ARABIAN SHIELD
DEVELOPMENT COMPANY
ANNUAL REPORT TO STOCKHOLDERS
FOR THE YEAR ENDED DECEMBER 31, 1996
TO OUR STOCKHOLDERS:
The Company obtained the mining lease to the Al Masane area in Saudi Arabia on
May 22, 1993, and thereafter commissioned Watts, Griffis & McOuat of Toronto,
Canada ("WGM") to update the feasibility study for that area, which was
subsequently updated in 1996. The mining lease has an initial thirty (30) year
term, with the Company having the option to renew or extend the term of the
lease for additional periods not to exceed twenty (20) years. The Company will
pay the Saudi Arabian government income taxes in accordance with the income tax
law then in force, in accordance with Article 45 of the Mining Code (the current
tax is now 45% of net income). However, in accordance with Article 46 of the
Mining Code, such income tax will not be due in respect to mining operations
during the period of five years starting from the date of the first sale of
products or five years from the beginning of the fourth year after the issue of
the mining lease, whichever occurs first.
Under the mining lease agreement, the Company is obligated, when actual profits
are realized from its commercial mining operations in the Al Masane area, to
form a Saudi public stock company in which the Company will own 50% of the
shares, the Petroleum and Mineral Organization ("Petromin"), a company wholly
owned by the Saudi Arabian government, will have the option to acquire up to 25%
of the shares, and the remaining shares will be offered for public subscription
to Saudi Arabian citizens. In the 1996 update to the 1994 full bank feasibility
study of the Al Masane lease area, the independent mining consultants estimated
the total capital costs of the Al Masane project to be $88.6 million. The
Company and its Saudi Arabian advisors are in the process of forming a Saudi
limited liability company to own and operate the project, 50% of which will be
owned by the Company and the remaining 50% of which will be owned by the Saudi
Arabian investors. The Saudi Arabian investors will contribute 25% of the
capital cost of the project. The Company believes that another 25% of the
capital cost of the project may be obtained through loans from commercial banks,
and that the remaining 50% of the capital cost of the project would come from an
interest-free loan from the Saudi Industrial Development Fund ("SIDF"). To be
eligible for an interest-free loan from the SIDF to fund 50% of the capital cost
of the project, the Company together with its Saudi Arabian advisors obtained an
industrial license from The Ministry of Industry and Electricity on December 3,
1996. The Company owns 50% of the license and the Saudi Arabian advisors the
remaining 50%. When actual profits are realized from commercial mining
operations of the project, the Saudi limited liability company will be
transformed into a Saudi public stock company, 50% of the shares of which will
be owned by the Company and the remaining shares of which will be owned by
Petromin, up to 25%, and Saudi Arabian investors.
Pursuant to the terms of the mining lease agreement, the Company undertakes to
repay the $11 million loan provided to the Company and National Mining Company
in 1979 by the Ministry of Finance and National Economy, in accordance with the
terms of an agreement to be reached between the Company and the Ministry of
Finance and National Economy. In a memorandum to His Majesty the King in 1986,
the Minister of Petroleum and Mineral Resources and the Minister of Finance and
National Economy recommended that the $11 million loan be rescheduled with the
terms of rescheduling to be agreed upon after the mining lease is granted. The
Company will instigate negotiations on that basis with the Ministry of Finance
and National Economy.
Under the terms of the mining lease agreement, the Company agreed to pay in
advance rental to the Ministry of Petroleum and Mineral Resources of 10,000
Saudi Riyals (approximately $2,667 at current exchange rate) per square
kilometer per year (approximately $117,300 annually) during the period of the
lease for the total lease area of 44 square kilometers. The Company made rental
payments for the first year of the lease. As of December 31, 1996, the Company
has not paid for rentals of approximately $309,000. It is contemplated that the
Saudi limited liability company will assume responsibility for the rental
payments and all arrearages.
Following the granting of the mining lease to the Al Masane area, the Company
commissioned WGM to prepare a new fully bankable feasibility study for
presentation to financial institutions in connection with obtaining financing
for the project. The feasibility study includes more metallurgical work
incorporating advances in grinding of the ore; incorporation of the latest
advances in technology and reagents
1
developed during the past ten years; incorporation of new mill designs and the
latest water recycling methods; investigation into the shipping and marketing of
zinc and copper concentrates; and an economic analysis of the project. The
feasibility study contains specific recommendations to insure that the
construction of the project is accomplished as expeditiously and economically as
possible. Engineering design and costing of the project was done by Davy
International of Toronto, Canada. The feasibility study cost the Company
approximately $1 million and was presented to the Company on July 22, 1994. The
feasibility study was updated in July 1996.
The Al Masane ore is located in three mineralized zones known as Saadah, Al
Houra and Moyeath. The diluted minable, proven and probable ore reserves at the
Al Masane project were estimated to be 7.2 million tonnes, including mining
dilution. Mining dilution is the amount of wallrock adjacent to the ore body
which is included in the ore extraction process. The average grade of the proven
and probable diluted ore reserves was estimated to be 1.42% copper, 5.31% zinc,
1.19 grams of gold per tonne and 40.20 grams of silver per tonne. For purposes
of calculating the proven and probable reserves, a dilution of 5% at zero grade
on the Saadah zone and 15% at zero grade on the Al Houra and Moyeath zones was
assumed. A mining recovery of 80% has been used for the Saadah Zone and 88% for
the Al Houra and Moyeath Zones.
A review by WGM of the equipment and process flowsheet contained in the 1982
feasibility study prepared by WGM indicated that new technology developed during
the past ten years could be used to reduce the capital cost and improve the
metallurgical recoveries. In particular, the use of semi-autogenous grinding to
reduce the capital cost of the grinding section and developments in reagents
were believed to hold the greatest potential for improving the economies of the
project. A detailed metallurgical testwork program was undertaken by Lakefield
Research in 1994 to address potential improvements and provide detailed design
criteria for the concentrator design. Results from this testwork program showed
that copper recovery could be improved by 5.7% and zinc recoveries improved by
13% compared to the 1982 results.
The metallurgical studies conducted on the ore samples taken from the zones
indicated that 87.7% of the copper and 82.6% of the zinc could be recovered in
copper and zinc concentrates. Overall, gold and silver recovery from the ore was
estimated to be 77.3% and 81.3%, respectively, partly into copper concentrate
and partly as bullion through cyanide processing of zinc concentrates and mine
tailings.
A test program to evaluate the economies of the cyanidation of the zinc
concentrate and tailings in order to improve gold and silver recoveries found
gold and silver recoveries to range from 50% to 77%. To recover gold and silver
from the zinc concentrate and tailings, WGM recommended that a cyanidation plant
be included in the process flowsheet. Dore bullion would be produced. WGM
concluded that the inclusion of a cyanidation plant would make a positive
contribution to the economies of the project under the base conditions.
The mining and milling operation recommended by WGM for Al Masane would involve
the production of 2,000 tonnes of ore per day (700,000 tonnes per year), with a
mine life of over ten years. Annual production is estimated to be 34,900 tonnes
of copper concentrate (25% copper per tonne) containing precious metal and
58,000 tonnes of zinc concentrate (54% zinc per tonne). Total output per year of
gold and silver is estimated to be 22,000 ounces of gold and 800,000 ounces of
silver from the copper concentrate and bullion produced. The construction of
mining, milling and infrastructure facilities is estimated to take 18 months to
complete. Construction necessary to bring the Al Masane project into production
includes the construction of a 2,000 tonne per day concentrator, infrastructure
with a 300 man housing facility and the installation of a cyanidation plant to
increase the recovery of precious metals from the deposit. Project power
requirements will be met by diesel generated power.
WGM recommended that the Al Masane reserves be mined by underground methods
using trackless mining equipment. Once the raw ore is mined, it would be
subjected to a grinding and treating process resulting in three products to be
delivered to smelters for further refining. These products are zinc concentrate,
copper concentrate and dore bullion. The copper concentrate will contain
valuable amounts
2
of gold and silver. These concentrates are estimated to be 22,000 ounces of gold
and 800,000 ounces of silver and will be sold to copper and zinc custom smelters
and refineries worldwide.
In the feasibility study, WGM states that there is potential to find more
reserves within the lease area, as the ore zones are all open at depth. Further
diamond drilling, which will be undertaken by the Company, is required to
quantify the additional mineralization associated with these zones. A
significant feature of the Al Masane ore zones is that they tend to have a much
greater vertical plunge than strike length; relatively small surface exposures
such as the Moyeath zone are being developed into sizeable ore tonnages by
thorough and systematic exploration. Similarly, systematic prospecting of the
small gossans in the area could yield significant tonnages of new ore.
WGM prepared an economic analysis of the project utilizing cash flow projections
in the 1996 update of the feasibility study. A base case was prepared that
included those project elements which are most likely to be achieved. WGM
believed that a majority of the base case assumptions used in the 1994
feasibility study remained valid, including the ore reserves, mill feed grade,
production rate, metal recoveries and concentrate grade and smelter returns.
Metal prices, capital costs, operating costs and the corporate structure were
adjusted to reflect more current information. Capital and operating costs were
adjusted in conformity with the updated estimates prepared by Davy
International.
The base case assumes the corporate structure of the entity to be formed to
operate the project, currently planned to be a Saudi limited liability company,
will be owned 50% by the Company and 50% by Saudi Arabian investors and that the
owners of this entity would contribute an aggregate of $21.2 million to the cost
of the project. The base case further assumes financing for the project from
commercial loans in the aggregate amount of $21.2 million bearing interest at
the rate of 8% per year and a loan in the amount of $43.8 million from the SIDF
repayable in equal annual installments over the initial life of the mine. The
remainder of the project financing would be contributed by cash generated by the
operation of the project. The base case assumes that the $11 million loan
outstanding to the Saudi Arabian government will be paid by the Company in
accordance with a repayment schedule to be agreed upon with the Saudi Arabian
government. Based on these assumptions, and assuming the average prices of metal
over the life of the mine to be $1.05 per pound for copper, $.60 per pound for
zinc, $400 per ounce of gold and $6.00 per ounce of silver, WGM's economic
analysis of the base case shows the project will realize an internal rate of
return of 13.1%, the Company's and the Saudi Arabian investors' internal rates
of return would be 27.3% and 12.1%, respectively, and projected net cash flow
from the project of $95.1 million. The 1994 feasibility study base case showed
the project would realize a 14.05% internal rate of return. Cash flow under the
base case is exclusive of income tax as the base case assumes that any such tax
would be paid by individual investors and not by the project. Assuming a 10%
discount rate, the net present value of the project as shown in the update is
$12.16 million compared to the $15.5 million net present value of the project
shown in the 1994 feasibility study. Based on the update, WGM believes that the
economic analysis shows that the project remains viable.
The Company retained Carlyle SEAG ("Carlyle"), of Washington, D.C. and Saudi
Arabia, on March 27, 1995 as the Company's financial advisor in connection with
the Al Masane mining project. On March 13, 1996, the agreement with Carlyle was
effectively terminated by mutual consent. A new financial and legal services was
signed on May 20, 1996. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
On September 30, 1995, the Company made a formal application to the SIDF for an
interest-free loan to fund 50% of the capital cost of the Al Masane project. The
1994 feasibility study was submitted to the SIDF together with the application.
The SIDF informed the Company that in order to be eligible for a loan, the
Company and its Saudi Arabian advisors had to obtain an industrial license for
the project from The Ministry of Industry and Electricity. An industrial license
was issued on December 3, 1996. The industrial license and the 1996 update to
the feasibility study were presented to the SIDF on December 23, 1996. As
required by the SIDF, the Company is preparing, through its engineering
consultants, bid documents to be given to three bidders who have been qualified
to construct the plants and infrastructure of the
3
project. The Company anticipates that these bid documents will be completed
before April 15, 1997. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
On May 15, 1991, the Company filed a complaint with the U.S. Department of
Justice ("DOJ") against Hunt Oil Company of Dallas, Texas ("Hunt"), alleging
violations of the Foreign Corrupt Practices Act ("FCPA") by Hunt in obtaining
its Petroleum Production Sharing Agreement ("PSA") in Yemen in 1981, subsequent
to the Company presenting a bid to the Yemen government for the same area before
Hunt made its application. The Company's Washington, D.C. attorneys opined that,
because the PSA of Hunt is still ongoing, and under its auspices, payments and
receipts occur daily, the DOJ still has jurisdiction to continue its
investigation. A letter from the DOJ on December 19, 1995 stated its interest in
receiving additional documentation regarding the Company's allegations. On
February 28, 1996, the Company sent more documents to the DOJ which it believed
further supported its allegations. The Company's Washington, D.C. attorneys
opined also that the Victim Restitution Act provides for restitution to the
Company of monies lost as a result of the alleged wrongdoing by Hunt, if Hunt is
convicted under the FCPA. A letter from the DOJ dated October 1, 1996 stated
that the documents presented did not suggest any criminal events occurred within
the statute of limitations, and that, at that time, the DOJ did not intend to
pursue the investigation. On November 18, 1996, legal counsel retained by the
Company, after studying the facts of the case, sent the DOJ an analysis
concluding that while the statute of limitations of FCPA may have lapsed, the
statute of limitations for conspiracy to violate the FCPA had not lapsed, and
that, as a consequence, the DOJ could criminally prosecute Yemen Hunt for
conspiracy to violate the FCPA. The Company's legal counsel met with the Fraud
Section of the DOJ on December 13, 1996 and were told that the DOJ would take a
more aggressive stance if more information of evidentiary quality were presented
to the DOJ. The Company intends to vigorously pursue obtaining such further
information in the United States and in Yemen.
Late in 1994, articles were published in two prominent Yemen newspapers in which
Yemen Hunt Oil Company, a wholly owned subsidiary of Hunt Oil Company of Dallas,
Texas ("Yemen Hunt"), was accused of obtaining a petroleum production sharing
agreement in Yemen in 1981 through the corruption of Yemen officials in order to
exclude the application of the Company and its then partner, Dorchester Gas
Company, from consideration for the same area. A letter to the editor of one of
these newspapers, published on December 7, 1994 and signed by the executive vice
president of Yemen Hunt, after explicitly mentioning the Company and Dorchester
Gas Company, stated that "[Yemen Hunt] knows well those suspicious companies who
are mainly engaged in political activities for the purpose of undermining the
economic interest of Yemen..." On December 26, 1995, the Company filed a
complaint of criminal libel with the Yemen Attorney General for Publications in
Sana'a, Yemen against Yemen Hunt, alleging that Yemen Hunt, in its published
letter to the prominent Yemen newspaper, had criminally libeled the Company,
which, if not addressed, could seriously affect the business and reputation of
the Company and its employees in the Middle East. In October 1996, the Company
received the official decision from the Deputy Attorney General for Publications
of Yemen which stated that, after taking the statement of the President of the
Company and the statement of the chief of the legal department of Yemen Hunt, it
was evident that the letter from Yemen Hunt published in the Yemen newspaper on
December 7, 1994 was libelous to the Company. However, since the four month
statute of limitations period under Yemen criminal law had run, Yemen Hunt could
not be prosecuted for criminal libel. The Company intends to vigorously pursue
the matter under the civil libel laws of Yemen.
The Company owns, through a wholly owned subsidiary, South Hampton Refining
Company, of Silsbee, Texas which owns and operates a special products refinery
which produces pure pentanes and hexanes and other specialty chemicals for the
plastics industry. Total gross revenues for 1996 for the refinery were
approximately $21.4 million and the cash flow realized was approximately
$655,000. It is significant that the plant sells about 40% of all pentanes
consumed in the United States.
4
The Company directly owns approximately 46% and beneficially owns approximately
55% of the outstanding capital stock of Pioche-Ely Valley Mines, Inc.
("Pioche"), an inactive mining company. Pioche's principal assets are a 300 ton
per day mill, and 48 patented and 84 unpatented federal lode mining claims in
the Pioche Mining District in southeastern Nevada, on which is located the Ely
Valley Mine which, between 1941 and 1952, produced 675,207 tons of ore with an
average grade of 9.09% zinc. The Company intends to conduct limited exploration
of the Pioche properties when funds are available.
Respectfully submitted,
John A. Crichton
Chairman of the Board
Hatem El-Khalidi
President and Chief Executive
Officer
March 28, 1997
5
THE COMPANY.
Arabian Shield Development Company (the "Company") was organized as a Delaware
corporation in 1967 and is principally engaged in the business of developing its
undeveloped mineral properties. None of the undeveloped mineral properties are
currently producing and significant capital expenditures will be necessary
before any commercial operations are commenced. The Company has operations in
both the United States and Saudi Arabia. The Company is primarily engaged in the
exploration and development of minerals in Saudi Arabia.
SAUDI ARABIAN ACTIVITIES. The Company holds a mining lease covering a 44 square
kilometer area in the Al Masane area in southwestern Saudi Arabia. The lease was
granted to the Company by Royal Decree in May 1993. The lease has an initial
thirty (30)-year term and is renewable for additional periods not to exceed
twenty (20) years. The Al Masane area has proven and probable ore reserves of
copper, zinc, gold and silver (7.2 million tonnes of ore containing 1.42%
copper, 5.31% zinc, 1.19 grams per tonne of gold and 40.20 grams per tonne of
silver). The results of the 1996 update to the 1994 bankable feasibility study
conducted by an independent mineral consulting firm indicate that the proposed
Al Masane mining operation is economically viable.
National Mining Company, a private Saudi company ("National Mining"), which
previously had a 50% interest in the joint venture formed to explore and develop
the Al Masane area, relinquished its rights to the mining lease and assigned
them to the Company. The Company was granted exploration licenses for the Wadi
Qatan and Jebel Harr areas in southwestern Saudi Arabia, approximately 30
kilometers east of the Al Masane area, in 1971 and 1977, respectively. The
exploration licenses by their terms have expired. The Company has been orally
advised by Saudi Arabian government officials that the licenses will be extended
as long as mineral exploration is being conducted on the areas which they cover,
although there can be no assurance that the Company's license rights will be
honored. Although the expired exploration licenses for Wadi Qatan and Jebel Harr
were awarded jointly to the Company and National Mining, the exploration work on
the licensed areas has been carried on exclusively by the Company. Pursuant to
an agreement among the Company, National Mining and the Petroleum and Mineral
Organization ("Petromin"), the official mining and petroleum company of the
Saudi Arabian government, which governed the rights of the parties if an
exploration license was converted into a mining lease, National Mining's rights
in these jointly held expired exploration licenses entailed responsibilities of
joint exploration expenditures which National Mining did not want to assume. For
this reason, National Mining has orally advised the Company that it has
relinquished its rights in all other areas in Saudi Arabia and assigned them to
the Company. No consideration was paid by the Company to National Mining for the
relinquishment of National Mining's rights in all other areas of Saudi Arabia.
The Company remains a party to the agreement with Petromin notwithstanding
National Mining's relinquishment of its rights. When financing for the Al Masane
project is completed, the Company plans to make an application for an expanded
exploration license for an area of approximately 2,800 square kilometers which
includes the original Greater Al Masane area and the Wadi Qatan and Jebel Harr
areas.
In May 1993, the Company had discussions with Chevron Chemical Company regarding
the Company's proposal to purchase 5,000 barrels per day of mixed pentanes from
an Aromax(R) petrochemical project to be built in Jubail, Saudi Arabia by
Chevron Chemical in a joint venture with Saudi Venture Capital Group (SVCS). The
Company and some Saudi partners, all of whom are directors and/or stockholders
of the Company, plan to form a Saudi limited liability company which will build
and manage a processing plant located next to the Aromax(R) plant in Saudi
Arabia. The Company would have a 25% interest in the limited liability company
and would manage the plant. The plant will be similar to the South Hampton
refinery in producing purified pentanes from a feedstock of mixed pentanes
obtained from the Aromax(R) plant. Chevron Chemical advised the Company by
letter in July 1993 that Chevron Chemical and SVCS have jointly agreed to commit
to supply the proposed pentane project with up to 5,000 barrels per day of mixed
pentane feedstock. Engineering and marketing studies of the project made in 1994
by outside consultants reflected positive results. Planning then began toward
the construction and operation of the Aromax(R) plant and the processing plant
but was delayed during 1995 because of the absence of a firm commitment for the
feedstock supply to the Aromax(R) plant. The Aromax(R) plant received final
approval
6
from the Saudi Arabian government in March 1996 and the Company and its Saudi
partners, following the confirmation of their agreement with Chevron Chemical,
are preparing an application for an industrial license from the Ministry of
Industry to build the processing plant. The application will be submitted in the
near future.
In December 1993, the Company commissioned Sherritt Ltd. of Fort Saskatchewan,
Canada, to prepare a conceptual engineering design for a proposed zinc refinery
based on Sherritt's two stage pressure leach process, to be built by the Company
and Saudi partners at the Red Sea port of Yanbu, Saudi Arabia. The refinery
would have the capacity to produce 100,000 tonnes of slab zinc per year, with
elemental sulfur as a by-product. Sherritt Ltd. completed the study in May 1994
which contains a proposed flow sheet that has been commercialized and designed
for a state of the art zinc refinery. Sherritt's zinc pressure leach technology
provides significant advantages over other existing zinc production processes,
including having the reputation as the most favored technology for environmental
considerations. In its study, Sherritt concluded, after considering all of the
presently identifiable elements, that they offer a strong potential for the
project and enhance the concept. Sherritt encouraged the Company to carry out
further studies toward the implementation of the project. There has been a
recent inquiry about this project from a zinc smelting and refining company in
Asia.
UNITED STATES ACTIVITIES. The Company's United States operations include the
ownership and operation of a special products refinery and the leasing of
mineral properties.
An indirect wholly owned subsidiary of the Company owns and operates a special
products refinery near Silsbee, Texas which sells its products primarily to
companies in the chemical and plastics industry. The refinery is presently
devoted to specialized processing activities. Another indirect wholly owned
subsidiary owns and operates three pipelines connected to the refinery.
The Company owns all of the capital stock of a coal company which does not
presently own or hold any mineral interests and is presently inactive. The coal
company had a net operating loss carryforward of approximately $5.9 million at
December 31, 1996. The Company has had negotiations with several companies
toward the possible use of the Coal Company's carryforward amount, but no
agreements have been reached.
The Company beneficially owns approximately 55% and directly owns approximately
46% of the outstanding capital stock of a company which leases mineral
properties containing 132 inactive mining claims totalling approximately 3,700
acres in southeastern Nevada. There are prospects and mines on these claims
which formerly produced silver, gold, lead, zinc and copper.
The Company leases office space in Jeddah, Saudi Arabia and in Dallas, Texas. It
also has a base camp with a capacity to accommodate 60 people in its Al Masane
mining lease area. The Company owns heavy mining equipment at the lease area,
which will be used for future mining operations. The Company also has an
exploration and drilling camp in the Wadi Qatan area in Saudi Arabia.
MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock traded on The NASDAQ Stock Market under the symbol:
ARSD. The following table sets forth the high and low closing sale prices for
each quarter of 1996 and 1995, respectively, as reported by NASDAQ.
1996 1995
-------------------------------------------- --------------------------------------------
1st 2nd 3rd 4th 1st 2nd 3rd 4th
--- --- --- --- --- --- --- ---
High 3 3/4 3 3/8 2 5/8 2 3/32 2 3/8 2 3/8 1 7/8 1 1/4
Low 1/4 1 1/2 1 1/2 1 5/8 1 3/4 1 5/8 5/8 5/8
At March 17, 1997, there were 900 record holders of the Company's Common Stock.
The Company has not paid a dividend since its inception.
7
SELECTED FINANCIAL DATA.
The following is a five-year summary of selected financial data of the Company
(in thousands, except per share amounts):
1996 1995 1994 1993 1992
------- ------- ------- ------- -------
Revenues................................. $22,014 $18,359 $17,765 $15,267 $13,468
Net Income (Loss)........................ $ (391) $ (369) $ 2,852 $(1,338) $(2,196)
Net Income (Loss) Per Share.............. $ (.02) $ (.02) $ .14 $ (.08) $ (.14)
Total Assets (at December 31)............ $44,096 $40,805 $41,057 $41,090 $38,729
Notes Payable (at December 31)........... $11,376 $15,086 $15,945 $18,044 $18,571
Total Long-Term Obligations
(at December 31)....................... $ 4,423 $ 1,676 $ 1,148 $ 908 $ 889
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
With the exception of revenues generated by the operations of the refinery, the
Company has been without any significant operating revenues since 1972.
Accordingly, it has financed its development activities and its general and
administrative costs through the sale of shares of its Common Stock and loans.
The Company experienced serious difficulties during prior years in obtaining
additional financing, and is currently in need of additional funds to meet its
obligations and continue development activities. The Company is exploring
various alternatives for obtaining additional operating funds, including
additional debt or equity financing, but there is no assurance that sufficient
funds can be obtained. It is also possible that the terms of any additional
financing that the Company is able to obtain will be unfavorable to the Company
and its existing stockholders. For example, additional equity financing could
result in a significant dilution of the interests of existing stockholders.
Management of the Company expects to be devoting a significant amount of its
attention in the near future to addressing the Company's immediate and longer
term needs for the funds that are required in order to continue its business and
maintain and develop its properties.
During 1996, the Company took certain actions designed to generate additional
equity capital and improve its financial condition, including: (i) the
negotiation by South Hampton Refining Company, an indirect wholly owned
subsidiary of the Company ("South Hampton"), of an Amended and Restated Credit
Agreement with Den norske Bank ASA, amending and restating the then outstanding
credit agreement to provide for a revolving credit facility in an aggregate
principal amount of up to $1,965,000; (ii) the restructuring of certain
indebtedness of South Hampton owed to Saudi Fal Co., Ltd., a limited liability
company owned by a stockholder of the Company ("Saudi Fal"), and American Shield
Refining Company, a wholly owned subsidiary of the Company (the "Refining
Company"), pursuant to promissory notes in the original principal amounts of
$1,945,773.49 and $1,694,605.08, respectively, which promissory notes are
subordinated to the Amended and Restated Credit Agreement with Den norske Bank
ASA; (iii) approval by the Company's Board of Directors in June 1996 of the sale
of up to 1 million shares of the Company's Common Stock through private
placements at a price no less than $1.00 per share; (iv) the sale of 450,000
shares of the Company's Common Stock at $1.00 per share to a Saudi Arabian
investor who is a stockholder of the Company and approval of the sale of an
additional 450,000 shares of the Company's Common Stock at $1.00 per share to
the same investor, the purchase price for such additional shares being payable
in monthly installments of $100,000; and (v) approval of the sale of 50,000
shares of the Company's Common Stock to a Saudi Arabian investor.
The exploration licenses held by the Company for the Wadi Qatan and Jebel Harr
areas in Saudi Arabia, by their terms, have expired, although officials of the
Saudi Arabian government have provided verbal assurance to the Company that the
licenses will be extended as long as exploratory work is being carried out on
the areas which they cover. None of the related projects at Al Masane or the
other interests in Saudi Arabia were being developed at December 31, 1996 and
significant additional expenditures will be necessary before commercial
operations are commenced. A substantial portion of the Company's total assets is
comprised of the mineral acquisition, exploration and development costs in Saudi
Arabia. The
8
ultimate recoverability of these deferred costs cannot be determined at the
present time. The Company holds the mining lease for the Al Masane area
exclusively.
The 1996 update to the 1994 feasibility study shows the estimated total capital
cost to bring the Al Masane project into production to be $88.6 million. At the
present time, the Company does not have sufficient funds to bring the project
into production.
To assist the Company in obtaining financing for the project, on March 27, 1995,
the Company retained Carlyle SEAG of Washington, D.C. ("Carlyle") as the
Company's financial advisor. On March 13, 1996, the agreement with Carlyle was
terminated by mutual consent after Carlyle informed the Company that it had to
withdraw as the Company's financial advisor because of a conflict of interest
since the Carlyle Group, which owns Carlyle, advises the Saudi Arabian
government on its offset program.
After the agreement with Carlyle was terminated, on May 20, 1996, the Company
entered into a Financial and Legal Services and Advice Agreement with Nasir Ali
Kadasah, for legal advice, and Dar Al Khaleej, a Saudi Arabian consulting
company, for research and economic advice. The purpose of this agreement is for
the two Saudi Arabian advisors to assist the Company in obtaining financing for
the Al Masane project. To this end, the agreement contemplates that the Saudi
Arabian advisors will perform the following:
1. The formation of a Saudi limited liability company, "The Saudi Company
for Mining Industries," 50% of which would be owned by the Company and the
remaining 50% of which would be owned by Saudi Arabian investors who will
contribute 25% of the capital cost of the project.
2. Obtain an industrial license for the project from the Ministry of
Industry and Electricity. This license is a necessary prerequisite for
obtaining an interest-free loan from the Saudi Industrial Development Fund
("SIDF") to fund 50% of the capital cost of the project.
3. Finalize the necessary procedures to obtain such loan from the SIDF, the
application for which was submitted on September 30, 1995.
4. Apply for and receive loans from commercial banks necessary to finance
the project.
5. Apply for and obtain the Ministerial Resolution from the Minister of
Petroleum and Mineral Resources approving the transfer of the mining lease
to the Saudi limited liability company.
The agreement provides that the Saudi Arabian advisors are solely responsible
for the performance of the foregoing obligations and that the Company has no
obligation therefor.
As consideration for performing these obligations, the Company has agreed to pay
Mr. Kadasah and Dar Al Khaleej $10,000 each upon the issuance of the industrial
license and Mr. Kadasah $10,000 upon approval of the loan by the SIDF. The
Company has also agreed to issue to Mr. Kadasah and Mr. Tawfiq Abdulaziz
Al-Sowailim, as agent for Dar Al Khaleej, up to 1,025,000 and 975,000 shares of
the Company's Common Stock, respectively, and to grant Mr. Kadasah and Mr.
Tawfiq Abdulaziz Al-Sowailim, as agent for Dar Al Khaleej, options to purchase
up to 1,425,000 and 875,000 shares of the Company's Common Stock, respectively.
The Company is obligated to issue such shares and grant such options in
designated amounts upon completion of each of the foregoing obligations. The
issuance of the shares would be for consideration consisting solely of services
rendered to the Company. The options are immediately exercisable on the date of
grant, have a five-year term commencing on the date of formation of the Saudi
limited liability company and an exercise price of $1.00 per share.
The SIDF makes interest-free loans to industrial projects in Saudi Arabia and
charges a 2.5% service fee. The Company believes that it may also be able to
finance the remaining cost of the project through arrangements with suppliers
and equipment manufacturers, custom smelters and additional debt or equity
financing secured by the Company, however, there can be no assurances to that
effect.
Pursuant to the mining lease agreement, when the profitability of the project is
established, the Company is obligated to form a Saudi public stock company with
Petromin. The Company will own 50% of the shares of the Saudi public stock
company and Petromin no more than 25% of the shares. The remaining shares will
be offered for sale in Saudi Arabia pursuant to a public subscription. Title to
the mining lease
9
and the other obligations specified in the mining lease will be transferred to
the Saudi public stock company. Responsibility for the repayment of the $11
million loan from the Saudi Arabian government will remain with the Company. In
December 1994, the Company received instructions from the office of the Minister
of Petroleum and Mineral Resources stating that it is possible for the Company
to form a Saudi company without Petromin but that the sale of stock to the Saudi
public could occur only after two years of profits from commercial operations of
the mine. The instructions added that Petromin will still have the right to
purchase shares in the Saudi public stock company any time it desires.
On October 15, 1996, South Hampton entered into an Amended and Restated Credit
Agreement (the "Credit Agreement") with Den norske Bank ASA (the "Bank"),
amending and restating the then outstanding credit agreement to provide for a
revolving loan facility in an aggregate principal amount of up to $1,965,000.
The Bank's commitment to make funds available under the credit facility will be
reduced by (i) $75,000 on the last day of each fiscal quarter commencing
December 31, 1996 and (ii) the amount of any distribution by South Hampton to
Saudi Fal, the Company, the Refining Company or Texas Oil and Chemical Co. II, a
wholly owned subsidiary of the Refining Company ("TOCCO"), in excess of amounts
permitted under the Credit Agreement. Advances under the Credit Agreement may
not at any time exceed the lesser of the commitment or a borrowing base
calculated based upon the cash collateral account, eligible accounts receivable
and inventory. Interest is payable monthly in arrears on all outstanding
advances under the credit facility at the Bank's prime lending rate, as in
effect from time to time, plus 1%. Principal and accrued and unpaid interest are
payable on December 31, 1998. Subject to certain conditions and South Hampton
maintaining various financial covenants and ratios, the Credit Agreement permits
South Hampton to make distributions to (i) Saudi Fal, the Company, the Refining
Company and TOCCO for legal, auditing and accounting fees attributable to the
operations of South Hampton in an annual aggregate amount not in excess of
$60,000, (ii) Saudi Fal and the Company in respect of accrued interest on any
debt owned by South Hampton to Saudi Fal or the Company in an amount not in
excess of $17,500 per month and (iii) Saudi Fal and the Company in respect of
principal on any debt owed by South Hampton to Saudi Fal or the Company. The
Credit Agreement is secured by all of the assets of South Hampton and Gulf State
Pipe Line Company, Inc., a wholly owned subsidiary of South Hampton ("Gulf
State"), and all of the issued and outstanding shares of TOCCO, South Hampton
and Gulf State. South Hampton is required to collect all receivables through a
cash collateral account at a local bank. South Hampton was not in compliance
with a certain financial covenant as of December 31, 1996, which noncompliance
has been waived by the Bank.
In connection with South Hampton's entry into the Credit Agreement with the
Bank, South Hampton issued a Second Lien Promissory Note to Saudi Fal and a
Third Lien Promissory Note to the Refining Company in the original principal
amounts of $1,945,773.49 and $1,694,605.08, respectively, evidencing certain
indebtedness of South Hampton owed to such parties. The promissory notes bear
interest at the Bank's prime lending rate, as in effect from time to time, plus
1%. Interest only is due and payable monthly on the promissory notes, and the
entire unpaid balance of principal and accrued and unpaid interest is due on
December 31, 1998. The promissory notes are secured by all of the assets of
South Hampton and Gulf State. The promissory notes and related liens are
subordinated to the Credit Agreement. The promissory note issued to the Refining
Company and related liens are subordinate to the promissory note issued to Saudi
Fal.
The Clean Air Act Amendments of 1990 have had a positive effect on the
refinery's business as plastics manufacturers are searching for ways to use more
environmentally acceptable solvents in their processes. Plastics manufacturers
have historically used C6 hydrocarbons (hexanes) as coolants and catalyst
carrying agents. There is a current trend among plastics manufacturers toward
the use of lighter and more recoverable C5 hydrocarbons (pentanes) which are a
large part of the refinery's product line. Management believes that the
refinery's ability to manufacture high quality solvents in the C5 hydrocarbon
market will provide the basis for growth over the next few years; however, there
can be no assurance that such growth will occur. While the refinery continues to
manufacture C6 solvents, its manufacturing of these solvents is being phased
out. The Aromax(R) unit, which was jointly developed by the refinery and Chevron
Research, has the ability to convert C6 hydrocarbons into benzene and other more
valuable
10
aromatic compounds, which was part of the reason the refinery participated in
the Aromax(R) development project initially.
The Company's financial statements have been prepared assuming that the Company
will continue as a going concern. The Company's current primary source of cash
flow is attributable to the refinery which is fully dedicated to the repayment
of debt and the funding of refinery operations. The Company is not presently
generating any cash flow from any of its other activities. Management plans to
fund future operations initially through sales of its Common Stock and
borrowings. It is expected that the operations and obligations of the Company
will be eventually funded from operations of the Al Masane mine. However,
because of uncertainties with respect to future sales of Common Stock, obtaining
suitable financing and reaching an agreement on the repayment of the loan to the
Saudi Arabian government, there is substantial doubt about the Company's ability
to continue as a going concern. The Company's financial statements do not
include any adjustments that might result from the outcome of these
uncertainties.
RESULTS OF OPERATIONS
COMPARISON OF THE YEARS 1996 TO 1995
During the fiscal year ended December 31, 1996, the Company had a net loss of
$390,896 compared to a net loss of $369,232 for the fiscal year ended December
31, 1995.
The gross refined product sales in 1996 of $21,367,438 was an increase of
$3,625,576 from 1995 while the cost of sales in 1996 of $19,357,737 was an
increase of $3,782,683 from 1995, resulting in a net margin decrease in 1996 of
$157,107. After processing fee income, general and administrative expenses and
depreciation and amortization, the operating loss of the Company in 1996 of
$321,124 was $54,888 more than the operating loss in 1995 of $266,236. The net
income for the refinery in 1996 of $134,391 was $225,210 less than the net
income in 1995 of $359,601.
The refinery's net income in 1996 was not indicative of its performance for the
year. The volume of refined products sold increased 18% to 24.5 million gallons
versus 20.8 million gallons sold in 1995. The strong volume of sales reflected
increased sales to existing customers and an increased marketing effort which
resulted in new customers. The plastics industry continued to experience a
steady demand which resulted in the continued growth in the volume of refined
products sold. However for much of 1996 and particularly in the last two months
of the year, gross and operating margins were weaker than the refinery had
experienced in recent years. During the fourth quarter and particularly in
November and December of 1996, feedstock prices and natural gas fuel prices
increased to unusual high levels eroding the refinery's steady performance over
the first ten months of the year. Sales commitments and competitive pressures
did not allow the refinery to pass through the higher costs immediately,
although by the first quarter of 1997 selling prices had been raised. The
refinery's focus on producing products in the higher priced solvents markets
allowed it to raise selling prices during the year although not enough to offset
the total spike in feed costs at year end.
The primary feedstock of the refinery, natural gasoline, is the heavier liquid
produced by natural gas processing plants and by LPG fractionators. Feedstock
prices in 1996 were 10% higher than in 1995 resulting in reduced gross margins
on sales. The chemical industry, particularly the ethylene crackers, continued
to be the big user of natural gasoline in 1996 which contributed to the higher
feedstock prices. Feedstock prices, which peaked during the period from November
1996 through February of 1997, have returned to their former levels and are
expected to remain there for most of 1997.
The refinery has experienced a healthy growth in its toll processing business
over the last three years and expects the opportunities to continue to develop,
although there can be no assurances to that effect. Toll processing and tank
rental fees were $297,757, $694,797 and $724,849 in 1994, 1995 and 1996,
respectively. The increase in the toll processing business is indicative of the
direction of the refining and petrochemical industries in the U.S. Many larger
companies are "right sizing" and outsourcing smaller jobs and processes which
have been formerly managed within their own facilities. The refinery has been
11
in the toll processing business for over 30 years and has a good reputation in
the industry for this type of work. Management intends to expand the refinery's
involvement in this area as opportunities arise.
General and administrative expenses decreased by $88,261 to $2,284,422 in 1996
from $2,372,683 in 1995. This decrease was mostly attributable to a stock option
expenses of $151,431 in 1995. Interest expense, which was practically all
attributable to the debt of the refinery, decreased slightly by $32,567 from
$369,546 in 1995 to $336,979 in 1996. This decrease was primarily due to a
reduced amount of debt at the refinery in 1996.
The equity in losses of affiliate in 1995 and 1994 was attributable to the cost
of maintaining the Nevada mining properties of Pioche Ely Valley Mines, Inc.
("Pioche"). In 1996, the Company concluded that its voting control of Pioche was
no longer temporary and, therefore, the asset and liability amounts of Pioche
have been consolidated into its financial statements. The minority interest in
1996 of $13,072 represents the Pioche minority shareholders portion of Pioche's
1996 loss. There has been no activity in several years on the Pioche properties
primarily due to the lack of financing for claims to be explored and developed.
Interest income in 1996 and 1995 was from the investment of temporary excess
cash in time deposits in Saudi Arabia and a short-term investment by the
refinery. In 1996 and 1995, there was no operating activity on any of the Saudi
Arabia mining properties. Assuming financing can be obtained, the results of the
1996 update to the 1994 feasibility study contemplate that construction of an
ore treatment plant and all infrastructure for a mining facility at Al Masane is
estimated to take 18 months to complete at an estimated cost of $88.6 million,
an increase of $7.3 million over the 1994 study estimate.
Miscellaneous income represents various items of other income which individually
are not significant enough to warrant being separately disclosed. These items
primarily include income from tank rentals, building rentals, commission income
and occasional small asset sale proceeds. In 1996 and 1995, the refinery
received $101,640 each year from the leasing of an office building. Tank rentals
accounted for $78,000 in each year.
Primarily as a result of the Company's write-off of its total investment in the
coal leases in 1988, the Company had net operating loss carryforwards of
approximately $33.3 million at December 31, 1996, of which approximately $5.9
million is limited to any future net income of the coal company and
approximately $1.7 million is limited to any future net income of the refinery.
These carryforwards expire during the years 1997 through 2010. The Company has
had negotiations with several companies toward the possible use of the coal
company's carryforward amount, but no agreements have been reached.
At December 31, 1996, a total of approximately $1,490,000 in salaries and
termination benefits accrued since 1971 was due to Company employees in Saudi
Arabia in accordance with Saudi Arabian employment laws, which includes
approximately $714,000 due to Hatem El-Khalidi, the Company's President and
Chief Executive Officer. Accrued salaries and termination benefits to Company
employees in Saudi Arabia and to Mr. El-Khalidi at December 31, 1995 were
approximately $1,373,000 and $636,000, respectively. The payment of these
amounts has been deferred until the Company's working capital position improves.
COMPARISON OF THE YEARS 1995 TO 1994
During the fiscal year ended December 31, 1995, the Company had a net loss of
$369,232 compared to net income of $2,852,306 for the fiscal year ended December
31, 1994.
The gross refined product sales in 1995 of $17,741,862 was an increase of
$177,636 from 1994 while the cost of sales in 1995 of $15,575,054 was an
increase of $1,824,304 from 1994, resulting in a net margin decrease in 1995 of
$1,646,668. After processing fee income, general and administrative expenses and
depreciation and amortization, the operating loss of the Company in 1995 of
$266,236 was $2,571,862 less than the operating income in 1994 of $2,305,626.
The net income for the refinery in 1995 of $359,605 was $3,154,593 less than the
net income in 1994 of $3,514,194. Two refining company items contributed to the
higher income in 1994: (i) operating income included $975,000 relating to the
reversal of a charge in 1992 for potential expenses relating to litigation that
was settled in
12
1994; and (ii) an extraordinary income item of $578,150 attributable to the
settlement of an indebtedness owed to a vendor.
The refinery's net income in 1995 reflected the steady demand which the plastics
industry experienced toward the end of 1994 and throughout 1995. Most of 1994
could be characterized as a period of rising prices, pent-up demand and high
operating utilization rates with strong gross margins on feedstock costs. In
comparison, the refinery's 1995 results reflect a 3% decrease in sales volume,
from 21,430,000 gallons in 1994 to 20,798,000 gallons in 1995, and a 43%
reduction in gross margins. The refinery's sales continued to be solid with the
majority of its products continuing to be placed into the higher priced
specialty markets. Several new customers were added during 1995 and product
sales attained a reasonable level of performance. The ability of the refinery to
produce the highest quality products available in its field has enabled it to
remain competitive even during the periods of low demand or high feedstock
prices.
The primary feedstock of the refinery, natural gasoline, is the heavier liquid
produced by natural gas processing plants and by LPG fractionators. Feedstock
prices in 1995 were approximately 23% higher than in 1994 resulting in reduced
gross margins. The chemical industry, primarily the ethylene crackers, continued
to be a big user of natural gasoline in 1995 which contributed to the higher
feedstock prices. Feedstock prices are expected to sustain 1995 levels
throughout most of 1996.
The refinery has experienced a healthy growth in its toll processing business
over the last three years and expects the opportunities to continue to develop,
although there can be no assurances to that effect. Toll processing fees were
$163,977, $200,757 and $616,796 in 1993, 1994 and 1995, respectively. The
increase in the toll processing business is indicative of the direction of the
refining and petrochemical industries in the U.S. Many larger companies are
"rightsizing" and outsourcing smaller jobs and processes which might have been
formerly managed in their own facilities. The refinery has been in the toll
processing business for over 30 years and has a good reputation in the industry
for this type of work. Management intends to expand the refinery's involvement
in this area as opportunities arise.
General and administrative expenses increased by $336,213 to $2,372,683 in 1995
from $2,036,470 in 1994. This increase was mostly attributable to higher
payroll, franchise tax, insurance and regulatory expenses at the refinery and
stock option expense incurred in 1995 by the Company. The expenses of regulatory
compliance and reporting continued to increase. Interest expense, which was
practically all attributable to the debt of the refinery, increased slightly by
$22,182 from $347,364 in 1994 to $369,546 in 1995. This increase was primarily
due to higher interest rates in 1995.
The equity losses of affiliate in 1995 of $24,112 represented a decrease of
$120,348 from 1994 and was applicable to the cost of maintaining the Nevada
mining properties of Pioche. The 1994 loss was higher than usual due to an
increased loss experienced by Pioche on the write-off of several unpatented
claims that were considered to have no future value. There was no activity in
1995 and 1994 on the Pioche properties primarily due to the lack of financing
for claims to be explored and developed. Interest income in 1995 and 1994 was
from the investment of excess cash in time deposits in Saudi Arabia and a short-
term investment by South Hampton. In 1995 and 1994, there was no operating
activity on any of the Saudi Arabia mining properties. Assuming financing can be
obtained, the results of the 1994 feasibility study contemplate that
construction of an ore treatment plant and all infrastructure for a mining
facility at Al Masane is estimated to take 18 months to complete. The 1994
feasibility study estimated the cost of the mining facility to be $81.3 million.
Miscellaneous income represents various items of other income which individually
are not significant enough to warrant being separately disclosed. Miscellaneous
income in 1994 included $172,737 relating to the write-off of a contingent
liability established in 1992 to provide for possible future expenses relating
to certain indebtedness of the coal company which were completely paid in 1994.
Other items included in miscellaneous income are tank rentals, building rentals,
cancellation of debt income, commission income and occasionally small asset sale
proceeds. In 1995 and 1994, the refinery received $101,640 each year from the
leasing of an office building. Tank rentals decreased from $97,000 in 1994 to
$78,000 in 1995 due to a change in lessees and a decrease in the rental rate.
13
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Arabian Shield Development Company
We have audited the accompanying consolidated balance sheet of Arabian Shield
Development Company and Subsidiaries as of December 31, 1996, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the year then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above, present fairly, in
all material respects, the consolidated financial position of Arabian Shield
Development Company and Subsidiaries as of December 31, 1996, and the
consolidated results of their operations and their consolidated cash flows for
the year then ended, in conformity with generally accepted accounting
principles.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 2 to the financial
statements, the Company's sources of cash flow in 1996 were the operations of
its refinery and the proceeds from the sale of common stock. Cash flow from the
refinery is dedicated to repaying debt and funding refinery operations. As
discussed in Notes 5 and 7 to the financial statements, the majority of the
Company's assets consist of costs related to the acquisition, exploration, and
development of mineral interests in Saudi Arabia. The ability of the Company to
develop these properties is dependent upon obtaining additional financing. As
discussed in Note 9, the Company is obligated to the Saudi Arabian government
for a loan in the amount of $11,000,000. The Company does not currently have
the financial resources to pay this obligation and is attempting to reschedule
the payment. Management's plans with regard to these matters are discussed in
Note 2. These matters raise substantial doubt about the Company's ability to
continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
As discussed in Note 3, the Company adopted the consolidation method of
accounting for its investment in Pioche-Ely Valley Mines, Inc. in 1996.
GRANT THORNTON LLP
Dallas, Texas
March 14, 1997
REPORT OF INDEPENDENT ACCOUNTANTS
To The Stockholders and Board of Directors
of Arabian Shield Development Company
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity and of cash
flows present fairly, in all material respects, the financial position of
Arabian Shield Development Company and its subsidiaries at December 31, 1995
and the results of their operations and their cash flows for each of the two
years in the period ended December 31, 1995, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As described in Note 2 to
the financial statements, the Company's primary source of cash flow is fully
dedicated to repayment of debt and funding of refinery operations.
Additionally, the Company is not generating cash flow from any of its other
activities. These matters raise substantial doubt about its ability to continue
as a going concern. Management's plans in regard to these matters are described
in Note 2. The financial statements do not include any adjustments that might
result from the outcome of these uncertainties.
As described in Notes 5 and 7 to the financial statements, a substantial
portion of the Company's total assets is comprised of mineral acquisition,
exploration and development costs relating to its interests in Saudi Arabia
which have been deferred at December 31, 1995. None of the related projects
have been developed for commercial operation as of December 31, 1995, and
significant expenditures, for which the Company must obtain financing, will be
necessary before commercial operations, if any, are commenced.
As described in Note 10 to the financial statements, the Company is in default
on repayment of an $11 million loan from the Saudi Arabian government which was
made to the Al Masane Project. The Company is attempting to reschedule payment
of the loan.
As described in Notes 5 and 10 to the financial statements, the Company's
refining subsidiary, South Hampton Refining Company ("South Hampton"), has
short-term notes payable and current portions of long-term obligations totaling
$3.8 million. South Hampton does not have the ability to fully repay these
current obligations from internally generated funds. Arabian Shield Development
Company has not guaranteed the debt obligations of South Hampton. The Company's
financial statements do not include any adjustments that might be necessary
should South Hampton be unable to satisfy its current obligations in an
orderly manner.
PRICE WATERHOUSE LLP
- ---------------------------
PRICE WATERHOUSE LLP
Dallas, Texas
March 25, 1996
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
-------------------------
ASSETS 1996 1995
----------- -----------
CURRENT ASSETS
Cash and cash equivalents in United States $ 209,251 $ 302,039
Short-term investments 298,726 294,610
Accounts receivable (net of allowance
for doubtful accounts of $168,484 in
1996 and $145,709 in 1995) 2,643,691 1,791,821
Inventories 565,346 430,732
----------- -----------
Total current assets 3,717,014 2,819,202
CASH IN SAUDI ARABIA 176,039 396,809
REFINERY PLANT, PIPELINE AND EQUIPMENT - AT COST 5,758,852 5,563,776
LESS ACCUMULATED DEPRECIATION 2,911,823 2,557,454
----------- -----------
REFINERY PLANT, PIPELINE AND EQUIPMENT, NET 2,847,029 3,006,322
AL MASANE PROJECT 32,882,838 30,897,883
OTHER INTERESTS IN SAUDI ARABIA 2,431,248 2,431,248
MINERAL PROPERTIES IN THE UNITED STATES 1,418,615 --
INVESTMENT IN AND ADVANCES TO
PIOCHE-ELY VALLEY MINES, INC -- 239,032
GOODWILL 117,598 397,902
OTHER ASSETS 505,566 617,019
----------- -----------
TOTAL ASSETS $44,095,947 $40,805,417
=========== ===========
The accompanying notes are an integral part of these statements.
3
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
December 31,
----------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995
------------ ------------
CURRENT LIABILITIES
Accounts payable $ 1,408,677 $ 674,641
Accrued liabilities 520,445 617,995
Accrued liabilities in Saudi Arabia 1,174,229 1,011,980
Notes payable 11,375,780 15,086,191
Current portion of long-term debt 992,729 78,090
Current portion of long-term obligations 150,904 20,285
------------ ------------
Total current liabilities 15,622,764 17,489,182
LONG-TERM DEBT 3,544,112 708,534
LONG-TERM OBLIGATIONS 35,009 185,875
ACCRUED LIABILITIES IN SAUDI ARABIA 714,143 636,047
DEFERRED REVENUE 129,685 145,189
COMMITMENTS AND CONTINGENCIES -- --
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY 1,003,590 --
STOCKHOLDERS' EQUITY
Common stock, authorized 40,000,000 shares of $.10
par value: issued and outstanding, 20,956,494 shares
in 1996 and 20,206,494 shares in 1995 2,095,649 2,020,649
Additional paid-in capital 34,932,700 33,210,750
Receivables from stockholders (126,000) (126,000)
Accumulated deficit (13,855,705) (13,464,809)
------------ ------------
Total stockholders' equity 23,046,644 21,640,590
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 44,095,947 $ 40,805,417
============ ============
The accompanying notes are an integral part of these statements.
4
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the three years ended December 31, 1996
1996 1995 1994
------------ ------------ ------------
Revenues
Refined product sales $ 21,367,438 $ 17,741,862 $ 17,564,226
Processing fees 646,848 616,796 200,757
------------ ------------ ------------
22,014,286 18,358,658 17,764,983
Operating costs and expenses
Cost of refined product sales and processing 19,357,737 15,575,054 13,750,750
General and administrative 2,284,422 2,372,683 2,036,470
Depreciation and amortization 693,251 677,157 647,137
Litigation -- -- (975,000)
------------ ------------ ------------
22,335,410 18,624,894 15,459,357
------------ ------------ ------------
Operating income (loss) (321,124) (266,236) 2,305,626
Other income (expense)
Interest income 25,310 33,395 56,491
Interest expense (336,979) (369,546) (347,364)
Minority interest 13,072 -- --
Equity in losses of affiliate -- (24,112) (114,460)
Miscellaneous income 228,825 257,267 443,836
------------ ------------ ------------
Income (loss) before income taxes and extraordinary item (390,896) (369,232) 2,314,129
Income tax expense -- -- (39,973)
------------ ------------ ------------
Income (loss) before extraordinary item (390,896) (369,232) 2,274,156
Extraordinary item -- -- 578,150
------------ ------------ ------------
Net income (loss) $ (390,896) $ (369,232) $ 2,852,306
============ ============ ============
Per common share
Income (loss) before extraordinary item $ (0.02) $ (0.02) $ 0.11
Extraordinary item -- -- 0.03
------------ ------------ ------------
Net income (loss) $ (0.02) $ (0.02) $ 0.14
============ ============ ============
Weighted average number of common shares outstanding 20,286,208 20,030,434 20,027,881
============ ============ ============
The accompanying notes are an integral part of these statements.
5
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Common stock Additional Receivables
---------------------------- paid-in from Accumulated
Shares Amount capital stockholders deficit Total
------------ ------------ ------------ ------------ ------------ ------------
December 31, 1993 20,014,494 $ 2,001,449 $ 32,886,519 $ (326,000) $(15,947,883) $ 18,614,085
Common stock and common
stock subscriptions sold 14,000 1,400 12,600 -- -- 14,000
Payment on stockholder
receivables -- -- -- 50,000 -- 50,000
Net income -- -- -- -- 2,852,306 2,852,306
------------ ------------ ------------ ------------ ------------ ------------
December 31, 1994 20,028,494 2,002,849 32,899,119 (276,000) (13,095,577) 21,530,391
Common stock and common
stock subscriptions sold 278,000 27,800 250,200 -- -- 278,000
Payment on stockholder
receivables -- -- -- 50,000 -- 50,000
Write-off of stockholder
receivable (100,000) (10,000) (90,000) 100,000 -- --
Stock options issued 151,431 151,431
Net loss -- -- -- -- (369,232) (369,232)
------------ ------------ ------------ ------------ ------------ ------------
December 31, 1995 20,206,494 2,020,649 33,210,750 (126,000) (13,464,809) 21,640,590
Common stock sold 450,000 45,000 405,000 -- -- 450,000
Common stock issued
for services 300,000 30,000 520,000 -- -- 550,000
Stock options issued -- -- 796,950 -- -- 796,950
Net loss -- -- -- -- (390,896) (390,896)
------------ ------------ ------------ ------------ ------------ ------------
December 31, 1996 20,956,494 $ 2,095,649 $ 34,932,700 $ (126,000) $(13,855,705) $ 23,046,644
============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of this statement.
6
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three years ended December 31, 1996
1996 1995 1994
----------- ----------- -----------
Operating activities
Net income (loss) $ (390,896) $ (369,232) $ 2,852,306
Adjustments for non-cash transactions
Depreciation and amortization 693,251 677,157 647,137
Equity in losses of affiliate -- 24,112 144,460
Stock options issued -- 151,431 --
Extraordinary item -- -- (578,150)
Effects of changes in
Decrease (increase) in accounts receivable (845,570) (388,839) 101,134
Decrease (increase) in inventories (134,614) 40,342 175,965
Decrease in other assets 135,287 87,016 30,052
(Decrease) increase in accounts payable and
accrued liabilities 454,810 (267,830) (821,334)
Decrease in deferred revenue (15,504) (15,504) (15,504)
Other (70,529) (12,190) (82,078)
----------- ----------- -----------
Net cash provided by (used for) operating
activities (173,765) (73,537) 2,453,988
----------- ----------- -----------
Investing activities
Additions to short-term investments (4,116) (291,915) (243,770)
Proceeds from sale of short-term investments -- 255,787 --
Additions to Al Masane Project (451,110) (785,751) (743,709)
Additions to refinery plant, pipeline and equip (195,076) (153,235) (279,122)
Decrease in cash in Saudi Arabia 220,770 34,167 1,257,042
Increase (decrease) in accrued liabilities in Saudi Arabia 53,450 276,366 (105,276)
----------- ----------- -----------
Net cash used for investing activities (376,082) (664,581) (114,835)
----------- ----------- -----------
Financing activities
Common stock issued for cash 450,000 -- --
Decrease in receivables from stockholders -- 50,000 50,000
Additions to notes payable and long-term obligations 445,773 721,000 --
Reduction of notes payable and long-term obligations (438,714) (809,192) (1,429,632)
----------- ----------- -----------
Net cash provided by (used for) financing
activities 457,059 (38,192) (1,379,632)
----------- ----------- -----------
Net increase (decrease) in cash (92,788) (776,310) 959,521
Cash and cash equivalents at beginning of year 302,039 1,078,349 118,828
----------- ----------- -----------
Cash and cash equivalents at end of year $ 209,251 $ 302,039 $ 1,078,349
=========== =========== ===========
The accompanying notes are an integral part of these statements.
7
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BUSINESS AND OPERATIONS OF THE COMPANY
Since its organization on May 4, 1967, the principal activity of Arabian
Shield Development Company (the "Company") has been the exploration and
development of mineral deposits in Saudi Arabia (Note 7). In February 1986,
the Company purchased all of the issued and outstanding capital stock of
Dorchester Coal Company, which was subsequently renamed American Shield
Coal Company (the "Coal Company") and is currently dormant. The Company,
through its wholly-owned subsidiary American Shield Refining Company (the
"Refining Company"), owns all of the outstanding common stock of Texas Oil
and Chemical Company II, Inc. ("TOCCO"). South Hampton Refining Company
("South Hampton") is a wholly-owned subsidiary of TOCCO, and Gulf State
Pipe Line Company, Inc. ("Gulf State") is a wholly-owned subsidiary of
South Hampton. The principal assets of TOCCO and its subsidiaries are a
specialty products refinery located outside of Beaumont, Texas, which
currently processes light naphtha feedstock, and 50 miles of natural gas
and product pipelines which connect the refinery to supplies and a marine
terminal on the Gulf of Mexico. The Company also owns 46% of Pioche-Ely
Valley Mines, Inc. ("Pioche") which owns mineral deposits in Nevada (Note
8). Pioche is consolidated for financial statement purposes at December 31,
1996.
NOTE 2 - GOING CONCERN
The accompanying consolidated financial statements have been prepared
assuming the Company will continue as a going concern. The Company's
sources of cash flow in 1996 were the operations of South Hampton and the
proceeds from a stock sale to a Saudi Arabian investor. The Company is not
currently generating cash flow from any other activities. As the cash flow
attributable to South Hampton is fully dedicated to repayment of debt and
funding of refinery operations (described in Note 9), the cash flow
attributable to South Hampton currently is not adequate to support the
Company's operations. As described in Note 9, the Company is liable to the
Saudi Arabian government for an $11,000,000 loan. The Company does not
currently have the financial resources to pay this obligation.
Management plans to fund future operations initially through sales
of its common stock and borrowings. It is expected that the operations
and obligations of the Company will be eventually funded from operations of
the Al Masane mine. However, because of uncertainties with respect to
future sales of common stock, obtaining suitable financing, and reaching an
agreement on the repayment of the loan to the Saudi Arabian government,
there is substantial doubt about the Company's ability to continue as a
going concern. These financial statements do not include any adjustments
that might result from the outcome of these uncertainties.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - The Company consolidates all subsidiaries for
which it has majority ownership or voting control which is other than
temporary. All material intercompany accounts and transactions are
eliminated.
8
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
As discussed in Note 8, the Company owns 46% of Pioche and has had voting
control for a number of years as a result of a loan which is collateralized
by 9% of the outstanding common stock of Pioche. In 1996, the Company
concluded that its voting control of Pioche was no longer temporary.
Therefore, Pioche has been consolidated in 1996. The financial statements
for 1995 and 1994, which account for the investment in Pioche on the equity
method, have not been restated.
CASH AND CASH EQUIVALENTS - The Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
SHORT-TERM INVESTMENT - At December 31, 1996 and 1995, the Company held a
United States treasury bill with an original maturity of less than one
year. The Company intends to hold this investment to maturity.
INVENTORIES - Refined products and feedstock are recorded at the lower of
cost, determined on the last-in, first-out method (LIFO), or market.
MINERAL EXPLORATION AND DEVELOPMENT COSTS - All costs related to the
acquisition, exploration, and development of mineral deposits are
capitalized until such time as (1) the Company commences commercial
exploitation of the related mineral deposits at which time the costs will
be amortized, (2) the related project is abandoned and the capitalized
costs are charged to operations, or (3) when any or all deferred costs are
permanently impaired. At December 31, 1996, none of the projects described
in Notes 7 and 8 had reached the commercial exploitation stage. No indirect
overhead or general and administrative costs have been allocated to any of
the projects. In 1996 the Company adopted Statement No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of" and has concluded that there was no impairment at December 31,
1996.
REFINERY PLANT, PIPELINE AND EQUIPMENT - Refinery plant, pipeline,
buildings and equipment are being depreciated using the straight-line
method over useful lives of 3 to 15 years. Maintenance and repairs are
charged to expense. Renewals and betterments are capitalized.
OTHER ASSETS - Other assets include catalysts used in refinery operations,
prepaid expenses and certain refinery assets which are being leased to a
third party.
ENVIRONMENTAL LIABILITIES - Remediation costs are accrued based on
estimates of known environmental remediation exposure. Such accruals are
recorded even if uncertainties exist over the ultimate cost of the
remediation. Ongoing environmental compliance costs, including maintenance
and monitoring costs, are expensed as incurred.
DEFERRED REVENUE - Deferred revenue represents funds advanced by a supplier
and customer for equipment purchases and is being amortized over a 15 year
period.
STATEMENTS OF CASH FLOWS - On the statements of cash flows, cash includes
cash held in the United States. Significant noncash changes in financial
position in 1996 include a restructure of debt to include $445,773 of
accrued interest in the loan principal, as well as the issuance of stock
and options for services, valued at
9
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
a total of $1,346,950, which is capitalized as a cost of the Al Masane
Project (Note 7). Transactions of this type in 1995 include the write-off
of a stockholder receivable to purchase 100,000 shares of common stock at
$1.00 per share and the issuance of 278,000 shares of common stock at $1.00
per share for the cancellation of $278,000 of indebtedness (Note 10).
Transactions of this type in 1994 include the issuance of 14,000 shares of
common stock in exchange for the cancellation of $14,000 of indebtedness
(Note 11).
HEDGING PROGRAM - In July 1994, South Hampton established a hedging program
to help decrease the volatility of the price of fuel gas to the refinery.
South Hampton purchased several commodity based derivative futures
contracts during 1994. Gains and losses related to these contracts are
recognized when the contracts expire. The natural gas market suffered
severe price declines in the last few months of 1994 and into 1995, which
resulted in net recognized losses of $101,000 in 1995 and $117,000 in 1994.
These losses are included as a cost of refined product sales and processing
in the consolidated statements of operations. Since the fuel prices
decreased in 1995 and were expected to soften in the next year or two, the
hedging program was discontinued in June 1995.
PER SHARE DATA - Net income (loss) per share has been computed on the basis
of the weighted average number of shares of common stock outstanding during
the year.
FOREIGN CURRENCY - Assets and liabilities denominated in foreign
currencies, principally Saudi Riyals, are translated at rates in effect at
the time the transaction occurs. There has been no significant change in
the exchange rate for Saudi Riyals to the United States dollar during the
period covered by these financial statements. Due to the stability of the
Saudi Riyal, the Company feels it has no material exposure to foreign
currency risks and does not employ any practices to minimize any such
risks. It is anticipated that its products in Saudi Arabia will be sold in
US dollars.
GOODWILL - Goodwill acquired in connection with the acquisition of TOCCO in
1987 is being amortized over ten years. The amounts reflected in the
balance sheet are net of accumulated amortization of $2,655,925 and
$2,378,785 at December 31, 1996 and 1995, respectively. The Company
periodically reviews goodwill for any permanent impairment in value or
life.
MANAGEMENT ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
STOCK-BASED COMPENSATION - Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("Statement No. 123") is
effective for 1996. Statement No. 123 establishes accounting and reporting
standards for various stock-based compensation plans. Statement No. 123
encourages the adoption of a fair value based method of accounting for
employee stock options, but permits continued application of the accounting
method prescribed by Accounting Principles Board Opinion No. 25 ("Opinion
25"), "Accounting for Stock Issued to Employees." Entities that continue to
apply the provisions of Opinion 25 are required to make pro forma
disclosures of net income and earnings per share as if the fair value based
method of accounting had been applied. Refer to Note 11.
10
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 4 - FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT
RISK
At December 31, 1996, the Company's financial instruments included cash,
cash equivalents, investments, accounts receivable, current obligations,
and noncurrent liabilities. The fair values of these items approximates
their carrying amounts at December 31, 1996. Accrued liabilities in Saudi
Arabia consist primarily of accrued salary and benefits. Payment of these
items is contingent on the Company's ability to obtain future financing. As
such, a fair value cannot be reasonably estimated.
Financial instruments that are potentially subject to concentrations of
credit risk consist of cash equivalents, short-term investments, and trade
accounts receivable. The Company places its cash equivalents and short-term
investments with high credit quality financial institutions.
South Hampton, the Company's only revenue producing asset, sells its
products primarily to companies in the chemical and plastics industry.
Downturns in these industries could negatively impact refinery operations
in the future. South Hampton does not require collateral on its outstanding
accounts receivable balances. South Hampton's largest customer accounted
for 17%, 25% and 13% of total sales in 1996, 1995 and 1994, respectively.
NOTE 5 - CONTINGENCIES
The operations of the Company in Saudi Arabia have been, and may in the
future be, affected from time to time in varying degree by political
developments and laws and regulations, such as forced divestiture of
assets; restrictions on production, imports and exports; price controls;
tax increases and retroactive tax claims; expropriation of property,
cancellation of contract rights and environmental regulations.
A major component of the Company's activities relates to the acquisition,
exploration and development of mineral deposits. There can be no assurance
that the Company will successfully develop any of the properties described
in Notes 7 and 8, and, if developed, whether the mineral acquisition,
exploration and development costs incurred will ultimately be recovered.
The recovery of such costs is dependent upon a number of future events,
some of which are beyond the control of the Company. The ability of the
Company to develop any of these properties is dependent upon obtaining
additional financing as may be required and, ultimately, its financial
success depends on its ability to attain successful operations from one or
more of its projects.
South Hampton, is a defendant in two lawsuits in two district courts in
Jefferson County, Texas brought on July 21, 1993 and July 18, 1994 by two
former employees of the Goodyear Tire & Rubber Company, seeking unspecified
actual and punitive damages for certain alleged illness and diseases
resulting from alleged exposure to certain chemicals during their
employment with Goodyear. One of these lawsuits was settled in March 1997.
The cost to the Company, net of expected insurance recovery, is not
significant. The outcome of the remaining lawsuit is not expected to have a
material effect on the Company's financial position, results of operations
or liquidity.
11
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 5 - CONTINGENCIES - CONTINUED
South Hampton has been spending an increased amount of time and expense on
environmental and regulatory functions and compliance. It is South
Hampton's policy to accrue costs associated with regulatory compliance when
those costs are reasonably determinable. In 1993, while remediating a small
spill area, The Texas Natural Resources Conservation Commission ("TNRCC")
requested that the refinery drill a well to check for groundwater
contamination under the spill area. The well disclosed a pool of
hydrocarbons on top of the groundwater under a truck loading rack area. An
analysis of the material indicated that the hydrocarbons were produced more
than fifteen years ago when the refinery was in the business of processing
crude oil. Consulting engineers were hired to help evaluate the size and
location of the pool. Monitoring wells were drilled around the perimeter of
the refinery property and it was determined that there was no migration of
hydrocarbons off the Company's property. Two large pools were located, one
under the South Hampton's historic refinery site and one under property
which had been purchased from an independent gas producer in 1981. The west
plant site had previously been the site of a natural gas processing plant
operated by Sinclair, Arco and others. The TNRCC has been cooperating in
the investigation and cleanup. Due to the apparent age of the material, no
fine or enforcement action is expected. A site assessment plan was
completed and approved in November 1995. Cleanup expenditures through 1996
were approximately $153,500, and an additional $60,000 was accrued at
December 31, 1996. The consulting engineers expect approximately 10,000
barrels of recoverable material will be available to South Hampton for use
in their refining process, but no accrued income has been recorded due to
the uncertainties relating to the recovery process.
In November 1996, South Hampton agreed to a proposed settlement with the
TNRCC's Air Permit Section for various alleged violations occurring during
the 1991 though 1994 inspections. An agreed fine of $50,000 will be paid
over a period of ten months and an amount adequate to cover the remaining
amounts to be paid was accrued as of December 31, 1996. South Hampton
vigorously denied many of the allegations in the settlement document, but
determined that to further protest the TNRCC's interpretation and
application of the rules would ultimately result in higher expenses.
12
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 5 - CONTINGENCIES - CONTINUED
In addition to the various Environmental Protection Agency and TNRCC air,
water and solid waste regulations, South Hampton is also subject to the
regulations of the U.S. Department of Transportation, the Occupational,
Health and Safety Administration and the Texas General Land Office, among
others. In response to various regulations from these and other agencies,
South Hampton has developed OPA-90 Emergency Response Plans for the
pipeline and the refinery, and is in the process of voluntarily adopting
the requirements of the OSHA Process Safety Management rules. Approximately
$35,000 and $80,000 was spent in 1996 and 1995, respectively, on
development of this OSHA program. The program is approximately 75%
completed and is expected to be completed in 1997 at an additional cost of
about $25,000. Due to the uncertain timing and scope of the additional
work, no accruals have been provided.
The Company has not made all of the surface rental payments due to the
government of Saudi Arabia under the terms of the Al Masane Project lease.
At December 31, 1996, the past due amount of these rent payments was
approximately $309,000. In addition, the Company has not complied with
certain statutory reporting requirements in Saudi Arabia. Management of the
Company believes that the lack of compliance with these requirements will
not have any effect on the Company's planned operations in Saudi Arabia.
At December 31, 1996, South Hampton had a $100,000 letter of credit in
support of payment for purchases of natural gas used in the refinery from
its main supplier.
NOTE 6 - INVENTORIES
Inventories include the following:
December 31,
---------------------
1996 1995
--------- ---------
Refinery feedstock $ -- $ 59,358
Refined products 565,346 371,374
--------- ---------
Total inventories $ 565,346 $ 430,732
========= =========
In 1994, liquidation of LIFO inventory quantities carried at lower costs
prevailing in prior years decreased cost of goods sold and increased net
income by approximately $57,000.
At December 31, 1996, current cost exceeded LIFO value by approximately
$163,000. At December 31, 1995, current cost approximated LIFO value.
13
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 7 - MINERAL EXPLORATION AND DEVELOPMENT COSTS IN SAUDI ARABIA
In the accompanying consolidated financial statements, the deferred
development costs have been presented based on the related projects'
geographic location within Saudi Arabia. This includes the "Al Masane
Project"(the "Project") and "Other interests in Saudi Arabia" which
primarily pertains to the costs of rentals, field offices and camps, core
drilling and labor incurred at the Wadi Qatan and Jebel Harr properties.
In 1971, the Saudi Arabian government awarded exploration licenses to the
Company and National Mining Company ("NMC"), a Saudi Arabian company, for
the Al Masane Project, Wadi Qatan and Jebel Harr areas. The Company and NMC
also obtained written authority to explore an area of 1,100 square
kilometers surrounding Al Masane ("Greater Al Masane"). An exploration
license for the Greater Al Masane area has been applied for and verbally
approved by the Saudi Arabian government (unaudited).
In 1992, NMC relinquished its rights to the exploration license and the
mining lease in the Al Masane area, and assigned them to the Company. The
Company accepted the conditions set by the Saudi Arabian government in a
letter dated March 30, 1992. In connection with NMC's assignment of its
interest to the Company, the Company agreed to provide for public
subscription in Saudi Arabia 50% of the capital of the Project at such time
as the Project proves to be profitable. Subsequently, a formal Mining Lease
Agreement assigning the lease solely to the Company was initialed by the
Company and the Ministry on October 4, 1992.
Since NMC assigned its 50% interest in the exploration license and any
resulting mining lease to the Company, the Company is solely responsible
for the repayment of an $11 million interest-free loan from the Saudi
Arabian government, the proceeds of which were used to fund the Project.
The loan was scheduled to be repaid in ten annual installments beginning in
1984. None of the scheduled payments have been made. Pursuant to Article 18
of the Mining Lease Agreement, the Company will repay the loan in
accordance with a repayment schedule to be agreed upon with the Saudi
Arabian government. As noted below, the mining lease was granted in 1993.
However, a rescheduling of the loan payments has not yet been negotiated.
All of the Company's assets in Saudi Arabia are pledged as collateral for
the loan.
The Company has held exploration licenses for the Wadi Qatan and Jebel Harr
areas in Saudi Arabia. Although the licenses have expired, the Saudi
Arabian government has verbally advised the Company that they will be
extended as long as mineral exploration is being carried out on the areas
which they cover. When financing for the Al Masane project is completed,
the Company anticipates applying for an exploration license for an area of
2,800 square kilometers which will include the original Greater Al Masane
area plus the Wadi Qatan and Jebel Harr areas. Although the licenses were
originally awarded jointly to the Company and NMC, the exploration work has
been carried on exclusively by the Company. NMC has verbally advised the
Company that it has relinquished its rights in these areas; therefore, the
Company intends to obtain the license extensions in the name of the Company
only. The Company has had positive results from its exploration work at
these sites; however, it has directed limited amounts of time and resources
to them in recent years while it negotiated with the Saudi government for
the Al Masane lease. The Company does not intend to abandon these sites.
14
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 7 - MINERAL EXPLORATION AND DEVELOPMENT COSTS IN SAUDI ARABIA -
CONTINUED
On April 26, 1993, the Council of Ministers passed a resolution granting
the Company a mining lease for the Al Masane Project, and on May 22, 1993,
a Royal Decree was issued by the King. The initial period of the mining
lease is 30 years, which can be renewed for another period or periods, not
to exceed 20 years. The lease area is 44 square kilometers in size. The
lease agreement stipulates that the Company is to pay the Saudi government
a surface rental of approximately $117,000 a year. The Company made the
first year's payment in August 1993. All subsequent payments, which amount
to $309,000 at December 31, 1996, are being deferred until a Saudi limited
liability company is formed and the mining lease is transferred to it. The
Company will own 50% of this new company, which will operate the Project
when approval is received for the loan from the Saudi Industrial
Development Fund ("SIDF"), which was applied for on September 30, 1995. The
lease agreement also stipulates that, after two years of profitable mine
operations, a Saudi public stock company will be formed in which the
limited liability company will transfer its interest in the Al Masane
Project. The Company will own 50% of the stock in the public stock company.
The Petroleum and Mineral Organization ("PETROMIN"), a company wholly-owned
by the Saudi government, has an option to acquire up to 25% of the stock
and the remaining interests not owned by the Company or acquired by
PETROMIN are to be put out for public subscription to Saudi citizens.
On March 27, 1995, the board of directors approved a Letter of Agreement
between the Company and Carlyle SEAG ("Carlyle"), whereby Carlyle had been
retained as the Company's financial advisor in connection with the Al
Masane mining project. In March 1996, the agreement with Carlyle was
terminated by mutual consent.
On May 20, 1996, the Company entered into a Financial and Legal Services
and Advice Agreement with two Saudi Arabian advisors to provide the
following services in connection with the Al Masane mining project: (1) the
formation of a Saudi limited liability company with the necessary capital
to purchase the Company's interest in the mining lease and to pay its share
of the project costs, (2) to finalize the required procedures for the
issuance of an industrial license, (3) to finalize the necessary procedures
to obtain the loan from the SIDF, (4) to apply for and receive loans from
commercial banks necessary to finance the project and (5) to apply and
obtain approval for the transfer of the mining lease to the limited
liability company. As consideration for their services, the Company agreed
to pay the two advisors $10,000 each for the issuance of the industrial
license and to pay one of them $10,000 upon approval of the loan by the
SIDF. The Company has also agreed to issue them up to 2,000,000 shares of
the Company's common stock and to grant them options to purchase up to
2,300,000 shares of the Company's common stock. The Company is obligated to
issue such shares and options in designated amounts upon completion of each
of the foregoing services. The options will have a five-year term
commencing on the date of formation of the Saudi limited liability company
with an exercise price of $1.00 per share. On December 3, 1996, the
industrial license was issued to the Company and its Saudi Arabian
advisors, and the Company was obligated at December 31, 1996 for the
payment of $20,000 in cash and the issuance of 300,000 shares of common
stock and stock options for 345,000 shares at $1.00 per share.
15
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 7 - MINERAL EXPLORATION AND DEVELOPMENT COSTS IN SAUDI ARABIA -
CONTINUED
Phase I of the work on the Project (sinking shaft, tunneling and drilling)
was completed in April 1981. Since that time, there have been a series of
project feasibility studies in 1982, 1984, 1989, 1992, and 1994, conducted
by Watts, Griffis and McOuat Limited, consulting geologist, indicating the
commercial viability of the Project. The 1994 report, and an update
prepared in 1996, estimates proven and probable reserves of copper, zinc,
silver and gold of 7.2 million tonnes in the Project with the potential to
increase these reserves with further exploration. The report projects
production of the proven and probable reserves over a twelve-year period.
The cash flow projection was made based on the assumption that 50% of the
financing of the project will come from loans from the Saudi Industrial
Development Fund, 25% from bank loans, and 25% from equity financing of the
new Saudi limited liability company. Revenues were estimated utilizing
projected mineral prices from a third party pricing expert. The report
projected positive net cash flows to the Company of $37 million over the
life of the Project. According to the provisions of Article 46 of the Saudi
Mining Code, no taxes will be payable to the Saudi government during the
first stage of operations on a mining lease, which is the period of five
years starting from the earlier of (a) the date of the first sale of
products or (b) the beginning of the fourth year since the issue of the
lease.
Deferred development costs of the Al Masane Project at December 31, 1996,
1995 and 1994, and the changes in these amounts for each of the three years
then ended are detailed below:
Balance at Balance at Balance at
December 31, Activity December 31, Activity December 31, Activity
1996 for 1996 1995 for 1995 1994 for 1994
----------- ----------- ----------- ----------- ----------- -----------
Property and equipment:
Mining equipment $ 2,160,206 $ 2,160,206 $ 2,160,206
Construction costs 3,140,493 3,140,493 3,140,493
----------- ----------- -----------
Total 5,300,699 5,300,699 5,300,699
Other costs:
Labor, consulting
services and project
administration costs 18,582,773 $ 1,942,586 16,640,187 $ 616,912 16,023,275 $ 237,908
Materials and
maintenance 6,167,924 914 6,167,010 5,326 6,161,684 683
Feasibility study 2,831,442 41,455 2,789,987 163,513 2,626,474 505,118
----------- ----------- ----------- ----------- ----------- -----------
Total 27,582,139 1,984,955 25,597,184 785,751 24,811,433 743,709
----------- ----------- ----------- ----------- ----------- -----------
$32,882,838 $ 1,984,955 $30,897,883 $ 785,751 $30,112,132 $ 743,709
=========== =========== =========== =========== =========== ===========
The deferred development costs of the "Other interests in Saudi Arabia", in
the total amount of approximately $2.4 million, consist of approximately
$1.5 million associated with the Greater Al Masane area and the balance of
approximately $900,000 is associated primarily with the Wadi Qatan and
Jebel Harr areas. These costs have not changed since 1993. In the event an
exploration license for these areas is not granted, the entire amount of
deferred development costs relating thereto would be written off.
16
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 7 - MINERAL EXPLORATION AND DEVELOPMENT COSTS IN SAUDI ARABIA -
CONTINUED
Since cash in Saudi Arabia is generally intended for the support and
development of the Saudi Arabian projects, a long-term asset, such cash and
certain associated liabilities relating to the Saudi Arabian projects have
been classified as noncurrent. Cash in Saudi Arabia includes time deposits
of $0 and $300,735 at December 31, 1996 and 1995, respectively.
NOTE 8 - MINERAL PROPERTIES IN THE UNITED STATES
The Company has voting rights of approximately 55% and directly owns
approximately 46% of the outstanding common stock of Pioche. During 1988,
634,223 shares of Pioche stock were deemed acquired through in-substance
foreclosure on a $114,537 note due from the issuer's estate. The original
date of the note was May 31, 1985, and the note was due on May 31, 1995;
however, management of the Company extended the due date to December 31,
1998 to allow the estate the opportunity to pay off the note. Until the
note is paid, the Company has the voting rights to these shares. At this
time, it is not possible to determine whether the issuer's estate will be
able to repay the note when due. If the note is not repaid, the Company
could take ownership of the shares. At December 31, 1996, the Company
determined the loan was not likely to be repaid, and has consolidated the
accounts of Pioche in the accompanying financial statements for 1996.
Previously, the investment in Pioche was accounted for on the equity
method. The consolidation of Pioche increased total assets at December 31,
1996 by approximately $1,200,000 and had no effect on the net loss reported
for 1996.
The principal assets of Pioche are an undivided interest in 48 patented and
84 unpatented mining claims and a 300 ton-per-day mill located on the
aforementioned properties in the Pioche Mining District in southeastern
Nevada. Due to the lack of capital , the properties held by Pioche have not
been commercially operated for approximately 35 years. During 1994, Pioche
attempted to drill a core hole on this property. The core hole was intended
to go down to 1,500 feet but encountered formation problems at 700 feet and
further drilling had to be abandoned. A new site will be selected and
management expects a second core hole to be drilled when financing becomes
available. In late 1996, Pioche was extended a proposal from a prominent
mining company for the lease of its mining claims. This proposal is
currently being negotiated.
In August 1993, Pioche entered into a lease of the Wide Awake mine
property. This agreement stipulated a 6% royalty on net smelter returns
with no annual rental required. The lease commenced on October 1, 1993, for
a primary term of twenty-seven months (to December 31, 1995). In August
1995, it was agreed by all parties concerned that the lease be extended for
one year to December 31, 1996, under the same terms. No significant work
took place on the property and no royalties were earned. The lease was not
extended and it has expired. In 1995, the Company received an extension of
its option to buy 720,000 shares (approximately 10% of the outstanding
shares) of Pioche common stock at $0.20 per share. The option expires on
June 1, 1997.
17
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 9 - NOTES PAYABLE, LONG-TERM DEBT AND LONG-TERM OBLIGATIONS
Notes payable, long-term debt and long-term obligations at December 31 are
summarized as follows:
1996 1995
------------ ------------
Notes payable:
Revolving bank note. See (A) $ -- $ 2,222,911
Secured note to Saudi Arabian government. See (B) 11,000,000 11,000,000
Unsecured note to a Saudi company. See (C) -- 1,500,000
Unsecured note to a Saudi investor. See (D) 13,280 13,280
Unsecured note to a Saudi investor. See (E) 350,000 350,000
Other 12,500 --
------------ ------------
Total $ 11,375,780 $ 15,086,191
============ ============
Long-term debt:
Revolving bank note. See (A) $ 1,890,000 $ --
Unsecured note to a Saudi company. See (C) 1,945,773 --
Unsecured notes to foreign investors. See (F) 598,000 598,000
Bank note. See (G) 103,068 188,624
------------ ------------
Total 4,536,841 786,624
Less current portion (992,729) (78,090)
------------ ------------
Total $ 3,544,112 $ 708,534
============ ============
Long-term obligations:
Noninterest-bearing note to a supplier and
customer for capital improvements. See (H) $ 128,683 $ 128,683
Deferred compensation contracts. See (I) 57,230 77,477
------------ ------------
Total 185,913 206,160
Less current portion (150,904) (20,285)
------------ ------------
Total $ 35,009 $ 185,875
============ ============
(A) In 1990, South Hampton and a bank entered into an Amended and Restated
Credit Agreement ("the Agreement"). Funding under the Agreement was provided
in two facilities: Facility A in the principal amount of $4,400,000, funded
in a lump-sum, and Facility B in the principal amount of up to $1,500,000,
to be used by South Hampton for working capital purposes and support of
feedstock purchases. Facility B was fully drawn down in the form of letters
of credit. In 1992, the bank drew on the letters of credit provided by a
related party of the Company (see (C) below.)
18
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 9 - NOTES PAYABLE, LONG-TERM DEBT AND LONG-TERM OBLIGATIONS -
CONTINUED
On October 15, 1996, South Hampton and the bank agreed to amend and
restate the Agreement (the "Restated Agreement"). South Hampton executed
a new Promissory Note in the original principal amount of $1,965,000
having a December 31, 1998 maturity date and bearing interest at the rate
of one percent above the prime lending rate in effect at the bank's New
York office payable monthly in arrears on the last day of each month.
Advances under the Restated Agreement are not to exceed the lesser of
$1,965,000 or the borrowing base, which is calculated as the cash
collateral account and eligible receivables and inventory. Minimum
principal payments of $75,000 are to be made, payable by the last day of
each quarter commencing December 31, 1996. As in the previous Agreement,
South Hampton has agreed to collect all receivables through a cash
collateral account at a local bank. Various restrictions have been placed
on how funds may be spent by South Hampton and periodic reports must be
provided to the bank. Under certain guidelines, the Restated Agreement
permits certain cash distributions to Saudi Fal Co., Ltd. ("Saudi Fal"),
TOCCO, the Refining Company, and the Company. The note is collateralized
by all of the assets of TOCCO and its subsidiaries and a pledge of TOCCO
common stock owned by the Refining Company. The Restated Agreement
contains certain financial covenants, including a minimum current ratio
and fixed charges coverage ratio. At December 31, 1996 South Hampton was
not in compliance with the fixed charges coverage requirement. However,
the noncompliance was waived by the lender.
(B) TheCompany has an interest-free loan of $11,000,000 from the Saudi Arabia
Ministry of Finance and National Economy, the proceeds of which were used
to finance the development phase of the Al Masane Project. The loan was
repayable in ten equal annual installments of $1,100,000, with the
initial installment payable on December 31, 1984. None of the ten
scheduled payments have been made. Pursuant to the mining lease agreement
covering the Al Masane Project, the Company will repay the loan in
accordance with a repayment schedule to be agreed upon with the Saudi
Arabian government. An agreement has not yet been reached regarding the
rescheduling of these payments. The loan is secured by all of the
Company's assets in Saudi Arabia.
(C) In 1990, Saudi Fal, a Saudi company owned by a shareholder of the
Company, agreed to issue a guarantee of $1,500,000 securing a letter of
credit facility to enable South Hampton to buy feedstock. In return for
the guarantee, Saudi Fal was given an option to purchase all of the
outstanding stock of TOCCO. The option was not exercised and has expired.
On March 31, 1992, the $1,500,000 guarantee was not renewed by Saudi Fal.
As a result, the bank drew on the letter of credit provided by Saudi Fal
for its guarantee and applied the $1,500,000 to reduce the principal
amount of the bank note. The note is now owed by South Hampton to Saudi
Fal. On October 15, 1996, South Hampton and Saudi Fal agreed to
restructure the loan terms, whereby the accrued interest to date of
$445,773 was added to principal, the interest rate was set at prime plus
1%, and the maturity date is now December 31, 1998. This new note has a
second lien position behind the bank's position as discussed in (A) above
and is convertible into 1,945,773 shares of common stock.
(D) Represents a noninterest demand loan payable to a Saudi investor. In
September 1995, this investor loaned the Company an additional $123,000.
The loan agreement granted an option to convert the loan into shares of
the Company's common stock at $1 per share. Also in September 1995, the
investor exercised this option and converted the $123,000 loan into
123,000 shares of the Company's common stock (see Note 11). In December
1995, the investor agreed to exchange $155,000 of his debt balance for
155,000 shares of the Company's common stock.
19
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 9 - NOTES PAYABLE, LONG-TERM DEBT AND LONG-TERM OBLIGATIONS -
CONTINUED
(E) Represents an unsecured, noninterest bearing advance made by a Saudi
investor in 1984 to the Al Masane Project.
(F) Represents loans payable to a stockholder of the Company for $245,000,
the Company's president for $53,000 and a relative of the Company's
president and stockholder for $300,000. Each loan is due in 1997, with
interest payable at the LIBOR rate plus 2% at maturity. Each loan
provides for an option to convert the loan amount to shares of the
Company's common stock at $1.00 per share anytime within five years from
the date of the loan. See Note 11 for a discussion of the related
options.
(G) This note payable is collateralized by land, an office building, and all
equipment and furniture and fixtures of TOCCO. As described in Note 10,
the building collateralized by this note has been leased to a third
party. The original balance of the note was due and payable on December
31, 1994. This note was refinanced effective December 31, 1994 with
principal and interest payments starting in March 1995 and each month
thereafter until February 1, 1998. The note bears interest of 10% from
the date of the agreement to February 1, 1996, 10.25% from February 1,
1996 to February 1, 1997, and 9.75% thereafter.
(H) Balance represents amount due under a note payable to an unrelated
refining company that provided loans to the refinery to fund certain
refining processes. Repayment is to be made when certain feed rate
criteria and number of days of operations have been reached. As of
December 31, 1996, these criteria have been met.
(I) In connection with the acquisition of TOCCO, deferred compensation
contracts between TOCCO and a certain former employee and one current
employee were restructured, reducing the gross payments due under the
original contracts. Default on payments due under the restructured
agreements would invalidate the negotiated settlement amounts resulting
in TOCCO being liable for the amounts due under the original contracts.
TOCCO has complied with the terms of these contracts through 1996.
However, if TOCCO were to default on these contracts, it would be liable
for an additional amount of $448,300. The recorded liability at December
31, 1996 and 1995 has been determined utilizing a discount rate of 8.0%.
Scheduled maturities of long-term debt and long-term obligations, which
exclude current notes payable balances aggregating $11,375,780, are as
follows:
1997 $1,143,633
1998 2,245,773
1999 1,333,348
----------
Total $4,722,754
==========
Interest of $186,190, $244,828 and $275,561 was paid in 1996, 1995 and 1994,
respectively.
20
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 9 - NOTES PAYABLE, LONG-TERM DEBT AND LONG-TERM OBLIGATIONS -
CONTINUED
In May 1994, South Hampton settled a note payable and accrued interest
payable to a vendor for $175,000 cash. An extraordinary gain of $578,150,
for which there was no tax effect after application of operating loss
carryforwards was recorded, representing the amounts forgiven.
NOTE 10 - COMMITMENTS
South Hampton entered into an arrangement in July 1991 with a partnership,
in which Silsbee Trading and Transportation Corp. ("STTC", a company owned
by the president and vice-president of TOCCO) and M.A. Bomer (the former
owner of the refinery) each owned a 50% interest, to facilitate the future
purchase of feedstock. In June 1992, Mr. Bomer withdrew from the partnership
and the feedstock agreement was terminated. On July 1, 1992, South Hampton
entered into a new agreement with STTC whereby STTC financed the feedstock
in the pipeline. As a result, South Hampton had a liability to STTC for the
cost of the 453,600 gallons of capacity of the pipeline. This amount was
$215,460 at December 31, 1994. Also in connection with this agreement, South
Hampton paid a one-half cent per gallon fee to STTC on each gallon of
feedstock transported through the pipeline. The agreement was operating on a
month to month basis and was terminated in August 1995. The fees paid by
South Hampton to STTC pursuant to this agreement were $76,080 and $103,212
in 1995 and 1994, respectively.
South Hampton leases vehicles and equipment for use in operations for
approximately $29,000 per month plus certain reimbursed costs from STTC
under a lease agreement. The lease agreement expired in September 1994 and
is currently continuing on a month to month basis. South Hampton incurred
costs related to this agreement of approximately $349,000, $316,000 and
$341,000 in 1996, 1995 and 1994, respectively.
The Company incurred rental expenses for office space and certain vehicles
and equipment of approximately $367,000, $302,000 and $302,000 in 1996, 1995
and 1994, respectively.
In February 1993, South Hampton entered into an agreement to lease to a
third party a building with a net book value at December 31, 1996 of
$310,926 which South Hampton does not use in its operations. The lease
provides for an option to the lessee to purchase the building after three or
five years. The lease is being recorded as an operating lease and the
building is included in other assets. As described in Note 9, the leased
building is pledged as collateral for a note payable. If the leasee
exercises its option to purchase the building, the proceeds will be used to
pay down the note payable . Miscellaneous income includes approximately
$102,000 in 1996, 1995 and 1994 of rental income pursuant to this lease.
A provision of the purchase agreement related to the acquisition of TOCCO by
the Refining Company requires TOCCO to reserve up to 10% of its common stock
to be available for sale to the employees of TOCCO on such terms and
conditions and at such times as determined by TOCCO.
South Hampton has guaranteed a note for $160,000 for a limited partnership
in which South Hampton has a 19% interest.
21
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 11 - COMMON STOCK AND STOCK OPTIONS
At December 31, 1996, Saudi Arabian investors owned approximately 63% of the
Company's outstanding common stock.
COMMON STOCK - The proceeds from common stock sales are used to finance
mineral exploration and development activities in Saudi Arabia and general
and administrative expenses in the United States. Agreements relating to
certain stock sold to investors provide that shares may not be traded in
United States markets unless registered under the United States Securities
Act of 1933 or unless they are sold pursuant to an available exemption from
registration.
Notes receivable from stockholders for the purchase of common stock of
$126,000 at December 31, 1996 and 1995 represents a note from a director and
officer which matures on December 31, 1998. Notes receivable from
stockholders are classified as a reduction of stockholders' equity.
At December 31, 1996, a note payable was convertible into 1,945,773 shares
of common stock (See Note 9).
STOCK OPTIONS - Under the terms of the Company's Employee Stock Option Plan
(the "Employee Plan"), incentive options are granted at the market price of
the stock on the date of grant and nonincentive options are granted at a
price not less than 85% of the market price of the stock on the date of
grant. The Employee Plan was adopted on May 16, 1983 for a term of ten
years. At the Company's annual stockholders meeting on December 29, 1992,
the stockholders approved an extension of the term of the Employee Plan for
another ten years to May 16, 2003 and also approved an increase in the
number of shares reserved for issuance thereunder from 250,000 to 500,000.
On September 26, 1994, the Compensation Committee of the board of directors
approved the granting of options to purchase a total of 75,000 shares of
common stock for $1.75 per share, the market value on the date of the grant,
to four employees of the Company. These options expire in 2004.
To enhance the Company's ability to obtain and retain qualified directors,
it instituted the 1987 Non-Employee Director Stock Option Plan (the
"Non-Employee Director Plan") which provides for each non-employee director
to receive an option for 10,000 shares of common stock upon election to the
board of directors with the exercise price equal to the fair market value of
the stock at the date of grant. The number of shares reserved for issuance
under this plan is 100,000. The Non-Employee Director Plan was instituted in
1987 for a duration of ten years and in 1997 it will expire. Then, a new
plan may be instituted at a later date. At December 31, 1996, 40,000 shares
had been granted, 20,000 had been forfeited and none had been exercised.
22
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 11 - COMMON STOCK AND STOCK OPTIONS - CONTINUED
A summary of stock option transactions under the Employee Plan and
Non-Employee Director Plan is as follows:
Outstanding December 31, 1993 160,000
Granted ($1.75 per share) 75,000
Expired (20,000)
-------
Outstanding at December 31, 1994, 1995 and 1996 215,000
=======
Under the above plans, 207,000 options were exercisable at prices ranging
from $1.38 to $3.75 per share and 385,000 shares were reserved for grant at
December 31, 1996. The options for the Employee Plan vest at such times and
in such amounts as is determined by the Compensation Committee of the board
of directors at the date of grant. The options for the Non-Employee Director
Plan vest in cumulative annual installments of 20% beginning one year from
the date of grant. The options for both plans are exercisable for a period
of ten years.
In 1994, a director and officer of the Company exercised an option to
purchase 14,000 shares of common stock at $1.00 per share in exchange for
cancellation of $14,000 of unpaid compensation.
In 1995, the Company wrote off a receivable from a company controlled by a
director of the Company in the amount of $100,000 resulting from the
exercise of stock options.
In 1995, three foreign investors and the president of the Company loaned the
Company $668,000 and $53,000, respectively (See Note 9). The agreements
provide that the lender would have the option, at anytime within five years
from the date of the loan, to convert the debt plus accrued interest into
shares of the Company's common stock at $1.00 per share. In September 1995,
one of the investors exercised his option and converted $123,000 of his loan
to 123,000 shares of common stock outstanding (See (D) in Note 9).
In October 1995, the board of directors approved an option for the president
of the Company to exchange $400,000 of his unpaid salary for shares of the
Company's common stock at $1.00 per share. The options do not expire and
they were exercisable immediately upon grant.
On May 20, 1996, the Company entered into a Financial and Legal Services and
Advice Agreement with two Saudi Arabian advisors who are to assist the
Company with the Al Masane Project (See Note 7). The Agreement provides for
consideration to the advisors of up to 2,000,000 shares of the Company's
common stock and options to purchase up to 2,300,000 shares of common stock
at $1.00 per share. The options are to be granted in designated amounts upon
the completion of various obligations by the advisors. The options are
immediately exercisable upon grant and will have a five year term beginning
on the date of the formation of the Saudi limited liability company. At
December 31, 1996, 300,000 shares of common stock, valued at $550,000, and
options to purchase 345,000 shares, valued at $796,950, had been earned
under the Agreement.
23
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - COMMON STOCK AND STOCK OPTIONS - CONTINUED
For stock options granted to employees and directors at an exercise price
below market price on the date of grant, the Company records an expense
equal to the difference between the exercise price and the market prices on
the date of grant. An expense is also recorded for the difference between
sales price and market price for stock sold to employees and directors, not
pursuant to options, at below market prices.
For the options to purchase 668,000 shares of stock granted to investors
during 1995, the Company recognized an expense of $ 76,500, which is
included in general and administrative expense in the Company's results of
operations for the year ended December 31, 1995. This expense is based on
the fair value of the options as of the grant date. For the options to
purchase 400,000 shares of stock granted to the Company's president in
1995, the Company recorded compensation expense in the amount of $74,900,
which is included in general and administrative expense in the Company's
results of operations for the year ended December 31, 1995. This expense is
based on the difference between the market price of the Company's stock as
of the grant date and the price of the option.
A summary of stock option transactions with individuals is as follows:
Outstanding December 31, 1993 14,000
Exercised (14,000)
----------
Outstanding at December 31, 1994 --
Granted ($1.00 per share) 1,121,000
Exercised (123,000)
----------
Outstanding at December 31, 1995 998,000
Granted ($1.00 per share) 345,000
----------
Outstanding at December 31, 1996 1,343,000
==========
All stock sold to individuals in connection with these options includes a
restriction that it cannot be traded for a three-year period.
The Company has adopted only the disclosure provisions of Statement No.
123, as discussed in Note 3. Therefore, compensation expense for stock
options granted to employees is measured as the excess, if any, of the
quoted market price of the Company's stock at the date of grant over the
amount an employee must pay to acquire the stock. If the Company recognized
compensation expense based upon the fair value at the grant date for
options granted to employees in 1995 (none were granted in 1996), the
Company's 1995 and 1996 net loss and loss per share would be increased to
the pro forma amounts indicated as follows:
1996 1995
----------- -----------
Net loss
As reported $ (390,896) $ (369,232)
Pro forma (390,896) $ (726,332)
Loss per common share
As reported $ (.02) $ (.02)
Pro forma $ (.02) $ (.04)
24
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 11 - COMMON STOCK AND STOCK OPTIONS - CONTINUED
The fair value of these options was estimated at the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions: expected volatility of 85 percent; risk-free interest rate of
6 percent; no dividend yield; and expected lives of 10 years.
The pro forma amounts presented are not representative of the amounts that
will be disclosed in the future because they do not take into effect pro
forma expenses related to grants before 1995.
Additional information with respect to all options outstanding at December
31, 1996, and changes for the three years then ended was as follows:
1994
---------------------------
Weighted average
Shares exercise price
-------- ---------------
Outstanding at beginning of year 174,000 $ 1.74
Granted 75,000 1.75
Forfeited (20,000) 1.38
Exercised (14,000) 1.00
--------
Outstanding at end of year 215,000 $ 1.83
======== =========
Options exercisable at December 31, 1994 161,500 $ 1.74
======== =========
1995
--------------------------
Weighted average
Shares exercise price
---------- ---------------
Outstanding at beginning of year 215,000 $ 1.83
Granted 1,121,000 1.00
Exercised (123,000) 1.00
----------
Outstanding at end of year 1,213,000 $ 1.15
========== ========
Options exercisable at December 31, 1995 1,163,500 $ 1.12
========== ========
1996
--------------------------
Weighted average
Shares exercise price
---------- ---------------
Outstanding at beginning of year 1,213,000 $ 1.15
Granted 345,000 1.00
----------
Outstanding at end of year 1,558,000 $ 1.11
========== ========
Options exercisable at December 31, 1996 1,550,000 $ 1.10
========== ========
Weighted average fair value per share of
options granted during 1996 $ 2.31
========
25
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 11 - COMMON STOCK AND STOCK OPTIONS - CONTINUED
Information about stock options outstanding at December 31, 1996 is
summarized as follows:
Options outstanding
-------------------------------------------------------
Weighted average
Number remaining Weighted average
Range of exercise prices outstanding contractual life exercise price
------------------------ ----------- ---------------- --------------
$0 to 1 1,343,000 8.1 years $1.00
$1 to 2 175,000 8.3 years 1.53
$2 to $3.75 40,000 4.3 years 3.10
---------
1,558,000 $1.11
========= =====
Options exercisable
----------------------------------
Number Weighted average
Range of exercise prices exercisable exercise price
------------------------ ----------- --------------
$0 to 1 1,343,000 $1.00
$1 to 2 175,000 1.53
$2 to $3.75 32,000 3.04
---------
1,550,000 $1.10
========= =====
NOTE 12 - INCOME TAXES
The income (loss) before income taxes and extraordinary item was ($390,896),
($369,232), and $2,314,129 for the years ended December 31, 1996, 1995 and
1994, respectively.
The Company's provision for income taxes was comprised of the following:
1996 1995 1994
-------- -------- --------
Federal
Current $ -- $ -- $522,938
Deferred -- -- --
Utilization of operating loss carryover -- -- (482,965)
-------- -------- --------
Provision for income taxes $ -- $ -- $ 39,973
======== ======== ========
26
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 12 - INCOME TAXES - CONTINUED
Income tax expense (benefit) for the years ended December 31, 1996, 1995 and
1994 differs from the amount computed by applying the applicable U.S.
corporate income tax rate of 34% to net income (loss) before income taxes.
The reasons for this difference are as follows:
1996 1995 1994
--------- --------- ----------
Income taxes at U.S. statutory rate $(132,905) $(125,539) $ 786,804
Goodwill amortization 94,228 95,303 95,303
Liability reserves -- -- (392,700)
Net operating losses 37,924 25,731 (482,965)
Alternative minimum tax -- -- 39,973
Other items 753 4,505 (6,442)
--------- --------- ---------
Total tax expense $ -- $ -- $ 39,973
========= ========= =========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities for 1996,
1995 and 1994 were as follows:
December 31,
--------------------------------------------
1996 1995 1994
------------ ------------ ------------
Deferred tax liabilities:
Refinery plant, pipeline and equipment $ (287,845) $ (368,385) $ (379,668)
Deferred tax assets:
Accounts receivable 57,284 49,544 44,070
Mineral interests 196,446 196,446 196,446
Accrued liabilities 32,300 -- --
Net operating loss carryovers (NOLs) 11,333,611 11,274,638 9,277,552
Tax credit carryovers 221,322 651,504 650,907
------------ ------------ ------------
Gross deferred tax assets 11,840,963 12,172,132 10,168,975
Valuation allowance (11,553,118) (11,803,747) (9,789,307)
------------ ------------ ------------
Net deferred tax assets 287,845 368,385 379,668
------------ ------------ ------------
Net deferred taxes $ -- $ -- $ --
============ ============ ============
27
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 12 - INCOME TAXES - CONTINUED
During 1995, the Company's gross deferred tax asset increased by $2,003,157
to $12,172,132 at December 31, 1995. The primary reason for this increase in
the gross deferred tax asset is due to a restatement of NOLs from prior
years. There was no change in judgment about the Company's ability to
realize its net deferred tax asset; therefore, the valuation allowance was
increased by a corresponding amount. If certain substantial changes in the
Company's ownership should occur, there would be an annual limitation on the
amount of tax carryovers which could be utilized.
At December 31, 1996, the Company had approximately $33,335,000 of net
operating loss carryforwards and approximately $180,000 of general business
credit carryforwards. These carryforwards expire in 1997 through 2010. In
addition, the Company has minimum tax credit carryforwards of approximately
$40,000 that may be carried over indefinitely. Approximately $1,700,000 of
the net operating loss carryforwards and $180,000 of the general business
credit carryforwards are limited to the net income of TOCCO. Approximately
$5,900,000 of the net operating loss carryforwards are limited to the net
income of the Coal Company.
The Company has no Saudi Arabian tax liability.
NOTE 13 - SEGMENT INFORMATION
The Company has operations in two industry segments and geographic regions.
Its refinery operations represent the significant portion of its current
operating results and are exclusively in the United States, whereas its
mining operations, conducted mainly in Saudi Arabia, mostly relate to costs
which have been deferred during the development phase of these operations.
The only mining operations conducted in the United States relate to the
Company's investment in Pioche for which the related investment and equity
income and losses are shown separately on the balance sheet and statement of
operations, respectively. The Company has no significant corporate
activities.
Since a substantial portion of the Company's mineral properties and
interests are located outside of the United States, its business and
properties are subject to foreign laws and foreign conditions, with the
attendant varying risks and advantages. Foreign exchange controls, foreign
legal and political concepts, foreign government instability, international
economics and other factors create risks not necessarily comparable with
those involved in doing business in the United States.
For 1996, 1995 and 1994, essentially all activity on the Company's
consolidated statement of operations relates to the refinery. The 1996,
1995 and 1994 results include $33,944, $54,063 and $74,580, respectively,
of unallocated costs recorded in general and administrative expenses related
to the Saudi Arabian operations. The 1996 and 1995 results include
immaterial amounts of interest expense related to notes payable entered
into in 1995 that relate to the Saudi Arabian mining operations. All items
included in the Company's consolidated balance sheet related to the Saudi
Arabian operations are specifically identified on the face of the
consolidated balance sheet with the exception of notes payable which have
been identified in Note 9.
28
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 14 - RELATED PARTY TRANSACTIONS
The Company shares office facilities and certain expenses with companies
owned by the chairman of the Company. At December 31, 1996 and 1995, these
companies did not owe any amounts to the Company.
Noncurrent accrued liabilities in Saudi Arabia in the consolidated balance
sheet represent amounts payable to the Company's president.
Other significant related party transactions have been addressed in the
related notes to the consolidated financial statements. In particular, see
Notes 9 and 11 for additional information.
29
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
----------------------------
1996 1995
------------ ------------
Current Assets
Cash and cash equivalents in United States................ $ 209,251 $ 302,039
Short-term investments.................................... 298,726 294,610
Accounts receivable (net of allowance for doubtful
accounts of $168,484 in 1996 and $145,709 in 1995)..... 2,643,691 1,791,821
Inventories............................................... 565,346 430,732
------------ ------------
Total current assets.............................. 3,717,014 2,819,202
Cash in Saudi Arabia........................................ 176,039 396,809
Refinery Plant, Pipeline and Equipment -- at Cost........... 5,758,852 5,563,776
Less Accumulated Depreciation............................... 2,911,823 2,557,454
Refinery Plant, Pipeline and Equipment, Net................. 2,847,029 3,006,322
Al Masane Project........................................... 32,882,838 30,897,883
Other Interests in Saudi Arabia............................. 2,431,248 2,431,248
Mineral Properties in the United States..................... 1,418,615 --
Investment in and Advances to Pioche-Ely Valley Mines,
Inc....................................................... -- 239,032
Goodwill.................................................... 117,598 397,902
Other Assets................................................ 505,566 617,019
------------ ------------
Total Assets...................................... $ 44,095,947 $ 40,805,417
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable.......................................... $ 1,408,677 $ 674,641
Accrued liabilities....................................... 520,445 617,995
Accrued liabilities in Saudi Arabia....................... 1,174,229 1,011,980
Notes payable............................................. 11,375,780 15,086,191
Current portion of long-term debt......................... 992,729 78,090
Current portion of long-term obligations.................. 150,904 20,285
------------ ------------
Total current liabilities......................... 15,622,764 17,489,182
Long-Term Debt.............................................. 3,544,112 708,534
Long-Term Obligations....................................... 35,009 185,875
Accrued Liabilities in Saudi Arabia......................... 714,143 636,047
Deferred Revenue............................................ 129,685 145,189
Commitments and Contingencies............................... -- --
Minority Interest in Consolidated Subsidiary................ 1,003,590 --
Stockholders' Equity
Common stock, authorized 40,000,000 shares of $.10 par
value: issued and outstanding, 20,956,494 shares in
1996 and 20,206,494 shares in 1995..................... 2,095,649 2,020,649
Additional paid-in capital................................ 34,932,700 33,210,750
Receivables from stockholders............................. (126,000) (126,000)
Accumulated deficit....................................... (13,855,705) (13,464,809)
------------ ------------
Total stockholders' equity........................ 23,046,644 21,640,590
------------ ------------
Total Liabilities and Stockholders' Equity........ $ 44,095,947 $ 40,805,417
============ ============
The accompanying notes are an integral part of these statements.
16
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 1996
1996 1995 1994
----------- ----------- -----------
Revenues
Refined product sales......................... $21,367,438 $17,741,862 $17,564,226
Processing fees............................... 646,848 616,796 200,757
----------- ----------- -----------
22,014,286 18,358,658 17,764,983
Operating costs and expenses
Cost of refined product sales and
processing................................. 19,357,737 15,575,054 13,750,750
General and administrative.................... 2,284,422 2,372,683 2,036,470
Depreciation and amortization................. 693,251 677,157 647,137
Litigation.................................... -- -- (975,000)
----------- ----------- -----------
22,335,410 18,624,894 15,459,357
----------- ----------- -----------
Operating income (loss)......................... (321,124) (266,236) 2,305,626
Other income (expense) Interest income.......... 25,310 33,395 56,491
Interest expense.............................. (336,979) (369,546) (347,364)
Minority interest............................. 13,072 -- --
Equity in losses of affiliate................. -- (24,112) (114,460)
Miscellaneous income.......................... 228,825 257,267 443,836
----------- ----------- -----------
Income (loss) before income taxes and
extraordinary item............................ (390,896) (369,232) 2,314,129
Income tax expense.............................. -- -- (39,973)
----------- ----------- -----------
Income (loss) before extraordinary item......... (390,896) (369,232) 2,274,156
Extraordinary item.............................. -- -- 578,150
----------- ----------- -----------
Net income (loss)............................... $ (390,896) $ (369,232) $ 2,852,306
=========== =========== ===========
Per common share Income (loss) before
extraordinary item............................ $ (0.02) $ (0.02) $ 0.11
Extraordinary item............................ -- -- 0.03
----------- ----------- -----------
Net income (loss)..................... $ (0.02) $ (0.02) $ 0.14
=========== =========== ===========
Weighted average number of common shares
outstanding................................... 20,286,208 20,030,434 20,027,881
=========== =========== ===========
The accompanying notes are an integral part of these statements.
17