/(used) by financing activities $ (2,000) $ 7,732
-------- --------
Net increase (decrease) in cash and cash equivalents $ (438) $ 1,022
Cash and cash equivalents at beginning of period 4,295 174
-------- --------
Cash and cash equivalents at end of period $ 3,857 $ 1,196
-------- --------
Supplemental cash flow disclosure
Interest paid $ 3,207 $ 239
Supplemental schedule of non-cash investing and
financing activities
Non-cash additions to oil and gas properties $ 2,519 $ --
Common stock issued for 10% interest in KKM $ -- $ 2,701
Discount recognized for note issued with stock
warrants $ -- $ 2,466
See accompanying notes.
7
Chaparral Resources, Inc.
Notes to Consolidated 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.
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 is owned jointly by CAP-G
(50%), MTI (10%), and KazMunayGaz JSC ("KMG") (40%). KMG is the national
petroleum company of Kazakhstan.
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.
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, 2002.
The information furnished herein was taken from the books and records of the
Company without audit. 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.
Certain reclassifications have been made in the periods presented for the 2002
financial statements to conform to the 2003 presentation.
2. New Accounting Standards
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") 143, Accounting for Asset Retirement
Obligations. SFAS 143 requires entities to record the fair value of a liability
for an asset retirement obligation in the period in which it is incurred and a
corresponding increase in the carrying amount of the related long-lived asset.
Subsequently, the asset retirement cost should be allocated to expense using a
systematic and rational method. SFAS 143 is effective for fiscal years beginning
after June 15, 2002. The Company adopted SFAS 143 on January 1, 2003. See Note 5
for results of the adoption of SFAS 143.
8
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
2. New Accounting Standards (continued)
In May 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts and hedging activities under SFAS No. 133. The
amendments set forth in SFAS No. 149 require that contracts with comparable
characteristics be accounted for similarly. SFAS No. 149 is generally effective
for contracts entered into or modified after June 30, 2003 (with a few
exceptions) and for hedging relationships designated after June 30, 2003. The
guidance is to be applied prospectively only. The adoption of SFAS No. 149 as of
July 1, 2003 has had no effect on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This statement
establishes standards for how an issuer classifies and measures on its balance
sheet certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances) because that
financial instrument embodies an obligation of the issuer. SFAS No. 150 was
effective for financial instruments entered into or modified after May 31, 2003,
and was otherwise effective for us as of July 1,2003. The adoption of the
applicable provisions of this statement as of the indicated dates has had no
effect on the Company's financial statements.
In November 2002, the FASB issued Interpretation No. (FIN) 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. FIN 45 requires certain guarantees to be
recorded at fair value. FIN 45 had a dual effective date. The initial
recognition and measurement provisions are applicable on a prospective basis
only to guarantees issued or modified after December 31, 2002. The disclosure
requirements in the interpretation were effective as of October 1, 2002. The
adoption of the applicable provisions of FIN 45 at the indicated dates has had
no effect on the Company's financial statements.
In January 2003, the FASB issued Interpretation (FIN) No. 46, Consolidation of
Variable Interest Entities (VIEs), in an effort to expand upon and strengthen
existing accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
In general, a VIE is a corporation, partnership, trust, or any other legal
structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not provide
sufficient financial resources for the entity to support its activities. FIN 46
requires a VIE to be consolidated by a company if that company is subject to a
majority of the risk of loss from the VIE's activities, is entitled to receive a
majority of the VIE's residual returns, or both. FIN 46 also requires
disclosures about VIEs that the Company is not required to consolidate, but in
which it has a significant variable interest. The consolidation requirements of
FIN 46 apply immediately to VIEs created after January 31, 2003, and to other
entities no later than the three months ended September 30, 2003. Certain
disclosure requirements are required in all financial statements issued after
January 31, 2003, regardless of when the VIE was established. The Company has
not identified any VIEs that must be consolidated.
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, 2003. In addition, the Company has experienced
limitations in obtaining 100% export quota for the sale of its hydrocarbons.
These conditions create uncertainties relating to the Company's ability to meet
all expenditure and cash flow requirements through the next twelve months. 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 obtaining 100% export of
all hydrocarbons produced from the Karakuduk Field through discussions with the
Government of Kazakhstan. On July 17, 2003, the Company took the first step
toward the commencement of arbitration proceedings in Switzerland for the breach
of the Agreement by the Government of Kazakhstan by initiating a required
three-month period of consultation with the Government. The Government indicated
an interest in trying to resolve this matter during the consultation period.
9
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
3. Going Concern (continued)
Although the consultation period has expired, the Company and the Government are
continuing to negotiate a possible resolution of this matter. If the matter
cannot be resolved in a satisfactory manner, the Company has reserved its right
to commence formal arbitration proceedings pursuant to its contractual
arrangements with the Government.
In addition, the Company is attempting to obtain additional debt financing to
cover any cash flow deficiencies that may occur and refinance the Company's loan
with JSC Kazkommertsbank ("Kazkommertsbank") in order to reduce the Company's
current interest rate of 14% and alleviate the Company's current working capital
deficiency.
No assurances can be provided, however, that if arbitration is instituted, it
will be successful or that if successful, the Company will be able to enforce
the award in Kazakhstan, or that the Company will be able to export 100% or a
significant 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.
4. Crude Oil Inventory
Crude oil inventory represents production costs associated with lifting and
transporting crude oil from the Karakuduk Field to the KazTransOil pipeline (the
"KTO export pipeline"). Crude oil placed into the KTO export pipeline is held as
inventory until formally nominated and delivered for sale. Crude oil inventory
as of September 30, 2003 represents approximately 93,000 barrels of crude oil,
an increase of 6,000 barrels from 87,000 barrels of crude oil as of December 31,
2002. The increase in crude oil inventory represents less than one day of
production.
5. Asset Retirement Obligation
As discussed in Note 2, effective January 1, 2003, the Company changed its
method of accounting for asset retirement obligations in accordance with SFAS
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, the Company now
recognize AROs in the period in which they are incurred if a reasonable estimate
of a 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 on prior years 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 core business of the Company 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 ARO 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 units of production method over proved reserves.
10
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
5. Asset Retirement Obligation (continued)
On February 12, 2003, the Company commenced a new drilling campaign to further
develop and commercially produce the oil reserves in the Karakuduk Field. As a
result of the new drilling campaign, the Company revised its estimate of
retirement costs to include expected additions to the Karakuduk Field during
2003. This change in estimate did not result in a direct charge to income for
the period ended September 30, 2003. The following table describes all changes
to the Company's asset retirement obligation liability:
For three months For nine months
ended ended
September 30, 2003 September 30, 2003
(In Thousands) (In Thousands)
------------ ------------
Asset retirement obligation at beginning of period $616 $--
Liability recognized in transition -- 516
Accretion expense 17 46
Revision in estimated cash flows 43 114
---- ----
Asset retirement obligation at end of period $676 $676
==== ====
The pro forma asset retirement obligation assuming the application of SFAS 143
for periods prior to January 1, 2003 as of January 1, 2002 and December 31, 2002
would have been $469,000 and $516,000, respectively.
6. Loans from Affiliates
CAIH Note
- ---------
In May 2002, the Company borrowed $4 million from Central Asian Industrial
Holdings, N.V. ("CAIH") in exchange for a three year note bearing interest at
12% per annum (the "CAIH Note"). Along with the CAIH Note, CAIH received a
warrant to purchase 3,076,923 shares of the Company's common stock at $1.30 per
share (the "CAIH Warrant"). The CAIH Note was recorded net of a $2.47 million
discount, based on the fair market value of the CAIH Warrant. The discount is
amortized using the effective interest rate over the life of the CAIH Note. The
principal balance of the CAIH Note is due on May 10, 2005 and accrued interest
is payable quarterly.
In June 2002, the Company repaid $2 million of the $4 million outstanding
principal balance of the CAIH Note. 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 on the CAIH Note. The Company
recognized $358,000 in interest expense on the CAIH Note for the nine months
ended September 30, 2003, including $180,000 of interest on outstanding
principal and $178,000 in discount amortization.
KKM Credit Facility
- -------------------
In May 2002, KKM established a five-year, $33 million credit line ("KKM Credit
Facility") with Kazkommertsbank an affiliate of CAIH. The KKM Credit Facility
consists 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
$3.45 million of interest expense on the KKM Credit Facility for the nine months
ended September 30, 2003.
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. KKM has made quarterly principal payments since May 2003. As of
September 30, 2003, the Company has repaid $2 million in principal.
11
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
6. Loans from Affiliates (continued)
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. Accrued interest on the revolving loan is
payable at maturity. The initial $3 million revolving loan to KKM was subject to
a three month term. The principal balance was repaid in July 2002 and KKM
immediately re-borrowed another $3 million with a maturity date of July 31,
2003. KKM has repaid the $3 million due on July 31, 2003 and exercised its right
to re-borrow another $3 million with a maturity date of July 31, 2004.
The original KKM Credit Facility included repayment terms of three years and
four years for the non-revolving and revolving portions of the KKM Credit
Facility, 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 to extend the repayment term to five years for the entire KKM Credit
Facility from May 2002.
The Company 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 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.
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 it obligations to third parties in excess of $100,000, and the
Company's involvement in legal proceedings in excess of $100,000 where an
adverse judgment against the Company 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/or
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, 2003, is
as follows:
Principal
Date Amount Due
---- ----------
2003 $ 1,000,000
2004 10,000,000
2005 10,000,000
2006 8,000,000
2007 4,000,000
---------------------------------------------------
Total principal due $ 33,000,000
Less:
Principal due within one year (9,000,000)
Unamortized debt issue cost (824,000)
---------------------------------------------------
Net long term principal due $23,176,000
===================================================
12
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
6. Loans from Affiliates (continued)
Line of Credit
- --------------
On April 29, 2003, Kazkommertsbank provided a line of credit for $2.5 million to
the Company to cover necessary operating expenditures ("Line of Credit"). On the
same day, the Company accessed $1.5 million from the line of credit to cover the
required transportation costs for the May 2003 oil sale. The $1.5 million was
due on May 29, 2003 and accrued simple interest at an annual rate of 14%. The
company repaid the $1.5 million and all accrued interest on May 22, 2003.
7. Common Stock
During the quarter ended September 30, 2003, stock options to purchase 584
shares of the Company's common stock granted in 1998 to employees of the Company
expired. Of the expired options 167 had an exercise price of $86.40 per share
and 417 had an exercise price of $80.40 per share.
During the quarter ended September 30, 2003, warrants to purchase 333 shares of
the Company's common stock granted during 1998 expired. The expired warrants had
an exercise price of $0.60 per share.
8. Income Taxes
Income tax expense as reported entirely relates 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.
9. Commitments and 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.
In December 2002, KKM received a claim from the Ministry of State Revenues of
the Republic of Kazakhstan for $9.6 million (the "Tax Claim") relating to
additional unpaid taxes and penalties covering the three years from 1999 to
2001. The original Tax Claim has been successfully reduced to approximately
$2.31 million. KKM has appealed the remaining claim and has contracted legal
firms in Kazakhstan to assist with the appeal process. Based on the assessments
of KKM's management and legal counsel, it is the Company's opinion that the
ultimate resolution of the Tax Claim, after taking into account reserves
previously made, will not have a material adverse effect on the financial
position or operating results of the Company.
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.
13
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
10. Related Party Transactions
During April 2003, the Company approved a one-year agreement with OJSC
Kazkommerts Securities ("KKS") an affiliate of Kazkommertsbank. The agreement
became effective as of January 7, 2003 and provides for KKS to assist the
Company's senior management with financial advisory and investment banking
services. In consideration for the services KKS will receive a monthly fee of
$25,000 (the "Advisory Fee").
On August 30, 2003, the Company extended its drilling contract with
KazMunayGas-Drilling ("KMGD"), an affiliate of KMG, for the drilling rig
currently operating in the Karakuduk Field until December 31, 2004. The rig was
originally contracted until February 6, 2004.
11. Subsequent Events
A payment of principal and interest was due on the KKM Credit Facility on
November 6, 2003. The Company paid the current interest due, but the Company and
Kazkommertsbank have agreed to defer the repayment of $1 million in principal to
a date that is currently being negotiated.
14
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
1. Liquidity and Capital Resources
Going Concern
- -------------
Our 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. We have a working capital
deficiency as of September 30, 2003. In addition, we have experienced
limitations in obtaining 100% export quota for the sale of our hydrocarbons.
These conditions create uncertainties relating to our ability to meet all
expenditure and cash flow requirements through the next twelve months. 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.
Our short and long-term liquidity is impacted by local oil sales obligations
imposed on oil and gas producers within Kazakhstan to supply local energy needs,
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 domestic market does not permit world market
prices to be obtained, resulting in approximately $10 to $12 lower cash flow per
barrel. Furthermore, the Government 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 an
export quota that will enable us to sell all of our crude oil production. On
July 17, 2003, we took the first step toward the commencement of arbitration
proceedings in Switzerland for the breach of the Agreement by the Government of
Kazakhstan by initiating a required three-month period of consultation with the
Government. The Government indicated an interest in trying to resolve this
matter during the consultation period. Although the consultation period has
expired, the Company and the Government are continuing to negotiate a possible
resolution of this matter. If the matter can not be resolved in a satisfactory
manner, we have reserved our right to commence formal arbitration proceedings
pursuant to our contractual arrangements with the Government.
The Company has been successful in 2003 in increasing its export sales and
reducing its local market deliveries. As of September 30, 2003, the Company has
sold approximately 1,917,000 barrels of its current year production, of which
approximately 1,814,000 barrels, or 95%, have been sold at world market prices
and 103,000 barrels, or 5%, have been sold at domestic market prices. This
represents a significant increase in sales at world market prices and
corresponding decrease in local market sales from the year 2002.
In addition, we are continuing with our efforts to obtain additional debt
financing to cover any short-term working capital deficiencies and to refinance
the KKM Credit Facility with terms and structure that are satisfactory to all
parties. If we are successful in these efforts, we plan to use the resulting
capital infusion to restructure the KKM Credit Facility with Kazkommertsbank and
eliminate or significantly reduce our current working capital deficiencies.
15
No assurances can be provided, however, that the Company will be able to obtain
additional financing and/or sufficient cash flow from operations to meet working
capital requirements in the future. Nor can any assurance be provided that if
arbitration is instituted, it will be successful or that if successful, the
Company will be able to enforce the award in Kazakhstan, or that the Company
will be able to sell a significant portion of its production at world market
prices.
Karakuduk Field Operations
- --------------------------
We are presently engaged in the development of the Karakuduk Field, which
requires substantial cash expenditures for drilling, well completions,
workovers, oil storage and processing facilities, pipelines, gathering systems,
plant and equipment (generators, pumps, communications, etc.) and other field
facilities. We expect to finance the continued development of the Karakuduk
Field primarily through cash flows from the sale of crude oil. Our short-term
operational priorities will have a high probability of increasing our daily
production levels through the use of the following proven methods: (i) water
injection, (ii) down-hole pumps, (iii) hydraulic fracturing, and (iv) further
drilling. Accordingly, management expects the Karakuduk Field production to
increase approximately 25% from its current production capacity of approximately
10,000 barrels of oil per day to in excess of 12,000 barrels of oil per day by
year-end. Our current daily production has been below our existing production
capacity due to input restrictions on the main KTO export pipeline imposed by
KazTransOil. While management is currently working to remove the input
restrictions, no assurances can be provided that these restrictions will be
removed in the near term or that the Company will be able to sell a significant
portion of its production at world market prices.
In 2003, KKM has made considerable improvements with respect to reservoir
management by maintaining an active drilling program, installing artificial lift
support, and establishing a good fracture stimulation record. The activities in
these areas to date are in line with expectations and will continue. Production
from the Karakuduk Field is expected to increase further due to: (i) the
introduction of additional new wells, (ii) the ongoing hydraulic fracturing
program, (iii) the ongoing installation of down hole pumps, and (iv) the
implementation of a water injection program.
KKM has successfully completed every well drilled to date. In February 2003, we
started an aggressive drilling program. As of November 10, 2003, we have drilled
11 new wells, 8 of which have been completed, with 5 more expected to be
completed by year-end. This will increase our total well stock to 49 wells by
year-end. The 11 wells drilled during 2003 have been drilled to depths between
10,170 feet (3,100 meters) and 11,300 feet (3,450 meters) accessing zones J1,
J2, J3, and J7. Karakuduk Wells No. 159 and 177 were drilled to depths of 10,512
feet and 10,170 feet, respectively, in less than 9 days.
The positive oil rate response following hydraulic fractures in three wells
(Nos. 101, 158, and 186) during April 2003, is an indication that other wells
will benefit in a similar fashion. We are expanding the hydraulic fracturing
program by performing up to 8 additional fractures during the 4th quarter 2003.
The water injection plan for 2003 includes injection into a total of 5 wells.
The water injection plan is already underway and management is optimistic that
the plan will maintain current production levels and increase proven reserves.
Actual changes in reserve estimates, if any, will be realized during the
year-end reserves determination process.
Capital Commitments and Other Contingencies
- -------------------------------------------
Our operations may be subject to regulations or other restrictions instituted 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 export quotas, local oil sales requirements, and
commissioning and approval of surface production facilities. It is possible
these regulations may limit the amount of revenue and cash flow obtainable from
crude oil production and sales, increase the costs of doing business, and/or
prevent or delay the starting or continuation of any given exploration or
development project.
16
All regulations are subject to future changes by legislative and administrative
action and by judicial decisions. Such changes could adversely affect the entire
petroleum industry. It is virtually impossible to predict the effect that any
current or future proposals or changes in existing laws or regulations will have
on our operations.
2. Results from Operations
Results of Operations for the Three Months Ended September 30, 2003 Compared to
the Three Months Ended September 30, 2002
- --------------------------------------------------------------------------------
Our operations for the three months ended September 30, 2003 resulted in a net
income of $2.07 million compared to a net income of $2.11 million for the three
months ended September 30, 2002. The $42,000 decrease in our net income is the
result of (i) higher revenues recognized during the three months ended September
30, 2003, offset by (ii) higher transportation, depletion, income tax, and
minority interest costs for the same period.
Revenue. Revenues were $23.31 million for the three months ended September 30,
2003 compared with $13.45 million for the three months ended September 30, 2002.
The $9.86 million increase is the result of higher volumes sold and higher oil
prices received during the three months ended September 30, 2003. The increase
in volumes sold during the three months ended September 30, 2003, was the result
of increased sales quotas obtained for the period and the delay of delivery of
approximately 200,000 barrels of oil, contracted during June 2003, until July
2003. The net value of this sale amounted to approximately $4.3 million and was
recognized as revenue in the month of July 2003. During the three months ended
September 30, 2003, we sold approximately 1,098,000 barrels of crude oil,
recognizing $23.31 million, or $21.23 per barrel, in revenue. Comparably, we
sold approximately 731,000 barrels of crude oil, recognizing $13.45 million in
revenue, or $18.40 per barrel, for the three months ended September 30, 2002.
Transportation and Operating expenses. Transportation costs for the three months
ended September 30, 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.
Comparatively, transportation costs for the three months ended September 30,
2002 were $2.39 million, or $3.27 per barrel, and operating costs associated
with sales were $2.21 million, or $3.03 per barrel. The increase in
transportation costs per barrel is mainly due to higher tariffs imposed on the
Company during 2003. The decrease in operating cost per barrel is mainly due to
(i) higher volumes of oil sold during the period, (ii) significantly lower
transportation costs from the wellhead to entry point of the KTO export
pipeline, following the commission of the KKM pipeline, and (iii) lower
work-over cost for the current year due to the increase in capital activities
during the year 2003.
Depreciation and Depletion. Depreciation and depletion expense was $7.14 million
for the three months ended September 30, 2003 compared to $3.71 million for the
three months ended September 30, 2002. The $3.43 million increase is the result
of higher effective depletion rates and higher volumes of oil sold during the
three months ended September 30, 2003. During the three months ended September
30, 2003, the Company recognized a total depletion expense of $6.95 million or
$6.33 per barrel, compared to $3.54 million or $4.84 per barrel in depletion
expense for the three months ended September 30, 2002. The increase in the
effective depletion rate of $1.49 per barrel is due to increased estimated
capital expenditures for the development of the field for future years and
reductions to the Company's estimated proved reserves.
Interest Expense. Interest expense for the three months ended September 30, 2003
remained the same as interest expense for the three months ended September 30,
2002.
General and Administrative Expense. General and administrative costs increased
from $1.56 million for the three months ended September 30, 2002 to $1.97
million for the three months ended September 30, 2003. The $410,000 change is
the result of higher legal fees in connection with the arbitration proceedings
and tax claim of $112,000 and the increase of labor costs due to a $278,000
production bonus given to the employees of the Company for achieving 10,000
barrels per day in production and 1 million tons (approximately 8 million
barrels) cumulative production.
17
Results of Operations for the Nine Months Ended September 30, 2003 Compared to
the Nine Months Ended September 30, 2002
- --------------------------------------------------------------------------------
Our operations for the nine months ended September 30, 2003 resulted in a net
income of $1.01 million compared to a net income of $4.04 million for the nine
months ended September 30, 2002. The $3.03 million decrease in our net income is
the result of several factors: (i) higher sales revenue during 2003, offset by
(ii) higher transportation and depletion costs, (iii) a $5.34 million
extraordinary gain recognized as a result of the restructuring of our
indebtedness during 2002, (iv) recognition of a $1.02 million gain as a result
of the adoption of SFAS 143 on January 1, 2003, and (v) lower interest costs.
Revenue. Revenues were $39.59 million for the nine months ended September 30,
2003 compared with $32.47 million for the nine months ended September 30, 2002.
The $7.12 million increase is the result of higher oil volumes sold and higher
prices received for our oil during the nine months ended September 30, 2003.
During the nine months ended September 30, 2003, we sold approximately 1,917,000
barrels of crude oil, recognizing $39.59 million, or $20.65 per barrel, in
revenue. Comparably, we sold approximately 1,881,000 barrels of crude oil,
recognizing $32.47 million in revenue, or $17.26 per barrel, for the nine months
ended September 30, 2002. The result is a favorable price variance of $6.51
million and a favorable volume variance of $0.61 million.
Transportation and Operating expenses. 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.
Comparatively, transportation costs for the nine months ended September 30, 2002
were $7.03 million or $3.74 per barrel, and operating costs associated with
sales were $5.95 million, or $3.16 per barrel. The increase in transportation
costs per barrel is mainly due to higher tariffs imposed on the Company during
2003. The decrease in operating cost per barrel is mainly due to (i) higher
volumes of oil sold during the period, (ii) significantly lower transportation
costs from the wellhead to entry point of the KTO export pipeline, following the
commission of the KKM pipeline, and (iii) lower work-over cost for the current
year due to the increase in capital activities during 2003.
Depreciation and Depletion. Depreciation and depletion expense was $12.90
million for the nine months ended September 30, 2003 compared to $9.71 million
for the nine months ended September 30, 2002. The $3.19 million increase is the
result of higher oil volumes sold and higher effective depletion rates during
2003. During the nine months ended September 30, 2003, the Company recognized a
total depletion expense of $12.33 million or $6.43 per barrel, compared to $9.16
million or $4.87 per barrel in depletion expense for the nine months ended
September 30, 2002. The increase in the effective depletion rate of $1.56 per
barrel is due to increased estimated capital expenditures for the development of
the field for future years and reductions to the Company's estimated proved
reserves.
Interest Expense. Interest expense decreased from $4.45 million for the nine
months ended September 30, 2002 to $3.36 million for the nine months ended
September 30, 2003. The $1.09 million decrease is due to the lower financing
costs of our restructured indebtedness. Our cost of financing the development of
the Karakuduk Field has improved from a pre-restructuring annual interest rate
of LIBOR plus 19.75% compounded daily during the first five months in 2002, to a
simple fixed annual interest rate of 14%, generating savings of approximately
$600,000 per quarter. In addition, interest expense for the period ended
September 30, 2003 reflects a loan discount of $178,000 and is net of
capitalized interest of $371,000.
General and Administrative Expense. General and administrative costs increased
from $4.84 million for the nine months ended September 30, 2002 to $5.13 million
for the nine months ended September 30, 2003. The $290,000 increase was due to
higher legal fees as a result of our arbitration proceedings of $118,000 and
higher labor costs of $352,000 due to a production bonus given to the employees
of the Company for achieving 10,000 barrels per day in production and 1 million
tons (approximately 8 million barrels) cumulative production, net of $180,000 in
cost savings in other general and administrative areas.
Cumulative effect of change in accounting principal. As a result of the adoption
of SFAS 143, the Company recognized a gain of $1.02 million as a cumulative
effect of change in accounting principal for the nine months ended September 30,
2003. In addition, the Company recognized $46,000 in accretion expense to
account for changes in the ARO liability. See Note 5 of our consolidated
financial statements.
18
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
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 and other assets that we hold
in Kazakhstan 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 carryforwards, 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 and 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, 2003, the exchange rate was
148.93 Tenge per U.S. Dollar.
5. Critical Accounting Policies
Application of GAAP 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. In
addition, alternatives can exist among various accounting methods. In such
cases, the choice of accounting method can also have a significant impact on
reported amounts.
Our determination of proved oil and gas reserve quantities, the application of
the full cost method of accounting for exploration and production activities,
and the application of standards of accounting for derivative instruments and
hedging activities require management to make numerous estimates and judgments.
Oil and Gas properties (Full Cost Method). The Company follows the full cost
method of accounting for oil and gas properties. Accordingly, all costs
associated with the acquisition, exploration, and development of oil and gas
reserves, including directly related overhead costs, are capitalized.
All capitalized costs of proved oil and gas properties, including the estimated
future costs to develop proved reserves, are amortized on the unit-of-production
method using estimated proved reserves. Investments in unproved properties and
major development projects are not amortized until proved reserves associated
with the projects can be determined or until impairment occurs. If the results
of an assessment indicate that the properties are impaired, the amount of the
impairment is added to the capitalized cost to be amortized.
Sales of proved and unproved properties are accounted for as adjustments of
capitalized costs with no gain or loss recognized, unless such adjustments would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in income.
Abandonments of properties are accounted for as adjustments of capitalized costs
with no loss recognized.
Cost Excluded. Oil and gas properties include costs that are excluded from
capitalized costs being amortized. These amounts represent costs of investments
in unproved properties and major development projects. The Company excludes
these costs until proved reserves are found or until it is determined that the
costs are impaired. All costs excluded are reviewed quarterly to determine if
impairment has occurred. Any impairment is transferred to the costs to be
amortized. For 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 or relinquishing drilling rights.
19
Capitalized Interest. SFAS 34, Capitalization of Interest Costs, provides
standards for the capitalization of interest costs as part of the historical
cost of acquiring assets. FIN 33 provides guidance for the application of SFAS
34 to the full cost method of accounting for oil and gas properties. Under FIN
33, costs of investments in unproved properties and major development projects,
on which DD&A expense is not currently taken and on which exploration or
development activities are in progress, qualify for capitalization of interest.
Capitalized interest is calculated by multiplying the weighted-average interest
rate on debt by the amount of costs excluded. Capitalized interest cannot exceed
gross interest expense.
Ceiling Test. Companies that use the full cost method of accounting for oil and
gas exploration and development activities are required to perform a ceiling
test each quarter. The full cost ceiling test is an impairment test prescribed
by SEC Regulation S-X Rule 4-10. The ceiling test is performed on a
country-by-country basis. The test determines a limit, or ceiling, on the book
value of oil and gas properties. That limit is basically the after tax present
value of the future net cash flows from proved crude oil and natural gas
reserves. This ceiling is compared to the net book value of the oil and gas
properties reduced by any related deferred income tax liability. If the net book
value reduced by the related deferred income taxes exceeds the ceiling, an
impairment or non-cash write down is required. A ceiling test impairment can
give the Company a significant loss for a particular period, however, future
DD&A expense would be reduced.
Reserves. Estimates of our proved oil and gas reserves are prepared by Ryder
Scott Company in accordance with guidelines established by the 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. 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.
Derivative Financial Instruments and Hedging Activities. We account for our
investment in derivative financial instruments in accordance with SFAS 133,
Accounting for Derivative Financial Instruments and Hedging Activities, as
amended. As a result, we recognize all derivative financial instruments in our
financial statements at fair value, regardless of the purpose or intent for
holding the instrument. Changes in the fair value of derivative financial
instruments are recognized periodically in income or in shareholders' equity as
a component of comprehensive income depending on whether the derivative
financial instrument qualifies for hedge accounting, and if so, whether it
qualifies as a fair value hedge or cash flow hedge. Generally, changes in fair
values of derivatives accounted for as fair value hedges are recorded in income
along with the portions of the changes in the fair values of the hedged items
that relate to the hedged risks. Changes in fair values of derivatives accounted
for as cash flow hedges, to the extent they are effective as hedges, are
recorded in other comprehensive income net of deferred taxes. Changes in fair
values of derivatives not qualifying as hedges are reported in income.
Legal, Environmental and Other Contingencies. A provision for legal,
environmental and other contingencies is charged to expense when the loss is
probable and the cost can be reasonably estimated. Determining when expenses
should be recorded for these contingencies and the appropriate amounts for
accrual is a complex estimation process that includes the subjective judgment of
management. In many cases, management's judgment is based on interpretation of
laws and regulations, which can be interpreted differently by regulators and/or
courts of law. Chaparral's management closely monitors known and potential
legal, environmental and other contingencies and periodically determines when
Chaparral should record losses for these items based on information available to
us.
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,"
or "continue," or by the negative of such terms or comparable terminology.
20
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 into 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 (148.93 and 155.60 Kazakh Tenge per U.S. Dollar as of
September 30, 2003 and December 31, 2002, 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.
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 cash and cash equivalents in U.S. dollars in bank
accounts within Kazakhstan, but KKM's statutory tax basis in its assets, tax
loss carryforwards, 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 and/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.
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 requirements to supply a portion of our
crude oil production to the Kazakhstan local market to meet domestic energy
needs, 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.
21
Item 4 - Controls and Procedures
An evaluation of the effectiveness of the design and operation of the Company's
disclosure controls and procedures conducted within 90 days of the date of
filing this Form 10-Q, was carried out by the Chief Executive Officer ("CEO")
and Chief Financial Officer ("CFO"). Based on that evaluation, the CEO and CFO
concluded that the Company's disclosure controls and procedures have been
designed and are being operated in a manner that provides reasonable assurance
that the information required to be disclosed by the Company in reports filed
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms. A
controls system, no matter how well designed and operated, cannot provide
absolute assurance that the objectives of the controls system are met, and no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within an entity have been detected. Subsequent
to the date of the most recent evaluation of the Company's internal controls,
there were no significant changes in Chaparral's internal controls or in other
factors that could significantly affect the internal controls, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Part II- Other Information
Item 1 - Legal Proceedings
In December 2002, KKM received a claim from the Ministry of State Revenues of
the Republic of Kazakhstan for $9.6 million (the "Tax Claim") relating to
additional unpaid taxes and penalties covering the three years from 1999 to
2001. The original Tax Claim has been successfully reduced to approximately
$2.31 million. KKM has appealed the remaining claim and has contracted legal
firms in Kazakhstan to assist with the appeal process. Based on the assessments
of KKM's management and legal counsel, it is the Company's opinion that the
ultimate resolution of the Tax Claim, after taking into account reserves
previously made, will not have a material adverse effect on the financial
position or operating results of the Company.
22
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None.
23
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 14, 2003
Chaparral Resources, Inc.
By: /s/ Nikolai D. Klinchev
--------------------------------------------
Nikolai D. Klinchev
Chief Executive Officer
By: /s/ Richard J. Moore
--------------------------------------------
Richard J. Moore,
VP Finance and Chief Financial Officer
(Principal Financial and Accounting Officer)
24
Certifications
I, Nikolai D. Klinchev, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Chaparral Resources,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2003 /s/ Nikolai D. Klinchev
---------------------------
Nikolai D. Klinchev
Chief Executive Officer
I, Richard J. Moore, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Chaparral Resources,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2003 /s/ Richard J. Moore
---------------------------------
Richard J. Moore
Chief Financial Officer