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.
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(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
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(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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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<