NEWS RELEASE TRANSMITTED BY CCNMatthews
FOR: ZARGON OIL & GAS LTD.
TSX SYMBOL: ZAR
MAY 13, 2004 - 16:57 ET
Zargon Oil & Gas Ltd. 2004 First Quarter Report
CALGARY, ALBERTA--(CCNMatthews - May 13, 2004) -
CORPORATE HIGHLIGHTS
Zargon Oil & Gas Ltd. is pleased to announce the results for the
three months ended March 31, 2004.
The first quarter of 2004 provided Zargon strong financial
results, solid operations and an active and successful
exploration program. First quarter revenues of $27.70 million,
cash flow from operations of $15.73 million ($0.84 per diluted
share) and net earnings of $5.54 million ($0.30 per diluted
share) were 13 percent, 19 percent and 35 percent higher
respectively than the preceding quarter and roughly comparable to
the first quarter of 2003. Year-over-year, the quarter's revenue
decreased five percent, cash flow from operations increased three
percent and net earnings declined 17 percent due to increased
depletion charges. Financial results were price-driven and
reflect first quarter 2004 commodity price increases over fourth
quarter 2003 levels to values that were very high but failed to
match the record numbers of first quarter 2003.
Average production in first quarter 2004 of 7,889 barrels of
equivalent per day exceeded the prior year's first quarter by 12
percent but was two percent less than the preceding quarter. The
year-over-year gains have come from our successful West Central
Alberta natural gas exploration initiative. The small
quarter-over-quarter decline reflected the natural production
decline from flush rates in newly tied-in natural gas wells. Net
capital expenditures in the current quarter of $9.77 million were
42 percent higher than in the prior year first quarter and were
largely expended on drilling, but still represented only 62
percent of the quarter's cash flow from operations. The quarter's
drilling program included 12 gross wells (9.9 net) of which seven
were exploratory. Zargon continued to purchase land at Crown
sales but was increasingly selective as bid prices escalated.
Similarly, Zargon was not active in the property acquisition
market as oil and natural gas property prices continue to reach
new lofty levels. Operating cash flows in the quarter easily
funded the capital expenditures and also helped reduce debt net
of working capital by $6.92 million to $6.17 million at March 31,
2004, an amount equivalent to less than two months of the current
cash flow from operations.
/T/
Percent
Three months ended March 31 (unaudited) 2004 2003 Change
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FINANCIAL
Income and Investments ($ million)
Petroleum and natural gas revenue 27.7 29.2 (5)
Cash flow from operations 15.7 15.2 3
Net earnings (note 1) 5.5 6.7 (17)
Net capital expenditures 9.8 6.9 42
Per Common Share, Diluted
Cash flow from operations ($/share) 0.84 0.84 -
Net earnings ($/share) (note 1) 0.30 0.36 (17)
Balance Sheet at Period End ($ million)
Property and equipment, net (note 1) 171.6 149.7 15
Bank indebtedness 3.7 20.8 (82)
Shareholders' equity (note 1) 119.1 93.6 27
Shares Outstanding at Period End (million) 18.24 17.73 3
Percent
Three months ended March 31 (unaudited) 2004 2003 Change
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OPERATIONS
Average Daily Production
Oil and liquids (bbl/d) 3,355 3,057 10
Natural gas (mmcf/d) 27.21 24.02 13
Equivalent (boe/d) (note 2) 7,889 7,060 12
Equivalent per million shares (boe/d)
(note 2) 435 399 9
Average Selling Price (before hedges)
Oil and liquids ($/bbl) 39.96 43.85 (9)
Natural gas ($/mcf) 6.26 7.92 (21)
Wells Drilled, Net 9.9 5.0 98
Undeveloped Land at Period End
(thousand net acres) 405 341 19
Note 1: Comparative period numbers reflect retroactive restatement due
to a change in accounting policy.
Note 2: 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/
PRODUCTION(1)
Natural gas production volumes averaged 27.21 million cubic feet
per day in first quarter 2004, a 13 percent increase over the
24.02 million cubic feet per day reported in the 2003 first
quarter but a three percent decline from the preceding 2003
fourth quarter. Over the last seven quarters starting with the
2002 second quarter, Zargon has increased natural gas production
volumes by 43 percent through successful exploration initiatives
in West Central Alberta with substantial new volumes coming from
the Highvale, Pembina and Peace River Arch properties. Over this
period the Alberta Plains gas production volumes have been
maintained at steady levels through successful modest maintenance
drilling programs. At the end of the 2003 third quarter, a
significant wholly owned natural gas producer was completed and
tied-in at the Peace River Arch Progress property with initial
flush production rates approaching five million cubic feet per
day that were reduced to a more sustainable rate of three million
cubic feet per day in the 2004 first quarter. During the quarter,
production additions at Jarrow (Alberta Plains) and Pembina (West
Central Alberta) were able to offset some of this well's flush
production decline. In the second quarter, further tie-ins at
Jarrow and Pembina plus the tie-in of the new Hamelin Creek
(Peace River Arch) dual Dunvegan and Gething discovery should
take average quarter production rates to about 28.5 million cubic
feet per day, despite some anticipated outages due to scheduled
third party gas plant turnarounds.
Production of oil and liquids averaged 3,355 barrels per day in
first quarter 2004, level with the preceding quarter and 10
percent higher than first quarter 2003. Zargon's oil and liquids
production is founded on the key Williston Basin (Southeast
Saskatchewan and North Dakota) long-life, shallow-decline
waterflood properties where production gains are derived from
exploitation and enhancement activities plus, when appropriately
priced, acquisitions of complementary exploitable properties.
These properties provide Zargon a solid foundation since
production levels can be maintained or grown slightly with only
moderate expenditures on exploitation and enhancement activities.
Although our balance sheet would permit sizeable oil property
acquisitions, we are not at this time comfortable with the
evaluation levels for Canadian assets and we choose to wait for
better values. In the meantime, we will continue with our
exploitation programs that should yield average second quarter
production rates of about 3,400 barrels per day, despite some
anticipated spring road ban shut-ins.
EXPLORATION AND EXPLOITATION(1)
During the 2004 first quarter, Zargon drilled 12 gross wells (9.9
net) that delivered 6.9 net natural gas wells, 1.0 net oil well
and 2.0 net dry holes for an 80 percent success ratio. Consistent
with Zargon's policy of balancing higher risk exploration with
lower risk development, five (4.4 net) of the wells were located
in the West Central Alberta core area and six (4.5 net) wells
located in the Alberta Plains properties. During the quarter,
only one horizontal development well at Forget was drilled in the
Williston Basin oil properties. Of the five West Central Alberta
exploration locations, three were exploratory tests at our
Pembina shallow gas play and the two dry holes were located at
the Highvale and the Peace River Arch properties.
Currently, the first quarter natural gas successes at Pembina and
Jarrow (Alberta Plains) are in the process of being tied-in.
Second quarter tie-ins will also include Zargon's fourth quarter
2003 new pool discoveries located on the Peace River Arch. The
Hamelin Creek Dunvegan/Gething natural gas discovery well was
tied-in during April 2004 and is now producing at rates of about
one million cubic feet per day. The current geological mapping
suggests that as many as three additional Dunvegan gas wells may
be drilled on this Hamelin Creek prospect later this year. At
Progress, a fourth quarter 2003 new pool Triassic gassy sour oil
well will be placed on extended production test in June to
evaluate further drilling and facility options.
Zargon continues to base 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 in prior years, Zargon
has built a 405 thousand net acre undeveloped land inventory.
Following spring breakup, Zargon will proceed with a very
interesting natural gas exploration program focused on our 181
thousand net acres of undeveloped lands in the West Central core
area. Over the next five months 14 to 16 gross wells are
scheduled including five wells on prospective Peace River Arch
sites, two wells at Highvale and two earning wells on our 28
thousand acre natural gas prospective farm-in at the Blackfeet
Reservation in Montana.
The upcoming spring/summer drilling program now underway is
slanted to higher-risk areas and has more potential for reward
than any of our previous programs. The five scheduled Peace River
Arch drills represent exploration ideas based on data from recent
successful wells and each is potentially interesting. The two
wells in Montana are pure exploration but are supported by
geological and seismic interpretation. If successful, this could
lead to a much larger play on the available land base. We see
similarities in the area to our successful low-pressure,
shallow-depth Pembina program and believe that the drilling and
completion techniques that we have learned may be transferable.
The current program also includes four exploitation wells in our
Williston Basin oil properties in Southeast Saskatchewan and
North Dakota, directed to sustaining and growing our oil
production.
ACQUISITIONS / DISPOSITIONS
During the 2004 first quarter, Zargon did not make significant
property acquisition expenditures due in part to an extremely
competitive Canadian property acquisition market. During the
quarter, Zargon continued to purchase land at Crown sales but was
increasingly selective as bid prices escalated. With resource
inventories of 405 thousand net acres of undeveloped land
available for natural gas exploration and with properties holding
158 million barrels of potentially exploitable oil-in-place,
Zargon perceives 2004 as a year to focus on the substantial
opportunities available in its existing properties.
GUIDANCE(1)
Zargon's 2004 capital program budget was initially set at $45
million and called for the drilling of 45 net wells. This budget
allocated $40 million to exploration and development field
activities and $5 million to property acquisitions. With our
industry's current record level of activity and enthusiasm, there
is a significant upward cost pressure for undeveloped land,
property acquisitions and field services. In these high cost
times, we will continue with our disciplined approach, adhering
to a focused strategy of exploring and exploiting our existing
large asset base, while executing value added acquisitions, if
and only when they become available. Zargon is not an agressive
spender in these expensive times and consequently we have elected
to reduce our capital budget and related guidance targets
accordingly.
Our new 2004 capital budget will be set at $35 million directed
to exploration and development field activities, and includes the
drilling of 41 net wells. The budget does not make an allowance
for any acquisitions, although, should value added property or
corporate acquisition opportunities be sourced (particularly in
the North Dakota portion of the Williston Basin), 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. The guidance for the oil production rate
assumed that Zargon would be successful in making a small
Williston Basin oil acquisition. It is now apparent that we will
not be acquiring any additional Williston Basin oil properties by
mid-year, and we need to adjust our mid-year guidance accordingly
to a 3,400 barrel per day rate. The mid-year natural gas guidance
of 30 million cubic feet per day remains unchanged and is
projected to be delivered from on-going second quarter tie-ins
and drilling programs. The revised guidance calls for a combined
mid-year rate of 8,400 barrels of equivalent per day, which would
represent a 13 percent increase over the average 2003 production
rate (10 percent gain on a production per outstanding share
basis).
(1) 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 March 31, 2004 and the
audited consolidated financial statements and MD&A for the year
ended December 31, 2003. 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.
This MD&A has been prepared as of May 13, 2004.
FINANCIAL ANALYSIS
In the first quarter of 2004, Zargon continued to report high
levels of petroleum and natural gas revenue and cash flow from
operations. First quarter 2004 revenue of $27.70 million was 13
percent above $24.51 million in fourth quarter 2003 and five
percent below $29.19 million in first quarter 2003. First
quarter 2003 had exceptional commodity pricing related to the
impending Iraqi war plus a much weaker Canadian dollar that, on a
comparative basis, by itself accounted for slightly more than the
year-over-year quarterly revenue difference. Hedging losses in
first quarter 2004 were $0.27 million, but much smaller than the
$2.22 million recorded in first quarter 2003 when commodity
prices rose very sharply, rising well beyond values anticipated
when the hedges were placed. Cash flow from operations in first
quarter 2004 of $15.73 million was 19 percent above the preceding
quarter and three percent above first quarter 2003. Net earnings
for first quarter 2004 of $5.54 million were 35 percent above the
preceding quarter and 17 percent below the prior year first
quarter. On a year-over-year basis the first quarter earnings
were negatively impacted by increased depletion and depreciation
expenses resulting in part from negative revisions made in the
2003 year-end proved reserves evaluation.
Natural gas production eased three percent in first quarter 2004
to 27.21 million cubic feet per day from 28.08 million cubic feet
per day in fourth quarter 2003 but was 13 percent above the 2003
first quarter. The year-over-year volume gains came from
successful West Central Alberta gas exploration drilling
initiatives throughout 2003 and the small first quarter 2004
decline reflected the natural declines from the flush production
rates of the new natural gas discoveries. Oil and liquids
production has been relatively constant since the second quarter
of 2003 with the additions coming from a modest drilling program
offsetting natural declines. On a year-over-year basis, first
quarter 2004 oil and liquids production was 10 percent above the
2003 first quarter, stemming primarily from the acquisition of
the Truro Unit in North Dakota in April 2003.
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 on cash
flow 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 that compares to a $0.17
million gain in fourth quarter 2003 and a $0.27 million loss in
first quarter 2004.
Royalties, inclusive of Alberta Royalty Tax Credit and
Saskatchewan Resource Surcharge, were $5.92 million for the first
quarter of 2004, an increase of seven percent from the preceding
quarter and a decrease of five percent from $6.24 million in the
2003 first quarter. The variations primarily track changes in
production prices and volumes. As a percentage of gross revenue,
royalty rates ranged from 21.4 percent in first quarter 2003 to
22.5 percent in fourth quarter 2003 and back to 21.4 percent in
the first quarter of 2004.
On a unit of production basis, production costs of $6.43 per
barrel of equivalent in first quarter 2004 compare with $6.30 in
the preceding quarter and $6.66 in first quarter 2003. These
costs were brought down progressively throughout 2003 from an
average of $6.75 per barrel of equivalent in 2002. The chief
instrument of change was the disposition in 2003 of $5.22 million
of smaller, higher cost properties. The preservation of these
improved per unit operating costs through expanded field-related
cost containment programs will be a key ongoing initiative for
Zargon during this current period of increasing cost pressures.
/T/
Operating Netbacks
2004 2003
------------------------------------
Oil and Natural Oil and Natural
Three months ended March 31 Liquids Gas Liquids Gas
-----------------------------------------------------------------------
($/bbl) ($/mcf) ($/bbl) ($/mcf)
Production revenue 39.96 6.26 43.85 7.92
Hedging (1.93) 0.13 (2.82) (0.67)
Royalties (8.30) (1.37) (8.29) (1.83)
Production costs (9.29) (0.72) (9.97) (0.69)
------------------------------------
Operating netbacks 20.44 4.30 22.77 4.73
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/T/
Measured on a unit of production basis, general and
administrative expenses are also showing good control. Net of
recoveries, general and administrative expenses were $1.34 per
barrel of equivalent in first quarter 2004 compared to $1.37 in
the preceding quarter, $1.40 in first quarter 2003 and $1.49 per
barrel of equivalent in all of 2002. Over the last two years,
reductions in general and administrative costs on a per unit of
production basis have been accomplished through increased
production volumes, increased cost recoveries from expanded field
capital programs and the disposition of some small,
overhead-intensive properties. In light of the substantially
increased regulatory reporting requirements that have been
mandated in the last year, we are experiencing upward cost
pressures that may result in future modest increases on a general
and administrative expense per unit of production basis.
Expensing of stock-based compensation in the consolidated
statements of earnings began in the fourth quarter of 2003, which
contained an adjustment for the entire 2003 year. Zargon
calculates this non-cash expense using the Black-Scholes
option-pricing model and it covers the earned portion of employee
and director stock options during the reporting period. This
expense was not recorded in first quarter 2003 but added $0.09
million or $0.13 per barrel of equivalent of expense in first
quarter 2004 and $0.36 per barrel of equivalent (four quarters of
expense booked in one quarter) in fourth quarter 2003.
High cash flows since January 2003 have progressively reduced
debt net of working capital from $28.74 million at December 31,
2002 to $6.17 million at March 31, 2004 and interest charges have
fallen proportionately to $0.08 million in first quarter 2004
compared to $0.11 million in the preceding quarter and $0.26
million in first quarter 2003. In the absence of major corporate
capital expenditures, Zargon can be expected to be close to
debt-free by the end of the second quarter 2004.
Zargon did not pay current income taxes in the first quarter of
2004, but incurred $0.11 million of federal and provincial
capital taxes, which was unchanged from the $0.11 million
incurred in the first quarter of 2003. Zargon reorganized its
operations into a partnership structure effective July 10, 2001
and acquired significant excess tax pools with both the 2001 Herc
Oil Corp. and 2002 Hadrian Energy Corp. acquisitions. These
transactions helped shelter 2003 and a portion of 2004 taxable
income. However, tax pools at December 31, 2003 were only
approximately $79 million and it is expected that they may not be
sufficient to shelter all of the budgeted 2004 taxable income.
/T/
Corporate Netbacks
Three months ended March 31 ($/boe) 2004 2003
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Petroleum and natural gas revenue 38.59 45.94
Hedging (0.38) (3.50)
Royalties (8.25) (9.83)
Production costs (6.43) (6.66)
----------------
Operating netbacks 23.53 25.95
General and administrative (1.34) (1.40)
Interest (0.12) (0.41)
Capital and current income taxes (0.16) (0.18)
----------------
Cash flow netbacks 21.91 23.96
Depletion and depreciation (note 1) (8.66) (6.51)
Accretion of asset retirement obligations (note 1) (0.36) (0.46)
Stock-based compensation (0.13) -
Unrealized foreign exchange 0.06 -
Future income taxes (note 1) (5.11) (6.53)
----------------
Net earnings 7.71 10.46
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Note 1: Comparative period numbers reflect retroactive restatements due
to a change in accounting policy.
/T/
Depletion and depreciation expense is calculated quarterly and
increased sharply in the fourth quarter of 2003 to $8.69 per
barrel of equivalent, a level that was consistent with the $8.66
per barrel of equivalent that was recorded in first quarter 2004.
The fourth quarter per unit of production depletion and
depreciation expense represents a 33 percent increase from the
$6.51 per barrel of equivalent booked in first quarter 2003. 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.
As disclosed in a note at the end of this report, in 2003 the
CICA approved a new Section 3110 "Asset Retirement Obligations"
that effectively requires site restoration expense to be treated
as a discounted future liability that is amortized over the
useful life of the related assets. The liability accretes until
the retirement obligations are settled. Zargon changed to this
standard effective January 1, 2004 and the expense line formerly
termed Site Restoration is now called Accretion of Asset
Retirement Obligations. The amounts are not directly comparable
as they were formerly calculated on a more generalized fixed
amount per well. For first quarter 2004, the accretion amount is
$0.26 million, 12 percent less than $0.29 million in both fourth
quarter 2003 and first quarter 2003.
Cash flow from operations in first quarter 2004 of $15.73 million
(see note at the beginning of the MD&A section) was $2.49 million
or 19 percent higher than the preceding quarter and $0.50 million
or three percent higher than the prior year first quarter. The
gain in cash flow over the preceding quarter was primarily due to
increased commodity pricing and the resulting increased revenue.
With the prior year quarterly comparison, commodity prices were
in fact higher in the prior year first quarter, but the impact of
increased production volumes and a large 2003 first quarter hedge
loss resulted in an increase in cash flow from operations in the
2004 first quarter. On a per share basis, the three percent
increase gain in cash flow per operations was offset by an
increase in the average number of shares, with the result that
the first quarter 2004 cash flow from operations remained steady
at $0.84 per diluted share as compared to the 2003 first quarter,
but 17 percent higher than the fourth quarter 2003 cash flow of
$0.72 per diluted share.
The provision for future taxes of $3.67 million for the first
quarter of 2004 was 53 percent higher than the preceding quarter
and 12 percent lower than in first quarter 2003. Except for the
impact of tax rate changes announced in 2003, this provision has
been effectively tracking the Company's before tax earnings. For
the 2004 first quarter, future taxes were 39 percent of before
tax earnings, which compares respectively with the 2003 first
quarter and 2003 fourth quarter rates of 38 percent and 37
percent.
Net earnings of $5.54 million for the first quarter of 2004 were
35 percent above $4.10 million in the preceding quarter and 17
percent below $6.65 million in first quarter 2003. The net
earnings reflect the same trends as the cash flow from operations
for the respective periods modified by the previously discussed
impacts of the additional charges for depletion and depreciation
and stock-based compensation booked in the 2003 fourth quarter
and 2004 first quarter. On a per share basis, the first quarter
2004 net earnings were $0.30 per diluted share, 36 percent higher
than the $0.22 reported in the 2003 fourth quarter, but 17
percent lower than 2003 first quarter net earnings of $0.36 per
diluted share.
/T/
Capital Expenditures
Three months ended March 31 ($ million) 2004 2003
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Undeveloped land 1.08 1.39
Geological and geophysical (seismic) 1.42 1.09
Drilling and completion of wells 5.06 2.78
Well equipment and facilities 1.78 1.14
--------------------
Exploration and development 9.34 6.40
--------------------
Property acquisitions 0.43 0.48
Property dispositions - (0.02)
--------------------
Net property acquisitions 0.43 0.46
--------------------
Total capital expenditures (net) 9.77 6.86
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/T/
LIQUIDITY AND CAPITAL RESOURCES
Capital expenditures of $9.77 million were 42 percent higher than
$6.86 million expended in the prior year quarter, reflecting a
more active field program in the current period. Field related
drilling, completion and facility expenses of $6.84 million were
74 percent higher than the prior years field related capital
program. Conversely, undeveloped land purchases decreased 22
percent as Crown land sales reached new high price levels that
Zargon did not find commensurate with the risks involved. Capital
expenditures in the preceding 2003 fourth quarter were higher at
$12.84 million, consistent with Zargon's historical practice of
scheduling larger fall drilling programs during periods of
relatively lower cost. No material acquisitions were made in
either period. Cash flow from operations in the current quarter
of $15.73 million and proceeds from the exercise of stock options
of $0.99 million covered the capital program and applied $3.30
million to the repayment of bank debt. At March 31, 2004, the
Company has an exceptionally strong balance sheet with no
long-term bank debt and a total working capital deficit of only
$6.17 million, which represents less than two months of the first
quarter 2004 cash flow.
As at May 13, 2004, Zargon has issued 18.28 million common shares
and has granted stock options to acquire an additional 1.43
million shares.
/T/
Capital Sources
Three months ended March 31 ($ million) 2004 2003
-----------------------------------------------------------------------
Cash flow from operations 15.73 15.23
Changes in working capital and other (3.65) (4.15)
Change in bank indebtedness (3.30) (4.50)
Issuance of common shares 0.99 0.28
------------------
Total capital sources 9.77 6.86
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/T/
CHANGES IN ACCOUNTING POLICIES
The following changes have been made to Zargon's accounting
policies effective January 1, 2004.
Petroleum and Natural Gas Assets - Full Cost Accounting
The new CICA Guideline 16, "Oil and Gas Accounting - Full Cost"
(AcG-16) is effective for fiscal years beginning on or after
January 1, 2004. The most significant change between AcG-16 and
the former guideline 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 former cost
recovery ceiling test that used undiscounted cash flows, and
constant prices, less general and administrative and financing
costs. No write-down of the Company's petroleum and natural gas
properties was required when the new guideline was adopted on
January 1, 2004 or as at March 31, 2004.
Asset Retirement Obligations
The new CICA Section 3110, "Asset Retirement Obligations"
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
depleted on a unit of production basis 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 on a retroactive basis with restatement
of prior periods. The site restoration liability on the balance
sheet at December 31, 2003 was replaced with a new "Asset
Retirement Obligation" liability in the amount of $12.19 million
on January 1, 2004.
OUTLOOK
Zargon continues to be well positioned. It has a very strong
balance sheet, 405 thousand net acres of undeveloped land and a
promising project inventory. Zargon and the industry are in a
period of high commodity prices in a cycle that appears to have
an unusually long life. Upward cost pressures are present in all
sectors of our business and property acquisitions are at very
high price levels. Zargon intends to continue with the
disciplined approach that has served us well to date. We will
adhere to a focused strategy of exploring and exploiting our
existing asset base while executing value-added property
acquisitions if and when they become available.
/T/
($ million, except per share amounts)
Earnings/
Net Diluted Cash Flow/ Petroleum and Total
Earnings Share Cash Diluted Natural Gas Assets Bank
Quarter (note 1) (note 1) Flow Share Revenue (note 1) Debt
-----------------------------------------------------------------------
2004 Q1 $5.54 $0.30 $15.73 $0.84 $27.70 $186.18 $3.68
2003 Q4 $4.10 $0.22 $13.24 $0.72 $24.51 $181.05 $6.98
2003 Q3 $4.44 $0.24 $12.34 $0.67 $23.76 $172.81 $8.92
2003 Q2 $9.17 $0.50 $13.53 $0.74 $24.20 $165.98 $11.47
2003 Q1 $6.65 $0.36 $15.23 $0.84 $29.19 $165.12 $20.78
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Note 1: Comparative period numbers reflect retroactive restatements due
to a change in accounting policy.
"Signed" C.H. Hansen
President and Chief Executive Officer
Calgary, Alberta
May 13, 2004
/T/
/T/
ZARGON OIL & GAS LTD.
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
($ thousand) 2004 2003
-------------------------
(unaudited) (restated -
note 2)
ASSETS
Current
Accounts receivable 13,099 12,183
Prepaid expenses and deposits 1,504 980
-------------------------
14,603 13,163
Property and equipment, net 171,576 167,888
-------------------------
186,179 181,051
-------------------------
-------------------------
LIABILITIES
Current
Bank indebtedness 3,675 6,978
Accounts payable and accrued liabilities 17,101 19,277
-------------------------
20,776 26,255
Asset retirement obligations (notes 2 and 3) 12,469 12,194
Future income taxes 33,841 30,133
-------------------------
67,086 68,582
-------------------------
SHAREHOLDERS' EQUITY
Share capital (note 4) 43,213 42,200
Contributed surplus 336 264
Retained earnings 75,544 70,005
-------------------------
119,093 112,469
-------------------------
186,179 181,051
-------------------------
-------------------------
See accompanying notes.
/T/
/T/
ZARGON OIL & GAS LTD.
CONSOLIDATED STATEMENTS OF EARNINGS AND RETAINED EARNINGS
Three months ended March 31 (unaudited)
($ thousand, except per share amounts) 2004 2003
----------------------------------------------------------------------
(restated -
note 2)
Revenue
Petroleum and natural gas revenue 27,704 29,193
Hedging (note 8) (273) (2,223)
Royalties (5,923) (6,244)
------------------------
21,508 20,726
------------------------
Expenses
Production 4,615 4,230
General and administrative 962 888
Stock-based compensation (note 4) 91 -
Interest 85 262
Foreign exchange (gain) loss (41) -
Accretion of asset retirement obligations
(notes 2 and 3) 259 293
Depletion and depreciation 6,217 4,141
------------------------
12,188 9,814
------------------------
Earnings before income taxes 9,320 10,912
------------------------
Income taxes
Future 3,667 4,147
Current 114 114
------------------------
3,781 4,261
------------------------
Net earnings for the period 5,539 6,651
------------------------
Retained earnings, beginning of period as
previously reported 70,125 45,598
Change in accounting policies (note 2) (120) 46
------------------------
Retained earnings, beginning of period as
restated 70,005 45,644
------------------------
Retained earnings, end of period 75,544 52,295
------------------------
------------------------
Earnings per common share (note 5)
Basic 0.31 0.38
Diluted 0.30 0.36
------------------------
------------------------
See accompanying notes.
/T/
/T/
ZARGON OIL & GAS LTD.
CONSOLIDATED STATEMENTS OF CASH FLOW
Three months ended March 31 (unaudited)
($ thousand) 2004 2003
----------------------------------------------------------------------
(restated -
note 2)
Operating activities
Net earnings for the period 5,539 6,651
Add (deduct) non-cash items:
Depletion and depreciation 6,217 4,141
Accretion of asset retirement obligations
(notes 2 and 3) 259 293
Stock-based compensation 91 -
Unrealized foreign exchange (gain) loss (41) -
Future income taxes 3,667 4,147
------------------------
Cash flow from operations 15,732 15,232
Site restoration expenditures (42) (30)
Changes in non-cash working capital (312) (1,898)
------------------------
15,378 13,304
------------------------
Financing activities
Advances (repayment) of bank indebtedness (3,303) (4,502)
Exercise of stock options 994 277
------------------------
(2,309) (4,225)
------------------------
Investing activities
Additions to property and equipment (9,768) (6,882)
Proceeds on disposal of property and
equipment - 25
Changes in non-cash working capital (3,301) (2,222)
------------------------
(13,069) (9,079)
------------------------
Change in cash - -
Cash, beginning of period - -
------------------------
Cash, end of period - -
------------------------
------------------------
See accompanying notes.
/T/
ZARGON OIL & GAS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the three months ended March 31, 2004 and 2003 (unaudited)
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 year ended December 31, 2003. 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 year
ended December 31, 2003.
2. CHANGES IN ACCOUNTING POLICIES
Full Cost Accounting
The Company has adopted the new CICA Accounting Guideline - 16
"Oil and Gas Accounting - Full Cost". The new guideline modifies
how the ceiling test is performed, and requires that cost centres
be tested for recoverability using undiscounted future cash flows
from proved reserves which are determined by using forward
indexed prices. When the carrying amount of a cost centre is not
recoverable, the cost centre would be written down to its fair
value. Fair value is estimated using accepted present value
techniques, which incorporate risks and other uncertainties when
determining expected cash flows. There is no impact on the
Company's reported financial results as a result of applying the
new Accounting Guideline - 16.
Asset Retirement Obligations
On January 1, 2004, the Company retroactively adopted the
Canadian accounting standard outlined in CICA Handbook Section
3110, "Asset Retirement Obligations". Previously, estimated
future site restoration costs were provided for over the life of
the proved reserves on a unit of production basis.
Under the new accounting standard, the Company records the fair
value of legal obligations associated with the retirement of
long-lived tangible assets, such as petroleum and natural gas
assets, in the period in which they are acquired or drilled and a
corresponding increase in the carrying amount of the long-lived
asset. The liability accretes until the Company expects to settle
the retirement obligation. The asset retirement costs are
depleted using the unit of production method. Actual costs to
retire the tangible assets are deducted from the liability as
incurred.
As required by the new standard, all prior periods have been
restated for the change in accounting policy. The effect of this
change on the consolidated balance sheet as of January 1, 2004 is
an increase in net capital assets of $5.98 million, recognition
of an asset retirement obligation liability of $12.19 million,
elimination of the site restoration liability of $6.03 million,
recognition of a future tax recovery of $0.06 million, and a
decrease to retained earnings of $0.12 million. The change also
results in a decrease in net earnings of $0.04 million for the
three months ended March 31, 2004 (2003 - $0.09 million). The
impact on basic and diluted per share amounts for the three
months ended March 31, 2004 and 2003 is negligible as a result of
adopting this new policy.
3. ASSET RETIREMENT OBLIGATIONS
The total future asset retirement obligation was estimated by
management based on the Company's net working interest in all
wells and facilities, estimated costs to reclaim and abandon
wells and facilities and the estimated timing of the costs to be
incurred in future periods. The Company has estimated the net
present value of its total asset retirement obligations to be
$12.19 million as at January 1, 2004 based on a total future
liability of $50.85 million. These payments are expected to be
made over the next 32 years with the majority of the costs not
being incurred until after 2012. The Company used a credit
adjusted risk-free rate of 8.5 percent and an inflation rate of
two percent to calculate the present value of the asset
retirement obligation.
The following table reconciles the Company's asset retirement
obligation:
/T/
Three months ended March 31
($ thousand) 2004 2003
-----------------
Balance, beginning of year 12,194 10,560
Liabilities incurred 137 60
Liabilities settled (42) (30)
Accretion expense 259 293
Other (79) -
-----------------
Balance, end of period 12,469 10,883
-----------------
-----------------
/T/
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.
/T/
Common Shares
(thousand)
March 31, 2004 March 31, 2003
------------------ ------------------
Number of Amount Number of Amount
Shares ($) Shares ($)
------------------ ------------------
Shares issued
Balance, beginning of year 17,992 42,200 17,637 40,997
Stock options exercised 246 994 91 277
Stock-based compensation
recognized - 19 - -
------------------ ------------------
Balance, end of period 18,238 43,213 17,728 41,274
------------------ ------------------
------------------ ------------------
/T/
A summary of the status of the Company's stock option plans as at
March 31, 2004 and 2003, and changes during the three months
ended on those dates is presented below:
/T/
Stock Options
March 31, 2004 March 31, 2003
-------------------- ----------------------
Weighted Weighted
Number of Average Number of Average
Shares Exercise Shares Exercise
(thousand) Price ($) (thousand) Price ($)
-------------------- ----------------------
Outstanding at
beginning of year 1,297 7.05 1,215 5.10
Granted 430 16.00 405 9.30
Exercised (246) 4.04 (91) 3.06
Cancelled (9) 9.61 - -
-------------------- ----------------------
Outstanding at end
of period 1,472 10.15 1,529 6.33
-------------------- ----------------------
-------------------- ----------------------
Options exercisable
at period end 739 6.99 1,106 5.20
-------------------- ----------------------
-------------------- ----------------------
/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 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.
The assumptions made for the options granted in 2004 include a
volatility factor of expected market price of 26.30 percent, a
weighted average risk-free interest rate of 3.33 percent, no
dividend yield and a weighted average expected life of options of
four years.
In the fourth quarter of 2003, the Company recognized the entire
$0.26 million of compensation expense for options granted during
2003 with a corresponding increase to contributed surplus on the
Company's consolidated balance sheet. This expense has not been
allocated over the prior quarters.
For purposes of pro forma disclosures the Company's net earnings
for the three months ended March 31, 2003, would be reduced by
$0.20 million. Basic and diluted earnings per share figures would
have both been reduced by $0.01 for the 2003 quarter. There is no
effect in 2004 pertaining to 2002 stock option grants because the
options were fully vested prior to 2004.
/T/
5. WEIGHTED AVERAGE NUMBER OF COMMON SHARES
Three months ended March 31
(thousand) 2004 2003
------------------
Basic 18,140 17,708
Diluted 18,725 18,240
------------------
------------------
/T/
6. SEGMENTED INFORMATION
The Company's entire operating activities are related to
exploration, development and production of oil and natural gas in
the geographic segments of Canada and the US.
/T/
Three Months Ended
March 31,
($ thousand) 2004 2003
------------------
Petroleum and Natural Gas Revenue
Canada 24,369 26,372
United States 3,335 2,821
------------------
Total 27,704 29,193
------------------
------------------
Net Capital Expenditures
Canada 9,458 6,805
United States 310 52
------------------
Total 9,768 6,857
------------------
------------------
Total Assets(a)
Canada 162,475 146,806
United States 23,704 18,317
------------------
Total 186,179 165,123
------------------
------------------
(a) Total asset amounts from prior year have been reclassified in
part from Canada to the US for consistency with the current year
presentation.
/T/
/T/
7. SUPPLEMENTAL CASH FLOW INFORMATION
Three Months Ended
March 31,
($ thousand) 2004 2003
------------------
Cash interest paid 74 242
Cash taxes paid 139 114
------------------
------------------
/T/
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 March 31, 2004 as
follows:
/T/
Volume Rate Price Term
--------------------------------------------------------------
Oil
swaps 18,200 bbl 200 bbl/d $26.44 US/bbl Apr. 1/04-Jun. 30/04
36,800 bbl 200 bbl/d $27.10 US/bbl Jul. 1/04-Dec. 31/04
36,800 bbl 200 bbl/d $30.45 US/bbl Jul. 1/04-Dec. 31/04
Oil
collars 18,200 bbl 200 bbl/d $22.50 US/bbl Put
$26.85 US/bbl Call Apr. 1/04-Jun. 30/04
18,200 bbl 200 bbl/d $24.00 US/bbl Put
$27.65 US/bbl Call Apr. 1/04-Jun. 30/04
36,800 bbl 200 bbl/d $24.00 US/bbl Put
$27.80 US/bbl Call Jul. 1/04-Dec. 31/04
Natural
gas
swaps 856,000 gj 4,000 gj/d $5.15/gj Apr. 1/04-Oct. 31/04
302,000 gj 2,000 gj/d $6.27/gj Nov. 1/04-Mar. 31/05
Natural
gas
collars 428,000 gj 2,000 gj/d $5.00/gj Put
$6.85/gj Call Apr. 1/04-Oct. 31/04
--------------------------------------------------------------
--------------------------------------------------------------
/T/
At March 31, 2004, the cost to settle the above contracts would
have been approximately $1.96 million.
9. COMPARATIVE FIGURES
Certain comparative figures have been restated to conform with
the current year's financial statement presentation.
/T/
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 Officer Valiant Trust Company
H. Earl Joudrie 510, 550 - 6th Avenue S.W.
Toronto, Ontario Mark I. Lake Calgary, Alberta T2P 0S2
Vice President,
Kyle D. Kitagawa Exploration Head Office
Calgary, Alberta
Daniel A. Roulston 700, 333 - 5th Avenue S.W.
John O. McCutcheon Vice President, Calgary, Alberta T2P 3B6
Vancouver, Operations Phone: (403) 264-9992
British Columbia Fax: (403) 265-3026
Sheila A. Wares Email: zargon@zargon.ca
Jim Peplinski Vice President,
Calgary, Alberta Accounting Website
Byron J. Seaman Kenneth W. Young www.zargon.ca
Calgary, Alberta 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 May 13, 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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