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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ 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
[ ] 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 0-9147
CANARGO ENERGY CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 91-0881481
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
CanArgo Energy Corporation
P.O. Box 291, St. Peter Port, Guernsey, British Isles GY1 3RR
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(44) 1481 729 980
(REGISTRANT'S TELEPHONE NUMBER)
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
__________ __________
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act). [ ]
The number of shares of registrant's common stock outstanding on September 30,
2003 was 103,356,206.
CANARGO ENERGY CORPORATION
FORM 10-Q
TABLE OF CONTENTS
PAGE
----
PART 1. FINANCIAL INFORMATION:
Item 1. Financial Statements
Consolidated Condensed Balance Sheets 3
Consolidated Condensed Statements of Operations 4
Consolidated Condensed Statements of Cash Flows 5
Notes to Unaudited Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition,
Results of Operations and Cash flows 22
Item 3. Quantitative and Qualitative Disclosures about Market Risk 34
Item 4. Controls and Procedures 34
PART 2. OTHER INFORMATION:
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit Index 35
(b) Reports on Form 8-K 38
Signatures 39
FORWARD-LOOKING STATEMENTS
The United States Private Securities Litigation Reform Act of 1995 provides a
"safe harbor" for certain forward-looking statements. Such forward-looking
statements are based upon the current expectations of CanArgo and speak only as
of the date made. These forward-looking statements involve risks, uncertainties
and other factors. The factors discussed elsewhere in this Quarterly Report on
Form 10-Q are among those factors that in some cases have affected CanArgo's
historic results and could cause actual results in the future to differ
significantly from the results anticipated in forward looking statements made in
this Quarterly Report on Form 10-Q, future filings by CanArgo with the
Securities and Exchange Commission, in CanArgo's press releases and in oral
statements made by authorized officers of CanArgo. When used in this Quarterly
Report on Form 10-Q, the words "estimate," "project," "anticipate," "expect,"
"intend," "believe," "hope," "may" and similar expressions, as well as "will,"
"shall" and other indications of future tense, are intended to identify
forward-looking statements. Few of the forward-looking statements in this Report
deal with matters that are within our unilateral control. Acquisition, financing
and other agreements and arrangements must be negotiated with independent third
parties and, in some cases, must be approved by governmental agencies. These
third parties generally have interests that do not coincide with ours and may
conflict with our interests. Unless the third parties and we are able to
compromise their various objectives in a mutually acceptable manner, agreements
and arrangements will not be consummated.
2
PART I - FINANCIAL INFORMATION
CANARGO ENERGY CORPORATION AND SUBSIDIARIES
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED CONDENSED BALANCE SHEETS
Unaudited
----------------------------
SEPTEMBER 30, December 31,
2003 2002
ASSETS (UNAUDITED) (AUDITED)
- ------ ------------ -----------
Cash and cash equivalents $ 2 ,690,920 $ 1,598,304
Accounts receivable 233,345 306,336
Inventory 289,751 185,924
Prepayments 411,367 211,623
Assets held for sale 8,982,564 8,095,947
Other current assets 186,475 175,951
------------ ------------
Total current assets $ 12,794,422 $ 10,574,085
Capital assets, net (including unevaluated amounts of $37,011,743 and
$36,843,425, respectively) 60,595,949 59,702,525
Investments in and advances to oil and gas and other
ventures -- net 463,469 459,308
------------ ------------
TOTAL ASSETS $ 73,853,840 $ 70,735,918
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable - trade $ 612,141 $ 871,996
Advance from joint venture partner 533,750 --
Loans payable 167,536 --
Other liabilities 3,850,000 1,500,000
Income taxes payable 61,000 61,000
Accrued liabilities 187,769 204,045
Liabilities held for sale 3,049,269 2,351,965
------------ ------------
Total current liabilities $ 8,461,465 $ 4,989,006
Provision for future site restoration 147,000 122,290
Minority interest in subsidiaries 2,880,860 3,519,342
Commitments and contingencies
Stockholders' equity:
Common stock, par value $0.10 per share 10,335,620 9,735,620
Capital in excess of par value 145,520,060 145,151,475
Foreign currency translation adjustment (7,602) 4,668
Accumulated deficit (93,483,563) (92,786,483)
------------ ------------
Total stockholders' equity $ 62,364,515 $ 62,105,280
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 73,853,840 $ 70,735,918
============ ============
See accompanying notes to unaudited consolidated condensed financial statements.
3
PART I - FINANCIAL INFORMATION
CANARGO ENERGY CORPORATION AND SUBSIDIARIES
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS -- UNAUDITED
Unaudited Three Months Ended Unaudited Nine Months Ended
---------------------------- ----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Operating Revenues from Continuing Operations:
Oil and gas sales $ 2,468,029 $ 696,406 $ 5,271,874 $ 3,159,850
Other 26,000 -- 223,608 1,398,153
----------- ----------- ----------- -----------
2,494,029 696,406 5,495,482 4,558,003
----------- ----------- ----------- -----------
Operating Expenses:
Field operating expenses 359,530 261,943 1,004,804 1,141,304
Direct project costs 266,378 176,556 690,508 1,158,258
Selling, general and administrative 530,588 403,313 2,021,995 2,703,952
Non cash stock compensation expense -- -- 276,507 --
Depreciation, depletion and amortization 1,064,489 316,830 2,360,280 1,601,327
----------- ----------- ----------- -----------
2,220,985 1,158,642 6,354,094 6,604,841
----------- ----------- ----------- -----------
OPERATING INCOME (LOSS) FROM CONTINUING OPERATIONS 273,044 (462,236) (858,612) (2,046,838)
----------- ----------- ----------- -----------
Other Income (Expense):
Interest, net (15,168) 34,507 (21,047) 31,710
Other (69,668) (829,444) (86,198) (724,388)
Equity income (loss) from investments 86,059 45,495 129,089 136,485
----------- ----------- ----------- -----------
TOTAL OTHER INCOME (EXPENSE) 1,223 (749,442) 21,844 (556,193)
----------- ----------- ----------- -----------
NET INCOME (LOSS) BEFORE MINORITY INTEREST 274,267 (1,211,678) (836,768) (2,603,031)
=========== =========== =========== ===========
Minority interest in income (loss) of consolidated
subsidiaries 7,284 (52,774) 23,159 (2,300)
----------- ----------- ----------- -----------
NET INCOME (LOSS) FROM CONTINUING OPERATIONS $ 281,551 $(1,264,452) $ (813,609) $(2,605,331)
=========== =========== =========== ===========
NET INCOME FROM DISCONTINUED OPERATIONS, NET OF TAXES AND
MINORITY INTEREST 32,167 36,608 75,239 173,390
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE -- -- 41,290 --
----------- ----------- ----------- -----------
NET INCOME (LOSS) 313,718 (1,227,844) (697,080) (2,431,941)
=========== =========== =========== ===========
OTHER COMPREHENSIVE INCOME:
Foreign currency translation 11,811 149,195 (12,270) 97,938
----------- ----------- ----------- -----------
COMPREHENSIVE INCOME (LOSS) $ 325,529 $(1,078,649) $ (709,350) $(2,334,003)
=========== =========== =========== ===========
Weighted average number of
common shares outstanding 99,117,076 97,356,206 97,949,613 96,479,984
----------- ----------- ----------- -----------
NET LOSS PER COMMON SHARE -- BASIC AND DILUTED BEFORE
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
- from continuing operations $ 0.00 $ (0.01) $ (0.01) $ (0.03)
- from discontinued operations $ 0.00 0.00 $ 0.00 0.00
----------- ----------- ----------- -----------
NET LOSS PER COMMON SHARE -- BASIC AND DILUTED $ 0.00 $ (0.01) $ (0.01) $ (0.03)
----------- ----------- ----------- -----------
See accompanying notes to unaudited consolidated condensed financial statements.
4
PART I - FINANCIAL INFORMATION
CANARGO ENERGY CORPORATION AND SUBSIDIARIES
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS - UNAUDITED
Nine Months Ended
---------------------------
SEPTEMBER 30, September 30,
2003 2002
------------ ------------
Operating activities:
Net (loss) from continued operations $ (813,609) $ (2,605,331)
Non cash stock compensation expense 276,507 --
Depreciation, depletion and amortization 2,360,280 1,601,327
Equity income from investments (129,089) (136,484)
Allowance for doubtful accounts -- 275,000
Minority interest in (loss) income of consolidated subsidiaries (23,159) 2,300
Changes in assets and liabilities:
Accounts receivable 72,991 1,110,730
Inventory (103,827) 208,185
Prepayments 13,516 --
Other current assets (10,524) (47,975)
Accounts payable (259,855) (48,009)
Deferred revenue 750,000 1,000,000
Accrued liabilities (16,276) (177,284)
------------ ------------
NET CASH GENERATED BY OPERATING ACTIVITIES 2,116,955 1,182,459
------------ ------------
Investing activities:
Capital expenditures (3,199,974) (10,055,351)
Acquisitions, net of cash acquired -- (25,000)
Repayments from (Investments in and advances to) oil and gas
and other ventures 124,928 225,058
Advance proceeds from the sale of CanArgo Standard Oil
Products 1,300,000 --
Advance proceeds from the sale of CanArgo Petroleum Products
Limited 300,000 --
Change in non cash working capital items (213,260) 1,789,202
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (1,688,306) (8,066,091)
------------ ------------
Financing activities:
Proceeds from sale of common stock -- 1,790,948
Share issue costs -- (162,215)
Advances from minority shareholder -- 1,373,954
Advances from joint venture partner 533,750 --
(Repayment of) Advances from minority interest 76,755 --
Proceeds from loans 167,536 --
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 778,041 3,002,687
NET CASH FLOWS FROM ASSETS AND LIABILITIES HELD FOR SALE (114,074) (299,802)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,092,616 (4,180,747)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,598,304 5,891,038
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,690,920 $ 1,710,291
============ ============
See accompanying notes to unaudited consolidated condensed financial statements.
5
PART I - FINANCIAL INFORMATION
CANARGO ENERGY CORPORATION AND SUBSIDIARIES
ITEM 1. FINANCIAL STATEMENTS
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(1) Basis of Presentation
The interim consolidated condensed financial statements and notes
thereto of CanArgo Energy Corporation and its subsidiaries
(collectively, CanArgo) have been prepared by management without audit
pursuant to the rules and regulations of the Securities and Exchange
Commission. In the opinion of management, the consolidated condensed
financial statements include all adjustments, consisting of normal
recurring adjustments, in addition to recognising stock compensation
expense, necessary for a fair statement of the results for the interim
period. Although management believes that the disclosures are adequate
to make the information presented not misleading, certain information
and footnote disclosures, including a description of significant
accounting policies normally included in the financial statements
prepared in accordance with accounting principles generally accepted in
the U.S., have been condensed or omitted pursuant to such rules and
regulations. The accompanying consolidated condensed financial
statements should be read in conjunction with the consolidated
financial statements and notes thereto included in CanArgo's Annual
Report on Form 10-K for the year ended December 31, 2002 filed with the
Securities and Exchange Commission. All amounts are in U.S. dollars.
The results of operations for interim periods are not necessarily
indicative of the results for any subsequent quarter or the entire
fiscal year ending December 31, 2003.
Certain items in the consolidated condensed financial statements have
been reclassified to conform to the current year presentation. There
was no effect on net loss as a result of these reclassifications.
During 2002, the Company adopted the self-sustaining method of
accounting for CanArgo Standard Oil Products. The adoption of the
self-sustaining method was necessitated by the fact that CanArgo
Standard Oil Products was no longer financially and operationally
dependant upon its parent company. Under the self-sustaining method of
foreign currency translation, assets and liabilities are translated
into US dollars at period end exchange rates and income and expenses
are translated into US dollars at average rates in effect during the
period. Exchange gains and losses on translation are reflected as a
separate component of shareholders' equity.
The Company is currently evaluating its accounting treatment of
minority interest in prior periods in respect of the refinery (see note
3 for a discussion of the possible restatement of the Company's
financial statements attributable to the Company's interest in the
Georgian American Oil Refinery).
In August 2003, the Company adopted SFAS No. 123 Accounting For
Stock-Based Compensation, as amended by SFAS No. 148 Accounting for
Stock-Based Compensation--Transition and Disclosure--an amendment of
FASB Statement No. 123, effective as of January 1, 2003. The Company
has elected to utilise the "prospective" method of transitioning from
the intrinsic value to the fair value method of accounting for
stock-based compensation as allowed by SFAS No. 148. This Statement
also amended the disclosure requirements of SFAS No. 123 and APB
Opinion No. 28, "Interim Financial Reporting," to require prominent
disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The disclosure
requirements of SFAS No. 148 were adopted in the Company's 2002 Annual
Report on Form 10-K. This change is estimated to decrease 2003 net
income by approximately $276,507. Stock based awards in existence prior
to 2003 will continue to be accounted for under APB Opinion No. 25,
"Accounting for Stock Issued to Employees," unless they are re-priced
or modified.
Prior to 2003, the Company applied APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations in accounting
for stock-based compensation. Under Opinion No. 25, stock-based
employee compensation cost was not recognized in net income when stock
options granted had an exercise price equal, or greater, to the market
value of the underlying common stock on the date of grant. In August
2003, effective January 1, 2003, the Company adopted the fair value
recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation," prospectively to all employee awards granted, modified,
or settled after December 31, 2002. The following table illustrates the
effect on net
6
income and net income per share if the fair value based method had
been applied to all outstanding and unvested awards for the nine month
period ended September 30, 2003, and the nine month period ended
September 30, 2002:
Income statement had compensation cost
for stock options been determined
consistent with SFAS No. 123
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
(UNAUDITED) (UNAUDITED)
-------------- --------------
Net Loss as reported $(697,080) $(2,431,941)
Net Loss per common share -- Basic and
Diluted as reported (0.01) (0.03)
Add: Stock-based compensation cost, net
of related tax effects, included in the
determination of net income reported
276,507 --
Less: Stock-based compensation cost,
net of related tax effects, that would
have been included in the determination
of net income reported if the fair
value based method had been applied to
all awards 659,214 694,005
-------------- --------------
Pro forma Net Loss as if the fair value
based method had been applied to all
awards (1,079,787) (3,125,946)
Pro forma Net Loss per common share --
Basic and Diluted as if the fair value
based method had been applied to all
awards (0.01) (0.03)
7
The following table illustrates the effect on net income and net income
per share if the fair value based method had been applied to all
outstanding and unvested awards for the three month period ended
September 30, 2003, and the three month period ended September 30,
2002:
Income statement had compensation cost
for stock options been determined
consistent with SFAS No. 123
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
(UNAUDITED) (UNAUDITED)
-------------- --------------
Net Income (Loss) as reported $313,718 $(1,227,844)
Net Loss per common share -- Basic and
Diluted as reported 0.00 (0.01)
Add: Stock-based compensation cost, net
of related tax effects, included in the
determination of net income reported
under the intrinsic method -- --
Less: Stock-based compensation cost,
net of related tax effects, that would
have been included in the determination
of net income reported if the fair
value based method had been applied to
all awards 127,569 231,335
-------------- --------------
Pro forma Net Loss as if the fair value
based method had been applied to all
awards 186,149 (1,459,179)
Pro forma Net Loss per common share --
Basic and Diluted as if the fair value
based method had been applied to all
awards 0.00 (0.01)
(2) Need for Significant Additional Capital, Possible Impairment of Assets
Development of the oil and gas properties and ventures in which CanArgo
has interests involves multi-year efforts and substantial cash
expenditures. Full development of these properties will require the
availability of substantial funds from external sources. CanArgo
believes that it will be able to generate funds from external sources
including quasi-governmental financing agencies, conventional lenders,
equity investors and other oil and gas companies that may desire to
participate in CanArgo's oil and gas projects, although no firm funding
commitments have been received and there can be no assurance that any
such commitments will be obtained, or, if obtained, will be on
commercially acceptable terms.
Ultimate realization of the carrying value of CanArgo's oil and gas
properties will require production of oil and gas in sufficient
quantities and marketing such oil and gas at sufficient prices to
provide positive cash flow to CanArgo. This is dependent upon, among
other factors, achieving significant production at costs that provide
acceptable margins, reasonable levels of taxation from local
authorities, the ability to transport production at acceptable costs
and the ability to market the oil and gas produced at or near world
prices. In addition, CanArgo must mobilize drilling equipment and
personnel to initiate drilling, completion and production activities.
If one or more of the above factors, or other factors, are different
than anticipated, CanArgo may not recover the carrying value of its oil
and gas properties.
8
CanArgo generally has the principal responsibility for arranging
financing for the oil and gas properties and ventures in which it has
an interest. There can be no assurance, however, that CanArgo or the
entities that are developing the oil and gas properties and ventures
will be able to arrange the financing necessary to develop the projects
being undertaken or to support the corporate and other activities of
CanArgo or that such financing if available will be on terms that are
acceptable to or are deemed to be in the best interests of CanArgo,
such entities or their respective stockholders or participants.
The consolidated financial statements of CanArgo do not give effect to
any additional impairment in the value of CanArgo's oil and gas
properties and ventures or other adjustments that would be necessary if
financing cannot be arranged for the development of such properties and
ventures or if they are unable to achieve profitable operations.
Failure to arrange such financing on reasonable terms or failure of
such properties and ventures to achieve profitability would have a
material adverse effect on the financial position, including
realization of assets, results of operations, cash flows and prospects
of CanArgo.
There is no assurance that external funds or financing will be
available, and if available, will be offered on attractive or
acceptable terms. Should such financing not be forthcoming and CanArgo
should be unable to maintain its current positive cash flow or unable
to sell some or all of its non-core assets, further cost reductions and
additional funding will be required in order to remain a going concern.
(3) Possible Restatement of Financial Statements
In September 1998, CanArgo purchased for $1,000,000 a 12.9% equity
interest in Georgian American Oil Refinery LLC ("GAOR"), a Georgian
limited liability company which owns a small refinery located at
Sartichala, Georgia. On November 12, 2000, CanArgo acquired a further
38.1% of the common stock of GAOR for Common Stock consideration valued
at $1,666,575. On completion of the acquisition, CanArgo held 51% of
the common stock of GAOR and GAOR became a subsidiary of CanArgo. Under
purchase accounting, GAOR's results have been included in CanArgo's
consolidated financial statements since the date of acquisition.
The Company is currently evaluating its accounting treatment of
minority interest in prior periods in respect of the refinery.
The refinery began operations in July 1998 and has a potential design
capacity of approximately 4,000 barrels per day. Operating as a
straight-run distillation unit it can potentially produce naphtha,
diesel, fuel oil and kerosene. Further product expansion is possible
with the addition of additives and or a catalytic reformer.
Since 2001, the refinery has not been operating. Since its acquisition,
sales from the refinery have been negatively impacted by the imposition
of restrictions and subsequent excise tax on feedstock and refined
products. Although in April 2001, new legislation addressing indigenous
refining activities was passed by the Republic of Georgia that removed
or reduced excise taxes on feedstock and refined product, the refinery
has since experienced unexpected product quality concerns which has
effectively curtailed the enhancement of the basic product stream into
gasoline. As a result, the refinery can only produce straight
distillation products such as naphtha, diesel and mazut and not high
octane gasoline as required by petrol stations. Due to the presence of
excise tax on naphtha, there is limited economic demand for the product
in Georgia, either as a feedstock for a separate refining company or
for the blending with higher octane gasoline to produce "normal" grade
gasoline for the local market.
Currently only naphtha, diesel and mazut can be produced and of these
products, an excise tax on naphtha and diesel sales remain in place. As
a result of these taxes and the local market for naphtha in the
Republic of Georgia, GAOR deemed production of naphtha as commercially
uneconomic and suspended refining activity in the fourth quarter of
2001. In January 2002, GAOR entered into a short-term lease of the
refinery to a third party for nominal revenue. During the lease period,
all operating costs of the refinery were borne by the lessee. This
lease expired in May 2002 and has not been renewed. GAOR continues to
monitor demand for products allowed to be produced by the refinery and
is seeking changes to the legislation in support of indigenous refining
activities, although no assurance can be given that such changes can be
made. As a result of the uncertainty as to the ultimate recoverability
of the carrying value of
9
the refinery, CanArgo recorded in 2001 a write-down of the refinery's
property, plant and equipment of approximately $3.5 million.
Minority interest share of losses recorded as of December 31, 2001 and
September 30, 2003 exceed the overall minority share of shareholders
equity by $1,250,063. U.S. generally accepted accounting principles
specifically provide the following guidance in Accounting Research
Bulletin No 51 Consolidated Financial Statements ("ARB51") paragraph
15: In the unusual case in which losses applicable to the minority
interest in a subsidiary exceed the minority interest in the equity
capital of the subsidiary, such excess and any further losses
applicable to the minority interest should be charged against the
majority interest, as there is no obligation of the minority interest
to make good such losses. However, if future earnings do materialize,
the majority interest should be credited to the extent of such losses
previously absorbed.
CanArgo is currently evaluating a number of options in respect of its
future interest in the refinery and its previous accounting treatment
of its minority interests. Should the Company not reach a satisfactory
conclusion, and given the continuing uncertainty as to the ultimate
recoverability of the carrying value of the refinery during 2003, the
minority share of losses would have to be written down by $1.3 million
in the appropriate period, which may result in restating prior period
financial statements.
(4) Asset Retirement Obligations
On January 1, 2003 CanArgo adopted FASB Statement No. 143 "Accounting
for Asset Retirement Obligations" ("SFAS 143"). SFAS 143 requires
companies to record the discounted fair value of a liability for an
asset retirement obligation in the period in which the liability is
incurred concurrent with an increase in the long-lived assets carrying
value. The increase and subsequent adjustments in the related
long-lived assets carrying value is amortised over its useful life.
Upon settlement of the liability a gain or loss is recorded for the
difference between the settled liability and the recorded amount. The
discount associated with the liability is accreted into income over the
related asset's useful life. Upon adoption of this standard an entity
is required to record the fair value of its existing asset retirement
obligations as if the liabilities had been initially accounted for in
accordance with SFAS 143 using assumptions present at the date of
adoption. The income statement effect of the treatment is recorded as a
cumulative effect in accounting principle in the period of adoption, no
retroactive restatement is permitted. During 2003, CanArgo recorded a
credit to income for the cumulative effect of change in accounting
principle of $41,290, increased long-term liabilities to recognise its
total obligation and increased net capital assets in accordance with
the provisions of SFAS No. 143 to the amount of $82,000. No deferred
tax expense has been recognised on the SFAS 143 credit as the group is
in a net deferred tax asset position against which full allowance has
been made as it is considered more likely than not that the deferred
tax asset will not be realised. There was no impact on the Company's
cash flows as a result of adopting SFAS No. 143. The pro forma asset
retirement obligation would have been $138,000 at December 31, 2002 had
the Company adopted SFAS No. 143 on January 1, 2002. The asset
retirement obligation, which is included on the Consolidated Balance
Sheet in Provision for Future site restoration, was $147,000 at
September 30, 2003. The pro-forma amounts assuming the new method of
determination under SFAS 143 were not materially different to the
amounts shown in the income statement and the balance sheet for the
prior year.
(5) Foreign Operations
CanArgo's current and future operations and earnings depend upon the
results of CanArgo's operations in the Republic of Georgia, Ukraine and
Russia. There can be no assurance that CanArgo will be able to
successfully conduct such operations, and a failure to do so would have
a material adverse effect on CanArgo's financial position, results of
operations and cash flows. The business environment in Ukraine,
particularly as a result of less effective oil and gas legislation than
there is in Georgia, makes investment somewhat more difficult. Also,
the success of CanArgo's operations generally will be subject to
numerous contingencies, some of which are beyond management control.
These contingencies include general and regional economic conditions,
prices for crude oil and natural gas, competition and changes in
regulation. Since CanArgo is dependent on international operations,
CanArgo will be subject to various additional political, economic and
other uncertainties. Among other risks, CanArgo's operations may be
subject to the risks and restrictions on transfer of funds, import and
export duties, quotas and embargoes, domestic and international customs
and tariffs, and changing taxation policies, foreign exchange
restrictions, terrorism, political conditions and restrictive
regulations. See footnote 8 below for a discussion of CanArgo's sale of
its interest in BOC.
10
(6) Accounts Receivable
Accounts receivable at September 30, 2003 and December 31, 2002
consisted of the following:
SEPTEMBER 30, December 31,
2003 2002
(UNAUDITED) (Audited)
------------ -----------
Accounts Receivable before allowance for doubtful debts $ 885,266 $ 958,257
Allowance for doubtful debts (651,921) (651,921)
--------- ---------
$ 233,345 $ 306,336
========= =========
(7) Inventory
Inventory at September 30, 2003 and December 31, 2002 consisted of the
following:
SEPTEMBER 30, December 31,
2003 2002
(UNAUDITED) (Audited)
------------ -----------
Crude oil $262,832 $158,896
Refined products 26,919 27,028
-------- --------
$289,751 $185,924
======== ========
(8) Capital Assets, Net
Capital assets, net of accumulated depreciation and impairment, at
September 30, 2003 and December 31, 2002 include the following:
SEPTEMBER 30,
2003 December 31, 2002
(UNAUDITED) (Audited)
------------------------------------------------------- -----------------
ACCUMULATED
DEPRECIATION NET NET
COST AND IMPAIRMENT CAPITAL ASSETS CAPITAL ASSETS
----------- -------------- -------------- --------------
OIL AND GAS PROPERTIES
Proved properties $35,822,319 $20,308,772 $15,513,547 $14,020,971
Unproved properties 37,011,743 37,011,743 36,843,425
----------- ----------- ----------- -----------
72,834,062 20,308,772 52,525,290 50,864,396
PROPERTY AND EQUIPMENT
Oil and gas related 11,685,361 4,148,028
equipment 7,537,333 8,203,963
Office furniture,
fixtures and
equipment and other 1,224,917 791,591 433,326 534,166
----------- ----------- ----------- -----------
12,910,278 4,939,619 7,970,659 8,738,129
REFINING 4,154,216 4,054,216 100,000 100,000
----------- ----------- ----------- -----------
TOTAL $89,898,556 $29,302,607 $60,595,949 $59,702,525
=========== =========== =========== ===========
Unproved property additions relate to CanArgo's exploration activity in
the period. Oil and gas related equipment includes new or refurbished
drilling rigs and related equipment, all of which are located in the
Republic of Georgia.
11
(9) Investments in and Advances to Oil and Gas and Other Ventures
CanArgo has acquired interests in oil and gas and other ventures
through less than majority interests in corporate and corporate-like
entities. A summary of CanArgo's net investment in and advances to oil
and gas and other ventures at September 30, 2003 and December 31, 2002
is set out below:
SEPTEMBER 30, December 31,
INVESTMENTS IN AND ADVANCES TO OIL AND GAS AND OTHER VENTURES 2003 2002
(UNAUDITED) (Audited)
------------ -----------
Ukraine -- Stynawske Field, Boryslaw
Through 45% ownership of Boryslaw Oil Company $ 6,485,253 $ 6,524,121
Other Investments 75,000 75,000
----------- -----------
TOTAL INVESTMENTS IN AND ADVANCES TO OIL AND GAS
AND OTHER VENTURES 6,560,253 6,599,121
----------- -----------
EQUITY IN PROFIT (LOSS) OF OIL AND GAS AND OTHER VENTURES
Ukraine -- Stynawske Field, Borysl aw (636,991) (680,020)
----------- -----------
CUMULATIVE EQUITY IN PROFIT (LOSS) OF OIL AND GAS
AND OTHER VENTURES (636,991) (680,020)
IMPAIRMENT -- STYNAWSKE FIELD, BORYSLAW (5,459,793) (5,459,793)
----------- -----------
TOTAL INVESTMENTS IN AND ADVANCES TO OIL AND GAS
AND OTHER VENTURES, NET OF EQUITY LOSS AND IMPAIRMENT $ 463,469 $ 459,308
=========== ===========
In September 2003, CanArgo announced it had reached conditional
agreement to sell its interest in Boryslaw Oil Company ("BOC"), the
joint venture in West Ukraine currently operating the Stynawske
oilfield. Fountain Oil Boryslaw ("FOB"), CanArgo's wholly owned
subsidiary which holds its 45% interest in BOC, was sold for $1,000,000
payable in eight equal tranches. The buyer has also acknowledged BOC's
debts to CanArgo for earlier loans in the total amount of $160,000. On
November 10, 2003 CanArgo announced that the full payment had been
received early and that CanArgo's interest in FOB had been transferred
to the buyer.
Other investments represent CanArgo's 10% interest in a Caspian Sea
exploration project.
(10) Loans Payable
Loans payable of $167,536 at September 30, 2003 relates to a short-term
secured loan facility maturing on February 27, 2004, which a subsidiary
of CanArgo entered into, locally in Georgia, at an annual interest rate
of 20% in order to fund the drilling of a new horizontal well, N4H, at
the Ninotsminda Field in Georgia. No parent company guarantees have
been provided by CanArgo with respect to this loan. The loan matures
and is due to be paid off in full by February 2004.
12
(11) Other Liabilities
Other liabilities as at September 30, 2003 and December 31, 2002
consisted of the following:
SEPTEMBER 30, December 31,
2003 2002
(UNAUDITED) (Audited)
------------ -----------
Prepaid sales $1,750,000 $1,000,000
Advanced proceeds from the sale of subsidiaries 2,100,000 500,000
---------- ----------
$3,850,000 $1,500,000
========== ==========
See note 17 for details of the sale of the subsidiary classified as
discontinued operation.
(12) Accrued Liabilities
Accrued liabilities at September 30, 2003 and December 31, 2002 include
the following:
SEPTEMBER 30, December 31,
2003 2002
(UNAUDITED) (Audited)
------------ -----------
Professional fees $ 30,000 $105,000
Other 157,769 99,045
-------- --------
$187,769 $204,045
======== ========
(13) Minority Interest
In November 2002, CanArgo reached agreement with the other shareholder
in CanArgo's subsidiary, CanArgo Norio Limited ("CanArgo Norio"), and
with third party investors on a financing arrangement to enable CanArgo
Norio to commence drilling the MK-72 well on the Norio prospect. This
agreement resulted in CanArgo's interest increasing from 50% to 64.2%
in CanArgo Norio and in its existing Norio (Block XIC) and North Kumisi
Production Sharing Agreement in the Republic of Georgia (the "Norio
PSA"). As a result of the finalisation of respective equity interest,
CanArgo's interest was adjusted to reflect its share of $6,031,070, the
carrying net asset value of CanArgo Norio. The nominal value of the
final shares issued in CanArgo Norio were $1,250 per share which gives
a nominal value for CanArgo Norio of $11,328,928 of which CanArgo's
share is $7,269,023 and the minority shareholders share was $4,059,905.
In September 2003 CanArgo Norio signed a Farm-In agreement (the
"Agreement") relating to the Norio PSA with a wholly owned subsidiary
of Georgian Oil, the Georgian State Oil Company ("Georgian Oil").
CanArgo Norio had previously been in negotiations with a large third
party energy company to farm-in to the Norio PSA, but Georgian Oil
exercised its pre-emption right under the Norio PSA. Georgian Oil is
already a party to the Norio PSA as the commercial representative of
the State.
The Agreement, which is subject to Georgian regulatory approval,
obligates Georgian Oil to pay up to US$2.0 million to complete the
MK-72 well on the Norio prospect in return for a 15% interest in the
contractor share of the Norio PSA. Georgian Oil will also have an
option (the "Option") exercisable for a limited period after completion
of the well, to increase its interest to 50% of the contractor share of
the Norio PSA on payment to CanArgo Norio of US$6.5 million.
13
Co-incident with the Georgian Oil farm-in CanArgo concluded a deal to
purchase some of the minority interests in CanArgo Norio by a share
swap for shares in CanArgo. Through this CanArgo has acquired an
additional 10.8% interest in CanArgo Norio, giving CanArgo a 75%
interest in CanArgo Norio at present. This approximately maintains
CanArgo's effective interest in the Norio PSA after Georgian Oil has
completed the first stage of the farm-in at 63.7%. The purchase was
achieved by issuing 6 million restricted CanArgo shares to the minority
interest holders in CanArgo Norio. 4.0% of these minority interests
were owned by Provincial Securities Limited, a company which J.F.
Russell Hammond, a non-executive director of CanArgo, is an investor
advisor. In the event that Georgian Oil exercises the Option and pays
the required $6.5 million, CanArgo (which would have received some $4.8
million of this payment with its previous interest) would receive a
further $1.2 million, resulting in a total payment to CanArgo of
approximately $6 million. If the Option is exercised CanArgo would
issue a further 3 million restricted shares to the minority interest
holders. As well as the Norio PSA, CanArgo Norio also owns 100% of the
contractor interest in the recently signed Block XIG and XIH Production
Sharing Contract ("Tbilisi PSC"). Georgian Oil is not currently farming
in to the Tbilisi PSC, which will remain solely with CanArgo Norio.
CanArgo Norio is consolidated in the accounts of CanArgo.
The Company is currently evaluating its accounting treatment of
minority interest in prior periods in respect of the refinery. In
September 1998, CanArgo purchased for $1,000,000 a 12.9% equity
interest in GAOR, a company which owns a small refinery located at
Sartichala, Georgia. On November 12, 2000, CanArgo acquired a further
38.1% of the common stock of GAOR for Common Stock consideration valued
at $1,666,575. On completion of the acquisition, CanArgo held 51% of
the common stock of GAOR and GAOR became a subsidiary of CanArgo. Under
purchase accounting, GAOR's results have been included in CanArgo's
consolidated financial statements since the date of acquisition.
The refinery began operations in July 1998 and has a potential design
capacity of approximately 4,000 barrels per day. Operating as a
straight-run distillation unit it can potentially produce naphtha,
diesel, fuel oil and kerosene. Further product expansion is possible
with the addition of additives and or a catalytic reformer.
Since 2001 the refinery has not been operating. Since its acquisition,
sales from the refinery have been negatively impacted by the imposition
of restrictions and subsequent excise tax on feedstock and refined
products. Although in April 2001, new legislation addressing indigenous
refining activities was passed by the Republic of Georgia that removed
or reduced excise taxes on feedstock and refined product, the refinery
has since experienced unexpected product quality concerns which has
effectively curtailed the enhancement of the basic product stream into
gasoline. As a result, the refinery can only produce straight
distillation products such as naphtha, diesel and mazut and not high
octane gasoline as required by petrol stations. Due to the presence of
excise tax on naphtha, there is limited economic demand for the product
in Georgia, either as a feedstock for a separate refining company or
for the blending with higher octane gasoline to produce "normal" grade
gasoline for the local market.
Currently only naphtha, diesel and mazut can be produced and of these
products, an excise tax on naphtha and diesel sales remain in place. As
a result of these taxes and the local market for naphtha in the
Republic of Georgia, GAOR deemed production of naphtha as commercially
uneconomic and suspended refining activity in the fourth quarter of
2001. In January 2002, GAOR entered into a short-term lease of the
refinery to a third party for nominal revenue. During the lease period,
all operating costs of the refinery were borne by the lessee. This
lease expired in May 2002 and has not been renewed. GAOR continues to
monitor demand for products allowed to be produced by the refinery and
is seeking changes to the legislation in support of indigenous refining
activities, although no assurance can be given that such changes can be
made. As a result of the uncertainty as to the ultimate recoverability
of the carrying value of the refinery, CanArgo recorded in 2001 a
write-down of the refinery's property, plant and equipment of
approximately $3.5 million.
Minority interest share of losses recorded as at September 30, 2003
exceed the overall minority share of shareholders equity by $1,250,063.
CanArgo are currently evaluating a number of options in respect of its
future interest in the refinery. Should the Company not reach a
satisfactory conclusion, and given the continuing uncertainty as to the
ultimate recoverability of the carrying value of the refinery during
2003, the minority share of losses would have to be written down in the
appropriate period.
14
(14) Stockholders' Equity
COMMON STOCK
-------------------------
NUMBER OF
SHARES ADDITIONAL FOREIGN TOTAL
ISSUED AND PAID-IN CURRENCY ACCUMULATED STOCKHOLDERS'
ISSUABLE PAR VALUE CAPITAL TRANSLATION DEFICIT EQUITY
----------- ----------- ------------ ----------- ------------- ------------
TOTAL, DECEMBER 31, 2002 97,356,206 $ 9,735,620 $145,151,475 $ 4,668 $(92,786,483) $62,105,280
Current year adjustment (12,270) (12,270)
Issuance and repricing of options 276,507 276,507
Issuance of Common Stock
persuant to the purchase of 10.8%
minority interest share of CanArgo
Norio Limited 6,000,000 600,000 92,078 692,078
Net loss -- -- -- -- (697,080) (697,080)
----------- ----------- ------------ --------- ------------ -----------
TOTAL, SEPTEMBER 30, 2003 103,356,206 $10,335,620 $145,520,060 $ (7,602) $(93,483,563) $62,364,515
=========== =========== ============ ========= ============ ===========
In September 2003, CanArgo Norio signed a farm-in agreement (the
"Agreement") relating to the Norio PSA with a wholly owned subsidiary
of Georgian Oil, the Georgian State Oil Company ("Georgian Oil").
Co-incident with the Georgian Oil farm-in, CanArgo concluded a deal to
purchase some of the minority interests in CanArgo Norio by a share
swap for shares in CanArgo. Through this CanArgo has acquired an
additional 10.8% interest in CanArgo Norio, giving CanArgo a 75%
interest in CanArgo Norio at present. This approximately maintains
CanArgo's effective interest in the Norio PSA after Georgian Oil has
completed the first stage of the farm-in at 63.7%. The purchase was
achieved by issuing 6 million restricted CanArgo shares to the minority
interest holders in CanArgo Norio. No additional shares were authorised
during the period.
(15) Net Loss Per Common Share
Basic and diluted net loss per common share for the three and nine
month periods ended September 30, 2003 and 2002 are based on the
weighted average number of common shares outstanding during those
periods. Options to purchase CanArgo's common stock were outstanding at
September 30, 2003 but were not included in the computation of diluted
net loss per common share because the effect of such inclusion would
have been anti-dilutive. The total numbers of such shares excluded from
diluted net loss per common share were 15,189,591 and 13,993,167, for
the nine months ended September 30, 2003 and September 30, 2002,
respectively.
(16) Commitments and Contingencies
OIL AND GAS PROPERTIES AND INVESTMENTS IN OIL AND GAS VENTURES
CanArgo has contingent obligations and may incur additional
obligations, absolute and contingent, with respect to acquiring and
developing oil and gas properties and ventures. At September 30, 2003,
CanArgo had the contingent obligation to issue an aggregate of 187,500
shares of its common stock, subject to the satisfaction of conditions
related to the achievement of specified performance standards by the
Stynawske field project.
In September 2003, CanArgo announced it had reached conditional
agreement to sell its interest in Boryslaw Oil Company ("BOC"), the
joint venture in West Ukraine currently operating the Stynawske
15
oilfield. Fountain Oil Boryslaw ("FOB"), CanArgo's wholly owned
subsidiary which holds its 45% interest in BOC, was sold for $1,000,000
payable in eight equal tranches. The buyer has also acknowledged BOC's
debts to CanArgo for earlier loans in the total amount of $160,000. On
November 10, 2003 CanArgo announced that the full payment had been
received early and that CanArgo's interest in FOB had been transferred
to the buyer. At September 30, 2003, CanArgo had the contingent
obligation to issue an aggregate of 187,500 shares of its common stock,
subject to the satisfaction of conditions related to the achievement of
specified performance standards by the Stynawske field project.
The shareholders agreement with the other shareholder of CanArgo Norio
calls for a bonus payment of $800,000 to be paid by CanArgo should
commercial production be obtained from the Middle Eocene or older
strata and a second bonus payment of $800,000 should production from
the Norio PSA from the Middle Eocene or older strata exceed 250 tonnes
of oil per day over any 90 day period.
In 2002, the Participation Agreement for the three well exploration
programme on the Ninotsminda area with a subsidiary of the US power
company AES was terminated without AES earning any rights to any of the
Ninotsminda Field reservoirs. The Company therefore has no present
obligations in respect of AES. However, under a separate Letter of
Agreement, if gas from the sub Middle Eocene is discovered and produced
from the area covered by the Participation Agreement (Ninotsminda and
Manavi areas), AES will be entitled to recover approximately $7.5
million, representing their prior funding under the Participation
Agreement, by way of a rebate of 15% being paid to one of AES'
associated companies, AES Georgia Gas Partner Ltd from future sub
Middle Eocene gas sales where the gas was produced commercially from
the sub Middle Eocene net of operating costs.
On July 2, 2003 CanArgo announced that its subsidiary CanArgo Norio had
entered into a new Production Sharing Contract (PSC) for Blocks XI(G)
and XI(H) (Mtskheta, Tetritskaro and Gardabani areas), named the
"Tbilisi PSC" in the Republic of Georgia. The licence was subsequently
issued on 9 July 2003 for a period of 25 years. These areas are located
adjacent to CanArgo's existing acreage close to Tbilisi and cover in
total some 485 km(2). Under the terms of the Tbilisi PSC, CanArgo Norio
will evaluate existing seismic and geological data during the first
year and acquire additional seismic data within four years of the
effective date of the Agreement which is 29th September 2003. The total
commitment over the next four years is $350,000. The commercial terms
of the Tbilisi PSC are similar to those governing CanArgo Norio's other
exploration areas.
In January 2003, CanArgo won exclusive rights to negotiate a Production
Sharing Contract (PSC) for Block XIX in southern Syria. In October
2003, CanArgo informed the authorities in Syria that it does not wish
to continue with the exclusive negotiations for a PSC for Block XIX in
that country. After careful assessment of the commercial terms being
offered in this contract compared to CanArgo's other opportunities, it
was decided to withdraw from this project. CanArgo had a contingent
obligation to issue an aggregate of 333,000 stock options at a proposed
exercise price of $0.17 per share, subject to the successful award and
ratification of the PSC for Block XIX. This contingent obligation has
now lapsed.
If Georgian Oil exercises the Option available to it under the terms of
the Norio farm-in agreement signed in September 2003, CanArgo would
issue a further 3 million restricted shares to the minority interest
holders from whom CanArgo acquired an additional 10.8% interest in
CanArgo Norio.
NOC has a commitment to repay $$2.3m arising from security payments
under oil sales agreements signed in May 2003 and October 2003. The
security will be paid in oil commencing in August 2004.
16
(17) Segment Information
Operating revenues from continued operations for the nine month periods
ended September 30, 2003 and 2002 by geographical area were as follows:
SEPTEMBER 30, September 30,
2003 2002
(UNAUDITED) (Unaudited)
------------ ------------
OIL AND GAS EXPLORATION, DEVELOPMENT AND PRODUCTION
Eastern Europe $5,271,874 $3,159,850
OTHER
Eastern Europe 223,608 1,398,153
---------- ----------
TOTAL $5,495,482 $4,558,003
========== ==========
Operating revenues from continued operations for the three month
periods ended September 30, 2003 and 2002 by geographical area were as
follows:
SEPTEMBER 30, September 30,
2003 2002
(UNAUDITED) (Unaudited)
------------ ------------
OIL AND GAS EXPLORATION, DEVELOPMENT AND PRODUCTION
Eastern Europe $2,468,029 $696,406
OTHER
Eastern Europe 26,000 --
---------- --------
TOTAL $2,494,029 $696,406
========== ========
Other Eastern Europe operating revenue for the three month and six
periods ended September 30, 2003 and 2002 relates to income from the
provision of drilling services in Georgia.
Operating income (loss) income from continued operations for the nine
month periods ended September 30, 2003 and 2002 by geographical area
was as follows:
SEPTEMBER 30, September 30,
2003 2002
(UNAUDITED) (Unaudited)
------------ ------------
OIL AND GAS EXPLORATION, DEVELOPMENT AND PRODUCTION
Eastern Europe $ 2,325,622 $ 2,060,386
REFINING
Eastern Europe (35,657) (5,053)
CORPORATE AND OTHER EXPENSES (3,148,577) (4,102,171)
----------- -----------
TOTAL OPERATING LOSS $ (858,612) $(2,046,838)
=========== ===========
17
Operating income (loss) from continued operations for the three month
periods ended September 30, 2003 and 2002 by geographical area was as
follows:
SEPTEMBER 30, September 30,
2003 2002
(UNAUDITED) (Unaudited)
------------ ------------
OIL AND GAS EXPLORATION, DEVELOPMENT AND PRODUCTION
Eastern Europe $ 1,430,175 $ 219,377
REFINING
Eastern Europe (8,859) 77,006
CORPORATE AND OTHER EXPENSES (1,148,272) (758,619)
----------- ----------
TOTAL OPERATING (LOSS) INCOME $ 273,044 $ (462,236)
=========== ==========
Net (loss) income before minority interest from continuing operations
for the nine month periods ended September 30, 2003 and 2002 by
geographic area was as follows:
SEPTEMBER 30, September 30,
2003 2002
(UNAUDITED) (Unaudited)
------------ ------------
OIL AND GAS EXPLORATION, DEVELOPMENT AND PRODUCTION
Eastern Europe $ 2,325,622 $ 1,616,824
REFINING
Eastern Europe (46,957) 5,680
CORPORATE AND OTHER EXPENSES (3,115,433) (4,225,535)
----------- ------------
NET (LOSS) INCOME BEFORE MINORITY INTEREST $ (836,768) $ (2,603,031)
=========== ============
Net (loss) income before minority interest from continuing operations
for the three month periods ended September 30, 2003 and 2002 by
geographic area was as follows:
SEPTEMBER 30, September 30,
2003 2002
(UNAUDITED) (Unaudited)
------------ ------------
OIL AND GAS EXPLORATION, DEVELOPMENT AND PRODUCTION
Eastern Europe $ 1,430,175 $ (224,185)
REFINING
Eastern Europe (14,862) 264,934
CORPORATE AND OTHER EXPENSES (1,141,046) (1,252,427)
----------- ------------
NET (LOSS) INCOME BEFORE MINORITY INTEREST $ 274,267 $ (1,211,678)
=========== ============
18
Identifiable assets of continuing and discontinued operations as of
September 30, 2003 and December 31, 2002 by business segment and
geographical area were as follows:
SEPTEMBER 30, September 30,
2003 2002
(UNAUDITED) (Unaudited)
------------ ------------
CORPORATE
Eastern Europe $ 926,801 $ 203,291
Western Europe (principally cash) 2,885,057 2,274,847
----------- -----------
TOTAL CORPORATE 3,811,858 2,478,138
OIL AND GAS EXPLORATION,
DEVELOPMENT AND PRODUCTION
Eastern Europe 60,495,949 59,602,525
REFINING
Eastern Europe 100,000 100,000
ASSETS HELD FOR SALE
Eastern Europe 8,373,706 7,536,677
Western Europe 608,859 559,270
----------- -----------
TOTAL ASSETS HELD FOR SALE 8,982,564 8,095,947
OTHER ENERGY PROJECTS
Eastern Europe 463,469 459,308
----------- -----------
TOTAL IDENTIFIABLE ASSETS $73,853,840 $70,735,918
=========== ===========
19
(18) Discontinued Operations
In September 2002, CanArgo approved a plan to sell CanArgo Standard Oil
Products to finance Georgian and Ukrainian development projects and in
October 2002, CanArgo agreed to sell its 50% holding to an unaffiliated
company for $4 million in an arms-length transaction, with legal
ownership being transferred upon receipt of final payment. Although the
original date for final payment was in August 2003, CanArgo agreed to a
rescheduling of payments with the final payment now due in June 2004.
To date $2 million has been received and the outstanding balance is
subject to interest payable monthly at an annual rate of 16%. The
agreed consideration to be exchanged does not result in an impairment
of the carrying value of assets held for sale. The assets and
liabilities of CanArgo Standard Oil Products have been classified as
"Assets held for sale" and "Liabilities held for sale" for all periods
presented. The results of operations of CanArgo Standard Oil Products
have been classified as discontinued for all periods presented. The
minority interest related to CanArgo Standard Oil Products has not been
reclassified for any of the periods presented, however net income from
discontinued operations is disclosed net of taxes and minority
interest.
The results of discontinued operations at September 30, 2003 and
September 30, 2002 consisted of the following:
SEPTEMBER 30, September 30,
2003 2002
(UNAUDITED) (Unaudited)
------------ ------------
Operating Revenues 7,094,118 5,086,458
(Loss) Income Before Income taxes and Minority Interest 190,067 367,174
Income Taxes 39,589 20,394
Minority Interest in Loss (Income) (75,239) (173,390)
---------- ----------
Net Income from Discontinued Operation $ 75,239 $ 173,390
========== ==========
Gross consolidated assets and liabilities of subsidiary held for sale
that are included in "assets and liabilities held for sale" at
September 30, 2003 and December 31, 2002 consisted of the following:
SEPTEMBER 30, December 30,
2003 2002
(UNAUDITED) (Unaudited)
------------ ------------
Assets held for sale:
Cash and cash equivalents 7,892 37,948
Accounts receivable 399,695 243,529
Inventory 427,554 224,733
Other current assets 204,799 155,079
Capital assets, net 6,758,977 6,326,478
Investment in other ventures, net 574,789 548,910
---------- ----------
$8,373,706 $7,536,677
========== ==========
Liabilities held for sale:
Accounts payable 21,643 143,296
Current portion of long term debt 1,217,524 1,268,422
Income taxes payable 42,802 48,880
Long term debt 1,767,300 891,367
---------- ----------
$3,049,269 $2,351,965
========== ==========
Investments in other ventures include three petrol station sites in
Tbilisi, Georgia in which CanArgo has a 50% non-controlling interest.
CanArgo accounts for its interest in the three petrol station sites
using the equity method and consolidates the remaining sites in which
it has controlling interest. In 2002, CanArgo
20
purchased the remaining 50% of Petro-Invest, a petrol station site in
which CanArgo previously held a 50% non-controlling interest. This
site is now consolidated in the results of CanArgo Standard Oil
Products, above.
Cash consideration received at September 30, 2003 in respect of this
transaction was $1,800,000 and has been recorded in other liabilities
(see Note 11), a further $200,000 was received in October 2003. The
sale will be reflected on payment of the consideration in full plus any
interest due which is now expected to be in June 2004. In any event,
ownership in the asset will only transfer to Westrade Alliance on
payment of the consideration in full.
In 2002, the three petrol station sites that CanArgo has a 50%
non-controlling interest entered into credit facility agreements of
$550,000 with a commercial lender in Georgia. As at September 30, 2003
$520,000 of these facilities were drawn of which $326,245 under the
facilities were outstanding. The loans bear interest at 18% per annum
and are secured by the assets of the petrol stations. The full amount
of the loans is to be repaid by June 2005. No company guarantees have
been provided by CanArgo with respect to these loans.
In November 2001, CanArgo Standard Oil Products Limited entered into a
$1,000,000 credit facility agreement, in May 2002, a further $240,000
credit facility agreement, in September 2002, a further $1,900,000
credit facility agreement, in February 2003, a further $400,000, in
June 2003, a further $350,000 and in August 2003, a further $1,500,000
with commercial lenders in Georgia and Greece to fund further expansion
of its petrol station network. In 2001, the full amount of the first
facility was drawn, in 2002 $180,000 of the second facility was drawn,
in September 2002, the full amount of the third facility was drawn, in
February 2003, the full amount of the fourth facility was drawn, in
June 2003, the full amount of the fifth facility was drawn and in
August 2003, the full amount of the sixth facility was drawn. As at
September 30, 2003, $2,927,100 of the total facility was outstanding.
The loans bear interest between 13% and 18% per annum and are secured
by the assets of petrol stations. The full amount of the first loan was
repaid by March 2003, the second loan is to be repaid by November 2004,
the third loan by July 2005, the fourth loan by August 2004, the fifth
loan by December 2003 and the sixth by August 2008. No parent company
guarantees have been provided by CanArgo with respect to these loans.
The remaining 50% interest in CanArgo Standard Oil Products is held by
Standard Oil Products of Georgia and an individual, Mr. Levan
Pkhakazde, who is one of the founders of Standard Oil Products and the
General Director of CanArgo Standard Oil Products.
In September 2003, CanArgo entered into a conditional agreement to sell
its interest in BOC. See footnotes 9 and 16 above.
(19) Stock Based Compensation Plans
For the year ended December 31, 2002 CanArgo had 6,734,501 share
options outstanding with exercise prices in the range of $0.14 to $1.85
a share. During March 2003, CanArgo re-priced 5,117,501 fully vested
options to an exercise price of US $0.10 to better align the option
value with current CanArgo share price ($0.04 at the date of the
re-pricing). In addition, during March 2003 CanArgo issued 1,589,166
new options at an exercise price of $0.10, which vested immediately and
expire in 5 years.
In connection with the option transactions described in the preceding
paragraph the Company recorded approximately $276,507 of stock-based
employee compensation expense in the three months ended March 31, 2003
(as restated) and nine months ended September 30, 2003 periods. The
fair value of each stock option granted or re-priced by CanArgo was
calculated using the Black-Scholes option-pricing model applying the
following weighted-average assumptions for the period ended September
30, 2003 and the year ended December 31, 2002 dividend yield of 0.00%,
risk-free interest rate of 2.91% for the period ended September 31,
2003, dividend yield of 0.00%, risk-free interest rate of 2.91% for the
year ended December 31, 2002, the average expected lives of options of
5.0 years and volatility of 80.47% for the period ended September 30,
2003 and 80.47% for the year ended December 31, 2002.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
QUALIFYING STATEMENT WITH RESPECT TO FORWARD-LOOKING INFORMATION
THE FOLLOWING INFORMATION CONTAINS FORWARD-LOOKING STATEMENTS. SEE
"FORWARD-LOOKING STATEMENTS" BELOW AND ELSEWHERE IN THIS REPORT.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2003, CanArgo had working capital of $4,333,000 compared to
working capital of $5,585,000 as of December 31, 2002. The $1,252,000 decrease
in working capital from December 31, 2002 to September 30, 2003 is principally
due to a reduction in cash related to capital expenditures on the Ninotsminda
project.
In order to preserve available cash resources while still maintaining essential
field operations and development activities in Georgia, a significant cost
reduction plan was implemented through the end of 2002 and into 2003 with both
direct project and general and administrative costs being reduced. These
reductions together with the additional capital resources being generated by the
successful horizontal production wells, N4H and N100H, in the Ninotsminda Field,
the receipt of a further $1 million payment from the agreed sale of CanArgo's
interest in its retail operation CanArgo Standard Oil Products with a further $2
million to be paid, the planned selective sale of certain non-core assets
including CanArgo's generator for which $300,000 has now been received with a
further $300,000 due before the end of the year, and a portion or all of
CanArgo's drilling equipment, means CanArgo should secure the working capital
necessary to cover CanArgo's immediate and near term funding requirements with
respect to its currently planned development activities in the Republic of
Georgia. CanArgo's principle development activities are carried out in Georgia
through its wholly owned subsidiary Ninotsminda Oil Company Limited ("NOC").
In January 2003, in order to increase production at the Ninotsminda Field and
further improve working capital, drilling of a new horizontal sidetrack well,
N4H, commenced targeting an existing producing reservoir of Middle Eocene age.
The well is a horizontal sidetrack from an existing well bore in the Middle
Eocene reservoir at approximately 2,356 metres. The horizontal production
section extends for a total distance of 400 metres in the west central area of
the field between the N4 and N9 wells. The well was successfully completed and
originally put on production at over 1,000 barrels of oil per day (bopd) in
April 2003. It was later reduced to approximately 700 bopd to ensure optimal
total production produced from the well. Drilling commenced on an additional
horizontal sidetrack well, N100H, in August 2003. This well was successfully
completed in September 2003. It was drilled along a similar orientation to the
N4H well along the crestal part of the Ninotsminda Field where the most
fracturing is believed to occur, and into an area of the reservoir that has not
yet been drained. The well tested at rates of over 2,000 bopd and has been put
on production at 1,300 bopd. This latest well is the largest producer in the
Ninotsminda Field. Provided funds are available, immediate and near term
development plans include the drilling of further production horizontal
sidetracks on the Ninotsminda Field.
In May 2003, NOC entered into a new 12-month crude oil sales agreement whereby
the buyer will provide a security payment of $1.75 million in return for the
right to lift up to 5,000 metric tonnes of oil per month for the 12-month period
commencing August 2003. At the end of the 12 months, the security payment will
be repaid through the delivery of additional crude oil equal to the value of the
security. This agreement replaces an existing crude oil sales agreement, where
the buyer had already provided $1 million security. Following the success of the
N100H well, NOC entered into a further oil sales agreement with the buyer for an
additional monthly quantity of 2,500 metric tonnes of oil. The agreement is for
a 12-month period and as security for payment and for having the option to lift
oil on a monthly basis the buyer will provide additional security in the amount
of $550,000. The security will be repaid in oil at the end of the contract
period.
The exploration programme in Georgia is being progressed primarily through third
party financing. In September 2003, drilling recommenced on the Manavi prospect
M11 well following a farm-in by a local Georgian company. The M11 well was
suspended in late 2002 following the withdrawal of the US power company AES from
the project. The farm-in partner will receive a 50% share in any oil or gas
produced from the well (the well only and not the structure) for investing funds
to contribute to the finishing of the well. The well reached a total depth (TD)
of 4,500 metres with the primary Cretaceous limestone target having been
encountered at 4,348 metres. Drilling data and wireline logs indicate the
presence of oil and gas in the Cretaceous limestone sequence and the well is
currently being prepared for a testing programme to ascertain whether or not
such hydrocarbons can be commercially
22
produced. In addition, the wireline logs and drilling data indicate the presence
of further hydrocarbons in the higher Middle Eocene sequence, which is the
productive sequence in CanArgo's nearby Ninotsminda Field.
In September 2003, CanArgo Norio signed a farm-in agreement (the "Agreement")
relating to the Norio PSA with a wholly owned subsidiary of Georgian Oil, the
Georgian State Oil Company ("Georgian Oil"). CanArgo Norio had previously been
in negotiations with a large third party energy company to farm-in to the Norio
PSA, but Georgian Oil exercised its pre-emption rights under the Norio PSA.
Georgian Oil is already a party to the Norio PSA as the commercial
representative of the State. The Agreement, which is subject to Georgian
regulatory approval, obligates Georgian Oil to pay up to US$2.0 million to
complete the MK-72 well on the Norio prospect in return for a 15% interest in
the contractor share of the Norio PSA. Georgian Oil will also have an option
(the "Option") exercisable for a limited period after completion of the well, to
increase its interest to 50% of the contractor share of the Norio PSA on payment
to CanArgo Norio of US$6.5 million. The well was suspended in 2002 due to lack
of available funding at that time. To date $1 million has been advanced by
Georgian Oil and the MK-72 well is expected to recommence drilling before the
end of the year.
Co-incident with the Georgian Oil farm-in, CanArgo concluded a deal to purchase
some of the minority interests in CanArgo Norio by a share swap for shares in
CanArgo. Through this CanArgo has acquired an additional 10.8% interest in
CanArgo Norio, giving CanArgo a 75% interest in CanArgo Norio at present. This
approximately maintains CanArgo's effective interest in the Norio PSA after
Georgian Oil has completed the first stage of the farm-in at 63.7%. The purchase
was achieved by issuing 6 million restricted CanArgo shares to the minority
interest holders in CanArgo Norio. 4.0% of these minority interests were owned
by Provincial Securities Limited, a company which J.F. Russell Hammond, a
non-executive director of CanArgo, is an investor advisor. In the event that
Georgian Oil exercises the Option and pays the required $6.5 million, CanArgo
(which would have received some $4.8 million of this payment with its previous
interest) would receive a further $1.2 million, resulting in a total payment to
CanArgo of approximately $6 million. If the Option is exercised CanArgo would
issue a further 3 million restricted shares to the minority interest holders.
In July 2003, CanArgo announced that its subsidiary, CanArgo Norio, had signed a
Production Sharing Contract for Blocks XI(G) and XI(H) ("Tbilisi PSC") in the
Republic of Georgia. The Contract was signed between CanArgo Norio (in which
CanArgo currently has a 75% interest) and the Georgian State, represented by the
State Agency for the Regulation of Oil and Gas Resources and the Georgian State
oil company, Saknavtobi. CanArgo Norio views these blocks as having good
potential, being adjacent to productive acreage. Under the terms of the PSC,
CanArgo Norio will evaluate existing seismic and geological data during the
first year and acquire additional seismic data within four years of the
effective date of the Contract which is 29 September 2003. The total commitment
over the next four years is $350,000. The commercial terms of the Tbilisi PSC
are similar to those governing CanArgo Norio's other exploration areas. The
abovementioned Georgian Oil farm-in to the Norio PSA does not apply to the
Tbilisi PSC.
In September 2002, CanArgo approved a plan to sell CanArgo Standard Oil Products
to finance Georgian and Ukrainian development projects and in October 2002,
CanArgo agreed to sell its 50% holding for $4 million with legal ownership being
transferred upon receipt of the final payment originally due in August 2003.
CanArgo agreed subsequently to re-schedule this payment in return for, the
purchaser, Westrade Alliance LLC, paying some of the funds early and paying
interest on the outstanding balance at a an annual rate of 16% payable monthly.
To date a total of $2 million has been received with a further $2 million to be
paid by end of June 2004.
Through the acquisition in 2001 of 100% of the share capital of Lateral Vector
Resources Inc. ("LVR") CanArgo gained certain rights in a Joint Investment
Production Activity (JIPA) agreement for the incremental development of the
Bugruvativske Field in Eastern Ukraine. In September 2002, LVR agreed terms with
Ukrnafta, the Ukrainian State Oil Company, on revisions to the JIPA and reached
an agreement with a local Ukrainian oil and gas company on the terms of a
farm-in to the JIPA. The terms of the farm-in are that the local Ukrainian oil
and gas company through its acquisition of IPEC (a party to the JIPA) would
invest approximately $3 million in the Bugruvativske Field over the course of 12
months in order to drill two new wells whilst bearing the financial risk under
the JIPA during this period. LVR can match up to the amount invested by IPEC
prior to 31 December 2003. The revised JIPA provides that (assuming LVR matches
IPEC's initial expenditure) LVR will be entitled to approximately 34.5% of net
profits generated under the JIPA (or a proportionally smaller amount if the
amount invested is less than that invested by IPEC). LVR has no obligation to
invest in the JIPA, however in the event that LVR decides not to invest in the
project by 31 December 2003 and IPEC has satisfied the terms of the farm-in, it
will still receive an ongoing project fee of between 3-4 % of the net profits
generated under the JIPA in recognition of its earlier involvement in the
project. As of September 30, 2003, IPEC had transferred only $1 million to the
JIPA account and drilling operations under the JIPA have not yet commenced due
to current disagreements that IPEC and LVR have with
23
Ukrnafta on activities under the JIPA. These disagreements have prevented IPEC
from fulfilling the terms of the farm-in agreement and have subsequently delayed
the date for fixing the participating interests of both IPEC and LVR in the
JIPA. Initial costs in respect of CanArgo's investment in the Bugruvativske
Field, through its direct investment in LVR, are included in "capital assets -
unproved properties". These costs will continue to be disclosed as unproved
properties until LVR participates in the JIPA by investing an amount up to the
cash contribution made by its JIPA partner, IPEC.
In September 2003, CanArgo announced it had reached conditional agreement to
sell its interest in Boryslaw Oil Company ("BOC"), the joint venture in West
Ukraine currently operating the Stynawske oilfield. Fountain Oil Boryslaw
("FOB"), CanArgo's wholly owned subsidiary which holds its 45% interest in BOC,
was sold for $1,000,000 payable in eight equal tranches. The buyer has also
acknowledged BOC's debts to CanArgo for earlier loans in the total amount of
$160,000. On November 10, 2003 CanArgo announced that the full payment had been
received early and that CanArgo's interest in FOB had been transferred to the
buyer. Management of CanArgo has concluded that the sale of CanArgo's interest
in BOC does not constitute the disposition of a material asset of the Company.
While a considerable amount of infrastructure for the Ninotsminda and
Bugruvativske Fields has already been put in place, CanArgo cannot provide
assurance that:
o for the Bugruvativske Field an adequate investment agreement and
development plan can be put in place, or that the current
disagreements with Ukrnafta can be resolved positively;
o funding of field development plans will be timely;
o that development plans will be successfully completed or will increase
production; or
o that field operating revenues after completion of the development plan
will exceed operating costs.
To pursue existing projects beyond CanArgo's immediate development plan and to
pursue new opportunities, CanArgo will require additional capital. While
expected to be substantial, without further exploration work and evaluation the
exact amount of funds needed to fully develop all of our oil and gas properties
cannot at present, be quantified. Potential sources of funds include additional
equity, project financing, debt financing and the participation of other oil and
gas entities in CanArgo's projects. Based on CanArgo's past history of raising
capital and continuing discussions, CanArgo believes that such required funds
may be available. However, there is no assurance that such funds will be
available, and if available, will be offered on attractive or acceptable terms.
Should such funding not be forthcoming and CanArgo should be unable to maintain
its current positive cash flow or unable to sell some or all of its non-core
assets, further cost reductions and additional funding will be required in order
for CanArgo to remain a going concern.
Development of the oil and gas properties and ventures in which CanArgo has
interests involves multi-year efforts and substantial cash expenditures. Full
development of CanArgo's oil and gas properties and ventures will require the
availability of substantial additional financing from external sources. CanArgo
may also, where opportunities exist, seek to transfer portions of its interests
in oil and gas properties and ventures to entities in exchange for such
financing. CanArgo generally has the principal responsibility for arranging
financing for the oil and gas properties and ventures in which it has an
interest. There can be no assurance, however, that CanArgo or the entities that
are developing the oil and gas properties and ventures will be able to arrange
the financing necessary to develop the projects being undertaken or to support
the corporate and other activities of CanArgo. There can also be no assurance
that such financing will be available on terms that are attractive or acceptable
to or are deemed to be in the best interest of CanArgo, such entities and their
respective stockholders or participants.
Ultimate realization of the carrying value of CanArgo's oil and gas properties
and ventures will require production of oil and gas in sufficient quantities and
marketing such oil and gas at sufficient prices to provide positive cash flow to
CanArgo. Establishment of successful oil and gas operations is dependent upon,
among other factors, the following:
o mobilization of equipment and personnel to implement effectively drilling,
completion and production activities;
o raising of additional finance;
o achieving significant production at costs that provide acceptable margins;
o reasonable levels of taxation, or economic arrangements in lieu of taxation
in host countries; and
o the ability to market the oil and gas produced at or near world prices; and
o the ability to repatriate profits on a reasonably acceptable basis.
24
Subject to the raising of additional capital, above, CanArgo has plans to
mobilize resources and achieve levels of production and profits sufficient to
recover the carrying value of its oil and gas properties and ventures. However,
if one or more of the above factors, or other factors, are different than
anticipated, these plans may not be realized, and CanArgo may not recover the
carrying value of its oil and gas properties and ventures. CanArgo should be
entitled to distributions from the various properties and ventures in which it
participates in accordance with the arrangements governing the respective
properties and ventures.
In October 2003, CanArgo announced that it had informed the authorities in Syria
that it did not wish to continue with the exclusive negotiations for a
Production Sharing Contract for Block XIX in that country. After careful
assessment of the commercial terms being offered in this contract compared to
CanArgo's other opportunities, it was decided to withdraw from this project.
BALANCE SHEET CHANGES
All balances represent results from continuing operations, unless disclosed
otherwise.
Cash and cash equivalents increased $1,093,000 to $2,691,000 at September 30,
2003 from $1,598,000 at December 31, 2002. The increase was primarily due to
additional cash generated from operating activities, advanced proceeds from the
sale of subsidiaries and advanced funds from the joint venture partner in
respect of the Norio farm-in agreement. These funds were offset by expenditure
in the period, provided to fund the cost of drilling new horizontal wells N4H
and N100H, at the Ninotsminda Field in Georgia.
Accounts receivable decreased to $233,000 at September 30, 2003 from $306,000 at
December 31, 2002.
Inventory increased to $290,000 at September 30, 2003 from $186,000 at December
31, 2002 primarily as result of increased production of oil by NOC.
Approximately 54,000 barrels of oil were held in storage by NOC at September 30,
2003 for sale to the Georgian domestic, regional or international markets.
Prepayments increased to $411,000 at September 30, 2003 from $212,000 at
December 31, 2002 as a result of payment of materials and services related to
CanArgo's exploration activities. This increase is included in the statement of
cash flows as an investing activity.
Assets held for sale, consisting of assets of CanArgo Standard Oil Products
operations and a 3 megawatt duel fuel power generator, increased by $887,000 to
$8,983,000 at September 30, 2003 from $8,096,000 at December 31, 2002 primarily
due to activity at CanArgo Standard Oil Products relating to the addition of new
petrol stations in Georgia.
Other currents assets increased from $176,000 at December 31, 2002 to $186,000
at September 30, 2003 due to a deposit payment for professional services.
Capital assets, net increased from $59,703,000 at December 31, 2002 to
$60,596,000 at September 30, 2003, primarily as a result of investment of
$3,083,000 in capital assets including oil and gas properties and equipment,
principally related to the Ninotsminda Production Sharing Contract.
Investments in and advances to oil and gas and other ventures, net increased
from $459,000 at December 31, 2002 to $463,000 at September 30, 2003. The
increase reflects an increase in equity income related to CanArgo's investment
in BOC partially offset by repayment by BOC of CanArgo's advances in 2003.
Accounts payable decreased to $612,000 at September 30, 2003 from $872,000 at
December 31, 2002 primarily due to an absolute decrease in corporate payables.
Advance from joint venture partner of $534,000 at September 30, 2003 relates to
an initial receipt from Georgian Oil in accordance with the Norio farm-in
agreement.
Loans payable of $168,000 at September 30, 2003 relates to a short-term secured
loan facility maturing on February 27, 2004, that a subsidiary of CanArgo
entered into, locally in Georgia, at an annual interest rate of 20% in order to
fund the drilling of a new horizontal well, N4H, at the Ninotsminda Field in
Georgia. No parent company guarantees have been provided by CanArgo with respect
to this loan.
25
Other liabilities increased to $3,850,000 at September 30, 2003 from $1,500,000
at December 31, 2002 due to advanced proceeds received for the sale of CanArgo
Standard Oil Products in the period, advance proceeds from the sale of a 3
megawatt duel fuel power generator and further security received resulting from
an oil sales agreement entered into during the quarter whereby the buyer
increased the security payment to $1.75 million in return for the right to lift
up to 5,000 metric tonnes of oil per month for the 12 month period commencing
August 2003. Proceeds received in respect of the CanArgo Standard Oil Products
sale are $1,800,000 at September 30, 2003.
Accrued liabilities decreased to $188,000 at September 30, 2003 from $204,000 at
December 31, 2002 primarily due a reduction in accrued professional fees.
Liabilities held for sale, in respect of discontinued operations, increased by
$697,000 to $3,049,000 at September 30, 2003 from $2,352,000 at December 31,
2002 primarily due to an increase in bank loans payable, drawn by CanArgo
Standard Oil Products in Tbilisi at an effective interest rate of 18% per annum,
in order to fund the construction of new petrol stations in Georgia. No parent
company guarantees have been provided by CanArgo with respect to these loans.
Minority interest in continuing and discontinued subsidiaries decreased by
$638,000 to $2,881,000 at September 30, 2003 from $3,519,000 at December 31,
2002, due to CanArgo purchasing some of the minority interests in CanArgo Norio
by a share swap for shares in CanArgo in the period, offset partially by
minority interest shareholder's share of income in the period.
The foreign currency translation is due to the Company adopted self-sustaining
method of accounting for CanArgo Standard Oil Products. The adoption of the
self-sustaining method was necessitated by the fact that CanArgo Standard Oil
Products was no longer financially and operationally dependant upon its parent
company. Under the self-sustaining method of foreign currency translation,
assets and liabilities are translated into US dollars at period end exchange
rates and income and expenses are translated into US dollars at average rates in
effect during the period. Exchange gains and losses on translation are reflected
as a separate component of shareholders' equity.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL TERMS
Our principal business and assets are derived from production sharing contracts
in the Republic of Georgia. The legislative and procedural regimes governing
production sharing contracts and mineral use licenses in Georgia have undergone
a series of changes in recent years resulting in certain legal uncertainties.
Our production sharing contracts and mineral use licenses, entered into prior to
the introduction in 1999 of a new Petroleum Law governing such agreements have
not, as yet, been amended to reflect or ensure compliance with current
legislation. As a result, despite references in the current legislation
grandfathering the terms and conditions of our production sharing contracts,
conflicts between the interpretation of our production sharing contracts and
mineral use licenses and current legislation could arise. Such conflicts, if
they arose, could cause an adverse effect on our rights under the production
sharing contracts. However the Norio (Block XI(C)) and North Kumisi Production
Sharing Agreement and the Block IX(G) and IX(H) Production Sharing Contract were
concluded after enactment of the Petroleum Law, and under the terms and
conditions of this legislation.
To confirm that the Ninotsminda Production Sharing Contract and the mineral
usage license issued prior to the introduction in 1999 of the Petroleum Law were
validly issued, in connection with its preparation of the Convertible Loan
Agreement with us, the International Finance Corporation, an affiliate of the
World Bank received in November 1998 confirmation from the State of Georgia,
that among other things:
o The State of Georgia recognizes and confirms the validity and
enforceability of the production sharing contract and the license and all
undertakings the State has covenanted with NOC thereunder;
o the license was duly authorized and executed by the State at the time of
its issuance and remained in full force and effect throughout its term; and
o the license constitutes a valid and duly authorized grant by the State,
being and remaining in full force and effect as of the signing of this
confirmation and the benefits of the license fully extend to NOC by virtue
of its interest in the license holder and the contractual rights under the
production sharing contract.
Despite this confirmation and the grandfathering of the terms of existing
production sharing contracts in the Petroleum Law, subsequent legislative or
other governmental changes could conflict with, challenge our rights or
otherwise change current operations under the production sharing contract. No
challenge has been made to date.
26
In 2002, the Participation Agreement for the three well exploration programme on
the Ninotsminda area with a subsidiary of the US power company AES was
terminated without AES earning any rights to any of the Ninotsminda Field
reservoirs. The Company therefore has no present obligations in respect of AES.
However, under a separate Letter of Agreement, if gas from the sub Middle Eocene
is discovered and produced from the area covered by the Participation Agreement
(Ninotsminda and Manavi areas), AES will be entitled to recover approximately
$7.5 million, representing their prior funding under the Participation
Agreement, by way of a rebate of 15% being paid to one of AES' associated
companies, AES Georgia Gas Partner Ltd from future sub Middle Eocene gas sales
where the gas was produced commercially from the sub Middle Eocene net of
operating costs.
In January 2003, CanArgo won exclusive rights to negotiate a Production Sharing
Contract (PSC) for Block XIX in southern Syria. CanArgo had a contingent
obligation to issue an aggregate of 333,000 stock options at a proposed exercise
price of $0.17 per share, subject to the successful award and ratification of
the PSC for Block XIX. Due to CanArgo's decision not to proceed in Syria, this
contingent obligation has now lapsed.
CanArgo has contingent obligations and may incur additional obligations,
absolute or contingent, with respect to the acquisition and development of oil
and gas properties and ventures in which it has interests that require or may
require CanArgo to expend funds and to issue shares of its Common Stock.
At September 30, 2003, CanArgo had a contingent obligation to issue 187,500
shares of common stock to Fielden Management Services PTY, Ltd (a third party
management services company) upon satisfaction of conditions relating to the
achievement of specified Stynawske field project performance standards.
The second phase of the preliminary work programme under the Norio PSA commenced
in January 2002 with the first exploration well at a cost of up to $4.4 million
of which CanArgo's share of costs was $3.2 million. The State Agency for Oil and
Gas Regulations in Georgia has confirmed that CanArgo Norio has satisfied all
drilling and work obligations under the terms of the Norio PSA. The well is
expected to recommence drilling before the end of this year following the
Georgian Oil farm-in. The shareholders agreement with the other shareholder of
CanArgo Norio calls for a bonus payment of $800,000 to be paid by CanArgo should
Commercial Production (as defined in the Production Sharing Agreement) be
obtained from the Middle Eocene or older strata and a second bonus payment of
$800,000 should Commercial Production from the Norio PSA from the Middle Eocene
or older strata exceed 250 tonnes of oil per day over any 90 day period. These
bonuses maybe paid in restricted CanArgo shares at the discretion of CanArgo.
In August 2002, NOC entered into a 12-month crude oil sales agreement to sell
its monthly share of oil produced under the Ninotsminda PSC. As security for
payment the buyer paid to NOC $1 million to be repaid at the end of the
twelve-month period through the delivery of additional crude oil equal to the
value of the security. In May 2003, the parties entered into a new oil sales
agreement whereby the buyer increased the security payment to $1.75 million in
return for the right to lift up to 5,000 metric tonnes of oil per month for the
12-month period commencing August 2003. At the end of the 12 months, the
security payment will be repaid through the delivery of additional crude oil
equal to the value of the security. Under both agreements, crude oil will be
sold at dated Brent less a fixed discount per barrel depending on the Brent
price. The discount ranges from a minimum of $6.00 per barrel when the Brent
quotation is less than $15.00 per barrel to a maximum $7.50 per barrel when
dated Brent is greater than $25.01 per barrel. Following the success of the
N100H well, NOC entered into a further oil sales agreement on similar commercial
terms with the buyer for an additional monthly quantity of 2,500 metric tonnes
of oil. This agreement is for a 12-month period and as security for payment and
for having the option to lift oil on a monthly basis the buyer provided
additional security in the amount of $550,000 during October 2003. The security
will be repaid in oil at the end of the contract period.
If Georgian Oil exercises the Option available to it under the terms of the
Norio farm-in agreement signed in September 2003, CanArgo would issue a further
3 million restricted shares to the minority interest holders from whom CanArgo
acquired an additional 10.8% interest in CanArgo Norio.
27
RESULTS OF CONTINUING OPERATIONS
Nine month period Ended September 30, 2003 Compared to Nine month period Ended
30 September 30, 2002
CanArgo recorded operating revenue from continuing operations of $5,495,000
during the nine month period ended September 30, 2003 compared with $4,558,000
for the nine month period ended September 30, 2002. The increase is primarily
attributable to higher oil and gas revenues, being partially offset by lower
other revenue being recorded in the nine month period ended September 30, 2003.
Other revenue for the nine month period ended September 30, 2003 and 2002,
represented the provision of drilling services in Georgia.
NOC generated $5,272,000 of oil and gas revenue in the nine month period ended
September 30, 2003 compared with $3,160,000 for the nine month period ended
September 30, 2002 due to higher volume of sales resulting from increased
production from the successful horizontal well completed in April 2003 and a
higher average net sales price achieved in the period. Its net share of the
443,026 barrels (1,623 barrels per day) of gross oil production for sale from
the Ninotsminda Field in the period amounted to 287,967 barrels. In the period,
21,509 barrels of oil were added to storage. For the nine month period ended
September 30, 2002, NOC's net share of the 217,608 barrels (797 barrels per day)
of gross oil production was 141,445 barrels. The increase in production is due
to the successful horizontal well completed at the Ninotsminda Field in April
2003.
NOC's entire share of production was sold locally in Georgia under both national
and international contracts. Net sale prices for Ninotsminda oil sold during the
first nine months of 2003 averaged $19.46 per barrel as compared with an average
of $16.61 per barrel in the first nine months of 2002. Its net share of the
84,535 thousand cubic feet (mcf) of gas delivered was 61,299 mcf at an average
net sale price of $1.44 per mcf of gas. For the nine month period ended
September 30, 2002, NOC's net share of the 143,233 mcf of gas delivered was
93,101 mcf at an average net sales price of $1.25 per mcf of gas.
CanArgo had other revenue of $1,398,000 for the nine month period ended
September 30, 2002 compared to other revenue of $224,000 for the nine month
period ended September 30, 2003. In 2003 and 2002, other revenue consisted of
the provision of drilling services. In September 2001, CanArgo entered into an
agreement to provide drilling services to a third party using one of CanArgo's
rigs. Commercial drilling operations commenced in October 2001 and continued
through February 2002. The company subsequently established a wholly owned well
services subsidiary (Argonaut Well Services Limited) and at the end of March
2003 concluded a new drilling service contract with an operating company in
Georgia. It will continue to bid in appropriate tenders for drilling contracts
in order to utilise drilling equipment not otherwise used in its own operations.
The operating loss from continuing operations for the nine month period ended
September 30, 2003 amounted to $859,000 compared with an operating loss of
$2,047,000 for the nine month period ended September 30, 2002. The decrease in
operating loss is attributable primarily to increased oil and gas sales; reduced
field operating costs; and reduced selling, general and administrative expenses
in the period, partially offset by non cash stock compensation expense, profit
generated from a drilling services contract in 2002; and increased depreciation,
depletion and amortization in the period.
Field operating expenses decreased to $1,005,000 for the nine month period ended
September 30, 2003 as compared to $1,141,000 for the nine month period ended
September 30, 2002. The decrease is primarily a result of a cost reduction
programme initiated in the last quarter of 2002 at the Ninotsminda Field,
partially offset by increased activity at the Ninotsminda Field in 2003.
Direct project costs decreased to $691,000 for the nine month period ended
September 30, 2003, from $1,158.000 for the nine month period ended September
30, 2002, primarily due to costs associated with the provision of drilling
services in Georgia in 2002.
Selling, general and administrative costs decreased to $2,022,000 for the nine
month period ended September 30, 2003, from $2,704,000 for the nine month period
ended September 30, 2002. The decrease is primarily as a result of a corporate
cost reduction programme initiated in the last quarter of 2002, and not
incurring $125,000 with respect to closure costs including severance at the
refinery recorded in 2002.
Non cash stock compensation expense increased to $277,000 for the nine month
period ended September 30, 2003, from nil for the nine month period ended
September 30, 2002 due to the Company, effective January 1, 2003, adopting the
fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation," prospectively to all employee awards granted, modified, or
settled after December 31, 2002.
28
The increase in depreciation, depletion and amortization expense to $2,360,000
for the nine month period ended September 30, 2003 from $1,601,000 for the nine
month period ended September 30, 2002 is attributable principally to higher
production resulting from the successful horizontal well at the Ninotsminda
Field completed in April, 2003.
CanArgo recorded net other income of $22,000 for the for the nine month period
ended September 30, 2003, as compared to net other expense of $556,000 for the
nine month period ended September 30, 2002. This is primarily due to due to
CanArgo's adjusted interest in its share of the carrying net asset value of its
subsidiary CanArgo Norio Limited (Norio) giving rise to a non-operating loss of
$444,000, in accordance with the application of SAB 51, following agreement with
the minority shareholders on the finalization of respective equity interest in
Norio during 2002 and an allowance for doubtful accounts of $93,000 relating to
the rental of CanArgo equipment during 2002.
Equity income from investments decreased to $129,000 for the nine month period
ended September 30, 2003 from an equity income of $136.000 for the nine month
period ended September 30, 2002 as a result of equity income from production and
sales of crude oil by BOC.
The cumulative effect of the change in accounting principle of $41,000 for the
nine month period ended September 30, 2003 is a result of the adoption of
accounting standard FAS 143 relating to the treatment of asset retirement
obligations.
The net loss from continuing operations of $814,000 or $0.01 per share for the
nine month period ended September 30, 2003 compares to net loss from continuing
operations of $2,605,000 or $0.03 per share for the nine month period ended
September 30, 2002. The weighted average number of common shares outstanding was
higher during the nine month period ended September 30, 2003 than during the
nine month period ended September 30, 2002, due in large part to private
placements in February and May 2002, and the issuance of shares in September
2003 in respect of CanArgo purchasing some of the minority interests in CanArgo
Norio.
Three Month Period Ended September 30, 2003 Compared to Three Month Period Ended
September 30, 2002
CanArgo recorded operating revenue from continuing operations of $2,494,000
during the three month period ended September 30, 2003 compared with $696,000
for the three month period ended September 30, 2002. The increase is primarily
attributable to higher oil and gas revenues being recorded, as noted below, in
the three month period ended September 30, 2003. Other revenue for the three
month period ended September 30, 2003 and for the three month period September
30, 2002, represented the provision of drilling services in Georgia.
NOC generated $2,468,000 of oil and gas revenue in the three month period ended
September 30, 2003 compared with $696,000 for the three month period ended
September 30, 2002 due to higher volume of sales resulting from increased
production from the successful horizontal well completed in April 2003 and a
higher average net sales price achieved in the period. Its net share of the
200,432 barrels (2,179 barrels per day) of gross oil production for sale from
the Ninotsminda Field in the period amounted to 130,281 barrels. In the period,
15,242 barrels of oil were added to storage. For the three month period ended
September 30, 2002, NOC's net share of the 74,924 barrels (814 barrels per day)
of gross oil production was 48,700 barrels. The increase in production is due to
the successful horizontal well completed at the Ninotsminda Field in April 2003.
NOC's entire share of production was sold locally in Georgia under both national
and international contracts. Net sale prices for Ninotsminda oil sold during the
third quarter of 2003 averaged $20.97 per barrel as compared with an average of
$20.28 per barrel in the third quarter of 2002. Its net share of the 51,656
thousand cubic feet (mcf) of gas delivered was 39,888 mcf at an average net sale
price of $1.39 per mcf of gas. For the three month period ended September 30,
2002, NOC's net share of the 74,797 mcf of gas delivered was 48,618 mcf at an
average net sales price of $1.27 per mcf of gas.
CanArgo had other revenue of $26,000 for the three month period ended September
30, 2003 compared compared with nil for the three month period ended September
30, 2002. Other revenue for the three month period ended September 30, 2003
represented the provision of drilling services in Georgia. The company
established a wholly owned well services subsidiary (Argonaut Well Services
Limited) and at the end of March 2003 concluded a new drilling service contract
with an operating company in Georgia which is now completed. The company will
continue to bid in appropriate tenders for drilling contracts in order to
utilise drilling equipment not otherwise used in its own operations.
29
The operating income from continuing operations for the three month period ended
September 30, 2003 amounted to $273,000 compared with operating loss of $462,000
for the three month period ended September 30, 2002. The decrease in operating
loss is attributable primarily to increased oil and gas sales in the period.
Field operating expenses increased to $360,000 for the three month period ended
September 30, 2003 as compared to $262,000 for the three month period ended
September 30, 2002. The increase is primarily a result of increased activity and
increased production at the Ninotsminda Field.
Direct project costs increased to $266,000 for the three month period ended
September 30, 2003, from $177,000 for the three month period ended September 30,
2002, primarily due to costs associated with the provision of drilling services
in Georgia in 2002.
Selling, general and administrative costs increased to $531,000 for the three
month period ended September 30, 2003, from $403,000 for the three month period
ended September 30, 2002. The increase is primarily due to a reclassification of
an allowance for a $275,000 doubtful debt that was made in the second quarter of
2002. It was subsequently reclassified from Selling, general and administration
to Other expenses in the third quarter of 2002. This was partially offset by a
corporate cost reduction programme initiated in the last quarter of 2002.
The increase in depreciation, depletion and amortization expense to $1,064,000
for the three month period ended September 30, 2003 from $317,000 for the three
month period ended September 30, 2002 is attributable principally to higher
production resulting from the successful horizontal well at the Ninotsminda
Field completed in April, 2003.
CanArgo recorded $1,000 other income for the for the three month period ended
September 30, 2003, as compared to net other expense of $749,000 for the three
month period ended September 30, 2002. This is primarily due to due to CanArgo's
adjusted interest in its share of the carrying net asset value of its subsidiary
CanArgo Norio giving rise to a non-operating loss of $444,000, in accordance
with the application of SAB 51, following agreement with the minority
shareholders on the finalization of respective equity interest in CanArgo Norio
during 2002 and an allowance for doubtful accounts of $93,000 relating to the
rental of CanArgo equipment during 2002.
Equity income from investments increased to $86,000 for the three month period
ended September 30, 2003 from an equity income of $45,000 for the three month
period ended September 30, 2002 as a result of increased equity income from
production and sales of crude oil by BOC.
Net income from continuing operations of $282,000 or $0.00 per share for the
three month period ended September 30, 2003 compares to net loss from continuing
operations of $1,264,000 or $0.01 per share for the three month period ended
September 30, 2002. The weighted average number of common shares outstanding was
higher during the three month period ended September 30, 2003 than during the
three month period ended September 30, 2002, due in large part to the issuance
of shares in September 2003 in respect of CanArgo purchasing some of the
minority interests in CanArgo Norio.
RESULTS OF DISCONTINUED OPERATIONS
Nine month period Ended September 30, 2003 Compared to Nine month period Ended
September 30, 2002
The net income from discontinued operations, net of taxes and minority interest
for the nine month period ended September 30, 2003 amounted to $75,000 compared
with net income of $173,000 for the corresponding period in 2002. The decrease
in net income from discontinued operations, net of taxes and minority interest
relates entirely to the activities of CanArgo Standard Oil Products, and is due
to more competitive operating margins for the nine month period ended September
30, 2003 compared with the corresponding period in 2002 and interest on
additional bank loans drawn by CanArgo Standard Oil Products in Tbilisi at an
effective interest rate of 18% per annum, in order to fund the construction of
new petrol stations in Georgia, offset partially by no depreciation charge for
the nine month period ended September 30, 2003 compared with the corresponding
period in 2002 due to the operation being discontinued.
30
Three Month Period Ended September 30, 2003 Compared to Three Month Period Ended
September 30, 2002
The net income from discontinued operations, net of taxes and minority interest
for the three month period ended September 30, 2003 amounted to $32,000 compared
with net income of $37,000 for the corresponding period in 2002. The decrease in
net income from discontinued operations, net of taxes and minority interest
relates entirely to the activities of CanArgo Standard Oil Products, and is due
to interest on additional short term bank loans drawn by CanArgo Standard Oil
Products in Tbilisi at an effective interest rate of 18% per annum, in order to
fund the construction of new petrol stations in Georgia. Offset partially by
higher volume of sales for the three month period ended September 30, 2003
compared with the corresponding period in 2002 and no depreciation charge for
the three month period ended September 30, 2003 compared with the corresponding
period in 2002 due to the operation being discontinued.
NEW ACCOUNTING STANDARDS
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("FAS 146"). This standard requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
The standard replaced the existing guidance provided by EITF Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The
statement became effective for CanArgo on January 1, 2003. CanArgo does not
expect the adoption of this standard to have a material effect on its financial
statements.
In August 2003, the Company adopted SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of FASB Statement No. 123,
effective January 1, 2003. The Statement provides for three methods of
transitioning from the intrinsic value to the fair value method of accounting
for stock-based compensation. This Statement also amended the disclosure
requirements of SFAS No. 123 and APB Opinion No. 28, "Interim Financial
Reporting," to require prominent disclosures in both annual and interim
financial statements about the method of Accounting stock-based employee
compensation and the effect of the method used on reported results. The
disclosure requirements of the Statement were adopted in the Company's 2002
Annual Report on Form 10-K. The Company adopted the fair value recognition
provisions of SFAS No. 148, on a prospective basis, effective January 1, 2003.
The Company will amend its Quarterly Report on Form 10-Q for the fiscal quarter
ended March 31, 2003 to make conforming amendments in accordance with SFAS No.
148.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107
and a rescission of FASB Interpretation No. 34." This Interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees issued. The Interpretation
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified became effective January 1, 2003.
CanArgo does not expect the adoption of this standard to have a material effect
on its financial statements. To date we have not entered into or modified any
such guarantees.
On January 1, 2003 CanArgo adopted FASB Statement No. 143 Accounting for Asset
Retirement Obligations. Statement 143 requires companies to record the fair
value of a liability for an asset retirement obligation in the period in which
the liability is incurred concurrent with an increase in the long-lived assets
carrying value. The increase and subsequent adjustments in the related
long-lived assets carrying value is amortised over its useful life. Upon
settlement of the liability a gain or loss is recorded for the difference
between the settled liability and the recorded amount.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51." This
Interpretation addresses the consolidation by business enterprises of variable
interest entities as defined in the Interpretation. The Interpretation applies
immediately to variable interests in variable interest entities created after
January 31, 2003, and to variable interests in variable interest entities
obtained after January 31, 2003. The application of this Interpretation is not
expected to have a material effect on the Company's financial statements. The
Interpretation requires certain disclosures in financial statements issued after
31
January 31, 2003 if it is reasonably possible that the Company will consolidate
or disclose information about variable interest entities when the Interpretation
becomes effective.
FORWARD LOOKING STATEMENTS
The forward looking statements contained in this Item 2 and elsewhere in this
Form 10-Q are subject to various risks, uncertainties and other factors that
could cause actual results to differ materially from the results anticipated in
such forward looking statements. Included among the important risks,
uncertainties and other factors are those hereinafter discussed.
Operating entities in various foreign jurisdictions must be registered by
governmental agencies, and production licenses for development of oil and gas
fields in various foreign jurisdictions must be granted by governmental
agencies. These governmental agencies generally have broad discretion in
determining whether to take or approve various actions and matters. In addition,
the policies and practices of governmental agencies may be affected or altered
by political, economic and other events occurring either within their own
countries or in a broader international context.
CanArgo does not have a majority of the equity or in some cases any interest in
the entity that is the operator under the licence of some projects for example,
the Caspian and Bugruvativske projects. In these circumstances, the concurrence
of co-venturers may be required for various actions. Other parties influencing
the timing of events may have priorities that differ from ours, even if they
generally share our objectives. As a result of all of the foregoing, among other
matters, any forward-looking statements regarding the occurrence and timing of
future events may well anticipate results that will not be realized. Demands by
or expectations of governments, co-venturers, customers and others may affect
CanArgo's strategy regarding the various projects. Failure to meet such demands
or expectations could adversely affect CanArgo's participation in such projects
or our ability to obtain or maintain necessary licenses and other approvals.
CanArgo's ability to finance all of its present oil and gas projects and other
ventures according to present plans is dependent upon obtaining additional
funding. An inability to obtain financing could require CanArgo to scale back or
abandon part or all of CanArgo's project development, capital expenditure,
production and other plans. The availability of equity or debt financing to
CanArgo or to the entities that are developing projects in which CanArgo has
interests is affected by many factors, including:
o world economic conditions;
o international relations;
o the stability and policies of various governments;
o fluctuations in the price of oil and gas, the outlook for the oil and
gas industry and competition for funds; and
o an evaluation of CanArgo and specific projects in which CanArgo has an
interest.
Rising interest rates might affect the feasibility of debt financing that is
offered. Potential investors and lenders will be influenced by their evaluations
of us and our projects and comparisons with alternative investment
opportunities.
The development of oil and gas properties is subject to substantial risks.
Expectations regarding production, even if estimated by independent petroleum
engineers, may prove to be unrealized. There are many uncertainties inherent in
estimating production quantities and in projecting future production rates and
the timing and amount of future development expenditures. Estimates of
properties in full production are more reliable than production estimates for
new discoveries and other properties that are not fully productive. Accordingly,
estimates related to CanArgo's properties are subject to change as additional
information becomes available.
Most of CanArgo's interests in oil and gas properties and ventures are located
in Eastern European countries. Operations in those countries are subject to
certain additional risks including the following:
o enforceability of contracts;
o currency convertibility and transferability;
o unexpected changes in tax rates;
o sudden or unexpected changes in demand for crude oil and or natural gas;
o availability of trained personnel; and
32
o availability of equipment and services and other factors that could
significantly change the economics of production.
Production estimates are subject to revision as prices and costs change.
Production, even if present, may not be recoverable in the amount and at the
rate anticipated and may not be recoverable in commercial quantities or on an
economically feasible basis. World and local prices for oil and gas can
fluctuate significantly, and a reduction in the revenue realizable from the sale
of production can affect the economic feasibility of an oil and gas project.
World and local political, economic and other conditions could affect CanArgo's
ability to proceed with or to effectively operate projects in various foreign
countries.
Demands by, or expectations of governments, co-venturers, customers and others
may affect CanArgo's strategy regarding the various projects. Failure to meet
such demands or expectations could adversely affect CanArgo's participation in
such projects or its ability to obtain or maintain necessary licenses and other
approvals.
POSSIBLE RESTATEMENT OF FINANCIAL STATEMENTS
The Company is currently evaluating its accounting treatment of minority
interest in prior periods in respect of the refinery. In September 1998, CanArgo
purchased for $1,000,000 a 12.9% equity interest in GAOR, a company which owns a
small refinery located at Sartichala, Georgia. On November 12, 2000, CanArgo
acquired a further 38.1% of the common stock of GAOR for Common Stock
consideration valued at $1,666,575. On completion of the acquisition, CanArgo
held 51% of the common stock of GAOR and GAOR became a subsidiary of CanArgo.
Under purchase accounting, GAOR's results have been included in CanArgo's
consolidated financial statements since the date of acquisition.
The refinery began operations in July 1998 and has a potential design capacity
of approximately 4,000 barrels per day. Operating as a straight-run distillation
unit it can potentially produce naphtha, diesel, fuel oil and kerosene. Further
product expansion is possible with the addition of additives and or a catalytic
reformer.
Since 2001 the refinery has not been operating. Since its acquisition, sales
from the refinery have been negatively impacted by the imposition of
restrictions and subsequent excise tax on feedstock and refined products.
Although in April 2001, new legislation addressing indigenous refining
activities was passed by the Republic of Georgia that removed or reduced excise
taxes on feedstock and refined product, the refinery has since experienced
unexpected product quality concerns which has effectively curtailed the
enhancement of the basic product stream into gasoline. As a result, the refinery
can only produce straight distillation products such as naphtha, diesel and
mazut and not high octane gasoline as required by petrol stations. Due to the
presence of excise tax on naphtha, there is limited economic demand for the
product in Georgia, either as a feedstock for a separate refining company or for
the blending with higher octane gasoline to produce "normal" grade gasoline for
the local market.
Currently only naphtha, diesel and mazut can be produced and of these products,
an excise tax on naphtha and diesel sales remain in place. As a result of these
taxes and the local market for naphtha in the Republic of Georgia, GAOR deemed
production of naphtha as commercially uneconomic and suspended refining activity
in the fourth quarter of 2001. In January 2002, GAOR entered into a short-term
lease of the refinery to a third party for nominal revenue. During the lease
period, all operating costs of the refinery were borne by the lessee. This lease
expired in May 2002 and has not been renewed. GAOR continues to monitor demand
for products allowed to be produced by the refinery and is seeking changes to
the legislation in support of indigenous refining activities, although no
assurance can be given that such changes can be made. As a result of the
uncertainty as to the ultimate recoverability of the carrying value of the
refinery, CanArgo recorded in 2001 a write-down of the refinery's property,
plant and equipment of approximately $3.5 million.
Minority interest share of losses recorded as of December 31, 2001 and September
30, 2003 exceed the overall minority share of shareholders equity by $1,250,063.
U.S. generally accepted accounting principles specifically provide the following
guidance in Accounting Research Bulletin No 51 Consolidated Financial Statements
("ARB51") paragraph 15: In the unusual case in which losses applicable to the
minority interest in a subsidiary exceed the minority interest in the equity
capital of the subsidiary, such excess and any further losses applicable to the
minority interest should be charged against the majority interest, as there is
no obligation of the minority interest to make good such losses. However, if
future earnings do materialize, the majority interest should be credited to the
extent of such losses previously absorbed.
33
CanArgo is currently evaluating a number of options in respect of its future
interest in the refinery and its previous accounting treatment of its minority
interests. Should the Company not reach a satisfactory conclusion, and given the
continuing uncertainty as to the ultimate recoverability of the carrying value
of the refinery during 2003, the minority share of losses would have to be
written down in the appropriate period which may result in restating prior
period financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
CanArgo's principal exposure to market risk is due to changes in oil and gas
prices and currency fluctuations. As indicated elsewhere in this Report, as a
producer of oil and gas CanArgo is exposed to changes in oil and gas prices as
well as changes in supply and demand which could affect its revenues. CanArgo
does not engage in any commodity hedging activities. Due to the ready market for
its production in the Republic of Georgia, CanArgo does not believe that any
current exposures from this risk will materially affect CanArgo's financial
position at this time, but there can be no assurance that changes in such market
will not affect CanArgo adversely in the future.
Also as indicated elsewhere in this Report, because all of CanArgo's operations
are being conducted in Eastern Europe, CanArgo is potentially exposed to the
market risk of fluctuations in the relative values of the currencies in areas in
which it operates. At present CanArgo does not engage in any currency hedging
operations since, to the extent it receives payments for its production,
refining and marketing activities in local currencies, it is utilizing such
currencies to pay for its local operations. In addition, it currently has
contracts to sell its production from the Ninotsminda Field in the Republic of
Georgia which provide for payment in US dollars.
While CanArgo Standard Oil Products marketing revenue is denominated in Lari,
the local Georgian currency, and is used to pay Lari denominated operating
costs, its long term debt is denominated in US dollars. As a result, changes in
the exchange rate could have a material adverse effect on its ability to pay off
non-Lari denominated indebtedness such as its existing credit facility. The
sensitivity to changes in exchange rates for CanArgo Standard Oil Products was
determined using current market pricing models. We estimate that a 10%
appreciation or devaluation in the foreign exchange rate of the Lari against the
dollar in 2003 would not have had a significant impact on operations.
CanArgo had no material interest in investments subject to market risk during
the period covered by this report.
ITEM 4. CONTROLS AND PROCEDURES
Based upon an evaluation within the 90 days prior to the filing date of this
report, our Chief Executive Officer and Chief Financial Officer have each
concluded that our disclosure controls and procedures as defined in Rules 13a-14
and 15d-14 of the Securities Exchange Act of 1934, as amended, are effective, as
of the evaluation date, in timely alerting them to material information relating
to our Company required to be included in our reports filed or submitted under
the Exchange Act. However, no cost-effective internal control system will
preclude all errors and irregularities, and management is necessarily required
to apply its judgment in evaluating the cost-benefit relationship of possible
controls and procedures. Since the date of the evaluation, there have been no
significant changes in our internal controls or in other factors that could
significantly affect such controls, including any corrective actions with regard
to significant deficiencies and material weaknesses.
34
PART II - OTHER INFORMATION
CANARGO ENERGY CORPORATION AND SUBSIDIARIES
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
Management Contracts, Compensation Plans and Arrangements are identified by an asterisk
(*) Documents filed herewith are identified by a cross (+).
1(1) Escrow Agreement with Signature Stock Transfer, Inc. (Incorporated herein by reference
from Form S-1 Registration Statement, File No. 333-72295 filed on September 9, 1999).
1(2) Selling Agent Agreement with each of Credifinance Securities Limited, David Williamson
Associates Limited, and Orkla Finans (Fondsmegling) ASA (Incorporated herein by reference
from Form S-1 Registration Statement, File No. 333-72295 filed on September 9, 1999).
1(3) Escrow Agreement with Orkla Finans (Fondsmegling) ASA (Incorporated herein by reference
from Form S-1 Registration Statement, File No. 333-72295 filed on September 9, 1999).
1(4) Selling Agent Agreement with National Securities Corporation (Incorporated herein by
reference from Post-Effective Amendment No. 1 to Form S-1 Registration Statement, File No.
333-72295 filed on July 29, 1999).
1(5) Escrow Agreement with Continental Stock Transfer & Trust Company (Incorporated herein by
reference from Post-Effective Amendment No. 1 to Form S-1 Registration Statement, File No.
333-72295 filed on July 29, 1999).
1(6) Engagement Agreement with Sundal Collier & Co ASA dated August 13, 2001. (Incorporated
herein by reference from Post-Effective Amendment No. 2 to Form S-1 Registration
Statement, File No. 333-85116 filed on September 10, 2002).
2(1) Agreement Relating to the Sale and Purchase of All the Issued Share Capital of Gastron
International Limited dated August 10, 1995 by and among Ribalta Holdings, Inc. as Vendor
and Fountain Oil Incorporated as Purchaser, and John Richard Tate as Warrantor
(Incorporated herein by reference from October 19, 1995 Form 8-K).
[Still effective?]
2(2) Supplemental Agreement Relating to the Sale and Purchase of All the Issued Share Capital
of Gastron International Limited dated November 3, 1995 by and among Ribalta Holdings,
Inc. as Vendor and Fountain Oil Incorporated as Purchaser, and John Richard Tate as
Warrantor (Incorporated herein by reference from October 19, 1995 Form 8-K). [Still
effective?]
2(3) Supplemental Deed Relating to the Sale and Purchase of All the Issued Share Capital of
Gastron International Limited dated May 29, 1996 by and among Ribalta Holdings, Inc.
as Vendor and Fountain Oil Incorporated as Purchaser, and John Richard Tate as Warrantor
(Incorporated herein by reference from September 30, 1997 Form
10-Q). [Still effective?]
2(4) Memorandum of Agreement between Fielden Management Services Pty, Ltd., A.C.N. 005 506 123
and Fountain Oil Incorporated dated May 16, 1995 (Incorporated herein by reference from
December 31, 1997 Form 10-K/A). [Still effective?]
2(5) Amended and Restated Combination Agreement between Fountain Oil Incorporated and
35
CanArgo Energy Inc. dated as of February 2, 1998 (Incorporated herein by reference from
Form S-3 Registration Statement, File No. 333-48287 filed on September 9, 1998).
2(6) Voting, Support and Exchange Trust Agreement (Incorporated herein by reference as Annex G
from Form S-3 Registration Statement, File No. 333-48287 filed on September 9, 1998).
3(1) Registrant's Certificate of Incorporation and amendments thereto
(Incorporated herein by reference from July 15, 1998 Form 8-K).
3(2) Registrant's Bylaws (Incorporated herein by reference from Post-Effective Amendment No. 1
to Form S-1 Registration Statement, File No. 333-72295 filed on July 29, 1999).
4(1) Registration Rights Agreement between Registrant and JKX Nederland B.V. dated September
28, 2000, relating to purchase of 21.2% interest in Ninotsminda Oil Company (Incorporated herein by
reference from July 20, 2000 Form 8-K).
*10(1) Form of Option Agreement for options granted to certain persons, including Directors (Incorporated
herein by reference from August 31, 1994 Form 10-KSB, filed by Electromagnetic Oil Recovery, Inc.,
the Company's predecessor).
*10(2) Amended and Restated 1995 Long-Term Incentive Plan (Incorporated herein by reference from
Post-Effective Amendment No. 1 to Form S-1 Registration Statement, File No. 333-72295
filed on July 29, 1999).
*10(3) Amended and Restated CanArgo Energy Inc. Stock Option Plan (Incorporated herein by
reference from September 30, 1998 Form 10-Q).
10(4) Agreement between Georgian American Oil Refinery Company and CanArgo Petroleum Products
Ltd. dated September 26, 1998 (Incorporated herein by reference from Form S-1 Registration
Statement, File No. 333-72295 filed on February 12, 1999).
10(5) Terrenex Acquisition Corporation Option regarding CanArgo (Nazvrevi) Limited (Incorporated
herein by reference from Form S-1 Registration Statement, File No. 333-72295 filed on
February 12, 1999).
10(6) Production Sharing Contract between (1) Georgia and (2) Georgian Oil and JKX Navtobi Ltd.
dated February 12, 1996 (Incorporated herein by reference from Form S-1 Registration
Statement, File No. 333-72295 filed on September 7, 1999).
10(7) Agreement on Financial Advisory Services between CanArgo Energy Corporation, Orkla Finans
(Fondsmegling) A.S and Sundal Collier & Co. ASA dated December 8, 1999 (Incorporated herein
by reference from December 28, 1999 Form 8-K).
10(8) Form of Subscription Agreement (Incorporated herein by reference from December 28, 1999
Form 8-K).
10(9) Agreement between CanArgo Energy Corporation and JKX Nederland BV dated January 19, 2000
(Incorporated herein by reference from December 31, 1999 Form 10-K).
10(10) Agreement between Ninotsminda Oil Company and AES Gardabani dated March 10, 2000
(Incorporated herein by reference from December 31, 1999 Form 10-K).
10(11) Term Sheet dated September 27, 2000 relating to sale of 15,660,916 shares of Registrant's
common stock (Incorporated herein by reference from July 20, 2000 Form 8-K).
10(12) Form of Subscription Agreement relating to sale of 15,660,916 shares of the Registrant's
common stock (Incorporated herein by reference from July 20, 2000 Form 8-K).
36
10(13) Subscription Agreement between Registrant and JKX Nederland B.V. dated September 15, 2000
relating to purchase of 21.2% interest in Ninotsminda Oil Company (Incorporated herein
by reference from July 20, 2000 Form 8-K).
*10(14) Management Services Agreement between CanArgo Energy Corporation and Vazon Energy Limited
relating to the provisions of the services of Dr. David Robson dated June 29, 2000
(Incorporated herein by reference from September 30, 2000 Form 10-Q).
10(15) Tenancy Agreement between CanArgo Energy Corporation and Grosvenor West End Properties
dated September 8, 2000 (Incorporated herein by reference from September 30, 2000 Form 10-Q).
10(16) Agreement between CanArgo Energy Corporation and Roger Brittain dated August 18, 2000
(Incorporated herein by reference from December 31, 2000 Form 10-K).
*10(17) Employment Agreements between CanArgo Energy Corporation and Murray Chancellor dated September
22, 2000 (Incorporated herein by reference from December 31, 2000 Form 10-K).
*10(18) Employment Agreements between CanArgo Energy Corporation and Anthony Potter dated October
1, 2000 (Incorporated herein by reference from December 31, 2000 Form 10-K).
10(19) Production Sharing Contract between (1) Georgia and (2) Georgian Oil and CanArgo Norio
Limited dated December 12, 2000 (Incorporated herein by reference from December 31, 2000 Form 10-K).
10(20) Agreement between CanArgo Energy Corporation and Georgian British Oil Services Company dated
November 10, 2000 relating to the purchase of 9.35% interest in Georgian American Oil Refinery
(Incorporated herein by reference from December 31, 2000 Form 10-K).
10(21) Share Exchange Agreement between CanArgo Energy Corporation and Argonaut Oil and Gas Limited
dated November 10, 2000, related to the purchase of 28.7% interest in Georgian American Oil Refinery
(Incorporated herein by reference from December 31, 2000 Form 10-K).
*10(22) Employment Agreements between CanArgo Energy Corporation and Vincent McDonnell dated December
1, 2000 (Incorporated herein by reference from December 31, 2001 Form 10-K).
10(23) Agreement Number 1 dated March 20, 1998 on Joint Investment Production Activity for further development
and further exploration of Bugruvativske Field (Incorporated herein by reference from
September 30, 2001 Form 10-Q).
10(24) Crude Oil Sales Agreement dated August 13, 2002 (Incorporated herein by reference from
September 30, 2002 Form 10-Q)
10(25) Covenant on terms and conditions of participation in investment activity under the Joint
Investment Production Activity agreement dated of March 20, 1998, dated July 23, 2002.
(Incorporated herein by reference from September 30, 2002 Form 10-Q)
10(26) Stock sale purchase contract of IPEC between Lateral Vector Resources and Northern Industrial
Development dated July 25, 2002. (Incorporated herein by reference from September 30, 2002 Form
10-Q)
10(27) Amendments of and Additions to Joint Investment Production Activity agreement of March 20,
1998, dated August 8, 2002. (Incorporated herein by reference from September 30, 2002 Form
10-Q)
10(28) Amendment of Clause 9.3.1 of Amendments of and Additions to the Joint Investment
37
Production Activity agreement of March 20, 1998, dated September 17, 2002. (Incorporated
herein by reference from September 30, 2002 Form 10-Q)
10(29) Stock sale purchase contract of IPEC between Lateral Vector Resources Inc. and Lystopad
dated September 24, 2002. (Incorporated herein by reference from September 30, 2002 Form
10-Q)
10(30) Stock sale purchase contract of IPEC between Lateral Vector Resources Inc. and Lyutyi
dated September 24, 2002. (Incorporated herein by reference from September 30, 2002 Form
10-Q)
10(31) Sale agreement of CanArgo Petroleum Products Limited between CanArgo Limited and Westrade
Alliance LLC dated October 14, 2002. (Incorporated herein by reference from September 30, 2002 Form
10-Q)
10(32) Crude Oil Sales Agreement dated May 5, 2003
+10(33) Farm-in Agreement dated September 4, 2003 relating to the Norio (Block XIC) and North Kumisi
Production Sharing Agreement in the Republic of Georgia with a wholly owned subsidiary of Georgian Oil,
the Georgian State Oil Company
+10(34) Farm-in Agreement dated September 7, 2003 relating to the M11 well on the Manavi Cretaceous
prospect within the Ninotsminda PSC area between Ninotsminda Oil Company Limited and Georgian
British Oil Services Company Limited
+10(35) Stock Purchase Agreement dated September 24, 2003 regarding the sale of all of the issued
and outstanding stock of Fountain Oil Boryslaw
21 List of Subsidiaries (Incorporated herein by reference from September 30, 2001 Form 10-Q)
+33(1) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer of CanArgo Energy
Corporation.
+31(2) Rule 13a-14(c)/15d-14(a) Certification of Chief Financial Officer of CanArgo Energy
Corporation.
+32 Section 1350 Certifications.
(B) Reports on Form 8-K:
The following current reports on form 8-K were filed during the
quarter ended September 30, 2003.
On August 19, 2003, CanArgo announced its second quarter results for
2003.
On September 4, 2003, CanArgo announced that it had signed a Farm-In
Agreement relating to the Norio (Block XIC) and North Kumisi
Production Sharing Agreement in the Republic of Georgia with a
wholly owned subsidiary of Georgian Oil, the Georgian State Oil
Company.
On September 4, 2003, CanArgo announced the initial results of
horizontal well N100H, in the Ninotsminda Field, Georgia.
On September 8, 2003, CanArgo announced that drilling had recommenced
on the Manavi prospect through a farm-in by a local Georgian oil and
gas company.
On September 30, 2003, CanArgo announced that it had reached
conditional agreement to sell its interest in Boryslaw Oil Company,
the joint venture in west Ukraine currently operating the Stynawske
oilfield.
38
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CANARGO ENERGY CORPORATION
Date: November 14, 2003 By: /s/Vincent McDonnell
--------------------
Vincent McDonnell
Chief Financial Officer
39