FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________.
Commission File Number: 0 - 7261
CHAPARRAL RESOURCES, INC.
----------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 84-0630863
------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
16945 Northchase Drive, Suite 1620
Houston, Texas 77060
--------------------
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (281) 877-7100
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.
YES |X| NO |_|
As of November 19, 2001 the Registrant had 14,283,801 shares of its common
stock, par value $0.0001 per share, issued and outstanding.
Part I - Summarized Financial Information
Item 1 - Financial Statements
Chaparral Resources, Inc.
Consolidated Balance Sheets
(In Thousands)
September 30, December 31,
2001 2000
(Unaudited) (Audited)
------------ ----------
Assets
Current assets:
Cash and cash equivalents $ 29 $ 604
Accounts receivable -- 30
Receivable from affiliate -- 265
Prepaid expenses 241 202
-------- --------
Total current assets 270 1,101
Investment in KKM and other oil and gas
property costs - full cost method
Republic of Kazakhstan: 68,360 64,902
Furniture, fixtures and equipment 109 91
Less: accumulated depreciation (58) (41)
-------- --------
51 50
-------- --------
Other assets
Hedge agreement 392 3,518
Other 484 585
-------- --------
Total other assets 876 4,103
-------- --------
Total assets $ 69,557 $ 70,156
======== ========
See accompanying notes.
2
Chaparral Resources, Inc.
Consolidated Balance Sheets (continued)
(In Thousands)
September 30, December 31,
2001 2000
(Unaudited) (Audited)
------------- -------------
Liabilities and stockholders' equity Current liabilities:
Accounts payable $ 563 $ 243
Accrued liabilities:
Accrued compensation 415 346
Accrued interest and other 200 213
Shell Capital loan, current portion net of discount 32,328 900
-------- --------
Total current liabilities 33,506 1,702
Shell Capital loan, net of discount -- 20,978
Redeemable preferred stock- cumulative, convertible,
Series A 75,000 designated, 50,000 issued and outstanding,
At stated value, $5.00 cumulative annual
Dividend, $5,937,000 redemption value 5,813 5,550
Stockholders' equity:
Common stock - authorized, 100,000,000 shares
of $0.0001 par value; issued
and outstanding, 14,283,801 and
14,283,634 shares as of September 30, 2001
and December 31, 2000, respectively 1 1
Capital in excess of par value 94,061 94,061
Preferred stock - 1,000,000 shares authorized,
925,000 shares undesignated. Issued and outstanding - none -- --
Accumulated deficit (63,824) (52,136)
-------- --------
Total stockholders' equity 30,238 41,926
-------- --------
Total liabilities and stockholders' equity $ 69,557 $ 70,156
======== ========
See accompanying notes.
3
Chaparral Resources, Inc.
Consolidated Statements of Operations (Unaudited)
(In Thousands, Except Share Data)
For the Three Months Ended For the Nine Months Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
----------------------------------------------------------------------
Revenue $ -- $ -- $ -- $ --
Costs and expenses:
Depreciation and depletion 250 116 593 230
General and administrative 940 1,054 3,099 2,520
------------ ------------ ------------ ------------
1,190 1,170 3,692 2,750
------------ ------------ ------------ ------------
Loss from operations (1,190) (1,170) (3,692) (2,750)
Other income (expense):
Interest income 371 2 1,188 10
Interest expense (6,312) (22,597) (10,009) (25,293)
Equity in income from investment 1,208 736 4,213 1,601
Hedge gains/(losses) 158 -- (607) --
Other -- 3 -- 69
------------ ------------ ------------ ------------
(4,575) (21,856) (5,215) (23,613)
------------ ------------ ------------ ------------
Loss before cumulative effect of change in
accounting principle (5,765) (23,026) (8,907) (26,363)
Cumulative effect of change in accounting
principle -- -- (2,519) --
------------ ------------ ------------ ------------
Net loss $ (5,765) $ (23,026) $ (11,426) $ (26,363)
============ ============ ============ ============
Cumulative annual dividend accrued
Series A Redeemable Preferred Stock (63) (63) (188) (188)
Discount accretion
Series A Redeemable Preferred Stock (25) (25) (75) (75)
------------ ------------ ------------ ------------
Net loss available to common stockholders $ (5,853) $ (23,114) $ (11,689) $ (26,626)
============ ============ ============ ============
Basic and diluted earnings per share:
Loss per share before cumulative
effect of change in accounting principle $ (0.41) $ (10.88) $ (0.64) $ (19.49)
Cumulative effect of change in
accounting principle $ -- $ -- $ (0.18) $ --
Net loss per share $ (0.41) $ (10.88) $ (0.82) $ (19.49)
Weighted average number of shares
outstanding (basic and diluted) 14,283,801 2,124,083 14,283,783 1,365,848
See accompanying notes.
4
Chaparral Resources, Inc.
Consolidated Statements of Cash Flows (Unaudited)
(In Thousands)
For the Nine Months Ended
September 30, September 30,
2001 2000
------------------- ------------------
Cash flows from operating activities
Net loss $(11,426) $(26,363)
Adjustments to reconcile net loss to
Net cash used in operating activities:
Equity income from investment (4,213) (1,601)
Depreciation, depletion, and amortization 694 354
Gain on the sale of oil and gas properties -- (75)
Loss on disposition of furniture and fixtures -- 6
Cumulative effect of change in
accounting principal 2,519 --
Hedge losses 607 --
Stock options issued for services and bonuses -- 16
Interest expense attributable to beneficial
conversion -- 20,340
Interest expense converted into capital -- 899
Interest expense from transfer of net profits
interest 4,369 --
Amortization of debt issuance cost 540 687
Amortization of note discount -- 464
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable 295 (348)
Prepaid expenses (39) (36)
Accrued interest income on advances to KKM (1,185) --
Interest payments from KKM 3,913 --
Hedge agreement -- (4,000)
Other -- (750)
Increase (decrease) in:
Accounts payable and accrued liabilities 376 (2,758)
Interest expense reclassified as principal
on the Shell Capital loan 4,260 2,273
-------- --------
Net cash provided (used) in operating activities 710 (10,892)
-------- --------
Cash flows from investing activities
Additions to furniture, fixtures and equipment $ (18) $ (10)
Investment in and advances to KKM and other oil and
gas property costs (6,917) (19,972)
Proceeds from sale of interest in oil and gas
properties - domestic -- 75
-------- --------
Net cash used in investing activities (6,935) (19,907)
-------- --------
5
Chaparral Resources, Inc.
Consolidated Statements of Cash Flows (Continued) (Unaudited)
(In Thousands)
For the Nine Months Ended
September 30, September 30,
2001 2000
---------------------------------
Cash flows from financing activities
Net proceeds from Shell Capital loan $ 5,650 $ 21,500
Net proceeds from note conversion -- 10,806
Debt issuance cost -- (482)
Restricted cash -- 578
-------- --------
Net cash provided by financing activities 5,650 32,402
-------- --------
Net (decrease) increase in cash and
cash equivalents (575) 1,603
Cash and cash equivalents at beginning
of period 604 23
-------- --------
Cash and cash equivalents at end of period $ 29 $ 1,626
======== ========
Supplemental cash flow disclosure
Interest paid $ 669 $ 624
Supplemental schedule of non-cash
investing and financing activities
Stock warrant issued to Shell Capital -- 1,175
Notes payable converted to common stock -- 20,846
See accompanying notes.
6
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
1. General
Chaparral Resources, Inc. ("Chaparral") was incorporated in the state of
Colorado on January 13, 1972, principally to engage in the exploration,
development and production of oil and gas properties. Chaparral focuses
substantially all of its efforts on the exploration and development of the
Karakuduk Field, an oilfield located in the Central Asian Republic of
Kazakhstan. In 1999, Chaparral reincorporated from Colorado to Delaware.
The consolidated financial statements include the accounts of Chaparral and its
100% owned subsidiaries, Central Asian Petroleum (Guernsey) Limited ("CAP-G"),
Road Runner Services Company ("RRSC"), Chaparral Acquisition Corporation
("CAC"), and Central Asian Petroleum, Inc. ("CAP-D"). Chaparral owns 80% of the
common stock of CAP-G directly and 20% indirectly through CAP-D. As discussed in
Note 7, Shell Capital Incorporated ("Shell Capital") owns a 40% interest in the
distributable profits of CAP-G. Hereinafter, Chaparral and its subsidiaries are
collectively referred to as the "Company." All significant intercompany
transactions have been eliminated.
CAP-G owns a 50% interest in Closed Type JSC Karakudukmunay ("KKM"), a
Kazakhstan joint stock company, which holds the rights for the exploration,
development and production of oil in the Karakuduk Field in Western Kazakhstan.
KKM is owned jointly by CAP-G (50%), KazakhOil JSC ("KazakhOil") (40%) and a
private Kazakhstan joint stock company (10%). KazakhOil, the national petroleum
company of Kazakhstan, is owned by the government of the Republic of Kazakhstan.
The Company shares control of KKM through participation on KKM's board of
directors.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. Reference should be made to the notes to the
financial statements in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2000.
The information furnished herein was taken from the books and records of the
Company without audit. However, such information reflects all adjustments, which
are, in the opinion of management, normal recurring adjustments necessary to a
fair statement of the results for the interim periods presented. The results of
operations for the interim periods are not necessarily indicative of the results
to be expected for any future interim period or for the year.
2. New Accounting Standards
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This standard provides a comprehensive and
consistent standard for the recognition and measurement of derivatives and
hedging activities. This statement, as amended by SFAS No. 137 and 138, is
effective for years beginning after June 15, 2000. On January 1, 2001, the
Company adopted SFAS No. 133.
7
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
2. New Accounting Standards (continued)
As a result of adoption of SFAS 133, the Company recognizes all derivative
financial instruments in the consolidated financial statements at fair value
regardless of the purpose or intent for holding the instrument. Changes in the
fair value of derivative financial instruments are recognized periodically in
income or in stockholders' equity as a component of comprehensive income
depending on whether the derivative financial instrument qualifies for hedge
accounting, and if so, whether it qualifies as a fair value hedge or cash flow
hedge. Generally, changes in fair values of derivatives accounted for as fair
value hedges are recorded in income along with the portions of the changes in
the fair values of the hedged items that relate to the hedged risks. Changes in
fair values of derivatives accounted for as cash flow hedges, to the extent they
are effective as hedges, are recorded in other comprehensive income net of
deferred taxes. Changes in fair values of derivatives not qualifying as hedges
are reported in income. The Company's put contracts entered into as part of its
loan agreement (the "Loan") with Shell Capital Incorporated ("Shell Capital"),
do not qualify for hedge accounting under SFAS 133. Therefore, effective January
1, 2001, the Company adjusted the carrying value of the contracts to their fair
value of $999,000, recognizing a loss from the cumulative effect of adoption of
approximately $2.52 million.
During 2001, the FASB has issued the following pronouncements, which have
potential future accounting implications for the Company:
SFAS 141, Accounting for Business Combinations, requires the use of the purchase
method of accounting for all business combinations and provides new criteria to
determine whether an acquired intangible asset should be recognized. SFAS 141
applies to all business combinations initiated after June 30, 2001 and to all
business combinations accounted for by the purchase method that are completed
after June 30, 2001.
SFAS 142, Accounting for Goodwill and Intangible Assets, requires that goodwill
as well as other intangible assets with indefinite lives be tested annually for
impairment. SFAS 142 is effective for fiscal years beginning after December 15,
2001.
SFAS 143, Accounting for Asset Retirement Obligations, requires entities to
record the fair value of a liability for an asset retirement obligation in the
period in which it is incurred and a corresponding increase in the carrying
amount of the related long-lived asset. SFAS 143 is effective for fiscal years
beginning after June 15, 2002.
SFAS 141 and 142 will not apply to the Company unless it enters into a future
business combination. The Company is currently assessing the impact of SFAS 143
on its financial condition and results of operations.
3. Going Concern
The Company's financial statements have been presented on the basis that it is a
going concern, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. The Company has incurred recurring
operating losses in previous years and has a working capital deficiency as of
September 30, 2001. In addition, the Company is in default under the Loan with
Shell Capital, which could result in the loss of the Company's investment in the
Karakuduk Field (see Note 7). These conditions raise substantial doubt about the
Company's ability to continue as a going concern. The financial statements do
not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of these uncertainties.
8
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
3. Going Concern (continued)
The Company is seeking to alleviate these conditions by restructuring the terms
of the Loan with Shell Capital, including obtaining a waiver of all existing
events of default, obtaining additional sources of equity or debt financing, and
increasing cash flows available from the sale of crude oil production from the
Karakuduk Field. No assurances can be provided, however, that the Company will
be able to restructure the Loan or successfully generate enough liquidity to
meet the working capital requirements necessary to conduct ongoing operations.
Shell Capital has reserved its right to exercise all remedies available under
the Loan, including calling the Loan immediately due and payable, seizing the
Company's investment in the Karakuduk Field, or retaining future proceeds from
oil sales currently being utilized by the Company to fund operations. The
Company requires Shell Capital's approval before it can raise any additional
equity or debt financing from other sources, which may hinder the Company's
attempts to raise the necessary working capital to continue operations if the
Company's negotiations with Shell Capital are unsuccessful. If the Company is
unable to re-negotiate the Loan with Shell Capital, the Company's investment in
the Karakuduk Field may be lost.
4. Restatement of Quarter and Nine Months Ended September 30, 2000
The Company's net loss available to common stockholders for the quarter ended
September 30, 2000 has been restated from $23.13 million to $23.11 million, or
by $0.01 per share of common stock. The adjustment is due to KKM's restatement
of proved oil reserves as of December 31, 1999 to reflect the SEC's definition
of proved undeveloped reserves versus the definition as accepted by the Society
of Petroleum Engineers. Specifically, the restated amounts represent proved
undeveloped reserves from "drilling units offsetting productive units that are
reasonably certain of production when drilled" or from "other undrilled
units...where it can be demonstrated with certainty that there is a continuity
of production from the existing productive formation." As a result of the
restatement, the Company's equity income from investment for the quarter ended
September 30, 2000 was increased by $88,000 to reflect adjustments to KKM's net
income for the period (see Note 9). The Company recognized an additional $77,000
in depreciation and depletion expense for the quarter ended September 30, 2000
due to the resulting increase in the effective depletion rate attributable to
the Company's acquisition costs of its equity interest in KKM. Equity income
from investment for the quarter ended September 30, 2000 also reflects the
elimination of $442,000 in interest income from KKM to eliminate 100% of
intercompany transactions due to the application of EITF 99-10, Percentage Used
to Determine the Amount of Equity Method Losses. The reclassification of
interest income did not impact the Company's net loss for the period.
The Company's net loss available to common stockholders for the nine months
ended September 30, 2000 was restated from $26.85 million to $26.63 million, or
by $0.17 per share of common stock, based on KKM's restatement of proved oil
reserves as of December 31, 1999 discussed above. The Company's equity income
from investment for the nine months ended September 30, 2000 was increased by
$377,000 to reflect adjustments to KKM's net income for the period (see Note 9).
The Company recognized an additional $149,000 in depreciation and depletion
expense due to the resulting increase in the effective depletion rate
attributable to the Company's acquisition costs of its equity interest in KKM.
Equity income from investment for the nine months ended September 30, 2000, as
adjusted, also reflects the elimination of $1.17 million in interest income from
KKM to eliminate 100% of intercompany transactions due to the application of
EITF 99-10, Percentage Used to Determine the Amount of Equity Method Losses. The
reclassification of interest income did not impact the Company's net loss for
the period.
9
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
5. Hedge Agreement
As a condition of the Loan, the Company paid $4 million for put contracts to
sell 1,562,250 barrels of North Sea Brent crude (the "Hedge Agreement") to hedge
price risk of future sales of oil production from the Karakuduk Field. The
exercise prices of the various put contracts in the Hedge Agreement range from
$22.35 to $17.25 per barrel, with monthly expiration dates beginning in October
2000 and ending in December 2002. The contracts are evenly spread between
October 2000 to December 2001 (62,750 barrels per month) and between January
2002 to December 2002 (51,750 barrels per month). Beginning in October 2000, the
Company amortized the Hedge Agreement ratably over the period the underlying
contracts expired, recognizing $482,000 in hedge losses as of December 31, 2000.
As discussed in Note 2, the Company adopted SFAS 133 effective January 1, 2001,
which requires derivative financial instruments be recorded at their fair value.
Accordingly, the Company recognized a $2.52 million loss from the cumulative
effect of change in accounting principle upon adoption. In addition, the Company
recognized $607,000 in losses for the nine months ended September 30, 2001
to record the Hedge Agreement at its fair value as of that date in accordance
with SFAS 133.
6. Other Assets
In March 2000, the Company paid $750,000 to Shell Capital for a beneficial
interest in Shell Capital's policy for transportation risk insurance, covering
certain circumstances whereby KKM would be unable to export crude oil production
outside of the Republic of Kazakhstan through the existing pipeline routes
currently available. In the event coverage under Shell Capital's policy is
triggered, proceeds from the policy would go to the benefit of the Company for
use in making principal and interest payments required under the Loan. The
Company is amortizing the transportation risk insurance over the life of the
Loan. The Company has recognized cumulative amortization expense of $271,000 on
the transportation risk policy, of which $101,000 was incurred during the nine
months ended September 30, 2001.
7. Shell Capital Loan
In November 1999, the Company entered into the Loan with Shell Capital, to
provide up to $24 million of financing for the development of the Karakuduk
Field. CAP-D, CAP-G, and KKM also signed the Loan as co-obligors. As of
September 30, 2001, the Company had drawn down the entire $24 million principal
balance available under the Loan.
The Loan accrues interest at an annual rate of the London Interbank Offered Rate
("LIBOR") plus 17.75%, compounding quarterly prior to project completion
("Project Completion"). Prior to Project Completion, an interest amount, equal
to annual rate of LIBOR plus .50%, is payable quarterly to Shell Capital. The
annual interest rate is reduced to LIBOR plus 12.75% after Project Completion.
The remaining unpaid interest is added to the Loan balance at the end of each
quarter. After Project Completion, all quarterly interest on the outstanding
Loan is fully due and payable by the Company at the end of each calendar
quarter.
Per the terms of the Loan, Project Completion occurs when various conditions are
met by the Company and KKM, including, but not limited to: (i) receipt by Shell
Capital of an independent engineer's reserve report evidencing proved developed
reserves of at least 30 million barrels in the Karakuduk Field, (ii) sustaining
average gross production of 13,000 barrels of oil per day from the Karakuduk
Field for a period of 45 consecutive days, (iii) sustaining water injection at
an average rate of 15,000 barrels per day over 45 consecutive days, (iv)
injection of lift gas into one well over a 24 hour period, and (v) various other
financial and technical milestones.
10
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
7. Shell Capital Loan (continued)
In May 2001, the Loan was amended to provide the Company with up to $8.0 million
in uncommitted working capital, which could be drawn down in increments of
$250,000 through August 31, 2001, at the sole discretion of Shell Capital (the
"Bridge Loan"). The Company borrowed a total of $3.15 million under the Bridge
Loan through August 31, 2001. The principal borrowed under the Bridge Loan
accrues interest at LIBOR plus 17.75% and is subject to an arrangement fee of
2%. Interest payments in the amount of LIBOR plus .50% are due at the end of
each month the Bridge Loan is outstanding. All unpaid interest is added to the
outstanding principal balance on each repayment date. The outstanding principal
of the Bridge Loan, plus all accrued interest, was due on or before September
30, 2001.
As an incentive for the Company to repay the Bridge Loan or refinance the entire
Loan (including the Bridge Loan), Chaparral's board of directors approved
CAP-G's issuance of Series A Preferred shares to Shell Capital. Per the terms of
the amendment, if the Company failed to repay or refinance the Bridge Loan on or
before September 30, 2001, the Series A Preferred shares automatically convert
and entitle Shell Capital to 40% of the distributable profits of CAP-G.
As of September 30, 2001, the Company was in default of the Loan for failure to
pay outstanding principal and interest due on the Bridge Loan totaling $3.34
million on or before September 30, 2001, failure to make an interest payment
totaling $189,280 due September 28, 2001, failure to achieve Project Completion
by September 30, 2001, failure to settle certain accounts payable within 90
days, KKM's failure to obtain Shell Capital's approval prior to entering a
short-term debt arrangement, and failure to maintain listing of the Company's
common stock on one of the major stock exchanges (i.e. Nasdaq, NYSE, or AMEX).
The Company had previously obtained a waiver from Shell Capital regarding the
delisting of its common stock from the Nasdaq SmallCap Market, subject to the
Company not incurring another event of default under the Loan. Shell Capital
terminated the waiver due to the other events of default discussed above. The
Company subsequently repaid all outstanding default interest due on both the
Loan and Bridge Loan and KKM repaid the short-term indebtedness obtained without
Shell Capital's approval.
As a result of the Company's failure to timely repay the Bridge Loan, Shell
Capital's Series A Preferred shares in CAP-G converted as of October 1, 2001,
entitling Shell Capital to 40% of the distributable profits of CAP-G. The
Company recorded an additional loan discount of $4.37 million, equal to 40% of
the Company's unamortized costs of acquiring its equity interest in CAP-G, which
is estimated to approximate the fair value of the net profits interest
transferred to Shell Capital. The discount was fully recognized as interest
expense on September 30, 2001, the maturity date of the Bridge Loan.
The Company and Shell Capital are in active negotiations to restructure the Loan
and Shell Capital has not exercised any of its remedies available under the
Loan, except for charging a default interest rate of LIBOR plus 19.75% on the
outstanding principal balance of the Bridge Loan. The Company is attempting to
restructure the Loan, including obtaining a waiver of all existing events of
default and re-acquiring Shell Capital's 40% interest in the distributable
profits of CAP-G. However, there can be no assurances that the Company will be
able to re-negotiate the Loan on acceptable terms, if at all. If not, Shell
Capital could exercise its remedies available under the Loan, including calling
the entire Loan immediately due and payable.
11
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
7. Shell Capital Loan (continued)
The Loan subjects the Company to a significant number of restrictions, including
various representations and warranties, positive and negative covenants, and
events of default, which are more fully described in the Company's Form 10-K for
the year ended December 31, 2000. In general, the Company has pledged
substantially all of its assets to Shell Capital as collateral for the Loan and
has committed to not engage in any other business activity besides the
development of the Karakuduk Field without Shell Capital's approval.
As of September 30, 2001, the outstanding Loan balance (including the Bridge
Loan) of $32.33 million is comprised of $27.15 million in cash borrowings plus
$7.74 million of interest added to the balance as additional principal, net of
$2.56 million in unamortized discount. Interest expense for the nine months
ended September 30, 2001 totaled $10.01 million, including $5.13 million of
interest on outstanding principal and $4.88 million in discount amortization.
Due to the fact the Loan is currently in default, the Company recorded the
entire outstanding principal balance of the Loan as a current liability in the
Company's financial statements.
8. Common Stock
On August 9, 2001, the Company's common stock was delisted from the Nasdaq
SmallCap Market for failure to comply with Nasdaq Marketplace Rules
4350(i)(1)(A), 4350(i)(1)(B) and 4350(i)(1)(D)(ii), which required the Company
to obtain stockholder approval prior to the conversion of its 8% Non-Negotiable
Subordinated Convertible Promissory Notes into 11,690,259 shares of its common
stock on September 21, 2000 and the issuance of 1,612,903 shares of common stock
on October 30, 2000. Nasdaq also cited a violation of its annual meeting
requirement. The Nasdaq Listing Qualifications Panel did not, however, cite any
public interest concerns as a basis for its determination. The Company's common
stock is being traded on the OTC Bulletin Board. The Company's failure to
maintain listing of its common stock on one of the major stock exchanges (i.e.
NASDAQ, NYSE, or AMEX), is an event of default under the Loan (see Note 7).
12
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
9. Investments
The results from operations of the Company's equity-based investment in KKM are
summarized below:
Closed Type JSC Karakudukmunay
Statement of Expenses and Accumulated Deficit
For the Periods Ended September 30, 2001 and 2000
(Amounts in Thousand US Dollars)
(Unaudited)
For The Three Months Ended For The Nine Months Ended
-------------------------------------------------------------------------
September 30, September 30, September 30, September 30,
2001 2000(2) 2001 2000(3)
------------------------------------------------------------------------
Revenues:
Oil Sales(1) $ 6,916 $ 4,341 $ 24,911 $ 8,893
Costs and expenses:
Transportation expenses 1,234 714 5,016 1,783
Operating expenses 812 1,521 3,310 2,315
Depreciation and depletion 1,828 884 5,891 1,892
Management service fee 144 173 401 454
General and administrative 711 615 2,753 1,637
----------------------------------------------------------------------
Total cost and expenses 4,729 3,907 17,371 8,081
----------------------------------------------------------------------
Income from operations 2,187 434 7,540 812
Other income (expense):
Interest income $ 3 $ 14 $ 13 $ 41
Interest expense from affiliates (514) (596) (1,446) (1,528)
Other 1 -- (51) (57)
----------------------------------------------------------------------
Net income (loss) $ 1,677 $ (148) $ 6,056 (732)
Accumulated deficit, beginning of
period (6,223) (12,591) (10,602) (12,007)
----------------------------------------------------------------------
Accumulated deficit, end of period $ (4,546) $(12,739) $ (4,546) $(12,739)
======================================================================
(1) Revenue is presented gross of transportation expenses in accordance
with EITF 00-10, Accounting for Shipping and Handling Fees and Costs.
(2) As discussed in Note 4, KKM's net loss for the quarter ended September
30, 2000 has been restated from $236,000 to $148,000 to reflect
additional interest capitalization of $287,000 and additional
depreciation and depletion expense of $199,000 during the period.
(3) As discussed in Note 4, KKM's net loss for the nine months ended
September 30, 2000 has been restated from $1,109,000 to $732,000 to
reflect additional interest capitalization of $806,000 and additional
depreciation and depletion expense of $429,000 during the period.
13
Chaparral Resources, Inc.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
9. Investments (continued)
During the quarter ended September 30, 2001, KKM sold approximately 385,000
barrels of crude oil for $6.92 million in revenue. Export sales for the period
were approximately 345,000 barrels of crude oil for approximately $6.57 million.
To fulfill government requirements, KKM also sold approximately 40,000 barrels
on the local market for approximately $350,000. Approximately 226,000 barrels of
crude oil were held in crude oil inventory as of September 30, 2001.
During the nine months ended September 30, 2001, KKM sold approximately 1.36
million barrels of crude oil for approximately $24.91 million in revenue. Export
sales for the period were approximately 1.06 million barrels of crude oil for
approximately $22.21 million. To fulfill government requirements, KKM also sold
approximately 295,000 barrels on the local market for approximately $2.70
million.
The Company's equity income or loss from investment in KKM represents its share
of KKM's net income or loss for the respective period after applying EITF 99-10,
adjusted for the elimination of the Company's proportional share of
inter-company interest charged by the Company to KKM during the period.
14
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
1. Liquidity and Capital Resources
General Liquidity Considerations.
---------------------------------
Going Concern
-------------
Our financial statements have been presented on the basis Chaparral is a going
concern, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. We are responsible for providing
100% of the funding for the development of the Karakuduk Field not provided from
oil sales or third party sources. We have recognized recurring operating losses
and have a working capital deficiency as of September 30, 2001. In addition,
Chaparral is in default under its loan with Shell Capital, which could result in
the loss of our investment in the Karakuduk Field.
We are seeking to alleviate these conditions by restructuring the terms of the
loan with Shell Capital, including obtaining a waiver of all outstanding
defaults, obtaining additional sources of equity or debt financing, and
increasing cash flows available from the sale of crude oil production from the
Karakuduk Field. No assurances can be provided, however, that we will be able to
restructure the loan or successfully generate enough liquidity to meet the
working capital requirements necessary to conduct ongoing operations. Shell
Capital has reserved the right to exercise all remedies available under the
loan, including calling the loan immediately due and payable, seizing our
investment in the Karakuduk Field, or retaining future proceeds from oil sales
currently being utilized by Chaparral and KKM to fund operations. We require
Shell Capital's approval before we can raise any additional equity or debt
financing from other sources, which may hinder our ability to raise the
necessary working capital to continue operations if our negotiations with Shell
Capital are unsuccessful. If we are unable to re-negotiate our loan with Shell
Capital, our investment in the Karakuduk Field may be lost.
Liquidity and Capital Resources
-------------------------------
We are presently engaged in the development of the Karakuduk Field, which
requires substantial cash expenditures for drilling costs, well completions,
workovers, oil storage and processing facilities, pipelines, gathering systems,
plant & equipment (generators, pumps, communications, etc.) and other field
facilities. We have invested approximately $59 million in the development of the
Karakuduk Field and have drilled or re-completed 35 productive wells, including
16 wells subsequent to December 31, 2000. Total capital expenditures for 2001
are estimated to be approximately $22.5 million in comparison to total capital
expenditures of $23.6 million incurred in 2000. Capital expenditures are
estimated to be at least $60.0 to $80.0 million for the period from 2002 through
2005, including drilling approximately 28 more well locations through this time
period.
We expect to finance the continued development of the Karakuduk Field primarily
through cash flows from the sale of crude oil. During the nine months ended
September 30, 2001, KKM sold approximately 1.36 million barrels of crude oil for
$19.90 million, net of transportation costs. As of November 19, 2001, daily
production, net of royalty, is approximately 8,300 barrels per day from 22 of
the 35 productive wells in the Field. The remaining 13 wells are shut-in for
various reasons, including installation of additional gathering lines and well
equipment (4 wells) and additional workover and well stimulation operations to
bring wells on to primary production (8 wells). Another shut-in well is being
considered for future use as an injection well for a pilot waterflood project.
KKM's maximum daily production is also restrained by certain field facility
constraints, including the lack of adequate storage capacity at the export
pipeline pumping station. KKM is presently installing a larger tank battery,
which is expected to alleviate this problem during the first quarter of 2002. In
the short-term, we expect to increase and maintain net daily production of
approximately 8,500 barrels of oil per day through the first quarter of 2002 as
these various restrictions are addressed. No assurances may be provided,
however, that production constraints will be alleviated as expected, due to
potential factors such as delays in obtaining necessary regulatory approvals,
inaccessibility of contractors and materials needed for construction, and
adequate working capital to timely fund field operations.
15
Our highest operational priority in the short-term is to alleviate production
constraints to obtain a level of operational cash flow sufficient to fund our
cash requirements. We anticipate up to $5 million in additional working capital
will be necessary to achieve this objective. Chaparral and KKM have also
initiated cost reduction measures to avoid incurring any unnecessary overhead or
operating expenses. Primarily, KKM has suspended drilling operations as of
October 2001 to allow the ongoing facilities development program to catch up to
current and future productive capacity and allow further analysis of available
geological data to most efficiently complete the development of the Karakuduk
Field. Subject to restructuring the loan with Shell Capital (see below), we
expect drilling operations to resume during 2002.
Our short and long-term operational liquidity is also impacted by local oil
sales obligations, imposed by the government of Kazakhstan on oil and gas
producers to supply local energy needs. Under the terms of its agreement with
the government, KKM has a right to export, and receive export quota for, 100% of
the production from the Karakuduk Field. Through November 19, 2001, however, KKM
was required by the government to sell approximately 18.5% of its crude oil on
the domestic market. The domestic market does not permit world market prices to
be obtained, resulting in approximately $6.0 to $8.0 less cash flow per barrel
on 2001 local oil sales. We are taking steps to reduce our local market
obligations, including petitioning the government to enforce our rights under
KKM's agreement and seeking an exemption from all local market obligations
during the early stages of development of the Karakuduk Field. While management
believes we will be successful in reducing KKM's local sales requirements, some
level of future local market obligation is expected for all oil and gas
producers in Kazakhstan, including KKM. If we are unsuccessful in reducing or
eliminating our future local sales obligations, we may be required to initiate
legal proceedings within Kazakhstan or make a claim under our political risk
insurance policy for the breach of our agreement by the government of
Kazakhstan. We can provide no assurances that legal proceedings within
Kazakhstan would be successful, or that any potential insurance proceeds
available under our political risk policy would fully offset losses incurred due
to additional local sales requirements. The initiation of formal legal
proceedings could lead to more material restrictions of our contractual rights,
including our right to develop the Karakuduk Field or sell any of our crude oil
production on the export market whatsoever.
Shell Capital loan.
-------------------
As of November 19, 2001, our most significant outstanding indebtedness is our
loan with Shell Capital. We entered into the loan on November 1, 1999, to
provide up to $24 million of financing for the development of the Karakuduk
Field, drawing down a total of $21.5 million of the facility as of December 31,
2000 and the remaining $2.5 million as of May 2001.
The loan accrues interest at an annual rate of LIBOR plus 17.75%, compounding
quarterly prior to project completion. Prior to project completion, an interest
amount, equal to annual rate of LIBOR plus .50%, is payable quarterly to Shell
Capital. The annual interest rate is reduced to LIBOR plus 12.75% after project
completion. The remaining unpaid interest is added to the loan balance at the
end of each quarter. After project completion, all quarterly interest on the
outstanding loan is fully due and payable at the end of each calendar quarter.
Per the terms of the loan, project completion occurs when various conditions are
met by us and KKM, including, but not limited to: (i) receipt by Shell Capital
of an independent engineer's reserve report evidencing proved developed reserves
of at least 30 million barrels in the Karakuduk Field, (ii) sustaining average
gross production of 13,000 barrels of oil per day from the Karakuduk Field for a
period of 45 consecutive days, (iii) sustaining water injection at an average
rate of 15,000 barrels per day over 45 consecutive days, (iv) injection of lift
gas into one well over a 24-hour period, and (v) various other financial and
technical milestones.
In May 2001, the loan was amended to provide Chaparral with up to $8.0 million
in uncommitted working capital as a bridge loan, which could be drawn down in
increments of $250,000 through August 31, 2001, at the sole discretion of Shell
Capital. We borrowed a total of $3.15 million under the bridge loan through
August 31, 2001. The principal borrowed under the bridge loan accrues interest
at LIBOR plus 17.75% and is subject to an arrangement fee of 2%. Interest
payments in the amount of LIBOR plus .50% are due at the end of each month the
bridge loan is outstanding. All unpaid interest is added to the outstanding
principal balance on each repayment date. The outstanding principal of the
bridge loan, plus all accrued interest, was due on or before September 30, 2001.
As an incentive for Chaparral to repay the bridge loan or refinance the entire
loan (including the bridge loan), Chaparral's board of directors approved
CAP-G's issuance of Series A Preferred shares to Shell Capital. Per the terms of
the amendment, if Chaparral failed to repay or refinance the bridge loan on or
16
before September 30, 2001, the Series A Preferred shares automatically convert
and entitle Shell Capital to 40% of the distributable profits of CAP-G.
As of September 30, 2001, Chaparral was in default of the loan for failure to
pay outstanding principal and interest due on the bridge loan totaling $3.34
million on or before September 30, 2001, failure to make an interest payment
totaling $189,280 due September 28, 2001, failure to achieve project completion
by September 30, 2001, failure to settle certain accounts payable within 90
days, KKM's failure to obtain Shell Capital's approval prior to entering a
short-term debt arrangement, and failure to maintain listing of Chaparral's
common stock on one of the major stock exchanges (i.e. Nasdaq, NYSE, or AMEX).
We had previously obtained a waiver from Shell Capital regarding the delisting
of our common stock from the Nasdaq SmallCap Market, subject to not incurring
another event of default under the loan. Shell Capital terminated the waiver due
to the other events of default discussed above. Chaparral subsequently repaid
all outstanding default interest due under the loan and bridge loan, and KKM
repaid the short-term indebtedness obtained without Shell Capital's approval.
As a result of our failure to timely repay the bridge loan, Shell Capital's
Series A Preferred shares in CAP-G converted as of October 1, 2001, entitling
Shell Capital to 40% of the distributable profits of CAP-G. We have recorded an
additional loan discount of $4.37 million, equal to 40% of Chaparral's
unamortized costs of acquiring its equity interest in CAP-G, which is estimated
to approximate the fair value of the net profits interest transferred to Shell
Capital. The discount was fully recognized as interest expense on September 30,
2001, the maturity date of the bridge loan.
We are in active negotiations to restructure the loan with Shell Capital, which
has not exercised any of its remedies available under the loan, except for
charging a default interest rate of LIBOR plus 19.75% on the outstanding
principal balance of the bridge loan. We are attempting to restructure the loan,
including obtaining a waiver of all existing events of default and re-acquiring
Shell Capital's 40% interest in the distributable profits of CAP-G. However,
there can be no assurances that we will be able to re-negotiate the loan on
acceptable terms, if at all. If not, Shell Capital could exercise its remedies
available under the loan, including calling the entire loan immediately due and
payable.
The loan subjects us to a significant number of restrictions, including various
representations and warranties, positive and negative covenants, and events of
default. These restrictions include, but are not limited to, the following:
o Pledge of Assets. We pledged substantially all of our assets to Shell
Capital, including our interest in the Karakuduk Field. If an event of
default occurs under the loan and is not timely cured, Shell Capital
is entitled to remedies, including the right to accelerate repayment
of the loan and obtain our rights to the Karakuduk Field.
o Business Alteration. We cannot engage in any other business except the
ownership of KKM and the operation of the Karakuduk Field without the
prior consent of Shell Capital.
o Change in Control. We cannot enter into any transaction where a
"group" as defined in the Securities Exchange Act of 1934 acquires or
otherwise gains control of 20% or more of our outstanding shares of
voting stock. Some transactions are exempt from this restriction,
including the conversion of our outstanding Series A Preferred Stock,
the exercise of the Shell warrant, and a grant of non-statutory or
statutory options to purchase up to 15% of our outstanding common
stock to our officers, directors, employees, and consultants (subject
to anti-dilution provisions). Furthermore, it is an event of default
under the loan if Allen & Company and Whittier Ventures let their
ownership in us fall below 20%, unless otherwise agreed with Shell
Capital.
o Charged Accounts. We must retain all cash receipts from oil sales,
proceeds from the loan, and any other funds raised through approved
equity or debt offerings in pledged bank accounts (the "Charged
Accounts"). The Charged Accounts are controlled by Shell Capital. We
retain title to the Charged Accounts, but Shell Capital directs all
cash movements at our request. On a monthly basis, we request
transfers of funds from the Charged Accounts into specific operating
accounts controlled directly by us or by KKM, respectively.
o Cash Expenditures. We must expend funds in accordance with capital and
operating budgets approved by Shell Capital on an annual basis, unless
otherwise approved by Shell Capital.
17
o Project Completion. KKM was required to reach project completion on or
before September 30, 2001. Failure to reach project completion is an
existing event of default under the loan.
o Share Capital. We cannot purchase, issue, or redeem any of our share
capital without the prior approval of Shell Capital.
o Future Indebtedness. We cannot borrow money, other than trade debt,
without the approval of Shell Capital.
o Sale of Significant Assets. We cannot dispose of any significant
assets, including capital stock in our subsidiaries, without the
approval of Shell Capital.
o Leases. Without Shell Capital's approval, KKM cannot enter into any
lease or license arrangement with annual payments in excess of $1.0
million and Chaparral will not enter into any lease or license
arrangement with annual payments in excess of $200,000.
o Dividends. KKM cannot pay dividends prior to project completion, and
then only subject to Shell Capital's approval. We cannot pay any
dividends without Shell Capital's consent.
o OPIC Insurance. We must maintain political risk insurance with the
Overseas Private Investment Company ("OPIC") throughout the duration
of the loan.
o Hedge Agreement. We will not cancel or terminate the hedging contracts
entered into as part of the loan or enter into any other hedging
transaction without Shell Capital's consent.
o Market Listing. Chaparral is required to list its common stock on
either the Nasdaq Stock Market, American Stock Exchange or the New
York Stock Exchange. The delisting of Chaparral's common stock from
the Nasdaq SmallCap Market in August 2001 is an event of default under
the loan.
As of September 30, 2001, the outstanding loan balance (including the bridge
loan) of $32.33 million is comprised of $27.15 million in cash borrowings plus
$7.74 million of interest added to the balance as additional principal, net of
$2.56 million in unamortized discount. Interest expense for the nine months
ended September 30, 2001 totaled $10.01 million, including $5.13 million of
interest on outstanding principal and $4.88 million in discount amortization. As
the loan is in default, the entire outstanding principal balance is recorded as
a current liability.
The terms and conditions and related financing costs of the loan are
significant. We estimate approximately $42 to $51 million of future cash flows
will be necessary to fully repay the loan and all accrued interest and fees
thereon, depending upon the amount of excess cash flows available from
operations, if any, to repay the loan prior to scheduled repayments. Future cash
flows from operations required for debt service will not be available for other
purposes. Our ability to obtain additional debt or equity financing in the
future for working capital, capital expenditures, or acquisitions is also
restricted, as well as our ability to acquire or dispose of significant assets
or investments. These restrictions may make us more vulnerable and less able to
react to adverse economic conditions. The failure of Chaparral to restructure
the loan, including the waiver of all existing defaults and to re-acquire Shell
Capital's 40% interest in CAP-G, could result in the loss or significant
impairment of our investment in the Karakuduk Field.
18
Capital Commitments and Other Contingencies
-------------------------------------------
Our operations may be subject to other regulations by the government of the
Republic of Kazakhstan or other regulatory bodies responsible for the area in
which the Karakuduk Field is located. In addition to taxation, customs
declarations and environmental controls, regulations may govern such things as
drilling permits and production rates. Drilling permits could become difficult
to obtain or prohibitively expensive. Production rates could be set so low that
they would make production unprofitable. These regulations may substantially
increase the costs of doing business and may prevent or delay the starting or
continuation of any given exploration or development project.
All regulations are subject to future changes by legislative and administrative
action and by judicial decisions. Such changes could adversely affect the
petroleum industry in general, and us in particular. It is impossible to predict
the effect that any current or future proposals or changes in existing laws or
regulations will have on our operations.
2. Results from Operations
Results of Operations for the Three Months Ended September 30, 2001 Compared to
the Three Months Ended September 30, 2000.
--------------------------------------------------------------------------------
We account for our investment in KKM using the equity method.
Our operations for the quarter ended September 30, 2001 resulted in a net loss
of $5.77 million, compared to a net loss of $23.03 million for the quarter ended
September 30, 2000. The $17.26 million decrease primarily relates to interest
expense from non-recurring transactions in our attempts to finance the
development of the Karakuduk Field. Alternatively, we recognized $1.21 million
in net equity income from our investment in KKM, reflecting KKM's increase in
the production and sale of crude oil during the quarter.
Interest expense decreased from $22.60 million for the quarter ended September
30, 2000 to $6.31 million for the quarter ended September 30, 2001. Interest
expense for the current period reflects additional loan discount of $4.37
million recorded and fully amortized as of September 30, 2001 due to the
transfer of a 40% interest in the distributable profits of CAP-G to Shell
Capital for our failure to repay a $3.15 million bridge loan to Shell Capital on
or before September 30, 2001. See Note 7 of the consolidated financial
statements. Interest expense for the quarter ended September 30, 2000 reflects a
non-recurring, non-cash interest charge of $20.34 million recognized upon
conversion of our notes with an aggregate principal amount of $20.85 million
into 11,690,259 shares of Chaparral's common stock. The notes' conversion
feature, at $1.86 per share, was a "beneficial conversion feature" as addressed
in EITF 98-5. EITF 98-5 required the recognition of additional interest expense
equal to the face value of the notes, net of original discount of $506,000, upon
conversion of the notes.
Interest income increased $369,000 to $372,000 for the three months ended
September 30, 2001, due to the impact of EITF 99-10, Percentage Used to
Determine the Amount of Equity Method Losses, on the equity method income or
losses recognized by Chaparral. We eliminate inter-company interest income from
KKM based upon the proportion of equity income or losses recognized from KKM for
the respective period. During the three months ended September 30, 2000, we
recognized 100% of KKM's equity method income and, therefore, eliminated 100% of
our interest income from KKM. As of December 31, 2000, we had recaptured all
non-proportional EITF 99-10 losses and currently recognize income from KKM based
on our proportional 50% interest. Therefore, 50% of our interest income from KKM
was eliminated against equity method income for the quarter ended September 30,
2001.
General and administrative costs decreased from $1.05 million for the three
months ended September 30, 2000 to $940,000 for the three months ended September
30, 2001, primarily due to a reduction in professional fees during the current
period.
Depreciation and depletion expense increased by $134,000 to $250,000 for the
three months ended September 30, 2001, due to the increase in oil production
from the Karakuduk Field. Our depreciation and depletion expense was $116,000
for the three months ended September 30, 2000.
Our equity income from investment was $1.21 million for the three months ended
September 30, 2001, compared to $736,000 for the three months ended September
30, 2000. During the three months ended September 30, 2001, KKM sold
approximately 385,000 barrels of crude oil, recognizing $6.92 million in
revenue, or $17.96 per barrel. Associated operating costs were $812,000, or
$2.11 per barrel, and associated transportation costs were $1.23 million, or
$3.21 per barrel. During the three months ended September 30, 2000, KKM sold
approximately 183,000 barrels of crude oil, recognizing $4.34 million in
revenue, or $23.72 per barrel. Associated operating costs were $1.52 million, or
$8.31 per barrel, and associated transportation costs were $714,000, or $3.90
per barrel. Our equity income or loss from investment also reflects the
elimination of $370,000 and $907,000 of inter-company interest income on our
loan to KKM for the three months ended September 30, 2001 and 2000,
respectively.
19
Results of Operations for the Nine Months Ended September 30, 2001 Compared to
the Nine Months Ended September 30, 2000.
--------------------------------------------------------------------------------
We account for our investment in KKM using the equity method.
Our operations for the nine months ended September 30, 2001 resulted in a net
loss of $11.43 million, compared to a net loss of $26.36 million as of September
30, 2000. The $14.93 million net decrease in our loss from operations primarily
relates to interest expense from non-recurring transactions in our attempts to
finance the development of the Karakuduk Field and the impact of the adoption of
SFAS 133, Accounting for Derivative Instruments and Hedging Activities as of
January 1, 2001. Alternatively, equity income from our investment in KKM
increased by $2.61 million due to KKM's significant increase in the production
and sale of crude oil during the period.
Interest expense decreased from $25.29 million for the nine months ended
September 30, 2000 to $10.01 million for the nine months ended September 30,
2001. Interest expense for the current period reflects additional loan discount
of $4.37 million recorded and fully amortized as of September 30, 2001, due to
the transfer of a 40% interest in the distributable profits of CAP-G to Shell
Capital for failure to repay a $3.15 million bridge loan to Shell Capital on or
before September 30, 2001. See Note 7 of the consolidated financial statements.
Interest expense for the quarter ended September 30, 2000 reflects a
non-recurring, non-cash interest charge of $20.34 million recognized upon
conversion of our notes with an aggregate principal amount of $20.85 million
into 11,690,259 shares of Chaparral's common stock. The notes' conversion
feature, at $1.86 per share, was a "beneficial conversion feature" as addressed
in EITF 98-5. EITF 98-5 required the recognition of additional interest expense
equal to the face value of the notes, net of original discount of $506,000, upon
conversion of the notes.
As a result of the adoption of SFAS 133, we recognized a loss of $2.52 million
as a cumulative effect of change in accounting principal and an additional loss
of $607,000 for the nine months ended September 30, 2001 to record the
derivatives at their fair value as of the end of the period. See Note 2 to our
consolidated financial statements.
Interest income increased $1.18 million from $10,000 for the nine months ended
September 30, 2000 to $1.19 million for the nine months ended September 30,
2001. The increase was due to additional financing of KKM's operations in
Kazakhstan and the impact of EITF 99-10, Percentage Used to Determine the Amount
of Equity Method Losses, on the equity method income or losses recognized by
Chaparral. We eliminate inter-company interest income from KKM based upon the
proportion of equity income or losses recognized from KKM for the respective
period. During the nine months ended September 30, 2000, we recognized 100% of
KKM's equity method losses and, therefore, eliminated 100% of our interest
income from KKM. As of December 31, 2000, we have recaptured all
non-proportional EITF 99-10 losses and recognize income from KKM based on our
proportional 50% interest. Therefore, 50% of our interest income from KKM was
eliminated against equity method income for the nine months ended September 30,
2001.
General and administrative costs increased from $2.52 million for the nine
months ended September 30, 2000 to $3.10 million for the nine months ended
September 30, 2001. The $579,000 increase was due to approximately $262,000 in
additional insurance expense for premiums on our OPIC political risk insurance
policy required by Shell Capital as part of the loan and a $271,000 increase in
professional fees associated with the development of the Karakuduk Field.
Depreciation and depletion expense increased by $363,000 to $593,000 for the
nine months ended September 30, 2001, due to the increase in oil production from
the Karakuduk Field. Our depreciation and depletion expense was $230,000 for the
nine months ended September 30, 2000.
Our equity income from investment was $4.21 million for the nine months ended
September 30, 2001, compared to $1.60 million for the nine months ended
September 30, 2000. During the nine months ended September 30, 2001, KKM sold
approximately 1.36 million barrels of crude oil, recognizing $24.91 million in
revenue, or $18.34 per barrel. Associated operating costs were $3.31 million, or
$2.44 per barrel, and associated transportation costs were $5.02 million, or
$3.69 per barrel. During the nine months ended September 30, 2000, KKM sold
approximately 409,000 barrels of crude oil, recognizing $8.89 million in
revenue, or $21.75 per barrel. Associated operating costs were $2.32 million or
$5.66 per barrel, and associated transportation costs were $1.78 million, or
$4.36 per barrel. Our equity income or loss from investment also reflects the
elimination of $1.19 million and $2.35 million of inter-company interest income
on our loan to KKM for the nine months ended September 30, 2001 and 2000,
respectively.
20
3. Commodity Prices for Oil and Gas
Our revenues, profitability, growth and value are highly dependent upon the
price of oil. Market conditions make it difficult to estimate prices of oil or
the impact of inflation on such prices. Oil prices have been volatile, and it is
likely they will continue to fluctuate in the future. Various factors beyond our
control affect prices for oil, including supplies of oil available worldwide and
in Kazakhstan, the ability of OPEC to effectively maintain oil prices through
production controls, political instability or armed conflict in Kazakhstan or
other oil producing regions, the price of foreign imports, the level of consumer
demand, the price and availability of alternative fuels, the availability of
transportation routes and pipeline capacity, and changes in applicable laws and
regulations. Recent events regarding the ongoing military efforts and terrorist
activities in Afghanistan and abroad, combined with the significant prospect of
a global economic recession, may adversely impact crude oil prices obtainable by
KKM for the sale of its crude oil production on both the export and local
markets.
4. Inflation
We cannot control prices received from our oil sales and to the extent we are
unable to pass on increases in operating costs, we may be affected by inflation.
The devaluation of the tenge, the currency of the Republic of Kazakhstan, can
significantly decrease the value of the monetary assets that we hold in
Kazakhstan as well as our assets in that country that are based on the tenge.
KKM retains the majority of its cash and cash equivalents in U.S. dollars in an
offshore bank account outside of Kazakhstan, but KKM's statutory tax basis in
its assets, tax loss carryforwards, and VAT receivables are all denominated in
tenge and subject to the effects of devaluation. Local tax laws allow basis
adjustments to offset the impact of inflation on statutory tax basis assets, but
there is no assurance that any adjustments will be sufficient to offset the
effects of inflation in whole or in part. If not, KKM may be subject to much
higher income tax liabilities within Kazakhtan due to inflation and or
devaluation of the local currency. Additionally, devaluation may create
uncertainty with respect to the future business climate in Kazakhstan and to our
investment in that country. As of September 30, 2001, the exchange rate was
147.7 tenge per U.S. dollar.
Special Note Regarding Forward-Looking Statements
-------------------------------------------------
Some of the statements in this Quarterly Report on Form 10-Q constitute
"forward-looking statements." Forward-looking statements relate to future events
or our future financial performance. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "estimates," "believes," "predicts," "potential," "likely,"
or "continue," or by the negative of such terms or comparable terminology.
Forward-looking statements are predictions based on current expectations that
involve a number of risks and uncertainties. Actual events may differ
materially. In evaluating forward-looking statements, you should consider
various factors, including the risks discussed above and in our Form 10-K for
the year ended December 31, 2000, which is incorporated by reference as part of
this report. These factors may cause our actual results to differ materially
from any forward-looking statement.
Although we believe that these statements are reasonable, we cannot guarantee
future results, levels of activity, performance or achievements, and you are
encouraged to exercise caution in considering such forward-looking statements.
Unless otherwise required by law, we are not under any duty to update any of the
forward-looking statements after the date of this Quarterly Report on Form 10-Q
to conform these statements to actual results.
21
Item 3 - Quantitative and Qualitative Disclosures About Market Risks
We are subject to various market risks, including interest rate risk and
commodity price risk.
Our loan is subject to a variable quarterly interest rate based upon LIBOR plus
17.75%. As of September 30, 2001, the outstanding loan balance subject to
interest was approximately $34.89 million. During the nine months ended
September 30, 2001, the high, low, and average interest rates applicable against
the loan were 24.27%, 21.41%, and 22.58%, respectively. The terms of the loan
are more fully described in Note 7 of our consolidated financial statements. An
increase in applicable interest rates will result in a corresponding increase in
the interest costs associated with the loan.
Under the original terms of the loan, we must begin repaying the principal
balance of the loan on December 31, 2001. The loan stipulates the minimum
principal repayments required, but also requires all excess cash flows available
from crude oil sales be utilized to repay the loan as quickly as possible.
Earlier repayment of the loan results in significantly less interest expense
charged on the loan. KKM's ability to generate excess cash flows is dependent
upon many factors, including production rates, access to export markets to sell
our crude oil production, and the available commodity price of crude oil. Lower
crude oil prices could significantly reduce cash flows earned by KKM, which
would otherwise be used to prepay the loan. We estimate approximately $42
million to $51 million of net cash flows from oil sales will be required to
repay the loan depending upon excess cash flows available to repay principal
earlier than scheduled.
To hedge the risk of a drop in commodity prices, we entered into the hedge
agreement as part of the loan, paying $4 million for put contracts to sell a
total of 1,562,250 barrels of North Sea Brent crude. The exercise prices of the
various put contracts range from $22.35 to $17.25 per barrel, with monthly
expiration dates beginning in October 2000 and ending in December 2002. The
contracts are evenly spread between October 2000 to December 2001 (62,750
barrels per month) and between January 2002 to December 2002 (51,750 barrels per
month). During the nine months ended September 30, 2001, the high, low, and
average price of the hedge agreement was $999,000, $234,000, and $617,000,
respectively. As of September 30, 2001, the put contracts had a fair market
value of $392,000. If oil prices drop below the exercise prices of the put
contracts, we will generate some income from the hedge contracts. We cannot sell
the contracts under the terms of the loan, however, without Shell Capital's
approval.
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Part II- Other Information
Item 3 - Defaults Upon Senior Securities
Chaparral has incurred various material defaults on its loan with Shell Capital,
including the failure to pay outstanding principal and interest due on the
bridge loan totaling $3.34 million on or before September 30, 2001, failure to
make an interest payment totaling $189,280 due September 28, 2001, failure to
achieve project completion by September 30, 2001, failure to settle certain
accounts payable within 90 days, KKM's failure to obtain Shell Capital's
approval prior to entering a short-term debt arrangement, and failure to
maintain the listing of Chaparral's common stock on one of the major stock
exchanges (i.e. Nasdaq, NYSE, or AMEX). We had previously obtained a waiver from
Shell Capital regarding the delisting of our common stock from the Nasdaq
SmallCap Market, subject to not incurring another event of default under the
loan. Shell Capital terminated the waiver due to the other events of default
discussed above. Chaparral subsequently repaid all outstanding interest due
under the loan and bridge loan, and KKM repaid the short-term indebtedness
obtained without Shell Capital's approval. Default principal and interest in
arrears as of November 19, 2001, totaled approximately $3.32 million. See Note 7
to our consolidated financial statements.
We are attempting to restructure the loan with Shell Capital, including
obtaining a waiver of all existing events of default and reacquiring Shell
Capital's 40% interest in the distributable profits of CAP-G. However, there can
be no assurances that we will be able to re-negotiate the loan on acceptable
terms, if at all. If not, Shell Capital could exercise its remedies available
under the loan, including calling the entire loan immediately due and payable.
If we are unable to restructure the loan with Shell Capital, our investment in
the Karakuduk Field may be lost.
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Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
None.
(b) Reports on Form 8-K
We filed a Current Report on Form 8-K, dated August 16, 2001 to report delisting
of Chaparral's common stock by the Nasdaq SmallCap Market as of August 9, 2001,
and the subsequent waiver of the delisting as an event of default under
Chaparral's loan agreement with Shell Capital on August 13, 2001.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 19, 2001
Chaparral Resources, Inc.
By: /s/ Michael B. Young
--------------------------------------------
Michael B. Young, Treasurer, Controller
and Principal Accounting Officer
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