Other publications: Report on Aspects of the Affairs of Max Resources Limited

Report of the Securities Commission on Aspects of the Affairs of Max Resources Limited

MAX'S FINANCIAL STATEMENTS FOR THE YEAR ENDED 30 JUNE 1997

Summary of reported financial position

3.1

Max's audited consolidated financial statements for the year ended 30 June 1997 disclosed the following financial position of the Company and its subsidiaries:


Shareholders' Equity
	Share capital	$10,602,000
	Reserves	8,255,000
	Accumulated losses	(6,063,000)

	Total shareholders' equity	$12,794,000




Current Assets		$279,000

Fixed Assets		$2,267,000

Other Long Term Assets		$4,639,000

Investments		$6,867,000

TOTAL ASSETS		$14,052,000

Current Liabilities		$1,258,000

NET ASSETS		$12,794,000

		3.2		These financial statements indicated a working capital deficiency (current liabilities greater than current assets) for Max of approximately NZ$1million at 30 June 1997, a situation similar to that existing at 30 June 1996.
		3.3		Note 21 to the financial statements disclosed several significant events that had occurred subsequent to balance date. These were: Max had acquired the minority interest in the Norseman Venture ¹ from Max's existing partner for A$1.1million and then onsold that interest to AusGM in exchange for 3.75 million fully paid shares in AusGM²; the Company had sold half the interest in the Norseman Venture it had held at 30 June 1997 (i.e. excluding the acquisition referred to in paragraph (a)) to AusGM for consideration of 5 million fully paid shares in AusGM²; and Max had conditionally sold the remaining 50% of that interest, also to AusGM, for A$2 million, an amount that was only payable upon a positive feasibility study being completed for the project. The arrangement would lapse if the acquisition was not completed by June 1999; the Max group had sold its holding of Intrepid for a total consideration of A$2.4 million (approximately NZ$2.64 million) which was described in the financial statements as being "... above the 30 June 1997 book value... " and "...having exceeded the original cost of the investment by A$1,000,000".
		3.4		The "Executive Summary", at page 3 of the Annual Report: When discussing the Norseman sale transaction, said: ... This process was commenced in July 1997 with the sale of a portion of our Norseman gold project at a satisfactory sales consideration consistent with the current book value; and After discussing the Intrepid and Norseman transactions, said: During 1998 the sale proceeds from the sale of these resource assets will provider [sic] a minimum of A$2.3 million cash (and possibly up to A$5 million) to the Company for use in developing its fertiliser business.
				Comment on various aspects of Max's June 1997 financial statements *Working capital and wealth effect of events subsequent to balance date*
		3.5		The Annual Report and financial statement disclosure of events subsequent to balance date gave positive information about the Company's working capital and financial position by referring to the profitable sale of mining assets, the acquisition of significant parcels of listed company shares, and to the sale of its Intrepid holdings. In contrast to this: Max's purchase of the minority interest in the Norseman Venture involved immediate payment of A$50,000 deposit with the balance, a future spending commitment of A$1.05 million due on 31 March 1998, that was not disclosed in the notes to the financial statements (although there was a reference in the text of the Annual Report); The value of consideration received for the sale of Max's Norseman Venture interests, being AusGM shares, although "...consistent with the current book value..." of the Norseman assets at the time the two sales transactions were agreed to (late June and late July 1997), had declined in value considerably by the time the Annual Report was finalised on 30 October 1997. For example the first 5.0 million AusGM shares had been issued at A$0.50� ($A2.5 million or NZ$2.75 million) and the second 3.75 million had been issued at the equivalent of nearly A$0.30� per share (A$1.1 million or NZ$1.21 million), making a total "value" of NZ$3.96 million. By 30 October 1997 the value of these 8.75 million shares had declined to A$1.5 million (NZ$1.63 million), or A$0.17� per share. This fact was not recorded in the notes to the financial statements, although there was a statement in the Annual Report that "at current market prices" Max's holding of AusGM shares was worth NZ$2.4 million. Langoulant told us that this value had been established when this section of the Annual Report was finalised, being around 10 October 1997 (when the market price of AusGM shares was around A$0.25� per share). Of the total consideration of A$2.4 million payable to Max for the sale of shares in Intrepid, only A$750,000 had been paid within 30 days of the time of sale, with the balance of A$1.65 million being due on 31 December 1998. The first payment of A$750,000 came from the sale of 5 million shares to Village Lake Pty Limited ("Village Lake"). The outstanding amount owing of A$1.65 million was due from two Hong Kong-based but Bahamas-registered companies, Garland Investments Limited ("Garland") and Wah Fung International Limited ("Wah Fung") and arose from the sale of 11 million fully paid and 10 million contributory shares in Intrepid. The amounts due were interest free.
		3.6		We do not think it was clear from the Annual Report or the financial statements that the value of AusGM shares acquired by Max in exchange for its Norseman assets was, at NZ$1.63 million, considerably less at the date of the Annual Report than the NZ$3.53 million (A$3.21 million) book value of the assets exchanged for them. We think that since the Annual Report had made reference to the value of AusGM shares received at the time of sale being "consistent with book value" the statement in the Annual Report concerning the "current" market value should have been updated to the date of the Report and should have been included a comparison to the value of the Norseman assets.
		3.7		As noted above (see paragraph 3.4) the Executive Summary in the Annual Report referred to the sale proceeds of the mining assets yielding at least A$2.3 million "during 1998". This statement did not mention that most of the cash was not due until 31 December 1998, so would hardly assist the funding of expansion during the year, nor did it mention that the proceeds did not earn any interest meantime.³
		3.8		According to the Horwath report the effect of these post balance date transactions was to worsen the reported working capital deficiency by NZ$387,000 so that the deficiency was close to NZ$1.4 million by December 1997.

				*Sale of shares in Intrepid - market announcement*
		3.9		As we have noted above (see para 3.3) Max's financial statements reported the sale of its Intrepid shares at "above the 30 June 1997 book value..." and "... having exceeded the original cost by A$1,000,000". An announcement to the NZSE was made on similar terms on 14 October 1997. We have several comments.
		3.10		First, a comparison with "book value" is not as useful as a comparison against market value when that book value is an amount determined by the directors. We think a comparison with 30 June 1997 market values would have been more helpful to the market.
		3.11		According to the working papers in Sinclair & Wood's audit file it appears the book value of Max's holdings in Intrepid at 30 June 1997 was NZ$2.51 million. A book "profit" of around NZ$130,000 was apparently derived from the sale. The 30 June 1997 book value was an amount determined by the directors based on 31 December 1996 market values. During the course of the financial year it had been revalued upwards by an amount of some NZ$0.99 million to NZ$2.51 million at 30 June 1997 (A$0.14.5� per share).
		3.12		According to submissions made by Wood (and confirmed by Langoulant), the entry to write up the value of the Intrepid holding by NZ$0.99 million "... was in accordance with the directors' resolution made on 7 January 1997..." when it was decided to revalue the shareholding "...to the market price as at 31 December 1996..." which was A$0.14.5� per share. This value compares to the market price of Intrepid shares at 30 June 1997 of just over A$0.20�. Wood submitted that "although the market price at 30 June 1997 was higher than this value, the value placed on the investment at that date had regard to the subsequent sale of the shares by the company. To carry the shares at a higher value would have been inappropriate given the subsequent sale value."
		3.13		At a price of $A0.20� per share Max's holding of Intrepid shares at 30 June 1997 would have been worth A$3.13 million or NZ$3.443 million (at the same exchange rates used in Max's financial statements), or around NZ$900,000 higher than the value at which the investment had been included in Max's audited financial statements. Had the proceeds from the sale of the Intrepid shares been compared to the 30 June 1997 market value of those shares there would have been a loss reported on the transaction of around NZ$770,000.
		3.14		Secondly, the profit comparison statement treated the consideration to be received by Max from the sale of its Intrepid shares as if it was all due for immediate settlement. The implied profit from the sale took no account of the lengthy delay in settlement of the shares sold to Wah Fung and Garland.
		3.15		Thirdly, it would not be apparent to financial statement readers that Max, despite announcing the sale of its "Intrepid holding" and making a comparison with the "cost" of its holdings, had, after balance date, brought and sold further shares in Intrepid. We noted that: between 3 July 1997 and 13 August 1997 Max had purchased a further 650,000 Intrepid shares at a cost of A$126,476 (average 19.4�); on 13 October 1997 Max had sold most of its Intrepid holdings at A$0.15� per share. However from 14 October 1997 to 28 October 1997 Max had purchased a further 2.1 million Intrepid shares at prices apparently ranging from A$0.24� to A$0.30� per share.
		3.16		Langoulant and Jeff Verheggen were directors of both Max and Intrepid at the time of these transactions.
		3.17		To summarise, while the statements about the Intrepid sale in the financial statements and to the NZSE may have been technically true we think they were misleading. They did not disclose that the amount received or to be received by Max from the sale of Intrepid shares was below the market value at 30 June 1997 and that a substantial part was not due for payment for some considerable time. Moreover the 30 June 1997 book value did not reflect either the cost of the shares to Max or their then market value but was based on a revaluation by directors.⁴

				*Move into organic fertiliser processing*
		3.18		Max's "other investments" in its 1997 financial statements included a loan of NZ$920,210 to an entity "proposed to become a controlled entity upon shareholder approval.". That entity was WRS Europe Limited ("WRS Europe"), a French company owned by Jeff Verheggen and Verheggen Snr that had agreed to acquire an 87% interest in another French company, Amendments et Fertilisants D'Amorique SA ("AFA") which was developing an organic fertiliser production factory at St Thois, France.
		3.19		The Company's records disclosed that as early as 27 November 1996 the directors of Max had decided to change the direction of the Company's business to that of processing organic fertiliser ("Waste Recovery Systems" or "WRS"). Minutes of a telephone conference meeting of the four Max directors on that date recorded that: Directors had been unable to complete acceptable negotiations to acquire Asian WRS plants; A WRS plant in Ohio, United States of America was available for purchase for US$700,000 but a non-refundable deposit of US$100,000 was required within the next week; Max had the opportunity to buy directly into the French WRS plant ("the French Venture"), with an issue of options in Max to be made to Max's then director Jeff Verheggen and his father Verheggen Snr in consideration for their interest in WRS Europe⁵, but that A$460,000 needed to be lodged with AFA's bankers within the next week; Further short term borrowings or asset sales would be needed to finance these purchases.
		3.20		Shareholder approval for a change in principal business is a requirement of the Listing Rules of the NZSE. We have already noted (see para 1.12 above) that Max obtained shareholder approval at an Extraordinary General Meeting on 8 May 1997 to change its principal business from mining to the processing of organic fertiliser.
		3.21		A teleconference meeting of the four Max directors was held on 12 December 1996. The interests of both Jeff Verheggen and Verheggen Snr in the French Venture were noted. The minutes recorded: It was noted that this transaction was a Material related party transaction and KPMG of Perth had been commissioned to prepare the required Appraisal Report. This report would ascertain whether the transaction was fair to all shareholders.
				Footnote(s): The Norseman Gold Joint Venture was Max's largest mining asset, with a book value in Max's financial statements of some NZ$4.6 million (A$4.22 million) at 30 June 1997. Return Although not mentioned in the Notes to the financial statements, earlier in the Annual Report it is disclosed that the AusGM shares acquired by Max had to be held, under Australian Stock Exchange Rules, in escrow until September 1998. This meant they could not be traded during that period. Return Langoulant has told us that the Company was given to understand that it could receive the A$2m due from AusGM early in 1998 once a positive feasibility study had been obtained. Return Max's accounting policy for investments stated "Except where revalued by directors, Investments are stated at the lower of cost or net realisable value". Max's policy was not to state investments at "market value". Return Our information suggests that in 1996 WRS Pacific Limited ("WRS Pacific"), a company owned by current Max director Briggs, and employees Mr Robert Skidmore and Mr Trevor Lunt, had an 87% interest in AFA. This interest involved financial commitments to the venture that WRS Pacific could not meet. Subsequently AFA decided to increase its issued capital by issuing new shares to WRS Europe, Jeff Verheggen and Verheggen Snr's company, which would result in WRS Europe having an 87% interest in AFA, although we understand the issue of shares to WRS Europe was not completed. Max purchased WRS Pacific by the issue of 5 million Max shares to companies associated with Briggs, and agreed to acquire WRS Europe in exchange for taking over WRS Europe's funding commitments to the French venture and the issue of 20 million options in Max shares to the Verheggens. Return