NEWS RELEASE TRANSMITTED BY CCNMatthews
FOR: ZARGON OIL & GAS LTD.
TSX SYMBOL: ZAR
MARCH 23, 2004 - 15:57 ET
Zargon Oil & Gas Ltd. 2003 Fourth Quarter Report
CALGARY, ALBERTA--(CCNMatthews - Mar 23, 2004) -
CORPORATE HIGHLIGHTS
Zargon reported strong fourth quarter results to close out this
record year. Fourth quarter 2003 revenue of $24.51 million and
cash flow from operations of $13.24 million ($0.72 per diluted
share) were significantly higher than the preceding third quarter
and the comparative 2002 fourth quarter results. Reflecting
higher per unit depletion and depreciation charges, fourth
quarter net earnings of $4.03 million ($0.22 per diluted share)
were slightly lower than the comparative quarters.
High oil and natural gas prices have powered financial results
throughout 2003 for both Zargon and the industry. Year-over-year
2003 natural gas prices received by Zargon averaged a remarkable
66 percent gain over the prior year. Oil prices received in both
years were historically high and increased six percent in 2003.
The price gains were bolstered by strong production volume
increases throughout the year. Fourth quarter 2003 production of
oil and liquids was 3,340 barrels per day, level with the
preceding quarter and 10 percent above the prior year fourth
quarter. Natural gas volumes increased strongly, 13 percent more
than the preceding quarter and 26 percent above the prior year
quarter to 28.08 million cubic feet per day for fourth quarter
2003. On an equivalent basis, fourth quarter volumes of 8,020
barrels of equivalent per day were seven percent and 19 percent
respectively above the preceding and the 2002 fourth quarter. Net
capital expenditures for the 2003 fourth quarter of $12.84
million were six percent above the preceding quarter and
significantly above the $8.03 million expended in the same prior
year period, reflecting continuation of the very active second
half 2003 field exploration program.
/T/
Three Months Year
Ended Ended
December 31, December 31,
(unaudited) Percent Percent
2003 2002 Change 2003 2002 Change
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FINANCIAL
Income and Investments
($ million)
Petroleum and
natural gas revenue 24.51 20.67 19 101.66 65.54 55
Cash flow from
operations 13.24 10.71 24 54.35 32.12 69
Net earnings 4.03 4.28 (6) 24.53 10.68 130
Net capital
expenditures 12.84 8.03 60 39.91 35.55 12
Per Common Share,
Diluted
Cash flow from
operations ($/share) 0.72 0.59 22 2.96 1.81 64
Net earnings
($/share) 0.22 0.24 (8) 1.33 0.60 122
Balance Sheet at
Period End
($ million)
Property and
equipment, net 161.91 141.01 15
Bank indebtedness 6.98 25.28 (72)
Shareholders'
equity 112.59 86.60 30
Shares Outstanding
at Period End
(million) 17.99 17.64 2
Three Months Year
Ended Ended
December 31, December 31,
(unaudited) Percent Percent
2003 2002 Change 2003 2002 Change
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OPERATIONS
Average Daily
Production
Oil and liquids
(bbl/d) 3,340 3,043 10 3,287 2,968 11
Natural gas
(mmcf/d) 28.08 22.26 26 24.95 20.29 23
Equivalent
(boe/d) 8,020 6,753 19 7,446 6,349 17
Equivalent
per million
shares (boe/d) 448 383 17 418 368 14
Average Selling
Price (before
hedges)
Oil and
liquids ($/bbl) 32.91 35.79 (8) 36.66 34.45 6
Natural
gas ($/mcf) 5.57 5.20 7 6.33 3.81 66
Wells Drilled, Net 16.1 17.4 (7) 38.6 31.6 22
Undeveloped Land
at Period End
(thousand net acres) 398 331 20
Note: The calculation of barrels of equivalent (boe) is based on the
conversion ratio that six thousand cubic feet of natural gas is
equivalent to one barrel of oil. Average daily production per million
shares uses the weighted average number of shares for the period.
/T/
For calendar 2003, revenue of $101.66 million, cash flow from
operations of $54.35 million ($2.96 per diluted share) and net
earnings of $24.53 million ($1.33 per diluted share) each set
all-time records and showed increases of 55, 69, and 130 percent,
respectively over 2002. Net capital expenditures for the twelve
months of 2003 totalled $39.91 million with $37.30 million
allocated to field related activities, increases of 12 percent in
total and 56 percent in field expenditures over the prior year.
The material expansion in fieldwork in 2003 took place largely in
the third and fourth quarters when 27.6 net wells were drilled in
a very active exploration program. Purchase of the Truro Unit in
North Dakota was the only sizeable acquisition made in 2003
(second quarter) and its cost was largely offset by non-core
dispositions made at opportunistic prices in the same quarter.
Over the year, Zargon increased its undeveloped land base by 20
percent at a cost of $6.98 million, shot or acquired seismic at a
cost of $5.69 million, drilled and completed 38.6 net wells for
$17.30 million, added new facilities and tie-ins for $7.33
million and made net property acquisitions of $2.61 million.
These expenditures were internally funded by a combination of
very strong cash flow and non-core dispositions that also allowed
the reduction of debt net of working capital by $15.65 million to
$13.09 million at December 31, 2003.
PRODUCTION
Natural gas production volumes showed good growth throughout 2003
and averaged 28.08 million cubic feet per day in fourth quarter
2003, a 13 percent improvement from the preceding quarter and a
26 percent increase over the 22.26 million cubic feet per day
reported in the 2002 fourth quarter. Zargon's natural gas growth
in 2003 has come from successful exploration initiatives in West
Central Alberta with substantial new volumes coming from the
Highvale, Pembina and Peace River Arch properties. During the
third quarter, a significant natural gas producer was completed
and tied-in at the Peace River Arch Progress property with
sustainable net production of three million cubic feet per day.
Since January 2002, Zargon has grown its West Central Alberta
undeveloped lands from 38 thousand net acres to 174 thousand net
acres and West Central Alberta natural gas production volumes
have grown commensurately from two million cubic feet per day to
the fourth quarter 2003 rate of 10.45 million cubic feet per day.
During this time East Central Alberta natural gas production
volumes, which include our key Jarrow property, have been
maintained at steady rates with a modest maintenance-drilling
program.
Production of oil and liquids averaged 3,340 barrels per day in
fourth quarter 2003, level with the preceding quarter and 10
percent higher than the prior year fourth quarter. Zargon's oil
and liquids production is founded on the key Williston Basin
(Southeast Saskatchewan and North Dakota) long-life,
shallow-decline properties. Production growth is derived from
exploitation and enhancement activities plus acquisitions of
complementary exploitable properties. An enhanced Haas Unit
waterflood program and a Truro Unit property acquisition, both in
North Dakota, were the source of the majority of this year's oil
production growth.
EXPLORATION AND EXPLOITATION
Zargon has based its growth on the complementary strategies of
exploring for natural gas reserves and exploiting existing oil
reservoirs. The key input resource for our natural gas
exploration program is undeveloped land, and through aggressive
activity at Crown land sales over recent years, Zargon has built
a 398 thousand net acre undeveloped land inventory by year-end
2003.
An expanded drilling program has accompanied this growing
undeveloped land inventory. After a slow beginning in the first
half of the year when only 11.0 net wells were drilled, 11.5 net
wells were drilled in the third quarter and 16.1 net wells were
drilled in the fourth quarter. For the year a total of 38.6 net
wells were drilled with an 84 percent success ratio resulting in
24.6 net natural gas wells, 8.0 net oil wells and 6.0 net dry
holes. During the year, Zargon continued to focus on natural gas
exploration, with 76 percent of the 2003 drilling classified as
exploration wells, and over 70 percent of the program targeting
natural gas prospects.
The fourth quarter program by itself delivered 9.1 net natural
gas wells, 4.0 net oil wells and 3.0 net dry holes for an 81
percent success ratio. The wells included 4.1 net natural gas
wells at the West Central Alberta Pembina property, 2.0 net
natural gas wells and 1.0 net gassy oil well on the Peace River
Arch property, and 3.0 net natural gas wells at the East Central
Alberta Jarrow and Hamilton Lake properties. Three net oil
exploitation wells were drilled at the Williston Basin properties
of Haas, North Dakota and Pinto and Frys in Southeast
Saskatchewan.
The most interesting result from the fourth quarter drilling
program came from the discovery of two new pools at the Peace
River Arch property. At Hamelin Creek a Dunvegan/Gething natural
gas well is scheduled to be tied-in during the 2004 second
quarter at rates exceeding one million cubic feet per day. The
current geological mapping suggests that as many as three
additional Dunvegan gas wells may be drilled this year on the
Hamelin Creek land block. At Progress, a fourth quarter new pool
Triassic gassy oil well will also be tied-in to area facilities
in the second quarter. Follow-up drilling on this project is
planned later this summer.
Since January 2003, Zargon has implemented oil reservoir
waterflood initiation or enhancement projects at West Frys,
Weyburn (Halbrite) and Weyburn (Elswick) in Saskatchewan and at
Taber, Alberta. Once the oil reservoirs are re-pressurized, our
exploitation programs proceed with 3D seismic reservoir
characterization and then ultimately horizontal drilling. The
Haas, North Dakota waterflood enhancement program was initiated
in late 2002 and, as the reservoir was re-pressured, production
rates increased by 35 percent. A 3D seismic survey was shot in
summer 2003 and just prior to year-end our first Haas horizontal
exploitation well was drilled. Further horizontal drilling is
planned on the Haas property this spring. In the 2003 third
quarter, four other 3D seismic shoots were completed in the
Williston Basin that will lead over time to numerous horizontal
exploitation wells. Oil reservoir analysis and exploitation
programs form an important part of Zargon's growth strategy and,
over the years, have provided steady growth from a portfolio of
long-life shallow-decline properties.
Zargon has an active drilling program underway in the 2004 first
quarter with a total of 12 wells planned to be drilled prior to
spring break-up. The program includes one horizontal well in
Southeast Saskatchewan and six wells at the East Central Alberta
properties of Jarrow and Hamilton Lake that are designed to
maintain the area's current production levels. Five wells will be
drilled in the West Central Alberta properties, with three wells
located at Pembina, and one well scheduled for each of the
Highvale and Peace River Arch properties.
Following spring break-up, a higher-risk, higher-reward program
is planned with five Peace River exploration natural gas
locations and four Williston Basin (Southeast Saskatchewan and
North Dakota) exploitation oil wells. Zargon has also agreed to
drill a minimum of two wells in the second quarter, and possibly
three additional wells this fall, on a large land block located
on the Blackfeet Indian Reservation in the northern portion of
the state of Montana. Although located several hundred miles
apart, we view that the Blackfeet and Pembina properties have
many similarities in terms of their shallow depth, low-pressure
natural gas shows and completion operations. With the drilling of
five wells, Zargon has the opportunity to earn 29 thousand net
undeveloped acres of natural gas prospective land that could lead
to a sizeable natural gas development project in subsequent
years.
Capital expenditures throughout the remainder of the year will
continue to focus on growing through exploration our West Central
Alberta natural gas volumes, maintaining steady East Central
Alberta natural gas production, while continuing to efficiently
exploit our large Williston Basin oil development and waterflood
project inventory.
ACQUISITIONS / DISPOSITIONS
The largest property acquisition made in 2003 was the $4.95
million Cdn. purchase of a 92.5 percent interest in the Truro
Unit in Renville County, North Dakota. Property acquisitions in
2003 totalled $7.83 million and were largely offset by $5.22
million realized through the sale of non-core, high-cost
properties as Zargon took advantage of a strong property market.
As an additional benefit, these dispositions in conjunction with
$3.13 million of similar 2002 dispositions have contributed to
Zargon's improving trend in per unit operating costs.
GUIDANCE(a)
Last May 2003, Zargon provided 2003 year-end production guidance
at 3,600 barrels of oil per day and 26.5 million cubic feet of
natural gas per day, for a combined rate of 8,017 barrels of
equivalent per day. Fourth quarter rates of 3,340 barrels per
day, 28.08 million cubic feet per day and 8,020 barrels of
equivalent per day met the year-end guidance targets for the
entire quarter, although the actual natural gas volume weighting
was higher than forecast.
Current oil production remains substantially unchanged from the
fourth quarter rate of 3,340 barrels per day. Year-end horizontal
drilling of two wells at Frys, Saskatchewan and at Haas, North
Dakota have offset declines, and a new horizontal well at Forget,
Saskatchewan promises to be a good producer. Substantial gains
will have to come from a four well Williston Basin exploitation
program (two vertical and two horizontal) that is scheduled
immediately after spring break-up.
First quarter 2004 natural gas production has averaged at levels
just under the 28.08 million cubic feet per day reported for the
2003 fourth quarter. Immediately following spring break-up, new
production from the tie-ins of first quarter 2004 Jarrow and
Pembina drilling successes and the tie-in of last year's two new
Peace River Arch discoveries (Hamelin Creek - Gething and
Dunvegan natural gas; Progress - Triassic gassy oil) should help
build the corporate natural gas rates towards the 30 million
cubic feet per day 2004 mid-year guidance level.
Zargon's 2004 capital program budget will be primarily sourced
from cash flow and is initially set at $45 million with the
drilling of 45 net wells. This budget is allocated $40 million to
exploration and development field activities and $5 million to
property acquisitions. The budget reflects our view that the
current property acquisition market is fully priced. Should value
added property or corporate acquisitions become available, our
unutilized bank lines will permit us to greatly expand the
acquisition component of our budget.
In November 2003, Zargon set mid-year 2004 production guidance
levels at 30 million cubic feet of natural gas per day and 3,750
barrels of oil per day, for a combined rate of 8,750 barrels of
equivalent per day, which would represent a 17 percent gain over
the 2003 average production rates. This guidance is based on a
$45 million 2004 capital budget with natural gas production gains
forecast to come from exploration-related growth in the West
Central Alberta exploration initiatives at the Peace River Arch,
Pembina and Highvale properties. Oil production gains are
projected from Williston Basin exploitation horizontal drilling,
but will also require augmentation by a small Williston Basin
property acquisition.
(a) Please see comments on "Forward Looking Statements" on the
last page of this report.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Management's discussion and analysis (MD&A) should be read in
conjunction with the unaudited interim consolidated financial
statements for the three months ended December 31, 2003 and the
audited consolidated financial statements and MD&A for the years
ended December 31, 2003 and 2002. In the MD&A, reserves and
production are commonly stated in barrels of equivalent (boe)
using a conversion of six thousand cubic feet of natural gas
being equal to one barrel of oil.
Non-GAAP Measurements: The MD&A contains the term "cash flow from
operations"("cash flow") which should not be considered an
alternative to, or more meaningful than, "cash flow from
operating activities" as determined in accordance with Canadian
GAAP as an indicator of the Company's financial performance.
Zargon's determination of cash flow from operations may not be
comparable to that reported by other companies. The
reconciliation between net earnings and cash flow from operations
can be found in the consolidated statements of cash flows in the
consolidated financial statements. The Company evaluates its
performance based on net earnings and cash flow from operations.
The Company considers cash flow from operations to be a key
measure as it demonstrates the Company's ability to generate the
cash necessary to repay debt and to fund future growth through
capital investment. Cash flow from operations per share is
calculated using the diluted weighted average number of shares
for the period.
FINANCIAL ANALYSIS
In the fourth quarter of 2003, Zargon reported continued gains in
petroleum and natural gas revenue and cash flow from operations.
Revenue for the 2003 fourth quarter of $24.51 million and cash
flow from operations of $13.24 million were three percent and
seven percent above the preceding quarter and 19 percent and 24
percent above the 2002 fourth quarter, respectively. Net earnings
of $4.03 million in fourth quarter 2003 while also historically
high, but due to a sharp increase in non-cash charges, were below
$4.51 million in the preceding quarter and $4.28 million in the
2002 fourth quarter. Commodity prices remained high and
production volumes showed substantial growth. While natural gas
pricing in the 2003 fourth quarter was little changed from the
preceding quarter, prices rose seven percent above the 2002
fourth quarter levels. Oil prices, while still historically high,
were ten percent below the preceding quarter and eight percent
below the 2002 fourth quarter levels.
Natural gas production increased to 28.08 million cubic feet per
day, showing gains of 13 percent over the preceding quarter and
26 percent over the 2002 fourth quarter. The volume gains came
from successful West Central Alberta gas exploration drilling
initiatives. Oil and liquids production jumped in the second
quarter of 2003 and then stayed flat over the balance of the year
so that fourth quarter volumes of 3,340 barrels per day were even
with the third quarter but 10 percent above the 2002 fourth
quarter levels. The oil gains in 2003 came from successful
Williston Basin exploitation drilling and the Truro Unit, North
Dakota property acquisition.
Zargon's commodity price risk management policy uses forward
sales, options, puts and costless collars for, on average, 20 to
30 percent of our net petroleum and natural gas production in
order to partially offset the effects of large price
fluctuations. As both Canadian oil and natural gas field prices
are closely correlated to US dollar denominated markets, Zargon
will also place US/Cdn. currency exchange hedges when considered
prudent. Because our hedging strategy is protective in nature and
is designed to guard the Company against extreme effects from
sudden falls in prices and revenues, upward price spikes tend to
produce overall losses. Thus the 2003 first quarter's extremely
high oil and natural gas prices brought about a net hedging loss
of $2.22 million through a number of fixed price swaps and
collars placed to ensure that a minimum level of cash flow would
be maintained. As prices moderated, hedging losses declined to
$0.47 million in the second quarter, $0.35 million in the third
quarter and changed to a gain of $0.17 million in the fourth
quarter. The currency exchange collar in place throughout 2003
was positive all year and provided an overall gain of $1.22
million. For the 2003 year, the hedging loss was $2.88 million
compared to a gain of $0.67 million in 2002, a year when natural
gas prices were much lower.
Royalties, inclusive of Alberta Royalty Tax Credit and
Saskatchewan Resource Surcharge, were $5.52 million for the
fourth quarter of 2003, a decrease of three percent from the
preceding quarter and an increase of 50 percent from $3.68
million in the 2002 fourth quarter. The increase over the prior
year quarter is due about 40 percent to a 19 percent gain in
revenue and about 60 percent to an increase in royalty rates to
22.5 percent of gross revenue from an adjusted 17.8 percent of
revenue in the 2002 quarter (20.6 percent for all of 2002). In
the second half of the current year, significant natural gas
production gains have come from high producing wells that incur a
higher royalty rate. For the 2003 year, royalties of $22.51
million were 67 percent higher than the 2002 year and royalty
rates were 22.1 percent of gross revenue in 2003 compared to 20.6
percent in 2002.
Production expenses were $4.65 million in the 2003 fourth
quarter, seven percent above the preceding quarter and two
percent higher than the prior year quarter. However, on a unit of
production basis, 2003 production expenses have improved
significantly, showing response to field cost containment
initiatives and an extended program to sell non-core, higher cost
properties. Fourth quarter 2003 production costs were $6.30 per
barrel of equivalent, down slightly from $6.32 in the preceding
quarter and well below $7.36 in the prior year's fourth quarter.
For the 2003 year, production costs were $6.33 per barrel of
equivalent, a six percent decrease from the 2002 annual rate of
$6.75 per barrel of equivalent.
/T/
Operating Netbacks
2003 2002
Year ended Oil and Natural Oil and Natural
December 31 Liquids Gas Liquids Gas
--------------------------------------------------------------------
($/bbl) ($/mcf) ($/bbl) ($/mcf)
Production revenue 36.66 6.33 34.45 3.81
Hedging (0.87) (0.20) (0.33) 0.14
Royalties (7.42) (1.49) (6.86) (0.82)
Production costs (8.95) (0.71) (9.72) (0.69)
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Operating netbacks 19.42 3.93 17.54 2.44
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/T/
General and administrative expenses rose to $1.01 million in the
fourth quarter of 2003, $0.14 million or 16 percent above the
preceding quarter and $0.33 million or 49 percent above the 2002
fourth quarter. These increases, which are an anomaly in a
reducing trend, were due in large part to increased bonus
accruals in 2003, reflecting the Company's very strong financial
results in 2003 in which the employees participated. On a unit of
production basis, general and administrative costs in the 2003
fourth quarter were $1.37 per barrel of equivalent compared to
$1.27 in the preceding quarter but for the 2003 year general and
administrative costs decreased 13 percent to $1.30 per barrel of
equivalent from $1.49 in 2002. The improvements in general and
administrative costs on a unit of production basis resulted from
increased production volumes, increased general and
administrative cost recoveries from expanded field capital
programs, and the disposition of a substantial number of small,
overhead-intensive properties.
Stock-based compensation of $0.26 million is recorded for the
first time in the 2003 fourth quarter income statement in
response to prospective adoption of a new CICA accounting
standard. This non-cash expense was calculated using the
Black-Scholes option-pricing model and covers all employee and
director stock options granted by Zargon in 2003. The
introduction of stock-based compensation expense added $0.10 per
barrel of equivalent to the fourth quarter and year-to-date unit
cost.
Bank indebtedness fell throughout the 2003 year as a result of
the year's strong cash flows exceeding the capital program. The
reduced debt, coupled with historically low short-term interest
rates, resulted in interest charges that were relatively low for
both the fourth quarter and the year when comparing the same
prior year periods.
/T/
Corporate Netbacks
Year ended December 31 ($/boe) 2003 2002
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Petroleum and natural gas revenue 37.40 28.28
Hedging (1.06) 0.29
Royalties (8.28) (5.83)
Production costs (6.33) (6.75)
-----------------------------
Operating netbacks 21.73 15.99
General and administrative (1.30) (1.49)
Interest (0.28) (0.47)
Capital and current income taxes (0.15) (0.17)
-----------------------------
Cash flow netbacks 20.00 13.86
Depletion and depreciation (6.99) (5.84)
Site restoration (0.58) (0.55)
Stock-based compensation (0.10) -
Unrealized foreign exchange 0.11 (0.03)
Future income taxes (3.41) (2.83)
-----------------------------
Net earnings 9.03 4.61
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/T/
Depletion and depreciation expense is calculated quarterly and
increased sharply in the fourth quarter of 2003 to $6.25 million,
a level 34 percent higher than the $4.67 million charged in the
preceding quarter and 62 percent higher than the $3.87 million
charged in the 2002 fourth quarter. This large increase in
depletion and depreciation expense is primarily related to a
December 31, 2003 year-over-year 14 percent reduction in the
Company's proved reserves as evaluated under the new policies of
National Instrument 51-101. The 2003 fourth quarter per unit
charge is $8.47 per barrel of equivalent, a 25 percent increase
over the 2003 third quarter and a 36 percent increase over the
prior year period. Depletion and depreciation expense for the
2003 year is $6.99 per barrel of equivalent, an increase of 20
percent over the $5.84 per barrel of equivalent recorded for the
2002 year.
Amounts set aside for site restoration expense were also
increased in fourth quarter 2003 to $0.58 million, 68 percent
higher than the preceding quarter and 81 percent higher than the
2002 fourth quarter. The site restoration charges were also
impacted by the year-end negative proved reserve adjustments and
a fourth quarter upward adjustment of the average future site
restoration charges to $30,000 per net well.
Cash flow from operations in fourth quarter 2003 of $13.24
million (see note above) was seven percent higher than the
preceding quarter and 24 percent higher than the prior year
period. In 2003, cash flow from operations reached the record
level of $54.35 million ($2.96 per diluted share), a gain of 69
percent from $32.12 million ($1.81 per diluted share) in 2002.
Future taxes of $2.35 million for the fourth quarter of 2003 were
10 percent below the preceding quarter and five percent higher
than the 2002 fourth quarter. A major change in future tax
provisions pertaining to second quarter 2003 federal tax
legislation distorts year-over-year comparisons. These tax
changes and their effects on Zargon's tax provisions were
described in detail in our 2003 second quarter report.
Net earnings for the full 2003 year of $24.53 million show a very
strong increase of 130 percent over 2002, reflecting the combined
effect of high cash flow from operations and the favourable tax
changes referred to above. The 2003 fourth quarter net earnings
of $4.03 million declined 11 percent from the preceding quarter
and were six percent lower than the 2002 fourth quarter earnings.
Despite higher 2003 fourth quarter cash flows, the lower earnings
were caused by increases in the non-cash items of depletion and
depreciation, site restoration and stock-based compensation. Net
earnings per diluted share were $0.22 for the 2003 fourth quarter
and $1.33 for the 2003 year, which is a gain of 122 percent over
the 2002 earnings of $0.60 per diluted share.
/T/
Capital Expenditures
Year ended December 31 ($ million) 2003 2002
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Undeveloped land 6.98 4.46
Geological and geophysical (seismic) 5.69 2.47
Drilling and completion of wells 17.30 12.49
Well equipment and facilities 7.33 4.48
-----------------------------
Exploration and development 37.30 23.90
-----------------------------
Property acquisitions 7.83 7.39
Property dispositions (5.22) (3.13)
-----------------------------
Net property acquisitions 2.61 4.26
-----------------------------
Hadrian acquisition assigned to
property and equipment - 7.39
-----------------------------
Total capital expenditures (net) 39.91 35.55
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/T/
LIQUIDITY AND CAPITAL RESOURCES
Total capital expenditures for 2003 were $39.91 million, 12
percent higher than $35.55 million in 2002. For the 2003 year,
$37.30 million was attributed to exploration and development
costs, 93 percent of the net capital expenditures and a 56
percent increase over the 2002 levels. Net property acquisitions
of $2.61 million in 2003 compared to net property acquisitions of
$4.26 million in the prior year. Zargon did not conclude a
corporate acquisition in 2003. Zargon's $39.91 million 2003
capital program was funded using 73 percent of the 2003 cash flow
from operations with the remaining cash flow applied to reduce
debt net of working capital. At December 31, 2003, Zargon's debt
net of working capital had declined to $13.09 million, an amount
slightly less than fourth quarter cash flow from operations.
As at March 23, 2004, Zargon has issued 18.16 million common
shares and has granted stock options to acquire an additional
1.13 million shares.
/T/
Capital Sources
Year ended December 31 ($ million) 2003 2002
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Cash flow from operations 54.35 32.12
Changes in working capital and other 2.66 (3.58)
Change in bank indebtedness (18.30) 1.14
Issuance of common shares 1.20 5.87
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Total capital sources 39.91 35.55
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/T/
RECENT ACCOUNTING PRONOUNCEMENTS ISSUED
Asset Retirement Obligations
In March 2003, the CICA approved Section 3110, "Asset Retirement
Obligations" which requires liability recognition for retirement
obligations associated with the Company's property, plant and
equipment. The obligations are initially measured at fair value,
which is the discounted future value of the liability. The fair
value is capitalized as part of the cost of the related assets
and amortized to expense over their useful lives. The liability
accretes until the retirement obligations are settled. Section
3110 is effective for fiscal years beginning on or after January
1, 2004. The site restoration liability currently on the balance
sheet, which has been calculated using the unit of production
method, will be reversed on January 1, 2004. The Company is
currently evaluating the impact of this standard on its
consolidated financial statements.
Petroleum and Natural Gas Assets - Full Cost Accounting
In September 2003, the CICA issued Accounting Guideline 16, "Oil
and Gas Accounting - Full Cost" (AcG-16), to replace AcG-5. The
new guideline is effective for fiscal years beginning on or after
January 1, 2004. The most significant change between AcG-16 and
AcG-5 is that AcG-16 limits the carrying value of petroleum and
natural gas properties to their fair value. The fair value is
equal to estimated future cash flows from proved and probable
reserves using future price forecasts and costs discounted at a
risk-free rate. This differs from the current cost recovery
ceiling test under AcG-5 that uses undiscounted cash flows, and
constant prices, less general and administrative and financing
costs. Zargon is following AcG-5 at December 31, 2003. No
write-down of the Company's petroleum and natural gas properties
would be required under either method at December 31, 2003.
AcG-16 also adopted the reserve evaluation and disclosure
requirements of NI 51-101, which have been followed in the
preparation of this report.
Variable Interest Entities
In June 2003 the CICA issued Accounting Guideline 15,
"Consolidation of Variable Interest Entities" (AcG-15), which
deals with the consolidation of entities that are subject to
control on a basis other than ownership of voting interests. This
guideline is effective for annual and interim periods beginning
on or after November 1, 2004. The Company has assessed that this
new guideline is not applicable based on the current structure of
the Company and therefore has no impact on the financial
statements of the Company.
Other accounting standards issued by the CICA during the year
ended December 31, 2003, are not expected to impact the Company
at this time.
OUTLOOK
Zargon is well positioned for 2004 with a very strong balance
sheet and a large project inventory on 398 thousand net acres of
undeveloped land. Recent operational momentum in terms of both
production growth and exploration successes coupled with the
current very strong oil and natural gas commodity prices are
providing our Company record cash flows which we continue to
redeploy on our exploration and exploitation growth programs.
With our industry's current record levels of activity, there is a
significant upward cost pressure for property acquisitions,
undeveloped land and field services. In these high cost times, we
will continue with our disciplined approach, by adhering to a
focused strategy of exploring and exploiting our existing large
asset base, while executing value-added property acquisitions if
and when they become available.
/T/
($ million, except per share amounts)
Petro-
leum
Cash and
Net Earnings/ Flow/ Natural
Earn- Diluted Cash Diluted Gas Total Bank
Quarter ings Share Flow Share Revenue Assets Debt
--------------------------------------------------------------------
2003 Q4 $4.03 $0.22 $13.24 $0.72 $24.51 $175.07 $ 6.98
2003 Q3 $4.51 $0.24 $12.34 $0.67 $23.76 $166.89 $ 8.92
2003 Q2 $9.25 $0.51 $13.53 $0.74 $24.20 $160.05 $11.47
2003 Q1 $6.74 $0.37 $15.23 $0.84 $29.19 $159.34 $20.78
2002 Q4 $4.28 $0.24 $10.71 $0.59 $20.67 $153.66 $25.28
2002 Q3 $2.27 $0.13 $ 7.75 $0.43 $16.65 $146.00 $28.71
2002 Q2 $2.55 $0.14 $ 7.47 $0.42 $15.50 $137.76 $28.00
2002 Q1 $1.58 $0.09 $ 6.19 $0.36 $12.73 $128.97 $25.26
2001 Q4 $1.77 $0.10 $ 5.81 $0.34 $11.18 $127.93 $24.14
--------------------------------------------------------------------
--------------------------------------------------------------------
"Signed" C.H. Hansen
President and Chief Executive Officer
Calgary, Alberta
March 23, 2004
ZARGON OIL & GAS LTD.
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
($ thousand) 2003 2002
--------------------------------------------------------------------
ASSETS
Current
Accounts receivable 12,183 11,942
Prepaid expenses and deposits 980 712
--------------------------
13,163 12,654
Property and equipment, net 161,907 141,006
--------------------------
175,070 153,660
--------------------------
--------------------------
LIABILITIES
Current
Bank indebtedness 6,978 25,279
Accounts payable and accrued
liabilities 19,277 16,118
--------------------------
26,255 41,397
Future site restoration 6,026 4,746
Future income taxes (note 9) 30,200 20,922
--------------------------
62,481 67,065
--------------------------
SHAREHOLDERS' EQUITY
Share capital (note 4) 42,200 40,997
Contributed surplus (note 2) 264 -
Retained earnings 70,125 45,598
--------------------------
112,589 86,595
--------------------------
175,070 153,660
--------------------------
--------------------------
See accompanying selected notes
ZARGON OIL & GAS LTD.
CONSOLIDATED STATEMENTS OF EARNINGS AND RETAINED EARNINGS
Three Months Ended Year Ended
December 31, December 31,
2003 2002 2003 2002
--------------------------------------------------------------------
($ thousand, except per (unaudited)(unaudited)
share amounts)
Revenue
Petroleum and natural
gas revenue 24,511 20,665 101,657 65,538
Hedging (note 8) 168 (712) (2,882) 669
Royalties (5,517) (3,677) (22,508) (13,508)
-----------------------------------------
19,162 16,276 76,267 52,699
-----------------------------------------
Expenses
Production 4,651 4,572 17,201 15,649
General and administrative 1,012 679 3,542 3,455
Stock-based compensation
(note 2) 264 - 264 -
Interest 110 297 771 1,100
Foreign exchange (gain) loss (87) 2 (297) 86
Site restoration 577 318 1,567 1,268
Depletion and depreciation 6,249 3,865 19,008 13,536
-----------------------------------------
12,776 9,733 42,056 35,094
-----------------------------------------
Earnings before income taxes 6,386 6,543 34,211 17,605
-----------------------------------------
Income taxes
Future (note 9) 2,354 2,242 9,278 6,548
Current 5 19 406 378
-----------------------------------------
2,359 2,261 9,684 6,926
-----------------------------------------
Net earnings for the period 4,027 4,282 24,527 10,679
Retained earnings, beginning
of period 66,098 41,316 45,598 34,919
-----------------------------------------
Retained earnings, end of
period 70,125 45,598 70,125 45,598
-----------------------------------------
-----------------------------------------
Earnings per common share
(note 5)
Basic 0.22 0.24 1.38 0.62
Diluted 0.22 0.24 1.33 0.60
-----------------------------------------
-----------------------------------------
See accompanying selected notes
ZARGON OIL & GAS LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended Year Ended
December 31, December 31,
2003 2002 2003 2002
--------------------------------------------------------------------
($ thousand) (unaudited)(unaudited)
Operating activities
Net earnings for the period 4,027 4,282 24,527 10,679
Add (deduct) non-cash items:
Depletion and depreciation 6,249 3,865 19,008 13,536
Site restoration 577 318 1,567 1,268
Stock-based compensation
(note 2) 264 - 264 -
Unrealized foreign exchange
(gain) loss (227) 2 (297) 86
Future income taxes 2,354 2,242 9,278 6,548
-----------------------------------------
Cash flow from operations 13,244 10,709 54,347 32,117
Changes in non-cash working
capital (1,242) (1,362) (936) (2,587)
-----------------------------------------
12,002 9,347 53,411 29,530
-----------------------------------------
Financing activities
Advances (repayment) of bank
indebtedness (1,941) (3,428) (18,301) 1,142
Exercise of stock options 289 307 1,203 1,262
-----------------------------------------
(1,652) (3,121) (17,098) 2,404
-----------------------------------------
Investing activities
Additions to property and
equipment (12,901) (11,063) (45,124) (31,296)
Proceeds on disposal of
property and equipment 60 3,037 5,215 3,134
Acquisition of Hadrian
Energy Corp. (cash portion) - - - (4,875)
Site restoration
expenditures (201) (219) (287) (423)
Changes in non-cash working
capital 2,692 2,019 3,883 1,325
-----------------------------------------
(10,350) (6,226) (36,313) (32,135)
-----------------------------------------
Decrease in cash - - - (201)
Cash, beginning of period - - - 201
-----------------------------------------
Cash, end of period - - - -
-----------------------------------------
-----------------------------------------
See accompanying selected notes
/T/
ZARGON OIL & GAS LTD.
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the three months and years ended December 31, 2003 and 2002
1. BASIS OF PRESENTATION
The interim unaudited consolidated financial statements of Zargon
Oil & Gas Ltd. (the "Company") have been prepared by management
in accordance with Canadian generally accepted accounting
principles. The interim unaudited consolidated financial
statements have been prepared following the same accounting
policies and methods in computation as the consolidated financial
statements for the fiscal years ended December 31, 2003 and 2002.
The interim unaudited consolidated financial statements should be
read in conjunction with the consolidated financial statements
and notes thereto in the Company's annual report for the years
ended December 31, 2003 and 2002.
2. CHANGE IN ACCOUNTING POLICY
Stock-Based Compensation
During the fourth quarter of 2003, the Company prospectively
adopted the fair-value method of accounting for stock options
granted to employees and directors. Stock-based compensation is
recorded on the consolidated statements of earnings as a separate
expense for all options granted on or after January 1, 2003, with
a corresponding increase recorded as contributed surplus.
Compensation expense for options granted during 2003 is based on
the estimated fair values at the time of the grant and the
expense is recognized over the vesting period of the option.
Given the insignificance of the expense for options granted
during 2003, the Company recognized the entire 2003 expense of
$264,000 in the fourth quarter (see note 4 for further details).
The prior 2003 quarters will not be restated. Upon the exercise
of the stock options, consideration paid together with the amount
previously recognized in contributed surplus is recorded as an
increase in share capital. The Company has not incorporated an
estimated forfeiture rate for stock options that will not vest,
rather, the Company accounts for forfeitures as they occur. In
the event that vested options expire without being exercised,
previously recognized compensation expense associated with such
stock options is not reversed. For options granted prior to
January 1, 2003, Zargon continues to disclose the pro forma
earnings impact of related stock-based compensation expense (see
note 4).
3. ACQUISITION
On June 17, 2002, the Company acquired all of the outstanding
shares of Hadrian Energy Corp. ("Hadrian"), a private oil and gas
company, for $9.60 million. Consideration consisted of $4.745
million cash and the issuance of 542,340 Zargon common shares
valued at $8.75 per share. Costs of $0.13 million were incurred
to effect the transaction and were charged to share capital. The
acquisition was accounted for by the purchase method and the
purchase price has been allocated as follows:
/T/
($ thousand) 2002
------
Working capital (816)
Property and equipment 7,386
Future income tax asset 3,792
Future site restoration (760)
------
Total consideration 9,602
------
------
4. SHARE CAPITAL
The Company is authorized to issue an unlimited number of common
shares with no par value and an unlimited number of first preferred
shares and second preferred shares.
Common Shares
(thousand) December 31, 2003 December 31, 2002
-------------------------------------
Number Amount Number Amount
of Shares $ of Shares $
-------------------------------------
Shares issued
Balance, beginning of year 17,637 40,997 16,666 35,066
Shares issued for Hadrian - - 542 4,669
Stock options exercised 355 1,203 429 1,262
-------------------------------------
Balance, end of period 17,992 42,200 17,637 40,997
-------------------------------------
-------------------------------------
A summary of the status of the Company's stock option plan as at
December 31, 2003 and 2002, and changes during the year ended on
those dates is presented below:
Stock Options
December 31, 2003 December 31, 2002
-----------------------------------------
Weighted Weighted
Average Average
Number of Exercise Number of Exercise
Shares Price Shares Price
(thousand) $ (thousand) $
-----------------------------------------
Outstanding at
beginning of year 1,215 5.10 1,199 3.36
Granted 459 9.50 466 7.69
Exercised (355) 3.39 (429) 2.94
Cancelled (22) 9.30 (21) 7.37
-----------------------------------------
Outstanding at end
of period 1,297 7.05 1,215 5.10
-----------------------------------------
-----------------------------------------
Options exercisable at
end of period 985 6.25 750 3.49
-----------------------------------------
-----------------------------------------
/T/
Stock-Based Compensation
The Company calculated the value of stock-based compensation
using a Black-Scholes option-pricing model to estimate the fair
value of stock options at the date of grant.
Compensation expense for options granted during 2003 is based on
the estimated fair values at the time of the grant and the
expense is recognized over the vesting period of the option. In
the fourth quarter the Company recognized the entire $264,000 of
compensation expense for options granted during 2003 with a
corresponding increase to contributed surplus on the Company's
consolidated balance sheet.
The assumptions made for the options granted for 2003 include a
volatility factor of expected market price of 21.92 percent, a
weighted average risk-free interest rate of 3.90 percent, no
dividend yield and a weighted average expected life of options of
four years.
For purposes of pro forma disclosures, the estimated fair value
of options is amortized to expense over the options' vesting
periods. For stock options granted in 2002, the Company's net
earnings would be reduced by $6,000 for the three months ended
December 31, 2003 and $215,000 for the year ended December 31,
2003. Basic and diluted earnings per share figures would have
both been unchanged for the 2003 quarter and would have both been
reduced by $0.01 for the 2003 year.
The assumptions made for the options granted for 2002 include a
volatility factor of expected market price of 18.60 percent, a
weighted average risk-free interest rate of 5.16 percent, no
dividend yield and a weighted average expected life of options of
four years.
Comparatively, the Company's prior period net earnings would be
reduced by $189,000 for the three months ended December 31, 2002
and $654,000 for the year ended December 31, 2002. Basic and
diluted earnings per share figures would have both been reduced
by $0.01 for the 2002 quarter and by $0.04 for the 2002 year.
/T/
5. WEIGHTED AVERAGE NUMBER OF COMMON SHARES
Three Months Ended Year Ended
December 31, December 31,
(thousand) 2003 2002 2003 2002
---------------------------------------
Basic 17,900 17,619 17,824 17,233
Diluted 18,490 18,095 18,373 17,795
---------------------------------------
---------------------------------------
6. SEGMENTED INFORMATION
The Company's entire operating activities are related to exploration,
development and production of oil and natural gas in the geographic
segments of Canada and the US.
Three Months Ended Year Ended
December 31, December 31,
($ thousand) 2003 2002 2003 2002
---------------------------------------
Petroleum and Natural
Gas Revenue
Canada 21,569 18,680 90,034 58,360
United States 2,942 1,985 11,623 7,178
---------------------------------------
Total 24,511 20,665 101,657 65,538
---------------------------------------
---------------------------------------
Net Capital Expenditures
Canada 11,827 6,754 33,373 33,603
United States 1,014 1,272 6,536 1,945
---------------------------------------
Total(1) 12,841 8,026 39,909 35,548
---------------------------------------
---------------------------------------
Total Assets
Canada 152,061 135,570
United States 23,009 18,090
-----------------
Total(2) 175,070 153,660
-----------------
-----------------
(1) Prior year includes property from corporate acquisition.
(2) Total asset amounts from prior year have been reclassified in
part from Canada to the US for consistency with the current year
presentation.
7. SUPPLEMENTAL CASH FLOW INFORMATION
Three Months Ended Year Ended
December 31, December 31,
($ thousand) 2003 2002 2003 2002
---------------------------------------
Cash interest paid 174 224 714 1,150
Cash taxes paid 55 19 360 378
---------------------------------------
---------------------------------------
8. FINANCIAL INSTRUMENTS
The Company is a party to certain off-balance sheet derivative
financial instruments that have fixed the price of a portion of its
oil and natural gas production. The Company enters into these
contracts for hedging purposes only, in order to protect a portion of
its future Canadian cash flow from the volatility of oil and natural
gas commodity prices.
The Company has outstanding contracts at December 31, 2003 as
follows:
Range
Volume Rate Price of Terms
---------------------------------------------------------------------
Oil swaps 36,400 bbl 200 bbl/d $26.44 US/bbl Jan. 1/04-
Jun. 30/04
36,800 bbl 200 bbl/d $27.10 US/bbl Jul. 1/04-
Dec. 31/04
Oil collars 36,400 bbl 200 bbl/d $22.50 US/bbl Put Jan. 1/04-
$26.85 US/bbl Call Jun. 30/04
36,400 bbl 200 bbl/d $24.00 US/bbl Put Jan. 1/04-
$27.65 US/bbl Call Jun. 30/04
36,800 bbl 200 bbl/d $24.00 US/bbl Put Jul. 1/04-
$27.80 US/bbl Call Dec. 31/04
Natural
gas swaps 364,000 gj 4,000 gj/d $7.21/gj Jan. 1/04-
Mar. 31/04
856,000 gj 4,000 gj/d $5.15/gj Apr. 1/04-
Oct. 31/04
Natural
gas put 273,000 gj 3,000 gj/d $5.00/gj Jan. 1/04-
Mar. 31/04
Natural gas
collars 91,000 gj 1,000 gj/d $5.50/gj Put Jan. 1/04-
$7.90/gj Call Mar. 31/04
428,000 gj 2,000 gj/d $5.00/gj Put Apr. 1/04-
$6.85/gj Call Oct. 31/04
9. TAX RATE ADJUSTMENT
In the March 2003 budget, the Government of Canada announced federal
corporate income tax changes affecting resource companies to be
phased in over a five year period that include reducing the federal
income tax rate from 28% to 21%, allowing the deductibility of Crown
charges and eliminating the resource allowance. As a result of both
federal and provincial corporate income tax changes, which are
considered to be "substantively enacted" for Canadian GAAP purposes,
the provision for future income taxes for the year ended December
31, 2003 include a recovery and liability reduction in the amount
of $4.31 million.
ZARGON OIL AND GAS LTD.
Corporate Information
Board of Directors Officers Stock Exchange Listing
Craig H. Hansen John O. McCutcheon Toronto Stock Exchange
Calgary, Alberta Chairman Trading Symbol: ZAR
K. James Harrison Craig H. Hansen Transfer Agent
Oakville, Ontario President and
Chief Executive Valiant Trust Company
H. Earl Joudrie Officer 510, 550 - 6th Avenue S.W.
Toronto, Ontario Calgary, Alberta T2P 0S2
Mark I. Lake
Kyle D. Kitagawa Vice President, Head Office
Calgary, Alberta Exploration 700, 333 - 5th Avenue S.W.
Calgary, Alberta T2P 3B6
John O. McCutcheon Daniel A. Roulston Phone: (403) 264-9992
Vancouver, Vice President, Fax: (403) 265-3026
British Columbia Operations Email: zargon@zargon.ca
James D. Peplinski Sheila A. Wares Website
Calgary, Alberta Vice President,
Accounting www.zargon.ca
Byron J. Seaman
Calgary, Alberta Kenneth W. Young
Vice President, Land
J. Graham Weir
Calgary, Alberta
William J. Whelan
Calgary, Alberta
Grant A. Zawalsky
Calgary, Alberta
/T/
Forward Looking Statements - This document contains statements
that are forward-looking, such as those relating to results of
operations and financial condition, capital spending, financing
sources, commodity prices, costs of production and the magnitude
of oil and natural gas reserves. By their nature, forward-looking
statements are subject to numerous risks and uncertainties that
could significantly affect anticipated results in the future and,
accordingly actual results may differ materially from those
predicted. The forward-looking statements contained in this
quarterly report are as of March 23, 2004 and are subject to
change after this date. Readers are cautioned that the
assumptions used in the preparation of such information, although
considered reasonable at the time of preparation, may prove to be
imprecise and, as such, undue reliance should not be placed on
forward-looking statements. Zargon disclaims any intention or
obligation to update or revise any forward-looking statements,
whether as a result of new information, future events or
otherwise.
-30-
FOR FURTHER INFORMATION PLEASE CONTACT:
Zargon Oil & Gas Ltd.
C.H. Hansen
President and Chief Executive Officer
(403) 264-9992
(403) 265-3026 (FAX)
Email: zargon@zargon.ca
Website: www.zargon.ca
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