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ARABIAN SHIELD
DEVELOPMENT COMPANY
ANNUAL REPORT TO STOCKHOLDERS
FOR THE YEAR ENDED DECEMBER 31, 1997
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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 Limited 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.
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. On November 5, 1997, the Company and the Al Mashreq
Company for Mining Investments ("Al Mashreq"), a Saudi limited liability company
owned by Saudi Arabian investors, initialed a joint venture agreement to form a
Saudi limited liability company which will be owned 50% by the Company and 50%
by Al Mashreq. The new company, called "The Arabian Shield Company for Mining
Industries Ltd.", is now under formation and has applied to the Saudi Ministry
of Commerce for a charter to operate the mine.
The Company believes that 25% of the capital cost of the project may be obtained
through loans from commercial banks, 50% of the capital cost of the project
would come from an interest-free loan from the Saudi Industrial Development Fund
("SIDF") and that Saudi Arabian investors will contribute the remaining 25% of
the capital cost of the project. A loan application was submitted to SIDF on
September 30, 1995 and conditional approval was received on December 17, 1997
for a $38.08 million loan. In order to be eligible for the interest-free loan
from the SIDF, the Company together with its Saudi Arabian advisors obtained an
industrial license from The Ministry of Industry and Electricity on December 3,
1996. The license was amended to reflect the transfer from the two Saudi Arabian
advisors to Al Mashreq on November 22, 1997. The Company owns 50% of the license
and Al Mashreq the remaining 50%. Under the mining lease agreement, when actual
profits are realized from commercial mining operations of the project, it is
contemplated that the Saudi limited liability company will be transformed into a
Saudi public stock company. The Company and Al Mashreq will own no less than 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.
Pursuant to the terms of the mining lease agreement, the Company will undertake
to repay the $11 million loan provided to the Company in 1979 by the Ministry of
Finance and National Economy, in accordance with the terms of an agreement to be
negotiated 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 advance
rentals 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 has made all rental
payments under the lease.
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
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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 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
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concentrate, copper concentrate and dore bullion. The copper concentrate will
contain valuable amounts 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.
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,
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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 1997 for the refinery operations
were approximately $26.2 million and earnings before interest, taxes and
depreciation and amortization were approximately $2.2 million. It is significant
that the plant sells about 40% of all pentanes consumed in the United States.
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The Company directly owns approximately 44% and beneficially owns approximately
52% 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 81 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. In October 1997, Pioche entered into an Exploration
Agreement and Option to Purchase with a large mining company which provides for
annual payments to Pioche of $50,000 for seven years until, or unless, the
mining company exercises an option to purchase an 85% interest in the mining
claims for $3 million. The agreement can be terminated upon 60 days written
notice from the mining company. The mining company has agreed to expend at least
$50,000 in exploration work each year and to drill at least one hole in the
first year.
Respectfully submitted,
John A. Crichton
Chairman of the Board
Hatem El-Khalidi
President and Chief Executive
Officer
March 30, 1998
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THE COMPANY.
Arabian Shield Development Company (the "Company") was organized as a Delaware
corporation in 1967 and is principally engaged in the refining of various
specialty petrochemical products and developing various mineral properties. All
of its mineral properties are undeveloped and require significant capital
expenditures before any commercial operations are commenced. The Company has
operations in both the United States and Saudi Arabia. The Company's undeveloped
mineral interests are primarily located 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.
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. The Company
remains a party to an agreement with the Petroleum and Mineral Organization
("Petromin"), the official mining and petroleum company of the Saudi Arabian
government, which governs the rights of the parties if an exploration license is
converted into a mining lease. 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 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.
The Aromax(R) plant received final approval from the Saudi Arabian government in
March 1996 and Chevron Chemical began construction soon thereafter. The source
of feedstock supply to the Aromax(R) plant has changed resulting in Chevon
Chemical and SVCS being unable to supply the proposed processing plant. The
Company has held discussions with several Saudi Arabian companies regarding
feedstock and transportation arrangements, although there can be no assurances
that any such arrangements can be made. The Company applied for and received a
license to build the proposed processing plant and further planning and design
work are underway.
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
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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, 1997.
The Company beneficially owns approximately 52% and directly owns approximately
44% of the outstanding capital stock of a company which leases mineral
properties containing 129 inactive mining claims totalling approximately 3,600
acres in southeastern Nevada. There are prospects and mines on these claims
which formerly produced silver, gold, lead, zinc and copper. In October 1997,
Pioche entered into an Exploration Agreement and Option to Purchase with a large
mining company which provides for annual payments to Pioche of $50,000 for seven
years until, or unless, the mining company exercises an option to purchase an
85% interest in the mining claims for $3 million. The agreement can be
terminated upon 60 days written notice by the mining company. The mining company
has agreed to expend at least $50,000 in exploration work each year and to drill
at least one hole in the first year.
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 1997 and 1996, respectively, as reported by NASDAQ.
1997 1996
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1st 2nd 3rd 4th 1st 2nd 3rd 4th
--- --- --- --- --- --- --- ---
High 2 3/4 2 6 3/8 3 31/32 3 3/4 3 3/8 2 5/8 2 3/32
Low 1 1/2 1 1 1 3/4 1/4 1 1/2 1 1/2 1 5/8
At March 16, 1998, there were 831 record holders of the Company's Common Stock.
The Company has not paid a dividend since its inception.
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SELECTED FINANCIAL DATA.
The following is a five-year summary of selected financial data of the Company
(in thousands, except per share amounts):
1997 1996 1995 1994 1993
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Revenues................................. $26,174 $22,014 $18,359 $17,765 $15,267
Net Income (Loss)........................ $ 818 $ (391) $ (369) $ 2,852 $(1,338)
Net Income (Loss) Per Share.............. $ .04 $ (.02) $ (.02) $ .14 $ (.08)
Total Assets (at December 31)............ $45,053 $44,096 $40,805 $41,057 $41,090
Notes Payable (at December 31)........... $11,376 $11,376 $15,086 $15,945 $18,044
Total Long-Term Obligations (at December
31).................................... $ 4,236 $ 4,293 $ 1,676 $ 1,148 $ 908
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
The Company's revenues and cash flows have been insufficient to meet its debt
service and capital expenditure requirements. Accordingly, it has been necessary
for the Company continually to seek additional debt and equity financing in
order to have funds to continue development and other investing activities. 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 assets.
During 1997, the Company took certain actions designed to generate additional
equity capital and improve its financial condition, including: (i) approval by
the Company's Board of Directors in August 1997 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; (ii) 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; (iii) the sale of 50,000 shares of the Company's Common Stock at
$1.00 per share to a Saudi Arabian investor; (iv) the issuance of 10,000 shares
of its Common Stock at $1.375 per share pursuant to an option exercise by an
officer of the Company; (v) the issuance of 345,000 shares of its Common Stock
in exchange for the cancellation of certain indebtedness; (vi) borrowing
$200,000 from a Saudi Arabian investor pursuant to a two-year demand promissory
note bearing interest at prime plus 2% per annum; (vii) the sale by South
Hampton Refining Company, an indirect, wholly owned subsidiary of the Company
("South Hampton"), in June 1997 of an office building to a third party for
approximately $695,000, on terms which included a ten-year promissory note
having a principal amount of $610,000 and bearing interest at 9% per annum; and
(viii) receiving conditional approval for a $38.08 million loan from the SIDF.
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, 1997 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 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.
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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.
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 was for the two Saudi Arabian advisors to assist the Company
in obtaining financing for the Al Masane project. To this end, the agreement
contemplated that the Saudi Arabian advisors would perform the following:
1. The formation of a Saudi limited liability company, 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 total capital cost
of the project.
2. Obtain an industrial license for the project from the Ministry of
Industry and Electricity. This license was 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 provided that the Saudi Arabian advisors would be solely
responsible for the performance of the foregoing obligations and that the
Company had no obligation therefor.
As consideration for performing these obligations, the Company 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 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 was 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. On December
3, 1996, the industrial license was issued to the Company and its Saudi Arabian
advisors. As a result, the Company paid the advisors $20,000 in the aggregate
and was obligated at December 31, 1997 to issue to these advisors 300,000 shares
of the Company's Common Stock in the aggregate and options to purchase 345,000
shares of the Company's Common Stock in the aggregate having an exercise price
of $1.00 per share. The agreement was terminated in August 1997 and negotiations
are being held to complete a new agreement, although there can be no assurances
that any such agreement can be reached.
A loan application was submitted to SIDF on September 30, 1995 and conditional
approval was received on December 17, 1997 for a $38.08 million loan. 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.
On November 5, 1997, the Company initialed a joint venture agreement with Al
Mashreq Company for Mining Investments ("Al Mashreq"), a Saudi limited liability
company owned by Saudi Arabian investors,
9
11
which contemplates the formation of a new Saudi limited liability company, "The
Arabian Shield Company for Mining Industries Ltd.", to be owned 50% by the
Company and 50% by Al Mashreq. As contemplated, the Saudi limited liability
company will be responsible for the construction and operation of the mining
facilities. Title to the mining lease would be transferred to the Saudi limited
liability company. The joint venture agreement further contemplates the Company
transferring its beneficial interest in the Al Masane project to the Saudi
limited liability company when title to the mining lease is transferred to the
Saudi limited liability company. The Company and Al Mashreq agree to attempt to
obtain financing for the project, and that if firm commitments for such
financing on acceptable terms are not obtained by November 5, 1998, either party
may terminate the agreement without liability, except that the Company will
return to Al Mashreq any consideration paid for the assignment of the beneficial
interest in the project and full title to the mining lease will revert to the
Company.
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. It is contemplated that the Saudi limited liability company then will
be transformed into a Saudi public stock company, that the Company and Al
Mashreq will own no less than 50% of the shares of the Saudi public stock
company, that Petromin will have an option to acquire up to 25% of the shares
and that the remaining shares will be offered for sale in Saudi Arabia pursuant
to a public subscription. Title to the mining lease 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 Co., Ltd. ("Saudi Fal"), the Company, American Shield Refining
Company, a wholly owned subsidiary of 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 was payable on December 31, 1998, but in March 1998
the maturity date was extended to December 31, 1999. 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.
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
10
12
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 was due on December 31, 1998, but in March 1998 the maturity
date was extended to December 31, 1999. 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 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 1997 TO 1996
During the fiscal year ended December 31, 1997, the Company had a net income of
$818,364 compared to a net loss of $390,896 for the fiscal year ended December
31, 1996.
The gross revenues in 1997 of $26,174,119 was an increase of $4,159,833 from
1996 while the cost of sales in 1997 of $22,119,668 was an increase of
$2,761,931 from 1996, resulting in a net margin increase in 1997 of $1,462,231.
After processing fee income, general and administrative expenses and
depreciation and amortization, the operating income of the Company in 1997 of
$821,168 was an improvement of $1,142,292 over the operating loss in 1996 of
$321,124. The net income for the refinery in 1997 of $1,171,206 was $1,036,815
more than the net income in 1996 of $134,391.
The refinery's net income for 1997 increased despite operating losses during the
first two months of the year resulting from the increased prices of natural
gasoline, its primary feedstock, and natural gas used for fuel. During March
1997, feedstock prices and natural gas fuel prices returned to their normal
levels which, combined with an increase in the sales prices of the refinery's
products, resulted in improved gross and operating margins. The volume of
refined products sold increased 14% to 28 million gallons versus 24.5 million
gallons sold in 1996. The total volume of refined product sales was the largest
volume achieved by the refinery since it began processing special products in
1985. The strong volume of sales
11
13
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.
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 1997 were on average identical to 1996 prices. The refinery's products
had an average selling price approximately 4% above 1996 levels, resulting in
gross margins for the year being slightly above the 1996 average gross margin.
The chemical industry, particularly the ethylene crackers, continued to be the
big user of natural gasoline in 1997 which contributed to feedstock prices
remaining higher than in recent years. Feedstock prices, which peaked during the
period from November 1996 through February of 1997, returned to their former
levels throughout most of 1997 and decreased in the fourth quarter of 1997.
With the exception of 1997 when toll processing fees decreased as a result of
the cancellation of a processing contract, the refinery has experienced a
healthy growth in its toll processing business over the last several years. Toll
processing and tank rental fees were $694,797, $724,849 and $660,519 in 1995,
1996 and 1997, 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 in the toll processing business for over 30 years and enjoys a
good reputation in the industry. Management intends to expand the refinery's
involvement in this area as opportunities arise.
General and administrative expenses increased by $410,621, or 18%, to $2,695,043
in 1997 from $2,284,422 in 1996. A portion of this increase was attributable to
stock option expenses of $125,000 and $50,000 for the cost of issuing 50,000
shares at no cost in 1997. Interest expense, which was practically all
attributable to the debt of the refinery, increased by $68,291 from $336,979 in
1996 to $405,270 in 1997. This increase was primarily due to an increased amount
of interest bearing debt, which was a result of a major debt restructuring in
October 1996 when accrued interest was rolled over into principal and the new
interest rates were higher.
There has been no activity in several years on the Pioche Ely Valley Mines, Inc.
("Pioche") properties primarily due to the lack of financing for claims to be
explored and developed; however, in October 1997, Pioche entered into an
Exploration Agreement and Option to Purchase with a large mining company.
Interest income in 1997 and 1996 was from the investment of temporary excess
cash in time deposits in Saudi Arabia and a short-term investment by the
refinery. In 1997 and 1996, 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 1997 and 1996, the refinery
received $25,410 and $101,640, respectively, from the leasing of an office
building. This office building was sold to the lessee in June 1997. 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 $32.3 million at December 31, 1997, 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 1998 through 2011.
At December 31, 1997, a total of approximately $1,581,000 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 $779,000 due to Hatem El-Khalidi, the Company's President and
Chief Executive Officer. Accrued salaries and termination benefits to Company
employees
12
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in Saudi Arabia and to Mr. El-Khalidi at December 31, 1996 were approximately
$776,000 and $714,000, respectively. The payment of these amounts has been
deferred until the Company's working capital position improves.
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 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
13
15
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.
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.
OTHER MATTERS
Year 2000. The Year 2000 issue relates to computer systems and applications that
currently use two-digit date fields to designate a year. As the century date
change occurs, date-sensitive systems will recognize the Year 2000 as 1900, or
not at all. This inability to recognize or properly treat the Year 2000 may
cause systems to process critical financial and operational information
incorrectly, which may have a material adverse effect on the Company's business,
operating results and financial condition.
The Company is utilizing both internal and external resources to identify,
correct or reprogram and test information systems for Year 2000 compliance. The
Company estimates that its costs for addressing the Year 2000 issue will be
approximately $25,000. These costs will be expensed as incurred.
Furthermore, there can be no assurance that the Company's customers and
suppliers are or will be Year 2000 compliant. The failure of the Company's
customers and suppliers to achieve Year 2000 compliance could have a material
adverse effect on the Company's business, operating results and financial
condition.
Quantitative and Qualitative Disclosures About Market Risks. The market risk
inherent in the Company's financial instruments represents the potential loss
resulting from adverse changes in interest rates, foreign currency rates and
commodity prices. The Company's exposure to interest rate changes results from
its variable rate debt instruments which are vulnerable to changes in short term
United States prime interest rates. At December 31, 1997, the Company had $4.0
million in variable rate debt outstanding. A hypothetical 10% change in interest
rates underlying these borrowings would result in approximately a $38,000 annual
change in the Company's earnings and cash flows.
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The Company is exposed to market risk in the exchange rate of the Saudi Arabian
riyal as measured against the United States dollar. The Company does not view
this exposure as significant and has not acquired or issued any foreign currency
derivative financial instruments. The Company's strategy in managing its
exposure to commodity prices is to purchase options on commodity based
derivative futures contracts. At December 31, 1997, the Company's investment in
such instruments was insignificant.
15
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(Intentionally Left Blank)
18
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Arabian Shield Development Company
We have audited the accompanying consolidated balance sheets of Arabian Shield
Development Company and Subsidiaries as of December 31, 1997 and 1996 and the
related consolidated statements of operations, stockholders' equity, and cash
flows for the years 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 audits.
We conducted our audits 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 audits provide 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, 1997 and 1996, and the
consolidated results of their operations and their consolidated cash flows for
the years 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 1997 were the operations of
its refinery and the proceeds from loans and 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 these uncertainties .
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 13, 1998
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REPORT OF INDEPENDENT ACCOUNTANTS
To The Stockholders and Board of Directors
of Arabian Shield Development Company
In our opinion, the accompanying consolidated statements of operations, of
stockholders' equity and of cash flows present fairly, in all material respects,
the results of operations and cash flows of Arabian Shield Development Company
and its subsidiaries for the year 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 audit. We conducted our audit
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 audit provides a
reasonable basis for the opinion expressed above. We have not audited the
consolidated financial statements of Arabian Shield Development Company for any
period subsequent to December 31, 1995.
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 9 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 Note 9 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
Dallas, Texas
March 25, 1996
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20
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
--------------------------
1997 1996
----------- -----------
Current Assets
Cash and cash equivalents................................. $ 534,086 $ 385,290
Short-term investments.................................... 407,542 298,726
Trade receivables......................................... 3,047,311 2,643,691
Inventories............................................... 548,320 565,346
----------- -----------
Total current assets.............................. 4,537,259 3,893,053
Refinery Plant, Pipeline and Equipment -- At Cost........... 5,926,188 5,758,852
Less Accumulated Depreciation............................... (3,238,623) (2,911,823)
----------- -----------
Refinery Plant, Pipeline and Equipment, Net................. 2,687,565 2,847,029
Al Masane Project........................................... 33,522,427 32,882,838
Other Interests in Saudi Arabia............................. 2,431,248 2,431,248
Mineral Properties in the United States..................... 1,411,190 1,418,615
Goodwill.................................................... -- 117,598
Other Assets................................................ 463,230 505,566
----------- -----------
Total Assets...................................... $45,052,919 $44,095,947
=========== ===========
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ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS -- CONTINUED
LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31,
--------------------------
1997 1996
----------- -----------
Current Liabilities
Accounts payable-trade.................................... $ 790,759 $ 1,408,677
Accrued liabilities....................................... 673,511 520,445
Accrued liabilities in Saudi Arabia....................... 1,283,401 1,174,229
Notes payable............................................. 11,375,780 11,375,780
Current portion of long-term debt......................... 598,000 992,729
Current portion of long-term obligations.................. 37,915 150,904
----------- -----------
Total current liabilities......................... 14,759,366 15,622,764
Long-Term Debt.............................................. 3,435,773 3,544,112
Long-Term Obligations....................................... 21,205 35,009
Accrued Liabilities in Saudi Arabia......................... 779,149 714,143
Deferred Revenue............................................ 114,181 129,685
Commitments and Contingencies............................... -- --
Minority Interest in Consolidated Subsidiary................ 1,044,487 1,003,590
Stockholders' Equity
Common stock, authorized 40,000,000 shares of $.10 par
value: issued and outstanding, 21,861,494 shares in
1997 and 20,956,494 shares in 1996..................... 2,186,149 2,095,649
Additional paid-in capital................................ 35,875,950 34,932,700
Receivable from stockholder............................... (126,000) (126,000)
Accumulated deficit....................................... (13,037,341) (13,855,705)
----------- -----------
Total stockholders' equity........................ 24,898,758 23,046,644
----------- -----------
Total Liabilities and Stockholders' Equity........ $45,052,919 $44,095,947
=========== ===========
The accompanying notes are an integral part of these statements.
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ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
1997 1996 1995
----------- ----------- -----------
Revenues
Refined product sales....................... $25,591,600 $21,367,438 $17,741,862
Processing fees............................. 582,519 646,848 616,796
----------- ----------- -----------
26,174,119 22,014,286 18,358,658
Operating costs and expenses
Cost of refined product sales and
processing............................... 22,119,668 19,357,737 15,575,054
General and administrative.................. 2,695,043 2,284,422 2,372,683
Depreciation and amortization............... 538,240 693,251 677,157
----------- ----------- -----------
25,352,951 22,335,410 18,624,894
----------- ----------- -----------
Operating income (loss)....................... 821,168 (321,124) (266,236)
Other income (expense)
Interest income............................. 51,062 25,310 33,395
Interest expense............................ (405,270) (336,979) (369,546)
Minority interest........................... 19,282 13,072 --
Equity in losses of affiliate............... -- -- (24,112)
Miscellaneous income........................ 332,122 228,825 257,267
----------- ----------- -----------
Net income (loss)............................. $ 818,364 $ (390,896) $ (369,232)
=========== =========== ===========
Net income (loss) per common share:
Basic....................................... $ 0.04 $ (0.02) $ (0.02)
=========== =========== ===========
Diluted..................................... $ 0.04 $ (0.02) $ (0.02)
=========== =========== ===========
Weighted average number of common and common
equivalent shares outstanding:
Basic....................................... 21,306,040 20,286,208 20,030,434
=========== =========== ===========
Diluted..................................... 22,017,652 20,286,208 20,030,434
=========== =========== ===========
The accompanying notes are an integral part of these statements.
20
23
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ADDITIONAL RECEIVABLE
------------------------ PAID-IN FROM ACCUMULATED
SHARES AMOUNT CAPITAL STOCKHOLDER DEFICIT TOTAL
---------- ---------- ----------- ----------- ------------ -----------
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
Common stock sold............. 500,000 50,000 450,000 -- -- 500,000
Common stock issued for
services.................... 50,000 5,000 45,000 -- -- 50,000
Common stock issued on debt
conversion.................. 345,000 34,500 310,500 -- -- 345,000
Stock options exercised....... 10,000 1,000 12,750 -- -- 13,750
Stock options issued for
services.................... -- -- 125,000 -- -- 125,000
Net income.................... -- -- -- -- 818,364 818,364
---------- ---------- ----------- --------- ------------ -----------
December 31, 1997............... 21,861,494 $2,186,149 $35,875,950 $(126,000) $(13,037,341) $24,898,758
========== ========== =========== ========= ============ ===========
The accompanying notes are an integral part of these statements.
21
24
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
1997 1996 1995
--------- --------- ----------
Operating activities
Net income (loss).................................. $ 818,364 $(390,896) $ (369,232)
Adjustments for non-cash transactions
Depreciation and amortization................... 538,240 693,251 677,157
Equity in losses of affiliate................... -- -- 24,112
Common stock and stock options issued for
services...................................... 175,000 -- 151,431
Effects of changes in
Increase in trade receivables................... (403,620) (845,570) (388,839)
Decrease (increase) in inventories.............. 17,026 (134,614) 40,342
Decrease in other assets........................ 42,336 135,287 87,016
(Decrease) increase in accounts payable and
accrued liabilities........................... (464,852) 454,810 (267,830)
Decrease in deferred revenue.................... (15,504) (15,504) (15,504)
Other.............................................. (7,945) (70,529) (12,190)
--------- --------- ----------
Net cash provided by (used for) operating
activities............................... 699,045 (173,765) (73,537)
--------- --------- ----------
Investing activities
Additions to short-term investments................ (108,816) (4,116) (291,915)
Proceeds from sale of short-term investments....... -- -- 255,787
Additions to Al Masane Project..................... (639,589) (451,110) (785,751)
Additions to refinery plant, pipeline and
equipment....................................... (167,336) (195,076) (153,235)
Reduction in mineral properties in the United
States.......................................... 7,425 -- --
Decrease in cash in Saudi Arabia................... -- 396,809 34,167
Increase in accrued liabilities in Saudi Arabia.... 174,178 53,450 276,366
--------- --------- ----------
Net cash used for investing activities..... (734,138) (200,043) (664,581)
--------- --------- ----------
Financing activities
Common stock sold.................................. 513,750 450,000 --
Decrease in receivable from stockholder............ -- -- 50,000
Additions to notes payable and long-term
obligations..................................... 200,000 445,773 721,000
Reduction of notes payable and long-term
obligations..................................... (529,861) (438,714) (809,192)
--------- --------- ----------
Net cash provided by (used for) financing
activities............................... 183,889 457,059 (38,192)
--------- --------- ----------
Net increase (decrease) in cash...................... 148,796 83,251 (776,310)
Cash and cash equivalents at beginning of year....... 385,290 302,039 1,078,349
--------- --------- ----------
Cash and cash equivalents at end of year............. $ 534,086 $ 385,290 $ 302,039
========= ========= ==========
The accompanying notes are an integral part of these statements.
22
25
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 Neches River near Beaumont. The Company also owns 44% of
Pioche-Ely Valley Mines, Inc. ("Pioche") which owns mineral deposits in Nevada
(Note 8). Pioche has been consolidated for financial statement purposes since
January 1, 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 1997 were the operations of South Hampton's refinery and the proceeds from
stock sales and loans. 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.
As discussed in Note 8, the Company owns 44% of Pioche and has had voting
control for a number of years as a result of a loan which is collateralized by
8% 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 and 1997. The financial statements for 1995, 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.
23
26
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Short-term investment -- At December 31, 1997 and 1996, 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, 1997, 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 of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of" and has concluded that there is no impairment.
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, a note receivable 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 and Saudi Arabia. Significant noncash changes in
financial position in 1997 include the issuance of 345,000 shares of common
stock at $1.00 per share for the conversion of $345,000 of indebtedness (Note
9), as well as the issuance of stock and options for services, valued at a total
of $175,000, which is included in general and administrative expenses (Note 11).
Transactions of this type 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 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 9).
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. 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. In June 1997, the
hedging program resumed and resulted in a net recognized gain of $46,000 in
1997.
24
27
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net Income (Loss) Per Share -- In the fourth quarter of 1997, the Company
adopted the provisions of Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (SFAS No. 128). In accordance with SFAS No. 128, the
Company computes basic income per common share based on the weighted-average
number of common shares outstanding. Diluted income per common share is computed
based on the weighted-average number of common shares outstanding plus the
number of additional common shares that would have been outstanding if dilutive
potential common shares, consisting of stock options and shares issuable upon
conversion of debt, had been issued (Note 15). Retroactive application, which is
required by SFAS No. 128, did not result in restatement of 1995 or 1996 per
share data.
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 was fully amortized in 1997. The amount reflected in the balance sheet at
December 31, 1996 is net of accumulated amortization of $2,655,925.
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
years after 1995. 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.
NOTE 4 -- FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
At December 31, 1997, the Company's financial instruments included cash, cash
equivalents, investments, accounts receivable, current obligations, and
noncurrent liabilities. The fair values of these items approximate their
carrying amounts at December 31, 1997. 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 industries. Downturns in
these industries could negatively impact refinery operations in the future.
South Hampton does not require collateral on its outstanding accounts
25
28
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
receivable balances. South Hampton's largest customer accounted for 10%, 17% and
25% of total sales in 1997, 1996 and 1995, 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, was 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 and the other in January 1998. The cost
to the Company was not significant. A new lawsuit by another former Goodyear
employee was filed in a Jefferson County District Court on December 16, 1997 for
unspecified actual and punitive damages for the same reasons as the other two.
The outcome of this lawsuit is not expected to have a material effect on the
Company's financial position, results of operations or liquidity.
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. Based on the results, estimated costs of $60,000 were accrued at December
31, 1996 to cover the recovery and remediation activity expected to take place
in 1997. However, no action was taken other than further study, and another
$50,000 was accrued at December 31, 1997, for a total of $110,000. This amount
is considered adequate in that various alternative and less expensive means of
recovery are being developed by the South Hampton. Approximately $85,000 has
been expended over a three year period to develop recovery alternatives. The
consulting engineers expect approximately 10,000 barrels of recoverable material
may be available to South Hampton for use in their refining process, but no
reduction has been made in the accrual for estimated remediation costs due to
the uncertainties relating to the recovery process.
In August 1997, the TNRCC notified South Hampton that it had violated various
rules and procedures and has proposed administrative penalties totaling $709,408
and recommended that South Hampton undertake certain actions necessary to bring
its operations at the refinery into compliance. The violations generally relate
to various air and water quality issues. South Hampton intends to vigorously
defend against this action on the basis that the allegations are in error or
involve matters that are relatively minor in importance.
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,
26
29
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 $37,000,
$35,000 and $80,000 was spent in 1997, 1996 and 1995, respectively, on
development of this OSHA program. The program is approximately 75% completed and
is expected to be completed in 1998 at an additional cost of approximately
$37,000. Due to the uncertain timing and scope of the additional work, no
accruals have been provided.
At December 31, 1997, the Company had not made all of the surface rental
payments due to the government of Saudi Arabia under the terms of the Al Masane
Project lease. The past due amount of these rent payments was approximately
$426,000 but, in February 1998, a payment in full of approximately $469,000 was
made. 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, 1997, 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,
----------------------
1997 1996
-------- --------
Refinery feedstock......................................... $ 86,591 $ --
Refined products........................................... 461,729 565,346
-------- --------
Total inventories................................ $548,320 $565,346
======== ========
At December 31, 1997, LIFO value approximated current cost. At December 31,
1996, current cost exceeded LIFO value by approximately $163,000.
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.
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. 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.
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
27
30
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. As of December 31, 1997, the Company had not paid
for rentals of approximately $426,000 but, in February 1998, a payment in full
of approximately $469,000 was made. A loan from the Saudi Industrial Development
Fund ("SIDF"), was applied for on September 30, 1995, and conditional approval
was received in December 1997. The Company intends to form a Saudi limited
liability company to be owned 50% by the Company and 50% by the Al Mashreq
Company for Mining Investments (Al Mashreq), and transfer the mining lease to
it, free and clear of any lien interest the Saudi government has. The lease
agreement stipulates that, after two years of profitable mine operations, a
Saudi public stock company will be formed to which the limited liability company
will transfer its interest in the Al Masane Project. The limited liability
company will own no less than 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 and Al Mashreq or acquired by
PETROMIN are to be put out for public subscription to Saudi citizens.
The Company has 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 intends to repay the loan in accordance with a repayment
schedule to be agreed upon with the Saudi Arabian government from its share of
Project cash flows. While the mining lease was granted in 1993, a rescheduling
of the loan payments has not yet been negotiated. All of the Company's "movable
and immovable" assets in Saudi Arabia are pledged as collateral for the loan.
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 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 was obligated to
issue such shares and options in designated amounts upon completion of each of
the foregoing services. The options would 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 has paid $20,000
in cash and is obligated at December 31, 1997 for the issuance of 300,000 shares
of common stock and stock options for 345,000 shares at $1.00 per share. The
Agreement was terminated in August 1997 and negotiations are being held to
complete a new agreement.
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
28
31
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
these reserves with further exploration. The report projects production of the
proven and probable reserves over a ten-year period. A 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 $47.5
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, 1997, 1996
and 1995, 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
1997 FOR 1997 1996 FOR 1996 1995 FOR 1995
------------ -------- ------------ ---------- ------------ --------
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.... 19,145,296 $562,523 18,582,773 $1,942,586 16,640,187 $616,912
Materials and
maintenance............. 6,168,661 737 6,167,924 914 6,167,010 5,326
Feasibility study......... 2,907,771 76,329 2,831,442 41,455 2,789,987 163,513
----------- -------- ----------- ---------- ----------- --------
Total.............. 28,221,728 639,589 27,582,139 1,984,955 25,597,184 785,751
----------- -------- ----------- ---------- ----------- --------
$33,522,427 $639,589 $32,882,838 $1,984,955 $30,897,883 $785,751
=========== ======== =========== ========== =========== ========
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. 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.
NOTE 8 -- MINERAL PROPERTIES IN THE UNITED STATES
The Company has voting rights of approximately 52% and directly owns
approximately 44% 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 1997 and 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.
29
32
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The principal assets of Pioche are an undivided interest in 48 patented and 81
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 and on October 1997, an "Exploration Agreement and Option to
Purchase" was entered into. The agreement provides for annual payments to Pioche
of $50,000 for seven years until, or unless, an option is exercised to purchase
an 85% interest in the mining claims for $3,000,000. The mining company will pay
all annual taxes and claim rentals and has agreed to expend at lease $50,000 in
exploration work each year and to drill at least one hole during the first year.
The agreement can be terminated upon 60 days written notice from the mining
company.
The Company has an 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, 2002.
On June 30, 1997, Pioche entered into an option agreement to lease the mill for
one year, or as long thereafter as there are operations within the mill and /or
active milling of ore. The lease provides for lease payments of $1.00 per short
ton of ore milled with a maximum daily payment of $300 and a minimum daily
payment of $100.
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:
1997 1996
----------- -----------
Notes payable:
Secured note to Saudi Arabian government. See (B)..... $11,000,000 $11,000,000
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 12,500
----------- -----------
Total......................................... $11,375,780 $11,375,780
=========== ===========
Long-term debt:
Revolving bank note. See (A).......................... $ 1,590,000 $ 1,890,000
Unsecured note to a Saudi company. See (C)............ 1,945,773 1,945,773
Unsecured notes to foreign investors. See (F)......... 498,000 598,000
Bank note. See (G).................................... -- 103,068
----------- -----------
Total......................................... 4,033,773 4,536,841
Less current portion.................................. (598,000) (992,729)
----------- -----------
Total......................................... $ 3,435,773 $ 3,544,112
=========== ===========
Long-term obligations:
Noninterest-bearing note to a supplier and customer
for capital improvements. See (H).................. $ 24,000 $ 128,683
Deferred compensation contracts. See (I).............. 35,120 57,230
----------- -----------
Total......................................... 59,120 185,913
Less current portion.................................. (37,915) (150,904)
----------- -----------
Total......................................... $ 21,205 $ 35,009
=========== ===========
30
33
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
- ---------------
(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.)
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 (extended in March 1998 to December 31,
1999) 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.
(B) The Company 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 intends to repay the loan in accordance
with a repayment schedule to be agreed upon with the Saudi Arabian
government from its share of Project cash flow. An agreement has not yet
been reached regarding either the rescheduling or source of these payments.
The loan is collateralized by all of the Company's "movable and immovable"
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 was
changed to December 31, 1998. In March 1998, the maturity date was extended
to December 31, 1999. 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-bearing demand loan payable.
(E) Represents an unsecured, noninterest-bearing advance made in 1984 to the Al
Masane Project.
31
34
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(F) Represents loans payable to a stockholder of the Company for $445,000, and
the Company's president for $53,000. $200,000 is due in 1999, with interest
payable at the LIBOR rate plus 2% at maturity. The remaining amounts are
due on demand, with interest payable at the LIBOR rate plus 2%. 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. In December 1997, a relative of the Company's
president and stockholder who had loaned $300,000 to the Company in 1995,
exercised the option and converted his loan amount, plus accrued interest
of $45,000, into common stock.
(G) This note payable was 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 had been leased to a third party and,
in June 1997, was sold and part of the proceeds was used by TOCCO to pay
off this note.
(H) Balance represents amount due under a note payable to an unrelated refining
company that provided loans to South Hampton to fund certain refining
processes. Repayment was to be made when certain feed rate criteria and
number of days of operations had been reached. As of December 31, 1997,
these criteria had been met and the loan is being repaid.
(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 1997. However, if
TOCCO were to default on these contracts, it would be liable for an
additional amount of $440,130. The recorded liability at December 31, 1997
and 1996 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:
1998........................................................ $ 635,915
1999........................................................ 3,456,978
----------
Total............................................. $4,092,893
==========
Interest of $305,007, $186,190 and $244,828 was paid in 1997, 1996 and 1995,
respectively.
NOTE 10 -- COMMITMENTS
South Hampton leases vehicles and equipment for use in operations for
approximately $29,000 per month from a related party on a month to month basis.
South Hampton incurred costs related to this agreement of approximately
$349,000, $349,000 and $316,000 in 1997, 1996 and 1995, respectively.
The Company incurred total rental expenses for office space and certain vehicles
and equipment of approximately $361,000, $361,000 and $302,000 in 1997, 1996 and
1995, respectively.
In February 1993, TOCCO 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 TOCCO did
not use in its operations. The lease was recorded as an operating lease and the
building was included in Other Assets. As described in Note 9, the leased
building was pledged as collateral for a note payable. In June 1997, the
building was sold for approximately $695,000. The sale resulted in a 10 year
note receivable for $610,000 bearing interest at 9%. The note is pledged to a
bank. Miscellaneous income includes approximately $25,000, $102,000, and
$102,000 in 1997, 1996 and 1995, respectively of rental income pursuant to this
lease. The gain on sale of approximately $387,000 has been deferred, and is
being recognized on the installment method as payments are received on the note.
The note is included in Other Assets, net of the deferred gain.
32
35
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
NOTE 11 -- COMMON STOCK AND STOCK OPTIONS
At December 31, 1997, Saudi Arabian investors owned approximately 64% 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, 1997 and 1996 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.
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 non-incentive 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 November 5, 1997, the Employee
Plan was registered with the Securities and Exchange Commission.
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 expired. A new plan may be instituted at a later date.
Under the above plans, 325,000 shares were reserved for grant at December 31,
1997. 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 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 restricted
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.
33
36
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 restricted 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 assisted the Company with
the Al Masane Project (See Note 7). The Agreement was terminated by the Company
in August 1997. The Agreement provided 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 were to be
granted in designated amounts upon the completion of various obligations by the
advisors. The options were immediately exercisable upon grant and would 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 restricted shares, valued at
$796,950, had been earned under the Agreement.
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. 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.
During 1997, the Company granted options to purchase 100,000 shares of stock and
issued 50,000 shares of stock for services to two directors of the Company. The
Company recorded compensation expense in the amount of $175,000, which is
included in general administrative expense in the Company's results of
operations for the year ended December 31, 1997. 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 1997 and 1995 (none were
granted in 1996), the Company's 1997, 1996 and 1995 net income (loss) and income
(loss) per share would be the pro forma amounts indicated as follows:
1997 1996 1995
-------- --------- ---------
Net income (loss)
As reported................................. $818,364 $(390,896) $(369,232)
Pro forma................................... $635,714 $(390,896) $(726,332)
Income (loss) per common share -- basic and
diluted
As reported................................. $ .04 $ (.02) $ (.02)
Pro forma................................... $ .03 $ (.02) $ (.04)
34
37
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (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 three to 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,
1997, and changes for the three years then ended was as follows:
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 in 1996 was $2.31.
1997
-----------------------------
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
--------- ----------------
Outstanding at beginning of year....................... 1,558,000 $1.11
Granted.............................................. 110,000 1.14
Forfeited............................................ (10,000) 3.50
Exercised............................................ (10,000) 1.38
---------
Outstanding at end of year............................. 1,648,000 $1.10
========= =====
Options exercisable at December 31, 1997............... 1,639,000 $1.09
========= =====
Weighted average fair value per share of options granted in 1997 was $1.77.
Information about stock options outstanding at December 31, 1997 is summarized
as follows:
OPTIONS OUTSTANDING
-------------------------------------------------
WEIGHTED AVERAGE
RANGE OF NUMBER REMAINING WEIGHTED AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE
--------------- ----------- ---------------- ----------------
$0 to 1................................ 1,443,000 7.1 years $1.00
$1 to 2................................ 165,000 7.3 years 1.55
$2 to $3.75............................ 40,000 5.7 years 2.85
---------
1,648,000 $1.10
========= =====
35
38
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OPTIONS EXERCISABLE
------------------------------
NUMBER WEIGHTED AVERAGE
RANGE OF EXERCISE PRICES EXERCISABLE EXERCISE PRICE
------------------------ ----------- ----------------
$0 to 1.............................................. 1,443,000 $1.00
$1 to 2.............................................. 165,000 1.55
$2 to $3.75.......................................... 31,000 2.84
---------
1,639,000 $1.09
========= =====
NOTE 12 -- INCOME TAXES
The income (loss) before income taxes was $818,364, ($390,896) and ($369,232)
for the years ended December 31, 1997, 1996 and 1995, respectively.
Income tax expense (benefit) for the years ended December 31, 1997, 1996 and
1995 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:
1997 1996 1995
--------- --------- ---------
Income taxes at U.S. statutory rate............ $ 278,244 $(132,905) $(125,539)
Goodwill amortization.......................... 39,252 94,228 95,303
Net operating losses carried forward
(utilized)................................... (326,839) 37,924 25,731
Other items.................................... 9,343 753 4,505
--------- --------- ---------
Total tax expense.................... $ -- $ -- $ --
========= ========= =========
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities for 1997, 1996 and 1995
were as follows:
DECEMBER 31,
--------------------------------------------
1997 1996 1995
------------ ------------ ------------
Deferred tax liabilities:
Refinery plant, pipeline and
equipment..................... $ (323,513) $ (287,845) $ (368,385)
Deferred tax assets:
Accounts receivable.............. 45,967 57,284 49,544
Mineral interests................ 196,446 196,446 196,446
Accrued liabilities.............. 49,341 32,300 --
Net operating loss carryforwards
(NOLs)........................ 10,943,970 11,333,611 11,274,638
Tax credit carryforwards......... 147,501 221,322 651,504
------------ ------------ ------------
Gross deferred tax assets.......... 11,383,225 11,840,963 12,172,132
Valuation allowance................ (11,059,712) (11,553,118) (11,803,747)
------------ ------------ ------------
Net deferred tax
assets................. 323,513 287,845 368,385
------------ ------------ ------------
Net deferred taxes....... $ -- $ -- $ --
============ ============ ============
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
carryforwards which could be utilized.
36
39
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1997, the Company had approximately $32,300,000 of net operating
loss carryforwards and approximately $148,000 of general business credit
carryforwards. These carryforwards expire during the years 1998 through 2011. In
addition, the Company has minimum tax credit carryforwards of approximately
$49,000 that may be carried over indefinitely. Approximately $1,700,000 of the
net operating loss carryforwards and $13,000 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 subsidiary,
Pioche. 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 1997, 1996 and 1995, essentially all activity on the Company's consolidated
statement of operations relates to the refinery. The 1997, 1996 and 1995 results
include $39,475, $33,944 and $54,063, respectively, of unallocated costs
recorded in general and administrative expenses related to the Saudi Arabian
operations. The 1997, 1996 and 1995 results include immaterial amounts of
interest expense related to notes payable 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.
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, 1997 and 1996, 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.
37
40
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 15 -- NET INCOME (LOSS) PER COMMON SHARE
Net income per share for 1997 has been calculated as follows:
WEIGHTED
AVERAGE
NET SHARES PER
INCOME OUTSTANDING SHARE
-------- ----------- -----
Basic income per share............................. $818,364 21,306,040 $.04
Dilutive effect of stock options................... -- 711,612 --
-------- ---------- ----
Diluted income per share........................... $818,364 22,017,652 $.04
======== ========== ====
In 1996 and 1995, the effect of stock options and convertible debt was
anti-dilutive. Accordingly, loss per share is calculated by dividing the net
loss by the weighted average shares outstanding. In 1997, the effect of assumed
debt conversions is anti-dilutive.
38
41
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULES
Board of Directors and Stockholders
Arabian Shield Development Company
In connection with our audit of the consolidated financial statements of Arabian
Shield Development Company and Subsidiaries referred to in our report dated
March 13, 1998, which is included in the annual report to stockholders in Part
II of this Form 10-K, we have also audited Schedule II at December 31, 1997 and
1996 and for the years then ended. In our opinion, this schedule presents
fairly, in all material respects, the information required to be set forth
therein. Our report on the financial statements referred to above includes an
explanatory paragraph which discusses that there is substantial doubt about the
Company's ability to continue as a going concern.
GRANT THORNTON LLP
Dallas, Texas
March 13, 1998
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SCHEDULE II
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
THREE YEARS ENDED DECEMBER 31, 1997
CHARGED
BEGINNING (CREDITED) ENDING
DESCRIPTION BALANCE TO EARNINGS DEDUCTIONS BALANCE
----------- ----------- ----------- ---------- -----------
Allowance for Deferred Tax Asset
December 31, 1995................ $ 9,789,307 $2,014,440 $ -- $11,803,747
December 31, 1996................ 11,803,747 179,553(a) (430,182) 11,553,118
December 31, 1997................ 11,553,118 --(b) (326,839) 11,059,712
(a) (166,567)
- ---------------
(a) Expiration of carryforwards
(b) Credit to earnings
40
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DIRECTORS
John A. Crichton
Chairman of the Board
Arabian Shield Development Company
Dallas, Texas
Hatem El-Khalidi
President and Chief Executive Officer
Arabian Shield Development Company
Jeddah, Saudi Arabia
Mohammed O. Al-Omair
Executive Vice President
Saudi Fal Group of Companies
Riyadh, Saudi Arabia
(Investments)
Ghazi Sultan
Chairman
Sultan Group of Companies
Jeddah, Saudi Arabia
(Investments and marble mining)
EXECUTIVE OFFICERS
John A. Crichton
Chairman of the Board
Hatem El-Khalidi
President and Chief Executive Officer
Jonathan Cocks
Vice President
Drew Wilson, Jr.
Secretary/Treasurer
Nicholas N. Carter
President of Texas Oil and Chemical Co. II, Inc.
TRANSFER AGENT AND REGISTRAR
Harris Trust
STOCK LISTING
NASDAQ National Market System
Symbol ARSD
FORM 10-K
Single copies of the Annual Report on Form 10-K which the Company has
filed with the Securities and Exchange Commission can be obtained by
stockholders without charge by writing to Arabian Shield Development
Company, Suite 175, 10830 North Central Expressway, Dallas, Texas
75231, Attention: Secretary.
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[ARABIAN SHIELD LOGO]
10830 North Central Expressway, Suite 175, Dallas, Texas
General Office: 75231
Field Office: P.O. Box 1516, Jeddah, Saudi Arabia
Transfer Agent: Harris Trust