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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, 2003.
Commission file number: 0-7261
CHAPARRAL RESOURCES, INC.
-------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 84-0630863
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2 Gannett Drive, Suite 418
White Plains, New York 10604
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(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (866) 559-3822
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $.0001 Per Share
----------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer.
YES |_| NO |X|
As of June 30, 2003, the aggregate market value of registrant's voting
common stock, par value $.0001 per share, held by non-affiliates was
$15,426,505.
As of March 15, 2004, 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
Our Business .............................................................................1
Available Information ....................................................................1
Crude Oil Sales ..........................................................................2
Risks of Oil and Gas Activities ..........................................................3
Risks of Foreign Operations ..............................................................4
Environmental Regulations ................................................................4
Competition ..............................................................................5
Employees ................................................................................5
Corporate Information ....................................................................5
Special Note Regarding Forward-Looking Statements ........................................5
Item 2. Properties
Properties ...............................................................................5
Net Quantities of Oil and Gas Produced ...................................................7
Drilling Activity ........................................................................8
Item 3. Legal Proceedings .........................................................................8
Item 4. Submission of Matters to Vote of Security Holders .........................................9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters .....................9
Item 6. Selected Financial Data ..................................................................11
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ....12
Item 7A Quantitative and Qualitative Disclosure about Market Risk ................................22
Item 8. Financial Statements and Supplementary Data ..............................................23
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures ....23
Item 9A. Controls and Procedures ................................................................ 23
PART III
Item 10. Directors and Executives Officers of the Registrant .....................................24
Item 11. Executive Compensation ..................................................................28
Item 12. Security Ownership of Certain Beneficial Owners and Management ..........................32
Item 13. Certain Relationships and Related Transactions ..........................................33
Item 14. Principal Accounting Fees and Services ..................................................34
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ........................35
PART I
ITEM 1. BUSINESS
Our Business
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Chaparral Resources, Inc. is an independent oil and gas exploration and
production company. Our strategy is to acquire and develop oil and gas projects
in emerging markets, specifically targeting fields with previously discovered
reserves, which have never been commercially produced or could be materially
enhanced by our management team and technical expertise.
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 were 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. On February 12, 2003, KKM commenced a new
drilling campaign to further develop and commercially produce the oil reserves
in the Karakuduk Field. By the end of 2003 the well stock had risen to 45
producing wells, 4 water injection wells and 3 water supply wells (one of which
was under completion at year end). The drilling campaign is to be continued
throughout 2004 when it is anticipated that a further 12 production wells, 4
water injection wells and 3 water supply wells will be drilled.
The other stockholder of KKM is KazMunayGaz JSC, the state owned national
petroleum and transportation company of the Republic of Kazakhstan, which owns a
40% interest.
Currently, the Karakuduk Field is our only oil field. We are continuing to
identify and evaluate other oil fields for possible acquisition and development.
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 to January 1, 2002. Chaparral previously accounted for
its 50% investment in KKM using the equity method of accounting, which is
reflected in Chaparral's financial statements for periods prior to 2002. The
consolidated financial statements for Chaparral for the three years ending
December 31, 2003 and separate financial statements for KKM for the two years
ended December 31, 2001 are included as part of this Annual Report on Form 10-K.
Available Information
- ---------------------
Chaparral files Annual Reports on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K, and registration statements and other items
with the Securities and Exchange Commission (SEC). Chaparral provides access
free of charge to all of these SEC filings, as soon as reasonably practicable
after filing, on its Internet site located at www.chaparralresources.com.
Chaparral will also make available to any stockholder, for a nominal fee, copies
of its Annual Report on Form 10-K as filed with the SEC. For copies of this, or
any other filing, please contact: Chaparral Resources, Inc., 2 Gannett Drive,
Suite 418, White Plains, New York 10604 or call (866) 559-3822.
1
In addition, the public may read and copy any materials Chaparral files
with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW,
Washington, DC 20549. The public may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an
Internet site (www.sec.gov) that contains reports, proxy and information
statements and other information regarding issuers, like Chaparral, that file
electronically with the SEC.
Crude Oil Sales
- ---------------
We derive all of our revenue through the production and sale of crude oil
from the Karakuduk Field. We remain in the early stages of development of the
Karakuduk Field and only began generating revenue from the sale of crude oil
during 2000. KKM recognized $57.61 million in revenue in 2003 from the sale of
approximately 2.69 million barrels of crude oil, net of royalty. In 2002, KKM
recorded $45.13 million in revenue based upon sales of approximately 2.47
million barrels of crude oil, net of royalty.
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 2003. 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. The off-taker is responsible for nominating and coordinating
oil tankers, if necessary, and arranging for the resale/marketing of the crude
oil purchased.
In 2003, KKM sold crude oil to the following major customers: Vitol Central
Asia S.A., Naftex Oil and Shipping Corporation ("Naftex"), and Euro-Asian Oil
Company Inc ("Euro-Asian"), accounting for 61%, 13% and 12% of total annual
deliveries, respectively.
The majority of our sales prices at the export port locations are based
upon quoted Urals crude oil prices from the Platt's Crude Oil Marketwire average
for the three banking days following the bill of lading. The price is net of
deductions that include freight charges published in both Platt's Dirty Tanker
Wire and the Worldscale Tanker Nominal Freight Scale. As of January 1, 2003,
additional deductions of approximately $1 per barrel have been implemented due
to increased regulatory pressure on owners/charter companies to improve safety
requirements. Recently, we have also witnessed a rise in both deductions and
demurrage costs, which is largely attributable to shipping delays at the
entrance to the Black Sea. Under contract terms, payment is made by the offtaker
within 30 days of receipt of the final bill of lading and KKM's invoice for the
sale, unless otherwise agreed by both parties. There are six delivery points for
export sales, including three preferred port facilities (Novorossiisk, Odessa,
and Ventspills) and three onshore pipeline facilities (Budkovce, Feyeshlitke,
and Adamovo). KKM must use its best efforts to deliver crude oil to one of the
three preferred port locations. To date, the majority of KKM's export oil sales
have been delivered to the Ukrainian port of Odessa. KKM has a contractual right
to deliver undersized cargoes to the port facilities, subject to additional
freight charges if a tanker is loaded below its tonnage capacity. Third-party
sellers, however, may offset capacity shortages in the tanker.
Under the terms of the Agreement with the Government of the republic of
Kazakhstan, 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 approximately $10 to $12 lower cash
flow per barrel. 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. On July 17, 2003, we took the first
step towards the commencement of arbitration proceedings in Switzerland for the
breach of the Agreement by the Government of Kazakhstan by initiating a required
three-month period of consultation with the Government. Although the
consultation period has expired, we continue to seek an amicable resolution with
the Government on this matter rather than proceeding with arbitration. If the
matter can not 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. See Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations.
2
Risks of Oil and Gas Activities
- -------------------------------
The current market for oil is characterized by instability. This
instability has caused fluctuations in world oil prices in recent years and
there is no assurance of any price stability in the future. The production and
sale of oil from the Karakuduk Field may not be commercially feasible under
market conditions prevailing in the future. The price we receive for our oil may
not be sufficient to generate revenues in excess of our costs of production or
provide sufficient cash flow to meet our investment and working capital
requirements.
We make no assurance that we will be able to sell oil that we produce nor
the price at which such sales will be made. Our estimated future net revenue
from oil sales is highly 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, or 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.
It is likely that oil prices will continue to fluctuate as they have in the
past. Current oil prices are not 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").
3
The 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 February 24, 2004, we have not experienced any
material losses due to these events.
Risks of Foreign Operations
- ---------------------------
Our ability to develop the Karakuduk Field is dependent on fundamental
contracts with governmental agencies in Kazakhstan, including 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") 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.
Environmental Regulations
- -------------------------
We must comply with laws of the Republic of Kazakhstan and international
requirements that regulate the discharge of materials into the environment.
Furthermore, KKM's 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 potential 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. We have not made
any material capital expenditures for environmental control facilities to date,
but we are currently performing a feasibility study, the results of which may
require capital expenditures to ensure environmental compliance for the
utilization of associated gas.
4
Competition
- -----------
We compete in all areas of the exploration and production segment of the
oil and gas industry with a number of other companies. These companies include
large multinational oil and gas companies and other independent operators, many
of which possess greater financial resources and more experience than Chaparral.
We do not hold a significant competitive position in the oil industry given that
we compete both with major oil and gas companies and with independent producers
for, among other things, rights to develop oil and gas properties, access to
limited pipeline capacity, procurement of available materials and resources, and
hiring qualified local and international personnel.
Employees
- ---------
As of February 24, 2004, Chaparral had 4 full-time employees. KKM had 209
employees and retains independent consultants on an as needed basis. We believe
that our relationship with our employees and consultants is good.
Corporate Information
- ---------------------
Chaparral was incorporated under the laws of the State of Colorado in 1972.
In 1999, Chaparral reincorporated under the laws of the State of Delaware.
Our address is 2 Gannett Drive, Suite 418, White Plains, New York 10604,
and our telephone number is (866) 559-3822.
Special Note Regarding Forward-Looking Statements
- -------------------------------------------------
Some of the statements in this Annual Report on Form 10-K constitute
"forward-looking statements." Forward-looking statements relate to future events
or our future financial performance. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "estimates," "believes," "predicts," "potential," "likely,"
or "continue," or by the negative of such terms or comparable terminology.
Forward-looking statements are predictions based on current expectations that
involve a number of risks and uncertainties. Actual events may differ
materially. In evaluating forward-looking statements, you should consider
various factors, including the risks discussed above in "Risks of Oil and Gas
Activities" and "Risks of Foreign Operations." These factors may cause our
actual results to differ materially from any forward-looking statement.
Although we believe that these statements are reasonable, we cannot
guarantee future results, levels of activity, performance or achievements, and
you are encouraged to exercise caution in considering such forward-looking
statements. Unless otherwise required by law, we are not under any duty to
update any of the forward-looking statements after the date of this Annual
Report on Form 10-K to conform these statements to actual results.
ITEM 2. PROPERTIES
Properties
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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 an agreement with Kazakhstan's Ministry of Energy and Natural
Resources to develop the Karakuduk Field.
The Karakuduk Field is geographically 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.
5
The Karakuduk Field structure is an asymmetrical anticline located on the
Aristan Uplift in the North Ustyurt 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 February 24, 2004, KKM had 47 productive wells in the Karakuduk
Field, including 34 new wells and 13 re-completions of previously existing
delineation wells. The 47 wells include 40 wells currently producing over 8,500
barrels of oil per day collectively and 7 which are shut-in for various reasons
that include completion, installation of additional gathering lines, equipment
and additional workover operations, water injection and stimulation activities
to bring wells on to primary production. KKM implemented an aggressive drilling
program during 2000, drilling a total of 12 development wells and re-completing
4 delineation wells using a combination of two drilling rigs and a workover rig.
KKM drilled an additional exploratory 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 13 wells (12 producers and one injector),
completing all of these wells prior to the year-end. Two water supply wells were
also drilled and 2 redundant producing wells were converted to injectors as part
of KKM's reservoir pressure maintenance program. The drilling program has
continued into 2004 and it is anticipated that a further 12 producers, 4
injectors and 3 water source wells will be drilled during the year. Oil has been
recovered from the originally identified J-1, J-2, J-4, J-6a, J-8, and J-9
formations, along with new discoveries in the J-6b, J-7 and J-10 horizons.
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 capable of transporting up to 18,000 barrels of oil per day to
the export pipeline terminal. To maximize efficiency of line and guarantee
throughput, KKM continues improvements at the facilities on mid pipeline, where
there are situated tanks, pumps, booster pumps and mid line heaters. The
pipeline runs from the central processing unit to the pump station, which lies
adjacent to the main export pipeline. While this has reduced the requirement for
trucking oil to the pump station, KKM does, however, continue to haul oil to the
central processing unit from remote wells and those awaiting flowline
installation.
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.
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 July in 2003, which is capable of
handling the throughput of up to 24 wells.
6
KKM currently has 2 drilling rigs and 2 workover rigs operating in the
Karakuduk Field. While the main rig continues the drilling of development wells,
the second rig is used for the drilling of water supply wells. The workover rigs
are expected to continue operations, performing standard well maintenance,
completions of new wells, re-completions of existing wells, and down-hole pump
installations. As of February 24, 2004 we estimate that up to 63 additional new
wells will be required to fully develop the Karakuduk Field together with a
further 6 water supply wells. We estimate that some 32 producing wells will
eventually be converted into water injection wells. The planned development
program includes a pressure maintenance operation involving water injection that
management believes will substantially enhance ultimate recovery.
The artificial lift program, while encompassing water injection, also
includes the ongoing installation of pumps at well sites. In 2003, 10 electrical
submersible pumps, 10 sucker rod ("nodding donkey") pumps and 1 screw pump were
installed in the Karakuduk field.
As part of the artificial lift program to improve well productivity, KKM
also performed hydraulic fracturing on 11 wells. As of year end 2003, 9 of these
wells were completed with 2 in the process of completion. Hydraulic fracturing
has proven reasonably successful. KKM has achieved marked increases in post frac
production rates on 5 wells and has witnessed production increases on a further
3 wells. Of the remaining 3 wells, 2 are awaiting completion while 1 requires
remedial work.
During 2002, Chaparral completed a simulation study, which we have used to
optimize the location of wells (both producers and injectors) and further define
the possible total productive capacity of the Karakuduk Field. We have a
contract in place with Ryder Scott Company ("Ryder Scott"), a petroleum
engineering firm, for the monitoring and analysis of reservoir performance on a
monthly basis.
Reserves
--------
As of December 31, 2003, the Karakuduk Field has total estimated proved
reserves of approximately 25.62 million barrels (compared with 21.86 million
barrels for prior year), net of government royalty, of which we have a
proportional interest in approximately 15.37 million barrels, based upon our 60%
interest in KKM. The reserve disclosure is based on a reserve study of the
Karakuduk Field conducted by Ryder Scott, including data available subsequent to
December 31, 2003.
No reserve estimates have been filed with any Federal authority or other
agency since January 1, 2003.
Net Quantities of Oil and Gas Produced
--------------------------------------
The following table summarized sales volumes, sales prices and production
cost information for our oil and gas production for each of the three years
ended December 31, 2003:
As of the Year Ended December 31,
------------------------------------
2001 2002 2003
---------- ---------- ----------
Net sales volumes
Oil (bbls) 1,092,000 2,467,000 2,694,000
Gas (mcf) -- -- --
Average sales price
Oil (per bbl) $ 16.75 $ 18.29 $ 21.39
Gas (per mcf) $ -- $ -- $ --
Average production cost (per bbl) $ 2.40 $ 3.11 $ 2.20
The average sales revenue, net of transportation costs, was approximately
$17.13 and $14.47 per barrel for the years ended December 31, 2003 and 2002,
respectively. For the same periods, the average transportation costs per barrel
were approximately $4.26 and $3.82, respectively.
7
Net sales volume for the year 2001 represents our 50% equity interest in
KKM's production, but does not reflect our right under the agreement with the
government of the Republic of Kazakhstan 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 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, 2003, we had interests in 45 gross productive oil wells,
and no producing gas wells. There were no multiple completion wells. Production
was from 16,900 gross acres, of which 5,000 acres are productive developed.
Undeveloped Acreage
-------------------
As of December 31, 2003, 5,000 acres in the Karakuduk Field are productive
undeveloped.
Drilling Activity
-----------------
During the three years ended December 31, 2003, 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
------------ ---------- --- ---------- ---
2001 .5 -- 8.0 --
2002 -- -- -- --
2003 -- -- 7.8 --
All wells are located in the Republic of Kazakhstan.
Present Activities
------------------
As of February 24, 2004, KKM has successfully completed an additional two
development wells (No. 195 and 190) and another development well (No. 143) is
expected to be completed in March 2004. Well No. 143 was spudded on February 19,
2004 and is expected to be drilled to a depth of approximately 10,700 feet
(3,250 meters). The Karakuduk Field is currently producing approximately 8,500
barrels of oil per day from 40 flowing wells. KKM has also successfully
completed 2 water supply wells and is currently drilling a third water supply
well. See Item 7 - Management's Discussion and Financial Condition and Results
of Operations for additional information on Chaparral's ongoing activities.
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 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 is currently
considering penalties with respect to the Tax Claim in the amount of $970,000.
Due to the success of the appeal on the Tax Claim, we expect that the liability
with regards to penalties will be reduced to approximately $55,000. The date for
the court hearing in respect of this claim is anticipated to be decided in March
2004, with the actual hearing to be conducted at a subsequent date. It is our
opinion that the ultimate resolution of this claim will not have a material
adverse effect on the financial position and operating results of Chaparral.
8
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 16, 2003, Chaparral held its Annual Meeting of Stockholders. Our
stockholders elected the following six persons as directors, each to serve until
the next Annual Meeting of Stockholders or until his successor is elected or
appointed: Askar Alshinbayev, Ian Connor, Nikolai D. Klinchev, Alan D. Berlin,
Peter G. Dilling, and John Duthie. 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, 2003.
The number of shares voted and withheld with respect to each director was
as follows:
Election of Directors For Withheld
--------------------- --- --------
Askar Alshinbayev - 36,406,860 16,993
Ian Connor - 36,407,878 15.975
Nikolai D. Klinchev - 36,406,862 16,991
Alan D. Berlin - 36,407,796 16,057
Peter G. Dilling - 36,403,402 20,811
John Duthie - 36,408,842 15,811
The number of shares voted with respect to the approval of Ernst & Young as
Chaparral's independent auditors was as follows:
For Against Abstained
--- ------- ---------
36,416,928 1,278 5,647
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 15, 2004, we have 1,373 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, 2003 and 2002, as
reported by the National Association of Securities Dealers, Inc.:
Price Range
-----------
Fiscal Quarter Ended High Low
-------------------- ---- ---
March 31, 2002 1.75 1.30
June 30, 2002 3.05 1.40
September 30, 2002 2.20 1.25
December 31, 2002 1.50 0.82
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
9
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 nonstatutory 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, 2003.
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, 2003.
We did not sell any securities since October 1, 2001, which were not
registered under the Securities Act of 1933, as amended.
10
ITEM 6. SELECTED FINANCIAL DATA
As of or for the Year Ended
December 31,
(In Thousands of U.S. Dollars)
--------------------------------------------------------------
2003(1) 2002(1) 2001 2000 1999
--------------------------------------------------------------
Oil and gas sales ................. $ 57,615 45,133 -- -- --
Total revenues .................... $ 57,615 45,133 -- -- --
Equity in income (loss) from
investment ..................... $ -- -- 4,616 2,827 (1,849)
Net income/(loss) ................. $ 2,061 4,117 (16,215) (26,803) (5,163)
Net income (loss) per
common share ................... $ 0.05 0.14 (1.16) (6.01) (5.63)
Working capital (deficit) ......... $ (12,487) (2,366) (39,357) (601) (2,941)
Total assets ...................... $ 98,668 87,308 69,037 70,156 41,303
Long-term obligations and
Redeemable preferred stock ..... $ 30,470 29,542 3,900 26,528 14,776
Stockholders' equity .............. $ 46,170 44,109 25,361 41,926 22,851
Other Data
----------
Present value of proved reserves(2) $ 167,182 128,739 40,344 70,281 61,312
Minority interest present value
of proved reserves ............. $ 66,873 51,496 -- -- --
Proved oil reserves (bbls) ........ 25,616 21,855 14,961 16,523 10,071
Minority interest of proved
oil reserves (bbls) ............ 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
2003 and 2002 are presented at 100%. Discount rate applied was 10%.
11
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 it 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, 2003. In addition, we have experienced limitations
in obtaining 100% export quota for the sale of our hydrocarbons. These
conditions create uncertainties relating to our ability to meet all expenditure
and cash flow requirements through the next twelve months.
These conditions raise substantial doubt about our ability to continue as a
going concern. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
assets or the amounts and classification of liabilities that may result from the
outcome of these uncertainties.
Chaparral has been successful in 2003 in increasing its export sales and
reducing its local market deliveries. As of December 31, 2003, Chaparral has
sold approximately 2,694,000 barrels of its current year production, of which
approximately 2,591,000 barrels, or 96%, have been sold at world market prices
and 103,000 barrels, or 4%, have been sold at domestic market prices. This
represents a significant increase in sales at world market prices and
corresponding decrease in local market price sales from the year 2002.
In addition, we are continuing with our efforts to obtain additional
financing to cover any short-term working capital deficiencies and to refinance
our loan with Kazkommertsbank on more favorable terms. If we are successful in
these efforts, we plan to use the resulting capital infusion to restructure the
loan with Kazkommertsbank and eliminate or significantly reduce our current
working capital deficiencies.
Liquidity and Capital Resources
- -------------------------------
We are presently engaged in the development of the Karakuduk Field, which
requires substantial cash expenditures for drilling costs, well completions,
workovers, oil storage and processing facilities, pipelines, gathering systems,
water injection facilities, plant and equipment (pumps, transformer sub-stations
etc.) and other field facilities. We have invested approximately $121.3 million
in the development of the Karakuduk Field and have drilled or re-completed 45
productive wells by the end of 2003, including 12 wells in the year 2003. Total
capital expenditures for 2003 were approximately $27.7 million compared to total
capital expenditures of $11.5 million incurred in 2002. Capital expenditures are
estimated to be at least $80 million from 2004 through 2008, including the
drilling of approximately 65 more wells over this period. We anticipate 2004
capital expenditures of approximately $28.4 million.
We expect to finance the continued development of the Karakuduk Field
primarily through cash flows from the sale of crude oil. During 2003, KKM sold
approximately 2.69 million barrels of crude oil for $57.61 million. In addition,
from May 2003 KKM has requested and received prepayment for approximately 90% of
the majority of crude sales in order to accelerate these cash flows, at a cost
in prepayment interest of $187,000. As of February 24, 2004, the daily oil
production is approximately 8,500 barrels per day from 40 of the 47 productive
wells in the field. The remaining 7 wells are shut-in for various reasons
including, completion, installation of additional gathering lines/ equipment and
additional workover, water injection and stimulation operations to bring wells
on production.
12
In 2004, KKM plans to increase its daily production by commissioning the
water injection facilities, installing further pumps, and drilling 16 additional
wells. Accordingly, management expects the Karakuduk Field production to
increase from approximately 8,500 to approximately 13,000 barrels of oil per day
by year-end 2004.
KKM successfully initiated a "pilot" reservoir pressure maintenance program
during 2003 by the injection of water into one well. KKM witnessed a favorable
increase in the reservoir pressure on surrounding well production performance.
In December 2003, KKM production peaked at over 12,000 barrels of oil per
day and daily production averaged over 11,000 barrels of oil per day for the
month. For the full implementation of the reservoir pressure maintenance program
and to ensure that gasification of the reservoir and reservoir pressure decline
is not accelerated due to delays in the implementation of this program, KKM has
taken a number of preventative measures in this regard so that ultimate
reservoir recovery will not be negatively affected. KKM has reduced choke sizes
and shut in a number of wells for pressure monitoring and analysis purposes.
Until the reservoir pressure maintenance program has been fully implemented, KKM
cannot fully maximize well productivity. As a result, oil production decreased
from 11,000 barrels per day average during December 2003 to our current level of
8,500 barrels per day.
While we expect the reservoir pressure maintenance program to be
commissioned by the end of March 2004, we do not anticipate a tangible benefit
in terms of increased production levels until the third quarter of 2004.
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
crude oil production on the international market. Under the terms of the
Agreement, we have a right to export, and receive export quota for, 100% of the
production from the Karakuduk Field. The domestic market does not permit world
market prices to be obtained, resulting in approximately $10 to $12 lower cash
flow per barrel. Furthermore, the Government has not allocated sufficient export
quota to allow us to sell all of our available crude oil production on the world
market. We are taking steps to reduce our local market obligations and to obtain
an export quota that will enable us to sell all of our crude oil production. On
July 17, 2003, we took the first step towards the commencement of arbitration
proceedings in Switzerland for the breach of the Agreement by the Government of
Kazakhstan by initiating a required three-month period of consultation with the
Government. Although the consultation period has expired, we continue to seek an
amicable resolution with the Government on this matter rather than proceeding
with arbitration. If the matter can not 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 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 its production and that we will be able to obtain additional
financing and 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, 2003.
Obligations by Period (In Thousands)
-------------------------------------------------
Later
1 Year 2-3 Years 4-5 Years Years Total
Debt $12,000 $18,000 $ 4,000 $-- $34,000
Interest on debt $ 4,314 $ 3,774 $ 212 $-- $ 8,300
Drilling contract $ 5,520 $ -- $ -- $-- $ 5,520
Operating leases $ 29 $ -- $ -- $-- $ 29
13
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 bearing interest at 12% per annum of
which $2 million was repaid during 2002. Additionally, Kazkommertsbank provided
KKM with a credit facility totaling $33 million bearing interest at 14% per
annum. As of December 31, 2003 the outstanding principal balance on the KKM
Credit Facility was $32 million. The terms and conditions of the CAIH Note and
the KKM Credit facility are more fully described in Note 11 of our consolidated
financial statements for the year ended December 31, 2003.
The financing costs of the KKM Credit Facility and the CAIH 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 $42.3 million of our future
available net cash flows from the Karakuduk Field will be utilized to service
the loan, 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.
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
pledge as collateral under the KKM Credit Facility. We are currently in
compliance with all the terms of the KKM Credit Facility. We had made all
principal and interest payment due under the KKM Credit Facility and CAIH Note
as of December 31, 2003. A payment of principal of $1 million and interest of
$983,000 was due on the KKM Credit Facility on February 6, 2004. KKM paid the
$983,000 interest on February 6, 2004, and KKM and Kazkommertsbank have agreed
to defer the repayment of $1 million in principal until March 31, 2004.
As of December 31, 2003, Chaparral has a drilling contract with
KazMunayGas-Drilling, an affiliate of KMG, for one development drilling rig
currently operating in the Karakuduk Field. The rig is contracted through
December 31, 2004. Our other drilling and operations related contracts are
either cancelable within 30 days or are on a call-off (as required) basis.
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, 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 and are
dependent upon the point of sale of KKM's exports. During 2003, KKM paid $12
million to KTO of which $11.29 million were recognized as transportation costs
for sales during 2003. At December 31, 2003, KKM had a prepayment balance of
$1.30 million with KTO in respect of sales to be made in January 2004.
Comparably during 2002, KKM paid $8.93 million to KTO of which $9.30 million
were recognized as transportation costs for sales during 2002. At December 31,
2002, KKM had a prepayment balance of $584,000 with KTO in respect of sales to
be made in January 2003.
KTO charges KKM for associated costs of oil storage within their pipeline
system, sales commission, and customs clearance fees in respect to export sales.
KTO also provides KKM with water through the Volga Water pipeline. Amounts
recognized for these services during 2003 and 2002 were $267,000 and $169,000 of
which $97,000 and 37,000 remained outstanding as of the end of the respective
period.
14
As mentioned above, KKM has a drilling contract with KazMunayGas-Drilling,
an affiliate of KMG, for one development drilling rig currently operating in the
Karakuduk Field. The rig is contracted through December 31, 2004.
All other related party transactions are disclosed in the notes to our
consolidated financial statements for December 31, 2003. The loans with
Kazkommertsbank and CAIH are disclosed in Note 11 and the drilling contract with
KMGD is described in Note 17 and 18, the lease with Nasikhat is described in
Note 14, prepaid transportation to KTO in Note 4 and Insurance policy with
Kazkommerts Policy in Note 18.
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 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 is currently
considering penalties with respect to the Tax Claim in the amount of $970,000.
Due to the success of the appeal on the Tax Claim, we expect that the liability
with regards to penalties will be reduced to approximately $55,000. The date for
the court hearing in respect of this claim is anticipated to be decided in March
2004, with the actual hearing to be conducted at a subsequent date. It is our
opinion that the ultimate resolution of this claim will not have a material
adverse effect on the financial position and operating results of Chaparral.
Capital Commitments and Other Contingencies
- -------------------------------------------
Our operations may be subject to other regulations by the government of the
Republic of Kazakhstan or other regulatory bodies responsible for the area in
which the Karakuduk Field is located. In addition to taxation, customs
declarations and environmental controls, regulations may govern such things as
drilling permits and production rates. Drilling permits could become difficult
to obtain or prohibitively expensive. Production rates could be set so low that
they would make production unprofitable. These regulations may substantially
increase the costs of doing business and may prevent or delay the starting or
continuation of any given exploration or development project.
All regulations are subject to future changes by legislative and
administrative action and by judicial decisions. Such changes could adversely
affect the petroleum industry in general, and us in particular. It is impossible
to predict the effect that any current or future proposals or changes in
existing laws or regulations 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.
Inflation
- ---------
We cannot control prices received from our oil sales and to the extent we
are unable to pass on increases in operating costs, we may be affected by
inflation. The devaluation of the Tenge, the currency of the Republic of
Kazakhstan, can significantly decrease the value of the monetary assets that we
hold in Kazakhstan as well as our assets in that country that are based on the
Tenge. KKM retains the majority of 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
15
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
2003, however, the Tenge has appreciated against the U.S. Dollar by 7.31%. There
remains no guarantee that this appreciation is either sustainable or permanent
in the foreseeable future. As of December 31, 2003, the exchange rate was 144.22
Tenge per U.S. Dollar compared to 155.60 as of December 31, 2002. It should be
noted that 96% of our crude oil sales in 2003 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, alternatives can exist among
various accounting methods. In such cases, the choice of accounting method can
also have a significant impact on reported amounts.
Our determination of proved oil and gas reserve quantities, the application
of the full cost method of accounting for KKM's exploration and production
activities, and the application of standards of accounting for derivative
instruments and hedging activities require management to make numerous estimates
and judgments.
Oil and Gas properties (Full Cost Method). 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 SFAS No. 143 in 2003, the carrying amount of oil and gas
properties also includes 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 on the
unit-of-production method using estimated proved reserves. Investments in
unproved properties and major development projects are not amortized until
proved reserves associated with the projects can be determined or until
impairment occurs. If the results of an assessment indicate that the properties
are impaired, the amount of the impairment is added to the capitalized cost to
be amortized.
Sales of proved and unproved properties are accounted for as adjustments of
capitalized costs with no gain or loss recognized, unless such adjustments would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in income.
Abandonments of properties are accounted for as adjustments of capitalized costs
with no loss recognized.
Cost Excluded. Oil and gas properties include costs that are excluded from
capitalized costs being amortized. These amounts represent costs of investments
in unproved properties and major development projects. 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 relinquishing drilling rights.
Capitalized Interest. Statement of Financial Accounting Standards ("SFAS")
34, Capitalization of Interest Costs, provides standards for the capitalization
of interest costs as part of the historical cost of acquiring assets.
FASB-Interpretation ("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.
16
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
Ryder Scott Company in accordance with guidelines established by the SEC. Those
guidelines require that reserve estimates be prepared under existing economic
and operating conditions with no provisions for increases in commodity prices,
except by contractual arrangement. Estimation of oil and gas reserve quantities
is inherently difficult and is subject to numerous uncertainties. Such
uncertainties include the projection of future rates of production, export
allocation, and the timing of development expenditures. The accuracy of the
estimates depends on the quality of available geological and geophysical data
and requires interpretation and judgment. Estimates may be revised either upward
or downward by results of future drilling, testing or production. In addition,
estimates of volumes considered to be commercially recoverable fluctuate with
changes in commodity prices and operating costs. Our estimates of reserves are
expected to change as additional information becomes available. A material
change in the estimated volumes of reserves could have an impact on the DD&A
rate calculation and the financial statements.
Derivative Financial Instruments and Hedging Activities. We account for our
investment in derivative financial instruments in accordance with SFAS 133,
Accounting for Derivative Financial Instruments and Hedging Activities, as
amended. As a result, we recognize all derivative financial instruments in our
financial statements at fair value, regardless of the purpose or intent for
holding the instrument. Changes in the fair value of derivative financial
instruments are recognized periodically in income or in shareholders' equity as
a component of comprehensive income depending on whether the derivative
financial instrument qualifies for hedge accounting, and if so, whether it
qualifies as a fair value hedge or cash flow hedge. Generally, changes in fair
values of derivatives accounted for as fair value hedges are recorded in income
along with the portions of the changes in the fair values of the hedged items
that relate to the hedged risks. Changes in fair values of derivatives accounted
for as cash flow hedges, to the extent they are effective as hedges, are
recorded in other comprehensive income net of deferred taxes. Changes in fair
values of derivatives not qualifying as hedges are reported in income.
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 FASB 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 10
to our consolidated financial statements for the year ended December 31, 2003
for results on 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.
17
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 December 2003, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 104 Revenue Recognition ("SAB 104"), which codifies,
revises and rescinds certain sections of SAB No. 101, Revenue Recognition, in
order to make this interpretive guidance consistent with current authoritative
accounting and auditing guidance and SEC rules and regulations. The changes
noted in SAB 104 did not have a material effect on our consolidated results of
operations, consolidated financial position or consolidated cash flows.
In April 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS No. 149 amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts and hedging activities under SFAS No. 133. The amendments set forth in
SFAS No. 149 require that contracts with comparable characteristics be accounted
for similarly. SFAS No. 149 is generally effective for contracts entered into or
modified after June 30, 2003 (with a few exceptions) and for hedging
relationships designated after June 30, 2003. The guidance is to be applied
prospectively only. The adoption of SFAS No. 149 as of July 1, 2003 has had no
effect on our consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This statement
establishes standards for how an issuer classifies and measures on its balance
sheet certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances) because that
financial instrument embodies an obligation of the issuer. SFAS No. 150 was
effective for financial instruments entered into or modified after May 31, 2003,
and was otherwise effective for 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
when and which business enterprise (the "primary beneficiary") should
consolidate the variable interest entity. 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.
18
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. Chaparral is currently evaluating the impact
of adopting FIN 46-R applicable to Non-SPEs created prior to February 1, 2003
but does not expect a material 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 10
to our consolidated financial statements for the year ended December 31, 2003
for results of the adoption of SFAS 143.
The EITF currently is deliberating on EITF No. 04-2 "Whether Mineral Rights
Are Tangible or Intangible Assets" and EITF No. 03-S "Application of FASB
Statement No. 142, Goodwill and Other Intangible Assets, to Oil and Gas
Companies." These proposed statements will determine whether contract-based oil
and gas mineral rights are classified as tangible or intangible assets based on
the EITF's interpretation of SFAS No. 141 and SFAS No.142. Historically,
Chaparral has classified all of its contract-based mineral rights within
property, plant, and equipment and has generally not identified these amounts
separately. If the EITF determines that these minerals rights should be
presented as intangible assets, Chaparral would have to reclassify its
contract-based oil and gas minerals rights acquired after June 30, 2001 to
intangible assets and make additional disclosures in accordance with SFAS No.
142. Chaparral has not acquired any contract-based mineral rights after June 30,
2001. Therefore, the adoption of this change will not have a material effect on
Chaparral's results from operations.
2. Results of Operations
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 (iii) higher revenues
recognized during 2003, (iv) the recognition of a $1.02 million gain as a result
of the adoption of SFAS 143 on January 1, 2003 and (v) lower interest costs for
2003.
19
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 $9.48 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.
General and Administrative Expense. General and administrative costs for
the year ended December 31, 2003, increased by $950,000 from $6.81 million for
the year 2002 to $7.76 million for the year 2003. The $950,000 increase is
largely due to higher salaries accrued during 2003 and consultant payments,
comprising of $673,000 accrued 2003 year end bonus and a $278,000 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 increase at the KKM level by $304,000 due to
increase 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 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. See Note 10 of our consolidated
financial statements.
20
Results of Operations Year Ended December 31, 2002 Compared to Year Ended
December 31, 2001
- -------------------------------------------------------------------------
In May 2002, Chaparral increased its ownership in KKM from 50% to 60%
through the acquisition of 100% of the outstanding stock of MTI. As a result of
the acquisition, Chaparral obtained a controlling interest in KKM. Consequently,
its financial statements have been consolidated with KKM on a retroactive basis
to January 1, 2002. We previously accounted for our 50% investment in KKM using
the equity method of accounting, which is reflected in our financial results for
periods prior to 2002.
Our operations for the year ended December 31, 2002 resulted in net income
of $4.12 million compared to a net loss of $16.22 million for the year ended
December 31, 2001. The $20.34 million increase in our net income relates to the
recognition of a $5.34 million extraordinary gain resulting from the May 2002
restructuring of our loan with Shell Capital, decreased interest charges
resulting from the refinancing of its debt obligations, and improved operational
results from the Karakuduk Field.
Interest expense decreased from $14.45 million for the year ended December
31, 2001 to $5.61 million for the year ended December 31, 2002, due to the lower
financing costs and the restructuring of our indebtedness. Chaparral's cost of
financing the development of the Karakuduk Field has improved from a
pre-restructuring annual interest rate of LIBOR plus 19.75% compounded daily, to
a simple fixed annual interest rate of 14%, generating a saving of approximately
$3 million per year. Interest expense for the year ended December 31, 2001
reflects an additional loan discount of $4.37 million recorded and fully
amortized as of September 30, 2001 due to the transfer of a 40% interest in the
distributable profits of CAP-G to Shell Capital for our failure to repay a $3.15
million bridge loan to Shell Capital on or before September 30, 2001. See Notes
10 and 11 to our consolidated financial statements for the year ended December
31, 2002.
As a result of the adoption of SFAS 133, we recognized a loss of $2.52
million as a cumulative effect of change in accounting principle and an
additional loss of $237,000 for the year ended December 31, 2001 to record the
hedges at their fair value as of the end of the period. Comparatively, Chaparral
recognized a loss of $762,000 to record the hedges at their fair value during
the year ended December 31, 2002. As of December 31, 2002, the hedge agreement
expired. See Note 7 to our consolidated financial statements for the year ended
December 31, 2002.
For the year ended December 31, 2002, Chaparral's financial results have
been consolidated with the financial results of its operating subsidiary, KKM.
During 2002, we sold approximately 2.47 million barrels of crude oil,
recognizing $45.13 million, or $18.29 per barrel, in revenue. Transportation
costs were $9.43 million, or $3.82 per barrel and operating costs associated
with sales were $7.68 million, or $3.11 per barrel. Comparatively, Chaparral
recognized $4.62 million in equity income from investment for the year ended
December 31, 2001, which represents our 50% share of KKM's results during the
period. During the year ended December 31, 2001, KKM sold approximately 2.18
million barrels of crude oil, recognizing $36.58 million in revenue, or $16.75
per barrel. Associated operating costs were $5.25 million, or $2.40 per barrel,
and associated transportation costs were $8.30 million, or $3.80 per barrel. The
increase in operating costs per barrel relates to increased utilization of a
workover rig in the Karakuduk Field to maintain production rates. During the
year ended December 31, 2001, our equity income from investment also reflects
the elimination of $1.45 million of inter-company interest income on our loan to
KKM. See Notes 5 and 19 to our consolidated financial statements for the year
ended December 31, 2002.
General and administrative costs increased from $4.33 million as of
December 31, 2001, to $6.81 million as of December 31, 2002. The $2.52 million
change was principally due to the consolidation of KKM financial results during
2002 as a result of the MTI acquisition. Comparably, general and administrative
expenses reported by Chaparral and KKM during the year ended December 31, 2001
were $4.33 million and $3.75 million, respectively. The $2.21 million decrease
was mainly due to lower insurance and lower professional services expenses.
During 2002, Chaparral canceled its Overseas Private Investment Corporation
("OPIC") political risk insurance as part of the restructuring of Chaparral
creating a savings of $650,000. In addition, expenses for professional services
decreased by $1.52 million from 2001 to 2002.
21
Depreciation and depletion expense increased $12.05 million from $753,000
in 2001 to $12.80 million in 2002, due to the consolidation of KKM's financial
results during 2002. Comparably, depreciation and depletion expense reported by
Chaparral and KKM during the year ended December 31, 2001 were $753,000 and
$9.48 million, respectively. Effectively, depreciation and depletion expense
increased by $2.57 million due to additional depletion of our investment in oil
and gas assets resulting from increased production from the Karakuduk Field and
an increase in the effective depletion rate from $3.97 per barrel during 2001 to
$4.59 per barrel during 2002. The increase in the effective depletion rate was
due to higher estimated development costs to produce proved reserve estimates.
Income taxes increased by $2.69 million from $0 in 2001 to $2.69 million in
2002, due to the consolidation of KKM financial results during 2002. All income
taxes payable relate to our operations in Kazakhstan. Chaparral has no U.S.
income taxes due to Chaparral's estimated domestic tax loss carryforwards of
$26.37 million as of December 31, 2002. These carryforwards will expire at
various times between 2003 and 2020. See Note 14 to our consolidated financial
statements for the year ended December 31, 2002.
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 (144.22 and 155.60 Kazakh Tenge per U.S. Dollar as
of December 31, 2003 and 2002, respectively). Non-monetary assets and
liabilities denominated in currencies other than U.S. Dollars have been
translated at the estimated historical exchange rate prevailing on the date of
the transaction. Exchange gains and losses arising from translation of non-U.S.
Dollar amounts at the balance sheet date are recognized as an increase or
decrease in income for the period.
The devaluation of the Tenge, the currency of the Republic of Kazakhstan,
can significantly decrease the value of the monetary assets that we hold in
Kazakhstan as well as our assets in that country that are based on the Tenge.
During 2003, however, the Tenge has appreciated against the U.S. Dollar by
7.31%. 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 in its assets, tax loss carryforwards, and VAT receivables
are all denominated in Tenge and subject to the effects of devaluation. Local
tax laws allow basis adjustments to offset the impact of inflation on statutory
tax basis assets, but there is no assurance that any adjustments will be
sufficient to offset the effects of inflation in whole or in part. If not, KKM
may be subject to much higher income tax liabilities within Kazakhstan due to
inflation and/ or devaluation of the local currency. Additionally, devaluation
may create uncertainty with respect to the future business climate in Kazakhstan
and to our investment in that country. It should be noted that 96% of our crude
oil sales in 2003 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 $3.70 million of net monetary liabilities denominated in Tenge as of
December 31, 2003.
22
Commodity Prices for Oil
- ------------------------
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.
Under the terms of the Agreement, we have a right to export, and receive
export quota for, 100% of the production from the Karakuduk Field. The domestic
market does not permit world market prices to be obtained, resulting in
approximately $10 to $12 lower cash flow per barrel. Furthermore, the Government
has not allocated sufficient export quota to allow us to sell all of our
available crude oil production on the world market. We are taking steps to
reduce our local market obligations and to obtain an export quota that will
enable us to sell all of our crude oil production. On July 17, 2003, we took the
first step towards the commencement of arbitration proceedings in Switzerland
for the breach of the Agreement by the Government of Kazakhstan by initiating a
required three-month period of consultation with the Government. Although the
consultation period has expired, we continue to seek an amicable resolution with
the Government on this matter rather than proceeding with arbitration. If the
matter can not 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.
Chaparral has been successful in 2003 in increasing its export sales and
reducing its local market deliveries. As of December 31, 2003, Chaparral has
sold approximately 2,694,000 barrels of its current year production, of which
approximately 2,591,000 barrels, or 96%, have been sold at world market prices
and 103,000 barrels, or 4%, have been sold at domestic market prices. This
represents a significant increase in sales at world market prices and
corresponding decrease in local market price sales from the year 2002.
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.
a) 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, 2003, 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.
(b) 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, 2003.
23
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
As of March 15, 2004, 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 executive officer will hold office until his successor duly
is 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
--------------------- ----- --- --------------------------------------------
Ian Connor 2002 38 Mr. Connor has served as the Chairman of the Board of
Chairman of the Board Chaparral since November 2002. Mr Connor is also Chairman of
Kazkommerts Securities, the investment-banking subsidiary of
Kazkommertsbank; is a Managing Director of Meridian Capital,
an investment company; and Chairman of UzPEC Limited, a UK
registered oil and gas company. Formerly, Mr. Connor served
as a Managing Director of Open Joint Stock Company
Kazkommertsbank, a commercial bank incorporated in
Kazakhstan. Prior to joining Kazkommertsbank, Mr. Connor
held several senior executive positions, including Chief
Executive Officer at Global Menkul Degerler A.S., an
Istanbul-based brokerage and investment house, from May 1997
to March 2001.
Nikolai D. Klinchev 2002 46 Mr. Klinchev has been the Chief Executive Officer of
Director and Chaparral since November 2002. From June 2002 to November
Chief Executive Officer 2002, he served as Vice President - Business Development of
Chaparral. Mr. Klinchev has served as the General Director
and as a board member of KKM since 1996. Mr. Klinchev
graduated from the Institute of Energy in Almaty,
Kazakhstan, as a power engineer and studied production
management in St. Petersburg (formerly Leningrad), Russia.
Askar Alshinbayev 2002 39 Mr. Alshinbayev has served as Managing Director and Chief
Director Executive Officer of Central Asian Industrial Holdings, N.V.
since May 2002. Since 1998, Mr. Alshinbayev has served as a
Managing Director of Open Joint Stock Company
Kazkommertsbank, a commercial bank incorporated in
Kazakhstan. From 1994 to 1998, he served as Deputy Chairman
of the Management Board of Kazkommertsbank. Mr. Alshinbayev
also serves on the Board of Directors of PetroKazakhstan,
Inc. and Nelson Resources, Ltd.
24
Name of Director or Officer and
Position in Chaparral Since Age Principal Occupation During the Last 5 Years
--------------------- ----- --- --------------------------------------------
Peter G. Dilling * 2002 54 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. Prior to joining
Anglo-African, Mr. Dilling was President and a director of
M-D International Petroleum, Inc., an exploration and
production company, from 1994 to 1997.
John Duthie * 2002 61 Since December 2002, Mr. Duthie has owned and operated
Director Bowler Hat Ltd., a H.K. based company active in Turkey and
the Black Sea region. He also serves as an advisor to PDF, a
corporate finance house, and provides financial and
investment advice to various Turkish and international
corporations and institutions. Prior to Bowler Hat, he
served as General Manager for Westdeutsche Landesbank
Turkey, a commercial bank headquartered in Germany, since
1994. He previously held various positions with Merrill
Lynch & Co., a stock brokerage house and investment bank,
and Deutsche Bank, a commercial bank and financial
institution.
Alan D. Berlin * 2002 64 Since 1995, Mr. Berlin has been a partner of the law firm
Director and Corporate Secretary Aitken Irvin Berlin & Vrooman, LLP. He was engaged in the
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.
Jonathan S. Wood 2004 40 Mr. Wood, currently the Finance Director of Closed Joint
VP-Finance and Stock Company Karakudukmunai ("KKM"), the Company's
Chief Financial Officer operating subsidiary in the Republic of Kazakhstan, assumed
the title of Vice President-Finance and Chief Financial
Officer of the Company in January 2004. Mr. Wood has been
with KKM since 1998 when he was appointed Financial
Controller of KKM. He has over 18 years experience in the
international petroleum industry, including over 9 years of
experience in the Former Soviet Union.
25
Name of Director or Officer and
Position in Chaparral Since Age Principal Occupation During the Last 5 Years
--------------------- ----- --- --------------------------------------------
Miguel C. Soto 2002 32 Mr. Soto has served as Treasurer and Financial Controller of
Treasurer and Controller Chaparral since November 2002. Since June 2002, Mr. Soto has
been the Financial Controller of KKM. From June 2002 to
November 2002, he served as the Financial Controller of
Chaparral. Prior to joining Chaparral, Mr. Soto worked as a
Tax Accountant for Arthur Andersen and spent several years
as a Staff Accountant for a technology company. * Audit
Committee member.
26
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 John Duthie 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 99.2 to this form 10-K.
Shareholder Nomination Procedures
There had been none material changes, during the fourth fiscal quarter, to
the procedures disclosed in the Proxy statement filed on September 9, 2003 with
the SEC.
Committees of the Board of Directors and Meeting Attendance
During the fiscal year 2003, Chaparral held six Board meetings. The Board
had several committees, including the Compensation Committee, the Audit
Committee, the Nominations Committee, and the Corporate Governance Committee.
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, 2003, and Form 5 and any
amendments furnished to Chaparral with respect to the same fiscal year, we
believe that our directors, officers, and greater than 10% beneficial owners
complied with all applicable Section 16 filing requirements.
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ITEM 11. EXECUTIVE COMPENSATION
The following table shows the compensation paid by Chaparral for services
rendered by Mr. Moore, who was the Vice President - Finance, and Chief Financial
Officer of Chaparral, Mr. Klinchev, who is the Chief Executive Officer of
Chaparral, Mr. Wood, who is currently the Vice President - Finance and Chief
Financial Officer of Chaparral, and Mr. Soto, who is currently the Treasurer and
Controller of Chaparral. There were no other executive officers of Chaparral
whose annual salary and bonus exceeded $100,000 during the fiscal year 2003.
Summary Compensation Table.
Annual Compensation Long-Term Compensation
------------------------------------- ------------------------------------------------
Awards Payouts
---------------------------------- -----------
Name and Other Annual Restricted Securities Underlying LTIP All Other
Principal Position Year Salary Bonus Compensation Stock Awards ($) Options/SARs (#) Payouts ($) Compensation
------------------ ---- ------ ----- ------------ ---------------- ---------------- ----------- ------------
Nikolai D. Klinchev 2003 $282,000 $290,000 -- -- -- -- $28,000(1)
Chief Executive 2002 $164,500(1) -- -- -- -- --
Officer (11/02 to
Present)
Jonathan S. Wood 2003 $235,000(2) $136,000(2) -- -- -- -- --
VP-Finance and
Chief Financial
Officer (01/04 to
Present)
Richard J. Moore 2003 $282,000 $40,000 -- -- -- -- $1,800
Former VP-Finance 2002 $164,500(3) $90,000 -- -- -- -- --
and Chief Financial
Officer (11/02 to
12/03)
Miguel C. Soto 2003 $172,000 $67,000 -- -- -- -- --
Treasurer and 2002 $116,933 $35,000 -- -- -- -- --
Controller (11/02
to present)
1. Represents compensation paid to Mr. Klinchev from June 2002 to December 31,
2002. In addition, $28,000 was paid by Chaparral for the education for Mr.
Klinchev's daughter during 2003.
2. Mr. Wood served as Financial Director of KKM during 2003 for which he
received salary of $235,000 and bonuses in the amount $136,000.
3. Represents compensation paid to Mr. Moore from June 2002 to December 31,
2002.
Options/SAR Grants.
For the fiscal year ended December 31, 2003, we did not grant any options.
Aggregated Option/SAR Exercises and Year-End Option/SAR Value.
As of December 31, 2003, there were no unexercised options/SARs and
additionally, no options were exercised in fiscal year 2003.
Director Interlocks.
Mr. Alshinbayev is a Managing Director of Kazkommertsbank and the Chief
Executive Officer of CAIH. Mr. Connor, Chaparral's current Chairman, is also a
Chairman of Kazkommerts Securities. Mr. Klinchev, Chaparral's current Chief
Executive Officer, has acted as a Director of KKM since 1996.
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Compensation of Directors.
During the fiscal year ended December 31, 2002, Chaparral implemented a
standard compensation arrangement for its directors, including providing