FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2004.
Commission file number: 0-7261
CHAPARRAL RESOURCES, INC.
----------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 84-0630863
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2 Gannett Drive, Suite 418
White Plains, New York 10604
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(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (866) 559-3822
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $.0001 Per Share
--------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer.
YES |_| NO |X|
As of June 30, 2004, the aggregate market value of registrant's voting
common stock, par value $.0001 per share, held by non-affiliates was
$17,001,179.
As of March 25, 2005, registrant had 38,209,502 shares of its common stock,
par value $.0001 per share, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: None
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business ...................................................1
Item 2. Properties .................................................5
Item 3. Legal Proceedings ..........................................8
Item 4. Submission of Matters to a Vote of Security Holders ........8
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters ......................................9
Item 6. Selected Financial Data ...................................10
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations .....................11
Item 7A. Quantitative and Qualitative Disclosure about
Market Risk .............................................20
Item 8. Financial Statements and Supplementary Data ...............21
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure .....................21
Item 9A. Controls and Procedures ...................................21
PART III
Item 10. Directors and Executive Officers of the Registrant ........22
Item 11. Executive Compensation ....................................24
Item 12. Security Ownership of Certain Beneficial Owners
and Management ..........................................28
Item 13. Certain Relationships and Related Transactions ............29
Item 14. Principal Accounting Fees and Services ....................30
PART IV
Item 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K .....................................31
i
PART I
ITEM 1. BUSINESS
Our Business
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Chaparral Resources, Inc. is an independent oil and gas development and
production company. Our strategy is to maximize stockholder returns from
existing assets. Through intermediate holding companies, Central Asian Petroleum
(Guernsey), Ltd., a Guernsey company ("CAP-G"), Korporatsiya Mangistau Terra
International Limited ("MTI"), a Kazakhstan company, and Central Asian
Petroleum, Inc., a Delaware company ("CAP-D"), we own a 60% interest in Closed
Type JSC Karakudukmunay ("KKM"), a Kazakh joint stock company that holds a
governmental license to develop the Karakuduk Oil Field. All references to
"Chaparral," "we," "us," and "our" refer to Chaparral Resources, Inc., and
Chaparral's greater than 50% owned subsidiaries, unless indicated otherwise.
Since 1995, the business of Chaparral has been the development of the
Karakuduk Field, a 16,900-acre oil field in the Republic of Kazakhstan. The U.S.
based oil and gas assets of Chaparral were divested during 1996 and 1997 to help
fund the development of the Karakuduk Field. The Government of the former Soviet
Union discovered the Karakuduk Field in 1972 and drilled 22 exploratory and
development wells, none of which produced commercially. KKM began to
aggressively develop the Karakuduk Field in early 2000, re-establishing oil
production from a majority of the existing wells and drilling a total of 23 new
wells through to September 2001. In February 2003, KKM commenced a new drilling
campaign to further develop and commercially produce the oil reserves in the
Karakuduk Field. By the end of 2004 the well stock had risen to 57 producing
wells and 6 water injection wells, plus 3 wells awaiting completion at year end.
In December 2004 KazMunayGaz JSC ("KMG"), the state owned national
petroleum and transportation company of the Republic of Kazakhstan, which owned
a 40% interest in KKM, sold its entire interest in KKM to Nelson Resources
Limited ("Nelson"). Since May 2004, Nelson has owned approximately 60% of the
outstanding common stock of Chaparral.
Currently, the Karakuduk Field is our only oil field. We have no other
significant subsidiaries besides CAP-G, MTI, and CAP-D.
During 2002, Chaparral obtained a controlling interest in KKM.
Consequently, Chaparral's financial statements have been consolidated with KKM
on a retroactive basis from January 1, 2002. Chaparral previously accounted for
its 50% investment in KKM using the equity method of accounting.
Available Information
---------------------
Chaparral files Annual Reports on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K, and registration statements and other items
with the Securities and Exchange Commission (SEC). Chaparral provides access
free of charge to all of these SEC filings, as soon as reasonably practicable
after filing, on its Internet site located at www.chaparralresources.com.
Chaparral will also make available to any stockholder, for a nominal fee, copies
of its Annual Report on Form 10-K as filed with the SEC. For copies of this, or
any other filing, please contact: Chaparral Resources, Inc., 2 Gannett Drive,
Suite 418, White Plains, New York 10604 or call (866) 559-3822.
In addition, the public may read and copy any materials Chaparral files
with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW,
Washington, DC 20549. The public may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an
Internet site (www.sec.gov) that contains reports, proxy and information
statements and other information regarding issuers, like Chaparral, that file
electronically with the SEC.
Crude Oil Sales
---------------
We derive substantially all of our revenue through the production and sale
of crude oil from the Karakuduk Field. We are continuing to develop the
Karakuduk Field from which we began generating revenue from the sale of crude
oil during 2000. KKM recognized $78.45 million in revenue in 2004 from the sale
of approximately 2.76 million barrels of crude oil, net of royalty. In 2003, KKM
recorded $57.61 million in revenue based upon sales of approximately 2.69
million barrels of crude oil, net of royalty.
1
KKM sells the majority of its crude oil on the "far" abroad export market.
Sales at world market prices were responsible for approximately 96% of KKM's oil
sales revenue in 2004. Currently, KKM has a month to month crude oil sales
agreement in place with Vitol Central Asia S.A. ("Vitol") for the sale of KKM's
oil production quota for the export market. KKM is responsible for obtaining
export quotas and all other permissions from Kazakhstan, Russia, or other
relevant jurisdictions necessary to transport and deliver KKM's oil production
to the off-taker, which is currently FOB Odessa on the Black Sea. The off-taker
is responsible for nominating and coordinating oil tankers, if necessary, and
arranging for the lifting of the crude oil purchased.
In 2004, all of KKM's crude oil export sales were to Vitol.
Transportation routes for our crude oil exports, and hence off-take points,
are constrained by the Ministry of Energy's quota allocations. The majority of
our crude oil is transported via the Kaztransoil and Transneft pipeline systems
to the port of Odessa in Ukraine. The other export point is the port of Primosk
on the Baltic Sea. Sales prices at the port locations are based on the average
quoted Urals crude oil price from Platt's Crude Oil Marketwire for the three
days following the bill of lading date. The actual price is net of deductions
that include freight charges and, if applicable, the cost associated with the
"detention time" of the tankers transiting the Turkish Straits in and out of the
Black Sea. Throughout 2004, all export sales have been made to Vitol, who have a
major share of oil exports from Odessa which has enabled them to become the most
competitive off-taker, capable of combining export parcels from different crude
oil suppliers to make cost efficient cargoes of up to 80,000 tons in one
lifting. Under the contract terms with Vitol, payment is made within 30 days of
receipt of the bill of lading and KKM's sales invoice, unless otherwise agreed
by both parties.
Under the terms of the KKM's Agreement with the Ministry of Energy and
Natural Resources for Exploration, Development and Production of Oil in the
Karakuduk Oil Field (the "Agreement"), we have a right to export, and receive
export quota for, 100% of the production from the Karakuduk Field. However, oil
producers within Kazakhstan are required to supply a portion of their crude oil
production to the local market to meet domestic energy needs. The domestic
market does not permit world market prices to be obtained, resulting in, on
average, approximately $15 to $16 lower cash flow per barrel in 2004.
Furthermore, the Government of Kazakhstan has not allocated sufficient export
quota to allow us to sell all of our available crude oil production on the world
market. We are taking steps to reduce our local market obligations and to obtain
an export quota that will enable us to sell all of our crude oil production on
the export market. The Company has determined that it is no longer in the best
interests of the Company to pursue arbitration proceedings in Switzerland for
the breach of the Agreement by the Government of Kazakhstan, instead we intend
to seek an amicable resolution of this matter. See Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations.
Risks of Oil and Gas Activities
-------------------------------
The current market for oil is characterized by instability. This
instability has caused fluctuations in world oil prices in recent years and
there is no assurance of any price stability in the future. The production and
sale of oil from the Karakuduk Field may not be commercially feasible under
market conditions prevailing in the future. The price we receive for our oil may
not be sufficient to generate revenues in excess of our costs of production or
provide sufficient cash flow to meet our investment and working capital
requirements.
We make no assurance that we will be able to sell oil that we produce nor
about the price at which such sales will be made. Our estimated future net
revenue from oil sales is dependent on the price of oil, as well as the quantity
of oil produced. The volatility of the energy market makes it difficult to
estimate future prices of oil. Various factors beyond our control affect these
prices. These factors include:
o domestic and worldwide supplies of oil;
o the ability of the members of the Organization of Petroleum Exporting
Countries (OPEC) to agree to and maintain oil price and production
controls;
o political instability or armed conflict in oil-producing regions;
o the price of foreign imports;
o the level of consumer demand;
o the price and availability of alternative fuels;
o the availability of pipeline capacity and;
o changes in existing federal regulation and price controls.
2
It is likely that oil prices will continue to fluctuate as they have in the
past. Current oil prices may not be representative of oil prices in either the
near- or long-term. We do not expect oil prices to maintain current price levels
and do not base our capital spending decisions on current market prices.
No assurances can be given that we will be able to successfully develop,
produce, and market the oil reserves underlying the Karakuduk Field. The
development of oil reserves inherently involves a high degree of risk, even
though the reserves are proved. Our risks are increased because our activities
are concentrated in areas where political or other unknown circumstances could
adversely affect commercial development of the reserves. Costs necessary to
acquire, explore, and develop oil reserves are substantial. No assurances can be
given that we will recover the costs incurred to acquire and develop the
Karakuduk Field. If we fail to generate sufficient cash flow from operations to
meet our working capital requirements or other long-term debt obligations, we
may lose our entire investment in the Karakuduk Field, which is currently
pledged as collateral to JSC Kazkommertsbank ("Kazkommertsbank") under the terms
of the loan with Kazkommertsbank (the "KKM Credit Facility").
Development of oil reserves is a high risk endeavor and is frequently
marked by unprofitable efforts, such as:
o drilling unproductive wells;
o drilling productive wells which do not produce commercial quantities
and;
o production of developed oil reserves which cannot be marketed or
achieve an adequate market price.
There are many additional risks associated with drilling for and producing
oil and gas. These risks include blowouts, cratering, fires, equipment failure
and accidents. Any of these events could result in personal injury, loss of life
and environmental and/or property damage. If such an event does occur, we may be
held liable and we are not fully insured against all of these risks. In fact,
many of these risks cannot be insured against. The occurrence of such events
that are not fully covered by insurance may require us to pay damages, which
would reduce our profits. As of March 1, 2005, we have not experienced any
material losses due to these events.
Risks of Foreign Operations
---------------------------
Our ability to develop the Karakuduk Field is dependent on fundamental
contracts with governmental agencies in Kazakhstan, including the Agreement and
KKM's petroleum license with the Government allowing KKM to operate and develop
the Karakuduk Field. Kazakhstan is a relatively new country and, as is inherent
in such developing markets, there is some uncertainty as to the interpretation
and application of Kazakh law and the stability of the region.
The laws of the Republic of Kazakhstan govern our operations and a number
of our significant agreements. As a result, we may be subject to arbitration in
Kazakhstan or to the jurisdiction of the Kazakh courts. Even if we seek relief
in foreign territories such as the courts of the United States or Switzerland,
we may not be successful in subjecting foreign persons to the jurisdiction of
those courts.
The export of oil from Kazakhstan depends on access to transportation
routes, particularly the Russian pipeline system. Transportation routes are
limited in number, and access to them is regulated and restricted. If any of our
agreements relating to oil transportation or marketing are breached, or if we
are unable to renew such agreements upon their expiration, we may be unable to
transport or market our oil. Also, a breakdown of the Kazakhstan or Russian
pipeline systems could delay or even halt our ability to sell oil. Any such
event would result in reduced revenues.
Obtaining the necessary quotas and permissions to export production through
the Russian pipeline system can be extremely difficult, if not impossible in
some circumstances. Our agreements with the Government of the Republic of
Kazakhstan grant us the right to export, and to receive export quota. We cannot,
however, provide any assurances that we will receive export quota or any other
approvals required to export and deliver our production in the future.
3
Environmental Regulations
-------------------------
We must comply with laws of the Republic of Kazakhstan and international
requirements that regulate the discharge of materials into the environment.
Furthermore, the KKM Credit Facility requires that we comply with the World
Bank's environment, health, and safety guidelines for onshore oil and gas
development. Environmental protection and pollution control could, in the
future, become so restrictive as to make production unprofitable. Furthermore,
we may be exposed to claims and lawsuits involving such environmental matters as
soil and water contamination and air pollution. We are currently in compliance
with all local and international environmental requirements and are closely
monitored by the environmental authorities of the Republic of Kazakhstan. During
2004, KKM completed the construction of a waste "polygon" as required by the
State Environmental Authorities. This is an area where KKM can safely dispose of
waste drilling fluids and cuttings and other harmful or toxic waste. KKM also
commenced construction of a 15 km gas pipeline from the central processing
facility at the field to the oil pipeline booster pumping station halfway
between the field and the transfer pumping facility. This pipeline represents
part of KKM's gas utilization project. The gas will be used to fuel the oil
heaters at the booster station, which presently, use diesel. Total expenditure
on these projects during the year was approximately $1 million. In January 2004,
KKM, as part of its obligations under the Agreement, commenced payments into an
escrow account controlled by KKM and the Government of the Republic of
Kazakhstan. The purpose of the payments is to provide a cash fund to use for
future site restoration costs at the Field when operations cease. Monthly
payments of $14,000 will be made until the fund reaches $3 million. In January
2004, an extra amount of $168,000 was paid for amounts due in 2003.
Competition
-----------
We compete in all areas of the development and production segment of the
oil and gas industry with a number of other companies. These companies include
large multinational oil and gas companies and other independent operators, many
of which possess greater financial resources and more experience than Chaparral.
We do not hold a significant competitive position in the oil industry given that
we compete both with major oil and gas companies and with independent producers
for, among other things, rights to develop oil and gas properties, access to
limited pipeline capacity, procurement of available materials and resources, and
hiring qualified local and international personnel.
Employees
---------
As of March 1, 2005, Chaparral had 2 full-time employees. KKM had 219
employees and retains independent consultants on an as needed basis. We believe
that our relationship with our employees and consultants is good.
Sale by KMG of Minority Interest in KKM to Nelson
-------------------------------------------------
In November 2004 the Company entered into an agreement with its majority
stockholder, Nelson, which provided that in the event Chaparral, through CAP-G
and/or MTI, received notice from KMG that KMG desired to sell its 40% equity
interest in KKM, then the Company would, if requested by Nelson, exercise its
right of first refusal under the Agreement to purchase such interest at the
price and on the terms specified in such notice. In December 2004, pursuant to
this agreement, the Company, through CAP-G, exercised its right of first refusal
to purchase from KMG the remaining 40% equity interest in KKM. The Company
entered into definitive sale and purchase agreements with both KMG and Nelson,
which provided that upon completion of the acquisition by CAP-G, ownership of
the newly acquired 40% interest in KKM would be transferred to Nelson. The
transfer of the 40% interest from KMG to CAP-G occurred in December 2004, and
the transfer from CAP-G to Nelson was completed in January 2005. The purchase
price of $34.6 million paid by CAP-G to KMG was determined on an open tender,
and the funds for this were made available to CAP-G by Nelson. In addition,
Nelson paid the Company a fee of $1.0 million, recorded as part of Other Income,
as well as all documentation and transaction costs relating to the acquisition.
Corporate Information
---------------------
Chaparral was incorporated under the laws of the State of Colorado in 1972.
In 1999, Chaparral reincorporated under the laws of the State of Delaware.
Our address is 2 Gannett Drive, Suite 418, White Plains, New York 10604,
and our telephone number is (866) 559-3822.
4
Special Note Regarding Forward-Looking Statements
-------------------------------------------------
Some of the statements in this Annual Report on Form 10-K 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 in "Risks of Oil and Gas
Activities" and "Risks of Foreign Operations." 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 Annual
Report on Form 10-K to conform these statements to actual results.
ITEM 2. PROPERTIES
Properties
----------
The Karakuduk Field is located in the Mangistau Region of the Republic of
Kazakhstan. The license to develop the Karakuduk Field covers an area of
approximately 16,900 acres and is effective for a 25-year period, which may be
extended if the productive life of the field exceeds this term. In 1995, KKM
entered into the Agreement with Kazakhstan's Ministry of Energy and Natural
Resources to develop the Karakuduk Field.
The Karakuduk Field is located approximately 227 miles northeast of the
regional capital city of Aktau, on the Ust-Yurt Plateau. The closest settlement
is the Say-Utes railway station approximately 51 miles southeast of the field.
The ground elevation varies between 590 and 656 feet above sea level. The region
has a dry, continental climate, with fewer than 10 inches of rainfall per year.
Mean temperatures range from minus 25 degrees Fahrenheit in January to 100
degrees Fahrenheit in July. The operating environment is similar to that found
in northern Arizona and New Mexico in the United States.
The Karakuduk Field structure is an asymmetrical anticline located on the
Aristan Uplift in the North Ust-Yurt Basin. Oil was discovered in the structure
in 1972, when Kazakhstan was a republic of the former Soviet Union, from
Jurassic age sediments between 8,500 and 10,000 feet. The former Soviet Union
drilled 22 exploratory and development wells to delineate the Karakuduk Field,
discovering the presence of recoverable oil reserves. The productive area of the
Karakuduk Field is estimated to contain a minimum of 8 separate productive
horizons present in the Jurassic formation. None of the original wells were ever
placed on commercial production prior to KKM obtaining the rights to the
Karakuduk Field.
The Karakuduk Field is approximately 18 miles north of the main utility
corridor, which includes the Makat-Mangishlak railroad, the Mangishlak-Astrakhan
water pipeline, the Beyneu-Uzen high voltage utility lines, and the
Uzen-Atrau-Samara oil and gas pipelines. KKM, according to its agreements with
the Republic of Kazakhstan, has a right to use the existing oil export pipeline
and related utilities. KKM also has a contract with CJSC Kaztransoil ("KTO"), a
100% subsidiary of KMG, granting KKM the right to use the export pipeline for
transportation of crude oil to local and export markets, subject to transit
quota restrictions, and as a temporary storage facility until the produced
hydrocarbons are sold by KKM.
As of December 31 2004, KKM had 45 active productive wells in the Karakuduk
Field out of a total well fund of 66 wells. Of these, 53 were drilled by KKM and
13 are re-completions of exploration and delineation wells drilled during the
Soviet period. Current production is approximately 9,000 barrels of oil per day.
The remaining wells include 12 that are temporarily shut in, three that are new
drills requiring completion and six water injection wells. KKM implemented an
aggressive drilling program during 2000, drilling a total of 12 development
wells and re-completing four delineation wells, using a combination of two
drilling rigs and a workover rig. KKM drilled an additional exploration well and
performed two re-completions prior to 2000. During 2001, KKM drilled an
additional 10 development wells and re-completed seven delineation wells. In
2002, KKM did not have any drilling activity. During 2003, KKM drilled and
completed 13 wells, 12 producers and one injector. Two water supply wells were
5
also drilled and two redundant producing wells were converted to injectors as
part of KKM's reservoir pressure maintenance program. The drilling program
continued into 2004 during which a total of 16 wells were drilled, 12 as
producers, three awaiting completion at year end and one water injector. In
addition, a well being drilled over the end of 2003 was completed in 2004 as a
water injector.
In the past, KKM's daily oil production has been limited due to various
facility constraints and lack of working capital to fund field operations. KKM
remains committed to improving efficiency of field facilities through continued
expansion of its oil storage capacity, installation of additional gathering and
processing facilities, and the full implementation of the central processing
facility.
In June 2002, KKM commissioned an 18-mile crude oil pipeline from the
Karakuduk Field currently capable of transporting up to 13,000 barrels of oil
per day to the transfer pumping station where KKM's crude oil is transferred to
the State owned Kaztransoil pipeline system. During 2004, KKM completed
installation of the booster pump station mid way along this pipeline which will
allow throughput of up to 18,000 barrels of oil per day. KKM still transports
oil from some wells by truck to the nearest field gathering station or to the
central processing facility at the field. These are either new wells which have
yet to be tied in to the field gathering system, or naturally flowing wells that
do not have sufficient wellhead pressure to overcome the back pressure in the
field flow line system.
In 2003, KKM further expanded the central processing unit in order to
improve its produced water processing capability in the field, to enable
reservoir pressure maintenance through water injection. KKM continued to expand
and upgrade all field production facilities in 2004. Additions to the field
processing facilities, gathering stations and export infrastructure were made to
enable increased production and higher fluid throughput anticipated from the
ongoing drilling, well mechanisation plans and hydraulic fracturing.
Having commissioned the field high line (providing electricity for the
field from the 110kv main grid) KKM continued the installation of 6kv power
lines to well sites during 2003. This project also included providing power to a
third gathering unit (GU3) commissioned in July 2003, which is capable of
handling the throughput of up to 24 wells.
As of January 5, 2005, KKM had one drilling rig and three workover rigs
operating in the Karakuduk Field. KKM will continue to use this drilling rig in
2005 for the planned 16 well development drilling program. The workover rigs
include one 100 ton unit, one 60 ton unit and one 40 ton unit. The 100 ton rig
will continue to work at the field during the first quarter of 2005. It will
re-complete wells after hydraulic fracturing and then repair four other wells
that are currently idle. The other two workover rigs will be retained throughout
the year to perform standard well maintenance, completions of new wells,
re-completions of existing wells and down-hole pump installations. In 2004, KKM
continued to convert wells to artificial lift. Eleven wells were converted to
sucker rod pumps, one electrical submersible pump (ESP) was installed, four
wells were converted from ESPs to sucker rod pumps and one screw pump was
replaced with a sucker rod pump.
During 2004, the reserves of the Karakuduk Field were re-estimated as
required by the State Reserves Committee of the Republic of Kazakhstan.
Development of the field has shown that the original State reserves were
underestimated by more than 20% and therefore KKM commissioned NIPINeftegas, a
local research institute, to prepare a reserves estimate in accordance with
Kazakh reporting standards. As a result of this, it is now estimated that more
wells will be required to develop the field than previously expected, an
increase from 110 to between 140 and 150 wells. Drilling is therefore likely to
continue at Karakuduk for several more years.
Full-scale water injection commenced at Karakuduk in April 2004. Although
KKM initially experienced several commissioning problems with the injection
pumps, the system is now fully operational. KKM is injecting into four wells at
the field and will add a fifth and sixth well in the first quarter of 2005.
Daily injection volume at the field is approximately 10,000 barrels of water per
day.
In late 2004, KKM performed a six-well hydraulic fracturing program to
improve well productivity. Initial results from this "fraccing" program are
encouraging.
6
Reserves
--------
As of December 31, 2004, the Karakuduk Field has total estimated proved
reserves of approximately 40.59 million barrels (compared with 25.62 million
barrels for prior year), net of government royalty, of which our proportional
interest is approximately 24.35 million barrels, based upon our 60% interest in
KKM. The reserve disclosure is based on a reserve study of the Karakuduk Field
conducted by McDaniel and Associates Consultants Limited ("McDaniel"), including
data available subsequent to December 31, 2004, in which total estimated proved
reseves were calculated in accordance with SEC Regulation SX Rule 4-10.
KKM was obliged to submit a new reserves estimate to the State Reserves
Committee of the Republic of Kazakhstan in 2004. NIPINeftegas, a research
institute based in Aktau, Kazakhstan, prepared a report that was received by KKM
in December. This reserves report determines the ultimate recoverable reserves
of the field (i.e. those thought by the institute to be obtainable from the
field regardless of any economic or licence timing constraints). The in-place
reserves attributed to the Karakuduk Field in this report are almost exactly the
same as those of KKM's own internal reserves report prepared by McDaniel.
Net Quantities of Oil and Gas Produced
--------------------------------------
The following table summarizes sales volumes, sales prices and production
cost information for our oil and gas production for each of the three years
ended December 31, 2004:
Year Ended December 31,
------------------------------------
2002 2003 2004
---- ---- ----
Net sales volumes
Oil (bbls) 2,467,000 2,694,000 2,758,000
Gas (mcf) -- -- --
Average sales price
Oil ($ per bbl) 18.29 21.39 28.44
Gas ($ per mcf) -- -- --
Average production cost ($ per bbl) 3.11 2.20 3.02
The average sales revenue, net of transportation costs, was approximately
$23.35 and $17.13 per barrel for the years ended December 31, 2004 and 2003,
respectively. For the same periods, the average transportation costs per barrel
were approximately $5.09 and $4.26, respectively.
Under the Agreement with the Government of the Republic of Kazakhstan we
are entitled to receive 65% of KKM's cash flow from oil sales, net of royalty,
on a quarterly basis until our loan to KKM has been fully repaid. The remaining
35% of net cash flows is used by KKM to meet capital and operating expenditures.
We may waive temporarily receipt of quarterly loan repayments, in whole or in
part, to provide KKM with additional working capital.
Productive Wells and Acreage
----------------------------
As of December 31, 2004, we had an interest in 57 gross producing oil wells
and no gas wells. KKM produces oil from the J1, J2, J4, J6, J7 and J8
reservoirs. In some wells, production is commingled from the J1 and J2
reservoirs (14 wells) and the J8 and J9 reservoirs (three wells). Production is
from 13,800 gross acres with the developed acreage being 5,700 acres.
Undeveloped Acreage
-------------------
As of December 31, 2004, 8,100 acres in the Karakuduk Field production area
are undeveloped.
7
Drilling Activity
-----------------
During the three years ended December 31, 2004, our net interests in
exploratory and development wells drilled were as follows:
Exploratory Wells, Net Development Wells, Net
Year Ended
December 31, Productive Dry Productive Dry
------------ ---------- --- ---------- ---
2002 -- -- -- --
2003 -- -- 7.8 --
2004 -- -- 10.2 --
All wells are located in the Republic of Kazakhstan.
Present Activities
------------------
As of January 5, 2005, KKM had reached target depth in well 126 and was
preparing to run casing on this well. The hydraulic fracturing program carried
out in December 2004 was completed on January 3, 2005 and the first well to be
placed on-line after clean out of fraccing fluid and proppant was well 196,
which is producing at a rate of approximately 500 barrels of oil per day, up
from 65 barrels of oil per day. As of March 3, 2005, KKM was drilling well 149
(at a depth of 1,148m) and the field was producing at a rate of approximately
9,000 bopd from 49 active producing wells. The results of the hydraulic
fracturing program are encouraging with wells showing a two to three fold
increase in production following the program.
ITEM 3. LEGAL PROCEEDINGS
In December 2002, KKM received a claim from the Ministry of State Revenues
of the Republic of Kazakhstan for $9.1 million (the "Tax Claim") relating to
taxes and penalties covering the three years from 1999 to 2001. KKM appealed the
claim through the courts in Kazakhstan, which eventually ruled in favor of KKM
with the exception of $255,000 which was upheld. As a result, during 2003 KKM
reversed $899,000 for income taxes accrued during 2002 for the Tax Claim net of
the $255,000 which was settled in January 2004.
The Ministry of State Revenues of the Republic of Kazakhstan had been
considering penalties with respect to the Tax Claim in the amount of $970,000.
In March 2004 a court hearing was conducted which resulted in a reduction of
these penalties to $53,000. This amount was paid in full during 2004.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On August 2, 2004, Chaparral held its Annual Meeting of Stockholders. Our
stockholders elected the following five persons as directors, each to serve
until the next Annual Meeting of Stockholders or until his successor is elected
or appointed: R. Frederick Hodder, Nicholas P. Greene, Peter G. Dilling, Alan D.
Berlin, and Simon K. Gill. Chaparral's stockholders also voted to ratify
selection by the board of directors of Ernst & Young as Chaparral's independent
auditors for the fiscal year ended December 31, 2004.
The number of shares voted and withheld with respect to each director was
as follows:
Election of Directors For Withheld
--------------------- --- --------
R. Frederick Hodder 32,498,365 14,635
Nicholas P. Greene 32,501,882 11,118
Peter G. Dilling 32,496,928 16,072
Alan D. Berlin 32,498,350 14,650
Simon K. Gill 32,498,390 14,610
8
The number of shares voted with respect to the approval of Ernst & Young as
Chaparral's independent auditors was as follows:
For Against Abstained
--- ------- ---------
32,510,617 726 1,657
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock is currently quoted on the OTC Bulletin Board under the
symbol "CHAR". As of March 14, 2005, we have 1,326 stockholders of record of our
common stock. No dividend has been paid on our common stock, and there are no
plans to pay dividends in the foreseeable future.
The following table shows the range of high and low bid prices for each
quarter during our last two calendar years ended December 31, 2004 and 2003, as
reported by the National Association of Securities Dealers, Inc:
Price Range
-----------
Fiscal Quarter Ended High Low
-------------------- ---- ---
March 31, 2003 1.05 0.60
June 30, 2003 1.50 0.88
September 30, 2003 2.20 1.00
December 31, 2003 1.45 1.00
March 31, 2004 2.00 1.00
June 30, 2004 1.43 1.08
September 30, 2004 1.40 1.05
December 31, 2004 1.75 1.21
In August 2001, our 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 Chaparral 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.
Chaparral's common stock is also subject to the rules and regulations of
the SEC concerning "penny stocks." The SEC's rules and regulations generally
define a penny stock to be an equity security that is not listed on Nasdaq or a
national securities exchange and that has a market price of less than $5.00 per
share, subject to certain exceptions. The SEC's rules and regulations require
broker-dealers to deliver to a purchaser of penny stock a disclosure schedule
explaining the penny stock market and the risks associated with it. Various
sales practice requirements are also imposed on broker-dealers who sell penny
stocks to persons other than established customers and accredited investors
(generally institutions). In addition, broker-dealers must provide the customer
with current bid and offer quotations for the penny stock, the compensation of
the broker-dealer and its salesperson in the transaction and monthly account
statements showing the market value of each penny stock held in the customer's
account.
1998 Incentive and Non-statutory Stock Option Plan
On June 26, 1998, the stockholders approved the 1998 Incentive and
Non-statutory Stock Option Plan (the "1998 Plan"), pursuant to which up to
50,000 options to acquire Chaparral's common stock may be granted to officers,
directors, employees, or consultants of Chaparral and its subsidiaries. The
stock options granted under the 1998 Plan may be either incentive stock options
or non-statutory stock options. The 1998 Plan has an effective term of ten
years, commencing on May 20, 1998. Chaparral has not granted any options under
the 1998 Plan as of December 31, 2004.
9
2001 Stock Incentive Plan
In June 2001, Chaparral's stockholders approved the 2001 Stock Incentive
Plan, which sets aside a total of 2.14 million shares of Chaparral's common
stock for issuance to Chaparral's officers, directors, employees, and
consultants. Chaparral has not made any grants under the 2001 Stock Incentive
Plan as of December 31, 2004.
We did not sell any securities since October 1, 2001, which were not
registered under the Securities Act of 1933, as amended.
ITEM 6. SELECTED FINANCIAL DATA
As of or for the Year Ended December 31,
----------------------------------------
$000 (except where stated)
-----------------------------------------------------------
2004 2003 2002(1) 2001 2000
-----------------------------------------------------------
Oil and gas sales ............... 78,451 57,615 45,133 -- --
Total revenues .................. 78,451 57,615 45,133 -- --
Equity in income from
investment ................... -- -- -- 4,616 2,827
Net income/(loss) ............... 8,522 2,061 4,117 (16,215) (26,803)
Net income/(loss) per
common share ($) ............. 0.22 0.05 0.14 (1.16) (6.01)
Working capital deficit ......... (23,474) (12,487) (2,366) (39,357) (601)
Total assets .................... 123,703 98,668 87,308 69,037 70,156
Long-term obligations and
redeemable preferred stock ... 28,888 30,470 29,542 3,900 26,528
Stockholders' equity ............ 54,692 46,170 44,109 25,361 41,926
Other Data
Present value of proved reserves(2) 204,585 167,182 128,739 40,344 70,281
Minority interest present value
of proved reserves ........... 81,834 66,873 51,496 -- --
Proved oil reserves (bbls) ...... 40,594 25,616 21,855 14,961 16,523
Minority interest of proved
oil reserves (bbls) .......... 16,238 10,246 8,742 -- --
Proved gas reserves (mcf) ....... -- -- -- -- --
(1) In 2002, Chaparral obtained a controlling interest in KKM.
Consequently, our financial statements have been consolidated with KKM
on a retroactive basis to January 1, 2002. Chaparral accounted for its
50% investment in KKM using the equity method of accounting, which is
reflected in our selected financial data for periods prior to 2002.
(2) Present value of proved reserves for the years prior to 2002 represent
our 50% equity interest in KKM. Present value of proved reserves for
the years 2002 and after are presented at 100%. Discount rate applied
was 10%.
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
1. Liquidity and Capital Resources
----------------------------------------
General Liquidity Considerations
--------------------------------
Going Concern
-------------
Our financial statements have been presented on the basis that the Company
is a going concern, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. Chaparral has a
working capital deficiency as of December 31, 2004. In addition, we have
experienced limitations in obtaining 100% export quota for the sale of our
hydrocarbons. Previously these conditions raised substantial doubt about our
ability to continue as a going concern. However, due to recently completed
refinancing of the Company's debt (see below) we now expect to be able to meet
all expenditure and cash flow requirements through the next twelve months.
Chaparral has been successful in 2004 in stabilizing the export sales/local
market deliveries ratio which had significantly improved from 2002 to 2003. For
the year ended December 31, 2004, Chaparral sold approximately 2,758,000 barrels
of its current year production, of which approximately 2,544,000 barrels, or 92%
(2003: 2,591,000 barrels, 96%), have been sold at world market prices and
214,000 barrels, or 8% (2003: 103,000 barrels, 4%), have been sold at domestic
market prices.
On March 24, 2005, KKM signed a $40 million Structured Crude Oil Pre-export
Credit Facility Agreement with BNP Paribas (Suisse) SA and others (the "BNP
Credit Facility"). Subject to meeting conditions precedent within 30 days of
signing, funds from this facility will be available for use to cover any
short-term working capital deficiencies and to pay down the existing loan with
Kazkommertsbank. Amounts borrowed under the BNP Credit Facility are repayable in
36 equal monthly installments commencing between six and seven months after the
signing date. The interest rate is LIBOR plus 3.25% for the first 12 months and
LIBOR plus 4.00% thereafter. The lenders also require that KKM implement a crude
oil price hedging program, in a form satisfactory to the lenders. In addition,
on March 22, 2005, Chaparral and CAP-G signed a Promissory Note Amendment
Agreement with Nelson (the "Amended Note"). This provides for a prepayment of $1
million of the $4 million due to be repaid to Nelson on May 10, 2005 under the
existing $4 million loan note and the replacement of the existing loan note with
a new loan note for $3 million on substantially similar terms, but with an
increase in the interest rate from 12% to 14% from May 10, 2005 and an extension
of the maturity date of one year to May 10, 2006. The debt refinancing, coupled
with current production and price levels, will enable the Company to meet all
current financial obligations and continue with field development.
Liquidity and Capital Resources
-------------------------------
We are presently engaged in the development of the Karakuduk Field, which
requires substantial cash expenditures for drilling, well completions,
workovers, oil storage and processing facilities, pipelines, gathering systems,
water injection facilities, plant and equipment (pumps, transformer sub-stations
etc.) and gas utilization. We have invested approximately $150 million in the
development of the Karakuduk Field and have drilled or re-completed 60
productive wells by the end of 2004, including 15 wells in the year 2004. Total
capital expenditures for 2004 were approximately $30 million compared to $28
million incurred in 2003. Capital expenditures are estimated to be at least $100
million from 2005 through 2009, including the drilling of approximately 70 more
wells over this period. We anticipate 2005 capital expenditures of approximately
$46 million.
We expect to finance the continued development of the Karakuduk Field
primarily through cash flows from the sale of crude oil. During 2004, KKM sold
approximately 2.8 million barrels of crude oil for $78 million. As mentioned
above, KKM has recently secured $40 million of new funding with which it intends
to re-finance the loans provided by Kazkommertsbank. As of January 5, 2005,
daily oil production was approximately 9,000 barrels per day from 45 of the 57
productive wells in the field.
In 2005, KKM expects to increase production by drilling new wells,
converting at least 15 more wells to artificial lift, converting three more
wells to water injection wells, adding four new water injection wells to the
injection fund and by continuing with hydraulic fracturing work in selected
wells. A sedimentological study was undertaken in 2004 which will also help in
identifying reservoir fairways that should result in more productive wells.
Management expects production from the Karakuduk Field to increase to nearly
13,000 barrels of oil per day by year-end 2005.
In addition, our short and long-term liquidity is impacted by local oil
sales obligations imposed on oil and gas producers within Kazakhstan to supply
local energy needs, and our ability to obtain export quota necessary to sell our
11
crude oil production on the international market. Under the terms of the
Agreement, we have a right to export, and receive export quota for, 100% of the
production from the Karakuduk Field. The domestic market does not permit world
market prices to be obtained, resulting in, on average, approximately $15 to $16
lower cash flow per barrel in 2004. Furthermore, the Government has not
allocated sufficient export quota to allow us to sell all of our available crude
oil production on the world market. We are taking steps to reduce our local
market obligations and to obtain an export quota that will enable us to sell all
of our crude oil production on the export market. The Company has determined
that it is no longer in the best interests of the Company to pursue arbitration
proceedings in Switzerland for the breach of the Agreement by the Government of
Kazakhstan, instead we intend to seek an amicable resolution of this matter. If
the matter cannot be resolved in a satisfactory manner, we have, however,
reserved our right to commence formal arbitration proceedings pursuant to our
contractual arrangements with the Government.
No assurances can be provided, however, that an amicable resolution will be
reached, or that if arbitration is instituted, it will be successful or that if
successful, Chaparral will be able to enforce the award in Kazakhstan, or that
we will be able to export 100% or a significant portion of production or that we
will be able to obtain additional cash flow from operations to meet working
capital requirements in the future.
Obligations and Commitments
---------------------------
The following table is a summary of Chaparral's future payments on
obligations as of December 31, 2004:
Obligations by Period
$000
-----------------------------------------------------------------------------
1 Year 2-3 Years 4-5 Years Later Years Total
Debt 20,000 12,000 - - 32,000
Interest on debt 3,060 1,489 - - 4,549
Drilling contract 4,500 - - - 4,500
In May 2002, Chaparral received a total equity and debt capital infusion of
$45 million. Chaparral received a total investment of $12 million from Central
Asian Industrial Holdings, N.V. ("CAIH"), including $8 million in exchange for
22,925,701 shares, or 60%, of Chaparral's outstanding common stock, and $4
million in exchange for a three year note (the "Note") bearing interest at 12%
per annum (of which $2 million was repaid during 2002 but re-borrowed in 2004).
These shares and the Note were sold to Nelson in May 2004. Additionally,
Kazkommertsbank provided KKM with a credit facility totaling $33 million bearing
interest at 14% per annum. As of December 31, 2004 the outstanding principal
balance on the KKM Credit Facility was $28 million. The terms and conditions of
the Note and the KKM Credit Facility are more fully described in Note 12 of our
consolidated financial statements for the year ended December 31, 2004.
The financing costs of the KKM Credit Facility and the Note represent
significant future cash flow requirements. A substantial portion of our future
cash flow from operations will be required for debt service and may not be
available for other purposes. We expect up to $36.5 million of our future
available net cash flows from the Karakuduk Field will be utilized to service
these loans, depending upon excess cash flows available from operations, if any,
to repay the loan prior to its stated maturity date. The availability of future
cash flows is contingent upon many factors beyond our control, including
successful development of the underlying oil reserves from the Karakuduk Field,
production rates, production and development costs, oil prices, access to oil
transportation routes, and political stability in the region. In addition under
the KKM Credit Facility, 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.
As mentioned above, the recently signed BNP Credit Facility will enable
refinancing of the KKM Credit Facility.
The failure of Chaparral to meet the terms of the KKM Credit Facility could
result in an event of default and the loss of our shares in KKM, currently
pledged as collateral under the KKM Credit Facility. We are currently in
compliance with all the terms of the KKM Credit Facility, as renegotiated. We
had made all principal and interest payments due under the KKM Credit Facility
and the Note as of December 31, 2004. Payments of principal of $3 million and $2
million, together with interest of $836,000 and $51,000, on the KKM Credit
Facility were due and paid on January 31, 2005 and February 6, 2005
respectively.
12
On December 31, 2004, KKM's drilling contract with Kazmunaigasburunie
(KMGD), an affiliate of KMG, expired. In January 2005, KKM signed a new contract
with Oil and Gas Drilling and Exploration of Kracow (OGEC). Drilling operations
continue uninterrupted at Karakuduk since the rig that was contracted via KMGD
is owned by OGEC. KKM will continue to use this rig, but at a substantially
reduced day rate. KKM also has a call-out contract for a 100 ton mobile workover
rig. This rig commenced operations at Karakuduk in late October 2004 and will
continue to work at the field for the first quarter of 2005. Mud engineering and
mud chemical services, oil well cement and cementing services, well logging,
perforating and tool and equipment supply are supplied on a short term basis or
under contracts which may be cancelled within 30 days of KKM giving notice.
Related Party Transactions
--------------------------
KKM has a contract to transport 100% of its oil sales through the pipeline
owned and operated by KTO, a wholly owned subsidiary of KMG, which was, until
December 2004, the 40% minority shareholder in KKM. The rates for transportation
are in accordance with those approved by the Government of the Republic of
Kazakhstan. Currently, the use of the KTO pipeline system is the only viable
method of exporting KKM's production. As KTO notifies KKM of the export sales
allocated to KKM on a monthly basis, KTO controls both the volume and
transportation cost of export sales.
KKM makes a prepayment for crude transportation based upon the allocation
of export sales received from KTO. This prepayment includes pipeline costs
charged by the operators of the Russian and Ukrainian pipeline systems which are
dependent upon the point of sale of KKM's exports. The following table
summarizes KKM's payments to, and balances with, KTO:
$000
2004 2003
KKM's payments to KTO during the year 13,348 12,003
of which transportation costs for the year 13,144 11,292
Prepayment balance with KTO at December 31 1,162 1,296
Charges for pipeline oil storage, sales commission,
export sales customs fees and Volga pipeline water 204 267
of which outstanding at December 31 8 97
As mentioned above, KKM had a drilling contract with KMGD, an affiliate of
KMG, for one development drilling rig operating in the Karakuduk Field. The
contract expired on December 31, 2004.
As previously mentioned, on March 24, 2005, Chaparral and CAP-G signed a
Promissory Note Amendment Agreement with Nelson (the "Amended Note"). This
provides for a prepayment of $1 million of the $4 million due to be repaid to
Nelson on May 10, 2005 under the existing $4 million loan note and the
replacement of the existing loan note with a new loan note for $3 million on
substantially similar terms, but with an increase in the interest rate from 12%
to 14% from May 10, 2005 and an extension of the maturity date of one year to
May 10, 2006.
All other related party transactions are disclosed in the notes to our
consolidated financial statements for December 31, 2004. The loans with
Kazkommertsbank and Nelson are disclosed in Note 12 and the drilling contract
with KMGD is described in Notes 18 and 19, prepaid transportation to KTO in Note
3 and an insurance policy with Kazkommerts Policy in Note 19.
Legal Proceedings
-----------------
In December 2002, KKM received a claim from the Ministry of State Revenues
of the Republic of Kazakhstan for $9.1 million (the "Tax Claim") relating to
taxes and penalties covering the three years from 1999 to 2001. KKM appealed the
claim through the courts in Kazakhstan, which eventually ruled in favor of KKM
with the exception of $255,000 which was upheld. As a result, during 2003 KKM
reversed $899,000 for income taxes accrued during 2002 for the Tax Claim net of
the $255,000 which was settled January 2004.
The Ministry of State Revenues of the Republic of Kazakhstan had been
considering penalties with respect to the Tax Claim in the amount of $970,000.
In March 2004 a court hearing was conducted which resulted in a reduction of
these penalties to $53,000. This amount was paid in full during 2004.
13
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 development project.
All regulations are subject to future changes by legislative and
administrative action and by judicial decisions. Such changes could adversely
affect the petroleum industry in general, and us in particular. It is impossible
to predict the effect that any current or future proposals or changes in
existing laws or regulations may have on our operations.
Commodity Prices for Oil
------------------------
Our revenues, profitability, growth and value are highly dependent upon the
price of oil. Market conditions make it difficult to estimate prices of oil or
the impact of inflation on such prices. Oil prices have been volatile, and it is
likely they will continue to fluctuate in the future. Various factors beyond our
control affect prices for oil, including supplies of oil available worldwide and
in Kazakhstan, the ability of OPEC to agree to maintain oil prices and
production controls, political instability or armed conflict in Kazakhstan or
other oil producing regions, the price of foreign imports, the level of consumer
demand, the price and availability of alternative fuels, the availability of
transportation routes and pipeline capacity, and changes in applicable laws and
regulations.
Exchange Rates and 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. A devaluation of the Tenge, the currency of the Republic of
Kazakhstan, can significantly decrease the value of the monetary assets that we
hold in Kazakhstan as well as our assets in that country that are based on the
Tenge. KKM retains the majority of cash and cash equivalents in U.S. Dollars,
but KKM's statutory tax basis for its assets, tax loss carryforwards, and VAT
receivables are all denominated in Tenge and subject to the effects of
devaluation. Local tax laws allow basis adjustments to offset the impact of
inflation on statutory tax basis assets, but there is no assurance that any
adjustments will be sufficient to offset the effects of inflation in whole or in
part. If not, KKM may be subject to much higher income tax liabilities within
Kazakhstan due to inflation and or devaluation of the local currency.
Additionally, devaluation may create uncertainty with respect to the future
business climate in Kazakhstan and to our investment in that country. During
2004, however, the Tenge has appreciated against the U.S. Dollar by
approximately 10%. There remains no guarantee that this appreciation is either
sustainable or permanent in the foreseeable future. As of December 31, 2004, the
exchange rate was 130.00 Tenge per U.S. Dollar compared to 144.22 as of December
31, 2003. It should be noted that 92% of our crude oil sales in 2004 were
denominated in U.S. Dollars, while the majority of our capital expenditures,
operating costs and general and administrative expenses are denominated in
Tenge.
Critical Accounting Policies
----------------------------
Application of generally accepted accounting principles requires the use of
estimates, judgments and assumptions that affect the reported amounts of assets
and liabilities as of the date of the financial statements and revenues and
expenses during the reporting period. In addition, alternative methods can exist
to meet various accounting principles. In such cases, the choice of accounting
method can also have a significant impact on reported amounts.
Our determination of proved oil and gas reserve quantities, the application
of the full cost method of accounting for KKM's development and production
activities, and the application of standards of accounting for derivative
instruments and hedging activities require management to make numerous estimates
and judgments.
Oil and Gas Properties (Full Cost Method). Chaparral follows the full cost
method of accounting for oil and gas properties. Accordingly, all costs
associated with the acquisition, exploration, and development of oil and gas
reserves, including directly related overhead costs, are capitalized. Effective
with the adoption of Statement of Financial Accounting Standards ("SFAS") No.
143 in 2003, the carrying amount of oil and gas properties also includes
14
estimated asset retirement costs recorded based on the fair value of the asset
retirement obligation when incurred. The application of the full cost method of
accounting for oil and gas properties generally results in higher capitalized
costs and higher DD&A rates compared to the successful efforts method of
accounting for oil and gas properties.
All capitalized costs of proved oil and gas properties, including the
estimated future costs to develop proved reserves, are amortized using the
unit-of-production method based on estimated proved reserves. Investments in
unproved properties and major development projects are not amortized until
proved reserves associated with the projects can be determined or until
impairment occurs. If the results of an assessment indicate that the properties
are impaired, the amount of the impairment is added to the capitalized cost to
be amortized.
Sales of proved and unproved properties are accounted for as adjustments of
capitalized costs with no gain or loss recognized, unless such adjustments would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in income.
Abandonment of properties is accounted for as adjustments of capitalized costs
with no loss recognized.
Cost Excluded. Oil and gas properties include costs that are excluded from
capitalized costs being amortized. These amounts represent costs of investments
in unproved properties and major development projects. Chaparral excludes these
costs on a country-by-country basis until proved reserves are found or until it
is determined that the costs are impaired. All costs excluded are reviewed
quarterly to determine if impairment has occurred. Any impairment is transferred
to the costs to be amortized or a charge is made against earnings for those
international operations where a reserve base has not yet been established. For
operations where a reserve base has not yet been established, an impairment
requiring a charge to earnings may be indicated through evaluation of drilling
results or relinquishment of drilling rights.
Capitalized Interest. SFAS 34, Capitalization of Interest Costs, provides
standards for the capitalization of interest costs as part of the historical
cost of acquiring assets. Financial Accounting Standards Board ("FASB")
Interpretation No. 33 ("FIN 33") provides guidance for the application of SFAS
34 to the full cost method of accounting for oil and gas properties. Under FIN
33, costs of investments in unproved properties and major development projects,
on which depreciation, depletion and amortization ("DD&A") expense is not
currently taken and on which exploration or development activities are in
progress, qualify for capitalization of interest. Capitalized interest is
calculated by multiplying the weighted-average interest rate on debt by the
amount of costs excluded. Capitalized interest cannot exceed gross interest
expense.
Ceiling Test. Companies that use the full cost method of accounting for oil
and gas exploration and development activities are required to perform a ceiling
test each quarter. The full cost ceiling test is an impairment test prescribed
by SEC Regulation S-X Rule 4-10. The ceiling test is performed on a
country-by-country basis. The test determines a limit, or ceiling, on the book
value of oil and gas properties. That limit is basically the after tax present
value of the future net cash flows from proved crude oil and natural gas
reserves. This ceiling is compared to the net book value of the oil and gas
properties reduced by any related deferred income tax liability. If the net book
value reduced by the related deferred income taxes exceeds the ceiling, an
impairment or non-cash write down is required. A ceiling test impairment can
give Chaparral a significant loss for a particular period; however, future DD&A
expense would be reduced.
Reserves. Estimates of our proved oil and gas reserves are prepared by
McDaniel in accordance with guidelines established by the SEC. Those guidelines
require that reserve estimates be prepared under existing economic and operating
conditions with no provisions for increases in commodity prices, except by
contractual arrangement. Estimation of oil and gas reserve quantities is
inherently difficult and is subject to numerous uncertainties. Such
uncertainties include the projection of future rates of production, export
allocation, and the timing of development expenditures. The accuracy of the
estimates depends on the quality of available geological and geophysical data
and requires interpretation and judgment. Estimates may be revised either upward
or downward by results of future drilling, testing or production. In addition,
estimates of volumes considered to be commercially recoverable fluctuate with
changes in commodity prices and operating costs. Our estimates of reserves are
expected to change as additional information becomes available. A material
change in the estimated volumes of reserves could have an impact on the DD&A
rate calculation and the financial statements.
15
Derivative Financial Instruments and Hedging Activities. We account for our
investment in derivative financial instruments in accordance with SFAS 133,
Accounting for Derivative Financial Instruments and Hedging Activities, as
amended. As a result, we recognize all derivative financial instruments in our
financial statements at fair value, regardless of the purpose or intent for
holding the instrument. Changes in the fair value of derivative financial
instruments are recognized periodically in income or in shareholders' equity as
a component of comprehensive income depending on whether the derivative
financial instrument qualifies for hedge accounting, and if so, whether it
qualifies as a fair value hedge or cash flow hedge. Generally, changes in fair
values of derivatives accounted for as fair value hedges are recorded in income
along with the portions of the changes in the fair values of the related hedged
items. 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.
Accounting for Asset Retirement Obligations. 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. Subsequently, the asset retirement cost should be allocated to
expense using a systematic and rational method. SFAS 143 is effective for fiscal
years beginning after June 15, 2002. As a result of the adoption of SFAS 143,
Chaparral has increased its assets and liabilities by $516,000 as of January 1,
2003 to reflect the net present value of its retirement obligations. See Note 11
to our consolidated financial statements for the year ended December 31, 2004
for results of the adoption of SFAS 143.
Legal, Environmental and Other Contingencies. A provision for legal,
environmental and other contingencies is charged to expense when the loss is
probable and the cost can be reasonably estimated. Determining when expenses
should be recorded for these contingencies and the appropriate amounts for
accrual is a complex estimation process that includes the subjective judgment of
management. In many cases, management's judgment is based on interpretation of
laws and regulations, which can be interpreted differently by regulators and/or
courts of law. Chaparral's management closely monitors known and potential
legal, environmental and other contingencies and periodically determines when
Chaparral should record losses for these items based on information available to
us.
Income Taxes. As part of the process of preparing our consolidated
financial statements, we are required to estimate our taxes in each of the
jurisdictions of operation. This process involves management estimating the
actual current tax expense together with assessing temporary differences
resulting from differing treatment of items for tax and accounting purposes in
accordance with the provisions of SFAS No. 109, Accounting for Income Taxes.
These differences result in deferred tax assets and liabilities, which are
included within the consolidated balance sheets. We then must assess the
likelihood that the deferred tax assets will be recovered from future taxable
income and, to the extent recovery is not likely, we must establish a valuation
allowance. Future taxable income depends on the ability to generate income in
excess of allowable deductions. To the extent we establish a valuation allowance
or increase this allowance in a period, an expense is recorded within the tax
provision in the consolidated statement of operations. Significant management
judgment is required in determining our provision for income taxes, deferred tax
assets and liabilities and any valuation allowance recorded against net deferred
tax assets. In the event that actual results differ from these estimates or we
adjust these estimates in future periods, we may need to establish a valuation
allowance that could materially impact our financial condition and results of
operations.
Change in Estimates. Chaparral has not materially changed the use of its
methodology for the estimates described above for the years presented and actual
results compared to estimates made have not had a material effect on Chaparral's
financial condition and results of operations. There are currently no known
trends, demands, commitments, events or uncertainties that are reasonably likely
to occur that could materially affect the methodology or assumptions described
above.
Recent Accounting Pronouncements
--------------------------------
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts and hedging activities under SFAS No. 133. The
amendments set forth in SFAS No. 149 require that contracts with comparable
characteristics be accounted for similarly. SFAS No. 149 is generally effective
for contracts entered into or modified after June 30, 2003 (with a few
exceptions) and for hedging relationships designated after June 30, 2003. The
guidance is to be applied prospectively only. The adoption of SFAS No. 149 as of
July 1, 2003 has had no effect on our consolidated financial statements.
16
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This statement
establishes standards for how an issuer classifies and measures on its balance
sheet certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances) because that
financial instrument embodies an obligation of the issuer. SFAS No. 150 was
effective for financial instruments entered into or modified after May 31, 2003,
and was otherwise effective for us as of July 1, 2003. The adoption of the
applicable provisions of this statement as of the indicated dates has had no
effect on our consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
Consolidation of Variable Interest Entities, an interpretation of ARB 51. The
primary objectives of this interpretation are to provide guidance on the
identification of entities for which control is achieved through means other
than through voting rights ("variable interest entities") and how to determine
which business enterprise (the "primary beneficiary") should consolidate the
variable interest entity and when. This new model for consolidation applies to
an entity in which either (i) the equity investors (if any) do not have a
controlling financial interest; or (ii) the equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support from other parties. In addition, FIN 46 requires
that the primary beneficiary, as well as all other enterprises with a
significant variable interest in a variable interest entity, make additional
disclosures. Certain disclosure requirements of FIN 46 were effective for
financial statements issued after January 31, 2003.
In December 2003, the FASB issued FIN No. 46 (revised December 2003),
Consolidation of Variable Interest Entities ("FIN 46-R") to address certain FIN
46 implementation issues. The effective dates and impact of FIN 46 and FIN 46-R
are as follows:
(i) Special purpose entities ("SPEs") created prior to February 1, 2003.
Chaparral must apply either the provisions of FIN 46 or early adopt the
provisions of FIN 46-R at the end of the first interim or annual reporting
period ending after December 15, 2003.
(ii) Non-SPEs created prior to February 1, 2003. Chaparral is required to
adopt FIN 46-R at the end of the first interim or annual reporting period
ending after March 15, 2004.
(iii) All entities, regardless of whether a SPE, that were created
subsequent to January 31, 2003. The provisions of FIN 46 were applicable
for variable interests in entities obtained after January 31, 2003.
Chaparral is required to adopt FIN 46-R at the end of the first interim or
annual reporting period ending after March 15, 2004.
The adoption of the provisions applicable to SPEs and all other variable
interests obtained after January 31, 2003 did not have a material impact on
Chaparral's financial statements. FIN 46-R applicable to Non-SPEs created prior
to February 1, 2003 does not impact on Chaparral's results of operations,
financial position and cash flows.
In June 2001, the FASB issued SFAS 143, Accounting for Asset Retirement
Obligations. SFAS 143 requires entities to record the fair value of a liability
for an asset retirement obligation in the period in which it is incurred and a
corresponding increase in the carrying amount of the related long-lived asset.
Subsequently, the asset retirement cost should be allocated to expense using a
systematic and rational method. SFAS 143 is effective for fiscal years beginning
after June 15, 2002. Chaparral adopted SFAS 143 on January 1, 2003. See Note 11
to our consolidated financial statements for the year ended December 31, 2004
for results of the adoption of SFAS 143.
In November 2004, the FASB issued SFAS 151, Inventory Costs, an Amendment
of APB Opinion No. 43, Chapter 4. SFAS 151 clarifies the accounting treatment
for various inventory costs and overhead allocations and is effective for
inventory costs incurred after July 1, 2005. It is not expected to have a
material impact on the Company's financial statements when adopted.
In December 2004, the FASB issued SFAS 153, Exchanges of Non-monetary
Assets, an Amendment of APB Opinion No. 29. SFAS 153 specifies the criteria
required to record a non-monetary asset exchange using carryover basis and is
17
effective for non-monetary asset exchanges occurring after July 1, 2005. It is
not expected to have a material impact on the Company's financial statements
when adopted.
In December 2004, the FASB issued SFAS 123 (revised 2004) ("SFAS 123R"),
Share Based Payments. SFAS 123R requires that the cost from all share-based
payment transactions, including stock options, be recognized in the financial
statements at fair value and is effective for public companies in the first
interim period after June 15, 2005. It is not expected to have a material impact
on the Company's financial statements.
2. Results of Operations
------------------------------
Results of Operations for the Year Ended December 31, 2004 Compared to the Year
-------------------------------------------------------------------------------
Ended December 31, 2003
-----------------------
Our operations for the year ended December 31, 2004 resulted in a net
income of $8.52 million compared to a net income of $2.06 million for the year
ended December 31, 2003. The $6.46 million increase in our net income is
primarily due to (i) higher oil prices, (ii) increased sales and (iii) the
receipt of pre-emption fee income, partially offset by (i) higher minority
interest and taxes as a result of higher profits at KKM, (ii) higher
transportation tariffs, (iii) higher workover costs, (iv) increased interest
charges and (v) the beneficial effect in 2003 of a change in accounting
principle.
Revenue. Revenues were $78.45 million for the year ended December 31, 2004
compared with $57.61 million for the year ended December 31, 2003. The $20.84
million increase is the result of higher volumes sold and higher oil prices
received during the year ended December 31, 2004. The increase in volumes sold
during 2004 was the result of increased production and sales quotas obtained for
the year. During 2004 we sold approximately 2,758,000 barrels of crude oil,
recognizing $78.45 million, or $28.44 per barrel, in revenue. In comparison, we
sold approximately 2,694,000 barrels of crude oil, recognizing $57.61 million in
revenue, or $21.39 per barrel, for the year ended December 31, 2003.
Transportation and Operating Expenses. Transportation costs for the year
ended December 31, 2004 were $14.05 million, or $5.09 per barrel, and operating
costs associated with sales were $8.32 million, or $3.02 per barrel. In
comparison, transportation costs for the year ended December 31, 2003 were
$11.47 million, or $4.26 per barrel, and operating costs associated with sales
were $5.92 million, or $2.20 per barrel. The increase in transportation costs
per barrel is mainly due to higher tariffs imposed on the Company and a 160,000
barrel sale to the local market in 2003 that carried no transportation cost. The
increase in operating cost per barrel is mainly due to higher work-over costs.
Depreciation and Depletion. Depreciation and depletion expense was $18.18
million for the year ended December 31, 2004 compared to $18.04 million for the
year ended December 31, 2003. The $0.14 million increase is the result of higher
sales volumes, offset by a slightly lower effective depletion rate. During the
year 2004, Chaparral recognized a total depletion expense of $17.55 million or
$6.36 per barrel, compared with $17.30 million or $6.42 per barrel in depletion
expense for the year 2003. The decrease in the effective depletion rate of $0.06
per barrel is due to additions to the Company's estimated proved reserves,
partially offset by increased estimated capital expenditures for the development
of the field for future years.
Interest Expense. Interest expense for the year ended December 31, 2004,
increased by $1.02 million from $4.53 million in 2003 to $5.55 million in 2004.
This increase is mainly due to $0.46 million of interest payable in 2004 by KKM
on advanced sales receipts, $0.21 million increase in discount on the Note,
higher interest on the Note of $0.18 million due to the re-borrowing of $2
million in March 2004, and a lower amount of capitalized interest of $0.45
million, offset by lower interest payable of $0.39 million on the KKM Credit
Facility .
General and Administrative Expense. General and administrative costs for
the year ended December 31, 2004, increased by $0.63 million from $7.76 million
for the year 2003 to $8.39 million for the year 2004. The increase is largely
due to $0.78 million of severance payments to former executives of the Company,
partially offset by reduced costs as a result of economies in consultancy
services and salaries and wages.
Other Income. Other income for the year ended December 31, 2004 includes $1
million received from Nelson as a fee for the Company exercising its pre-emption
rights regarding the sale in December 2004 by KMG of its 40% share of KKM, which
was then transferred to Nelson, who funded the purchase price. See Item 1 for a
fuller description of the transaction.
18
Income Taxes. Income tax expense for the year ended December 31, 2004,
increased by $3.00 million from $4.12 million for the year 2003 to $7.12 million
for the year 2004. The $3.00 million increase is due to KKM generating higher
taxable income in the Republic of Kazakhstan. (Net income at the KKM level for
the year ended December 31, 2004 was $18.66 million compared with $10.76 million
for the year ended December 31, 2003). All income taxes provided for relate to
our operations in Kazakhstan. Chaparral currently has no U.S. income tax
liability due to Chaparral's estimated USA domestic tax loss carryforwards of
$24.8 million as of December 31, 2004. These carryforwards will expire at
various times between 2005 and 2022. See Note 14 to our consolidated financial
statements for the year ended December 31, 2004.
Cumulative Effect of Change in Accounting Princple. As a result of the
adoption of SFAS 143, Chaparral recognized a gain of $1.02 million as a
cumulative effect of change in accounting principle for the year ended December
31, 2003. In addition, Chaparral recognized $73,000 in accretion expense to
account for changes in the ARO liability. There were no such items recorded in
2004. See Note 11 to our consolidated financial statements for the year ended
December 31, 2004.
Results of Operations for the Year Ended December 31, 2003 Compared to the Year
-------------------------------------------------------------------------------
Ended December 31, 2002
-----------------------
Our operations for the year ended December 31, 2003 resulted in a net
income of $2.06 million compared to a net income of $4.12 million for the year
ended December 31, 2002. The $2.06 million decrease in our net income is the
result of (i) higher transportation, depletion, general and administrative,
income tax, and minority interest costs for the year ended December 31, 2003,
(ii) a $5.34 million extraordinary gain recognized as a result of the
restructuring of our indebtedness during 2002, offset by (i) higher revenues
recognized during 2003, (ii) the recognition of a $1.02 million gain as a result
of the adoption of SFAS 143 on January 1, 2003 and (iii) lower interest costs
for 2003.
Revenue. Revenues were $57.61 million for the year ended December 31, 2003
compared with $45.13 million for the year ended December 31, 2002. The $12.48
million increase is the result of higher volumes sold and higher oil prices
received during the year ended December 31, 2003. The increase in volumes sold
during 2003 was the result of increased production and sales quotas obtained for
the year. During 2003 we sold approximately 2,694,000 barrels of crude oil,
recognizing $57.61 million, or $21.39 per barrel, in revenue. In comparison, we
sold approximately 2,467,000 barrels of crude oil, recognizing $45.13 million in
revenue, or $18.29 per barrel, for the year ended December 31, 2002.
Transportation and Operating Expenses. Transportation costs for the year
ended December 31, 2003 were $11.47 million, or $4.26 per barrel, and operating
costs associated with sales were $5.92 million, or $2.20 per barrel. In
comparison, transportation costs for the year ended December 31, 2002 were $9.43
million, or $3.82 per barrel, and operating costs associated with sales were
$7.68 million, or $3.11 per barrel. The increase in transportation costs per
barrel is mainly due to higher tariffs imposed on Chaparral and greater sales to
the export market during 2003. The decrease in operating cost per barrel is
mainly due to (i) economies of scale achieved by higher throughput during the
period, (ii) significantly lower transportation costs from the wellhead to entry
point of the KTO export pipeline, following the commission of the KKM pipeline,
and (iii) lower work-over cost for the current year due to the increase in
capital activities during the year 2003.
Depreciation and Depletion. Depreciation and depletion expense was $18.04
million for the year ended December 31, 2003 compared to $12.80 million for the
year ended December 31, 2002. The $5.24 million increase is the result of higher
effective depletion rates and higher volumes of oil sold during the year ended
December 31, 2003. During the year 2003, Chaparral recognized a total depletion
expense of $17.30 million or $6.42 per barrel, compared with $12.08 million or
$4.90 per barrel in depletion expense for the year 2002. The increase in the
effective depletion rate of $1.52 per barrel is due to increased estimated
capital expenditures for the development of the field for future years and
reductions to Chaparral's proved reserves, based on December 31, 2002 reserve
report.
Interest Expense. Interest expense for the year ended December 31, 2003,
decreased by $1.08 million from $5.61 million in 2002 to $4.53 million in 2003,
as a result of lower financing costs and the restructuring of our indebtedness
in 2002.
19
General and Administrative Expense. General and administrative costs for
the year ended December 31, 2003, increased by $0.95 million from $6.81 million
for the year 2002 to $7.76 million for the year 2003. The $0.95 million increase
is largely due to higher salaries accrued during 2003 and consultant payments,
comprising of $0.67 million accrued for 2003 year end bonus and a $0.28 million
production bonus paid in the year to employees and consultants of Chaparral for
achieving the milestone of 1 million tons (approximately 8 million barrels) of
cumulative production. In addition, salaries increased at the KKM level by $0.30
million due to increases in personnel and salary adjustments performed during
2003.
Income Taxes. Income tax expense for the year ended December 31, 2003
increased by $1.43 million from $2.69 million for the year 2002 to $4.12 million
for the year 2003. The $1.43 million increase is largely due to KKM generating
higher taxable income in the Republic of Kazakhstan. (Net income at the KKM
level for the year ended December 31, 2003 was $10.76 million compared with
$4.88 million for the year ended December 31, 2002). All income taxes provided
for relate to our operations in Kazakhstan. Chaparral currently has no U.S.
income tax liability due to Chaparral's estimated USA domestic tax loss
carryforwards of $24.7 million as of December 31, 2003. These carryforwards will
expire at various times between 2004 and 2021. See Note 13 to our consolidated
financial statements for the year ended December 31, 2003.
Cumulative Effect of Change in Accounting Principle. As a result of the
adoption of SFAS 143, Chaparral recognized a gain of $1.02 million as a
cumulative effect of change in accounting principle for the year ended December
31, 2003. In addition, Chaparral recognized $73,000 in accretion expense to
account for changes in the ARO liability. See Note 10 to our consolidated
financial statements for the year ended December 31, 2003.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency
----------------
Chaparral's functional currency is the U.S. Dollar. All transactions
arising in currencies other than U.S. Dollars, including assets, liabilities,
revenue, expenses, gains or losses are measured and recorded in U.S. Dollars
using the exchange rate in effect on the date of the transaction.
Cash and other monetary assets held and liabilities denominated in
currencies other than U.S. Dollars are translated at exchange rates prevailing
as of the balance sheet date (130.00 and 144.22 Kazakh Tenge per U.S. Dollar as
of December 31, 2004 and 2003, respectively). Non-monetary assets and
liabilities denominated in currencies other than U.S. Dollars have been
translated at the estimated historical exchange rate prevailing on the date of
the transaction. Exchange gains and losses arising from translation of non-U.S.
Dollar amounts at the balance sheet date are recognized as an increase or
decrease in income for the period.
A 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.
During 2004, however, the Tenge has appreciated against the U.S. Dollar by
approximately 10%. There remains no guarantee that this appreciation is either
sustainable or permanent in the foreseeable future. KKM retains the majority of
cash and cash equivalents in U.S. Dollars in bank accounts within Kazakhstan,
but KKM's statutory tax basis for its assets, tax loss carryforwards, and VAT
receivables are all denominated in Tenge and subject to the effects of
devaluation. Local tax laws allow basis adjustments to offset the impact of
inflation on statutory tax basis assets, but there is no assurance that any
adjustments will be sufficient to offset the effects of inflation in whole or in
part. If not, KKM may be subject to much higher income tax liabilities within
Kazakhstan due to inflation and/or devaluation of the local currency.
Additionally, devaluation may create uncertainty with respect to the future
business climate in Kazakhstan and to our investment in that country. It should
be noted that 92% of our crude oil sales in 2004 were denominated in U.S.
Dollars, while the majority of our capital expenditures, operating costs and
general and administrative expenses are denominated in Tenge.
The Tenge is not a convertible currency outside of the Republic of
Kazakhstan. The translation of Tenge denominated assets and liabilities in these
financial statements does not indicate that Chaparral could realize or settle
these assets and liabilities in U.S. Dollars.
We had $8.25 million of net monetary liabilities denominated in Tenge as of
December 31, 2004.
20
Commodity Prices for Oil
------------------------
During 2004 we sold approximately 2,758,000 barrels of crude oil,
recognizing $78.45 million, or $28.44 per barrel, in revenue. In comparison, we
sold approximately 2,694,000 barrels of crude oil, recognizing $57.61 million in
revenue, or $21.39 per barrel, for the year ended December 31, 2003.
Under the terms of the Agreement, we have a right to export, and receive
export quota for, 100% of the production from the Karakuduk Field. The domestic
market does not permit world market prices to be obtained, resulting in, on
average, approximately $15 to $16 lower cash flow per barrel in 2004.
Furthermore, the Government has not allocated sufficient export quota to allow
us to sell all of our available crude oil production on the world market. We are
taking steps to reduce our local market obligations and to obtain an export
quota that will enable us to sell all of our crude oil production on the export
market. The Company has determined that it is no longer in the best interests of
the Company to pursue arbitration proceedings in Switzerland for the breach of
the Agreement by the Government of Kazakhstan, instead we intend to seek an
amicable resolution of this matter.
Chaparral has been successful in 2004 in stabilizing the export sales/local
market deliveries ratio which had significantly improved from 2002 to 2003. For
the year ended December 31, 2004, Chaparral sold approximately 2,758,000 barrels
of its current year production, of which approximately 2,544,000 barrels, or
92%, have been sold at world market prices and 214,000 barrels, or 8%, have been
sold at domestic market prices.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 15(a) for a list of the Financial Statements and the supplementary
financial information included in this report following the signature page.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
------------------------------------------------
We maintain disclosure controls and procedures designed to provide
reasonable assurance that information required to be disclosed in the periodic
reports we file with the SEC is recorded, processed, summarized and reported
within the time periods specified in the rules of the SEC. We carried out an
evaluation as of December 31, 2004, under the supervision and the participation
of our management, including our chief executive officer and chief financial
officer, of the design and operation of these disclosure controls and procedures
pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934.
Based upon that evaluation, our chief executive officer and chief financial
officer concluded that our disclosure controls and procedures are effective in
timely alerting them to material information required to be included in our
periodic SEC filings.
Changes in Internal Controls over Financial Reporting
-----------------------------------------------------
There have been no significant changes in internal controls over financial
reporting or other factors subsequent to December 31, 2004.
21
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
As of March 14, 2005, the following table sets forth the names and ages of
our directors and executive officers of Chaparral, the principal offices and
positions with Chaparral held by each person and the date such person became a
director or executive officer. The executive officers are elected annually by
the board of directors. Executive officers serve terms of one year or until
their death, resignation or removal by the board of directors. The present term
of office of each director will expire at the next annual meeting of
stockholders. Each director will hold office until his successor is duly elected
and qualified, until his resignation or until he is removed in the manner
provided by our bylaws.
Name of Director or Officer
and Position in Chaparral Since Age Principal Occupation During the Last 5 Years
------------------------- ----- --- --------------------------------------------
R. Frederick Hodder 2004 63 Mr. Hodder has served as the Chairman of the Board of
Chairman of the Board Chaparral since May 2004. He is currently Senior Vice President
of Nelson Resources Limited where he was previously, from
July 2002, Chief Financial Officer. Prior to joining Nelson,
Mr. Hodder was President of Kazakhstan Investment Management
LLP from 1998 to 1999.
Simon K. Gill 2004 49 Mr. Gill was appointed Chief Executive Officer of Chaparral
Director and in May 2004. In January 2005, Mr. Gill was appointed Chief
Chief Executive Officer Operating Officer of Nelson Resources Ltd. Previously, from
October 2003, Mr. Gill served as Aktau Regional Manager of
Nelson Resources Ltd. Prior to this, Mr. Gill was employed
by Texaco (ChevronTexaco) for 24 years where he served as
General Manager of Texaco North Buzachi in Aktau, Kazakhstan
from 1998 to Oct 2003. Mr. Gill is a member of the Society
of Petroleum Engineers.
Peter G. Dilling * 2002 55 From 1995 to 1997, Mr. Dilling held various positions with
Director Chaparral, including Vice Chairman of the Board. Since 2000,
Mr. Dilling has served as President and Chief Executive
Officer and as a director of Trinidad Exploration and
Development, Ltd., an oil and gas exploration company. He
has served as President and Chief Executive Officer and as a
director of Anglo-African Energy, Inc., an exploration and
production company, since 1999.
Nicholas P. Greene * 2004 57 Since January 2005 Mr. Greene has been Chief Financial
Director Officer of Nelson Resources Ltd; where he was previously
Senior Vice President Corporate Finance. Before this, Mr.
Greene was an independent financial advisor, active in
providing support for cross border trade and acquisitions.
Previously, from 2002 to 2003, Mr. Greene was Senior Vice
President of the Structured Finance Department in AKB
Rosbank, a Russian bank with principal offices in Moscow
and, prior to that, from 1999 to 2002, a Vice President at
Access Industries Inc., a privately owned investment
management company, with offices in New York and Moscow. Mr.
Greene was appointed a Director of Chaparral in May, 2004.
22
Alan D. Berlin * 2002 65 Since 1995, Mr. Berlin has been a partner of the law firm
Director and Corporate Aitken Irvin Berlin & Vrooman, LLP. He was engaged in the
Secretary private practice of law for over five years prior to joining
Aitken Irvin. Mr. Berlin served as a Director of Chaparral
in 1997 and was the Secretary of Chaparral from January 1996
to August 1997. Since June 1998, he has served Chaparral in
the same position. From 1985 to 1987, Mr. Berlin was the
President of the International Division of Belco Petroleum
Corp. and held various other positions with Belco Petroleum
Corp. and Belco Oil and Gas Corp. from 1977 to 2001. Mr.
Berlin has been appointed an Honorary Associate of the
Centre for Petroleum and Mineral Law and Policy at the
University of Dundee, Scotland, and is a member of the
Association of International Petroleum Negotiators.
Nigel Penney 2004 45 Mr. Penney assumed the title of Vice President-Finance and
VP-Finance and Chief Financial Officer of the Company in August 2004. He
Chief Financial Officer was previously an oil and gas accounting and finance
consultant. Prior to this he was Vice President Finance for
PanAfrican Energy Corporation from 2001 to 2002, and Finance
Director of Ramco Oil and Gas Ltd. from 1998 to 2001. He is
a member of the Institute of Chartered Accountants in
England and Wales.
* Audit Committee member.
Audit Committee Financial Expert
The board of directors has determined that all audit committee members are
financially literate under the current listing standards of the New York Stock
Exchange. The board also determined that Nicholas P. Greene qualifies as an
"audit committee financial expert" as defined by the SEC rules adopted pursuant
to the Sarbanes-Oxley Act of 2002.
Code of Ethics
Chaparral has adopted a code of ethics that applies to all of its
directors, officers (including its chief executive officer, chief financial
officer, chief accounting officer, controller and any person performing similar
functions) and its employees. Chaparral has filed a copy of this Code of Ethics
as Exhibit 14 to this form 10-K.
Shareholder Nomination Procedures
There had been no material changes during the fourth fiscal quarter to the
procedures disclosed in the Proxy statement filed on July 7, 2004 with the SEC.
Committees of the Board of Directors and Meeting Attendance
During the fiscal year 2004, Chaparral held seven board meetings. The board
had three committees, namely the Compensation Committee, the Audit Committee and
the Corporate Governance Committee.
23
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based solely upon a review of Forms 3 and 4 and any amendments furnished to
Chaparral during our fiscal year ended December 31, 2004, and Form 5 and any
amendments furnished to Chaparral with respect to the same fiscal year, we
believe that our current directors, officers, and greater than 10% beneficial
owners complied with all applicable Section 16 filing requirements.
ITEM 11. EXECUTIVE COMPENSATION
The following table shows the compensation paid by Chaparral for services
rendered during the year by Mr. Gill as Chief Executive Officer of Chaparral,
and his predecessor Mr. Klinchev, and by Mr. Penney as Vice President - Finance
and Chief Financial Officer of Chaparral, and his predecessors, Messrs. Soto,
Wood and Moore. There were no other executive officers of Chaparral whose annual
salary and bonus exceeded $100,000 during the fiscal year 2004.
Summary Compensation Table.
---------------------------------------- ------------------------------------------------
Annual Compensation Long-Term Compensation
---------------------------------------- ------------------------------------------------
Awards Payouts
----------------------------------- -----------
Restricted Securities
Name and Other Annual Stock Awards Underlying LTIP All Other
Principal Position Year Salary Bonus Compensation ($) Options/SARs (#) Payouts ($) Compensation
------------------ ---- ------ ----- ------------ --- ---------------- ----------- ------------
Simon K. Gill 2004 $115,500(1) -- -- -- -- -- --
Chief Executive 2003 -- -- -- -- -- -- --
Officer (from
05/04 to 01/05)
Nikolai D. Klinchev 2004 $106,887 $250,000 -- -- -- -- $311,323 (2)
Former Chief 2003 $282,000 $290,000 -- -- -- -- $28,000 (3)
Executive Officer
(11/02 to 05/04)
Nigel F. Penney 2004 $101,500 -- -- -- -- -- --
VP-Finance and 2003 -- -- -- -- -- -- --
Chief Financial
Officer (from 08/04)
Miguel C. Soto 2004 $112,126 $50,000 -- -- -- -- $120,000 (4)
Former VP-Finance 2003 $172,000 $67,000 -- -- -- -- --
and Chief
Financial Officer
(05/04 to 08/04)
and former
Treasurer and
Controller (11/02
to 04/04)
Jonathan S. Wood 2004 $100,646 $82,000 -- -- -- -- $222,000 (4)
Former VP-Finance 2003 $235,000(5) $136,000(5) -- -- -- -- --
and Chief
Financial Officer
(01/04 to 05/04)
Richard J. Moore 2004 -- -- -- -- -- -- $160,000 (4)
Former VP-Finance 2003 $282,000 $40,000 -- -- -- -- $1,800
and Chief Financial
Officer (11/02 to
12/03)
----- ------------ ------------ -------------- --------------- ------------------- ------------ ------------
1. Paid to Nelson for the services of Mr. Gill for the period June to December
2004.
2. Represents $282,000 severance pay and $29,323 paid by Chaparral for the
education of Mr. Klinchev's daughter.
3. Payments by Chaparral for the education of Mr. Klinchev's daughter.
4. Severance pay.
5. Mr. Wood served as Financial Director of KKM during 2003 for which he
received a salary of $235,000 and bonuses of $136,000.
Options/SAR Grants.
For the fiscal year ended December 31, 2004, we did not grant any options.
24
Aggregated Option/SAR Exercises and Year-End Option/SAR Value.
As of December 31, 2004, there were no unexercised options/SARs and
additionally, no options were exercised in fiscal year 2004.
Director Interlocks.
Mr. Greene is Chief Financial Officer of Nelson. Mr. Hodder and Mr. Gill
are employees of Nelson.
Compensation of Directors.
During the fiscal year ended December 31, 2002, Chaparral implemented a
standard compensation arrangement for its directors, including providing (i)
$700 in compensation to each director for each board or committee meeting
attended via teleconference, (ii) $1,000 in compensation to each director for
each board or committee meeting attended in person, (iii) $2,000 in compensation
per day while traveling on Chaparral related business, including board meetings,
and (iv) $2,500 in quarterly compensation for serving on Chaparral's board.
Stock Performance Graph.
Comparison of Five Year Cumulative Total Return
The following table compares the total returns (assuming reinvestment of
dividends) of common stock, the Nasdaq Market Index and the SIC Code Index for
the five year period ending December 31, 2004.
1999 2000 2001 2002 2003 2004
---- ---- ---- ---- ---- ----
Chaparral Resources, Inc. 100.00 46.03 19.18 12.70 12.83 22.22
SIC Code Index 100.00 108.70 96.46 94.29 143.95 178.41
NASDAQ Market Index 100.00 60.82 48.18 33.13 49.95 54.53
25
Board Compensation Committee Report on Executive Compensation
Insider Participation in Compensation Decisions
and Compensation Committee
Report on Executive Compensation
The Compensation Committee of our board of directors determines the
compensation of the executive officers named in the Summary Compensation Table
included as part of "Item 11 - Executive Compensation." The Compensation
Committee will furnish the following report on executive compensation in
connection with the Annual Meeting:
Compensation Philosophy
-----------------------
As members of the Compensation Committee, it is our duty to administer the
executive compensation program for Chaparral. The Compensation Committee is
responsible for establishing appropriate compensation goals for the executive
officers of Chaparral, evaluating the performance of such executive officers in
meeting such goals and making recommendations to the board with regard to
executive compensation. Chaparral's compensation philosophy is to ensure that
executive compensation be directly linked to continuous improvements in
corporate performance, achievement of specific operational, financial and
strategic objectives, and increases in shareholder value. The Compensation
Committee regularly reviews the compensation packages of Chaparral's executive
officers, taking into account factors which it considers relevant, such as
business conditions within and outside the industry, Chaparral's financial
performance, the market composition for executives of similar background and
experience, and the performance of the executive officer under consideration.
The particular elements of Chaparral's compensation programs for executive
officers are described below.
Compensation Structure
----------------------
The base compensation for the executive officers of Chaparral named in the
Summary Compensation Table is intended to be competitive with that paid in
comparable situated industries, taking into account the scope of
responsibilities. The goals of the Compensation Committee in establishing
Chaparral's executive compensation program are:
o to compensate the executive officers of Chaparral fairly for their
contributions to Chaparral's short, medium and long-term performance; and
o to allow Chaparral to attract, motivate and retain the management personnel
necessary to Chaparral's success by providing an executive compensation
program comparable to that offered by companies with which Chaparral
competes for management personnel.
The elements of Chaparral's executive compensation program are annual base
salaries, annual bonuses and equity incentives. The Compensation Committee bases
its decisions on the scope of the executive's responsibilities, a subjective
evaluation of the executive's performance and the length of time the executive
has been in the position.
In June 2001, Chaparral's stockholders approved the 2001 Stock Incentive
Plan, which sets aside 2.14 million shares of Chaparral's common stock for
issuance to Chaparral's officers, directors, employees, and consultants.
Chaparral has not made any grants under the 2001 Stock Incentive Plan as of
December 31, 2004.
Compensation of the Chief Executive Officer
-------------------------------------------
During fiscal year 2004, Mr. Klinchev served as Chief Executive Officer of
Chaparral until May 2004 when he was succeeded by Mr. Gill. In establishing
their base salary, the Compensation Committee considered the factors set forth
above, including the level of CEO compensation in other publicly owned/similar
sized development and production companies in the oil and gas industry and their
level of involvement in the day-to-day operations of Chaparral.
26
Executive Compensation Deductibility
------------------------------------
Chaparral intends that amounts paid under Chaparral's compensation plans
generally will be deductible compensation expenses. The Compensation Committee
does not currently anticipate that the amount of compensation paid to executive
officers will exceed the amounts specified as deductible according to Section
162(m) of the Internal Revenue Code of 1986.
Compensation Committee Interlocks and Insider Participation
-----------------------------------------------------------
No executive officer or director of Chaparral serves as an executive
officer, director, or member of a compensation committee of any other entity,
for which an executive officer, director, or member of such entity is a member
of the board or the Compensation Committee of the board. There are no other
interlocks.
Compensation Committee of the Board of Directors,
R. Frederick Hodder, Chairman
Nicholas P. Greene
Simon K. Gill
27
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of March 14, 2005, with
respect to our directors, named executive officers and each person who is known
by us to own beneficially more than 5% of our common stock, and with respect to
shares owned beneficially by all of our directors and executive officers as a
group. The address for all of our directors and executive officers of Chaparral
is 2 Gannett Drive, Suite 418, White Plains, New York 10604.
Amount and Nature of Percent of
Beneficial Ownership Common
Name of Beneficial Owner Position (1) Stock (1)
--------------------------------------- ----------------------------------- ------------------------ ------------
Nelson Resources Limited -- 26,002,624(2) 62.98%
Chancery Hall, 52 Reid St;
Hamilton, Bermuda
Allen & Company Incorporated -- 5,168,812(3) 13.53%
711 Fifth Avenue
New York, New York 10022
Whittier Ventures, LLC -- 4,113,122 10.76%
1600 Huntington Drive
South Pasadena, California 91030
R. Frederick Hodder Chairman of the Board -- --
Simon K. Gill Director and Chief Executive -- --
Officer
Nicholas P. Greene Director -- --
Peter G. Dilling Director -- --
Alan D. Berlin Director and Corporate Secretary 167 *
Ian Connor Former Chairman of the Board -- --
Nikolai D. Klinchev Former Director and Chief 500,084 1.31%
Executive Officer
Askar Alshinbayev Former Director -- --
John Duthie Former Director -- --
Nigel F. Penney VP - Finance and Chief Financial -- --
Officer
Jonathan S. Wood Former VP - Finance and Chief -- --
Financial Officer
Miguel C. Soto Former VP - Finance and Chief -- --
Financial Officer
Richard J. Moore Former VP - Finance and Chief -- --
Financial Officer
All current directors, nominees, and -- 167 *
executive officers as a group (six
persons)
---------
* Represents less than 1% of the shares of Common Stock outstanding.
28
(1) Beneficial ownership of Common Stock has been determined for this
purpose in accordance with Rule 13d-3 under the Exchange Act, under
which a person is deemed to be the beneficial owner of securities if
such person has or shares voting power or investment power with
respect to such securities, has the right to acquire beneficial
ownership within 60 days or acquires such securities with the purpose
or effect of changing or influencing the control of Chaparral.
(2) In accordance with Rule 13d-3(d)(1)(i)(A), includes 3,076,923 shares
underlying warrants to purchase shares of Common Stock. Does not
include shares owned directly by officers and stockholders of Nelson
with respect to which Nelson disclaim beneficial ownership. Officers
and stockholders of Nelson may be deemed to beneficially own shares of
the Common Stock reported to be beneficially owned directly by Nelson.
(3) Does not include shares owned directly by officers and stockholders of
Allen Holding and Allen & Company with respect to which Allen Holding
and Allen & Company disclaim beneficial ownership. Officers and
stockholders of Allen Holding and Allen & Company may be deemed to
beneficially own shares of the Common Stock reported to be
beneficially owned directly by Allen Holding and Allen & Company.
1998 Incentive and Non-statutory Stock Option Plan
On June 26, 1998, the stockholders approved the 1998 Incentive and
Non-statutory Stock Option Plan (the "1998 Plan"), pursuant to which up to
50,000 options to acquire Chaparral's common stock may be granted to officers,
directors, employees or consultants of Chaparral and its subsidiaries. The stock
options granted under the 1998 Plan may be either incentive stock options or
non-statutory stock options. The 1998 Plan has an effective term of ten years,
commencing on May 20, 1998. Chaparral has not granted any options under the 1998
Plan as of December 31, 2004.
2001 Stock Incentive Plan
In June 2001, Chaparral's stockholders approved the 2001 Stock Incentive
Plan, which sets aside a total of 2.14 million shares of Chaparral's common
stock for issuance to Chaparral's officers, directors, employees and
consultants. Chaparral has not made any grants under the 2001 Stock Incentive
Plan as of December 31, 2004.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In May 2002, Chaparral received a total equity and debt capital infusion of
$45 million, which was partially utilized to repay a substantial portion of
Chaparral's loan agreement with Shell Capital. Chaparral received a total
investment of $12 million from CAIH, including $8 million in exchange for
22,925,701 shares, or 60%, of Chaparral's outstanding common stock, and $4
million in exchange for a three year note bearing interest at 12% per annum (the
"Note"). Along with the Note, CAIH received a warrant to purchase 3,076,923
shares of Chaparral's common stock at $1.30 per share (the "Warrant"). These
shares, the Note and the Warrant were purchased by Nelson in May 2004.
Additionally, Kazkommertsbank, an affiliate of CAIH, provided KKM with a
credit facility totaling $33 million, consisting of $28 million that was used to
repay a portion of the Shell Capital Loan and $5 million that was made available
for KKM's working capital requirements. Chaparral paid CAIH $1.79 million as a
related restructuring fee. See Note 12 to our consolidated financial statements
for the year ended December 31, 2004 for additional disclosure on loans with
affiliates.
In 2003, Chaparral approved a one-year agreement with OJSC Kazkommerts
Securities ("KKS"), an affiliate of Kazkommertsbank, The agreement was effective
as of January 7, 2003 and provided for KKS to assist Chaparral's senior
management with financial advisory and investment banking services. In
consideration for the services, KKS received a monthly fee of $25,000 (the
"Advisory Fee"). This agreement was extended until April 2004 when it was
cancelled.
In August 2004, the Company approved a two-year agreement with Nelson to
provide corporate administrative services and financial advisory services (the
"Service Agreement") to support its business activities. The Service Agreement
is effective as of June 1, 2004 and can be terminated upon 30 days written
notice by either party. In consideration for these services Nelson will receive
a fixed monthly fee of $20,000 for administrative services and $25,000 for
financial advisory services (the "Management Fee"). As part of the Service
Agreement, Nelson is also required to provide personnel to cover Chaparral's
executive and managerial needs. The cost of executive and managerial personnel
will be allocated on the basis of the cost of personnel involved and on the
percentage of time actually spent by such personnel on matters related to
Chaparral, as mutually agreed by the parties from time to time. In addition,
Nelson will use its greater buying power to obtain more favorable rates for
goods and services, including insurance coverage, for Chaparral. These
29
expenditures will be passed to Chaparral at cost with a ten percent mark-up. As
of December 31, 2004, the Company has booked $682,000 for the Management Fee,
the executive and managerial cost, insurance coverage and the mark-up under the
Service Agreement.
On June 3, 2004, KKM entered into a three year agency agreement with Nelson
(the "Marketing Agreement"), whereby Nelson becomes the duly authorized,
exclusive agent for the purpose of marketing crude oil, and is empowered to
represent the interests of KKM in relations with governmental authorities and
commercial organizations and also enter into contracts and agreements and any
other documents necessary for and related to the marketing of crude oil. The
Marketing Agreement is effective as of June 1, 2004 and can be terminated upon
90 days written notice by either party. As consideration for the services
provided under the Marketing Agreement, KKM shall pay Nelson a fixed fee of
$20,000 per month and a variable fee of five US cents per barrel of total
production in a reporting calendar month, if the amount of supplies to the local
market in that month is more than 10% of the total amount of production, or
eight US cents per barrel of total production in a reporting calendar month, if
the amount of supplies to the local market in that month is less than 10% of the
total amount of production (the "Marketing Fee"). For 2004, $274,000 was accrued
under the Marketing Agreement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table shows the fees paid or accrued by Chaparral for the
audit and other services provided by Ernst & Young and affiliated entities for
the years ended December 31, 2004 and 2003.
Description 2004 2003
----------- ------------ -----------
$000 $000
Audit Fees 219 261
Tax Fees 21 12
Audit Related Fees - -
All other fees - -
------------ -----------
Total 240 273
============ ===========
The Audit Committee must pre-approve audit-related and non-audit services
not prohibited by law to be performed by Chaparral's independent auditors. The
Audit Committee pre-approved all audit-related and non-audit services in 2004.
30
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
--------------------
Table of Contents
Page
Chaparral Resources, Inc.
-------------------------
Report of Independent Registered Public Accounting Firm ................F-1
Consolidated Balance Sheets - as of December 31, 2004
and December 31, 2003 ..............................................F-2
Consolidated Statements of Operations - Years ended
December 31, 2004, 2003 and 2002....................................F-4
Consolidated Statements of Cash Flows - Years ended
December 31, 2004, 2003 and 2002....................................F-6
Consolidated Statement of Changes in Stockholders'
Equity - Years ended December 31, 2004, 2003 and 2002...............F-8
Notes to Consolidated Financial Statements..............................F-9
Supplemental Information - Disclosures About Oil and Gas
Producing Activities - Unaudited.................................F-33
Supplemental Information - Selected Quarterly Financial
Data - Unaudited...................................................F-37
(a)(2) Financial Statement Schedules
-----------------------------
All schedules for which a provision is made in the applicable
accounting regulations of the SEC that are not required under the related
instructions or are inapplicable have been omitted.
(b) Exhibits.
---------
Exhibit No. Description and Method of Filing
----------- --------------------------------
*2.1 Stock Acquisition Agreement and Plan of Reorganization dated
April 12, 1995 between Chaparral Resources, Inc., and the
Shareholders of Central Asian Petroleum, Inc.
*2.2 Escrow Agreement dated April 12, 1995 between Chaparral
Resources, Inc., the Shareholders of Central Asian
Petroleum, Inc. and Barry W. Spector.
*2.3 Amendment to Stock Acquisition Agreement and Plan of
Reorganization dated March 10, 1996 between Chaparral
Resources, Inc., and the Shareholders of Central Asian
Petroleum, Inc.
3.1 Certificate of Incorporation, dated April 21, 1999,
incorporated by reference to Chaparral Resources, Inc.'s
Notice and Definitive Schedule 14A dated April 21, 1999.
3.2 Bylaws, dated April 21, 1999, incorporated by reference to
Annex IV to our Notice and Definitive Schedule 14A dated
April 21, 1999.
4.1 Written Resolutions of the Shareholders of Central Asian
Petroleum (Guernsey) Limited dated May 30, 2001, authorizing
the issuance of Series A Preferred Shares in Central Asian
Petroleum (Guernsey) Limited, incorporated by reference to
Exhibit 4.1 to Chaparral Resources, Inc.'s Quarterly Report
on Form 10-Q for the quarter ended June 30, 2001, filed with
SEC on August 14, 2001.
*10.1 Agreement dated August 30, 1995 for Exploration, Development
and Production of Oil in Karakuduk Oil Field in Mangistau
Oblast of the Republic of Kazakhstan between Ministry of Oil
and Gas Industries of the Republic of Kazakhstan for and on
Behalf of the Government of the Republic of Kazakhstan and
Joint Stock Company of Closed Type Karakuduk Munay Joint
Venture.
31
Exhibit No. Description and Method of Filing
----------- --------------------------------
*10.2 License for the Right to Use the Subsurface in the Republic
of Kazakhstan.
*10.3 Amendment dated September 11, 1997, to License for the Right
to Use the Subsurface in the Republic of Kazakhstan.
10.4 Amendment to License for the Right to Use the Subsurface in
the Republic of Kazakhstan, dated December 31, 1998,
incorporated by reference to Exhibit 10.25 to Chaparral
Resources, Inc.'s Annual Report on Form 10-K for the fiscal
year ended December 31, 1998, filed with the SEC on April
15, 1999.
10.5 Letter from the Agency of the Republic of Kazakhstan on
Investments to Central Asian Petroleum (Guernsey) Limited
dated July 28, 1999 regarding License for the Right to Use
the Subsurface in the Republic of Kazakhstan, incorporated
by reference to Exhibit 10.5 to Chaparral Resources, Inc.'s
Annual Report on Form 10-K for the fiscal year ended
December 31, 1999, filed with the SEC on March 30, 2000.
10.6 1998 Incentive and Non-statutory Stock Option Plan,
incorporated by reference to Exhibit 10.24 to Chaparral
Resources, Inc.'s Annual Report on Form 10-K for the fiscal
year ended December 31, 1998, filed with the SEC on April
15, 1999.
10.7 CRI-CAP(G) Loan Agreement, dated February 7, 2000, between
Chaparral Resources, Inc. and Central Asian Petroleum
(Guernsey) Limited, incorporated by reference to Exhibit
10.13 to Chaparral Resources, Inc.'s Current Report on 8-K
dated February 14, 2000, filed with the SEC on March 22,
2000.
10.8 CAP(G)-KKM Loan Agreement, dated February 7, 2000, between
Closed Type JSC Karakudukmunay and Central Asian Petroleum
(Guernsey) Limited, incorporated by reference to Exhibit
10.16 to Chaparral Resources, Inc.'s Current Report on 8-K
dated February 14, 2000, filed with the SEC on March 22,
2000.
10.9 2001 Stock Incentive Plan approved by the stockholders of
Chaparral Resources, Inc. on June 21, 2001, incorporated by
reference to Exhibit 10.43 to Chaparral Resources, Inc.'s
Annual Report on Form 10-K for the fiscal year ended
December 31, 2001, filed with the SEC on April 15, 2000.
10.10 Master Agreement, dated May 9, 2002, between Chaparral
Resources, Inc. and Central Asian Industrial Holdings, N.V.,
incorporated by reference to Exhibit 10.1 to Chaparral
Resources, Inc.'s Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002, filed with the SEC on May 20,
2002.
10.11 Mutual Release Agreement, dated May 7, 2002, among Chaparral
Resources, Inc., Central Asian Petroleum (Guernsey) Limited,
Central Asian Petroleum, Inc. and Closed Type JSC
Karakudukmunay, and Shell Capital Inc., Shell Capital
Services Limited and Shell Capital Limited, incorporated by
reference to Exhibit 10.2 to Chaparral Resources, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended March
31, 2002, filed with the SEC on May 20, 2002.
10.12 Promissory Note, dated May 10, 2002, jointly and severally
between Chaparral Resources, Inc. and Central Asian
Petroleum (Guernsey) Limited and Central Asian Industrial
Holdings, N.V., incorporated by reference to Exhibit 10.3 to
Chaparral Resources, Inc.'s Quarterly Report on Form 10-Q
for the quarter ended March 31, 2002, filed with the SEC on
May 20, 2002.
10.13 Stock Purchase Warrant, dated May 10, 2002, between
Chaparral Resources, Inc. and Central Asian Industrial
Holdings, N.V., incorporated by reference to Exhibit 10.4 to
Chaparral Resources, Inc.'s Quarterly Report on Form 10-Q
for the quarter ended March 31, 2002, filed with the SEC on
May 20, 2002.
32
Exhibit No. Description and Method of Filing
----------- --------------------------------
10.14 Registration Agreement, dated May 10, 2002, between
Chaparral Resources, Inc. and Central Asian Industrial
Holdings, N.V., incorporated by reference to Exhibit 10.5 to
Chaparral Resources, Inc.'s Quarterly Report on Form 10-Q
for the quarter ended March 31, 2002, filed with the SEC on
May 20, 2002.
10.15 Agreement, dated May 8, 2002, between Chaparral Resources,
Inc. and Exeter Finance Group, Inc., incorporated by
reference to Exhibit 10.6 to Chaparral Resources, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended March
31, 2002, filed with the SEC on May 20, 2002.
10.16 Stock Purchase Agreement, dated May 9, 2002, between
Chaparral Resources, Inc. and Dardana Limited, incorporated
by reference to Exhibit 10.7 to Chaparral Resources, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended March
31, 2002, filed with the SEC on May 20, 2002.
10.17 Loan Agreement #250, dated May 6, 2002, among Closed Joint
Stock Company Karakudukmunai and Open Joint Stock Company
Kazkommertsbank, incorporated by reference to Exhibit 10.1
to Chaparral Resources, Inc.'s Quarterly Report on Form 10-Q
for the quarter ended June 30, 2002, filed with the SEC on
August 19, 2002.
10.18 Additional Agreement, dated May 6, 2002, to Loan Agreement
#250, among Closed Joint Stock Company Karakudukmunai and
Open Joint Stock Company Kazkommertsbank, incorporated by
reference to Exhibit 10.2 to Chaparral Resources, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002, filed with the SEC on August 19, 2002.
10.19 Additional Agreement, dated June 6, 2002, to Loan Agreement
#250, among Closed Joint Stock Company Karakudukmunai and
Open Joint Stock Company Kazkommertsbank, incorporated by
reference to Exhibit 10.3 to Chaparral Resources, Inc.'s
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002, filed with the SEC on August 19, 2002.
10.20 Accessorial Agreement #5382A, dated May 6, 2002, among
Closed Joint Stock Company Karakudukmunai and Open Joint
Stock Company Kazkommertsbank, incorporated by reference to
Exhibit 10.4 to Chaparral Resources, Inc.'s Quarterly Report
on Form 10-Q for the quarter ended June 30, 2002, filed with
the SEC on August 19, 2002.
10.21 Additional Agreement, dated May 7, 2002, to Accessorial
Agreement #5382A, among Closed Joint Stock Company
Karakudukmunai and Open Joint Stock Company Kazkommertsbank,
incorporated by reference to Exhibit 10.5 to Chaparral
Resources, Inc.'s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002, filed with the SEC on August
19, 2002.
10.22 Accessorial Agreement #5896A, dated July 31, 2002, among
Closed Joint Stock Company Karakudukmunai and Open Joint
Stock Company Kazkommertsbank, incorporated by reference to
Exhibit 10.6 to Chaparral Resources, Inc.'s Quarterly Report
on Form 10-Q for the quarter ended June 30, 2002, filed with
the SEC on August 19, 2002.
10.23 Open Joint Stock Company Kazkommertsbank letter dated August
16, 2002, to Closed Joint Stock Company Karakudukmunai,
incorporated by reference to Exhibit 10.7 to Chaparral
Resources, Inc.'s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002, filed with the SEC on August
19, 2002.
33
Exhibit No. Description and Method of Filing
----------- --------------------------------
10.24 Amendment to License dated December 11, 2002, to provide for
the stabilization of taxes and clarification on tax laws
applicable to KKM, incorporated by reference to Exhibit
10.58 to Chaparral Resources, Inc.'s Annual Report on Form
10-K for the year ended December 31, 2002, filed with the
SEC on March 31, 2003.
10.25 Service Agreement, dated January 7, 2003, between Chaparral
Resources, Inc. and OJSC Kazkommerts Securities,
incorporated by reference to Exhibit 10.1 to Chaparral
Resources, Inc.'s Quarterly Report on Form 10-Q for the
period ended June 30, 2003, filed with the SEC on August 14,
2003.
10.26 Agency Agreement, dated June 3, 2004, between Nelson
Resources Limited and Closed Type JSC Karakudukmunay
incorporated by reference to Exhibit 10.1 to Chaparral
Resources, Inc.'s Quarterly Report on Form 10-Q for the
period ended June 30, 2004, filed with the SEC on August 13,
2004.
10.27 Corporate Administrative and Financial Advisory Service
Agreement, effective June 1, 2004, between Chaparral
Resources, Inc. and Nelson Resources Limited, incorporated
by reference to Exhibit 10.2 to Chaparral Resources, Inc.'s
Quarterly Report on Form 10-Q for the period ended June 30,
2004, filed with the SEC on August 13, 2004.
10.28 Additional agreement to Accessorial agreement # 5382/A,
dated July 28, 2004, between Kazkommertsbank OJSC and Closed
Type JSC Karakudukmunay, incorporated by reference to
Exhibit 10.3 to Chaparral Resources, Inc.'s Quarterly Report
on Form 10-Q for the period ended June 30, 2004, filed with
the SEC on August 13, 2004.
10.29 Accessorial agreement # 615/A, dated June 14, 2004, between
Kazkommertsbank OJSC and Closed Type JSC Karakudukmunay,
incorporated by reference to Exhibit 10.4 to Chaparral
Resources, Inc.'s Quarterly Report on Form 10-Q for the
period ended June 30, 2004, filed with the SEC on August 13,
2004.
10.30 Letter agreement between Chaparral Resources, Inc. and
Nelson Resources Limited dated November 24, 2004,
incorporated by reference to Exhibit 1.01 to Chaparral
Resources, Inc.'s Report on Form 8-K dated November 24,
2004, filed with the SEC on November 29, 2004.
14 Chaparral's Code of Ethics, incorporated by reference to
Exhibit 99.2 to Chaparral Resources, Inc.'s Annual Report on
Form 10-K for the year ended December 31, 2003, filed with
the SEC on March 29, 2004.
21 Subsidiaries of the Registrant, incorporated by reference to
Exhibit 21 to Chaparral Resources, Inc.'s Annual Report on
Form 10-K for the fiscal year ended December 31, 1997, filed
with the SEC on April 6, 1998.
**31.2 Certification Pursuant to Item 601(b)(31) of Regulation S-K,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
**32.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(furnished pursuant to Item 601(b)(32) of Regulation S-K).
**32.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(furnished pursuant to Item 601(b)(32) of Regulation S-K).
**99.1 Promissory Note Amendment Agreement by and among Chaparral
Resources, Inc. and Central Asian Petroleum (Guernsey)
Limited and NRL Acquisition Corp. dated March 22, 2005.
* These exhibits, previously incorporated by reference to Chaparral's reports
under file number 0-7261, have now been on file with the Commission for more
than 5 years and are not filed with this Annual Report. We agree to furnish
these documents to the Commission upon request.
** Filed herewith.
34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
CHAPARRAL RESOURCES, INC.,
a Delaware corporation
By: /s/ Simon K. Gill
------------------------------------
Simon K. Gill
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Nigel Penney
-------------------------------------
Nigel Penney
Chief Financial Officer
(Principal Financial and Accounting Officer)
Dated: March 25, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Date Name and Title Signature
---- -------------- ---------
March 25, 2005 Alan D. Berlin, Director and
Corporate Secretary /s/ Alan D. Berlin
------------------------
March 25, 2005 R. Frederick Hodder, /s/ R. Frederick Hodder
Chairman of the Board ------------------------
March 25, 2005 Peter G. Dilling, Director /s/ Peter G. Dilling
------------------------
March 25, 2005 Nicholas P. Greene, Director /s/ Nicholas P. Greene
------------------------
March 25, 2005 Simon K. Gill, /s/ Simon K. Gill
Chief Executive Officer ------------------------
35
Consolidated Financial Statements
Chaparral Resources, Inc.
As of December 31, 2004 and 2003 and for the Three Years ended
December 31, 2004 with
Report of Independent Registered Public Accounting Firm
Chaparral Resources, Inc.
Consolidated Financial Statements
Contents
Chaparral Resources, Inc.
Report of Independent Registered Public Accounting Firm .....................F-1
Audited Consolidated Financial Statements
Consolidated Balance Sheets .................................................F-2
Consolidated Statements of Operations........................................F-4
Consolidated Statements of Cash Flows........................................F-6
Consolidated Statements of Changes in Stockholders' Equity...................F-8
Notes to Consolidated Financial Statements...................................F-9
Supplemental Information - Disclosures About Oil and Gas
Producing Activities - Unaudited.........................................F-33
Supplemental Information - Selected Quarterly
Financial Data - Unaudited...............................................F-37
i
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Chaparral Resources, Inc.
We have audited the accompanying consolidated balance sheets of Chaparral
Resources, Inc. and subsidiaries (the "Company") as of December 31, 2004 and
2003, and the related consolidated statements of operations, cash flows, and
changes in stockholders' equity for each of the three years in the period ended
December 31, 2004. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. We were not engaged to perform an
audit of the Company's internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Chaparral
Resources, Inc. and subsidiaries at December 31, 2004 and 2003, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2004, in conformity with US
generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, effective
January 1, 2003 the Company changed its method of accounting for asset
retirement obligations.
/s/ Ernst & Young Kazakhstan LLP
-----------------------------------
Ernst & Young Kazakhstan LLP
March 25, 2005
Almaty, Kazakhstan
F-1
CHAPARRAL RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
2004 2003
--------- ---------
Assets $000 $000
Current assets:
Cash and cash equivalents 9,611 2,639
Accounts receivable:
Oil sales receivable 316 215
VAT receivable (Note 2) 2,212 2,907
Other receivables from affiliates 1,002 --
Prepaid expenses (Note 3) 3,472 3,236
Crude oil inventory 36 544
--------- ---------
Total current assets 16,649 9,541
Materials and supplies 5,238 3,188
Other (Note 4) 336 --
Property, plant and equipment:
Oil and gas properties, full cost: (Note 5)
Properties subject to depletion 153,001 118,347
Properties not subject to depletion -- 2,942
--------- ---------
153,001 121,289
Other property, plant and equipment (Note 6) 10,974 9,408
--------- ---------
163,975 130,697
Less - accumulated depreciation, depletion and amortization (62,495) (44,758)
--------- ---------
Property, plant and equipment, net 101,480 85,939
Total assets 123,703 98,668
========= =========
See accompanying notes.
F-2
CHAPARRAL RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
2004 2003
--------- ---------
Liabilities and stockholders' equity $000 $000
Current liabilities:
Accounts payable (Note 19) 8,540 7,229
Advances received 387 --
Prepaid sales (Note 7) 6,590 --
Accrued liabilities:
Accrued compensation 241 949
Other accrued liabilities (Note 9) 1,822 1,571
Accrued interest payable (Note 12) 713 776
Current income tax liability (Note 14) 2,052 3
Current portion of loans payable (Note 12) 19,778 12,000
--------- ---------
Total current liabilities 40,123 22,528
Accrued production bonus (Note 10) 299 190
Loans payable (Note 12) 12,000 21,284
Deferred tax liability (Note 14) 3,258 3,057
Minority interest 12,099 4,635
Asset retirement obligation (Note 11) 1,232 804
Commitments and contingencies (Note 16) -- --
Stockholders' equity:
Common stock (Note 13) - authorized, 100,000,000
shares of $0.0001 par value; issued and outstanding,
38,209,502 shares as of December 31, 2004
and December 31, 2003 4 4
Capital in excess of par value 107,226 107,226
Preferred stock - 1,000,000 shares authorized, 925,000 shares
undesignated. Issued and outstanding - none -- --
Accumulated deficit (52,538) (61,060)
--------- ---------
Total stockholders' equity 54,692 46,170
--------- ---------
Total liabilities and stockholders' equity 123,703 98,668
========= =========
See accompanying notes.
F-3
CHAPARRAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
2004 2003 2002
-------- -------- --------
$000 $000 $000
Revenue 78,451 57,615 45,133
Costs and expenses:
Transportation costs 14,046 11,474 9,427
Operating expenses 8,319 5,915 7,678
Impairment of materials inventory 409 -- 203
Marketing fee (Note 19) 274 -- --
Depreciation, depletion and amortization 18,180 18,038 12,804
Management fee (Note 19) 450 -- --
Advisory fee (Note 19) 100 300 --
Hedge losses (Note 8) -- -- 762
Accretion expense 112 73 --
General and administrative 8,390 7,762 6,811
-------- -------- --------
50,280 43,562 37,685
-------- -------- --------
Income from operations 28,171 14,053 7,448
Other income/(expense):
Interest income 118 24 8
Interest expense (5,552) (4,526) (5,605)
Currency exchange loss (628) (62) (131)
Minority interest (7,464) (4,314) (241)
Other 997 (11) (15)
-------- -------- --------
(12,529) (8,889) (5,984)
-------- -------- --------
Income before income taxes,
extraordinary gain, and cumulative effect of
change in accounting principle 15,642 5,164 1,464
Income tax expense (Note 14) (7,120) (4,121) (2,685)
-------- -------- --------
Income/(loss) before extraordinary gain
and cumulative effect of change in
accounting principle 8,522 1,043 (1,221)
Extraordinary gain (Note 12) -- -- 5,338
Cumulative effect of change in accounting
principle, net of taxes of $436,000 (Notes 1
& 11) -- 1,018 --
-------- -------- --------
Net income available to common Stockholders 8,522 2,061 4,117
======== ======== ========
F-4
CHAPARRAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
2004 2003 2002
----------- ----------- -----------
Basic earnings per share (Note 13):
Income/(loss) per share before extraordinary
gain and cumulative effect of change in
accounting principle $ 0.22 $ 0.03 $ (0.04)
Extraordinary gain $ -- $ -- $ 0.18
Cumulative effect of change in
accounting principle $ -- $ 0.02 $ --
Net income per share $ 0.22 $ 0.05 $ 0.14
Weighted average number of shares
outstanding (basic) 38,209,502 38,209,502 29,753,569
Diluted earnings per share (Note 13):
Income/(loss) per share before extraordinary
gain and cumulative effect of change in
accounting principle $ 0.22 $ 0.03 $ (0.04)
Extraordinary gain $ -- $ -- $ 0.18
Cumulative effect of change in
accounting principle $ -- $ 0.02 $ --
Net income per share $ 0.22 $ 0.05 $ 0.14
Weighted average number of shares
outstanding (diluted) 38,407,283 38,209,502 29,753,569
See accompanying notes.
F-5
CHAPARRAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
2004 2003 2002
-------- -------- --------
$000 $000 $000
Cash flows from operating activities
Net income 8,522 2,061 4,117
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, depletion and amortization 18,180 18,038 12,804
Impairment of materials inventory 409 -- 203
Loss on disposition of assets 3 11 15
Deferred income taxes 201 2,311 746
Cumulative effect of change in accounting principle -- (1,018) --
Hedge losses -- -- 762
Accretion expense 112 73 --
Amortization of note discount 494 286 234
Currency exchange loss 628 62 131
Extraordinary gain on restructuring of debt -- -- (5,338)
Non-cash interest expense -- -- 2,753
Minority interest 7,464 4,314 241
Changes in assets and liabilities:
(Increase)/decrease in:
Accounts receivable (407) 870 (1,960)
Prepaid expenses (237) (775) (614)
Crude oil inventory 110 55 (240)
Increase/(decrease) in:
Accounts payable and accrued liabilities 2,463 (2,156) (5,691)
Accrued interest payable (63) 526 261
Other liabilities 7,212 213 288
-------- -------- --------
Net cash provided by operating activities 45,091 24,871 8,712
-------- -------- --------
F-6
CHAPARRAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
2004 2003 2002
-------- -------- --------
$000 $000 $000
Cash flows from investing activities
Additions to property, plant and equipment (33,324) (24,800) (11,834)
Acquisition of 10% interest in KKM,
net of cash acquired -- -- (644)
Materials and supplies inventory (2,459) (732) 150
Proceeds from disposition of assets -- 5 5
-------- -------- --------
Net cash used in investing activities (35,783) (25,527) (12,323)
-------- -------- --------
Cash flows from financing activities
Proceeds from sale of stock -- -- 8,000
Proceeds from loans 7,000 6,500 40,000
Payments on Shell Capital loan -- -- (30,450)
Debt restructuring and issuance costs -- -- (2,518)
Payments on loans (9,000) (7,500) (5,000)
Other long term assets (336) -- --
Redemption of Series A Preferred Stock -- -- (2,300)
-------- -------- --------
Net cash provided/(used) by financing activities (2,336) (1,000) 7,732
-------- -------- --------
Net increase/(decrease) in cash and
cash equivalents 6,972 (1,656) 4,121
Cash and cash equivalents at beginning
of year 2,639 4,295 174
-------- -------- --------
Cash and cash equivalents at end of year 9,611 2,639 4,295
======== ======== ========
Supplemental cash flow disclosure
Interest paid, net of amounts capitalized 4,839 4,282 3,019
Income taxes paid 1,984 5,019 --
Supplemental schedule of non-cash
investing and financing activities
Non-cash additions to oil and gas properties 372 3,939 --
Common stock issued for 10% interest in KKM -- -- 2,701
Discount recognized for note issued
with stock warrants -- -- 2,466
See accompanying notes.
F-7
CHAPARRAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Capital in
------------------------- Excess of Par Accumulated
Shares Amount Value Deficit Total
----------- ----------- ----------- ----------- -----------
$000 $000 $000 $000
Balance at December 31, 2001 14,283,801 1 94,061 (68,701) 25,361
Capital stock issued in private
placement 22,925,701 3 7,998 -- 8,001
Capital stock issued for 10% interest
in KKM 1,000,000 -- 2,701 -- 2,701
CAIH warrants issued -- -- 2,466 -- 2,466
Discount accretion on redeemable
preferred stock -- -- -- (36) (36)
Cumulative dividend Series A
Redeemable Preferred Stock -- -- -- (90) (90)
Redemption of Series A
Redeemable Preferred Stock -- -- -- 3,726 3,726
Adjustment due to full
consolidation of KKM -- -- -- (2,137) (2,137)
Net income for the year 2002 -- -- -- 4,117 4,117
----------- ----------- ----------- ----------- -----------
Balance at December 31, 2002 38,209,502 4 107,226 (63,121) 44,109
Net income for the year 2003 -- -- -- 2,061 2,061
----------- ----------- ----------- ----------- -----------
Balance at December 31, 2003 38,209,502 4 107,226 (61,060) 46,170
Net income for the year 2004 -- -- -- 8,522 8,522
----------- ----------- ----------- ----------- -----------
Balance at December 31, 2004 38,209,502 4 107,226 (52,538) 54,692
=========== =========== =========== =========== ===========
See accompanying notes.
F-8
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies and Organization
Organization, Principles of Consolidation and Basis of Presentation
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
greater than 50% owned subsidiaries, Closed Type JSC Karakudukmunay ("KKM"),
Central Asian Petroleum (Guernsey) Limited ("CAP-G"), Korporatsiya Mangistau
Terra International ("MTI"), Road Runner Services Company ("RRSC"), Chaparral
Acquisition Corporation ("CAC") and Central Asian Petroleum, Inc. ("CAP-D").
Chaparral owns 80% of the common stock of CAP-G directly and 20% indirectly
through CAP-D. Hereinafter, Chaparral and its subsidiaries are collectively
referred to as the "Company". All significant intercompany transactions have
been eliminated.
As of December 31, 2004, Chaparral owns a 60% interest in KKM, a Kazakhstan
Joint Stock Company of Closed Type. KKM was formed to engage in the exploration,
development and production of oil and gas properties in the Republic of
Kazakhstan. KKM's only significant investment is in the Karakuduk Field, an
onshore oil field in the Mangistau region of the Republic of Kazakhstan. On
August 30, 1995, KKM entered into an agreement with the Ministry of Oil and Gas
Industry for Exploration, Development and Production of Oil in the Karakuduk Oil
Field in the Mangistau Region of the Republic of Kazakhstan (the "Agreement").
KKM's rights and obligations regarding the exploration, development and
production of underlying hydrocarbons in the Karakuduk Field are determined by
the Agreement.
KKM's rights to the Karakuduk Field may be terminated under certain conditions
specified in the Agreement. The term of the Agreement is 25 years commencing
from the date of KKM's registration. The Agreement can be extended to a date
agreed between the Ministry of Energy and Mineral Resources and KKM as long as
production of petroleum and/or gas is continued in the Karakuduk Field.
KKM is owned jointly by CAP-G (50%), MTI (10%) and Nelson Resources Ltd.
("Nelson") (40%). In May 2002, Chaparral increased its ownership in KKM from 50%
to 60% through the acquisition of 100% of the outstanding stock of MTI, a
Kazakhstan company.
As a result of the acquisition of MTI during 2002, the Company obtained a
controlling interest in KKM. Consequently, the Company's financial statements
have been consolidated with KKM on a retroactive basis to January 1, 2002. The
Company previously accounted for its 50% investment in KKM using the equity
method of accounting, which is reflected in the Company's financial statements
for periods prior to 2002.
In May 2004, Nelson became the majority shareholder in Chaparral when it
purchased 22,925,701 shares from Central Asian Industrial Holdings, N.V. See
Note 12 for further details.
Certain comparative figures presented for the 2003 financial statements have
been reclassified to conform to the 2004 presentation. Certain reclassifications
have been made in the periods presented for the 2002 financial statements to
conform to the 2003 presentation.
Acquisitions
In May 2002, the Company acquired 100% of the outstanding shares of MTI from
Dardana Limited. MTI's only asset was its 10% ownership interest in KKM. The
Company acquired MTI to obtain a controlling interest in KKM as well as to
increase the Company's ownership interest in the Karakuduk Field. The aggregate
purchase price was $3.9 million, comprising $1.2 million of cash and common
stock valued at $2.7 million. The value of the 1 million common shares issued
was determined based on the average market price of the Company's common shares
over the 3-day period before and after the terms of the acquisition were agreed
to and announced. As a result, the total purchase price of $3.9 million was
recorded as an addition to the Company's oil and gas properties.
F-9
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. Summary of Significant Accounting Policies and Organization (continued)
Exercise of Right of First Refusal of Purchase of Minority Interest in KKM
In November 2004 the Company entered into an agreement with its majority
stockholder, Nelson, which provided that in the event Chaparral, through CAP-G
and/or MTI, received notice from KazMunayGaz JSC ("KMG"), the state owned
national petroleum and transportation company of the Republic of Kazakhstan,
that KMG desired to sell its 40% equity interest in KKM, then the Company would,
if requested by Nelson, exercise its right of first refusal under the Agreement
to purchase such interest at the price and on the terms specified in such
notice. In December 2004, pursuant to this agreement, the Company, through
CAP-G, exercised its right of first refusal to purchase from KMG the remaining
40% equity interest in KKM. The Company entered into definitive sale and
purchase agreements with both KMG and Nelson, which provided that upon
completion of the acquisition by CAP-G, ownership of the newly acquired 40%
interest in KKM would be transferred to Nelson. The transfer of the 40% interest
from KMG to CAP-G occurred in December 2004, and the transfer from CAP-G to
Nelson was completed in January 2005. The purchase price of $34.6 million paid
by CAP-G to KMG was determined on an open tender, and the funds for this were
made available to CAP-G by Nelson. In addition, Nelson paid the Company a fee of
$1.0 million, recorded as part of Other Income, as well as all documentation and
transaction costs relating to the acquisition.
Cash and Cash Equivalents
Cash equivalents consist of highly liquid investments purchased with an original
maturity of three months or less.
Revenue Recognition
Revenue and related costs are recognized upon delivery of commercial quantities
of oil production from proved reserves, in accordance with the accrual method of
accounting. Losses, if any, are provided for in the period in which the loss is
determined to occur.
Revenue is presented gross of transportation expenses in accordance with EITF
00-10, Accounting for Shipping and Handling Fees and Costs.
Foreign Currency Translation
The Company's functional currency is the U.S. Dollar. All transactions arising
in currencies other than U.S. Dollars, including assets, liabilities, revenue,
expenses, gains or losses are measured and recorded in U.S. Dollars using the
exchange rate in effect on the date of the transaction.
Cash and other monetary assets held and liabilities denominated in currencies
other than U.S. Dollars are translated at exchange rates prevailing as of the
balance sheet date (130.00 and 144.22 Kazakh Tenge per U.S. Dollar as of
December 31, 2004 and 2003, respectively). Non-monetary assets and liabilities
denominated in currencies other than U.S. Dollars have been translated at the
estimated historical exchange rate prevailing on the date of the transaction.
Exchange gains and losses arising from translation of non-U.S. Dollar amounts at
the balance sheet date are recognized as an increase or decrease in income for
the period.
The Tenge is not a convertible currency outside of the Republic of Kazakhstan.
The translation of Tenge denominated assets and liabilities in these financial
statements does not indicate that the Company could realize or settle these
assets and liabilities in U.S. Dollars.
The Company had $8.2 million of net monetary liabilities denominated in Tenge as
of December 31, 2004.
F-10
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. Summary of Significant Accounting Policies and Organization (continued)
Interest Capitalization
The Company capitalizes interest on significant construction projects. Statement
of Financial Accounting Standards ("SFAS") 34, Capitalization of Interest Costs,
provides standards for the capitalization of interest costs as part of the
historical cost of acquiring assets. FASB Interpretation No. 33 ("FIN 33")
provides guidance for the application of SFAS 34 to the full cost method of
accounting for oil and gas properties. Under FIN 33, costs of investments in
unproved properties and major development projects, on which depreciation,
depletion and amortization (DD&A) expense is not currently taken and on which
exploration or development activities are in progress, qualify for
capitalization of interest. Capitalized interest is calculated by multiplying
the weighted-average interest rate on debt by the amount of costs excluded.
Capitalized interest cannot exceed gross interest expense. The Company incurred
interest costs of $5.76 million and $5.19 million for the years ended December
31, 2004 and 2003, respectively. For the same periods, the Company capitalized
interest totaling $213,000, and $662,000, respectively.
Oil and Gas Properties - Full Cost Method
The Company follows the full cost method of accounting for oil and gas
properties. Accordingly, all costs associated with the acquisition, exploration
and development of oil and gas reserves, including directly related overhead
costs, are capitalized.
All capitalized costs of proved oil and gas properties, including the estimated
future costs to develop proved reserves, are amortized using the
unit-of-production method based on estimated proved reserves. Investments in
unproved properties and major development projects are not amortized until
proved reserves associated with the projects can be determined or until
impairment occurs. If the results of an assessment indicate that the properties
are impaired, the amount of the impairment is added to the capitalized cost to
be amortized.
In addition, the capitalized costs are subject to a "ceiling test." The full
cost ceiling test is an impairment test prescribed by SEC Regulation S-X Rule
4-10. The ceiling test is performed on a country-by-country basis. The test
determines a limit, or ceiling, on the book value of oil and gas properties.
That limit is basically the after tax present value of the future net cash flows
from proved crude oil and natural gas reserves. This ceiling is compared to the
net book value of the oil and gas properties reduced by any related deferred
income tax liability. If the net book value reduced by the related deferred
income taxes exceeds the ceiling, an impairment or non-cash write down is
required. A ceiling test impairment can give the Company a significant loss for
a particular period; however, future DD&A expense would be reduced.
Sales of proved and unproved properties are accounted for as adjustments of
capitalized costs with no gain or loss recognized, unless such adjustments would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in income.
Abandonment of properties is accounted for as adjustments of capitalized costs
with no loss recognized.
Other Property, Plant and Equipment
Other property, plant and equipment are valued at historical cost and
depreciated on a straight line basis over the estimated useful lives of the
assets, as follows:
Description Period
----------- ------
Office buildings and apartments 20 years
Office equipment 3 years
Vehicles 5 years
Field buildings 15 years
Field equipment Up to 10 years
F-11
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. Summary of Significant Accounting Policies and Organization (continued)
Inventory
Crude oil inventory is valued using the first-in, first-out method, at the lower
of cost or net realizable value. Crude oil inventory value represents production
costs associated with lifting and transporting crude oil from the Karakuduk
Field to the KazTransOil pipeline. Crude oil placed into the KazTransOil
pipeline is held as inventory until formally nominated and delivered for sale.
Crude oil inventory as of December 31, 2004 and 2003 was approximately 4,000
barrels and 74,000 barrels of crude oil, respectively.
Materials and supplies inventory is valued using the first-in, first-out method,
at the lower of cost or net realizable value. Certain unique items, such as
drilling equipment, are valued using the specific identification method.
Materials and supplies represent plant and equipment for development activities,
drill bits, tubing, casing, wellheads, etc. required for development drilling
operations, spare parts, diesel fuel and various other materials for use in oil
field operations.
Earnings Per Common Share
Basic Earnings Per Share ("EPS") is computed by dividing the income or loss
available to common stockholders by the weighted-average number of common shares
outstanding during the period. The computation of diluted EPS is similar to the
computation of basic EPS except that the numerator is increased to exclude
certain charges which would not have been incurred, and the denominator is
increased to include the number of additional common shares that would have been
outstanding (using the if-converted and treasury stock methods), if securities
containing potentially dilutive common shares (warrants, convertible notes
payable and options) had been converted to such common shares, and if such
assumed conversion is dilutive. The Company's basic and diluted EPS for the
first three quarters of 2004 and for the years ended December 31, 2003 and 2002
are the same, as the assumed conversion of all potentially dilutive securities
would have been anti-dilutive. Diluted EPS has been calculated for the year
ended December 31, 2004 as the assumed conversion of all potentially dilutive
securities would have been dilutive for the last quarter of 2004.
New Accounting Standards
In April 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No.
149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS No. 149 amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts and hedging activities under SFAS No. 133. The amendments set forth in
SFAS No. 149 require that contracts with comparable characteristics be accounted
for similarly. SFAS No. 149 is generally effective for contracts entered into or
modified after June 30, 2003 (with a few exceptions) and for hedging
relationships designated after June 30, 2003. The guidance is to be applied
prospectively only. The adoption of SFAS No. 149 as of July 1, 2003 had no
effect on the Company's consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This statement
establishes standards for how an issuer classifies and measures on its balance
sheet certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances) because that
financial instrument embodies an obligation of the issuer. SFAS No. 150 was
effective for financial instruments entered into or modified after May 31, 2003,
and was otherwise effective for the Company as of July 1, 2003. The adoption of
the applicable provisions of this statement as of the indicated dates had no
effect on the Company's financial statements.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), Consolidation
of Variable Interest Entities, an interpretation of ARB 51. The primary
objectives of this interpretation are to provide guidance on the identification
of entities for which control is achieved through means other than through
voting rights ("variable interest entities") and how to determine which business
enterprise (the "primary beneficiary") should consolidate the variable interest
F-12
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. Summary of Significant Accounting Policies and Organization (continued)
New Accounting Standards (continued)
entity and when. This new model for consolidation applies to an entity in which
either (i) the equity investors (if any) do not have a controlling financial
interest; or (ii) the equity investment at risk is insufficient to finance that
entity's activities without receiving additional financial support from other
parties. In addition, FIN 46 requires that the primary beneficiary, as well as
all other enterprises with a significant variable interest in a variable
interest entity, make additional disclosures. Certain disclosure requirements of
FIN 46 were effective for financial statements issued after January 31, 2003.
In December 2003, the FASB issued FIN No. 46 (revised December 2003),
Consolidation of Variable Interest Entities ("FIN 46-R") to address certain FIN
46 implementation issues. The effective dates and impact of FIN 46 and FIN 46-R
are as follows:
(i) Special purpose entities ("SPEs") created prior to February 1,
2003. The company must apply either the provisions of FIN 46 or early
adopt the provisions of FIN 46-R at the end of the first interim or
annual reporting period ending after December 15, 2003.
(ii) Non-SPEs created prior to February 1, 2003. The company is
required to adopt FIN 46-R at the end of the first interim or annual
reporting period ending after March 15, 2004.
(iii) All entities, regardless of whether a SPE, that were created
subsequent to January 31, 2003. The provisions of FIN 46 were
applicable for variable interests in entities obtained after January
31, 2003. The company is required to adopt FIN 46-R at the end of the
first interim or annual reporting period ending after March 15, 2004.
The adoption of the provisions of FIN 46-R did not have a material impact on the
Company's financial statements.
In June 2001, the FASB issued SFAS 143, Accounting for Asset Retirement
Obligations. SFAS 143 requires entities to record the fair value of a liability
for an asset retirement obligation in the period in which it is incurred and a
corresponding increase in the carrying amount of the related long-lived asset.
Subsequently, the asset retirement cost should be allocated to expense using a
systematic and rational method. SFAS 143 is effective for fiscal years beginning
after June 15, 2002. The Company adopted SFAS 143 on January 1, 2003. See Note
11 for the effect of the adoption of SFAS 143.
In November 2004, the FASB issued SFAS 151, Inventory Costs, an Amendment of APB
Opinion No. 43, Chapter 4. SFAS 151 clarifies the accounting treatment for
various inventory costs and overhead allocations and is effective for inventory
costs incurred after July 1, 2005. It is not expected to have a material impact
on the Company's financial statements when adopted.
In December 2004, the FASB issued SFAS 153, Exchanges of Non-monetary Assets, an
Amendment of APB Opinion No. 29. SFAS 153 specifies the criteria required to
record a non-monetary asset exchange using carryover basis and is effective for
non-monetary asset exchanges occurring after July 1, 2005. It is not expected to
have a material impact on the Company's financial statements when adopted.
In December 2004, the FASB issued SFAS 123 (revised 2004) ("SFAS 123R"), Share
Based Payments. SFAS 123R requires that the cost from all share-based payment
transactions, including stock options, be recognized in the financial statements
at fair value and is effective for public companies in the first interim period
after June 15, 2005. It is not expected to have a material impact on the
Company's financial statements.
F-13
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. Summary of Significant Accounting Policies and Organization (continued)
Fair Value of Financial Instruments
All of the Company's financial instruments, including cash and cash equivalents,
accounts receivable, notes receivable, and loans payable, have fair values which
approximate their recorded values as they are either short-term in nature or
carry interest rates which approximate market rates.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Risks and Uncertainties
The ability of the Company to realize the carrying value of its assets is
dependent on being able to develop, transport and market hydrocarbons.
Currently, exports from the Republic of Kazakhstan are restricted since they are
dependent on limited transport routes and, in particular, access to the Russian
pipeline system. Domestic markets in the Republic of Kazakhstan do not permit
world market prices to be obtained. Management believes, however, that over the
life of the project, transportation restrictions will be alleviated by
additional pipeline capacity being planned or currently under construction and
prices will be achievable for hydrocarbons extracted to allow full recovery of
the carrying value of its assets.
F-14
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. VAT Receivable
The value added tax (VAT) receivable is a Tenge denominated asset due from the
Republic of Kazakhstan. The VAT receivable consists of VAT paid on local
expenditures and imported goods. Under the Agreement, VAT charged to the Company
is recoverable in future periods as either cash refunds or offsets against the
Company's fiscal obligations, including future income tax liabilities.
Periodically, the Company reviews its outstanding VAT receivable for possible
impairment. During the years ended December 31, 2004 and 2003, the Company
utilized its VAT receivable to offset fiscal obligations for approximately $3.33
million and $2.58 million, respectively.
3. Prepaid Expenses
The breakdown of prepaid expenses is as follows:
December 31, December 31,
Description 2004 2003
----------- ------------ ------------
$000 $000
Prepaid transportation costs 1,151 1,296
Advanced payments for materials and supplies 1,461 1,616
Prepaid insurance 568 210
Other prepaid expenses 292 114
------------ ------------
Total prepaid expenses 3,472 3,236
============ ============
Prepaid transportation costs represent prepayments to CJSC KazTransOil ("KTO"),
a 100% subsidiary of KMG, for export tariffs necessary to sell oil on the export
market, which is expensed in the period the related oil revenue is recognized.
Advanced payments for materials and supplies represent prepayments for general
materials and supplies to be used in the development of the Karakuduk Field.
4. Other Non-current Assets
In January 2004, KKM, as part of its obligations under the Agreement, commenced
payments into an escrow account controlled by KKM and the Government of the
Republic of Kazakhstan. The purpose of the payments is to provide a cash fund to
use for future site restoration costs at the Karakuduk Field when operations
cease. Monthly payments of $14,000 will be made until the fund reaches $3
million. In January 2004, an extra amount of $168,000 was paid for amounts due
in 2003.
5. Oil and Gas Properties - Full Cost
The Company has capitalized all direct costs associated with acquisition,
exploration, and development of the Karakuduk Field. These costs include
geological and geophysical expenditures, license acquisition costs, tangible and
intangible drilling costs, production facilities, pipelines and related
equipment, access roads, gathering systems, management fees related to the
salary costs of individuals directly associated with exploration and development
activities, related interest costs associated with unproved properties and other
costs permitted to be capitalized under the full cost method of accounting.
Overhead and general and administrative costs have been expensed as incurred.
The Company calculates depreciation, depletion and amortization of oil and gas
properties using the unit-of-production method. A depletion rate is computed by
dividing the unamortized costs of proved oil and gas properties by the total
estimated proved reserves. This depletion rate is applied to the physical units
of oil and gas produced during the relevant period. The unamortized costs of
proved oil and gas properties include all capitalized costs net of accumulated
amortization, estimated future costs to develop proved reserves and estimated
dismantling and abandonment costs. Estimates of proved oil and gas reserves are
prepared in accordance with guidelines established by the SEC. Those guidelines
require that reserve estimates be prepared under existing economic and operating
F-15
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. Oil and Gas Properties - Full Cost (continued)
conditions with no provisions for increases in commodity prices, except by
existing contractual arrangement. Estimation of oil and gas reserve quantities
is inherently difficult and is subject to numerous uncertainties. Such
uncertainties include the projection of future rates of production, export
allocation and the timing of development expenditures. The accuracy of the
estimates depends on the quality of available geological and geophysical data
and requires interpretation and judgment. Estimates may be revised either upward
or downward by results of future drilling, testing or production. In addition,
estimates of volumes considered to be commercially recoverable fluctuate with
changes in commodity prices and operating costs. The Company's estimates of
reserves are expected to change as additional information becomes available. A
material change in the estimated volumes of reserves could have an impact on the
DD&A rate calculation and the financial statements.
The Company recognized total amortization expense of $17.55 million and $17.30
million for the years ended December 31, 2004 and 2003, respectively. For the
same periods, the Company has an effective amortization rate of $6.36 and $6.42
per barrel, respectively. The Company's amortization expense during 2002 was
$12.08 million.
In accordance with SFAS 19, Financial Accounting and Reporting by Oil and Gas
Producing Companies, the Company includes amortization of crude oil production
as a component of crude oil inventory value until the related crude oil is sold.
For the years ended December 31, 2004 and 2003, the Company had $24,000 and
$423,000 of amortization expense allocated to crude oil inventory, respectively.
Costs capitalized to oil and gas properties consist of:
December 31, December 31,
Description 2004 2003
----------- --------- ---------
$000 $000
Acquisition costs 10,633 10,633
Exploration and appraisal costs 22,277 22,277
Development costs 111,950 80,766
Other capitalized costs 1,097 1,097
Capitalized interest 6,088 5,875
Asset Retirement Obligation 956 641
--------- ---------
Total oil and gas properties at cost 153,001 121,289
Total costs not subject to amortization -- 2,942
--------- ---------
Total costs subject to amortization 153,001 118,347
Accumulated amortization (58,035) (40,915)
--------- ---------
Net properties subject to amortization 94,966 77,432
========= =========
F-16
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. Oil and Gas Properties - Full Cost (continued)
The condensed financial statements of KKM are as follows:
December 31, December 31,
2004 2003
--------- ---------
$000 $000
Condensed balance sheet
Current assets 14,427 9,109
Non-current assets (primarily oil and gas properties,
full cost method) 100,893 81,551
Current liabilities 38,790 24,544
Non-current liabilities:
Loans payable 41,492 49,977
Other non-current liabilities 4,789 4,551
Charter capital 200 200
Retained earnings 30,049 11,388
Condensed income statement
Revenues 78,451 57,615
Costs and expenses (59,791) (46,830)
--------- ---------
Net income 18,660 10,785
========= =========
6. Other Property, Plant and Equipment
A summary of other property, plant and equipment is provided in the table below:
December 31, December 31,
Description 2004 2003
----------- -------- --------
$000 $000
Office buildings and apartments 960 879
Office equipment and furniture 1,146 1,026
Vehicles 1,626 1,435
Land 25 25
Field buildings 6,327 5,413
Field equipment and furniture 890 630
-------- --------
Total cost 10,974 9,408
Accumulated depreciation (4,460) (3,843)
-------- --------
Property, plant and equipment, net 6,514 5,565
======== ========
Depreciation expense for property, plant and equipment was $625,000, $734,000,
and $724,000 for the years ending December 31, 2004, 2003 and 2002,
respectively.
F-17
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. Prepaid Sales
Under the terms of its sales agreements with Vitol Central Asia S.A. ("Vitol"),
KKM can receive up to one months forecast revenues one month in advance. Vitol
charges interest on these prepaid sales amounts at LIBOR plus 3%. At December
31, 2004, KKM had $6.59 million of prepaid sales.
8. Hedge Agreement
During 2000, the Company paid $4 million for put contracts to sell approximately
1.56 million 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 ranged from
$22.35 to $17.25 per barrel, with monthly expiration dates beginning in October
2000 and ending in December 2002. The contracts were 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).
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, 138, and 149, is
effective for years beginning after June 15, 2000. The Company adopted SFAS 133
on January 1, 2001. 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 shareholders' equity as a component of
comprehensive income depending on whether the derivative financial instrument
qualifies for hedge accounting, and if so, whether it qualifies as a fair value
hedge or cash flow hedge. Generally, changes in fair values of derivatives
accounted for as fair value hedges are recorded in income along with the
portions of the changes in the fair values of the hedged items that relate to
the hedged risks. Changes in fair values of derivatives accounted for as cash
flow hedges, to the extent they are effective as hedges, are recorded in other
comprehensive income net of deferred taxes. Changes in fair values of
derivatives not qualifying as hedges are reported in income, which require
derivative financial instruments to 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 and in
accordance with SFAS 133, the Company recognized $762,000 loss for the year
ended December 31, 2002 to record the Hedge Agreement at its fair value as of
that date. The Hedge Agreement expired in December 2002 and the Company did not
enter into any hedge agreements during 2003 and 2004.
9. Other Accrued Liabilities
December 31, December 31,
Description 2004 2003
----------- ------------ ------------
$000 $000
Accrued taxes payable 1,178 910
Production bonus - 500
Other accrued liabilities 644 161
------------ ------------
Total accrued liabilities 1,822 1,571
============ ============
F-18
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. Accrued Production Bonus
Accrued production bonus represents production based bonuses payable to the
Government of Kazakhstan, of $500,000 when cumulative production reaches 10
million barrels and $1.2 million when cumulative production reaches 50 million
barrels. Under current Kazakhstan tax law, the production bonuses will be
considered tax deductible expenditures in the calculation of income taxes. The
Company accrues the production bonuses in relation to cumulative oil production.
The Company accrued $109,000 and $213,000 in production bonuses for the years
ended December 31, 2004 and 2003, respectively. The first production bonus of
$500,000 was settled in July 2004 via offset against VAT repayable to the
Company.
11. Asset Retirement Obligation
As discussed in Note 1, effective January 1, 2003, the Company changed its
method of accounting for asset retirement obligations in accordance with SFAS
143, Accounting for Asset Retirement Obligations. Under the new accounting
method, the Company now recognizes AROs in the period in which they are incurred
if a reasonable estimate of a fair value can be made. The associated asset
retirement costs are capitalized as part of the carrying amount of the
long-lived asset.
The cumulative effect of the change on prior years resulted in a gain of $1.02
million, net of tax of $436,000, or $0.02 per share, which is included in income
for the year ended December 31, 2003.
Since 1995, the core business of the Company has been the development of the
Karakuduk Field. The Company has developed an asset that is capable of
producing, processing and transporting crude oil to export markets. The field
still requires up to possibly 80 new wells, but the oil processing and
transportation infrastructure, apart from the obligatory gathering lines and up
to four more gathering stations, are in place. However, further infrastructure
development is planned to increase profitability of the operation, utilize gas
and to maximise oil and produced fluid processing. The Company is legally
required under the Agreement to restore the field to its original condition. The
Company recognized the fair value of its liability for an ARO as of January 1,
2003 in the amount of $516,000 and capitalized that cost as part of the cost
basis of its oil and gas properties and depletes it using the unit-of-production
method over proved reserves.
The following table describes all changes to the Company's asset retirement
obligation liability:
2004 2003
---- ----
$000 $000
Asset retirement obligation at beginning of year 804 -
Liability recognized in transition - 516
Accretion expense 112 73
Liability incurred 316 215
----- -----
Asset retirement obligation at end of year 1,232 804
===== =====
The pro forma effects of the application of SFAS 143 on the 2002 financial
statements, the period prior to the change in accounting, are presented below:
- The pro forma asset retirement obligation liability balances as if Statement
143 had been adopted on January 1, 2002 are as follows:
2002
----
$000
Pro forma amounts of liability for asset retirement
obligation at beginning of year 467
Pro forma amounts of liability for asset retirement
obligation at end of year 516
F-19
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. Asset Retirement Obligation (continued)
- The Pro forma amounts assuming the accounting change is applied retroactively,
net of tax:
2002
----
$000
Loss before extraordinary gain and cumulative effect of change in accounting
principle (708)
Net income 4,630
Loss per share before extraordinary gain and cumulative effect of change in
accounting principle $ (0.02)
Net income per share $ 0.16
12. Loans Payable
The Note
--------
In May 2002, the Company received a total equity and debt capital infusion of
$45 million, which was partially utilized to repay a substantial portion of the
Company's loan agreement with Shell Capital, Inc. (the "Shell Capital Loan").
The Company received a total investment of $12 million from Central Asian
Industrial Holdings, N.V. ("CAIH"), including $8 million in exchange for
22,925,701 shares, or 60%, of the Company's outstanding common stock, and $4
million in exchange for a three year note bearing interest at 12% per annum (the
"Note"). Along with the Note, CAIH received a warrant to purchase 3,076,923
shares of the Company's common stock at $1.30 per share (the "Warrant").
Additionally, Kazkommertsbank, an affiliate of CAIH, provided KKM with a credit
facility totaling $33 million (the "KKM Credit Facility"), consisting of $28
million that was used to repay a portion of the Shell Capital Loan and $5
million that was made available for KKM's working capital requirements. The
Company paid CAIH $1.79 million as a related restructuring fee.
The Note was recorded net of a $2.47 million discount, based on the fair market
value of the Warrant issued in conjunction with the Note. The discount is
amortized using the effective interest rate over the life of the Note. The
principal balance of the Note is due on May 10, 2005 and accrued interest is
payable quarterly. The Warrant is fully discussed in Note 13.
In June 2002, the Company prepaid $2 million of the $4 million outstanding
principal balance of the Note. As a result, the Company recognized an
extraordinary loss on the early extinguishment of debt of $1.22 million from the
write-off of 50% of the unamortized discount on the Note. The extraordinary loss
was netted against the extraordinary gain from the restructuring of the Shell
Capital Loan. In March 2004, the Company reborrowed the $2 million.
In May 2004, the CAIH shares, the Warrant and the Note were purchased by Nelson.
See Note 20 for details of recent restructuring of the Note.
The Company recognized the following amounts of interest relating to the Note:
Year ended December 31,
2004 2003 2002
---- ---- ----
$000 $000 $000
Interest on principal 422 240 189
Discount amortization 494 286 234
-------- -------- -------
916 526 423
======== ======== =======
F-20
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. Loans Payable (continued)
The Note (continued)
---------------------
Of the $422,000 interest paid by the Company during 2004, $362,000 was paid to
Nelson.
In addition, as a result of the restructuring of the Shell Capital Loan, in 2002
the Company recognized a $6.56 million extraordinary gain on the extinguishment
of debt. The extraordinary gain reflects the forgiveness of $9.07 million in
principal, interest, and fees previously owed to Shell Capital, less $1.79
million in restructuring fees paid to CAIH, $509,000 in professional fees, and
$220,000 in other costs and expenses. The Company recognized $2.75 million in
interest expense on the Shell Capital loan during 2002. After May 2002, the
Company has no further commitments or obligation under the Shell Capital Loan.
KKM Credit Facility
-------------------
As mentioned above, in May 2002, KKM established the KKM Credit Facility, a
five-year, $33 million credit line with Kazkommertsbank. The KKM Credit Facility
consisted of a $30 million non-revolving line and a $3 million revolving line,
both of which were fully borrowed by KKM in May 2002. The Company recognized
$4.18 million and $4.0 million of interest expense on the KKM Credit Facility
for the years ended December 31, 2004 and 2003, respectively.
The non-revolving portion of the KKM Credit Facility accrues simple interest at
an annual rate of 14% and is repayable over a five-year period with final
maturity in May 2007. Accrued interest is payable quarterly, beginning in
December 2002, and KKM began making quarterly principal repayments in May 2003.
As of December 31, 2004, the Company had repaid $5 million in principal, with
another $5 million of principal payments due in 2004 being deferred, on
agreement with Kazkommertsbank, to 2005. The principal payment of $1 million due
May 31, 2004 was deferred until August 31, 2004 and then to January 31, 2005,
together with $2 million scheduled for payment on August 6, 2004. A principal
payment of $2 million scheduled for payment on November 6, 2004 has been
deferred until May 31, 2005.
The revolving portion of the KKM Credit Facility accrues simple interest at an
annual rate of 14%. The revolver is loaned to KKM for short-term periods up to
one year, but KKM has the right to re-borrow the funds through May 2006 with
final repayment due in May 2007. On December 30, 2003, Kazkommertsbank increased
the revolving portion of the KKM Credit Facility from $3 million to $5 million.
On the same date, KKM borrowed the additional $2 million to finance ongoing
operations. The additional $2 million accrues interest at 14%. As at December
31, 2004, there was an outstanding balance of $3 million on the revolving
portion of the loan which matured and was repaid on February 9, 2005. The
revolving portion of the KKM Credit Facility is classified as current as of
December 31, 2004. Accrued interest on the revolving loan is payable at
maturity, except as noted.
The original KKM Credit Facility included repayment terms of three years and
four years for the non-revolving and revolving portions, respectively, with an
option to extend the final maturity date for repayment of the entire KKM Credit
Facility to five years. KKM exercised the option as of May 2002.
KKM is subject to certain pledges, covenants, and other restrictions under the
KKM Credit Facility, including, but not limited to, the following:
(i) CAP-G pledged its 50% interest in KKM to Kazkommertsbank as
collateral for the KKM Credit Facility;
(ii) Chaparral has provided a written guarantee to Kazkommertsbank that it
will repay the KKM Credit Facility in the event KKM fails to do so;
(iii) KKM may not incur additional indebtedness or pledge its assets to
another party without the written consent of Kazkommertsbank; and
(iv) KKM may not pay dividends without the written consent of
Kazkommertsbank.
The KKM Credit Facility stipulates certain events of default, including, but not
limited to, KKM's inability to meet the terms of the KKM Credit Facility, KKM's
failure to meet its obligations to third parties in excess of $100,000, and
F-21
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. Loans Payable (continued)
KKM Credit Facility (continued)
KKM's involvement in legal proceedings in excess of $100,000 where an adverse
judgment against KKM occurs or is expected to occur. If an event of default does
occur and is not waived by the lender, Kazkommertsbank has a right to call the
KKM Credit Facility immediately due and payable and exercise its security
interest by enforcing its collateral right on the Company's shares in KKM.
Furthermore, in the event of a material adverse change in the financial or
credit markets, Kazkommertsbank has a right to unilaterally alter any terms and
conditions of the KKM Credit Facility, including the rate of interest, by
written request. KKM may either agree to the amended terms or repay the
outstanding KKM Credit Facility within 10 days of notification.
The maturity schedule of the Company's indebtedness as of December 31, 2004 is
as follows:
Date Principal Amount Due
---- --------------------
$000
2005 20,000
2006 8,000
2007 4,000
----------------------
Total principal due 32,000
======================
Balances as of December 31, 2004 under the different facilities are as follows:
Principal Amount Due
--------------------
$000
KKM Credit Facility (Non - revolving) 25,000
KKM Credit Facility (Revolving) 3,000
The Note 4,000
-----------------------
Total principal due 32,000
=======================
The loans are shown in the balance sheet net of the loan discount, which
amounted to $222,000 at December 31, 2004 and $716,000 at December 31, 2003.
13. Common Stock
General
1998 Incentive and Non-statutory Stock Option Plan
On June 26, 1998, the stockholders approved the 1998 Incentive and Non-statutory
Stock Option Plan (the "1998 Plan"), pursuant to which up to 50,000 options to
acquire the Company's common stock may be granted to officers, directors,
employees or consultants of the Company and its subsidiaries. The stock options
granted under the 1998 Plan may be either incentive stock options or
non-statutory stock options. The 1998 Plan has an effective term of ten years,
commencing on May 20, 1998. The Company has not granted any options under the
1998 Plan as of December 31, 2004.
F-22
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. Common Stock (continued)
2001 Stock Incentive Plan
In June 2001, the Company's stockholders approved the 2001 Stock Incentive Plan,
which sets aside a total of 2.14 million shares of the Company's common stock
for issuance to the Company's officers, directors, employees and consultants.
The Company has not made any grants under the 2001 Stock Incentive Plan as of
December 31, 2004.
Non-Qualified Stock Options
During 2003, stock options to purchase 2,816 shares of the Company's common
stock granted in 1997 to various employees and consultants of the Company
expired. The expired options had exercise prices ranging between $43.20 and
$142.50 per share.
Common Stock Offerings and Common Stock Warrant Issuances
In 1996, the Company sold 233,334 shares of common stock in a private placement
at a price of $30 per share. In connection with the private placement, the
Company issued warrants to purchase 17,033 shares of the Company's common stock
for a total of $10 to the sales agent as a commission. In April 2002, these
warrants expired.
As discussed in Note 12, Shell Capital's warrant for 1,785,455 shares of the
Company's common stock was cancelled on May 2002 as part of the Shell Capital
Loan restructuring. The warrants had an exercise price of $9.79.
In November 1997, the Company entered into a subscription agreement with an
unaffiliated investor to purchase 225,000 shares of the Company's designated
Series A, B, and C Redeemable Preferred Stock, for $100 per share. As of
December 31, 1997, the investor had purchased 50,000 shares of the Company's
Series A Redeemable Preferred Stock for $5 million. The Company issued a warrant
for 15,000 shares at an exercise price of $0.60 per share as compensation to the
placement agent in connection with the subscription agreement. On November 24,
2002, this share warrant expired.
On August 5, 1998, the Company retired two outstanding loans, totaling $1
million. The Company borrowed the $1 million on June 3, 1998, subject to a 7%
interest rate. In conjunction with the loans, the Company issued warrants to
purchase 16,667 shares of the Company's common stock, at an exercise price of
$210 per share. On November 25, 2002, these warrants expired.
In May 2002, the Company issued 1 million shares of its outstanding common stock
valued at $2.7 million and $1.2 million in cash to Dardana Limited, in exchange
for 100% of the stock of MTI, which owns a 10% interest in KKM.
As discussed in Note 12, the Company issued to CAIH a warrant to purchase
3,076,923 shares of the Company's common stock at an exercise price of $1.30 per
share, subject to certain anti-dilution provisions. The Warrant is exercisable
for five years from May 10, 2002, the date of grant. The fair market value of
the Warrant of $2.47 million was recorded as a discount on the Note. The fair
market value of the Warrant was estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions: risk free interest rate of 4.09%, dividend yield of 0%, volatility
factor of the expected market price of the Company's common stock of 0.624, and
a weighted average life expectancy of 3.5 years. The Warrant was sold to Nelson
in May 2004.
As discussed in Note 12, the Company received a total investment of $12 million
from CAIH, including $8 million in exchange for 22,925,701 shares, or 60%, of
the Company's outstanding common stock. These shares were sold to Nelson in May
2004.
In May 2002, the Company repurchased 50,000 shares of its Series A Redeemable
Preferred Stock from an unrelated party for $2.3 million. The Series A
Redeemable Preferred Stock had a carrying value of approximately $6 million,
including $1.1 million in accrued dividends. The $3.7 million difference between
the redemption price and the carrying value was booked directly to retained
earnings.
F-23
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. Common Stock (continued)
SFAS 123 Disclosure
SFAS 123 requires that pro forma information regarding net income and earnings
per share are determined as if the Company had accounted for its employee stock
options under the fair value method as defined in SFAS 123. The fair value for
the options issued is estimated at the date of grant using the Black-Scholes
option pricing model by using weighted average assumptions, volatility factors
of the expected market price of the Company's common stock and the weighted
average life expectancy of the options. The Company did not issue any options
during the period 2000 to 2004 and all outstanding options were fully vested as
of December 31, 1999, therefore pro-forma information is not presented.
A summary of the Company's stock option activity and related information for the
last three years ended December 31 is as follows:
Shares Weighted Weighted
Under Average Exercise Average
Option Price Fair Value
-------- ----------------- ----------
$ $
Unexercised options outstanding - December 31, 2001 57,516 67.73 -
Options Cancelled (54,700) 66.32 -
-------- -------- --------
Unexercised options outstanding - December 31, 2002 2,816 95.10 -
Options Cancelled (2,816) 95.10 -
-------- -------- --------
Unexercised options outstanding - December 31, 2003 - - -
-------- -------- --------
Unexercised options outstanding - December 31, 2004 - - -
-------- -------- --------
Exercisable options - December 31, 2002 2,816 95.10
- December 31, 2003 - -
- December 31, 2004 - -
The following table summarizes all common stock purchase warrant activity:
Number of Exercise
Stock Price
Warrants Range
------------------- ---------------
$
Outstanding, December 31, 2000 1,837,822 0.0006 - 210
Expired (3,334) 51 - 75
------------------- ---------------
Outstanding, December 31, 2001 1,834,488 0.0006 - 210
Granted 3,076,923 1.30
Expired (48,700) 0 - 210
Cancelled (1,785,455) 9.79
------------------- ---------------
Outstanding as of December 31, 2002 3,077,256 0.60 - 1.30
Expired (333) 0.60
------------------- ---------------
Outstanding as of December 31, 2003 3,076,923 1.30
Expired/cancelled/granted - -
------------------- ---------------
Outstanding as of December 31, 2004 3,076,923 1.30
=================== ===============
F-24
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. Common Stock (continued)
Earnings per Share
The following table reconciles basic and diluted earnings per share
calculations:
Income Shares Per-Share
Amount
$000 $
Basic Earnings per Share
Income available to common stockholders 8,522 38,209,502 0.223
Effect of Dilutive Securities
Warrants -- 197,781 0.001
Diluted Earnings per Share
Income available to common stockholders
and assumed conversions 8,522 38,407,283 0.222
14. Income Taxes
The Company accounts for income taxes under FASB 109, Accounting for Income
Taxes. Deferred income tax assets and liabilities are determined based upon
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
For financial reporting purposes, income before income taxes, extraordinary
gain, and cumulative effect of change in accounting principle includes the
following components:
Year ended December 31,
2004 2003 2002
---- ---- ----
$000 $000 $000
Domestic (1,745) (3,883) (5,923)
Foreign 17,387 9,047 7,387
--------- --------- ---------
15,642 5,164 1,464
========= ========= =========
F-25
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. Income Taxes (continued)
The components of the income tax provision are as follows:
Year ended December 31,
2004 2003 2002
------ ------ ------
$000 $000 $000
Income tax provision:
Current:
Domestic -- -- --
Foreign 6,919 2,246 1,939
------ ------ ------
Total current 6,919 2,246 1,939
------ ------ ------
Deferred:
Domestic -- -- --
Foreign 201 1,875 746
------ ------ ------
Total deferred 201 1,875 746
------ ------ ------
Total provision for income taxes 7,120 4,121 2,685
====== ====== ======
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's net deferred income taxes are as follows:
Year Ended December 31,
2004 2003
-------- --------
$000 $000
Deferred tax assets:
Oil and gas assets 1,279 983
Sales of assets 25 23
Obsolete inventory 82 52
Amortization of derivatives 1,400 1,400
Compensation and accrued expenses 517 1,022
Capital loss on transfer of net
profits interest 1,529 1,529
Net operating loss carry-forwards 8,428 8,645
Other 93 --
-------- --------
Deferred tax assets 13,353 13,654
Valuation allowance (12,517) (13,046)
-------- --------
Total deferred tax assets 836 608
Deferred tax liabilities:
Depreciation and other basis
differences (4,094) (3,665)
-------- --------
Net deferred tax liabilities (3,258) (3,057)
======== ========
F-26
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. Income Taxes (continued)
SFAS 109 requires a valuation allowance to reduce the deferred tax assets
reported if, based on the weight of the evidence, it is more likely than not
that some portion or all of the deferred tax assets will not be realized. After
consideration of all the evidence, both positive and negative, management has
determined that a $12.52 million valuation allowance at December 31, 2004 is
necessary to reduce the deferred tax assets to the amount that will more likely
than not be realized. The change in the valuation allowance for the current year
is $529,000. The decrease in valuation allowance is mainly due to expiration of
net operating losses from prior years and prior year return to provision
adjustments.
As of December 31, 2004, the Company has estimated domestic tax loss
carry-forwards of $24.8 million. These carry-forwards will expire at various
times between 2005 and 2022.
Expiration of domestic tax loss carry-forward
Later
1 Year 2-3 Years 4-5 Years Years Total
---------------------------------------------------------
$000 $000 $000 $000 $000
Tax loss carry-forward 433 520 1,137 22,676 24,766
During 2000, 2002 and 2004 the Company had an ownership change under ss.382 of
the Internal Revenue Code, which significantly limits the Company's use of its
net operating tax loss carry-forwards.
Undistributed earnings associated with the Company's interest in KKM amounted to
approximately $18.03 million at December 31, 2004. Those earnings are considered
to be indefinitely reinvested and, accordingly, no provision for U.S. federal
income taxes has been provided thereon. Upon distribution of those earnings in
the form of dividends, the Company would be subject to both U.S. income taxes
(subject to an adjustment for foreign tax credits) and withholding taxes payable
to the Republic of Kazakhstan. Determination of the amount of unrecognized
deferred U.S. income tax liability is not practical because of the complexities
associated with the hypothetical calculation; however, unrecognized foreign tax
credit carry forwards would be available to reduce some portion of the U.S.
liability. Withholding taxes of approximately $2.70 million would be payable
upon remittance of all previously unremitted earnings at December 31, 2004.
F-27
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. Income Taxes (continued)
The following table summarizes the significant differences between the statutory
tax rate and the Company's effective tax rate for financial statement purposes:
Year ended December 31,
2004 2003 2002
------- ------- -------
$000 $000 $000
Income before minority interest, income taxes, 23,106 9,478 1,705
extraordinary gain, and cumulative effect of change
in accounting principle
Statutory tax rate 35% 35% 35%
Income taxes computed at statutory rate 8,087 3,317 597
Losses and expenses with no tax benefit 1,662 1,919 840
Expiration of NOL carry forwards 152 320 597
Difference in foreign tax rate (1,289) (694) (378)
Valuation allowance (529) 295 221
Reversal of provision for tax (791) (899) --
Additional foreign taxes/(benefit) (172) (137) 808
------- ------- -------
Income tax provision 7,120 4,121 2,685
======= ======= =======
Foreign taxes applicable to the Company are specified under the Agreement with
the Government of the Republic of Kazakhstan. As of December 31, 2004, the
Company has utilized all available foreign tax loss carry forwards.
In December 2002, KKM received a claim from the Ministry of State Revenues of
the Republic of Kazakhstan for $9.1 million (the "Tax Claim") relating to taxes
and penalties covering the three years from 1999 to 2001. KKM appealed the claim
through the courts in Kazakhstan, which eventually ruled in favor of KKM with
the exception of $255,000 which was upheld. As a result, KKM reversed $899,000
of income taxes accrued during 2002 for the Tax Claim net of $255,000 which was
settled in January 2004.
The Ministry of State Revenues of the Republic of Kazakhstan had been
considering penalties with respect to the Tax Claim in the amount of $970,000.
In March 2004 a court hearing was conducted which resulted in a reduction of
these penalties to $53,000. This amount was paid in full during 2004.
The Company has used the best estimates available to determine the Company's
deferred tax assets and liabilities. Refer to Note 16 regarding the
uncertainties of taxation in the Republic of Kazakhstan.
15. Operating Leases
The Company entered into a sublease agreement for office space extending from
March 2000 through November 2003. At the expiration date of the lease, the
Company moved its registered office from Houston, Texas to White Plains, New
York. In addition, the Company entered into a new 6 month lease agreement for
reduced office space at a new location in Houston; as of March 31, 2004 this
lease was renewed for a further 6 months. Effective June 30, 2004 the Company
relocated its administrative offices to London and the Houston office lease was
cancelled as at the same date. The remaining lease payments of approximately
$6,000 were contractually paid in full for the remainder of the lease. The
F-28
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. Operating Leases (continued)
Company also cancelled its lease for its executive office in Almaty, Kazakhstan.
The Almaty office was subleased from Nasikhat, an affiliate of Kazkommertsbank,
for approximately $3,000 per month renewable at the Company's option on
September 1, 2004. The remaining lease payments of approximately $10,200 were
contractually paid in full for the remainder of the lease.
The Company's rental expense for 2004, 2003 and 2002 was approximately $30,000,
$144,000 and $83,000, respectively.
16. Commitments and Contingencies
Taxation
--------
As part of the process of preparing the Company's consolidated financial
statements, the Company is required to estimate its taxes in each of the
jurisdictions of operation. This process involves management estimating the
actual current tax expense together with assessing temporary differences
resulting from differing treatment of items for tax and accounting purposes in
accordance with the provisions of SFAS No. 109, Accounting for Income Taxes.
These differences result in deferred tax assets and liabilities, which are
included within the consolidated balance sheets. Management then must assess the
likelihood that the deferred tax assets will be recovered from future taxable
income and, to the extent recovery is not likely, management must establish a
valuation allowance. Future taxable income depends on the ability to generate
income in excess of allowable deductions. To the extent the Company establishes
a valuation allowance or increases this allowance in a period, an expense is
recorded within the tax provision in the consolidated statement of operations.
Significant management judgment is required in determining our provision for
income taxes, deferred tax assets and liabilities and any valuation allowance
recorded against net deferred tax assets. In the event that actual results
differ from these estimates or the Company adjusts these estimates in future
periods, the Company may need to establish a valuation allowance that could
materially impact the Company's financial condition and results of operations.
In addition, the existing legislation with regard to taxation in the Republic of
Kazakhstan is constantly evolving as the Government manages the transition from
a command to a market economy. Tax and other laws applicable to the Company are
not always clearly written and their interpretation is often subject to the
opinions of the local or central tax authorities. Instances of inconsistent
opinions between local, regional and national tax authorities are not unusual.
In December 2002, KKM received an amendment to the Agreement to provide for the
stabilization of taxes and clarification on tax laws applicable to KKM. The
amendment increased the KKM royalty rate from 8% to 8.14% and allowed KKM to use
the lower current tax rates for payroll taxes, social taxes and pension taxes.
In addition, during 2003 the royalty rate was increased to 8.4% from 8.14%. The
effect of these changes is reflected in the Company's financial statements from
the year ended December 31, 2003 onwards.
Basis of Accounting
-------------------
KKM maintains its statutory books and records in accordance with U.S. generally
accepted accounting principles and calculates taxable income or loss using the
existing Kazakh tax legislation in effect on August 30, 1995, the date the
Agreement was signed. The Company considers these accounting methods correct
under the terms of the Agreement. The Republic of Kazakhstan currently requires
companies to comply with Kazakh accounting regulations and to calculate tax
profits or losses in accordance with these regulations as well as the prevailing
tax law.
F-29
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. Local Oil Sales Requirements and Export Quotas
The ability of the Company to realize the carrying value of its assets is
dependent on being able to transport hydrocarbons and finding appropriate
markets for their sale. Domestic markets in the Republic of Kazakhstan currently
do not permit world market prices to be obtained. The Company is responsible for
obtaining export quotas and finalizing access routes through the KTO pipeline
and onward through the Russian pipeline system. The Company has a right to
export, and receive export quota for, 100% of the production from the Karakuduk
Field under the terms of the Agreement.
During 2004, the Company sold all of its exported crude oil to Vitol Central
Asia S.A.
Oil and gas producers within Kazakhstan are required to sell a certain portion
of their crude oil production to the local market to supply local energy needs.
Sales to export and local markets can be summarized as follows:
Year Ended December 31,
2004 2003
--------- ---------
Export market sales
bbls 2,544,000 2,591,000
$000 75,631 56,668
% by value 96% 98%
Local market sales
bbls 214,000 103,000
$000 2,820 947
% by value 4% 2%
The Company continues to seek an amicable resolution with the Government to
eliminate local market requirements and is no longer considering commencing
formal arbitration proceedings pursuant to its contractual arrangements with the
Government.
18. Capital Commitments
On December 31, 2004, the Company's contract with KazMunayGas-Drilling ("KMGD"),
an affiliate of KMG, for one development drilling rig currently operating in the
Karakuduk Field expired. The same rig is now contracted through Oil and Gas
Drilling and Exploration of Kracow (OGEC) for a one year term to December 31,
2005. The minimum payments under the drilling contract with OGEC for 2005 are
$4.50 million. The Company's other drilling and operations related contracts can
either be cancelled within 30 days or are on a call-off (as required) basis.
The Company has no other significant commitments other than those incurred
during the normal performance of the work program to develop the Karakuduk
Field.
19. Related Party Transactions
In 2003, the Company approved a one-year agreement with OJSC Kazkommerts
Securities ("KKS"), an affiliate of Kazkommertsbank. The agreement was effective
as of January 7, 2003 and provided for KKS to assist the Company's senior
management with financial advisory and investment banking services. In
consideration for the services KKS received a monthly fee of $25,000 (the
"Advisory Fee"). The agreement was extended for four months and ended April 30,
2004.
F-30
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. Related Party Transactions (continued)
Kazkommerts Policy, an affiliate of Kazkommertsbank, is the major insurer of
KKM's oil and gas activities. The current insurance policy expires in March
2005, when the policy will be awarded according to a tender process that is
currently in progress.
KKM has a contract to transport 100% of its oil sales through the pipeline owned
and operated by KTO, a wholly owned subsidiary of KMG, the 40% minority
shareholder in KKM until December 2004. The rates for transportation are in
accordance with those approved by the Government of the Republic of Kazakhstan.
Currently, the use of the KTO pipeline system is the only viable method of
exporting KKM's production. As KTO notifies KKM of the export sales allocated to
it on a monthly basis, KTO controls both the volume and transportation cost of
export sales.
KKM makes a prepayment for crude transportation based upon the allocation of
export sales received from KTO. This prepayment includes pipeline costs charged
by the operators of the Russian and Ukrainian pipeline systems which are
dependent upon the point of sale of KKM's exports. During 2004, KKM paid $13.35
million to KTO, of which $13.14 million related to transportation costs for
sales during 2004. Comparably during 2003, KKM paid $11.56 million to KTO, of
which $11.29 million related to transportation costs for sales during 2003. See
Note 3 for prepaid transportation as of December 31, 2004 and 2003.
KTO charges KKM for associated costs of oil storage within their pipeline
system, sales commission and customs clearance fees in respect to export sales.
KTO also provides KKM with water through the Volga Water pipeline. Amounts
recognized for these services during 2004 and 2003 were $204,000 and $267,000,
respectively.
KMGD, a subsidiary of KMG, provided a drilling rig for the drilling campaign,
which commenced February 12, 2003 and was contracted to provide the services of
a drilling rig until the end of December 2004.
The total amounts of the transactions with the above related companies are as
follows:
2004 2003
---- ----
$000 $000
Kazkommerts Policy 778 524
KTO 13,348 11,561
KMGD 5,256 5,999
Included in accounts payable as of December 31 are the following amounts:
2004 2003
---- ----
$000 $000
Kazkommerts Policy 195 48
KTO 8 97
KMGD 371 998
---------- ----------
574 1 ,143
========== ==========
F-31
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. Related Party Transactions (continued)
In August 2004, the Company approved a two-year agreement with Nelson to provide
corporate administrative services and financial advisory services (the "Service
Agreement") to support its business activities. The Service Agreement is
effective as of June 1, 2004 and can be terminated upon 30 days written notice
by either party. In consideration for these services Nelson will receive a fixed
monthly fee of $20,000 for administrative services and $25,000 for financial
advisory services (the "Management Fee"). As part of the Service Agreement,
Nelson is also required to provide personnel to cover Chaparral's executive and
managerial needs. The cost of executive and managerial personnel will be
allocated on the basis of the cost of personnel involved and on the percentage
of time actually spent by such personnel on matters related to Chaparral, as
mutually agreed by the parties from time to time. In addition, Nelson will use
its greater buying power to obtain more favorable rates for goods and services,
including insurance coverage, for Chaparral. These expenditures will be passed
to Chaparral at cost with a ten percent mark-up. As of December 31, 2004, the
Company has recorded $682,000 related to the Management Fee, the executive and
managerial cost, insurance coverage and the mark-up under the Service Agreement.
On June 3, 2004, KKM entered into a three year agency agreement with Nelson (the
"Marketing Agreement"), whereby Nelson becomes the duly authorized, exclusive
agent for the purpose of marketing crude oil, and is empowered to represent the
interests of KKM in relations with governmental authorities and commercial
organizations and also enter into contracts and agreements and any other
documents necessary for and related to the marketing of crude oil. The Marketing
Agreement is effective as of June 1, 2004 and can be terminated upon 90 days
written notice by either party. As consideration for the services provided under
the Marketing Agreement, KKM shall pay Nelson a fixed fee of $20,000 per month
and a variable fee of five US cents per barrel of total production in a
reporting calendar month, if the amount of supplies to the local market in that
month is more than 10% of the total amount of production, or eight US cents per
barrel of total production in a reporting calendar month, if the amount of
supplies to the local market in that month is less than 10% of the total amount
of production (the "Marketing Fee"). For 2004, $274,000 was accrued under the
Marketing Agreement.
All other related party transactions are disclosed in other notes to the
financial statements. The loans with Kazkommertsbank and Nelson are disclosed in
Note 12 and prepaid transportation to KTO in Note 3. See Note 20 for details of
recent restructuring of the Note.
20. Subsequent Events
The payment of principal of $3 million on the KKM Credit Facility that was
deferred from 2004 was paid on the rescheduled date of January 31, 2005. The
principal payment of $2 million due on February 6, 2005 was paid on time. The $3
million revolving loan amount due on February 9, 2005 was repaid and redrawn on
that day, with a maturity date of August 9, 2005. An additional $2 million was
drawn under the revolving portion of the facility on February 17, 2005 with a
maturity date of August 17, 2005.
In February 2005, the Kazakh tax authorities started an audit of KKM's tax
records for the years 2002 and 2003. In March 2005, KKM received a preliminary
assessment for underpaid taxes and related fines and penalties of approximately
$1.35 million and $0.29 million, respectively. This assessment is subject to
further discussions and could differ significantly from the final assessment.
KKM's assessment is that the additional tax obligation may be only $0.26
million. Management is of the opinion that the eventual outcome of the tax audit
will not have a material adverse effect on the Company's consolidated financial
position or results of operations.
On March 24, 2005, KKM signed a $40 million Structured Crude Oil Pre-export
Credit Facility Agreement with BNP Paribas (Suisse) SA and others (the "BNP
Credit Facility"). Subject to meeting conditions precedent within 30 days of
signing, funds from this facility will be available for use to cover any
short-term working capital deficiencies and to pay down the existing loan with
Kazkommertsbank. Amounts borrowed under the BNP Credit Facility are repayable in
36 equal monthly installments commencing between six and seven months after the
signing date. The interest rate is LIBOR plus 3.25% for the first 12 months and
LIBOR plus 4.00% thereafter. The lenders also require that KKM implement a crude
oil price hedging program, in a form satisfactory to the lenders. In addition,
on March 22, 2005, Chaparral and CAP-G signed a Promissory Note Amendment
Agreement with Nelson (the "Amended Note"). This provides for a prepayment of $1
million of the $4 million due to be repaid to Nelson on May 10, 2005 under the
existing $4 million loan note and the replacement of the existing loan note with
a new loan note for $3 million on substantially similar terms, but with an
increase in the interest rate from 12% to 14% from May 10, 2005 and an extension
of the maturity date of one year to May 10, 2006. The debt refinancing, coupled
with current production and price levels, will enable the Company to meet all
current financial obligations and continue with field development.
F-32
CHAPARRAL RESOURCES, INC.
SUPPLEMENTAL INFORMATION - DISCLOSURES ABOUT OIL AND GAS
PRODUCING ACTIVITIES - UNAUDITED
The following supplemental information regarding the oil and gas activities of
the Company is presented pursuant to the disclosure requirements promulgated by
the Securities and Exchange Commission (the "SEC") and SFAS 69, Disclosures
About Oil and Gas Producing Activities.
The following estimates of reserve quantities and related standardized measure
of discounted net cash flows are estimates only, and are not intended to reflect
realizable values or fair market values of the Company's reserves. The Company
emphasizes that reserve estimates are inherently imprecise and that estimates of
new discoveries are more imprecise than producing oil and gas properties.
Additionally, the price of oil has been very volatile and downward changes in
prices can significantly affect quantities that are economically recoverable.
Accordingly, these estimates are expected to change as future information
becomes available and these changes may be significant.
KKM sold 2.76 million barrels of crude oil in 2004, of which 214,000 barrels, or
approximately 8%, were sold to the local market. Comparatively, the Company sold
2.69 million barrels of crude oil in 2003, of which 103,000, or approximately
4%, was sold to the local market. Under the Agreement, KKM has the right to sell
100% of its production on the export market for world market prices and a right
to export 100% of its production under the terms of its Agreement with the
Government. Although the Company expects to sell 100% of its production on the
export market in future years, the year-end prices used for the standardized
measure of discounted net cash flows for 2004 reflects the assumption that 10%
of KKM's production will be sold on the local market for a substantially lower
net oil price. Year-end prices used for the standardized measure of discounted
net cash flows for 2003 and 2002 reflect the assumption that 5% and 15% of KKM's
production would have been sold on the local market for a substantially lower
net oil price, respectively.
Proved reserves are estimated reserves of crude oil and natural gas that
geological and engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating conditions. Proved developed reserves are those expected to be
recovered through existing wells, equipment and operating methods.
The standardized measure of discounted future net cash flows is computed by
applying year-end prices of oil and gas (with consideration of price changes
only to the extent provided by contractual arrangements) to the estimated future
production of proved oil and gas reserves, less estimated future expenditures
(based on year-end costs) to be incurred in developing and producing the proved
reserves and estimated future income tax expenses. The estimated future net cash
flows are then discounted using a rate of 10% a year to reflect the estimated
timing of the future cash flows.
F-33
CHAPARRAL RESOURCES, INC.
SUPPLEMENTAL INFORMATION - DISCLOSURES ABOUT OIL AND GAS
PRODUCING ACTIVITIES - UNAUDITED
Proved Oil and Gas Reserve Quantities (All within the Republic of Kazakhstan)
Year Ended December 31,
-----------------------------------------------------------------------------
2004 2003 2002
---- ---- ----
Oil Gas Oil Gas Oil Gas
Reserves Reserves Reserves Reserves Reserves Reserves
(mbbls.) (Mcf.) (mbbls.) (Mcf.) (mbbls.) (Mcf.)
------------- ----------- ------------ ----------- ------------- ------------
Proved developed and undeveloped reserves:
Balance January 1 25,616 - 21,855 - 29,921 -
Revision of previous estimates 17,813 - 6,455 - (5,348) -
Extensions, discoveries and other additions - - - - - -
Production (2,835) - (2,694) - (2,718) -
------------- ----------- ------------ ----------- ------------- ------------
Balance December 31 40,594 - 25,616 - 21,855 -
============= =========== ============ =========== ============= ============
Minority interest in KKM's proved
developed and undeveloped reserves 16,238 - 10,246 - 8,742 -
============= =========== ============ =========== ============= ============
Proved developed reserves 10,714 - 15,107 - 9,321 -
============= =========== ============ =========== ============= ============
Minority interest in KKM's
proved developed reserves 4,286 - 6,043 - 3,728 -
============= =========== ============ =========== ============= ============
Capitalized Costs Relating to Oil and Gas Producing Activities (All within the Republic of Kazakhstan)
Year Ended December 31,
2004 2003 2002
---- ---- ----
$000 $000 $000
Unproved oil and gas properties
Expenditures on oil and gas properties - 2,942 8,814
Material and supplies inventory 5,238 3,189 2,456
Proved oil and gas properties 153,001 118,347 84,853
------------------ ----------------- -----------------
158,239 124,478 96,123
Accumulated depreciation and depletion (58,035) (40,915) (25,105)
------------------ ----------------- -----------------
Net capitalized cost 100,204 83,563 71,018
================== ================= =================
F-34
CHAPARRAL RESOURCES, INC.
SUPPLEMENTAL INFORMATION - DISCLOSURES ABOUT OIL AND GAS
PRODUCING ACTIVITIES - UNAUDITED
Cost Incurred in Oil and Gas Property Acquisition, Exploration and Development
Activities
(All within the Republic of Kazakhstan)
Year Ended December 31,
2004 2003 2002
------- ------- -------
$000 $000 $000
Acquisition costs (1) -- -- 3,881
Exploration and appraisal costs -- -- --
Development costs (2) 31,712 27,642 10,287
------- ------- -------
31,712 27,642 14,168
======= ======= =======
(1) Acquisition cost for the year 2002 represents the cost of acquiring an
additional 10% interest in KKM through the acquisition of 100% of the
outstanding stock of MTI.
(2) Development costs include costs for asset retirement obligations.
Results of Operations for Producing Activities (All within the Republic of
Kazakhstan)
Year Ended December 31,
2004 2003 2002
-------- -------- --------
$000 $000 $000
Oil revenue 78,451 57,615 45,133
Transportation costs (14,046) (11,474) (9,427)
Operating expenses (8,319) (5,915) (7,678)
Depreciation, depletion and amortization (18,180) (18,038) (12,804)
Accretion expense (112) (73) --
-------- -------- --------
37,794 22,115 15,224
Provision for income taxes (1) (11,595) (6,964) (3,633)
-------- -------- --------
26,199 15,151 11,591
======== ======== ========
(1) Income tax expense is calculated by applying the statutory tax rate to
operating profit, adjusted for applicable net operating loss carry
forwards.
F-35
CHAPARRAL RESOURCES, INC.
SUPPLEMENTAL INFORMATION - DISCLOSURES ABOUT OIL AND GAS
PRODUCING ACTIVITIES - UNAUDITED
Standardized Measure of Discounted Future Net Cash Flows and Changes Therein
Relating to Proven Oil and Gas Reserves
(All within the Republic of Kazakhstan)
Year Ended December 31,
2004 2003 2002
--------- --------- ---------
$000 $000 $000
Future cash inflows 971,463 476,969 377,660
Future development costs (1) (171,210) (73,642) (83,189)
Future production costs (293,295) (53,338) (50,952)
Future income tax expenses (136,557) (90,699) (55,699)
--------- --------- ---------
Future net cash flows 370,401 259,290 187,820
10% annual discount for
estimated timing of cash flows (165,816) (92,108) (59,081)
--------- --------- ---------
Standardized measure of discounted net
cash flows 204,585 167,182 128,739
========= ========= =========
Minority interest 81,834 66,873 51,496
========= ========= =========
(1) Development costs include costs for asset retirement obligations.
Principal Sources of Change in the Standardized Measure of Discounted Future Net
Cash Flows
Year Ended December 31,
2004 2003 2002
--------- --------- ---------
$000 $000 $000
Beginning balance 167,182 128,739 80,688
Sales of oil produced, net of production
and transportation costs (56,086) (40,226) (28,028)
Extensions and discoveries -- -- --
Net changes in prices, production
costs and future development costs (186,144) (3,377) 129,412
Net changes due to revisions of previous
quantity estimates 267,752 79,054 (63,344)
Development cost incurred 31,712 27,642 10,287
Accretion of discount 9,892 463 10,393
Net change in income taxes (29,723) (25,113) (10,669)
--------- --------- ---------
Ending balance 204,585 167,182 128,739
========= ========= =========
F-36
CHAPARRAL RESOURCES, INC.
SUPPLEMENTAL INFORMATION
SELECTED QUARTERLY FINANCIAL DATA - UNAUDITED
2004 Quarterly Information
For the Three Months Ended Total as of
--------------------------------------------------------- ---------------
March 31, June 30, September 30, December 31, December 31,
$000 (except share amounts) 2004 2004 2004 2004 2004
--------------------------------------------------------- ---------------
Revenue (1) 15,609 17,471 22,078 23,293 78,451
Transportation and operating costs 5,363 4,755 5,089 7,157 22,364
Depreciation and depletion 4,386 4,150 4,276 5,368 18,180
--------------------------------------------------------- ---------------
Operating income 5,860 8,566 12,713 10,768 37,907
========================================================= ===============
Income before taxes and cumulative effect of
change in accounting principle 1,776 3,182 6,681 4,003 15,642
Income taxes 1,142 1,882 3,122 974 7,120
--------------------------------------------------------- ---------------
Income before extraordinary gains 634 1,300 3,559 3,029 8,522
Cumulative effect of change in accounting principle -- -- -- -- --
--------------------------------------------------------- ---------------
Net income available to common Stockholders 634 1,300 3,559 3,029 8,522
========================================================= ===============
Basic earnings per share:
Income per share before cumulative effect of
change in accounting principle $ 0.02 $ 0.03 $ 0.09 $ 0.08 $ 0.22
Cumulative effect of change in accounting
principle -- -- -- -- --
Net income per share $ 0.02 $ 0.03 $ 0.09 $ 0.08 $ 0.22
Basic weighted average number of shares outstanding 38,209,502 38,209,502 38,209,502 38,209,502 38,209,502
Diluted earnings per share:
Income per share before cumulative effect of
change in accounting principle $ 0.02 $ 0.03 $ 0.09 $ 0.08 $ 0.22
Cumulative effect of change in accounting principle -- -- -- -- --
Net income per share $ 0.02 $ 0.03 $ 0.09 $ 0.08 $ 0.22
Diluted weighted average number of shares
outstanding 38,209,502 38,209,502 38,209,502 38,754,051 38,407,283
(1) Revenue is presented gross of transportation and marketing cost in
accordance with EITF 00-10, Accounting for Shipping and Handling Fees and
Costs
F-37
CHAPARRAL RESOURCES, INC.
SUPPLEMENTAL INFORMATION
SELECTED QUARTERLY FINANCIAL DATA - UNAUDITED
2003 Quarterly Information
For the Three Months Ended Total as of
--------------------------------------------------------- ---------------
March 31, June 30, September 30, December 31, December 31,
$000 (except share amounts) 2003 2003 2003 2003 2003
--------------------------------------------------------- ---------------
Revenue (1) 7,813 8,472 23,308 18,022 57,615
Transportation and operating costs 2,785 3,048 6,288 5,268 17,389
Depreciation and depletion 2,438 3,319 7,140 5,141 18,038
--------------------------------------------------------- ---------------
Operating income 2,590 2,105 9,880 7,613 22,188
========================================================= ===============
Income/(loss) before taxes and cumulative effect
of change in accounting principle (617) (779) 4,550 2,010 5,164
Income taxes 352 330 2,479 960 4,121
--------------------------------------------------------- ---------------
Income/(loss) before extraordinary gains (969) (1,109) 2,071 1,050 1,043
Cumulative effect of change in accounting principle 1,018 - - - 1,018
--------------------------------------------------------- ---------------
Net income/(loss) available to common Stockholders 49 (1,109) 2,071 1,050 2,061
========================================================= ===============
Basic earnings per share:
Income/(loss) per share before cumulative effect of
change in accounting principle $(0.03) $ (0.03) $ 0.05 $ 0.03 $ 0.03
Cumulative effect of change in accounting $ 0.03 $ 0.00 -- -- $ 0.02
principle
Net income/(loss) per share $(0.00) $ (0.03) $ 0.05 $ 0.03 $ 0.05
Basic weighted average number of shares
outstanding 38,209,502 38,209,502 38,209,502 38,209,502 38,209,502
Diluted earnings per share:
Income/(loss) per share before cumulative effect of
change in accounting principle $(0.03) $(0.03) $ 0.05 $ 0.03 $ 0.03
Cumulative effect of change in accounting $ 0.03 $ 0.00 -- -- $ 0.02
principle
Net income/(loss) per share $(0.00) $(0.03) $ 0.05 $ 0.03 $ 0.05
Diluted weighted average number of shares
outstanding 38,209,502 38,209,635 38,408,726 38,209,502 38,209,502
(1) Revenue is presented gross of transportation and marketing cost in
accordance with EITF 00-10, Accounting for Shipping and Handling Fees and
Cost
F-38