UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2006
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to __________
COMMISSION FILE NUMBER 0-6247
ARABIAN AMERICAN DEVELOPMENT COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 75-1256622
(State or other jurisdiction of (I.R.S. employer
identification no.) incorporation or organization)
10830 NORTH CENTRAL EXPRESSWAY, SUITE 175 75231
DALLAS, TEXAS (Zip code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (214) 692-7872
Former name, former address and former fiscal year, if
changed since last report.
NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the
Act).
LARGE ACCELERATED FILER [ ] ACCELERATED FILER [ ] NON-ACCELERATED FILER [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act).
YES [ ] NO [X]
Number of shares of the Registrant's Common Stock (par value $0.10 per share),
outstanding at September 30, 2006: 22,771,994.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ARABIAN AMERICAN DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------ ------------
ASSETS
CURRENT ASSETS
Cash $ 3,814,261 $ 1,738,558
Trade Receivables, Net 10,682,636 12,972,657
Financial Contracts -- 74,752
Prepaid Derivative Settlement 2,300,000 --
Inventories 369,329 1,164,674
------------ ------------
Total Current Assets 17,166,226 15,950,641
PLANT, PIPELINE AND EQUIPMENT 20,643,705 17,905,048
Less: Accumulated Depreciation (10,619,956) (9,678,443)
------------ ------------
Net Plant, Pipeline and Equipment 10,023,749 8,226,605
AL MASANE PROJECT 37,085,131 36,804,098
OTHER INTERESTS IN SAUDI ARABIA 2,431,248 2,431,248
MINERAL PROPERTIES IN THE UNITED STATES 1,058,079 1,058,492
OTHER ASSETS 2,542,024 2,476,865
------------ ------------
TOTAL ASSETS $ 70,306,457 $ 66,947,949
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts Payable $ 1,115,496 $ 1,787,353
Financial Contracts 2,261,284 --
Accrued Liabilities 1,431,247 1,638,742
Accrued Liabilities in Saudi Arabia 1,619,919 2,407,282
Notes Payable 11,012,500 11,025,833
Current Portion of Long-Term Debt 2,429,743 1,425,932
------------ ------------
Total Current Liabilities 19,870,189 18,285,142
LONG-TERM DEBT 4,617,237 9,838,662
DEFERRED REVENUE 2,281,617 1,732,556
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES 801,653 808,443
STOCKHOLDERS' EQUITY
COMMON STOCK-authorized 40,000,000
shares of $.10 par value; issued and
outstanding, 22,571,994 and 22,431,994 shares in 2006
and 2005, respectively 2,257,199 2,243,199
ADDITIONAL PAID-IN CAPITAL 37,087,206 36,512,206
RETAINED EARNINGS (ACCUMULATED DEFICIT) 3,391,356 (2,472,259)
------------ ------------
Total Stockholders' Equity 42,735,761 36,283,146
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 70,306,457 $ 66,947,949
============ ============
See notes to consolidated financial statements.
1
ARABIAN AMERICAN DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------ ------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
REVENUES
Petrochemical Product Sales $ 26,253,133 $ 19,521,900 $ 72,635,032 $ 55,608,233
Processing Fees 1,288,351 1,211,825 3,305,099 3,100,040
------------ ------------ ------------ ------------
27,541,484 20,733,725 75,940,131 58,708,273
OPERATING COSTS AND EXPENSES
Cost of Petrochemical Product
Sales and Processing 24,763,985 12,826,547 61,158,976 42,690,272
General and Administrative 1,522,286 1,125,042 4,289,185 3,251,672
Depreciation 379,021 170,231 941,512 481,561
------------ ------------ ------------ ------------
26,665,292 14,121,820 66,389,673 46,423,505
------------ ------------ ------------ ------------
OPERATING INCOME 876,192 6,611,905 9,550,458 12,284,768
OTHER INCOME (EXPENSE)
Interest Income 72,592 23,519 171,918 42,018
Interest Expense (92,973) (230,560) (632,804) (659,052)
Minority Interest 3,184 3,314 6,791 6,948
Miscellaneous Income (Expense) (43,544) (194) 199,519 50,617
------------ ------------ ------------ ------------
(60,741) (203,921) (254,576) (559,469)
------------ ------------ ------------ ------------
INCOME FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES 815,451 6,407,984 9,295,882 11,725,299
INCOME TAXES 300,849 481,000 3,432,267 829,600
------------ ------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS 514,602 5,926,984 5,863,615 10,895,699
DISCONTINUED OPERATIONS
Income from Operations of Coin -- -- -- 989,856
Gain on Disposal of Coin -- -- -- 5,825,668
------------ ------------ ------------ ------------
GAIN FROM DISCONTINUED OPERATIONS -- -- -- 6,815,524
------------ ------------ ------------ ------------
NET INCOME $ 514,602 $ 5,926,984 $ 5,863,615 $ 17,711,223
============ ============ ============ ============
Basic Earnings per Common Share
Income from Continuing Operations $ 0.023 $ 0.261 $ 0.257 $ 0.479
Discontinued Operations 0.000 0.000 0.000 0.300
------------ ------------ ------------ ------------
Net Income $ 0.023 $ 0.261 $ 0.257 $ 0.779
============ ============ ============ ============
Basic Weighted Average Number
of Common Shares Outstanding 22,808,954 22,731,994 22,782,092 22,731,994
============ ============ ============ ============
Diluted Earnings per Common Share
Income from Continuing Operations $ 0.022 $ 0.261 $ 0.255 $ 0.479
Discontinued Operations 0.000 0.000 0.000 0.300
------------ ------------ ------------ ------------
Net Income $ 0.022 $ 0.261 $ 0.255 $ 0.779
============ ============ ============ ============
Diluted Weighted Average Number
of Common Shares Outstanding 23,073,902 22,731,994 22,967,626 22,731,994
============ ============ ============ ============
See notes to consolidated financial statements.
2
ARABIAN AMERICAN DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006
RETAINED
COMMON STOCK ADDITIONAL EARNINGS
-------------------- PAID-IN (ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT) TOTAL
----------- ----------- ----------- ----------- -----------
DECEMBER 31, 2005 22,431,994 $ 2,243,199 $36,512,206 $(2,472,259) $36,283,146
Common Stock
Issued to Employees 40,000 4,000 56,000 -- 60,000
Issued to Directors 100,000 10,000 290,000 -- 300,000
Stock Options to Directors -- -- 229,000 -- 229,000
Net Income -- -- -- 5,863,615 5,863,615
----------- ----------- ----------- ----------- -----------
SEPTEMBER 30, 2006 22,571,994 $ 2,257,199 $37,087,206 $ 3,391,356 $42,735,761
=========== =========== =========== =========== ===========
See notes to consolidated financial statements.
3
ARABIAN AMERICAN DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------
2006 2005
------------ ------------
OPERATING ACTIVITIES
Net Income $ 5,863,615 $ 17,711,223
Adjustments to Reconcile Net Income
To Net Cash Provided by Operating Activities:
Depreciation 941,512 481,561
Increase (Decrease) in Deferred Revenue 549,061 (29,140)
Unrealized (Gain) Loss on Financial Contracts 2,336,036 (3,269,202)
Gain on Disposal of Coin -- (5,825,668)
Minority Interest/Other (6,789) (6,947)
Common Stock/Option Compensation Expense 589,000 --
Changes in Operating Assets and Liabilities:
(Increase) Decrease in Trade Receivables 2,290,021 (4,399,321)
Increase in Prepaid Derivative Settlement (2,300,000) --
Decrease in Inventories 795,345 600,368
(Increase) Decrease in Other Assets 9,593 (261,860)
Increase (Decrease) in Accounts Payable and
Accrued Liabilities (886,415) 601,095
Increase (Decrease) in Accrued Interest 7,063 (578,959)
Increase in Accrued Liabilities in Saudi Arabia (787,363) (221,377)
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 9,325,927 4,801,773
------------ ------------
INVESTING ACTIVITIES
Additions to Al Masane Project (281,033) (161,248)
Additions to Plant, Pipeline and Equipment (2,738,657) (3,113,412)
Reduction in Mineral Properties in the United States 413 181
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (3,019,277) (3,274,479)
------------ ------------
FINANCING ACTIVITIES
Additions to Notes Payable and Long-Term Obligations 4,558,726 1,379,890
Reduction of Notes Payable and Long-Term Obligations (8,789,673) (253,000)
------------ ------------
NET CASH PROVIDED (USED) IN FINANCING ACTIVITIES (4,230,947) 1,126,890
------------ ------------
NET INCREASE IN CASH 2,075,703 2,654,184
CASH AT BEGINNING OF PERIOD 1,738,558 623,202
------------ ------------
CASH AT END OF PERIOD $ 3,814,261 $ 3,277,386
============ ============
See notes to consolidated financial statements.
4
ARABIAN AMERICAN DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
of America ("GAAP") for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by GAAP for
complete financial statements, but, in our opinion, all adjustments
(consisting of normal recurring accruals) necessary for a fair presentation
of consolidated financial position, consolidated results of operations, and
consolidated cash flows at the dates and for the periods presented have been
included. Interim period results are not necessarily indicative of the
results for the calendar year. For additional information please refer to the
consolidated financial statements and footnotes thereto and to Management's
Discussion and Analysis of Financial Condition and Results of Operations
included in the Company's December 31, 2005 Annual Report on Form 10-K.
These financial statements include the accounts of Arabian American
Development Company (the "Company") and its wholly-owned subsidiary, American
Shield Refining Company (the "Petrochemical Company" or "ASRC"), which owns
all of the capital stock of Texas Oil and Chemical Company II, Inc.
("TOCCO"). TOCCO owns all of the capital stock of South Hampton Resources,
Inc., formerly known as South Hampton Refining Co. ("South Hampton"), and,
until June 9, 2005, approximately 99.9% of the capital stock of Productos
Quimicos Coin, S.A. de C.V. ("Coin"), a specialty petrochemical products
company located near Coatzacoalcos, Mexico. South Hampton owns all of the
capital stock of Gulf State Pipe Line Company, Inc. ("Gulf State"). The
Company also owns approximately 55% of the capital stock of a Nevada mining
company, Pioche-Ely Valley Mines, Inc. ("Pioche"), which does not conduct any
substantial business activity. The Petrochemical Company and its subsidiaries
constitute the Company's Specialty Petrochemicals Segment. Pioche and the
Company's mineral properties in Saudi Arabia constitute its Mining Segment.
2. ACCOUNTING PRONOUNCEMENTS
FASB STATEMENT NO. 123 (REVISED 2004)
In December 2004 the Financial Accounting Standards Board (FASB) issued
Statement No. 123 (revised 2004), "Share-Based Payment" (Statement No. 123R),
which requires the fair value of all share-based payments to employees,
including grants of employee stock options, to be recognized as expense over
the employees' requisite service period. The Company adopted Statement No.
123R on a prospective basis effective January 1, 2006. Under the prospective
method, the Company continues to account for previously outstanding stock
options at the date of adoption of SFAS 123R under APB 25. The specific
impact of our adoption will depend on the levels of share-based incentive
awards granted in the future.
FASB STATEMENT NO. 155
In February 2006 the FASB issued Statement No. 155, "Accounting for Certain
Hybrid Financial Instruments," which amends Statement No. 133, "Accounting
for Derivative Instruments and Hedging Activities," and Statement No. 140,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." Statement No. 155 is effective for all
financial instruments acquired or issued after the beginning of an entity's
fiscal year that begins after September 15, 2006. We are currently evaluating
the impact, if any, of adopting FAS 155 on our financial statements.
5
FASB STATEMENT NO. 48
In June 2006 the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes-an interpretation of FASB Statement No.
109(FIN48). FIN48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise's financial statements in accordance with FASB
Statement NO. 109. "Accounting for Income Taxes," by prescribing a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken
in a tax return. If a tax position is more likely than not to be sustained
upon examination, then an enterprise would be required to recognize in its
financial statements the largest amount of benefit that is greater than 50%
likely of being realized upon ultimate settlement. The provisions of FIN 48
will be effective as of the beginning of our 2007 fiscal year, with the
cumulative effect of the change in accounting principle recorded as an
adjustment to opening retained earnings. We are currently evaluating the
impact, if any, of adopting FIN 48 on our financial statements.
EITF ISSUE NO. 06-3
In June 2006 the FASB ratified its consensus on EITF Issue No. 06-3, "How
Taxes Collected from Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement (That Is, Gross versus Net
Presentation)" (EITF No. 06-3). The scope of EITF No. 06-3 includes any tax
assessed by a governmental authority that is imposed concurrent with or
subsequent to a revenue-producing transaction between a seller and a
customer. For taxes within the scope of this issue that are significant in
amount, the consensus requires the following disclosures: (i) the accounting
policy elected for these taxes and (ii) the amount of the taxes reflected
gross in the income statement on an interim and annual basis for all periods
presented. The disclosure of those taxes can be done on an aggregate basis.
The consensus is effective for interim and annual periods beginning after
December 15, 2006, with earlier application permitted. Adoption of EITF No.
06-3 is not expected to affect our financial position or results of
operations.
FASB STATEMENT NO. 157
In September 2006 the FASB issued Statement No. 157, "Fair Value
Measurements." Statement No. 157 defines fair value, established a framework
for measuring fair value under GAAP, and expands disclosures about fair value
measures. Statement No. 157 is effective for fiscal years beginning after
November 15, 2007, with early adoption encouraged. The provisions of
Statement No. 157 are to be applied on a prospective basis, with the
exception of certain financial instruments for which retrospective
application is required. The adoption of Statement No. 157 is not expected to
materially affect our financial position or results of operations.
3. INVENTORIES
Inventories include the following:
SEPTEMBER 30, 2006 DECEMBER 31, 2005
------------------ -----------------
Petrochemical products $ 369,329 $1,164,674
========== ==========
Inventories are recorded at the lower of cost, determined on the last-in,
first-out method (LIFO), or market. At September 30, 2006, and December 31,
2005, current cost exceeded LIFO value by approximately $596,000 and
$601,000, respectively,
6
4. NET INCOME PER COMMON SHARE
The following table (in thousands, except per share amounts) sets forth the
computation of basic and diluted net income per share for the three and nine
months ended September 30, 2006 and 2005, respectively.
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------------- -------------------------
Per Share Per Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
CONTINUING OPERATIONS
BASIC NET INCOME PER SHARE:
Income from continuing operations $ 515 22,809 $0.023 $5,927 22,732 $0.261
Dilutive stock options outstanding 265
------ ------ ------ ------ ------ ------
DILUTED NET INCOME PER SHARE:
Income from continuing operations $ 515 23,074 $0.022 $5,927 22,732 $0.261
====== ====== ====== ====== ====== ======
DISCONTINUED OPERATIONS
BASIC NET INCOME PER SHARE:
Income from discontinued operations $ -- 22,809 $0.000 $ -- 22,732 $0.000
Dilutive stock options outstanding 265
------ ------ ------ ------ ------ ------
DILUTED NET INCOME PER SHARE:
Income from discontinued operations $ -- 23,074 $0.000 $ -- 22,732 $0.000
====== ====== ====== ====== ====== ======
TOTAL OPERATIONS
BASIC NET INCOME PER SHARE:
Net income $ 515 22,809 $0.023 $5,927 22,732 $0.261
Dilutive stock options outstanding 265
------ ------ ------ ------ ------ ------
DILUTED NET INCOME PER SHARE:
Net income $ 515 23,074 $0.022 $5,927 22,732 $0.261
====== ====== ====== ====== ====== ======
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
--------------------------- ----------------------------
Per Share Per Share
Income Shares Amount Income Shares Amount
------- ------- ------ ------- ------- ------
CONTINUING OPERATIONS
BASIC NET INCOME PER SHARE:
Income from continuing operations $ 5,864 22,782 $0.257 $10,896 22,732 $0.479
Dilutive stock options outstanding 185
------- ------- ------ ------- ------- ------
DILUTED NET INCOME PER SHARE:
Income from continuing operations $ 5,864 22,967 $0.255 $10,896 22,732 $0.479
======= ======= ====== ======= ======= ======
DISCONTINUED OPERATIONS
BASIC NET INCOME PER SHARE:
Income from discontinued operations $ -- 22,782 $0.000 $ 6,816 22,732 $0.300
Dilutive stock options outstanding 185
------- ------- ------ ------- ------- ------
DILUTED NET INCOME PER SHARE:
Income from discontinued operations $ -- 22,967 $0.000 $ 6,816 22,732 $0.300
======= ======= ====== ======= ======= ======
TOTAL OPERATIONS
BASIC NET INCOME PER SHARE:
Net income $ 5,864 22,782 $0.257 $17,711 22,732 $0.779
Dilutive stock options outstanding 185
------- ------- ------ ------- ------- ------
DILUTED NET INCOME PER SHARE:
Net income $ 5,864 22,967 $0.255 $17,711 22,732 $0.779
======= ======= ====== ======= ======= ======
For the three and nine months ended September 30, 2005, options for 400,000
shares were excluded from diluted shares outstanding because their effect was
anti-dilutive.
7
5. SEGMENT INFORMATION
As discussed in Note 1, the Company has two business segments. The Company
measures segment profit or loss as operating income (loss), which represents
income (loss) before interest, minority interest, miscellaneous income and
foreign exchange transaction gain or loss. Information on the segments is as
follows:
THREE MONTHS ENDED SEPTEMBER 30, 2006 PETROCHEMICAL MINING TOTAL
- ------------------------------------- ------------- ------------ ------------
Continuing operations:
Revenue from external customers $ 27,541,484 $ -- $ 27,541,484
Depreciation 378,942 79 379,021
Operating income (loss) 1,012,130 (135,938) 876,192
Total assets $ 29,615,506 $ 40,690,951 $ 70,306,457
THREE MONTHS ENDED SEPTEMBER 30, 2005 PETROCHEMICAL MINING TOTAL
- ------------------------------------- ------------- ------------ ------------
Continuing operations
Revenue from external customers $ 20,733,725 $ -- $ 20,733,725
Depreciation 170,231 -- 170,231
Operating income (loss) 6,764,647 (152,742) 6,611,905
Total assets $ 23,374,655 $ 40,232,814 $ 63,607,469
NINE MONTHS ENDED SEPTEMBER 30, 2006 PETROCHEMICAL MINING TOTAL
- ------------------------------------- ------------- ----------- -----------
Continuing operations:
Revenue from external customers $75,940,131 $ -- $75,940,131
Depreciation 941,344 168 941,512
Operating income (loss) 10,141,422 (590,964) 9,550,458
NINE MONTHS ENDED SEPTEMBER 30, 2005 PETROCHEMICAL MINING TOTAL
- ------------------------------------------------- ------------- ----------- -----------
Continuing operations
Revenue from external customers $58,708,273 $ -- $58,708,273
Depreciation 481,561 -- 481,561
Operating income (loss) 12,731,951 (447,183) 12,284,768
Discontinued operations (Productos Quimicos Coin)
Revenue from external customers $ 2,042,676 $ -- $ 2,042,676
Depreciation -- -- --
Operating income 497,730 -- 497,730
Information regarding foreign operations for the three and nine months ended
September 30, 2006 and 2005 follows (in thousands). Revenues are attributed
to countries based upon the origination of the transaction.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2006 2005 2006 2005
------- ------- ------- -------
REVENUES
United States $27,541 $20,734 $75,940 $58,709
Mexico -- -- -- 2,042
Saudi Arabia -- -- -- --
------- ------- ------- -------
$27,541 $20,734 $75,940 $60,751
======= ======= ======= =======
LONG-LIVED ASSETS
United States $11,082 $ 9,182
Mexico -- --
Saudi Arabia 39,516 39,013
------- -------
$50,598 $48,195
======= =======
6. LEGAL PROCEEDINGS
For the period ending September 30, 2006, South Hampton had no outstanding
lawsuits.
In August 1997, the Executive Director of the Texas Commission on
Environmental Quality (TCEQ) filed a preliminary report and petition with
TCEQ alleging that South Hampton violated various TCEQ rules, TCEQ permits
issued to South Hampton, a TCEQ order issued to South Hampton, the Texas
Water Code, the Texas Clean Air Act and the Texas Solid Waste Disposal Act.
No action occurred on this item in the third quarter of 2006. See the 10-K
Report as of December 31, 2005 for more detail on this topic.
8
7. LIABILITIES AND LONG-TERM DEBT
In May 2006, South Hampton signed a credit agreement with Bank of America for
a $12.0 million working capital line of credit secured by Accounts Receivable
and Inventory. The agreement expires October 31, 2008. The proceeds of the
credit line were used to pay the outstanding balance of $1.8 million borrowed
from the Catalyst Fund in 2005 for expansion of the tolling facilities at the
petrochemical plant, the credit line with Amegy Bank, and for feedstock
acquisition as necessary. The credit agreement contains a sub-limit of $3.0
million available to be used in support of the hedging program. At September
30, 2006, approximately $4.6 million was outstanding.
A contract was signed on June 1, 2004, between South Hampton and a supplier
for the purchase of 65,000 barrels per month of natural gasoline on open
account for the period from June 1, 2004 through May 31, 2006 and year to
year thereafter with thirty (30) days written notice of termination by either
party. The contract requires South Hampton to reduce its debt to the supplier
by $250,000 per quarter. Therefore, $1.0 million of the balance of
approximately $4.26 million was classified as current at December 31, 2005.
At September 30, 2006, the total balance of $2.4 million is classified as
current. The supplier is currently the sole provider of the facility's
feedstock supply. On June 1, 2005, the contract was extended to May 31, 2007.
In the first three quarters of 2006 TOCCO paid dividends to ASRC in amounts
sufficient to repay approximately $340,000 of the liability to its President
and Chief Executive Officer. During the first three quarters of 2006,
approximately $730,000 of this liability was paid and $585,000 remained
outstanding.
8. DERIVATIVE INSTRUMENTS
Statement of Financial Accounting Standard (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS Nos. 138
and 149, establishes accounting and reporting standards for derivative
instruments and hedging activities. SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
The statement requires that changes in the derivative instrument's fair value
be recognized currently in earnings unless specific hedge accounting criteria
are met. Special accounting for qualifying hedges allows a derivative
instrument's gains and losses to offset related results on the hedged item in
the income statement, to the extent effective, and requires that a company
must formally document, designate and assess the effectiveness of
transactions that receive hedge accounting treatment.
On January 30, 1992, the Board of Directors of TOCCO adopted a resolution
authorizing the establishment of a commodities trading account to take
advantage of opportunities to lower the cost of feedstock and natural gas for
its subsidiary, South Hampton. The policy adopted by the Board specifically
prohibits the use of the account for speculative transactions. The operating
guidelines adopted by management generally limit exposures to 50% of the
monthly feedstock volumes of the facility for up to six months forward and up
to 100% of the natural gas requirements. Except in rare cases, the account
uses options and financial swaps to meet the targeted goals. These derivative
agreements are not designated as hedges per SFAS 133, as amended. TOCCO had
option and swap contracts outstanding as of September 30, 2006, covering
various natural gas price movement scenarios through October of 2007 and
covering from 50% to 100% of the natural gas requirements for each month. As
of the same date, TOCCO had committed to financial swap contracts for up to
50% of its required monthly feed stock volume with settlement dates through
March of 2007. For the nine months ended September 30, 2006 and 2005, the net
realized gain from the derivative agreements was approximately $1,192,000 and
$760,000, respectively. There was an estimated unrealized loss for the nine
months ended September 30, 2006 of approximately
9
$2,336,000 and an unrealized gain for the nine months ended September 30,
2005 of approximately $3,269,000. The realized and unrealized gains are
recorded in Cost of Petrochemical Product Sales and Processing for the
periods ended September 30, 2006 and 2005.
In September 2006, margin calls were made on the financial swaps for
$2,300,000, due to a decrease in the price of natural gasoline. As of
September 30, 2006, this amount is recorded in Other Assets in the
consolidated balance sheet as a prepayment against potential hedge
settlements.
9. DISCONTINUED OPERATIONS
A creditor (bank) of Coin, holding a first lien, initiated a mortgage
foreclosure proceeding that resulted in the court ordered public auction of
the plant facilities in Mexico on February 23, 2004. As a result, the court
awarded the plant facilities to the creditor in partial settlement of the
outstanding debt owed by Coin. The court order required legal transfer of the
assets to the creditor within three days; however, the transfer was delayed
by the legal filings of the Company. Ultimately, management and Coin's legal
counsel were unable to determine if or when the legal transfer of ownership
would occur. As a result, management recorded the loss on the foreclosure of
the facility with a charge to consolidated operations of $2,900,964 during
the fourth quarter of 2004. In April 2005, management ceased operating the
plant and shut down the facility. In late April 2005, management met with a
third party having a contract with the Mexican bank to take over the Coin
facility in the event the foreclosure proceedings were completed. An
agreement was reached whereby the Company would sign appropriate
documentation transferring title to the facility in exchange for relief from
certain outstanding liabilities. In exchange for an orderly and clean
transfer of title, the Company received relief from the remaining outstanding
bank interest and penalties of approximately $530,000, was relieved of
severance liabilities of approximately $160,000 due the remaining employees
at the Coatzacoalcos location, and received $100,000 cash with which to
satisfy miscellaneous expenses associated with closing the Mexico City
office. Documentation was completed and signed on May 19, 2005.
On June 9, 2005, the Company sold the stock in the Mexican corporation to an
independent third party in Mexico and essentially ceased all operations in
the country. The stock was sold for an immaterial amount and the sale was
designed to allow the third party to make use of the accumulated tax losses.
The Company recorded a gain on disposal of Coin of approximately $5.9
million. There are no material continuing liabilities associated with the
Company's prior ownership of the Coin operation.
10. SHARE-BASED COMPENSATION
Common Stock
In January 2006, the Company issued 40,000 shares of its common stock to
certain employees and executives of the Company for services rendered. In
August 2006, the Company issued 100,000 shares of its common stock to an
independent director of the Company as recognition for many years of service.
Compensation expense recognized in connection with these issuances was
$300,000 and $360,000 for the three and nine months ended September 30, 2006,
respectively.
10
Stock Options
In August 2006, the Company issued 100,000 stock options to a director of the
Company for his many years of service. The options have a three year exercise
period at an exercise price of $2. Stock option compensation expense
recognized for the three and nine months ended September 30, 2006 was
$300,000. The fair value for these options was estimated on the date of grant
using the fair value option pricing model with the following assumptions: (1)
risk-free interest rate of 4.8%, (2) an expected life of 3 years, (3) 115%
volatility and (4) no dividends.
A summary of the status of our stock option awards is presented below:
WEIGHTED
AVERAGE
NUMBER EXERCISE
OF PRICE
STOCK PER
OPTIONS SHARE
------- --------
OUTSTANDING AT JANUARY 1, 2006 400,000 $1.00
GRANTED 100,000 $2.00
EXERCISED --
FORFEITED --
-------
OUTSTANDING AT SEPTEMBER 30, 2006 500,000 $1.20
=======
EXERCISABLE AT SEPTEMBER 30, 2006 500,000 $1.20
=======
</Table>
The outstanding options of 400,000 at January 1, 2006 have an indefinite life
and the 100,000 options issued during the period have a remaining contractual
life of 35 months.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
Statements in Part 1, Item 2 as well as elsewhere in, or incorporated by
reference in, this Quarterly Report on Form 10-Q regarding the Company's
financial position, business strategy and plans and objectives of the
Company's management for future operations and other statements that are not
historical facts, are "forward-looking statements" as that term is defined
under applicable Federal securities laws. In some cases, "forward-looking
statements" can be identified by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "contemplates," "proposes," believes,"
"estimates," "predicts," "potential" or "continue" or the negative of such
terms and other comparable terminology. Forward-looking statements are
subject to risks, uncertainties and other factors that could cause actual
results to differ materially from those expressed or implied by such
statements. Such risks, uncertainties and factors include, but are not
limited to, general economic conditions domestically and internationally;
insufficient cash flows from operating activities; difficulties in obtaining
financing; outstanding debt and other financial and legal obligations;
competition; industry cycles; feedstock, specialty petrochemical product and
mineral prices; feedstock availability; technological developments;
regulatory changes; environmental matters; foreign government instability;
foreign legal and political concepts; and foreign currency fluctuations, as
well as other risks detailed in the Company's filings with the U.S.
Securities and Exchange Commission, including this Quarterly Report on Form
10-Q, all of which are difficult to predict and many of which are beyond the
Company's control.
On August 25, 2005, South Hampton legally changed its name from South Hampton
Refining Co. to South Hampton Resources, Inc. The former name had been used
by South Hampton since the late 1970's when it was involved in the processing
of crude oil and the production of motor fuels. Since South Hampton had
emphasized the petrochemical and specialty product business for the past
twenty years and no longer produced motor fuels of any nature, it was felt
the name was misleading and needed to be changed.
On July 31, 2006, the Company, which was quoted on the Pink Sheets for the
last four (4) years, began trading on the OTC Bulletin Board. The change was
pursued by the Company in an effort to expand the availability of information
and increase the liquidity of the Company's common stock for the benefit of
its shareholders. Assisting the Company in changing its trading venue to the
OTC Bulletin Board was Westminster Securities Corp., a full service brokerage
firm headquartered in New York.
LIQUIDITY AND CAPITAL RESOURCES
The Company operates in two business segments, specialty petrochemicals
(which is composed of the entities owned by the Petrochemical Company) and
mining. Its corporate overhead needs are minimal. A discussion of each
segment's liquidity and capital resources follows.
SPECIALTY PETROCHEMICALS SEGMENT. Historically, this segment has contributed
all of the Company's internally generated cash flows. As the petroleum
markets have fluctuated the last twenty years, South Hampton was able to
adapt by raising prices, cutting costs, shifting focus, or developing new
markets as necessary. When oil prices began their dramatic rise in 2004,
TOCCO had financial swaps in place which protected it against sudden and
volatile price swings in feedstock prices and to a lesser extent, fuel gas
costs. Product demand has continued to be strong during the last several
years of fluctuating petroleum markets. These conditions allowed the
Petrochemical segment to report significant earnings and to meet continued
volatility
12
of the markets in the future. The Company also moved to take advantage of the
increased demand by increasing its production capacity by 30% in the first
quarter of 2005. The increased capacity has been fully utilized over the last
eighteen months and further expansion is being considered.
A contract is in place between South Hampton and the supplier for the
purchase of 65,000 barrels per month of natural gasoline on open account
through May 31, 2007, and year to year thereafter, with thirty days written
notice of termination by either party. A provision of the contract states
that South Hampton will reduce the debt to the supplier by $250,000 per
quarter. South Hampton has paid the account ahead of the scheduled balance
reductions, and the account is now operating as an open account, secured by
inventory and fixed assets. The supplier is currently the sole provider of
feedstock, although other sources are available in the open market. At
September 30, 2006, South Hampton owed the supplier approximately $2.39
million.
On August 1, 2004, South Hampton entered into a capital lease with Silsbee
Trading and Transportation, which is owned by an officer of the Company, for
the purchase of a diesel powered man lift. The lease is for five years with
title transferring to South Hampton at the end of the term.
On February 23, 2004, the Coin plant facilities were awarded to a creditor in
a foreclosure hearing. The foreclosure was contested successfully until early
2005. On May 19, 2005, through a negotiated settlement, the facility was
transferred to the acquirer and on June 9, 2005, the stock in Coin was sold.
See Note 9 to the notes to the consolidated financial statements (unaudited).
There are no material continuing liabilities associated with the Company's
prior ownership of the Coin operation.
MINING SEGMENT. This segment is in the development stage. Its most
significant asset is the Al Masane mining project in Saudi Arabia, which is a
net user of the Company's available cash and capital resources.
Implementation of the project was delayed over the last five years because
open market prices for metals were insufficient to attract additional
investment required to achieve production. As world economy and metal prices
have improved over the last two years, investment viability has improved and
steps are being taken to take advantage of the improved investment climate.
During 2005, the Company paid past due lease amounts of $586,000 plus
$117,000 due for 2006. The 2007 lease payment of $117,000 will be due on
January 1, 2007. On May 29, 2006, the Company's President notified the
Ministry by letter of the progress made in the formation of a joint venture
which will directly implement the work plan.
The Company is presently working with three companies organized and existing
under the laws of the Kingdom of Saudi Arabia, to achieve the formation of a
joint stock company under the name Al Masane Al Kobra Mining Company
("ALAK"). ALAK's primary activity will be the mining of base metals ore and
concomitant metals, and refining the ore into condensed copper, zinc, gold
and silver alloys, at the Al Masane mining project location. On June 10,
2006, the Company developed a preliminary Memorandum of Understanding ("MOU")
with Thamarat Najran Company, a company organized and existing under the laws
of the Kingdom of Saudi Arabia ("TNC"). The basis of the MOU was approved by
the Boards of the Company and TNC on July 7 and July 3, 2006, respectively. A
Partnership Agreement including two additional Saudi investment companies,
Qasr Al-Ma'adin Corporation and Durrat Al-Masani' Corporation, was negotiated
and approved by the Saudi partners on August 9, 2006 and was approved by the
Board of the Company on August 28, 2006. While final detailed arrangements
may change as the project develops, the basic terms of agreement are as
follows: (1) The capitalization of the joint stock company will be the amount
necessary to develop the project, approximately $120 million, (2)the Company
will own 50% of ALAK and the remainder will be held by the Saudi investors;
(3) the Company will contribute the mining assets, mining lease, and
outstanding debt of approximately $11 million for a credit of $30 million and
the Saudi investors will contribute $30 million, and (4) the remaining
capital will be raised by ALAK by other means which may include application
for a loan from the Saudi Industrial Development Fund. ALAK will have all
13
powers of administration over the Al Masane mining project. The Company will
have three directors representing its interests on a six-member board of
directors with the Chairman of ALAK chosen from the three directors
representing the Saudi investors. The original documents are in Arabic, and
English translations have been provided to the parties. ALAK is in the
process of being established under the rules of the Saudi Ministry of
Commerce and Industry. The Company has hired an attorney and a consultant in
Saudi Arabia to facilitate (1)the formation of the Joint Stock Company,
(2)the net transfer of the mining assets and lease into the newly formed
company, and (3)the raising of the additional capital. The attorney and
consultant are to be paid in stock issued by the Company and up to one
million shares will be issued in increments as the steps are completed. The
formation of a new Joint Stock company and the transfer of the assets are
dependent upon successfully negotiating the regulations and bureaucracy of
the Saudi Government and the Company expects to accomplish this in early
2007. Any guarantees which might be required to raise the additional capital
for ALAK is undetermined at this time.
After initialization, the work plan will take approximately twenty-two (22)
months to complete, after which commercial production would begin. The
Company, on April 20, 2005, signed an agreement with SNC-Lavalin Engineering
and Construction Company of Toronto, Canada ("SNC-Lavalin"), to update the
feasibility study. The prices of zinc, copper, gold and silver have increased
significantly over the last two years, and the updated study with current
prices was completed in August of 2005. The study by SNC-Lavalin also updated
the estimated capital cost and operating expenses of the project. The firm
concluded that capital expenditure of approximately $115 million is needed to
bring the mine into production with an additional $6.7 million for a cyanide
leach process for gold recovery. The study was then turned over to a separate
and independent consultant for further analysis and to allow the economic
feasibility to be reviewed. The consultant, Molinari and Associates, Inc. of
Toronto, Canada, ("Molinari") concluded that the study by SNC-Lavalin was
conservative and there were many opportunities for cost savings and
improvements in the projections as presented.
Metal prices were at record lows worldwide during 2003, and therefore, mining
projects were not economically feasible. As the prices have recovered for the
2004-2006 time period, the project becomes near breakeven over the three year
period, 2003 through 2005. If spot prices as of September 29, 2006, are used
in the analysis, or even the ten year average of prices is used, the project
becomes economically very attractive. Mining economics, as with other capital
intensive extractive industries such as offshore petroleum exploration, will
vary over time as market prices rise and fall with worldwide economic
performance.
The following chart illustrates the change from the prices of 2003 and 2005
to current levels:
AVERAGE PRICE SPOT PRICE AS OF INCREASE
FOR 2003-2005 09/29/2006
GOLD $406.00 per ounce $601.75 per ounce $195.75 per ounce
SILVER $6.29 per ounce $11.50 per ounce $5.21 per ounce
COPPER $1.26 per pound $3.44 per pound $2.18 per pound
ZINC $0.49 per pound $1.53 per pound $1.04 per pound
On June 22, 1999, the Company submitted a formal application for a five-year
exclusive mineral exploration license for the Greater Al Masane Area of
approximately 2,850 square kilometers surrounding the Al Masane mining lease
area and including the Wadi Qatan and Jebel Harr areas. The Company
previously worked in the Greater Al Masane Area after obtaining written
authorization from the Saudi Ministry of Petroleum and Mineral Resources, and
has expended over $3 million in exploration work. Geophysical, geochemical
and geological work and diamond core drilling on the Greater Al Masane areas
revealed mineralization similar to that discovered at Al Masane.
14
In August of 2006, the Ministry notified the Company that its application for
a mineral exploration license did not comply with requirements of the Mining
Code adopted in 2004. The Ministry invited the Company to re-apply, taking
into consideration the new requirement that each application be limited to
100 square kilometers in area. There is no limit on the number of
applications, so the Company intends to re-apply for multiple areas, choosing
the areas previously identified as the highest grade locations. Information
is being accumulated currently and the applications are expected to be
submitted in early 2007.
Management is also addressing two other significant financing issues within
this segment. These issues are the $11 million note payable to the Saudi
Arabian government and accrued salaries and termination benefits of
approximately $1,007,000 due employees working in Saudi Arabia (this amount
does not include any amounts due the Company's President and Chief Executive
Officer who also primarily works in Saudi Arabia and was owed approximately
$1,255,000 at December 31, 2005 and $585,000 as of September 30, 2006).
Regarding the note payable, this loan was originally due in ten annual
installments beginning in 1984. The Company has neither made any repayments
nor received any payment demands or other communications regarding the note
payable from the Saudi government. By memorandum to the King of Saudi Arabia
in 1986, the Saudi Ministry of Finance and National Economy recommended that
the $11 million note be incorporated into a loan from the Saudi Industrial
Development Fund ("SIDF") to finance 50% of the cost of the Al Masane
project, repayment of the total amount of which would be made through a
mutually agreed upon repayment schedule from the Company's share of the
operating cash flows generated by the project. As a part of the current
arrangement with the formation of the Joint Stock Company (ALAK), the
liability for the loan is intended to be transferred along with the assets
and lease of the mining activity to the new organization. Any continuing
guarantees or liability is undetermined at this time. In the event the Saudi
government demands immediate repayment of this obligation, which management
considers unlikely, the Company would be unable to pay the entire amount due.
With respect to the accrued salaries and termination benefits due employees
working in Saudi Arabia, the Company plans to continue employing these
individuals depending upon the needs of the mining operation until ALAK
actually takes over the facility. Management believes it has sufficient
resources to manage this severance liability as necessary. The President has
been paid approximately $730,000 in 2006 of the total amount owed, and plans
are to eliminate the balance by the end of the year.
As noted previously, the Company's mineral interests in the United States are
its ownership interest in Pioche, which has been inactive for many years. Its
properties include forty-eight (48) patented and five (5) unpatented claims
totaling approximately 1,500 acres in Lincoln County, Nevada. A claim
consists of 22.5 acres and by being "patented", the Company actually owns the
surface area. "Unpatented" means the Company leases the surface area, and
owns the mineral deposits. There are prospects and mines on these claims that
previously produced silver, gold, lead, zinc and copper. There is also a 300
ton/day processing mill on property owned by Pioche; however, the mill is not
currently in use and a significant expenditure would be required in order to
put the mill into continuous operation if commercial mining is to be
conducted on the property. In August 2004, the Company exercised its option
to purchase 720,000 shares of the common stock of Pioche at $0.20 a share for
a total amount of $144,000. Pioche agreed to accept payment for the stock
purchase by the cancellation of $144,000 of debt it owed to the Company. This
purchase increased the Company's ownership interest in Pioche to
approximately 55%. The recent high metal prices and positive outlook on the
metals markets have generated a renewed interest in the properties. Inquiries
are evaluated as they appear and the Company is investigating the best use of
the properties. A recent review of the property indicates the real estate
value may preclude the practicality of developing mining operations.
15
The Company's management and Board of Directors have many years of experience
in the exploration for, and development of, mineral prospects in various
parts of the world. Mr. John Crichton, Chairman of the Board, has world wide
experience as a renowned oil and mineral consultant to major companies. He is
the holder of a MSc. Degree in Petroleum Engineering from MIT. Mr. Hatem
El-Khalidi, who holds an MSc. Degree in Geology from Michigan State
University, is also a consultant in oil and mineral exploration. Mr.
El-Khalidi is the person who discovered the Al Masane deposits, which under
his direct supervision were subsequently developed by the Company. The third
board member, Mr. Ghazi Sultan, a Saudi citizen, holds a MSc. Degree in
Geology from the University of Texas. Mr. Sultan served as the Saudi Deputy
Minister of Petroleum and Mineral Resources 1965-1988 and was responsible for
the massive expansion of the mineral resources section of the Ministry. In
that position, a $200 million annual budget was under his direct control and
supervision. Mr. Sultan supervised the work of the USGS (United States
Geological Survey) Mission in Saudi Arabia, the BRGM (French Government
Mineral Survey), and the British Riofenix Mission (owned by Rio Tinto Mining
Company). All of these studies explored and evaluated many mineral deposits
for the Ministry in Saudi Arabia with some becoming mines. Mr. Sultan is the
member responsible for the Audit Committee of the Company. Mr. Nicholas
Carter, the Company's Secretary and Treasurer, is a graduate of Lamar
University with a BBA Degree in Accounting, is a CPA, and has extensive
experience in the management of the Company's petrochemical plant. His
employment in the petrochemical business predates the acquisition by the
Company in 1987. Mr. Carter replaced Mr. Mohammed Al-Omair on the Board
effective April 27, 2006.
RESULTS OF OPERATIONS
SPECIALTY PETROCHEMICALS SEGMENT. In the quarter ended September 30, 2006,
total petrochemical product sales and processing fees from continuing
operations increased approximately $6,808,000 or 33%, while the cost of
petrochemical sales and processing (excluding depreciation) increased
approximately $11,937,000 or 93% from the same period in 2005. Consequently,
the total gross profit margin on revenue in the third quarter of 2006
decreased approximately $5,130,000 or 65% compared to the same period in
2005. The change in gross profit margin for the period was primarily due to
the change in the fair value of derivatives for feedstock purchases. See Note
8. of the notes to the consolidated financial statements (unaudited)
concerning the accounting for Derivative Instruments. The derivatives program
as operated by the Company is designed to allow for increased predictability
of pricing for natural gas and feedstock over time which unfortunately
sometimes has negative results during the short term when price fluctuations
are significant as they were in the third quarter of 2006.
In the nine months ended September 30, 2006, total petrochemical product
sales and processing fees from continuing operations increased approximately
$17,232,000 or 29%, while the cost of petrochemical sales and processing
(excluding depreciation) increased approximately $18,469,000 or 43% from the
same period in 2005. Consequently, the total gross profit margin on
petrochemical product sales and processing in the first nine months of 2006
decreased approximately $1,237,000 compared to the same period in 2005. The
cost of petrochemical product sales and processing and gross profit margin
for the nine months ended September 30, 2006 includes an estimated unrealized
loss of approximately $2,336,000 on the derivative agreements.
The Petrochemical segment completed a de-bottlenecking project on the
solvents unit during the later part of the first quarter of 2005. The project
added two new, larger fractionation towers and divided the solvent production
into two trains. Total capacity of the unit was increased by approximately
30% and was functional by March 31, 2005. Consistent operation at full
capacity of the expanded equipment was attained in the early part of the
third quarter 2005. The project cost approximately $1.5 million and was
accomplished using current maintenance department employees. The expanded
capacity has allowed the Company to increase sales to meet demand growth
16
and to increase market share. The expanded capacity has operated at maximum
rates for the last twelve months and further expansion is being considered.
Sales from discontinued operations decreased approximately $2,043,000 or
100%, while its cost of sales (excluding depreciation) decreased
approximately $1,545,000 or 100%. Therefore, discontinued operations had a
gross profit margin on product sales for the nine months of $0, compared to a
gross profit margin of approximately $498,000 for the same period in 2005.
The discontinued operations relates to the Mexican venture discussed in Note
9 to the notes to the consolidated financial statements (unaudited).
Sales demand has remained high during the last twenty-four (24) months
despite constant price increases to customers. Management attributes the
strong sales demand to improved general economic activity during the past
year and to growth in the industries served by the petrochemical product
lines. Growth of markets served has generally been 2% to 3% annually over the
last ten (10) years. The Company's growth in volume has generally matched
that trend over the same time period, although with the recently expanded
capacity, the growth rate in sales has increased above the industry wide
growth rate. The Company bases its marketing philosophy on high quality,
consistent product, and service to the customer and believes this is
essential to being successful in this specialty product marketplace.
By January of 2006 most of the feedstock price fluctuation related to
hurricanes Rita and Katrina had worked out of the markets. Throughout 2006
sales prices have generated acceptable margins, and the need for constant
price increases has deminished. Demand has remained strong on most products
through the nine months of 2006, and the process ran at 92% of capacity for
the first quarter, 88% in the second quarter and 97% in the third quarter.
Small operational equipment modifications were made as the Company continues
to fine tune the equipment which was added in the previous year. Reliability
and mechanical integrity of the equipment is continually being improved by
the Company to assist its ability to meet market demand.
Since 2003, the Company has entered into derivative agreements to dampen
sudden price spikes and provide feedstock price protection. Management
believes that if the derivative agreements can moderate rate of change in the
overall cost of feedstock, product prices can be adjusted sufficiently as
needed. Approximately 50% of the Company's monthly feedstock requirements for
three to six months ahead are covered at any one time. This ratio cushions
price increases and allows the Company to experience partial benefit when the
price drops. In the third quarter of 2006, the natural gasoline derivative
agreements had a realized gain of approximately $619,000 and an estimated
unrealized loss of approximately $1,814,000 for a total negative effect of
approximately $1,195,000. The program is designed to be insurance against
unforeseen dramatic price swings rather than as a speculative profit center.
It operates mostly as a "buy and hold" program. See Note 8 to the
consolidated financial statements (unaudited) for a discussion of the
accounting methods used for Derivatives.
The price of natural gas (fuel gas), which is the petrochemical operation's
largest single operating expense, continued to be high during the third
quarter of 2006 as compared to historical levels. Of course what is
historically considered a "high" price has changed within the industry as the
Company's natural gas price, including the effect of the hedge program, has
fluctuated within the $6.00 to $8.00 per mmbtu range for the last twenty-four
(24) months. The Company has option contracts in place for fuel gas through
the third quarter of 2007 in order to minimize the impact of price
fluctuations in the market (see Note 8 to the consolidated financial
statements (unaudited)). The Company was also able to pass through price
increases as they have occurred. In the third quarter of 2006, the natural
gas derivative agreements had a realized loss of approximately $33,000 and an
estimated unrealized loss of approximately $447,000.
17
Toll processing fee revenue for the third quarter of 2006 of approximately
$1,288,000 represents an increase of approximately $77,000 or 6% above the
fees for the same period in 2005. Toll processing fee revenue for the first
nine months of 2006 of approximately $3,305,000 represents an increase of
approximately $205,000 or 7% above the fees for the same period in 2005. The
toll processing customers are very active and remain on long-term contracts.
While there are some fluctuations in tolling volumes handled, toll processing
has developed into a stable business and the Company intends to continue to
develop opportunities when available. Toll processing fees are expected to
rise during the remainder of 2006 and beyond as expanded facilities for a
major customer were completed in October 2005. The revised contract with this
customer will generate additional processing fees and contains a capital
repayment feature. The project began operations on schedule (considering the
hurricane caused delay) and is producing high quality products in the volumes
requested by the customer. There are shortages in the markets served by this
process, and it is expected the expanded unit will run at capacity for the
remainder of 2006. A project expanding the capacity of a tolling unit for a
different customer was operational by August 3, 2006, and is expected to
further enhance tolling revenues.
Interest expense for the third quarter of 2006 of approximately $93,000
represents a decrease of approximately $129,000 or 58% below the fees for the
same period in 2005. Interest expense for the first nine months of 2006 of
approximately $632,000 represents an increase of approximately $258,000 or
69% above the fees for the same period in 2005. Interest expense increased in
2006 primarily due to the penalties associated with the buyout of the
Catalyst note.
While the volume of feedstock purchased is rising because of expanded
capacity, significant price changes in the petroleum markets have also
increased the dollar amount of such purchases. The Company has absorbed most
of the increased working capital needs through cash flow, and the line of
credit is only partially used. Insurance expenses will remain flat throughout
2006 with the exception of property coverage. The hurricanes caused the
premiums for that line of coverage to increase by 250% upon renewal in June
of 2006. The increase is not material to the results of the operation.
MINING SEGMENT AND GENERAL CORPORATE EXPENSES. None of the Company's other
operations generate significant operating or other revenues. The minority
interest amount represents the Pioche minority stockholders' shares of the
losses from the Pioche operations. Pioche losses are primarily attributable
to the costs of maintaining the Nevada mining properties.
The Company assesses the carrying values of its assets on an ongoing basis.
Factors which may affect the carrying values of the mining properties
include, but are not limited to, mineral prices, capital cost estimates,
estimated operating costs of any mines and related processing, ore grade and
related metallurgical characteristics, design of any mines and the timing of
any mineral production. Prices currently used to assess the recoverability of
the Al Masane project costs for 2006 are $3.35 per pound for copper and $1.51
per pound for zinc for the projected life of the mine. Copper and zinc
comprise in excess of 80% of the expected value of production. Using these
price assumptions, there were no asset impairments at September 30, 2006.
There are no assurances that, particularly in the event of a prolonged period
of depressed mineral prices, the Company will not be required to take a
material write-down of its mineral properties in the future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
Other than as disclosed, there have been no material changes in the Company's
exposure to market risk from the disclosure included in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2005.
18
ITEM 4. CONTROLS AND PROCEDURES.
The Company carried out an evaluation, under the supervision and with the
participation of Company management, including the Company's President and
Chief Executive Officer and Treasurer, of the effectiveness of the Company's
disclosure controls and procedures, as of the end of the period covered by
this report. Based upon that evaluation, the President and Chief Executive
Officer and Treasurer concluded that, as of the end of the period covered by
this report, the Company's disclosure controls and procedures were effective
such that information relating to the Company (including its consolidated
subsidiaries) required to be disclosed in the Company's Securities and
Exchange Commission reports (i) is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission rules and forms and (ii) is accumulated and communicated to the
Company's management, including the President and Chief Executive Officer and
Treasurer, as appropriate, to allow timely decisions regarding required
disclosure.
During the period covered by this report, there were no changes in the
Company's internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Company's
internal control over financial reporting.
19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Reference is made to Note 6 to the notes to the consolidated financial
statements (unaudited) contained in this Report for a discussion of material
pending legal proceedings.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
ISSUER PURCHASES OF EQUITY SECURITIES
The following table sets forth information about the Company's Common Stock
repurchases during the three months ended September 30, 2006:
<Table>
<Caption>
(a) (c) (d)
Total Total Number of Maximum Number
Number of (b) Shares of
Shares Average Purchased as Shares that May
Period Purchased Price Paid Part of Yet be
- ------ --------- Per Share Publicly Purchased Under
---------- Announced the
Plans or Plans or
Programs Programs
--------------- ---------------
July 1, 2006 through
July 31, 2006 -- $-- -- --
August 1, 2006 through
August 31, 2006 -- $-- -- --
September 1, 2006 through
September 30, 2006 -- $-- -- --
Total -- $-- -- --
== == == ==
ITEM 3. DEFAULTS ON SENIOR SECURITIES.
Reference is made to Notes 6, 7 and 9 to the notes to consolidated financial
statements (unaudited) and Part I. Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations contained in this
Report for a discussion of the $11 million note payable to the Saudi Arabian
government.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
NONE.
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ITEM 5. OTHER INFORMATION.
Reference is made to Part I. Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations for a discussion of activities
related to formation of a joint venture company under the name Al Masane Al
Kobra Mining Company ("ALK") to mine base metals ore at the Al Masane mining
project.
ITEM 6. EXHIBITS.
The following documents are filed or incorporated by reference as exhibits to
this Report. Exhibits marked with an asterisk (*) are management contracts or
a compensatory plan, contract or arrangement.
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3(i) - Certificate of Incorporation of the Company as amended through
the Certificate of Amendment filed with the Delaware Secretary of
State on July 19, 2000 (incorporated by reference to Exhibit 3(a)
to the Company's Annual Report on Form 10-K for the year ended
December 31, 2000 (File No. 0-6247)).
3(ii) - Bylaws of the Company, as amended through March 4, 1998
(incorporated by reference to Exhibit 3(b) to the Company's
Annual Report on Form 10-K for the year ended December 31, 1999
(File No. 0-6247)).
10(a) - Loan Agreement dated January 24, 1979 between the Company,
National Mining Company and the Government of Saudi Arabia
(incorporated by reference to Exhibit 10(b) to the Company's
Annual Report on Form 10-K for the year ended December 31, 1999
(File No. 0-6247)).
10(b) - Mining Lease Agreement effective May 22, 1993 by and between the
Ministry of Petroleum and Mineral Resources and the Company
(incorporated by reference to Exhibit 10(c) to the Company's
Annual Report on Form 10-K for the year ended December 31, 1999
(File No. 0-6247)).
10(c) - Equipment Lease Agreement dated November 14, 2003, between
Silsbee Trading and Transportation Corp. and South Hampton
Refining Company (incorporated by reference to Exhibit 10(o) to
the Company's Annual Report on Form 10-K for the year ended
December 31, 2003 (File No. 0-6247)).
10(d) - Addendum to Equipment Lease Agreement dated August 1, 2004,
between Silsbee Trading and Transportation Corp. and South
Hampton Refining Company (incorporated by reference to Exhibit
10(q) to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2004 (file No. 0-6247)).
10(e) - Letter Agreement dated May 7, 2005 between Sheikh Fahad Al-Athel
and the Company (incorporated by reference to Exhibit 10(p) to
the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2005 (file No. 0-6247)).
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<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10(f) - Judicial Agreement dated May 19, 2005 between Fabricante Y
Comercializadora Beta, S.A. de C.V. and Productos Coin, S.A.de
C.V. (incorporated by reference to Exhibit 10(r) to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2005
(file No. 0-6247)).
10(g) - Agreement dated June 6, 2005 between Fabricante Y
Comercializadora Beta, S.A. de C.V. and Productos Quimicos Coin,
S.A. de C.V. (incorporated by reference to Exhibit 10(s) to the
Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2005 (file No. 0-6247)).
10(h) - Mercantile Shares Purchase and Sale Agreement dated June 9, 2005
between Texas Oil & Chemical Co. II. Inc. and Ernesto Javier
Gonzalez Castro and Mauricio Ramon Arevalo Mercado. (incorporated
by reference to Exhibit 10(t) to the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 2005 (file No.
0-6247)).
10(i) - Partnership Agreement dated August 6, 2006 between Arabian
American Development Company, Thamarat Najran Company, Qasr
Al-Ma'adin Corporation, and Durrat Al-Masani' Corporation.
10(j) - Financial and Legal Service and Advice Agreement dated August 5,
2006 between Arabian American Development Company, Nassir Ali
Kadasa, and Dr. Ibrahim AL-Mounif.
31.1 - Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 - Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 - Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 - Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
</Table>
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DATE: November 14, 2006 ARABIAN AMERICAN DEVELOPMENT COMPANY
------------------------------------
(Registrant)
By: /s/ NICHOLAS CARTER
-------------------------------------------
Nicholas Carter Secretary/Treasurer
Authorized Officer and Principal Financial
Officer)
23