UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended
September 30, 2006
[ ] 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 000-28638
BMB MUNAI, INC.
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
Nevada 30-0233726
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
202 Dostyk Ave, 4th Floor
Almaty, Kazakhstan 050051
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
+7 (3272) 375-125
--------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for any shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filed, an
accelerated filer, or non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act: (Check
one):
Large accelerated Filer [ ] Accelerated Filer [X] Non-accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act.) Yes [ ] No [X]
As of October 27, 2006, the registrant had 43,690,652 shares of common stock,
par value $0.001, issued and outstanding.
BMB MUNAI, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I -- FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Financial Statements
Consolidated Balance Sheets as of September 30, 2006 and
March 31, 2006 .......................................................3
Consolidated Statements of Operations for the Three and Six
Months Ended September 30, 2006 and 2005..............................4
Consolidated Statements of Cash Flows for the Six Months Ended
September 30, 2006 and 2005...........................................5
Notes to Consolidated Financial Statements............................6
Item 2. Managements' Discussion and Analysis of Financial Condition
and Results of Operations...................................22
Item 3. Qualitative and Quantitative Disclosures About Market Risk......37
Item 4. Controls and Procedures.........................................37
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings...............................................38
Item 1A. Risk Factors...................................................39
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.....39
Item 4. Submission of Matters to a Vote of Security Holders.............39
Item 5. Other Information...............................................39
Item 6. Exhibits........................................................40
Signatures...............................................................40
2
PART I - FINANCIAL INFORMATION
Item 1 - Unaudited Consolidated Financial Statements
BMB MUNAI, INC.
CONSOLIDATED BALANCE SHEETS
- ----------------------------------------------------------------------------------------------------------------------------
Notes September 30, 2006 March 31, 2006
(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents 3 $ 34,283,815 $ 18,046,123
Marketable securities 4 - 33,095,609
Trade accounts receivable 731,540 1,675,202
Inventories 5 7,438,115 3,239,947
Prepayments for materials 5,431,142 712,526
Other prepaid expenses and other assets, net 6 5,210,565 1,902,891
----------------------- -----------------------
Total current assets 53,095,177 58,672,298
----------------------- -----------------------
LONG TERM ASSETS
Oil and gas properties, full cost method, net 7 80,583,564 66,683,297
Other fixed assets, net 8 1,373,035 1,020,951
Intangible assets, net 37,013 49,656
Long term prepayments 9 2,470,000 -
Restricted cash 156,454 156,454
----------------------- -----------------------
Total long term assets 84,620,066 67,910,358
----------------------- -----------------------
TOTAL ASSETS $ 137,715,243 $ 126,582,656
======================= =======================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 6,658,245 $ 3,629,338
Due to reservoir consultants - 500,000
Taxes payable 201,082 145,406
Accrued liabilities and other payables 199,291 349,231
----------------------- -----------------------
Total current liabilities 7,058,618 4,623,975
----------------------- -----------------------
LONG TERM LIABILITIES
Liquidation fund 988,650 924,592
Deferred income tax liabilities 10 7,394,732 6,405,285
----------------------- -----------------------
Total long term liabilities 8,383,382 7,329,877
----------------------- -----------------------
COMMITMENTS AND CONTINGENCIES 14 - -
SHAREHOLDERS' EQUITY
Share capital 11 43,691 42,224
Additional paid in capital 11 133,598,388 123,831,007
Accumulated deficit (11,368,836) (9,244,427)
----------------------- -----------------------
Total shareholders' equity 122,273,243 114,628,804
----------------------- -----------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 137,715,243 $ 126,582,656
======================= =======================
See notes to the unaudited consolidated financial statements.
3
BMB MUNAI, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
- -----------------------------------------------------------------------------------------------------------------------------------
Three months ended Three months ended Six months ended Six months ended
Notes September 30, 2006 September 30, 2005 September 30, 2006 September 30, 2005
(unaudited) (unaudited) (unaudited) (unaudited)
REVENUES 12 $ 4,016,972 $ 1,385,336 $ 6,362,944 $ 2,047,973
EXPENSES
Oil and gas operating 575,698 186,434 990,573 266,707
General and administrative 1,955,246 4,880,514 7,322,942 5,881,752
Depletion 427,477 313,912 667,968 665,644
Amortization and depreciation 41,366 34,368 76,511 64,806
Accretion expenses 24,453 - 64,058 -
------------------ ------------------- -------------------- ------------------
Total expenses 3,024,240 5,415,228 9,122,052 6,878,909
------------------ ------------------- -------------------- ------------------
INCOME / (LOSS) FROM OPERATIONS 992,732 (4,029,892) (2,759,108) (4,830,936)
OTHER INCOME (EXPENSE)
Realized gain on marketable securities 254,663 118,909 501,948 181,688
Unrealized gain / (loss) on marketable
securities - - 112,666 (7,539)
Foreign exchange (loss) / gain, net (232,907) 8,279 (74,263) (124,136)
Interest income, net 234,831 - 390,115 12,022
Other (expense) / income, net (57,454) 17,247 (120,254) 23,839
------------------ ------------------- -------------------- ------------------
Total other income 199,133 144,435 810,212 85,874
------------------ ------------------- -------------------- ------------------
INCOME / (LOSS) BEFORE INCOME TAXES 1,191,865 (3,885,457) (1,948,896) (4,745,062)
INCOME TAX EXPENSE 10 (175,513) - (175,513) -
------------------ ------------------- -------------------- ------------------
NET INCOME / (LOSS) $ 1,016,352 $(3,885,457) $(2,124,409) $(4,745,062)
================== =================== ==================== ==================
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC 43,690,652 32,376,574 43,270,313 32,187,708
INCOME / (LOSS) PER COMMON SHARE - BASIC $ 0.02 $ (0.12) $ (0.05) $ (0.15)
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - DILUTED 43,811,962 - - -
INCOME PER COMMON SHARE - DILUTED $ 0.02 $ - $ - $ -
See notes to the unaudited consolidated financial statements.
4
BMB MUNAI, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------------------------------------------------
Six months Six months ended
ended September
Notes September 30, 30, 2005
2006 (unaudited)
(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (2,124,409) $(4,745,062)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depletion 7 667,968 665,644
Depreciation and amortization 76,511 64,806
Accretion expenses 64,058 -
Stock based compensation expense 11 3,555,346 3,815,158
Stock issued for services 11 455,000 172,682
Deferred income taxes 10 175,513 -
Unrealized (gain) / loss on marketable securities (112,666) 7,539
Changes in operating assets and liabilities
Decrease in marketable securities 33,208,275 163,885
Decrease / (increase) in trade accounts receivable 943,662 (674,212)
Increase in inventories (4,198,168) (788,763)
(Increase) / decrease in prepaid expenses and other assets (8,026,290) 103,966
Increase /(decrease) in liabilities 2,434,643 (3,677,384)
---------------- ------------------
Net cash provided by / (used in) operating activities 27,119,443 (4,891,741)
---------------- ------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of oil and gas properties 7 (13,688,784) (9,294,889)
Acquisition of other fixed assets 8 (481,469) (67,093)
Acquisition of intangible assets - (56,745)
Increase in long term prepayments (2,470,000) -
---------------- ------------------
Net cash used in investing activities (16,640,253) (9,418,727)
---------------- ------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock - 5,221,685
Proceeds from exercise of common stock options and warrants 11 5,758,502 863,934
---------------- ------------------
Net cash provided by financing activities 5,758,502 6,085,619
---------------- ------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 16,237,692 (8,224,849)
CASH AND CASH EQUIVALENTS at beginning of period 18,046,123 9,989,632
---------------- ------------------
CASH AND CASH EQUIVALENTS at end of period $ 34,283,815 $ 1,764,783
================ ==================
See notes to the unaudited consolidated financial statements.
5
BMB MUNAI, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS
BMB Munai, Inc. (the "Company" or "BMB Munai") was incorporated in Utah in
July 1981. The Company later changed its domicile to Delaware on February
7, 1994. Prior to November 26, 2003, the Company existed under the name
InterUnion Financial Corporation ("InterUnion"). The Company changed its
domicile from Delaware to Nevada in December 2004.
On November 26, 2003, InterUnion executed an Agreement and Plan of Merger
(the "Agreement") with BMB Holding, Inc ("BMB"), a private Delaware
corporation, formed for the purpose of acquiring and developing oil and
gas fields in the Republic of Kazakhstan. As a result of the merger, the
shareholders of BMB obtained control of the Company. BMB was treated as
the acquiror for accounting purposes. A new board of directors was elected
that was comprised primarily of the former directors of BMB Holding, Inc.
The Company's consolidated financial statements presented are a
continuation of BMB, and not those of InterUnion Financial Corporation,
and the capital structure of the Company is now different from that
appearing in the historical financial statements of InterUnion Financial
Corporation due to the effects of the recapitalization.
The Company has a representative office in Almaty, Republic of Kazakhstan.
From inception (May 6, 2003) through January 1, 2006 the Company had
minimal operations and was considered to be in the development stage. From
January 1, 2006 the Company started to generate significant revenues and
is no longer in the development stage.
2. SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial information included herein is unaudited,
except for the balance sheet as of March 31, 2006, which is derived from
the Company's audited consolidated financial statements for the year ended
March 31, 2006. However, such information includes all adjustments
(consisting solely of normal recurring adjustments), which are, in the
opinion of management, necessary for a fair statement of the results of
operations for the interim periods. The consolidated results of operations
for the interim period are not necessarily indicative of the consolidated
results to be expected for an entire year.
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 in
this Form 10-Q Report pursuant to certain rules and regulations of the
Securities and Exchange Commission. These consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes included in our March 31, 2006 Form 10-KSB Report.
The accounting principles applied are consistent with those as set out in
the Company's annual Consolidated Financial Statements for the year ended
March 31, 2006.
6
Basis of consolidation
The Company's consolidated financial statements present the consolidated
results of BMB Munai, Inc., and its wholly owned subsidiary, Emir Oil LLP
(hereinafter collectively referred to as the "Company"). All significant
inter-company balances and transactions have been eliminated from the
Consolidated Financial Statements.
All transactions of Emir Oil LLP from the date of its acquisition by BMB
(June 7, 2003) through September 30, 2006 are reflected in the
Consolidated Financial Statements and Notes to the Consolidated Financial
Statements.
Use of estimates
The preparation of Consolidated Financial Statements in conformity with US
GAAP requires management to make estimates and assumptions that affect
certain reported amounts of assets and liabilities and the disclosures of
contingent assets and liabilities at the date of the Consolidated
Financial Statements and revenues and expenses during the reporting
period. Accordingly, actual results could differ from those estimates and
affect the results reported in these Consolidated Financial Statements.
Licences and contracts
Emir Oil LLP is the operator of the Aksaz, Dolinnoe and Emir oil and gas
fields in western Kazakhstan (the "ADE Block", the "ADE Fields"). The
Government of the Republic of Kazakhstan (the "Government") initially
issued the license to Zhanaozen Repair and Mechanical Plant on April 30,
1999. On June 9, 2000, the contract for exploration of the Aksaz, Dolinnoe
and Emir oil and gas fields was entered into between the Agency of the
Republic of Kazakhstan on Investments and the Zhanaozen Repair and
Mechanical Plant. On September 23, 2002, the contract was assigned to Emir
Oil LLP. On September 10, 2004 the Government extended the term of the
Contract for exploration and License from five years to seven years
through July 9, 2007. On December 7, 2004 the Government assigned to Emir
Oil LLP exclusive right to explore the additional territory during the
remaining term of the License. To move from the exploration and
development stage to the commercial production stage, the Company must
apply for and be granted a commercial production contract. The Company is
legally entitled to receive this commercial production contract and has an
exclusive right to negotiate this Contract and the Government is obligated
to conduct these negotiations under the Law of Petroleum in Kazakhstan. If
the Company does not move from the exploration and development stage to
the commercial production stage, it has the right to produce and sell oil,
including export oil, under the Law of Petroleum for the term of its
existing contract, which may be extended for an additional two-year term.
7
Foreign currency translation
Transactions denominated in foreign currencies are reported at the rates
of exchange prevailing at the date of the transaction. Monetary assets and
liabilities denominated in foreign currencies are translated to U.S.
dollars at the rates of exchange prevailing at the balance sheet dates.
Any gains or losses arising from a change in exchange rates subsequent to
the date of the transaction are included as an exchange gain or loss in
the Consolidated Statements of Operations.
Share-based compensation
The Company accounts for options granted to non-employees at their fair
value in accordance with SFAS No. 123R, Share Based Payment and EITF
Abstracts Issue 96-18, Accounting for Equity Instruments That Are Issued
to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services. Under SFAS No. 123R, share-based compensation is
determined as the fair value of the equity instruments issued. The
measurement date for these issuances is the earlier of the date at which a
commitment for performance by the recipient to earn the equity instruments
is reached or the date at which the recipient's performance is complete.
Stock options granted to the "selling agents" in the private equity
placement transactions have been offset to the proceeds as a cost of
capital. Stock options and stocks granted to other non-employees are
recognized in the Consolidated Statements of Operations.
The Company has a stock option plan as described in Note 11. Compensation
expense for options and stocks granted to employees is determined based on
their fair values at the time of grant, the cost of which is recognized in
the Consolidated Statements of Operations over the vesting periods of the
respective options.
Risks and uncertainties
The ability of the Company to realize the carrying value of its assets is
dependent on being able to develop, transport and market oil and gas.
Currently exports from the Republic of Kazakhstan are primarily dependent
on transport routes either via rail, barge or pipeline, through Russian
territory. Domestic markets in the Republic of Kazakhstan historically and
currently do not permit world market price to be obtained. However,
management believes that over the life of the project, transportation
options will be improved by further increases in the capacity of the
transportation options.
Recognition of revenue and cost
Revenue and associated costs from the sale of oil are charged to the
period when goods were shipped or when ownership title transferred.
Produced but unsold products are recorded as inventory until sold.
8
Income taxes
The Company accounts for income taxes using the liability method. Under
the liability method, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between
financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be
recovered or settled. Under the liability method, the effect on previously
recorded deferred tax assets and liabilities resulting from a change in
tax rates is recognized in earnings in the period in which the change is
enacted.
Cash and cash equivalents
The Company considers all demand deposits and money market accounts
purchased with an original maturity of three months or less to be cash and
cash equivalents. The fair value of cash and cash equivalents approximates
their carrying amounts due to their short-term maturity.
Marketable securities
Marketable securities represent debt and equity securities
held-for-trading that are acquired principally for the purpose of
generating a profit from short-term fluctuations in price. Trading
securities are initially recorded at cost, which approximates fair value
of the consideration given, and subsequently measured at fair value. The
Company uses quoted market prices to determine fair value for the
Company's marketable securities. When reliable market prices are not
available fair value is determined by reference to price quotations for
similar instruments traded in different markets or management's estimates
of the amounts that can be realized from an orderly disposition over a
period of time, assuming current market conditions. Fair value adjustment
on trading securities is recognized in profit and loss for the period.
Trade accounts receivable and prepaid expenses
Accounts receivable and prepaid expenses are stated at their net
realizable values after deducting provisions for uncollectable amounts.
Such provisions reflect either specific cases or estimates based on
evidence of collectability. The fair value of accounts receivable and
prepaid expense accounts approximates their carrying amounts due to their
short-term maturity.
Inventories
Inventories of equipment for development activities, tangible drilling
materials required for drilling operations, spare parts, diesel fuel, and
various materials for use in oil field operations are recorded at the
lower of cost and net realizable value. Under the full cost method,
inventory is transferred to oil and gas properties when used in
exploration, drilling and development operations in oilfields.
9
Inventories of crude oil are recorded at the lower of cost or net
realizable value. Cost comprises direct materials and, where applicable,
direct labor costs and overhead, which has been incurred in bringing the
inventories to their present location and condition. Cost is calculated
using the weighted average method. Net realizable value represents the
estimated selling price less all estimated costs to completion and costs
to be incurred in marketing, selling and distribution.
The Company periodically assesses its inventories for obsolete or slow
moving stock and records an appropriate provision, if there is any.
Oil and gas properties
The Company follows the full cost method of accounting for its costs of
acquisition, exploration and development of oil and gas properties.
Under full cost accounting rules, the net capitalized costs of evaluated
oil and gas properties shall not exceed an amount equal to the present
value of future net cash flows from estimated production of proved oil and
gas reserves, based on current economic and operating conditions,
including the use of oil and gas prices as of the end of the period.
Given the volatility of oil and gas prices, it is reasonably possible that
the estimate of discounted future net cash flows from proved oil and gas
reserves could change. If oil and gas prices decline, even if only for a
short period of time, it is possible that impairments of oil and gas
properties could occur. In addition, it is reasonably possible that
impairments could occur if costs are incurred in excess of any increases
in the cost ceiling, revisions to proved oil and gas reserves occur, or if
properties are sold for proceeds less than the discounted present value of
the related proved oil and gas reserves.
All geological and geophysical studies, with respect to the ADE Block,
have been capitalized as part of the oil and gas properties.
The Company's oil and gas properties primarily include the value of the
license and other capitalized costs.
Depletion of producing properties is computed using the unit-of-production
method based on estimated proved reserves.
Liquidation fund
Liquidation fund (site restoration and abandonment liability) is related
primarily to the conservation and liquidation of the Company's wells and
similar activities related to its oil and gas properties, including site
restoration. Management assessed an obligation related to these costs with
sufficient certainty based on internally generated engineering estimates,
current statutory requirements and industry practices. The Company
recognized the estimated fair value of this liability. These estimated
costs were recorded as an increase in the cost of oil and gas assets with
a corresponding increase in the liquidation fund. The oil and gas assets
related to liquidation fund are depreciated on the unit-of-production
basis separately for each field. An accretion expense, resulting from the
changes in the liability due to passage of time by applying an interest
method of allocation to the amount of the liability, is recorded as
accretion expenses in the Consolidated Statement of Operations.
10
The adequacies of the liquidation fund are periodically reviewed in the
light of current laws and regulations, and adjustments made as necessary.
Other fixed assets
Other fixed assets are valued at historical cost adjusted for impairment
loss less accumulated depreciation. Historical cost includes all direct
costs associated with the acquisition of the fixed assets.
Depreciation of other fixed assets is calculated using the straight-line
method based upon the following estimated useful lives:
Buildings and improvements 7-10 years
Machinery and equipment 6-10 years
Vehicles 3-5 years
Office equipment 3-5 years
Other 2-7 years
Maintenance and repairs are charged to expense as incurred. Renewals and
betterments are capitalized.
Other fixed assets of the Company are evaluated for impairment. If the sum
of expected undiscounted cash flows is less than net book value,
unamortized costs of other fixed assets will be reduced to a fair value.
Intangible assets
Intangible assets include accounting and other software. Amortization of
intangible assets is calculated using straight-line method upon estimated
useful life ranging from 3 to 4 years.
Restricted cash
Restricted cash includes funds deposited in a Kazakhstan bank and is
restricted to meet possible environmental obligations according to the
regulations of the Republic of Kazakhstan.
Recent accounting pronouncements
In September 2006, the FASB issued Statement No. 157, "Fair Value
Measurements" This Statement defines fair value, establishes a framework
for measuring fair value in generally accepted accounting principles
(GAAP), and expands disclosures about fair value measurements. This
Statement applies under other accounting pronouncements that require or
permit fair value measurements, the Board having previously concluded in
those accounting pronouncements that fair value is the relevant
measurement attribute. This Statement is effective for financial
statements issued for the fiscal years beginning after November 15, 2007.
Management does not anticipate this Statement will impact the Company's
consolidated financial position or consolidated results of operations and
cash flows.
11
In September 2006, the FASB issued Statement No. 158, "Employers'
Accounting for Defined Benefit Pension and Other Postretirement Plans", an
amendment of FASB Statements No. 87, 88, 106, and 132(R) This Statement
improves financial reporting by requiring an employer to recognize the
overfunded or underfunded status of a defined benefit postretirement plan
(other than a multiemployer plan) as an asset or liability in its
statement of financial position and to recognize changes in that funded
status in the year in which the changes occur through comprehensive income
of a business entity or changes in unrestricted net assets of a
not-for-profit organization. This Statement is effective for employers
with publicly traded equity securities is required to initially recognize
the funded status of a defined benefit postretirement plan and to provide
the required disclosures as of the end of the fiscal year ending after
December 15, 2006. Management does not anticipate this Statement will
impact the Company's consolidated financial position or consolidated
results of operations and cash flows.
In September 2006, the SEC staff issued Staff Accounting Bulletin (SAB)
Topic 1N, "Financial Statements - Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements" (SAB 108). This Bulletin provides guidance on how prior year
misstatements should be taken into consideration when quantifying
misstatements in current year financial statements for purposes of
determining whether the current year's financial statements are materially
misstated and should be restated. SAB 108 is effective for fiscal years
ending after November 15, 2006. The company does not believe SAB 108 will
have a material impact on its results of operations, financial condition
and cash flows.
In September 2006, the EITF issued EITF Abstracts Issue No. 06-3 (EITF
06-3). The EITF is providing guidance on how taxes collected from
customers and remitted to Governmental Authorities should be presented in
the income statements. EITF 06-3 is effective for interim and annual
periods beginning after December 15, 2006. The company does not anticipate
EITF 06-3 will have a material impact on its results of operations,
financial condition and cash flows.
In June 2006, the FASB issued FASB Interpretation No. 48 "Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109".
This Interpretation clarifies the accounting for uncertainty in income
taxes recognized in an enterprise's financial statements in accordance
with FASB No. 109 "Accounting for Income taxes". This interpretation is
effective for the fiscal years beginning after December 15, 2006.
Management does not anticipate this Statement will impact the Company's
consolidated financial position or consolidated results of operations and
cash flows.
3. CASH AND CASH EQUIVALENTS
As of September 30, 2006 and March 31, 2006 cash and cash equivalents
included:
September 30, 2006 March 31, 2006
US Dollars $ 33,050,219 $ 17,863,455
Foreign currency 1,233,596 182,668
---------------------- -------------------
$ 34,283,815 $ 18,046,123
====================== ===================
As of September 30, 2006 cash and cash equivalents included the amount of
$27,954,986 placed in money market funds having a 30 day simple yield of
4.97%.
As of March 31, 2006 cash and cash equivalents included the amount of
$11,100,262 placed in money market funds having a 30 day simple yield of
4.28%.
4. MARKETABLE SECURITIES
Marketable securities as of September 30, 2006 and March 31, 2006 were as
follows:
September 30, 2006 March 31, 2006
General Electric Corporation corporate commercial papers $ - $ 22,064,587
Fannie Mae discount notes - 11,031,022
---------------------- -------------------
$ - $ 33,095,609
====================== ===================
5. INVENTORIES
Inventories as of September 30, 2006 and March 31, 2006 were as follows:
September 30, 2006 March 31, 2006
Construction material $ 6,919,318 $ 3,069,144
Spare parts 32,990 13,486
Crude oil produced 8,520 8,840
Other 477,287 148,477
---------------------- -------------------
$ 7,438,115 $ 3,239,947
====================== ===================
6. OTHER PREPAID EXPENSES AND OTHER ASSETS, NET
Other prepaid expenses and other assets, net, as of September 30, 2006 and
March 31, 2006 were as follows:
September 30, 2006 March 31, 2006
Advances for services $ 2,858,020 $ 452,839
VAT recoverable 2,356,321 1,335,971
Other 207,699 309,533
Reserves against uncollectible advances and prepayments (211,475) (195,452)
---------------------- -------------------
$ 5,210,565 $ 1,902,891
====================== ===================
13
7. OIL AND GAS PROPERTIES, FULL COST METHOD, NET
Oil and gas properties, full cost method, net, as of September 30, 2006
and March 31, 2006 were as follows:
September 30, 2006 March 31, 2006
Cost of drilling wells $22,716,384 $14,895,604
Subsoil use rights 20,788,119 20,788,119
Professional services received in exploration and development
activities 12,354,541 10,600,327
Material and fuel used in exploration and development activities 8,363,089 6,840,976
Deferred tax 7,219,219 6,405,285
Infrastructure development costs 2,007,365 1,412,999
Geological and geophysical 1,434,065 1,432,418
Other capitalized costs 7,765,391 5,704,210
Accumulated depletion (2,064,609) (1,396,641)
---------------------- -------------------
$ 80,583,564 $ 66,683,297
====================== ===================
In nontaxable business combination, deferred taxes were provided for the
basis difference related to oil and gas properties. Since goodwill was not
recognized in subsidiary's acquisition involving oil and gas properties,
recognition of a deferred tax liability increased the financial reporting
basis of the oil and gas properties.
8. OTHER FIXED ASSETS, NET
Construction Machinery Vehicles Office Other Total
and equipment equipment
Cost
at March 31, 2006 $ 149,272 $ 372,427 $ 432,121 $ 206,890 $ 148,645 $ 1,309,355
Additions 37,312 156,582 204,640 36,935 63,600 499,069
Disposals - - - (2,890) (14,710) (17,600)
--------------- -------------- -------------- ---------------- ------------- --------------
at September 30, 2006 186,584 529,009 636,761 240,935 197,535 1,790,824
--------------- -------------- -------------- ---------------- ------------- --------------
Accumulated depreciation
at March 31, 2006 24,922 26,187 152,719 51,650 32,926 288,404
Charge for the period 10,624 11,984 64,571 31,283 14,220 132,682
Disposals - - - (667) (2,630) (3,297)
--------------- -------------- -------------- ---------------- ------------- --------------
at September 30, 2006 35,546 38,171 217,290 82,266 44,516 417,789
--------------- -------------- -------------- ---------------- ------------- --------------
Net book value at March
31, 2006 $ 124,350 $ 346,240 $ 279,402 $ 155,240 $ 115,719 $ 1,020,951
=============== ============== ============== ================ ============= ==============
Net book value at
September 30, 2006 $ 151,038 $ 490,838 $ 419,471 $ 158,669 $ 153,019 $ 1,373,035
=============== ============== ============== ================ ============= ==============
14
In accordance with SFAS No. 19, Financial Accounting and Reporting by Oil
and Gas Producing Companies, depreciation related to support equipment and
facilities used in exploration and development activities in the amount of
$65,517 was capitalized to oil and gas properties for the six month ended
September 30, 2006.
9. LONG TERM PREPAYMENTS
On April 13, 2006 the Company entered into Agreement on Joint Business
(the "Agreement") with Ecotechnic Chemicals AG incorporated in Switzerland
(the "Ecotechnic") for construction of facility on utilization of
associated gas on Company's fields (the "Facility"). After completion of
the Facility construction the Company and Ecotechnic will sign the
agreement on formation of joint venture company, which will operate the
Facility.
In accordance with terms of the Agreement the Company made prepayments of
USD $2,470,000 to Ecotechnic for development of project documentation and
purchase of equipment.
10. INCOME TAXES
The income tax charge in the Consolidated Statements of Operations
comprised:
Three months Three months Six months Six months
ended ended ended ended
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
Current tax expense $ - $ - $ - $ -
Deferred tax expense 175,513 - 175,513 -
-------------- --------------- ------------- --------------
$ 175,513 $ - $ 175,513 $ -
============== =============== ============= ==============
Relationship between tax expenses and accounting income for the three and
six months ended September 30, 2006 and 2005 is explained as follows:
Three months Three months Six months Six months
ended ended ended ended
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
Income/(loss) before income taxes $ 1,191,865 $ (3,885,457) $(1,948,896) $ (4,745,062)
Expected tax provision 357,560 (1,165,637) (584,669) (1,423,519)
Add tax effect of:
Permanent differences (182,047) 1,165,637 760,182 1,423,519
-------------- --------------- ------------- --------------
$ 175,513 $ - $ 175,513 $ -
============== =============== ============= ==============
15
Deferred taxes reflect the estimated tax effect of temporary differences
between assets and liabilities for financial reporting purposes and those
measured by tax laws and regulations. The components of deferred tax
assets and deferred tax liabilities are as follows:
September 30, 2006 March 31, 2006
Deferred tax assets:
Stock-based compensation $ 904,400 $ -
Tax losses carried forward 1,821,926 593,122
------------------- -------------------
2,726,326 593,122
Deferred tax liabilities:
Oil and gas properties 9,668,533 6,636,522
Accrued interest income 452,525 361,885
------------------- -------------------
10,121,058 6,998,407
------------------- -------------------
Net deferred tax liability $ 7,394,732 $ 6,405,285
=================== ===================
Deferred income taxes for US and Kazakhstan tax jurisdiction are as
follows:
September 30, 2006 March 31, 2006
US tax Kazakhstan tax US tax Kazakhstan tax
jurisdiction jurisdiction jurisdiction jurisdiction
Deferred tax assets:
Stock-based compensation $ 904,400 $ - $ - $ -
Tax losses carried forward 1,812,133 9,793 583,329 9,793
------------------- ------------------- ------------------- -------------------
2,716,533 9,793 583,329 9,793
Deferred tax liabilities:
Oil and gas properties 7,219,219 2,449,314 6,369,899 266,623
Accrued interest income 452,525 - 361,885 -
------------------- ------------------- ------------------- -------------------
7,671,744 2,449,314 6,731,784 266,623
------------------- ------------------- ------------------- -------------------
Net deferred tax liability $ 4,955,211 $ 2,439,521 $ 6,148,455 $ 256,830
=================== =================== =================== ===================
Deferred tax liability from oil and gas properties for US tax
jurisdiction, also described in Note 7, resulted from temporary difference
related to oil and gas basis from non-taxable business combination.
11. SHARE AND ADDITIONAL PAID IN CAPITAL
Common and preferred stock as of September 30, 2006 and March 31, 2006
were as follows:
September 30, 2006 March 31, 2006
Preferred stock, $0.001 par value
Authorized 20,000,000 20,000,000
Issued and outstanding - -
Common stock, $0.001 par value
Authorized 500,000,000 100,000,000
Issued and outstanding 43,690,652 42,223,685
16
On June 21, 2006 the Company filed Certificate of Amendment to BMB Munai,
Inc. Articles of Incorporation with the Nevada Secretary of State to
increase the Company's authorized common stock from 100,000,000 to
500,000,000 shares. Authorized preferred stock remained unchanged.
Share-Based Compensation
During the fiscal year ended March 31, 2005 the shareholders of the
Company approved an incentive stock option plan (the "Plan") under which
directors, officers and key personnel may be granted options to purchase
common shares of the Company, as well as other stock based awards.
5,000,000 common shares were reserved for issuance under the Plan. The
Board determines the terms of options and other awards made under the
Plan. Under the terms of the Plan, no incentive stock options shall be
granted with an exercise price at a discount to the market.
Common Stock
On June 20, 2006 the Company granted common stock to officers and
directors and certain employees and consultants of the Company under the
Plan. The total number of restricted common shares granted was 495,000.
The stock grants were valued at $7.00 per share. Of the stock grants,
380,000 shares vested immediately, the balance are restricted stock
grants. Compensation expense in the amount of $3,465,000 was recognized in
the Consolidated Statements of Loss and Consolidated Balance Sheet.
Stock Options
On June 20, 2006 the Company granted stock options to directors of the
Company under the Plan. The total number of options was 200,000. The
options are exercisable at a price of $7.00 per share. The options will
expire three years from the grant date. All of the options vested
immediately upon grant. Compensation expense for options granted is
determined based on their fair values at the time of grant, the cost of
which in the amount of $545,346 was recognized in the Consolidated
Statements of Operations and Consolidated Balance Sheet.
On November 12, 2004 the Company granted stock options to its former
corporate secretary for past services rendered. These options grant the
employee the right to purchase up to 60,000 shares of the Company's common
stock at an exercise price of $4.00 per share. The options vested
immediately and expire five years from the date of grant. In April 2006,
options to acquire 7,200 common shares were exercised.
Stock options outstanding and exercisable as of September 30, 2006 were as
follows:
Weighted Average
Number of Exercise
Shares Price
----------------- --------------------
As of March 31, 2006 980,783 $ 4.97
Granted 200,000 7.00
Exercised (7,200) 4.00
Expired - -
----------------- --------------------
As of September 30, 2006 1,173,583 $ 5.33
================= ====================
17
Additional information regarding outstanding options as of September 30,
2006 was as follows:
Options Outstanding Options Exercisable
------------------------------------------------------------------------- ----------------------------------
Weighted
Weighted Average Weighted Average
Range of Average Contractual Exercise
Exercise Price Options Exercise Price Life (years) Options Price
------------------ ----------------- --------------- ------------------ --------------- ------------------
$ 4.00 - $ 7.40 1,173,583 $ 5.33 4.15 1,173,583 $ 5.33
The estimated fair value of the stock options issued were determined using
Black-Scholes option pricing model with the following assumptions:
Six months Year ended
ended September March 31, 2006
30, 2006
Risk-free interest rate 5.23% 4.01% - 4.51%
Expected option life 2 years 2 - 4 year
Expected volatility in the price of the Company's common shares 65% 65% - 74%
Expected dividends 0% 0%
Weighted average fair value of options and warrants granted
during the period $2.73 $2.01 - $3.92
Warrants
On April 12, 2005, the Company granted warrants to placement agents in
connection with funds raised on the Company's behalf. These warrants
granted the placement agents the right to purchase up to 110,100 shares of
the Company's common stock at an exercise price of $5.00 per share. These
warrants have been offset to the proceeds as a cost of capital. In October
2005, warrants to purchase 60,000 shares were exercised. In April 2006,
the remaining warrants to purchase 50,100 shares were exercised.
On December 31, 2005, the Company granted warrants to placement agents in
connection with funds raised on the Company's behalf. These warrants
granted the placement agents the right to purchase up to 916,667 shares of
the Company's common stock at an exercise price of $6.00 per share. These
warrants have been offset to the proceeds as a cost of capital. On May 13,
2006 these warrants were exercised.
18
Warrants outstanding and exercisable as of September 30, 2006 were as
follows:
Weighted Average
Number of Exercise
Shares Price
----------------- -----------------
As of March 31, 2006 1,109,624 $ 5.63
Granted - -
Exercised (966,767) 5.95
Expired - -
----------------- -----------------
As of September 30, 2006 142,857 $ 3.50
================= =================
Additional information regarding warrants outstanding as of September 30,
2006 is as follows:
Warrants Outstanding Warrants Exercisable
----------------------------------------------------------------------- ------------------------------------
Weighted Weighted
Weighted Average Averaage
Range of Average Contractual Exercise
Exercise Price Warrants Exercise Price Life (years) Warrants Price
------------------ ----------------- --------------- ---------------- ----------------- ------------------
$ 3.50 142,857 $3.50 5.01 142,857 $3.50
12. REVENUES
Three months ended Three months ended Six months ended Six months ended
September 30, 2006 September 30, 2005 September 30, 2006 September 30, 2005
Export sales $ 4,016,972 $ - $ 6,362,944 $ -
Domestic sales - 1,385,336 - 2,047,973
-------------------- -------------------- ------------------- -------------------
$ 4,016,972 $ 1,385,336 $ 6,362,944 $ 2,047,973
==================== ==================== =================== ===================
13. RELATED PARTY TRANSACTIONS
The Company leases ground fuel tanks and other oil fuel storage facilities
and warehouses from Term Oil LLC. The lease expenses for the three months
ended September 30, 2006 and 2005, totaled to $54,021 and $54,478,
respectively. One of our shareholders is an owner of Term Oil LLC.
19
14. COMMITMENTS AND CONTINGENCIES
Historical investments by the Government of the Republic of Kazakhstan
The Government of the Republic of Kazakhstan made historical investments
in the ADE Block in total amount of $5,994,200 in relation to ADE Block
and $5,350,680 in relation to the Extended Territory. When the Company
applies for and is granted commercial production rights for the ADE Block
and Extended Territory, the Company will be required to begin repaying
these historical investments to the Government of the Republic of
Kazakhstan. The terms of repayment will be negotiated at the time the
Company applies for commercial production rights.
Capital Commitments
Under the terms of its subsurface exploration contract, Emir Oil LLP is
required to spend a total of $32 million in exploration and development
activities on the ADE Block. To retain its rights under the contract, the
Company must spend a minimum of $6 million in 2006 and $4.5 million in
2007. The Company must also comply with the terms of the work program
associated with the contract, which includes the drilling of at least nine
additional new wells by July 9, 2007. Under the terms of its contract, the
Company can apply for a two-year extension of time to complete its work
program. The Company recently applied to extend the subsurface exploration
contract to July 2009 and is awaiting approval of the extension. The
failure to meet the minimum capital expenditures or to comply with the
terms of the work program could result in the loss of the subsurface
exploration contract.
Litigation
In December 2003, Brian Savage, Thomas Sinclair and Sokol Holdings, Inc.,
filed a lawsuit in Florida naming the Company and some of its former
officers and directors as defendants. The plaintiffs in the case alleged
breach of contract, unjust enrichment, breach of fiduciary duty,
conversion and violation of a Florida trade secret statute in connection
with a business plan for the development of the Aksaz, Dolinnoe and Emir
oil and gas fields owned by Emir Oil LLP. The plaintiffs seek unspecified
compensatory and exemplary damages. The parties have mutually agreed to
dismiss this lawsuit without prejudice.
In April 2005, Sokol Holdings, Inc., filed a complaint in United States
District Court, Southern District of New York alleging that the Company,
and others, wrongfully induced Mr. Tolmakov, Director of Emir Oil, to
breach a contract under which Mr. Tolmakov had agreed to sell to Sokol 70%
of his 90% interest in Emir Oil LLP. Sokol Holdings, Inc. seeks damages in
an unspecified amount exceeding $75,000 to be determined at trial,
punitive damages, specific performance in the form of an order compelling
BMB to relinquish its interest in Emir and the underlying interest in the
ADE fields to Sokol Holdings, Inc. and such other relief as the court
finds just and reasonable.
20
In October 2005, Sokol Holdings amended its complaint in New York to add
Brian Savage and Thomas Sinclair as plaintiffs and adding Credifinance
Capital, Inc., and Credifinance Securities, Ltd., (collectively
"Credifinance") as defendants in the matter. The amended complaint alleges
tortious interference with contract, specific performance, breach of
contract, unjust enrichment, breach of fiduciary duty, conversion,
misappropriation of trade secrets, tortuous interference with fiduciary
duty and aiding and abetting breach of fiduciary duty in connection with a
business plan for the development of the Aksaz, Dolinnoe and Emir oil and
gas fields owned by Emir Oil, LLP. The plaintiffs seek damages in an
amount to be determined at trial, punitive damages, specific performance
and such other relief as the Court finds just and reasonable.
The Company is confident that the matters shall be resolved in the
Company's favor. The Company has retained legal counsel to protect its
interests. In the opinion of the Company's management and legal counsel,
the resolution of those lawsuits will not have a material adverse effect
on Company's financial condition, results of operations or cash flows.
Other than the foregoing, to the knowledge of management, there is no
other material litigation or governmental agency proceeding pending or
threatened against the Company or management.
15. FINANCIAL INSTRUMENTS
As of September 30, 2006 and March 31, 2006 marketable securities of $0
and $33,095,609, respectively, are presented by discount bonds issued by
General Electric Corporation and discount notes issued by Fannie Mae.
As of September 30, 2006 and March 31, 2006 cash and cash equivalents
included deposits in Kazakhstan banks in the amount $6,190,856 and
$3,881,255, respectively. As of September 30, 2006 and March 31, 2006 the
Company made advance payments to Kazakhstan companies and government
bodies in the amount $7,281,647 and $2,473,985, respectively. As of
September 30, 2006 and March 31, 2006 restricted cash reflected in the
long-term assets consists of $156,454 and $156,454, respectively,
deposited in a Kazakhstan bank and restricted to meet possible
environmental obligations according to the regulations of Kazakhstan.
Furthermore, the primary asset of the Company is Emir Oil LLP; an entity
formed under the laws of the Republic Kazakhstan.
21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion is intended to assist you in understanding our
results of operations and our present financial condition. Our Consolidated
Financial Statements and the accompanying notes included in this Form 10-Q
contain additional information that should be referred to when reviewing this
material and this document should be read in conjunction with the Form 10-KSB of
the Company for the year ended March 31, 2006.
Statements in this discussion may be forward-looking. These
forward-looking statements involve risks and uncertainties, including those
discussed below, which could cause actual results to differ from those
expressed.
Forward Looking Statements
Certain of the statements contained in all parts of this document
including, but not limited to, those relating to our drilling plans, future
expenses, changes in wells operated and reserves, future growth and expansion,
future exploration, future seismic data, expansion of operations, our ability to
generate new prospects, our ability to obtain a production license, review of
outside generated prospects and acquisitions, additional reserves and reserve
increases, managing our asset base, expansion and improvement of capabilities,
integration of new technology into operations, credit facilities, new prospects
and drilling locations, future capital expenditures and working capital,
sufficiency of future working capital, borrowings and capital resources and
liquidity, projected cash flows from operations, future commodity price
environment, expectations of timing, the outcome of legal proceedings,
satisfaction of contingencies, the impact of any change in accounting policies
on our consolidated financial statements, the number, timing or results of any
wells, the plans for timing, interpretation and results of new or existing
seismic surveys or seismic data, future production or reserves, future
acquisitions of leases, lease options or other land rights, management's
assessment of internal control over financial reporting, financial results,
opportunities, growth, business plans and strategy and other statements that are
not historical facts contained in this report are forward-looking statements.
When used in this document, words like "expect," "project," "estimate,"
"believe," "anticipate," "intend," "budget," "plan," "forecast," "predict,"
"may," "should," "could," "will" and similar expressions are also intended to
identify forward-looking statements. Such statements involve risks and
uncertainties, including, but not limited to, market factors, market prices
(including regional basis differentials) of crude oil and natural gas, results
of future drilling and marketing activity, future production and costs and other
factors detailed herein and in our other Securities and Exchange Commission
filings. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual outcomes may vary
materially from those indicated. These forward-looking statements speak only as
of their dates and should not be unduly relied upon. We undertake no obligation
to publicly update or revise any forward-looking statement, whether as a result
of new information, future events or otherwise.
22
Overview
BMB Munai, Inc. is an independent oil and natural gas company engaged
in the exploration, development, acquisition and production of crude oil and
natural gas properties in the Republic of Kazakhstan (sometimes also referred to
herein as the "ROK" or "Kazakhstan"). We hold a contract that allows us to
explore and develop approximately 460 square kilometers in western Kazakhstan.
Our contract grants us the right to explore and develop the Aksaz, Dolinnoe and
Emir oil and gas fields, referred to herein as "the ADE Block" as well as an
area adjacent to the ADE Block referred to herein as "the Extended Territory."
The ADE Block and Extended Territory are collectively referred to herein as "our
properties."
Exploration Stage Activities
Under the statutory scheme in the Republic of Kazakhstan prospective
oil fields are developed in two stages. The first stage is an exploration and
appraisal stage during which a private contractor, such as BMB, is given a
license to explore for oil and gas on a territory for a set term of years.
During this stage the primary focus is on the search for a commercial discovery,
i.e., a discovery of a sufficient quantity of oil and gas to make it
commercially feasible to pursue execution of, or transition to, a production
contract with the government.
In order to be assured that adequate exploration activities are
undertaken by the contractor, the Ministry of Energy and Mineral Resources,
("MEMR") establishes an annual mandatory work program to be accomplished in each
year of an exploration contract. The minimum work program is comprised of two
parts. The first part sets a minimum dollar amount to be invested in exploration
activities on the contract territory that may include geophysical studies,
construction of field infrastructure or drilling activities. The second factor
is to establish a minimum number of wells to be drilled in the contract
territory during the term of an exploration contract. Failure to complete the
minimum work program during the term of an exploration contract would preclude a
contractor from entitlement to a longer-term production contract, regardless the
success of the contractor in proving commercial reserves during the partial
fulfillment of the minimum work program. Therefore, completion of the
exploration contract's minimum work program is essential to the success of any
oil company working in Kazakhstan.
The contract we hold follows the above format. Our contract was granted
for an initial term that expired in 2005. The contract also provided for two
extensions of two years each. The current contract extension will run through
July 2007. Following this extension, we have the right to request a second
extension to run through July 2009. Application for this second extension was
recently submitted to the MEMR and we are awaiting approval of the request for
the extension.
The contract sets the minimum dollar amount to be expended by the
Company through July 2007 as follows:
23
- ----------------------- --------------------- ------------------------- ------------------- -----------------
Amount of Through July Through July Through July Total
Expenditure 2005 2006 2007
- ----------------------- --------------------- ------------------------- ------------------- -----------------
Mandated by $21,500,000 $6,000,000 $4,500,000 $32,000,000
Contract
- ----------------------- --------------------- ------------------------- ------------------- -----------------
Actually Made $38,400,000 $12,700,000 $9,650,000* $60,750,000
- ----------------------- --------------------- ------------------------- ------------------- -----------------
* Investment as of September 30, 2006
Under the rules of the MEMR our expenditures above the minimum
requirements in one period may be carried over to meet minimum obligations in
future periods. As the above chart shows we have exceeded the minimum
expenditure requirement in each period of the contract. We expect that the
second extension scheduled to begin in July 2007 will impose an additional
investment consistent with the amount imposed on the extension covering the
2006-2007 period. However, we expect our scheduled drilling activities to exceed
any new amounts added to our minimum work program.
The second aspect of the mandatory minimum work program is the
establishment of a minimum number of wells to be drilled on the contract
territory before permitting the transition to a production contract. The number
of wells to be drilled is generally determined by the number of structures
identified by the seismic studies done on a territory. The 3D seismic studies of
our contract territory, as extended, have identified six potential structures.
Therefore, our contract requires that we complete a minimum of 18 wells during
the exploration phase of our contract as reflected on the top half of the
following chart:
- ------------------ --------------- ---------------- -------------- ---------------- ------------ ------------
Structures Aksaz Dolinnoe Emir Kariman Borly Yessen
- ------------------ --------------- ---------------- -------------- ---------------- ------------ ------------
Exploratory Wells 1 1 1 1 1 1
Appraisal Wells 2 2 2 2 2 2
Existing Wells 2 3 1 1 0 0
Wells in 0 1 1 1 0 0
Progress
Remaining Wells 1 0 1 1 3 3
to Drill by
July 2009
- ------------------ --------------- ---------------- -------------- ---------------- ------------ ------------
The bottom half of the above chart shows our current progress on
drilling of exploratory and appraisal wells, the second aspect of our mandatory
minimum work program. As the chart shows, for purposes of meeting the minimum
work program requirements, we have seven wells completed and three wells
currently in progress. However, only two of those wells will count toward our
total minimum required wells because the Dolinnoe structure already has three
existing wells completed.
24
To date we have been conservative in our approach to exploration. It
has been our practice to drill our first few wells serially. Our first well was
the Dolinnoe-2 well drilled in 2004. This was followed by the Dolinnoe-3 well,
and then the Aksaz-4 and Kariman-1 wells. We have verified the presence of oil
and gas in all our wells thus far. And we have expended substantial time and
money to study our wells very closely.
It is important to remember that the purpose of the exploration phase
is to study the geology and geophysical characteristics of each field and
individual wells, with a view to qualifying for a longer-term production
contract. Once drilling of a well is completed, our emphasis focuses on an
extended period of testing a well's production characteristics and capacities to
determine the best method for producing oil from a well and to gain insight into
the further development of the entire field. During this stage of exploration,
oil production is subject to wide fluctuations caused by varying pressures
commonly experienced by new wells and by significant periods of well closure to
accommodate various mandatory testing. Maximizing oil production only becomes
the central focus during the post-exploration phase when exploiting the
commercial discovery commences under a production contract.
In addition to the wells currently in progress, our minimum work
program mandates that we complete nine wells by July 2009, the end of our
exploration contract term. This will require that we continue to accelerate our
drilling activities during the next two and a half years.
Drilling Operations
During the fourth fiscal quarter of last year we took steps to secure
drilling rigs that would allow us to accelerate our drilling activities over
previous years. In January 2006 we signed one-year contracts with Great Wall, a
Chinese drilling company, and Oil and Gas Exploration Krakow, a Polish drilling
company, to furnish heavy rigs of sufficient size to drill wells to the depth of
4,000 meters, which is generally our target depth in Triassic period carbonate
structures. We also signed a turnkey contract with KandyagashBurService, LLP, a
Kazakhstani drilling company, for drilling of new wells on the Emir oil field.
In addition, we hired Great Wall and Kezbi, Kazakhstani drillers, to provide
lighter rigs we use for workover and testing activities on completed wells.
When we acquired our contracts, there were several existing wells
within the contract territory. State-owned drilling companies drilled most of
these wells during the first several years after formation of the Republic of
Kazakhstan. The wells were only partially completed and the depth of the wells
was shallower than expected pay zones we have identified from our 3D seismic
studies.
We have attempted to make re-entry into three of these pre-existing
wells in the belief that we would realize cost savings by taking advantage of
the existing well bores drilled to depths of up to 3,800 meters. However, our
experience has lead us to conclude that the existing well bores are of inferior
25
condition and have not resulted in any cost savings and in some cases have
yielded completed well structures that are subject to numerous limitations.
We have concluded that new wells can be drilled at approximately the
same cost as a well re-entry and we are able to place casing and tubing in the
new well bores that are better suited to the conditions we find at greater
drilling depth. For these reasons we stopped re-entry on the Borly-2 well as of
September 5, 2006 and moved the rig from the Borly-2 to the Kariman-1 well
following the conclusion of the pressure build-up test completed at the
Kariman-1 well.
By the summer of 2006 all of our contracted rigs had arrived on-site
and we were able to expand our drilling activities on new wells. We currently
have three new wells in various stages of progress. We anticipate that our
testing activities will be completed near our current fiscal year end and we
should be able to realize stable production from these wells commencing in the
spring of 2007.
Well Performance
Following is a brief description of the production status and
performance of each of our seven completed wells.
Aksaz-1
This well is currently under workover and is not producing. Prior to
workover, four producing intervals were tested. The single interval test
production rates in Aksaz-1 using a 10 mm diameter choke was 140 bpd.
Aksaz-4
Drilling of this well was completed in August 2005. Two producing
intervals have been tested. Current production rates from single interval
testing using a 6 mm diameter choke ranges from 50 to 125 bpd.
Dolinnoe-1
Currently this well is producing. We recently completed acid treatment
of this well. Current production rates from single interval testing using a 6 mm
diameter choke ranges 60 to 100 bpd.
Dolinnoe-2
Currently this well is also producing. We recently completed acid
treatment of this well. Current production rates from single interval testing
using an 8 mm diameter choke ranges from 60 to 100 bpd.
26
Dolinnoe-3
This well was initially completed to a depth of 3,800 meters in
September 2005. During initial testing, we were able to perforate only 17 of 24
meters of the producing interval because of intensive oil and gas shows.
Subsequent, perforation of the remaining 7 meters of the interval was disrupted
when tubing was impacted by the heavy drilling mud components, and the blowout
preventer was damaged, which required the forced killing of the well. Although
we were able to restore limited oil production from the well, the production was
substantially lower than the well's initial test production performance. We have
conducted numerous tests during the past six months in an effort to increase
daily production rates to levels consistent with management expectations. In
August 2006 we completed the acid treatment of the Dolinnoe-3 well. During the
ten days following completion of the acid treatment the well produced between
460 and 630 bpd while being tested using chokes between 6mm and 10mm in size. We
believe these initial test results indicate that we have developed a suitable
hydrochloric acid formula to conduct effective acid treatment of the carbonate
formations with temperature and pressure conditions characterized by the
Dolinnoe field.
Emir-1
This well is currently producing. Current production rates from single
interval testing using a 8 mm diameter choke ranges from 8 to 20 bpd.
Kariman-1
We began our current fiscal year continuing the re-entry of Kariman-1
well, our first project within the Extended Territory. The re-entry was
completed on June 30, 2006 and well completion was undertaken and completed
between July 7, 2006 and July 17, 2006 to the upper Triassic formation. Despite
the fact that the flows from this horizon are partially blocked by drilling
fluid, preliminary testing conducted during the first month of testing using
chokes ranging from 20 mm to 30 mm yielded results ranging from 250 to 530
barrels per day. The well was then put into a pressure-build up test to better
understand the source of the high pressures located during earlier re-entry
operations at the upper four meters of Middle Triassic formation at the
Karamin-1 well.
27
Results of Operations
Three months ended September 30, 2006, compared to the three months
ended September 30, 2005.
Revenue and Production
The following table summarizes production volumes, average sales prices
and operating revenue for our oil and natural gas operations for the three
months ended September 30, 2006 and the three months ended September 30, 2005.
Three months ended
September 30, 2006
to the three months ended
September 30, 2005
For the three For the three -------------------------------
months ended months ended $ %
September 30, September 30, Increase Increase
2006 2005 (Decrease) (Decrease)
------------------ ------------------ -------------- -------------
Production volumes:
Natural gas (Mcf) - - - -
Natural gas liquids (Bbls) - - - -
Oil and condensate (Bbls) 75,767 70,365 5,402 8%
Barrels of Oil equivalent (BOE) 75,767 70,365 5,402 8%
Average Sales Price
Natural gas ($ per Mcf) - - - -
Natural gas liquids ($ per Bbl) - - - -
Oil and condensate ($ per Bbl) $ 53.37 $ 22.11 $ 31.26 141%
Barrels of Oil equivalent
($ per BOE) $ 53.37 $ 22.11 $ 31.26 141%
Operating Revenue:
Natural gas - - - -
Natural gas liquids - - - -
Oil and condensate $ 4,016,972 $ 1,385,336 $ 2,631,636 190%
Gain on hedging and derivatives(1) - - - -
------------------ ------------------ -------------- -------------
(1) We did not engage in hedging transactions, including derivatives during the
three months ended September 30, 2006, or the three months ended September
30, 2005.
Revenues. We generate revenue under our contract from the sale of oil
recovered during test production. During the quarter ended September 30, 2006,
we realized revenue from oil sales of $4,016,972 compared to $1,385,336 during
the quarter ended September 30, 2005. The largest contributing factor to the
increase in revenue was the 141% increase in the price per barrel we received
for oil sales during the quarter ended September 30, 2006 compared to the fiscal
quarter ended September 30, 2005. During the fiscal quarter ended September 30,
2006 we exported our oil to the world markets and realized the world market
price for those sales. By comparison, during the fiscal quarter ended September
30, 2005 all oil sales were to the domestic market in Kazakhstan, where the
28
price per barrel of oil is significantly lower than the world market price. Also
during the three months ended September 30, 2006, we had one additional well in
testing or test production as compared to the three months ended September 30,
2005. We anticipate production will continue to increase in upcoming years as we
complete more wells. We plan to continue our drilling activities. We also hope
to continue to be granted export quotas, which allow us to realize world market
prices. This should continue to lead to increased revenue from oil sales during
the upcoming quarters of the current fiscal year as compared to our prior fiscal
quarters.
As discussed above, our revenue is sensitive to changes in prices
received for our products. Our production is currently being sold at the
prevailing world market price, which fluctuates in response to many factors that
are outside our control. Imbalances in the supply and demand for oil can have a
dramatic effect on the prices we receive for our production. Similarly, if we
were denied an export quota and were forced to sell our production to the
domestic market in Kazakhstan, we anticipate the price we would receive per
barrel of oil would be much lower than the price we currently realize. Political
instability, the economy, weather and other factors outside our control could
have an impact on both supply and demand.
Costs and Operating Expenses
The following table presents details of our expenses for the three
months ended September 30, 2006 and 2005:
For the three months ended For the three months ended
September 30, 2006 September 30, 2005
------------------------------- ------------------------------
Expenses:
Oil and gas operating(1) $ 575,698 $ 186,434
General and administrative 1,955,246 4,880,514
Depletion 427,477 313,912
Accretion expenses 24,453 -
Amortization and depreciation 41,366 34,368
------------------------------- ------------------------------
Total $ 3,024,240 $ 5,415,228
=============================== ==============================
Expenses ($ per BOE):
Oil and gas operating(1) 7.65 2.98
Depletion (2) 5.68 5.01
(1) Includes transportation cost, production cost and ad valorem taxes.
(2) Represents depletion of oil and gas properties only.
Oil and Gas Operating Expenses. During the three months ended September
30, 2006 we incurred $575,698 in oil and gas operating expenses compared to
$186,434 during the three months ended September 30, 2005. This significant
increase is primarily the result of several factors. Royalty paid to the
Government of $91,964 during the three months ended September 30, 2006 compared
to $35,765 during the fiscal quarter ended September 30, 2005 increased due to
the fact that all sales in the current fiscal quarter were to the world markets
and realized the world market price for those sales. By comparison, during the
fiscal quarter ended September 30, 2005 all oil sales were to the domestic
market in Kazakhstan, where the price per barrel of oil is significantly lower
29
than the world market price. Because of the increase in revenue from oil sales
in the current year, we recognized a corresponding increase in our royalty
payment. Another reason for increase in oil and gas operating expenses during
the three months ended September 30, 2006 is increases in salary expenses and
transportation expenses of $172,593 and $ 160,472, respectively. Salary and
transportation expenses increased primarily because during the current quarter
we had two additional wells in testing or test production as compared to the
fiscal quarter ended September 30, 2006. This required us to retain additional
production and maintenance personnel and oil tankers. While we expect oil and
gas operating expenses to continue to increase in upcoming fiscal quarters as
the number of wells we have in testing and test production continues to increase
we do not expect such increases will be as significant in the future.
General and Administrative Expenses. General and administrative
expenses during the three months ended September 30, 2006 were $1,955,246
compared to $4,880,514 during the three months ended September 30, 2005. This
represents a 60% decrease in general and administrative expenses. The primary
contributing factor to this significant decrease was an 82% decrease in payroll
and other compensation. During the quarter ended September 30, 2005 we granted
restricted stock and stock options to our directors, officers and key employees.
Fair value of stock and stock options was recognized in our consolidated
financial statements as compensation expense. The total amount of compensation
expense recognized as a result of the stock and option grants was $3,815,158.
The decrease in compensation expense during the three months ended September 30,
2006 was partially offset by increased rent expenses of $34,862, increased
professional services of $150,088 and tax expenses of $133,895 due to increased
environmental payments and transportation expenses, a $283,250 increase in
travel expense and payroll increases of $211,544 due to hiring of administrative
and professional employees during three months ended September 30, 2006. We
anticipate general and administrative expenses in upcoming fiscal quarters will
remain fairly consistent with the expenses incurred during the three months
ended September 30, 2006.
Income from Operations. During the three months ended September 30,
2006 we realized income from operations of $992,732 compared to a loss from
operations of $4,029,892 during the three months ended September 30, 2005. As
discussed above, the change to income from operations in the current quarter
compared to a loss from operations in the prior quarter is primarily
attributable to the significantly higher price per barrel of oil sold we
realized in the current fiscal quarter compared to the same quarter of last
fiscal year. Another contributing factor was the reduction in general and
administrative expenses in the current fiscal quarter. In future periods, if
production rates, oil prices and expenses do not change materially, we should
generate sufficient revenue from oil sales to offset our expenses. If, however,
production levels or the price per barrel of oil we realize were to decrease, or
expenses were to increase, we would likely be unable to offset our operating
expenses with revenue from production and would experience losses from
operations.
Other Income. During the fiscal quarter ended September 30, 2006 we
realized total other income of $199,133 compared to $144,435 during the fiscal
quarter ended September 30, 2005. This 38% increase is largely attributable to
$234,831 increase in interest income and $135,754 increase in realized gain on
marketable securities. This income is partially offset by a $241,186 increase in
exchange loss resulting from fluctuations of foreign currency rates against the
U.S. Dollar and $74,701 increase in other expenses. We anticipate the funds held
30
in deposits and marketable securities will be used to fund our operations and
therefore expect interest income and gains from marketable securities, both
realized and unrealized, to decrease in upcoming quarters.
Net Income. For the reasons discussed above, during the three months
ended September 30, 2006 we realized a net income of $1,016,352 compared to a
net loss of $3,885,457 for the three months ended September 30, 2005.
Six months ended September 30, 2006, compared to the six months ended
September 30, 2005
Revenue and Production
The following table summarizes production volumes, average sales prices
and operating revenue for our oil and natural gas operations for the six months
ended September 30, 2006 and the six months ended September 30, 2005.
Six months ended
September 30, 2006
to the six months ended
September 30, 2005
For the six For the six -------------------------------
months ended months ended $ %
September 30, September 30, Increase Increase
2006 2005 (Decrease) (Decrease)
------------------ ------------------ -------------- -------------
Production volumes:
Natural gas (Mcf) - - - -
Natural gas liquids (Bbls) - - - -
Oil and condensate (Bbls) 126,031 111,821 14,210 13%
Barrels of Oil equivalent (BOE) 126,031 111,821 14,210 13%
Average Sales Price
Natural gas ($ per Mcf) - - - -
Natural gas liquids ($ per Bbl) - - - -
Oil and condensate ($ per Bbl) $ 53.08 $ 20.58 $ 32.50 158%
Barrels of Oil equivalent
($ per BOE) $ 53.08 $ 20.58 $ 32.50 158%
Operating Revenue:
Natural gas - - - -
Natural gas liquids - - - -
Oil and condensate $ 6,362,944 $ 2,047,973 $ 4,314,971 211%
Gain on hedging and derivatives(1) - - - -
------------------ ------------------ -------------- -------------
(1) We did not engage in hedging transactions, including derivatives during the
six months ended September 30, 2006, or the three months ended September 30,
2005.
31
Revenues. We generate revenue under our contract from the sale of oil
recovered during test production. During the six months ended September 30,
2006, we realized revenue from oil sales of $6,362,944 compared to $2,047,973
during the six months ended September 30, 2005. The largest contributing factor
to the increase in revenue was a 158% increase in the price per barrel we
received for oil sales during the six month period ended September 30, 2006
compared to the six month period ended September 30, 2005. During the six months
ended September 30, 2006 we exported our oil to the world markets and realized
the world market price for those sales. By comparison, during the six months
ended September 30, 2005 all oil sales were to the domestic market in
Kazakhstan, where the price per barrel of oil is significantly lower than the
world market price. Also during the six months ended September 30, 2006, we had
an additional well in testing or test production as compared to the six months
ended September 30, 2005. As discussed above, we anticipate production and
revenue will continue to increase in upcoming years. We plan to continue
drilling activities in the upcoming periods. We also hope to continue to be
granted export quotas, which allow us to realize world market prices. If we
continue to be granted export quotas, we should continue to realize higher
revenues from oil sales compared to our prior fiscal years because of the
increased price per barrel we will realize from oil sales to the world market.
Costs and Operating Expenses
The following table presents details of our expenses for the six months
ended September 30, 2006 and 2005:
For the six months ended For the six months ended
September 30, 2006 September 30, 2005
------------------------------- ------------------------------
Expenses:
Oil and gas operating(1) $ 990,573 $ 266,707
General and administrative 7,322,942 5,881,752
Depletion 667,968 665,644
Accretion expenses 64,058 -
Amortization and depreciation 76,511 64,806
------------------------------- ------------------------------
Total $ 9,122,052 $ 6,878,909
=============================== ==============================
Expenses ($ per BOE):
Oil and gas operating(1) 8.26 2.68
Depletion (2) 5.57 6.69
(1) Includes transportation cost, production cost and ad valorem taxes.
(2) Represents depletion of oil and gas properties only.
Oil and Gas Operating Expenses. During the six months ended September
30, 2006 we incurred $990,573 in oil and gas operating expenses compared to
$266,707 during the six months ended September 30, 2005. This significant
increase is primarily the result of several factors. During the six months ended
September 30, 2006 royalties paid to the government increased 147% compared to
32
the six months ended September 30, 2005. This increase resulted from the fact
that all sales in current six-month period were to the world markets and
realized the world market price for those sales. By comparison, during the six
month period ended September 30, 2005 all oil sales were to the domestic market
in Kazakhstan, where the price per barrel of oil is significantly lower than the
world market price. Another reason for increase in oil and gas operating
expenses is increase in salary expenses and transportation expenses for $323,124
and $344,286, respectively. These expenses increased primarily because during
the six months ended September 30, 2006 we had two additional wells in testing
or test production as compared to the six months ended September 30, 2006. This
required attraction of more production and maintenance personnel and additional
oil tankers. While we expect oil and gas operating expenses to continue to
increase in the upcoming fiscal year as revenue continues to increase we do not
expect such increases will be as significant in the future.
General and Administrative Expenses. General and administrative
expenses during the six months ended September 30, 2006 were $7,322,942 compared
to $5,881,752 during the six months ended September 30, 2005. This represents a
25% increase in general and administrative expenses. This increase is
attributable to a 18% increase in payroll and other compensation. During the
six-month period ended September 30, 2006 we granted restricted stock and stock
options to our directors, officers and key employees. The fair value of these
stock and stock option grants was recognized in our consolidated financial
statements as compensation expense. The total amount of compensation expense
recognized as a result of the stock and option grants was $4,010,346. During the
six-month period ended September 30, 2005 we also granted restricted stock and
stock options to our directors, officers and key employees. The total amount of
compensation expense recognized as a result of the stock and option grants was
$3,815,158. Other factors contributing to the increase in general and
administrative expense were a 10% increase in rent expense an 83% increase in
professional services fees and a 404% increase in taxes resulting from increased
environmental payments and a 298% increase in travel and related expenses
resulting from increased business travel. We anticipate increases in revenue
will outpace the increases in general and administrative expenses in upcoming
quarters.
Loss from Operations. During the six months ended September 30, 2006 we
realized a loss from operations of $2,759,108 compared to a loss from operations
of $4,830,936 during the six months ended September 30, 2005. We realized a 211%
increase in revenue during the six month period ended September 30, 2006
compared to the comparable period 2005, this increase was offset by a 271%
increase in oil and gas operating expenses and a 25% increase in general and
administrative expenses. This resulted in a 43% decrease in loss from operations
during the six months ended September 30, 2006 compared to the six months ended
September 30, 2005. While we experienced a loss from operations during the
six-month period ended September 30, 2006, we did realize income from operations
during the three-month period ended September 30, 2006. In future periods, if
production rates, oil prices and expenses do not change materially, we should
generate sufficient revenue from oil sales to offset our expenses. If, however,
production levels or the price per barrel of oil we realize were to decrease, or
expenses were to increase, we would likely be unable to offset our operating
expenses with revenue from production and would experience losses from
operations.
33
Other Income. During the six-month period ended September 30, 2006 we
realized total other income of $810,212 compared to $85,874 realized during the
fiscal quarter ended September 30, 2005. This 843% change is largely
attributable to $378,093 increase in interest income, $320,260 increase in
realized gain on marketable securities, $120,205 increase in unrealized gains on
marketable securities and $49,873 increase in exchange gain resulting from
fluctuations of foreign currency rates against the U.S. Dollar. This income was
partially offset by a $144,093 increase in other expenses. We anticipate the
funds held in deposits and marketable securities will be used to fund our
operations and therefore expect interest income and gains from marketable
securities, both realized and unrealized, to decrease in upcoming quarters.
Net Loss. During the six-month period ended September 30, 2006 we
realized a net loss of $2,124,409 compared to a net loss of $4,745,062 during
the comparable period of 2005. Due to the significant increase in revenue
resulting from increased oil production during the six months ended September
30, 2006 net loss decreased significantly. We anticipate that we will continue
to realize significant increases in revenue as our production levels continue to
increase. Based on these expectations, we anticipate net losses in upcoming
quarters will continue to decrease.
Liquidity and Capital Resources
Funding for our activities has historically been provided by funds
raised through the sale of our common stock. From inception on May 6, 2003
through September 30, 2006 we have raised $94,626,926 through the sale of our
common stock. As of September 30, 2006 we had cash and cash equivalents on hand
of $34,283,815. We anticipate our capital resources in the upcoming three months
will likewise consist primarily of revenue from the sale of oil recovered.
Our need for capital is primarily to fund our ongoing operations to
meet the drilling requirements of our minimum work program. For the period from
inception on May 6, 2003 through September 30, 2006, we have incurred capital
expenditures of $80,583,564 for exploration, development and acquisition
activities.
We continually evaluate our capital needs and compare them to our
capital resources. At the beginning of the current fiscal year we had budgeted
capital expenditures of about $60 million to $70 million for exploration,
development, production and acquisitions. At the time the budget was prepared,
we believed our production would be sufficient to allow us to generate enough
revenue from oil sales to finance the gap of $10 million to $20 million required
for our planned exploration, development, production and acquisitions. However,
the drilling schedules we initially anticipated have been delayed and production
has developed more slowly than expected.
One of the challenging tasks we have faced is how to make accurate
production forecasts during the exploration stage. There are many factors that
contribute to the complexity of reliable forecasting by an exploration stage
company. Our first challenge has been to secure qualified drilling
subcontractors and to obtain timely performance. The current energy boom in
34
Kazakhstan has created considerable competition for good rigs and qualified
labor. In the case of the heavy rig of Great Wall, the original estimate
scheduled a new heavy rig in place in March 2006. It was July 2006 before the
rig was in place and ready to begin drilling the Dolinnoe-6 well. The delay was
not the fault of the driller, but arose from delay at the China-Kazakhstan
border.
Second, we are in continuous test production on each well. We are
required by law to test each interval using different choke sizes. The minimum
testing periods usually extend over a period of months. There is considerable
down time while equipment is being put in place and removed during this process.
In addition, we have experimented with various reworking methodologies
attempting to determine the best methods to suit the characteristics of the oil,
gas and pressure variations encountered in each structure.
Although our monthly production figures have remained steadily within a
range below our expectations, at our current levels of oil production we are
operating above the break-even point, exclusive of our drilling program
expenditures. However, if our operations are to generate a significant portion
of the future capital needed to complete our exploration contract, then our
monthly production will have to increase significantly. In addition to our
efforts to increase revenue from oil sales to help fund our drilling program
expenditures, we are also negotiating with interested banks to secure a credit
facility that will allow us to continue our exploration contract drilling
obligations without delay.
Cash Flows
During the six month ended September 30, 2006 cash was primarily used
to fund exploration and development expenditures. We had a net increase in cash
and cash equivalents of $16,237,692 during the current fiscal quarter. See below
for additional discussion and analysis of cash flow.
Six months ended Six months ended
September 30, 2006 September 30, 2005
----------------------------- ------------------------------
Net cash used in operating activities $ 27,119,443 $ (4,891,741)
Net cash used in investing activities $ (16,640,253) $ (9,418,727)
Net cash provided by financing activities $ 5,758,502 $ 6,085,619
----------------------------- ------------------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS $ 16,237,692 $ (8,224,849)
============================= ==============================
During the six months ended September 30, 2006, we spent $14 million in
exploration, development and production. We funded these expenditures primarily
from cash on hand and oil sales revenue. We anticipate revenue to increase in
upcoming quarters as we drill new wells and increase production from our
existing wells.
35
Certain operating cash flows are denominated in local currency and are
translated into U.S. dollars at the exchange rate in effect at the time of the
transaction. Because of the potential for civil unrest, war and asset
expropriation, some or all of these matters, which impact operating cash flow,
may affect our ability to meet our short-term cash needs.
Contractual Obligations and Contingencies
The following table lists our significant commitments at September 30,
2006, excluding current liabilities as listed on our consolidated balance sheet:
Payments Due By Period
----------------------------------------------------------------------------
Contractual obligations Total Less than 1 1-3 years 4-5 years After 5
year years
---------------- --------------- --------------- ------------- -------------
Capital Expenditure
Commitment(1) $ 10,500,000 $ 6,000,000 $ 4,500,000 - -
Due to the Government of
the Republic of Kazakhstan(2) $ 11,344,880 - $11,344,880 - -
Liquidation Fund $ 988,650 - $ 988,650 - -
---------------- --------------- --------------- ------------- -------------
Total $ 22,833,530 $ 6,000,000 $16,833,530 - -
================ =============== =============== ============= =============
(1) Under the terms of our contract with the ROK, we are required to spend a
total of at least $10.5 million dollars in exploration, development and
improvements within the ADE Block, as extended during the term of the
license, including $6 million in the 2006 calendar year and $4.5 million in
the 2007 calendar year. If we fail to do so, we may be subject to the loss
of our exploration license.
(2) In connection with our acquisition of the oil and gas contract covering the
ADE Block and the Extended Territory, we are required to repay the ROK for
historical costs incurred by it in undertaking geological and geophysical
studies and infrastructure improvements. The repayment terms of this
obligation will not be determined until such time as we apply for and are
granted commercial production rights by the ROK. Under our contract, if we
wish to commence commercial production, we must apply for such right prior
to the expiration of our exploration and development rights in July 2007 or
we must apply for a two-year extension of our exploration license. We are
legally entitled to the two-year extension. We are also legally entitled to
receive commercial production rights and have the exclusive right to
negotiate such with the ROK, and the ROK is required to conduct the
negotiations under the Law of Petroleum in Kazakhstan. Although we can
apply for commercial production rights at any time, we enjoy certain
benefits under our contract that currently make it more economically
advantageous for us to continue exploration and development activities at
this time. At this time, we anticipate that we will apply for a two-year
extension of our exploration license during the first half of the 2007
calendar year. This would give us an additional two years to explore and
prove up our properties before we apply for commercial production rights.
Should we decide not to pursue a commercial production contract, we can
relinquish the ADE Block and Extended Territory to the ROK in satisfaction
of this obligation. Our repayment obligation for the ADE Block is
$5,994,200. Our repayment obligation for the Extended Territory is
$5,350,680.
Off-Balance Sheet Financing Arrangements
As of September 30, 2006, we had no off-balance sheet financing
arrangements.
Item 3. Qualitative and Quantitative Disclosures About Market Risk
Our primary market risks are fluctuations in commodity prices and
foreign currency exchange rates. We do not currently use derivative commodity
36
instruments or similar financial instruments to attempt to hedge commodity price
risks associated with future crude oil production.
Commodity Price Risk
Our revenues, profitability and future growth depend substantially on
prevailing prices for crude oil. Prices also affect the amount of cash flow
available for capital expenditures and our ability to either borrow or raise
additional capital. Price affects our ability to produce crude oil economically
and to transport and market our production either through export to
international markets or within Kazakhstan. Our second quarter 2006 crude oil
sales in the international export market were based on prevailing market prices
at the time of sale less applicable discounts due to transportation.
Historically, crude oil prices have been subject to significant
volatility in response to changes in supply, market uncertainty and a variety of
other factors beyond our control. Crude oil prices are likely to continue to be
volatile and this volatility makes it difficult to predict future oil price
movements with any certainty. Any declines in oil prices would reduce our
revenues, and could also reduce the amount of oil that we can produce
economically. As a result, this could have a material adverse effect on our
business, financial condition and results of operations.
Foreign Currency Risk
Our functional currency is the U.S. dollar. Emir Oil, LLP, our
Kazakhstani subsidiary, also uses the U.S. dollar as its functional currency. To
the extent that business transactions in Kazakhstan are denominated in the
Kazakh Tenge we are exposed to transaction gains and losses that could result
from fluctuations in the U.S. Dollar--Kazakh Tenge exchange rate. We do not
engage in hedging transactions to protect the Company from such risk.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our principal executive officers and our principal financial officer
(the "Certifying Officers") are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e). Such officers have concluded (based upon their evaluations of
these controls and procedures as of the end of the period covered by this
report) that our disclosure controls and procedures are effective to ensure that
information required to be disclosed by it in this report is accumulated and
communicated to management, including the Certifying Officers as appropriate, to
allow timely decisions regarding required disclosure. Based on this evaluation,
our Certifying Officers have concluded that our disclosure controls and
procedures are effective as of September 30, 2006.
37
Changes in Internal Control over Financial Reporting
There were no changes in our internal controls over financial reporting
during the quarter ended September 30, 2006 that materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In December 2003, a complaint was filed in the 15th Judicial Court in
and for Palm Beach County, Florida, naming, among others, us, Georges Benarroch
and Alexandre Agaian, former BMB directors, as defendants. The plaintiffs, Brian
Savage, Thomas Sinclair and Sokol Holdings, Inc., allege claims of breach of
contract, unjust enrichment, breach of fiduciary duty, conversion and violation
of a Florida trade secret statute in connection with a business plan for the
development Aksaz, Dolinnoe and Emir oil and gas fields owned by Emir Oil, LLP.
The parties mutually agreed to dismiss this lawsuit without prejudice.
In April 2005, Sokol Holdings, Inc., also filed a complaint in United
States District Court, Southern District of New York alleging that BMB Munai,
Inc., Boris Cherdabayev, Alexandre Agaian, Bakhytbek Baiseitov, Mirgali Kunayev
and Georges Benarroch wrongfully induced Toleush Tolmakov to breach a contract
under which Mr. Tolmakov had agreed to sell to Sokol 70% of his 90% interest in
Emir Oil LLP.
In October 2005, Sokol Holdings amended its complaint in the U.S.
District Court in New York to add Brian Savage and Thomas Sinclair as plaintiffs
and to add Credifinance Capital, Inc., and Credifinance Securities, Ltd.,
(collectively "Credifinance") as defendants in the matter. The amended complaint
alleges tortious interference with contract, specific performance, breach of
contract, unjust enrichment, breach of fiduciary duty by Georges Benarroch,
Alexandre Agaian and Credifinance, conversion, breach of fiduciary duty by Boris
Cherdabayev, Mirgali Kunayev and Bakhytbek Baiseitov, misappropriation of trade
secrets, tortuous interference with fiduciary duty by Mr. Agaian, Mr. Benarroch
and Credifinance and aiding and abetting breach of fiduciary duty by Mr.
Benarroch, Mr. Agaian and Credifinance in connection with a business plan for
the development of the Aksaz, Dolinnoe and Emir oil and gas fields owned by Emir
Oil, LLP. The plaintiffs have not named Toleush Tolmakov as defendant in the
action nor have the plaintiffs ever brought claims against Mr. Tolmakov to
establish the existence or breach of any legally binding agreement between the
plaintiffs and Mr. Tolmakov. The plaintiffs seek damages in an amount to be
determined at trial, punitive damages, specific performance and such other
relief as the Court finds just and reasonable.
We have retained the law firm of Bracewell & Giuliani LLP in New York,
New York to represent us in the lawsuit. We moved for dismissal of the amended
complaint or for a stay pending arbitration in Kazakhstan. That motion was
denied, without prejudice to renewing it, to enable defendants to produce
38
documents to plaintiffs relating to the issues raised in the motion. Following
completion of document production, the motion has been renewed. Briefing on the
motion was completed on August 24, 2006, and the motion is awaiting decision.
In the opinion of management, the resolution of this lawsuit will not
have a material adverse effect on our financial condition, results of operations
or cash flows.
Other than the foregoing, to the knowledge of management, there is no
other material litigation or governmental agency proceeding pending or
threatened against the Company or our management.
Item 1A. Risk Factors
There have been no material changes in the risk factors previously
described in Items 1 and 2 to Part I of our Form 10-KSB filed on June 29, 2006.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
There were no unregistered sales of equity securities during the fiscal
quarter ended September 30, 2006.
Item 4. Submission of Matters to a Vote of Security Holders
On October 5, 2006, we held our annual meeting of stockholders. The
total number of shares entitled to vote at the meeting was 43,690,652. The
number of shares represented at the annual meeting of stockholders, present or
by proxy was 26,586,774. At the meeting the shareholders were asked to vote on
the following matter:
1) To elect two Class II directors to our board of directors.
The nominees for Class II directors were Stephen Smoot, who had been
serving as a member of the board of directors and Leonard Stillman, who was a
new nominee to the board of directors. The following individuals were elected to
the board of directors for a term of three years and until their respective
successors shall be elected.
For Withhold
--------------- --------------
Class II Directors:
Stephen Smoot 26,353,591 233,183
Leonard Stillman 26,586,774 -0-
The terms of Valery Tolkachev and Troy Nilson, Class I directors, and
Boris Cherdabayev, a Class III director will continue after the meeting.
No other items were submitted to a vote of our shareholders at the
meeting.
39
Item 5. Other Information
On September 7, 2006, Mr. Georges Benarroch tendered his resignation as
a director of BMB Munai, Inc., (the "Company"). Mr. Benarroch was not a member
of any committee of the board of directors. Mr. Benarroch's resignation was not
the result of any disagreement with the Company on any matter relating to our
operations, policies or practices. Mr. Benarroch's resignation did not arise
from any act or omission which would constitute grounds for removal for cause
under our bylaws.
During the quarter, our common stock was approved for listing on the
American Stock Exchange. Our common stock began trading on the American Stock
Exchange under the symbol "KAZ" on September 21, 2006.
Item 6. Exhibits
Exhibits. The following exhibits are included as part of this report:
Exhibit 31.1 Certification of Principal Executive Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification of Principal Financial Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certification of Principal Executive Officer Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2 Certification of Principal Financial Officer Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
SIGNATURES
In accordance with Section 12 of the Securities Exchange Act of 1934,
the registrant caused this registration statement to be signed on its behalf,
thereunto duly authorized.
BMB MUNAI, INC.
Date: November 9, 2006 /s/ Boris Cherdabayev
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Boris Cherdabayev,
Chief Executive Officer
Date: November 9, 2006 /s/ Sanat Kasymov
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Sanat Kasymov,
Chief Financial Officer
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