AMENDMENT NO. 1
ON
FORM 10-K/A
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, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________________ to ________________.
Commission file number: 0-7261
CHAPARRAL RESOURCES, INC.
-------------------------
(Exact name of registrant as specified in its charter)
Colorado 84-0630863
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2211 Norfolk, Suite 1150
Houston, Texas 77098
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(Address of principal executive offices)
Registrant's telephone number, including area code: (713) 807-7100
Securities registered pursuant to Section 12(g) of the Act:
$0.10 Par Value Common Stock
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months 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. |_|
As of March 31, 1999, the aggregate market value of Registrant's voting
stock held by nonaffiliates was $24,311,368.
As of March 31, 1999, Registrant had 58,588,790, shares of its $0.10 par
value common stock issued and outstanding.
Total Pages ___
Exhibit Index ___
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PART I
ITEM 1. BUSINESS
Business
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Chaparral Resources, Inc. ("Company"), incorporated under the laws of the
state of Colorado in 1972, is an independent oil and gas exploration and
production company, based in Houston, Texas. In June 1999, the Company plans to
move its corporate offices to Golden, Colorado. The Company currently owns all
of the outstanding common stock of Central Asian Petroleum Guernsey Limited
("CAP-G") which has a 50% interest in Karakuduk-Munay, Inc. ("KKM"). KKM holds
100% of the rights to develop the Karakuduk Field in the Republic of Kazakhstan
("Kazakhstan").
The Company's business strategy is to acquire and develop oil and gas
projects in emerging markets, specifically targeting fields with previously
discovered reserves, which either have never been placed on production or could
be materially enhanced with efficient management and technical experience
provided by the Company. The Karakuduk Field ("Karakuduk Field" or "Karakuduk
Project") described below is the Company's first oil field to be acquired under
the Company's new corporate strategy.
The Company has called for a special meeting of the Company's shareholders
to approve proposals for reincorporating the Company from the state of Colorado
to the state of Delaware and to effect a reverse stock split in which one new
share of the Company's common stock would be exchanged for every 60 shares of
common stock presently outstanding. The Company expects the special meeting to
occur in late April 1999.
Risks Inherent in Oil and Gas Exploration
There can be no assurance that the Company will be able to discover,
develop and produce sufficient reserves in the Karakuduk Field, or elsewhere.
Further, there can be no assurance that the Company will recover the expenses
incurred when it explores the Karakuduk Field or that it will achieve
profitability. The odds against discovering commercially exploitable oil and gas
reserves are always substantial and are increased as a result of the
concentration of the Company's activities in areas that have not yet been
significantly explored and where political or other unknown developments could
adversely affect commercialization. The Company, through KKM, will be required
to perform extensive geological and/or seismic surveys on its properties.
Depending on the results of the surveys, only subsequent drilling at substantial
cost and high risk can determine whether commercial development of the
properties is feasible. Oil and gas drilling is frequently marked by
unprofitable efforts, including unproductive wells, productive wells which do
not produce sufficient amounts of reserves to return a profit, and developed
reserves which cannot be marketed. The Company will be subject to all of the
risks inherent to drilling for and producing oil and gas. These risks include
blowouts, cratering, fires and accidents. Any of the risks could result in the
Company being liable for damages from loss of life and property. The Company is
not fully insured against these risks. Many of these risks are not insurable.
Risks of Operations in Kazakhstan
As a result of the Company's interest in KKM and the Karakuduk Field, it
will be subject to certain risks inherent in the ownership and development of
properties in Kazakhstan. The contracts that the Company has with the government
of Kazakhstan may be arbitrarily cancelled or forced into re-negotiation.
Cancellation or re-negotiation will or is likely to adversely affect the
Company's ability to profitably extract oil from the Karakuduk Field. The
government of Kazakhstan may impose royalty increases, tax increases and
retroactive tax claims against the Company. These taxes would adversely affect
the Company's ability to profitably extract oil from the Karakuduk Field because
of increased expenses. Expropriation, environmental controls, and other laws and
regulations may adversely affect the Company's interest in the Karakuduk Project
because of increased costs, inaccessibility or delays.
Due to the fact that the Company only controls a 50% interest in KKM, the
Company must seek the approval of KKM's other two shareholders, KazakhOil JSC
("KazakhOil"), which is the national petroleum company for the Republic of
Kazakhstan, and a private Kazakhstan joint stock company, before any major
actions are taken by KKM. If the Company is unable to obtain the approval of one
of KKM's remaining shareholders, the operations of KKM may come to a standstill,
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which could result in the loss of KKM's rights to explore and develop the
Karakuduk Field. There are no practical mechanisms in the agreement with
KazakhOil and the joint stock company to resolve any such stalemate.
The Company's operations and agreements are also governed by the laws of
Kazakhstan. The Company may be subject to arbitration in Kazakhstan or to the
jurisdiction of the courts in Kazakhstan. The Company may not be successful in
subjecting foreign persons to the jurisdiction of courts in the United States.
The Company may be hindered or prevented from enforcing its rights with respect
to a government agency, instrumentality or other government entity of Kazakhstan
because such entities may consider themselves immune from the jurisdiction of
any court.
KKM's Kazakhstan license for the Karakuduk Field includes the right to
export oil produced and to establish and maintain bank accounts in U.S. dollars
or other foreign currency outside of Kazakhstan. The Kazakhstan government's
agreement with KKM allows KKM to maintain its books and records in U.S. dollars,
but requires local Kazakh taxes be reported in tenge, the local Kazakh currency.
KKM's functional currency is the U.S. dollar. Because Kazakh law prohibits the
export of tenge, any payment for oil sold in tenge will be used for the payment
of local costs and expenses. KKM expects that the majority of the oil it
produces will be exported and sold outside of Kazakhstan and that payment will
be in U.S. dollars. The U.S. dollars will be deposited in bank accounts
established outside of Kazakhstan.
The Company may encounter unexpected difficulties in conducting foreign
operations. Although management of the Company believes that the recent and
continuing political, social and economic developments in Kazakhstan have
created opportunities for foreign investment, uncertainty exists about the
status of Kazakhstan law, the stability of Kazakhstan and the autonomy of the
parties involved with the Company in Kazakhstan.
Political Risk Insurance.
The Company has applied with Overseas Private Investment Corporation
("OPIC") for political risk insurance. OPIC insurance can cover the following
political risks:
o Currency Inconvertibility--deterioration of the investor's ability to
convert profits, debt service and other remittances from local
currency into U.S. dollars;
o Expropriation--loss of an investment due to expropriation,
nationalization or confiscation by a foreign government;
o Political Violence--loss of assets or income due to war, revolution,
insurrection or politically motivated civil strife, terrorism and
sabotage; and
o Interference With Operations--loss of assets or income due to
cessation of operations lasting six months or more caused by political
violence.
The coverage elections for each category of insurance are computed on a
ceiling and an active amount. The coverage ceiling represents the maximum
insurance available for the insured investment and future earnings under an
insurance contract. The premiums for each category are based on a maximum
insured amount ("MIA"), a current insured amount ("CIA") and a standby amount.
The MIA represents the maximum insurance available for the insured investment
under an insurance contract. The CIA represents the insurance actually in force
during the contract period. The CIA cannot exceed the book value of the insured
assets physically in Kazakhstan. The difference between the CIA and the MIA is
the standby amount. There is a charge for standby coverage.
The Company has applied with OPIC for all four political risk coverages on
the Company's investment in the Karakuduk Field. The Investment Committee of
OPIC approved the Company's Karakuduk operations for political risk insurance
coverage on December 19, 1995. The Company received an executed Letter of
Commitment from OPIC on September 25, 1996, binding issuance of Political Risk
Insurance for the Karakuduk Project. Currently, the Company has a standby
facility for which it has made eight equal payments of $31,250 and two payments
of $15,625. The Company expects to execute the actual contract offered to the
Company by OPIC on or before June 30, 1999.
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The final terms of the contract must be agreed upon at the time the
contract is executed. The CIA will be equal to the book value of the Company's
assets physically located in Kazakhstan. The MIA will equal the total coverage
available for current and future assets placed in Kazakhstan by the Company. The
MIA directly impacts both the premiums and deductible requirements in the
contract. Premiums will be paid quarterly. The Company will not know the
specific terms of the contract until the MIA required has been firmly
established. In the event of a loss, the reimbursement by OPIC to the Company
will be limited to the Company's actual loss of physical property in Kazakhstan.
The maximum reimbursement cannot exceed 90% of the MIA. The Company has delayed
execution of a final OPIC contract until the substantial costs of the premiums
are justified by the Company's investment in the Karakuduk Field.
Under the terms of OPIC's Expropriation and Interference with Operations
insurance coverage, the Company must be able to transfer to OPIC the shares of
beneficial interests related to the insured investment, free and clear of all
encumbrances. There are certain restrictions on the transfer of shares and
assignment of the Company's beneficial interests in KKM. At such time as the
Company obtains coverage, the Company will seek a waiver of the transfer
restrictions from the shareholders of KKM that are not affiliated with the
Company. While there is no assurance the waiver will be obtained, the Company
does not anticipate significant problems in obtaining the waiver, if required to
secure long- term financing for the benefit of KKM.
Markets
There is substantial uncertainty as to the future prices the Company could
obtain for any oil reserves produced from the Karakuduk Field. It is possible
that, under the market conditions prevailing in the future, the production and
sale of oil from the Karakuduk Field may not be commercially feasible. The
availability of ready markets and the price obtained for oil produced depends
upon numerous factors beyond the control of the Company. The current market for
oil is characterized by instability, which has caused dramatic declines and
increases in world oil prices in recent years. There can be no assurance of any
price stability in the current, and future, oil and gas market.
During 1998, the oil industry experienced major declines in oil prices
worldwide. The Commonwealth of Independent States ("CIS"), and Kazakhstan in
particular, were impacted severely, with competition increasing dramatically for
limited pipeline capacity required to access the world oil market. Furthermore,
instability in the economies of Russia and other CIS countries led to the
devaluation of the ruble and weakening of other regional currencies. Competition
to sell oil on the world market, in exchange for more stable, western currencies
(i.e. the U.S. dollar), drove oil prices in the CIS down even farther than
declines in other markets.
On March 7, 1998, KKM entered into a contract with the export-import firm
of Munay-Impex, a subsidiary of KazakhOil, to export up to 100,000 tons of crude
oil produced by KKM to both the CIS and other countries. KKM was to supply crude
oil to Munay-Impex in amounts of not less than five to 10 thousand metric tons.
Munay-Impex, acting as a broker, would market KKM's crude oil production for
sale on either the local or export market. KKM produced a total of 11,103 tons
(81,052 barrels) of oil during 1998, which has been stored as inventory in the
KazTransOil pipeline. Due to existing market conditions, however, Munay-Impex
was unable to find a suitable market to sell KKM's limited crude oil production
for an economical return. As a result, KKM did not sell any crude oil in 1998,
and allowed the Munay-Impex contract to terminate on December 31, 1998 at the
end of the contractual term. During December of 1998 and throughout the first
quarter of 1999, KKM continued to attempt to sell it's crude oil production at
acceptable economic terms, but was unsuccessful.
On March 30, 1999, KKM entered into a contract with KazakhOil, a
shareholder of KKM, to export up to 19,000 tons of crude oil during April 1999.
Under the contract, KazakhOil guaranteed KKM the necessary transit quota to sell
to export markets outside of Kazakhstan, via the KazTransOil pipeline. As of
March 31, 1999, KKM had approximately 18,000 tons of crude oil production stored
in the KazTransOil pipeline, and expects to achieve 19,000 tons of cumulative
production in early April 1999. KKM expects to sell the entire 19,000 tons of
oil during April, with payment expected in late April or May of 1999.
KKM anticipates that production facilities required to process and
transport larger volumes of expected future production from the Karakuduk Field
will be completed during 1999. The production facilities currently under
construction will initially allow up to 16,000 barrels of oil per day to be
transported to the KazTransOil pipeline. Until the production facilities are
completed, crude oil production is being placed into storage tanks and then
trucked to the pipeline. The number of crude oil trucks operating in the
Karakuduk Field has been increased to facilitate 24 hours a day transportation
to the pipeline, which allows increased production from existing wells.
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The Company's business is not seasonal, except that severe weather
conditions could limit the Company's exploration and drilling activities.
However, severe cold weather increases the demand for oil and natural gas, which
are used for heating purposes.
See also "Item 2. Properties - The Karakuduk Field."
Competition
Foreign oil and gas exploration and the acquisition of producing and
undeveloped properties is a highly competitive and speculative business. In
seeking suitable opportunities, the Company competes in all areas of the oil and
gas industry with a number of other companies, including large multi-national
oil and gas companies and other independent operators with greater financial
resources and, in some cases, with more experience than the Company. The Company
does not hold a significant competitive position in the oil and gas industry.
Such competition may adversely affect the Company's ability to market its oil
and/or obtain a competitive price for any oil sold. At this time, no prediction
can be made as to the effect such competition will ultimately have upon the
Company.
Even considering the recent downturn in the oil and gas industry, the CIS
is currently a primary focal point for substantial exploration and development
activities. Within Kazakhstan, the Company competes with both major oil and gas
companies and independent producers for, among other things, rights to develop
available oil and gas properties, access to limited pipeline capacity,
procurement of available materials and resources, and hiring qualified
international and local personnel.
Regulation
General. The Company's operations may be subject to regulation by
governments or other regulatory bodies governing the area in which the Company's
overseas operations are located. Regulations govern such things as drilling
permits, production rates, environmental protection and pollution control,
royalty rates and taxation rates, among others. These regulations may
substantially increase the costs of doing business and sometimes may prevent or
delay the starting or continuing of any given exploration or development
project. Moreover, regulations are subject to future changes by legislative and
administrative action and by judicial decisions, which may adversely affect the
petroleum industry in general and the Company in particular. At the present
time, it is impossible to predict the effect any current or future proposals or
changes in existing laws or regulations will have on the Company's operations.
The Company believes that it complies with all applicable legislation and
regulations in all material respects.
KKM is subject to various taxes in Kazakhstan, including, but not limited
to, income tax, value added tax ("VAT"), customs duties, excise taxes, property
taxes, payroll taxes, and excess profits tax. Furthermore, payments made by KKM
to the Company or its subsidiaries may also be subject to additional withholding
tax depending upon the type of payment and the country of incorporation of the
recipient of the payment. Without consideration of tax treaty benefits,
Kazakhstan requires 15% withholding on payments for dividends and interest to
foreign persons. Royalties and services are subject to a 20% withholding rate,
as well.
The Company and all its subsidiaries, other than CAP-G, are incorporated in
the United States and enjoy the tax benefits provided by the tax treaty between
the United States and Kazakhstan. Under the U.S./Kazakhstan tax treaty currently
in effect, withholding rates are substantially reduced. Generally, the tax
treaty rates are 5% for dividends paid to 10% or greater shareholders, 10% for
interest and royalties, and no withholding on payments for services as long as a
permanent residence has not been established by the foreign person.
CAP-G is incorporated in the Isle of Guernsey, which currently does not
have a tax treaty with Kazakhstan. Under KKM's license with Kazakhstan ,
interest payments made by KKM to CAP-G are not subject to withholding tax. Any
dividends paid by KKM to CAP-G, however, are currently subject to a withholding
tax rate of 15%. Currently, and for the foreseeable future, the Company does not
expect KKM to pay any income tax in Kazakhstan or to declare any dividends for
the benefit of its shareholders.
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Environmental. Based upon a study undertaken on behalf of the Company by an
unaffiliated party, the Company believes that its business operations presently
meet all legally required environmental quality standards. However, compliance
with foreign laws and regulations, which have been enacted or adopted regulating
the discharge of materials into the environment could have an adverse effect
upon the Company, the extent of which the Company is unable to assess. As is the
case with other companies engaged in oil and gas exploration, production and
refining, the Company faces exposure from potential claims and lawsuits
involving environmental matters. These matters may involve alleged soil and
water contamination and air pollution. Since inception the Company has not made
any material capital expenditures for environmental control facilities and has
no plans to do so.
Devaluation of Currency. On April 5, 1999, the government of Kazakhstan,
with the approval of the International Monetary Fund, allowed the national
currency of Kazakhstan, the tenge, to float freely against the U.S. dollar.
Immediately thereafter, the official exchange rate declined from 87.5 tenge to
the U.S. dollar to 142 tenge to the U.S. dollar. As of April 12, 1999, the
exchange rate was approximately 115 tenge to the U.S. dollar. The devaluation of
the tenge significantly decreases the realizable value of tenge monetary assets,
but also decreases the financial obligation of tenge denominated liabilities.
The instability resulting from the tenge devaluation creates uncertainty
regarding the future business climate in Kazakhstan and for the Company's
investment in KKM. The Company, however, does not expect a material adverse
impact to its operations. The majority of KKM's current assets and current
liabilities are denominated in U.S. dollars and are unaffected. While statutory
tax reporting is done in tenge, the Kazakh government allows revaluation
adjustments to step-up the tax basis in assets to offset the effects of Kazakh
deflation. KKM expects to utilize the revaluation adjustments to determine
taxable income or loss reported to the Kazakh tax authorities.
Expected revenue from KKM's pending sale of crude oil is denominated in
U.S. dollars, although final settlement is expected in tenge based upon the
exchange rate on the date of payment. KKM expects future sales to be both
denominated and settled in U.S. dollars.
Employees
As of March 31,1999, the Company had eight full-time employees and one
part-time employee. CAP-G operates through its officers and directors and had no
employees. KKM had 161 employees and retains independent contractors on an as
needed basis through the Company's wholly owned subsidiary, Road Runner Service
Company, Inc.
ITEM 2. PROPERTIES
Properties
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The Karakuduk Field
The Karakuduk Field is located in the Mangistau Region of the Republic of
Kazakhstan. KKM's license to develop the Karakuduk Field covers an area of
approximately 16,922.5 acres and has been granted to KKM for a period of 25
years. The agreement granting KKM the right to develop the Karakuduk Field was
approved by Kazakhstan's Ministry of Energy and Natural Resources on August 30,
1995.
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 -25 degrees Fahrenheit
in January to 100 degrees Fahrenheit in July. The operating environment is
similar to that found in northern Arizona and New Mexico in the United States.
The Karakuduk 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. Twenty-two exploratory and development
wells were drilled to delineate the field. However, none of the wells were ever
placed on production. The productive area of the Karakuduk Field is 11,300
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acres, with a minimum of seven separate productive horizons present in the
Jurassic formation. Oil has been recovered in tests from seven horizons within
the Jurassic formation with flow rates ranging from 3 to 966 barrels per day.
The Company estimates that drilling a maximum of 80 additional oil wells and 26
water injection wells may be required to fully develop the field. Peak oil
production from the field is expected to occur by 2002, although the time or
amount of development or production cannot presently be assured. The planned
development program for the Karakuduk Field will include a pressure maintenance
operation that the Company believes could result in additional recoverable
reserves.
The ability of the Company to realize the carrying value of its assets is
dependent on the Company being able to extract and transport hydrocarbons and
finding appropriate markets for their sale. Currently, exports from Kazakhstan
are dependent on limited transport routes and, in particular, access to the
Russian pipeline system. Domestic markets in Kazakhstan might not permit world
market prices to be obtained. Management believes, however, over the life of the
project, transportation restrictions will be alleviated and adequate prices will
be obtained for hydrocarbons produced from the Karakuduk Field, for the Company
to fully recover the carrying value of its assets.
The Karakuduk Field is approximately 18 miles north of the Mukat-Mangishlak
railroad, the Mangishlak-Astrakghan water pipeline, the Beyneu-Uzen high voltage
utility lines, and the Uzen-Atrau-Samara oil and gas pipelines. KKM, according
to its license agreement with Kazakhstan, has a priority use of the existing
pipeline network. In early 1998, KKM entered into a contract with KazTransOil
JSC, the state-owned company controlling the Uzen-Atrau-Samara pipeline. The
contract grants KKM rights to use the 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.
Currently, KKM is producing oil through field separators, into storage tanks and
then into crude oil trucks, for delivery to the pipeline. As of March 31, 1999,
KKM had produced approximately 18,000 tons (131,000 barrels) of crude oil, which
has been stored in the KazTransOil pipeline.
On March 30, 1999, KKM entered into a contract with KazakhOil JSC, a
shareholder of KKM, to export up to 19,000 tons of crude oil during April 1999.
Under the contract, KazakhOil guaranteed KKM the necessary transit quota to sell
to export markets outside of Kazakhstan, via the KazTransOil pipeline. KKM
expects to achieve 19,000 tons of cumulative production in early April 1999. KKM
nominated 13,000 tons for sale in early April, and expects to sell the remaining
6,000 tons of oil in late April, with payment expected in late April or May of
1999. KKM has no other existing contracts for sales of future crude oil
production. Although the management of the Company believes long-term sales
contracts for KKM's crude oil production will be available in the future, at
terms acceptable to KKM, there is no assurance that any such agreements will
ever be obtained by KKM.
Because of uncertainties surrounding the Karakuduk Project, no proved
reserves have been attributed to the field as of March 31, 1999. The crude oil
production stored in the KazTransOil pipeline throughout 1998 was not considered
commercially viable by the Company as of December 31, 1998, primarily due to the
depressed crude oil prices during the fall of 1998 and early spring of 1999. The
Karakuduk Project will require significant development costs for which the
financing is not complete. There can be no assurances that the project will be
adequately financed or that the field will be successfully developed.
On December 31, 1998, the government of Kazakhstan approved KKM's request
to amend KKM's license to develop the Karakuduk Field. The license, as amended,
requires the KKM to meet expenditure commitments of $16.5 million by December
31, 1998 and $30 million by December 31, 1999. Expenditure commitments through
December 31, 1998 exceeded the commitment requirement of $16.5 million by
approximately $480,000. The excess is applicable against the expenditure
commitment required as of December 31, 1999. As of March 31, 1999, KKM has
incurred approximately $3.5 million in expenses against its 1999 expenditure
commitment. Should the license terms not be adhered to, the license may be
withdrawn by the government of Kazakhstan.
The Company is responsible for providing 100% of the funding necessary for
the development of the Karakuduk Field, which is not provided by third-party
sources. KKM plans to meet its funding requirements through loans from CAP-G to
KKM, and through proceeds from the sale of oil extracted by KKM from the
Karakuduk Field. As of March 31, 1999, the Company has loaned CAP-G in excess of
$25 million to fund KKM's current operations. The Company is attempting to
obtain project financing for either CAP G or KKM, which may reduce the amount of
loans from the Company to CAP-G.
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KKM first produced crude oil from the Karakuduk Field in December 1997. At
present, the oil is transported by truck to the export pipeline at Say-Utes,
which is approximately 51 miles from the field. By the end of the second quarter
of 1999, it is anticipated that any oil produced will be transported by pipeline
from the field to the pipeline terminal to be built at Railroad Station No. 6,
which is approximately 18 miles from the Karakuduk Field. During 1998, KKM began
construction of an 18-mile pipeline from the field to the Station No. 6 pipeline
terminal, capable of transporting up to 16,000 barrels of oil per day to the
KazTransOil pipeline. Once construction is completed on the Station No. 6
terminal, allowing direct access into the export pipeline, KKM plans to complete
and bring on-line the 18-mile pipeline.
Until the pipeline and related production facilities are completed, daily
crude oil production is being processed, placed into storage tanks, and then
trucked to the Say-Utes pipeline terminal. Production placed into the pipeline
is considered inventory of KKM until the production is sold. As of March 31,
1999, KKM had not recognized any revenue from the sale of oil production, but
expects to complete a sale during April 1999.
During 1998, KKM re-entered four of the original twenty-two wells drilled
in the Karakuduk Field, establishing production from two wells. KKM plans to
complete the other two workover wells in the spring of 1999. KKM began drilling
the initial exploratory Well No. 101, on February 14, 1999, and reached total
depth in early April. KKM plans to complete Well No. 101 during April 1999. If
Well No. 101 is successful, KKM expects to bring production on-line in May of
1999. KKM also plans to drill 7 new wells before December 31, 1999, in
accordance with KKM's license obligation to the government of Kazakhstan.
Additional field facilities are either in place or under construction to
support the development and production of the wells to be drilled during 1999.
KKM has constructed a base camp with living quarters for 150 men, a mini-camp
for the drilling contractor and other service company personnel, storage
facilities, processing facilities, warehouses, a repair shop, and other related
support facilities. KKM has also completed a main road between the KazTransOil
pipeline terminal at the Station No. 6 and the field. KKM is also clearing
access roads and performing other required site preparation activities for other
planned drilling locations.
Management of the Company believes the risk-to-reward considerations
involved with the development of the Karakuduk Field are very positive and may
lead to substantial growth of the Company over the next several years. However,
the Company can provide no assurances that the Karakuduk Field will produce oil
in any specific amounts or that the Company will ever realize a profit as a
result of the Company's interest in the field.
KKM was re-registered on July 24, 1997, with the government of Kazakhstan.
The re-registration was required as a result of new legislation in Kazakhstan.
The Company believes that KKM is now in compliance with all Kazakhstan laws and
regulations relating to the registration requirements for legal entities. The
current KKM shareholders' include CAP-G, KazakhOil, and a local Kazakhstan joint
stock company. KazakhOil , the national petroleum company of the government of
Kazakhstan holds a 40% ownership interest in KKM. The private Kazakhstan joint
stock company owns the remaining 10%.
The permits and licenses required to develop the Karakuduk Field have been
obtained. However, there is no assurance that any further permits or licenses,
if required, will be obtained. Also, because of uncertainties surrounding the
project and lack of proven commercial viability of crude oil production
extracted during 1998 and early 1999, no proved reserves have been attributed to
the Karakuduk Field. The project will require significant development costs for
which the financing is not in place. There can be no assurance that the project
will be financed or that the Karakuduk Field will be successfully developed.
Further, the Company will face all of the risks inherent in attempting to
develop an oil and gas property in a foreign country.
See also Item 7 - "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Reserves. The Company claims no proved reserves as of December 31, 1998.
As a result of the Company recently reentering a well in the Karakuduk
Field and because of the Company's future drilling plans for the Karakuduk
Field, the Company expects to be able to obtain a reserve report for the
Karakuduk Field during 1999.
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Since January 1, 1998, the Company has not filed with or included in any
reports to any other federal authority or agency any estimates of total, proved
net oil or gas reserves.
Net Quantities of Oil and Gas Produced. The Company's net oil and gas
production for each of the last three fiscal years and for the month of December
1996 (all of which prior to 1997 was from properties located in the United
States) was as follows:
<TABLE>
<CAPTION>
Year ended Year ended Month of Year ended
December 31, 1998 December 31, 1997 December 1996 November 30, 1996
----------------- ----------------- ------------- -----------------
<S> <C> <C> <C> <C>
Oil (Bbls) 81,052 Less than 1,000 -0- 1,737
Gas (Mcf) -0- -0- -0- 96,906
KKM did not sell any oil during 1998. Oil production for 1998 represents
100% of KKm's 1998 production, which was placed into the KazTransOil pipeline.
While the Company, through CAP-G, owns 50% of KKm, the Company will receive the
entire economic benefit from the sale of KKM's initial production. The net
proceeds to be received from the same of KKM's 1998 production will be used to
partially repay CAP-G's loan to KKM and to fund KKM's ongoing operations,
reducing CAP-G's funding commitment to do the same.
The average sales price per barrel of oil and Mcf of gas, and average
production costs per barrel of oil equivalent ("BOE") excluding depreciation,
depletion and amortization were as follows:
Average Average Average
Year Ended Month of Year Ended Sales Price Sales Price Production
December 31, December, November 30, Oil (Bbls) Gas (Mcf) Cost Per BOE
------------ --------- ------------ ---------- --------- ------------
1998 * * *
1997 * * *
1996 * * *
1996 $17.53 $1.17 $2.07
</TABLE>
The above table represents activities related only to oil and gas
production.
* The Company did not sell any significant quantities of oil or gas
during these periods. KKM did not sell any oil or gas during the years
presented.
Productive Wells and Acreage. As of December 31, 1998, KKM had interests in
one productive oil well, one shut-in productive oil well, and no productive gas
wells. As of December 31, 1998, the Company had a net 50% beneficial interest in
KKM which holds a governmental license to develop the Karakuduk Field, a 16,900
acre oil field in Kazakhstan which was discovered in 1972 with the drilling of
22 exploratory and development wells by the former Soviet Union. None of these
wells were produced commercially prior to 1998.
On December 31, 1997, KKM delivered by truck to the pipeline oil that KKM
had recovered from testing Well No. 21, the first well KKM reentered in the
Karakuduk Field. Well No. 21 tested on a sustained flow of 526 barrels of oil
per day. The well was subsequently shut-in until additional facilities are put
in place to process and transport the combined daily production from Well No. 21
and Well No. 10. In February 1998, Well No. 10 was re-perforated and produced at
a sustained test flow rate of 1,450 barrels of oil per day. Well No. 10 was
placed on limited production to fill storage tanks and transport trucks that
deliver oil to the export pipeline. In March 1999, KKM acquired additional
trucks and personnel to increase the amount of daily production currently
deliverable to the pipeline terminal. KKM also has begun preparations to
workover Well Nos. 7 and 20 and, if the wells are productive, will place them on
production at such time as the field facility construction is completed.
9
<PAGE>
On February 14, 1999, KKM began drilling Well No. 101, reaching total depth
in early April. The well has not been completed as of the filing date of this
report.
Drilling Activity. During the last two fiscal years ended December 31,
1998, the month of December 1996 and the fiscal year ended November 30, 1996,
the Company did not participate in the drilling of any productive exploratory or
development wells. The Company did participate in the capital workover of four
previous drilled wells, which had never been placed on production.
Present Activities. As of April 13, 1999, the Company was in the process of
drilling Well No. 101, reopening Well No. 21, previously shut-in during 1998,
and planning the reentry of Well No. 20. Well No. 10 is currently producing
approximately 1,200 barrels of oil per day.
Offices. On March 1, 1999, the Company announced that it is relocating its
principal office from Houston, Texas to Golden, Colorado. On this date, the
Company leased office space from a related party, on 1010 Tenth Street, Suite
100, Golden, Colorado 80401. The offices consist of approximately 2,255 square
feet and will be leased until August 31, 1999 at an initial rent of
approximately $4,000 per month, and on a month to month basis after that. On
April 1, 1999, the Company assigned its office space at 2211 Norfolk, Suite
1150, Houston, Texas 77098 to an unaffiliated third party. The Company is
currently subleasing the Houston office space on a month by month basis for
approximately $5,000 per month. The Company expects the relocation to be
completed by the fall of 1999.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any legal proceedings required to be reported
hereunder.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's security holders during
the Company's fiscal quarter ended December 31, 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's $0.10 par value common stock is currently traded on the
Nasdaq Small-Cap Market ("Nasdaq") under the symbol CHAR. The Company has been
advised that the Company's common stock is subject to being de-listed by Nasdaq
as a result of the common stock not meeting the minimum bid price requirements.
The Company has scheduled a hearing with Nasdaq for April 30, 1999, to request
additional time to satisfy Nasdaq's minimum bid price requirements.
Additionally, the Company has requested a special meeting of the Company's
shareholder's in late April, 1999 to approve a reverse stock split in which one
new share of the Company's common stock would be exchanged for every 60 shares
of common stock presently outstanding.
As of April 7, 1999, the Company had approximately 2,022 shareholders of
record of its $0.10 par value common stock. No dividend has been paid on the
Company's common stock, and there are no plans to pay dividends in the
foreseeable future.
10
<PAGE>
The following table shows the range of high, low and closing sales prices
for each quarter during the Company's last two calendar years ended December 31,
1998 and December 31, 1997, as reported by the National Association of
Securities Dealers, Inc.
Price Range
---------------------------------
Fiscal Quarter Ended High Low Closing
-------------------- ---- --- -------
March 31, 1997 1 3/16 3/4 7/8
June 30, 1997 * 1 3/4 13/16
September 30, 1997 1 1/4 11/16 1 5/32
December 31, 1997 3 3/32 1 1/16 2 1/2
March 31, 1998 2 25/32 2 2 7/16
June 30, 1998 2 1/2 1 1/2 1 11/16
September 30, 1998 2 1/2 3/4 1 9/32
December 31, 1998 1 3/4 11/32 11/32
* On May 29, 1997, the Company changed its fiscal year end from November 30
to December 31.
The following is information as to all securities of the Company sold by
the Company since October 1, 1998, which were not registered under the
Securities Act of 1933, as amended ("Securities Act").
On October 30, 1998, the Company issued warrants to purchase 200,000 shares
of the Company's common stock at an exercise price of $1.00 per share as part of
the settlement for a lawsuit filed against the Company and others in the
District Court of Harris County, Texas, by Heartland, Inc. of Wichita and
Collins & McIlhenny, Inc. on November 14, 1997. The warrants are exercisable
through January 2, 1999. The Company issued the warrants in reliance upon the
exemption from registration under Section 4(2) of the Securities Act. The
recipients had available all material information concerning the Company. The
warrant certificates bear an appropriate restrictive legend under the Securities
Act. No underwriter was involved in the transaction.
During the quarter ended December 31, 1998, the Company granted 5-year
options to purchase 38,500 shares of the Company's common stock to employees of,
and consultants to, the Company. The Company made the grants in reliance upon
the exemption from registration under Section 4(2) of the Securities Act. Such
persons had available to them all material information concerning the Company.
The options will have an appropriate restrictive legend under the Securities
Act. No underwriter was involved in the transaction.
On December 31, 1998, warrants to purchase 80,000 shares of the Company's
common stock were exercised, at a price of $0.25 per share, for a total of
$20,000.
11
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following is selected consolidated financial information concerning the
Company. This information should be read in conjunction with the Consolidated
Financial Statements appearing elsewhere in this Annual Report on Form 10-K.
<TABLE>
<CAPTION>
As of or for As of or for
the Year the Year As of or for the Year Ended
Ended Ended Month of ----------------------------
December 31, December 31, December November 30, November 30, November 30,
1998 1997 1996 1996 1995 1994
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Oil and gas sales (1)........... -- -- -- $ 147,000 $ 255,000 $ 374,000
Total revenues.................. -- -- -- 147,000 255,000 374,000
Noncash write-down of oil an
gas properties -- -- -- -- 619,000 416,000
Net income (loss)............... (4,266,000) (2,603,000) (130,000) (2,416,000) (704,000) (474,000)
Net income (loss) per
common share.................. (.09) (.06) (.00) (.08) (0.04) (0.02)
Working capital................. (287,000) 3,356,000 * 259,000 366,000 497,000
Total assets.................... 34,324,000 23,519,000 * 14,498,000 5,595,000 2,388,000
Long-term obligations and
redeemable preferred stock 5,060,000 4,710,000 * 1,491,000 461,000
Shareholders' equity............ 27,579,000 18,578,000 * 12,114,000 4,920,000 2,035,000
Other Data
- ----------
Present value of proved reserves -- -- -- -- 427,000 1,084,000
Proved oil reserves (bbls) -- -- -- -- 66,185 111,690
Proved gas reserves (mcf) -- -- -- -- 3,062,417 3,294,730
</TABLE>
(1) In 1994, the Company made a strategic decision to pursue international
oil and gas projects and, by early 1997, had completely disposed of
all domestic oil and gas properties.
* Not applicable due to one month short period ended December 31, 1996.
12
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Liquidity and Capital Resources
- -------------------------------
During 1998, the Company raised additional capital to finance CAP-G's
obligation for the development of the Karakuduk Field and to satisfy other
working capital needs of the Company. Since January 1, 1998, the Company raised
$12,500,000 through the sale of common stock and $20,000 through the exercises
of common stock warrants. The Company also raised an additional $2,070,000
through various loans to the Company, of which $975,000 was outstanding as of
December 31, 1998. The Company's material capital and financing transactions
during 1998 were as follows:
On April 3, 1998, the Company sold 1,250,000 shares of the Company's common
stock for $2.00 per share for at total of $2,500,000 to a private investor.
Allen & Company, Incorporated acted as placement agent in connection with the
sale of the 1,250,000 shares. As a result, Allen & Company, Incorporated's
warrants to purchase shares of the Company's common stock, originally issued as
a commission in connection with the Redeemable Preferred Stock sale on November
24, 1997, became exercisable for an additional 100,000 shares. The warrants to
purchase the additional 100,000 shares of the Company's common stock are
exercisable through November 25, 2002, at an exercise price of $0.01 per share.
On July 28 and July 29, 1998, the Company sold 6,666,667 shares of the
Company's common stock for $1.50 per share for at total of $10,000,000 to
certain investors. Issuance costs incurred were approximately $50,000 and have
been recorded as a reduction to the proceeds received from the sale. Allen &
Company, Incorporated acted as placement agent in connection with the sale of
the 6,666,667 shares. As a result, Allen & Company, Incorporated's warrants to
purchase 900,000 shares of the Company's common stock, originally issued as
commission in connection with the Redeemable Preferred Stock sale on November
24, 1997, became exercisable for an additional 400,000 shares of the Company's
common stock. The 400,000 warrants are exercisable through November 25, 2002, at
an exercise price of $0.01 per share. As of December 31, 1998, 200,000 warrants
held by Allen & Company, Incorporated were unexercisable pending the performance
of future services.
Due to the fact, the sales price of the 6,666,667 shares was below a price
of $2.00 per share, the Company was required to issue an additional 416,667
shares to the investor who purchased 1,250,000 shares of the Company's common
stock for $2,500,000 in April 1998 in order to satisfy certain price protection
agreements the Company has with such investor.
On August 5, 1998, the Company retired two outstanding loans, totaling
$1,000,000, from two related parties: Allen & Company, Incorporated ($900,000)
and John McMillian, a director and current Chairman and Chief Executive Officer
of the Company ($100,000). The Company borrowed the $1,000,000 on June 3, 1998,
subject to a 7% interest rate. The note was payable in full, plus accrued
interest, on the earlier of 180 days from the funding of the loans or upon the
Company's receipt of a minimum of $10,000,000 in equity investments. In
conjunction with the loans, the Company issued warrants to purchase 1,000,000
shares of the Company's common stock, at an exercise price of $3.50 per share.
The Company recorded the warrants at their fair market value of $367,000, as a
discount of notes payable, amortizable over the life of the loans. On July 27,
1998, the Company received $10,000,000 in equity financing and repaid the loans,
recognizing an extraordinary loss on the extinguishment of debt of approximately
$236,000.
On July 3, 1998, the Company borrowed $975,000 from the Chase Bank of Texas
("Chase"). The Company subsequently amended the Chase note on December 3, 1998
and on February 28, 1999. Under the restructured terms of the note dated
February 28, 1999, the loan accrues interest at an adjustable prime rate, as
determined by Chase. As of December 31, 1998, the stated prime rate was 7.75%.
Principal payments in the amount of $250,000, plus accrued interest, are due
quarterly, beginning on August 31, 1999.
The $975,000 loan is fully guaranteed with a stand-by letter of credit from
Whittier Ventures, LLC, an investor in the Company. In return for issuing the
loan guarantee, the Company paid the guarantor $10,000 plus related costs,
issued warrants to purchase 20,000 shares of the Company's common stock, and
granted the guarantor a security interest in the Company's common stock of
Central Asian Petroleum (Guernsey) ("CAP-G").
13
<PAGE>
In the event of the Company's default on the $975,000 note, the guarantor's
security interest in the Company's common stock in CAP-G cannot be perfected for
at least 30 days after notification of such default. In the event of default,
the Company may make full payment of any outstanding principal and interest on
the note plus any additional charges incurred by the guarantor to completely
remove any security interest held by the guarantor.
The Company may seek to obtain additional capital through debt or equity
offerings, encumbering properties, entering into arrangements whereby certain
costs of development will be paid by others to earn an interest in the
properties, or sale of a portion of the Company's interest in the Karakuduk
Field. The present environment for financing the acquisition of oil and gas
properties or the ongoing obligations of an oil and gas business is uncertain,
due in part, to the instability of oil and gas prices in recent years. The
Company's small size and the early stage of development of the Karakuduk Field
may also increase the difficulty in raising any financing that may be needed in
the future. There can be no assurance that the debt or equity financing that
might be required to fund the Company's operations and obligations in the future
will be available to the Company on economically acceptable terms if at all.
During the first quarter of 1999, the Company borrowed an additional
$3,800,000 from related party investors. The notes are repayable in full on
August 31, 1999 and accrue interest at an 8% rate. The financing was primarily
utilized to fund KKM's operations during the first quarter of 1999.
The Company's financial statements have been presented on the basis that it
is a going concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company has
incurred recurring operating losses and has no operating assets presently
generating cash to fund its operating and capital requirements. The Company does
not anticipate that its current cash reserves and cash flow from operations will
be sufficient to meet its capital requirements through fiscal 1999.
As of December 31, 1998, substantially all of the Company's assets are
invested in the development of the Karakuduk Field. The Karakuduk Field has not
produced any revenues as of December 31, 1998 and is not expected to produce
revenues sufficient to meet KKM's cash needs during 1999. The development of the
Karakuduk Field, through KKM, will require substantial amounts of additional
capital. KKM's revised license with the government required KKM to expend $10
million as of December 31, 1997 and another $16.5 million as of December 31,
1998. Total expenditure commitments, from the commencement of operations through
December 31, 1998, of $26,500,000 have been satisfied by KKM. KKM has an
additional expenditure commitment of $30 million for the year ending December
31, 1999, of which KKM has spent approximately $3.5 million as of April 8, 1999.
The 1999 expenditure commitment is expected to be spent primarily for KKM's
drilling operations and completion of the field facilities capable of sustaining
expected future production from the Karakuduk Field, along with general overhead
expenses. Without additional funding and significant revenues from oil sales, of
which there are no assurances, the Company will not be able to provide necessary
funds to KKM in order to satisfy these requirements. As a result, the Company's
interest in the Karakuduk Field may be lost.
The Company received an extension to June 30, 1999, from the Overseas
Private Investment Corp. ("OPIC") for political risk insurance. OPIC granted the
Company a binding executed letter of commitment on September 25, 1996. The
Company has a standby facility for which it has made eight payments of $31,250
and another two payments of $15,625. The Company expects to execute the contract
on or before June 30, 1999.
Year 2000 Issue
The year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company has addressed the availability and integrity of financial
systems and the reliability of operational systems. The Company has specifically
reviewed the status of readiness for the year 2000 for its management and
financial reporting systems in the U.S. and in Kazakhstan, and believes the
systems are year 2000 compliant. The Company does not expect to incur any
material operating expenses or be required to make significant investment in
computer system improvements to become year 2000 compliant.
14
<PAGE>
Third party systems that expose the Company to risk are primarily those
surrounding the Company's equity investee, KKM. Management has begun
communications with KKM regarding their readiness for the year 2000 and is
currently assisting KKM to formalize an evaluation and assessment process.
KKM has completed a partial assessment and currently believes that the
computer systems it has in place are year 2000 compliant. KKM has initiated
formal communication with all of its significant suppliers and large customers
to determine the extent to which the Company is vulnerable to those third
parties failure to remediate their own year 2000 issues. In particular, it is
unclear as to the extent the Kazakh government and other organizations who
provide significant infrastructure services within the Kazakh Republic have
addressed the year 2000 issue. Furthermore, the current crisis in Russia and the
CIS could adversely affect the ability of the government and such organizations
to fund adequate Year 2000 compliance programs. There is no guarantee that the
systems of the government or of other organizations on which the Company and KKM
rely will be timely converted and will not have an adverse effect on the Company
and its systems.
The most likely worst case scenario the Company can foresee from a failure
of internal or third-party systems would include an inability of vendors to
timely deliver required materials, supplies, or services to the Karakuduk Field
necessary to conduct drilling or other field operations. In order to mitigate
the possibility of timely delivery of critical materials and supplies, KKM can
fully stock materials to sustain drilling operations over the transition period
from December 1999 through the first quarter of the 2000. At this time, KKM will
assess if any critical vendors are having difficulties due to year 2000 issues.
KKM has an extensive selection of vendors for all types of materials and service
needs. If certain vendors cannot perform on a timely basis, KKM will simply
utilize a different service provider.
Furthermore, a breakdown of the existing KazTransOil pipeline required by
KKM to export oil outside of Kazakhstan would seriously delay or even halt KKM's
ability to sell oil. KKM management has performed physical inspections of the
KazTransOil pipeline and do not foresee any problems with placing production
into the pipeline and properly recording the volumes attributable to KKM. There
are no assurances, however, that problems will not occur at different points
along the pipeline, inside or outside of Kazakhstan, including points of
destination for the throughput. Due to the limited transportation options for
marketing crude oil within Kazakhstan and the CIS, KKM will not be able to avoid
the negative consequences associated with a breakdown in the export pipeline if
it should occur. The management of KKM, however, considers this likelihood to be
remote.
Results of Operations Year Ended December 31, 1998 Compared to Year Ended
December 31, 1997
Interest income increased by $763,000 from the year ended December 31,
1997 due to increased financing of 100% of KKM's operations in Kazakhstan. As of
December 31, 1998, the Company held a 50% equity interest in KKM.
General and administrative costs increased by $1,363,000 from the year
ended December 31, 1997 due mainly to the Company's increase in compensation
expense and legal fees. Compensation expense increased by $992,000, primarily
due to stock based compensation granted to directors, employees, and consultants
of the Company during 1998 plus amortization of prior year equity based
compensation. Furthermore, the Company's cash based compensation increased due
to the hiring of additional personnel required for normal business operations.
Legal fees increased $125,000, primarily relating to the Heartland lawsuit,
which was settled on October 30, 1998. The Company's equity loss in KKM,
increased $912,000 from the year ended December 31, 1997. These increases are
the result of KKM's increased operational activity in Kazakhstan.
In 1998, the Company settled a lawsuit filed against the Company on
November 14, 1997, for a total of $200,000 and warrants to purchase 200,000
shares of the Company's common stock at an exercise price of $1.00, exercisable
through January 2, 1999. The warrants were recorded at the fair market value of
the warrants (approximately $34,000).
In 1998, the Company recognized a $236,000 extraordinary loss on the
extinguishment of long-term debt. The Company has debt obligations of $940,000
outstanding as of December 31, 1998.
15
<PAGE>
Inflation. The Company cannot control prices in its oil and gas sales and
to the extent the Company is unable to pass on increases in operating costs, it
may be affected by inflation.
Results of Operations Year Ended December 31, 1997 Compared to Year Ended
November 30, 1996
As mentioned above, during 1997 the Company changed from a fiscal year
ended November 30 to a fiscal year ended December 31. The Company's operations
during the fiscal year ended December 31, 1997 and the month ended December 31,
1996, resulted in losses before extraordinary items, if any, of $2,389,000 and
$130,000, respectively, due to the Company's ongoing transition to international
exploration and production operations. The Company's operational loss for
December 1996 consisted of miscellaneous corporate level expenses and is
immaterial to the overall operational results of the Company.
Results for the fiscal year ended November 30, 1996 have also been restated
to reflect the equity method of accounting for the Company's investment in KKM.
In 1996, the Company accounted for KKM using proportional consolidation. After
adoption of the equity method, the Company's net loss for the fiscal year ended
November 30, 1996, $2,416,000, remained unchanged from the amount originally
reported.
Oil and gas revenues and production costs decreased by $147,000 and
$37,000, respectively, from the year ended November 30, 1996, due to the
disposition of all of the Company's domestic oil and gas properties during the
first quarter of 1997. Interest income increased by $267,000 from the year ended
November 30, 1996 due to increased financing of 100% of KKM's operations in
Kazakhstan. As of December 31, 1997, the Company held a 50% equity interest in
KKM.
General and administrative costs and interest expense increased by $186,000
and $208,000, respectively, also due to KKM's increased operational activity in
Kazakhstan. The Company's equity loss in KKM, however, decreased by $139,000
from the year ended November 30, 1996 due to additional capitalization of costs
directly related to development of oil and gas properties held by KKM. The
Company recognized a $36,000 economic loss on the disposition of the Company's
domestic properties.
In 1997, the Company recognized a $214,000 extraordinary loss on the
extinguishment of long term debt. The Company did not have any other debt
obligations outstanding as of December 31, 1997.
Inflation. The Company cannot control prices in its oil and gas sales and
to the extent the Company is unable to pass on increases in operating costs, it
may be affected by inflation.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14(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.
16
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
As of March 31, 1999, the following table sets forth the names and ages of
the current directors and executive officers of the Company, the principal
offices and positions with the Company held by each person and the date such
person became a director or executive officer of the Company. The executive
officers of the Company 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 shareholders. 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 the Company's
Bylaws.
<TABLE>
<CAPTION>
Name of Director or Officer and Principal Occupation
Position in the Company Since Age During the last Five Years
- ----------------------- ----- --- --------------------------
<S> <C> <C> <C>
John G. McMillian 1997 72 Mr. McMillian has served as the Chairman of the Board of the Company
Chairman since January 1999. From 1995 to 1997, Mr. McMillian was retired. Mr.
McMillian served as the Chairman, President, and Chief Executive
Officer of Allegheny & Western Energy Corporation, an oil and gas
company, from 1987 to 1995. Mr. McMillian founded Northwest Energy
Company, a major supplier of natural gas, and served as its Chairman
and Chief Executive Officer from 1973 to 1983. From 1986 to 1989,
Mr. McMillian was the owner, Chairman and Chief Executive Officer of
Burger Boat Company, a boat manufacturing company. Mr. McMillian has
served as a director of Excalibur Technologies and a member of its
Audit Committee since 1996.
Dr. Jack A. Krug 1999 53 President and Chief Operating Officer of the Company since January
President and Chief 1999; A director, Vice President, and former owner of Questa
Operating Officer Engineering, LLC, prior to 1999; First Deputy Project Manager,
LukOil-AIK, an oil and gas joint venture in Russia, from October 1994
to December 1998; First Deputy of Zhetaby Quest an oil and gas joint
venture in the Republic of Kazakhstan, from 1993 to November, 1994.
David A. Dahl 1997 37 Mr. Dahl served as Secretary of the Company from August 1997 until May
1998. Currently, Mr. Dahl is the President of Whittier Energy Company,
an oil and gas exploration and production company, a position that he
has held since 1997. Since 1996, Mr. Dahl has also served as the
President of Whittier Ventures, LLC, a private investment entity. In
addition, since 1993, Mr. Dahl is also Vice President of Whittier
Trust Company, a private trust company. From 1990 to 1993, Mr. Dahl
was a Vice President of Merus Capital Management, an investment firm.
17
<PAGE>
Name of Director or Officer and Principal Occupation
Position in the Company Since Age During the last Five Years
- ----------------------- ----- --- --------------------------
Ted Collins, Jr. 1997 60 Since 1988, Mr. Collins has been the President of Collins & Ware,
Inc., an independent oil and gas company. From 1982 to 1988, Mr.
Collins was the President of Enron Oil & Gas Co., an oil and gas
company. Beginning in 1969 and until 1982, Mr. Collins was an
Executive Vice President and director of American Quasar Petroleum
Co., an oil and gas company. Mr. Collins also serves on the Board of
Directors of Hanover Compression Company, MidCoast Energy Resources,
Inc. and Queen Sand Resources, Inc.
Richard L. Grant 1998 44 Mr. Grant is the President of Cabot LNG Corporation, an importer of
liquefied natural gas, a position he has held since September 1988.
Mr. Grant served in various capacities at Mountaineer Gas Company, the
largest natural gas distribution company in West Virginia, including
President, from September 1988 to August 1998, and Executive Vice
President and General Counsel, from 1986 to 1988. Mr. Grant was an
engineer for and legal counsel with The Cincinnati Gas & Electric
Company, from 1980 to 1986.
James A. Jeffs 1999 46 Since 1994, Mr. Jeffs has served as Managing Director and the Chief
Investment Officer for The Whittier Trust Company, a trust and
investment management company, and as a director of M-D International
Petroleum, Inc., a private oil and gas company. From 1993 to 1994, Mr.
Jeffs was a Senior Vice President of Union Bank of California. Mr.
Jeffs was the Chief Investment Officer for Northern Trust of
California, N.A., a trust and investment management company from 1992
to 1993. Mr. Jeffs was the President of TSA Capital Management, an
investment management company, and Chief Executive Officer and
Senior Vice President of Trust Services of America, a trust and
investment management company from 1988 to 1992.
Arlo G. Sorensen 1996 58 Chief Financial Officer and Principal Accounting Officer of the
Company from March 1997 to June 1998; Treasurer of the Company from
February 1997 to February 1998; Trustee of M.H. Whittier Corporation,
a private investment entity, since 1985; Chairman of the Board and a
director of Whittier Trust Company since 1988.
Michael B. Young 1998 30 Treasurer & Controller of the Company since February 1998 and
Treasurer and Controller Principal Accounting Officer of the Company since June 1998; Tax
Manager in the oil & gas tax practice of Arthur Andersen LLP, an
accounting firm, from June 1991 to February 1998.
18
<PAGE>
Name of Director or Officer and Principal Occupation
Position in the Company Since Age During the last Five Years
- ----------------------- ----- --- --------------------------
Alan D. Berlin 1997 58 A partner of Aitken Irvin Lewin Berlin Vrooman & Cohn, LLP since 1995.
Secretary Engaged in the private practice of law for over five years prior to
joining Aitken Irvin Lewin Berlin Vrooman & Cohn LLP; Secretary of the
Company from January 1996 to August 1997 and from June 1998 to the
present; President of the International Division of Belco Petroleum
Corp. from 1985 to 1987 and held various other positions with Belco
Petroleum Corp. from 1977 to 1985; Currently a director of Belco Oil &
Gas Corp.
</TABLE>
Except as indicated in the above table, no director of the Company is a
director of an entity that has its securities registered pursuant to Section 12
of the Securities Exchange Act of 1934.
In connection with the Company's acquisition of all of the stock of Central
Asian Petroleum (Delaware), Inc. ("CAP-D") in 1995, the former shareholders of
CAP-D were granted certain rights to nominate directors of their choosing for
election to the Company's board of directors. In June 1998, the former
shareholders of CAP-D agreed to relinquish their rights to future board
representation in exchange for the accelerated release from escrow of 1,250,000
shares of the Company's common stock issued to the CAP-D shareholders as part of
the Company's acquisition of 100% of CAP-D's stock. As part of the agreement,
the escrowed shares will be released upon the earlier of production reaching
2,500 barrels of oil per day for a period of sixty days or when the Company
obtains "full project financing," neither which have occurred as of April 15,
1999. The Company recorded the issuance of the escrowed shares in 1995.
In connection with borrowings in August 1996, the Company agreed to add two
directors selected by two of the lenders, Whittier Ventures LLC and Whittier
Energy Company (collectively "Whittiers"). In connection with the transactions,
James A. Jeffs resigned from the Company's board of directors. At the request of
the Whittiers, on December 2, 1996, Arlo G. Sorensen replaced Mr. Jeffs on the
Company's board of directors and on January 3, 1997, David A. Dahl was appointed
to the Company's board of directors. The Whittiers will have the right to have
their two representatives nominated for directors of the Company until the
Whittiers no longer have any investment in the Company. In January 1999, Mr.
Jeffs was re-appointed as a director of the Company, in addition to Mr. Dahl and
Mr. Sorensen.
There are no other arrangements or understandings between any executive
officer and any director or other person pursuant to which any person was
selected as a director or an executive officer.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based solely upon a review of the Forms 3 and 4 and any amendments
furnished to the Company during the Company's fiscal year ended December 31,
1998, and Form 5 and any amendments furnished to the Company with respect to the
same fiscal year, during the Company's fiscal year ended December 31, 1998, the
Company believes that its directors, officers, and greater than 10% beneficial
owners complied with all applicable filing requirements, except that (i) Mr.
Young failed to file, on a timely basis, a report representing one transaction
in which Mr. Young received options to acquire shares of common stock and (ii)
Mr. Dahl, through his beneficial ownership of shares owned by Whitter Ventures,
LLC, failed to file one report, on a timely basis, representing three
transactions pursuant to which Whitter Ventures, LLC received warrants to
purchase shares of common stock.
19
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
In May 1997, the Company changed its fiscal year end from November 30 to
December 31. The following table shows all cash compensation paid by the Company
for services rendered during the fiscal years ended December 31, 1998 and
December 31, 1997, during the month of December 1996 and during the fiscal year
ended November 30, 1996 to Howard Karren (there were no executive officers of
the Company whose annual salary and bonus exceeded $100,000 during the fiscal
year ended December 31, 1998).
<TABLE>
<CAPTION>
Summary Compensation Table
Long-Term
Compensation
Annual Compensation Awards
------------------- ------
Year Year Year Other
Ended Ended Ended Annual Securities All Other
Name and December December Month of November Compen- Underlying Compens-
Principal Position 31, 31, December 30, Salary ($) Bonus($) sation ($) Options (#) sation ($)
- ------------------- -------- -------- -------- -------- ---------- -------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Howard Karren 1998 -- -- -- -- --
Chief Executive Officer and
President from January 1997 -- -- -- 1,025,000 --
and February 1997,
respectively, 1996 -- -- -- -- --
to January 1999 1996 -- -- $175,000(1) -- --
1995 -- -- -- -- --
</TABLE>
(1) In connection with Howard Karren becoming a Director and Chairman of the
Company, subject to a certain contingency which was satisfied in April
1996, the Company agreed to issue 350,000 shares of the Company's
restricted common stock to Howard Karren, a director of the Company, or his
designees. The $175,000 represents the market value of the 350,000 shares
on April 5, 1996, the date the contingency was satisfied.
On January 11, 1999, the Company entered into an employment agreement with
Dr. Jack A. Krug pursuant to which Dr. Krug was employed as the President and
Chief Operating Officer of the Company. The employment agreement has a term of
three years and is automatically extended for successive one year terms
thereafter unless either the Company or Dr. Krug elects to terminate the
agreement. Under the terms of the employment agreement, the Company pays Dr.
Krug a salary of $250,000 and has agreed to grant Dr. Krug 200,000 shares of the
Company's common stock for each year, up to a maximum of five years, of Dr.
Krug's services under the agreement. The first stock grant was made on January
15, 1999. Each subsequent grant is to be made on each subsequent January 15.
Option Grants in Last Fiscal Year
The Company did not grant any options to Howard Karren, the former Chairman
and Chief Executive Officer of the Company, during the year ended December 31,
1998.
Fiscal Year-End Option Values
The following table sets forth information concerning unexercised options
held by Howard Karren on December 31, 1998:
<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised
Options as of In-the-Money Options at
December 31, 1998(#) December 31, 1998($)
--------------------------------- --------------------------
Name Exercisable/ Unexercisable Exercisable/ Unexercisable
- ---- ------------ ------------- --------------------------
<S> <C> <C> <C> <C>
Howard Karren.............. 1,025,000 - 0 - $ -0- - 0 -
</TABLE>
(1) The value was determined by multiplying the number of shares underlying the
warrants by the difference between the exercise price and the closing sale
price of the Company's common stock on December 31, 1998.
20
<PAGE>
Compensation of Directors
On July 17, 1997, the shareholders of the Company approved a 1997 Incentive
Stock Plan pursuant to which all non-employee directors were to receive an award
of 250 shares of common stock of the Company for each meeting of the board of
directors attended by such director. The directors have waived their rights to
receive shares for the meetings in 1997 and 1998. Also on July 17, 1997, the
shareholders approved a 1997 Non-Employee Directors' Stock Option Plan pursuant
to which each year each non- employee director was to receive an option to
purchase 25,000 shares of common stock of the Company. The only options granted
were granted effective July 17, 1997 and relate to a total of 200,000 shares
that were exercisable at a price of $0.828125 per share. Both plans were
terminated in June 1998.
On January 23, 1998, the Board of Directors of the Company granted each
director of the Company 10,000 shares of the Company's common stock for their
service to the Company. There were no other standard or other arrangements for
the compensation of the Company's directors in effect for the Company's fiscal
year ended December 31, 1998.
21
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth as of April 7, 1999, the number of shares of
the Company's outstanding $0.10 par value common stock beneficially owned by
each of the Company's current directors and the Company's executive officers
named in Item 11, sets forth the number of shares of the Company's outstanding
common stock beneficially owned by all of the Company's current directors and
executive officers as a group, sets forth the number of shares of the Company's
outstanding common stock owned by each person who owned of record, or was known
to own beneficially, more than 5% of the Company's outstanding shares of common
stock and sets forth the number of shares of the Company's outstanding common
stock owned by Howard Karren. The address for all directors and executive
officers of the Company is 2211 Norfolk, Suite 1150, Houston, Texas 77098-4096.
<TABLE>
<CAPTION>
Amount and Nature Percent of
of Beneficial Common
Name of Beneficial Owner Position Ownership (1) Stock (1)
- ------------------------ -------- ------------- ---------
<S> <C> <C>
Allen & Company Incorporated -- 11,222,387 (2) 18.31%
711 Fifth Avenue
New York, New York 10022
Cascade Investment, LLC -- 3,333,333 5.69%
2365 Carillon Point
Kirkland, WA 98033
Whittier Ventures, LLC -- 3,373,556 (3) 5.73%
1600 Huntington Drive
South Pasadena, California 91030
Jack A. Krug President and Chief Operating 200,000 (4) *
Officer
John G. McMillian Chairman of the Board, 460,000 (5) *
Director, and Chief Executive
Officer
David A. Dahl Director 5,679,803 (6) 8.84%
Ted Collins, Jr. Director 60,000 *
James Jeffs Director 2,568,247(7) 4.38%
Arlo G. Sorensen Director 96,242 (8) *
Richard L. Grant Director -0- *
Howard Karren Former President and Chief 1,195,000 (9) 2.00%
Executive Officer
All Current Directors and Executive 9,079,292 (10) 15.03%
Officers as a Group (nine persons)
</TABLE>
* Represents less than 1% of the shares of the common stock outstanding.
22
<PAGE>
(1) Beneficial ownership of the common stock has been determined for this
purpose in accordance with Rule 13d-3 under the Securities Exchange Act of
1934, as amended ("Exchange Act"), under which a person is deemed to be the
beneficial owner of securities if he or she has or shares voting power or
investment power with respect to such securities or has the right to
acquire beneficial ownership within 60 days.
(2) Includes 2,697,720 shares underlying warrants to purchase shares of common
stock. The number of warrants reflected includes 225,000 warrants that
Allen & Company Incorporated ("ACI") acquired and holds for the benefit of
certain of its officers, directors and employees. ACI is a wholly owned
subsidiary of Allen Holding Inc. ("AHI"), and, consequently, AHI may be
deemed to beneficially own the shares beneficially owned by ACI. Does not
include certain shares owned directly by certain officers and stockholders
of AHI and ACI with respect to which AHI and ACI disclaim beneficial
ownership. Certain officers and stockholders of AHI and ACI may be deemed
to beneficially own certain shares of the common stock reported to be
beneficially owned directly by AHI and ACI.
(3) Includes 282,500 shares underlying currently exercisable warrants.
(4) Does not include 800,000 shares that vest annually at a rate of 200,000
shares on January 15th of each year. If Dr. Krug's employment terminates,
the stock award will be prorated as to that year.
(5) Includes 25,000 shares underlying a currently exercisable option and 25,000
shares underlying a currently exercisable warrant.
(6) Includes 75,000 shares underlying currently exercisable options owned by
Mr. Dahl, 3,091,056 shares beneficially owned by Whittier Ventures LLC,
282,500 shares underlying currently exercisable warrants beneficially owned
by Whittier Ventures LLC, 349,185 shares owned by Whittier Energy Company,
87,500 shares underlying currently exercisable warrants owned by Whittier
Energy Company, 1,285,192 shares beneficially owned by Whittier Trust
Company, 9,370 shares owned by Whittier Opportunity Fund and 500,000 shares
underlying currently exercisable options owned by Whittier Opportunity
Fund. Although Mr. Dahl has no pecuniary interest in the shares
beneficially owned by Whittier Ventures LLC, Whittier Energy Company,
Whittier Trust Company or Whittier Opportunity Fund, as the President of
Whittier Ventures LLC and Whittier Energy Company, as the Vice President of
Whittier Trust Company, and as a Manager of Whittier Opportunity Fund, Mr.
Dahl has voting power and investment power over such shares and, thus, may
be deemed to beneficially own such shares.
(7) Includes 349,185 shares owned by Whittier Energy Company, 87,500 shares
underlying currently exercisable options owned by Whittier Energy Company,
1,285,192 shares beneficially owned by Whittier Trust Company, 9,370 shares
owned by Whittier Opportunity Fund and 500,000 shares underlying currently
exercisable options owned by Whittier Opportunity Fund. Although Mr. Jeffs
has no pecuniary interest in the shares beneficially owned by Whittier
Energy Company, Whittier Trust Company and Whittier Opportunity Fund, as
Vice President of Whittier Energy Company, Vice President of Whittier Trust
Company and a Manager of Whittier Opportunity Fund, Mr. Jeffs has voting
power and investment power over such shares and, thus, may be deemed to
beneficially own such shares. Does not include 235,000 shares subject to an
escrow agreement which provides that such shares will be released to Mr.
Jeffs if the Company's oil and gas interests attain specified performance
levels.
(8) Includes 75,000 shares underlying currently exercisable options and 11,242
shares owned by Whittier 1982 Oil Trust for which Mr. Sorensen is the
trustee and has voting and investment power over such shares. Mr. Sorensen
is a director of Whittier Ventures LLC and Whittier Energy Company. Mr.
Sorensen disclaims beneficial ownership of the shares that are owned by
Whittier Ventures LLC and Whittier Energy Company.
(9) Includes 1,025,000 shares underlying currently exercisable options. Mr.
Karren is no longer employed by the Company.
23
<PAGE>
(10) Includes the shares as described in notes (4) through (8) above. Also
includes (i) 20,000 shares owned by Michael B. Young, the Treasurer and
Controller of the Company, and 70,000 shares underlying presently
exercisable options owned by Mr. Young, and (ii) 10,000 shares owned by Mr.
Berlin, the Secretary of the Company, and 25,000 shares underlying a
presently exercisable option owned by Mr. Berlin. Does not include a grant
for 20,000 shares that will vest with respect to 10,000 shares on each of
January 30, 2000 and 2001, if Mr. Young is still employed by the Company on
those dates. The shares will vest earlier if Mr. Young is terminated
without due cause or if the Company is acquired or merges with another
entity.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Aitken Irvin Lewin Berlin Vrooman & Cohn, LLP, a law firm in which Alan D.
Berlin, who is currently the Secretary of the Company and who was a director of
the Company from March 1997 to May 1998, is a partner, provides legal services
to the Company for which the law firm charges the Company an amount not in
excess of the law firm's normal billing rates. The total amount of fees that
were paid by the Company to the law firm during the Company's fiscal year ended
December 31, 1998 did not exceed 5 of the law firm's gross revenues for the law
firm's last full fiscal year. The Company believes that the fees paid to the law
firm were reasonable for the services rendered.
Allen & Company Incorporated, which acted as placement agent in connection
with the sale of the Company's Series A Preferred Stock in November 1997, was
paid a fee in the form of warrants to purchase 900,000 shares of common stock
that were exercisable through November 25, 2002, at an exercise price of $0.01
per share. In March 1999, the Company and Allen & Company entered into an
agreement pursuant to which Allen & Company would retain warrants to purchase
700,000 of the original 900,000 shares of common stock; provided, however, the
exercise of such warrants is subject to several conditions. In particular, a
warrant to purchase one share of common stock is deemed exercisable for each $25
of additional capital arranged by Allen & Company for the Company on or before
November 25, 1999. Allen & Company arranged for $2.5 million and $10 million of
additional capital for the Company during April 1998 and July 1998,
respectively; consequently, warrants to purchase 500,000 of the 700,000 shares
of common stock are currently exercisable.
The Company borrowed $900,000 from Allen & Company and $100,000 from Mr.
McMillian in June 1998, at an interest rate of 7% per annum. In connection with
such loans, the Company issued to (i) Allen & Company warrants to purchase
975,000 shares of common stock and (ii) Mr. McMillian warrants to purchase
25,000 shares of common stock. The warrants expire on November 25, 2002 and have
an exercise price of $3.50 per share. The Company recorded such warrants at
their fair value of $367,000 at the time of issuance as a discount of the loans
to be amortized over the life of the loans. The loans were repaid, together with
interest, in August 1998.
In July 1998, Whittier Ventures, LLC provided a stand-by letter of credit
as collateral for a $975,000 loan from the Chase Bank of Texas, N.A. to the
Company. In return for issuing the loan guarantee, the Company paid Whittier
$10,000 plus related costs, issued warrants to purchase 20,000 shares of common
stock at $0.01 per share, and granted Whittier a security interest in capital
stock of Central Asian Petroleum (Guernsey) ("CAP-G"), a subsidiary of the
Company. In March 1999, Whittier loaned the Company, in two transactions, an
aggregate of $1.0 million at an interest rate of 8% per annum. The loans are due
and payable on or before August 31, 1999. If the Company issues convertible
securities within one year from the date of each of the notes, Whittier has the
right to exchange the outstanding balance of the loans, together with accrued
and unpaid interest, for such convertible securities. The amount of convertible
securities issuable to Whittier is determined by dividing the outstanding
principal balance of the loans, together with accrued but unpaid interest, by
the issue price of the convertible securities.
Allen & Company loaned, at an interest rate of 8% per annum, to the
Company, in three transactions, an aggregate of $700,000 in January 1999 and, in
three transactions, an aggregate of $1,050,000 in February 1999. The Company
issued a promissory note during March 1998 in the principal amount of
$2,769,978.08 to Allen & Company, representing an additional $1,000,000 loan to
the Company by Allen & Company and retiring the January and February loans. The
promissory note bears interest at a rate of 8% per annum and matures on August
31, 1999. The promissory note is secured in the same manner and is convertible
on the same terms and conditions as the July 1998 loan by Whitter to the
Company.
24
<PAGE>
The Company borrowed $75,000 in May 1998 and $20,000 in July 1998 from
Howard Karren. The loans from Mr. Karren were repaid in July 1998, together with
interest at an interest rate of 8% per annum.
In January 1998, the Board granted each director 10,000 shares of common
stock for their service as a director.
The Company granted Michael B. Young, in connection with the commencement
of his employment with the Company in February 1998, (i) a five year option to
purchase 50,000 shares of common stock at an exercise price of $2.25 per share
and (ii) 40,000 shares of common stock that, subject to certain conditions,
vested as to 10,000 shares on each of January 30, 1998 and 1999, and will vest
as to 10,000 shares on each of January 30, 2000, and 2001.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements.
---------------------
Table of Contents
Chaparral Resources, Inc.
-------------------------
Report of Independent Auditors.................................... 33
Consolidated Balance Sheets-As of December
31, 1998 and December 31, 1997 ................................. 34
Consolidated Statements of Operations-Years ended
December 31, 1998, December 31, 1997, November 30,
1996 and the month ended December 31,1996...................... 36
Consolidated Statements of Cash Flows-Years ended
December 31, 1998, December 31, 1997, November 30,
1996 and the month ended December 31, 1996...................... 37
Consolidated Statement of Changes in Stockholders' Equity-
Year ended December 31, 1998, Thirteen months ended
December 31, 1997 and the year ended November 30, 1996......... 40
Notes to Consolidated Financial Statements........................ 41
Supplemental Information - Disclosures About Oil
and Gas producing Activities - Unaudited....................... 59
Karakuduk-Munay, Inc.
Report of Independent Auditors ................................... 63
Balance Sheets-As of December 31, 1998 and 1997 .................. 64
Statements of Expenses and Accumulated Deficit-
Years ended December 31, 1998, 1997 and 1996.................... 65
Statements of Cash Flows-Years ended December 31,
1998, 1997 and 1996 ............................................ 66
Statements of Shareholders' Deficit............................... 67
Notes to the Financial Statements ................................ 68
(a)(2) Financial Statement Schedules.
------------------------------
All schedules for which a provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and, therefore, have been omitted.
(b) Current Reports on Form 8-K.
----------------------------
The Company did not file any Current Reports on Form 8-K during the last
fiscal quarter ended December 31, 1998.
25
<PAGE>
(c) Exhibits
No. Description and Method of Filing
- --- --------------------------------
2.1 Stock Acquisition Agreement and Plan of Reorganization dated
April 12, 1995 between Chaparral Resources, Inc., and the
Shareholders of Central Asian Petroleum, Inc., incorporated by
reference to Exhibit 2.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended May 31, 1995.
2.2 Escrow Agreement dated April 12, 1995 between Chaparral
Resources, Inc., the Shareholders of Central Asian Petroleum,
Inc. and Barry W. Spector, incorporated by reference to Exhibit
2.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended May 31, 1995.
2.3 Amendment to Stock Acquisition Agreement and Plan of
Reorganization dated March 10, 1996 between Chaparral Resources,
Inc., and the Shareholders of Central Asian Petroleum, Inc.,
incorporated by reference to the Company's Registration Statement
No. 333-7779.
3.1 Restated Articles of Incorporation + Amendments dated September
25, 1976, incorporated by reference to Exhibit 3.1 to the
Company's Annual Report on Form 10-K for the fiscal year ended
November 30, 1993.
3.2 Articles of Amendment to the Restated Articles of Incorporation +
Amendments dated April 21, 1988, incorporated by reference to
Exhibit 3.2 to the Company's Annual Report on Form 10-K for the
fiscal year ended November 30, 1993.
3.3 Articles of Amendment to the Restated Articles of Incorporation +
Amendments dated April 12, 1994, incorporated by reference to
Exhibit 3.3 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997.
3.4 Articles of Amendment to the Restated Articles of Incorporation +
Amendments dated June 21, 1995, incorporated by reference to
Exhibit B to the Company's Quarterly Report on Form 10-Q for the
quarter ended May 31, 1995.
3.5 Articles of Amendment to the Restated Articles of Incorporation +
Amendments dated July 17, 1996, incorporated by reference to the
Company's Registration Statement No. 333-7779.
3.6 Articles of Amendment to the Restated Articles of Incorporation +
Amendments dated November 25, 1997, incorporated by reference to
Exhibit 3.1 to the Company's Current Report on Form 8-K dated
October 31, 1997.
3.7 Bylaws, as amended through October 31, 1997, incorporated by
reference to Exhibit 3(ii) to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997.
10.1 Chaparral Resources, Inc. 1989 Stock Warrant Plan effective May
1, 1989, incorporated by reference to Exhibit 10.3 to the
Company's Annual Report on Form 10-K for the fiscal year ended
November 30, 1993.
10.2 Warrant Certificate entitling Allen & Company to purchase up to
1,022,000 shares of Common Stock of Chaparral Resources, Inc.,
incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K dated April 1, 1996.
10.3 Amendments to Chaparral Resources, Inc. Stock Warrant Plan,
incorporated by reference to Exhibit 10.16 to the Company's
Annual Report on Form 10-K for the fiscal year ended November 30,
1996.
26
<PAGE>
Exhibit No. Description and Method of Filing
- ----------- --------------------------------
10.4 Agreement dated August 30, 1995 for Exploration Development and
Production of Oil in Karakuduk Oil Field in Mangistan Oblast of
the Republic of Kazakhstan between Ministry of Oil and Gas
Industries of the Republic of Kazakhstan for and on Behalf of the
Government of the Republic of Kazakhstan and Joint Stock Company
of Closed Type Karakuduk Munay Joint Venture, incorporated by
reference to Exhibit 10.17 to the Company's Annual Report on Form
10-K for the fiscal year ended Novembe
10.5 License for the Right to Use the Subsurface in the Republic of
Kazakhstan, incorporated by reference to Exhibit 10.18 to the
Company's Annual Report on Form 10-K for the fiscal year ended
November 30, 1996.
10.6 Subscription Agreement dated April 22, 1997 between Chaparral
Resources, Inc. and Victory Ventures LLC, incorporated by
reference to Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997.
10.7 Warrant Certificate dated December 31, 1997 entitling Victory
Ventures LLC to purchase up to 4,615,385 shares of Common Stock
of Chaparral Resources, Inc., incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1997.
10.8 Form of Warrant issued to Black Diamond Partners LP, Clint D.
Carlson, John A. Schneider, Victory Ventures LLC, Whittier Energy
Company and Whittier Ventures LLC in connection with loans made
by them to Chaparral Resources, Inc. in November and December
1996 and to Black Diamond Partners LP, Clint D. Carlson, Wittier
Energy Company and Whittier Ventures LLC in July 1997 in
connection with the same loans, incorporated by reference to
Exhibit 10.3 to the Company's Quarterly Report quarter ended June
30, 1997.
10.9 Chaparral Resources, Inc. 1997 Incentive Stock Plan, incorporated
by reference to Exhibit 10.4 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997.
10.10 Amendment to Common Stock Purchase Warrant dated December 31,
1997 entitling Victory Ventures LLC to purchase up to 4,615,385
shares of Common Stock of Chaparral Resources, Inc., incorporated
by reference to Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997.
10.11 Amendment dated September 11, 1997, to License for Right to Use
the Subsurface in the Republic of Kazakhstan, incorporated by
reference to Exhibit 10.2 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997.
10.12 Warrant Certificate entitling Allen & Company, Incorporated to
purchase up to 900,000 shares of Common Stock of Chaparral
Resources, Inc., incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K/A dated October 31, 1997.
10.13 Form of Subscription Agreement dated November 21, 1997,
incorporated by reference to Exhibit 10.19 to the Company's
Current Report on Form 8-K dated October 31, 1997.
10.14 Letter dated February 4, 1998, from the Company to Michael B.
Young, incorporated by reference to Exhibit 10.29 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1997.
10.15 Release and Understanding with H. Guntekin Koksal, incorporated
by reference to Exhibit 10.30 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1997.
27
<PAGE>
Exhibit No. Description and Method of Filing
- ----------- --------------------------------
10.16 Termination Agreement dated March 6, 1998 with Exeter Finance
Group, incorporated by reference to Exhibit 10.31 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1997.
10.17 Agreement dated March 7, 1998, with Munay-Imp ex, incorporated by
reference to Exhibit 10.32 to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1997.
10.18 Agreement dated March 31, 1998, effective as of November 4, 1997,
between the Company and Allen & Company, Incorporated,
incorporated by reference to Exhibit 10.33 to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31,
1997.
10.19 Subscription Agreement dated April 1, 1998 between the Company
and Network Fund III, Ltd., incorporated by reference to Exhibit
10.1 to the Company's Current Report on Form 8-K dated April 3,
1998.
10.20 Form of Subscription Agreement between the Company and certain
investors, incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K dated July 28, 1998.
10.21 Subordinated Loan Agreement dated as of June 4, 1997 between the
Company and Allen & Company, Incorporated, incorporated by
reference to Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998.
10.22 Warrants issued to Allen & Company, Incorporated and John G.
McMillian, incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1998.
10.23 Loan agreements between the Company and Howard Karren dated May
27, 1998 and July 1, 1998, respectively, incorporated by
reference to Exhibit 10.3 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998.
10.24 1998 Incentive and Nonstatutory Stock Option Plan
10.25 Amendment to License for the Right to Use the Subsurface in the
Republic of Kazakhstan, dated December 31, 1998.
10.26 Credit Support and Pledge Agreement between Whittier Ventures,
LLC and Chaparral Resources, Inc. dated July 2, 1998,
incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1998.
10.27 Warrants issued to Whittier Ventures, LLC, incorporated by
reference to Exhibit 10.2 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998.
10.28 Settlement Agreement and Release between Heartland, Inc. of
Wichita and Collins & McIlhenny, Inc. and Chaparral Resources,
Inc., Howard Karren, Whittier Trust Company and James A. Jeffs
dated October 30, 1998, incorporated by reference to Exhibit 10.3
to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1998.
10.29 Warrants issued to Heartland, Inc. of Wichita and Collins &
McIlhenny, Inc., as joint tenants and to Don M. Kennedy,
incorporated by reference to Exhibit 10.4 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1998.
10.30 Loan Agreement between Challenger Oil Services, PLC and Chaparral
Resources, Inc. dated September 10, 1998, incorporated by
reference to Exhibit 10.5 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998.
28
<PAGE>
Exhibit No. Description and Method of Filing
- ----------- --------------------------------
10.31 Promissory Note between Challenger Oil Services, PLC and
Chaparral Resources, Inc. dated September 10, 1998, incorporated
by reference to Exhibit 10.6 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998.
10.32 International Daywork Drilling Contract - Land between Challenger
Oil Services, PLC and Karakuduk-Mu nay, Inc., dated April 7, 1998
10.33 Amendment No. 1 to the International Daywork Drilling Contract -
Land between Challenger Oil Services, PLC and Karakuduk-Munay,
Inc., dated April 7, 1998.
10.34 Amendment No. 2 to the International Daywork Drilling Contract -
Land between Challenger Oil Services, PLC and Karakuduk-Munay,
Inc., dated March 17, 1999.
10.35 Letter Agreement dated March 17, 1999, between Karakuduk-Munay,
Inc. and Challenger Oil Services, PLC.
10.36 Letter Agreement and Restated Amendment No. 1 to Loan Agreement
and Promissory Note dated March 18, 1999, between Challenger Oil
Services, PLC and the Company.
21 Subsidiaries of the Registrant, incorporated by reference to
Exhibit 21 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997.
23.1 Consent of Ernst & Young LLP.
23.2 Consent of Ernst & Young Kazakhstan
27 Financial Data Schedule
29
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CHAPARRAL RESOURCES, INC.,
a Colorado corporation
By /s/ Dr. Jack A. Krug
-------------------------------------------
Dr. Jack A. Krug
President and Chief Operating Officer
By /s/ Michael B. Young
-------------------------------------------
Michael B. Young, Treasurer, Controller,
and Principal Accounting Officer
Dated April 14, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Date Name and Title Signature
- ---- -------------- ---------
April 14, 1999 Ted Collins, Jr., Director /s/ Ted Collins, Jr.
------------------------
April 14, 1999 David A. Dahl, Director /s/ David A. Dahl
------------------------
April 14, 1999 James A. Jeffs, Director /s/ James A. Jeffs
------------------------
April 14, 1999 Richard L. Grant, Director /s/ Richard L. Grant
------------------------
April 14, 1999 John G. McMillian, Director /s/ John G. McMillian
------------------------
April 14, 1999 Arlo G. Sorensen Director /s/ Arlo G. Sorensen
------------------------
April 14, 1999 *By /s/ Dr. Jack A. Krug
------------------------
Dr. Jack A. Krug,
Attorney-in-Fact
30
<PAGE>
Consolidated Financial Statements
Chaparral Resources, Inc.
Years ended December 31, 1998, December 31, 1997,
and November 30, 1996 and the One Month Period ended December 31,
1996 with Reports of Independent Auditors
31
<PAGE>
CHAPARRAL
CHAPARRAL RESOURCES, INC.
Consolidated Financial Statements
Contents
Chaparral Resources, Inc.
Report of Independent Auditors ............................................33
Audited Consolidated Financial Statements
Consolidated Balance Sheets ...............................................34
Consolidated Statements of Operations......................................36
Consolidated Statements of Cash Flows......................................37
Consolidated Statements of Changes in Stockholders' Equity.................40
Notes to Consolidated Financial Statements.................................41
Supplemental Information - Disclosures About Oil and Gas
Producing Activities - Unaudited........................................59
Karakuduk-Munay, Inc.
Report of Independent Auditors.............................................63
Audited Financial Statements
Balance Sheets.............................................................64
Statements of Operations...................................................65
Statements of Cash Flows...................................................66
Statements of Shareholders' Deficit........................................67
Notes to Financial Statements..............................................68
32
<PAGE>
Report of Independent Auditors
The Board of Directors and Stockholders
Chaparral Resources, Inc.
We have audited the accompanying consolidated balance sheets of Chaparral
Resources, Inc. as of December 31, 1998 and 1997 and the related consolidated
statements of operations, cash flows and changes in stockholders' equity for
each of the two years then ended and for the one month period ended December 31,
1996 and the year ended November 30, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Chaparral
Resources, Inc. as of December 31, 1998 and 1997, and the consolidated results
of its operations and its cash flows for the two years then ended and for the
one month period ended December 31, 1996 and the year ended November 30, 1996 ,
in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 2 to the financial
statements, the Company has incurred recurring operating losses and has no
operating assets which are presently generating cash to fund its operating and
capital requirements. The Company requires significant additional financing to
meet its financial commitments and requirements through calendar year 1999.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management's plans in regard to these matters are also
described in Note 2. 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 this uncertainty.
/S/ ERNST & YOUNG LLP
Houston, Texas
April 8, 1999
33
<PAGE>
<TABLE>
<CAPTION>
CHAPARRAL RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
December 31 December 31
1998 1997
------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 121,000 $ 3,423,000
Restricted cash (Note 3) 756,000 --
Accounts receivable 25,000 102,000
Prepaid expenses 76,000 62,000
Current portion of note receivable (Note 4) 420,000 --
------------------------------------
Total current assets 1,398,000 3,587,000
Note receivable (Note 4) 589,000 --
Oil and gas properties and investments - full cost method
Republic of Kazakhstan (Karakuduk Field)--
Not subject to depletion (Notes 5 and 6): 32,261,000 19,922,000
Furniture, fixtures and equipment 93,000 13,000
Less accumulated depreciation (17,000) (3,000)
------------------------------------
76,000 10,000
------------------------------------
Total assets $ 34,324,000 $ 23,519,000
====================================
See accompanying notes
34
<PAGE>
CHAPARRAL RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
December 31 December 31
1998 1997
---------------------------------
Liabilities and stockholders' equity
Current liabilities:
Trade accounts payable $ 223,000 $ 177,000
Accrued liabilities:
Accrued compensation 418,000
Accrued other 104,000 54,000
Current portion of note payable, net of discount (Note 7) 940,000 --
---------------------------------
Total current liabilities 1,685,000 231,000
Accrued compensation (Note 13) 210,000 210,000
Redeemable preferred stock (Note 10)- cumulative, convertible,
Series A, 50,000 issued and outstanding,
at stated value, $5.00 cumulative annual
dividend, $5,250,000 redemption value 4,850,000 4,500,000
Stock Subscription - 0 shares subscribed at
December 31, 1998 175,000 shares subscribed
(25,000 Series A; 75,000 Series B;
75,000 Series C) at December 31, 1997 -- --
Stockholders' equity (Note 8):
Common stock - authorized, 100,000,000 shares
at December 31, 1998 and December 31, 1997, of
$.10 par value; issued and outstanding,
58,378,790 and 49,720,456 shares at
December 31, 1998 and December 31, 1997 5,837,000 4,971,000
Capital in excess of par value 41,774,000 30,340,000
Unearned portion of restricted stock awards (56,000) (109,000)
Preferred stock - 1,000,000 shares authorized,
225,000 shares designated of
Series A, B, and C as per above -- --
Stock subscription receivable (Note 10) (506,000) (1,770,000)
Accumulated deficit (19,470,000) (14,854,000)
------------------------------------
Total stockholders' equity 27,579,000 18,578,000
-------------------------------------
Total liabilities and stockholders' equity $ 34,324,000 $ 23,519,000
====================================
See accompanying notes.
35
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CHAPARRAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended Year Ended Month Ended Year Ended
December 31 December 31 December 31 November 30
1998 1997 1996 1996
---------------------------------------------------------------------
Revenue:
<S> <C> <C> <C> <C>
Oil and gas sales $ -- $ -- $ -- $ 147,000
Costs and expenses:
Production costs -- -- -- 37,000
Depreciation and depletion 14,000 7,000 -- 3,000
General and administrative 3,017,000 1,654,000 118,000 1,468,000
----------------------------------------------------------------------
3,031,000 1,661,000 118,000 1,508,000
----------------------------------------------------------------------
Loss from operations (3,031,000) (1,661,000) (118,000) (1,361,000)
Other income (expense):
Interest income 1,184,000 421,000 4,000 154,000
Interest expense (205,000) (298,000) (17,000) (90,000)
Equity in loss from investment (Note 5, (1,744,000) (832,000) -- (971,000)
Note 6, and Note 19)
Legal settlement (Note 9) (234,000) -- -- --
Other, net -- (19,000) 1,000 89,000
---------------------------------------------------------------------
(999,000) (728,000) (12,000) (818,000)
---------------------------------------------------------------------
Loss before extraordinary item (4,030,000) (2,389,000) (130,000) (2,179,000)
Extraordinary loss on extinguishment of
long-term debt (236,000) (214,000) -- (237,000)
---------------------------------------------------------------------
Net loss $ (4,266,000) $ (2,603,000) $ (130,000) $ (2,416,000)
=====================================================================
Basic and diluted earnings per share:
Net loss per share before extraordinary item $ (.08) $ (.05) $ -- $ (.07)
Extraordinary loss per share $ (.01) $ (.01) $ -- $ (.01)
Loss per share $ (.09) $ (.06) $ -- $ (.08)
Weighted average number of shares
outstanding 53,908,649 41,561,432 37,526,517 32,081,382
See accompanying notes
36
<
<PAGE>
CHAPARRAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASHFLOWS
Year ended Year ended Month Ended Year Ended
December 31 December 31 December 31 November 30
1998 1997 1996 1996
-----------------------------------------------------------------
Cash flows from operating activities
Net loss $(4,266,000) $(2,603,000) $ (130,000) $(2,416,000)
Adjustments to reconcile net loss to
net cash used in operating
Activities:
Equity loss from investment 1,744,000 832,000 -- 971,000
Depreciation and depletion 14,000 7,000 -- 4,000
Loss on the sale of oil and gas properties -- 3,000 (3,000) --
Bad debt expense 29,000 37,000 -- --
Write-down of oil and gas properties -- 30,000 -- --
Stock issued for services and bonuses 600,000 78,000 -- --
Stock options issued for services and bonuses 113,000 117,000 -- --
Warrants issued for legal settlement 34,000 -- -- --
Amortization of note discount 154,000 198,000 -- --
Loss on extinguishment of debt 236,000 214,000 -- 237,000
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable 48,000 (129,000) 51,000 25,000
Prepaid expenses (14,000) (59,000) -- 10,000
Note receivable (1,009,000) -- -- --
Other -- 95,000 -- --
Increase (decrease) in:
Accounts payable 46,000 177,000 (44,000) 108,000
Accrued liabilities other 50,000 19,000 (19,000) (317,000)
Accrued compensation 418,000 -- -- 385,000
-----------------------------------------------------------------
Net cash used in operating activities $(1,803,000) $ (984,000) $ (145,000) $ (993,000)
37
<PAGE>
CHAPARRAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASHFLOWS (CONTINUED)
Cash flows from investing activities
Additions to property and equipment $ (80,000) $ (6,000) $ -- $ --
Investment in and advances to foreign oil and
gas properties (14,083,000) (6,504,000) (17,000) (6,936,000)
Proceeds from sale of interest in oil and gas
properties - domestic -- 282,000 -- 161,000
Increase in other assets -- -- -- (74,000)
------------ ------------ ------------ ------------
Net cash used in investing activities (14,163,000) (6,228,000) (17,000) (6,849,000)
Cash flows from financing activities
Net proceeds from notes payable $ 2,045,000 $ 300,000 $ 500,000 $ 1,650,000
Restricted cash (756,000) -- -- --
Payable for CAP-G shares -- (744,000) -- --
Repayment of note payable (1,095,000) (450,000) (200,000) (750,000)
Proceeds from warrant exercise 20,000 3,309,000 -- 316,000
Net proceeds from redeemable preferred stock
issuance -- 5,000,000 -- --
Net proceeds from private placement 12,450,000 2,300,000 -- 6,907,000
------------ ------------ ------------ ------------
Net cash provided by financing activities 12,664,000 9,715,000 300,000 8,123,000
------------ ------------ ------------ ------------
Net increase in cash and cash equivalents (3,302,000) 2,503,000 138,000 281,000
Cash and cash equivalents at beginning
of period 3,423,000 920,000 782,000 501,000
------------ ------------ ------------ ------------
Cash and cash equivalents at end of period $ 121,000 $ 3,423,000 $ 920,000 $ 782,000
============ ============ ============ ============
38
<PAGE>
CHAPARRAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASHFLOWS (CONTINUED)
Supplemental cash flow disclosure
Interest paid $ 58,000 $ 53,000 $ 17,000 $ 36,000
Supplemental schedule of noncash
Investing and financing activities
Common stock issued for acquisition
of CAP-G $ -- $1,000,000 $ -- $1,833,000
Accounts payable--CAP-G shares -- -- -- 744,000
Discount recognized for note issued
with detachable stock warrants 146,000 74,250 93,750 290,000
Warrants issued for common stock in
conjunction with subscription and issuance
of preferred stock -- 2,270,000 -- --
Common stock issued for accrued
compensation -- 175,000 -- --
Common stock issued upon:
Conversion of debentures -- 1,500,000 -- 264,000
Conversion of accrued interest -- 50,000 -- --
See accompanying notes.
39
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CHAPARRAL RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Capital in Stock Unearned
--------------------- Excess of Par Subscription Restricted Accumulated
Shares Amount Value Receivable Stock Awards Deficit Total
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at November 30, 1995 20,484,192 2,048,000 12,577,000 -- -- (9,705,000) 4,920,000
Warrants exercised for
capital stock 857,325 86,000 230,000 -- -- -- 316,000
Conversion of debentures for
capital stock 600,000 60,000 204,000 -- -- -- 264,000
Investment in affiliate 1,585,000 159,000 1,674,000 -- -- -- 1,833,000
Capital stock issued in
private placement 14,000,000 1,400,000 5,507,000 -- -- -- 6,907,000
Debt issuance costs-stock
warrants issued -- -- 290,000 -- -- -- 290,000
Net loss -- -- -- -- -- (2,416,000) (2,416,000)
---------------------------------------------------------------------------------------------
Balance at November 30, 1996 37,526,517 3,753,000 20,482,000 -- -- (12,121,000) 12,114,000
Warrants exercised for capital
stock 5,648,077 564,000 2,745,000 -- -- -- 3,309,000
Conversion of debentures for
capital stock 2,169,732 216,000 1,333,000 -- -- -- 1,549,000
Capital stock issued for services 87,669 9,000 69,000 -- -- -- 78,000
Stock options issued for services -- -- 227,000 -- (109,000) -- 118,000
Capital stock issued for accrued
compensation 350,000 35,000 140,000 -- -- -- 175,000
Capital stock issued for
investment in affiliate 400,000 40,000 960,000 -- -- -- 1,000,000
Capital stock issued in private
placement 3,538,461 354,000 1,946,000 -- -- -- 2,300,000
Debt issuance costs--stock
warrants issued -- -- 168,000 -- -- -- 168,000
Preferred stock issuance and
related common stock warrants -- -- 2,270,000 (1,770,000) -- -- 500,000
Net loss -- -- -- -- -- (2,733,000) (2,733,000)
---------------------------------------------------------------------------------------------
Balance at December 31, 1997 49,720,456 4,971,000 30,340,000 (1,770,000) (109,000) (14,854,000) 18,578,000
Warrants exercised for capital
stock 80,000 8,000 12,000 -- -- -- 20,000
Conversion of debentures for
capital stock -- -- -- -- -- -- --
Capital stock issued for services 245,000 25,000 620,000 -- (45,000) -- 600,000
Stock options issued for service -- -- 34,000 -- (34,000) -- --
Stock options expired -- -- (19,000) -- 17,000 -- (2,000)
Amortization of restricted stock
awards -- -- -- -- 115,000 -- 115,000
Capital stock issued in private
placement 8,333,334 833,000 11,617,000 -- -- -- 12,450,000
Legal Settlement
warrants issued -- -- 34,000 -- -- -- 34,000
Debt issuance costs--stock
warrants issued -- -- 400,000 -- -- -- 400,000
Preferred stock issuance and
related common stock warrants -- -- (1,264,000) 1,264,000 -- -- --
Cumulative dividend Series A
Redeemable Preferred Stock -- -- -- -- -- (250,000) (250,000)
Discount accretion on redeemable
preferred stock -- -- -- -- -- (100,000) (100,000)
Net loss -- -- -- -- -- (4,266,000) (4,266,000)
---------------------------------------------------------------------------------------------
Balance at December 31, 1998 58,378,790 5,837,000 41,774,000 (506,000) (56,000) (19,470,000) 27,579,000
=============================================================================================
See accompanying notes.
40
</TABLE>
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies and Organization
Organization, Principles of Consolidation, and Basis of Presentation
Chaparral Resources, Inc. was incorporated in the state of Colorado on January
13, 1972, principally to engage in the exploration, development and production
of oil and gas properties. During 1998, Chaparral Resources, Inc. focused
substantially all of its efforts on the exploration and development of the
Karakuduk Field, located in the central Asian Republic of Kazakhstan.
The consolidated financial statements include the accounts of Chaparral
Resources, Inc. and its 100% owned subsidiaries, Central Asian Petroleum
(Guernsey) Limited ("CAP-G"), Road Runner Services Company ("RRSC"), and Central
Asian Petroleum, Inc. (Delaware). Hereinafter, Chaparral Resources, Inc. and its
wholly-owned subsidiaries are collectively referred to as "the Company". All
significant intercompany transactions have been eliminated.
In order to unite the reporting period of the Company with that of its
subsidiaries, the fiscal year of the Company was changed to a December 31
year-end from the previous November 30 year-end. This change took effect on May
29, 1997. As a result of this change, a statement of operations and cash flows
for the year ended November 30, 1996 and the month ended December 31, 1996, are
presented.
In 1995, the Company's ownership in CAP-G increased from 25% to 45%. The Company
acquired an additional 45% interest in CAP-G in 1996. In 1997, the Company
concluded the acquisition of the remaining 10% minority interest in CAP-G,
increasing its total ownership to 100%.
CAP-G owns a 50% interest in Karakuduk-Munay, Inc.. ("KKM"), a Kazakhstan joint
stock company, which is a participant in an agreement for the exploration,
development and production of oil in the Karakuduk Field. The Company shares
control of KKM through participation on the Board and accordingly accounts for
its investment using the equity method.
On February 1, 1997, KKM was informed that a Kazakhstan Presidential Edict had
been issued announcing the liquidation of Munaygaz, the government-owned company
which held a 20% interest in KKM. As a result of this action, KKM was required
to re-register as required by Kazakh regulations. KKM was re-registered on July
24, 1997, with the government of Kazakhstan. The Company believes that KKM is
now in compliance with all laws and regulations related to the registration
requirements relating to Kazakhstan legal entities. The re-registered KKM is
owned jointly by CAP-G (50%), KazakhOil (40%) and a private Kazakhstan joint
stock company (10%). KazakhOil, the national petroleum company of Kazakhstan,
represents the majority of the ownership interest in KKM held by the Kazakhstan
government.
Cash and Cash Equivalents
Cash equivalents are defined as highly liquid investments purchased with an
original maturity of three months or less.
Oil and Gas Property and Equipment
The Company and KKM use the full cost method of accounting for their oil and gas
properties. All costs incurred directly associated with the acquisition,
exploration and development of oil and gas properties are capitalized in cost
pools for each country in which the Company operates. The limitation on such
capitalized costs is determined in accordance with rules specified by the
Securities and Exchange Commission. Capitalized costs are depleted using the
units of production method based on proven reserves.
41
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. Summary of Significant Accounting Policies and Organization (Continued)
Sales of Proved Oil and Gas Property
Sales of oil and gas properties, whether or not being amortized currently, are
accounted for as adjustments of capitalized costs, with no gain or loss
recognized unless such adjustments significantly alter the relationship between
capitalized costs and proved reserves of oil and gas. A significant alteration
would not ordinarily be expected to occur for sales involving less than 25% of
the reserve quantities of a given cost center. If gain or loss is recognized on
such a sale, total capitalized costs within the cost center are allocated
between the reserves sold and reserves retained on the same basis used to
compute amortization, unless there are substantial economic differences between
the properties sold and those retained, in which case capitalized costs are
allocated on the basis of the relative fair values of the properties.
Oil and Gas Properties Not Subject to Depletion
Costs associated with acquisition and evaluation of unproved properties are
excluded from the amortization computation until it is determined if proved
reserves can be attributed to the properties. These unevaluated properties are
assessed annually for possible impairment and the amount impaired, if any, is
added to the amortization base. Costs of exploratory dry holes and geological
and geophysical costs not directly associated with specific unevaluated
properties are added to the amortization base as incurred.
Revenue Recognition
Revenues and their related costs are recognized upon delivery of commercial
quantities of oil and gas production, in accordance with the accrual method of
accounting. Losses, if any, are provided for in the period in which the loss is
determined to occur.
Depreciation of Other Property and Equipment
Furniture, fixtures and equipment are recorded at cost and are depreciated using
the straight-line method over estimated useful lives, which range from three to
ten years.
Income Taxes
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes,
which require that taxes be provided on the liability method based upon the tax
rate at which items of income and expense are expected to be settled in the
Company's tax return.
Loss Per Common Share
Basic loss per common share is calculated by dividing net loss, after deducting
preferred stock dividends, by the aggregate of the weighted average shares
outstanding during the period. Diluted loss per common share considers the
dilutive effect of the average number of common stock equivalents that are
outstanding during the period.
42
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. Summary of Significant Accounting Policies and Organization (Continued)
Loss Per Common Share (Continued)
Diluted loss per share is not presented because the exercise of 3,483,500 stock
options and 4,554,500 warrants are antidilutive. In addition, the effect of the
conversion of the convertible preferred stock into 2,335,178 shares of common
stock is also antidilutive.
The following table sets forth the computation of the numerator for purposes of
determining basic and diluted loss per share.
<TABLE>
<CAPTION>
Year ended Year ended Month Ended Year Ended
December 31 December 31 December 31 November 30
1998 1997 1996 1996
--------------------------------------------------------------------
<S> <C> <C> <C> <C>
Loss before extraordinary item ($4,030,000) ($2,389,000) ($ 130,000) ($2,179,000)
Cumulative annual dividend
Series A Redeemable Preferred Stock (250,000) -- -- --
Discount accretion
Series A Redeemable Preferred Stock (100,000) -- -- --
--------------------------------------------------------------------
Numerator for basic and diluted loss per share ($4,380,000) ($2,389,000) ($ 130,000) ($2,179,000)
=========== =========== =========== ===========
</TABLE>
Stock Based Compensation
The Company follows the method of accounting for employee stock based
compensation plans prescribed by APB No. 25, which is allowed by SFAS No. 123,
Accounting for Stock-Based Compensation. In accordance with APB No. 25, the
Company has not recognized compensation expense for stock options in situations
where the exercise price of the options equals the market price of the
underlying stock on the date of grant, otherwise known as the measurement date.
New Accounting Standards
In February 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 132, Employers' Disclosures about Pensions and Other Postretirement
Benefits, which revises employers' disclosures about pension and other
postretirement benefit plans. It does not change the measurement or recognition
of those plans. The Company adopted SFAS 132 during 1998. The impact of SFAS 132
on the Company's reporting of pension and other post retirement benefits is not
material.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This standard provides a comprehensive and
consistent standard for the recognition and measurement of derivatives and
hedging activities. This statement is effective for years beginning after June
15, 1999. As of December 31, 1998, the Company has not adopted SFAS 133. The
Company is evaluating SFAS 133 and intends to adopt the statement no later than
January 1, 2000. The impact of SFAS 133 on the Company's financial position and
results of operations is not expected to be material.
Fair Value of Financial Instruments
All of the Company's financial instruments, including cash and cash equivalents,
trade receivables, notes receivable, and notes payable, have fair values which
approximate their recorded values as they are either short-term in nature or
carry interest rates which approximate market rates.
43
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. Summary of Significant Accounting Policies and Organization (Continued)
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Risks and Uncertainties
The ability of KKM to realize the carrying value of its assets is dependent on
being able to extract, transport and market hydrocarbons. Currently, exports
from the Republic of Kazakhstan are restricted since they are dependent on
limited transport routes and, in particular, access to the Russian pipeline
system. Domestic markets in the Republic of Kazakhstan might not currently
permit world market prices to be obtained. Management believes, however, that
over the life of the project, transportation restrictions will be alleviated and
prices will be achievable for hydrocarbons extracted to allow full recovery of
the carrying value of its assets.
2. Going Concern
The Company's financial statements have been presented on the basis that it is a
going concern, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. As of December 31, 1998,
substantially all of the Company's assets are invested in the development of the
Karakuduk Field, an oil field in the central Asian Republic of Kazakhstan, which
will require significant additional funding.
The Company has incurred recurring operating losses and has no operating assets
presently generating cash to fund its operating and capital requirements. The
Company's current cash reserves and cash flow from operations will not be
sufficient to meet the expenditure requirements required of KKM by its operating
license through 1999. Should the Company not meet its expenditure requirements
under the license agreement to develop the Karakuduk Field, the Company's rights
under the agreement can be terminated (see Note 16). The Company believes that
additional financing will be available; however, there is no assurance that
additional financing will be available, or if available, that it is timely or on
terms favorable to the Company. The Company's continued existence as a going
concern is dependent upon the success of future KKM operations, which are, in
the near term, dependent on the successful financing and development of the
Karakuduk Field, of which there is no assurance.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
assets or the amounts and classification of liabilities that may result from the
outcome of this uncertainty.
3. Restricted Cash
As of December 31, 1998, the Company held $756,000 cash on hand, as collateral
for loans made by a financial institution to KKM for the acquisition of tangible
equipment used in the Karakuduk Field.
44
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. Notes Receivable
As of December 31, 1998, the Company has an outstanding $1,009,000 note
receivable, dated September 10, 1998, from a third-party drilling contractor
(Contractor). The note consists of $1,000,000 in cash advances from the Company,
plus accrued interest, used by the Contractor to ready a drilling rig for use in
Kazakhstan.
Under the original terms of the note, the principal balance was to be repaid in
twelve monthly payments of approximately $84,000, plus accrued interest,
beginning on the date the first payment is made to the Contractor by KKM for use
of the drilling rig.
On March 17, 1999, the Company amended the terms of the note to extend the
repayment period from twelve to twenty four months, beginning with the first
payment to the Contractor for services provided to KKM. The Company will receive
principal payments of approximately $42,000 per month, plus accrued interest,
through February 2001. As of December 31, 1998, the Company recorded $420,000 as
the current portion of note receivable, reflecting management's estimated
repayment to be received during 1999.
5. Acquisition of CAP-G
As of December 31, 1998, the Company owns 100% of the outstanding common stock
of CAP-G. This wholly-owned subsidiary was acquired on a step basis. The Company
acquired 45% of the outstanding stock of CAP-G prior to December 1, 1995. In
January and February 1996, the Company entered into agreements to acquire, for a
total of $5,850,000 cash and 1,785,000 shares of the Company's restricted common
stock, the remaining 55% of the outstanding stock of CAP-G.
The Company consummated the purchase of 25% of the outstanding stock of CAP-G in
April 1996 by paying $2,000,000 in cash and issuing 685,000 shares of the
Company's common stock. The Company acquired an additional 5% of the outstanding
common stock of CAP-G in April 1996 for $250,000 cash.
To acquire an additional 15% of the outstanding common stock of CAP-G, the
Company agreed to pay $1,975,000 in cash and issue 900,000 shares of the
Company's common stock. This purchase was consummated on March 11, 1996, when
the Company paid $750,000 in cash and issued 900,000 shares of the Company's
common stock. The remaining cash balance of $1,225,000 for the purchase was to
be paid in four quarterly equal payments of $306,250 between June 11, 1996 and
March 11, 1997. The first payment of $306,250 was paid in June 1996 and an
additional $175,000 was paid in September 1996. The agreement was subsequently
revised so that the Company paid $200,000 in December 1996 and the remaining
balance of $543,750 in a series of payments in 1997.
Finally, in 1997 the Company exercised an option to acquire the remaining 10% of
the outstanding common stock of CAP-G. The Company paid $1,625,000 (which
includes $800,000 of loans the Company previously made to GAP-G on behalf of the
prior owner of the 10% interest) and issued 400,000 shares of common stock,
which includes an additional 200,000 shares above the original agreed amount.
On September 17, 1997, the Company granted an option to an investor entitling
the investor to acquire 5% of the issued and outstanding shares of CAP-G on or
before October 31, 1997. Upon the closing of this agreement, the investor paid
the Company $450,000 of the $1.5 million purchase price, with the remaining due
on or before September 30, 1997. The option agreement expired and the Company
was not required to return the deposit. The Company has recorded the $450,000
deposit as a reduction in the oil and gas properties and investments in
Kazakhstan.
The acquisition costs exceeding the underlying net assets at the time of each
acquisition of CAP-G common stock have been added to Oil and Gas Investments
reflected on the balance sheet. The equity in losses for 1997 and 1996 have been
recorded at the full 50% interest due to the earlier agreements to acquire the
remaining shares in CAP-G and the Company financing 100% of CAP-G's operations.
45
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. Oil and Gas Investments
All costs capitalized related to the Karakuduk license are included in oil and
gas properties not subject to depletion. Certain license acquisition costs and
geological and geophysical expenditures incurred by the Company but not rebilled
to KKM have been capitalized. Certain overhead costs and general administrative
costs have been expensed as incurred by KKM.
Costs capitalized to Oil and Gas Investments consist of:
December 31, December 31,
1998 1997
-----------------------------
Oil and Gas Investments:
Investments in KKM common stock $ 100,000 $ 100,000
Advances to and interest due from KKM 23,380,000 9,820,000
Acquisition costs 10,613,000 10,613,000
Other capitalizable costs 1,715,000 1,192,000
-----------------------------
Total gross oil and gas investments 35,808,000 21,725,000
Less: equity losses (3,547,000) (1,803,000)
-----------------------------
Total oil and gas investment $ 32,261,000 $ 19,922,000
=============================
The condensed financial statements of KKM are as follows:
December 31, December 31,
1998 1997
------------------------------
Condensed Balance Sheet
Current Assets $ 730,000 $ 796,000
Non-Current Assets (primarily oil
and gas properties,
full cost method) 19,130,000 7,975,000
Current Liabilities
Current Loan Payable to Related Party 3,000,000 --
Other Current Liabilities 3,205,000 2,767,000
Non-Current Liabilities
Loan Payable to Related Party 20,380,000 9,820,000
Other Non-Current Liabilities 578,000 --
Common stock 200,000 200,000
Accumulated Deficit 7,503,000 4,016,000
Condensed Income Statement
Revenues $ -- $ --
Cost and Expenses 3,488,000 1,665,000
Net Loss $ 3,488,000 $ 1,665,000
The Karakuduk Field is still in a preliminary stage of development by KKM. The
estimated future development expenditures in order to ascertain the quantities
of proved reserves attributable to the Karakuduk Field are significant. All
costs incurred related to the workover program have been capitalized as
exploration costs to oil and gas properties not subject to depletion.
While the future ability of the Company to export hydrocarbons and therefore
realize world market prices is uncertain under current restricted transport
options in the Republic of Kazakhstan, management believes that over the life of
the project as a whole, future cash flows justify the carrying amount of the oil
and gas properties. No impairment provision has been reflected in these
financial statements.
46
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. Notes Payable
On December 3, 1998, the Company restructured a $975,000 loan that the Company
borrowed on July 3, 1998, from the Chase Bank of Texas ("Chase"). Under the new
terms, the note accrues interest at an adjustable prime rate, as determined by
Chase. As of December 31, 1998 the stated prime rate was 7.75%. Principal
payments in the amount of $250,000, plus accrued interest, are due quarterly,
beginning on February 28, 1999.
The $975,000 loan is fully guaranteed with a stand-by letter of credit from an
investor in the Company. In return for issuing the loan guarantee, the Company
paid the guarantor $10,000 plus related costs, issued warrants to purchase
20,000 shares of the Company's common stock (See Note 8), and granted the
guarantor a security interest in the Company's common stock of Central Asian
Petroleum (Guernsey) ("CAP-G").
In the event of the Company's default on the $975,000 note, the guarantor's
security interest in the Company's common stock in CAP-G cannot be perfected for
at least 30 days after notification of such default. In the event of default,
the Company may make full payment of any outstanding principal and interest on
the note plus any additional charges incurred by the guarantor to completely
remove any security interest held by the guarantor.
8. Common Stock
1989 Stock Warrant Plan
During 1989, the Board of Directors approved a stock warrant plan for key
employees and directors. The Company reserved 1,175,000 shares of its common
stock for issuance under the plan. The warrants must be granted and exercised
within a 10-year period ending April 30, 1999. Immediately following approval of
the plan by the Board of Directors, warrants for 1,175,000 shares were granted
with an exercise price of $.28 per share. Warrants for 100,000, 225,000, and
100,000 shares were exercised for values of $28,000, $63,000, and $28,000 during
1997, 1996, and 1995, respectively.
1997 Incentive Stock Plan
On July 17, 1997, the shareholders of the Company approved the 1997 Incentive
Stock Plan pursuant to which up to 1,000,000 shares of the Company's common
stock may be granted to directors and employees of, or consultants to, the
Company. On June 26, 1998, the shareholders of the Company repealed the 1997
Incentive Stock Plan and approved the 1998 Incentive and Nonstatutory Stock
Option Plan, described below. No options were granted under this plan.
1997 Non-employee Directors' Stock Option Plan
On July 17, 1997, the shareholders approved the 1997 Non-employee Directors'
Stock Option Plan, which authorized granting 25,000 options annually to each
non-employee director in office or elected to the Board of Directors of the
Company, as of the date of the annual meeting of the Company's shareholders. On
June 26, 1998, the shareholders of the Company repealed the 1997 Non-employee
Directors' Stock Option Plan and approved the 1998 Incentive and Nonstatutory
Stock Option Plan, described below. As of June 26, 1998, the date of termination
of the plan, options for 200,000 shares with an exercise price of $.83 had been
issued to non-employee directors.
47
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Common Stock (Continued)
1998 Incentive and Nonstatutory Stock Option Plan
On June 26, 1998, the shareholders approved the 1998 Incentive and Nonstatutory
Stock Option Plan (the "Plan"), pursuant to which up to 3,000,000 options to
acquire the Company's common stock may be granted to officers, directors,
employees, or consultants of the Company and its subsidiaries. The stock options
granted under the Plan may be either incentive stock options or nonstatutory
stock options. The Plan has an effective term of ten years, commencing on May
20, 1998. The Company did not grant any options under the Plan during 1998.
Non-Qualified Stock Options
During 1997, the Company granted five year non-qualified options, generally with
vesting periods of one year, to purchase 2,885,000 restricted shares of the
Company's common stock to various directors of, and consultants to, the Company.
Options relating to 1,442,500 shares have an exercise price of $.75 per share
and options relating to 1,442,500 shares have an exercise price of $1.50 per
share.
The Company issued various five-year, non-qualified stock options to employees,
consultants and directors of the Company during 1997. The Company granted
options to purchase 126,000 shares of the Company's common stock, at an exercise
price of $.75. The Company granted options to purchase another 131,000 shares of
the Company's common stock, at an exercise price of $1.50 a share. The Company
has recorded the fair value of these stock options at the date of grant at
$227,000.
During 1998, the Company granted five-year non-qualified options to purchase
297,500 shares of the Company's common stock to various employees of, and
consultants to, the Company at various exercise prices ranging between $.72 and
$2.43 per share. The Company recorded the stock options granted to the
consultants at their fair value of $34,000 on the date of grant.
During 1998, 156,000 options to purchase the Company's common stock granted to
various employees of, and consultants to, the Company expired. The options had
exercise prices ranging between $.75 and $2.43 per share.
Common Stock Offerings and Common Stock Warrant Issuances
During 1993, the Company sold a total of 2,685,750 shares of common stock and
issued 1,342,875 warrants to purchase common stock with an exercise price of
$.40. An additional 105,540 warrants to acquire shares of common stock were paid
as commission. Prior to 1995, 650,625 of these warrants were exercised. During
1995, 165,375 of these warrants were exercised for the purchase of shares of
common stock. The exercise price was $.40 per share, for a total of $66,000.
During 1996, 632,325 of these warrants were exercised at an exercise price of
$.40 per share, for a total of $252,930. All warrants issued in connection with
the 1993 private placement have been exercised.
During December 1995 and January 1996, the Company borrowed $1,050,000. In
connection to the loans, the Company issued 780,000 warrants to purchase common
stock at an exercise price of $0.25. During 1998, 80,000 warrants were exercised
at a price of $0.25 for a total of $20,000. On October 30, 1998, 200,000
warrants to purchase the Company's common stock at an exercise price of $0.25
expired.
During 1996, the Company sold 14,000,000 shares of common stock in a private
placement at a price of $.50 per share. In connection with the private
placement, the Company issued warrants to purchase 1,022,000 shares of the
Company's common stock for a total of $10.00 to the sales agent as a commission.
48
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Common Stock (Continued)
In April 1996, private investors converted promissory notes totaling $300,000
into 600,000 shares of the Company's common stock at a conversion price of $.50
per share.
During 1997, the Company entered into an agreement to allow the Company to
acquire M-D, International Petroleum ("MDI"), a private company. Accordingly, on
January 8, 1997 the Company agreed to issue 180,000 shares of the Company's
common stock having a value of $90,000 to the potential joint venture partner.
Simultaneously, the principal stockholders of MDI put 180,000 shares of the
Company's common stock into escrow. These shares would be returned to the
Company if the Company did not acquire MDI by July 7, 1997. Under the agreement,
the Company was to acquire a 5% joint venture interest for the development of
certain natural gas fields in Uzbekistan. The agreement of the Company to
acquire MDI was contingent upon the potential joint venture partner successfully
obtaining rights to develop the natural gas fields in Uzbekistan. As of July 7,
1997, the agreement with Uzbekistan to develop the natural gas fields had not
been obtained. Consequently, the agreement by the Company to acquire MDI was
nullified and the escrowed shares were returned to the Company and retired.
During February 1997, the Company entered into a severance agreement with Paul
V. Hoovler, a former Chief Executive Officer and President of the Company,
pursuant to which Mr. Hoovler received warrants to purchase 100,000 shares of
the Company's common stock at an exercise price of $.85 per share and warrants
to purchase 100,000 shares of the Company's common stock at an exercise price of
$1.25 per share.
During 1997, the Company sold 3,076,923 shares of the Company's common stock for
$.65 per share for a total of $2,000,000 to a private investor. In connection
with the transaction, the Company also issued a warrant to the investor to
purchase up to an additional 4,615,385 shares of the Company's common stock for
$3,000,000 or $.65 per share. The warrant was to expire on December 31, 1997. In
October and November 1997, the private investor exercised warrants to acquire
4,615,385 shares of the Company's common stock. The same party exercised another
warrant for 125,000 shares of the Company's common stock exercisable at an
exercise price of $0.25 per share. In April 1997, a private investor converted a
$500,000 promissory note (plus $2,000 of accrued interest) that had previously
been issued by the Company into 772,991 shares of the Company's common stock at
a conversion price of $.65 per share.
On October 28, 1997, 423,076 shares of the Company's common stock were issued to
a private investor by way of a "cashless" exercise of a warrant as allowed by
the warrant. This warrant was originally exercisable for 500,000 shares at a
conversion price of $.25 per share.
In November 1997, a private investor converted a $1,000,000 promissory note
(plus $48,000 of accrued interest) that previously had been issued by the
Company into 1,396,741 shares of the Company's common stock at a conversion
price of $.75 per share.
During 1997, the Company issued 87,669 shares of the Company's common stock to a
consultant in lieu of $78,000 of accrued fees that had not been paid.
As further described in Note 13, The Company issued 350,000 shares of the
Company's restricted common stock to Mr. Howard Karren, former Chairman of the
Board of Directors of the Company, as payment of $175,000 for services during
1996. The Company recorded accrued compensation of $175,000 in 1996, and issued
the common stock in 1997.
In December 1997, the Company exercised an option to acquire the remaining 10%
of the outstanding shares of CAP-G (Note 3). As part of the consideration, the
Company issued 400,000 shares valued at $1,000,000.
During 1997, the Company sold 461,538 shares of the Company's common stock for
$.65 per share for a total of $300,000 to a private investor. In connection with
the transaction, the Company also issued warrants to the investor to purchase up
to an additional 461,538 shares of the Company's common stock for $300,000 or
$.65 per share. The private investor exercised a portion of the warrant on
December 31, 1997, and received a total of 384,616 shares of the Company's
common stock. The remaining warrants expired on the same day.
49
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Common Stock (Continued)
On January 23, 1998, the Company, granted 90,000 shares of the Company's common
stock to the directors of the Company and granted 185,000 shares of the
Company's common stock to various employees of, and consultants to, the Company,
of which 30,000 shares will vest with respect to 10,000 shares on each of
January 30, 1999, 2000, and 2001. As a result of these transactions, the Company
recognized $600,000 in 1998 compensation expense. An additional $45,000 relating
to the non-vested stock grants will be amortized over the vesting period of the
grants.
On April 3, 1998, the Company sold 1,250,000 shares of the Company's common
stock for $2.00 per share for at total of $2,500,000 to a private investor.
Allen & Company, Incorporated acted as placement agent in connection with the
sale of the 1,250,000 shares. As a result, Allen & Company, Incorporated's
warrants to purchase shares of the Company's common stock, originally issued as
a commission in connection with the Redeemable Preferred Stock sale on November
24, 1997 (See Note 10), became exercisable for an additional 100,000 shares. The
warrants to purchase the additional 100,000 shares of the Company's common stock
are exercisable through November 25, 2002, at an exercise price of $0.01 per
share.
In connection with the $1,000,000 loan referred to in Note 12, on June 4, 1998,
the Company issued warrants to purchase 1,000,000 shares of the Company's common
stock to two related parties, one of which is a director of the Company. The
warrants are exercisable through November 25, 2002, at an exercise price of
$3.50 per share. The Company recorded the fair market value of the warrants
($367,000) as a discount of notes payable, amortizable as interest expense over
the life of the loan. The fair market value of the warrants was estimated as of
June 4, 1998, using the Black-Scholes option pricing model with the following
weighted average assumptions: risk free interest rates of 5.53%, dividend yield
of 0%, volatility factors of the expected market price of the Company's common
stock of .593, and a weighted average life expectancy of the warrants of 4.5
years.
On July 3, 1998, as discussed in Note 7, the Company issued warrants to purchase
20,000 shares of the Company's common stock at an exercise price of $.01 per
share. The Company recorded the fair market value of the warrants (approximately
$32,000) plus the related loan costs, as a discount of notes payable and is
being amortized as additional interest expense over the life of the loan. The
fair market value of the warrants was determined using the Black-Scholes option
pricing model, with the following weighted average assumptions: risk free
interest rate 5.53%, dividend yield of 0%, volatility factors of the Company's
common stock of .644, and a weighted average life expectancy of the warrants of
5 years.
On July 28 and July 29, 1998, the Company sold 6,666,667 shares of the Company's
common stock for $1.50 per share for at total of $10,000,000 to certain
investors. Issuance cost incurred were approximately $50,000 and has been
recorded as a reduction to the proceeds received from the sale. Allen & Company,
Incorporated acted as placement agent in connection with the sale of the
6,666,667 shares. As a result, Allen & Company, Incorporated's warrants to
purchase 900,000 shares of the Company's common stock, originally issued as
commission in connection with the Redeemable Preferred Stock sale on November
24, 1997, became exercisable for an additional 400,000 shares of the Company's
common stock. The 400,000 warrants are exercisable through November 25, 2002, at
an exercise price of $0.01 per share. As of December 31, 1998, 200,000 warrants
held by Allen & Company were unexercisable pending the performance of future
services.
Due to the fact, the sales price of the 6,666,667 shares was below a price of
$2.00 per share, the Company was required to issue an additional 416,667 shares
to the investor who purchased 1,250,000 shares of the Company's common stock for
$2,500,000 in April 1998 in order to satisfy certain price protection agreements
the Company has with such investor.
On October 30, 1998, the Company issued warrants to purchase 200,000 shares of
the Company's common stock at an exercise price of $1.00, exercisable through
January 02, 1999, to settle the lawsuit filed against the Company by Heartland,
Inc. of Wichita and Collins & McIlhenny, Inc. on November 14, 1997. The Company
recorded legal settlement expense of $34,000, equal to the fair market value of
the warrants issued on the date of grant. On January 03, 1999, the 200,000
warrants expired. See Note 9.
50
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Common Stock (Continued)
SFAS 123 Disclosure
SFAS 123 requires that pro forma information regarding net income and earnings
per share be determined as if the Company had accounted for its employee stock
option under the fair value method as defined in that Statement for options
granted or modified after December 31, 1994. SFAS 123 requires disclosure of
option plans for the previous three years, but since 1997 was the first year for
stock option issuances to meet the new requirement, weighted average assumptions
are calculated only for 1997 and 1998. The fair value for applicable options was
estimated at the date of grant using the Black-Scholes option pricing model with
the following weighted average assumptions for 1997 and 1998: risk free interest
rates of 5.53%; dividend yield of 0%; volatility factors of the expected market
price of the Company's common stock between 0.528 and 1.07; and a weighted
average life expectancy of the options of 4.9 years
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the option's vesting period. The Company's pro
forma information follows:
Year ended Year ended Month ended
December 31, December 31, December 31,
1998 1997 1996
----------------------------------------
Net Loss under APB 25 (4,616,000) (2,603,000) (130,000)
Effect of FASB 123 (190,000) (525,000) --
-----------------------------------------
Pro forma Net Loss (4,806,000) (3,128,000) (130,000)
========================================
Pro forma Basic and Diluted
Earnings per Share $ (0.09) $ (0.08) $ --
51
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Common Stock (Continued)
A summary of the Company's stock option activity and related information for the
periods ended follows:
<TABLE>
<CAPTION>
Shares Weighted Weighted
Under Average Exercise Average
Option Price Fair Value
-------------------------------------------------------
<S> <C> <C> <C>
Unexercised options outstanding -
November 30, 1996 -- --
Options Granted 3,342,000 $ 1.11 $ 0.59
Options Exercised -- --
Options Cancelled -- --
-----------------------------------------------------
Unexercised options outstanding -
December 31, 1997 3,342,000 $ 1.11
Options Granted 297,500 $ 1.63 $ 1.09
Options Exercised -- --
Options Cancelled (156,000) $ 1.54
-----------------------------------------------------
Unexercised options outstanding -
December 31, 1998 3,483,500 $ 1.13
Price range $0.72-$1.00
(weighted-average contractual
life of 4.2 years) 1,817,000 $ 0.76
Price range $1.34-$2.43
(weighted-average contractual
life of 3.7 years) 1,666,500 $ 1.53
Exercisable options
November 30, 1996 -- --
December 31, 1997 200,000 $ 0.83
December 31, 1998 3,297,000 $ 1.11
52
</TABLE>
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Common Stock (Continued)
The following table summarizes all common stock purchase warrant activity for
the year ended December 31, 1998:
<TABLE>
<CAPTION>
Number of Exercise
Stock Price
Warrants Range
--------------------------------------------
<S> <C> <C> <C>
Outstanding, November 30, 1995 2,407,325 $ 0.25 - $0.40
Granted 1,439,500 $ 0.00001 - $0.40
Exercised (857,325) $ 0.25 - $0.40
--------------------------------------------
Outstanding, November 30, 1996 2,989,500 $ 0.00001 - $0.28
Granted 6,426,923 $ 0.01 - $1.25
Exercised (5,648,077) $ 0.25 - $0.65
Expired (153,846) $ 0.25 - $0.65
--------------------------------------------
Outstanding, December 31, 1997 3,614,500 $ 0.00001 - $1.25
Granted 1,220,000 $ .01 - $3.50
Exercised (80,000) $ .40
Expired (200,000) $ .25
--------------------------------------------
Outstanding, December 31, 1998 4,554,500 $ 0.00001 - $3.50
============================================
</TABLE>
The following table summarizes the price ranges of all common stock purchase
warrants outstanding as of December 31, 1998:
Stock Warrants Outstanding as of December 31, 1998
--------------------------------------------------
Number of Warrants Exercise Price
-------------------------------------------
1,000,000 $3.50
200,000 $1.00
100,000 $0.85
100,000 $1.25
750,000 $0.28
462,500 $0.25
920,000 $0.01
1,022,000 $.00001
--------------------------------------
4,554,500 $0.00001 - $3.50
9. Legal Settlement
On October 30, 1998, the Company settled the lawsuit filed against the Company
and others in the District Court of Harris County, Texas, by Heartland, Inc. of
Wichita and Collins & McIlhenny, Inc. on November 14, 1997, for a total of
$200,000 and warrants to purchase 200,000 shares of the Company's common stock
at an exercise price of $1.00, exercisable through January 02, 1999. The lawsuit
was dismissed with prejudice for all defendants involved. The Company believes
the lawsuit was without merit, but a settlement was reached to avoid incurring
additional legal costs. The Company recorded the fair market value of the
warrants using the Black-Scholes option pricing model. On January 03, 1999, the
200,000 warrants expired.
10. Redeemable Preferred Stock and Related Common Stock Warrants
On November 24, 1997, the Company entered into a Subscription Agreement
("Agreement") with an unaffiliated investor to purchase 225,000 shares of the
Company's designated Series A, B, and C Redeemable Preferred Stock, for $100 per
share. As of December 31, 1997, the investor had purchased 50,000 shares of the
Company's Series A Redeemable Preferred Stock for $5,000,000. In March 1998, the
Company and the investor mutually released each other from any further
obligations. The Company is not required to issue any additional preferred stock
under the Agreement and the investor has no obligation to provide funds to the
Company in exchange for such stock.
53
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. Redeemable Preferred Stock and Related Common Stock Warrants (Continued)
The Series A Redeemable Preferred Stock is convertible and accrues an annual,
cumulative dividend of $5 per share. The dividends are payable semi-annually on
May 31 and November 30, as declared by the Company's Board of Directors. As of
December 31, 1998, dividends in arrears relating to the Series A Redeemable
Preferred Stock were $250,000. The Company increased the carrying value of the
Series A Redeemable Preferred Stock by $250,000 by accreting this amount
directly to accumulated deficit.
The number of shares of common stock issuable upon conversion of each share of
Series A Redeemable Preferred Stock is determined by dividing $100 by the
conversion price of the preferred stock. As of December 31, 1997, the conversion
price was $2.25 per share. The conversion price is subject to recalculation if,
and when, the Company issues additional common stock or common stock equivalents
to obtain additional equity or debt financing. During 1998, the Company issued
common stock and common stock warrants in both equity and debt financing
transactions. Adjusted for these transactions, the conversion price as of
December 31, 1998 was $2.14 per share (rounded), equivalent to 46.7 shares of
common stock for each share of Series A Redeemable Preferred Stock.
The Series A Redeemable Preferred Stock has voting privileges identical to the
Company's common stock. The total number of votes allowed to the holders of the
Series A Redeemable Preferred Stock is equal to the number of shares of common
stock the Series A Redeemable Preferred Stock could be converted into on the
specific date of record. As of December 31, 1998, the 50,000 shares of Series A
Redeemable Preferred Stock were convertible into 2,335,178 shares of common
stock.
The Series A Redeemable Preferred Stock has preferential liquidation rights over
the Company's common stock. In the event of liquidation or dissolution of the
Company, any assets available for distribution to the Company's shareholders
will first be distributed to the holders of the Series A Redeemable Preferred
Stock up to each redeemable preferred share's liquidation value. The liquidation
value equals $100 per share, plus all unpaid dividends in arrears.
The Series A Redeemable Preferred Stock is subject to mandatory redemptions,
beginning on November 30, 2002. As of December 31, 1998, the schedule of
redemptions of the stated value, plus any unpaid dividends, is as follows:
Year Amount
---------------------------------------
1999 -
2000 -
2001 -
2002 $1,750,000
2003 and Thereafter $3,500,000
----------
Total $5,250,000
=======================================
On November 24, 1997, the Company also designated Series B and C Redeemable
Preferred Stock, authorizing 75,000 shares for each class of preferred. As of
December 31, 1998, none of the Series B or Series C Redeemable Preferred Stock
was issued or outstanding. The conversion price of the Series B Redeemable
Preferred Stock is $3.00 per share and the conversion price of the Series C
Redeemable Preferred Stock is $4.25 per share and the conversion price is
subject to change in a manner similar to the Series A. Except for the conversion
price, the terms and conditions of both the Series B and Series C Redeemable
Preferred Stock are similar in nature to the Series A Redeemable Preferred
Stock.
54
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. Redeemable Preferred Stock and Related Common Stock Warrants (Continued)
Allen & Company, Incorporated ("Allen & Company"), a significant shareholder of
the Company, acted as placement agent in connection with the Agreement. Allen &
Company elected to receive its fees in the form of warrants to purchase 900,000
shares of the Company's common stock that were all originally exercisable
through November 25, 2002, at an exercise price of $.01 per share. The warrants
were recorded at their fair value. Out of the 900,000 warrants issued to Allen &
Company, 200,000 directly relate to the issuance of 50,000 shares of the Series
A Preferred Stock. The 200,000 warrants were recorded as issuance costs of
$500,000, reducing the $5,000,000 proceeds from Series A Preferred Stock. The
remaining 700,000 warrants, discussed below, were recorded as a stock
subscription receivable. The basis difference of $500,000 upon issuance of the
Series A Redeemable Preferred Stock is accreted directly to accumulated deficit
for the period through the redemption date. During 1998, the Company increased
the carrying value of the Series A Redeemable Preferred Stock by $100,000 to
reflect the current year accretion.
In an agreement dated March 31, 1998, the Company agreed to allow Allen &
Company to retain, subject to certain performance criteria, the warrants to
purchase 700,000 shares of the Company's common stock related to the
subscriptions not received under the original terms of the Agreement. The
unearned portion of the warrants is presented as a $1,770,000 stock subscription
receivable as of December 31, 1997.
The unearned warrants to purchase 700,000 shares of the Company's common stock
held by Allen & Company are fully restricted from exercise unless Allen &
Company assists the Company in raising additional capital on acceptable terms to
the Company's Board of Directors. For each $25 of additional capital raised, a
warrant to purchase one share of common stock is deemed earned by Allen &
Company.
During 1998, Allen & Company assisted the Company in raising an additional
$12,500,000 in equity capital. As a result, 500,000 of the 700,000 warrants are
no longer restricted. As of December 31, 1998, the remaining 200,000 restricted
warrants are presented as a $506,000 stock subscription receivable in equity.
If, before November 25, 1999, Allen & Company fails to assist the Company in
raising an additional $5,000,000 in capital under acceptable terms, the unearned
portion of the warrants will expire.
11. Income Taxes
The following is a summary of the provision for income taxes:
<TABLE>
<CAPTION>
One Month
Year Ended Year Ended Ended Year Ended
December 31, December 31, December 31, November 30,
1998 1997 1996 1996
--------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income taxes (benefit) computed
at federal statutory rate $(1,493,000) $ (910,000) (46,000) $ (762,000)
Other 121,000 (60,000) (3,000) (86,000)
Change in asset valuation
Allowance 1,372,000 970,000 49,000 848,000
--------------------------------------------------------------------------
Income taxes $ -- $ -- $ -- $ --
==========================================================================
The components of the Company's deferred tax assets and liabilities under FASB No. 109 are as follows:
1998 1997 1996
----------------------------------------------------------
Deferred tax assets:
Net operating loss carryforwards $ 6,807,000 $ 5,812,000 $ 4,958,000
Full cost pool capitalization -- -- 267,000
Valuation allowance (6,807,000) (5,812,000) (5,225,000)
-----------------------------------------------------------
Deferred tax assets $ -- $ -- $ --
===========================================================
55
</TABLE>
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. Income Taxes (Continued)
The Company did not record any deferred tax assets or income tax benefits for
net operating loss carryforwards as the future realization of the related tax
benefits is not considered likely as of December 31, 1998.
At December 31, 1998, the Company has tax loss carryforwards for federal income
tax purposes of approximately $11,456,000 available to offset future taxable
income. These carryforwards will expire at various times between 1999 and 2013.
During the two years ended December 31, 1998 and 1997, respectively, the Company
has issued a significant number of shares of common stock, stock warrants, and
preferred stock in private equity and debt financing transactions. The Company
is continuing to negotiate for additional capital, which, if obtained, may
require additional shares of stock to be issued. The changes in ownership may
significantly restrict the use of net operating loss carryforwards by the
Company. As of December 31, 1998, unused statutory depletion carryforwards,
which have unlimited duration, are approximately $567,000. The unused investment
tax credit carryover was approximately $86,000 as of December 31, 1998 and
expires through 2000. The loss carryforward at December 31, 1998 for financial
reporting purposes is approximately $18,167,000, consisting of $13,212,000 in
domestic and $4,954,000 in foreign loss carryforwards, respectively. The
difference between the loss carryforward for financial reporting and income tax
purposes results principally from the difference in book and tax basis of oil
and gas properties and organizational costs related to foreign activities.
12. Related Party Transactions
The Company paid a director $24,000 during 1995 for public relations consulting
services.
During 1996, the Company paid a basic consulting fee of approximately $500,000
to MDI, of which the stockholders included two former directors and one current
director of the Company, for assistance in seeking means for meeting the
Company's funding obligation for the Karakuduk Project. During 1997, the Company
paid an additional $180,000 to MDI, but terminated the agreement in the first
quarter of 1997.
The Company leased office space under a non-cancelable operating lease, which
expired on March 31, 1997 from a related party. Beginning April 1, 1997, the
Company leased office space at a rate of approximately $2,000 per month. This
lease expired in November 1997, was renewed and then later canceled. In February
1998, the Company signed a new lease with an unrelated party. Rent expense was
$37,000 for 1997, $46,000 for 1996, and $36,000 for 1995. The Company believes
these rental expenses were at an arms length basis.
On July 31, 1998, the Company retired two outstanding loans, totaling $95,000,
from Howard Karren, the former Chairman and Chief Executive Officer of the
Company. The Company borrowed $75,000 on May 27, 1998 and 20,000 on July 1,
1998. The notes were paid during 1998.
On August 5, 1998, the Company retired two outstanding loans, totaling
$1,000,000, from two related parties: Allen & Company, Incorporated ($900,000)
and John McMillian, the current Chairman and Chief Executive Officer of the
Company ($100,000). The Company borrowed the $1,000,000 on June 3, 1998, subject
to a 7% interest rate. The note was payable in full, plus accrued interest, on
the earlier of 180 days from the funding of the loans or upon the Company's
receipt of a minimum of $10,000,000 in equity investments. In conjunction with
the loans, the Company issued warrants to purchase 1,000,000 shares of the
Company's common stock, at an exercise price of $3.50 per share. The Company
recorded the warrants at their fair market value of $367,000, as a discount of
notes payable, amortizable over the life of the loans. On July 27, 1998, the
Company received $10,000,000 in equity financing and repaid the loans,
recognizing an extraordinary loss on the extinguishment of debt of approximately
236,000.
56
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. Accrued Compensation
On August 19, 1996, the Company's Board of Directors awarded a former Chief
Executive Officer and a former Vice President of the Company cash bonuses
totaling $210,000 as recognition for past and present services to be used to
exercise certain warrants granted in connection with the Company's 1989 Stock
Warrant Plan. These bonuses will not become payable until the earlier of (i)
completion of a sale or farmout by the Company of all or a portion of its
interest in the Karakuduk Project, or (ii) the date when the Company makes a
public disclosure of a sale or farmout of the Karakuduk Project. The Company
does not expect any events to occur in the near future, therefore, the bonus
payable is considered long-term in nature.
In connection with the appointment of Mr. Howard Karren as the Chairman of the
Board of Directors of the Company in 1996, the Company agreed to issue to Mr.
Karren 350,000 shares of restricted common stock of the Company. In 1996, the
Company recorded accrued compensation for this transaction in the amount of
$175,000. During 1997, the common stock was issued.
14. Operating leases
The Company has a noncancelable operating lease for office facilities.
Approximate future minimum annual lease payments under the lease are as follows:
1999 $ 95,000
2000 99,000
2001 104,000
2002 106,000
2003 26,000
---------------------------------------
Total $430,000
========
The Company's rental expense for 1998, 1997, and 1996 was approximately $87,000,
$37,000, and $46,000 respectively.
15. Defined Contribution Plans
The Company adopted a 401(k) plan covering all full-time employees, effective
January 1, 1991. The plan was terminated as of December 31, 1997.
16. Commitments and Contingencies
Under the terms of the license agreement, approved by the Ministry of Oil and
Gas Industries of the Republic of Kazakhstan, granting KKM the right to develop
the Karakuduk Field, KKM has committed to minimum expenditures of $30 million
for the year ended December 31, 1999. The Company has excess expenditures from
1998 of $480,000, which will be applied against the 1999 commitment. The Company
has no other expenditure commitments under the license after December 31, 1999.
The license, as amended, also establishes a minimum work program, requiring the
Company to drill 8 new wells before December 31, 1999.
17. Extraordinary Losses
During 1997, the Company retired several notes payable totaling $1,850,000 As
additional consideration for these notes, the Company issued to the note
holders, warrants to purchase 462,500 shares of the Company's common stock at
$.25 per share, exercisable at any time, but no later than November 30, 1999.
The notes were discounted by $290,000, the estimated fair value of the warrants,
with the discount being amortized over the life of the notes.
57
<PAGE>
CHAPARRAL RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. Extraordinary Losses (Continued)
If the notes were still outstanding on May 31, 1997, the Company agreed to issue
185,000 warrants as additional consideration to the holders. Furthermore, if the
notes were still outstanding on November 30, 1997, the Company agreed to issue
370,000 warrants as additional consideration to the holders. Under these
provisions, the Company issued 125,000 of the 185,000 warrants due to the May
31, 1997 deadline and none due to the November 30, 1997 deadline. The Company
recorded debt issuance costs of $168,000 for the estimated fair value of the
additional warrants issued, to be amortized over the life of the notes. On dates
between May 1997 and November 1997 the notes were repaid by the Company at their
face value. The Company recorded an extraordinary loss on extinguishment of debt
of approximately $214,000.
On August 5, 1998, the Company retired two outstanding loans, totaling
$1,000,000, from two related parties: Allen & Company, Incorporated ($900,000)
and John McMillian, a director of the Company ($100,000). The Company borrowed
the $1,000,000 on June 3, 1998, subject to a 7% interest rate. The note was
payable in full, plus accrued interest, on the earlier of 180 days from the
funding of the loans or upon the Company's receipt of a minimum of $10,000,000
in equity investments. In conjunction with the loans, the Company issued
warrants to purchase 1,000,000 shares of the Company's common stock, at an
exercise price of $3.50 per share. The Company recorded the warrants at their
fair market value of $367,000, as a discount of notes payable, amortizable over
the life of the loans. On July 27, 1998, the Company received $10,000,000 in
equity financing and repaid the loans, recognizing an extraordinary loss on the
extinguishment of debt of approximately $236,000.
18. Subsequent Events
On January 15, 1999, the Company granted 1,000,000 shares of common stock to the
Company's President and Chief Operating Officer, Dr. Jack Krug, as part of his
employment contract with the Company. Of the 1,000,000 shares granted, 200,000
vested immediately. The remaining 800,000 shares vest ratably over four years,
on the anniversary date of grant.
On February 28, 1999, the terms relating to the note between Chase and the
Company were amended. The $250,000 principal payment that was due on February
28, 1999 was deferred. Under the revised terms, the Company is required to begin
making installments in August 1999.
From January 01, 1999 to March 31, 1999, the Company has borrowed approximately
$3,800,000 from certain shareholders of the Company, repayable by the Company on
or before August 31, 1999. The loans are subject to an 8% annual interest rate.
Effective March 1, 1999, the Company announced that it is relocating its
principal office from Houston, Texas to Golden, Colorado. The Company expects
the relocation to be completed by the fall of 1999. Effective April 1, 1999, the
Company assigned its operating lease, disclosed in Note 14, to an unaffiliated
third party.
On April 8, 1999, the Board of Directors has recommended for shareholder
approval, a 60 to 1 reverse stock split. Management is anticipated a vote on
this matter in a special meeting of the Company's shareholders, expected to
occur in late April 1999.
19. Karakuduk-Munay, Inc. Financial Statements
Due to the significance of the Company's equity investee, the Company has
attached audited financial statements for KKM. Reflected in the financial
statements are management fees of $1,980,000, $1,020,000, $85,000, and
$1,020,000, that have been charged by the Company to KKM for the years ending
December 31, 1998, December 31, 1997, and the month period ended December 31,
1996, and the year ended November 30, 1996 respectively. These amounts are
exclusive of any local withholding tax, which may be accrued by KKM. Also, (for
the same periods) the financial statements include interest on the note payable
to the Company from KKM in the amounts $1,043,565, $389,624, $20,102, and
$117,431.
58
<PAGE>
CHAPARRAL RESOURCES, INC.
SUPPLEMENTAL INFORMATION - DISCLOSURES ABOUT OIL AND GAS
PRODUCING ACTIVITIES-UNAUDITED
The following supplemental information regarding the oil and gas activities of
the Company is presented pursuant to the disclosure requirements promulgated by
the Securities and Exchange Commission and Statement of Financial Accounting
Standards ("SFAS") No. 69, Disclosures About Oil and Gas Producing Activities.
The Company entered into an agreement effective January 1, 1997 to sell its
domestic oil and gas properties. Accordingly, the Company's domestic oil and gas
properties were classified as oil and gas properties under an agreement for sale
at November 30, 1996 and no disclosures for proved reserves or future cash flows
have been made at November 30, 1996. The properties were sold in accordance with
the above agreement. Due to the uncertainties surrounding the development of the
Karakuduk Field, along with the limited amount of production established as of
December 31, 1998, no proved reserves have been attributed to the field. The
Company acquired no additional producing properties in 1998. Therefore, no
disclosures for proved reserves or future cash flows have been made at December
31, 1998. Acquisition and exploratory costs incurred related to the Company's
interest in the Karakuduk Field, however, are disclosed below. The exploration
costs reflect the entire exploratory costs incurred by the Company and KKM.
The following estimates of reserve quantities and related standardized measure
of discounted net cash flow are estimates only, and do not purport to reflect
realizable values or fair market values of the Company's reserves. The Company
emphasizes that reserve estimates are inherently imprecise and that estimates of
new discoveries are more imprecise than producing oil and gas properties.
Additionally, the price of oil has been very volatile and downward changes in
prices can significantly affect quantities that are economically recoverable.
Accordingly, these estimates are expected to change as future information
becomes available and the changes may be significant. All of the Company's
proved reserves were located in the United States.
Proved reserves are estimated reserves of crude oil and natural gas that
geological and engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating conditions. Proved developed reserves are those expected to be
recovered through existing wells, equipment and operating methods.
The standardized measure of discounted future net cash flows is computed by
applying year-end prices of oil and gas (with consideration of price changes
only to the extent provided by contractual arrangements) to the estimated future
production of proved oil and gas reserves, less estimated future expenditures
(based on year-end costs) to be incurred in developing and producing the proved
reserves, less estimated future income tax expenses. The estimated future net
cash flows are then discounted using a rate of 10% a year to reflect the
estimated timing of the future cash flows.
59
<PAGE>
<TABLE>
<CAPTION>
CHAPARRAL RESOURCES, INC.
SUPPLEMENTAL INFORMATION - DISCLOSURES ABOUT OIL AND GAS
PRODUCING ACTIVITIES-UNAUDITED
Proved Oil and Gas Reserve Quantities
(All Within the United States)
Oil Gas
Reserves reserves
(bbls.) (Mcf.)
---------------------------------
<S> <C> <C>
Balance November 30, 1995 66,185 3,062,417
Revisions of previous estimates (58,749) 18,703
Sales of reserves (531) (34,417)
Extensions, discoveries and other additions 267 6,638
Production (1,737) (96,906)
Transfer to oil and gas properties under agreement
For sale (5,435) (2,956,435)
Balance November 30, 1996 -- --
Revisions of previous estimates -- --
Sales of reserves -- --
Extensions, discoveries and other additions -- --
Production -- --
Balance December 31, 1997 -- --
Revisions of previous estimates -- --
Sales of reserves -- --
Extensions, discoveries and other additions -- --
Production -- --
----------------------------------
Balance December 31, 1998 -- --
==================================
Capitalized Costs Relating to Oil and Gas Producing Activities
December 31, December 31, November 30,
1998 1997 1996
----------------------------------------------------
Unproved oil and gas properties in the Republic of
Kazakhstan $22,696,000 $15,934,000 $12,091,000
Proved oil and gas properties -- -- --
---------------------------------------------------
$22,296,000 $15,934,000 $12,091,000
---------------------------------------------------
Accumulated depreciation, depletion, and amortization
And valuation allowances -- -- --
---------------------------------------------------
Net capitalized costs $22,296,000 $15,934,000 $12,091,000
===================================================
Company's share of equity method investee's
Capitalized costs $ 9,565,000 $ 3,988,000 $ 1,143,000
===================================================
60
<PAGE>
CHAPARRAL RESOURCES, INC.
SUPPLEMENTAL INFORMATION - DISCLOSURES ABOUT OIL AND GAS
PRODUCING ACTIVITIES-UNAUDITED
Costs Incurred in Oil and Gas Property Acquisition,
Exploration, and Development Activities
Year Ended Year Ended Year Ended
December 31, December 31, November 30,
1998 1997 1996
------------------------------------------------------------------
Costs Incurred
Property acquisition costs--
unproved leases:
United States $ -- $ -- $ --
Republic of Kazakhstan -- 2,625,000 6,058,000
Property acquisition costs-- proved properties:
United States -- -- --
Republic of Kazakhstan -- -- --
Exploration costs
United States -- -- --
Republic of Kazakhstan 6,761,000 1,218,000 1,610,000
Development costs
United States -- -- --
Republic of Kazakhstan -- -- --
Company's share of equity method investee's
Costs of property acquisition, exploration,
And development $ 5,578,000 $ 2,845,000 $ 874,000
-----------------------------------------------------
$12,339,000 $ 6,688,000 $ 8,542,000
=====================================================
Results of Operations for Producing Activities
Year Ended Year Ended Year Ended
December 31, December 31, November 30,
1998 1997 1996
---------------------------------------------------
Revenues
Sales $ -- $ -- $147,000
Transfers -- -- --
---------------------------------------------------
Total -- -- 147,000
Production Costs -- -- 37,000
Exploration Expenses -- -- --
Depreciation, depletion, and amortization
and valuation provisions -- -- 3,000
-- -- 107,000
Income tax expenses -- -- --
---------------------------------------------------
Results of operations from producing
Activities (excluding corporate overhead
And interest costs) $ -- $ -- $107,000
===================================================
Company's share of equity method investee's
Results of operations for producing
Activities -- -- --
===================================================
61
<PAGE>
CHAPARRAL RESOURCES, INC.
SUPPLEMENTAL INFORMATION - DISCLOSURES ABOUT OIL AND GAS
PRODUCING ACTIVITIES-UNAUDITED
Standardized Measure of Discounted Future Net Cash Flows
and Changes Therein Relating to Proved Oil and Gas Reserves
The following are the principal sources of changes in the standardized measure
of discounted future net cash flows:
Thirteen
Year Ended Months Ended Year Ended
December 31 December 31 November 30
1998 1997 1996
-----------------------------------------------------------
Beginning balance $ -- $ -- $ 27,000
Expenditures which reduced future
development costs -- -- --
Acquisition of proved reserves -- -- --
Sale of proved reserves -- -- (54,000)
Sales and transfers of oil and gas
produced, net of production costs -- -- (110,000)
Net increase (decrease) in price -- -- 860,000
Net decrease in costs -- -- --
Extensions and discoveries -- -- 17,000
Revisions of previous quantity
Estimates -- -- (91,000)
Accretion of discount -- -- 99,000
Effect of change in timing and other -- -- 253,000
Transfer to oil and gas properties
under agreement for sale -- -- (1,401,000)
----------- ----------- -----------
Ending balance $ -- $ -- $ --
=========== =========== ===========
62
</TABLE>
<PAGE>
Report of Independent Auditors
The Board of Directors and Shareholders
Karakuduk-Munay, Inc.
We have audited the accompanying balance sheets of Karakuduk-Munay, Inc. ("the
Company") as of December 31, 1998 and 1997, and the related statements of
operations and cash flows and changes in shareholders' deficit for each of the
three years ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audits in accordance with US generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements present fairly, in all material
respects, the financial position of Karakuduk-Munay, Inc. as of December 31,
1998 and 1997, and the results of its operations and its cash flows for each of
the three years ended December 31, 1998, in conformity with US generally
accepted accounting principles.
Without qualifying our opinion, we draw your attention to the fact that the
accompanying financial statements have been prepared assuming the Company will
continue as a going concern. As more fully described in Note 3 to the financial
statements, the Company has incurred recurring operating losses and relies
solely on the foreign shareholder to provide all funding in the form of an
interest bearing loan. The Company requires significant additional financing to
meet its financial commitments and requirements through calendar year 1999 as
described in Note 18. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. The financial statements do
not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.
/S/ ERNST & YOUNG KAZAKHSTAN
April 8, 1999
Almaty, Kazakshtan
63
<PAGE>
Karakuduk-Munay, Inc.
Balance Sheets as at
December 31, 1998 and 1997
(Amounts in US dollars)
December 31, December 31,
1998 1997
----------------------------
ASSETS
Cash $ 52,958 $ 414,384
Prepaid and other receivables (Note 4) 125,231 272,455
VAT receivable (Note 5) -- 109,099
Crude oil inventory (Note 6) 551,342 --
----------------------------
Total current assets 729,531 795,938
Long term VAT receivable (Note 5) 863,077 --
Materials and supplies inventory (Note 7) 1,494,572 511,858
Property, plant and equipment, net (Note 8) 4,209,396 1,589,057
Oil and gas properties - full cost
method (Note 9) 12,563,120 5,874,525
----------------------------
TOTAL ASSETS $ 19,859,696 $ 8,771,378
============================
LIABILITIES AND SHAREHOLDERS' DEFICIT
Accounts payable (Note 11) $ 2,247,954 $ 2,100,722
Accrued liabilities (Note 12) 779,596 666,856
Current portion of loans payable
to third parties (Note 13) 177,780 --
Current portion of loans payable
to partner (Note 13) 3,000,000 --
----------------------------
Current liabilities 6,205,330 2,767,578
Loans payable to third parties (Note 13) 577,775 --
Loans payable to partner (Note 13) 20,380,080 9,819,497
TOTAL LIABILITIES $ 27,163,185 $ 12,587,075
SHAREHOLDERS' DEFICIT
Charter capital (Note 15) 200,000 200,000
Accumulated deficit (7,503,489) (4,015,697)
----------------------------
(7,303,489) (3,815,697)
----------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 19,859,696 $ 8,771,378
============ ============
See accompanying notes which form an integral
part of these financial statements.
64
<PAGE>
<TABLE>
<CAPTION>
Karakuduk-Munay, Inc.
Statements of Operations
for the years ended December 31, 1998, 1997 and 1996
(Amounts in U.S. dollars)
December 31, December 31, December 31,
1998 1997 1996
--------------------------------------------------------
<S> <C> <C> <C>
Management service fee (Note 13) $ 845,840 $ 495,000 $ 825,000
General and administrative expenses 1,297,513 836,868 909,520
Interest expense (Note 13) 508,539 155,624 137,533
Depreciation on fixed assets (Note 8) 440,901 147,660 42,709
Miscellaneous taxes 135,441 30,214 2,937
Write-down of crude oil inventory (Note 6) 192,481 -- --
Exchange loss/(gain) 67,077 (387) 24,475
----------- ----------- -----------
Net loss 3,487,792 1,664,979 1,942,174
===========
See accompanying notes which form an integral
part of these financial statements.
65
<PAGE>
Karakuduk-Munay, Inc.
Statements of Cash Flows
(Amounts in U.S. dollars)
December 31, December 31, December 31,
1998 1997 1996
----------------------------------------------------
Cash flows from operating activities:
Net loss $ (3,487,792) $ (1,664,979) $ (1,942,174)
Adjustments to reconcile net loss to net
cash used by operating activities:
Write-down of crude oil inventory 192,481 -- --
Depreciation of fixed assets 440,901 147,660 42,709
Changes in working capital:
(Increase)/decrease in prepaid and other receivables 147,224 (255,979) 76,230
(Increase) in VAT receivable (753,978) (51,803) (57,296)
(Increase) in crude oil inventory (743,823) -- --
(Increase) in materials and supplies inventory (982,714) (483,437) (28,421)
Increase in accounts payable and accrued liabilities 259,972 2,022,350 146,819
Increase/(decrease) in long term payable for land usage -- (34,000) 34,000
--------------------------------------------------
Net cash used by operating activities (4,927,729) (320,188) (1,728,133)
Cash flows from investing activities
Purchase of fixed assets (3,061,240) (1,284,782) (464,208)
Investments in oil and gas assets (net of assets
contributed in-kind through Charter Fund) (6,688,595) (4,068,937) (1,237,718)
Payment of signature bonus -- -- (513,000)
--------------------------------------------------
Net cash used in investing activities (9,749,835) (5,353,719) (2,214,926)
Cash flows from financing activities
Cash contributed as charter fund -- -- 40,000
Increase in loans from third parties 800,000 -- --
Principal payments on third party loans (44,445) -- --
Increase in loan due to cash contribution 10,422,567 4,134,783 2,240,000
Increase in loans payable for management
services and other expenditures 2,094,451 1,526,995 1,527,339
Increase in loans payable for interest 1,043,565 389,624 137,533
----------------------------------------------------
Net cash provided by financing activities 14,316,138 6,051,402 3,944,872
Net increase/(decrease) in cash (361,426) 377,495 1,813
Cash at beginning of year 414,384 36,889 35,076
----------------------------------------------------
Cash at end of year $ 52,958 $ 414,384 $ 36,889
============ ============ ============
See accompanying notes which form an integral
part of these financial statements.
66
<PAGE>
Karakuduk-Munay, Inc.
Statements of Shareholders' Deficit
(Amounts in U.S. dollars)
Authorized Accumulated
Charter Capital Deficit Total
-------------------------------------------------------------
Balance at December 31,1995 $ 100,000 $ (408,544) $ (308,544)
Charter capital contributions 100,000 -- 100,000
Net loss for the year 1996 -- (1,942,174) (1,942,174)
Balance at December 31,1996 200,000 (2,350,718) (2,150,718)
Net loss for the year 1997 -- (1,664,979) (1,664,979)
Balance at December 31,1997 200,000 (4,015,697) (3,815,697)
Net loss for the year 1998 -- (3,487,792) (3,487,792)
------------------------------------------------------------
Balance at December 31,1998 $ 200,000 $(7,503,489) $(7,303,489)
============================================================
See accompanying notes which form an integral
part of these financial statements.
67
</TABLE>
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements
(Amounts in US dollars unless otherwise stated)
1. Organization and Background Information
Formation
- ---------
Karakuduk-Munay Inc. (the "Company"), a Kazakhstan Joint Stock Company of Closed
Type, was founded by "Munaygaz" State Holding Company (formerly
Kazakhstanmunaygaz National Petroleum Company), "Jarkin" State Holding Company
(formerly PGO Mangistauneftegazgeologiya), and Korporatsiya Mangistau Terra
International (formerly Korporatsiya Kramds-Mangistau Inc.), collectively the
"Kazakh Shareholders", and Central Asian Petroleum (Guernsey) Limited. The
Company and the Ministry of Energy and Natural Resources (formerly the Ministry
of Oil and Gas) in the Republic of Kazakhstan, entered into an agreement on
August 30, 1995 ("Inception") referred to as the Agreement for Exploration,
Development and Production of Oil in Karakuduk Oil Field in Mangistau Oblast of
the Republic of Kazakhstan (the "Agreement"). The management and operational
framework within which the Company must conduct its activities are dictated by
the Agreement.
The Company may be terminated under certain conditions specified in the
Agreement. The term of the Agreement is 25 years commencing from the date of the
Company's registration. The Agreement can be extended to a date agreed between
the Ministry of Energy and Natural Resources and the Company as long as
production of petroleum and/or gas is continued in the Karakuduk oil field.
Changes in Shareholders
- -----------------------
In accordance with Edict # 410 dated March 24, 1997 and Edict # 1287 dated
August 26, 1997 issued by the Government of the Republic of Kazakhstan, 40 % of
the Charter Fund of the Company belonging to "Jarkin"/"Aksay" and "Munaygaz"
were transferred to KazakhOil, the state owned oil and gas company. The Company
and new shareholder were legally re-registered with the Ministry of Justice of
the Republic of Kazakhstan on July 24, 1997. There were no shareholder changes
in 1998.
Principal Activity
- ------------------
The Company was established for the purposes of exploring, developing, and
producing oil and gas deposits in the Karakuduk Field in the Republic of
Kazakhstan acting on the basis of the Agreement which the Company entered into
with the Ministry of Energy and Natural Resources in the Republic of Kazakhstan
on August 30, 1995. Prior to the Company entering into the Agreement, the
Government of Kazakhstan drilled 22 test wells in the Karakuduk Field,
establishing the existence of crude oil reserves. No additional exploration or
production operations have been conducted on the Karakuduk Field. Neither were
there any commercial quantities of crude oil produced from the original test
wells, prior to Inception of the Agreement. In accordance with the Agreement,
the Company retains the contractual rights to explore, develop, and produce the
crude oil reserves, if any, underlying the Karakuduk Field.
The Company's work program and minimum expenditure commitment was stipulated in
License MG 249 dated June 28, 1995. These expenditure obligations were
subsequently amended by Resolution P65-H of September 18, 1996, Resolution P97-H
of December 8, 1997, and Decree No. 1392 of December 31, 1998. Decree No. 1392
requires the Company to meet expenditure commitments of $16.5 million by
December 31, 1998 and $30 million by December 31, 1999. Expenditure commitments
through December 31, 1998 exceeded the commitment requirement of $16.5 million
by approximately $480,000. The excess is applicable against the expenditure
commitment required as of December 31, 1999. Should the license terms not be
adhered to, the License may be withdrawn by the Government of Kazakhstan.
68
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
1. Organization and Background Information (Continued)
During 1998, the Company was engaged in various exploration and appraisal
activities associated with the Karakuduk Field. The Company's activities
included conducting capital workover operations, processing and transportation
of limited crude oil production to the KazTransOil pipeline, completing
construction of the field camp and main access road, beginning construction of
various field facilities required to bring the Karakuduk Field onto full
production, and importing a drilling rig into Kazakhstan for commencement of
exploratory drilling activities in 1999. The Company's operations also included
general corporate affairs, such as applying for, and obtaining, an amendment of
the Company's License MG-249 with the Government of Kazakhstan as well as other
general and administrative activities.
The Company conducted capital workover operations on four test wells, which were
drilled prior to the Company entering into the Agreement. Production was
established from two of the four wells. The Company did not commence exploratory
drilling operations during 1998.
The Company produced limited amounts of crude oil throughout the majority of
1998. The crude oil was produced, processed, and transported to the KazTransOil
pipeline by truck. As of December 31, 1998, the Company had placed 11,103 tons
(81,052 barrels) of crude oil into the KazTransOil pipeline, but did not sell
any of the crude oil produced during 1998. In accordance with an agreement
between the Company and KazTransOil, all of the crude oil production placed into
the pipeline is recorded as crude oil inventory, until formally nominated for
sale by the Company.
2. Basis of Presentation
The Company maintains its accounting records and prepares its financial
statements in U.S. dollars in accordance with the accounting procedures
prescribed by the Agreement. The accompanying financial statements, prepared in
accordance with U.S. generally accepted accounting principles, differ in minor
respects (related to disclosure) from those issued for statutory purposes in
Kazakhstan.
The Company has reclassified some of its comparative numbers in order to be
consistent with the current year classifications in the Balance Sheet and
Statement of Operations. This has no impact on the results for the year or the
net assets of the Company.
The material accounting principles adopted by the Company are described below:
Foreign Currency Translation
- ----------------------------
The Company's functional currency is the U.S. dollar. All transactions arising
in currencies other than U.S. dollars, including assets, liabilities, revenue,
expenses, gains, or losses are measured and recorded into 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 to U.S. dollars at the rates of exchange
ruling as of December 31, 1998 (83.80 Kazakh Tenge per U.S. dollar).
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. By using the
U.S. dollar as its reporting currency for the financial statements and by using
the temporal method of translation where applicable, the effects of inflation
have been taken into consideration in all material respects since movements in
the exchange rate between the U.S. dollars and Tenge during 1996 to 1998 are
considered a reasonable approximation of the general price index. (See Note 19).
69
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
2. Basis of Presentation (Continued)
The Tenge is not a convertible currency outside of the Republic of Kazakhstan.
The translation of Tenge denominated assets and liabilities in these financial
statements does not indicate that the Company could realize or settle these
assets and liabilities in dollars.
As of December 31, 1998, $530,511 of net monetary assets are denominated in
Tenge.
Interest Capitalization
- -----------------------
The Company capitalizes interest on significant construction projects for which
expenditures are being made. The Company follows the full cost method of
accounting. Accordingly, the Company's assets qualifying for interest
capitalization include unusually significant investments in unproved properties
and other major development projects that are not being depreciated, depleted,
or amortized currently, provided that work is currently in progress.
The Company began exploration activities in 1997. As of December 31, 1998, the
Company's oil and gas investment in the Karakuduk Field is not considered a
proven property and economic production has not commenced. Consequently, none of
the capital costs related to the Karakuduk Field have been depreciated,
depleted, or amortized during 1998. Beginning in 1997, and throughout all of
1998, the Company capitalized certain borrowing costs to significant, unproven
oil and gas properties on which the Company is currently conducting exploration
and appraisal activities. The Company capitalized $565,542 in 1998 and $234,000
in 1997, respectively. Other interest costs are expensed as incurred.
Oil and Gas Assets Subject to Depreciation, Depletion and Amortization
- ----------------------------------------------------------------------
The Company follows the full cost method of accounting for oil and gas
properties. Accordingly, all costs directly associated with acquisition,
exploration and development of oil and gas reserves are capitalized in cost
pools for each country in which the Company operates. The limitation on such
capitalized costs is determined in accordance with rules specified by the
Securities and Exchange Commission. Capitalized costs are depleted using the
units of production method based on proven reserves.
Oil and Gas Properties Not Subject to Depletion
- -----------------------------------------------
Costs associated with acquisition and evaluation of unproved properties are
excluded from the amortization computation until it is determined if proved
reserves can be attributed to the properties. These unevaluated properties are
assessed annually for possible impairment and the amount impaired, if any, is
added to the amortization base. Costs of exploratory dry holes and geological
and geophysical costs not directly associated with specific unevaluated
properties are added to the amortization base as incurred.
Depreciation of Property Plant and Equipment
- --------------------------------------------
Depreciation of equipment is calculated on the straight-line method based on the
estimated useful life of the assets as follows:
Period
------
Office buildings and apartments 20 years
Office equipment 3 years
Vehicles 5 years
Field buildings 15 years
Field equipment up to 10 years
70
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
2. Basis of Presentation (Continued)
Inventory
- ---------
Crude oil inventory is valued using the first-in, first-out method, at the lower
of cost or net realizable value. The Company's capitalized cost of crude oil
inventory is the lesser of the actual costs to produce, transport and store the
crude oil in inventory, or the inventory's net realizable value.
Materials and supplies inventory is valued using the first-in, first-out method
and is recorded at the lower of cost or net realizable value. Certain unique
items, such as drilling equipment, are valued using the specific identification
method.
Revenue Recognition
- -------------------
Revenues and their related costs are recognized upon delivery of commercial
quantities of oil and gas production, in accordance with the accrual method of
accounting. Losses, if any, are provided for in the period in which the loss is
determined to occur.
Income Taxes
- ------------
The Company accounts for income taxes under the provisions of the Statement of
Financial Accounting Standards ("SFAS") 109, Accounting for Income Taxes, which
require that taxes be provided on the liability method based upon the tax rate
at which items of income and expense are expected to be settled in the Company's
tax return.
Earnings Per Common Share
- -------------------------
Basic earnings (loss) and diluted earnings (loss) are not presented due to the
Company being of a "closed" nature, and having no underlying shares outstanding.
New Accounting Standards
- ------------------------
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This standard provides a comprehensive and
consistent standard for the recognition and measurement of derivatives and
hedging activities. This statement is effective for years beginning after June
15, 1999. As of December 31, 1998, the Company has not adopted SFAS 133.
The Company is evaluating SFAS 133 and intends to adopt the statement no later
than January 1, 2000. The impact of SFAS 133 on the Company's financial position
and results of operations is not expected to be material.
Fair Value of Financial Instruments
- -----------------------------------
All of the Company's financial instruments, including loans payable to partner,
cash and trade receivables, have fair values which approximate their recorded
values as they are either short-term in nature or carry interest rates which
approximate market rates.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
71
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
2. Basis of Presentation (Continued)
Leases
- ------
The Company expenses rentals on operating leases over the lease term, on a
straight-line basis, as the rents become payable.
3. Going Concern
These financial statements have been prepared assuming that Karakuduk-Munay,
Inc., will continue as a going concern. The Company has recurring operating
losses and relies solely on Central Asian Petroleum (Guernsey) Limited ("CAP-G")
to provide all funding in the form of an interest bearing loan, as discussed in
Note 13. In accordance with the license agreement, CAP-G is required to provide
all funding to the Company which is not provided by self-generated income from
the sale of oil and gas production or borrowed from other third-party sources.
The Company does not anticipate that its current cash reserves and cash flows
from operations will be sufficient to meet its capital requirements through
fiscal year 1999. Should the Company not meet its capital requirements, as
described in Note 18, under the license agreement to develop the Karakuduk
Field, the Company's rights under the agreement may be terminated. The Company
believes additional financing will be available; however there is no assurance
that additional financing will be available, or if available, that it can be
obtained on terms favorable or affordable to the Company.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
liabilities that may result from the outcome of this uncertainty.
4. Prepaid and Other Receivables
As of December 31, 1998, Prepayments and Other Receivables, primarily consisted
of advances to the Custom's Post for payment of value added tax ("VAT") and
custom's duties on future imported materials and supplies. As of December 31,
1997, Prepayments and Other Receivables primarily consisted of prepaid
equipment, which was capitalized to plant & equipment during 1998. The breakdown
of Prepaid and Other Receivables is as follows:
December 31, December 31,
1998 1997
--------------------------
Travel advances to employees $ -- $ 18,606
Import VAT, custom duties and prepaid taxes 120,631 41,256
Advance payment for oil and gas assets 4,600 212,593
-------- --------
Total $125,231 $272,455
======== ========
5. VAT Receivable
VAT receivable is a Tenge denominated asset due from the Republic of Kazakhstan.
The VAT receivable consists of VAT paid on local expenditures (Local VAT) and
VAT paid on Imported goods (Import VAT). Currently, VAT is calculated as 20% of
the value of goods received (Import and Local VAT) or services rendered (Local
VAT only). VAT charged to the Company is recoverable in future periods as an
offset against the Company's fiscal obligations.
72
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
5. VAT Receivable (Continued)
From December 31, 1997 to December 31, 1998, the Company's VAT receivable
increased from $109,099 to $863,077, respectively, due to the Company's
increased spending on operations. During 1998, the Company offset both the Local
and Import VAT receivable against additional VAT charged on imported goods. In
prior years, the Company received several refunds of VAT previously paid into
the Government of Kazakhstan. The ability of the Company to obtain future
refunds or to offset the VAT receivable against future Import VAT liabilities is
uncertain. The Company does expect, however, to obtain full economic benefit
from the VAT receivable through the Company's right of offset against future
fiscal obligations, as provided for in the Agreement.
6. Crude Oil Inventory
During 1998, the Company produced approximately 11,103 tons of crude oil from
two capital workover wells re-completed in the Karakuduk Field in early 1998.
The crude oil was produced into storage tanks, transferred to heated oil trucks,
transported to the KazTransOil pipeline terminal at Say-Utes (approximately 89
kilometers), and placed into the KazTransOil pipeline. In an agreement with
KazTransOil, the entity controlling the export pipeline, the Company's oil
production placed into the pipeline is recorded as crude oil inventory until
formally nominated for sale by the Company.
As of December 31, 1998, the Company had not completed a sale of crude oil,
either to the local or export markets. The Company recorded all operating
(lifting) costs required to produce, transport, and store the Company's 1998 oil
production as costs of crude oil inventory. As of December 31, 1998, the actual
costs of the inventory, based upon year-end crude oil prices, exceeded the net
realizable value of the inventory. Therefore, the Company recognized an
impairment to crude oil inventory, to properly reflect the estimated net
realizable value of $551,342. The impairment, totaling $192,481, was charged
directly to expense.
7. Materials and Supplies Inventory
The categories of Materials and Supplies Inventory listed below represent plant
and equipment for development activities, tangible drilling costs (drillbits,
tubing, casing, wellheads, etc.) required for exploratory drilling operations,
spare parts, diesel fuel, and various materials for use in oil field operations.
The Inventory in Transit as of December 31, 1998 includes additional tubing and
casing required for drilling planned exploratory wells in 1999.
December 31, December 31,
1998 1997
-------------------------------
Inventory in-house $1,084,359 $ 224,998
Inventory in-transit 410,213 286,860
---------- ----------
Total $1,494,572 $ 511,858
========== ===========
73
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
8. Property, Plant and Equipment
Upon full amortization of tangible assets, the right of ownership of the
tangible assets shall be transferred to the Kazakhstan Ministry of Energy and
Natural Resources in accordance with the Agreement. The Company is entitled to
the use of the fully amortized tangible assets during the whole term of the
Agreement. A summary of property, plant and equipment is provided in the table
below:
December 31, December 31,
1998 1998
-------------------------------
Office buildings and apartments $ 214,468 $ 67,212
Office equipment and furniture 390,671 227,318
Vehicles 1,663,364 541,479
Field buildings 2,248,920 329,936
Field equipment and furniture 323,824 169,190
Capital work-in progress -- 444,872
----------- -----------
Total 4,841,247 1,780,007
Accumulated depreciation (631,851) (190,950)
----------- -----------
Net book value $ 4,209,396 $ 1,589,057
=========== ===========
Vehicles includes both vehicles for specialized tasks (cranes, bulldozers, heavy
trucks, crude oil trucks, etc.) and vehicles for personnel transport. Field
buildings include the construction of the main field camp and construction of a
mini-camp to house the drilling crew and service company personnel required to
perform exploratory drilling operations. Field equipment and furniture includes
furniture and fixtures for the field camp and other equipment. The majority of
plant and equipment was placed in service in the latter part of 1998.
The office and apartment buildings, office and apartment furniture and fixtures,
office equipment, vehicles, field buildings, field furniture and fixtures and
other equipment are all depreciated on a straight-line basis over the estimated
useful life of each asset.
9. Oil and Gas Properties
As of December 31, 1998, the Company's Oil and Gas Properties are not subject to
amortization under the Full Cost method of accounting. While the Company has
obtained a certain level of crude oil production in 1998, the reserves
underlying the Karakuduk Field are classified as unproven until the Company can
establish the commercial viability of the reserves. As of December 31, 1998, the
Company's reserves are not considered commercially viable, as the production
costs required to obtain the crude oil in inventory exceeded the net realizable
value of the production, based upon year-end crude oil prices.
Management fees related to the salary costs of individuals directly associated
with exploration and appraisal activities on the Karakuduk field have been
capitalized along with the license acquisition costs, geological and geophysical
expenditures, and related interest costs. Other overhead and general and
administrative costs have been expensed as incurred.
74
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
9. Oil and Gas Properties (Continued)
Costs of Oil and Gas Properties excluded from the amortization consist of the
following:
December 31, December 31,
1998 1997
-----------------------------
Acquisition costs $ 507,870 $ 507,870
Exploration and appraisal costs 11,255,708 5,132,655
Capitalized interest 799,542 234,000
----------- -----------
Total $12,563,120 $ 5,874,525
=========== ===========
Management believes that over the life of the project, future cash flows justify
the carrying amount of assets disclosed above. No impairment provision has
therefore been deemed necessary in these financial statements.
10. Bonuses
The Company was required to pay an unrecoverable (non-tax deductible) signature
bonus to the Kazakhstan Ministry of Geology amounting to $513,000 in accordance
with the Agreement. The Company capitalized the initial signature bonus to Oil
and Gas Assets - Acquisition Costs (see Note 9). This amount will be amortized
by the units of production method, when the Company begins producing proven
reserves. Production based bonuses will be payable to the Kazakhstan Ministry of
Geology amounting to $500,000 when cumulative production reaches ten million
barrels and $1,200,000 when cumulative production reaches fifty million barrels.
Under current Kazakhstan tax law, the production bonuses will be considered tax
deductible expenditures in the calculation of profits taxes. No amounts related
to the production bonuses have been achieved as of December 31, 1998.
11. Accounts Payable
Accounts Payable as of December 31, 1998 includes payables for equipment and
services required for field operations, including construction of field
facilities, transportation services, catering services, mobilization of the
drilling rig, project design costs of capital projects, etc.
12. Accrued Current Liabilities
December 31, December 31,
1998 1997
------------------------------
Accrued management service fee 573,750 573,750
Accrued audit fees 75,000 48,000
Accrued interest payable 3,613 --
Miscellaneous taxes payable 127,233 45,106
-------- --------
Total accrued liabilities $779,596 $666,856
======== ========
75
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
13. Loans Payable
Loans Payable to Third Parties
- ------------------------------
During 1998, the Company borrowed a total of $800,000 from the Chase Bank of
Texas, N.A. ("Chase"), a U.S. financial institution. On March 6, 1998, the
Company borrowed the initial $500,000 from Chase. The note accrues interest at a
fixed, annual interest rate of 6.84% and is repayable in 18 equal, quarterly
installments of $27,778, which began on December 6, 1998. The final principal
payment is due on or before February 26, 2003. On June 9, 1998, the Company
borrowed an additional $300,000 from Chase. The second note accrues interest at
a fixed, annual interest rate of 6.875% and is repayable in 18 equal, quarterly
installments of $16,667, which also began on December 6, 1998. The final
principal payment is payable on or before March 6, 2003.
As of December 31, 1998, the Company's outstanding principal balance on the
notes totaled $755,555, of which $177,780 is due before December 31, 1999.
Loans Payable to Partners
- -------------------------
As discussed in Note 3, the major shareholder, CAP-G bears sole financial
responsibility for providing all funding for the Company, which is not generated
by the Company's operations through the sale of oil and gas production or
borrowed from third party sources. The various forms of funding from CAP-G are
treated as long term loans to the Company and bear interest at the rate of LIBOR
plus 1%. The Agreement requires installment payments on the loan to be
calculated and paid on a quarterly basis and to be equal to 65% of gross revenue
after deduction of royalties due to the Republic of Kazakhstan. No sales of
crude oil production occurred in 1998 and no payments on the loan have been made
or are due as of December 31, 1998.
The loan is made up as follows (U.S. dollars):
December 31,
---------------------------
1998 1997
----------- -----------
Cash funding $16,897,350 $ 6,474,783
Management services fee 4,275,000 2,295,000
Other expenditures 634,594 520,143
Accrued interest payable 1,573,136 529,571
----------- -----------
Total interest and loan payable to partner $23,380,080 $ 9,819,497
=========== ===========
Management services are provided by a subsidiary of Chaparral Resources, Inc.,
the parent company of CAP-G. Services were provided in 1998 for a fixed fee of
$140,000 per month for January and February, 1998, and $170,000 per month for
the remainder of 1998. Management services were provided to the Company in the
amount of $1,980,000 and $1,275,000 for the years ended December 31, 1998 and
1997, respectively.
As of December 31, 1998, the Company's outstanding principal and accrued
interest balance on Loans Payable to Partners totaled $23,380,080, of which
$3,000,000 is due before December 31, 1999. The Company determined the current
portion of Loans Payable to Partner based upon best estimates of projected 1999
sales revenue, of which 65% will be distributed to CAP-G on a quarterly basis as
described above.
76
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
14. Taxes
The following is a summary of the provision for income taxes:
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997 1996
-----------------------------------------------------------
<S> <C> <C> <C>
Income taxes (benefit) computed
at statutory rate $(1,046,338) $ (499,494) $ (582,652)
Non-deductible expenses 347,012 -- --
Change in asset valuation allowance 699,326 499,494 582,652
-----------------------------------------------------------
Income taxes $ -- $ -- $ --
===========================================================
The components of the Company's deferred tax assets and liabilities under FASB No. 109 are as follows:
Year ended December 31,
1998 1997 1996
-----------------------------------------------------------
Deferred tax assets:
Net operating loss carryforwards $ 1,904,035 $ 1,204,709 $ 705,215
Valuation allowance (1,904,035) (1,204,709) (705,215)
-----------------------------------------------------------
Deferred tax assets $ -- $ -- $ --
===========================================================
</TABLE>
There were no net deferred tax assets or net income tax benefits recorded in the
financial statements for deductible temporary differences or net operating loss
carryforwards due to the fact that the realization of the related tax benefits
is not considered likely.
The Agreement specifies profits taxes and other taxes applicable to the Company,
which are subject to the laws of the Republic of Kazakhstan. As discussed in
Note 10, the signature bonus is not recoverable or deductible in calculating
income tax expense and has not been recorded as a recoverable asset for tax
purposes.
The Company began extracting hydrocarbons from the Karakuduk Field in 1998. At
December 31, 1998, the Company has tax loss carryforwards of approximately
$6,346,783 available to offset against future taxable income, in accordance with
the terms of the contract and legislation existing as of the date the contract
was signed. There is a five-year carryforward of tax losses beginning with the
first year the Company generates net income.
The Company has used the best estimates available to determine the Company's
deferred tax assets before consideration of the valuation allowance. Please
refer to Note 16 regarding the uncertainties of taxation in the Republic of
Kazakhstan.
77
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
15. Charter Capital
The total Charter Fund contribution specified in the new Founders Agreement of
Karakuduk-Munay (dated June 12, 1997) is $200,000. Each of the shareholder's
portion of the Charter Fund and their respective participating interest in the
Company is:
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
Charter Percent Charter Percent
Contribution Contribution
-----------------------------------------------------------
<S> <C> <C> <C> <C>
KazakhOil 80,000 40 % 80,000 40 %
Korporatsiya Mangistau Terra International 20,000 10 % 20,000 10 %
Central Asian Petroleum (Guernsey)
Limited - CAP(G) 100,000 50 % 100,000 50 %
--------------------------------------------------------
Total charter capital $200,000 100 % $200,000 100 %
======== ========
</TABLE>
During 1997, KazakhOil as the successor to Munaygaz state holding company,
contributed U.S. $ 40,000 as Munaygaz's initial charter contribution obligation
that was previously settled by CAP(G). The CAP(G) 1996 contribution has been
reclassified as additional funding of the Company's operations in 1997.
16. Contingencies
Taxation
- --------
The existing legislation with regard to taxation in the Republic of Kazakhstan
is constantly evolving as the Government manages the transition from a command
to a market economy. Tax and other laws applicable to the Company are not always
clearly written and their interpretation is often subject to the opinions of the
local or main State Tax Service. Instances of inconsistent opinions between
local, regional and national tax authorities are not unusual.
Basis of Accounting
- -------------------
The Company maintains its statutory books and records and calculates its taxable
loss in accordance with U.S. generally accepted accounting principles, which it
believes it may do under the terms of the Agreement. The Republic of Kazakhstan
currently requires companies to comply with Kazakh accounting regulations and to
calculate tax profits or losses in accordance with these regulations as well as
prevailing tax law. There is currently uncertainty, therefore, as to the extent
of tax losses available to the Company.
17. Current Kazakhstan Environment
The ability of the Company to realize the carrying value of its assets is
dependent on being able to transport hydrocarbons and finding appropriate
markets for their sale. The Company has various options available to it in terms
of possible exportation routes to potential markets, based on experience of
other joint venture operations in the vicinity of the Company's activity.
Domestic markets in the Republic of Kazakhstan currently do not permit world
market prices to be obtained.
78
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
18. License Commitments and Operating Lease Commitment
As specified in Note 1, under the terms of the license the Company has committed
to minimum expenditures of $30 million for the year ended December 31, 1999. The
Company has excess expenditures from 1998 of $480,000, which will be applied
against the 1999 commitment. The Company has no other expenditure commitments
under the license after December 31, 1999. The license, as amended, also
establishes a minimum work program, requiring the Company to drill eight new
wells before December 31, 1999. The new wells must be between 3,250 and 3,500
meters in depth.
As of December 31, 1998, the Company's only major operating contractual
commitment is the drilling contract with Challenger Oil Services, PLC
("Contractor") entered into on April 7, 1998. The Company mobilized the drilling
rig in late 1998, but did not begin drilling operations until early 1999.
The drilling contract was retroactively amended as of March 17, 1999, to reflect
the current economic environment in the oil and gas industry as a whole, and
specifically in the Commonwealth of Independent States ("CIS"). The amended
contract terms are disclosed in Note 19, Subsequent Events. Any cost reductions
relating to the contract amendments have been incorporated in the Company's
financial statements as of December 31, 1998.
The terms of the drilling contract, as amended, require the Company to minimum
lease commitments for two years (1999 and 2000) of $3,102,500 per year. The
original drilling contract obliged the Company to minimum lease commitments of
$3,102,500 for one year only. Minimum lease payments are based upon stand-by
rates without crews.
19. Subsequent Events
Drilling contract
- -----------------
As stated in Note 18, on March 17, 1999, the Company retroactively amended its
drilling contract with Challenger Oil Services, PLC, originally entered into on
April 7, 1998. The Company is subject to the following terms of the amended
contract:
Amount
------
Operational rate $12,500/Day
Stand-by-rate with crews 11,250/Day
Stand-by rate without crews 8,500/Day
Rig move rate 20,000/Move
Rig demobilization (one time charge only) $250,000
Lease term 2 years
The Company spudded the first exploratory well (#101) on February 14, 1999.
Sales contract with KazakhOil
- -----------------------------
On March 30, 1999, the Company entered into a contract with KazakhOil, JSC,
shareholder of the Company, for the sale of 19,000 tons (138,700 barrels) of the
Company's crude oil production in April 1999. Under the terms of the contract,
the Company has been granted a transit quota to export 19,000 tons of crude oil
to the far abroad and near abroad markets. KazakhOil will act as a broker for
the sale.
According to the contract, net revenue to the Company is based upon a formula
indexed to the price of Brent crude on the date of sale, adjusted for
transportation costs and other minor charges. The sale will occur in two
batches: 13,000 tons and 6,000 tons. The Company expects the initial 13,000 tons
to be nominated for sale in early April. The Company expects the remaining 6,000
tons to be nominated before April 30, 1999.
79
<PAGE>
Karakuduk-Munay, Inc.
Notes to the Financial Statements - (Continued)
(Amounts in US dollars unless otherwise stated)
19. Subsequent Events (Continued)
Devaluation of Tenge
- --------------------
On April 5, 1999, the government decided not to continue its support of the
National currency, the Tenge and allowed it to float freely against the U.S.
dollar. Immediately thereafter, the official exchange rate declined from 87.5
tenge to the U.S. dollar to 142 tenge to the U.S. dollar.
The devaluation decreases the tenge realizable value of any U.S. dollar or other
hard currency denominated monetary assets held by the Company, and increases the
tenge obligation of any U.S. dollar or other hard currency denominated monetary
liabilities held by the Company.
As these financial statements are denominated in U.S. dollars, the only impact
will relate to that described on Note 2 to these accounts. The net impact is not
expected to be material to the Company's financial statements.
20. Impact of Year 2000 (unaudited)
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive software which is not "Year 2000
Compliant" may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions or engage in normal business activities.
The Company has completed an assessment and currently believes that the computer
systems it has in place are Year 2000 compliant.
The Company has initiated formal communication with all of its significant
suppliers and large customers to determine the extent to which the Company is
vulnerable to those third parties failure to remediate their own Year 2000
Issue. In particular, it is unclear as to the extent the Kazakh government and
other organizations who provide significant infrastructure services within the
Kazakh Republic have addressed the Year 2000 Issue. Furthermore, the current
crisis in Russia and the CIS could adversely affect the ability of the
government and such organizations to fund adequate Year 2000 compliance
programs. There is no guarantee that the systems of the government or of other
organizations on which the Company relies will be timely converted and would not
have an adverse effect on the Company and its systems.
The Company's financial statements as of December 31, 1998 and 1997 and for the
periods then ended do not include any adjustments to reflect the possible future
effect on the recoverability and classification of assets or the amounts or
classifications of liabilities that may result from the outcome of this
uncertainty.
80
