United States
Securities and Exchange Commission
Washington, DC 20549
FORM 10-QSB
Quarterly Report Under Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the Quarter Ended Commission File Number
December 31, 2005 000-28638
BMB MUNAI, INC.
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
NEVADA
--------------------------------------------------------------
(State or other jurisdiction of incorporation or organization)
30-0233726
------------------------------------
(I.R.S. Employer Identification No.)
202 Dostyk Ave, 4th Floor, Almaty, 050051, Kazakhstan
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(Address of principal executive offices)
+7 (3272) 375-125
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None.
Securities registered pursuant to section 12(g) of the Exchange Act: Common,
$0.001 par value
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
State the number of shares outstanding of each of the registrant's classes of
common equity, as of the latest practicable date: common stock, par value
$0.001; 42,004,705 shares outstanding as of January 27, 2006.
Transitional small business disclosure format (check one). Yes [ ] No [X]
BMB MUNAI, INC.
FORM 10-QSB
TABLE OF CONTENTS
PART I -- FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 2005 and
March 31, 2005.................................................... 3
Consolidated Statements of Operations for the Three
Months Ended December 31, 2005 and 2004, for the Nine
Months Ended December 31, 2005 and 2004, and the
period from inception (May 6, 2003) to December 31, 2005.......... 4
Consolidated Statements of Cash Flows for the Nine
Months Ended December 31, 2005, the Nine Months Ended
December 31, 2004, and the period from inception (May
6, 2003) to December 31, 2005..................................... 5
Notes to Consolidated Financial Statements.......................... 6
Item 2. Managements' Discussion and Analysis of Financial Condition
and Results of Operations..................................20
Item 3. Controls and Procedures........................................33
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings..............................................33
Item 2. Unregistered Sales of Equity Securities........................35
Item 4. Submission of Matters to a Vote of Security Holders............37
Item 5. Other Information..............................................37
Item 6. Exhibits.......................................................38
Signatures..............................................................38
2
PART I - FINANCIAL INFORMATION
Item 1 - Unaudited Consolidated Financial Statements
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
CONSOLIDATED BALANCE SHEETS
-----------------------------------------------------------------------------------------------------------------------------
Notes December 31, 2005 March 31, 2005
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 54,293,874 $ 9,989,632
Marketable securities 670,905 788,921
Trade accounts receivable 800,584 132,400
Inventories 3 3,321,055 3,227,411
Prepaid expenses and other assets, net 4 3,922,709 4,172,291
----------------------- -----------------------
Total current assets 63,009,127 18,310,655
----------------------- -----------------------
LONG TERM ASSETS
Oil and gas properties, full cost method, net 6 55,577,220 42,964,359
Other fixed assets, net 7 994,013 683,459
Intangible assets, net 56,102 14,435
Restricted cash 155,973 60,973
----------------------- -----------------------
Total long term assets 56,783,308 43,723,226
----------------------- -----------------------
TOTAL ASSETS $ 119,792,435 $ 62,033,881
======================= =======================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 3,038,460 $ 5,844,639
Due to reservoir consultants 278,000 278,000
Taxes payable 401,926 333,063
Due to Astana Fund 5 - 250,000
Accrued liabilities and other payables 313,092 291,969
----------------------- -----------------------
Total current liabilities 4,031,478 6,997,671
----------------------- -----------------------
LONG TERM LIABILITIES
Due to reservoir consultants 222,000 222,000
Liquidation fund 918,504 60,973
Deferred income tax liabilities 343 343
----------------------- -----------------------
Total long term liabilities 1,140,847 283,316
----------------------- -----------------------
COMMITMENTS AND CONTINGENCIES 10 - -
SHAREHOLDERS' EQUITY
Share capital 8 42,005 30,514
Additional paid in capital 8 122,311,011 58,460,520
Deficit accumulated during the development stage (7,732,906) (3,738,140)
----------------------- -----------------------
Total shareholders' equity 114,620,110 54,752,894
----------------------- -----------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 119,792,435 $ 62,033,881
======================= =======================
See notes to the consolidated financial statements.
3
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
CONSOLIDATED STATEMENTS OF OPERATIONS
------------------------------------------------------------------------------------------------------------------------------------
Period from
inception
Three Three Nine Nine (May 6, 2003)
months ended months ended months ended months ended through
December 31, December 31, December 31, December 31, December 31,
2005 2004 2005 2004 2005
----------- ----------- ----------- ----------- -----------
REVENUES $ 2,058,792 $ 55,904 $ 4,106,765 $ 347,891 $ 5,080,411
EXPENSES
Oil and gas operating 242,582 83,933 509,289 168,181 913,915
General and administrative 1,497,515 1,239,050 7,379,267 2,634,332 12,221,986
Depletion 145,078 - 313,435 - 380,887
Amortization and depreciation 35,316 21,917 100,122 49,103 171,331
----------- ----------- ----------- ----------- -----------
Total expenses 1,920,491 1,344,900 8,302,113 2,851,616 13,688,119
----------- ----------- ----------- ----------- -----------
INCOME/(LOSS) FROM OPERATIONS 138,301 (1,288,996) (4,195,348) (2,503,725) (8,607,708)
OTHER INCOME (EXPENSE)
Realized gain on marketable securities - 46 181,688 58,944 386,123
Unrealized gain / (loss) on marketable
securities 62,729 4,666 55,190 (287,944) 50,830
Foreign exchange gain / (loss), net 58,450 329,339 (65,686) 532,025 504,784
Interest income / (expense), net 36,348 126,331 48,370 122,430 (17,838)
Other income / (expense), net (42,819) (9,049) (18,980) (9,049) 33,230
----------- ----------- ----------- ----------- -----------
Total other income 114,708 451,333 200,582 416,406 957,129
----------- ----------- ----------- ----------- -----------
INCOME/(LOSS) BEFORE INCOME TAXES 253,009 (837,663) (3,994,766) (2,087,319) (7,650,579)
INCOME TAX EXPENSE - (6,750) - (6,750) (343)
----------- ----------- ----------- ----------- -----------
INCOME/(LOSS) BEFORE MINORITY INTEREST 253,009 (844,413) (3,994,766) (2,094,069) (7,650,922)
----------- ----------- ----------- ----------- -----------
MINORITY INTEREST - - - - (81,984)
----------- ----------- ----------- ----------- -----------
NET INCOME/(LOSS) $ 253,009 $ (844,413) $(3,994,766) $(2,094,069) $(7,732,906)
=========== =========== =========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC 33,426,080 28,513,761 32,676,428 25,128,792
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - DILUTED 34,648,800 - - -
INCOME/(LOSS) PER COMMON SHARE (BASIC) $ 0.0076 $ (0.0030) $(0.1223) $ (0.0833)
INCOME PER SHARE (DILUTED) $ 0.0073 - - -
See notes to the consolidated financial statements.
4
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------------------------------------------------------
Period from
Nine months Nine months inception
ended ended (May 6, 2003)
December 31, December 31, through
Notes 2005 2004 December 31, 2005
----- ------------ ------------ -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (3,994,766) $ (2,094,069) $ (7,732,906)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation, depletion and amortization 413,557 49,103 552,218
Provision for doubtful accounts - - 129,051
Deferred income tax expense - - 343
Stock based compensation expense 8 3,876,658 - 3,876,658
Stock issued for services 8 172,682 - 172,682
Unrealized gain / (loss) on marketable securities 55,190 (287,944) 50,830
Changes in operating assets and liabilities
Decrease / (increase) in marketable securities 62,826 2,390,263 (721,735)
Increase in trade accounts receivable (668,184) - (800,584)
Increase in inventories (93,644) (3,169,371) (3,321,055)
Decrease / (increase) in prepaid expenses and other assets 249,582 (4,265,281) (4,030,588)
(Decrease) / increase in liabilities (2,966,193) 1,495,595 4,242,485
Restricted cash (95,000) (40,057) (155,973)
Rent deposit - (2,500) (21,172)
------------ ------------ ------------
Net cash used in operating activities (2,987,292) (5,924,261) (7,759,746)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in short term loan receivable - (370,987) -
Acquisition of oil and gas properties 6 (12,016,813) (11,292,383) (35,851,990)
Acquisition of other fixed assets 7 (445,607) (775,016) (1,246,622)
Acquisition of intangible assets (58,688) (12,344) (76,444)
------------ ------------ ------------
Net cash used in investing activities (12,521,108) (12,450,730) (37,175,056)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock 57,410,892 17,311,906 94,626,926
Proceeds from short-term financing - - 500,000
Repayment of short-term financing - - (500,000)
Proceeds from issuance of convertible debt - - 2,000,000
Proceeds from exercise of common stock options and warrants 2,401,750 - 2,601,750
------------ ------------ ------------
Net cash provided by financing activities 59,812,642 17,311,906 99,228,676
------------ ------------ ------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 44,304,242 (1,063,085) 54,293,874
CASH AND CASH EQUIVALENTS at beginning of period 9,989,632 2,126,355 -
------------ ------------ ------------
CASH AND CASH EQUIVALENTS at end of period $ 54,293,874 $ 1,063,270 $ 54,293,874
============ ============ ============
Significant non cash transactions:
Oil and gas properties liquidation fund $ $ 857,531 $ $ 60,973 $ 918,504
Conversion of debt into common stock - - $ 2,000,000
Accrual of liabilities to Astana Fund - - $ 250,000
Acquisition of 30% of Emir Oil LLP by issuance of
3,500,000 shares of common stock - $ 19,075,000 $ 19,075,000
See notes to the consolidated financial statements.
5
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS
BMB Munai, Inc. (the "Company") 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, the Republic of
Kazakhstan.
The Company has minimal operations to date and is considered to be 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, 2005, which is derived from
the Company's audited consolidated financial statements for the year ended
March 31, 2005. 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 generally accepted
accounting principles have been condensed or omitted in this Form 10-QSB
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, 2005 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, 2005.
6
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
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 from the date of its purchase by BMB (June 7,
2003) through December 31, 2005 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
accounting principles generally accepted in the United States of America
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.
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 FAS No. 123, Accounting for Stock-Based
Compensation. Under FAS No. 123, 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 8. 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.
7
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
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. As of
December 31, 2005 the production unit of the Company - Emir Oil had test
production sales at Kazakhstan domestic market price, which is
considerably lower than world market prices.
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 consist of short-term repurchase agreements for
securities issued by Kazakhstan banks and Kazakhstan financial
institutions. The Company records these marketable securities as trading
securities and any change in the fair market value is recorded in
earnings.
8
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
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.
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.
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.
9
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Costs of acquiring unproved leases shall be evaluated for impairment until
such time as the leases are proved or abandoned. In addition, if the sums
of expected undiscounted cash flows are less than net book value,
unamortized costs at the field level will be reduced to fair value.
Depletion of producing properties is computed using the unit-of-production
method based on estimated proved recoverable reserves.
Other fixed assets
Other fixed assets are valued at the 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
sums of expected undiscounted cash flows are less than net book value,
unamortized costs of other fixed assets will be reduced to a fair value.
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 $112,613 was capitalized to oil and gas properties.
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.
10
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
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.
Comparative figures
The presentation of certain amounts for the previous periods has been
reclassified to conform to the presentation adopted for the current
quarter.
Recent accounting pronouncements
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and
Error Corrections", a replacement of APB Opinion 20, "Accounting Changes"
and FASB Statement No. 3, "Reporting Accounting Changes in Interim
Financial Statements." This Statement changes the requirements for the
accounting for and reporting of a change in accounting principle. APB
Opinion 20 previously required that most voluntary changes in accounting
principles be recognized by including in net income of the period of the
change the cumulative effect of changing to the new accounting principle.
FASB Statement No. 154 requires retrospective application to prior
periods' financial statements of changes in accounting principle, unless
it is impracticable to determine either the period specific effects or the
cumulative effect of the change. This statement is effective for
accounting changes and corrections of errors made in fiscal periods that
begin after December 15, 2005. Management does not anticipate this
statement will impact the Company's consolidated financial position or
consolidated results of operations and cash flows.
3. INVENTORIES
Inventories as of December 31, 2005 and March 31, 2005 were as follows:
December 31, 2005 March 31, 2005
----------------- --------------
Construction material $ 3,150,024 $ 3,103,555
Spare parts 98,515 59,706
Crude oil produced 5,543 7,735
Other 66,973 56,415
----------- -----------
$ 3,321,055 $ 3,227,411
=========== ===========
11
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
4. PREPAID EXPENSES AND OTHER ASSETS, NET
Prepaid expenses and other assets, net, as of December 31, 2005 and March
31, 2005 were as follows:
December 31, 2005 March 31, 2005
----------------- --------------
Advances for services $ 2,048,436 $ 589,944
VAT recoverable 1,145,306 1,217,751
Advances for material 575,671 2,301,074
Other 282,347 192,573
Reserves against uncollectible
advances and prepayments (129,051) (129,051)
----------- -----------
$ 3,922,709 $ 4,172,291
============ ===========
5. DUE TO ASTANA FUND
In 2004 the Government of the Republic of Kazakhstan imposed a liability
in the amount of $250,000 to make cash contributions to the Astana Fund.
The Astana Fund is a government fund used by the Government of the
Republic of Kazakhstan to accumulate cash for construction and development
of Astana, the new capital of the Republic of Kazakhstan. On May 27, 2005
the Company made a cash contribution of $250,000 to Astana Fund.
6. OIL AND GAS PROPERTIES, FULL COST METHOD, NET
Oil and gas properties, full cost method, net, as of December 31, 2005 and
March 31, 2005 were as follows:
December 31, 2005 March 31, 2005
----------------- --------------
Subsoil use rights $20,788,119 $20,788,119
Cost of drilling wells 13,735,673 9,334,021
Professional services received
in exploration and development
activities 8,285,364 4,798,314
Material and fuel used in
exploration and development
activities 5,750,773 2,891,765
Infrastructure development costs 1,404,817 1,231,391
Geological and geophysical 1,026,140 653,571
Other capitalized costs 4,967,221 3,334,630
Accumulated depletion (380,887) (67,452)
----------- -----------
$55,577,220 $42,964,359
=========== ===========
12
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
7. OTHER FIXED ASSETS, NET
Machinery Office
Constructions and equipment Vehicles equipment Other Total
------------------------------ -------------- ---------------------------------------------
Cost
at April 1, 2005 $ 86,205 $234,200 $313,207 $128,983 $38,421 $ 801,016
Additions 63,067 279,413 7,858 42,488 53,899 446,725
Disposals - - - (349) (769) (1,118)
------------------------------ -------------- ---------------------------------------------
at December 31, 2005 149,272 513,613 321,065 171,122 91,551 1,246,623
------------------------------ -------------- ---------------------------------------------
Accumulated depreciation
at April 1, 2005 10,789 18,286 58,866 23,834 5,782 117,557
Charge for the period 9,124 20,971 68,154 15,243 22,105 135,597
Disposals - - - (349) (195) (544)
------------------------------ -------------- ---------------------------------------------
at December 31, 2005 19,913 39,257 127,020 38,728 27,692 252,610
------------------------------ -------------- ---------------------------------------------
Net book value at
March 31, 2005 75,416 215,914 254,341 105,149 32,639 683,459
============================== ============== =============================================
Net book value at
December 31, 2005 $129,359 $474,356 $194,045 $132,394 $63,859 $ 994,013
============================== ============== =============================================
In accordance with FAS 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 amount of $
112,613 was capitalized to oil and gas properties.
8. SHARE AND ADDITIONAL PAID IN CAPITAL
Common and preferred stock as of December 31, 2005 and March 31, 2005 are
as follows:
December 31, 2005 March 31, 2005
----------------- --------------
Preferred stock, $0.001 par value
Authorized 20,000,000 20,000,000
Issued and outstanding - -
Common stock, $0.001 par value
Authorized 100,000,000 100,000,000
Issued and outstanding 42,004,705 30,513,761
Reverse merger
During the period ended March 31, 2004, the Company completed a reverse
merger with BMB Holding, Inc. Additionally the Company:
a) Completed a private placement for the total amount of $11,113,562.
b) Converted a $2,000,000 debt to the shareholders of BMB Holding, Inc.
into equity.
c) Issued 200,000 shares of stock upon exercise of stock option worth
$200,000.
13
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
d) Completed a 10 for 1 reverse stock split.
Acquisition
On May 24, 2004, the Company agreed to purchase the remaining 30% interest
of its minority interest partner in Emir Oil LLP in exchange for 3,500,000
shares of restricted Company common stock. On August 6, 2004, the Company
issued the 3,500,000 shares to its minority partner in Emir Oil LLP. The
aggregate purchase price was determined to be $19,075,000 using a price of
the Company's common shares on OTCBB on August 6, 2004 of $5.45 per share.
The entire purchase price has been allocated to oil and gas properties in
the accompanying Consolidated Balance Sheets.
Private placements
On July 2, 2004, the Company sold an aggregate of 4,584,340 common shares
of the Company at $4.00 per share in a private placement offering. The
Company received $17,311,906 net of the agent fees and out of pocket
expenses.
On March 9, 2005, the Company sold an aggregate of 2,000,000 common shares
of the Company at $5.00 per share in a private placement offering. The
Company received $9,968,254 net of the agent fees and out of pocket
expenses.
On March 31, 2005, the Company sold an aggregate of 1,101,000 common
shares of the Company at $5.00 per share in a private placement offering.
On April 12, 2005 the Company received $5,221,685 net of the agent fees
and out of pocket expenses.
On December 23, 2005, the Company sold an aggregate of 9,166,667 common
shares of the Company at $6.00 per share in a private placement offering.
On December 29, 2005 the Company received $52,189,207 net of the agent
fees and out of pocket expenses.
Common stock sold in private placements as of December 31, 2005 is as
follows:
Number of Gross amount Net amount
shares sold Share price raised received
----------- ----------- ------ --------
First private placement 4,830,494 $ 2.15-$ 2.50 $ 11,113,562 $ 9,935,874
Second private placement 4,584,340 $ 4.00 18,337,360 17,311,906
Third private placement 3,101,000 $ 5.00 15,505,000 15,189,939
Fourth private placement 9,166,667 $ 6.00 55,000,002 52,189,207
---------- ------------ ------------
21,682,501 $ 99,955,924 $ 94,626,926
========== ============ ============
The offerings were made only to accredited investors in the United States
of America under Regulation D and pursuant to Regulation S to non-U.S.
Persons.
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
14
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
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 July 18, 2005, the Company granted common shares to Company's directors
and officers for past services rendered. The number of shares granted was
360,270. The shares were valued at $4.75 per share. This stock grant
vested immediately. Compensation expense in the amount of $1,711,283 was
recognized in the Consolidated Statements of Operations and Consolidated
Balance Sheet.
On July 18, 2005, the Company granted 90,000 restricted common shares to
three Company employees. Each employee's stock grants vest in three equal
tranches of 10,000 shares on the first, second and third anniversaries of
their employment with the Company. The first 10,000 shares of stock grants
were valued at $4.75 per share. The second 10,000 shares vested during the
three months ended December 31, 2005 and were valued at $6.15 per share.
We record the fluctuations in the fair value of certain unvested stock
grants as a deferred compensation asset (reported as a reduction of
shareholders' equity on the balance sheet). This asset is amortized upon
vesting of related stock grants as non-cash compensation expense.
Compensation expense for vested stock grants in the amount of $109,000 has
been recognized in the Consolidated Statements of Operations and
Consolidated Balance Sheet.
On July 18, 2005, the Company also granted common shares to legal counsel,
for the legal services rendered. The number of such stock grants has been
set at 18,947 shares at the price of $4.75 per share. Stock grants vest
immediately. Expense in the amount of $89,998 was recognized in the
Consolidated Statements of Operations and Consolidated Balance Sheet.
During the quarter ended September 30, 2005 the Company granted restricted
common shares to the Company's former co-chief executive officer and
president for services rendered. He was granted 70,526 shares. The shares
were valued at $5.02 per share. The stock grants vested immediately.
Compensation expense in the amount of $354,041 was recognized in the
Consolidated Statements of Operations and Consolidated Balance Sheet.
Stock Options
On July 18, 2005, the Company granted stock options to Company's directors
and officers for the past services rendered. These options grant the
directors and officers the right to purchase up to 779,730 shares of the
Company's common stock at an exercise price of $4.75 per share. The
options expire five years from the date of grant. Granted options vest
immediately. Compensation expense for options granted is determined based
on their fair value at the time of grant, the cost of which in the amount
of $1,569,223 was recognized in the Consolidated Statements of Operations.
15
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
On July 18, 2005, the Company granted options to legal counsel, for the
legal services rendered. These options grant legal counsel the right to
purchase up to 41,053 shares of the Company's common stock at an exercise
price of $4.75 per share. The options expire five years from the date of
grant. Granted options vest immediately. Expense for options granted is
determined based on fair value of stocks at the time of grant, the cost of
which, $82,684, is recognized in the Consolidated Statements of
Operations.
Stock options outstanding and exercisable as of December 31, 2005 are as
follows:
Weighted Average
Number Exercise
of Shares Price
----------- ----------------
As of March 31, 2005 60,000 $ 4.00
Granted 820,783 4.75
Exercised - -
Expired - -
------- ------
As of December 31, 2005 880,783 $ 4.70
======= ======
Additional information regarding outstanding options as of December 31,
2005 is as follows:
Options Outstanding Options Exercisable
------------------------------------------------------------------------ -----------------------------------
Weighted
Weighted Average Weighted Average
Range of Average Contractual Exercise Price
Exercise Price Options Exercise Price Life (years) Options
------------------ ----------------- --------------- ----------------- ---------------- ------------------
$ 4.00 - $ 4.75 880,783 $4.70 5.00 880,783 $4.70
Warrants
On April 12, 2005, the Company granted warrants to placement agents in
connection with funds raised on the Company's behalf. These warrants grant
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. In October
2005, warrants to purchase 60,000 shares were exercised. These warrants
have been offset to the proceeds as a cost of capital. These warrants
expire on April 11, 2006.
On December 31, 2005, the Company granted warrants to placement agents in
connection with funds raised on the Company's behalf. These warrants grant
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. These
warrants expire on June 30, 2007.
16
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Warrants outstanding and exercisable as of December 31, 2005 are as
follows:
Weighted Average
Number Exercise
of Shares Price
----------- ----------------
As of March 31, 2005 1,084,341 $ 3.18
Granted 1,026,767 5.89
Exercised (753,534) 3.19
Expired (98,970) 2.50
---------- ------
As of December 31, 2005 1,258,604 $ 5.44
========== ======
Additional information regarding warrants outstanding as of December 31,
2005 is as follows:
Warrants Outstanding Warrants Exercisable
------------------------------------------------------------------------------------------------------------
Weighted
Weighted Average
Range of Average Contractual Weighted Average
Exercise Price Warrants Exercise Price Life (years) Warrants Exercise Price
------------------ ----------------- --------------- ---------------------------------- ------------------
$ 3.50 - $ 6.00 1,258,604 $5.44 1.89 1,258,604 $5.44
9. 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 December 31, 2005, totaled to $109,913. One of our shareholders is
an owner of Term Oil LLC.
During the three months ended September 30, 2005, the Company also
retained the services of several companies. Expenses for those services
rendered during the three months ended December 31, 2005, totaled to
$24,015. The suppliers which rendered services are affiliated with
shareholders of the Company.
10. 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. When the Company applies
for and is granted commercial production rights for the ADE Block, 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.
17
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
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. We must also comply with the terms of the work program associated
with the contract, which includes the drilling of at least six additional
new wells by July 9, 2007. The failure to make these 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, a lawsuit was filed in Florida naming the Company as one
of the defendants. The claim 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
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
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.
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 counsels to protect its
interests. In the opinion of the Company's management and legal counsels,
the resolution of those lawsuits will not have a material adverse effect
on Company's financial condition, results of operations or cash flows.
18
BMB MUNAI, INC.
(A DEVELOPMENT STAGE ENTITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In November 2005, we learned that the Company has been added as a
defendant in a lawsuit filed by Bank CenterCredit against Optima Systems,
LLP, KazOvoshProm Company, LLP and Intexi LLP and a number of other
parties. The lawsuit was filed in the Special Interregional Economic Court
of Almaty, Kazakhstan. Under Kazakh law, it is illegal for a party to
purchase stock of a bank with borrowed funds. The lawsuit alleges that
Optima Systems, KazOvoshProm Company and Intexi illegally purchased shares
of Bank CenterCredit in open market transactions in the Kazakhstan Stock
Market from a number of parties, including BMB Munai, with borrowed funds.
Bank CenterCredit has delivered a letter to the Company confirming that
its has been joined in this matter to comply with the procedural
requirements of Kazakh law. In the letter, the Bank acknowledges that the
Company acted as a party to the transaction as a good faith seller of
shares of the Bank. The Bank further acknowledges that the case has no
property or material nature as it relates to BMB Munai. The Bank also
guarantees to reimburse the Company for any expenses it may incur in
connection with the litigation.
In the opinion of management and the Company's counsel in Kazakhstan, the
resolution of this lawsuit will not have a material adverse effect on the
Company's financial condition, results of operations or cash flows.
11. FINANCIAL INSTRUMENTS
As of December 31, 2005 and March 31, 2005 marketable securities of
$670,905 and $788,921, respectively, are held in short term repurchase
agreements for securities issued by Kazakhstan banks and Kazakhstan
financial institutions. As of December 31, 2005 and March 31, 2005 cash
and cash equivalents include deposits in Kazakhstan banks in the amount
$1,268,381 and $9,090,276, respectively. As of December 31, 2005 and March
31, 2005 the Company made advance payments to Kazakhstan companies and
government bodies in the amount $3,793,658 and $4,301,342, respectively.
As of December 31, 2005 and March 31, 2005 trade accounts receivable of
$800,584 and $132,400, respectively, are with the Kazakhstan companies.
Restricted cash reflected in the long-term assets consists of $155,973
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.
12. SUBSEQUENT EVENTS
Subsequent to the quarter ended December 31, 2005, the Company entered
into a separation agreement with an employee of the Company where the
Company agreed, among other conditions, to issue to the employee 50,000
restricted common shares of the Company; and grant to the employee an
option to purchase up to 100,000 shares of the Company's restricted common
stock at $7.40 per share expiring five years from the date of grant.
Subsequent to the quarter ended December 31, 2005, a placement agent
exercised stock warrants for 83,980 shares at the exercise price of $4.
19
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-QSB
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, 2005.
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 natural gas and oil, results for
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.
20
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."
We are currently in the development stage. We generate revenue, income
and cash flow by marketing crude oil from our oil and natural gas properties
produced during test production. We make significant capital expenditures in our
exploration and development activities that we anticipate will allow us to
increase and improve our ability to generate revenue. Our drilling strategy is
focused toward enhancing cash flows and increasing proved developed reserves by
drilling developmental wells within a proximity of existing wells, which we
believe decreases our likelihood of drilling a dry hole, while at the same time
increasing our current production and cash flow. As our cash flow and proved
developed reserves grow, we will begin drilling exploratory wells to find new
reservoirs or extend known reservoirs. We believe this strategy will result in
growth of proved developed reserves, production and financial strength.
Industry and Economic Factors
We are a development stage company and have not yet generated
significant production or revenues from the development of our properties. To
date, we have relied primarily on funds raised through the sell of our equity
securities to fund operations. We currently use more cash in operations than we
generate. We believe, however, that we have now raised sufficient capital to
fund exploration and development of our properties to a point where the revenue
derived from our properties will be sufficient to meet our future operating
needs.
In managing our business, we must deal with many factors inherent in
our industry. First and foremost is the fluctuation of oil and gas prices.
Historically, oil and gas markets have been cyclical and volatile, with future
price movements that are difficult to predict. While our revenues are a function
of both production and prices, wide swings in commodity prices will likely have
the greatest impact on our results of operations. We have no way to predict
those prices or to control them without losing some advantage of the upside
potential. The oil and gas industry has continued to experience high commodity
prices in 2005 and 2006, which has positively impacted the entire industry as
well as our Company.
21
Our operations entail significant complexities. Advanced technologies
requiring highly trained personnel are utilized in both exploration and
development. Even when the technology is properly used, we may still not know
conclusively if hydrocarbons will be present or the rate at which they may be
produced. Despite our best efforts to limit risk, exploration is a high-risk
activity, often times resulting in no commercially productive reserves being
discovered. Moreover, costs associated with operating within our industry are
substantial.
Our business, as with other extractive industries, is a depleting one
in which each oil and gas equivalent produced must be replaced or our business,
and a critical source of future liquidity, will shrink.
The oil and gas industry is highly competitive. Competition in
Kazakhstan and Central Asia includes other junior hydrocarbons exploration
companies, mid-size producers and major exploration and production companies.
Many of our competitors have greater financial resources and larger technical
staff than we have.
We are subject to various levels of government regulation and control,
both in Kazakhstan and the United States of America. In particular, our
activities are subject to stringent operational and environmental regulations.
These regulations affect our costs of planning, designing, drilling, installing
and operating oil and gas wells and related facilities. These regulations may
become more demanding in the future.
Recent Developments
During our third fiscal quarter 2006 we continued testing and
development works on Dolinnoe-1, Dolinnoe- 2, Dolinnoe- 3, Emir -1, Aksaz -1 and
Aksaz -4 wells.
We performed mini formation fracturing by hydrochloric acid at the
Dolinnoe-2 well during the quarter. In January 2006 we undertook perforating
works to join certain oil bearing horizons within the well.
While testing various intervals of the Dolinnoe-3 well, we determined
that the current interval from which solid production rates occurred is 24
meters , but only 17 meters were perforated. After perforation of the 17meters a
blowout occurred and we could not run in hole with the pipe. As a result we
killed the well by squeezing mud into the formation to avoid an open flush.
While cleaning out the bottomhole zone, barite and carbomix contained in the
drilling mud had settled at the hole bottom due to high formation temperature.
This sediment caused the oil well tubing to become stuck. Mud cuttings samples
indicated that carbomix accounted for approximately 30% of the mud cuttings. We
conducted acid treatment for dissolution of the settlements. Subsequent walking
up and down operations were successful and we have been successful at cleaning
out the bottomhole zone. After perforation we will lower tubing and start
testing again in order to determine the proper rate. In the course of continued
testing and development works on the Dolinnoe-3 well we will also continue to
undertake a complex of geophysical studies aimed at identifying additional
productive intervals.
22
During our third fiscal quarter, we also continued testing and
development operations at the Emir -1 well. Based on logging, four prospective
objects were identified and perforated and all 4 objects were tested. This well
is awaiting a service rig to perform workover.
During our third fiscal quarter we performed well logging in the
Aksaz-4 well to determine the source of annular water flow. Based on geophysical
data there was water inflow from the 4,313 to 4,315 intervals through
perforation due to poor cement bonding. As we did not expect water formation in
these intervals, we are currently analyzing the water formation, including the
isolation of the water-bearing horizon, installation of a cement plug,
performing services on determination of bottom hole and undertaking perforation
works.
During our third fiscal quarter we completed construction of drilling
sites and approach roads to the Kariman - 1 and Dolinnoe - 6 wells. During the
period we also paved 800 meters of delivery line to the Aksaz group unit.
In December 2005 the Government assigned our Company an export quota as
a result of our previous application. We intend to continue to apply for export
quotas in the future. The export quota we were granted allows us to export up to
29,200 barrels of oil during January 2006, to the world markets and to realize
world market prices on those barrels of oil. As the world market price is
currently considerably higher than the domestic market price, we anticipate this
will result in us realizing greater revenue per barrel of oil for these barrels
of oil as compared to the oil we sell in the Kazakhstan domestic market.
Outlook
During the third fiscal quarter of 2006 we raised an additional
$52,189,207 through a private placement of our common stock to qualified
institutional buyers in the United States and to non-U.S. persons. These funds
will be used to continue our exploration and development activities. During the
2006 calendar year, we plan to drill a total of four exploratory and
developmental wells in the Extended Territory. We are also planning to drill an
additional four developmental wells in the Dolinnoe oilfield of the ADE Block.
Development activities under our present business plan also include
re-processing and reinterpretation of seismic data and development of the
oilfield by constructing additional electric lines and oil collection units,
test and research operations at the Extended Territory.
Additionally during the 2006 calendar year we plan to conduct
horizontal and directional drilling at two of our existing wells to increase
rate of production and revenue.
During the next calendar year, we also will continue workover and
research operations on the existing six wells in the ADE Block.
Our outlook as described above is subject to change based upon factors
that include, but are not limited to, drilling results, availability of drilling
23
rigs, commodity prices, access to capital and other factors referred to in
"Forward Looking Statements."
We have and will continue to seek to increase our proven reserves
through continued exploration and development of our properties, as well as the
acquisition of other properties with exploration and production potential.
For us to operate profitability and grow in the future we need to
significantly increase production. Our revenue, profitability and future growth
depend substantially on factors beyond our control, such as economic, political
and potential regulatory and competition from other sources of energy. Oil and
natural gas prices historically have been volatile and may fluctuate widely in
the future. Sustained periods of low prices for oil or natural gas could
materially and adversely affect our financial position, results of operations,
the quantities of oil and natural gas reserves that we can economically produce,
the markets into which we can sell our oil and our access to additional capital.
In a worst case scenario, future drilling operations could be largely
unsuccessful, oil and gas prices could sharply decline, we could fail to gain
access to the world oil markets and/or other factors beyond our control could
cause us to modify or substantially curtail our exploration and development
plans, which could negatively impact our earnings, cash flow and most likely the
trading price of our securities.
Results of Operations
Three months ended December 31, 2005, compared to the three months
ended December 31, 2004
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 December 31, 2005 and the three months ended December 31, 2004.
Three months ended
December 31, 2005
to the three months ended
December 31, 2004
-------------------------------
For the three For the three $ %
months ended months ended Increase Increase
December 31, 2005 December 31, 2004 (Decrease) (Decrease)
------------------ ------------------ -------------- -------------
Production volumes:
Natural gas (Mcf) - - - -
Natural gas liquids (Bbls) - - - -
Oil and condensate (Bbls) 92,342 14,426 77,916 540%
Barrels of Oil equivalent (BOE) - - - -
Average Sales Price
Natural gas ($ per Mcf) - - - -
Natural gas liquids ($ per Bbl) - - - -
24
Oil and condensate ($ per Bbl) $ 22.08 $ 13.67 $ 8.41 62%
Barrels of Oil equivalent
($ per BOE) - - - -
Operating Revenue:
Natural gas - - - -
Natural gas liquids - - - -
Oil and condensate $ 2,058,792 $ 55,904 $ 2,002,888 3,583%
Gain on hedging and derivatives(1) - - - -
------------------ ------------------ -------------- -------------
(1) We did not engage in hedging transactions, including derivatives during the
three months ended December 31, 2005, or the three months ended December 31,
2004.
Revenues. We generate revenue under our contract from the sale of oil
and natural gas recovered during test production. During the three months ended
December 31, 2005 and 2004, 100% of our revenue was generated from the sale of
crude oil. During the three months ended December 31, 2005 we realized revenue
from oil sales of $2,058,792 compared to $55,904 during the three months ended
December 31, 2004. This increase in revenues is primarily the result of several
factors. During the three months ended December 31, 2005, the number of
producing wells had doubled from three to six compared to the three months ended
December 31, 2004. Moreover, one of the new wells, Dolinnoe-3, constituted about
76% of total production during the three months ended December 31, 2005, which
resulted in an average monthly production rate increase of 274% compared to the
average monthly production rate of wells during the three months ended December
31, 2004. Additionally oil sale prices were approximately 62% higher during the
three months ended December 31, 2005 compared to three months ended December 31,
2004. We anticipate production will continue to increase in the upcoming fiscal
quarters as a result of the drilling of new wells. Also, during the third
quarter 2005 we were granted an export quota to export and sell up to 29,200
barrels of oil. We anticipate this will lead to an increase in revenue from oil
sales in January 2006 because the price per barrel of oil in the world markets
is higher than the price per barrel of oil in domestic market in Kazakhstan,
where we have been selling our oil.
Costs and Operating Expenses
The following table presents details of our expenses for the three
months ended December 31, 2005 and 2004:
For the three months ended For the three months ended
December 31, 2005 December 31, 2004
-------------------------- --------------------------
Expenses:
Oil and gas operating(1) $ 242,582 $ 83,933
General and administrative 1,497,515 1,239,050
Depletion 145,078 -
Amortization and depreciation 35,316 21,917
----------- -----------
Total $ 1,920,491 $ 1,344,900
=========== ===========
Expenses ($ per BOE):
Oil and gas operating(1) 2.60 20.52
Depreciation, depletion and
amortization(2) 1.94 5.36
25
(1) Includes transportation cost, production cost and ad valorem taxes.
(2) Represents depreciation, depletion and amortization of oil and gas
properties only.
Oil and Gas Operating Expenses. During the three months ended December
31, 2005 we incurred $242,582 in oil and gas operating expenses compared to
$83,933 during the three months ended December 31, 2004. Oil and gas operating
expenses increased due to increased production. During the third fiscal quarter
2006 production volume increased by 77,916 barrels or 540% compared to the three
months ended December 31, 2004. Such increase led to hiring more production and
maintenance personnel which resulted in payroll increases of 238% during the
third quarter 2006 compared to the third quarter 2005. We also incurred
transportation expenses of $155,966 during the three months ended December 31,
2005 compared to $59,563 during the three months ended December 31, 2004.
Transportation expenses during the three months ended December 31, 2005
increased by 162% as a direct result of significant increase in production
during the three months ended December 31, 2005 compared to the three months
ended December 31, 2004. We transport oil from our fields to the storage
facility we use. As a result of the increased production, we rented more oil
tank trucks, used more gasoline, enlarged the tank field and incurred more
overhead expenses. We expect oil and gas operating expense continue to increase
in the upcoming fiscal quarter as revenue continues to increase.
General and Administrative Expenses. General and administrative
expenses during the three months ended December 31, 2005 were $1,497,515
compared to $1,239,050 during the three months ended December 31, 2004. This
represents a 21% increase in general and administrative expenses. This increase
is attributable to a 92% increase in payroll and other compensation to
employees. This increase is largely the result of hiring personnel to operate
our business, as well as travel expenses. While we anticipate general and
administrative expenses will continue to increase, we expect increases in
revenue to outpace increases in general and administrative expenses in upcoming
quarters.
Gain from Operations. During the three months ended December 31, 2005
we realized income from operations of $138,301 compared to a loss from
operations of $1,288,996 during the three months ended December 31, 2004. As
described above, this change from a loss to net income is directly attributable
to the 3,583% increase in revenue we realized during the three months ended
December 31, 2005 compared to the comparable period 2004.
Other Income. During the three months ended December 31, 2005 we
realized total other income of $114,708 compared to total other income of
$451,333 for the three months ended December 31, 2004. This decrease in other
income is largely attributable to a decrease in foreign exchange gain in the
amount of $270,889 resulting from fluctuations in foreign currency rates against
the U.S dollars and decrease in our interest income in the amount of $89,983.
This decrease was partially offset by an increase in unrealized gain on
marketable securities of $58,063.
26
Net Income/Loss. During the three months ended December 31, 2005 we
realized a net income of $253,009 compared to a net loss of $844,413 for the
three months ended December 31, 2004. As stated above, this change from a net
loss to net income is the direct result of a 3,583% increase in revenue, as we
produced sufficient oil and gas to offset our expenses during the three months
ended December 31, 2005.
Nine months ended December 31, 2005, compared to the nine months ended
December 31, 2004
Revenue and Production
The following table summarizes production volumes, average sales prices
and operating revenue for our oil and natural gas operations for the nine months
ended December 31, 2005 and the nine months ended December 31, 2004.
Nine months ended
December 31, 2005
to the nine months ended
December 31, 2004
For the nine For the nine -------------------------------
Months ended months ended $ %
December 31, 2005 December 31, 2004 Increase Increase
------------------ ------------------ -------------- -------------
Production volumes:
Natural gas (Mcf) - - - -
Natural gas liquids (Bbls) - - - -
Oil and condensate (Bbls) 204,163 41,783 162,380 389%
Barrels of Oil equivalent (BOE) - - - -
Average Sales Price
Natural gas ($ per Mcf) - - - -
Natural gas liquids ($ per Bbl) - - - -
Oil and condensate ($ per Bbl) $ 21.31 $ 13.33 $ 7.98 60%
Barrels of Oil equivalent
($ per BOE) - - - -
Operating Revenue:
Natural gas - - - -
Natural gas liquids - - - -
Oil and condensate $ 4,106,765 $ 347,891 $ 3,758,874 1,080%
Gain on hedging and derivatives(1) - - - -
------------------ ------------------ -------------- -------------
(1) We did not engage in hedging transactions, including derivatives during the
nine months ended December 31, 2005, or the nine months ended December 31,
2004.
Revenues. During the nine months ended December 31, 2005 we realized
revenue from oil and gas sales of $4,106,765 compared to $347,891 during the
nine months ended December 31, 2004. Our revenue for the nine months ended
December 31, 2005 increased by 1,080% compared to the revenue for the nine
months ended December 31, 2004. This increase in revenues is primarily the
result of two factors. First, we performed works related to the perforation of a
27
productive stratum which led to a significant flow of oil and gas at Dolinnoe-3
well. As a result during the nine months ended December 31, 2005 oil production
increased by about 389% comparing to total production during the nine months
ended December 31, 2004. Second, oil prices in the domestic market in Kazakhstan
increased 60% during the nine months ended December 31, 2005 compared to nine
months ended December 31, 2004. We anticipate production will continue to
increase in upcoming quarters. Also, during the third fiscal quarter 2005 we
were granted an export quota from the Government that allows us to export up to
29,200 barrels of oil during January 2006. We anticipate this will lead to an
revenue from oil sales during our fourth fiscal quarter of 2006 because the
world market price of oil is considerably higher than the domestic market price
in Kazakhstan.
Costs and Operating Expenses
The following table presents details of our expenses for the nine
months ended December 31, 2005 and 2004:
For the nine months ended For the nine months ended
December 31, 2005 December 31, 2004
------------------------- -------------------------
Expenses:
Oil and gas operating(1) $ 509,289 $ 168,181
General and administrative 7,379,267 2,634,332
Depletion 313,435 -
Amortization and depreciation 100,122 49,103
----------- ===========
Total $ 8,302,113 $ 2,851,616
=========== ===========
Expenses ($ per BOE):
Oil and gas operating(1) 2.64 6.45
Depreciation, depletion and
amortization(2) 2.15 1.88
(1) Includes transportation cost, production cost and ad valorem taxes.
(2) Represents depreciation, depletion and amortization of oil and gas
properties only.
Oil and Gas Operating Expenses. During the nine months ended December
31, 2005, we incurred $509,289 in oil and gas operating expenses compared to
$168,181 during the nine months ended December 31, 2004. Oil and gas operating
expenses increased due to increased production. During the nine months ended
December 31, 2005 production volume increased by 162,380 barrels or 389%
compared to the nine months ended December 31, 2004. Such increase led to hiring
more production and maintenance personnel and a corresponding payroll increase
during the nine months ended December 31, 2005 of 250% compared to the nine
months ended December 31, 2004. Increased production also led to an increase in
the royalty paid to the Government of 216% during the nine months ended December
31, 2005 compared to nine months ended December 31, 2004. As discussed above,
another result of increased production was a $250,231 or 303% increase in
transportation expenses during the nine months ended December 31, 2005 compared
to the nine months ended December 31, 2004. We expect oil and gas operating
expense continue to increase in the upcoming fiscal quarter as revenue continues
to increase.
28
General and Administrative Expenses. General and administrative
expenses during the nine months ended December 31, 2005 were $7,379,267 compared
to $2,634,332 during the nine months ended December 31, 2004. This represents a
180% increase in general and administrative expenses. This significant increase
is attributable to a 481% increase in payroll and other compensation and a 46%
increase in professional services fees. During our second fiscal quarter 2006 we
granted restricted stock and stock options to directors, officers and key
employees of the Company. 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 $4,049,340. Additionally during the nine months ended December 31,
2005 we hired more administrative personnel to operate our business, using
services of technicians, engineers, accountants and lawyers, as well as
incurring other general corporate expenses. We do not expect general and
administrative expenses to increase at such a significant rate in the upcoming
periods. We anticipate increases in revenue will outpace the increase in general
and administrative expenses in upcoming quarters.
Loss from Operations. During the nine months ended December 31, 2005 we
realized a loss from operations of $4,195,348 compared to a loss from operations
of $2,503,725 during the nine months ended December 31, 2004. We realized a
1,080% increase in revenue during the nine months ended December 31, 2005
compared to the comparable period 2004. This increase was offset by a 106%
increase in oil and gas operating expenses and a 180% increase in general and
administrative expenses, which resulted in a 68% increase in loss from
operations during the period ended December 31, 2005 compared to the period
ended December 31, 2004. Until such time as expenses exceed revenue from oil and
gas sales we will continue to generate operating losses. At this time, we
believe current production rates and current oil prices are such that we are now
able to generate sufficient revenue from oil sales to offset our expenses. If,
however, current production levels or oil prices were to decrease, we may be
unable to offset all of our operating expenses with revenue from production and
could experience additional losses from operations.
Other Income. During the nine months ended December 31, 2005 we
realized total other income of $200,582 compared to total other income of
$416,406 for the nine months ended December 31, 2004. This decrease in other
income is largely attributable to decrease in foreign exchange gain in the
amount of $597,711 resulting from fluctuations in foreign currency rates against
the U.S. dollar and a decrease in interest income of $74,060 that was partially
offset by the net increase in realized and unrealized gains and losses on
marketable securities of $465,878.
Net Loss. During the nine months ended December 31, 2005 we realized a
net loss of $3,994,766 compared to a net loss of $2,094,069 for the nine months
ended December 31, 2004. Notwithstanding the significant increase in revenue
resulting from increased oil and gas production during the period ended December
31, 2005 net loss increased significantly. This significant increase in net loss
is largely attributable to 180% increase in general and administrative expenses.
29
During the nine months ended December 31, 2005 our general and administrative
expenses increased by $4,744,935 compared to the nine months ended December 31,
2004. While expenses have risen significantly in past quarters, we do not expect
such significant expense increases in upcoming quarters. We also anticipate that
we will continue to realize significant increases in revenue as our production
levels continue to increase. Based on these expectations, we anticipate that we
will begin to realize net income in upcoming fiscal quarters.
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 December 31, 2005, we have raised $99,955,924 ($96,626,926 net) through
the sale of our common stock and proceeds from the issuance of convertible debt.
As of December 31, 2005, we had cash and cash equivalents of $54,293,874. We
anticipate our capital resources in the upcoming quarters will consist primarily
of revenue from the sale of oil and gas recovered during the production.
Our need for capital, in addition to funding our ongoing operations, is
primarily related to the exploration and development of our properties as
required under our contract, and the potential acquisition of additional oil and
gas properties. For the period from inception on May 6, 2003 through December
31, 2005, we have incurred capital expenditures of $55,577,220 for exploration,
development and acquisition activities including $19,075,000 non-cash
transaction for acquisition of the remaining 30% interest of its minority
interest partner in Emir Oil LLP in exchange for 3,500,000 shares of restricted
Company common stock, $112,613 for capitalized depreciation related to support
equipment and facilities used in exploration and development activities and
$918,504 non-cash transactions for accrual of asset retirement obligation.
Cash Flows
During the nine months ended December 31, 2005 cash was primarily used
to fund exploration and development expenditures. During the nine months ended
December 31, 2005 we had a net increase in cash and cash equivalents of
$44,304,242 as a result of the last private placement in December 2005 where we
raised $52,189,207 ,net of offering expenses, through the sale of our common
stock. See below for additional discussion and analysis of cash flow.
30
Nine months ended Nine months ended
December 31, 2005 December 31, 2004
----------------- -----------------
Net cash used in operating activities $ (2,987,292) $ (5,924,261)
Net cash used in investing activities $ (12,521,108) $ (12,450,730)
Net cash provided by financing activities $ 59,812,642 $ 17,311,906
------------- -------------
NET INCREASE / (DECREASE) IN CASH AND
CASH EQUIVALENTS $ 44,304,242 $ (1,063,085)
============= =============
We continually evaluate our capital needs and compare them to our
capital resources. Our budgeted capital expenditures for the upcoming fiscal
year are about $60 million to $70 million for exploration, development,
production and acquisitions. We believe our export quota and favorable world
market prices will let allow to generate sufficient oil and gas revenues to
finance the gap of $10 million to $20 million required for our planned
exploration, development, production and acquisitions. Through the nine months
ended December 31, 2005, we have spent $12 million in exploration, development
and production. We have funded these expenditures primarily from cash on hand
and oil sales revenue. We anticipate significant increase of our revenue during
the upcoming quarter. As discussed herein, in December 2005 we were granted an
export quota which would allow us to sell up to 29,200 barrels of crude oil
during January 2006 in the world markets and will allow us to realize world
market price which is considerable higher than the domestic market price in
Kazakhstan.
The minimum level of capital expenditures on our properties is dictated
by the contract and the work program set forth in the contract. The amount of
funds we devote to any particular activity in excess of the minimum required
capital expenditures may increase or decrease significantly depending on
available opportunities, cash flows and development results, among others.
We were successful in obtaining additional funding and we plan to
develop existing wells and infrastructure, construct new wells and increase our
oil reserves which will let us generate more revenue to finance our further
operations.
We hold marketable securities consisting of short-term repurchase
agreements for securities issued by Kazakhstan banks and Kazakhstan financial
institutions. Additionally, 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.
31
Contractual Obligations and Contingencies
The following table lists our significant commitments at December 31,
2005:
Payments Due By Period
----------------------------------------------------------------------
Contractual obligations Less than 1 After 5
Total year 1-3 years 4-5 years years
----------- ---------- ----------- ----------- ----------
Capital Expenditure
Commitment(1) $10,500,000 $6,000,000 $ 4,500,000 - -
Due to the Government of
the Republic of Kazakhstan(2)(3) $ 5,994,200 - $ 5,994,200 - -
Due to Reservoir Consultants $ 500,000 $ 278,000 $ 222,000 - -
Liquidation Fund $ 918,504 - $ 918,504 - -
Office Lease $ 89,380 $ 82,505 $ 6,875 -
----------- ---------- ----------- ----------- ----------
Total $18,002,084 $6,360,505 $11,641,579 - -
=========== ========== =========== =========== ==========
(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. Under the terms of the work program associated with the contract,
we are required to drill a total of six additional new wells by July 9, 2007. If
we fail to comply with the terms of the contract or the work program, 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, 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. We are 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. We anticipate that we will apply for
commercial production rights sometime during the first half of the 2007 calendar
year. Should we decide not to pursue a commercial production contract, we can
relinquish the ADE Block to the ROK in satisfaction of this obligation.
(3) As with the ADE Block, we will also be required to repay the ROK
its historical costs for access to and use of geological and geophysical data
gathered and infrastructure improvement previously made by the ROK within the
Extended Territory. We are presently negotiating the amount and terms of this
obligation with the ROK. This approximately $6 million obligation represents
only our repayment obligation with respect to the ADE Block, and not the
extended territory.
Off-Balance Sheet Financing Arrangements
As of December 31, 2005, we had no off-balance sheet financing
arrangements.
Recently Issued Accounting Pronouncements
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and
Error Corrections", a replacement of APB Opinion 20, "Accounting Changes" and
FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial
Statements." This Statement changes the requirements for the accounting for and
reporting of a change in accounting principle. APB Opinion 20 previously
required that most voluntary changes in accounting principle be recognized by
including in net income of the period of the change the cumulative effect of
32
changing to the new accounting principle. This statement requires retrospective
application to prior periods' financial statements of changes in accounting
principle, unless it is impracticable to determine either the period specific
effects or the cumulative effect of the change. This statement is effective for
accounting changes and corrections of errors made in fiscal periods that begin
after December 15, 2005. Management does not anticipate this statement will
impact the Company's consolidated financial position or consolidated results of
operations and cash flows.
Item 3. 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.
The Certifying Officers have also indicated that there were no
significant changes in our internal controls over financial reporting or other
factors that could significantly affect such controls subsequent to the date of
their evaluation, and there were no significant deficiencies and material
weaknesses.
Management, including our Certifying Officers, do not expect that our
disclosure controls or its internal controls will prevent all error and all
fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. In addition, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within a company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people or by management
override of the control. The design of any systems of controls is also based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions. Because of these inherent limitations in
a cost-effective control system, misstatements due to error or fraud may occur
and may not be detected.
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
33
and Alexandre Agaian, current or former BMB directors, as defendants. The
plaintiffs, Brian Savage, Thomas Sinclair and Sokol Holdings, Inc., alleged
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 of the Aksaz, Dolinnoe and Emir oil and gas
fields owned by Emir Oil, LLP. The parties have 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 Baisietov, 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 Toluesh 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 have moved for dismissal of the
amended complaint or for a stay pending arbitration in Kazakhstan. The parties
have had several telephone conferences with the magistrate judge hearing this
matter.
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.
In November 2005, we learned that the Company has been added as a
defendant in a lawsuit filed by Bank CenterCredit against Optima Systems, LLP,
KazOvoshProm Company, LLP and Intexi LLP and a number of other parties. The
34
lawsuit was filed in the Special Interregional Economic Court of Almaty,
Kazakhstan. Under Kazakh law, it is illegal for a party to purchase stock of a
bank with borrowed funds. The lawsuit alleges that Optima Systems, KazOvoshProm
Company and Intexi illegally purchased shares of Bank CenterCredit in open
market transactions in the Kazakhstan Stock Market from a number of parties,
including BMB Munai, with borrowed funds.
Bank CenterCredit has delivered a letter to us confirming that we have
been joined in this matter to comply with the procedural requirements of Kazakh
law. In the letter, the Bank acknowledges our Company acted as a party to the
transaction as a good faith seller of shares of the Bank. The Bank further
acknowledges that the case has no property or material nature as it relates to
BMB Munai. The Bank also guarantees to reimburse us for any expenses we may
incur in connection with the litigation.
In the opinion of management and the Company's counsel in Kazakhstan,
the resolution of this lawsuit will not have a material adverse effect on the
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 our management.
Item 2. Unregistered Sales of Equity Securities
In October 2005, Aton Securities Inc. exercised warrants granted in
July 2004 to purchase 309,454 common shares for $4 per share and warrants
granted in April 2005 to purchase 60,000 common shares for $5 per share, for an
aggregate purchase price of $1,537,816. The shares were issued without
registration under the Securities Act of 1933 in reliance on an exemption from
registration provided by Section 4(2) of the Securities Act of 1933. There was
no underwriter involved in these transactions.
On December 23, 2005, the Company completed a private placement of its
common shares to U.S. Qualified Institutional Buyers and non-U.S. investors for
$50,000,000. Additionally, the private placement included a 10% over allotment
option to the placement agent, Aton Securities, Inc., which was fully subscribed
for.
The Company received subscriptions for the following:
Date of Sale Number of Shares Price per Share Exemption Relied Upon
------------ ---------------- --------------- ---------------------
December 23, 2005 8,174,667 $6.00 Regulation S
December 23, 2005 992,000 $6.00 Regulation D
Total proceeds from the private placement were $55,000,002. From the
total proceeds, the Company paid the placement agent a cash fee totaling 5% of
the total proceeds raised, or $2,750,000. The Company is required to reimburse
the placement agent for expenses incurred up to $50,000. The Company also issued
warrants to the placement agent to purchase restricted common stock of the
35
Company equal to 10% of the total shares sold or 916,667 shares. The exercise
price of the warrants is $6.00 per share. The warrants are immediately
exercisable and expire on June 30, 2007. The placement agent is not an officer,
director or greater than 10% shareholder of the Company. None of the fees to be
paid or warrants granted to the placement agent will either directly or
indirectly be paid to any officer, director or greater than 10% shareholder of
the Company.
Investors in this offering were granted the right to request the
Company file a registration statement on their behalf registering for resale the
shares they purchased in this private placement. The Registration Rights
Agreement requires that at least 51% of the shares purchased in the private
placement request registration before the Company must undertake any efforts to
register the shares for resale. The investors in this private placement may not
request registration for at least 90 days from the closing of the private
placement.
As set forth above, the shares were issued without registration under
the Securities Act of 1933 in reliance upon exemptions from registration
pursuant to Rule 506 of Regulation D and Regulations S of the rules and
regulations promulgated by the Securities and Exchange Commission under the
Securities Act of 1933.
Sales Pursuant to Rule 506 of Regulation D
No general solicitation or general advertising was made in connection
with the sales of these shares. All investors purchasing shares in the offering
were provided with a confidential information memorandum containing the
information specified in paragraph (b)(2) of Rule 502. The Company believes that
all purchasers are purchasing for their own accounts and not with a view to
distribution. Each of the three entities purchasing shares in this offering have
represented that they are "qualified institutional buyers" as that term is
defined in Section (a) Rule 144A of the Securities Act of 1933 and offers and
sales made within the United States were made only to qualified institutional
buyers. All shares issued in connection with these sales will be restricted
stock, as defined in Rule 144(a)(3).
Sales Pursuant to Regulation S
All offers and sales were made to non-U.S. persons in offshore
transactions. No directed selling efforts were made in the United State by the
issuer, placement agent or any person acting on their behalf. The shares sold
are subject to the offering restrictions set forth in Rule 903(b)(3), including
a one-year distribution compliance period.
In January 2006, Credifinance Capital Corp. exercised warrants granted
in July 2004 to purchase 83,980 common shares for $4 per share for an aggregate
purchase price of $335,920. The shares were issued without registration pursuant
to Regulation S of the rules and regulations promulgated by the Securities and
Exchange Commission under the Securities Act of 1933. There was no underwriter
involved in this transaction.
36
During January 2006, the Company entered into a separation agreement
with its former CFO, Anuar Kulmagambetov, to issue Mr. Kulmagambetov 50,000
restricted common shares of the Company; and an option to purchase up to 100,000
shares of the Company's restricted common stock at $7.40 per share expiring five
years from the date of grant. The shares an the option were issued without
registration pursuant to Regulation S of the rules and regulations promulgated
by the Securities and Exchange Commission under the Securities Act of 1933.
Item 4. Submission of Matters to a Vote of Security Holders
On October 28, 2005, the Company held its annual meeting of
stockholders. The total number of shares entitled to be voted at the meeting was
32,458,589. At the meeting the shareholders were asked to vote on the following
matter:
1) To elect three individuals as Class I Directors to our Board of
Directors. The following individuals, each of whom was previously
serving as a Director of the Company, were elected as Class I
Directors to serve for a term of three years and until their
respective successors shall be elected:
Class I Directors: For Abstain
------------------ --- -------
Georges Benarroch 20,839,569 -0-
Troy Nilson 20,839,569 -0-
Valery Tolkachev 20,839,569 -0-
The terms of Mr. Stephen Smoot, a Class II Director, and Mr. Boris
Cherdabayev, a Class III Director continued after the meeting.
No other items were submitted to a vote of our shareholders at the
meeting.
Item 5. Other Information
On January 26, 2006, Mr. Anuar Kulmagambetov resigned as the Chief
Financial Officer of the Company. Mr. Kulmagambetov's resignation was not the
result of any disagreement with the Company on any matter relating to our
operations, policies or practices.
As a result of Mr. Kulmagambetov's resignation, on January 26, 2006,
our board of directors appointed Sanat Kasymov to serve as our Chief Financial
Officer. Following is a brief description of the business background of Mr.
Kasymov:
Mr. Kasymov graduated from Istanbul University of Istanbul, Turkey in
1998 where he was awarded a Bachelors degree in Economics with an emphasis in
International Relations. In 2003, Mr. Kasymov passed the AICPA Uniform CPA
Examination. From April 1999 through December 2001 Mr. Kasymov was employed as
37
the Chief Specialist of the Corporate Relations Department of Demir Kazakhstan
Bank. From December of 2001 through 2004 Mr. Kasymov was employed at Deloitte &
Touche as a Senior Auditor where he became proficient in the application of both
international and national accounting (ISA/ US GAAS) and auditing standards
(IAS/ US GAAP). Since February 2005 Mr. Kasymov has been serving as the
Financial Manager of BMB Munai, Inc. Mr. Kasymov is not a director of any SEC
reporting company. Mr. Kasymov is 30 years old.
There are no family relationships among any of the Company's officers
or directors.
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: February 13, 2006 /s/ Boris Cherdabayev
-----------------------
Boris Cherdabayev,
Chief Executive Officer
Date: February 13, 2006 /s/ Sanat Kasymov
-----------------------
Sanat Kasymov,
Chief Financial Officer
38