-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VUnutfMRNri5UD0fiokmKGAe1qPpVP5fvGe1fY0FNEvTr5gjW1xlJ4UTMFcoHVMK TBt5GPoewBV1s+j5+JQJ5w== 0001050502-05-000399.txt : 20050812 0001050502-05-000399.hdr.sgml : 20050812 20050812135729 ACCESSION NUMBER: 0001050502-05-000399 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20050630 FILED AS OF DATE: 20050812 DATE AS OF CHANGE: 20050812 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHAPARRAL RESOURCES INC CENTRAL INDEX KEY: 0000019252 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 840630863 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-07261 FILM NUMBER: 051020594 BUSINESS ADDRESS: STREET 1: 2 GANNETT DRIVE CITY: WHITE PLAINS STATE: NY ZIP: 10604 BUSINESS PHONE: 2818777100 MAIL ADDRESS: STREET 1: 2 GANNETT DRIVE CITY: WHITE PLAINS STATE: NY ZIP: 10604 10-Q 1 chaparral605.txt 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2005. OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to ________________. Commission File Number: 0 - 7261 CHAPARRAL RESOURCES, INC. ------------------------- (Exact Name of Registrant as Specified in Its Charter) Delaware 84-0630863 - ------------------------------- ------------------------------------ (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 2 Gannett Drive, Suite 418 White Plains, New York 10604 ---------------------------- (Address of Principal Executive Offices) Registrant's telephone number, including area code: (866) 559-3822 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 whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES |_| NO |X| As of August 10, 2005 the Registrant had 38,209,502 shares of its common stock, par value $0.0001 per share, issued and outstanding. CHAPARRAL RESOURCES, INC. FORM 10-Q JUNE 30, 2005 TABLE OF CONTENTS PAGE ---- PART I. FINANCIAL INFORMATION Item l. Financial Statements Consolidated Condensed Balance Sheets as of June 30, 2005 and December 31, 2004 1 Consolidated Condensed Statements of Operations for the Three Months Ended June 30, 2005 and 2004 and Consolidated Condensed Statements of Operations for the Six Months Ended June 30, 2005 and 2004 3 Consolidated Condensed Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004 4 Notes to Consolidated Condensed Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 Item 3. Quantitative and Qualitative Disclosures About Market Risk 19 Item 4. Controls and Procedures 20 PART II. OTHER INFORMATION Item 6. Exhibits 21 Signatures 22
Part I - Financial Information Item 1 - Financial Statements Chaparral Resources, Inc. Consolidated Condensed Balance Sheets June 30, December 31, 2005 2004 (Unaudited) --------- --------- $ 000 $ 000 Assets Current assets: Cash and cash equivalents 34,604 9,611 Accounts receivable: Oil sales receivable 6,731 316 VAT receivable 5,358 2,212 Other receivables from affiliates 2 1,002 Prepaid expenses 4,043 3,472 Current portion of deferred financing charges 1,229 -- Crude oil inventory 1,121 36 --------- --------- Total current assets 53,088 16,649 Deferred financing charges 571 -- Materials and supplies 6,675 5,238 Other 420 336 Property, plant and equipment: Oil and gas properties, full cost 165,717 153,001 Other property, plant and equipment 11,287 10,974 --------- --------- 177,004 163,975 Less - accumulated depreciation, depletion and amortization (73,997) (62,495) --------- --------- Property, plant and equipment, net 103,007 101,480 --------- --------- Total assets 163,761 123,703 ========= ========= See accompanying notes. 1 Chaparral Resources, Inc. Consolidated Condensed Balance Sheets (continued) June 30, December 31, 2005 2004 (Unaudited) --------- --------- $ 000 $ 000 Liabilities and Stockholders' equity Current liabilities: Accounts payable 9,107 8,540 Advances received -- 387 Prepaid sales -- 6,590 Accrued liabilities: Accrued compensation 226 241 Accrued interest payable 553 713 Other accrued liabilities 3,415 1,822 Current income tax liability 4,326 2,052 Current portion of loans payable 30,222 19,778 --------- --------- Total current liabilities 47,849 40,123 Accrued production bonus 341 299 Loans payable 25,778 12,000 Deferred tax liability 3,276 3,258 Minority interest 19,961 12,099 Asset retirement obligation 1,427 1,232 Stockholders' equity: Common stock - authorized, 100,000,000 shares of $0.0001 par value; issued and outstanding, 38,209,502 shares as of June 30, 2005 and December 31, 2004 4 4 Capital in excess of par value 107,226 107,226 Preferred stock - 1,000,000 shares authorized, 925,000 shares undesignated. Issued and outstanding - none -- -- Accumulated deficit (42,101) (52,538) --------- --------- Total Stockholders' equity 65,129 54,692 --------- --------- Total liabilities and Stockholders' equity 163,761 123,703 ========= ========= See accompanying notes. 2 Chaparral Resources, Inc. Consolidated Condensed Statements of Operations (Unaudited) For the Three Months Ended For the Six Months Ended -------------------------- -------------------------- June 30, June 30, June 30, June 30, 2005 2004 2005 2004 ----------- ----------- ----------- ----------- $000 (except share data) $000 (except share data) Revenue 33,160 17,471 57,487 33,080 Costs and expenses: Transportation costs 4,056 3,067 7,544 6,220 Operating expenses 3,568 1,688 7,393 3,899 Marketing fee 136 39 258 39 Depreciation and depletion 5,829 4,150 10,847 8,536 Management fee 200 25 393 100 Advisory fee -- 100 -- 100 Accretion expense 38 22 74 47 General and administrative 1,625 2,109 3,046 3,757 ----------- ----------- ----------- ----------- Total costs and expenses 15,452 11,200 29,555 22,698 ----------- ----------- ----------- ----------- Income from operations 17,708 6,271 27,932 10,382 Other income/(expense): Interest income 57 10 143 55 Interest expense (1,056) (1,265) (2,281) (2,499) Currency exchange gain/(loss) 9 (77) 17 (157) Minority interest (5,040) (1,757) (7,862) (2,823) Loss on disposition of assets (1) -- (1) -- ----------- ----------- ----------- ----------- Income before income taxes 11,677 3,182 17,948 4,958 Income tax expense (5,075) (1,882) (7,511) (3,024) ----------- ----------- ----------- ----------- Net income available to common Stockholders 6,602 1,300 10,437 1,934 =========== =========== =========== =========== Basic earnings per share: Net income per share $ 0.17 $ 0.03 $ 0.27 $ 0.05 Weighted average number of shares outstanding (basic) 38,209,502 38,209,502 38,209,502 38,209,502 Diluted earnings per share: Net income per share $ 0.17 $ 0.03 $ 0.27 $ 0.05 Weighted average number of shares outstanding (diluted) 39,500,312 38,209,502 39,327,414 38,209,502 See accompanying notes. 3 Chaparral Resources, Inc. Consolidated Condensed Statements of Cash Flows (Unaudited) For the Six Months Ended ------------------------ June 30, June 30, 2005 2004 -------- -------- $ 000 $ 000 Cash flows from operating activities Net income 10,437 1,934 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion and amortization 10,847 8,536 Deferred income taxes 18 1,955 Accretion expense 74 47 Amortization of note discount 222 227 Currency exchange (gain)/loss (17) 157 Loss on disposition of assets 1 -- Minority interest 7,862 2,823 Changes in assets and liabilities: (Increase)/decrease in: Accounts receivable (8,561) (2,654) Prepaid expenses (571) 830 Crude oil inventory (406) 103 Increase/(decrease) in: Accounts payable and accrued liabilities 2,250 2,306 Accrued interest payable (160) (80) Other liabilities (6,548) 71 -------- -------- Net cash provided by operating activities 15,448 16,255 -------- -------- Cash flows from investing activities Additions to property, plant and equipment (339) (1,130) Capital expenditures on oil and gas properties (12,595) (15,517) Materials and supplies inventory (1,437) -- Other long-term assets -- (911) -------- -------- Net cash used by investing activities (14,371) (17,558) -------- -------- 4 Chaparral Resources, Inc. Consolidated Condensed Statements of Cash Flows (Unaudited) (continued) For the Six Months Ended ------------------------ June 30, June 30, 2005 2004 -------- -------- $ 000 $ 000 Cash flows from financing activities Proceeds from loans 37,000 4,000 Payments on loans (13,000) (4,000) Other long-term assets (84) -- -------- -------- Net cash provided by financing activities 23,916 -- -------- -------- Net increase/(decrease) in cash and cash equivalents 24,993 (1,303) Cash and cash equivalents at beginning of period 9,611 2,639 -------- -------- Cash and cash equivalents at end of period 34,604 1,336 ======== ======== Supplemental cash flow disclosure Interest paid 2,220 2,302 Income taxes paid 5,068 1,645 Supplemental schedule of non-cash investing and financing activities Non-cash additions to oil and gas properties 121 175 See accompanying notes. 5
Chaparral Resources, Inc. Notes to Consolidated Condensed Financial Statements (Unaudited) 1. General Chaparral Resources, Inc. ("Chaparral") was incorporated in the state of Colorado on January 13, 1972, principally to engage in the exploration, development and production of oil and gas properties. Chaparral focuses substantially all of its efforts on the development of the Karakuduk Field, an oil field located in the Central Asian Republic of Kazakhstan. In 1999, Chaparral reincorporated from Colorado to Delaware. The consolidated financial statements include the accounts of Chaparral and its greater than 50% owned subsidiaries, Closed Type JSC Karakudukmunay ("KKM"), Central Asian Petroleum (Guernsey) Limited ("CAP-G"), Korporatsiya Mangistau Terra International ("MTI"), Road Runner Services Company ("RRSC"), Chaparral Acquisition Corporation ("CAC"), and Central Asian Petroleum, Inc. ("CAP-D"). Chaparral owns 80% of the common stock of CAP-G directly and 20% indirectly through CAP-D. Hereinafter, Chaparral and its subsidiaries are collectively referred to as the "Company." All significant inter-company transactions have been eliminated. As of June 30, 2005, Chaparral owns a 60% interest in KKM, a Kazakhstan Joint Stock Company of Closed Type. KKM was formed to engage in the exploration, development, and production of oil and gas properties in the Republic of Kazakhstan. KKM's only significant investment is in the Karakuduk Field, an onshore oil field in the Mangistau region of the Republic of Kazakhstan. On August 30, 1995, KKM entered into an agreement with the Ministry of Oil and Gas Industry for Exploration, Development and Production of Oil in the Karakuduk Oil Field in the Mangistau Region of the Republic of Kazakhstan (the "Agreement"). KKM's rights and obligations regarding the exploration, development, and production of underlying hydrocarbons in the Karakuduk Field are determined by the Agreement. KKM's rights to the Karakuduk Field may be terminated under certain conditions specified in the Agreement. The term of the Agreement is 25 years commencing from the date of KKM's registration. The Agreement can be extended to a date agreed between the Ministry of Energy and Mineral Resources and KKM as long as production of petroleum and/or gas is continued in the Karakuduk Field. KKM is owned jointly by CAP-G (50%), MTI (10%) and Nelson Resources Limited ("Nelson") (40%). Nelson bought its 40% share in December 2004 from KazMunayGas JSC ("KMG"), the national petroleum company of Kazakhstan, owned by the government of the Republic of Kazakhstan. Since May 2004, Nelson has owned approximately 60% of the outstanding common stock of Chaparral. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. Reference should be made to the relevant notes to the Company's financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004. The unaudited information furnished herein was taken from the books and records of the Company. However, such information reflects all adjustments which are, in the opinion of management, normal recurring adjustments necessary for the fair statement of the results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results to be expected for any future interim period or for the year. Use of Estimates Application of generally accepted accounting principles requires the use of estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. The determination of proved oil and gas reserve quantities and the application of the full cost method of accounting for exploration and production activities requires management to make numerous estimates and judgments. 6 Chaparral Resources, Inc. Notes to Consolidated Condensed Financial Statements (Unaudited) (continued) 2. Recent Accounting Pronouncements In November 2004, the FASB issued SFAS 151, Inventory Costs, an Amendment of APB Opinion No. 43, Chapter 4. SFAS 151 clarifies the accounting treatment for various inventory costs and overhead allocations and is effective for inventory costs incurred after July 1, 2005. It is not expected to have a material impact on the Company's financial statements when adopted. In December 2004, the FASB issued SFAS 153, Exchanges of Non-monetary Assets, an Amendment of APB Opinion No. 29. SFAS 153 specifies the criteria required to record a non-monetary asset exchange using carryover basis and is effective for non-monetary asset exchanges occurring after July 1, 2005. It is not expected to have a material impact on the Company's financial statements when adopted. In December 2004, the FASB issued SFAS 123 (revised 2004) ("SFAS 123R"), Share Based Payments. SFAS 123R requires that the cost from all share-based payment transactions, including stock options, be recognized in the financial statements at fair value and is effective for public companies in the first interim period after June 15, 2005. It is not expected to have a material impact on the Company's financial statements. 3. Prepaid Expenses The breakdown of Prepaid Expenses is as follows: $000 --------------------- June 30, December 31, Description 2005 2004 ----------- ---- ---- Prepaid transportation costs 1,986 1,151 Advanced payments for materials and supplies 1,130 1,461 Prepaid insurance 670 568 Other prepaid expenses 257 292 ----- ----- Total prepaid expenses 4,043 3,472 ===== ===== Prepaid transportation costs represent prepayments of export tariffs to CJSC KazTransOil ("KTO"), a 100% subsidiary of KMG, necessary to sell oil on the export market, which is expensed in the period the related oil revenue is recognized. Advanced payments for materials and supplies represent prepayments for general materials and supplies to be used in the development of the Karakuduk Field. 4. Asset Retirement Obligation FASB No. 143 requires entities to record the fair value of the liability for asset retirement obligations (ARO) in the period in which the liability is incurred, if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Since 1995, the core business of the Company has been the development of the Karakuduk Field. The Company has developed an asset that is capable of producing, processing and transporting crude oil to export markets. The field still requires up to possibly 80 new wells, but the oil processing and transportation infrastructure, apart from the obligatory gathering lines and up to four more gathering stations, are in place. However, further infrastructure development is planned to increase profitability of the operation, utilize gas and to maximise oil and produced fluid processing. The Company is legally required under the Agreement to restore the field to its original condition. 7 Chaparral Resources, Inc. Notes to Consolidated Condensed Financial Statements (Unaudited) (continued) 4. Asset Retirement Obligation (continued) The following table shows movements in the Company's asset retirement obligation liability: $000 ------------------ June 30, June 30, 2005 2004 ---- ---- Asset retirement obligation at beginning of period 1,232 804 Accretion expense 74 47 Additional provision for new wells 121 175 ----- ----- Asset retirement obligation at end of period 1,427 1,026 ===== ===== 5. Change in Control In May 2004, Nelson purchased from Central Asian Industrial Holdings, N.V. ("CAIH") 22,925,701 shares of Chaparral, representing approximately 60% of Chaparral's issued and outstanding common stock. As part of the transaction, a Stock Purchase Warrant exercisable for 3,076,923 shares of the Company's common stock originally issued to CAIH, and a promissory note of the Company payable to CAIH, with a principal amount of $4 million (see Note 6), were transferred by CAIH to Nelson. The total purchase price was $23.9 million. 6. Loans The Note - -------- In May 2002, the Company received a total equity and debt capital infusion of $45 million, which was partially utilized to repay a substantial portion of the Company's loan agreement with Shell Capital, Inc. (the "Shell Capital Loan"). The Company received a total investment of $12 million from CAIH, including $8 million in exchange for 22,925,701 shares, or approximately 60%, of the Company's outstanding common stock, and $4 million in exchange for a three year note bearing interest at 12% per annum (the "Note"). Along with the Note, CAIH received a warrant to purchase 3,076,923 shares of the Company's common stock at $1.30 per share (the "Warrant"). Additionally, Kazkommertsbank, an affiliate of CAIH, provided KKM with a credit facility totaling $33 million (the "KKM Credit Facility"), consisting of $28 million that was used to repay a portion of the Shell Capital Loan and $5 million that was made available for KKM's working capital requirements. The Company paid CAIH $1.79 million as a related restructuring fee. The Note was recorded net of a $2.47 million discount, based on the fair market value of the Warrant issued in conjunction with the Note. The discount was amortized using the effective interest rate over the original life of the Note. The principal balance of the Note was originally due on May 10, 2005 and accrued interest is payable quarterly. On March 24, 2005, Chaparral and CAP-G signed a Promissory Note Amendment Agreement pursuant to which a $1 million prepayment of the Note was made on March 31, 2005 and the maturity of the remaining balance of the Note was extended to May 10, 2006 (see further discussion below). In June 2002, the Company prepaid $2 million of the $4 million outstanding principal balance of the Note. As a result, the Company recognized an extraordinary loss on the early extinguishment of debt of $1.22 million from the write-off of 50% of the unamortized discount on the Note. The extraordinary loss was netted against the extraordinary gain from the restructuring of the Shell Capital Loan. In March 2004, the Company re-borrowed the $2 million. In May 2004, the CAIH shares, the Warrant and the Note were purchased by Nelson. On March 24, 2005, Chaparral and CAP-G signed a Promissory Note Amendment Agreement with Nelson. This provided for a prepayment of $1 million of the $4 million due to be repaid to Nelson on May 10, 2005 under the existing $4 million loan note and the replacement of the existing loan note with a new loan note for 8 Chaparral Resources, Inc. Notes to Consolidated Condensed Financial Statements (Unaudited) (continued) 6. Loans (continued) $3 million on substantially similar terms, but with an increase in the interest rate from 12% to 14% from May 10, 2005 and an extension of the maturity date of one year to May 10, 2006. On March 31, 2005 the $1 million prepayment was made, the existing loan note was cancelled and the new loan note was signed. See Item 2 paragraph 1, General Liquidity Considerations. KKM Credit Facility - ------------------- As mentioned above, in May 2002, KKM established the KKM Credit Facility, a five-year, $33 million credit line with Kazkommertsbank. The KKM Credit Facility consisted of a $30 million non-revolving line and a $3 million revolving line, both of which were fully borrowed by KKM in May 2002. The Company recognized $2.22 million and $1.71 million of interest expense on the KKM Credit Facility for the six months ended June 30, 2004 and 2005 respectively. The non-revolving portion of the KKM Credit Facility accrued simple interest at an annual rate of 14% and was repayable over a five-year period with final maturity in May 2007. Accrued interest was payable quarterly, beginning in December 2002, and KKM began making quarterly principal repayments in May 2003. As of June 30, 2005, the Company had repaid $14 million in principal. The revolving portion of the KKM Credit Facility accrued simple interest at an annual rate of 14%. The revolver was loaned to KKM for short-term periods up to one year, but KKM had the right to re-borrow the funds through May 2006 with final repayment due in May 2007. On December 30, 2003, Kazkommertsbank increased the revolving portion of the KKM Credit Facility from $3 million to $5 million. On the same date, KKM borrowed the additional $2 million to finance ongoing operations. The additional $2 million accrued interest at 14%. As at June 30, 2005, there was an outstanding balance of $5 million on the revolving portion of the loan, $3 million maturing on August 9, 2005 and $2 million maturing on August 17, 2005. Accrued interest on the revolving loan was payable at maturity. The original KKM Credit Facility included repayment terms of three years and four years for the non-revolving and revolving portions, respectively, with an option to extend the final maturity date for repayment of the entire KKM Credit Facility to five years. KKM exercised the option as of May 2002. On July 1, 2005, the total outstanding principal of $21 million of the KKM Credit Facility, together with outstanding interest, was repaid, and was classified as current as at June 30, 2005. The BNP/KBC Credit Facility (see below) provided the funds for this repayment. BNP/KBC Credit Facility - ----------------------- On March 24, 2005, KKM signed a $40 million Structured Crude Oil Pre-export Credit Facility Agreement with BNP Paribas (Suisse) SA ("BNP") and KBC Bank N.V. (the "BNP/KBC Credit Facility"). On June 30, 2005, $32 million was drawn down from this facility. For six months from 30 June, 2005 the facility is a revolving credit, after which the amount outstanding becomes a term loan repayable in 36 equal monthly installments commencing on December 30, 2005. The purpose of the loan is to refinance the KKM Credit Facility, fund future development costs and fund fees related to the facility. Each year the lenders may propose, but are under no obligation to do so, an extension of the facility by one year, for an agreed fee, and/or an increase of the facility amount for an agreed fee. Each month during the term loan period, KKM may make full or partial prepayments of the facility at no extra cost. Partial prepayments must be for amounts of $2 million or more. 9 Chaparral Resources, Inc. Notes to Consolidated Condensed Financial Statements (Unaudited) (continued) 6. Loans (continued) The interest rate applicable under the facility is LIBOR plus 3.25% in the first year and LIBOR plus 4.00% thereafter. Interest is payable monthly. Fees payable by KKM include a 1.75% arrangement fee, a 1.65% p.a. commitment fee on the unused commitment during the revolving credit period, $100,000 for the lenders' legal costs and $15,000 per quarter in advance for agency and technical bank fees. A total of $0.8 million has been accrued for the arrangement fee and legal costs which will be amortized over the life of the facility. As part of the BNP/KBC Credit Facility conditions, an Offtake Agreement was signed in June 2005 with Vitol Central Asia S.A. ("Vitol") whereby KKM is obligated to sell to Vitol, and Vitol is obligated to buy, all of KKM's crude oil production available for export at international market prices for five years from July 1, 2005, with step-in rights in favor of the lenders. In accordance with the BNP/KBC Credit Facility conditions, accounts receivable from Vitol are pledged as collateral for the loan. In addition, a performance and financial guarantee was issued by Nelson (the "Nelson Guarantee") in support of all amounts owing by KKM under the BNP/KBC Credit Facility. Under a separate agreement, in consideration for issuing the Nelson Guarantee, KKM will pay Nelson, annually in advance, a fee of 2.5% p.a. on the facility amount of $40 million for the first six months and on the daily principal amount of the loan outstanding during the term period. An amount of $1.0 million, which was paid in July for the estimated first years guarantee fee, has been accrued in June and will be amortized over twelve months. A further condition of the BNP/KBC Credit Facility is that KKM enter into a Crude Oil Hedging Agreement before the end of August 2005. Nelson has already entered into such a hedging agreement with BNP, and both Nelson and KKM intend that this agreement will be transferred, at cost, to KKM in August 2005. Under this agreement, Nelson has the option each month, from April 2005 to December 2005, to require BNP to pay it an amount per barrel of specified monthly amounts of crude oil equivalent to the excess of $33.00 per barrel over the monthly average for that month of dated Brent. The crude oil amounts specified are 75,000 barrels per calendar month during the second quarter of 2005, 160,000 barrels per calendar month during the third quarter of 2005 and 170,000 barrels per calendar month during the last quarter of 2005. Nelson paid BNP $267,300 as consideration, equivalent to $0.22 per barrel. KKM is subject to certain pledges, covenants, and other restrictions under the BNP/KBC Credit Facility, including, but not limited to, the following: (i) KKM has signed an Offtake Agreement for 100% of its export production, with step-in rights in favor of the lenders; (ii) Nelson has provided a written guarantee to the lenders that it will repay the BNP/KBC Credit Facility in the event KKM fails to do so; (iii)KKM may not incur additional indebtedness or pledge its assets to another party without the written consent of the lenders; (iv) Subordination of existing loans, including inter-company, and any additional loans; (v) KKM may not pay dividends without the written consent of the lenders; and (vi) Nelson to maintain a controlling interest in KKM. The BNP/KBC Credit Facility stipulates certain events of default, including, but not limited to, KKM's inability to meet the terms of the BNP/KBC Credit Facility and the Offtake Agreement, default by KKM or Nelson under any other agreements and material litigation involving Nelson or KKM. If an event of default does occur and is not waived by the lenders, they can require KKM to immediately repay the full amount outstanding under the facility and may enforce the Nelson Guarantee and their step-in rights under the Offtake Agreement. 10 Chaparral Resources, Inc. Notes to Consolidated Condensed Financial Statements (Unaudited) (continued) 6. Loans (continued) The maturity schedule of the Company's indebtedness as of June 30, 2005, which reflects the repayment on July 1, 2005 of all of the $21 million principal to Kazkommertsbank, is as follows: Date Principal Amount Due ---- -------------------- $000 2005 21,889 2006 13,667 2007 10,667 2008 9,777 -------------------- Total principal due 56,000 ==================== Balances as of June 30, 2005 under the different facilities are as follows: Principal Amount Due -------------------- $000 BNP/KBC Credit Facility 32,000 KKM Credit Facility (non - revolving) 16,000 KKM Credit Facility (revolving) 5,000 The Note 3,000 -------------------- Total principal due 56,000 ==================== The loans are shown in the balance sheet net of the loan discount, which was nil at June 30, 2005 and $222,000 at December 31, 2004. 7. Income Taxes Income tax expense as reported relates entirely to foreign income taxes provided on the Company's operations within the Republic of Kazakhstan. KKM's principal agreement with the government of the Republic of Kazakhstan for the exploration, development and production of oil in the Karakuduk Field specifies the income taxes and other taxes applicable to KKM, which is subject to the tax laws of the Republic of Kazakhstan. The Company has used the best estimates available to determine its current and deferred tax liabilities within Kazakhstan. 8. Capital Commitments On December 31, 2004, the Company's contract with KazMunayGas-Drilling ("KMGD"), an affiliate of KMG, for one development drilling rig currently operating in the Karakuduk Field, expired. The same rig is now contracted through Oil and Gas Drilling and Exploration of Kracow ("OGEC") for a one year term to December 31, 2005. The minimum payments under the drilling contract with OGEC for 2005 are $4.50 million. The Company's other drilling and operations related contracts can either be cancelled within 30 days or are on a call-off (as required) basis. The Company has no other significant commitments other than those incurred during the normal performance of the work program to develop the Karakuduk Field. 11 Chaparral Resources, Inc. Notes to Consolidated Condensed Financial Statements (Unaudited) (continued) 9. Related Party Transactions In August 2004, the Company approved a two-year agreement with Nelson to provide corporate administrative services and financial advisory services (the "Service Agreement") to support its business activities. The Service Agreement is effective as of June 1, 2004 and can be terminated upon 30 days written notice by either party. In consideration for these services Nelson will receive a fixed monthly fee of $20,000 for administrative services and $25,000 for financial advisory services (the "Management Fee"). As part of the Service Agreement, Nelson is also required to provide personnel to cover Chaparral's executive and managerial needs. The cost of executive and managerial personnel will be allocated on the basis of the cost of personnel involved and on the percentage of time actually spent by such personnel on matters related to Chaparral, as mutually agreed by the parties from time to time. In addition, Nelson will use its greater buying power to obtain more favorable rates for goods and services, including insurance coverage, for Chaparral. These expenditures will be passed to Chaparral at cost with a ten percent mark-up. For the six months to June 30, 2005, the Company has booked $444,000 for the Management Fee, the executive and managerial cost, insurance coverage and the mark-up under the Service Agreement. In June 2004, KKM entered into a three year agency agreement with Nelson (the "Marketing Agreement"), whereby Nelson becomes the duly authorized, exclusive agent for the purpose of marketing crude oil, and is empowered to represent the interests of KKM in relations with governmental authorities and commercial organizations and also enter into contracts and agreements and any other documents necessary for and related to the marketing of crude oil. The Marketing Agreement is effective as of June 1, 2004 and can be terminated upon 90 days written notice by either party. As consideration for the services provided under the Marketing Agreement, KKM shall pay Nelson a fixed fee of $20,000 per month and a variable fee of five US cents per barrel of total production in a reporting calendar month, if the amount of supplies to the local market in that month is more than 10% of the total amount of production, or eight US cents per barrel of total production in a reporting calendar month, if the amount of supplies to the local market in that month is less than 10% of the total amount of production (the "Marketing Fee"). For the period ending June 30, 2005, $258,000 was accrued under the Marketing Agreement. In 2003, the Company approved a one-year agreement with OJSC Kazkommerts Securities ("KKS"), an affiliate of Kazkommertsbank. The agreement was effective as of January 7, 2003 and provided for KKS to assist the Company's senior management with financial advisory and investment banking services. In consideration for these services KKS received a monthly fee of $25,000 (the "Advisory Fee"). The agreement with KKS was cancelled as of April 30, 2004. Kazkommerts Policy, an affiliate of Kazkommertsbank, is the major insurer of KKM's oil and gas activities. KKM has a contract to transport 100% of its oil sales through the pipeline owned and operated by KTO, a wholly owned subsidiary of KMG, the 40% minority shareholder in KKM until December 2004. The rates for transportation are in accordance with those approved by the government of the Republic of Kazakhstan. Currently, the use of the KTO pipeline system is the only viable method of exporting KKM's production. As KTO notifies KKM of the export sales allocated to KKM on a monthly basis, KTO controls transportation of export sales. KKM makes a prepayment for crude transportation costs based upon the allocation of export sales received from the Ministry of Energy and Mineral Resources of the Republic of Kazakhstan. This prepayment includes pipeline costs charged by the operators of the pipeline systems outside Kazakhstan and is dependent upon the point of sale of KKM's exports. For the six months ended June 30, 2005, KKM incurred $7.1 million for transportation costs with KTO. As of June 30, 2005, KKM had a prepayment balance of $2.0 million with KTO in respect of sales to be made in July 2005. Comparably, for the six months ended June 30, 2004, KKM incurred $6.2 million for transportation costs with KTO. As of December 31, 2004, KKM had a prepayment balance of $1.2 million with KTO in respect of sales that were not completed until January 2005. KTO charges KKM for associated costs of oil storage within their pipeline system, sales commission, customs clearance fees in respect of export sales and for water through the Volga Water pipeline. Amounts recognized for these services during the six months ended June 30, 2005 and 2004 were $179,000 and $72,000, respectively. 12 Chaparral Resources, Inc. Notes to Consolidated Condensed Financial Statements (Unaudited) (continued) 9. Related Party Transactions (continued) The total amounts of the transactions with the above related companies for the six months ended June 30, 2005 and 2004 are as follows: $000 --------------- 2005 2004 ------ ------ Nelson 717 139 KKS -- 100 Kazkommerts Policy 247 356 KTO 7,237 6,189 KMGD -- 2,657 Accounts payable balance to affiliates as at June 30, 2005 and December 31, 2004 are as follows: $000 ---------------- 2005 2004 ------ ------ Nelson 143 -- Kazkommerts Policy -- 195 KTO 91 8 KMGD -- 371 ------ ------ 234 574 ====== ====== The loans with Kazkommertsbank and Nelson are disclosed in Note 6. 10. 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 - ------------------- KKM maintains its statutory books and records in accordance with U.S. generally accepted accounting principles and calculates taxable income or loss using the existing Kazakh tax legislation in effect on August 30, 1995, the date the Agreement was signed. The Company considers these accounting methods correct under the terms of the Agreement. The Republic of Kazakhstan currently requires companies to comply with Kazakh accounting regulations and to calculate tax profits or losses in accordance with these regulations as well as the prevailing tax law. 13 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 1. Liquidity and Capital Resources General Liquidity Considerations - -------------------------------- Going Concern - ------------- Our financial statements have been presented on the basis that the Company is a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. Until recently, Chaparral had a working capital deficiency. In addition, we have experienced limitations in obtaining 100% export quota for the sale of our hydrocarbons. Previously these conditions raised substantial doubt about our ability to continue as a going concern. However, due to recently completed refinancing of the Company's debt (see below), we now expect to be able to meet all expenditure and cash flow requirements through the next twelve months. Chaparral has been successful in 2004 in stabilizing the export sales/local market deliveries ratio which had significantly improved from 2002 to 2003. For the year ended December 31, 2004, Chaparral sold approximately 2,758,000 barrels of its current year production, of which approximately 2,544,000 barrels, or 92% (2003: 2,591,000 barrels, 96%), have been sold at world market prices and 214,000 barrels, or 8% (2003: 103,000 barrels, 4%), have been sold at domestic market prices. During the first half of 2005, exports accounted for 93% of total sales. On March 24, 2005, KKM signed a $40 million Structured Crude Oil Pre-export Credit Facility Agreement with BNP Paribas (Suisse) S.A. and KBC Bank N.V. (the "BNP/KBC Credit Facility"). On June 30, 2005, $32 million of funds from this facility were drawn down. On July 1, 2005, the total outstanding principal of $21 million of the KKM Credit Facility, together with outstanding interest, was repaid. See Item 1 Note 6 for further details of the BNP/KBC Credit Facility. In addition, on March 24, 2005, Chaparral and CAP-G signed a Promissory Note Amendment Agreement with Nelson (the "Amendment Agreement"). This provided for a prepayment of $1 million of the $4 million due to be repaid to Nelson on May 10, 2005 under the existing $4 million loan note and the replacement of the existing loan note with a new loan note for $3 million on substantially similar terms, but with an increase in the interest rate from 12% to 14% from May 10, 2005 and an extension of the maturity date of one year to May 10, 2006. On March 31, 2005 the $1 million prepayment was made, the existing loan note was cancelled and the new loan note was signed. See Item 1 Note 6. The BNP/KBC Credit Facility and Amendment Agreement significantly improve the Company's financial position, enabling it to meet all its current financial obligations and continue with field development. Liquidity and Capital Resources - ------------------------------- We are presently engaged in the development of the Karakuduk Field, which requires substantial cash expenditures for drilling, well completions, workovers, oil storage and processing facilities, pipelines, gathering systems, water injection facilities, plant and equipment (pumps, transformer sub-stations etc.), a rail loading facility and gas utilization. We have invested approximately $165 million in the development of the Karakuduk Field and have drilled 60 new wells and re-completed 13 of the pre-existing wells at the field by June 30, 2005. Total capital expenditures for the first half of 2005 were approximately $13 million. Capital expenditures are estimated to be at least $100 million from 2005 through 2009, including the drilling of approximately 70 more wells over this period. We anticipate 2005 capital expenditures of approximately $46 million. We expect to finance the continued development of the Karakuduk Field primarily through cash flows from the sale of crude oil. During the second quarter of 2005, KKM sold approximately 794,000 barrels of crude oil for $33 million, compared to 679,000 barrels for $24 million in the first quarter of 2005. As mentioned above, KKM has recently secured $40 million of new funding with which it has re-financed the loans provided by Kazkommertsbank. Current daily oil production is in excess of 11,500 barrels per day. During 2005, KKM expects to further increase production by drilling new wells, converting at least 15 more wells to artificial lift, converting three more wells to water injection wells, adding four new water injection wells to the injection fund and by continuing with hydraulic fracturing work in selected 14 wells. Work on the utilization of associated gas produced from the field will continue throughout the year. Also, in the second half of 2005, KKM expects to commence the construction of a rail loading facility near the field so that by the second half of 2006 KKM will be able to transport crude oil by rail to Aktau. This is expected to result in significantly higher netbacks. In addition, our short and long-term liquidity is impacted by local oil sales obligations imposed on oil and gas producers within Kazakhstan to supply local energy needs, and our ability to obtain export quota necessary to sell our crude oil production on the international market. Under the terms of the Agreement, we have a right to export, and receive export quota for, 100% of the production from the Karakuduk Field. The domestic market does not permit world market prices to be obtained, resulting in, on average, $19 lower cash flow per barrel in the first half of 2005. Furthermore, the Government has not allocated sufficient export quota to allow us to sell all of our available crude oil production on the world market. We are taking steps to reduce our local market obligations and to obtain an export quota that will enable us to sell all of our crude oil production on the export market. The Company has determined that it is no longer in its the best interests to pursue arbitration proceedings in Switzerland for the breach of the Agreement by the Government of Kazakhstan, instead we intend to seek an amicable resolution of this matter. If the matter cannot be resolved in a satisfactory manner, we have, however, reserved our right to commence formal arbitration proceedings pursuant to our contractual arrangements with the Government. No assurances can be provided, however, that an amicable resolution will be reached, or that if arbitration is instituted, it will be successful or that if successful, Chaparral will be able to enforce the award in Kazakhstan, or that we will be able to export 100% or a significant portion of production or that we will be able to obtain additional cash flow from operations to meet working capital requirements in the future. During the first half of 2005 the Company continued with the development of the Karakuduk Field. As of June 30, 2005 the total field well count had risen to 72 compared to 66 on December 31, 2004. The producing well count at the field as of June 30, 2005 was 52 wells compared to 45 at the end of 2004. One producing well was converted to an injection well. Production for the first half of 2005 was 1.73 million barrels, equivalent to 9,555 barrels of oil per day ("bopd"), compared to 1.43 million barrels, or 7,867 bopd, in the first half of 2004, an increase of 21%. The Company sold 178,500 tonnes to export markets (93% of total sales) and 14,000 tonnes locally during the first half of 2005, compared with 156,000 tonnes exported (88% of total sales) and 21,000 tonnes to the local market in the first half of 2004. Drilling activity continued in the second quarter. The "closed circulation system", whereby waste drill cuttings and fluids are collected and taken to a specially prepared pit near the field, was fully implemented. The Company drilled 3.6 wells (11,409m)in the second quarter of 2005 compared to 2.8 wells (8,624m) in the first quarter of the year. In July, production rose to an average of just over 11,500 bopd. The Company will continue with the development of the Karakuduk Field throughout the remainder of 2005. One drilling rig and two workover rigs will operate at the field. The Company forecasts that up to 16 wells will be drilled, including two horizontal wells, the first such wells to be drilled at Karakuduk. Phase 2 of the gas utilization project commenced in May. The gas pipeline from km 15 to the Transfer Pumping Station is approximately 50% complete. The Company will also continue with its water injection programme, and the 2006 hydraulic fracturing program that includes 6 wells is due to commence in August. We expect KKM's production to reach a level of just over 12,000 bopd by the end of the year. Capital Commitments and Other Contingencies - ------------------------------------------- On December 31, 2004, the Company's contract with KMGD, an affiliate of KMG, for one development drilling rig currently operating in the Karakuduk Field, expired. The same rig is now contracted through Oil and Gas Drilling and Exploration of Kracow ("OGEC") for a one year term to December 31, 2005. The minimum payments under the drilling contract with OGEC for 2005 are $4.50 million. The Company's other drilling and operations related contracts can either be cancelled within 30 days or are on a call-off (as required) basis. 15 The Company has no other significant commitments other than those incurred during the normal performance of the work program to develop the Karakuduk Field. Our operations may be subject to other regulations by the government of the Republic of Kazakhstan or other regulatory bodies responsible for the area in which the Karakuduk Field is located. In addition to taxation, customs declarations and environmental controls, regulations may govern such things as drilling permits and production rates. Drilling permits could become difficult to obtain or prohibitively expensive. Production rates could be set so low that they would make production unprofitable. These regulations may substantially increase the costs of doing business and may prevent or delay the starting or continuation of any given development project. All regulations are subject to future changes by legislative and administrative action and by judicial decisions. Such changes could adversely affect the petroleum industry in general and us in particular. It is impossible to predict the effect that any current or future proposals or changes in existing laws or regulations may have on our operations. 2. Results of Operations Results of Operations for the Three Months Ended June 30, 2005 Compared to the Three Months Ended June 30, 2004 - ------------------------------------------------------------------------------ Our operations for the three months ended June 30, 2005 resulted in a net income of $6.60 million compared to a net income of $1.30 million for the three months ended June 30, 2004. The $5.30 million increase in our net income is primarily a result of higher crude prices and higher sales volumes. Revenues. Revenues were $33.16 million for the second quarter of 2005 compared with $17.47 million for the second quarter of 2004. The $15.69 million increase is the result of higher crude prices and sales volumes achieved during the second quarter of 2005 as compared to the same period of 2004. During the second quarter of 2005, we sold approximately 793,500 barrels of crude oil, recognizing $33.16 million in revenue, or $41.79 per barrel after quality differential losses. Comparably, we sold approximately 666,000 barrels of crude oil, recognizing $17.47 million in revenue, or $26.24 per barrel, during the second quarter of 2004. The result is a positive price variance of $12.34 million and a positive volume variance of $3.35 million. Transportation and Operating Expenses. Transportation costs for the second quarter of 2005 were $4.06 million, or $5.11 per barrel, and operating costs associated with sales were $3.57 million, or $4.50 per barrel. Comparatively, transportation costs for the second quarter of 2004 were $3.07 million, or $4.61 per barrel, and operating costs associated with sales were $1.69 million, or $2.54 per barrel. The increase in transportation cost per barrel during the second quarter of 2005 is the result of higher tariffs imposed on the Company. The main reason for the increase in operating cost per barrel is changes in cost allocation procedures resulting in a lower percentage of field expenditures being capitalized. Depreciation and Depletion. Depreciation and depletion expense was $5.83 million for the second quarter of 2005 compared with $4.15 million for the second quarter of 2004. The $1.68 million increase is the result of higher sales volumes and a higher effective depletion rate which is due to a proportionately higher increase in future capital costs associated with increased reserves. During the second quarter of 2005, the Company recognized a total depletion expense of $5.64 million or $5.93 per barrel produced, compared to $4.00 million or $5.50 per barrel produced for the second quarter of 2004. Estimates of our proved oil and gas reserves are prepared by an independent engineering company in accordance with guidelines established by the Securities and Exchange Commission ("SEC"). Those guidelines require that reserve estimates be prepared under existing economic and operating conditions with no provisions for increases in commodity prices, except by contractual arrangement. Estimation of oil and gas reserve quantities is inherently difficult and is subject to numerous uncertainties. Such uncertainties include the projection of future rates of production, export allocation, and the timing of development expenditures. The accuracy of the estimates depends on the quality of available 16 geological and geophysical data and requires interpretation and judgment. Estimates may be revised either upward or downward by results of future drilling, testing or production. In addition, estimates of volumes considered to be commercially recoverable fluctuate with changes in commodity prices and operating costs. Our estimates of reserves are expected to change as additional information becomes available. A material change in the estimated volumes of reserves could have an impact on the depletion rate calculation and the financial statements. Interest Expense. Interest expense was $1.06 million for the second quarter of 2005 compared to $1.27 million for the second quarter of 2004. The decrease is primarily a result of $0.28 million lower interest under the KKM Credit Facility due to reduction in principal outstanding. General and Administrative Expense. General and administrative costs decreased from $2.11 million for the three months ended June 30, 2004 to $1.63 million for the three months ended June 30, 2005. The decrease of $0.48 million is primarily due to accrued severance costs for former executives in the second quarter of 2004, reductions in expatriate staff numbers and lower salaries and wages, partially offset by an accrual of $0.57 million for Kazakh withholding tax payable on management fees charged by CAP-G to KKM for the period January 2004 to June 2005. This withholding tax liability has only recently arisen due to changes in KKM's income tax returns. Income Tax Expense. Income tax expense increased from $1.88 million for the three months ended June 30, 2004 to $5.08 million for the three months ended June 30, 2005, representing 59% and 43% respectively of pre-tax income. The tax charge has increased as income has increased. The effective tax rate has decreased largely because Chaparral parent company administrative costs, which are not deductible against KKM's Kazakh taxable income, are smaller relative to pre-tax income as KKM's profits rise. Results of Operations for the Six Months Ended June 30, 2005 Compared to the Six Months Ended June 30, 2004 - -------------------------------------------------------------------------------- Our operations for the six months ended June 30, 2005 resulted in a net income of $10.44 million compared to a net income of $1.93 million for the six months ended June 30, 2004. The $8.51 million increase in our net income is primarily a result of higher crude prices. Revenues. Revenues were $57.49 million for the first half of 2005 compared with $33.08 million for the first half of 2004. The $24.41 million increase is the result of higher crude prices and sales volumes achieved during the first half of 2005 as compared to the same period of 2004. During the first half of 2005, we sold approximately 1,472,500 barrels of crude oil, recognizing $57.49 million in revenue, or $39.04 per barrel after quality differential losses. Comparably, we sold approximately 1,354,000 barrels of crude oil, recognizing $33.08 million in revenue, or $24.42 per barrel, for the first half of 2004. The result is a positive price variance of $21.52 million and a positive volume variance of $2.89 million. Transportation and Operating Expenses. Transportation costs for the first half of 2005 were $7.54 million, or $5.12 per barrel, and operating costs associated with sales were $7.39 million, or $5.02 per barrel. Comparatively, transportation costs for the first half of 2004 were $6.22 million, or $4.59 per barrel, and operating costs associated with sales were $3.90 million, or $2.88 per barrel. The increase in transportation cost per barrel during the first half of 2005 is the result of higher tariffs imposed on the Company. The main reason for the increase in operating cost per barrel is changes in cost allocation procedures resulting in a lower percentage of field expenditures being capitalized. Depreciation and Depletion. Depreciation and depletion expense was $10.85 million for the first half of 2005 compared with $8.54 million for the first half of 2004. The $2.31 million increase is the result of higher sales volumes and a higher effective depletion rate which is due to a proportionately higher increase in future capital costs associated with increased reserves. During the first half of 2005, the Company recognized a total depletion expense of $10.47 million or $6.05 per barrel produced, compared to $8.23 million or $5.74 per barrel produced for the first half of 2004. Estimates of our proved oil and gas reserves are prepared by an independent engineering company in accordance with guidelines established by the Securities and Exchange Commission ("SEC"). Those guidelines require that reserve estimates be prepared under existing economic and operating conditions with no provisions for increases in commodity prices, except by contractual arrangement. Estimation of oil and gas reserve quantities is inherently difficult and is subject to 17 numerous uncertainties. Such uncertainties include the projection of future rates of production, export allocation, and the timing of development expenditures. The accuracy of the estimates depends on the quality of available geological and geophysical data and requires interpretation and judgment. Estimates may be revised either upward or downward by results of future drilling, testing or production. In addition, estimates of volumes considered to be commercially recoverable fluctuate with changes in commodity prices and operating costs. Our estimates of reserves are expected to change as additional information becomes available. A material change in the estimated volumes of reserves could have an impact on the depletion rate calculation and the financial statements. Interest Expense. Interest expense was $2.28 million for the first half of 2005 compared to $2.50 million for the first half of 2004. Interest charges under the KKM Credit Facility were $0.62 million lower due to reduction in principal outstanding, but this was partially offset by no interest being capitalized in the first half of 2005 compared to $0.26 million in the first half of 2004. General and Administrative Expense. General and administrative costs decreased from $3.76 million for the six months ended June 30, 2004 to $3.05 million for the six months ended June 30, 2005. The decrease of $0.71 million is primarily due to accrued severance costs for former executives in the first half of 2004, reductions in expatriate staff numbers and lower salaries and wages, partially offset by an accrual of $0.57 million for Kazakh withholding tax payable on management fees charged by CAP-G to KKM for the period January 2004 to June 2005. This withholding tax liability has only recently arisen due to changes in KKM's income tax returns. Income Tax Expense. Income tax expense increased from $3.02 million for the six months ended June 30, 2004 to $7.51 million for the six months ended June 30, 2005, representing 61% and 42% respectively of pre-tax income. The tax charge has increased as income has increased. The effective tax rate has decreased largely because Chaparral parent company administrative costs, which are not deductible against KKM's Kazakh taxable income, are smaller relative to pre-tax income as KKM's profits rise. 3. Commodity Prices for Oil and Gas Our revenues, profitability, growth and value are highly dependent upon the price of oil. Market conditions make it difficult to estimate prices of oil or the impact of inflation on such prices. Oil prices have been volatile, and it is likely they will continue to fluctuate in the future. Various factors beyond our control affect prices for oil, including supplies of oil available worldwide and in Kazakhstan, the ability of OPEC to agree to maintain oil prices and production controls, political instability or armed conflict in Kazakhstan or other oil producing regions, the price of foreign imports, the level of consumer demand, the price and availability of alternative fuels, the availability of transportation routes and pipeline capacity, and changes in applicable laws and regulations. 4. Inflation and Exchange Rates We cannot control prices received from our oil sales and to the extent we are unable to pass on increases in operating costs, we may be affected by inflation. The devaluation of the Tenge, the currency of the Republic of Kazakhstan, can significantly decrease the value of the monetary assets that we hold in Kazakhstan as well as our assets in that country that are based on the Tenge. KKM retains the majority of its cash and cash equivalents in U.S. dollars, but KKM's statutory tax basis in its assets, tax loss carry-forwards, and VAT receivables are all denominated in Tenge and subject to the effects of devaluation. Local tax laws allow basis adjustments to offset the impact of inflation on statutory tax basis assets, but there is no assurance that any adjustments will be sufficient to offset the effects of inflation in whole or in part. If not, KKM may be subject to much higher income tax liabilities within Kazakhstan due to inflation or devaluation of the local currency. Additionally, devaluation may create uncertainty with respect to the future business climate in Kazakhstan and to our investment in that country. As of June 30, 2005, the exchange rate was 135.26 Tenge per U.S. dollar compared to 130.00 as of December 31, 2004. 5. Critical Accounting Policies The preparation of the Company's consolidated financial statements requires management to make estimates, assumptions and judgments that affect the Company's assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. Management bases these estimates and 18 assumptions on historical data and trends, current fact patterns, expectations and other sources of information it believes are reasonable. Actual results may differ from these estimates under different conditions. For a full description of the Company's critical accounting policies, see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 2004 Annual Report on Form 10-K. 6. Special Note Regarding Forward-Looking Statements Some of the statements in this Quarterly Report on Form 10-Q constitute "forward-looking statements." Forward-looking statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "estimates," "believes," "predicts," "potential," "likely," or "continue," or by the negative of such terms or comparable terminology. Forward-looking statements are predictions based on current expectations that involve a number of risks and uncertainties. Actual events may differ materially. In evaluating forward-looking statements, you should consider various factors, including the risks discussed above. These factors may cause our actual results to differ materially from any forward-looking statement. Although we believe that these statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements, and you are encouraged to exercise caution in considering such forward-looking statements. Unless otherwise required by law, we are not under any duty to update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results. Item 3 - Quantitative and Qualitative Disclosures About Market Risk Foreign Currency The functional currency is the U.S. dollar. All transactions arising in currencies other than U.S. dollars, including assets, liabilities, revenue, expenses, gains, or losses are measured and recorded in U.S. dollars using the exchange rate in effect on the date of the transaction. Cash and other monetary assets held and liabilities denominated in currencies other than U.S. dollars are translated at exchange rates prevailing as of the balance sheet date (135.26 and 130.00 Tenge per U.S. dollar as of June 30, 2005 and December 31, 2004, respectively). Non-monetary assets and liabilities denominated in currencies other than U.S. dollars have been translated at the estimated historical exchange rate prevailing on the date of the transaction. Exchange gains and losses arising from translation of non-U.S. dollar amounts at the balance sheet date are recognized as an increase or decrease in income for the period. See Item 2 section 4 for discussion on inflation and exchange rate risks. 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 Chaparral could realize or settle these assets and liabilities in U.S. dollars. Commodity Prices for Oil Our revenues, profitability, growth and value are highly dependent upon the price of oil. Market conditions make it difficult to estimate prices of oil or the impact of inflation on such prices. Oil prices have been volatile, and it is likely they will continue to fluctuate in the future. Various factors beyond our control affect prices for oil, including supplies of oil available worldwide and in Kazakhstan, the ability of OPEC to agree to maintain oil prices and production controls, political instability or armed conflict in Kazakhstan or other oil producing regions, the price of foreign imports, the level of consumer demand, the price and availability of alternative fuels, the availability of transportation routes and pipeline capacity, and changes in applicable laws and regulations. In addition, under the terms of our Agreement with the government of the Republic of Kazakhstan, the Company has the right to export, and receive export quota for, 100% of the production from the Karakuduk Field. However, oil 19 producers within Kazakhstan are required to supply a portion of their crude oil production to the local market to meet domestic energy needs. Local market oil prices are significantly lower than prices obtainable on the export market. For the six months ended June 30, 2005, the Company sold 102,000 barrels of crude oil, or 7% of its total oil sales, to the local market, compared to 161,000 barrels, or 12%, during the six months ended June 30, 2004. During the first half of 2005, local market prices obtained by the Company were, on average, $19 per barrel below export market prices, net of transportation costs. We have attempted, in accordance with the Agreement, to effect the 100% export of all hydrocarbons produced from the Karakuduk Field, through discussions with the government of the Republic of Kazakhstan. We plan to continue to work with the government to increase our export quota and minimize or eliminate future local sales requirements. In addition, we entered into an agency agreement with Nelson to assist in reducing our local market obligation (see Note 9 to the interim financial statements presented in Item 1). However, no assurances can be provided that we will be able to export a higher portion of our production and that our cash flow from operations will be sufficient to meet working capital requirements in the future. Item 4 - Controls and Procedures Evaluation of Disclosure Controls and Procedures We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in the periodic reports we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the rules of the SEC. The Company carried out an evaluation as of June 30, 2005, under the supervision and the participation of our management, including our chief executive officer and chief financial officer, of the design and operation of these disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934. Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC filings. Changes in Internal Controls over Financial Reporting As a result of the evaluation referred to in the preceding paragraph, there were no changes that materially affected or are reasonably likely to materially affect our internal control over financial reporting during the quarter ended June 30, 2005. 20 Part II- Other Information Item 6 - Exhibits *10.1 Guarantee Fee Agreement, dated April 19, 2005, between Closed Type JSC Karakudukmunay and Nelson Resources Limited. *31.1 CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *31.2 CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *32.1 CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *32.2 CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Filed herewith. 21 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: August 10, 2005 Chaparral Resources, Inc. By: /s/ Simon Gill -------------------------------------- Simon Gill Chief Executive Officer By: /s/ Nigel Penney --------------------------------------- Nigel Penney VP Finance and Chief Financial Officer (Principal Financial and Accounting Officer) 22 EX-10.1 2 chaparral10-1.txt AGREEMENT EXHIBIT 10.1 GUARANTEE FEE AGREEMENT ----------------------- THIS AGREEMENT dated as of the 19th day of April , 2005. B E T W E E N: JSC KARAKUDUKMUNAY, a joint stock company of closed type organized and existing under the laws of Kazakhstan ("KKM") OF THE FIRST PART - and - NELSON RESOURCES LIMITED, a limited liability company organized under the laws of Bermuda ("Nelson") OF THE SECOND PART WHEREAS by a credit facility agreement (the "Credit Facility Agreement") dated March 24, 2005 between KKM, BNP Paribas (Suisse) SA, BNP Paribas New York Branch, KBC Bank N.V., BNP Paribas SA and the Banks listed in Schedule 1 thereto, the said Banks agreed to make available to KKM a credit facility in the authorized amount of US$40,000,000 (the "Credit Facility") upon the terms and conditions contained in the Credit Facility Agreement; AND WHEREAS it is condition of the availability of the Credit Facility that Nelson issue a performance and financial guarantee (the "Guarantee") in support of all amounts owing pursuant to the Credit Facility; AND WHEREAS as consideration for Nelson issuing the Guarantee, the parties have agreed to enter into this Agreement providing for a guarantee fee payable by KKM to Nelson upon the terms and conditions set out herein; NOW THEREFORE THIS AGREEMENT WITNESSETH THAT in consideration of the premises and other good and available consideration (the receipt and adequacy whereof is hereby acknowledged), the parties hereto covenant and agree as follows: 1. KKM agrees to pay to Nelson a guarantee fee (the "Fee") in the amount of 2.5% per annum calculated on the US$40,000,000 authorized principal amount of the Credit Facility during the Availability Period and on the daily outstanding principal balance under the Credit Facility during the period the Term Loan is outstanding. The Fee is payable as follows: (a) US$1,000,000 at the time of the initial advance of the Credit Facility in respect of the first year the Credit Facility is outstanding; and (b) on each anniversary date of the initial advance of the Credit Facility an amount equal to 2.5% of the principal amount of the Credit Facility outstanding or, if the Availability Period has been extended and has not yet expired, authorized, whichever is greater, on the respective anniversary date in respect of the following twelve months (or such lesser amount as Nelson has advised KKM in writing if the Projected Maturity Date is within the following twelve months). If the Fee paid by KKM hereunder in advance for a particular twelve month period (the "Applicable Year") is more or less than the fee which is ultimately owing based on the aforesaid 2.5% per annum rate calculated daily, KKM shall provide notice to Nelson (with a copy to BNP Paribas (Suisse) SA to be delivered by KKM in accordance with Clause 33 of the Credit Facility Agreement) of the amount of such difference within 30 days of the end of the Applicable Year. If the amount of the Fee previously paid in respect of the Applicable Year is less than the amount owing hereunder, KKM shall pay such difference to Nelson forthwith upon receipt of such notice. If the amount of the Fee previously paid in respect of the Applicable Year is more than the amount owing hereunder, Nelson shall pay such difference to KKM forthwith following Nelson's issuance of such notice. 2. Any and all payments made by KKM hereunder shall be made, in accordance with this Section 2, free and clear of and without deduction for any and all present or future Taxes, excluding any Taxes imposed on or measured by the income of Nelson. If KKM shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder (excluding any Taxes imposed on or measured by the income of Nelson), (i) the sum payable shall be increased as much as shall be necessary so that after making all required withholdings and deductions (including withholdings and deductions applicable to additional sums payable under this Section 2) Nelson receive an amount equal to the sum that it would have received had no such withholdings or deductions been made, (ii) KKM shall make such deductions and pay the full amount deducted to the relevant taxing or other authority in accordance with applicable law. Within 30 days after the date of any payment of Taxes, KKM shall furnish to Nelson the original or a certified copy of a receipt evidencing payment thereof. The "Guarantee Fee" for the purposes of the Credit Facility Agreement shall be the amount of the Fee owing to Nelson pursuant to Section 1 as increased by any amount by which KKM is obliged to increase such amount pursuant to Section 2 herein. 3. KKM shall pay on demand all costs and expenses (including legal fees) incurred by Nelson in enforcing or attempting to enforce all its rights hereunder, including its rights to monies owing hereunder, and all proceedings taken in relation hereto. 4. All monies due but unpaid hereunder shall bear interest at the rate then provided for in connection with the Credit Facility (or the last interest date applicable to the Credit Facility if there is then no indebtedness or obligations owing in connection with the Credit Facility). 5. If any one or more of the provisions contained in this Agreement should be determined to be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein shall not in any way be affected or impaired thereby. 6. All capitalized terms used herein and not defined herein shall have the respective meanings ascribed thereto in the Credit Facility Agreement. 7. Each notice or other communication to be given under this Agreement shall be given in writing in English and, unless otherwise provided, shall be made by fax, electronic mail or letter. Any notice or other communication to be given by one party to another under this Agreement shall (unless one party has by 15 day's notice to the other party specified another address) be given to that other party at the following respective addresses and fax numbers: (a) JSC Karakudukmunay: Republic of Kazakhstan Mangistau Oblast Aktau, 466200, 3 micro district Bldg 82 Attention: General Director Fax: +73292 518 336 E-mail: pties@kkm.kz ------------ with a copy to: JSC Karakudukmunay c/o Commonwealth & British Services Ltd. 19 Berkeley Street London W1J 8ED England Attention: Arman Tuyakov Fax: +44 (20) 7495 8909 Email: arman@nelsonresources.co.uk (b) Nelson Resources Limited: Address: Chancery Hall 52 Reid Street Hamilton HA12 Bermuda Attention: Fax: Email: with a copy to: Nelson Resources Limited Address: c/o Commonwealth & British Services Ltd. 19 Berkeley Street London W1J 8ED England Attention: Arman Tuyakov Fax: +44 (20) 7495 8909 Email: arman@nelsonresources.co.uk Any notice or other communication given hereunder shall be deemed to have been received: (a) if sent by fax, with a confirmed receipt of transmission from the receiving machine, on the day on which transmitted; (b) in the case of a notice given by hand, on the day of actual delivery; (c) in the case of electronic mail, on the day on which the confirmation of delivery of that e-mail is received; and (d) if posted, on the fifth Business Day following the day on which it was despatched by airmail postage prepaid, provided that a notice given in accordance with the above but received on a day which is not a Business Day or after normal business hours in the place of receipt shall be deemed to have been received on the next Business Day. 8. This Agreement shall enure to the benefit and be binding upon the parties hereto and their respective successors and assigns. 9. This Agreement may be executed in any number of counterparts each of which when so executed shall be deemed to be an original and all of such counterparts taken together shall be deemed to constitute one and the same agreement. 10. This Agreement is governed by and shall be construed in accordance with English law. IN WITNESS WHEREOF this Agreement has been executed by the parties hereto this 19 day of April, 2005. JSC KARAKUDUKMUNAY: ) ) SIGNED by ) duly authorized for and ) on behalf of ) /s/ P. Ties JSC KARAKUDUKMUNAY ) ---------------------------------------- ) Authorized Signatory/ies ) NELSON RESOURCES LIMITED: ) ) SIGNED by ) duly authorized for and ) on behalf of ) NELSON RESOURCES LIMITED ) ) /s/ N. Greene ) ---------------------------------------- ) Authorized Signatory/ies EX-31.1 3 chaparral31-1.txt CERTIFICATION Exhibit 31.1 Certifications I, Simon K. Gill, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Chaparral Resources, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 10, 2005 /s/ Simon K. Gill ----------------------------------- Simon K. Gill Chief Executive Officer EX-31.2 4 chaparral31-2.txt CERTIFICATION Exhibit 31.2 Certifications I, Nigel F. Penney, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Chaparral Resources, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 10, 2005 /s/ Nigel F. Penney ----------------------------------- Nigel F. Penney Chief Financial Officer EX-32.1 5 chaparral32-1.txt CERTIFICATION EXHIBIT 32.1 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Simon K Gill, Chief Executive Officer of Chaparral Resources, Inc. (the "company"), certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: 1. The company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005 ("Quarterly Report") fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934; and 2. All of the information contained in the Quarterly Report fairly presents, in all material respects, the financial condition and result of operations of the company. Date: August 10, 2005 /s/ Simon K. Gill - ----------------------------- Simon K. Gill Chief Executive Officer EX-32.2 6 chaparral32-2.txt CERTIFICATION EXHIBIT 32.2 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Nigel F. Penney, Chief Financial Officer of Chaparral Resources, Inc. (the "company"), certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: 1. The company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005 ("Quarterly Report") fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and 2. All of the information contained in the Quarterly Report fairly presents, in all material respects, the financial condition and result of operations of the company. Date: August 10, 2005 /s/ Nigel F. Penney - --------------------------------- Nigel F. Penney Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----